Climate Change: The European Union's Emissions Trading System (EU-ETS)

Congressional research reportJul 31, 2006

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Climate Change: The European Union’s

Emissions Trading System (EU-ETS)

July 31, 2006

(name redacted)

Specialist in Energy Policy

Resources, Science, and Industry Division

Congressional Research Service ˜ The Library of Congress

Climate Change: The European Union’s Emissions

Trading System (EU-ETS)

Summary

The European Union’s (EU’s) Emissions Trading System (ETS) is a cornerstone

of the EU’s efforts to meet its obligation under the Kyoto Protocol. It covers more

than 11,500 energy intensive facilities across the 25 EU member countries, including

oil refineries, powerplants over 20 megawatts (MW) in capacity, coke ovens, and

iron and steel plants, along with cement, glass, lime, brick, ceramics, and pulp and

paper installations. Covered entities emit about 45% of the EU’s carbon dioxide

emissions. The trading program does not cover emissions of non-CO2 greenhouse

gases, which account for about 20% of the EU’s total greenhouse gas emissions. The

first trading period began January 1, 2005. A second trading period is scheduled to

begin in 2008, with a third one planned for 2013. In deciding on its trading program,

the European Commission (EC) adopted a “learning-by-doing” approach to prepare

the EU for the Kyoto Protocol’s emission limitations. The EU does not have major

experience with emissions trading, and the EC felt that an initial program beginning

in 2005 would give the EU practical familiarity in operating such a system.

At first glance, it would appear that the EU may have little difficulty meeting

its Kyoto Protocol requirements during the second trading period. The anticipated

deficit between the second trading period for the original 15 Member States can be

covered by trading with the 10 newer Member States that anticipate a surplus. Also,

credits are likely to be available through Joint Implementation (JI) and Clean

Development Mechanism (CDM) projects sanctioned under the Protocol.

However, there are other considerations. The availability of surplus credits

created via JI and CDM is restricted by the EC requirement that such credits be

“supplemental” to a country’s domestic efforts. Each country is to spell out what

“supplemental” means in its National Allocation Plans (NAPs) for the second trading

period. Individual countries are likely to define that term differently — restricting

allowance trades and purchases in some countries.

Another consideration is the overall commitment of the Kyoto Protocol. As

noted earlier, the ETS covers only a percentage of the overall greenhouse gas

emissions in the various Member States of the EU. Some sectors not covered by the

ETS may grow faster than sectors covered by it, creating difficulties for compliance.

In particular, the transportation area is already a source of concern.

A final consideration for the ETS is its suitability for directing long-term

investment toward a low-carbon future — the ultimate goal of any climate change

program. It is too early to tell whether the ETS’s market signal and individual

countries’ NAPs will move investment in the appropriate direction. The early signs

are not particularly encouraging, with the 2005-2008 NAPs producing an overallocation of allowances and one major Member State (Germany) attempting to direct

its second NAP toward carbon-intensive, coal-fired electric-generating facilities

rather than low-carbon alternatives. Reluctance by countries to redirect their NAPs

and an inconsistent price signal from the ETS make the long-term effect of the ETS

uncertain.

Contents

Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Implementing the ETS: National Allocation Plans . . . . . . . . . . . . . . . . . . . . . . . . 4

Results From the First Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Emissions Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Market Activity, Prices, and Impact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Use of Clean Development Mechanism (CDM) and Joint

Implementation (JI) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Tightening of Emissions Caps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Harmonizing NAPs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

New Entrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Definition of Affected Units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Expansion of Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Appendix: Norway’s Trading System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

List of Figures

Figure 1. CO2 Market: Even If No “Big” News Highly Volatile . . . . . . . . . . . . . 9

Figure 2. CO2 Market: Large Price Changes in Very Short Amount

of Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Figure 3. There is a Very Long-Term Correlation Between CO2 and

Electricity Price: Link Via Marginal Producer . . . . . . . . . . . . . . . . . . . . . . 11

List of Tables

Table 1: Cost of Reaching Kyoto Target to EU Member States in 2010 . . . . . . . . 3

Table 2. Summary Information Per Member State . . . . . . . . . . . . . . . . . . . . . . . . 6

Table 3. Importance of EU ETS Topics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Table 4: Comparison of 1st and 2nd Trading Period ETS Caps . . . . . . . . . . . . . . . 14

Table 5: NAP Harmonization Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Table 6: International Supply of Emissions Credits and Allowances . . . . . . . . . 21

Climate Change: The European Union’s

Emissions Trading System (EU-ETS)

Overview

Climate change is generally viewed as a global issue, but proposed responses

typically require action at the national level. With the 1997 Kyoto Protocol now in

force, countries that ratified the protocol are developing appropriate implementation

strategies to begin reducing their emissions of greenhouse gases.1 In particular, the

European Union (EU) has decided to use an emissions trading scheme (called a “capand-trade” program), along with other market-oriented mechanisms permitted under

the Protocol, to help it achieve compliance at least cost.2 The decision to use

emission trading to implement the Kyoto Protocol is at least partly based on the

successful emissions trading program used by the United States to implement its

sulfur dioxide (acid rain) control program contained in Title IV of the 1990 Clean

Act Amendments.3

The EU’s Emissions Trading System (ETS) is a cornerstone of the EU’s efforts

to meet its obligation under the Kyoto Protocol. It covers more than 11,500 energy

intensive facilities across the 25 EU Member countries, including oil refineries,

powerplants over 20 megawatts (MW) in capacity, coke ovens, and iron and steel

plants, along with cement, glass, lime, brick, ceramics, and pulp and paper

installations. Covered entities emit about 45% of the EU’s carbon dioxide emissions.

The trading program does not cover emissions of non-CO2 greenhouse gases, which

account for about 20% of the EU’s total greenhouse gas emissions. The first trading

Six gases are included under the Kyoto Protocol: carbon dioxide, methane, nitrous oxide,

hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride. The United States has not

ratified the Kyoto Protocol and, therefore, is not covered by its provisions. For more

information on the Kyoto Protocol, see CRS Report RL30692, Global Climate Change: The

Kyoto Protocol, by Susan Fletcher.

Norway, a non-EU country, also has instituted a CO2 trading system (described in

Appendix A). Various other countries and a state-sponsored regional initiative located in

the northeastern United States involving several states are developing mandatory cap-andtrade system programs, but are not operating at the current time. For a review of these

emerging programs, along with other voluntary efforts, see International Energy Agency,

Act Locally, Trade Globally (2005).

P.L. 101-549, Title IV (Nov. 15, 1990).

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period began January 1, 2005. A second trading period is scheduled to begin in

2008, covering the period of the Kyoto Protocol, with a third one planned for 2013.4

Under the Kyoto Protocol, the then-existing 15 nations of the EU agreed to

reduce their emissions by 8% from 1990 levels under a collective arrangement called

a “bubble.” By 2001, collective greenhouse gas emissions in the EU were 2.3%

below 1990 levels, mostly the result of a structural shift from coal to natural gas in

the United Kingdom and the incorporation of East Germany into West Germany.

Several countries, including Ireland, Spain, and Portugal, experienced emissions

growth of over 30% during this period.5 In light of the Kyoto Protocol targets, the

EU adopted a directive establishing the EU-ETS that entered into force October 13,

2003.6 The importance of emissions trading was elevated by the accession of 10

additional central and eastern Europe countries to EU membership in May 2004.

Collectively, these 10 countries’ greenhouse gas emissions dropped 22.6% from

1990-2001, with only Slovenia’s emissions increasing during that time (10.4%). This

expansion of the EU trading zone to 25 countries greatly increases the opportunities

for cost-effective allowance trades.

In deciding on its trading program, the European Commission (EC) adopted a

“learning-by-doing” approach to prepare the EU for the Kyoto Protocol’s emissions

limitations. The EU does not have major experience with emissions trading, and the

EC felt an initial program beginning in 2005 would give the EU practical familiarity

in operating such a system. The EC also wanted the most comprehensive program

possible. As stated in its “Green Paper”:

The wider the scope of the system, the greater will be the variation in the costs

of compliance of individual companies, and the greater the potential for lowering

costs overall. This argues in favour of a comprehensive trading scheme across

different Member States covering all 6 greenhouse gases and sinks, and

encompassing all emissions sources.7

Economic analysis conducted by the European Commission confirms the

potential cost-saving available from a comprehensive trading scheme. As shown in

Table 1, a comprehensive trading program is estimated by the EC to reduce Kyoto

compliance costs to EU countries by 3 billion euro, or one-third over a compliance

scenario that does not include trading among Member countries, and by 0.9 billion

More information, including relevant directives, on the EU-ETS is available on the

European Union’s website at [http://europa.eu.int/scadplus/leg/en/lvb/l28012.htm].

Pew Center on Global Climate Change, The European Union Emissions Trading Scheme

(EU-ETS): Insights and Opportunities (no date), available at [http://www.pewclimate.org/

docUploads/EU%2DETS%20White%20Paper%2Epdf].

Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003

establishing a scheme for greenhouse gas emissions allowance trading within the

Community and amending Council Directive 96/61/EC.

Commission of the European Communities, Green Paper on Greenhouse Gas Emissions

Trading within the European Union (presented by the Commission), Brussels, COM(2000)

87 final (Mar. 8, 2000), p. 10.

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euro, or 13% below the estimate cost of compliance with the trading scheme

ultimately chosen by the EC.

Table 1: Cost of Reaching Kyoto Target to EU Member States

in 2010

(in billions of 1999 euro)

No Trading

Among EU

Member States

EU-wide

Trading Among

Energy

Producers

EU-wide Trading

Among Energy

Producers and

Energy-Intensive

Industries

EU-wide Trading

Among All

Sectors

9.0

7.2

6.9

6.0

Source: EC Green Paper (Mar. 8, 2000), p. 27.

For a variety of reasons, the EC chose a trading system with limited coverage

rather than a comprehensive system covering all sources and gases. Some European

analysts have noted that EU politics played an important role in preventing serious

consideration of a comprehensive program. As noted by Boemare and Quirion:

A significantly wider coverage could have been provided only by an upstream

system, which had been excluded by the [European] Commission at the

beginning of the process. The reason was again political: an upstream scheme

would have too much looked like a tax.8

Not surprisingly, this reason was not employed by the EC in explaining its

decision to create a less comprehensive trading scheme at this time. As stated by the

EC:

... there are sound scientific and practical reasons why the Community might not

wish to establish a comprehensive scheme at this stage. There are considerable

uncertainties surrounding the emissions of the fluorinated gases [HFC, PFC, SF6]

and the absorption of carbon dioxide by sinks. Allocating allowances,

monitoring emissions and enforcing compliance of small mobile emitters, such

as private cars, raise complex technical and administrative issues.9

For determining the size of the trading program, the EC looked at five criteria:

(1) environmental effectiveness, (2) economic efficiency, (3) the potential effects on

competition, (4) feasibility, and (5) existence of alternative policies and measures.

The first political decision noted by the authors was the exclusion of process emissions

from the chemical industry from the ETS. Catherine Boemare and Philippe Quirion,

Implementing Greenhouse Gas Trading in Europe: Lessons from Economic Theory and

International Experiences, Centre International de Recherche sur l’Environnement et le

Developpement, CNRS/EHESS, France (June 2002), p. 5.

Commission of the European Communities, Green Paper on Greenhouse Gas Emissions

Trading with the European Union (presented by the Commission), Brussels, COM(2000)

87 final (Mar. 8, 2000), p. 10.

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It felt that starting with a relatively small number of economic sectors and sources

that contribute significantly to total emissions and for which trading could reduce

cost significantly would “substantially” satisfy these criteria.10 As noted, the six

sectors chosen emit about 45% of the EU15’s CO2 emissions (which are about 80%

of the EU’s total greenhouse gas emissions). The coverage for individual countries

varies widely; only 20% of France’s greenhouse gas emissions are covered, compared

with 69% of Estonia’s emissions.11

Implementing the ETS: National Allocation Plans

National Allocation Plans (NAPs) are central to the EU’s effort to achieve its

Kyoto obligations. Each Member of the EU must submit a NAP that lays out its

allocation scheme under the ETS, including individual allocations to each affected

unit. For the first trading period, each country had to prepare a NAP by March 31,

2004 (May 1, 2004 for the 10 new EU Members). NAPs for the second period were

due June 30, 2006. These NAPs are assessed by the EC to determine compliance

with 11 criteria (12 for the second period) delineated in an annex to the emissions

trading directive.12 Criteria include requirements that the emissions caps and other

measures proposed by the state are sufficient to put it on the path toward its Kyoto

target, protections against discrimination between companies and sectors, along with

provisions for new entrants, clean technology, and early reduction credits. For the

second period, the NAP must guarantee Kyoto compliance.

For the first period, the EC approved most of the necessary NAPs by the end of

2004. The last NAP was approved June 20, 2006 (from Greece). In general, the

primary problem the EC found with NAPs that resulted in revisions were excessive

allocation of allowances and state efforts to permit “ex-post adjustments” to their

allocations. Excessive allocation problems resulted from states that left a gap in how

they would achieve their target, to be filled with measures to be defined later;

insufficiently delineated plans to purchase allowances; and unrealistic economic or

emissions growth assumptions. Ex-post adjustments by states are not allowed; such

adjustments are seen by the EC as potentially disruptive to the emissions market and

creating uncertainty for companies.

Commission of the European Communities, Green Paper on Greenhouse Gas Emissions

Trading with the European Union (presented by the Commission), Brussels, COM(2000)

87 final (Mar. 8, 2000), p. 13

International Energy Agency, Act Locally, Trade Globally (OCED/IEA, 2005), p. 74

Commission of the European Communities, Directive 2003/87/EC, available at

[http://ec.europa.eu/environment/climat/emissions_plans.htm]

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Results From the First Year

Emissions Levels

For the 2005-2007 period, the European Union is not attempting to meet the

Kyoto Protocol but to get experience with emissions trading with some modest

emissions targets (i.e., to put the EU on the path toward meeting the Kyoto

requirements). Table 2 provides the national emissions allocations and 2005

emissions levels for 21 EU countries as recorded by the Community Independent

Transaction Log (CITL) by the compliance deadline of April 30, 2006.13 For the first

trading period, the 21 countries have allocated an annual average of 1.8295 billion

allowances and set aside 73.4 million allowances for allocation to new sources or for

auctions. Verified emissions in 2005 for covered sources is 1.7853 billion metric

tons, according to the CITL.14 The 44.2 million allowances allocated in excess of

actual 2005 emissions have been characterized by EU’s Environment Commissioner

as an “over-allocation” of allowances15 and is considered responsible for a significant

drop in allowances prices in May, 2006. The 2005 emissions total reflects emissions

from 8,980 sources representing more than 99% of the allowances allocated. As of

April 30, 849 sources in the 21 countries had not surrendered sufficient allowances.

The EC will determine whether the insufficiency is the result of technical difficulties

in national registries, tardiness, or noncompliance. Noncomplying sources are

subject to a 40-euro penalty for each ton of emissions in excess of surrendered

allowances under the ETS.

Four of the 25 Member States (Cyprus, Luxembourg, Malta, and Poland) have not

submitted information because their allowance registries are not operational yet. Cyprus

and Malta do not have emissions targets under the Kyoto Protocol.

European Commission, EU Emissions Trading Scheme Delivers First Verified Emissions

Data for Installations (Brussels, 15 May 2006), available at[http://ec.europa.eu/comm/

environment/climat/pdf/citl_pr.pdf]

Comments of EU Environment Commissioner Stavros Dimas, as reported by Jeff Mason

in “EU’s Dimas Says States Allocated too Much CO2 in ‘05” (Reuters, May 22, 2006).

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Table 2. Summary Information Per Member State

Member State

CO2 emissions for

2005 in tonnes

Installations that

Share of installations

have not reported by

with verified

Installations covereda

30 April

emissions reports

Installations not in

compliance on 30

April 2006

Annual average

allocation in 2005

to 2007 in tonnesb

Annual average

allocation not

allocated at the

outset in tonnesc

Austria

33,372,841

100.0%

199

32,674,905

330,050

Belgium

55,354,096

99.9%

309

59,853,575

2,545,876

Czech

Republicd

82,453,727

98.4%

389

96,907,832

348,020

Denmark

26,090,910

98.9%

380

31,039,618

2,460,382

Estonia

12,621,824

100.0%

18,763,471

189,529

Finland

33,072,638

100.0%

578

44,587,032

862,952

131,147,905

99.7%

1075

150,500,685

4,871,317

473,715,872

99.8%

1842

495,073,574

3,926,426

France

Germany

Greece

71,033,294

99.5%

141

71,135,034

3,286,839

Hungary

25,714,574

99.0%

229

30,236,166

1,424,738

Ireland

22,397,678

100.0%

109

19,238,190

3,081,180

Italy

215,415,641

208

95.4%

943

647

207,518,860

15,551,575

Latvia

2,854,424

99.9%

4,054,431

505,760

Lithuania

6,603,869

99.9%

11,468,181

797,213

Netherlands

80,351,292

100.0%

209

86,439,031

2,503,305

Portugal

36,413,004

99.9%

243

36,898,516

1,262,898

Slovak

Republicd

25,237,739

100.0%

175

30,364,848

7,180

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Member State

Slovenia

CO2 emissions for

2005 in tonnes

8,720,550

Installations that

Share of installations

have not reported by

with verified

Installations covereda

30 April

emissions reports

100.0%

99.1%

800

Installations not in

compliance on 30

April 2006

Annual average

allocation in 2005

to 2007 in tonnesb

Annual average

allocation not

allocated at the

outset in tonnesc

8,691,990

66,667

162,111,391

13,162,130

Spain

181,063,141

Sweden

19,306,761

99.4%

705

22,530,831

678,149

United

Kingdom

242,396,039

99.9%

768

209,387,854

15,527,484

99.1%

9,420

1,829,476,015

73,389,670

Total

1,785,337,819

Note: As all data are held in the CITL and national registries, no data are available for those Member States without an active registry.

a. The figures in this column indicate the number of installations with active registry accounts on 30 April 2006. They differ from figures communicated in earlier press releases

because they are updated for installations that opted-out for the first trading period, opted-in, and installations without open accounts.

b. The figures in this column are allowances allocated to existing installations at the start of the scheme.

c. The figures in this column are allowances not allocated to existing installations at the start of the scheme but put aside mainly for new entrants and auctioning (in the cases of

Denmark, Hungary, Ireland, and Lithuania).

d. Due to technical problems in the national registries of the Czech Republic, France, the Slovak Republic, and Spain, the CITL did not receive wholly reliable information on the

installation level surrenders from these Member States. Therefore, some fields are empty for these Member States. All data represented in the table were communicated

directly to the European Commission by the respective authorities of these Member States.

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Some commentators have suggested that annual average 2005-2007

allocations that are actually 44.1 million metric tons higher than the reported 2005

emissions are neither putting the EU on the path to the Kyoto requirements nor

developing the trading market. In addition, this “over-allocation” does not include

the 73.4 million metric tons of allowances held in reserve by the various countries

for new entrants. The Climate Action Network (CAN), a network of 365 nongovernmental organizations, stated the following:

Emissions limits set by Member States for the first phase were a major

disappointment. To ensure maximum environmental benefit of the ETS and

the overall success of the system as a whole, they need to be strengthened

considerably. The Kyoto targets require ambitious caps with absolute

reductions for the phase 2008-2012.16

In general, the EC has seen the over-allocation issue as part of the “learningby-doing” process that should help the EU in implementing the second trading

period beginning in 2008. As stated in its press release:

The new 2005 emissions data gives independently assessed installation-level

figures for the first time and so provides Member States with an excellent

factual basis for deciding upon the caps in their forthcoming national

allocations plans for the second trading period, when the Kyoto targets have

to be met. The plans are subject to approval by the Commission, which will

also be making extensive use of the 2005 emissions data.17

Market Activity, Prices, and Impact

According to Point Carbon’s proprietary databases, the EU-ETS traded 362

million metric tons of CO2 in 2005, valued at 7.218 billion euro. Brokers were

responsible for 57% of the volume, exchange markets did 15%, and bilateral

transactions accounted for 28%. Of the exchange market volume, the European

Climate Exchange (ECX) had the largest share at 63%, followed by Nord Pool

with 24%, and Powernext with 7.9%.18

The average price for an allowance traded in 2005 was 19.9 euro, with

brokered and exchanged allowances averaging 20.6 euro and bilateral transactions

averaging 18.2 euro. However, allowance prices have been quite volatile since

trading begin in 2005, as indicated in Figure 1 below.19 In particular, allowance

CAN Europe, National Allocation Plans 2005-7: Do They Deliver? Summary for

Policymakers (April 2006), p. 2.

European Commission, EU Emissions Trading Scheme Delivers First Verified Emissions

Data for Installations (Brussels, May 15, 2006), available at [http://europa.eu.int/

luxembourg/docs/217-2006_en.pdf]

Point Carbon, Carbon 2006: Towards a Truly Global Market (28 February 2006) pp. 1516. It should be noted that there is significant uncertainty in the estimates of the bilateral

market.

Margus Kaasik (CFO Eesti Energia), Carbon Market: EU ETS (May 9, 2006). Implied

(continued...)

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prices dropped from almost 30 euro to about 9-11 euro in April and May, sparked

by a series of reported over-allocation of allowances in several Member States.

By July 2006, allowance prices had recovered to about 17 euro in July.

Figure 1. CO2 Market: Even If No “Big” News Highly Volatile

Source: Margus Kaasik, Eesti Energia, Carbon Market: EUETS (May 9, 2006), p. 14.

There are several reasons for the overall volatility in the allowance market.

The EU-ETS is a maturing but still narrow market. Monthly volumes are

increasing, but have never exceeded a 1.6% share of phase 1 allocations.20

Modest volume for a new system is not surprising; trading volumes under the U.S.

Clean Air Act Title IV sulfur dioxide trading program were very thin in the

beginning. Even after several years of operation, SO2 allowances prices can

change unpredictably and inexplicably.21

Some reasons for ETS allowance price derivatives are explicable. As

illustrated by Figure 2, the ETS market responded to a variety of regulatory,

climatic, and economic events over the first trading period. Regulatory events

include the late approval of NAPs for several countries, along with the resulting

(...continued)

volatility is a measure used primarily in options analysis to estimate how much the market

expects an asset price to move for an option price. Two hundred-fifty days is commonly

used for this analysis, as it represents the number of business days in a year.

Margus Kaasik (CFO Eesti Energia), Carbon Market: EU ETS (May 9, 2006), p. 13.

Vivian E. Thomson in collaboration with the Pew Center on Global Climate Change,

Early Observations on the European Union’s Greenhouse Gas Emissions Trading Scheme:

Insights for United States Policymakers (Apr. 19, 2006), p. 16

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over-allocation causing the sudden market correction in May 2006. Climatic

events influencing prices include cold weather, which increased energy usage, and

dry conditions, which decreased the availability of hydroelectric power.22

Figure 2. CO2 Market: Large Price Changes in Very Short Amount of

Time

Source: Margus Kaasik, Eesti Energia, Carbon Market: EUETS (May 9, 2006), p. 14.

The primary economic influence on the ETS revolved around fuel prices.

During 2005, Point Carbon analysis indicates 79% of the variance (R2) in

allowance prices was explained by changes in fuel prices (particularly for electric

power), with 23% of the variance explained by the weather. This linkage between

allowance prices and the power market is not surprising, as the power sector

conducted the majority of trades in 2005 and therefore significantly influenced

price development.

Kaasik argues that the evidence from the past year indicates that fuel prices

influence carbon prices, but not the reverse. Specifically, Kaasik sees allowance

prices as a derivative of natural gas and coal pricing, at least in the short-term.

Assuming natural gas-fired and coal-fired generation are the marginal cost

suppliers of power, allowance prices will respond positively to increasing natural

gas prices or decreasing coal prices. Likewise, allowance prices will respond

negatively to decreasing natural gas prices or increasing coal prices. This creates

a correlation over time between allowance prices and electricity price by

influencing the marginal price of electricity. How this has evolved during the first

trading period is illustrated by Figure 3.

Point Carbon, Carbon 2006: Towards a Truly Global Market (Feb. 28, 2006) pp. 18-19.

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Figure 3. There is a Very Long-Term Correlation Between CO2 and

Electricity Price: Link Via Marginal Producer

Source: Margus Kaasik, Eesti Energia, Carbon Market: EUETS (May 9, 2006) p. 11.

Use of Clean Development Mechanism (CDM) and Joint

Implementation (JI)

The EU-ETS has provisions for linking its trading scheme to the Joint

Implementation (JI) and Clean Development Mechanism (CDM) components of

the Kyoto Protocol for countries that have ratified it. These project-based

instruments involve Annex 1 countries in the case of JI, and between Annex 1 and

developing countries in the case of CDM.23 The EC’s linking directive allows

operators to fulfil their allowance obligations under the EU-ETS using credits

derived from JI and CDM projects. Their credits are equivalent to allowances in

environmental and economic terms, but are not interchangeable. “Certified

Emissions Reductions” (CERs) under the CDM must be issued by the Clean

Development Mechanism Executive Board and may be used in either the first or

banked for use in the second trading period.24 Emissions Reduction Units

(ERUs) under JI are transferred from one country to another — an exchange that

cannot begin until the second trading period. Neither CERs nor ERUs are

Annex 1 countries are the 36 industrialized countries and economies-in-transition listed

in Annex 1 of the United Nations Framework Convention on Climate Change and allowed

to engaged in JI and CDM projects under the Kyoto Protocol.

The time between submission of a CDM project design document and approval can be as

much as 18 months because CDM credits must be approved by the Designated National

Authority (DNA) and the CDM Executive Board. Brown Rudnick Berlack Israels LLP,

Emissions Trading: Questions and Answers (February 2006), p. 7.

CRS-12

converted into EU-ETS allowances; rather, they are entered directly into the

surrendered allowance table. There are other restrictions on the use of CERs and

ERUs. In particular, for the second trading period the amount of CERs and ERUs

that can used by an affected unit is limited by a percentage specified by its

country. Several EU countries have established carbon funds to pursue JI and

CDM opportunities.25

In general, CER and ERU credits have sold at a discount to ETS allowance

prices. The degree of discount has depended on the riskiness of the project. CER

and ERU credits are available only when the projects are completed. Thus, where

buyers take the risk of non-delivery, such as an emissions reduction purchase

agreement (ERPA), prices are in the range of 8-12 euro. In contrast, for CERs

already issued, or where the sellers take the risk, prices are in the range of 13-15

euro.26 The real impact of CDM and JI on the EU-ETS system will not be fully

known until the second trading period, when EU demand for credits will increase

substantially and other non-EU countries would be implementing their own Kyoto

compliance strategies.

Issues

To assist its review of the ETS, the EC has surveyed stakeholders’

viewpoints on ETS implementation and long-term issues.27 The report surveys

the viewpoints of participating companies, governments, industry associations,

market intermediaries, and non-governmental organizations (NGOs) from June to

September 2005. Asked which of 12 topics surrounding ETS implementation

entities felt were most important to them, companies, industry associations, and

governments all ranked topics such as emissions reduction targets, allocation

rules, and rules for new entrants and closures as the most important — topics that

all relate to long-term uncertainty. Table 3 indicates the top five topics according

to governments surveyed, along with their corresponding ranking by other

stakeholders. The five issues are discussed below.

For a list of countries with carbon funds, see [http://carbonfinance.org/Router.cfm?Page=

Funds&ItemID=24670]

As reported in Carbon Positive, “CER Prices Stabilise After EU Market Hit” (June 14,

2006), available at [http://www.carbonpositive.net/viewarticle.aspx?articleID=137].

European Commission, Review of EU Emissions Trading Scheme (November 2005).

CRS-13

Table 3. Importance of EU ETS Topics

(ranking)

Governments Companies

Industry

Market

NGOs

Associations Intermediaries

1st

3rd

1st

Further

2nd

harmonization

of allocation

plans

3rd

2nd

Tied for 5th

Tied

for 6th

Treatment of

new entrants/

closures

3rd

2nd

5th

7th

Tied

for 6th

Definition of

combustion

installations

4th

10th

Tied for 8th

Tied

for 11th

Inclusion of

sectors and

gases

5th

Tied for 6th

Tied for 8th

Tied for 4th

3rd

Topic

Emissions

reduction

targets

Source: European Commission, Review of EU Emissions Trading Scheme (November

2005), p. 13.

Tightening of Emissions Caps

With the over-allocation issue in the first trading period, it is likely that the EC

will take a harder stance in reviewing NAPs for the second trading period. The

relationship between the ETS cap for the first trading period and the estimated ETS

cap for the second trading period (the Kyoto Protocol requirements) varies

substantially between countries, as illustrated in Table 4. In general, the original EU15 countries have to reduce their emissions caps the most to meet their share of the

EU’s requirements under the Kyoto Protocol, with several countries facing doubledigit percentage reductions. As indicated, EU-15 states, on average, have to reduce

their emissions caps 6.8% (119 million metric tons) from their current levels to meet

their requirements under the Kyoto Protocol-based second trading period. In

contrast, as a group, the newer countries and the EU as a whole are in substantially

better shape.28

Two EU countries, Malta and Cyrus, are not included here because they are non-Annex

1 countries and, therefore, do not have mandatory reduction requirements under the Kyoto

Protocol.

CRS-14

Table 4: Comparison of 1st and 2nd Trading Period ETS Caps

(in millions of metric tons of CO2 Equivalent unless otherwise noted)

Average Annual

ETS Cap (first

trading period)a

Estimated Annual

ETS Cap (Kyoto

Protocol)

Austria

33.0

24.6

-25.5%

Belgium

62.9

57.9

-8.0%

Czech Republic

97.6

118.6

21.6%

Denmark

33.5

24.9

-25.6%

Estonia

19.0

35.4

86.5%

Finland

45.5

37.5

-17.7%

France

156.5

159.6

2.0%

Germany

499.0

483.2

-3.2%

Greece

74.4

75.5

1.5%

Hungary

31.3

43.0

37.3%

Ireland

22.3

20.1

-9.7%

Italy

232.5

194.7

-16.3%

Latvia

4.6

10.1

119.8%

Lithuania

12.3

33.4

171.5%

Luxembourg

3.4

2.7

-19.4%

Netherlands

95.3

88.9

-6.7%

Poland

239.1

331.0

38.4%

Portugal

38.2

35.4

-7.2%

Slovakia

30.5

38.9

27.7%

Slovenia

8.8

8.3

-5.4%

Spain

174.4

142.8

-18.1%

Sweden

22.9

24.4

6.7%

245.3

247.8

1.0%

EU-ETS 15

1,739.1

1,620.1

-6.8%

EU-ETS 23

2,182.3

2,239.0

2.6%

Percentage

Difference

Source: Based on data provided in Annex 1, European Commission, “Further Guidance

on Allocation Plans for the 2008 to 2012 trading period of the EU Emissions Trading

Scheme” (Brussels, Dec. 12, 2005) p. 11.

a. These figures do not account for changes to the number of installations subsequent to the

respective Commission decision (e.g., opt-ins or opt-outs of installations).

CRS-15

At first glance, it would appear that the EU would have little difficulty meeting

its Kyoto Protocol requirements during the second trading period. The anticipated

deficit between the second trading period for the original 15 Member States can be

covered by trading with the newer Member States that anticipate a surplus. However,

there are other considerations. First, countries with potential surpluses may want to

retain at least some of that surplus to help fuel their countries’ economic growth,

possibly at the expense of a Member State that needs allowances. Second, the extent

to which surplus credits would be created via JI, the EC linking directive, requires

that such credits (including from CDM) be “supplemental” to a country’s domestic

efforts. Each country is to spell out what “supplemental” means in its NAP for the

second trading period.

A third consideration is the overall commitment of the Kyoto Protocol. As

noted earlier, the ETS only covers a percentage of the overall greenhouse gas

emissions in the various Member States of the EU. The analysis provided in Table

3 assumes that the ETS will have to provide a proportional amount of that reduction

based on 2003 emissions. However, some sectors not covered by the ETS may grow

faster than sectors covered by the ETS, creating difficulties for compliance. In

particular, the transportation area has become a major source of concern. The

transportation sector is not a part of the ETS and is not likely to be included before

the third trading period.29 Instead, transport controls are based on voluntary

agreements with automobile manufacturers to improve fuel economy, fuel-economy

labelling of cars, and promoting fuel efficiency by fiscal measures.30 The cornerstone

is the agreements with automobile manufacturers to achieve improve new car fleet

average CO2 emissions rates. As announced in 1996, the objective of the EU Council

of Environmental Ministers and European Parliament was to achieve a new car fleet

average CO2 emissions rate of 120 grams per kilometer (g CO2/km) by 2005, or by

2010 at the latest.31

This objective was not met in 2005 and is unlikely to be met by 2010.

Voluntary commitments by the European, Japanese, and Korean Automobile

Manufacturers Associations in 1998 and subsequently endorsed by the EC set targets

of 140 g CO2/km by 2008/2009. At the end of 2005, the average new car emissions

rate is about 160 g CO2/km. The rate of reduction in CO2/km for new cars would

have to double for the automobile manufacturers to achieve their commitments,

which appears unlikely.32 Indeed, despite improvements in emissions rates, CO2

emissions in the EU continue to rise because of increased miles driven, increased size

and weight of cars, and falling car occupancy rates. The EC 2005 progress report

also notes that despite EU’s effort to increase information on fuel efficiency and CO2

EurActiv.com, Transport to Stay Out of CO2 Trading until 2013 (June 21, 2006).

European Commission, Implementing the Community Strategy to Reduce CO2 Emissions

from Cars: Fifth Annual Communication on the Effectiveness of the Strategy (Brussels, June

22, 2005).

Council conclusions of June 25, 1996.

European Federation for Transport and Environment, Cleaner is Cheaper (Brussels,

2005). p. 1.

CRS-16

emissions for consumers, the effectiveness of the effort seems low: “a significant

impact on consumer’s decisions could not yet be noticed.”33

Attempts to balance the burden between ETS and non-ETS sectors have already

created tension in Germany with respect to the second trading period. In its draft

NAP for the second trading period (NAP II) submitted June 28, 2006, Germany

proposes to reduce its ETS allocation from about 499 million metric tons to about

471 million metric tons, a decrease of 5.6%.34 However, Germany’s 2005 emissions

were only 474 million metric tons; thus the reduction is only 0.6% from last year’s

emissions. In addition, Germany is proposing to permit every new power station

built between 2008 and 2012 to opt out from CO2 caps and the ETS for 14 years,

generally to encourage construction of coal-fired facilities. These emissions

increases will have to be covered by the non-ETS sectors — commercial, residential,

and transportation. An assessment done for Greenpeace International states that the

German NAP II places “a disproportionate burden for emissions reductions on the

non-ETS sectors” in terms of meeting its commitments under the EU Burden Sharing

agreement.35 Policies to fill in the gap reportedly include one plan to reduce

emissions by 3 million tons by training German drivers to drive more economically.36

As noted by the EC Report cited above, the effectiveness of public education

programs such as this may be problematic.

Harmonizing NAPs

The EU-ETS system involves an interplay between definitions and procedures

that are EU-wide and those that are nationwide. The groundwork for the system is the

Kyoto Protocol, which (1) defines the pollutants and sets the countries’ emissions

targets; (2) defines the scope of participation: Annex 1 countries may implement

emissions trading programs, and non-Annex 1 countries may participate through the

CDM; (3) defines baseline emissions years and sinks; and (4) sets national inventory

and compliance requirements. Within this framework, the EU defines the elements

that make the EU-ETS work, including industry participants, the unit of trade

(tradeable allowances equal to 1 metric ton of CO2), trading periods, settling up

procedures, and linkages within and beyond the EU.

With respect to the individual Member’s NAPs, the EC harmonizes the NAPs

with respect to penalties, allocation method (e.g., grandfathering), monitoring, and

registries with the goal of achieving the Kyoto targets. It allows Members flexibility

European Commission, Implementing the Community Strategy to Reduce CO2 Emissions

from Cars: Fifth Annual Communication on the Effectiveness of the Strategy (Brussels, June

22, 2005) p. 7.

On a like-kind basis. The NAP II cap is actually 482 million metric tons because it

include 11 million tons for facilities covered under the second phase that were not covered

under the first phase.

Karoline Rogge, Joachim Schleich, Regina Betz, and Jos Cozijnsen, Increasing the

Ambition of EU Emissions Trading (June 2006), p. 1.

Roger Harrabin, BBC environmental analyst, Germany to Spark “Climate Crisis” (June

28, 2006).

CRS-17

with respect to allocations to individual participants, the extent to which banking is

permitted, and whether to permit the auctioning of up to 10% of allowances in the

second trading period. As a result of this framework, there are significant differences

between Members with respect to participant definitions, industry level emissions

caps and allocations, and enforcement.

To increase the economic and administrative efficiency of the ETS, some

stakeholders are interested in improved harmonization of NAPs by the EC. Besides

the issue of new entrants and definition of affected units specifically identified by the

EC survey, harmonization issues include allocation methods and the use of auctions,

the degree to which JI and CDM credits may be used for compliance, and monitoring,

verification, and reporting rules. Table 5 illustrates the scope of potential

harmonization issues facing the EU-ETS.

Table 5: NAP Harmonization Issues

Subject

Source of Member Differences

Definition of allowances

Financial and tax treatment of allowances

Reliable emissions

inventories

Inventory standards

Banking of allowances

Whether and how much banking permitted

Emissions caps

Stringency of caps and the extent of JI and CDM credits

permitted

Monitoring, verification and

Procedures and processes

reporting

Allocation

Allocation methods and whether and how much

auctioning permitted

National registries

Design details

Voluntary participants

Whether to allow pooling or opt-in/opt-out

Definition of mandatory

participants

Definition of sectors, size, installation, new entrant, and

treatment of closures

Source: Adapted from Fiona Mullins, EU ETS Implementation: Room for Harmonisation

(The Royal Institute of International Affairs, 2005).

One issue of particular interest is the effort to increase the use of

“benchmarking” standards in setting allocations. Benchmarking generally involves

allocating allowances based on best available technology and practices, rather than

on historical emissions. However, the EC does not have the authority to scrutinize

allocations at the facility level, so any allocation harmonization would be on a

voluntary basis (“soft harmonization”). Also, allocation schemes, such as

benchmarking, may not be suitable for some industries.37 The EC’s survey of ETS

stakeholders revealed that although more than two-thirds of the respondents from the

For more, see Michael Grubb and Karsten Neuhoff, “Allocation and Competitiveness in

the EU Emissions Trading Scheme: Policy Overview,” 6 Climate Policy (2006) pp. 7-30.

CRS-18

cement, aluminum, and chemical industries thought benchmarking was an

“interesting alternative,” less than a third of the respondents from the pulp and paper

industry and refineries thought so.38

In many ways, diversity between Member countries with respect to the ETS is

inevitable. As stated by Grubb and Neuhoff with respect to allocation:

The final way in which the EU ETS differs from many other trading systems is

in the devolution of allocation responsibilities, in this case to its 25 Member

States. This was an essential part of the deal that enabled the adoption of the

Directive: Member States would have never ceded to the European Commission

the power to distribute valuable assets to their industries. Nor is the EU ETS

unique in devolving powers of allocation: it is typical in a number of US systems.

Moreover, there are different degrees of harmonization, applicable to different

aspects of the EU ETS, and the Commission can and does seek to increase the

degree of harmonization through guidance notes.39 [footnote omitted]

New Entrants

The economic value of allowances is nowhere more evident than in discussions

of new entrants. Indeed, as noted above, Germany is proposing to permit new coalfired powerplants built between 2008-2012 to opt-out of the ETS for the first 14

years of operation in order to encourage construction. In its survey of ETS

stakeholders, the EC found that 85% of all respondents favor a harmonized approach

to new entrants and closures. Nearly 75% believed that those allowances should be

provided free.40 Likewise, an EU questionnaire conducted by the European

Environmental Agency’s Topic Centre on Air and Climate Change indicated that

most Member States would welcome harmonization of the treatment of new entrants

and closures across the EU.41

Analogous to the U.S. acid rain program, EU states have set up reserves to

provide allowances to new entrants. In general, these allowances are provided free,

as that is widely seen as helping boost new investment. However, the allocation

methods developed by the Member States differ. Most states have yet to dip into

their reserves for new entrants; however, the importance of the reserve will increase

as the ETS enters its second, and eventually third, trading period. The manner in

which new entrants receive allowances may have a significant effect on the long-term

direction of investment — whether it is directed toward low-carbon opportunities or

used to support continuation of current economic development irrespective of its

European Commission, Review of EU Emissions Trading Scheme: Survey Highlights

(November 2005), p. 15.

Michael Grubb and Karsten Neuhoff, “Allocation and Competitiveness in the EU

Emissions Trading Scheme: Policy Overview,” 6 Climate Policy (2006), p. 17.

European Commission, Review of EU Emissions Trading Scheme: Survey Highlights

(November 2005), pp. 18-19.

European Environment Agency’s Topic Centre for Air and Climate Change, Application

of the Emissions Trading Directive by EU Member States, (EEA Technical Report No.

2/2006, 2006), p. 30.

CRS-19

carbon intensity. Allocating allowances according to output and not differentiating

according to the carbon intensity of the project would provide an incentive to develop

low carbon alternatives. An example provided by Grubb and Neuhoff:

New entrant reserves should be based on output or capacity, and avoid

differentiating according to the CO2-intensity of the new investment. In

particular, giving more to coal than gas plants rewards investment in new coal

facilities, which would conflict with objectives to tackle climate change, increase

the cost of future emissions reductions, and in the long run could lead to higher

electricity prices. The damaging effects would be amplified if carbon-intensive

new entrants not only receive free allowances for the period 2008-2012 but also

receive promises for subsequent periods.42

The proposed treatment of coal-fired powerplants by the German Government

indicates how difficult it will be to direct future investment toward low-carbon

projects. However, it could be argued that the long-term success of the ETS and the

EU’s commitment to Kyoto and any subsequent agreements rests on such a

redirection with respect to new entrants and long-term investment.

Definition of Affected Units

Another area in which several Member States would like more harmonization

across the EU is the definition of a combustion installation.43 Concerns revolve

around ambiguity in the current definition of a combustion installation and the

number of small installations covered under the ETS. The ETS applies to energy

activities for all sectors with combustion installations above 20 MW of thermal rated

input, oil refineries, coke ovens, and, subject to size criteria, iron and steel, cement,

lime, glass, ceramics, and pulp and paper facilities. However, Finland and Sweden

opted to include small district heating installations with a rated thermal input below

20 MW.44 In contrast, as noted previously, Germany is attempting to have some

planned coal-fired powerplants, which will be large producers of CO2, able to opt-out

of the ETS for 14 years.

In addition to the consistency issue, small installations (between 20MW and

50MW) account for 30% (about 3,000) of the total facilities covered under the ETS,

but a very small percentage of total CO2 emissions.45 Surveying 22 Member States,

Michael Grubb and Karsten Neuhoff, “Allocation and Competitiveness in the EU

Emissions Trading Scheme: Policy Overview” 6 Climate Policy (2006), p. 22.

European Environment Agency’s Topic Centre for Air and Climate Change, Application

of the Emissions Trading Directive by EU Member States (EEA Technical Report No.

2/2006, 2006), p. 30.

These are generally owned by larger facilities which operate several installations covered

by the ETS. See European Environment Agency’s Topic Centre for Air and Climate

Change, Application of the Emissions Trading Directive by EU Member States (EEA

Technical Report No. 2/2006, 2006), p. 16.

The installation number is for 22 Member States (Poland did not provide sufficient data).

Emissions estimates were provided by only 14 States. Based on those 14 States, the

(continued...)

CRS-20

36% of the covered installations produced less than 10,000 metric tons of CO2

annually.46 The somewhat weak emissions data available at the time of the EU

questionnaire suggest that while three-quarters of all emissions are produced by the

largest 7.5% of installations, the small installations (under 10,000 metric tons) are

responsible for less than 1%. Whether the ETS should continue to cover the roughly

3,500 facilities under 10,000 metric tons annually remains a hotly debated issue.

Expansion of Coverage

In choosing a gradual, incremental approach to emissions trading, the EU is

relying on other programs to control greenhouse gas emissions in other sectors, such

as transportation. The difficulties the EC may encounter in not choosing a

comprehensive approach to begin with is suggested by its survey of stakeholders.

The survey suggests that the future direction of the ETS in terms of increasing

coverage is toward incrementally adding more economic sectors, rather than

addressing the more complex issue of a comprehensive system. Based on the survey,

the focus is currently on the chemical, aviation, and aluminum industries.47 Given

that the number-one recommendation for future implementation of the ETS is to

provide participants with a longer time frame for implementation, it is unclear when

the ETS will become as comprehensive as the European Commission would like.

Conclusion

At first glance, the ETS would appear an effective vehicle for the EU to meet

its Kyoto Protocol obligations during the second trading period. The anticipated

deficit between the second trading period for the original 15 Member States can be

covered by trading with the newer Member States that anticipate a surplus. In

addition, potential CERs and ERUs from the CDM and JI respectively may help

maintain limits on allowance costs. Table 6 provides one series of estimates of

available allowances for the Kyoto Protocol’s five-year compliance period.

Obviously, not all these allowances may be available to the EU alone; other

countries, such as Japan and Canada, may decide to incorporate emissions trading

into their implementation strategies and acquire allowances from these sources. Yet,

the totals suggest that all else being equal, the supply of allowances would be

adequate.

(...continued)

allowance allocations to small installation accounted for about 2% of the total. See

European Environment Agency’s Topic Centre for Air and Climate Change, Application of

the Emissions Trading Directive by EU Member States (EEA Technical Report No. 2/2006,

2006), p. 15.

European Environment Agency’s Topic Centre for Air and Climate Change, Application

of the Emissions Trading Directive by EU Member States (EEA Technical Report No.

2/2006, 2006).

European Commission, Review of EU Emissions Trading Scheme (November 2005), p.

11.

CRS-21

Table 6: International Supply of Emissions Credits and

Allowances

(cumulative total 2008-2012, million metric tons CO2)

Source of Supply

Low Estimate

High Estimate

Clean Development Mechanism (CERs)

680

1,200

Joint Implementation (ERUs

120

980

<1,000-3,000

8,000

Surplus Kyoto Allowances from Eastern

Europe, Russia, and the Ukraine (AAUs)

Source: Compiled by Grubb and Neuhoff, “Allocation and Competitiveness in the EU

Emissions Trading Scheme: Policy Overview,” p. 20.

However, there are other considerations. The availability of surplus credits

created via JI and CDM is restricted by the EC linking directive that requires that

such credits be “supplemental” to a country’s domestic efforts. Each country is to

spell out what “supplemental” means in its NAP for the second trading period.

Individual countries are likely to define that term differently — restricting allowance

trades and purchases in some countries.

Another consideration is the overall commitment of the Kyoto Protocol. As

noted earlier, the ETS only covers a percentage of the overall greenhouse gas

emissions in the various Member States of the EU. Some sectors not covered by the

ETS may grow faster than sectors covered by the ETS, creating difficulties for

compliance. In particular, the transportation area is already a major source of

concern.

A final consideration for the ETS is its suitability for directing long-term

investment toward a low-carbon future — the ultimate goal of any climate change

program. It is too early to tell whether the ETS market signal and individual

countries’ NAPs will move investment in the appropriate direction. The early signs

are not particularly encouraging, with the 2005-2008 NAPs producing an overallocation of allowances, and one major Member State, Germany, attempting to

direct its second NAP toward carbon-intensive, coal-fired electric generating

facilities rather than low-carbon alternatives. Reluctance by countries to redirect

their NAPs and an inconsistent price from the ETS make the long-term effect of the

ETS uncertain.

CRS-22

Appendix: Norway’s Trading System

Norway, a non-EU country, also has an emissions trading system that began

operating on January 1, 2005. Norway’s system covers 51 facilities in the energy and

process sectors such as oil refining and iron and steel processing, and has several

features in common with the EU ETS.48 These sectors account for about 10-15% of

the country’s emissions. Other parts of Norway’s industry, particularly its offshore

oil and gas sector, are covered by the country’s carbon tax of almost 40 euro per

metric tonne of CO2 — much higher than the anticipated allowance price under the

trading program. The carbon tax is levied on about 64% of the country’s CO2

emissions — about half the country’s total greenhouse gas emissions.49 The first

phase of the trading program covers the period 2005-2007, with a second, expanded

phase to begin in 2008.

Developing its initial trading scheme independently of the EU, Norway’s

“Quota Commission” (created in 1998) stressed that the 2008 program be as

comprehensive as possible, suggesting that the system could include close to 90% of

the country’s greenhouse gas emissions.50 To achieve this coverage, the Commission

envisioned a hybrid system of quotas, depending on cost-effectiveness and

practicality considerations. Arguing in favor of regulating CO2 emissions at the

producer (upstream) level from mobile sources and some stationary sources, the

Quota Commission states:

For these emissions, regulation at the producer level will not create weaker

incentives for reducing emissions than regulation at the consumer level, because

the volume of emissions from a particular commodity is not dependent on

technology. For those process emissions which are recommended for inclusion

in the system, regulation by quotas should be imposed at the end-user level in

cases where the processes originate with major industrial companies. For

process emissions stemming from a series of small sources, e.g. emissions of

N2O from commercial fertilizers, regulation by quotas should be imposed on

retailers, or importers in order to avoid unacceptably high system costs.51

The Commission’s recommendation that “regulation by quotas be imposed in

part on the producer, in part on the sales or import chain, and in part on the enduser”52 may be overtaken by development of the EU ETS, which is likely to influence

International Energy Agency, Act Locally, Trade Globally (2005), p. 102.

Ministry of the Environment, Report 54 to the Storting (2000-2001): Norwegian Climate

Policy, at [http://odin.dep.no/md/engelsk/publ/stmeld/022001-040012/index-dok000-b-na.html]

Ministry of the Environment, Trading in Greenhouse Gases (press release, Dec. 17, 1999),

at [http://www.odin.no/odinarkiv/english/bondevik_I/md/022001-990070/dok-bn.html].

The Quota Commission, A Quota System for Greenhouse Gases (Dec. 17, 1999), p.7, at

[http://odin.dep.no/odinarkiv/norsk/dep/md/1999/eng/022021-220003/index-dok000-b-na.html]

Ibid., p. 19.

CRS-23

the future direction of Norway’s trading system. The International Energy Agency

(IEA) states:

The government had indicated earlier that it would consider expanding the

[trading] system from 2008 to include as many sources of emissions as practical

through an upstream system allocating allowances to fossil fuel producers and

importers. With the adoption of the EU ETS design features, Norway seems to

move away from this option.53

International Energy Agency, Act Locally, Trade Globally (2005), p. 103.

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