SPRU - Science and Technology Policy Research, Mantell Building,
University of Sussex, Brighton, BN1 9RF, UK
(Published in: International Journal of Environment and Pollution,
2001, Vol.15, No.1, pp.22-41.)
As the number of environmental policy instruments grows, so the
potential for interaction between different instruments increases. This interaction can be
detrimental or beneficial. To avoid conflict, it is essential that the potential for
interaction be assessed during the formulation of new policy instruments. This paper
illustrates this through an analysis of how the European Directive on Integrated Pollution
Prevention and Control might interact with future schemes for carbon emissions trading.
Both instruments encourage industrial energy efficiency, but in fundamentally different
ways. This is demonstrated through a detailed comparison of the two policy instruments,
followed by the development of three implementation scenarios for IPPC, in which the
interaction with potential carbon trading schemes is assessed. The paper concludes that
the interpretation of the IPPC energy efficiency requirements could either constrain or
facilitate the participation of regulated installations in any carbon trading scheme.
environmental policy instruments; IPPC; emissions trading; regulatory
Environmental policy has grown enormously over the last 30 years, both
in the number of policy instruments and the variety of institutional levels and arenas
from which they arise (Weale, 1992). As environmental policy matures so the potential for
interaction between different policy instruments grows. This interaction can be
complementary and mutually reinforcing - such as the implementation of industrial
pollution regulations assisting the development of business environmental management
systems (Smith, 1996) - but there is also the risk that different policy instruments might
interfere with one another and undermine the objectives and credibility of each. It is
important, therefore, that policy makers understand the features and dynamics of existing
policy instruments and assess the likely interactions with any new measures they propose (Hahn
& Noll, 1983).
This paper seeks to illustrate policy interaction by examining two
instruments whose objectives include, directly or indirectly, the promotion of energy
efficiency in European industry. The first policy instrument, the Integrated Pollution
Prevention and Control (IPPC) Directive (96/61/EC) will be introduced in all Member States
in 1999. The IPPC Directive shares many features with the existing system of Integrated
Pollution Control (IPC) in the UK (Skea & Smith, 1997). Its central requirement is
that operators of industrial processes use the Best Available Techniques (BAT) to control
polluting releases to all three environmental media (air, land and water) and to promote
energy efficiency. It is this last element of IPPC which is relevant to this paper.
The second policy instrument considered here is currently being debated
in the wake of the 1997 Kyoto Protocol to the Framework Convention on Climate Change,
namely tradable permits for greenhouse gas (GHG) emissions (Skea &
Sorrell, 1998). The Kyoto Protocol provides a framework for international
emissions trading between countries with legally binding emission targets (Article 17).
While the rules for this trading regime are still being negotiated, it is likely that some
countries will wish to develop national GHG trading schemes that may be integrated with
the emerging international market. Monitoring difficulties for GHGs are likely to confine
trading schemes to carbon dioxide (CO2) in the first instance. Therefore, this
paper focuses solely upon carbon emissions. The focus of any national carbon
trading schemes is likely to be large industrial energy users, such as those installations
regulated under IPPC.
This paper does not aim to map out the future shape of national carbon
trading schemes, nor to assess the pros and cons of trading. Rather, the paper seeks to
illustrate how the implementation of IPPC energy efficiency requirements could either
constrain or facilitate the participation of regulated installations in any trading
The fact that a trading scheme is not yet in place makes our analysis
particularly relevant. Within the EU, the UK in particular is debating the merits of
carbon trading. Some UK business leaders are strongly supportive of carbon trading as it
provides an attractive alternative to carbon/energy taxes for energy intensive users. BP,
for example, are developing an internal system for trading carbon emissions between their
refineries, and both the Association of Electricity Producers and the International
Petroleum Exchange are advocating the development of a national carbon trading scheme
(AEP, 1998; IPE, 1998). Trading was examined as an option in a Treasury study on Economic
Instruments and the Business Use of Energy (Her Majestys Treasury, 1998) and the
government is considering the establishment of a dry run trading pilot (Her
Majestys Customs & Excise, 1999). Hence, whilst our analysis is relevant
throughout the EU, the paper focuses on the UK, where discussion on carbon trading is most
So how would a trading scheme interact with IPPC? And could a trading
scheme be bolted onto IPPC as a recent government consultation paper suggests (Department
of Environment, Transport & the Regions, 1998, p.18)? Our analysis cannot provide
definitive answers, but we do illustrate a process by which policy interaction can be
explored. We conclude that the manner in which IPPC is implemented will significantly
affect the scope for regulated processes to participate in future carbon trading schemes.
The paper begins with an exploration of the IPPC policy target, namely
the character of energy efficiency measures in industry. Improved energy efficiency will
lower carbon emissions, both from reduced fossil fuel combustion at the installation and
from reducing the demand for imported electricity. Indeed, since carbon emissions cannot
be abated like other pollutants, energy efficiency and fuel switching must form the
central elements of climate policy. Interaction between IPPC and carbon trading will
therefore hinge on the interpretation of the IPPC energy efficiency requirements.
In sections 3 and 4, we analyse the fundamental features of the two
policy instruments: first IPPC, then carbon trading. In sections 5 to 8 we evaluate the
overlap between the instruments, the potential for interaction and conflict, and the
feasibility of operating both in parallel for IPPC regulated installations. This is
achieved through the development of three implementation scenarios. The concluding section
assesses the conditions and scope for IPPC regulated installations to participate in
carbon trading, and the relevance of our analysis to broader issues of policy design.
2: Energy efficiency in industry
Broadly speaking, energy efficiency improvements to industrial
processes fall into one of two types. The first type (Type I) are discrete measures
dedicated to energy efficiency. These may include, for example, insulation, improved
boiler control systems, variable speed drives on electric motors, waste heat recovery,
heat pumps and the cogeneration of heat and power. Type I measures can be categorised by
the scale of investment, beginning with minor housekeeping measures and moving through low
cost engineering/operational improvements, higher cost improvements, investment in new
plant with improved performance and finally, investment in new facilities incorporating
fundamental changes in the basic technology (Bell, 1990, p12).
The key feature of Type I measures is that their primary purpose is to
reduce energy use and energy expenditure. A corollary is that calculating the
cost-effectiveness of Type I measures ought to be relatively straightforward - though
determining the relevant cost-effective criteria can be problematic, e.g. should we look
at private costs and benefits alone or should we include social costs and benefits? With
this qualification, it nevertheless seems that Type I energy efficiency improvements are
broadly suited to the costs and advantages assessment necessary for the determination of
BAT under IPPC (see below).
Type II industrial energy efficiency measures are less straightforward.
These are instances in which energy saving is largely a by-product of investment and
improvement in process technologies, where the primary motivation is improvement in
productivity or product quality. This type of technical change is of fundamental
importance. Empirical evidence suggests the historical improvement in the energy intensity
of industrial economies has depended as much on these broader changes as on energy
specific investments (Bell, 1990; Schipper, 1987). This is the primary reason that energy
efficiency has continued to improve when energy prices were low or falling, albeit not as
fast as growth in absolute energy consumption. Furthermore, these broader changes result
as much from incremental forms of technical and organisational change (learning by doing)
as from major investment in new production facilities (Bell, 1990).
The characteristics of Type II measures suggest that calculating their
energy efficiency cost-effectiveness is much less straightforward. Given that the primary
purpose behind the measure is not energy efficiency but a production investment, how large
a proportion of the investment cost do we attribute to our energy efficiency
cost-effectiveness calculation? Furthermore, if the savings result from behavioural or
organisational change, or from minor engineering improvements, the notion of investment
cost may be inappropriate. This suggests that identification of discrete energy costs and
savings from Type II measures can be extremely difficult. Consequently, determining
cost-effectiveness criteria might be even less straightforward than for Type I measures.
Energy savings are made nevertheless and these could reduce carbon emissions from the
firm. In a trading scheme, these could free up tradable permits for sale
outside the company.
3: The regulatory framework for Integrated Pollution Prevention and
The IPPC Directive was passed in September 1996. The central thrust of
IPPC is multi-media pollution control from major industrial installations, where the aim
is to prevent pollution being displaced from one media to another. Included in this is an
energy efficiency requirement, introduced during the Directives long negotiation,
which could have major implications for any carbon reduction policy. Implementation of
IPPC will be phased in, sector by sector, beginning in 1999. By 2008 all relevant sectors
will be included within IPPC. The scope of the Directive is wide, including energy
intensive industrial sectors such as electricity generation, iron and steel, non-ferrous
metal, cement, paper and board, and chemicals.
In contrast to trading, IPPC is a bottom-up regulatory regime.
The mechanism IPPC uses to achieve emission reductions is a permit regime. Each operator
of a prescribed industrial installation must seek a permit containing emission limits and
improvement targets to prevent and reduce environmental releases to air, water and land. A
prescribed installation cannot operate without this permit which must also take account of
efficiency of energy use, consumption of raw materials, and noise.
IPPC contains no overall reduction targets. The negotiation of a permit
with a regulator will turn upon the technology-based regulatory principle best
available techniques (BAT). In practice, BAT is implemented through ..emission
limit values...... equivalent parameters or technical measures (Article 9(3)), where
these are understood to be based on the underlying technology-based BAT principle (Article
9(4)). BAT has several precedents in European regulatory practice including: Best
Available Technology Not Entailing Excessive Costs (the Air Framework Directive);
Stand der Technik (Germany); and Best Practicable Means (UK). A
common feature of such principles is that they require a high level of technical
competence on behalf of the regulator before they can be effectively implemented.
Regulation is thus a hands on process, with the regulator becoming involved in
The European Commission is committed to produce guidance on BAT for
each industrial sector in the form of BAT Reference Documents (BREFs), but these will not
prescribe the technology to be used in specific cases. In the final analysis, BAT for
emissions reduction and energy efficiency must take into account the technical
characteristics of the installation concerned, its geographical location and the local
environmental conditions (Article 9(4)). Thus a distinction must be drawn between generic
standards produced for guidance purposes, such as in BREFs, and the local or site
specific limits set in individual permits. Some Member States, such as the UK, have a
regulatory culture which emphasises negotiation and discretion and which allows local
standards to depart significantly from those in the generic guidance. Others, such as
Germany, adopt a more standardised approach in which the generic standards are transposed
directly into local limits (Boehmer-Christiansen and Skea, 1991).
Member State interpretation of BREF generic standards and the way they
relate these to local limits will determine the extent to which regulators and operators
can negotiate flexibility. While BREF notes may support greater uniformity of
environmental standards, the final decision on BAT limits in each permit is in the hands
of the regulator.
There is less scope for flexibility over system boundaries. The
unit of regulation is the industrial installation, or technical unit, carrying
out the activities listed in the Directive (Annex I). BAT will apply to fairly fixed
industrial installations within industrial sites.
To be successful, IPPC requires that operators and regulators have good
information about the technologies used in Annex I activities, their energy efficiency and
associated emissions. and the costs and benefits of their use. As regulators move away
from reliance on end-of-pipe controls and seek pollution prevention measures (less
discrete, more embodied in cleaner production processes) so this knowledge will need to
become increasingly detailed. In addition, environmental expertise will be required in
order to balance the overall profile of releases to air, water and land. However, there
are limits to our scientific knowledge of environmental toxicology, and methods for
comparing the impacts of different pollutants are inherently subjective and context
dependent (Stirling, 1996). Judgements are therefore necessary, and IPPC provides for the
outcome of these judgements (the permit) to be transparent to the public.
Procedures must be established for public consultation over an operators application
for an IPPC permit; and both the permit and the subsequent monitoring records must be
placed on a public register (Article 15).
The Directive requires the permits to be reviewed periodically, with
the review period being at the discretion of the Member State (Article 13). However, if
changes in BAT make it possible to reduce emissions without imposing excessive costs then
the permit must be reviewed in any event. Continuous improvement is therefore
required, with the timetable for emission reduction open to negotiation.
Pollution control is, fundamentally, as much a political task as it is
a technical task so the public legitimacy for any pollution reduction regime is
crucial (Davies and Davies, 1975). For IPPC this will rest on the stringency of the
standards in the permits, the adequacy of pollution monitoring, and the credibility of the
regulator in detecting and punishing violations. Legitimacy therefore depends on the
transparency of the regulatory process and the resources available to the regulator.
Finally, BAT regulation such as IPPC seems primarily suited to
encouraging Type I energy efficiency improvements, where costs and benefits can be clearly
identified. Type II improvements are much harder to encourage through this type of
4: Emissions trading schemes
Traditional responses to pollution problems have frequently been based
on fixed emission limits for individual sources. Economists have long criticised such
approaches for being unable to control pollution in the most cost effective manner. While
it may be cheaper for some sources to control pollution than others, this information may
not be known to the regulator. The sources have the required information, but have no
incentive to transfer it to the regulator. Economists offer two broad solutions to this
dilemma. Pollution may be subject to a tax to ensure that environmental damage costs are
reflected in the polluters decisions. Or emission allowances may be
created by the state, allocated or sold to polluters and made tradable. This second
instrument is known as emissions trading.
In its simplest form, the operation of an emissions trading scheme is
straightforward. Once the political process has determined that a particular level of
emissions is acceptable, a fixed number of emission allowances can be allocated to the
sources responsible. This allocation may decline in time in a phased manner. Each source
must ensure that its emissions are equal to or less than its current allowance holdings.
If allowances can be traded, those who face high pollution abatement costs can continue to
pollute by buying additional allowances. Those facing low costs can take abatement action
and sell their surplus allowances for a profit. In this way, each source can trade off the
cost of controlling pollution with the cost of buying or selling allowances. This
flexibility allows each source to minimise its overall abatement costs. In practice, the
implementation of trading schemes is far from straightforward and success depends heavily
on details of the design (Sorrell & Skea, 1999b).
Emissions trading developed in an incremental fashion in the United
States as a means of introducing flexibility into an extremely rigid regulatory framework
(Sorrell, 1994). While the early schemes met with mixed results, the second generation of
US schemes, including the nation-wide Acid Rain Program, have proved highly successful
(Ellerman et al, 1999). Attempts to introduce trading in Europe have so far been
unsuccessful and have highlighted the conflicts between trading and existing regulatory
traditions (Sorrell & Skea, 1999a).
The Kyoto Protocol greatly expands the scope for emissions trading. It
provides the framework for an international system of GHG trading between countries with
agreed emission targets (Article 17), together with the provision for emission
credits from projects that reduce GHG emissions in countries without targets
(Article 12). While states are responsible for compliance with the Protocol, it is widely
accepted that effective trading requires the direct involvement of individual companies.
This may either be through individual joint implementation projects or through
the development of national carbon trading schemes.
In contrast to source specific regimes such as IPPC, trading is a top
down regulatory approach. Priority is given to the aggregate target for the sum of
emissions from all the regulated sources. The final distribution of emissions between
sources is decided through trading in the allowance market. The regulator is concerned
solely to ensure that the emissions from each individual source do not exceed their
allowance holdings and hence that the overall target is attained.
Flexibility, or cost effectiveness, in a trading scheme is
achieved through use of the allowance market. A well functioning market gives scope for
cost effective trades with other sources while an extra dimension of flexibility may be
introduced through the use of allowance banking. Regulation is then a hands-off
process. While the regulator must monitor emissions, track allowance holdings and verify
compliance, there is no involvement in individual technology decisions. Similarly,
negotiations with the regulator form no part of scheme operation, although negotiations
may be of considerable importance during the initial design of the scheme. Disputes over
the equity of the initial allowance allocation can create a major obstacle to the
introduction of such a scheme (Sorrell, 1999).
Trading schemes are generally confined to a single pollutant in
a single media. The Kyoto Protocol is a rare exception to this as, in principle,
six different greenhouse gases can be traded using global warming potential (GWP) as the
exchange rate. A successful trading scheme requires the pollutants to be readily
quantifiable and easily measured, and their environmental effect to be largely independent
of the location of the source. Trading schemes do not prevent the displacement of
pollution from one media to another and are poorly suited to pollutants having multiple
environmental effects. This fact, coupled with other requirements, tends to confine
trading to a relatively small number of environmental problems (Klaassen, 1998; Sorrell
& Skea, 1999b). Carbon emissions from large point sources satisfy these conditions.
The system boundary of a trading scheme can be flexible. It can
be confined to multiple sources at a single site, to multiple sites owned by a single
company, to an industrial sector, to a region, or to a national economy. To be fully
effective, a domestic carbon trading regime needs to be compatible with the international
market in greenhouse gas emissions. A constraint is the need for certainty and
predictability in a trading scheme and the difficulty of expanding the scheme once
established (Sorrell, 1994, p 129-134; Atkeson, 1997).
Success with a trading scheme depends upon the environmental objective
being clearly defined, sufficiently stringent to pose a challenge, and unlikely to be
modified for a reasonable period of time. The Kyoto Protocol provides national targets for
a budget period of 2008-2012. Average annual emissions during this period must
be an agreed percentage below 1990 emissions - after adjusting for any international
trades. The budget period will be followed by a second when the targets will be reduced.
This firm timetable provides a framework for domestic trading schemes.
Trading schemes are transparent in that the overall target and
the standards achieved by individual participants are public knowledge. While the
allowance price in individual trades may be confidential, an overall market price should
emerge. This provides an indication of the cost of emission reduction and hence the
stringency of the target.
The legitimacy of a trading scheme hinges on the adequacy of
monitoring and enforcement and on the political acceptability of both the pollution target
and allowance allocations to individual participants. The inclusion of requirements that
trading be ..supplemental to domestic action (Article 17) within the Kyoto
Protocol reflects a basic legitimacy concern: countries should be seen to be doing
something at home before engaging in international trade. Similar concerns could lead to
restrictions being imposed on the freedom to trade within a domestic trading scheme.
With regard to energy efficiency measures for carbon emissions
reduction, an important advantage of instruments such as trading is that they factor
considerations about energy efficiency into all business decisions, without the regulator
needing to become involved. Trading schemes can therefore encourage both Type I and Type
II energy efficiency improvements. Furthermore, trading provides a continuous incentive
for technical innovation since efficiency improvements can allow for the profitable sale
of surplus allowances.
5: Analysing interaction between the two policy instruments
The previous sections have demonstrated that IPPC and emission trading
are fundamentally different policy instruments. The basic features of each are summarised
and compared in Table 1 below. Recognising IPPC and trading as different does not mean
they are incompatible. However, the scale of the differences suggests that careful
implementation is required if conflict between them is to be prevented.
Table 1. A comparison between emissions trading schemes and the IPPC
Offset policy first introduced in 1976
Technology based principles date from the last century.
Pollution arises from an absence of well defined property rights.
Cost effective control is achieved through issuing a limited number of allowances (rights)
to emit which can be freely traded.
Pollution abatement is considered a technological problem, and
regulation is designed explicitly to promote cleaner (or clean-up) technologies.
Basis for pollution control is an aggregate emission reduction
target for the whole scheme.
Basis for pollution control is the site-specific BAT for an
Overall pollution target, with no specification of individual
technologies or emissions standards.
No overall pollution target, beyond the requirement to minimise
pollution using BAT
Technology decisions are the responsibility of individual firms.
Regulator is involved in individual technological decisions.
Wide system boundary
The system under the aggregate emission target can be as wide as a
sector, an economy or a geographic region.
Narrow system boundary
BAT limits are set for an individual installation at a single site.
Usually controls a single polluting substance in a single media.
Climate change an exception as there are six greenhouse gases.
Controls releases of a wide range of substances to all three media
in an integrated manner.
Flexibility via the market
Installation operators can seek flexibility and reduced costs
through trading in the allowance market.
Installation operators can seek flexibility and reduced costs
through BAT negotiations with the site inspector. Scope for this depends on Member State
Transparency via the market
Aggregate target, participants performance and allowance
price are public knowledge.
Transparency via an institutional
Public can comment on operator applications. Public register of
permit conditions and monitoring returns.
Timetable given by budget period
Should be predictable and stable.
Timetable determined by
Regulator periodically reviews and updates permit conditions.
Legitimacy depends on target
Secured through stringency of overall target. Resources sufficient
to monitor trades and enforce transgressions are important. Problems with hot
air and rights to pollute.
Legitimacy depends on
Achieved by public regulator setting individual standards and
monitoring specific installations. Regulatory resources sufficient for this task are
Given these differences, the following sections explore the conditions
under which interaction between the two policy instruments is more or less favourable. The
analysis hinges upon the implementation of IPPC, since it is this which will influence the
scope for regulated processes to participate in any subsequent trading schemes.
5.1: Overlap between IPPC and trading
A primary question is, to what extent will IPPC (in its present form)
overlap with any likely carbon trading scheme? It is important to note that IPPC does not
regulate CO2 directly. Instead, energy efficiency forms one of the general
obligations on operators (Article 3), and represents one of the considerations to be taken
into account when determining BAT (Annex IV). CO2 is not listed in Annex
III as one of the substances for which emission limit values are particularly applicable
(Article 2(6)). However, the wording of the Directive is such that CO2 emission
limits may be justified. Article 2(6) suggests that emission limit values may be assigned
for substances not listed in Annex III, while Article 9(4) requires that in all
circumstances provision should be made for the minimisation of long distance or
transboundary pollution. Hence, whilst CO2 is not mentioned explicitly in the
Directive, the ambiguity of language permits a range of interpretation - including CO2
The first paragraph of Article 3 requires authorities to ensure
that installations are operated in such a way that.... energy is used efficiently.
But the second paragraph modifies this by stating ...it shall be sufficient if
Member States ensure that the competent authorities take account of the general principles
set out in this Article..... A strict interpretation could be that the Article
requires quantitative standards for the amount of energy used, while a loose
interpretation could be that authorities must simply ensure that energy efficiency is
pursued more broadly. One possible way of achieving this, which is relevant for our
purposes, is through participation in a carbon trading scheme.
Table 2 summarises the options available for a quantitative
interpretation of the energy efficiency requirements, and the implications of these for
different abatement measures. The limits are assumed to apply to the total installation,
although limits on individual process technologies are also a possibility.
Non-quantitative interpretations could include a requirement to use particular Type
1 energy efficient technologies.
Table 2 Possible limits on energy use and carbon emissions
Improve energy efficiency
Switch to low carbon fuel
Limit on energy use per unit of output
Limit on total energy use (MJ)
Limit on carbon emissions per unit of
Limit on total carbon emissions (tonnes)
Turning to trading, the scope of any national scheme is at present
unclear. However, the choice of which sources to include should be governed by a number of
principles, including: i) covering as high a percentage of total emissions as possible;
ii) keeping the total number of regulated sources to a manageable level; and iii) ensuring
adequate methods of measurement, monitoring and verification. A trading scheme linked to
the energy intensive IPPC installations scores well under these criteria. As Table 3
indicates, IPPC covers around 1200 installations that are typically considered as energy
intensive in the UK. Taken together, these installations account for over half of UK CO2
emissions (Department of Environment, Transport and the Regions, 1997, p.13). The total
number of IPPC installations in the UK is around 8000, which is considered
administratively feasible for a trading scheme (Festa, 1998) and compares to 2200
installations in the US Acid Rain Program. In addition: IPPC procedures provide a basis
for monitoring and verification; the industries are sufficiently large and sophisticated
to participate in trade; and some of them are strong supporters of such a scheme. While
other criteria for inclusion in a scheme are possible, it seems inevitable there will be
significant overlap between IPPC installations and potential trading participants.
Table 3: IPPC installations, energy use and carbon dioxide emissions in
Energy used by companies liable to
Energy covered by IPPC, % of sector
Estimated carbon dioxide emissions
from IPPC sites (ktC)
Number of installations covered by
Iron and steel
Food, drink, tabacco
Textiles, leather, clothing
Plastics and rubber
Source: ETSU (cited in HM Treasury, 1998, p.53)
Excludes power stations. England & Wales only
5.2 Interpretation of energy efficiency under IPPC and implications for trading
The ambiguity of the IPPC Directive allows for a wide range of
interpretations. Member States have different regulatory traditions with respect to
industrial pollution control, and it is likely that each will read the Directive to mean
something different. In Germany, for example, standards are applied fairly uniformly -
specifying an emissions ceiling for each process which no operator is allowed to exceed
(Scharer, 1998). By contrast, the UK tends to publish guidance which the regulator
considers to be the best possible - a target to which installation operators should aspire
but which they need not necessarily meet (HMIP, 1995, p.1). The final interpretation is an
issue, which will be influenced by decisions at four levels:
legal guidance from the Commission;
the content of the BREF notes;
legal interpretations by Member State governments; and
the implementation practice of the relevant regulators.
To overcome uncertainty and variety in the future implementation of
IPPC, we analyse the likely interaction with trading under three implementation scenarios.
All three scenarios have been suggested in our conversations with policy practitioners in
A strict interpretation, in which quantitative BAT limits for
energy use or carbon emissions are set individually for each site.
A minimalist interpretation, in which energy efficiency is not
interpreted as requiring quantitative limits and treated as a secondary consideration
A trading-based interpretation, in which the energy efficiency
requirements of IPPC are assumed to be met through participation in a trading scheme. Two
alternatives are of particular interest here:
a local BAT allocation scenario, in which site specific BAT
assessments are used to guide the initial allocation of carbon allowances; and
a generic BAT allocation scenario, in which generic BAT
assessments are used to guide the initial allocation of carbon allowances.
6. Scenario 1: a strict interpretation
The strict interpretation of IPPC is taken to mean a situation in which
Member State regulatory authorities require installation operators to achieve locally
determined quantitative BAT standards for carbon emissions or energy use. In other words,
a regulatory regime in which the costs and advantages for specific installations are
determined, and IPPC permit conditions are set which include quantitative limits on carbon
emissions or energy use for the installation in question. Specification of BAT limits for
energy use require assessment of the full range of energy using and energy conversion
technologies at the installation, while BAT limits for carbon require additional decisions
on the costs and advantages of switching to fuels with a lower carbon content.
It is important to note that setting quantitative BAT limits for carbon
or energy use pose some major practical challenges. These challenges are associated with
the nature of energy efficiency measures (Type I and Type II), the variety of
installations and their circumstances, and with the information gaps and asymmetries
between regulators and regulated. Assuming good information, and depending upon the
uniformity of installation technologies in a given sector, it might be possible to set generic
BAT standards for energy efficiency. These could appear in the BREF notes or in Member
State guidance on IPPC and are most likely to represent Type I efficiency measures.
Generic standards differ from the local limits considered here because they do not allow
for site specific considerations.
If the BAT standards take the form of a limit on carbon emissions, it
is difficult to see how the installation could participate in a trading scheme. To
illustrate this, suppose the installation has been allocated a number of carbon allowances
and that these sum to less than the current BAT carbon emission limit. Suppose further
that the installation is able to operate with this number of allowances. But operating
with emissions below the BAT limit immediately signals to the regulator that the BAT
determination was wrong in the first place, or has become outdated. If a plant can operate
with emissions below its BAT limit then it is clearly using a technology that is both
better and affordable. In that case, the BAT limit should be reduced to reflect this.
Similarly, suppose the number of carbon allowances sum to more than the current BAT limit.
The installation would be unable to make use of this flexibility as increasing emissions
above the BAT limit would constitute a violation of the IPPC permit. There is no
flexibility for operators struggling to meet carbon limits to buy up allowances from
This strict BAT scenario has a precedent in the UK governments
aborted attempt to introduce a sulphur trading scheme alongside the existing Integrated
Pollution Control regulations (see Box 1). The latter required sulphur emissions to be cut
using the BATNEEC principle, which is essentially the same as BAT under IPPC (Skea &
Smith, 1997). Strict interpretation of BATNEEC by the regulator prevented a trading scheme
from getting off the ground.
There is marginally more flexibility if the BAT standards take the form
of a limit on energy consumption; however, this is unlikely to be sufficient to
accommodate trading. In this situation, energy consumption could remain at the level of
the BAT limit but a switch to a lower carbon fuel could reduce the associated carbon
emissions. The installation could then profit from the sale of surplus carbon allowances.
The same could be achieved through an improvement in energy efficiency, but the incentive
to do this is undermined by the existence of the BAT energy limit. Lowering energy
consumption is likely to trigger a revision of the BAT limit and a consequent reduction in
the operators flexibility. Similarly, a switch to a more energy intensive process is
precluded, regardless of whether surplus allowances are available in the allowance market.
In summary, if the IPPC energy efficiency requirements are interpreted
to mean quantitative limits for energy use or carbon emissions, there is effectively no
room for installations to participate in a carbon trading scheme.
7. Scenario 2: a minimalist interpretation
In the second scenario, the IPPC energy efficiency requirements are
implemented in a minimalist way. The Directive is interpreted as not requiring specific
BAT energy efficiency measures. Instead, the energy efficiency requirements are simply
interpreted as ensuring that integrated pollution control measures have no perverse,
energy intensifying effects. Regard for energy efficiency then becomes a back-stop measure
which may tilt the balance in favour of a lower energy solution to a pollution problem
compared with the alternative abatement techniques on offer. Process modifications and
improvements will be made to reduce other polluting emissions, but checks will be made to
ensure they do not lead to an unjustified increase in energy use.
Such a scenario should leave room for installations to participate in a
carbon trading scheme since there would be little prescription in the IPPC permit
conditions relating to energy use, and none relating directly to carbon emissions. Thus,
carbon trading could operate alongside the IPPC regulation of other pollutants, yet
include IPPC installations. Relatively little interaction between IPPC and trading should
arise, owing to the clear separation of policy targets between the two policy instruments.
IPPC becomes primarily an instrument for non-CO2 pollution control, while
carbon trading (or some other instrument) is used to improve industrial energy efficiency.
Member States adopting a minimalist interpretation must be confident
that this is a robust interpretation of the Directive. If it seems to stretch
interpretation too far then it may prove difficult to sustain, particularly if other
Member States, the EU BREF notes, or the Commission decide upon a stricter approach.
Even a minimalist interpretation could create some phenomena of
interaction. First, some IPPC regulatory decisions will indirectly affect energy use,
thereby restricting an operators flexibility to balance energy costs against allowance
prices. This interaction seems both unavoidable and justifiable, and may stimulate the
market in some instances by freeing up allowances for sale. Second, the mismatch between
the IPPC and Kyoto timetables may create problems. Article 13 of the IPPC Directive
requires that permit standards be reviewed periodically, which in the case of the UK is
every four years. For practical reasons, different sectors will undergo reviews at
different times and these will not be coincident with the reviews of the national targets
under the Kyoto Protocol. Regulatory decisions during IPPC reviews may have implications
for the subsequent requirement for carbon allowances and it is possible that this may
inhibit sources from engaging in trade. Again, if IPPC decisions only affect energy use in
a minor and indirect fashion this should not be a crucial issue.
One important point here is that a minimalist interpretation
effectively prevents IPPC from becoming a viable instrument for reducing industrial energy
use. Some parties may legitimately argue that the widening of the concept of integration
that is implied by the energy efficiency requirements is largely invalidated by this form
8. Scenario 3: a trading based interpretation
The third scenario falls somewhere between the alternatives above.
Under this interpretation, IPPC energy efficiency obligations are assumed to be met
through participation in a carbon trading scheme. No additional obligations are imposed
that restrict the flexibility to trade.
The simplest solution would be for all IPPC installations to
participate in the trading scheme. If only a portion of installations participate, a
decision would still be required on how to interpret the energy efficiency obligations for
Interpreting the energy efficiency obligations in this way raises two
what is the overall target under the carbon trading scheme (i.e. how
many carbon allowances should be distributed); and
what is the criteria for allowance allocation (i.e. how many allowances
should each installation receive)
The first question relates to the overall strategy for meeting a
countries Kyoto obligations and hence is largely beyond the scope of this paper.
However, any climate strategy should give some confidence that the Kyoto targets will be
met and should ensure that each sector makes a contribution. In the spirit of trading, the
aggregate target in any trading scheme should be related primarily to the Kyoto target.
This means that, in principle, the allowance allocations to each installation could be
more or less stringent than implied by site specific BAT determinations.
The second question is where the interaction between IPPC and trading
could potentially be beneficial. This is because the IPPC BAT determinations could provide
benchmarks that may help resolve the issue of initial allowance allocation.
Allocation decisions are typically presented as a choice between
distributing allowances free on the basis of historic emissions (grandfathering), or
selling allowances in an auction. While auctions are economically efficient, the revenue
transfers involved tend to make them politically difficult. Grandfathering avoids this
problem, but tends to penalise those installations that have reduced emissions already
while rewarding those that have not. To avoid this, existing trading schemes have used
some form of benchmarking, where allowance allocation is not directly related to
historic emissions. For example, the US Acid Rain Program distributed allowances according
to a formula based on historic fuel consumption multiplied by an emission factor. Such
formulae are typically combined with extensive negotiations over concessions and bonus
allowances (Sorrell, 1994, pp 83-85). The attraction of using BAT assessments in a
benchmarking formula is that they include explicit consideration of costs and advantages
and thereby address equity concerns. They also provide a direct link to the IPPC
framework. Indeed, such an approach has been suggested in recent consultation documents
from the UK Treasury (HM Treasury, 1998, p10) and the Department of the Environment,
Transport and the Regions (1998).
There are two broad possibilities for BAT benchmarking:.
8.1 Scenario 3a: Local BAT benchmarking
Here, initial site specific BAT assessments for carbon emissions are
made at each installation. The BAT assessments are then used to apportion a share of the
total number of allowances between each installation. The aggregate carbon limit itself
(total number of allowances) is defined separately, in relation to the Kyoto targets. The
site-specific BAT assessment provides a benchmark, but the installation is not
required to comply with this benchmark subsequently. Instead, the benchmark is used as one
element of an allocation formula for carbon allowances. IPPC thus becomes the vehicle for
allowance allocation in the trading scheme.
This scenario represents a more radical departure from the intent of
IPPC than the previous scenarios. It may therefore prove harder to provide adequate legal
justification. It also suffers from a fundamental drawback. The use of locally determined
BAT limits for allocation negates the important hands off benefit of trading
schemes - avoiding the regulator getting into the details of assessing BAT. The proposal
therefore compounds the cost of making local BAT determinations with the cost of
administering a trading scheme.
8.2 Scenario 3b: Generic BAT benchmarking
The second option is similar to that above, but avoids some of the
associated problems. Here generic BAT standards rather than local limits become the basis
for allocation. Industrial sectors in which installation technologies are fairly
homogenous, such as cement and steel, may be amenable to the development of generic BAT
standards. Carbon allowances could then be allocated using a formula of the form (Skea et
al, 1998) :
plant capacity (tonnes) *
generic BAT standard for energy intensity (GJ/tonne)*
carbon intensity (tonnes CO2/GJ) *
sectoral adjustment factor (linked to Kyoto targets)
Hence, whilst local BAT limits could prove too burdensome for
allocation purposes, generic BAT standards, which might appear in BREFs or national
documents, could be a suitable allocation vehicle in certain sectors. Of course, not all
sectors have installation technologies sufficiently homogenous to facilitate generic
standards. In such sectors recourse to grandfathering and other allocation formulae may
have to be made. No doubt the final allocation process will involve a pragmatic mix of
benchmarking, grandfathering, negotiation and auctions. The process will inevitably be
protracted and contentious as different operators lobby for their sector to be allocated
carbon allowances according to their preferred methodology.
The attraction of this scenario is its use of information generated by
the IPPC process to facilitate a trading scheme, while avoiding the additional burden of
site level BAT assessments. The allocation formula includes consideration of costs and
advantages at the generic process level, but not at the site level. Individual companies
may dispute the allocation formula, but in principle will have unrestricted freedom to
With both options: a) the energy efficiency obligations of IPPC are
assumed to be ensured through participation in a trading scheme; and b) the stringency of
the overall target under this scheme is linked to the Kyoto targets. Whether this provides
adequate assurance that the IPPC energy efficiency obligations have been met is a matter
for legal judgement.
9. Factors influencing the choice of implementation scenario
The regulatory cultures and traditions in each Member State will have
an important influence on how each interprets and implements the IPPC Directive. But the
European Commission will also play an influential role. First, the interpretation of the
energy efficiency requirements in the BREF notes may restrict the scope for Member State
flexibility. A minimalist interpretation may be particularly difficult to sustain if the
BREF notes suggest BAT standards for energy efficiency. Early draft BREFs do not set BAT
standards for energy efficiency, so such a constraint appears unlikely. Second, the scope
for trading could be enhanced if the Commission were to clarify the legal conditions under
which it may operate. Useful precedents here include the recent Communication on the use
of environmental agreements (COM (96) 561 final), and the Communication on environmental
taxes, charges and levies in the Single Market (COM (97) 9).
Third, the relative roles assigned to IPPC and flexible mechanisms in
the EU Post-Kyoto strategy will be highly influential. The current Communication advocates
a step-by-step approach to flexible mechanisms, sees a role for an EC wide approach to
emissions trading, and makes no mention of IPPC (COM (98) 353). However, the conclusions
of a June 1998 Environment Council meeting on a Community Strategy on Climate Change noted
that significant emission reductions could be achieved through the ...more
widespread adoption of current energy efficiency best practice, in particular taking into
account the application of Best Available Techniques as provided for under the IPPC
Directive (Council of the European Union, 1998).
At the Member State level, a factor of primary importance is the
national regulatory culture and in particular the balance between uniform or more flexible
approaches. The level and quality of resources available to regulators is also crucial
(Smith, 1997). Staff, information, time, political support, and other resources have to be
sufficiently available for regulators to undertake their activities. If any one of these
is limited then the scope and boundaries of interpretation may also be limited. So, for
example, it may not be possible to take a strict, BAT interpretation of the IPPC energy
efficiency requirement because the regulator is ill-equipped, and resources dictate a more
minimalist interpretation. This resource issue is important for the success of IPPC alone,
quite apart from trading.
The nature of the interaction between IPPC and carbon trading will
hinge on the interpretation of the IPPC energy efficiency requirements. This paper
identifies some tensions between the two policy instruments, but practitioners are only
beginning to appreciate that these tensions exist.
By considering three possible scenarios for the implementation of IPPC,
it has been possible to identify how these tensions vary in quality and magnitude. The
following conclusions may be drawn:
IPPC and carbon trading are fundamentally different regulatory
approaches. Both aim, either directly or indirectly, to improve industrial energy
efficiency. Some interaction between them is inevitable, and the IPPC energy efficiency
requirements must be interpreted carefully if the interaction is to be positive.
IPPC is primarily suited to the promotion of discrete, Type I energy
efficiency measures. The advantage of trading mechanisms is that they can promote both
Type I and Type II efficiency gains.
The energy efficiency requirements within the IPPC Directive
potentially constrains the full participation of regulated installations in a trading
scheme. Participation will be impossible if the BAT requirements are interpreted in a
strict, quantitative manner. Fuller participation may be viable if either:
the IPPC energy efficiency requirements are interpreted in a minimalist
way (scenario 2); or
the energy efficiency requirements are assumed to be met through
participation in a trading scheme (scenario 3).
The generic BAT standards developed under IPPC may facilitate allowance
allocation. In contrast, the use of local BAT standards for allocation would entail
unnecessary administrative effort.
While generic BAT standards could be used to assist allowance
allocation, the total number of allowances should be linked to the Kyoto targets. This
means that, in scenario 3 above, the required energy efficiency of IPPC installations will
be linked to the Kyoto targets rather than BAT determinations. This may pose a challenge
to the legal interpretation of IPPC.
A minimalist interpretation of the energy efficiency requirements may
still interact with a trading scheme owing to the indirect energy consequences of other
pollution control measures.
The IPPC/trading case highlights a broader conflict between integrated
approaches to environmental problems and market based policy instruments. Both are
advocated as solutions to problems associated with earlier regulatory instruments and both
are increasingly represented in European environmental policy. But neither are appropriate
in all situations. Principles such as BAT are suited to complex regulatory situations
where a large number of chemical compounds are emitted from many different release points.
These represent the most common situations encountered under IPPC and would be impossible
to handle with emissions taxes or tradable permits. But for point source emissions of a
single pollutant into a single medium, market based instruments can have significant
advantages. Carbon dioxide emissions is one area where emissions trading seems
particularly appropriate and where the framework created by the Kyoto Protocol offers
significant opportunities. This opportunity may be undermined if the potential interaction
with IPPC is not addressed at an early stage.
Integration is required in policy design to in the sense that the
pursuit of one objective does not undermine another. To do this we need a collection of
policy instruments that target effectively the desired policy objectives. This
IPPC/trading case study illustrates how important it is to view the collection of policy
instruments together. In assessing the scope for interaction it is necessary to identify
the nature of the target objective (energy efficiency in this case); the features and
dynamics of the relevant policy instruments; and the conditions for positive and negative
interaction. It seems certain that as policy attempts to deliver sustainability grow, so
the issue of interaction will grow too.
The authors are grateful to a number of SPRU colleagues for helpful
comments, including Frans Berkhout, Malcolm Eames, Kath Kidd, Jim Skea and Jim Watson.
Thanks also to Chris Hewitt, Martin OConnor and an anonymous referee.
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The UK experience with sulphur trading
Under the EU Large Combustion Plant Directive (LCPD), the UK was
obliged to reduce the total volume of sulphur emissions from large combustion plants in
industry, oil refining and electricity generation. Implementation took the form of annual
emissions quotas assigned to individual sectors within each country (England, Scotland,
Wales, Northern Ireland), followed by the distribution of quotas to combustion plant
within each sector. At the same time, combustion plants were required to meet BATNEEC
standards under the UK system of Integrated Pollution Control (IPC). BATNEEC was typically
interpreted as an annual emissions limit (the BATNEEC limit) and the plants were required
to submit an upgrading program to demonstrate how emissions could be reduced in the
The original quota allocation lead to some plants being constrained
while the UK overall was well within its target. To prevent this, the government proposed
a system of emissions trading in which plants could trade quotas in order to reduce the
cost of abatement. For trading to work under this system, the BATNEEC limits would have to
act as an overall emissions ceiling which was set some way above the quota allocation to
allow room for trade. But if the ceiling exceeded current emissions, it did not represent
the best that was achievable. Giving priority to tradable quotas rather than
BATNEEC was difficult to justify under IPC legislation and represented a reversal of
traditional regulatory practice. With the regulator claiming that a strict interpretation
of BATNEEC was necessary, the government was forced to conclude that any trading scheme
would be redundant as there would be no room left for trade.
Electricity generators were given a limited form of flexibility,
analogous to trading, through the use of company emission bubbles. But this flexibility
was radically reduced by the stringent emissions reductions required by the IPC upgrading
program. These went substantially further than was required for the UK to meet its
international obligations and followed the IPC timetable rather than that required for the
LCPD. Again, the site specific interpretation of BATNEEC took priority over aggregate
targets and the proposed trading regime.
The UK experience demonstrates clearly that emissions trading cannot
coexist with a strict interpretation of regulatory principles such as BAT.