Corporate Responses to EU Emissions Trading

Resistance, Innovation or Responsibility?

Jon Birger Skjærseth, Per Ove Eikeland

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317159421
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Geopolitics
• Index: Politics & International Relations

The European Union (EU) aims to put Europe on track toward a low-carbon economy. In this striking challenge, the EU Emissions Trading System (EU ETS) has been singled out as the Union's key climate policy instrument, ultimately aimed as a model for a global carbon market. The learning effect of the EU ETS could thus be tremendous. This study explores how the EU ETS actually works on the ground, affecting corporate climate strategies. It covers general sector responses as well as systematic comparative studies of companies across the sectors. The latter enables improved understanding of causal effects and the role of interaction between different policy instruments and other factors that impact corporate climate strategies. The study explores a broad set of mechanisms at play potentially linking the EU ETS to company climate strategies. These include how corporate norms of responsibility are affected by the EU ETS and how economic incentives provide opportunities for innovation. The book's main contribution lies in its systematic examination of corporate responses to the EU ETS from a broad empirical and analytical social science perspective covering companies in all main EU ETS sectors: electric power, oil, cement, steel and pulp and paper.

Chapter 1
Introduction

Jon Birger Skjærseth and Per Ove Eikeland

The European Union (EU) Emissions Trading System (EU ETS) has been described as a ‘grand policy experiment’ – the first-ever international system for emissions trading (Kruger and Pizer 2004). Adopted in 2003 and launched in 2005, the EU ETS covers some 11,000 industrial installations in Europe accounting for almost half of EU carbon dioxide (CO₂) emissions. The EU has invested significant political capital in making this innovative cap-and-trade system work as the ‘flagship’ of its climate policy. The ultimate aim is to create a global carbon market by encouraging other major emitters, not least the USA and China, to follow suit.1 The learning effect of the EU ETS could thus be tremendous. However, the recent economic recession and slow progress on an international climate agreement for the post-2012 period have put EU climate policy and the EU ETS to the test.2 Some actors would like to see the EU ETS experiment fail, so as to provide stronger signals for low-carbon investment. Others argue that the system should be strengthened as key driver for decarbonization in Europe (van Renssen 2012). Whether the EU ETS stays on course, keeps afloat or sinks may have ramifications far beyond the EU itself. By exploring how the system actually works on the ground, we seek to shed light on whether the system has helped to start a process towards low-carbon corporate strategies.

With the EU ETS as core instrument, the EU aims to put Europe on a long-term track toward a low-carbon economy. EU leaders have agreed that greenhouse gas (GHG) emissions are to be cut by 20 per cent by 2020 compared to 1990 levels and by 80–95 per cent by 2050 to contribute to limiting the rise in global temperature to 2°C.3 The long-term task is indeed daunting: to promote almost full decarbonization by ‘driving a wide range of low-carbon technologies into the market’.4 This will entail speeding up the development and diffusion of new breakthrough technologies (Egenhofer et al. 2011).5 One example is Carbon Capture and Storage (CCS), set to play a key role in meeting EU long-term climate targets.6

Studies of the EU ETS abound (e.g. van Asselt 2009, Convery 2009). The story of how the system was initiated, decided and implemented has been analysed in detail (Skjærseth and Wettestad 2008a, b, 2010a, b). We know a great deal about the economic incentives and how they are expected to drive the system toward abatement and innovation. We are also learning more about the actual short-term aggregate effects at sector and EU levels (Ellerman and Buchner 2008, Ellerman et al. 2010) – see below for a more comprehensive review of the literature.

However, less is known about how the EU ETS affects companies in different sectors. Does it influence their interests, beliefs, norms, strategies, long-term innovation plans and deployment of low-carbon solutions? These questions are of particular salience because private sector companies will be the key transformation agents in dealing with the long-term challenge of climate change. The necessary changes are not only a matter of economic incentives and incremental innovation: ultimately, what is needed is a fundamental transformation of Europe’s industries, including changes in company norms of responsibility.

With this book we want to contribute to filling this knowledge gap about how the EU ETS actually works on the ground, and to see whether the system has helped to spur a process towards formulating and implementing long-term low-carbon strategies. This aim led us to embark on a systematic examination of corporate responses to the EU ETS from a broad empirical and analytical social science perspective. The study covers all the main ETS sectors: electric power, oil, cement, steel and pulp and paper industries – which account for most CO₂ emissions covered by the EU ETS. To what extent have companies in these sectors been affected by the EU ETS? How have they responded? Why have there been such apparently differing responses to one and the same system? This final question points to the conditions under which different response strategies develop and unfold. The ETS does not operate in a vacuum. What we seek here is a better understanding of how different drivers may co-produce outcomes – do they reinforce or counter the effect of the ETS?

Our study builds on the literature on the relationship between regulation and corporate strategies within a broader institutional approach. Earlier strategy studies may indicate that regulatory pressure is likely to affect corporate climate strategies – but how companies will respond and why they respond in specific ways are still contested questions. The literature has viewed environmental regulation like the EU ETS as either a threat to company profitability and competitiveness, or alternatively as an opportunity to improve profitability and competitiveness through abatement and innovation. Other contributions have taken the social risk of environmental challenges as a point of departure, arguing that corporate norms of responsibility can be strengthened or weakened by new regulation (see Chapter 2).

This chapter begins by introducing the EU ETS, its basic generic features and how it evolved in the EU context. Next, we provide an extended review of earlier studies focusing on the consequences of the EU ETS. We then outline the research approach of this volume, followed by a brief introduction to the chapters that follow.

Evolution of the EU ETS: A Snapshot7

The EU ETS is a cap-and-trade system covering about 11,000 installations owned by the electricity-producing and energy-intensive industry companies, representing close to 50 per cent of CO₂ emissions in the EU. Under a cap-and-trade system, each company typically starts the year with a certain number of tons allowed emitted – implying a right to pollute. The company then decides how to use its allowance: it might restrict output, switch to a cleaner fuel, or cut emissions in other ways. Companies with surplus allowances can sell to other companies. With a sufficient volume of allowances traded in the market, a clearing price should emerge that would reflect the marginal costs of CO₂ reductions for the entire system. This price would provide individual facilities with a yardstick for comparing the least costly modes of compliance: investments in abatement, purchases of allowances or acceptance of any penalty set for excess emissions compared to allowances held. The market price for carbon will thus give important signals for changing corporate behaviour. For this price signal to see an upward trend the market should experience scarcity in allowances, with fewer allowances handed out than the projected need.

The total cap of the EU ETS became a hotly discussed design element, alongside the method of allocating allowances – for free, for payment (auctioning) or a combination. The allocation method is important as a distribution mechanism for the economic value of the allowances, but auctioning would also impose extra regulatory pressure on the companies as compared to free allowances. Other design elements to evolve since the EU ETS was launched include the degree of harmonization and centralization of the system with regard to allocation of allowances, the coverage of the system in terms of sectors and GHGs, monitoring, verification and enforcement, guidelines on how to use the revenues from auctioning to support ‘climate-friendly’ technology, and restrictions on the import of external credits for compliance with the EU ETS.

The EU ETS has evolved through various stages, from its inception in the late 1990s to the revisions made in 2008 for the post-2012 period. The system was formally adopted in July 2003 and launched on 1 January 2005, with a pilot phase from 2005 to 2007 as the first step. This was followed by the Kyoto Protocol commitment phase 2008–2012 as the second step. On the basis of experience gained, in December 2008 the EU adopted a revised system for the post-2012 phase (2013–2020). This revised EU ETS formed part of a larger EU climate and energy package which included binding policies on sectors not covered by the ETS, renewables, CCS, fuel quality and vehicle emissions. In the following, we detail how the EU ETS evolved for the two first trading phases and the revision of the system for the third trading phase.

The Making and Implementation of the EU ETS

The 1997 Kyoto Protocol established emissions trading as an optional mechanism for the global deal on reducing GHG emissions, in line with the preferences of the USA.8 The EU was initially sceptical. And yet, only five years later, the EU agreed on the world’s first international emissions trading system for large industrial power-producing and energy-intensive emitters. The reasons for this turnabout were both external and internal. The Kyoto Protocol provided for the optional use of such an instrument for trade between countries, and fixed the target and the timeframe for the EU commitment to reduce emissions by 8 per cent (from 1990 levels) between 2008 and 2012.9 Although the Kyoto Protocol did not enter into force until 2005, the EU perceived this commitment as mandatory and difficult to achieve without new EU-level climate policy instruments. Economists in the European Commission’s Directorate-General for the Environment (DG Environment) acted as policy entrepreneurs – taking the initiative, building up knowledge and crafting support among reluctant stakeholders, including parts of industry, green groups, Members of the European Parliament (MEPs) and most member states, keen to avoid a repetition of the failure in the early 1990s to get support for an EU carbon/energy tax (Skjærseth 1994).

The first hints regarding an EU-wide emissions trading system were given by the European Commission in the late spring of 1998.10 Based on a June 1998 Communication on the EU’s post-2012 strategy, the idea of such a system was taken one step further in a May 1999 Communication on preparing for the implementation of the Kyoto Protocol.11 This Communication envisaged a system that would initially be fairly narrow in scope (with regard to the coverage of industry sectors and greenhouse gases), targeting only large emitters or a single economic sector, and CO₂ emissions only. Issues of harmonization and central EU control were mentioned only briefly.

The March 2000 ETS Green Paper outlined specific design proposals.12 These included an implicit recommendation for the total number of allowances to be determined at the EU level, and that the system should cover six sectors, with electricity production by far the largest. In order to sell the idea to reluctant stakeholders, the Commission set up a working group under the European Climate Change Programme (ECCP), where representatives from industry, green groups and the European Commission met regularly in the period March 2000–January 2001. Already at this point then, corporate actors had good reason to take seriously the Commission’s plans for an EU-wide trading system.

The framing of the ETS proved effective in reducing resistance and building support. To industry stakeholders, the instrument was framed as a cost-effective tool that could provide economic opportunities for decreasing emitters to sell their allowances. To green groups as well as the European Parliament, it was framed as environmentally effective – a tool that, if appropriately designed, would automatically bring emissions down to the cap set. To governments, these arguments were combined and linked to their commitments for implementation of the burden-sharing agreement and the Kyoto Protocol targets. Initially, only Denmark, Ireland, the Netherlands, Sweden and the UK supported emissions trading within the EU, with the remaining 10 members either opposed or indifferent.

The Commission plans were significantly advanced by the decision of newly elected US President George W. Bush not to ratify the Kyoto Protocol. The US exit served to unify the positions within and among the EU actors and institutions in supporting the EU ETS as the key measure for ensuring the entry into force of the Kyoto Protocol.13 In October 2001, the European Commission adopted the proposal for the Emissions Trading (ET) Directive.14 The Commission had taken the various member state interests into account, and the final proposal included decentralized allocations of allowances at the member state level. The final ET Directive was agreed in late 2002 and formally adopted by the Council in July 2003.15 The main shape and content of the proposed directive remained intact through the complex EU decision-making process.16 By this time, corporate actors knew for certain that a mandatory cap-and-trade system would materialize.

In 2004, the EU adopted the associated Linking Directive connecting the EU ETS to the Kyoto Protocol’s flexible project mechanisms, the CDM and JI.17 This Directive admitted the use of credits stemming from such projects to comply with the EU ETS. These credits would be more affordable than EU ETS allowances, due to the lower abatement costs in developing countries.18 Together, these two Directives established a three-year pilot phase (2005–2007) of the EU ETS to precede the main commitment period of the Kyoto Protocol (2008–2012).

The central issue concerning implementation of the ET Directive was decentralized cap-setting in the form of National Allocation Plans (NAPs).19 These NAPs would determine the environmental ambition of the system: set the cap, determine which sectors get how many allowances, and provide the allocation method. According to the ET Directive, at least 95 per cent of the allowances were to be allocated free of charge for the pilot phase, and at least 90 per cent for the second phase starting in 2008. The production of NAPs started in the summer of 2003. The European Commission was given the authority to assess the NAPs and reject those found not in compliance with the relevant provisions of the Directive’s Annex III – particularly the need to be on a path towards the Kyoto target in the period 2005–2007 ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• List of Figures
• List of Tables
• Notes on Contributors
• Preface and Acknowledgements
• List of Acronyms
• 1 Introduction
• 2 Analytical Framework
• 3 Electric Power Industry
• 4 Oil Industry
• 5 Pulp and Paper Industry
• 6 Cement Industry
• 7 Steel Industry
• 8 Comparative Analysis
• 9 Concluding Remarks and the Road Ahead
• Index