European Union Emission Trading Scheme

European Union Emission Trading Scheme

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The European Union Emissions Trading Scheme (EU ETS) also known as the European Union Emissions Trading System, was the first large emissions trading
Emissions trading
Emissions trading is a market-based approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants....

 scheme in the world. It was launched in 2005 to combat climate change
Avoiding Dangerous Climate Change
The related terms "avoiding dangerous climate change" and "preventing dangerous anthropogenic interference with the climate system" date to 1995 and earlier, in the Second Assesment Report of the International Panel on Climate Change and previous science it cites.In 2002, the United Nations...

 and is a major pillar of EU climate policy
Energy policy of the European Union
Although the European Union has legislated in the area of energy policy for many years, and evolved out of the European Coal and Steel Community, the concept of introducing a mandatory and comprehensive European energy policy was only approved at the meeting of the European Council on 27 October...

. The EU ETS currently covers more than 10,000 installations with a net heat excess of 20 MW in the energy and industrial sectors which are collectively responsible for close to half of the EU's emissions of CO2 and 40% of its total greenhouse gas emissions.

Under the EU ETS, large emitters of carbon dioxide within the EU must monitor their CO2 emissions
Carbon monitoring
Carbon dioxide monitoring refers to tracking how much carbon dioxide is produced by particular activity at a particular point in time. For example, it may refer to tracking carbon dioxide emissions from land use change, such as deforestation or agriculture, or from burning fossil fuels, whether in...

, and annually report them, as they are obliged every year to return an amount of emission allowances to the government that is equivalent to their CO2 emissions in that year.
In order to neutralize annual irregularities in CO2-emission levels that may occur due to extreme weather events (such as harsh winters or very hot summers), emission credits for any plant operator subject to the EU ETS are given out for a sequence of several years at once. Each such sequence of years is called a Trading Period. The 1st EU ETS Trading Period expired in December 2007; it had covered all EU ETS emissions since January 2005. With its termination, the 1st phase EU allowances became invalid.
Since January 2008, the 2nd Trading Period is under way which will last until December 2012.
Currently, the installations get the trading credits from the NAPS (national allowance plans) which is part of each country's government. Besides receiving this initial allocation, an operator may purchase EU and international trading credits. If an installation has performed well at reducing its carbon emissions then it has the opportunity to sell its credits and make a profit. This allows the system to be more self contained and be part of the stock exchange without much government intervention.

In January 2008, the European Commission
European Commission
The European Commission is the executive body of the European Union. The body is responsible for proposing legislation, implementing decisions, upholding the Union's treaties and the general day-to-day running of the Union....

 proposed a number of changes to the scheme, including centralized allocation (no more national allocation plans) by an EU authority, a turn to auctioning a greater share (60+ %) of permits rather than allocating freely, and inclusion of other greenhouse gases, such as nitrous oxide
Nitrous oxide
Nitrous oxide, commonly known as laughing gas or sweet air, is a chemical compound with the formula . It is an oxide of nitrogen. At room temperature, it is a colorless non-flammable gas, with a slightly sweet odor and taste. It is used in surgery and dentistry for its anesthetic and analgesic...

 and perfluorocarbons. These changes are still in a draft stage; the mentioned amendments are only likely to become effective from January 2013 onwards, i.e. in the 3rd Trading Period under the EU ETS.
Also, the proposed caps for the 3rd Trading Period foresee an overall reduction of greenhouse gases for the sector of 21% in 2020 compared to 2005 emissions. The EU ETS has recently been extended to the airline industry as well, but these changes will not take place until 2012.

Mechanisms


The first phase of the EU scheme was created to operate apart from international climate change treaties such as the pre-existing United Nations Framework Convention on Climate Change
United Nations Framework Convention on Climate Change
The United Nations Framework Convention on Climate Change is an international environmental treaty produced at the United Nations Conference on Environment and Development , informally known as the Earth Summit, held in Rio de Janeiro from June 3 to 14, 1992...

 (UNFCCC, 1992) or the Kyoto Protocol
Kyoto Protocol
The Kyoto Protocol is a protocol to the United Nations Framework Convention on Climate Change , aimed at fighting global warming...

 that was subsequently (1997) established under it. When the Kyoto Protocol came into force on 16 February 2005, Phase I of the EU ETS had already become operational. The EU later agreed to incorporate Kyoto flexible mechanism certificates as compliance tools within the EU ETS. The "Linking Directive" allows operators to use a certain amount of Kyoto certificates from flexible mechanism projects in order to cover their emissions.

The Kyoto flexible mechanisms are:
  • Joint Implementation
    Joint Implementation
    Joint implementation is one of three flexibility mechanisms set forth in the Kyoto Protocol to help countries with binding greenhouse gas emissions targets meet their obligations. JI is set forth in Article 6 of the Kyoto Protocol...

     projects (JI) defined by Article 6 of the Kyoto Protocol, which produce Emission Reduction Unit
    Emission Reduction Unit
    The Emission reduction unit is a trading unit under the Kyoto Protocol representing a reduction of greenhouse gases under the Joint Implementation mechanism, where it represents one tonne of equivalent reduced....

    s (ERUs). One ERU represents the successful emissions reduction equivalent to one tonne of carbon dioxide equivalent (te).
  • the Clean Development Mechanism
    Clean Development Mechanism
    The Clean Development Mechanism is one of the "flexibility" mechanisms defined in the Kyoto Protocol . It is defined in Article 12 of the Protocol, and is intended to meet two objectives: to assist parties not included in Annex I in achieving sustainable development and in contributing to the...

     (CDM) defined by Article 12, which produces Certified Emission Reduction
    Certified Emission Reduction
    Certified Emission Reductions are a type of emissions unit issued by the Clean Development Mechanism Executive Board for emission reductions achieved by CDM projects and verified by a DOE under the rules of the Kyoto Protocol...

    s (CERs). One CER represents the successful emissions reduction equivalent to one tonne of carbon dioxide equivalent (te).
  • International Emissions Trading (IET) defined by Article 17.


IET is relevant as the reductions achieved through CDM projects are a compliance tool for EU ETS operators. These Certified Emission Reductions (CERs) can be obtained by implementing emission reduction projects in developing countries, outside the EU, that have ratified (or acceded to) the Kyoto Protocol. The implementation of Clean Development Projects is largely specified by the Marrakech Accords
Marrakech Accords
The Marrakech Accords is a set of agreements reached at the 7th Conference of the Parties to the United Nations Framework Convention on Climate Change, held in 2001, on the rules of meeting the targets set out in the Kyoto Protocol....

, a follow-on set of agreements by the Conference of the Parties to the Kyoto Protocol.
The legislators of the EU ETS drew up the scheme independently but called on the experiences gained during the running of the voluntary UK Emissions Trading Scheme
UK Emissions Trading Scheme
The UK Emissions Trading Scheme was a voluntary emissions trading system created as a pilot prior to the mandatory European Union Emissions Trading Scheme which it now runs in parallel with. It ran from 2002 and it closed to new entrants in 2009...

 in the previous years, and collaborated with other parties to ensure its units and mechanisms were compatible with the design agreed through the UNFCCC.

Under the EU ETS, the governments of the EU Member States agree on national emission caps which have to be approved by the EU commission. Those countries then allocate allowances to their industrial operators, and track and validate the actual emissions in accordance with the relevant assigned amount. They require the allowances to be retired after the end of each year.

The operators within the ETS may reassign or trade their allowances by several means:
  • privately, moving allowances between operators within a company and across national borders
  • over the counter
    Over-the-counter (finance)
    Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange. Products traded on the exchange must be well standardised to transparent trading....

    , using a broker
    Broker
    A broker is a party that arranges transactions between a buyer and a seller, and gets a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal...

     to privately match buyers and sellers
  • trading on the spot market
    Spot market
    The spot market or cash market is a public financial market, in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market in which delivery is due at a later date...

     of one of Europe's climate exchanges.


Like any other financial instrument, trading consists of matching buyers and sellers between members of the exchange and then settling by depositing a valid allowance in exchange for the agreed financial consideration. Much like a stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...

, companies and private individuals can trade through brokers who are listed on the exchange, and need not be regulated operators.

When each change of ownership of an allowance is proposed, the national registry
Emissions Trading Registry
An Emissions Trading Registry is a web-based application that records:*CO2 allowances and units allocated to and held in operator, person and Government accounts...

 and the European Commission are informed in order for them to validate the transaction. During Phase II of the EU ETS the UNFCCC also validates the allowance and any change that alters the distribution within each national allocation plan.

Like the Kyoto trading scheme, the EU scheme allows a regulated operator to use carbon credit
Carbon credit
A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent equivalent to one tonne of carbon dioxide....

s in the form of Emission Reduction Units (ERU) to comply with its obligations. A Kyoto Certified Emission Reduction
Certified Emission Reduction
Certified Emission Reductions are a type of emissions unit issued by the Clean Development Mechanism Executive Board for emission reductions achieved by CDM projects and verified by a DOE under the rules of the Kyoto Protocol...

 unit (CER), produced by a carbon project
Carbon project
A carbon project refers to a business initiative that receives funding because of the cut the emission of greenhouse gases that will result...

 that has been certified by the UNFCCC's Clean Development Mechanism
Clean Development Mechanism
The Clean Development Mechanism is one of the "flexibility" mechanisms defined in the Kyoto Protocol . It is defined in Article 12 of the Protocol, and is intended to meet two objectives: to assist parties not included in Annex I in achieving sustainable development and in contributing to the...

 Executive Board, or Emission Reduction Unit (ERU) certified by the Joint Implementation
Joint Implementation
Joint implementation is one of three flexibility mechanisms set forth in the Kyoto Protocol to help countries with binding greenhouse gas emissions targets meet their obligations. JI is set forth in Article 6 of the Kyoto Protocol...

 project's host country or by the Joint Implementation Supervisory Committee, are accepted by the EU as equivalent.

Thus one EU Allowance Unit of one tonne of CO2, or "EUA
EUA
EUA can stand for:* European University Association* End User Agreement* European Unit of Account* EU emission Allowance , see European Union Emission Trading Scheme* Portuguese, Spanish and French abbreviation of USA...

", was designed to be identical ("fungible") with the equivalent "Assigned Amount Unit
Assigned amount units
An Assigned Amount Unit is a tradable 'Kyoto unit' or 'carbon credit' representing an allowance to emit greenhouse gases comprising one metric tonne of carbon dioxide equivalents calculated using their Global Warming Potential....

" (AAU) of CO2 defined under Kyoto. Hence, because of the EU's decision to accept Kyoto-CERs as equivalent to EU-EUA
EUA
EUA can stand for:* European University Association* End User Agreement* European Unit of Account* EU emission Allowance , see European Union Emission Trading Scheme* Portuguese, Spanish and French abbreviation of USA...

's, it is possible to trade EUA
EUA
EUA can stand for:* European University Association* End User Agreement* European Unit of Account* EU emission Allowance , see European Union Emission Trading Scheme* Portuguese, Spanish and French abbreviation of USA...

's and UNFCCC-validated CERs on a one-to-one basis within the same system. (However, the EU was not able to link trades from all its countries until 2008-9 because of its technical problems connecting to the UN systems.)

During Phase II of the EU ETS, the operators within each Member State must surrender their allowances for inspection by the EU before they can be "retired" by the UNFCCC.

Allocation


In an ETS, the total number of permits issued (either auctioned or allocated) determines the price for carbon. The actual carbon price is determined by the market. Too many allowances will result in a low carbon price, and reduced emission abatement efforts (Newbery, 2009). Too few allowances will result in too high a carbon price (Hepburn, 2006, p. 239).

For each EU ETS Phase, the total quantity to be allocated by each Member State is defined in the Member State National Allocation Plan (NAP) (equivalent to its UNFCCC-defined carbon account.) The European Commission has oversight of the NAP process and decides if the NAP fulfills the 12 criteria set out in the Annex III of the Emission Trading Directive (EU Directive 2003/87/EC). The first and foremost criterion is that the proposed total quantity is in line with a Member State's Kyoto target.

Of course, the Member State's plan can, and should, also take account of emission levels in other sectors not covered by the EU ETS, and address these within its own domestic policies. For instance, transport is responsible for 21% of EU greenhouse gas emissions, households and small businesses for 17% and agriculture for 10%.

During Phase I, most allowances in all countries were given freely (known as grandfathering
Grandfather clause
Grandfather clause is a legal term used to describe a situation in which an old rule continues to apply to some existing situations, while a new rule will apply to all future situations. It is often used as a verb: to grandfather means to grant such an exemption...

). This approach has been criticized as giving rise to windfall profit
Windfall gain
-Types of Windfall Gains:The list of windfall gains includes, but is not limited to:*Lottery winnings*Unexpected inheritance*Gains from demutualization-Uses of Windfall Gains:What people do with windfall gains is subject to much debate...

s, being less efficient than auctioning, and providing too little incentive for innovative new competition to provide clean, renewable energy. On the other hand, allocation rather than auctioning may be justified for a few sectors, e.g., aluminium and steel, that face international competition, and where the price of carbon is important (Neuhoff, 2009; Newbery, 2009; Carbon Trust, 2009; See also the section on competitiveness).

To address these problems, the European Commission proposed various changes in a January 2008 package, including the abolishment of NAPs from 2013 and auctioning a far greater share (ca. 60% in 2013, growing afterward) of emission permits.

From the start of Phase III (January 2013) there will be a centralised allocation of permits, not National Allocation Plans, with a greater share of auctioning of permits.

Competitiveness


Allocation can act as a means of addressing concerns over loss of competitiveness
Competitiveness
Competitiveness is a comparative concept of the ability and performance of a firm, sub-sector or country to sell and supply goods and/or services in a given market...

, and possible "leakage" (carbon leakage
Carbon leakage
Carbon leakage occurs when there is an increase in carbon dioxide emissions in one country as a result of an emissions reduction by a second country with a strict climate policy.Carbon leakage may occur for a number of reasons:...

) of emissions outside the EU. Leakage is the effect of emissions increasing in countries or sectors that have weaker regulation of emissions than the regulation in another country or sector (Barker et al., 2007). Carbon Trust (2009) cited research that showed competitiveness concerns could affect the following sectors: cement
Cement
In the most general sense of the word, a cement is a binder, a substance that sets and hardens independently, and can bind other materials together. The word "cement" traces to the Romans, who used the term opus caementicium to describe masonry resembling modern concrete that was made from crushed...

, steel
Steel
Steel is an alloy that consists mostly of iron and has a carbon content between 0.2% and 2.1% by weight, depending on the grade. Carbon is the most common alloying material for iron, but various other alloying elements are used, such as manganese, chromium, vanadium, and tungsten...

, aluminium
Aluminium
Aluminium or aluminum is a silvery white member of the boron group of chemical elements. It has the symbol Al, and its atomic number is 13. It is not soluble in water under normal circumstances....

, pulp and paper
Papermaking
Papermaking is the process of making paper, a substance which is used universally today for writing and packaging.In papermaking a dilute suspension of fibres in water is drained through a screen, so that a mat of randomly interwoven fibres is laid down. Water is removed from this mat of fibres by...

, basic inorganic chemicals
Chemical industry
The chemical industry comprises the companies that produce industrial chemicals. Central to the modern world economy, it converts raw materials into more than 70,000 different products.-Products:...

 and fertilisers/ammonia. Leakage from these sectors was thought likely not to be more than 1% of total EU emissions.

According to the Carbon Trust (2009), correcting for leakage by allocating permits acts as a temporary subsidy
Subsidy
A subsidy is an assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributors in an industry to prevent the decline of that industry or an increase in the prices of its products or simply to encourage it to hire more labor A subsidy (also...

 for affected industries, but does not fix the underlying problem. Border adjustments would be the economically efficient choice, where imports are taxed according to their carbon content (Neuhoff, 2009; Newbery, 2009). A problem with border adjustments is that they might be used as a disguise for trade protectionism
Protectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...

 (Grubb et al., p. 5). Some adjustments may also not prevent emissions leakage.

Banking and borrowing


Within a trading phase, banking and borrowing is allowed. For example, a 2006 EUA
EUA
EUA can stand for:* European University Association* End User Agreement* European Unit of Account* EU emission Allowance , see European Union Emission Trading Scheme* Portuguese, Spanish and French abbreviation of USA...

 can be used in 2007 (Banking) or in 2005 (Borrowing). Interperiod borrowing is not allowed. Member states had the discretion to decide if banking EUA
EUA
EUA can stand for:* European University Association* End User Agreement* European Unit of Account* EU emission Allowance , see European Union Emission Trading Scheme* Portuguese, Spanish and French abbreviation of USA...

's from Phase I to Phase II was allowed or not.

Phase I


In the first phase (2005–2007), the EU ETS included some 12,000 installations, representing approximately 40% of EU CO2 emissions, covering energy activities (combustion installations with a rated thermal input exceeding 20 MW, mineral oil refineries, coke ovens), production and processing of ferrous metals, mineral industry (cement clinker, glass and ceramic bricks) and pulp, paper and board activities.

Launch and operation


The scheme, in which all 15 member states that were then members of the European Union
European Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...

 participated, nominally commenced operation on 1 January 2005, although national registries were unable to settle transactions for the first few months. However, the prior existence of the UK Emissions Trading Scheme
UK Emissions Trading Scheme
The UK Emissions Trading Scheme was a voluntary emissions trading system created as a pilot prior to the mandatory European Union Emissions Trading Scheme which it now runs in parallel with. It ran from 2002 and it closed to new entrants in 2009...

 meant that market participants were already in place and ready. In its first year, 362 million tonnes of CO2
Carbon dioxide
Carbon dioxide is a naturally occurring chemical compound composed of two oxygen atoms covalently bonded to a single carbon atom...

 were traded on the market for a sum of €7.2 billion, and a large number of futures and options. The price of allowances increased more or less steadily to a peak level in April 2006 of about €30 per tonne CO2, but fell in May 2006 to under €10/ton on news that some countries were likely to give their industries such generous emission caps that there was no need for them to reduce emissions. Lack of scarcity under the first phase of the scheme continued through 2006 resulting in a trading price of €1.2 a tonne in March 2007, declining to €0.10 in September 2007.

Verified emissions have seen a net increase over the first phase of the scheme. For the countries for which data is available (all 27 member states minus Romania, Bulgaria and Malta), emissions increased by 1.9% between 2005 and 2007.
Country Verified emissions Change
2005 2006 2007 2005–2007
33,372,826 32,382,804 31,751,165
55,363,223 54,775,314 52,795,318
5,078,877 5,259,273 5,396,164 6.2%
82,454,618 83,624,953 87,834,758 6.5%
474,990,760 478,016,581 487,004,055 2.5%
26,475,718 34,199,588 29,407,355 11.1%
12,621,817 12,109,278 15,329,931 21.5%
183,626,981 179,711,225 186,495,894 1.6%
33,099,625 44,621,411 42,541,327 28.5%
131,263,787 126,979,048 126,634,806
71,267,736 69,965,145 72,717,006 2.0%
26,161,627 25,845,891 26,835,478 2.6%
22,441,000 21,705,328 21,246,117
225,989,357 227,439,408 226,368,773 0.2%
6,603,869 6,516,911 5,998,744
2,603,349 2,712,972 2,567,231
2,854,481 2,940,680 2,849,203
80,351,288 76,701,184 79,874,658
203,149,562 209,616,285 209,601,993 3.2%
36,425,915 33,083,871 31,183,076
19,381,623 19,884,147 15,348,209
8,720,548 8,842,181 9,048,633 3.8%
25,231,767 25,543,239 24,516,830
242,513,099 251,159,840 256,581,160 5.8%
Total 2,012,043,453 2,033,636,557 2,049,927,884 1.9%

  • Figures are in tonne
    Tonne
    The tonne, known as the metric ton in the US , often put pleonastically as "metric tonne" to avoid confusion with ton, is a metric system unit of mass equal to 1000 kilograms. The tonne is not an International System of Units unit, but is accepted for use with the SI...

    s of
  • Source: European Commission Press Release 23 May 2008



Consequently, observers and NGO's have accused national governments of abusing the system under industry pressure, and have urged for far stricter caps in the second phase (2008–2012).

Phase II

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Million Metric Tonnes of CO2 yearly allowances
Member State 1st period cap 2005 verified emissions 2008-2012 cap
State request Cap allowed
33.0 33.4 32.8 30.7
62.08 55.58 † 63.33 58.5
42.3 40.6 67.6 42.3
5.7 5.1 7.12 5.48
97.6 82.5 101.9 86.8
33.5 26.5 24.5 24.5
19 12.62 24.38 12.72
45.5 33.1 39.6 37.6
156.5 131.3 132.8 132.8
31.3 26.0 30.7 26.9
499 474 482 453.1
74.4 71.3 75.5 69.1
22.3 22.4 22.6 21.15
223.1 222.5 209 195.8
4.6 2.9 7.7 3.3
12.3 6.6 16.6 8.8
3.4 2.6 3.95 2.7
†††† 2.9 1.98 2.96 2.1
95.3 80.35 †† 90.4 85.8
239.1 203.1 284.6 208.5
38.9 36.4 35.9 34.8
74.8 70.8 95.7 75.9
30.5 25.2 41.3 30.9
8.8 8.7 8.3 8.3
174.4 182.9 152.7 152.3
22.9 19.3 25.2 22.8
245.3 242.4 ††† 246.2 246.2
Totals 2057.8 1910.66 2054.92 1859.27
Source: Last EU press release IP/07/1614: "Emissions trading: EU-wide cap for 2008-2012 set at 2.08 billion allowances after assessment of national plans for Bulgaria", 26 October 2007. Access to the previous press releases (Nov 2006 - October 2007) in the linked page.

Additional installations and emissions included in the second trading period are not included in this table but are given in the sources.

*† Including installations opted out in 2005.

*†† Verified emissions for 2005 do not include installations opted out in 2005 which will be covered in 2008 and 2012 and are estimated to amount to some 6 Mt.

*††† UK's verified emissions for 2005 do not include installations opted out in 2005 which will be covered in 2008 and 2012 and are estimated to amount to some 30 Mt.

*††††Cyprus and Malta, as new EU accession states, but not Annex I countries, will have their own NAPs and participate in trading during Phase II.


The second phase (2008–12) expands the scope significantly:
  • CDM
    Clean Development Mechanism
    The Clean Development Mechanism is one of the "flexibility" mechanisms defined in the Kyoto Protocol . It is defined in Article 12 of the Protocol, and is intended to meet two objectives: to assist parties not included in Annex I in achieving sustainable development and in contributing to the...

     and JI
    Joint Implementation
    Joint implementation is one of three flexibility mechanisms set forth in the Kyoto Protocol to help countries with binding greenhouse gas emissions targets meet their obligations. JI is set forth in Article 6 of the Kyoto Protocol...

     credits are introduced in second phase through the EU's 'Linking Directive'. Although this was a theoretical possibility in phase I, the over-allocation of permits combined with the inability to bank them for use in the second phase meant it was not taken up.
  • Aviation
    Aviation
    Aviation is the design, development, production, operation, and use of aircraft, especially heavier-than-air aircraft. Aviation is derived from avis, the Latin word for bird.-History:...

     emissions are expected to be included from 2012.
  • In 2007, it was announced that three non-EU members, Norway
    Norway
    Norway , officially the Kingdom of Norway, is a Nordic unitary constitutional monarchy whose territory comprises the western portion of the Scandinavian Peninsula, Jan Mayen, and the Arctic archipelago of Svalbard and Bouvet Island. Norway has a total area of and a population of about 4.9 million...

    , Iceland
    Iceland
    Iceland , described as the Republic of Iceland, is a Nordic and European island country in the North Atlantic Ocean, on the Mid-Atlantic Ridge. Iceland also refers to the main island of the country, which contains almost all the population and almost all the land area. The country has a population...

    , and Liechtenstein
    Liechtenstein
    The Principality of Liechtenstein is a doubly landlocked alpine country in Central Europe, bordered by Switzerland to the west and south and by Austria to the east. Its area is just over , and it has an estimated population of 35,000. Its capital is Vaduz. The biggest town is Schaan...

     joined the scheme.


The inclusion of aviation is a move considered important due to the large and rapidly growing emissions of the sector. The inclusion of aviation is estimated to lead to an increase in demand of allowances about 10-12 million tonnes of CO2 per year in phase two. This in turn is expected to lead to an increased use of JI credits from projects in Russia and Ukraine, which would offset the increase in prices and eventually result in no discernible impact on average annual CO2 prices.

Ultimately, the Commission wishes the post-2012 ETS to include all greenhouse gases and all sectors, including aviation, maritime transport and forestry. For the transport sector, the large number of individual users adds complexities, but might be implemented either as a cap-and-trade system for fuel suppliers or a baseline-and-credit system for car manufacturers.

The National Allocation Plans for Phase II, the first of which were announced on 29 November 2006, result in an average cut of nearly 7% below the 2005 emission levels. The use of offsets from JI and CDM projects was allowed, with the result that no reductions in the EU will be required to meet the Phase II cap (CCC, 2008, pp. 145, 149). According to verified EU data from 2008, the ETS saw an emissions reduction of 3%, or 50 million tons. At least 80 million tons of "carbon offset
Carbon offset
A carbon offset is a reduction in emissions of carbon dioxide or greenhouse gases made in order to compensate for or to offset an emission made elsewhere....

s" which were bought as part of the scheme.

The annual Member State CO2 yearly allowances in million tonnes are shown in the table:

In late 2006, European Commission
European Commission
The European Commission is the executive body of the European Union. The body is responsible for proposing legislation, implementing decisions, upholding the Union's treaties and the general day-to-day running of the Union....

 started infringement proceedings against Austria
Austria
Austria , officially the Republic of Austria , is a landlocked country of roughly 8.4 million people in Central Europe. It is bordered by the Czech Republic and Germany to the north, Slovakia and Hungary to the east, Slovenia and Italy to the south, and Switzerland and Liechtenstein to the...

, Czech Republic
Czech Republic
The Czech Republic is a landlocked country in Central Europe. The country is bordered by Poland to the northeast, Slovakia to the east, Austria to the south, and Germany to the west and northwest....

, Denmark
Denmark
Denmark is a Scandinavian country in Northern Europe. The countries of Denmark and Greenland, as well as the Faroe Islands, constitute the Kingdom of Denmark . It is the southernmost of the Nordic countries, southwest of Sweden and south of Norway, and bordered to the south by Germany. Denmark...

, Hungary
Hungary
Hungary , officially the Republic of Hungary , is a landlocked country in Central Europe. It is situated in the Carpathian Basin and is bordered by Slovakia to the north, Ukraine and Romania to the east, Serbia and Croatia to the south, Slovenia to the southwest and Austria to the west. The...

, Italy
Italy
Italy , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and...

 and Spain
Spain
Spain , officially the Kingdom of Spain languages]] under the European Charter for Regional or Minority Languages. In each of these, Spain's official name is as follows:;;;;;;), is a country and member state of the European Union located in southwestern Europe on the Iberian Peninsula...

, for failure to submit their proposed National Allocation Plans on time.

Carbon price

The carbon price within Phase II increased to over €20/tCO2 in the first half of 2008 (CCC, 2008, p. 149). The average price was €22/tCO2 in the second half of 2008, and €13/tCO2 in the first half of 2009. CCC (2009, p. 67) gave two reasons for this fall in prices:
  • Reduced output in energy-intensive sectors as a result of the recession. This means that less abatement will be required to meet the cap, lowering the carbon price.
  • The market perception of future fossil fuel prices may have been revised downwards.


Projections indicate that like Phase I, Phase II will see a surplus in allowances. According to Grubb et al. (2009, p. 12), carbon prices are being sustained by the prospect of banking allowances to use them in the tougher third phase.

Phase III


For Phase III (2013–20), the European Commission has proposed a number of changes, including (CCC, 2008, p. 149):
  • the setting of an overall EU cap, with allowances then allocated to EU members;
  • tighter limits on the use of offsets;
  • unlimiting banking of allowances between Phases II and III;
  • and a move from allowances to auctioning.


Projections to 2020

CCC (2008, p. 151) made projections of the expected cap for the EU ETS out to 2020. For a 20% cut in EU economy-wide emissions relative to 1990 levels, the reduction in total emissions was projected to be around 36 million tonnes per annum. CCC (2009, p. 68) projected a carbon price in 2020 of around 22 Euro/tCO2. Most market commentators project a price around or below 30 Euro/tCO2. These carbon price projections are subject to great uncertainty, e.g., over future fossil fuel prices, and predicting business-as-usual emissions (p. 69).

Costs


According to Grubb et al. (2009, pp. 3–4), the EU ETS has been able to meet its environmental objectives at costs significantly lower than projected. The estimated cost was a small fraction of 1% GDP. It was suggested that if permits were auctioned, and the revenues used effectively, e.g., to reduce distortionary tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...

es and fund low-carbon technologies, costs could be eliminated, or even create a positive economic impact.

Overall emission reductions


A number of design flaws have limited the effectiveness of the EU ETS (Jones et al., 2007, p. 64). In the initial 2005-07 period, emission caps were not tight enough to drive a significant reduction in emissions (CCC, 2008, p. 140). The total allocation of allowances turned out to exceed actual emissions. This was a factor in driving the carbon price down to zero in 2007, the other main factor being that allowances were not allowed to be 'banked' for use in Phase II, therefore had no monetary value outside of Phase I. This oversupply reflects the difficulty in predicting future emissions which is necessary in setting a cap (Carbon Trust, 2009).

Phase I

In 2004, Ecofys analysed the then available preliminary NAPs of all EU countries.
The information suggested that the caps for Phase I were lenient; in most countries, the power sector would not need to reduce CO2 emissions as much as the country as a whole, in other words the other sectors must make more ambitious emission reductions than the power sector under the scheme. More strikingly, a few countries (such as the Netherlands) gave more allowances than Ecofys estimated to be needed under a business-as-usual scenario, implying that no 'real' efforts to reduce emissions would be required. In their analysis of the Phase I NAPs, the NGO Climate Action Network
Climate Action Network
Climate Action Network is an umbrella group of environmental non-governmental organisations active on the issue of climate change...

 called the caps a 'major disappointment', arguing that only two (UK and Germany) of the 25 EU states asked the participating industry sectors to reduce emissions compared to historic levels and found that in the 15 old EU member states as a whole, allocations were 4.3% higher than the base year. In May 2006, when several countries revealed registries indicating that their industries had been allocated more allowances than they could use, trading prices crashed from about €30/ton to €10/ton, and (after an initial slight recovery) declined further to €4 in January 2007 and below €1 in February 2007, reaching an all time low of €0.03 at the beginning of December 2007

Ellerman and Buchner (2008) (referenced by Grubb et al., 2009, p. 11) suggested that during its first two years in operation, the EU ETS turned an expected increase in emissions of 1-2 percent per year into a small absolute decline. Grubb et al. (2009, p. 11) suggested that a reasonable estimate for the emissions cut achieved during its first two years of operation was 50-100 MtCO2 per year, or 2.5-5%.

Phase II

In 2006, Ecofys performed an initial assessment of NAPs for phase II, using the proposed but not-yet-approved NAPs. They found that most member states did not have sufficiently strict caps, and that they would be insufficient in assisting the members in meeting their Kyoto targets. They also compared caps with official business-as-usual (BAU) projections and with independent BAU projections to assess stringency of caps. They concluded that the caps were 7% under official BAU but (except for Portugal, Spain, and UK) the proposed cap was "higher" than the independently estimated BAU, suggesting overallocation.

Partly in response to this, the Commission cut eleven of the first twelve Phase II plans it reviewed (accepting only the U.K.'s plan without revision). The commission tightened the caps some 7%, also corresponding with 7% below the 2005 emissions. For Phase II, the cap is expected to result in an emissions reduction in 2010 of about 2.4% compared to expected emissions without the cap (business-as-usual emissions) (Jones et al., 2007, p. 64).
According to UBS Investment Research the system has cost $287 billion till 2011 with "almost zero impact" on overall emissions in European Union and the money could have result in over 40% reduction if used in targeted way, e.g. to upgrade power plants.

The inclusion of sinks


Currently, the EU does not allow CO2 credits under ETS to be obtained from sinks
Carbon dioxide sink
A carbon sink is a natural or artificial reservoir that accumulates and stores some carbon-containing chemical compound for an indefinite period. The process by which carbon sinks remove carbon dioxide from the atmosphere is known as carbon sequestration...

 (e.g. reducing CO2 by planting trees). However, some governments and industry representatives lobby for their inclusion. The inclusion is currently opposed by NGOs as well as the EU commission itself, arguing that sinks are surrounded by too many scientific uncertainties over their permanence and that they have inferior long-term contribution to climate change compared to reducing emissions from industrial sources.

28 Million Euro Cyberfraud


On January 19, 2011, the EU emissions spot market for pollution permits was closed after computer hackers stole 28 to 30 million euros ($41.12 million) worth of emissions allowances from the national registries of several European countries within a few day time period. The Czech Registry for Emissions Trading was especially hard hit with 7 million euros worth of allowances stolen by hackers from Austria, the Czech Republic, Greece, Estonia and Poland. A phishing
Phishing
Phishing is a way of attempting to acquire information such as usernames, passwords, and credit card details by masquerading as a trustworthy entity in an electronic communication. Communications purporting to be from popular social web sites, auction sites, online payment processors or IT...

 scam is suspected to have enabled hackers to log into unsuspecting companies' carbon credit accounts and transfer the allowances to themselves, allowing them to then be sold.

The European Commission said it would "proceed to determine together with national authorities what minimum security measures need to be put in place before the suspension of a registry can be lifted." Maria Kokkonen, E.C. spokeswoman for climate issues, said that national registries can be reopened once sufficient security measures have been enacted and member countries submit to the EC a report of their IT security protocol.

The Czech registry said there are still legal and administrative hurdles to be overcome and Jiri Stastny, chairman of OTE AS, the Czech registry operator, said that until there is recourse for victims of such theft, and a system is in place to return allowances to their rightful owners, the Czech registry will remain closed. Registry officials in Germany and Estonia have confirmed they have located 610,000 allowances stolen from the Czech registry, according to Mr. Stastny. Another 500,000 of the stolen Czech allowances are thought to be in accounts in the U.K., the OTE said.

The security breaches raised fears among some traders that they might have unknowingly purchased stolen allowances which they might later have to forfeit. The ETS experienced a previous phishing scam in 2010 which caused 13 European markets to shut down, and criminals cleared 5 million euros in another cross-border fraud in 2008 and 2009.

Views on the EU ETS


Different people and organizations have responded differently to the EU ETS. Mr Anne Theo Seinen, of the EC's Directorate-General for the Environment, described Phase I as a "learning phase," where, for example, the infrastructure and institutions for the ETS were set up (UK Parliament, 2009). In his view, the carbon price in Phase I had resulted in some abatement. Seinen also commented that the EU ETS needed to be supported by other policies for technology and renewable energy. According to CCC (2008, p. 155), technology policy is necessary to overcome market failure
Market failure
Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...

s associated with delivering low-carbon technologies, e.g., by supporting research and development.

The World Wildlife Fund (2009) commented that there was no indication that the EU ETS had influenced longer-term investment decisions. In their view, the Phase III scheme brought about significant improvements, but still suffered from major weaknesses. Jones et al. (2008, p. 24) suggested that the EU ETS needed further reform to achieve its potential.

Criticisms

The EU ETS has been criticized for several failings, including: over-allocation, windfall profits, price volatility, and in general for failing to meet its goals. Proponents argue, however, that Phase I of the EU ETS (2005–2007) was a "learning phase" designed primarily to establish baselines and create the infrastructure for a carbon market, not to achieve significant reductions.

In addition, the EU ETS has been criticized as having caused a disruptive spike in energy prices. They say that it does not correlate with the price of permits, and in fact the largest price increase occurred at a time (Mar-Dec 2007) when the cost of permits was negligible.

Over-allocation

There was an oversupply of emissions allowances for EU ETS Phase I. This drove the carbon price down to zero in 2007 (CCC, 2008, p. 140). This oversupply reflects the difficulty in predicting future emissions which is necessary in setting a cap (Carbon Trust, 2009). Given poor data about emissions baselines, inherent uncertainty of emissions forecasts, and the very modest reduction goals of the Phase I cap (1-2% across the EU), it was entirely expected that the cap might be set too high.

This problem naturally diminishes as the cap tightens. The EU's Phase II cap is more than 6% below 2005 levels, much stronger than Phase I, and readily distinguishable from business-as-usual emissions levels.

Also, note that over-allocation does not imply that no abatement occurred. Even with over-allocation, there was a real price on carbon, and that price had an effect on emitters' behavior. Verified emissions in 2005 were 3-4% below projected emissions, and analysis suggests that at least part of that reduction was due to the EU ETS.

Windfall profits

According to Newbery (2009), the price of EUAs was passed fully in the final price of electricity. The free allocation of permits was cashed in at the EUA price by fossil generators, resulting in a "massive windfall gain." Newbery (2009) wrote that "[there] is no case for repeating such a willful misuse of the value of a common property resource that should be owned by the country." In the view of 4CMR (2009), all permits in the EU ETS should be auctioned. This would avoid possible windfall profits in all sectors.

Price volatility

The price of emissions permits tripled in the first six months of Phase I, collapsed by half in a one-week period in 2006, and declined to zero over the next twelve months. Such movements and the implied volatility raise questions about the viability of this trading system to provide stable incentives to emitters.

This criticism has face validity. In future phases, measures such as banking of allowances and price floors may be used to mitigate volatility. However, it's important to note that considerable volatility is expected of this type of market, and the volatility seen is quite in line with that of energy commodities generally. Nonetheless, producers and consumers in those markets respond rationally and effectively to price signals.

Newbery (2009) commented that the EU ETS was not delivering the stable carbon price necessary for long-term, low-carbon investment decisions. He suggested that efforts should be made to stabilize carbon price, e.g., by having a price-ceiling and a price-floor.

Crime

In 2009 Europol
Europol
Europol is the European Union's criminal intelligence agency. It became fully operational on 1 July 1999....

 informed that 90% market volume of emissions traded in some countries could be result of tax fraud, more specifically missing trader fraud
Missing trader fraud
Missing trader fraud is the theft of Value Added Tax from a government by organised crime gangs who exploit the way VAT is treated within multi-jurisdictional trading where the movement of goods between jurisdictions is VAT-free...

, costing governments more than 5 billion euro. Cyber fraudsters have also attacked the EU ETS with a "phishing" scam which cost one company €1.5 million. In response to this, the EU has revised the ETS rules to combat crime.

Offsetting

The EU ETS allows the use of offset credits from JI and CDM projects. The main advantage of allowing free trading of credits is that it allows mitigation to be done at least-cost (CCC, 2008, p. 160). This is because the marginal
Margin (economics)
In economics, a margin is a set of constraints conceptualised as a border. A marginal change is the change associated with a relaxation or tightening of constraints — either change of the constraints, or a change in response to this change of the constraints.- Extensive and intensive margins...

 costs (that is to say, the incremental costs of preventing the emission of one extra ton of CO2e
Carbon dioxide equivalent
Carbon dioxide equivalent and Equivalent carbon dioxide are two related but distinct measures for describing how much global warming a given type and amount of greenhouse gas may cause, using the functionally equivalent amount or concentration of carbon dioxide as the reference.- Global warming...

 into the atmosphere) of abatement differs among countries. In terms of the UK's climate change policy, CCC (2008), noted three arguments against too great a reliance on credits:
  • Rich countries need to demonstrate that a low-carbon economy is possible and compatible with economic prosperity. This is in order to convince developing countries to lower their emissions. Additionally, domestic action by rich countries drives investment towards a low-carbon economy.
  • An ambitious long-term target to reduce emissions, e.g., an 80% cut in UK emissions by 2050, requires significant domestic progress by 2020 and 2030 to reduce emissions.
  • CDM credits are inherently less robust than a cap and trade system, where reductions are required in total emissions.


Due to the economic downturn, states have pushed successfully for a more generous approach towards the use of CDM/JI credits post-2012. The 2009 EU ETS Amending Directive states that credits can be used for up to 50 % of the EU-wide reductions below the 2005 levels of existing sectors over the period 2008-2020. Moreover, it has been argued that the volume of CDM/JI credits, if carried over from phase II (2008–2012 to phase III 2013-2020) in the EU ETS will undermine its environmental effectiveness, despite the requirement of supplementarity
Supplementarity
"Supplementarity", also referred to as "the supplementary principle", is one of the main principles of the Kyoto Protocol. The concept is that internal abatement of emissions should take precedent before external participation in flexible mechanisms...

 in the Kyoto Protocol.

See also


  • Carbon emissions trading
  • Carbon finance
    Carbon finance
    Carbon finance is a new branch of Environmental finance. Carbon finance explores the financial implications of living in a carbon-constrained world, a world in which emissions of carbon dioxide and other greenhouse gases carry a price....

  • Energy policy of the European Union
    Energy policy of the European Union
    Although the European Union has legislated in the area of energy policy for many years, and evolved out of the European Coal and Steel Community, the concept of introducing a mandatory and comprehensive European energy policy was only approved at the meeting of the European Council on 27 October...

  • European Climate Change Programme
    European Climate Change Programme
    The European Climate Change Programme was launched in June 2000 by the European Union's European Commission, toward avoiding dangerous climate change....

  • Mitigation of global warming
    Mitigation of global warming
    Climate change mitigation is action to decrease the intensity of radiative forcing in order to reduce the potential effects of global warming. Mitigation is distinguished from adaptation to global warming, which involves acting to tolerate the effects of global warming...

  • Single European Sky
    Single European Sky
    The Single European Sky is a European Commission initiative by which the design, management and regulation of airspace will be coordinated throughout the European Union ....


External links


Official pages

How ETS works

Key reports, and assessments