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Europe’s Heads of State today reached agreement on the final elements of a complex package of inter-relating energy policies designed to reduce the EU’s carbon footprint. The negotiations over the details of the final package have been intense and have resulted in quite significant changes to the proposals initially proposed by the Commission. It may take months before analysts are able to get a clear picture of what the package means for European industry and the whole thing is still contingent on a global deal being reached before the end of 2012.

The measures agreed can be split roughly into two categories, measures which seek to curtail activities causing emissions, and those which are designed to incentivise investment in cleaner technologies. Unsurprisingly the measures trying to do the curtailing, essentially the EU Emissions Trading Scheme, experienced a lot more resistance than the positive measures, such as policies to promote renewable energy and carbon capture and storage.

These negotiations represented in microcosm the same issues that help to complicate negotiations around a global deal. Some countries are richer than others, some more polluting, all have overwhelming political concerns about costs to the economy and the possibility of losing jobs in existing industries. The outcome? A deal with very little ambition and lots of holes in it where emissions trading is essentially relegated to an accounting process while the real heavy lifting is done by more traditional policies like renewable subsidies and efficiency standards. UN negotiators should take note!

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The grand irony is that the package could work – caps tightened, all polluters paying up front – but only if a comprehensive global deal is reached in the next few years. And yet this package was meant to help convince the world that Europe was serious and thereby make it easier to reach that deal. The circular nature of the argument would be funny if it weren’t for the fact that so far we’ve wasted a lot of time trying to work out how teach the world how to do this, only to find we are incapable of finding the political will to do it properly unless everyone else does it too.

It is not all doom and gloom, however. We have at least invented a set of brakes for the juggernaut of our rising emissions – they are a bit complicated and we’re not sure if they will work (hell we’re not even sure how long we’ve got before we hit the brick wall) but we can at least start testing them and hit them hard as and when the global political will is found to truly solve this problem.

The package in summary:

The EU Emissions Trading Scheme is meant to be the main policy instrument by which Europe drives change but to date it has had a faltering start – and the concessions agreed today have further watered down its impact and have been drafted with such complexity that it is virtually impossible to say for sure whether it will have any impact at all going forward. Other more aspirational and traditional policies have proved easier to negotiate and will be what Europe relies on to improve its carbon footprint in the continuing absence of a global deal.

All eyes must now shift to the UN process and to Copenhagen next year.

The key elements, what was agreed and why it matters:

The cap

– The whole package is intended to reduce EU’s emissions footprint by 20% compared to 1990 – roughly an 11% reduction over the period 2013-20 compared to 2008-12. A per annum reduction rate of around 1.5%. Allocation to Member States will be according to a complex burden sharing agreement where accession countries are treated very favourably. All Member States will also be allowed to borrow forward up to 5% of their annual allowance to meet their caps – a significant concession.

– A tougher cap of a 30% reduction could be agreed if a global deal is enacted before 2013.

– This is the most important factor determining whether the scheme is actually delivering anything – too low a target and it’s just business as usual – too high and industrialists will complain and seek concessions.

The level of offsetting

– Limits on the use of overseas credits have been agreed – they may sound low – 3-4% of 2005 emissions levels but this has to viewed in the context of the overall level of the cap – which is declining by only 1.5% a year. This means those in the EU ETS can meet half of their expected emissions cuts overseas and for those outside the trading scheme this rises to around 70% of the effort required to meet targets.

– This is important in that it reduces compliance costs – savings overseas can by and large be cheaper than in Europe – but it also undermines Europe’s claims that they want to lead the world to a low carbon economy – what they are saying is they are happy to pay others to invest but not to actually to commit to making the investments here.

How the permits are handed out

– This is where there was most disagreement and where the biggest concessions had to be made – because it determines the extent to which industry has to pay to pollute. It was always going to complicated but today’s agreement is particularly complex. It will take a long time to fully analyse and the Commission has bought itself some time to do a proper assessment of how it all pans out it will then make recommendations on the effort sharing – but not until March 2011.

The principle that industries not exposed to international competition should pay for all their allowances is more of less intact – but they have pushed the deadline back to 2025 though and massively expanded the definitions of who can claim to be exempt.

The power sector still starts paying for 100% of its allowances in 2013 but there are some exemptions for countries and plant with particularly difficult circumstances. The competing sectors – or exposed to ‘carbon leakage’ will continue to receive their permits for free for longer and the number of sectors now qualifying looks to cover over 20 different industries (many believe as few as 7 can justifiably make this claim). There is an incentive on them to improve their efficiency and also, if a global deal is reached then the provisions should not apply.

The rest of the package

Members states are still expected to generate 20% of the energy from renewable by 2020 – a challenging target which has been widely welcomed. It is evidently easier to be aspirational than draconian.

Carbon capture and storage projects will have around 300M allowances set aside and then auctioned to generate revenues to cover the extra costs involved in demonstration projects. This could be sufficient to get up to nine plant up and running but the value of the deal is dependent on there being a good price for carbon – EU estimates of around €30 per tonne look highly optimistic unless the target is moved to a 30% cut by 2020.

The transport sector has a legal fleet average energy efficiency target to meet of 95gCO2 per km by 2020 (down from 164g today).

Member States are expected to improve their energy efficiency by 20% by 2020 – a number of specific policies around building and appliances are expected to be introduced by Member States to meet this.

And all Member States are required to meet legally binding targets in the heating and transport sectors. But with significantly increased access to overseas credits should it prove too difficult to achieve.