Overstretching the EU ETS

EU ETS can’t do everything – generous leakage provisions are not the way to run industrial policy.

The EU wants to stimulate investment in clean technology but at the same time it wants to protect its industry from competition from companies based in counties which do not have emissions regulations.

The EU ETS is not good for stimulating investment in clean technology in cases where the sectors are exposed to competition from outside the EU ETS and where we are committed to open markets and the unimpeded import and export of goods.  It is cheaper to import dirty goods from abroad than figure out how to manufacture cleaner ones at home.

When the EU wants to impose a CO2 charge on manufacturers in the EU, they are criticised because this affects competitiveness. As a result the EU comes under pressure to reduce the CO2 charge by giving generous free allocation.

When you start thinking about this dilemma it bursts into a lots of questions, expanding like a Chinese jasmin tea flower.  This is a way of looking at it.

First we have to consider what our real, deep-down goals are at a social or political level.  I don’t think our real goals are to make cement or steel.  Cement and steel are tools.  The real goals are to have people doing meaningful and fulfilling things during their waking hours; and to have peace.  Today cement and steel contribute to that goal, partly because they keep lots of people meaningfully employed with interesting and fulfilling challenges.  Partly because we need those products for security and shelter and a thousand other things.  But that goal can in principle be achieved without cement and steel.

It does not matter at the level of society if we have to close down a cement plant. But it matters a hell of a lot to the people working at the cement plant.  It matters, not because they will miss the cement, but something much more important: they are losing their meaningful livelihood and their community.  It also matters a bit for the shareholders of the cement plant, but at the level of society we are likely to be a bit less sympathetic to them than to the employees.

This is a question of social policy and employment policy.  At some stage a lot of time and money will have to be spent to support people who get into financial difficulty because industrial facilities close down.  This has already happened around the world where heavy industries such as coal-mining, steel production have been transformed by changes in regulation and technology.  It happened less dramatically, and for various reasons, with specialists in the manufacture of stone axes, spears, muskets, carts (as in “horse and cart”), gallows, whale soap, corsets, scythes, typewriters, incandescent light bulbs, lead and chloroflorocarbons.  We know how to help people stranded in obsolete industries, there are many lessons learnt over the last centuries years around the world.

Second, we do want to cut CO2 by 90% by 2050.  But if we do that it is unlikely that anyone will be able to make cement in 2050.  Or steel.  Or ammonia.  Unless the dream of carbon capture and storage comes good.  Food production and the provision of clean water will remain our priority and so it will probably have the priority claim on emissions rights.  This means two things: the assets we are working with today are probably not going to be replaced (we are only looking 35 years ahead).  It also means we need to work like crazy developing new ways to stick bricks together, and create new materials strong enough for bridges, buildings, and so forth.

A reasonable, medium-sighted owner of a cement plant is not going to take it upon himself to take responsibility for developing the-new-sticky-material-which-will-save-the-brick.  So even if he does not need to reinvest his amortisation cashflow, he is not going to single-handedly set up a lab for R&D.  No-one can reasonably expect him to sense responsibility for this.  If he does, it is great, but it is not obviously his responsibility.

This becomes a question of technology and social innovation.  At the level of society we have to be much more aggressive in finding zero-carbon technologies or at rejigging the way society works so that we don’t need them.  Trivial and not very good examples: if we share offices or work at home, we don’t need so many office blocks; if we get better at re-engineering old buildings we don’t need to replace so many.

I don’t think that relying on a high carbon price is the smartest way to get people to do this research.  It is accepted by the mainstream that some research is too fundamental to be stimulated by the market incentive.  Space exploration and particle acceleration, for example.  Then, by having a vote on those two scientific indulgences, you free up billions with which to speed up a more urgent fundamental search for low-energy ways of sticking bricks, holding up structures, fertilising plants and so forth.

Third, we should look at the question of why companies shift production abroad.  CO2 is not “the reason” why companies move abroad.  Imagine there is a bridge with a thousand vehicles on.  A 1,001^st vehicle drives onto it and the bridge collapses.  Whose fault is it?  Is it the Fiat Polski which was the 1,001st car or is it the fleet of 40 ton Volvo trucks already on the bridge?  It is true that things were ok before the 1,001^st vehicle arrived, but all the vehicles there contributed to the fall of the bridge.  In the same way, companies shift production because of the sum of lots of different reasons: they compare demographics, market prospects, labour rates and labour culture, education systems, tax levels, energy and raw material costs, costs and quality of transport, supply and infrastructure, quality of the rule of law, stability and security, neighbours and so forth.  The cost of CO2 is one of a dozen factors.

So when we talk about leakage we must talk about it holistically – we need to look at all the reasons why companies decide to employ people in the EU rather than other countries and vice versa.  To talk just of CO2 leakage gives a false picture.  There is a risk that we could end up compromising the EU ETS without actually affecting the overall decisions of companies on where to locate.

For all we know, a tweak in education policy or a little extra funding of R&D could be worth one euro on the EUA.  And at the same time, the difference in energy cost that the USA enjoys through shale gas is so great that even shutting down the EU ETS would bring no tangible advantage to European manufacturers.

Finally, the question of windfall gains.  By way of the EU ETS society gave substantial windfall gains to certain industries – power, cement, steel among others – in the billions of euro.  Partly through simple over allocation; partly because in earlier phases of the scheme the marginal cost of carbon was so much higher than the average cost.  There was a transfer for billions of euro from the economy as a whole to shareholders of a relatively small number of energy and industrial companies.  In a spirit of fairness, this needs to be remembered by those shareholders when they are now faced by a higher cost of CO2.  It was the gift of society.

I have the impression that people expect the EU ETS to do everything.  They are expecting it to ration CO2 emissions; to act as a driver of innovation; and at the same time to do social policy – through the leakage list it is expected to provide the buffer which delays an inevitable and painful revolution in our industry.

This is a mistake.  It is the job of social and employment policy to figure out what to do if cement factories stop producing and put people out of work.  I think it is the job of innovation policy to figure out how to speed up the development of the technologies we need.  It is the job of industrial and education policy to help encourage investors to invest in Europe rather than other regions.  Stretching and deforming the EU ETS in order to meet the conflicting demands of social, innovation and industrial policy is not fair, when the EU ETS is actually an environmental policy.

We should: have a tough EU ETS which makes our commitment clear; have inspired innovation policy and a brilliant education system which puts us at the forefront of discovering new materials, technologies, business and non-business models (not least, ways of enjoyably, meaningfully living simply) for shifting to a zero-carbon economy; have a compassionate industrial and training policy to ensure that we care for those buffeted by the transition.  Shift resources from indulgences accordingly.

Finally we have to set higher expectations of our entrepreneurs and investors: policy cannot and should not do everything; stop bitching and be gracious, magnanimous and generous in your contribution to transform society.  Keep on giving back.

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