DEFRA's Martin Nesbit Forecasts Europe's Low Carbon Policies

A forthcoming, much anticipated report from the European Commission will redefine Europe's path to a low carbon economy. Hopefully the report will also set a succesful example for the rest of the world in how to establish sophisticated, well-regulated measures to mitigate carbon emissions. In an exclusive VerdeXchange News interview, Martin Nesbit, the head of the National Climate Change Policy Division for the U.K. Department for Environment, Food, and Rural Affairs (DEFRA) reviews the lessons alredy learned by Europe regarding climate change regulation and predicts the reforms likely to be offered when the report is released.

The European Commission is expected within weeks to issue a report advancing Europe-wide green policy options for adoption. What is the significance of this report? How is DEFRA and the U.K. Government expecting it to align climate change policy and economic growth goals?

The European Commission is a body within the E.U. that proposes legislation and polices for member states to anything can become law in Europe, it has to be proposed in legislative form by the member states and the European Parliament. So, the Commission's report is an essential step in turning the policy commitments that were made by heads of governments in spring into reality - into law. Those policy commitments included:

1. 20 percent renewable fuels targets, applying not just to electricity but also to the transport and to the heat sector
2. Commitment to reduce our greenhouse gas emissions to 30 percent below 1990 levels by 2020.

On the renewables target, we're expecting the commission to recommend contributions from member states—including what sort of opportunities there will be for tradeability of renewable sourcing certificates across the European Union. On the greenhouse gas emissions target, we're looking to the commission to propose changes to the emissions trading system that will make it a much more top-down system, essentially making it much more predictable for operators working within the system. They must be able to rely on what is said from year to year, phase to phase. That is very important in order to generate much greater predictability for investors of the returns that are going to come from the carbon price for their investment decision. Also, we're hoping that the commission proposes a significant increase in the level of auctioning of allowances and a move away from grand-fathered rights to allowances from the European Commission. There are a number of reasons why we in particular support of that, but part of it is about, again, making the system more predictable for investors.

When you have a system where fresh decisions on allocations are being made once every five years, there's always the possibility for someone operating within the system to say, "Okay, well I did quite badly in my free allocations this time, but maybe what I could do is step up my lobbying efforts and get more free allocations next time." The status quo is not focusing people's attention enough on the real focus of this, which is to ensure that we look for innovative ways to reduce carbon emissions. It becomes a much more transparent and predictable system once you move away from free allocation and toward an essentially market-based approach to the allocation of allowances.

In past issues, VerdeXchange News interviewees have suggested that U.K. financial markets and regulations for carbon trading are much more advanced than those in the U.S., and that's partly why so much investment capital has moved there. But they also shared that there are flaws in the U.K.'s carbon trading system. Will the European Commission's report be a platform for the next generation of trading regulations?

The first phase of the European emissions trading system induced significant investment and public attention to climate change policy options. It demonstrated that it's technically possible to set up this kind of system, it's possible to secure regulatory compliance with it from a wide range of operators, and some of the technical verification and monitoring challenges of emissions trading are entirely manageable. The second phase is going to start in 2008 and run until 2012 with the Kyoto Protocol commitment period. The European Commission has already learned a lot of the lessons of the first phase and is tackling over-allocation of allowances and trying to move toward a more predictable system. The changes in the system I'm talking about are now all applied from 2013 onwards for the third phase and beyond.

On the question of whether London is more sophisticated than the U.S. in financial terms, I don't think that's really true. Certainly, the whole idea of emissions trading is, in its origins, an American idea. It was pioneered in the U.S. to deal with acidification at the federal level, and there have also been some slightly less successful pioneering efforts in California in earlier decades. It was also, let's not forget, something that was inserted into the Kyoto Protocol by U.S. negotiators. It's the U.S.'s gift to the world in implementation of the Kyoto Protocol, and in the E.U. we're very grateful for that gift. The U.K. interest in climate change derives in part from a coincidence of London being a powerful financial center offering a financial market able to help operators make the most of the trading opportunities available to them. To be honest, however, I sometimes get a little nervous that we overemphasize the benefits of trading to London as a financial center, because although those benefits are true, it's not the fundamental reason why the U.K. is interested in promoting emissions trading.

We're interested in promoting emissions trading because it seems to us to be the best way of securing a "least-cost path" toward tackling the problem of climate change, and this is a problem which is sufficiently significant and sufficiently challenging that we can't afford not to choose a least-cost path.

Elaborate more on your reference to a market-based trading system as the "least-cost path."?

Essentially, through a trading regime, as opposed to a purely standard-space regulatory regime, you allow operators in the market to work out who is best able to deliver a given level of political commitment to reduced emissions. It won't work absolutely; no market works absolutely perfectly. But you ensure that there is a marginal incentive to reduce emissions even for those operators who are below the levels of any regulatory standard. It's ensuring that there is an incentive to reduce emissions applying to everybody covered by your system. One of the difficulties in regulatory systems is that it does not apply to those who know what their investment ensures but fall below the set regulatory standard. They, in reality, no longer have any incentive to make further emissions reductions. The regulations in such cases are not actually driving innovation through that kind of system. You're relying on innovation to inform you about the options in future regulatory improvement, but you're not providing a mechanism that actually drives that innovation and causes it to happen.

For those still unfamiliar with the significance of emission trading for inducing innovation in green and clean technology, please elaborate on the promise of the E.U. market reforms likely to be advanced.

The premise of emissions trading assumes that there will be arbitrage between opportunities for emissions reductions in different organizations and in different jurisdictions. The market operators are the people that provide that arbitrage. This is arbitrage that is going to help ultimately save the planet from dangerous climate change. Companies and innovators are eager for an emissions trading approach because, if you're offered the choice between emissions trading, taxation, and regulation to deliver a given environmental objective, emissions trading is the one that is most predictable and probably going to deliver the least cost-burden on those organizations. The reason operators within the U.K. and the European system are keen on emissions trading is not because of a purely altruistic response to a global change, it's because they know that there is the political will there in the U.K., as there is in California, to deliver change. They want that change to happen in ways that also work for all companies and provide predictable incentives towards innovation and investment.

It would seem obvious that there won't be emissions trading without the existence of standard units of measurement and accountability. Do such standards exist? And how will emissions credits be monitored and verified?

Any emissions trading system depends on the credibility of its systems for measurement of carbon emissions. So far, the market seems happy with the system that has been put in place within the E.U. I think there is some potential for improving those systems. But my impression is that, in the U.S., there is likely to be a much greater use of sophisticated measurement techniques, and my expectation is that that will provide an even more robust system than applies here in the E.U. and the U.K. There's a separate set of questions around how you monitor and verify credits from baseline and credit regimes, like the clean development mechanism or the offset projects in the U.S. and other developed countries. There are plenty of issues around how it is that you measure a business-asusual baseline. How you can ensure that reductions below that baseline are genuinely being delivered?

I think it's a challenge for the U.S. because it's clear that we need to use the power of the carbon market in order to generate some of the supplies of investment for developing economies that are clearly needed in order to tackle the problem of climate change, but it means that we end up trading subtly different products on the same market. In an emissions trading market, you have a product that is about the "rights to emit" carbon. In baseline and credit regimes, like the clean development mechanism you have, you're selling a product that is about demonstrated reductions in carbon emissions. The two are different in nature; they provoke very similar responses in terms of how people can benefit from those mechanisms, but it's important as we continue to develop the markets to recognize that difference in the nature of the product.

What is DEFRA's role in developing U.K. carbon trading policies?

We are the policy part of the U.K. government that contributes to the U.K.'s position on European legislation involving greenhouse gas emissions. We're then involved through a body called the Environments Agency in the implementation of that legislation in the U.K., so we both advise on what the legislation should be and then we have a role in implementing that legislation domestically. We obviously work very closely with the other parts of the U.K. government that have a very strong interest in this, particularly our Industry Ministry and our Transport Ministry.

Lastly, the European Commission's report is expected to address aviation. What importance should be ascribed to aviation within an E.U. regulatory scheme for emissions trading?

One of the fastest growing sectors for greenhouse gas emissions isn't covered by the Kyoto Protocol, which is international aviation emissions. The Kyoto Protocol says that it wants to see progress in battling aviation emissions but leaves that task to another U.N. organization, the International Civil Aviation Organization (ICAO). The ICAO has had that responsibility for many years and has made very little progress in tackling the problem. The E.U. decided a couple of years ago, under the U.K.'s presidency, to produce proposals to include aviation within the European emissions trading system. The commission has produced those proposals, and we're now negotiating them. They apply not just to aviation within the European Union but also to flights to and from Europe from other jurisdictions.

Clearly, we need to demonstrate that we're applying those obligations fairly between European airlines and airlines from other jurisdictions. The clear political message is that European governments are unable to demonstrate to their populations that they're factoring in the problem of climate change unless they're also factoring in the impact of international aviation, the contribution to international aviation that has come from the European economy.