Latest from the EU bazaar: From carpet trading to emissions trading?

The 95 g/km standard for 2020 passenger cars in the EU continues to come under attack. On October 14, the environment ministers of the EU member states decided to reopen negotiations on the compromise deal that was originally agreed upon back in June. As previously reported here, in September Germany suddenly brought forward a phase-in proposal that would delay introduction of the 95 g/km standard until 2024. This week, Lithuania, which holds the Presidency of the Council of the European Union for the second half of 2013, was asked by the environment ministers to develop a new compromise proposal that could be accepted by all member states and the European Parliament (see here for details). Germany’s Environment Minister Peter Altmaier told reporters that he is convinced a solution will be found within the next weeks.

Members of the European Parliament are furious about the unusual actions taken by the German government, reopening negotiations on an already agreed upon compromise deal. Accusations about potentially inappropriate donations by the Quandt family (which owns nearly 50% of BMW shares) to German Chancellor Angela Merkel’s CDU party have recently heated up the debate even more.

In the meantime, Daimler boss Dieter Zetsche, during a panel discussion in Stuttgart, called the development of the EU CO2 vehicle targets “carpet trading”, and suggested a move away from mandatory CO2 emission standards and toward integrating the transport sector into the existing EU emissions trading system (ETS) instead (see the print edition of FAZ, Oct 15).

Some simple number crunching illustrates the implications of such a change of the regulatory framework, should it ever become reality:

The price per ton of CO2 in the ETS currently is around 5 EUR. The average passenger car in the EU emits about 130 grams of CO2 per kilometer and consumes about 5.3 liters of fuel per 100 kilometers (assuming it is a petrol car). Let us assume this car can drive up to 1,000 km before it needs to be refilled, i.e., the fuel tank volume is 53 liters. If passenger cars were integrated into the EU-ETS, the additional cost per tankful therefore would be 65 cents (130 g/km × 1,000 km × 5 EUR/ton). This would be equivalent to a price increase of around 1 cent per liter of fuel. Instead of 1.50 EUR per liter, fuel price would now be 1.51 EUR per liter. Even if you had to pay the ETS fee for the entire lifetime of the vehicle (150,000 km) in advance, the amount would be only around 100 Euro—not nearly enough to incentivize you to buy a more fuel-efficient vehicle.

Now, one could argue that integrating vehicles into the ETS would cause the price per ton of CO2 in general to increase, and more CO2 reductions would take place in other sectors, like buildings or power. The problem is that, according not only to EU Commission plans, all sectors have to drastically reduce CO2in parallel in order for us to meet our agreed objectives of limiting climate change.

So far, so bad. But there is also a second important consideration: CO2 emission targets for cars are not only about climate protection, but also about consumer protection. Going from 130 g/km in 2015 to 95 g/km in 2020 would not only decrease CO2 emissions by 27% but also reduce fuel consumption and expenditures for fuel by 27%. These fuel savings are so high that they easily outweigh the necessary investments into more efficient vehicle technologies. The European Commission, in its Impact Assessment for the 95 g/km regulatory proposal, calculated cost reductions of 80 to 300 EUR per ton of CO2 abated.

Standard economic theory in this case suggests that consumers will choose much more fuel-efficient vehicles themselves, without any regulation, simply because economically it makes sense for them to do so. But this is not what we are seeing when we analyze historical trends in the EU and around the world, though.

The underlying phenomenon is called the “energy paradox”, and it has been described in numerous scientific publications (for a recent example, see here). In short, the problem is that customers heavily discount future fuel savings and only value fuel savings for approximately the first three years. In so doing, they underestimate the savings they would get from investing in more fuel-efficient vehicles by a factor of about three. As a result, the economic optimum from a societal point of view is not reached and we are spending more on fuel and oil than makes economic sense—a classic case of market failure.

The ETS by itself cannot fix this. Mandatory vehicle CO2 targets, “pushing” new technologies into the market, in combination with CO2-based vehicle taxation, incentivizing customers to demand new technologies (“pulling” them into the market), are necessary to complete the regulatory framework.