GREEN BUSINESS AND CLIMATE GOVERNANCE CONTROVERSIES: IS ... · GREEN BUSINESS AND CLIMATE GOVERNANCE CONTROVERSIES: IS THE ... Luka VAVTAR (corresponding author) University of Ljubljana,

ECPR Graduate Student Conference 2016, University of Tartu (10th to 13th of July 2016)

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GREEN BUSINESS AND CLIMATE GOVERNANCE CONTROVERSIES: IS THE EU ETS EFFECTIVENESS AT STAKE?

Luka VAVTAR (corresponding author)

University of Ljubljana, Faculty of Administration

E-mail: [email protected]

Žiga KOTNIK, PhD

University of Ljubljana, Faculty of Administration, Chair of Economics and PS Management

E-mail: [email protected]

ABSTRACT

The paper contributes to the debate on the European Union (EU) Emission Trading Scheme

(ETS) effectiveness. Main focus of the article is to explain the dominant factors that influence

the ETS implementation process, identify weaknesses and suggest some exemplary

modifications. The article offers an in-depth theoretical and empirical review of a complex

environmental issue by addressing relations between private, public, national and

supranational stakeholders. We systematically focus on four main ETS challenging scopes,

namely: (i) lobbying pressure and carbon permits over-supply; (ii) political justification of

energy non-sustainable projects; (iii) intense sovereignty and authority disputes between

states, supranational regimes and their international linkage to other cap-and-trade systems;

and (iv) the outcome orientation and adequacy of the enforcing ETS mechanism. The literature

review and empirical results revealed some important diametric concepts that may present an

obstacle for the EU ETS effectiveness. The main research finding is that common EU climate

policies can only be effective by harmonised implementation of the EU ETS and the Effort

Sharing Decision.

Keywords: Global Warming, Climate, Emission Trading Scheme, EU, Sovereignty, Carbon

Permits, Climate Governance


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INTRODUCTION

The issues of global warming and climate change have been attracting a huge discourse in

the professional and lay public. Despite researcher like Harris (2014) who argue, that carbon

pricing is not the appropriate mitigation policy due to its failure for international linkage and

controversial legitimization of reliance on fossil fuel, emission trading has become a

cornerstone to combat climate change, especially in the EU context. The EU ETS is the world´s

largest multi-state and multi-sector scheme for trading GHG emission allowances. It covers

more than 11 000 power stations and industrial plants in 31 countries, as well as the aviation

scope. It was initially developed as the policy instrument to achieve the EU`s targets under the

Kyoto protocol, followed by intense growth resulting in the accountability for the majority of the

world`s allowances trades. Nowadays it is striving to be an example for the global mandatory

global cap-and-trade scheme, in order to achieve the internationally agreed premise of climate

governance. In reality, the system is sometimes associated with permits over-supply that

together with the practise of free allowances allocation artificially elongates or even legitimatize

the fossil fuel usage. The latter is clearly seen by proposed and newly operating lignite power

stations, which were granted a political green light in several EU countries. These tensions are

being managed under the modern climate governance rationale, which explores whether

states, corporations and individuals are prepared to accept a joint approach to climate issues

(Bailey, 2007). The internationally coordinated emission trading also has major implications,

irrespective the question of the enforcing mechanism (taxes vs. cap-and-trade). The bulk of

legal, institutional and technological performance required for effective implementation,

administrating and monitoring is inherently very specific.

However, much remains to be learned about how the EU ETS is functioning on a broader

perspective. It is worth mentioning, that the EU ETS covers only a good 40 % of the total EU

GHG emissions. We examine the effectiveness of the GHG emissions mitigation as part of the

collective climate change policy built on shared efforts of all EU Member States by carbon

trading. The aim of this paper is to elucidate main factors that affect the effectiveness of the

EU ETS implementation process. The paper is organised as follows: 1) literature review offers

a brief evolution of the EU ETS, together with determining a position of lobbying pressure, non-

sustainable infrastructure justification, sovereignty or authority disputes and issues of the

enforcing mechanism as rationales in the (in)effective implementation process; 2) discussion

analysis of the incorporated clashes among generating profit vs. protecting the environment;

polluter pays principle vs. consumer pays principle; interests of nations vs. the global good;

and carbon tax vs. cap-and-trade system. The analysis reveals that policies, which are good

for business and environment, are generally not getting to scale; 3) the paper concludes with


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the indication for stronger climate governance cooperation and a need for effective

complementary methods for regulation and reduction of GHG emissions.

METHOD AND MATERIALS

The method for this study is a combination of the following. Firstly, traditional literature analysis

and a thorough research of the concerned topics in the selected pertinent scientific literature

were conducted. Our study reviews and interprets previous findings, but also offers some new

insights as well. In order to assess the main factors influencing the EU ETS effectiveness, also

a challenging issue of causality is incorporated. Generally, we relied on a rudimentary notion

of causality that presumes particular policies and programmes accomplished, when their

results relate to the improvement of the situation over the duration of the case studies or

examined situations, on the basis of certain improvement criteria. In addition, we also applied

an in-depth qualitative analysis and discursive illustrations, while trying to take into account the

dimensions of reverse causality (e. g. firms who reduced emissions are more likely to be

affected by the policy), as described by Martin et al. (2012). In the article, we tried to ascertain

and elucidate what factors influence the EU ETS effectiveness, rather than solely assessing

and distinguishing the system´s effectiveness as such (input-output analysis).

Secondly, we carried out an analysis of the several case studies regarding lobbying pressure

(including the empirical analysis and own calculations of carbon trading prices – EU

allowances, current and “proposed” CO2 emissions), political aspects (e. g. Šoštanj Thermal

Power Plant), sovereignty (authority) disputes (including the analysis of the following EU Court

of Justice verdict: Air Transport Association of America and Others vs. Secretary of State for

Energy and Climate) and the adequacy of the enforcing mechanism as well (EU ETS vs.

carbon tax).

Thirdly, short interviews in Slovenia with a handful of key persons, including the

representatives of the Ministry, local self-government and companies were performed. In this

study, the examined factors are analysed qualitatively in order to detect concerned attitudes

or effects towards the EU ETS (in)effective implementation. In addition, secondary sources

and other relevant studies have been taken into account when applicable.


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LITERATURE REVIEW

The climate protection process integrates a wide business area that remains an under-

explored scope of the EU ETS. The reason often lies in the (non)corporate lobbying pressure,

which can result in the carbon permits over-supply. The existence of the European Climate

Exchange (ECX), involvement of banks, brokers and professional lobbying firms are a

contributory elements in overshadowing the awareness about the main reason for which

(carbon) tackling schemes were actually initiated, namely preventing environmental

destruction and therefore preserving or even improving environmental conditions.

Furthermore, the evidence on GHG emissions impacts is sometimes uncertain or relegated

into the background.

The EU ETS is designed in a way where the market itself determines the carbon price, while

the state acts as a market manager. During the phase I (2005—2007) and phase II (2008—

2012), governments of the EU Member States were bound to draw up national allocation plans

(NAPs) under the Emissions Trading Directive (2003/87EC), which also established the ETS.

The NAPs defined the total amount of carbon dioxide that can be emitted, the number of

installations in certain country and the number of emission allowances allocated (to each

individual installation). This approach has stimulated cardinal differences in allocation

standards, reflecting in an incentive for each Member State to favour certain industries, which

has led to a very complex system. The logic of emission trading follows the polluter pays

principle1 that is well acknowledged in the environmental law. Namely, the polluter who emits

less has the possibility to sell its surplus allowances, on the other hand the polluter who emits

more than stipulated, needs to buy additional allowances. In 2013, phase III (2013—2020), of

the EU ETS has started. Itis characterised by amendments to the scheme that were made due

to lessons learned on the basis of previous phases. Main modifications are as follows: a single

EU-wide cap (NAPs are no longer needed), gradual substitution of free allocation with

auctioning (harmonised allocation rules apply for those permits still given away for free) and

inclusion of more sectors.2The European Commission already started a revision process of the

EU ETS Directive for post 2020 period, which is declared as phase IV (2021—2028). Before

1 The polluter pays principle (PPP) was first mentioned by the OECD in 1972 and was later upgraded in

Rio in 1992 into the Principle 16 of the UN Declaration on Environment and Development. Since the

adoption of the Directive 2004/35/EC on environmental liability (European Commission, 2015a) it is part

of the EU acquis.

2For more information on the development and the implementation of the EU ETS phases, see Bailey

(2007) and Laing et al. (2014).


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that period a market stability reserve (MRS) will become operational in 2019, in order to

achieve a 40 % reduction of GHG (compared to 1990 levels), as stipulated in the 2030

framework for climate and energy policies.

There are basically two means for allocating allowances. Firstly, most of the participants have

to purchase allowances through auctions that are held on a centralised auctioning platform or

platforms selected by certain countries. Secondly, some companies receive allowances freely,

because they are deemed to be affected by international competition, and because their

performance is among the top 10 % of the most efficient installations. What might change in

the future is the volume and types of international credits allowed for compliance. It is all

dependable on EU emissions reduction commitment, which is currently stipulated at -20 % by

2020 compared to 1990 levels. Certain projects are excluded from the scheme, for instance

nuclear energy projects, afforestation of reforestation activities and projects involving

destruction of industrial gases. Moreover, the regulation introduces exclusion for non-

commercial flights by aircraft operators with total annual emissions lower than 1000 tonnes

CO2 per year.The central institution in connection to carbon trading in the European Union is

definitely the European Climate Exchange (ECX). Currently, there are two types of carbon

credits traded: EU allowances (EUAs) and Certified Emissions Reductions (CERs).3 ECX

began operating in 2005 and is a member of the Climate Exchange Plc group, which is listed

on the AIM market of the London Stock Exchange. It is an important fact, that ECX volumes

are increasing tremendously each year. Carbon contracts are listed for trading on ICE Futures

Europe, with whom they have a partnership agreement. ICE is liable for listing the contracts

on the electronic trading platform and ECX provides product development and management.

Most of the major global businesses have signed up for trading the ECX products and there

are thousands of them who have access to the emissions marker via their banks or brokers.

However, according to Behn (2008/09) the practise of the ETS implementation showed that

industries receiving allowances for free have been able to sometimes enjoy windfall profits.

The problem is particularly seen in the power sector, where the power producers passed on

the price of emission allowances over to consumers as opportunity costs. The market price

determination is inter alia advocated by argument that power industries would become less

competitive, especially in comparison to companies outside the EU. Sandbag (2011)

3The United Nations Framework Convention on Climate Change is therefore acknowledging two

additional types: a removal unit (RMU) for activities such as reforestation and an emission reduction unit

(ERU), which was generated under a joint implementation (JI) project as a part of the Kyoto Protocol

(UNFCCC, 2015).


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arguesthat the bulk of the EU ETS windfall profits added up to total of 240 million EUAs surplus

that are retained in possession of only top ten highest benefiting companies. What was even

more controversial is the data about the value of mentioned allowances, which estimated at

around 4.1 billion EURs (at the time four times higher than the whole EU´s environmental

budget). As mentioned in the previous paragraph, the Commission initiated the auctioning pay

systems, since the power sector is afraid of competition outside the EU. Nichols (2014), who

analysed the research by campaign group Sandbag,shows that carbon allowances (EUAs)

could reach 4.5 billion ton surplus until the end of this decade, which would undermine theEU

2020 emissions reduction commitment. The surplus would rise for shocking 13 tonnes each

second. One of the reasons lies in the 2008 production slowdown, which coupled with the

distribution of a high number of free allowances. On the other hand oversupply happened as

a consequence of lobbying activities, some connected to the carbon fraud. Laing et al. (2014)

state it was not a surprise, that a possible gain in the form of windfall profits, soon allured heavy

lobbying induced by the industry.Corporate actors were gaming the market by buying the

permits in countries that did not impose the value added tax (VAT) and sold it in other countries,

were tax was included in the price. According to Carbon trade watch (2011), the traders

engaged in these practices went missing after, without declaring the tax income, consequently

resulting in high amount of loss in tax revenues. Some frauds also happened as phishing

scams and under the Clean Development Mechanism (CDM), where some allowances were

resold. Martin et al. (2012) state, that CDM represents only a small part of the EU carbon story

that comprises around one twentieth of the whole permit allocations. Interestingly, CDM credits

were traded constantly, yet still only reaching approximately one third of the legal limit. Besides,

there are no assessments about how the CDM lowered the EUAs prices. According to Victor

and House (2006) carbon trading force companies to regard pollution as a business problem,

rather than an environmental and social problem. Even if climate change is accelerated,

companies can treat the emission trading as an opportunity to gain new property rights, assets,

openings for capital accumulation, attributing the costs of emission reductions to consumers,

etc. Thus, companies actually do not need to reduce their pollution to trade in the scheme, due

to an EU-wide cap, which assures that cuts are made somewhere else. Moreover, the scheme

is responsible for more lobbying activities instead of capital investments oriented towards

innovations in the field of emission reductions.

Political justification of energy non-sustainable projects is the next phenomenon in the story.

The decision-makers advocate, that these types of projects are not environmentally harmful

as they will not raise emissions due to the compensation cuts made somewhere else. A good

example for this is the case of controversy Šoštanj Thermal Power Plant in Slovenia that was

granted a political green light. The Thermal Power Plant in Šoštanj became trial operational in


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2014, which will greatly contribute to the state´s upcoming years of carbon footprint. The case

was very controversial, resulting in a start of a referendum process, but it was turned down by

the Constitutional Court. The project’s acceptance was based on the fact that the state needs

energy independence and that there will be emissions cuts made elsewhere (TEŠ, 2015).

Nevertheless, Slovenia already has one nuclear plant in Krško, four thermal power plants, 18

hydroelectric power plants and a decent potential in sun or wind exploitation. The advocates

argue that existing thermal power plant will be replaced by this new modern lignite power

station, which is more energy efficient, actually decreasing the carbon dioxide emissions by 35

% in contrast to the previous plant (TEŠ, 2015). On the long run, this is certainly not creating

a sustainable system, by bending the data the way that is currently more suitable. Harvey

(2015) highlighted the OECD warning, that governments should rethink their newly proposed

coal-fired power plants, because these could be the essential threat to the future climate

conditions - predictions show that 500bn tonnes of CO2 will be emitted by 2050 on the global

scale.

As we can see from the Chart 1 and 2, Slovenia´s CO2emissions are definitely not in

accordance to the size and other needs of the country. Although only nine EU Member States

have operational lignite stations, which are regarded as least carbon efficient power stations.

Especially Germany poses a big threat against achieving the EU´s emissions targets, as their

lignite power plants emit three times more than the second higher emitter, i.e. Poland. Sandbag

(2015) reported that last year was the first time, since the EU ETS set up in 2005, when 4 out

of 5 (and 6 out of 10) largest EU emitters are German lignite power stations. However, in July

2015 German government announced to shutter around five largest lignite power plants, in

order to guarantee the 40 % emissions cut by 2020 (Reuters, 2015). At the same time, we

have to be aware of the fact, that lignite is still crucial to meet German electricity demand. Its

share of the electricity productions has been at around 25 % for the last 15 years. Poland is

problematic due to the newly proposed lignite plants (see Chart 2).Ottery (2014) stresses out

that there are plans for two new Polish mines (Gubin and Legnica), which would increase the

country`s emissions for around 20 %. By 2050, their emissions alone would exceed Polish

limits under the EU emission targets. Greenpeace even released a motion that 90 % of the

carbon contained in Poland’s lignite reserves should remain buried in order to pursue the

common international environmental goals.4 Stations powered by lignite, i.e. brown coal,

contribute to more than 10 % of the EU´s total CO2 emissions, taking into account that only

nine Member States burn lignite. Situation in Greece is also alarming, since half of the

4 Pursuing the increase of the global average temperatures below 2 °C, was amongst others,

internationally agreed on the Copenhagen 2009 and the Cancun 2010 UN Climate Change conferences.


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country`s electricity generation already relies on lignite, moreover it is also fourth on the list for

planned emissions (Mathiesen, 2014).

Chart 1: Emissions of CO2 from lignite combustion (in 2012; Mt/year)

Source: adopted from Ottery (2014), own calculations.

0

20

40

60

80

100

120

140

160

CO2 (Mt/year)


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Chart 2: Emissions of CO2 from proposed new lignite power stations (as of 2013; Mt/year)

Source: adopted from Ottery (2014), own calculations.

A wide political consent will be needed in order to assure that EU´s dependence on coal will

not pose a major threat against the climate goals. Mathiesen (2014) shows the case of

Sweden´s state energy company Vattenfall, which was exposed to closer scrutiny by

Greenpeace. In Lusatia, Germany, the company operates power stations and mines, and emits

as much CO2 as the whole of Sweden, which is a bone of contention between the countries.

The company’s plan is to further expand its operations to new mines, as well a new power

station, what may present additional environmental threat.

Next challenging scope presents intense sovereignty and authority disputes over emissions

allowances allocation. The state acceptance provides little guarantees that the commitments

will be met, as there are territorially defined interest present in relation to restructure of

governance on a supra-national, national and non-state actors’ level.

In the last decade, the cornerstone movements in emission trading have happened in the

process of the so called “communal” approach to environmental issues. The later have

occurred within increasingly neoliberalized systems of the modern states. Whether optimistic

or cynical about the emission trading approach, it is a fact that these versions of collective

0

10

20

30

40

50

60

Poland GermanyRomania Greece Bulgaria CzechRepublic

Slovenia

CO2 (Mt/year)


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climate governance and neoliberalism have major implications for the role of the state, e.g.

jurisdictional powers do not coincide with state’s boundaries. The latter inherently includes a

certain transfer of power authority to the supra-national level (Bailey, 2007). According to Peck

(2001) this neoliberal public policies are in most cases introduced within the context of fiercely

competitive economic situation abroad in relation to national problems, which leaves no

alternative to initiate processes like deregulation, marketization and privatization. In the field

of climate policies, the states are adopting the role of market managers. Considering the state

circumstances, they are often forced to reduce their own capacities and potentialities in order

to restructure and design their own downsizing reform. Bailey (2007) highlights the main

question whether states, corporations, individuals and supra-national organizations are willing

to accept that kind of governance, even if it means a compromise of current or future economic

prospects and national sovereignty. Regrettably, sovereignty was not proven as effective

concept in settling disagreements (Crawford, 2012). Hartmann (2013) shows that the

application of the ETS to international sphere, is coping with a problem of sovereign powers.

On one hand, states want to assert their power according to the territorial principle, on the

other hand, they direct to the same principle, when preventing interference with their domestic

affairs. They also argue that the ETS is interfering with the state´s freedom, which is a part of

the sovereignty concept. According to Crawford (2012) in international law, sovereignty is the

key principle that is probably most argued issue in the international disputes. The extent of the

sovereignty is measured and positioned by the argument that some states domestic affairs are

being interfered or relying on the territorial principle. Lowe and Staker (2010) state, that when

addressing the linking aspects of the sovereignty principle, a parallel principle is the

territoriality. The latter authorises states to conduct all events within their territory (economic,

social, cultural, etc.). Consequently, the limelight has shifted from the rigid and hierarchically

driven state governance to more complex, internationally performed forms of political economic

interaction. Although the European Commission has relatively little power in enforcing a

centralised approach for emission powers, its efforts has paid some dividends. In the process

of setting the new agenda for ETS phase III, the states willingness to accede some authority

to the EU had been shown. The results are displayed in forms of a first step to build a global

carbon market: extension to aviation, harmonising allocations under an EU level cap, the

incorporation of more greenhouse gas emissions (GHGs) and extending the allowances

auctioning.

So far no wide affecting legal action has been occurring at an international tribunal. But the

debate is especially turbulent when discussing the aviation sector. There has been a judicial

review proceeding, which was started by non-EU airlines with their governments support (ATA

and others). The case started in the United Kingdom, due to stipulation that each airline is


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assigned an administrating state where the operating license was granted. The claimants

argued that by implementing the Aviation Greenhouse Gas Trading Scheme Regulations in

third countries’ airspace and over the high seas, the EU had infringed conventional obligations

and fundamental principles of customary international law. The bone of contention lied in the

claimants’ position, that they could only obey the EU legislation when they are actually

entering, departing or within the EU territory. Hence, the plaintiffs were challenging the EU’s

legislative authority, in relation to its conventional obligations and its competence to control the

extraterritorial command under the international law (Hartmann, 2013). In 2011 the Court of

Justice of the European Union (2011) released a verdict,5 speaking in favour of the defendant.

The EU’s legislation on aviation emissions is compatible with international law due to several

reasons. The EU ETS extension to aviation is violating neither the principle of territoriality, nor

the sovereignty of third countries. Moreover, the EU ETS does not introduce a tax, free on fuel,

which could be infringing the EU-US Air Transport Agreement. Finally, the uniform application

of the system to the European and non-European countries is in consistence with stipulations

about prohibiting discriminatory treatment between aircraft operators on nationality grounds,

written in the EU-US Air Transport Agreement (European Commission, 2015b). Following the

result of the 2011 EU Court of Justice proceeding, many airlines have subordinate the emission

trading regulation, but there are still some issues remaining unresolved. For instance in 2012,

the USA introduced a law that authorise the US Secretary of Transportation to prohibit US

aircraft from taking part in the ETS. Thus, the debate about sovereignty (and authority) remains

unsettled.

On the other hand, there is an increased interest for linkages between cap-and-trade systems

for GHG, which is a clear sign of international cooperation. It can be done directly, between

systems or indirectly, via connections to credit systems such as the Clean Development

Mechanism (CDM). The latter was introduced under the Kyoto Protocol as the first international

offset program creating a global market for GHG reduction. It seeks to fund different kind of

reduction, prevention, etc. of GHG projects (Gillenwater and Seres, 2011).It can be seen as a

system of jurisdictional improvements for receiving states.The EU ETS represents a form of

multilateral linkage system, consisted of countries that negotiated a common agreement.

Important issue regarding international linkage is a certain loss in control over domestic carbon

policies, which is an inherent part of the process. The primary goal of the linkage is to achieve

5According to the Judgment of the Court (Grand Chamber) of 21 December2011, Air Transport

Association of America and Others vs. Secretary of State for Energy and Climate, Case C-366/10 (Court

of Justice of the EU, 2011).


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the same levels of emissions reduction at lower cost. Under the assumption that states act in

their own best interest, the expanded amount of different linkage systems speaks in favour of

its outweighing cost in comparison to traditional methods (Ranson and Stavins, 2013).

The outcome orientation and adequacy of the enforcing mechanism is being questioned

regarding environmental taxes in relation to carbon permits trading. We suggest neither taxes

nor emission trading systems are solely enough to reduce the impacts of GHG. Therefore, they

both should be considered as complementary policies, especially in order to assure that policy

objectives will be honoured.

There is relatively wide agreement between scholars about the possible advantages of

emissions pricing.Galiana and Green (2009) suggest carbon price is reasonable to use in two

ancillary, but important ways. Firstly, the focus should be concentrated to raise revenues to

finance the energy R&D, i.e. propose to charge each tonne of CO2 a 5 $ fee/charge. Secondly,

the carbon fee could gradually rise, doubling in every 10 years. In this way the message is

send as a reminder to deploy new, scalable, cost-effective and low-carbon technologies. When

new technologies will be available, CO2 emitting will most likely make their implementation

profitable. To sum up, the proposal is looking for strategies and policies that will reduce

emissions and invest in technology-led climate and energy R&D at the same time. Another

important point to stress out, is that a technology-led climate, is inconsistent with specific dates

for emission downsize and their stipulated reduction mandates. It is almost impossible to

accurately predict the technological breakthroughs. In spite of that, technology-led policies do

contain commitments. Firstly, to ensure long-term funding and secondly, to establish grounds

for deploying the cost-effective energy solutions by allowing the carbon fee to gradually rise.

Measures are provided by performance evaluations in terms of the rate of decline in the carbon

intensity, which is also called the rate of de-carbonization. According to all this, technology

success is likely to cherish and emission-reduction targets are likely to breed similar failures

(Galiana and Green, 2009).

There has been an unresolved debate about how to use the carbon pricing instrument most

effectively, i.e. via taxes or cap-and-trade systems. We have traditional »green« or »eco« and

environmentally motivated taxes on one hand, and the double-dividend hypothesis on the other

hand. The latter, according to Goulder (1995), proposes that increased taxes on polluting

activities may both improve the environment and reduce the costs of the tax system, e.g.

income taxes. Moreover, the effect of double dividend is not only limited to reducing tax costs,

but also in increasing non-environmental welfare. Bovenberg (1999) states that green tax

would be a no-regret option, because even if environmental gains might be in doubt, an


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environmental tax reform may still be desirable due to the broader implications. On the other

hand, the weak form6 of the double dividend hypothesis defines that taxes from green tax

systems, can be used to cut distorting taxes, but the price is the lowering level of the efficiency

cost in implementation of the green tax reforms. Some researches (e.g. Keohane, 2009;

Stavins,2007) favour cap-and-trade systems, while others (e.g. Metcalf,2007; Avi-Yonah and

Uhlmann, 2009) favour the carbon taxes. Goulder and Schein (2013) explain the important

difference in the method of the method how price is specified. The tax rate (i.e. price) is

determined directly by the regulatory authority, whereas cap-and-trade price is established

indirectly. The authority only determines the overall emissions amount, meanwhile the carbon

price depends on the market for allowances. Çiçek and Çiçek (2012) suggest that it is not a

question whether to choose carbon tax over emission trading or vice versa. It is simply not

productive to analyse which way is more effective, due to the nature of both systems.

Therefore, they are more likely to be regarded as complementary policies. Firstly, carbon tax

is designed to compensate the marginal cost that appeared due to the negative externality of

GHG. Secondly, the goal of carbon trading is to reduce the total amount via its prior set upper

limit. Hence, none of the mentioned systems may be treated as solely sufficient means of

reducing emissions. Also, environmental tax regulation as a whole, incentives and other

measures should be taken into consideration.T he main reason why the EU ETS cap-and-

trade was initiated to protect the environment. Outcome orientation is also one of the main

aspects speaking in favour of the ETS. According to Stavins (2008) the level of certainty by

which the emission targets will be achieved is an important factor. Cap-and-trade systems can

achieve the proposed goals, as the guarantees are built in the policy. In contrast, carbon taxes

and other policies7 are less effective in establishing a plausible future prediction on emission

reductions, consequently lowering the level of certainty. Keohane (2009) contends the position,

that it is almost impossible to set or guess the appropriate carbon price, thus tax rate is not a

felicitous method. But at the same time we must be aware of the environmental outcome to

which all the policies are endeavouring. In the EU context, this means 20 % decline according

to the Europe 2020 strategy,8bearing in mind that some scholars (e.g. Steinacher et al., 2013)

6Goulder (1995) defines three double dividend claims: a weak form (it is desirable to return tax revenues

by lowering distortionary taxes, rather than by lump sum returns), an intermediate form and a strong

form(they ponder whether surplus burden enlarges or diminishes as a result of a swap towards

environmental taxes).

7 E.g. setting technology standards. Uncertainty incorporate the future energy prices, the ability of

adoption for new technologies, etc. (Stavins, 2008).

8 The absence of the international binding agreement on emission reductions reflects in separated

policies, like the EU 2020 agenda. The latter stipulates a 20 % GHG emissions reduction in comparison


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are warning that this might not be enough to avoid the worst impacts of climate changes. Their

position is that on the UN Climate Change conferences internationally agreed temperature

targets (reduction of 2 °C on the global scale since preindustrial times) will not be enough to

tackle the risks from anthropogenic emissions. Furthermore, even if substantial reductions of

GHG will be met, the risks may still not be comprehensively limited until aspects like transient

sea level rise, ocean acidification and net primary production will not be taken into holistic

consideration. However, there are two ways to achieve (extensive) climate stabilization and

inherently, climate change mitigation in connection to the emission reduction (Galiana and

Green, 2009): (a) emissions should be targeting per period, in connection to the economic

development; (b) emissions should be targeting cumulative and long-term, in connection to the

development of low-carbon technologies.

According to Goulder and Schein (2013) the system´ dimensions in terms of the enforcing

mechanism (taxes, cap-and-trade, hybrid) do not discriminate each other. Furthermore, when

designed in a comparable way, the mentioned systems generate similar incentives for GHG

decrease. The latter thus primarily depend on the (policy) design specification rather than the

implementation instrument. Stavins (2008) states that cap-and-trade system is the best option

to tackle climate changes due to several factors: higher certainty, easy compensation for

unequal burdens and not difficult harmonization with other countries´ strategies. It is important

to stress out the conclusions of Horák et al. (2012) who show that the current system is a

hybrid by instrument type. Because some sectors are exempted from the scheme, those are

subject to different national taxes. An efficient system would be provided with an almost

uniform price of CO2, while all sectors would be obliged to cooperate. It is also very important

to take into account the specificities of certain country´ liberalization.

to the 1990 levels. The policy is also being conducted under the Kyoto Protocol´s second commitment

period (2013—2020), which is based on voluntarily participation (European Commission, 2015c).


15

DISCUSSION

The EU ETS as a market-based system produced a rather expected side effect of a clash in

the form of business (generating profit) vs. protecting the environment. Although, there are

studies (e.g. Carbon trade watch, 2011; Sandbag, 2011) proving that companies were

manoeuvring towards the windfall profits and market allowances oversupply, it is too soon to

predict the outcomes of these contrariety on long-term accomplishment of the EU ETS.

Particularly, as new instruments for more effective execution were introduced in the current

phase, especially the auctioning system instead of free allowances allocation and incorporation

of new sectors. Though, researchers, e.g. Horák et al. (2012) contend the position, that

auctioning may not solve the windfall problems, since the factor of price sensitivity can play a

cardinal part in the pass through relation. A big challenge in the emissions trading business is

still posed by the CDM system and carbon leakage,9 which is interestingly more the EU´s

internal (pass through to the new Member States) than a global problem. In this case, as

suggested by Davis and Caldeira (2010) a big dilemma occurs, since emission cuts made by

the affluent countries may be later on replaced by an even higher level of emissions, as they

could be redistributed via worldwide. Furthermore, the EU ETS case exposes the positive and

negative aspects of climate collective governance. One of the system´s main ideas at the time

of emergence was an internationally oriented framework for inclusion of externalities taking its

source from certain polluters. These externalities were supposed to offset in the polluter pays

principle. In reality, sometimes the spill over effect caused a new form of a consumer pays

principle, as they were the ones bearing the higher final price (Horák et al, 2012). According

to Harris (2013) this is not inherently a negative aspect, owing to the importance of promotion

the consumer-oriented responsibilities in a globalized world. On the other hand it offers a

premise for new instruments of compelling the companies to reinvest the potential windfall

profits into green measures.

The construction approval and operating of non-sustainable fossil-fuel energy based projects,

especially lignite power plants, might be one of the largest weak points of the EU ETS

effectiveness. Namely, the system is inherently outcome oriented, notwithstanding the definite

cases. But as companies and governments discovered the full potential of this partially

insufficient market-oriented policy, the political justification of such projects provides very little

9The term is used to describe situations, when companies are relocating their production abroad, to the

countries with less stringent environment measures. Consequently, the ominous issue is the global rise

of GHG, though this argument is becoming less powerful as likely moving countries (e.g. China and

India) are also introducing limits on emissions emitting (Sandbag, 2011).


16

assurance, that the binding emission targets will be met. Bear in mind the premise defending

the position of the necessity to leave the majority of fossil fuels in the ground, i.e. 50 % of gas

reserves, 80 % of coal reserves (e.g. McGlade and Ekins, 2015). On the other hand, the

constant lobby and governments pressure to rapidly exploit the geographical fossil reserves is

inconsistent with the temperature limit commitments. According to Monbiot (2015), there are

basically no instruments specified for the implementation of the phasing down high-carbon

investments and fossil fuel subsidies, as agreed on the World Climate Summit in Lima, 2014.

At the same time, as we can see from Chart 1, there are new lignite power stations planed,

which is simultaneously speaking in favour of maximising the production of fossil based energy

projects and the strategy for minimising GHG emissions. Addressing of this contradictory issue

will be of key importance in the future fossil governance.

The contemporary collective governance and international linkage inherently incorporates a

certain level of harmonizing between the participating countries. Ros (2012) shows the

example of Australia and the EU, who both agreed to start a two-way link between their cap-

and-trade systems no later than 1 July 2018. In this case, Australia lowered the total domestic

usage of Kyoto units liability from 50 % to 12,5 %. The main clash discussed here is between

interest of nations or governments vs. the global good in form of a healthy climate system.

According to Harris (2013) a constellation of interest within each nation should directly

incorporate the climate governance of common good, taking into account the presumption that

state acts in favour of all citizens and not only some narrow interests. Furthermore, the state

not tackling the climate changes is in direct contradiction to the basic democratic obligingness.

Hence, Bailey (2007) claims that the aspect of international GHG trading is not the most

contributory factor in establishing an effective implementation. We argue than the importance

of sovereignty or authority disputes are being exaggerated, since in reality the implementation

process is mostly dependable on companies and their modus operandi. This way the long ago

established Westphalian10 system of sovereign nation-states (nation-level diplomacy and

disputes) overshadows the importance about emission trading in connection to the bottom-up

solutions (Harris, 2013).

We argue that in principle the EU ETS is as good system as any other. More important is to

strengthen the awareness about the overall outcome (emissions abatement), which is the main

reason why the system was created. As Goulder and Schein (2013) stressed out, several forms

of the regulation (taxes, cap-and-trade or hybrid) are able to reach the goals, as they are

10 Peace of Westphalia was signed in 1648, it represent a cornerstone for a sovereignty concept, which

constellates the edifice of international relations.


17

flexible and permanent enough to pursue the targets in a cost-effective way. Furthermore, it is

important to enhance the debate about the impacts of tax revenues. For example, Hoerner and

Robinson (2008) argued the framework of the so called cap and dividend policy involving

auctioned allowances. Also, there are several additional instruments in the framework: raised

revenues should be redistributed to households on a per capita basis; climate asset plans

should be targeted to ease low and moderate income households; revenues should be used

for investments in energy efficient projects and renewable energy, along with other tax

reductions. We can find some parallel aspects to the EU ETS, which can be a win-win system

in terms of revenue redistribution. It is significant to establish a democratic scrutiny over EU

ETS revenues recycling, since annually reports from Member States will define the usage and

amounts of the generated revenue. The whole EU climate policy is a hybrid scheme anyway,

combining upstream and downstream systems (at the EU and Member States level). The EU

ETS only accounts for a good 40 % of the total EU GHG emissions, therefore leaving space

for other measures as a part of the holistic mitigation approach. Consequently, the common

EU climate policies can only be effective by harmonised implementation of the EU ETS and

the Effort Sharing Decision (covers sectors not included in the EU ETS) as well.

Although lots of the recent debates in connection to the EU ETS are often linked to the CO2

(i.e. allowances) prices, rather than to the question of the enforcement mechanism

adequacy,we cannot overlook the fact, that the annual verified emissions from sources

covered by the EU ETS during the period 2009—2013 stayed below the annual cap (see Chart

3). This can be mainly attributed to the lower production volumes due to the economic crisis.

Taking into account all the previously analysed and discussed factors that are influencing the

EU ETS implementation, there are also some external factors which cannot be foreseen. As

for the low prices, it is expected that the rates can even further decline, unless an ambitious

cap after 2020 will be presented. The cumulative 2020 cap is still binding, but is very uncertain

how traders form their expectations, especially in situations when yearly caps are not

constraining elements. Knopf and Edenhofer (2014) argue that an announced MRS will not be

enough to reform the EU ETS, while establishing a price band for permits may be a right

solution.


18

Chart 3: Development of the EU ETS cap, actual emissions, offsets and CO2 prices

Source: Knopf and Edenhofen (2014); Grosjean et al. (2014).


19

CONCLUSION

The theoretical review shows that business activities along with political justification of energy

non-sustainable projects and climate governance restructuring have a rather negative effect

on the EU ETS implementation process and its effectiveness. In connection to (fossil fuel)

industry lobbying, the biggest threat by far remains, that carbon permits oversupply will result

in an insufficient inclusion of other green measures. In the current Phase III, the EU ETS

somehow managed to refuse critics worrying that the scheme is actually prolonging extraction

of fossil fuels, due to the introduction of auctioning. However, the lobbyists still find their ways

for companies, so they do not need to actually reduce carbon pollution in order to trade in the

scheme (owing it to the EU-wide cap).

A very big challenge occurred, because the EU ETS can only address overall emission targets

as opposed to mostly specific oriented conventional regulation. Consequently, the

implementation is corresponded with continuous development of non-sustainable projects.

Improvements of this aspect, which should apply to substantial restrictions in fossil fuel based

technologies, would offer basis for the sustainable development in the global economy. The

process should be also accompanied with enhancements on the field of alternative energy

sources.

Sovereignty and authority are neither new nor unexplored. The dynamics of conflicts can be

observed form the Westphalian heritage point of view. There are successful international

linkages between cap-and-trade systems established (e.g. EU ETS) or in the process of

establishing (e.g. EU ETS and Australia´s system). They demonstrate an example for further

links, especially when nations have similar objectives, so the control dispute is not the main

determining factor. In any case, collective climate change governance caused the liability shifts

in connection to the emission cuts. At the same time, traditional territorially defined interests

are lowering the international carbon trading effectiveness.

The EU ETS is definitely able to reach the specified targets, bearing in mind the fact, that it is

not the only instrumental tool available. The global climate pollution will not be solved simply

by implementing a cap-and-trade system. It may be a positive example of synergy between

specific tensions, but also a competitive disadvantage for the EU in comparison to other

countries with less strict regulations. Hence, the complementary approach towards the carbon

taxes, cap-and-trade or hybrid systems might be much desirable.


20

It is hard to predict the development of the current EU ETS. Nonetheless, Phase III indicates

an important shift towards protecting the environment in comparison to the Phase I and II. This

is particularly seen by introducing new components (EU-wide cap, auctioning) and a closer

connection to the 2020 climate and energy package targets (part of the Europe 2020 strategy),

while the climate governance is becoming more and more important on the global scale.

Sustainability in the long run will be achieved by continuing the implementation into Phase IV,

owing to the revision process that already started. Thus, the threats of the windfall profits,

authority disputes, fossil fuel reliance and the carbon leakages still remain present. The EU

ETS present a political prestige project, which has no clear alternatives. Consequently, it is

expected that the system will become tighter, along with the permits decrease and a stringent

centralized management. Overall, the united EU response towards the climate change can

only be successful when holistically considering the EU ETS sectors and other (Effort Sharing

Decision) areas.


21

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