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ETS – How does it work? Dr Marzena Chodor, Clima East Key Expert Moscow, 08.04.2014

ETS – How does it work? Dr Marzena Chodor, Clima East Key Expert Moscow, 08.04.2014. Contents:. Cap and trade system: main elements Cap and trade system: how does it work and why does it work? EU ETS: history Legal framework Scope of the EU ETS ETS: main elements in 2005-2012

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ETS – How does it work? Dr Marzena Chodor, Clima East Key Expert Moscow, 08.04.2014

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  1. ETS – How does it work? • Dr Marzena Chodor, Clima East Key Expert • Moscow, 08.04.2014

  2. Contents: • Cap and trade system: main elements • Cap and trade system: how does it work and why does it work? • EU ETS: history • Legal framework • Scope of the EU ETS • ETS: main elements in 2005-2012 • Carbon market in 2005-2012 • Main lessons from 2005-2012 • EU climate policy goals until 2020 • EU approach from 2013 • Aviation in emissions trading • ETS 2013 – 2020. Main features • Lessons from target setting – creating the market

  3. Cap and trade system: main elements • A cap on annual emissions/ a cap on annual allocation (of emission allowances) • Identified participants • registered (eg. through permits) • obliged to comply with rules • Allowances distributed or acquired (auction, market) • tradeable • transferable freely/with constraints • bankable/not bankable • 1 allowance equals one tonne of CO2 • MRV

  4. Cap and trade system: how does it work? • Regulator determines allowed emissions level (the cap), and creates and distributes allowances corresponding to the cap • Allowances are put in circulation • Scarcity gives allowances value • Carbon market develops • Price signal guides companies by how much to reduce emissions • Regulator enforces rules and levies sanctions, if needed

  5. Cap and trade system: why does it work? • The emissions allowance is an asset with immediate value • Some companies find it easier and less expensive to reduce their emissions below their required limits than other • More efficient companies, which release less carbon dioxide equivalent than their limit set in a given year/period, can sell their surplus allowances to companies that cannot reduce their emissions or want to increase production • Cap and trade systems reward the most efficient companies and provide incentive to increase carbon efficiency over time • The prices of allowances are visible signals of current cost of carbon dioxide reductions

  6. EU ETS: history • The EU ETS started in January 2005 • First EU ETS phase (trial) 2005 -2007 • Second EU ETS phase 2008-2012 • Third EU ETS phase 2013 – 2020 (and beyond) • GHGs included: • Carbon dioxide (2005-2012) • N2O, PFC (from 2013) • Coverage: about 11 thousand installations • Around 45% of EU GHG emissions • 28 EU Member States and 3 EEA-EFTA states

  7. EU ETS: legal framework • Directive 2003/81/EC (adopting emissions trading) • Directive 2004/101/EC (linking directive) • Directive 2008/101/EC (including aviation activities in ETS) • Directive 2009/29/EC (ETS review – part of the climate and energy package) • Current key implementing provisions: • Commission Regulation No 389/2013 establishing a Union Registry • Forthcoming: • Draft Regulation on determining international credit entitlements

  8. Scope of the ETS: activities • Combustion installations above 20 MW • Oil refineries • Ferrous metals production above 2,5t/hr • Cement production • Glass production above 20 t/d • Ceramics production above 75 t/day • Pulp and paper production above 20 t/d • International aviation (flights from and to the EU airports) - entry into force in 2012 • A retroactive suspension applied to intercontinental flights (stop the clock in April 2013) • PFCs from alluminium production and N2O emissions from chemical plants included from 2013

  9. ETS 2005-2012 • Applicable since January 2005 • Environmental outcome determined – puts a cap on emissions from 10,000 energy-intensive installations across EU (25, later 27, and 30 countries, around 2 billion tonnes/ yr) • Covering around half of EU’s total CO2 emissions • Companies can choose: • To emit allocated emission rights (allowances) or • To reduce emissions below allocation and sell or bank • To emit more than allocation and buy • Cost-effective emissions reductions to the level of the cap, because investments take place where cheapest

  10. ETS design • Simple “downstream” cap-and-trade system for major emitting industries that is part of a comprehensive policy • the largest cap-and-trade scheme ever implemented • Monitoring rules for direct emissions, independent verification • Robust penalties to ensure compliance (€100 + shortfall) • Electronic registry system to record holdings of allowances • Market development driven by the private sector

  11. ETS 2005-2012 • Member States initially responsible for setting the cap on national level and distribution of allowances through NAPs (National Allocation Plans) • NAPs approved by the European Commission • assessment of national allocation plans against agreed common criteria: • consistency with actual and projected emissions, consistency with potential to reduce emissions, not more allowances than needed, on track for reduction commitments, not unfairly discriminating • transparency, comments by the public • 25 (in phase II 27) registries • National authorities overseeing compliance • only on average 5% allowances auctioned, the remainder distributed free of charge • Dominant allocation methodology - grandfathering

  12. Allocation • In the period 2005-2012 the task of each Member State • Main challenges in the inception phase: • Identifying covered installations • Gathering and processing of relevant data • Fixing the national cap and deciding on the path to the Kyoto target • Elaborating allocation rules at sector and installation level • Elaborating new entrants and closure rules • Overcoming know-how gaps in authorities and among stakeholders • Organizing public consultation and securing political acceptability • Tight time schedule

  13. Compliance • Member State competence, harmonized elements: • no permit, no operation • blocking transfers if no verified emission report by 31 March • name & Shame if not surrendered sufficient allowances • €40 penalty and compensate shortfall for insufficient surrendering

  14. Links to the Kyoto Protocol mechanisms • Art 30 ETS Directive: “emission credits from the project-based mechanisms will be recognised for their use in this scheme subject to provisions adopted by Parliament and Council on a proposal from the Commission” • Directive 2004/101/EC (linking directive) • Clean Development Mechanism (CDM) from 2005, Joint Implementation (JI) from 2008 • Supplementarity: from 2008, use limited to % of allocation of allowances to each installation • Harmonised EU-wide exclusion of nuclear energy projects and temporary forestry credits, national decisions on other types of credits • Double-counting guidelines – Commission Decision C(2006)5362 • Large hydro: MSs to make sure that relevant international criteria and guidelines will be respected during the development phase

  15. Carbon market prices in 2005-2012 ETS emissions down 13.7% 2007 - 2009 2 ETS cut emissions by 2 % to 5% in Phase1 1 1 assessment by Ellerman et al, ‘Pricing Carbon 2010 2 verified emissions data, European Commission Source Point Carbon

  16. Main lessons from 2005-2012: • EU ETS developed into the largest carbon market in the world • Carbon market infrastructure operational: • MRV, institutional capacity in EU Member States, electronic registries • Strong, harmonised provisions to ensure compliance (€40/tonne) • Liquid carbon market and reflective carbon pricing • However: • Member States’ NAPs not based on verified emissions + litigation • Reductions projected by MS proved insufficient in terms of scarcity, which led to a price crash • Long term - a market-based signal for low carbon investments

  17. EU (unconditional) climate policy goals until 2020: • 20% reduction in EU greenhouse gas emissions from 1990 levels; • 20% increase in the share of EU energy consumption produced from renewable resources • 20% improvement in the EU's energy efficiency • implemented through a package of binding legislation entering into force from 2013 • Climate and Energy Package adopted in 2008 • contains directives to be implemented by MS (ETS, RES, CCS) • and Effort Sharing Decision

  18. -20% / -30% wrt 1990 levels by 2020 cross-sectoral targets & instruments Carbon capture and storage Directive CO2&cars Renewable Energy Directive Fuel Quality Directive technology specific & product policies Instruments of EU emission reductions from 2013 Effort SharingDecision EU ETS large industrial installations & aviation “small emitters”

  19. GHG reduction target: -20% compared to 1990 -14% compared to 2005 EU ETS -21% compared to 2005 Non-ETS sector -10% compared to 2005 27 national targets, from -20% to +20% EU approach

  20. Aviation in emissions trading - rationale • Contributes to climate change through emissions of carbon dioxide, nitrogen oxides and cirrus effects • Taxation not blocked by 1944 Chicago Convention, but various bilateral air service agreements historically foresee exemption from general fuel taxation • 1992 UNFCCC requires States to take measures to reduce emissions • Under Kyoto Protocol, States were asked to make progress working in international forum: International Civil Aviation Organisation (ICAO) • International emissions from aviation not part of States’ Kyoto commitments for emission reductions

  21. Aviation in emissions trading - rationale • Overall EU objective: limit global warming to 2° C above pre-industrial level to avoid dangerous climate change • All sectors should contribute to emission reductions • Early industry preference for open emissions trading above taxes and charges and technical regulation • more disagreement than agreement in ICAO discussions on any market-based action

  22. Projections of aviation emissions growth • Source: EC 2050 290% to 667% increase 2020 63% to 88% increase

  23. Aviation in emissions trading - design • All flights to and from EU airports • Small aircraft and certain flights excluded • Equivalent action on aviation emissions taken by other countries recognised • Total quantity of allowances equivalent to 97% of average annual emissions 2004-6 • From 2013, total quantity of allowances equivalent to 95% of average annual emissions 2004-6 • Allocation based on commonly-agreed benchmark (T/km) combined with harmonised level of auctioning • 15% auctioning from 2012 until 2020 • All auction revenues should be used for addressing climate change and to adapt to its effects

  24. ETS 2013-2020 • Directive 2009/29/EC amending Directive 2003/81/EC • One single EU –wide cap (limit) set on the total GHG emitted by installations included in the EU ETS • EU ETS cap set at 2,084,301,856 allowances in 2013 • Decreasing by 1.74% anually • Reduction continued beyond 2020 (revised no later than 2025) • Aiming at -21% reduction against 2005 levels • Harmonised allocation - main allocation method: auctioning • The proportion increasing annually • At least 48 % in ETS phase III • The remaining allowances allocated free of charge to industry threatened by carbon leakage, based on benchmarking • Strengthened MRV • Increased scope (new GHG, new activities)

  25. ETS 2013-2020 – broader scope: • New sectors • Aluminium • Basic chemical production • New gases: • PFCs from aluminium • nitrous oxide from certain chemicals • Broad interpretation of “combustion”, Annex I listing only activities • Combined effect: approx. 6 - 7% increase of scope compared to current trading period • Confirmation that all sectors should contribute to emission reduction commitments • Aviation • Maritime transport: future action foreseen

  26. ETS 2013-2020 – strengthened MRV: • Monitoring and Reporting Regulation • Replaced earlier guidelines • Verification and Accreditation Regulation • New EU-wide rules replacing regulation on MS level • Harmonised €100 penalty for non-compliance • requirement to surrender allowances remains • Single Union registry • MS responsible for operations on MS level

  27. ETS 2013-2020 – allocation principles: • Harmonised allocation rules to ensure a level playing field across the EU: • No distortion of competition • Fully equal treatment within sectors across EU • Auctioning as the general rule, with transitional free allocation up to 2020 • In terms of allocation rules, three categories of operators: • No free allocations (i.e. full auctioning) • Partial free allocation (no carbon leakage) • Up to 100% free allocation (carbon leakage – based on benchmarks)

  28. ETS 2013-2020 – auctioning: • Basic long-term principle for allocation: • Eliminates ‘windfall’ profits • Simplest and most transparent allocation system • Level playing field for new entrants and incumbents • Auctioning on the basis of harmonised rules: • Transparency and non-discrimination • Full access for SMEs • Full auctioning for sectors able to pass on costs: • Power sector, except CHP and district heating (except agreed derogations) • Revenues to accrue to Member States, with 50% used to address climate change and its effects

  29. ETS 2013-2020 – auctioning: • Auctioning Regulation agreed unanimously by Member States and adopted (12 November 2010, with later amendments) • MS determine use of revenues, but at least 50% should be used for climate related purposes • MSs shall inform on use of revenues through the reports under GHG monitoring Decision 280/2004/EC • 88% of auction rights distributed according to MS’ share in verified emissions in 2005 or average of period from 2005 – 07 (whichever is the highest) • 10% for purpose of solidarity and growth (Annex IIa) • 2% “Kyoto bonus”: at least 20% below Kyoto base year emission levels

  30. ETS 2013-2020 – transitional free allocation • Transitional free allocation to industry • quantities determined in accordance with Community-wide rules • Annual reductions of free quantity • To result in full auctioning by 2020 for “normal” industry (no carbon leakage) • Community-wide rules - benchmarking, for free allocation • determined taking into account most efficient techniques, substitutes, alternative production processes, etc. • Levels of allocation under rules reducing over time in line with reduction pathway • No free allocation for electricity production (as a rule, except transtional measures in some MS) • installations in sectors exposed to a significant risk of carbon leakage can receive up to 100% free allocation of the quantity of allowances determined under the general Community-wide rules

  31. ETS 2013-2020 – transitional option of free allocation for electricity producers • 10 Member States qualify • New EU12 except SI, SK, maximum 14% of EU power generation • For existing installations only • Conditional upon national plan to modernise energy infrastructure, clean technologies, diversification of energy mix • Taking into account the need to limit as far as possible directly linked prices rises • Monitoring and enforcement provisions. • Annual reporting (to the European Commission) • Total amount in 2013 maximised at 70% of 2005-2007 verified emissions, gradual decrease to zero in 2020 • For the amount corresponding to gross final national consumption of the MS • Individual allocation based on 2005-2007 verified emissions/benchmark • Option of non-transferable allowances • Commission guidance

  32. ETS 2013-2020 – use of JI and CDM credits • Use of CDM should not exceed 50% of reduction below 2005 over period 2008-2020 for existing operators and not exceed 50% of reductions below 2005 over period 2013-2020 for new sectors and aviation • Existing operators receive no less than 11% of 2008-2012 allocation • Least endowed operators receive additional access up to a certain % • New entrants and new sectors receive access to no less than 4.5% of verified emissions • Aviation receives no less than 1.5% of actual emissions • Exact percentages determined through a regulation

  33. EU ETS Reform • Proposal to reform ETS to increase its effectiveness and robustness in the next trading period from 2021 • Market stability reserve, improving the system’s resilience to shocks and dealing with the surplus of allowances from the previous trading periods • - a legislative proposal put forward together with the Communication • No import of international credits from 2021 • - envisaged linking with other carbon markets • Change of the annual linear reduction factor from 2021 from 1.74% to 2.2% • neccesary to achieve ETS contribution to -40% reduction in 2030 • Free allocation kept as a safeguard against carbon leakage, if no comparable climate action from other major economies 33

  34. Lessons from target setting – creating the market • Markets do not function properly without demand • Demand means scarcity • Scarcity depends on • Getting baseline data – monitoring and reporting • Capping emissions below demand (taking into account accuracy) • Accuracy depends on MRV and Scope • Keep systems simple • Cover installations/ gases at the outset where sufficiently accurate monitoring is feasible, extend later in line with technical progress • No need to re-invent the wheel • Use verified data as basis for any free allocation • EU ETS development and recent review show EU’s practical experience

  35. More information: http://ec.europa.eu/clima/policies/brief/eu/index_en.htm http://ec.europa.eu/clima/policies/ets/documentation_en.htm#Implementation Or contact us on: Info@climaeast.eu

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