The EU's climate agenda hangs in the balance

The EU has entered a severe economic downturn. Not only does Europe face the deepest recession since the 1970s, but the recovery when it does arrive will be weak and patchy. One casualty of the economic crisis could be the EU's ambitious climate policy agenda. Eighteen months ago, EU governments agreed that by 2020 the Union would cut emissions of greenhouse gases by 20 per cent; improve energy efficiency by 20 per cent; and draw on renewable sources for 20 per cent of its energy. The EU now needs to agree on the policies needed to meet these targets. A failure to do so will undermine the EU's negotiating position ahead of the UN summit in Copenhagen in December 2009, and make it much harder to secure an international climate agreement.

The EU's emissions reduction targets are by far the most ambitious in the world. But if Europe is to persuade the US and emerging economic powers like China and India to take similar action, it has to back up its rhetoric with action. Also, if the EU retreats from its leading position on climate policy it will surrender its first-mover advantage and with it the chance to make European firms leaders in key environmental technologies. In the furore over the costs of cutting emissions, the huge economic opportunities of a move to a low carbon economy are being ignored.

The timing of the negotiations could not be worse. The European consensus in favour of ambitious action on climate change has always been fragile. Many member-states have been wary of the costs of unilateral EU action to reduce emissions. They believe Europe should only act when (and if) there are corresponding commitments by all the major emitters of greenhouse gases. Their position has been strengthened by the dramatic deterioration in economic conditions since the targets were agreed last year, and by a growing sense that other countries will be slow to take equivalent action. A host of member-states now claim that unilateral EU action to cut emissions would endanger economic growth and jobs in the Union. The Italian government has even threatened to use its veto over the Commission's package.

The most contentious issue is the auctioning of permits under the EU's emissions trading scheme (ETS). The Commission has proposed that from 2013 there should be full auctioning of permits for energy generators and a progressive shift to full auctioning for all other industries. It has left the door open for exemptions for industries that can demonstrate that the cost of permits would force them to relocate production outside the EU. The argument for auctioning, instead of free allocation of permits, is that having to pay upfront maximises incentives to use energy more efficiently.

National business federations, led by those from Germany, Italy and Austria, argue that it is not just highly energy-intensive industries that will move their production out of the EU if auctioning is introduced. They claim that Europe's manufacturing sector as a whole will cut back on investment in the EU and gradually shift production to other jurisdictions. These industry groups are demanding free allocation for manufacturers covered by the system, so long as there is no international agreement imposing similar requirements on competitors in non-EU countries. They have the support of Business Europe, the club of EU industrial associations, as well as their national governments.

The demand of many governments for a blanket exemption for the manufacturing sector, and the rejection of a case by case assessment of which sectors might be vulnerable, suggests that governments have become too close to their industrial lobbies. There is considerable evidence that auctioning could force highly energy-intensive industries such as cement or aluminium producers out of the EU, with damaging economic and environmental consequences (it would be very energy-intensive to ship cement to EU markets). But there is no evidence that auctioning would have a significant impact on the vast majority of manufacturers such as car-makers.

The new Central and East European member-states also oppose the Commission's plans. Their criticism centres on the proposed move to full auctioning for energy generators. A group of countries led by Poland is demanding that greater allowance be made for their disproportionate dependence on coal to generate electricity. Although they could have increased their use of gas (which emits less carbon dioxide than coal), they claim that would have meant increased reliance on Russia for their energy supplies, which they oppose on strategic grounds.

The Central and Eastern Europeans have a case, up to a point. They are relatively poor compared to most of the old EU states and they are still contending with the legacy of inefficient energy generating capacity built under communist rule. However, the Commission's proposals already allow for financial compensation to poorer member-states. Industries based in these countries would receive relatively more emissions permits than the same industries based in wealthier ones. And the emissions targets themselves were set with reference to existing energy mixes, topography and GDP per capita.

There is a possibility that the EU's 2020 climate package will unravel, especially if agreement is not reached under the French presidency. The Czech government, which takes over from the French in January, has expressed only very lukewarm support for the Commission's proposals. But for all the difficulties, there is a real chance that EU governments can reach a compromise. Cautious optimism is justified. There is no evidence that Italy or any other government actually wants to be held responsible for bringing the whole package down.

The concerns of the new member-states will be addressed by additional financial compensation beyond that already envisaged. The fears of Austria, Germany and Italy will be assuaged by postponing the move to full auctioning for broader range of industries than the Commission has hitherto considered. Neither of these compromises would fundamentally dilute the package. Energy users would still have an interest in curbing emissions, because they would have to purchase additional permits if they exceeded their allowances, and because they would be free to sell any they do not use. The credibility of the EU's claim to environmental leadership would survive.