Late allocation is symptomatic of a deeper problem: the governance of the EU ETS

Each year companies in the EU Emission Trading Scheme (EU ETS) receive an allocation of free allowances.  The due date for issuing the allowances is 28th February.  Member states, as the so-called “competent” authorities are obliged to issue these allowances by 28th February.  This year the allocation has not happened and there is no information on when it is to be expected.  Digging beneath the surface this points to grave problems with the scheme.

The free allocation is late.  Once again the shambolic governance of the EU ETS is exposed.  Tardiness of member states and secretive dealings behind the darkened windows of the Commission have combined to ensure that the authorities are unable to calculate in time and agree on the number of allowances to be allocated for free.  Although the EU ETS Directive clearly states that by 28th February the competent authorities shall issue the free allocation to operators of installations, it did not happen.  Further, the Commission is unable to give any new deadline for the allocation.

There are several problems with this, described in the following.

Jobs and commerce are put at risk

First, it makes life very difficult for a number of operators who have acted in good faith and assumed that, this not being Zimbabwe, the authorities can be relied on to meet their own legal obligations.  There are some operators whose very existence depends on this allocation: short of Phase 2 allowances and with financing difficulties, they are dependent on receiving the allocation on time to be able to raise funds to buy Phase 2 allowances for compliance.  There are other operators which have made commercial arrangements which involve the delivery of Phase 3 allowances, for example for financing or trading purposes.  With the total uncertain about when the allocation will happen these operators are left in the lurch and their commercial dealings are frustrated.  Some might well have to close with resulting losses of livelihoods.

Lots of uncertainty is only good for speculators

Second, uncertainty remains and uncertainty feeds price volatility.  Yet the Commission refuses to commit to a new date.  Now some analysts believe that the free allocation will not happen until the summer.  This fundamental uncertainty is good for speculative traders only.  However much politicians might rail against speculators, they only have themselves to blame for the rich pickings which speculators make over bureaucratic dithering.

Companies cannot plan

Third, well-run businesses need to plan their operations.  The whole idea of the EU ETS is that the cost of carbon should be integrated into businesses’ decision-making.  Yet today, more than two months into the year, companies cannot finalise their budgets and EU ETS compliance plans because they do not know how many free allowances to count on.

Suspicion that there is more to it than incompetence

Fourth, uncertainty gives rise to suspicion.  Is the Commission deliberately delaying the free allocation because it is frustrated at its inability to cut supply of allowances by rescheduling auctions?  Could it be part of a Plan B for boosting the carbon price?  Since the Commission does not communicate clearly and openly, such suspicion is only natural.

The rule of law is undermined

Finally, the rule of law.  Our society is based on the rule of law.  This means that when there are laws they have to be observed and enforced.  Here we see that the Commission has an untenable conflict of interest.  The way the EU works is that the Commission should start proceedings against the member states for the late allocation.  But since the Commission is complicit in the late allocation, it can hardly start such an action.  Thus, not only do the authorities break their own law, they are also never going to do anything about that.

If the authorities do not enforce their laws then we lose confidence in the law and in the institutions of the state.  As a result, those that abide by the law are at a disadvantage, and chaos is likely to follow: one day a company somewhere will fail to comply, the member state will arbitrarily waive the fine because its own authority is at fault, and this will unleash such a tsunami of legal action that the scheme will be fatally wounded.

Who is responsible and what do they say?

The delay has happened because member states have been slow in providing the Commission with the necessary data, because of lack of resources, lack of political priority or squabbles between vested interests.  Clearly member states and the Commission are both at fault.

According to the Directive, the strict responsibility for timely allocation lies with the member states (articles 3e (5) and 11 (2)).  But the Commission is instrumental in the process and thus is also responsible.  When you put the question of the late allocation to them, the (unofficial) response is that “as Phase 3 allowances cannot be used for compliance with 2012 emissions there is no pressing need for putting these allowances in circulation.”

I drew two conclusions from this:

First, the Commission does not respect the mechanism which it set up.  It has knowingly set up a market mechanism with all the ramifications of a market.  It should assume that participants in the market will take advantage of every opportunity afforded by a reasonable interpretation of the rules.  The fact that it is oblivious to companies which are dependent on timely allocation shows that it does not really understand or respect the very system that it has constructed.

Second, the Commission feels that there is no problem about being late with the free allocation.  But there is a problem, because the law sets a date of 28th February.  I see that the Commission feels that it is above the law and has the right to observe or ignore parts of the law as it sees fit.

This blasé and irresponsible attitude to the law by the Commission and, for that matter, member states will come to haunt them.  History repeats itself.

A question of governance

This is not the only problem with the EU ETS and it is important to look beyond free allocation.  VAT fraud, stealing of allowances, incompetent choices on software, IT failure, a poorly designed registry, panicky and arbitrary rule-making on the use of Kyoto credits, damaging delays over dealing with the question of oversupply, and amateurish communication are other serious problems from the last eight years.  Something is gravely wrong with the way that the EU ETS is managed – something to do with the multiple conflicting roles that the Commission takes on to initiate, implement, operate and evaluate the system; and something to do with the dysfunctional relationship between the Commission and the member states.

What should be done?

Neither the Commission nor the member states respect the laws they have created.  We are let down by our politicians and bureaucrats who are unwilling to abide by their own rules.  We can draw our own conclusions about the calibre and fibre of the individuals responsible.

There are three levels at which to address the issue.  First, as member states are in breach of their obligations under the EU ETS, the Commission should issue proceedings against them and see that they are fined for failure to comply.  It is like the pot calling the kettle black, but that seems to be the proper process.

Second, we need proper governance of the EU ETS.  This needs to receive far more emphasis in the forthcoming discussions on structural reform of the scheme.  Because the Commission would lose political power in the event of any governance reform, they have been carefully avoiding that question by focusing structural reform on the question of price management.

Reform of the governance would involve a separation between responsibility for supervising and operating the scheme.  It would involve the right to impose strong fines for delays and mal-administration.  To overcome the many conflicts of interest and unspoken loyalties within Brussels, independent experts need to be involved in supervision of the scheme.  Civil organisations and operators need to have the right to sue the authorities for failure to observe their own laws, and need strong support from the courts in this.

Both the people and organisations running it and the member states are too conflicted for the scheme to flourish.  Reform in the governance of the EU ETS is urgently needed.

Finally, if you dig even deeper you see that all these problems stem from one thing: politicians in member states want a scheme but they are scared that if it works too well, it will harm the economy; or, in some cases, harm their own interests.  If they were enthusiastic about the scheme they would not let the Commission get away with its bumbling and they would make sure that their competent authorities worked smoothly with the Commission.  It is vital to continue to try to resolve this apparently fundamental political and economic dilemma.  Without that the scheme will always be hobbled by political compromise.

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