EU and UK experience: Lessons learned

Martin NesbitDeputy Director, Climate and Energy – Business and TransportUK Department for Environment, Food and Rural Affairsmartin.nesbit@defra.gsi.gov.ukhttp://www.defra.gov.uk/

Stern Review: “The economics of climate change”

• July 2005: UK Finance Minister commissions Nick Stern (former World Bank chief economist) to study economics of climate change

• October 2006: report published • Key messages:

• Urgency - benefits of strong early action outweigh the costs• Mitigation = investment• Poorest countries and people will suffer earliest and most• Growth v. tackling climate change is a false choice• Prices need to reflect climate change impacts – either

through taxes, regulation, or trading. Trading likely to be the best way of securing an international carbon price.

Cap and Trade – the UK Experience

• Voluntary cap and trade scheme 2002-2007 covering all Kyoto gases (indirect emissions)

• Climate Change Agreements: energy-intensive firms commit to significant carbon reductions to secure a rebate from the UK’s carbon tax (climate change levy = CCL)

• Lessons learned:• Valuable experience in mechanics of trading (registries, etc.)• Limited value in voluntary schemes • Importance of ensuring scarcity• Behavioural effects can be more powerful than expected

European Union

25 countries in ETS

2 joined EU in 2007

European Union action: Emissions Trading Scheme (ETS)

• 1998: EU Member States agree share-out of EU 8% Kyoto reduction target. Shares range from -20% (Germany, Denmark), -12.5% (UK), to some states which are allowed to increase emissions.

• 2001: European Commission proposes legislation for ETS; Member States (Council) + European Parliament reach agreement in 2003.

• Why? Because emissions trading -

- means emissions reductions take place where cost is lowest, thereby maximising action possible for a given level of economic cost;

- provides certainty of the level of emissions reductions (through setting a cap on emissions levels).

• New approach to environmental legislation for Europe, to meet new global challenge of climate change. Most other policies (e.g. air quality, acid rain, water quality) use a combination of tough limit values, and environmental standards.

Key features of EU ETS

• “Cap and trade” scheme covering CO2 emissions from combustion processes (approx 46% of EU CO2 emissions)

• Phase 1 EU ETS - 2005-2007 - ‘learning phase’

• Phase 2 EU ETS - 2008-2012 - ‘Kyoto Commitment Period’

• 1 European Union Allowance (EUA) = 1 metric tonne of CO2

• Allowances freely tradable throughout 25 EU Member States

• Majority of allowances allocated for free - range of methods, including historical emissions, projected emissions, sector benchmarks etc

• Businesses can make limited use of Kyoto project credits

EU allowance prices: phase 1 (2005-07) and phase 2 (2008-2012)

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• Need real scarcity – over-allocation in phase 1

• Price fluctuations are to be expected in a young system – but can create political uncertainty

• In a multi-state system, potential for competitive distortion

• Need good data as a basis for allocation decisions

But also:

• A functioning market system was created to an ambitious timetable, with a high level of compliance in year 1 (99%+)

• Early evidence of behavioural impacts, including much higher level of boardroom attention

• Decisions on phase II allocation much stricter, because (a) better data now available (b) Kyoto targets

Learning how to manage a trading system

EU emissions trading: Daily Volume Jan 05 – Feb 07

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EU ETS Phase I (2005-2007)• Data for 2nd year of operation (2006) due around May

EU ETS Phase II (2008-2012)• Allocation plans now being finalised, following Commission announcement in

November 2006, which included criteria for checking member state allocation plans.

EU ETS Review (Post 2012)

• European Commission conducting Review of EU ETS, with changes being considered for post-2012. EU ETS now has widespread political endorsement, and will be used as a key long-term mechanism for reducing greenhouse gas emissions in Europe

• Important issues for review: sectoral coverage, auctioning, cap-setting, long-term predictability for businesses

Future of EU ETS

Future levels of ambition, and linking with other schemes

• EU Member States agreed last week a unilateral commitment to reduce to 20% below 1990 levels by 2020; and are ready to reduce to 30% as part of a “global and comprehensive agreement”.

• EU wants to “strengthen the EU ETS” and to “extend the global carbon market”.

• Current EU legislation restricts linking EU ETS only to schemes in developed countries that have ratified Kyoto Protocol (e.g. Canada, Japan, Switzerland).

• Unilateral recognition by other schemes still a possibility (e.g. US state and regional-level schemes).

• EU ETS Review will consider potential for future links to other greenhouse emissions trading schemes. Impact on incentives for countries not currently signed up to international action a key factor.

EU and UK experience: Lessons learned

Martin NesbitDeputy Director, Climate and Energy – Business and TransportUK Department for Environment, Food and Rural Affairsmartin.nesbit@defra.gsi.gov.ukhttp://www.defra.gov.uk/