Introduction

The EU Emissions Trading Scheme (EU ETS) is a European wide scheme aimed at reducing carbon dioxide emissions in an attempt to combat climate change. The EU ETS effectively puts a price on carbon that businesses can use, therefore creating a market for carbon. The scheme has been in place since 2005, and is the first scheme of its kind in the world.

The scheme is divided into three main specific phases for which Member States must develop a ‘National Allocation Plan’, and which must be approved by the European Commission. These plans must set an overall ‘cap’ on the total amount of emissions allowed from all of the installations that are covered within the scheme, this is then converted into allowances – i.e. 1 allowance = 1 tonne of CO₂. The allowances are subsequently distributed by Member States to installations in the scheme as they see fit.

The installations covered by the scheme are required to monitor and annually report their CO₂ emissions, and are obliged every year to surrender (give back) an amount of emission allowances to the government that is equivalent to their CO₂ emissions in that year. Installations may get these allowances for free from the government, or purchase them from others (installations, the government or traders). If an installation has received more allowances than they require, they can then sell them to anybody for a profit.

Some of the major industries covered by the EU ETS include:

• Iron & Steel
• Electricity generation
• Pulp and paper processing industries
• Mineral processing industries, such as cement and lime manufacture (including BLA Members)

How the EU ETS works

The EU scheme is largely modelled on the mechanisms in the ‘Marrakech Accords’ of the ‘Kyoto Protocol’ and the experienced gained during the running of the voluntary UK ETS in the previous years. The rationale behind the concept of the EU ETS, is that it enables emission reductions to take place where the cost of the reduction is lowest, thus lowering the overall costs of dealing with climate change. More abatement will therefore be undertaken by operators with lower abatement costs, thus reducing the overall costs of meeting the ‘cap’ target.

Emissions trading will overall, provide more certainty regarding the level of emissions reductions which will be achieved, when compared to similar schemes. What remains uncertain, however, is where the emissions savings will be made – depending on exactly who makes the emissions reductions and who ends up trading them. Nevertheless, in the long run, the reduction of greenhouse gas regardless of where they are made will still have the same environmental effect.

The cost of emissions allowances will be determined by the carbon market, and the demand for/availability of allowances. Additional compliance options, such as allowable use of offsets in the scheme will mean greater price flexibility for emissions reductions.  

UK National Action Plans (NAP)

Phase I

In the first phase (from 2005 to 2007), the EU ETS included some 12,000 installations, representing approximately 40% of total EU Carbon Dioxide emissions, covering all the energy intensive industries (listed in introduction). All 15 EU member states participated in the scheme, which started officially on the 1st January 2005, although many national registries were unable to settle transactions for the first few months. 

One of the bonuses of phase 1 was due to the prior existence of the UK ETS, which meant that market participants were already in place and ready. For example, in its first year, 362 million tonnes of CO₂ were traded on the market for an overall sum of €7.2 billion, as well as a large number of futures and options. The price of allowances also increased steadily towards its peak level in April 2006 of about €30 per tonne CO₂. The prices however did fall in May 2006 to under €10 per tonne on the understanding that some countries were likely to give their industries such generous emission caps that there was no need for them to reduce their emissions. This lack of overall scarcity under the first phase of the scheme continued and escalated throughout 2006, resulting in a trading price of only €1.2 per tonne by March 2007, declining all the way to €0.1 in September 2007.

Phase II

The second phase (2008-2012) now expands the scope significantly. The following changes have now been made and are currently in process:

• All greenhouse gases, not only CO₂ are included.
• Clean Development Mechanism (CDM) and Joint Implementation (JI) credits are being incorporated through the EU’s ‘Linking Directive’, although it has been argued that schemes can be started in advance during Phase I.
• Aviation emissions are expected to be included from 2010.
• 4 non-EU members have joined the scheme: Norway, Iceland, Liechtenstein and Switzerland.

The inclusion of aviation emissions is considered a huge and important move, due to the ever increasing and large amount of greenhouse gases that are emitted by aircrafts, and is expected to lead to an increase in demand of allowances of about 10-12 million tonnes of CO₂ per year in phase 2. Consequently this is expected to increase the use of JI credits from projects in Russia and Ukraine, thus offsetting the increase in prices and eventually resulting in no discernible impact on average CO₂ prices.

In the long term (post 2012) the EU ETS want to include all greenhouse gases as well as all sectors, including; aviation, maritime transport and forestry. When incorporating the transport sector, due to the large number of individual users, a ‘cap-and-trade’ system for fuel suppliers or a ‘baseline-and-credit’ system for car manufacturers.

Overall, the environmental effectiveness of the scheme generally rests on the tightness of the caps themselves. As it stands, Phase I is widely regarded to be over-allocated, meaning that overall little additional emissions reductions have been achieved. In terms of Phase II, in 2006 Ecofys performed an initial assessment of NPA’s and found that most member states did not have sufficiently strict caps, and that they would be insufficient in assisting the members in meeting their Kyoto targets. They also compared caps with official business-as-usual (BAU) projections and independent (BAU) projections in order to assess the stringency of the caps. They concluded that the caps were 7% under official BAU but the proposed cap was higher than the independently estimated BAU, suggesting over-allocation.

In response to this, the Commission cut 11 of the first 12 Phase II plants it reviewed (accepting only the UK’s plant without revision). The Commission then tightened the caps some 7%, also corresponding with 7% below the 2005 emissions.

Phase III and future plans

Phase III will begin in 2013, the changes for which are currently under review as part of the Commissions Review of the EU ETS directive.

The EC have in fact already started working on this review under Article 30 of the EU Directive on the EU ETS. The role of the review is to develop the EU ETS in a positive way post 2012 and learn from the experiences and problems that have arisen from Phase I in particular and Phase II to a certain extent. The Commission have made it clear, that there aims will be to:

• Analyse the functioning and design of the system with respect to a number of specific issues.
• Evaluate the impact of expanding the EU ETS to other sectors
• Understand the actual impact of the EU ETS on competitiveness.

Once the review and its subsequent changes have been agreed by the European Council and European Parliament, the changes are expected to be transposed into UK law by 2010.