The world’s largest carbon emissions cap-and-trade program — the European Union’s Emissions Trading System (ETS) — is facing increasing controversy and threats of trade retaliation over the EU’s efforts to pursue the aviation industry’s compliance with ETS. At the same time, the market for ETS carbon allowances has seen a precipitous drop in demand and prices, thus weakening the market. These developments have left open questions regarding the long-term viability of the ETS.
Opposition to ETS in the United States and Abroad
In 2009, the EU passed legislation that extended the ETS requirements to international airlines serving European airports. Following a suit brought by several U.S. airlines and their trade association Airlines for America, the European Court of Justice upheld the 2009 legislation, finding that: (1) it does not violate international principles of territoriality and sovereignty because the rule only applies when aircraft are physically located in EU territory, and (2) the law is consistent with the Open Skies Agreement, which prohibits discriminatory treatment between European and American airlines. Airlines with flights serving EU member states are now obligated to purchase allowances sufficient to cover their 2012 greenhouse gas (GHG) emissions.
In addition to the Airlines for America suit, non-European airline companies and political bodies have voiced opposition to the ETS requirements in a number of ways:
The International Air Transport Association — the world’s largest airline trade organization — continues to call on the EU to drop its ETS compliance requirement for international airlines and argues that a global solution should instead be negotiated through the ICAO, a United Nations agency.
Meanwhile, trading of ETS credits has ground to a halt due to a glut of emissions allowances and very low prices — roughly €6 – €7 (US$7.50 – $8.50) per ton of carbon dioxide equivalent (CO2e), down from a historical high of more than €18. Prices on ETS credits have slowly declined over the past year due in large part to Europe’s sluggish economy, in which decreases in industrial production and energy use have created a surplus of unneeded credits. In addition, numerous loopholes and inefficiencies in the ETS regulations can be exploited by industry participants to avoid strict compliance. Key among these is the rule allowing companies that fall below their cap one year to keep surplus allowances for three additional years. Because most industry caps were set before the 2008–2009 economic downturn, many companies emitted GHGs in those years at levels well below their caps — leading to a huge supply of banked allowances now. According to a June 11 study issued by the environmental organizations World Wildlife Fund (WWF) and Greenpeace (German branch) and authored by the Öko-Institut in Freiburg/Germany, companies in the ETS will possess around 2 billion surplus emission allowances by 2013.
The trading difficulties have left EU officials and environmental groups concerned that trading of ETS credits throughout the EU will not result in the emission reductions intended. Indeed, evidence suggests that the use of coal for electricity is on the rise when compared to natural gas and renewable resources. The EU will need to make drastic changes to its ETS program if it hopes to have the marketplace drive emissions down to meet the GHG reductions goals of 30 percent below 1990 levels by 2020. Under the status quo, the “historic low” price for CO2e deprives regulated companies of any incentives for climate-friendly investments, the Öko-Institut said.
Troubles in the ETS may result in a re-evaluation of the system and the assumptions employed in establishing the system. At a minimum, the ETS will continue to be the target of criticism from both the international airline community and the environmental NGO community. Given the general instability in the European economy, the threats of boycotts and other sanctions by foreign carriers and countries cannot be taken lightly. At the same time, the EU remains committed to the GHG reduction goals. Ultimately, the EU will need to find ways to achieve reductions of (or offset) GHG emissions from airlines as well as address the imbalance in the ETS credit market. At this point, it does not appear that there are any easy answers. However, the difficulties facing the EU may be instructive, particularly for programs like the planned AB 32 cap-and-trade market in California.
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This article was originally published by Bingham McCutchen LLP.