National Allocation Plan

The European Union Emission Trading System (EU ETS) is the largest multi-national, emissions trading scheme in the world,^[1] and is a major pillar of EU climate policy. The ETS currently covers more than 10,000 installations 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.^[2]

Under the EU ETS, large emitters of carbon dioxide within the EU must monitor and annually report their CO₂ emissions, and 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 neutralise annual irregularities in CO₂-emission levels that may occur due to extreme weather events (such as harsh winters or very hot summers), emission allowances 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 allowances for free from the EU member states' governments. Besides receiving this initial allocation on a plant-by plant basis, an operator may purchase EU allowances from others (installations, traders, the government.) If an installation has received more free allowances than it needs, it may sell them to anybody.

In January 2008, the European Commission proposed a number of changes to the scheme, including centralized allocation (no more national allocation plans) by a 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 and perfluorocarbons.^[2]. 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. It is also under consideration whether or not to extend the EU ETS to other industries (airlines^[3]).

Mechanisms

The EU scheme used to be a system of climate change policy that was completely independent of International Climate Change Policy such as the United Nations' Framework Convention on Climate Change (UNFCCC, 1992) or the Kyoto Protocol that was subsequently (1997) established under it. When the Kyoto Protocol came into force on 16th February 2005, the EU ETS had already become operational. Only later, the EU decided to accept 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 the Joint Implementation (JI, Art. 6 Kyoto Protocol), the Clean Development Mechanism (CDM, Art. 12 Kyoto Protocol) and the International Emissions Trading (Art. 17 Kyoto Protocol). The latter bears no direct relevance for the EU ETS, but certificates from Clean Development Mechanism projects have become a relevant compliance tool for EU ETS operators. These Certified Emission Reductions (CERs) can be obtained by implementing emission reduction projects in developing nations that have ratified (or acceded to) the Kyoto Protocol. The implementation of Clean Development Projects is largely specified by the Marrakech Accords, a row of decisions by the Conference of the Parties to the Kyoto Protocol. Although the Kyoto process had no direct influence on the designing of the EU ETS, its legislators drew on the experiences gained during the running of the voluntary UK Emissions Trading Scheme in the previous years.^[4]

Under the EU ETS, the governments of the EU Member States agree national emission caps which have to be approved by the EU commission, allocate allowances to their industrial operators, track and validate the actual emissions in accordance against the relevant assigned amount, and 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:

When each change of ownership of an allowance is proposed, the national registry and the European Commission are informed in order for them to validate the transaction. During Phase II of the EU ETS the UNFCCC will also validate any change that alters the distribution within each national allocation plan.

Thus one EU Allowance Unit of one tonne of CO₂, or "EUA", was designed to be identical ("fungible") with the equivalent "Assigned Amount Unit" (AAU) of CO₂ defined under Kyoto. Hence, because of the EU's decision to accept Kyoto-CERs as equivalent to EU-EAUs, it will be possible to trade EAUs and UNFCCC-validated CERs on a one-to-one basis within the same system. (However, the EU has announced that this facility is being delayed, possibly until 2009, until it can overcome its technical problems connecting to the UN systems.^[5])

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 order to make sure that real trading emerges (and that CO₂ emissions are reduced), EU governments must make sure that the total amount of allowances issued to installations is less than the amount that would have been emitted under a business-as-usual scenario. For each 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%.^[6]

During Phase I, most allowances in all countries were given freely (known as grandfathering). This approach has been criticized as giving rise to windfall profits, being less efficient than auctioning, and providing too little incentive for innovative new competition to provide clean, renewable energy.^[7]^[8]

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. At the time of writing (January 2008), the proposal would still need approval from the European member states and the EU Parliament to come into effect.

Banking and Borrowing

Within Phase I, banking and borrowing is allowed. For example, a 2006 EUA can be used in 2007 (Banking) or in 2005 (Borrowing). Banking and borrowing of EUA's from Phase I to Phase II is not allowed. ^[9]

Phase I

In the first phase (2005-2007), the EU ETS includes some 12,000 installations, representing approximately 40% of EU CO₂ emissions,^[10] 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 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 meant that market participants were already in place and ready. In its first year, 362 million tonnes of CO₂ were traded on the market for a sum of €7.2 billion, and a large number of futures and options.^[11] The price of allowances increased more or less steadily to its peak level in April 2006 of about €30 per tonne CO₂,^[12] 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.

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).^[14]

Phase II

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 of 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.^[20]

Ultimately, the Commission wishes the post-2012 ETS to include all greenhouse gases and all sectors, including aviation, maritime transport and forestry.^[21] 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.^[22]

The National Allocation Plans for Phase II, the first of which were announced on 29 November 2006, will result in an average cut of nearly 7% below the 2005 emission levels.^[23] The annual Member State CO₂ allowances in million tonnes allowances are:

Overall emission reductions

The environmental effectiveness of the scheme rests on the tightness of the caps. Phase 1 was widely believed to be overallocated, implying that little, if any, additional overall emission reductions have been achieved.

In 2004, Ecofys analysed the then available preliminary NAPs of all EU countries.^[25] 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 called the caps a 'major disappointment',^[26] 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^[27] and below €1 in February 2007, reaching an all time low of €0.03 at the beginning of December 2007^[28]

In 2006, Ecofys performed an initial assessment of NAPs for phase II, using the proposed but not-yet-approved NAPs.^[29] 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%,^[30] also corresponding with 7% below the 2005 emissions. However, as of January 2007, not all plans have been finalized.

The inclusion of sinks

Currently, the EU does not allow CO₂ credits under ETS to be obtained from sinks (e.g. reducing CO₂ by planting trees). However, some governments and industry representatives lobby for their inclusion. The inclusion is currently opposed by NGO's 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.^[31]

References

^ The European Union Emissions Trading System Review of Environmental Economics and Policy 2007
^ ^a ^b Questions and Answers on the Commission's proposal to revise the EU Emissions Trading System, MEMO/08/35, Brussels, 23 January 2008
^ Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions – Limiting global climate change to 2 degrees Celsius - The way ahead for 2020 and beyond, Brussels, 10 October 2007
^ UK Emissions Trading Scheme DEFRA
^ ITL link, EU ETS review key for 2008 prices Carbon Finance 9 January, 2008
^ Questions and Answers on Emissions Trading and National Allocation Plans for 2008 to 2012 EU November 2006
^ Öko-Institut report: "The environmental effectiveness and economic efficiency of the EU ETS WWF November 2005
^ NAPs 2005-7: Do they deliver? Climate Action Network Europe 2006
^ MIT Article Accessed 26JUN2008
^ Q&A: Europe's carbon trading scheme BBC November 2006
^ Carbon 2006 market survey Point Carbon 28 February 2006
^ Analyse van de CO₂-markt Emissierechten November 2007(in Dutch)
^ Rapid - Press Releases - EUROPA
^ Emissierechten (in Dutch)
^ Emissions trading: Commission adopts decision on Austria's national allocation plan for 2008-2012 EU Europa
^ Emissions trading: Commission adopts decision on Italy's national allocation plan for 2008-2012
^ DEAD LINK Evomarkets
^ Questions & Answers on Aviation & Climate Change EU Europa
^ Iceland, Norway, Liechtenstein to join EU emissions trading system EU Business 27 October 2007
^ Including Aviation into the EU ETS: Impact on EU allowance prices ICF Consulting for DEFRA February 2006
^ Stavros Dimas Speech House of Commons London, EU Europa 21 November 2005
^ DEAD LINK Naturvardsverket (in Swedish)
^ Emissions trading: Commission decides on first set of national allocation plans for the 2008-2012 trading period EU Europa November 2006
^ Member States' compliance with the Emissions Trading Scheme EU Europa Environment Committee 27 November 2006
^ Analysis of NAPs for the EU ETS Ecofys August 2004
^ NAPsReport_Summary Climate Action Network 2006
^ Market analysis Emissierechten (in Dutch)
^ Market information EEX
^ NAP Assessment summary Ecofys (registration required)
^ Emissions trading: Commission decides on first set of national allocation plans for the 2008-2012 trading period EU Europa
^ Hotspot newsletter Climate Action Network, March 2006

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