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Cap-and-Trade in the European Union: Policy and Politics in the EU ETS


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Cap-and-Trade in the European Union: Policy and Politics in the EU ETS

  1. 1. Cap-and-Trade in the European Union: Policy and Politics in the EU ETS Guest lecture at the School of Resource and Environmental Management, Simon Fraser University Vancouver, BC | 15 November 2013 Stefan U. Pauer PhD Student, Faculty of Law The University of British Columbia @StefanPauer
  2. 2. Roadmap Structure and operation of the EU ETS Important design elements Cap, distribution of allowances, carbon leakage Evolution and politics involved Policy-making at EU-level Creation of the EU ETS, changes of the system over time Carbon market reform
  3. 3. EU ETS in a Nutshell EU’s main climate policy instrument Overall EU 2020 target: GHG emissions 20% below 1990 Purpose: Reduction of GHG emissions at least cost Largest cap-and-trade system in the world 84% (value) and 76% (volume) of global carbon market In operation since 2005 Mandatory system
  4. 4. EU ETS in a Nutshell Coverage >12.000 large installations in 31 countries Incl. electricity and heat producers, steel, chemicals, cement, glass, pulp & paper, … ~2.000 Mt CO2e per year (almost half of EU’s total emissions) Each year, operators must report verified emissions and hand in allowances to cover for their emissions Cap on emissions creates scarcity and ensures allowances have economic value Market-based system: allowances can be traded Long-term reduction of cap to ensure emissions reductions
  5. 5. Compliance Cycle Operators monitor and report their emissions of previous year January: Preparation of report on emissions of previous year 28 February: Free allocation for current year By end of March: Verification of emissions of previous year by independent verifier By 28 April: Surrender allowances for emissions of previous year
  6. 6. Enforcement and Compliance No or insufficient surrendering entails high penalties €100 per t/CO2e not covered by surrendered allowances Payment does not release operators from surrendering obligation Compliance rate usually higher than 99%
  7. 7. Important Design Elements Declining emissions cap Distribution of allowances Carbon leakage provisions
  8. 8. Declining Emissions Cap EU-wide cap on total emissions in the system Determines and guarantees environmental outcome Declines, ensuring reduction of emissions over time (21% in 2020 compared to 2005)
  9. 9. Distribution of Allowances Distribution via Auctioning Free allocation Long-term goal to phase out free allocation
  10. 10. Auctioning >50% of allowances auctioned between 2013 and 2020 Auctioning mandatory for power sector Progressive phase-in for all others (manufacturing industry) Auction platforms European Energy Exchange (EEX), located in Germany ICE Futures Europe (ICE), located in London Revenues distributed to Member States based on their share of verified emissions in 2005 At least half should be used to combat climate change
  11. 11. Free Allocation Manufacturing industry receives allowances free of charge on a transitional basis No free allocation for power sector Based on greenhouse gas (GHG) performance benchmarks Benchmarks reflect average GHG emissions performance of 10% most efficient installations producing a product in the EU ‘One product – one benchmark’ 52 industrial products benchmarked, covering ~80% of manufacturing emissions System rewards best practice in low-emissions production
  12. 12. Carbon Leakage Issue: Absence of comparable carbon constraints in third countries could lead to Economic disadvantage for domestic industry from international competition (competitiveness impact) Potential overall increase in GHG emissions in case of relocation (environmental impact) Policy response: More free allocation for sectors at risk Factors applied in assessing risk Estimate increase in production costs due to EU ETS Trade-intensity with non-EU countries
  13. 13. Evolution and Politics Involved Policy-making at EU-level Creation of the EU ETS From proposal for a carbon tax in 1992… …to adoption of cap-and-trade in 2003 Changes of the system over time Natural evolution – or deliberate strategy?
  14. 14. Political Decision-Making and Exertion of Influence by Stakeholders Structure of EU political institutions akin to national institutions Executive (Commission), legislative (Council, Parliament), judiciary (Court of Justice) Typical decision-making procedure Commission department in charge drafts proposal Inter-Service Consultation Commission submits proposal to Council & Parliament Negotiations between Council & Parliament Implementation of adopted legislation Stakeholders seek to exert influence at each stage of process Industry, NGOs, national governments, academics
  15. 15. Attempt to Introduce an EU-wide Carbon Tax in 1992 In 1992 EU Commission proposed a carbon-energy tax To be phased in gradually (rising price) Revenue-neutral Conditional upon approval of similar measures in other countries Tax reductions for energy-intensive companies But not approved in Council – main reasons: Industry fears of loss of competitiveness Unanimity required in tax matters
  16. 16. From Proposed Carbon Tax to Emissions Trading Kyoto Protocol (1997) prompted EU Commission to focus on emissions trading (ET) During negotiations EU was highly skeptical of ET EU insisted on binding numerical emissions reduction targets US not willing to accept without inclusion of ET Compromise: binding numerical targets, inclusion of ET EU’s insistence on binding numerical targets implied special obligation for EU to comply with Kyoto Protocol ET seen as economic opportunity, reducing compliance costs Qualified majority sufficient to pass into EU-law
  17. 17. From Proposed Carbon Tax to Emissions Trading Commission crafted support among stakeholders Industry: Cost-effective, economic opportunities NGOs: Environmentally effective, cap guarantees emissions reductions Member States: Combination of above, highlighting ET as tool for achieving emissions targets agreed under Kyoto Protocol US withdrawal from Kyoto Protocol in 2001 Unified Member States and EU institutions, eager to become leaders on global climate diplomacy Formal proposal of EU ETS in 2001 – adoption in 2003
  18. 18. Phase I (2005-2007) Purpose: learning by doing, “pilot” phase Compliance entities Administration (national governments, EU Commission) Building up infrastructure necessary for monitoring, reporting, and verification of emissions Setting up registers to keep track of ownership of allowances National Allocation Plans (NAPs) Allowances distributed free of charge Sum of NAPs forms emissions cap Based on best guesses in absence of reliable emissions data
  19. 19. Phase I (2005-2007) Publication in 2006 of verified emissions More allowances were distributed than installations needed Significant drop in allowance price No banking of allowances for carry-over into phase II Price falls to zero at end of phase I Bulgaria and Romania acceded to EU and thus joined ETS in 2007 (although did not have all infrastructure in place to participate effectively in trading in that year) Emissions became a matter of economic considerations
  20. 20. Phase II (2008-2012) Norway, Iceland, Liechtenstein joined EU ETS in 2008 Global financial crisis in 2008/2009 Inclusion of aviation sector in 2012 International offset credits allowed (CDM, JI) Banking of allowances for carry-over into phase III National Allocation Plans (NAPs) Caps tightened Share of free allocation falls slightly (still ~95%) Some Member States hold first auctions
  21. 21. Phase II (2008-2012) Generous levels of free allocation Member States had incentives to protect their own industries by providing generous allocations (“race to the bottom”) National variations in allocation lead to distortions of competition within EU Free allocation mostly based on past emissions “Grandfathering” relatively straightforward, but… Perverse reward: the more emissions, the more free allowances Economic rents for electricity producers Carbon leakage? 2013 study (Ecorys et al.) does not find any evidence for relocation due to EU ETS between 2005 and 2012
  22. 22. Phase III (2013-2020) Reform of EU ETS passed into law in 2009, changes effective as of phase III Move from decentralized to centralized system EU-wide, declining cap (no more NAPs) Auctioning as default allocation method, mandatory for power sector Common rules on free allocation, based on GHG performance benchmarks
  23. 23. Phase III (2013-2020) Concessions to new Member States as part of 2009 reform Derogation from auctioning for power sector Value of free allocation must be matched by investments modernizing the power sectors in these Member States Concerns 700m allowances during phase III Redistribution of revenues from auctioning 10% of revenues to least wealthy Member States as additional source of income for mitigation and adaptation Croatia accedes to EU and thus joins ETS in 2013
  24. 24. Natural Evolution – or Deliberate Strategy? Evolution suggestive of deliberate strategy Initial buy-in, subsequent ratcheting up Achieve initial acceptance among stakeholders… Member States retain autonomy (NAPs) Compliance entities get allowances for free …then improve the system over time From national autonomy to centralization Ramp up auctioning, decrease free allocation Tightening of the cap, extensions of scope Gradual increase of ambition from phase I to III
  25. 25. Carbon Market Reform The problem Causes Consequences of inaction Possible solutions
  26. 26. Carbon Price Evolution 2008-2012 Source: Point Carbon
  27. 27. Causes and Consequences Some of the main causes Over-generous free allocation by national governments Economic recession Increased use of (cheap) international offset credits = Imbalance of supply and demand Consequences Weak price signal weakens incentive to invest in low-carbon technology Reduced government revenue from auctioning Risk of fragmentation
  28. 28. Possible Solutions Short-term: “back-loading” Postpone auctioning of allowances Affects temporal distribution of allowances, not their overall number One-off measure Contemplated as a quick, temporary solution before tackling long-term measures, but… Encountered opposition in Parliament and Council
  29. 29. Possible Solutions Long-term: structural reform Address imbalance between supply and demand Options Increasing the EU’s emissions reduction target Retiring allowances permanently Tightening the emissions cap Extending the scope of the system (e.g. inclusion of transport sector, shipping) Limiting access to international credits Introducing discretionary price management mechanisms (e.g. price floor)
  30. 30. Thank You Thank you for your attention! Any questions or comments? @StefanPauer