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Skip to 0 minutes and 12 seconds My name is Edwin Woerdman. I’m associate professor of law and economics at the University of Groningen, as well as co-director of the Groningen Centre of Energy Law. We have heard in earlier lectures that renewable energy sources are more expensive than fossil fuels. The question is therefore, how to make an effective energy transition without spending too much money. The answer is emissions trading. Emissions trading is a market-based instruments that aims to achieve an emissions target in a cost-effective way. It does so by allowing legal entities, usually companies, to buy and sell emission rights. Emissions trading is also referred to as allowance trading or cap and trade.

Skip to 1 minute and 3 seconds First, a law needs to be adopted that puts a collective limit, called the cap, on the emissions of certain firms such as energy companies and steel industries. Each emitter is allocated a small piece of this collective limit in the form of emission rights called allowances. To incentivise compliance, the law must impose financial penalties on those emitters that exceed their emissions cap. Second, a law needs to be adopted that makes these allowances tradable. Trading allowances enables firms to achieve their emissions caps at the lowest possible cost. A registry needs to be created by law to record the allowance transactions of companies. Allowance trading occurs under an emissions cap. A firm that buys allowances is allowed to emit more.

Skip to 2 minutes and 0 seconds But the firm that sells the allowances must first reduce its emissions before it is able to free up those allowances. This ensures that total emissions stay under the emissions cap. Moreover, the number of allowances decreases every year in order to reduce total emissions. Emissions trading therefore contributes to the process of energy transition by imposing an emissions cap, which becomes more stringent over time. As an example, consider the European Union Emissions Trading Scheme, abbreviated as EU ETS. This cap and trade scheme was introduced by the Emissions Trading Directive. Article 1 of this directive says that emissions trading is established “to promote reductions of greenhouse gas emissions in a cost-effective and economically efficient manner.”

Skip to 2 minutes and 56 seconds Cost-effectiveness, the economic rationale for emissions trading, has become a legal principle by incorporating it in the law. The trade element of cap and trade works pretty well in the EU. Since 2005, more than half a million allowance transactions were concluded. There is no market failure. The cap aspect of cap and trade is a different story. On a positive note, company emissions in the EU do not exceed the emissions cap. Compliance is nearly 100%. Unfortunately however, the cap does not bite. In fact, the number of allowances in the EU actually exceeds emissions, which is called over-allocation. This situation is the result of government failure. EU member states listen too much to industry lobbyists that prefer large emissions budgets.

Skip to 3 minutes and 56 seconds Moreover, the EU did not devise instruments upfront to cope with unexpected events such as the large emission reductions that occurred due to the economic crisis. The resulting over-allocation of allowances leads to a low allowance price, which slows down the energy transition process. Fortunately, the EU has recently decided to improve the EU ETS. The law will be amended to make the emissions cap more stringent after 2020, and to reduce the allowance auction volume in case of an allowance surplus. This will strengthen the incentives for an energy transition. These regulatory issues and developments in the EU ETS demonstrate that the law has a crucial role to play in the process of energy transition.

Skip to 4 minutes and 50 seconds And it’s also clear that the EU ETS cannot be the only instrument. There is still the need for additional stimulation of renewable energy sources, since renewables not only reduce CO2 emissions, but also play a role in providing security of supply. The next lecture will therefore focus on the development of wind energy offshore.

Emissions trading

In this video Edwin (a) explains how greenhouse gas emissions trading works and (b) clarifies which implementation problems hamper the European Union Emissions Trading Scheme (EU ETS).

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This video is from the free online course:

Solving the Energy Puzzle: A Multidisciplinary Approach to Energy Transition

University of Groningen