The Kyoto Protocol has several inconsistencies and outright design flaws that seriously hinder its effectiveness. There is clear evidence that the Protocol doesn’t work as initially envisioned: since its entry into force, in the countries that have ratified it greenhouse gas emissions to a large extent have increased. In those few cases where emissions did actually decrease, this was due to reasons independent of the Protocol. Clearly stated, the Kyoto Protocol is the wrong tool for the task. The number of its detail regulations is overwhelming, but they miss the wider picture of real life. Greenhouse gases, and in particular carbon dioxide, are at the center of all economic, technical and biological processes in very complex forms, yet the Protocol looks at emissions reductions in an overly simplified fashion, focussing on each gas on its own and disregarding the overall situation. To a large extent, this follows from the fact that the Kyoto Protocol was designed by analogy with earlier solutions and on the basis of unproven, theoretical economic models. Here will be discussed the major contradictions between the Kyoto Protocol and everyday realities. The global warming problem is serious and so must be the analysis of the current solutions. Only by identifying the shortcomings of the Protocol it will be possible to design a new and workable tool.


MONITORING AND CONTROL: MISSION IMPOSSIBLE
Under the UNFCCC Convention (United Nations Framework Convention on Climate Change) and the Kyoto Protocol the different countries, the “Parties”, must periodically assess and report their emissions and take measures to reduce them according to quantified objectives. This is a task that cannot be accomplished because:

► emissions are observable only to a limited extent;
► emissions originating in one country do not necessarily depend on something that can be acted upon in that country;
► emissions cannot be reduced directly.

Greenhouse gas (GHG) emissions can be estimated only to a partial extent and with notable errors. About half of the total emissions in a country are generated at known locations, such as power plants and industrial installations, while a very large share comes from diffuse or distributed sources, as for example motorised traffic and agriculture. Even at well-defined source points the measurement of volumes and rates of greenhouse gases, in first place carbon dioxide, is expensive and gives only approximate results. For this reason, greenhouse gas emissions are estimated indirectly on the basis of so-called activity data such as fuel consumption, the number of registered cars, the size of agricultural land plots and the type of harvest, and thousands others. Activity data require consistent and complete statistical data, which only few countries collect with the required precision; beyond a point, no government institution really knows what goes on on its territory. Activity data is then linked with the actual GHG emissions by means of conversion factors. Their uncertainty is small for processes with known chemical relations such as fuel combustion or cement production, but it becomes very large for most types of emissions, in particular those from the agricultural and forestry sector.

The combined effect of uncertainties on a national scale leads to estimation errors in the order of 5 to 20%. The error is larger for countries with a large agricultural sector and a limited use of fossil fuels. A further aspect makes emissions very difficult to observe and to relate to their cause. In the open, global market economy a very large number of commodities and products is traded internationally. The bulk of commodities and products are today sourced in countries that under the Kyoto Protocol do not underlie any obligation to report or limit their greenhouse gas emissions, this is for example the case for all Asian countries with the exception of Japan. The result is that these emissions do not appear in any inventory at all, neither in the countries where they originate nor in the countries where the commodities and products are used. The implicit assumption of the UNFCCC Convention and of the Kyoto Protocol, that emissions can be exactly assessed by the countries where they take place, doesn’t hold in today’s world. On the contrary, the data officially reported by the different countries is entirely out of synch with global trading realities.

Last but not least, extensive international trade is in itself a notable emission source because of the demand for transport. A third part of the problem is that states cannot act directly to cap even those emissions that originate on their territories. On the one hand, national states are still the only recognised entities that can define and administer justice on their territory and that in extreme cases can make legitimate use of force to support their decisions and goals. On the other hand, with open market economies the states have only limited intervention capabilities, in particular after the liberalisations of the 1980’s and 1990’s. The levers that governments can pull today aren’t any longer development plans, industrial policies up to the setting of the base rates, but only loosely defined instruments such as research funding, the definition of standards and the verification that industrial and financial companies – the real actors of the economy – formally comply with competition law. States cannot explicitly forbid their citizens to drive large cars or overheat their homes because of GHG emissions limits or any other reason, except in emergency situations and only for a limited time. Despite such fundamental changes, the UNFCCC Convention and the Kyoto Protocol have been defined around the post-WWII state model, which ceased to exist long ago.


DESIGN BY ANALOGY
The Kyoto Protocol has been drafted in analogy with three other solutions, whose objectives might at first appear similar to the goals of the Protocol, but are in fact deeply different: the depletion of stratospheric ozone, the control of nuclear weapons and the reduction of acid rain from sulphur oxides emissions. All these problems are difficult, but compared to climate change they are relatively simple. Ozone depletion is caused by a small number of artificial gases, in first place the chlorofluorocarbons (CFCs) used in refrigeration and other technical applications. CFCs are produced by only few companies and at a small number of known locations, which simplifies regulatory intervention. In addition, thanks to the evidence provided by the “ozone hole” pictures over Antarctica, international public opinion was broadly in support of the limitation of ozone-depleting gases. The most important aspect in support of a ban of these gases, however, was that substitutes for CFCs were quickly found in hydrofluorocarbons (HFCs), which have similar physical and chemical properties but do not impact the ozone layer. Because of all these concurrent factors, the Montreal Protocol could be drafted in a short time and approved with a broad consensus in 1988. The Kyoto Protocol has overtaken many of its provisions, while a paradoxical, unforeseen consequence is that HFCs count now among the most powerful greenhouse gases, those that the Kyoto Protocol is bound to limit.

The reduction of nuclear arms stockpiles was achieved when the few governments holding them recognised a common interest in lowering defense budgets, which by the 1970’s had reached untenable levels. Despite being ideological and geopolitical enemies, the USA and USSR could agree on limits and cuts to their weapons and define the necessary verification procedures, of course conceived only for two or few actors. The Kyoto Protocol has a similar approach, but, with up to two hundred countries involved. the procedures have become extremely formalistic and bureaucratic. Of course, their real contribution towards reaching any emissions reductions is nil.


THE TECHNICAL FEASIBILITY OF EMISSIONS TRADING
Emissions trading is the most elegant tool of the whole Kyoto Protocol, at least from an academic point of view. Formally, emissions trading is defined in the Kyoto Protocol to be used at national level, though it is understood that states can introduce similar systems at company level. The foremost example is EU Directive 2003/87/EC instituting emissions trading in the Community, which is clearly based on the Kyoto Protocol.

To a large extent, the emissions trading model in the Kyoto Protocol and in Directive 2003/87 was defined in analogy with the US Clean Air Act of the 1990’s to reduce sulphur dioxide (SO2) emissions from coal combustion. In the American solution the cap-and-trade mechanism enabled each coal power plant operator to choose his strategy for SO2 emissions abatement, without the need for explicit top-down command and control solutions. Two technical solutions were possible: the use of low-sulphur coal, which is more expensive than regular coal because of this property, or the retrofit of power plants with expensive desulphurisation equipment, the “scrubbers”. A plant operator could even choose not to do anything, provided he purchased allowances from other plants, thereby contributing to finance emission reductions at other locations. According to economic theory, emissions trading provides the “optimal” solution, keeping the total costs for compliance at the lowest level compared to other approaches. A further aspect that made possible emissions trading is that SO2 quantities in the flue gases can be assessed automatically and with the required precision.

At the international meetings leading to the definition of the Kyoto Protocol the USA pressed hard to introduce emissions trading instead of a carbon tax, with a solution similar to their Clean Air Act. The analogy between SO2 and CO2 emissions, however, is entirely misplaced because of the very different chemical properties of these two gases and the lack of comparable alternative solutions. The low-emissions fuel alternative to coal is natural gas, which is increasingly difficult to obtain because of geological and geopolitical reasons; its price is also steadily increasing. The second analogy is even more misplaced. Differently to the scrubbers for SO2, there isn’t today any technical solution for the sequestration and storage of CO2 emissions. SO2 combines chemically with lime and limestone to form calcium sulphate and calcium sulphite, which can be disposed of or processed to gypsum, but there aren’t any readily available chemicals that can absorb CO2 in a practical and economic way and at the required scale. Solutions for carbon sequestration are much more complex than SO2 scrubbing and come at very high efficiency cost, at the very least in the order of 10-20% of the energy output of a plant. No full-size carbon sequestration installation has yet been built and even the most optimistic forecasts put commercial maturity of this technology beyond year 2030. A test plant is currently under construction in Germany (Schwarze Pumpe), while in the USA plans for the construction of the much-hyped Future- Gen plant were cancelled at beginning of 2008. This plant should have produced electricity and hydrogen from coal and stored CO2 emissions underground, but its costs proved to be excessive. On the bottom line, emissions trading for CO2 is supposed to find a balance between an unworkable solution, the increased use of natural gas, and one that does not yet exist, i.e., carbon sequestration.

This approach can hardly lead to any positive results. Market supporters claim that trading will contribute to find new technical solutions anyway, but it requires a real stretch of faith to believe it. An issue related to emissions trading is the number of the plants participating in the system and the criteria for their inclusion. The European ETS system counts ca. 10,500 plants, though only few of them produce the bulk of CO2 emissions: the largest 7% of installations represent 60% of total emissions, while the 1400 smallest installations account for only 0.14% of emissions (Graphic 1). According to economic models, the more plants are involved, the more efficient become trading operations and the total costs for compliance are lowered. This position is appealing, but it goes against two realities. For the first, there aren’t any small or cheap measures to reduce emissions only to a partial extent; on the contrary, interventions can only deal with the refurbishment of entire plants, which requires major investments. The second aspect is that the assessment and verification of emissions, even for small plants, costs some tens of thousand EUR/year. For thousands of EU installations the compliance costs alone, i.e. without any measures for actually reducing emissions, are higher than the costs for purchasing the allowances they need or the penalties for non-compliance.


OFFSETS AND SINKS
Because of the technical difficulties of carbon sequestration, two different types of offsets and sinks for CO2 and other greenhouse gases have been proposed and strongly supported by the USA at the different international meetings. The base assumption is that it doesn’t matter where the emissions reductions are actually achieved – gases mix up in the atmosphere anyway – and it is therefore preferable that emissions are reduced first in countries with lower costs than in the developed world. This assumption is not supported by evidence and it is not clear why the costs for technical solutions and for fuels should be lower in developing countries than in industrialised countries. This assumption, however, provides the foundation for the so-called “flexible mechanisms”, i.e., projects carried out in third countries to reduce emissions or to capture atmospheric CO2.

The first sink type builds on the idea that vegetation during the growth phase, in particular tropical trees, can remove carbon dioxide from the atmosphere and that such removals can be quantified. In practice, the absorption of atmospheric carbon by trees is a very long process (trees take some decades to grow), and a risky one: several types of disturbances can lead to the release of the carbon stored in the plants and it must therefore be guaranteed that the trees remain in place for a long time, a guarantee that nobody can give. The estimation of the quantities of bound carbon in plants is also very difficult and unprecise, with errors in the range of 50-100%.

To put it bluntly, the sequestration of fossil carbon by biological sinks is a hoax. The equivalence is carried out only on the basis of the mass of stored carbon, without considering other essential aspects such as the energy content of the chemical carbon bounds. Compensating the coal used to fuel a power plant orthe kerosine to power an aircraft with some ha of tropical forest is not correct, because the stored energy quantities are very different. A real compensation would be achieved only by growing such a quantity of raw biomass that alternative fuels with the same heat content as the original fuel could be obtained from it. This would be equivalent to make use of biomass-derived fuels in power plants or aircraft, which today is still an unpractical, or extremely expensive proposition. The recently opened debate about the real costs of agrofuels reflects this aspect.

The other type of “sink” are international projects under the flexible mechanisms JI (Joint Implementation) and CDM (Clean Development Mechanism). Without entering the overly bureaucratic and detailed nature of these tools, their emission reductions can only be evaluated versus a theoretical alternative, the so-called “baseline”, i.e. what happens if a project isn’t implemented. This is an highly arbitrary approach and one much too prone to abuse. The easiest way to generate emission “reductions” is by defining unrealistically high baselines for alternative scenarios rather than with the implementation of effective reduction measures. After much criticism, the UNFCCC has changed part of its rulework and now demands much more conservative assumptions, which, however, puts in doubt the economicity of several projects .


THE MISSING LINK
One of the main design flaws of emissions trading is to focus only on the visible source of emissions, i.e. the power stations or industrial plants, while disregarding the whole value chain. A power plant doesn’t generate electricity for itself, but to feed electrical loads and industries work to meet the demand for their products. Plant owners can intervene to reduce only the emissions due to internal inefficiencies at the installation, but in most cases the possible improvements are very expensive and their outcome is limited. The real lever to act on to reduce emissions is the quality and quantity at the product demand side, from electricity and heat to commodities and transport. Any reduction in demand would lead to a reduction in production and, ultimately,also in emissions. This approach, however, clashes with the expectations of a market economy. The owners and operators of industrial plants or power generators have no economic interest to reduce demand, because this would go against their profit targets. In general, the market system works today only on offer-side increases, not on demand-side reductions. The support of demand-side efficiency and demand reductions is not yet covered by the Kyoto Protocol, but it should become one of its basic foundations if the Protocol were to bring any results at all.

It is not without reason that the emissions trade has been compared to the Catholic Church’s indulgence trade in the 15th century, in particular after indulgence certificates had been turned into commodities and were exchanged on a commercial basis. Allowances help little, if anything, to reduce or limit emissions, yet they let individual and national consciences believe that they are doing the right thing, that the “wrong” emissions can be compensated with certified good deeds in form of Kyoto units.


POLICY PARADIGMS
The European policy for emissions reduction has followed two entirely different approaches before and after the signature of the Kyoto Protocol. Throughout most of the 1990’s the EU favored coordinated policies and measures, with some form of carbon tax as primary policy instrument. Any efforts to introduce a Communitywide carbon tax, however, failed because fiscal policy is competence of the Member States and the Council couldn’t reach unanimity on this issue. Emissions trading represented a way out of the impasse. At the UNFCCC Conference of the Parties of July 2001 the European Union declared its full support of market instruments, in this way also hoping to secure ratification of the Kyoto Protocol by the USA. Shortly after, the USA withdrew from the Kyoto Protocol altogether, while the EU put market instruments at the core of its whole climate policy, disregarding other options.

EU policy is too complex and not always so rational that it could be described in few words. To make a long story short,the EU emissions reductions policy has not been coordinated with other major sectoral policies, in first place the different electricity and gas reform packages. Be it sufficient to mention that a key energy-efficiency measure such as heat and power cogeneration is difficult to plan and implement under open market conditions,while it would prove economically feasible with a carbon tax. The main argument in support of a tax is its simplicity and that it provides more certainty in carbon pricing, making long-term planning easier. Cap-and-trade proponents argue instead that a tax cannot guarantee a predefined volume of reductions. In fact, neither can trading, as long as the envisioned emissions reduction measures aren’t feasible in practice.

The current picture in the USA is much more structured and forward-looking than the one offered by Brussels. While the federal state is now waiting to put climate policy in the hands of the next President, some local administrations, with California and New York at the forefront, are already taking an active stand on climate and energy issues, in an integrated way and with policies built on a pragmatic approach rather than aprioristic market definitions. In California, electricity customers can “sell” demand reductions to the utilities; the market is designed to handle short-term capacity bids as well as long-term energy efficiency measures. New York is planting one million new trees, not to absorb CO2 from the atmosphere but to provide shading and heat mitigation and thus reduce the overall energy consumption of the city and make it more livable. Contrary to Europe, in the USA there is also a much more lively discussion on the urban form of the future, whether to keep the suburbs to their present extent or to build more compact and thus more efficient cities. The European city form is considered by American architects as a positive model to follow.

The paradoxical outcome of the change of policy on both sides of the Atlantic became clear during the G8 meeting in 2007 in Heiligendamm (Germany). The arguments presented by Germany and the European Union in favour of emissions trading and by the United States about planning and energy efficiency were essentially the same as those of ten years earlier, but the parties in their support had changed. The EU overtook the former US proposals, while the USA had embraced the earlier European positions.


A NEW APPROACH?
Several proposals are currently being studied to improve the operation of the emissions market. There is broad agreement that the compliance periods should be longer than five years to provide for adequate long-term investment planning, that the rules for the estimation and reporting of emissions should be simplified and that small plants should be excluded from the trading scheme when the costs for participation outweigh the possible benefits.

Last January the EU Commission has published a proposal for a new Directive amending the Directive 2003/87/EC. Its main points are the exclusion of a large number of small plants, the inclusion of other industrial plants and gases, the inclusion of carbon capture and storage, a compliance period of eight years (2013-2020), a predefined linear reduction goal of -20% on total emissions until 2020, the auctioning of allowances, the use of one Community-wide registry instead of several, all slightly incompatible national ones, and a wider use of the flexible mechanisms. Undoubtely, the new proposal has benefited from practical experience and the Commission is now beginning to show its teeth. On the negative side there is the still full reliance on emissions trading and the fact that the proposal doesn’t really face directly most of the problems described here, in first place the role of international trade and the focus on load-side and efficiency interventions. The new proposal is also uncoordinated with the energy reform packages and with strategic issues: it is still unclear where the necessary bulk quantities of natural gas shall be obtained from. Unless the new Directive will present a qualitative improvement, the risk is that it will, as its predecessor, only remain a list of good intentions, impossible to turn into reality. It will fail to deliver on its envisioned goal: real, quantifiable reductions of greenhouse gas emissions.