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Linking domestic emissions trading schemes to the EU ETS

Technology Transfer and Investment Risk in

International Emissions Trading

Work package 4

June 20, 2006

Dr. Urs Springer, Ecoplan

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1. Aims and scope of work package 4

2. Approach

3. Emissions trading in Switzerland

4. Ready to link up? The Case of Norway

< Natsource: ETS in North America and Japan >

5. Conclusions

Overview

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to describe the climate policy framework in Switzerland,

Norway, Canada, and Japan;

to assess the potential and problems of linking these schemes

to the EU ETS

to deliver data about early technology transfer trends related to

Canada and Japan

Objectives1 Aims and scope of WP4

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End of April: D2 completed and sent to partners for comments

Beginning of May: Short paper submitted to Climate Policy

External review (Norway: CICERO) and internal quality check

(ZEW) completed

End of May: D2 submitted to Commission

Status of work1 Aims and scope of WP4

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Key elements of the EU ETS1 Aims and scope of WP4

GHG covered CO2 emissions from the combustion of fossil fuels

Trading system Mandatory cap-and-trade system for large emitters in

the energy sector and selected industrial sectors

Coverage Mandatory system for large emitters in the energy and

selected industrial sectors

Tradable units EU allowances (≠ AAUs), CERs and ERUs (excluding

nuclear power and LULUCF projects)

Trading

periods

Phase 1: 2005 – 2007. Phase 2: 2008 – 2012

Allocation Responsibility of Member states (phase 1: mostly free

allocation based on historical emissions)

Sanctions Penalty of EUR 40 (phase 1) and EUR 100 (phase 2)

and obligation to cover deficit in subsequent period

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Compatibility assessment2 Approach

Criteria

1) System designa) Trading scheme

b) System boundaries

c) Currency

d) Use of Kyoto mechanisms

Economic literature

EU Commission:

Criteria for NAP evaluation (Annex III)

EU Commission:

Speeches and personalcommunication.

2) Target and allocationa) Kyoto target

• Consistency• Progress

b) Allocation• Reduction potential• Non-discrimination• New entrants

c) Transparency

3) Compliancea) Monitoring

b) Sanctions

Sources

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Background3 Emissions trading in Switzerland

Kyoto target: -8%

Current GHG emissions: about 1990 level

Projected gap in 2010: 5%

CO2 tax on heating and process fuels. Rate (22 EUR / t CO2) still

to be approved by Parliament.

Companies that conclude voluntary agreements with the government are excluded from the CO2 tax.

Climate cent: Levy on transport fuels (1 cent / liter). Revenues used for mitigation projects in Switzerland and abroad.

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Key features of proposed trading scheme3 Emissions trading in Switzerland

Companies can be exempt from CO2 tax if they take on voluntary

targets. These targets are the basis for the (free) allocation of

tradable allowances for the period 2008-12.

Compliance options:– implement internal emission reduction measures

– purchase allowances from other Swiss companies

– purchase CERs or ERUs

Sanctions: Repayment of entire CO2 tax plus interest.

Monitoring of each installation, verification by government or

private agencies.

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Linkage of Swiss and EU ETS

Existing link

Link to be established

Switzerland

Transport Households Industry

Climate penny

CO2 taxCO2 tax

ETS

Rest of the World

All sectors

JI / CDM

European Union

Energy and industry Other sectors

Other policiesEU ETS

3 Emissions trading in Switzerland

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1) System design - sectoral coverage

Problem: Swiss refineries not covered

3 Swiss and EU ETS: Assessment of compatibility

EU ETS Swiss ETS

• Iron & steel

• Cement & ceramics

• Pulp & paper

• Chemical industry

• Food & beverages

• Financial services

•

• …

EU ETS Swiss ETS

• Energy activities(including refineries)

• Iron & steel

• Cement & ceramics

• Pulp & paper

• Chemical industry

• Food & beverages

• Financial services

• Tourism

• …

Aluminum•

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Currency– Main problem: „Hot air“

– In CH: No problem, since „hot air“ is banned

Use of Kyoto mechanisms– Nuclear projects: Explicitly excluded in EU, implicitly excluded in CH

– LULUCF: Banned in EU, allowed in CH. But: Swiss rule to be adapted, if

ban in EU maintained.

– GMO projects: Allowed in EU, banned in CH.

– Large hydro: Must follow international guidelines in EU, no restriction in CH.

Overall: Only minor differences, no compatibility problems.

1) System design – Currency, flexible mechanisms3 Swiss and EU ETS: Assessment of compatibility

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Total allocation: In accordance with national target.

Installation-level allocation– Cement industry: Allocation 45% above current emissions: Over-allocation!

– Energy agency umbrella agreement: -11.5% compared to 1990 =>

ambitious target.

– Other sectors: No signs of over-allocation.

=> NAP criterion regarding allocation only partially fulfilled (“taking reduction

potential into account”).

Allocation to new entrants (gas-fired power plants) not clear.

Transparency: – Swiss voluntary agreements confidential, but will be published.

2) Target and allocation3 Swiss and EU ETS: Assessment of compatibility

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Monitoring: – EU: Annual reports for all installations, independent verification

– CH: Annual reports by companies, first report in 2008 for groups. No

independent verification.

Less strict in CH

Sanctions: – EU ETS: 40 EUR (phase 1) and 100 EUR (phase 2) plus surrendering of

missing allowances.

– CH: Repayment of CO2 tax since introduction plus interest

– Problem: For EUA prices > CO2 tax (EUR 22), the most profitable option is

to sell all allowances and default (pay tax).

3) Compliance3 Swiss and EU ETS: Assessment of compatibility

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Ex-post adjustments

EU Commission: “Ex-post adjustments are incompatible with the

legal framework and represent interventions that disrupt the

market and create uncertainty for companies.”

Consequences:– Commission has disallowed intended ex-post adjustments in 13 NAPs.

– Proposed ex-post adjustment in Swiss ETS is likely to be a major

obstacle to linkage.

3 Swiss and EU ETS: Assessment of compatibility

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Conclusions and policy recommendations

Conclusions– Swiss ETS is, in principle, compatible with EU ETS.

– Some adaptations should be made to increase the chances of linkage.

Recommendations

1. Refrain from implementing the ex-post adjustment of targets.

2. Strengthen compliance regime by imposing stricter sanctions or prevent

over-selling.

3. Renegotiate voluntary agreement with cement industry and aim for

voluntary agreement with Swiss refineries. Define detailed rules for new

entrants.

4. Increase the transparency of the system (list of companies, independent

verification of emission reports).

3 Swiss and EU ETS: Result of compatibility assessment

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Background

Kyoto target: +1%

Current GHG emissions: +9.5%

Booming petroleum industry, energy intensive industries

CO2 tax for offshore oil, domestic and transport sectors (23-40

EUR/t). Reduced rate for pulp & paper industry.

Voluntary agreement with energy intensive industries (target:

-20% vs. 1990)

Emissions trading scheme along the lines of EU ETS

4 Ready to link up? The case of Norway

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Emissions trading scheme

System design– Cap-and-trade

– First period: 2005-07, second period not yet defined

Coverage:– Same as EU ETS

– But: Installations liable to the CO2 tax (offshore petroleum activities, pulp

& paper) are exempt from the ETS.

Allocation:– Free of charge

– General rule: 95% of demonstrated need

– 20.5 mill. t for 2005-07 allocated to 51 companies

4 Ready to link up? The case of Norway

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1) System design – sectoral coverage

System design: Cap-and-trade => no problems

Overlapping coverage: no problem

Opt-out of offshore petroleum and pulp & paper: Likely to pose problem for phase 2

Restrictions on use of CERs and ERUs: Same as EU ETS

4 Norwegian and EU ETS: Assessment of compatibility

PIL VA

ETS Norway

• District heating

• Energy production

• Gas processing

• Other minerals

• Aluminium

• Ferrosilicon

• Carbides

• Other metals

• Mineral fertilizer

• Pulp & paper

• Transport

• Offshore petroleum

• Domestic heating

CO22 tax

• Steel

• Cement

• Petrochem

• Refineries

(Pulp & paper)

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2) Target and allocation

Allocation: – Installation level: Overall allocation factor 90.6%. => stricter than most

European countries

– Uncertainty regarding new gas-fired power plants (CCS required or not?).

– No guarantee for reaching Kyoto target due to narrow scope of Norwegian

ETS (transport and petroleum activities not covered).

Ex post adjustment of targets– Initial allocation can be changed for 2006/07 “if the conditions on which the

allocation was based are changed significantly”.

– Modifications can only result in a reduction of the number of allowances

issued to an installation, not an increase.

– Likely to be disapproved by the European Commission.

4 Norwegian and EU ETS: Assessment of compatibility

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3) Compliance

Monitoring– Annual reporting of emissions required.

– Verification by independent party only in special cases

(EU ETS: mandatory).

Sanctions– Fine (EUR 40) and obligation to surrender missing allowances in the

subsequent year. Same as EU ETS.

4 Norwegian and EU ETS: Assessment of compatibility

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EU vs. EFTA law

ETS Norway supposed to be linked to the EU ETS through a

linking agreement according to Article 25 of the ET directive.

EC: Norway, Liechtenstein and Iceland have to implement the

Directive under the rules of the European Free Trade

Association EFTA.

Norway accepted, but Liechtenstein and Iceland have been

reluctant to do so (even though they do not have any

installations falling under the Directive).

=> linkage not yet established.

4 Norwegian and EU ETS: Assessment of compatibility

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Conclusions and policy recommendations

Conclusions– ETS Norway is, in principle, compatible with EU ETS.

– The main compatibility problems are: Sectoral coverage: Offshore petroleum and pulp & paper excluded. Unclear treatment of new entrants, particularly new gas-fired power

plants (CCS). Ex post adjustment of targets allowed (only reduction of allocation).

Recommendations– Include offshore petroleum activities and pulp & paper industry in the

scheme.

– Clarify treatment of new entrants.

– Refrain from applying ex post adjustment.

4 Norwegian and EU ETS: Result of compatibility assessment

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What have we learned?

1. Linkage between EU ETS and domestic schemes– Norway and Switzerland: Linkage likely and feasible.

– Japan and North America: Linkage faces great challenges of legal,

economic and technical nature.

2. Economic potential– Significant benefits for Norway and Switzerland, but negligible efficiency

gains for the EU.

– Japan and North America: Linkage would greatly expand the market and

provide substantial benefits for all parties.

5 Summary and conclusions

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What have we learned?

3. Main obstacles– Price caps: Segment the market, reduce efficiency.

– Eligibility of tradable units: Probably impossible to maintain in practice.

– Voluntary nature of trading schemes: Sanctions for non-compliance?

4. Lessons for policy development– Linkage requires that ETS have key elements in common => ETS should

not be developed independently of each other

– Path dependence: Once an instrument (e.g. carbon tax) is implemented, it is likely to remain in place even when new instruments are introduced

5. Outlook– No global uniform carbon market in the near term

– In the long term, better prospects for linkage of major markets

5 Summary and conclusions

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