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R 231621Z FEB 09 - ZDK - UR SVC 4323
FM USEU BRUSSELS
TO RUEHC/SECSTATE WASHDC
INFO RUEHZN/ENVIRONMENT SCIENCE AND TECHNOLOGY COLLECTIVE
RUCNMUC/EU CANDIDATE STATES COLLECTIVE
RUCNMEM/EU MEMBER STATES COLLECTIVE
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UNCLAS SECTION 01 OF 04 BRUSSELS 000259 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EIND ENRG EUN EWWT KGHG SENV TPHY TRGY
TSPL 
SUBJECT: EU EAGER TO WORK WITH U.S. ON CAP AND TRADE SYSTEMS 
 
BRUSSELS 00000259  001.2 OF 004 
 
 
USEU would like to thank Embassy London for its assistance in 
preparing this cable. 
 
¶1. (SBU) Summary:  EU Commission officials, industry reps, 
climate traders, and NGOs, are eager for a U.S. cap and trade 
system and anxious to share their experiences on the 2008 
revision process of the EU,s Emissions Trading Scheme (ETS). 
Seeking U.S. leadership on climate change, all aspire to a 
global carbon market, commencing with a common transatlantic 
market.  Thus, the EU Commission is pushing to establish a 
U.S.-EU task-force to explore ways to link the ETS with a 
U.S. cap and trade system. The overwhelming consensus is that 
once a transatlantic market is established, the other major 
economies will join.  The main recommendations for developing 
a cap and trade system, according to the different groups: 
 
     -- any carbon market should aim to "reward the efficient 
and penalize the inefficient," drive technology development, 
and foster sustainable growth in developing economies; 
 
     -- there are three keys to linking systems: (1) the 
ambition level of the caps must be compatible, including the 
distribution system for emissions allowances; (2) limiting 
safety valves or price floors in the carbon price; and (3) 
comparable level of quality and quantity of offsets; 
 
     -- in the absence of an international agreement, there 
will be continuing pressure to level the playing field 
vis-a-vis imports if industries in other countries are not 
required to purchase carbon credits.  End Summary. 
 
------------------------------------------- 
EU anxious for U.S. to take leadership role 
------------------------------------------- 
 
¶2. (SBU) Following the December 2008 enactment of its 
comprehensive internal climate legislation, the EU has now 
set its sights on the U.S.  One component of the EU's Climate 
and Energy package was the revision of its emissions trading 
scheme (ETS) and the extension to its third phase.  (Note: 
ETS entered in force in 2005 and phase I ran from 2005 to 
2008, phase II runs from 2008 to 2012, and phase III 
commences in 2013.  End note.)  As we consider whether to 
develop our own cap and trade system, Europeans are eager to 
engage us in hope of eventually linking the two systems, so 
much so, that the EU has proposed a U.S.-EU task force on 
carbon markets. 
 
¶3. (SBU) EU leaders, such as Commission President Barroso, 
Environment Commissioner Dimas, and several parliamentarians 
are anxious for the U.S. to resume the leadership role on 
climate.  "The EU wants the U.S. back in the mix," said MEP 
Avril Doyle (EPP-ED, IR) the rapporteur for the ETS 
legislation.  "The U.S. should be leading world debate." 
However, the EU defines the global climate agreement as 
distinct from the development of a global carbon market.  The 
former, as it argues in the recent Communication on the 
Copenhagen process, should be handled under the UN Framework. 
 (Note:  The EU,s objectives for Copenhagen are: (1) 
mitigation targets, (2) financing mechanisms, and (3) 
international offsets.  End note.) Linking carbon markets, on 
the other hand, is a critical aspect to addressing climate 
change, but should be handled under bilateral and other 
multilateral processes.  Indeed, Robert Stavins, co-chair of 
Harvard's Project on International Climate Agreements, told 
us that even if no agreement is reached in Copenhagen, an 
international carbon trading system would suffice.    The 
EU's ultimate goal is a global carbon market, but one that is 
led by an OECD-wide market, preferably by 2015.  EU leaders 
view the ETS as global model to which other schemes can be 
docked and see the U.S. as a natural partner.  Germany's 
foreign minister Steinmeier has called for a "powerful new 
trans-Atlantic (carbon) market."  Doyle said the "U.S. and EU 
can provide the building blocks for an international system." 
 Combined, "our leverage will be irresistible to countries 
that seek to trade with us." 
 
-------------------------------------------- 
EU realizes difficulty in designing a system 
-------------------------------------------- 
 
¶4. (SBU) Despite their (over)eagerness to have the U.S. 
rejoin the fold, the Europeans realize that designing a cap 
and trade system is a time consuming, complex process.  In 
this respect, they are anxious to share their experiences. 
"We identified a lot of problems during the second phase, 
especially allocation of credits, carbon leakage and affect 
on jobs," said Dimas.  A report prepared for the Parliament 
 
BRUSSELS 00000259  002 OF 004 
 
 
cited a number of deficiencies in the first two phases of 
ETS, notably over allocation of credits, distortion in the 
allocations to member states and windfall profits for the 
power sector. 
 
¶5. (SBU) Doyle said the first objective is to "establish a 
functioning carbon market" with participation by the 
political, scientific, and industrial communities.  She 
stressed the importance of buy-in from the latter: "let 
industry know the government will support it through the 
transition.  There is no need to go for the jugular at the 
outset; the legislation can be strengthened in the future." 
Industry representatives stressed the need for incentives to 
develop technology.  NGO representatives agreed, urging that 
new legislation "reward the efficient and penalize the 
inefficient." Sanjeev Kuma of WWF said cap and trade 
legislation should "drive technology, reduce emissions, and 
build capacity in developing countries." 
 
------------------------------------- 
If the U.S. leads, others will follow 
------------------------------------- 
 
¶6. (SBU) Government and industry leaders alike believe a 
transatlantic carbon market would open the way to a global 
market.  Dimas predicted that if the U.S. and EU link trading 
systems, Australia and Japan would quickly enter.  The 
general consensus is that China would be compelled to join a 
U.S.-EU based carbon market.  Jill Duggan of the UK's 
Department of Energy and Climate predicted that China would 
enter such a market within ten years of its inception, but 
without U.S. participation, China would be less inclined. 
Duggan said that linked systems would "provide more certainty 
and stability for industry."  Industry representatives 
concurred, stating that a global system would provide a level 
playing field, minimize trade barriers, and encourage Russia, 
China, and the Middle East to follow suit.  In addition to 
attracting emerging economies and diversifying abatement 
options, linkage would increase the scale of the market, 
improve the liquidity of carbon credits, and more efficiently 
allocate resources. 
 
----------------------------------------- 
Linking requires substantial coordination 
----------------------------------------- 
 
¶7. (SBU) Linking the EU's ETS with a U.S. cap and trade 
system may sound ideal in the abstract, but several 
complications could arise should U.S. legislation be enacted. 
 Thus, understanding the differences between schemes will be 
necessary to determine the expediency of linkage. 
Government, industry, and NGO officials are in general 
agreement that there are three keys to linking systems. 
First and foremost, the ambition level of the caps must be 
compatible.  Too large a divergence will cause a large 
fluctuation in market prices and drive allowances in one 
direction.  Second, the existence of safety valves or price 
floors in one system where none exist in the other could 
provide a "money printing machine" for one of the economies. 
Finally, the quality and quantity of offsets must be 
comparable.  If it is too easy to gain credit through 
offsets, the carbon price will be driven by one market, again 
causing an imbalance. 
 
¶8. (SBU) Setting the emissions cap will be a key component of 
the U.S. system that will impact the prospects for linkage. 
The EU learned the hard way during the early phases of the 
ETS by establishing an emissions cap that was too high to 
stimulate reductions.  The EU based its initial cap on 
"business-as-usual" predictions without factoring in other 
considerations such as economic growth/decline and fuel 
costs.  At the time, it also had to deal with limitations on 
available data and intense lobbying by affected sectors.  The 
result was an early flood of carbon allowances in the market 
and a sharp decline in their price.  Targets should be based 
on historical data for emissions over an extended period and 
should use the best available technology as the baseline. 
 
¶9. (SBU) Complications could arise if the margin between the 
market prices is too great.  Market prices will be greatly 
influenced by the emissions cap, the amount of credits and 
manner in which they are distributed, and any 
cost-containment measures.  Other factors to be considered 
include offsets and trade restrictions, such as border 
adjustment measures (BAMs).  Nevertheless, Dimas said "once 
the U.S. system is designed, we will cooperate to link them." 
 Doyle and Duggan concurred, noting that the EU institutions 
would work to harmonize the ETS with U.S. legislation. 
 
BRUSSELS 00000259  003 OF 004 
 
 
Indeed, the EU Parliament commissioned a study for this very 
purpose.  In the meantime, EU officials will seek to 
influence the U.S. legislative process to encourage the 
highest degree of compatibility.  Duggan said an 
internationally compatible system is in the interests of the 
U.S. 
 
¶10. (SBU) Another aspect our European colleagues will follow 
closely is the distribution and handling of emissions 
allowances, which has been a contentious issue for the EU. 
It began during the early phases of the ETS, when power 
companies were given free allowances to help ease what Duggan 
termed "the burden of compliance."  Given the inflated cap, 
the power companies reaped windfall profits from increased 
rates passed on to consumers and revenues from the free 
emissions credits.  This led to a debate over whether credits 
should be given away or auctioned. Doyle acknowledged that 
the EU was under political pressure to provide power 
companies with free credits, most recently by the 
coal-dependent, eastern member states. Notwithstanding the 
influence of regulated sectors to receive free credits, 
traders Neil Eckerts of the Climate Exchange and Patrick 
Birley of the European Climate Exchange advocated for the 
U.S. to issue free credits.  Birley compared emissions caps 
to a tax and likened auctioning of credits to a double tax on 
businesses.  He said credits should be provided except where 
the covered emitter has a monopoly.  In theory, free credits 
would stem carbon leakage, but there is a risk that companies 
would sell the credits and relocate operations to a cap-free 
jurisdiction. 
 
¶11. (SBU) Proponents of auctions contend they are necessary 
to abate emissions and promote innovation.  Chris Leeds of 
Barclay's Bank said that if companies must purchase emissions 
allowances, they will purchase what they need and seek to 
reduce emissions to cut costs.  If the allowances are free, 
they will gobble up what they can get, eliminating incentives 
to reduce emissions.  Many business representatives adamantly 
advocated the "polluter pay principle"; "don't reward dirty 
companies" they urged, citing the example of the power 
companies.  Doyle said that auctions, while imposing costs on 
businesses, generate revenues which can be used to offset 
costs to consumers or fund new technologies.  The third phase 
of the ETS will combine auctioning with free credits for 
certain sectors.  If the U.S. were to implement an auction 
only scheme, a Commission official said the EU would revert 
to a total auction scheme if the two were to be linked. 
 
¶12. (SBU) Most all of our interlocutors stressed the need for 
minimal intervention in the market.  Birley warned against 
price ceilings.  He said the object of a cap and trade system 
is to encourage abatement, which a ceiling could inhibit. 
Leeds also spoke against cost containment. He and Doyle 
warned that excessive intervention could chill investment. 
(Note:  Not all of Doyle's fellow parliamentarians subscribe 
to this view, and this proved to be very contentious in 
Parliamentary debates.  End note.) The EU has no controls in 
place, and if the U.S. were to do so, it could impact on 
linkage.  For instance, if the systems were linked and the 
U.S. had a price ceiling of $30 dollars per ton, all EU 
credits would become subject to the same ceiling.  Doyle said 
the market can be regulated, but the price should not be 
interfered with.  To the extent necessary, governments can 
influence the price through auctions and the availability of 
credits.  In fact, the ETS does have a price stability 
mechanism which authorizes the Commission to intervene only 
if the price is too high or low, but even then, the amount of 
power given to the Commission is very limited.  Leeds also 
recommends unlimited banking of credits, which, if the cap is 
properly set, could increase abatement in the short-term. 
Borrowing presents another potential obstacle.  If one scheme 
permits borrowing from future allocations, it could draw down 
the price of carbon.  Under the ETS, credits can be banked 
for future use, but they cannot be borrowed against future 
allocations. 
 
¶13. (SBU) Offsets and use of the clean development mechanisms 
can also pose a challenge to linkage.  Dimas noted the U.S. 
fondness for sinks is a potential obstacle, given the EU's 
skepticism on reforestation, but he believes this can be 
worked out. Environmental NGOs were even more blunt, saying 
(with some disregard to the overall carbon level) the U.S. 
use of extensive re-forestation offsets would make linking 
the systems impossible.  Birley said that CDMs are laborious 
to implement and difficult to manage.  If schemes are to be 
merged, CDMs would have to be well regulated "to maintain the 
quality of the currency."  Industry representatives noted the 
need to find common ground on CDMs, which they suggested be 
 
BRUSSELS 00000259  004 OF 004 
 
 
capped.  One proposal is to specify permissible offsets in 
domestic and international markets.  This is one area where 
the EU expects the UN process to drive the discussion, as the 
EU plans to argue for a global reassessment of offset 
mechanisms to ensure the quality is sufficient to effect 
change.  As one EU official put it, "in all projects, one of 
the two partners has to suffer," or there will be no true 
emissions reduction. 
 
¶14. (SBU) A final issue that came up in our discussions was 
treatment of imports from non-regulated economies.  Both in 
the United States and in the EU, there will be continuing 
pressures to "level the playing field" vis-a-vis imports if 
companies in the United States or the EU have to purchase 
carbon credits and their exporting competitors do not.  One 
of the options that has been proposed in both jurisdictions 
is a border adjustment mechanism (BAM) which could, for 
instance, require importers to purchase credits or to simply 
pay an offsetting charge. A unilateral BAM, however, can 
present challenges under international trading rules, and the 
EU in its climate package postponed consideration of such 
unilateral measures until 2011, when the results of 
international discussions are clearer. 
 
-------------------------------------------- 
Comment: Working Group Concept Likely Useful 
-------------------------------------------- 
 
16 (SBU) The EU,s checkered experience with ETS has 
demonstrated amply that devising a successful carbon 
emissions trading scheme within an economy is tremendously 
difficult; building a linked and eventually a global carbon 
market will be much more so.  The EU's proposal to develop a 
U.S.-EU task force on carbon markets, with an eye toward 
eventual linking, thus would seem useful.  The EU, having 
experienced many of the same obstacles and pitfalls likely to 
be encountered in the U.S., in particular with "carbon 
leakage," free allowances vs. full or partial auctioning, and 
the definition of "economy-wide," can provide insights that 
could help as the U.S. considers this option.  Additionally, 
given the anxiousness of the EU to link the systems, a task 
force could provide a venue to encourage revisions to ETS to 
promote harmonization, which Commission officials have stated 
they are prepared to do. 
 
MURRAY 
.