The Inflated EU Emissions Trading System

Published 17 march 2017

A main part of EU climate policy is the so-called EU ETS, which caps the emission of greenhouse gases. ETS stands for Emissions Trading System and is a system for trading CO2 allowances with a view to gradually reducing carbon dioxide emissions in Europe, wherever it is cheapest. The system is one of the international framework conditions for Danish climate policy, and therefore, this analysis by the Danish Council on Climate Change (hereafter the Council) will focus attention on the subject.

The EU’s ETS is a decisive factor when organizing Danish climate policies. In the analysis “The inflated EU Emissions Trading System - Consequences of the EU ETS and Surplus of Allowances for Danish Climate Policy”, the Council therefore analyses how Danish climate policies should relate to the trading system as well as the large surplus of unused allowances in the market.   

The emission trading system does not work as intended

Since its implementation in 2005 the EU ETS has been considered one of the main tools for ensuring that the EU climate targets are met. Today, however, many observers argue that it is failing due to a large surplus of unused allowances.

Participants in the Danish climate debate often argue that Denmark’s expansion in renewable energy and energy efficiency fails to benefit the climate. The argument is that if Denmark expands its renewable energy resources or increases its energy efficiency it will only free up allowances to be used in other countries – and thus the total emission of CO2 remains unchanged. This is called the waterbed effect, as the carbon emissions, when ‘pushed down’, will simply ‘pop up’ elsewhere – like a waterbed. The amount of water in the bed remains unchanged, just like the number of allowances in the EU ETS.

The Council’s analysis shows that the waterbed effect does not work as intended in the short run and will not “pop up” elsewhere before the end of this century. At the same time, there is reasonable cause to doubt whether such future emissions will in fact take place. Therefore, allowances freed up through an expansion in renewable energy will at the earliest result in increased CO2 emissions many years from now.

It is unwise for Denmark to cancel allowances

If Denmark chooses to focus on cancelling allowances, emissions are likely to be reduced in the long term, but it will take many years for the effect to materialise. This analysis shows that an expansion in renewable energy (or energy efficiency) is very likely to represent a more efficient climate change mitigation measure than cancellation of allowances at national level, as renewable energy leads to greater reductions when there is a surplus of allowances.

Continue the transition within the ETS

The Danish Council on Climate Change recommends that Denmark work for an efficient emission trading system while continuing the green transition. The following points are emphasized by the Danish Council on Climate Change:

  • Denmark should not use EU ETS as an argument for refraining from supporting renewable energy in the ETS sector if it wants to contribute to the global effort to combat climate change.
  • Denmark should not independently cancel allowances in order to reduce emissions within the ETS sector as an alternative to expansion in renewable energy.
  • Denmark should not use the flexibility mechanism which makes it possible to use EU ETS allowances to meet non-ETS sector targets.

The Danish Council on Climate Change's analysis “The inflated EU Emissions Trading System - Consequences of the EU ETS and Surplus of Allowances for Danish Climate Policy” can be downloaded from the menu.