Which is more important – the EU ETS or the EU RE Directive?

10Mar09

I thought it would be interesting to compare the EU ETS and the EU RE Directive and consider which of these initiatives will have the greatest impact on CO2 emissions and investment within the EU by 2020? This is not a detailed economic assessment, so I accept that the comparison is not the most rigorous, however it is insightful nonetheless.

Taking into account forecast business as usual emissions, the allocation of EUAs and the eligibility of CERs/ERUs under the EU ETS we find that the EU ETS will require a net reduction of about 5 billion tCO2 over the period 2008 to 2020 (assuming there is no significant economic slowdown – the figure falls to 2.5GtCO2 if the downturn is prolonged). The majority of that reduction can be met either with emission reduction projects at home or overseas via the use of the CDM and JI mechanisms.

The EU RE Directive will require 20% of total EU energy use to come from renewable sources. Given the baseline forecasts for final energy demand within the EU-27, this would represent about 270 Mtoe, or 3,130 TWh of renewable energy. If these renewable sources replaced typical fossil fuel alternatives they would reduce GHG emissions by about 600 to 900 Mt-CO2 per annum by 2020. To achieve the renewable energy objectives according to the EC we will require additional investment of about €670 billion; all of which must be deployed in Europe. This of course assumes that all countries meet their renewable targets, which is quite a big assumption.

So what does the comparison show us?

eu-ets-re-dir-comparison

1./ Even assuming that there is no prolonged slow down in industrial production and therefore business-as-usual GHG emissions, the EU ETS will probably deliver slightly more emissions reduction than the RE Directive – but not substantially greater.

2./ However, because of the eligibility of CDM and JI projects under the EU ETS up to one half of that emission reduction can be achieved outside of the EU.

3./ That also means that a significant part of the investment required under the EU ETS will be made outside the EU, thus limiting the financial benefits for the EU-27 bloc. Though there will of course be benefits for emerging countries and that is an important consideration.

4./ The internal investment required to meet the EU ETS is likely to be small in comparison with the RE Directive. Even using an average cost of abatement of €40/t-CO2, the EU ETS would require just €100 billion worth of additional investment within the EU. McKinsey & Co asserts that there is greater than 2.5Gt-CO2 emissions abatement available within the EU upto 2020, at costs below €40/t-CO2. They estimate that an additional €140 billion of investment would be required to realise this abatement potential.

5./ The economic efficiency of the EU ETS is clearly demonstrated. If we compare the cost of each scheme to deliver a 1tCO2 reduction in emissions, the EU ETS is five times more cost effective.

6./ However, this ignores the economic benefits of increased investment that the RE Directive would deliver. So whereas the EU ETS may be five times more cost effective at delivering a 1tCO2 reduction in emissions, the RE Directive creates four times more economic value than the EU ETS.

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