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We were very pleased when Ian Rodgers, the Director of the trade group UK Steel, agreed to participate in the launch of this year’s Environmental Outlook for the EU ETS report “Buckle Up!”. We are sincere in our desire to have an open and honest debate with industry, and, continuing in that spirit are taking this opportunity to publish EEF’s 5 page response to our report on which Mr Rodgers’ presentation was based. The full text can be read on the EEF website at [this link](http://www.eef.org.uk/NR/rdonlyres/2FD2AB1C-331E-43AF-83D6-CBE12D8BF88A/19256/Sandbag_paper_6Jul12.pdf “”).

There are some surprising and important concessions from the industry in this document regarding the economic assistance surplus carbon permits have provided, but also some important misinterpretations of our argument which we would like to redress.

**Demonising steel**

On page 2, Rodgers states “it is indeed ironic that the system we argued against helped us to survive, but it is illogical and insulting to demonise the sector from benefitting from it.”

As a point of clarification, we do not admonish the steel industry for benefitting from the scheme, but rather for continuing to obstruct greater ambition despite benefitting from it. We should also make it clear that we at no point propose that any free allocations to the steel sector should be removed. Rather, we recommend that the number of permits available at auction be reduced. It is therefore not entirely clear how our proposals risk “bring[ing] forward the point at which steel companies run out of allowances” as Rodgers suggests.

This misreading was repeated by Eurofer in the [press release](http://www.eurofer.org/index.php/eng/News-Publications/Press-Releases/EU-should-reject-flawed-Sandbag-report “”) they published on the day of our Brussel’s report launch, which inaccurately states “‘Buckle Up’ suggests that the EC’s climate change objectives would be more easily attained were the supply of free allocations under the EU ETS to be very substantially reduced”. But despite immediately notifying Eurofer’s public affairs director that this inaccurately represents our report, the press release stands uncorrected on their website.

**Waste gas transparency**

Rodgers accuses Sandbag of inappropriately maligning the industry on the issue of waste gas transfers, suggesting these are merely an “accounting quirk”. This misses the thrust of our point on this issue which is, quite simply, that in order for waste gas transfers to be counted against steel surpluses, precise information on the quantity of carbon permits involved should be made publically available. Until direct records of free EUAs transferred by steelmakers to third parties are made explicit, these unknown quantities cannot be used to diffuse concerns about the sector’s surplus. Without accurate and precise figures on this “accounting quirk” it risks becoming an “accounting trick”. As steel companies with the largest waste gas transfers have the most to gain from transparency on this issue, we would expect them to the first to support this recommendation.

**The Purpose of the EU ETS**

But our main disagreements with Rodgers are about the fundamental nature of the scheme. This is highlighted by two quotes in the document. The first reads:

_”Phase 2 surpluses do not weaken the system. The Phase 3 cap has been calculated as being the traded sector’s contribution to the EU’s emissions reduction target of 20% by 2020. The cap will be met…the only change from the original plan is that the curve of emissions reductions will be different.”_

This seems to miss the thrust of our argument, which is that irrespective of the 2020 target, the starting point for the Phase 3 trajectory was set too high because it is based on overly generous Phase 2 allocations.

Even after the Commission cut them back down to size, the Phase 2 National Allocation Plans submitted by Member States were inflated by overly optimistic industrial growth projections, especially from industries like steel that were hungry for a slice of the growing markets in emerging economies. This demand, which would have protected European steelmakers from recession, clearly never materialised, largely because China and India found they could supply steel domestically at lower labour costs. We contend that the Phase 3 budget should set aside 1Gt from auctions to reflect this, as well as roughly 700Mt to reflect the Phase 2 industrial surpluses we expect to carryover to Phase 3.

Rodgers accuses us of missing the point of an _ex ante_ cap in proposing such adjustments, as is clear in his reflections about price:

_”There is an abiding obsession, which also features in Sandbag’s report, that the EU carbon price is too low. This misunderstand the purpose of the ETS. The purpose is not to deliver a given level of carbon cost internalisation, but to deliver a fixed level of emissions reduction. The theory of emissions trading is that it will facilitate cost-effective abatement, and according to this theory, the lower the carbon price, the more effective the trading scheme.”_

This both misrepresents our view and is a simplistic reading of why the low prices currently arise within the scheme. Sandbag has in fact consistently resisted price-floor proposals which risk breaking the link between price and supply from which the advantages of cap and trade derive. More importantly, past and potential future price crashes within the scheme are not a symptom of low-cost abatement opportunities being uncovered, but because caps are being set too high. Professor Michael Grubb has perhaps given the clearest rebuttal to this view when he states:

_”The current ‘orthodoxy’ […] is that once the quantity is set, it doesn’t really matter how the market behaves – it will still deliver the set quantity target. **This reflects a fundamental intellectual confusion about the nature of emissions trading systems.** [emphasis added]_

_It is not a natural market, connecting supply of a “natural” good to a private demand, but an instrument to achieve collective public goals. That is an absolutely fundamental difference, because it establishes that the instrument needs to be assessed against the goals it is intended to achieve.”_

Setting the level of the cap is a political act, not a purely scientific one, as lobbyists for the Steel companies well know – and after having argued for larger allocations to protect them from carbon prices it is inappropriate for them to block action to adjust the cap when it becomes clear that there is an excess of allowances. In fact, at an evidence session for the UK Parliament’s Environmental Audit Committee on ‘The Role of Carbon Markets in Preventing Dangerous Climate Change’, business representatives from the CBI, being pressed on carbon pricing, stated: “would it not be more logical, perhaps, to look again at the caps, if it was completely clear the carbon price was not recovering… let us make sure the scheme is functioning, let us make sure the caps are right.” It is now clear that the scheme is not functioning, and that just such an adjustment to the cap is required.

**Summary**

In summary, we see no reason why the a sector that has benefitted from a windfall in carbon assets in Phase 2 and that will start Phase 3 with a head-start against other competitively exposed sectors (such as aluminium) newly entering the scheme, should object to a set-aside which diminishes the supply of permits elsewhere within the ETS. Indeed the increase in price this would bring about would benefit the sector further in the short to medium term. Nor do we understand why it should stand in the way of economy-wide emissions targets which better align Europe with its 2050 goals which will boost demand for metals for new power stations, grid infrastructure and vehicles.

We look forward to exploring further with the industry how the longer term concerns of steel sector can be addressed within the scheme.