Daylight robbery: Energy firms and excessive profits

My Econ211 Environmental Economics students will soon be examining the different types of policies available to governments to reduce pollution. Grandfathering and the initial allocation of permits is crucial to the running of any permit scheme.

The fact that the biggest historical polluters are simply give free permits has always struck me as rather odd leaving the system open to game playing, strategic polluting and manipulation.

There is something distasteful about the dirtiest companies in Europe making such large profits as a result of their previously high polluting capacity. Does any of this really matter as long as pollution is reduced and is lower than it would have been without such a system? The question then is whether we could have achieved the same level of pollution reduction by spending the money elsewhere perhaps by subsidising technological innovation and implementation.

The "bribe" to companies to accept the scheme is the first place is compelling. See below.

Climate Fight Brings Mega Profits to EU Power Firms

LONDON - European power companies are making billions of euros in excess profits in the European Union's battle to beat global warming by cutting emissions of carbon gases, and consumers are paying for it, economists say.

The electricity generators are given, free of charge, permits to emit millions of tonnes of carbon dioxide which are currently worth around 20 euros a tonne, but are then charging consumers as if they had been made to pay for the permits.
Michael Grubb, Chief Economist at the Carbon Trust and Director of Climate Strategies, calculates that this practice which he says is economically justifiable gives the industry windfall profits of some 20 billion euros (US$27.14 billion) a year.

"It is free money," he told Reuters. "It's how you'd expect companies to behave, but politically and morally it is going to be hard to justify making so much money out of a scheme designed to reduce emissions -- with consumers footing the bill."

But Chris Rogers, head of European utilities at J. P. Morgan, says this understates the scale of excess profits because it is based on coal-powered generation and ignores the low carbon generators such as nuclear and wind who nevertheless get the carbon-inflated price for their electricity.

"Let's just say that in Phase II of the EU trading scheme the power utilities will still be making very healthy profits. The compact they have to strike with governments is that they will invest this in clean energy," he said.

Under Phase I of the EU's emissions trading scheme running through 2007 smokestack industries including power generators were allocated free permits to emit carbon and allowed to sell any surplus to those who exceeded their ceilings.

Under Phase II which runs from 2008 to 2012 ceilings have been reduced and a small percentage will be auctioned, although the vast majority will still be handed out free.

News of the vast windfall profits has generated controversy in the Netherlands and Germany but raised barely a ripple in Britain where consumers have been repeatedly told their rising energy bills are due to supply problems -- notably from Russia.

"The power companies have got away with it because the price rises are disguised by rising gas prices and because people don't respond in the short term to higher power prices," said Matt Lockwood of the Institute for Public Policy Research.

Figures from the EU's statistics agency Eurostat suggest that carbon represents about 12 percent of domestic electricity prices in Germany and six percent in Britain.

"Carbon allowances have a value even if they are handed out for free," said Cambridge University economist Karsten Neuhoff. "The question should be why give them away for free in the first place," he added.

One of the answers given is that it was a bribe to the power companies to accept the scheme in the first place. Another is as a transition payment for firms which had bought coal-fired power stations which will lose value in a decarbonising world.

Germany's E.ON -- the world's biggest utility company -- has after a boardroom battle come out in favour of 100 percent auction of emission allowances after 2012.

"It is going to be extremely hard for utilities to explain and justify their pricing actions publicly," said Grubb, who judged the scheme a success despite the problems.

"But there will be tensions between using these profits in a way the public and politicians find acceptable and how shareholders would like to see them being used," he added.