The EU Emissions Trading System: an Introduction

A robust carbon price also promotes investment in clean, low-carbon technologies. Progress report to Parliament Committee on Climate Change. As a signatory to the Kyoto Protocol in its own right, the Community is also obliged to maintain a registry. The Member State may choose to co-finance the project as well, but will in any case transfer the market value of the attributed allowances to the operator, who will not receive any allowances. 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. In response, the price for both phase I and phase II allowances fell significantly:

The EU emissions trading system (EU ETS) is a cornerstone of the EU's policy to combat climate change and its key tool for reducing greenhouse gas emissions cost-effectively. It is the world's first major carbon market and remains the biggest one.

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The main difference as compared to the proposal is that auctioning of allowances will be phased in more slowly. In their NAPs for the first and the second trading periods, Member States determined the total quantity of allowances to be issued — the cap — and how these would be allocated to the installations concerned. This approach has generated significant differences in allocation rules, creating an incentive for each Member State to favour its own industry, and has led to great complexity.

As from the third trading period, there will be a single EU-wide cap and allowances will be allocated on the basis of harmonised rules. National allocation plans will therefore not be needed any more. From , the total number of allowances will decrease annually in a linear manner.

The starting point of this line is the average total quantity of allowances phase 2 cap to be issued by Member States for the period, adjusted to reflect the broadened scope of the system from as well as any small installations that Member States have chosen to exclude. The linear factor by which the annual amount shall decrease is 1. The starting point for determining the linear factor of 1. The division that minimises overall reduction cost amounts to:.

All absolute figures indicated correspond to the coverage at the start of the second trading period and therefore don't take account of aviation, which will be added in , and other sectors that will be added in phase 3.

The final figures for the annual emission caps in phase 3 will be determined and published by the Commission by 30 September The linear factor of 1. It may be revised by at the latest. No, flexibility for installations will not be reduced at all. In any year, the allowances to be auctioned and distributed have to be issued by the competent authorities by 28 February. The last date for operators to surrender allowances is 30 April of the year following the year in which the emissions took place.

So operators receive allowances for the current year before they have to surrender allowances to cover their emissions for the previous year. Allowances remain valid throughout the trading period and any surplus allowances can now be "banked" for use in subsequent trading periods. In this respect nothing will change. The system will remain based on trading periods, but the third trading period will last eight years, from to , as opposed to five years for the second phase from to For the second trading period Member States generally decided to allocate equal total quantities of allowances for each year.

The linear decrease each year from will correspond better to expected emissions trends over the period. These figures are based on the scope of the ETS as applicable in phase 2 to , and the Commission's decisions on the national allocation plans for phase 2, amounting to million tonnes.

These figures will be adjusted for several reasons. Firstly, adjustment will be made to take into account the extensions of the scope in phase 2, provided that Member States substantiate and verify their emissions accruing from these extensions. Secondly, adjustment will be made with respect to further extensions of the scope of the ETS in the third trading period. Thirdly, any opt-out of small installations will lead to a corresponding reduction of the cap.

Fourthly, the figures do not take account of the inclusion of aviation, nor of emissions from Norway, Iceland and Liechtenstein. Industrial installations will receive transitional free allocation. And in those Member States that are eligible for the optional derogation, power plants may, if the Member State so decides, also receive free allowances.

It is estimated that at least half of the available allowances as of will be auctioned. While the great majority of allowances has been allocated free of charge to installations in the first and second trading periods, the Commission proposed that auctioning of allowances should become the basic principle for allocation. This is because auctioning best ensures the efficiency, transparency and simplicity of the system and creates the greatest incentive for investments in a low-carbon economy.

These rules will fully harmonise allocations and thus all firms across the EU with the same or similar activities will be subject to the same rules. The rules will ensure as far as possible that the allocation promotes carbon-efficient technologies. The adopted rules provide that to the extent feasible, allocations are to be based on so-called benchmarks, e. Such rules reward operators that have taken early action to reduce greenhouse gases, better reflect the polluter pays principle and give stronger incentives to reduce emissions, as allocations would no longer depend on historical emissions.

All allocations are to be determined before the start of the third trading period and no ex-post adjustments will be allowed. Taking into account their ability to pass on the increased cost of emission allowances, full auctioning is the rule from onwards for electricity generators. However, Member States who fulfil certain conditions relating to their interconnectivity or their share of fossil fuels in electricity production and GDP per capita in relation to the EU average, have the option to temporarily deviate from this rule with respect to existing power plants.

If the option is applied, the Member State has to undertake to invest in improving and upgrading of the infrastructure, in clean technologies and in diversification of their energy mix and sources of supply for an amount to the extent possible equal to the market value of the free allocation.

However, an exception will be made for installations in sectors that are found to be exposed to a significant risk of 'carbon leakage'. This risk could occur if the EU ETS increased production costs so much that companies decided to relocate production to areas outside the EU that are not subject to comparable emission constraints.

The Commission will determine the sectors concerned by 31 December The share of these industries' emissions is determined in relation to total ETS emissions in to CO 2 costs passed on in electricity prices could also expose certain installations to the risk of carbon leakage. In order to avoid such risk, Member States may grant a compensation with respect to such costs. In the absence of an international agreement on climate change, the Commission has undertaken to modify the Community guidelines on state aid for environmental protection in this respect.

Under an international agreement which ensures that competitors in other parts of the world bear a comparable cost, the risk of carbon leakage may well be negligible.

Therefore, by 30 June , the Commission will carry out an in-depth assessment of the situation of energy-intensive industry and the risk of carbon leakage, in the light of the outcome of the international negotiations and also taking into account any binding sectoral agreements that may have been concluded. The report will be accompanied by any proposals considered appropriate.

These could potentially include maintaining or adjusting the proportion of allowances received free of charge to industrial installations that are particularly exposed to global competition or including importers of the products concerned in the ETS.

Member States will be responsible for ensuring that the allowances given to them are auctioned. Each Member State has to decide whether it wants to develop its own auctioning infrastructure and platform or whether it wants to cooperate with other Member States to develop regional or EU-wide solutions. The distribution of the auctioning rights to Member States is largely based on emissions in phase 1 of the EU ETS, but a part of the rights will be redistributed from richer Member States to poorer ones to take account of the lower GDP per head and higher prospects for growth and emissions among the latter.

Nine Member States benefit from this provision. Any auctioning must respect the rules of the internal market and must therefore be open to any potential buyer under non-discriminatory conditions. By 30 June , the Commission will adopt a Regulation through the comitology procedure that will provide the appropriate rules and conditions for ensuring efficient, coordinated auctions without disturbing the allowance market.

All allowances which are not allocated free of charge will be auctioned. The ETS covers installations performing specified activities. Since the start it has covered, above certain capacity thresholds, power stations and other combustion plants, oil refineries, coke ovens, iron and steel plants and factories making cement, glass, lime, bricks, ceramics, pulp, paper and board.

As for greenhouse gases, it currently only covers carbon dioxide emissions, with the exception of the Netherlands, which has opted in emissions from nitrous oxide. As from , the scope of the ETS will be extended to also include other sectors and greenhouse gases. CO 2 emissions from petrochemicals, ammonia and aluminium will be included, as will N2O emissions from the production of nitric, adipic and glyocalic acid production and perfluorocarbons from the aluminium sector.

The capture, transport and geological storage of all greenhouse gas emissions will also be covered. These sectors will receive allowances free of charge according to EU-wide rules, in the same way as other industrial sectors already covered.

A large number of installations emitting relatively low amounts of CO 2 are currently covered by the ETS and concerns have been raised over the cost-effectiveness of their inclusion. As from , Member States will be allowed to remove these installations from the ETS under certain conditions. For combustion installations, an additional capacity threshold of 35MW applies. In addition Member States are given the possibility to exclude installations operated by hospitals.

The installations may be excluded from the ETS only if they will be covered by measures that will achieve an equivalent contribution to emission reductions. For the second trading period, Member States allowed their operators to use significant quantities of credits generated by emission-saving projects undertaken in third countries to cover part of their emissions in the same way as they use ETS allowances.

For existing installations, and excluding new sectors within the scope, this will represent a total level of access of approximately 1.

New sectors and new entrants in the third trading period will have a guaranteed minimum access of 4. For the aviation sector, the minimum access will be 1. The precise percentages will be determined through comitology. On the quality side only credits from project types eligible for use in the EU trading scheme during the period will be accepted in the period Furthermore, from 1 January measures may be applied to restrict the use of specific credits from project types.

Such a quality control mechanism is needed to assure the environmental and economic integrity of future project types. To create greater flexibility, and in the absence of an international agreement being concluded by 31 December , credits could be used in accordance with agreements concluded with third countries. Such agreements would not be required for new projects that started from onwards in Least Developed Countries. Based on a stricter emissions reduction in the context of a satisfactory international agreement , additional access to credits could be allowed, as well as the use of additional types of project credits or other mechanisms created under the international agreement.

However, once an international agreement has been reached, from January onwards only credits from projects in third countries that have ratified the agreement or from additional types of project approved by the Commission will be eligible for use in the Community scheme. It concluded that doing so could undermine the environmental integrity of the EU ETS, for the following reasons:.

The Commission, the Council and the European Parliament believe that global deforestation can be better addressed through other instruments. In this respect the Commission has proposed to set up the Global Forest Carbon Mechanism that would be a performance-based system for financing reductions in deforestation levels in developing countries.

These Community projects would need to be managed according to common EU provisions set up by the Commission in order to be tradable throughout the system. Such provisions would be adopted only for projects that cannot be realised through inclusion in the ETS.

The provisions will seek to ensure that credits from Community projects do not result in double-counting of emission reductions nor impede other policy measures to reduce emissions not covered by the ETS, and that they are based on simple, easily administered rules.

A stable and predictable regulatory framework is vital for market stability. The revised Directive makes the regulatory framework as predictable as possible in order to boost stability and rule out policy-induced volatility.

Important elements in this respect are the determination of the cap on emissions in the Directive well in advance of the start of the trading period, a linear reduction factor for the cap on emissions which continues to apply also beyond and the extension of the trading period from 5 to 8 years. For the second and subsequent trading periods, Member States are obliged to allow the banking of allowances from one period to the next and therefore the end of one trading period is not expected to have any impact on the price.

A new provision will apply as of in case of excessive price fluctuations in the allowance market. If, for more than six consecutive months, the allowance price is more than three times the average price of allowances during the two preceding years on the European market, the Commission will convene a meeting with Member States.

The price of allowances is determined by supply and demand and reflects fundamental factors like economic growth, fuel prices, rainfall and wind availability of renewable energy and temperature demand for heating and cooling etc. A degree of uncertainty is inevitable for such factors. The markets, however, allow participants to hedge the risks that may result from changes in allowances prices. One of the key means to reduce emissions more cost-effectively is to enhance and further develop the global carbon market.

The Commission sees the EU ETS as an important building block for the development of a global network of emission trading systems. Linking other national or regional cap-and-trade emissions trading systems to the EU ETS can create a bigger market, potentially lowering the aggregate cost of reducing greenhouse gas emissions. The increased liquidity and reduced price volatility that this would entail would improve the functioning of markets for emission allowances.

This may lead to a global network of trading systems in which participants, including legal entities, can buy emission allowances to fulfil their respective reduction commitments. The EU is keen to work with the new US Administration to build a transatlantic and indeed global carbon market to act as the motor of a concerted international push to combat climate change. While the original Directive allows for linking the EU ETS with other industrialised countries that have ratified the Kyoto Protocol, the new rules allow for linking with any country or administrative entity such as a state or group of states under a federal system which has established a compatible mandatory cap-and-trade system whose design elements would not undermine the environmental integrity of the EU ETS.

Where such systems cap absolute emissions, there would be mutual recognition of allowances issued by them and the EU ETS. Registries are standardised electronic databases ensuring the accurate accounting of the issuance, holding, transfer and cancellation of emission allowances.

As a signatory to the Kyoto Protocol in its own right, the Community is also obliged to maintain a registry. This is the Community Registry, which is distinct from the registries of Member States. Allowances issued from 1 January onwards will be held in the Community registry instead of in national registries.

A separate Regulation on the verification of emission reports and the accreditation of verifiers should specify conditions for accreditation, mutual recognition and cancellation of accreditation for verifiers, and for supervision and peer review as appropriate.

The allocations from this reserve should mirror the allocations to corresponding existing installations. A part of the new entrant reserve, amounting to million allowances, will be made available to support the investments in up to 12 demonstration projects using the carbon capture and storage technology and demonstration projects using innovative renewable energy technologies.

There should be a fair geographical distribution of the projects. In principle, any allowances remaining in the reserve shall be distributed to Member States for auctioning. The distribution key shall take into account the level to which installations in Member States have benefited from this reserve. The "Linking Directive" allows operators to use a certain amount of Kyoto certificates from flexible mechanism projects in order to cover their emissions.

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 , 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 in the previous years, [17] and collaborated with other parties to ensure its units and mechanisms were compatible with the design agreed through the UNFCCC.

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. 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 , 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 and the European Commission are informed in order for them to validate the transaction.

However, the EU was not able to link trades from all its countries until because of its technical problems connecting to the UN systems. The total number of permits issued either auctioned or allocated determines the supply for the allowances. The actual price is determined by the market. Too many allowances compared to demand will result in a low carbon price, and reduced emission abatement efforts.

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.

This approach has been criticized [22] 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. To address these problems, [ citation needed ] the European Commission proposed various changes in a January package, including the abolishment of NAPs from and auctioning a far greater share ca. From the start of Phase III January there will be a centralised allocation of permits, not National Allocation Plans, with a greater share of auctioning of permits.

Allocation can act as a means of addressing concerns over loss of competitiveness , and possible "leakage" carbon leakage 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. Correcting for leakage by allocating permits acts as a temporary subsidy 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. Within a certain trading period, banking and borrowing is allowed. For example, a EUA can be used in banking or in borrowing. Interperiod borrowing is not allowed. However, the prior existence of the UK Emissions Trading Scheme meant that market participants were already in place and ready.

In , carbon prices for the trial phase dropped to near zero for most of the year. Meanwhile, prices for Phase II remained significantly higher throughout, reflecting the fact that allowances for the trial phase were set to expire by 31 December Verified emissions show a net increase over the first phase of the scheme. For the countries for which data was available, emissions increased by 1.

Consequently, observers have accused national governments of abusing the system under industry pressure, and have urged for far stricter caps in the second phase — The second phase —12 expanded the scope of the scheme significantly. 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.

The full activation process will include the migration of over 30, EU ETS accounts from national registries. Aviation emissions were to be included from The airline industry and other countries including China, India, Russia, and the United States reacted adversely to the inclusion of the aviation sector.

The EU insisted that the regulation should be applied equally to all carriers, and that it did not contravene international regulations.

In the absence of a global agreement on airline emissions, the EU argued that it was forced to go ahead with its own scheme. But only flights within the EEA are covered; international flights are not. Ultimately, the Commission intended that the third trading period should cover all greenhouse gases and all sectors, including aviation, maritime transport, and forestry. The annual Member State CO 2 yearly allowances in million tonnes are shown in the table:. Additional installations and emissions included in the second trading period are not included in this table but are given in the sources.

Prices for EU allowances for December delivery dropped 8. The market had been oversupplied with permits. In July , Thomson Reuters Point Carbon stated that it considered that without intervention to reduce the supply of allowances, the price of allowances would fall to four Euros.

As well as more sectors and gases included in Phase III. Also, millions of allowances set aside in the New Entrants Reserve NER to fund the deployment of innovative renewable energy technologies and carbon capture and storage through the NER programme,one of the world's largest funding programmes for innovative low-carbon energy demonstration projects.

Phase IV will commence on 1 January and finish on 31 December The European Commission plans a full review of the Directive by Connie Hedegaard, the EU Commissioner for Climate Change, hoped "to link up the ETS with compatible systems around the world to form the backbone of a global carbon market" with Australia cited as an example.

Before the European Council summit on 20 March , [73] the European Commission decided to propose a change in the functioning of the carbon market CO2 permits. The reserve would operate on predefined rules with no discretion for the Commission or Member States. The European Parliament and the European council informally agreed on an adapted version of this proposal, which sets the starting date of the MSR to so already in Phase III , puts the million backloaded allowances in the reserve and reduces the reaction time of the MSR to one year.

This adapted proposal has already passed the European parliament and is to be approved by the Council of ministers in September Emissions in the EU have been reduced at costs that are significantly lower than projected, [29] though transaction costs are related to economies of scale and can be significant for smaller installations.

It was suggested that if permits were auctioned, and the revenues used effectively, e. 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.

A phishing 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, EC 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 , allowances stolen from the Czech registry, according to Mr. The security breaches raised fears among some traders that they might have unknowingly purchased stolen allowances which they might later have to forfeit.

In December a German court sentenced six people to jail terms of between three years and seven years and 10 months in a trial involving evasion of taxes on carbon permits. A French court sentenced five people to one to five years in jail, and to pay massive fines for evading tax through carbon trading. Seinen also commented that the EU ETS needed to be supported by other policies for technology and renewable energy.

According to CCC , p. Researchers Preston Teeter and Jorgen Sandberg have argued that it is largely the uncertainty behind the EU's scheme that has resulted in such a tepid and informal response by regulated organizations. Their research has revealed a similar outcome in Australia, where organizations saw little incentive to innovate and even comply with cap and trade regulations.

This drove the carbon price down to zero in CCC, , p. This problem naturally diminishes as the cap tightens. Over-allocation does not imply that no abatement occurred. Even with over-allocation, there was theoretically a price on carbon except for installations that received hundreds of thousands of free allowances.

For some installations, the price had a some effect on emitters' behavior. In September Thomson Reuters Point Carbon calculated that the first Kyoto Protocol commitment period had been oversupplied by about 13 billion tonnes According to Newbery , the price of EUAs was included in the final price of electricity. Newbery wrote that "[there] is no case for repeating such a wilful misuse of the value of a common property resource that should be owned by the country". The price of emissions permits tripled in the first six months of Phase I, collapsed by half in a one-week period in , 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.

Nonetheless, producers and consumers in those markets respond rationally and effectively to price signals. Newbery commented that the EU ETS was not delivering the stable carbon price necessary for long-term, low-carbon investment decisions. The main theoretical advantage of allowing free trading of credits is that it allows mitigation to be done at least-cost CCC, , p. In terms of the UK's climate change policy, CCC , noted three arguments against too great a reliance on credits:.

The ban includes nitrous oxide N2O from adipic acid production. The reasons given were the perverse incentives, the lack of additionality, the lack of environmental integrity,the under-mining of the Montreal Protocol, costs and ineffectiveness and the distorting effect of a few projects in advanced developing countries getting too many CERs.

This is a way to avoid several problems of CDM and JI such as additionality, measurement, leakage, permanence, and verification. Furthermore, it reduces the available allowances in the cap-and-trade system, which means that it reduces the emissions that can be produced by covered sources. The EU is negotiating a link with Switzerland's domestic trading system. Linking [] systems creates a larger carbon market, which can reduce overall compliance costs, increase market liquidity and generate a more stable carbon market.

Some scholars have argued that linking may provide a starting point for developing a new, bottom-up international climate policy architecture whereby multiple unique systems successively link their various systems. From Wikipedia, the free encyclopedia. This section's tone or style may not reflect the encyclopedic tone used on Wikipedia. See Wikipedia's guide to writing better articles for suggestions.

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The European Union Emissions Trading System (EU ETS) puts limits on carbon dioxide emissions from more than 11, power stations and industrial plants, as well as aircraft operators, in more than 30 participating countries. It covers approximately 45% of the EU’s total greenhouse gas emissions. Data about the EU emission trading system (ETS). The EU ETS data viewer provides aggregated data on emissions and allowances, by country, sector and year. The European Union's Emissions Trading System (ETS) is the world's biggest scheme for trading greenhouse gas emissions allowances. Launched in , it covers some 11, power stations and industrial plants in 30 countries, whose carbon emissions make up almost 50% of Europe's total.