ETS – How does it work?Dr Marzena Chodor, Clima East Key Expert

Moscow, 08.04.2014

Contents:

• Cap and trade system: main elements• Cap and trade system: how does it work and why does it work?• EU ETS: history • Legal framework• Scope of the EU ETS• ETS: main elements in 2005-2012 • Carbon market in 2005-2012• Main lessons from 2005-2012• EU climate policy goals until 2020• EU approach from 2013• Aviation in emissions trading• ETS 2013 – 2020. Main features• Lessons from target setting – creating the market

Cap and trade system: main elements• A cap on annual emissions/ a cap on annual allocation

(of emission allowances)• Identified participants

– registered (eg. through permits)– obliged to comply with rules

• Allowances distributed or acquired (auction, market)– tradeable– transferable freely/with constraints– bankable/not bankable– 1 allowance equals one tonne of CO2

• MRV

Cap and trade system: how does it work?

• Regulator determines allowed emissions level (the cap), and creates and distributes allowances corresponding to the cap

• Allowances are put in circulation

• Scarcity gives allowances value

• Carbon market develops– Price signal guides companies by how much to reduce

emissions

– Regulator enforces rules and levies sanctions, if needed

Cap and trade system: why does it work?• The emissions allowance is an asset with immediate value • Some companies find it easier and less expensive to reduce

their emissions below their required limits than other • More efficient companies, which release less carbon dioxide

equivalent than their limit set in a given year/period, can sell their surplus allowances to companies that cannot reduce their emissions or want to increase production

• Cap and trade systems reward the most efficient companies and provide incentive to increase carbon efficiency over time

• The prices of allowances are visible signals of current cost of carbon dioxide reductions

EU ETS: history

• The EU ETS started in January 2005• First EU ETS phase (trial) 2005 -2007• Second EU ETS phase 2008-2012• Third EU ETS phase 2013 – 2020 (and beyond)• GHGs included:

– Carbon dioxide (2005-2012)– N2O, PFC (from 2013)

• Coverage: about 11 thousand installations• Around 45% of EU GHG emissions• 28 EU Member States and 3 EEA-EFTA states

EU ETS: legal framework

• Directive 2003/81/EC (adopting emissions trading)• Directive 2004/101/EC (linking directive)• Directive 2008/101/EC (including aviation activities in

ETS)• Directive 2009/29/EC (ETS review – part of the climate

and energy package)• Current key implementing provisions:

– Commission Regulation No 389/2013 establishing a Union Registry

• Forthcoming:– Draft Regulation on determining international credit entitlements

Scope of the ETS: activities

• Combustion installations above 20 MW• Oil refineries• Ferrous metals production above 2,5t/hr• Cement production• Glass production above 20 t/d• Ceramics production above 75 t/day• Pulp and paper production above 20 t/d• International aviation (flights from and to the EU airports) - entry

into force in 2012– A retroactive suspension applied to intercontinental flights (stop the clock in

April 2013)

• PFCs from alluminium production and N2O emissions from chemical plants included from 2013

ETS 2005-2012

• Applicable since January 2005• Environmental outcome determined – puts a cap on

emissions from 10,000 energy-intensive installations across EU (25, later 27, and 30 countries, around 2 billion tonnes/ yr)

• Covering around half of EU’s total CO2 emissions • Companies can choose:

• To emit allocated emission rights (allowances) or• To reduce emissions below allocation and sell or bank• To emit more than allocation and buy

• Cost-effective emissions reductions to the level of the cap, because investments take place where cheapest

ETS design

• Simple “downstream” cap-and-trade system for major emitting

industries that is part of a comprehensive policy

– the largest cap-and-trade scheme ever implemented

• Monitoring rules for direct emissions, independent verification

• Robust penalties to ensure compliance (€100 + shortfall)

• Electronic registry system to record holdings of allowances

• Market development driven by the private sector

ETS 2005-2012

• Member States initially responsible for setting the cap on national level and distribution of allowances through NAPs (National Allocation Plans)

• NAPs approved by the European Commission– assessment of national allocation plans against agreed common criteria: – consistency with actual and projected emissions, consistency with potential to reduce

emissions, not more allowances than needed, on track for reduction commitments, not unfairly discriminating

– transparency, comments by the public

• 25 (in phase II 27) registries• National authorities overseeing compliance• only on average 5% allowances auctioned, the remainder

distributed free of charge• Dominant allocation methodology - grandfathering

Allocation

• In the period 2005-2012 the task of each Member State• Main challenges in the inception phase:

– Identifying covered installations– Gathering and processing of relevant data– Fixing the national cap and deciding on the path to the Kyoto

target– Elaborating allocation rules at sector and installation level– Elaborating new entrants and closure rules– Overcoming know-how gaps in authorities and among

stakeholders– Organizing public consultation and securing political

acceptability– Tight time schedule

Compliance

• Member State competence, harmonized elements:

– no permit, no operation

– blocking transfers if no verified emission report by 31 March

– name & Shame if not surrendered sufficient allowances

– €40 penalty and compensate shortfall for insufficient

surrendering

Links to the Kyoto Protocol mechanisms • Art 30 ETS Directive: “emission credits from the project-based

mechanisms will be recognised for their use in this scheme subject to provisions adopted by Parliament and Council on a proposal from the Commission”

• Directive 2004/101/EC (linking directive) • Clean Development Mechanism (CDM) from 2005, Joint

Implementation (JI) from 2008• Supplementarity: from 2008, use limited to % of allocation of

allowances to each installation• Harmonised EU-wide exclusion of nuclear energy projects and

temporary forestry credits, national decisions on other types of credits• Double-counting guidelines – Commission Decision C(2006)5362• Large hydro: MSs to make sure that relevant international criteria and

guidelines will be respected during the development phase

Carbon market prices in 2005-2012

Source Point Carbon

ETS cut emissions by 2 % to 5% in Phase1 1

ETS emissions down 13.7% 2007 - 2009 2

1 assessment by Ellerman et al, ‘Pricing Carbon 20102 verified emissions data, European Commission

Main lessons from 2005-2012:• EU ETS developed into the largest carbon market in the world

• Carbon market infrastructure operational: • MRV, institutional capacity in EU Member States, electronic registries

• Strong, harmonised provisions to ensure compliance (€40/tonne)

• Liquid carbon market and reflective carbon pricing

• However: Member States’ NAPs not based on verified emissions + litigation Reductions projected by MS proved insufficient in terms of scarcity,

which led to a price crash

• Long term - a market-based signal for low carbon investments

EU (unconditional) climate policy goals until 2020:

• 20% reduction in EU greenhouse gas emissions from 1990 levels;

• 20% increase in the share of EU energy consumption produced from

renewable resources

• 20% improvement in the EU's energy efficiency

• implemented through a package of binding legislation entering into

force from 2013

• Climate and Energy Package adopted in 2008

• contains directives to be implemented by MS (ETS, RES, CCS)

• and Effort Sharing Decision

Carbon capture and storage Directive

CO2&cars

Renewable Energy Directive

Fuel Quality Directive

-20% / -30% wrt 1990 levels by 2020

technology specific & product policies

cross-sectoral targets & instruments

large industrial installations & aviation

“small emitters”

EU ETS

Effort SharingDecision

Instruments of EU emission reductions from 2013

GHG reduction target:

-20% compared to 1990

-14% compared to 2005

EU ETS-21% compared

to 2005

Non-ETS sector -10% compared to 2005

27 national targets, from -20% to +20%

EU approach

Aviation in emissions trading - rationale• Contributes to climate change through emissions of carbon

dioxide, nitrogen oxides and cirrus effects

• Taxation not blocked by 1944 Chicago Convention, but various bilateral air service agreements historically foresee exemption from general fuel taxation

• 1992 UNFCCC requires States to take measures to reduce emissions

• Under Kyoto Protocol, States were asked to make progress working in international forum: International Civil Aviation Organisation (ICAO)

• International emissions from aviation not part of States’ Kyoto commitments for emission reductions

Aviation in emissions trading - rationale• Overall EU objective: limit global warming to 2° C

above pre-industrial level to avoid dangerous climate change

• All sectors should contribute to emission reductions

• Early industry preference for open emissions trading above taxes and charges and technical regulation

• more disagreement than agreement in ICAO discussions on any market-based action

Projections of aviation emissions growth

Source: EC

Predicted Global Future Aviation Emissions Growth(2006 baseline)

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Mt

CO

eq.

202063% to 88%

increase

2050 290% to 667%

increase

Aviation in emissions trading - design• All flights to and from EU airports • Small aircraft and certain flights excluded• Equivalent action on aviation emissions taken by other

countries recognised

• Total quantity of allowances equivalent to 97% of average annual emissions 2004-6

• From 2013, total quantity of allowances equivalent to 95% of average annual emissions 2004-6

• Allocation based on commonly-agreed benchmark (T/km) combined with harmonised level of auctioning– 15% auctioning from 2012 until 2020

• All auction revenues should be used for addressing climate change and to adapt to its effects

ETS 2013-2020

• Directive 2009/29/EC amending Directive 2003/81/EC• One single EU –wide cap (limit) set on the total GHG emitted by

installations included in the EU ETS– EU ETS cap set at 2,084,301,856 allowances in 2013– Decreasing by 1.74% anually– Reduction continued beyond 2020 (revised no later than 2025)– Aiming at -21% reduction against 2005 levels

• Harmonised allocation - main allocation method: auctioning– The proportion increasing annually– At least 48 % in ETS phase III

• The remaining allowances allocated free of charge to industry threatened by carbon leakage, based on benchmarking

• Strengthened MRV• Increased scope (new GHG, new activities)

ETS 2013-2020 – broader scope:

• New sectors– Aluminium– Basic chemical production

• New gases:– PFCs from aluminium– nitrous oxide from certain chemicals

• Broad interpretation of “combustion”, Annex I listing only activities

• Combined effect: approx. 6 - 7% increase of scope compared to current trading period

• Confirmation that all sectors should contribute to emission reduction commitments– Aviation– Maritime transport: future action foreseen

ETS 2013-2020 – strengthened MRV:• Monitoring and Reporting Regulation• Replaced earlier guidelines• Verification and Accreditation Regulation

– New EU-wide rules replacing regulation on MS level• Harmonised €100 penalty for non-compliance

– requirement to surrender allowances remains• Single Union registry

– MS responsible for operations on MS level

ETS 2013-2020 – allocation principles:• Harmonised allocation rules to ensure a level

playing field across the EU:– No distortion of competition– Fully equal treatment within sectors across EU

• Auctioning as the general rule, with transitional free allocation up to 2020

• In terms of allocation rules, three categories of operators:– No free allocations (i.e. full auctioning) – Partial free allocation (no carbon leakage)– Up to 100% free allocation (carbon leakage – based on

benchmarks)

ETS 2013-2020 – auctioning:

• Basic long-term principle for allocation: – Eliminates ‘windfall’ profits– Simplest and most transparent allocation system– Level playing field for new entrants and incumbents

• Auctioning on the basis of harmonised rules:– Transparency and non-discrimination– Full access for SMEs

• Full auctioning for sectors able to pass on costs: – Power sector, except CHP and district heating (except agreed

derogations)

• Revenues to accrue to Member States, with 50% used to address climate change and its effects

ETS 2013-2020 – auctioning:

• Auctioning Regulation agreed unanimously by Member States and adopted (12 November 2010, with later amendments)

• MS determine use of revenues, but at least 50% should be used for climate related purposes

• MSs shall inform on use of revenues through the reports under GHG monitoring Decision 280/2004/EC

• 88% of auction rights distributed according to MS’ share in verified emissions in 2005 or average of period from 2005 – 07 (whichever is the highest)

• 10% for purpose of solidarity and growth (Annex IIa)• 2% “Kyoto bonus”: at least 20% below Kyoto base year

emission levels

ETS 2013-2020 – transitional free allocation• Transitional free allocation to industry

– quantities determined in accordance with Community-wide rules– Annual reductions of free quantity

• To result in full auctioning by 2020 for “normal” industry (no carbon leakage)

• Community-wide rules - benchmarking, for free allocation– determined taking into account most efficient techniques, substitutes, alternative

production processes, etc.• Levels of allocation under rules reducing over time in line with

reduction pathway• No free allocation for electricity production (as a rule, except

transtional measures in some MS)• installations in sectors exposed to a significant risk of carbon leakage

can receive up to 100% free allocation of the quantity of allowances determined under the general Community-wide rules

ETS 2013-2020 – transitional option of free allocation for electricity producers• 10 Member States qualify

– New EU12 except SI, SK, maximum 14% of EU power generation• For existing installations only• Conditional upon national plan to modernise energy infrastructure, clean

technologies, diversification of energy mix– Taking into account the need to limit as far as possible directly linked prices rises– Monitoring and enforcement provisions.– Annual reporting (to the European Commission)

• Total amount in 2013 maximised at 70% of 2005-2007 verified emissions, gradual decrease to zero in 2020

– For the amount corresponding to gross final national consumption of the MS• Individual allocation based on 2005-2007 verified emissions/benchmark

– Option of non-transferable allowances – Commission guidance

ETS 2013-2020 – use of JI and CDM credits

• Use of CDM should not exceed 50% of reduction below 2005 over period 2008-2020 for existing operators and not exceed 50% of reductions below 2005 over period 2013-2020 for new sectors and aviation– Existing operators receive no less than 11% of 2008-2012 allocation

– Least endowed operators receive additional access up to a certain %

– New entrants and new sectors receive access to no less than 4.5% of verified emissions

– Aviation receives no less than 1.5% of actual emissions

• Exact percentages determined through a regulation

Lessons from target setting – creating the market• Markets do not function properly without demand• Demand means scarcity• Scarcity depends on

– Getting baseline data – monitoring and reporting– Capping emissions below demand (taking into account accuracy)

• Accuracy depends on MRV and Scope• Keep systems simple

– Cover installations/ gases at the outset where sufficiently accurate monitoring is feasible, extend later in line with technical progress

– No need to re-invent the wheel– Use verified data as basis for any free allocation– EU ETS development and recent review show EU’s practical experience

More information:

http://ec.europa.eu/clima/policies/brief/eu/index_en.htmhttp://ec.europa.eu/clima/policies/ets/documentation_en.htm#Implementation

Or contact us on:Info@climaeast.eu