Linking domestic emissions trading schemes to the EU ETS

1. Linking domestic emissions trading schemes to the EU ETS Technology Transfer and Investment Risk in International Emissions Trading Work package 4 Brussels, 30 November 2006 Dr. Urs Springer, Ecoplan (Switzerland) Dirk Forrister, Natsource (UK)

2. Overview • Introduction • Switzerland • Norway • United States • Japan • Summary and conclusions

3. 1 Introduction Objectives and approach • Objectives • to describe the climate policy framework in Switzerland, Norway, Canada, Japan, and the United States; • to assess the potential and problems of linking these schemes to the EU ETS • Assessment criteria: • System design (trading scheme, system boundaries, currency, use of Kyoto mechanisms) • Target and allocation (Kyoto target, allocation, transparency) • Compliance (Monitoring, sanctions)

4. 2 Switzerland Background • Targets and emissions: • Kyoto target: -8% • Current GHG emissions: about 1990 level. Projected gap in 2010: 5% • Instruments: • CO2 tax on heating and process fuels. Rate (22 EUR / t CO2) still to be approved by Parliament Trading scheme not yet implemented. • Companies that conclude voluntary agreements with the government are excluded from CO2 tax and can participate in emissions trading scheme. Targets of voluntary agreements are the basis for the (free) allocation of tradable allowances for the period 2008-12. • Climate cent: Levy on transport fuels (1 cent / liter). Revenues used for mitigation projects in Switzerland and abroad.

5. EU ETS EU ETS Swiss ETS Swiss ETS • Aluminum • • Chemical industry Chemical industry • • Iron & steel Iron & steel • • Food & beverages Food & beverages Energy activities(including refineries) • • Cement & ceramics Cement & ceramics • • • Financial services Financial services • • Pulp & paper Pulp & paper • • Tourism • • … … 2 Switzerland 1) System design • Swiss refineries not covered • Use of Kyoto mechanisms: Only minor differences • Currency: AAU in Switzerland, “hot air” not allowed

6. 2 Switzerland 2) Target and allocation • Total allocation: In accordance with national target. • Installation-level allocation • Cement industry: Allocation 45% above current emissions: Over-allocation! • Energy agency umbrella agreement: Ambitious target (11.5% below 1990) • Other sectors: No signs of over-allocation.  NAP criterion regarding allocation only partially fulfilled (“taking reduction potential into account”). • Allocation to new entrants (gas-fired power plants) not clear. • Transparency: • Swiss voluntary agreements confidential, but will be published.

7. 2 Switzerland 3) Compliance • Monitoring – Less strict in Switzerland: • EU: Annual reports for all installations, independent verification • Switzerland: Annual reports by companies, first report in 2008 for groups. No independent verification. • Sanctions – Different approaches • EU ETS: 40 EUR and 100 EUR plus surrendering of missing allowances. • Switzerland: Repayment of CO2 tax since introduction plus interest. Problem: EUA prices > CO2 tax (EUR 22) • Ex-post adjustment: • EU ETS: Ex-post adjustments incompatible with legal framework. • Switzerland: Ex-post adjustments based on energy intensity (until 2010). Major obstacle to linkage.

8. 3 Norway Background • Targets and emissions: • Kyoto target: +1% • Booming petroleum industry, energy intensive industries. • Current GHG emissions: +9.5% • Instruments: • CO2 tax for offshore oil, domestic and transport sectors (23-40 EUR/t). Reduced rate for pulp & paper industry. • Voluntary agreement with energy intensive industries (target: -20% vs. 1990) • Emissions trading scheme along the lines of EU ETS

9. ETS Norway • District heating • Energy production • Gas processing • Other minerals CO2 tax PIL VA • Steel • Cement • Petrochem • Refineries (Pulp & paper) • Aluminium • Ferrosilicon • Carbides • Other metals • Mineral fertilizer • Pulp & paper • Transport • Offshore petroleum • Domestic heating 3 Norway 1) System design • Overlapping coverage: no problem • Petroleum and pulp & paper opted out • Use of Kyoto mechanisms: Same as EU ETS

10. 3 Norway 2) Target and allocation • Allocation: • Installation level: Overall allocation factor 90.6%.  stricter than many European countries • Uncertainty regarding new gas-fired power plants (CCS required or not?). • No guarantee for reaching Kyoto target due to narrow scope of Norwegian ETS (transport and petroleum activities not covered). • Ex post adjustment of targets • Initial allocation can be changed for 2006/07 “if the conditions on which the allocation was based are changed significantly”. • Modifications can only result in a reduction of allowances, not an increase. • Likely to be disapproved by the European Commission.

11. 3 Norway 3) Compliance • Monitoring • Annual reporting of emissions required. • Verification by independent party only in special cases (EU ETS: mandatory). • Sanctions • Fine (EUR 40) and obligation to surrender missing allowances in the subsequent year. Same as EU ETS. • EU vs. EFTA law • Norway, Liechtenstein and Iceland have to implement the Directive under the rules of the European Free Trade Association EFTA. Norway accepted, but Liechtenstein and Iceland have been reluctant to do so.  linkage not yet established.

12. Climate Stewardship Act (McCain/Lieberman) (Pending in Senate Environment Committee) Absolute targets: cap at 2000 level by 2010-15 Coverage: 85% of national GHGs downstream large emitters upstream suppliers of transport fuels Tradable units Allowances from another nation’s market Eligible domestic offsets including sequestration Credit against future reductions Financial penalty (3x market value), but no payback of tons Climate & Economy Insurance Act (Bingaman) (Pending in Senate Energy Committee) Relative targets – less stringent than CSA Devolves absolute targets to sectors/companies Program-wide 2010 target: 2.4% below 2009 (est) emissions intensity * forecasted 2010 GDP 2011-19: 2.4% below previous year’s intensity target * forecasted GDP Coverage: downstream process emissions + all upstream sources Auctioning = 9% in 2010, 13% in 2020 Tradable units: Allowances + foreign offsets geologic sequestration, use of covered fuels as feedstocks, exports of covered fuels, exports/destruction of HFCs, PFCs, SF6, N20, eligible early reductions Price cap US$7/ton in 2010, increasing 5%/year Financial penalty (3x safety valve), no payback tons 4 United States Proposed Trading Programs – Overview

13. 4 United States Proposed Trading Programs – Overview (cont’d) • North-eastern States’ Regional Greenhouse Gas Initiative (RGGI) (8/06) • 7 North-eastern / Mid-Atlantic States, plus Maryland in June 2007 • Cap and trade for electricity sector • 3-year compliance periods, extendable to 4-year if $10 trigger price reached (average during 1 year) • Certified offsets anywhere in U.S. (limit of 3.3% of entity’s emissions): LFG, afforestation, end-use efficiency for home heating, natural gas, agricultural methane capture, oil and gas fugitive methane reductions, reduction in SF6 emissions • Offset trigger: if average prices equal or exceed • $7 over period of 1 year, offset limit increases to 5% • $10 over period of 1 year, offset limit increases to 10%, and CERs and ERUs become eligible

14. 4 United States Proposed Trading Programs: Obstacles to Linking with EU ETS • Formal linking requires amendment of Emissions Trading Directive • Possible to informally link, but EU purchases of US allowances endanger EU Kyoto compliance • Gateway could be implemented, but reduces efficiency gains • Price cap (Bingaman) • Creates arbitrage opportunities, which can be reduced by limiting cap use to difference between US firms’ emissions and allocations • Cap reduces economic efficiency benefits by segmenting market, preventing efficient trades by US firms, potentially distorting pricing by US sellers • All 3 U.S. programs allow for types of reductions not eligible under EU ETS • Allows for circumvention of EU restrictions • Allows for greater purchases of EU-restricted instruments in the U.S. than under no-linking scenario

15. 4 United States Proposed Trading Programs: Obstacles to Linking with EU ETS (cont’d) • Comparability of effort • McCain-Lieberman, RGGI targets somewhat less stringent, Bingaman targets much less stringent than EU ETS • Implication: U.S. would become major seller to EU • Leakage under RGGI • RGGI cap could be undermined by electricity imports into region • Total U.S. emissions could increase while program goals met

16. 5 Japan Background • Ambitious Kyoto target (-6%), given Japan’s low emissions intensity • Significant Government purchases if no tax or mandatory cap and trade imposed after policy review in 2007 • Keidanren voluntary emission reduction targets are centerpiece of KP compliance plan • Reduce industry, energy emissions below 1990 levels by 2010 • Targets may be based on energy intensity, energy consumption, CO2 emissions intensity, or absolute CO2 emissions • 35+ industries covered • May purchase CERs, ERUs to meet targets • Mandatory cap and trade could be considered, but strongly opposed by industry, METI

17. 5 Japan Climate Policies • Japan Voluntary Emissions Trading Scheme (JVETS) • Small program • 34 companies taking on voluntary targets with subsidies for energy conservation, switching from oil • Reductions below ~ 2003 baseline of 1.3 Mt • Subsidies awarded based on cost-effectiveness, must be returned if target not met • Can use traded allowances or CERs for compliance

18. 5 Japan Compatibility with EU ETS • Environmental integrity • No sanctions for non-compliance with Keidanren targets • JVETS has no penalty, only withdrawal of subsidies • Both programs may allow CERs from large hydro and sinks projects • Could circumvent EU prohibitions • Many Keidanren targets are not absolute, unlike EU ETS • Subsidies provide advantage to JVETS firms, also obscure marginal costs, reduce efficiency • JVETS is small

19. 6 Summary and conclusions Prospects and potential of linking • Linkage between EU ETS and domestic schemes • Norway: Linkage likely and feasible. Legal issues to be resolved. • Switzerland: Linkage feasible, only if CO2 tax implemented. • North America: Great challenges of legal, economic and technical nature. • Japan: Linkage unlikely given voluntary targets and subsidies. • Economic potential • Significant benefits for Norway and Switzerland, but negligible efficiency gains for the EU. • Japan and North America: Linkage would greatly expand the market and provide substantial benefits for all parties.

20. 6 Summary and conclusions Conclusions • Main obstacles • Price caps: Segment the market, reduce efficiency. • Eligibility of tradable units: Probably impossible to maintain in practice. • Ex-post adjustments • Voluntary nature of trading schemes: Sanctions for non-compliance? • Lessons for policy development • ETS should not be developed independently of each other • Path dependence: Once an instrument (e.g. carbon tax) is implemented, it is likely to remain in place even when new instruments are introduced • Outlook • No global uniform carbon market in the near term • In the long term, better prospects for linkage of major markets

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