European Union Emissions Trading Scheme (EU ETS)

http://ec.europa.eu/environment/climat/emission/

Overview

Market Size and Scope

Offset Project Eligibility

Additionality and Quantification Procedures

Project Approval Process

Selected Issues

References

Overview

Type of Standard and Context

The European Union Emissions Trading Scheme (EU ETS) is a mandatory cap and trade program, which allows operators use of compliance carbon credits from Kyoto project based mechanisms (Clean Development Mechanism and Joint Implementation), up to a certain limit. The EU ETS began in January 2005 as the first emissions trading scheme to regulate GHG emissions and continues to be the largest (Ellis and Tirpak, 2006). The EU ETS is a key component to the EU climate policy commitment to the Kyoto Protocol and beyond (Kopp, 2007). Emissions sources regulated by the EU ETS include 12,000 downstream emissions sources, accounting for half of all EU emissions, from the following industrial sectors: iron and steel; cement, glass, and ceramics; pulp and paper; electric-power generation; and refineries (Kopp, 2007). The cap covers only CO2 emissions, but may in the future include other GHGs, as well as air transport emissions (Kopp. 2007). The implementation of the EU ETS began with Phase I (2005-2007) which - although mandatory - was primarily designed as a trial period. It is currently in Phase II (2008-2012), which coincides with the Kyoto commitment period. For Phase III of the EU ETS several revisions to the scheme are planned including a single EU-wide cap to increase harmonization. (Capoor and Ambrosi, 2009). On September 30, 2010 the final Phase III annual emissions cap for the EU ETS is expected to be announced (Capoor and Ambrosi, 2009).

Emissions sources regulated by the EU ETS may meet their compliance obligation either through surrendering emissions allowances (EUAs) or they may supplement in part allowances through the purchase of offset credits available through the Kyoto Protocol project based mechanisms, including CDM and JI credits. Regulated entities which do not meet their compliance obligation are required to pay, as of 2008, a penalty of $157 (€ 100) per metric ton, and are required to make up the shortfall in subsequent calendar years, in addition to having their names published and being ‘named and shamed’ for non-compliance. Under the EU ETS program, the use of CDM and JI project credits is supposed to be “supplemental” to emissions reductions that take place within the EU. Limitations on the use of CDM/JI credits for compliance under the EU ETS vary by member state. Under Phase II of the EU ETS, the member state emissions cap, the CO2 emission source allowance allocations, and member state limit on the use of CDM/JI credits are based on National Allocation Plans (NAPs) submitted by each member state for approval by the European Commission. Member States specify a limit up to which individual installations will be able to use external credits to comply with the ETS. These limits vary between 0% (Estonia) and 22% (Germany) of allowances. There are also restrictions on use of CERs from forestry projects and from certain types of large hydro projects. Under the third phase (2013-2020) the system of national allocation plans will be abandoned to make place for harmonized EU-wide caps and allocation rules.

Standard Authority and Administrative Bodies

The EU ETS has been established through binding legislation proposed by the European Commission and approved by the EU Member States and the European Parliament. The Member States are responsible for the implementation of the emission trading scheme at the national level, in line with the National Allocation Plans approved by the Commission. They also have to submit annual reports on the implementation of the Directive to the Commission, in line with Article 21 of the ETS Directive. National administrators of the scheme manage national registries, while the Commission oversees the Community Independent Transaction Log (CITL) at the Community level, which registers changes in national registries. The proposed reform of the EU ETS envisages that from 2013 onwards the European emissions trading system will be more harmonized through abolishing National Allocation Plans, introducing auctioning as a primary method of allocation (with 100% auctioning for electricity production and a gradual increase of auctioning for other industrial processes covered by the system. The transitional free allocation will be based on benchmarking. Compliance of individual installations is attested by annual compliance reports which are verified by the European Commission.

Regional Scope

The EU ETS focuses on emission reduction targets for the 27 member states of the EU and targets for the countries that have linked their trading system to the EU ETS. For the time being this includes Norway, Iceland and Lichtenstein.

Recognition of Other Standards/ Linkage with Other Trading Systems

The EU Linking Directive, which was passed in 2004, allows operators in phase 2 of the ETS to use credits from Joint Implementation (JI) and the Clean Development Mechanism (CDM) to meet their targets in place of emission cuts within the EU. The EU ETS has been open to linking with other countries that have ratified the Kyoto Protocol and established compatible greenhouse gas emission trading systems, in order to enlarge the market for trading. The first expansion of the EU ETS took place on 1 January 2008, when Norway, Iceland and Liechtenstein joined the EU ETS (European Commission, 2007). As well, preliminary discussions on future linkages have taken place with other programs and countries. The EU ETS has expressed interest in and encouragement for plans to set up absolute and mandatory cap and trade emissions trading systems in Australia, New Zealand, Switzerland, California, RGGI, and other US states and Canadian provinces. In October 2007, the International Carbon Action Partnership (ICAP) was created, of which the EU is a founder member, in order to help support the linking of the EU ETS with other compatible trading systems in future (European Commission, 2007).

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Market Size and Scope

Tradable Unit and Pricing Information

Tradable units and pricing information for offset credits under the EU ETS are based on those used for the CDM and JI project based mechanisms respectively. Because the EU is the greatest purchaser of such credits the secondary market price for JI/CDM credits follows the same trend as the price for EUA's, be it with a discount to take account of delivery uncertainties.

Participants/Buyers

Participants and buyers of CDM and JI offset credits under the EU ETS include regulated emissions sources, as well as EU Member States themselves. Major European banks and other financial institutions both in the private and public sector have also become active in providing finance or managing funds for prospective emission reduction projects (European Commission, 2007)

Current Project Portfolio

Limits on the use of CDM and JI credits for compliance under Phase II of the EU ETS vary by Member State, as shown in Table 1, based on National Allocation Plans (NAPs) submitted by each Member State to the European Commission for review and approval. Based on these national limits, the upper limit for the total use of JI/CDM credits under the EU ETS under Phase II is 278.2 MMtCO2e per year, as shown in the last column of Table 1.

To date, European buyers have dominated the CDM market and it is estimated that much of the demand from EU ETS regulated entities for CDM and JI credits has already been contracted either directly by the regulated installations themselves, or indirectly by institutions planning to sell the credits back on the secondary market (Capoor and Ambrosi, 2007).

Table 1. EU ETS National Allocation Plans Summary Table

Member State	Annual Cap 2008-2012 in MMt CO2e	Annual JI/CDM limit in %	Annual JI/CDM limit in MMt CO2e
Austria	30.7	10	3.1
Belgium	58.5	8.4	4.9
Bulgaria	42.3	12.55	5.3
Cyprus	5.48	10	0.5
Czech Rep.	86.8	10	8.7
Denmark	24.5	17.01	4.2
Estonia	12.72	0	0.0
Finland	37.6	10	3.8
France	132.8	13.5	17.9
Germany	453.1	20	90.6
Greece	69.1	9	6.2
Hungary	26.9	10	2.7
Iceland
Ireland	22.3	10	2.2
Italy	195.8	14.99	29.4
Latvia	3.43	10	0.3
Lichtenstein
Lithuania	8.8	20	1.8
Luxembourg	2.5	10	0.3
Malta	2.1	tbd	tbd
Netherlands	85.8	10	8.6
Norway
Poland	208.5	10	20.9
Portugal	34.8	10	3.5
Romania	75.9	10	7.6
Slovakia	30.9	7	2.2
Slovenia	8.3	15.76	1.3
Spain	152.3	ca. 20	30.5
Sweden	22.8	10	2.3
UK	246.2	8	19.7
Total	2080.93	-	278.2

Values calculated by the author based on emissions cap and JI/CDM % limit.

Source: European Commission, 2007a

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Offset Project Eligibility

Project Types

During the second phase all CDM and JI project types are eligible, except those from nuclear facilities and land use, land-use change and forestry activities. In the case of hydroelectric power production project activities with a generating capacity exceeding 20 MW, Member States shall ensure that relevant international criteria and guidelines, including those contained in the World Commission on Dams November 2000 Report “Dams and Development: A New Framework for Decision-Making”, will be respected during the development of such project activities. (European Commission, 2007).