European Union's Emissions Trading System

European Union's Emissions Trading System free pdf ebook was written by on May 02, 2008 consist of 64 page(s). The pdf file is provided by www.pewclimate.org and available on pdfpedia since May 02, 2012.

policy + + european union’s emissions trading system the in perspective + a. denny ellerman paul l. joskow mas sac..european union’s e missions trading system in perspective + foreword eileen claussen, president, pew..need to build knowledge and program architecture, eu leaders began by...

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European Union's Emissions Trading System pdf




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European Union's Emissions Trading System - page 1
policy + + European Union’s Emissions Trading System The + in perspective A. Denny Ellerman Paul L. Joskow M AS SAC HUS E T TS I N ST I T U T E O F T E C H N O L O GY +
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European Union's Emissions Trading System - page 2
European Union's Emissions Trading System - page 3
European Union’s Emissions Trading System The in perspective Prepared for the Pew Center on Global Climate Change by A. Denny Ellerman Paul L. Joskow M AS SAC HUS E T TS I N ST I T U T E O F T E C H N O L O GY May 2008
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Contents Foreword ii iii 1 1 7 Executive Summary I. Introduction A. Motivation 1 7 9 12 15 + B. Description of the EU ETS II. Context A. The Trial Period (2005-2007) B. A Multinational System III. Performance 12 16 18 A. The Emergence of a Single Price B. Why EUA Prices Were So High and Then So Low C. The Volume and Types of Trading D. Emissions and Allowances: 2005-2006 Results IV. Controversies 24 35 24 B. “Over-Allocation” 31 A. Windfall Profits C. The Allocation Process D. Price Volatility E. Linkage 40 45 + 43 47 V. Conclusion: The EU ETS in Perspective References Endnotes 49 i The European Union’s Emissions Trading System in perspective +
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Foreword Eileen Claussen, President, Pew Center on Global Climate Change To meet its obligations to reduce greenhouse gas (GHG) concentrations under the Kyoto Protocol, the European Union (EU) established the first cap-and-trade system for carbon dioxide emissions in the world starting in 2005. Proposed in October 2001, the EU’s Emissions Trading System (EU ETS) was up and running just over three years later. The first three-year trading period (2005-2007)—a trial period before Kyoto’s obligations began—is now complete and, not surprisingly, has been heavily scrutinized. This report examines the development, structure, and performance of the EU-ETS to date, and provides insightful analysis regarding the controversies and lessons emerging from the initial trial phase. Recognizing their lack of experience with cap and trade and the need to build knowledge and program architecture, EU leaders began by covering only one gas (carbon dioxide) and a limited number of sectors. Once the infrastructure was in place, other GHGs and sectors could be included in subsequent phases of the program, when more significant emissions reductions were needed. As authors Denny Ellerman and Paul Joskow describe, the system has so far worked as it was envisioned—a European-wide carbon price was established, businesses began incorporating this price into their decision-making, and the market infrastructure for a multi-national trading program is now in place. Moreover, despite the condensed time period of the trial phase, some reductions in emissions from the covered sectors were realized. The development of the EU-ETS has not, however, proceeded without its challenges. The authors explain some of the controversies regarding the early performance of the EU-ETS and describe potential remedies planned for later compliance periods: • Due to a lack of accurate data in advance of the program, allowances to emitters were overallocated. Now with more accurate emissions data and a centralized cap-setting and reporting process, the emissions cap should be sufficiently binding; • Concerns about program volatility emerged when initially high allowances prices (driven largely by high global energy costs) dropped precipitously in April 2006 upon the release of more accurate, verified emissions data. Late in the trial phase, there was another sharp decline in allowance price because there were no provisions for banking emissions reductions for use in the second phase of the program. Improved data quality and provisions for unrestricted banking between compliance periods will help moderate price fluctuations in the future; • Windfall profits by electric power generators that passed along costs (based on market value) of their freely issued allowances resulted in improved understanding of how member country electricity sector regulations affect the market and calls for increased auctioning in subsequent phases of the program. Interest in developing a national cap-and-trade program in the United States has intensified in recent years. The first comprehensive greenhouse gas reduction bill ever to be reported out of a committee emerged from the Senate Environment and Public Works Committee in December 2007. As debate continues on this landmark legislation, the House of Representatives has signaled its intention to design its own emissions trading program. This report provides an excellent resource for those developing U.S. proposals. As Europe’s experience with the EU-ETS suggests, everything does not have to be perfect at the outset of a cap-and-trade program. We do, however, need to get started and, for this, the EU-ETS has provided valuable lessons for us all. The Pew Center and the authors would like to thank Robert Stavins and Peter Zapfel for comments and suggestions on earlier drafts. None of them are responsible for the analysis, conclusions or any remaining errors. The views expressed here are solely those of the authors. + + ii + The European Union’s Emissions Trading System in perspective
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Executive Summary The performance of the European Union’s Emissions Trading System (EU ETS) to date cannot be evaluated without recognizing that the first three years from 2005 through 2007 constituted a “trial” period and understanding what this trial period was supposed to accomplish. Its primary goal was to develop the infrastructure and to provide the experience that would enable the successful use of a cap-and-trade system to limit European GHG emissions during a second trading period, 2008-12, corresponding to the first commitment period of the Kyoto Protocol. The trial period was a rehearsal for the later more serious engagement and it was never intended to achieve significant reductions in CO 2 emissions in only three years. In light of the speed with which the program was developed, the many sovereign countries involved, the need to develop the necessary data, information dissemination, compliance and market institutions, and the lack of extensive experience with emissions trading in Europe, we think that the system has performed surprisingly well. Although there have been plenty of rough edges, a transparent and widely accepted price for tradable CO 2 emission allowances emerged by January 1, 2005, a functioning market for allowances has developed quickly and effortlessly without any prodding by the Commission or member state governments, the cap-and-trade infrastructure of market institutions, registries, monitoring, reporting and verification is in place, and a significant segment of European industry is incorporating the price of CO 2 emissions into their daily production decisions. The development of the EU ETS and the experience with the trial period provides a number of useful lessons for the U.S. and other countries. • Suppliers quickly factor the price of emissions allowances into their pricing and output behavior. • Liquid bilateral markets and public allowance exchanges emerge rapidly and the “law of one price” for allowances with the same attributes prevails. • The development of efficient allowance markets is facilitated by the frequent dissemination of information about emissions and allowance utilization. + + iii in perspective The European Union’s Emissions Trading System +
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• Allowance price volatility can be dampened by including allowance banking and borrowing and by allocating allowances for longer trading periods. • The redistributive aspects of the allocation process can be handled without distorting abatement efficiency or competition despite the significant political maneuvering over allowance allocations. However, allocations that are tied to future emissions through investment and closure decisions can distort behavior. • The interaction between allowance allocation, allowance markets, and the unsettled state of electricity sector liberalization and regulation must be confronted as part of program design to avoid mistakes and unintended consequences. This will be especially important in the U.S. where 50 percent of the electricity is generated with coal. The EU ETS provides a useful perspective on the problems to be faced in constructing a global GHG emission trading system. In imagining a multinational system, it seems clear that participating nations will retain significant discretion in deciding tradable national emission caps albeit with some negotiation; separate national registries will be maintained with some arrangement for international transfers; and monitoring, reporting and verification procedures will be administered nationally although + necessarily subject to some common standard. All of these issues have had to be addressed in the trial period and they continue to present challenges to European policy makers. The deeper significance of the trial period of the EU ETS may be its explicit status as a work in progress. As such, it is emblematic of all climate change programs, which will surely be changed over the long horizon during which they will remain effective. The trial period demonstrates that everything does not need to be perfect at the beginning. In fact, it provides a reminder that the best can be the enemy of the good. This admonition is especially applicable in an imperfect world where the income and wealth effects of proposed actions are significant and sovereign nations of widely varying economic circumstance + and institutional development are involved. The initial challenge is simply to establish a system that will demonstrate the societal decision that GHG emissions shall have a price and to provide the signal of what constitutes appropriate short-term and long-term measures to limit GHG emissions. In this, the EU has done more with the ETS, despite all its faults, than any other nation or set of nations. iv + The European Union’s Emissions Trading System in perspective
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I. Introduction A. Motivation As the world’s first cap-and-trade program for carbon dioxide (CO 2 ) emissions, the European Union’s Emissions Trading System (EU ETS) has attracted a lot of attention, some of it favorable and some of it unfavorable. Based on what can be observed to date, this paper attempts to place the EU ETS in perspective for the observer who is interested in understanding the key features and performance of this important public policy experiment. In the following sections, we describe the principal design features of the EU ETS; we highlight two contextual features that are important in understanding the development of the EU ETS; we provide a brief evaluation of the performance of the EU ETS to date; and finally we discuss several of the controversies that have arisen during its first three years of operation. B. Description of the EU ETS The EU ETS was inspired by the Kyoto Protocol but it is also independent of it. The EU ETS would not exist if it were not for the Kyoto Protocol and it is the ”flagship measure” by which the member states of the EU will meet their obligations under the Kyoto Protocol during the first commitment period from 2008 through 2012 (Delbeke (ed.), 2006). Yet, the EU ETS exists independently of the Kyoto Protocol. It was enacted before the Kyoto Protocol became legally binding in international and EU law and it would have become operational even if the Kyoto Protocol had not entered into force in February 2005. In particular, the trial or first trading period from 2005 through 2007 was wholly outside of the Kyoto Protocol, although conceived as a means of ensuring the EU’s compliance with the Kyoto Protocol during 2008-12, when the second trading period of the EU ETS would occur. Finally, the EU ETS is expected to continue beyond 2012 whatever the shape of the Kyoto Protocol or a successor agreement as concerns the post-2012 period. The EU ETS is a classic cap-and-trade system. However, it also contains some significant design differences from those reflected in cap-and-trade systems for other emissions that have been implemented in the U.S. The common features are that 1) an absolute quantity limit (or cap) on CO 2 + + 1 The European Union’s Emissions Trading System in perspective +
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emissions has been placed on some 12,000 emitting facilities located in the European Union, 2) tradable allowances have been distributed to these facilities (typically for free) in an amount equal to the cap, and 3) these facilities must measure and report their CO 2 emissions and subsequently surrender an allowance for every ton of CO 2 they emit during annual compliance periods. The primary differences from U.S. experience with cap-and-trade mechanisms relate to how the cap is set, the process for allocating emission allowances, banking and borrowing provisions, the monitoring, reporting, and verification procedures, and the linking or off-system provisions. While the basic outline of the EU ETS was established during the trial period, significant changes in the design of the system have been proposed by the European Commission in a set of amendments to the Emissions Trading Directive, the authorizing legislation for the EU ETS, which was made public in late January 2008. These proposed amendments resulted from a process that was mandated by the Directive, known as the ETS Review, and which was to consider changes to the Directive in light of the first three years’ experience. Consultations with stakeholders have been held over the past year and a half and the proposed amendments will now be taken up by the European Parliament and the European Council in the European Union’s co-decision process. 1 The Cap-setting Process + A first important difference between the EU ETS and the classic cap-and-trade model is the decentralized nature by which the cap has been determined. There was no initially determined overall limit; it was the sum of 25 (now 27) 2 separate decisions concerning the total number of European Union Allowances (EUAs) that each member state could distribute to affected installations within its jurisdiction. Each member state proposed a quantity of EUAs, but that quantity was subject to review and approval by the European Commission according to procedures and criteria specified in the EU Emissions Trading Directive. + A second significant difference is that the long-term trajectory of the overall cap and of the member state allocations was not known initially since the decentralized cap-setting process is repeated for relatively short sequential multi-year “trading periods.” The EU ETS Directive mandates a first, three- year trading period for 2005-07, often called the pilot or trial phase, to be followed by a second, five-year trading period for 2008-12 that corresponds to the First Commitment Period under the Kyoto Protocol, 2 + The European Union’s Emissions Trading System in perspective
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