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In the build up to the release of the 2009 budget on Wednesday there is much discussion anticipating the environmental measures the budget might or should contain. Most prominent have been the calls for a greater proportion of the UK’s stimulus package to be dedicated to green investment.

Sandbag support calls for larger and smarter green expenditure in the upcoming budget, and still hope that some of the measures we suggested in response to the [2008 budget](http://www.sandbag.org.uk/node/35 “”) are introduced. The chief goal must be to usher in a transformed, low carbon economy. There is now broad agreement in the climate change community that the essential vehicle for delivering this is a robust and reliable carbon price.

Unfortunately, the world’s most advanced carbon market – the EU Emissions Trading Scheme – has suffered a beating of late. An over-allocation of permits for the current phase (Phase II) combined with the effects of the recession has served to seriously undermine the price of carbon. European emissions fell some 5% in 2008 and are expected to fall further this year as the recession continues. As a result, according to [Barclays Capital](http://www.businessgreen.com/business-green/news/2240529/recession-leads-supply-credits “”), the Phase II carbon market contains some 23 Megatonnes of superfluous carbon dioxide permits (sufficient permits to cover a new Kingsnorth power station for nearly three years). With so much “hot air” in the system, all that is keeping the European carbon price from crashing completely is the fact that companies can carry over their existing permits into Phase III of the scheme, which runs from 2013-2020.

There is a real danger, then, with ETS caps now covering half the UK economy, that investing public money in green jobs and infrastructure might fail to deliver any of the carbon reductions it promises. If investments are not supported through a tightening of caps, a recovery package which affects ETS compliant industries is likely to drive emissions even further below the existing cap, generating more spare permits for sale to other would-be polluters in the scheme. This undermines any environmental “additionality” and potentially drives the carbon price down further still.

So how can we best synchronize the ETS with a green stimulus package in the short to medium term? As [Professor Michael Grubb](http://news.bbc.co.uk/1/hi/sci/tech/8000156.stm#comments “”) recently commented, “The defining feature of the carbon market – that governments set the quantity – is the key to its salvation.”

Grubb recommends that countries like the UK and Germany, which have held aside some of their Phase II permits for auction across the 2008-2012 period, set a minimum reserve price on their remaining permits. If companies refuse to purchase these, these permits simply won’t enter the market, thereby tightening the Phase II cap. It’s a clever and elegant solution that simultaneously removes “flab” from the market while introducing an unobtrusive price floor. Furthermore, echoing the logic of a corporate share buy-back, government revenues from auction should not be grossly diminished, as the reduced number of permits sold at the reserve price will be offset by their increased value.

In addition to Grubb’s suggestion, Sandbag supports the introduction of tax incentives that encourage companies with large permit surpluses to voluntarily cancel them as an act of corporate social responsibility, rather than selling them on or banking them into future phases. Taking permits out of circulation in this way would be especially appropriate to companies whose surplus permits were originally “grandfathered”, i.e. bestowed to them for free by government.

Individuals, too, could be encouraged to cancel permits in the carbon market, either through offering them analogous tax rebates when they use specialist cancellation agents like Sandbag, or by subsidising their permit cancellations through Gift Aid.

Beyond setting a reserve price and introducing tax incentives to retire permits from circulation, we also propose a third measure. In order to protect Phase III of the ETS from the “hot air” resulting from the recession in Phase II, we recommend future caps are adjusted downwards. This could be achieved by setting the emissions baseline from actual emissions in 2008-2009 rather than, as is currently proposed, from the emissions allocation for 2010. The ETS carbon budget for Phase II was based around economic projections and political expediency, not climate science. It is only appropriate that future allocations be revised downwards in the light of the economic realities.

When it comes to evaluating Wednesday’s budget, many commentators will be seeking to assess whether Government interventions to bolster the economy are legitimate, well targeted and effective. The CBI, a long standing protector of the market and critic of unnecessary Government intervention is calling for more action to address the market failure of climate change. The political stage is therefore set for a Government-led revolution in the energy market. If the Government is serious about securing investment to achieve this, it must aggressively pursue mechanisms to tighten the EU carbon cap, raise the price of carbon and protect the market from crashes.