The European Union Emission trading Scheme

The European Union Emission Trading Scheme

The members of the European Union (EU) agreed to jointly fulfil their commitments to reduce greenhouse gas emissions caused by human activity under the Kyoto Protocol. On 13 October 2003, the European Parliament and Council published a directive establishing a scheme for greenhouse gas emission trading between the member states and the EU Emission Trading Scheme (EU ETS) was launched on 1 January 2005. It is the largest cap-and-trade scheme in the world. The second stage (or trading period) of this scheme commenced on 1 January 2008. The second trading period under the ETS coincides with the five-year period—known as the 'first commitment period'—in which the EU and member states must meet their targets for limiting or reducing emissions of greenhouse gases under the Kyoto Protocol on climate change. A third stage will commence from 2012.

The overall aim of the EU ETS is to reduce greenhouse gas emissions in an economically efficient manner. Currently, the scheme has the following features:

  • Each participating country produced a national emissions permits allocation plan.
  • The total EU emissions cap is an amalgamation of the separate national plans as approved by the European Commission.
  • Once a national emissions plan had been decided upon, individual facilities within each county were allocated a number of emission permits. Each permit represented a tonne of carbon dioxide (CO2) (these permits were also known as European Emission Allowances or EUAs).
  • During the second and subsequent trading periods, unused emissions permits may be 'banked' by their holders and used during following trading periods. This is a significant change from the first trading period.
  • At least 90 per cent of the emission allowances were distributed free of charge during the second trading period. The remaining 10 per cent of permits may be auctioned. The overall proportion of permits auctioned will increase in the third and subsequent trading periods, reaching 100 per cent in 2027.
  • As emissions occur the emitter is required to surrender the relevant number of emission permits to cover those emissions. This occurs each December.
  • A country can partly meet its emissions targets by the limited use of emissions offsets (but not from forestry).
  • There is limited acceptance of emissions credits generated by the Kyoto Protocol Clean Development and Joint Implementation Mechanisms.
  • A fine of €100 per tonne of CO2 made over the prescribed limits is payable to the Commission.
  • Reporting, enforcement and compliance are undertaken by participating states during the second trading period. A central administrator verifies the operation of the EU ETS.
  • Initially, the scheme covered only about 45 per cent of the projected CO2 emissions, but not other greenhouse gases such as methane. However, the directive establishing the scheme clearly includes the six main Kyoto Protocol greenhouse gases and contemplates the addition of other gases as the scheme develops. For example, CO2 emissions from petrochemicals, ammonia and aluminium will be covered during the third and later trading periods, as will nitrous oxide (N2O) emissions from the production of nitric, adipic and glyocalic acid production and perfluorocarbons from the aluminium sector.
  • The scheme covers a wide range of power generation and metals/minerals processing facilities (but not aluminium, yet). However, the first trading period did not cover the transport, construction, waste processing and farm sectors and some industrial plants.
  • The aviation sector will be included in the scheme from 2012 with ongoing consideration of including the general transport sector.
  • Norway, Iceland and Liechtenstein have joined the scheme and negotiations are underway for Switzerland to join.
  • Over the long term other countries' emissions trading schemes may be linked to the EU ETS.

The first trading period of the EU Emission Trading Scheme had as its overall objective the creation of the critical mass for a liquid and well-functioning carbon market. The first trading period was always intended to be a 'learning by doing' phase for all the parties involved. The first trading period led to the following:

  • A European CO2 market was firmly established.
  • There was an over-supply of permits compared to actual emissions.
  • A volatile emissions permit price in 2005–06 and a ridiculously low permit price in 2007.
  • A small reduction in emissions during 2005 and 2006, but a small rise in emissions during 2007. There have been significant emissions reductions since 2008.
  • Emissions reductions from unexpected sources, such as using hard black coal in previously brown coal fired power stations.
  • Emissions trading became a firm part of European industry and business planning.
  • There was minimal impact on industrial competitiveness during the first trading period. However, this was over a time of buoyant economic conditions and with a limited application of emissions trading.
  • Some sectors made windfall profits during the first trading period.

There are a number of lessons for the design of an Australian ETS from the experience of the EU ETS during its first trading period, such as:

  • The EU ETS further entrenched cap-and-trade schemes as the preferred way to control emissions.
  • The scarcity of emissions permits in such schemes must be maintained.
  • There is no substitute for accurate verifiable emissions data for the efficient operation of such schemes.
  • Emission permits must be allocated on a consistent basis, preferably by a central administrator or by a market-based mechanism such as auctioning (this will occur during the EU ETS third trading period, starting 2013).
  • Unused emission permits must be able to be 'banked' for later use (this is currently the case in the EU ETS).
  • The best may be the enemy of the good. The EU ETS was still able to achieve a reduction in emissions, even with a comparatively low emissions price and many economic sectors not covered by the scheme. This suggests that a trading scheme need not be perfectly designed to produce worthwhile outcomes and to gather relevant operational experience.

Further reading:

European Commission, EU Action against climate change: The EU Emissions Trading Scheme, 2009.



19 November, 2010

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