Learn about the Emissions Trading Market in Europe.

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Emissions Trading in Europe 2007

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Over the last few decades,

there has been growing concern about global warming and climate change caused by greenhouse gases (GHG) - emissions from human activities that involve fossil fuel combustion. In 1992, the United Nations Framework Convention on Climate Change (UNFCCC) adopted the Kyoto Protocol, signed by 84 countries, under which all the major industrialized nations must limit their GHG emissions and bring them back down to 1990 levels. One approach to mitigating global warming is emissions trading - the trading of permits to emit carbon dioxide and other greenhouse gases, calculated in tons of carbon dioxide equivalent (tCO2e). Emissions trading has emerged over the last two decades as a preferred environmental policy tool. One key advantage to emissions trading is that it gives countries and firms flexibility in meeting their emissions targets, rather than imposing predetermined technologies or standards.

The European Union (EU), under the Kyoto Protocol, has committed to reducing its GHG emissions by 8 percent from 1990 levels between 2008 and 2012. The European Union's Emissions Trading Scheme or EU-ETS was enacted in January 2005 as one of the policy measures to enable the EU to meet its Kyoto targets. EU-ETS is a landmark environmental policy, representing the world's first large-scale GHG trading program, covering approximately 12,000 installations in 25 countries and six major industrial sectors. The EU-ETS offers an opportunity for critical insights into the design and implementation of a market-based environmental program of significant size and complexity. The EU-ETS grants allowances to companies for their GHG emissions in accordance with their government's environmental objectives. The program permits a company to emit more than its allowance of GHGs as long as it has reached an agreement to buy allowances from other companies that emit less than they are permitted to.

Within the EU, the supply of allowances is initially determined by individual member states, which develop National Allocation Plans showing the allowances they plan to allocate over a given period and the methods to be used for granting allowances to various facilities. The total quantity of allowances made available by each member state must correspond to the target assigned to it under the Kyoto Protocol. The member state must therefore ensure that the allowances it grants will enable it to reach its target. In 2005, the EU member states issued allowances for 2.2 billion tons of CO2. These amounts make the European allowance the leading CO2 unit of value in the world, with a potential market of more than 50 billion Euros. Considering that the market is young and has encountered delays in getting up to speed, this trading volume is noteworthy and encouraging.

The rise in market prices for allowances reflects a growing recognition of the effect of carbon constraints on industries and of the European Commission's authority to enforce these limits. It is the ability of public authorities to enforce compliance with emissions reductions that creates scarcity of allowances on the nascent carbon market and determines their value. Despite the challenges and some flaws in the EU-ETS and regardless of developments in the European exchanges over the next few years, Europe is developing a real financial industry for carbon allowances that will ultimately have its own specialized professions and institutions.

Table of content

Executive Summary

Introduction

Concerns about Global Climate Change

The Kyoto Protocol

GHG Emissions

Emission Reduction Targets

Progress towards Kyoto Targets

GHG Emissions in Europe

EU-25 Member States

EU-15 Member States

New Member States

European Kyoto Protocol Targets

Emission Trade to Tackle Climate Change

International Emissions Trading

Green Investment Schemes

Clean Development Mechanism (CDM)

Joint Implementation (JI)

Domestic Emissions Trading

European Union Emissions Trading Scheme

EU Emissions Trading Scheme (EU-ETS)

Background

Scheme Coverage

National Allocation Plans

Emission Allowances

Monitoring and Verification

Compliance

Transaction Registries

Effect on JI and the CDM

Impact of Policies and Measures

National and Common EU Policies

Energy Supply and Use

Transportation

Agriculture

Waste Management

Trends

Manufacturing

Agriculture

Households

Transportation

Renewable Energy

Combined Heat and Power

Auctioning of Emission Allowances

Overview

Initiatives in Phase I

Auctioning Methods

Static Auctions

Dynamic Auctions - Ascending Clock

Other Elements in Auctioning

Advantages and Disadvantages

Efficient Allowances Distribution

Allocation of Auction Revenues

Environmental Effectiveness

Opportunity for New Entrants

Role of Smaller Players

Chances of Market Distortion

Auctioning versus Sale

Impact of Auctioning

Compliance Costs

Transaction Costs

Harmonization versus Competitiveness

New Entrants

Comparison with Other Trading Programs

SO2 Trading Program

NOx Trading Program

Outcome of Phase I

Emissions Levels

Prices and Other Market Activities

Issues and Uncertainties

Tightening of Emission Caps

Harmonizing NAPs

New Entrants

Coverage Expansion

Lessons for Phase II

Outlook for EU ETS

Prospects for EU Phase II and Post-2012

Dynamic Targets

Temporal Flexibility

Non-Binding Targets

Price Caps

Sectoral Approaches

Linking Emission Trading Systems

Assessment of Key EU Member States

Bulgaria

Denmark

France

Germany

Italy

The Netherlands

Poland

Portugal

Slovak Republic

Spain

United Kingdom

Case Studies

Norway's Emission Trading System

Aviation Sector

Power Intensive Industries

UK's Cement Sector

Major Factors Influencing Sector

Appendix

Glossary

List of Figures

Figure 1: Integrated Framework of Climate Changes

Figure 2: Global Increase in GHG Concentrations - Since Pre-Industrial Times

Figure 3: Global Air Temperatures - Annual Anomalies (1850-2006)

Figure 26: EU Emission Trends vs. Kyoto Targets

Figure 27: European Member States under EU-ETS

Figure 4: GHG Emissions per Capita of EU-25

Figure 5: Actual and Projected GHG Emissions Aggregated for New Member States

Figure 6: Burden Sharing Targets for EU-15 Member States

Figure 7: Emission Targets of EU-15 Member States for 2008-2012

Figure 8: Emission Targets of New EU Member States for 2008-2012

Figure 9: Linkages between CCPMs and National Policies and Measures

Figure 10: Changes in EU-15 GHG Emissions by Sector

Figure 11: EU-15 CO2 Emissions from Manufacturing and Construction

Figure 12: Factors Influencing EU-15 CO2 Emissions from Manufacturing and Construction

Figure 13: EU-15 GHG Emissions from Agriculture

Figure 14: EU-15 CO2 Emissions from Households

Figure 15: EU-15 GHG Emissions from Transportation

Figure 16: Share of Renewable Energy in Electricity Consumption (2004) and Targets (2010) for the EU-25

Figure 17: EU-15 Shares of CHP in Electricity Production

Figure 18: Aggregate Demand Curve

Figure 19: Uniform Price Auction

Figure 20: Pay-As-Bid Auction

Figure 21: Price and Volatility in CO2 Market

Figure 22: Changes in Prices of the CO2 Market

Figure 23: CO2 Prices Corresponding to Electricity Prices

Figure 24: UK Cement Sector Projections, Allocations and Emissions

Figure 25: CO2 Emissions from Cement Installations in UK

List of Tables

Table 1: Actual GHG Emissions vs. Kyoto Protocol Targets

Table 2: EU-15 Targets and Emission Reductions for Different National Projections

Table 3: National Allocation Plans (NAP) Implementation in EU

Table 10: EU ETS Costs in 2010

Table 9: EU ETS Phase I - Annual Emission Allowance Allocations and Sectoral Shares

Table 4: Comparison of EU ETS and U.S. Trading Programs

Table 5: Review of Emissions Trading under EU ETS (as of April 30, 2006)

Table 6: Major Issues During the Phase I of EU ETS

Table 7: Comparison of ETS Caps in Phase I and Phase II (Million mtCO2e)

Table 8: NAP Harmonization Issues

Table 11: Estimated Number of Installations in the EU ETS

Table 12: Fulfillment Factors for Various Regions in 2005 and 2020

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