Covered entities emit about 45% of the EU's carbon dioxide emissions. A "Phase 1" trading period began January 1, 2005. A second, Phase 2, trading period began January 1, 2008, covering the period of the Kyoto Protocol, with a Phase 3 planned to begin in 2013. Several positives resulted from the Phase 1 experience that assisted the ETS in making the Phase 2 process run smoothly, at least so far. Second, the ETS helped jump-start the project-based mechanisms—Clean Development Mechanism (CDM) and Joint Implementation (JI)—created under the Kyoto Protocol. However, several issues that arose during the first phase remain contentious as the ETS implements Phase 2, including allocation (including use of auctions and reliance on model projections), shutdown credits and new entrant reserves, and others. In addition, the expansion of the EU and the implementation of the linking directives create new issues to which Phase 2 has had to respond. However, through almost four years of carbon emissions trading the EU has gained valuable experience. This experience, along with the process of developing Phase 3, may provide some insight into current cap-and-trade design issues in the United States. As suggested by the EU-ETS experience, expanding equivalent data requirements to all facilities covered under a cap-and-trade program would be the foundation for developing the allocation systems, reduction targets, and enforcement provisions. Most bills are more comprehensive than the ETS, covering 80% to 100% of the country's greenhouse gas emissions. As noted, the EU's experience with the ETS suggests that adding sectors to an emission trading scheme can be a slow and contentious process. Like the situation in the ETS, most U.S. industry groups either oppose auctions outright or want them to be supplemental to a base free allocation. Given the experience with the ETS where the EC and individual governments have been unwilling or unable to move away from free allocation, the Congress, like the EC, may ultimately be asked to consider specifying any auction requirement if it wishes to incorporate market economics more fully into compliance decisions. Analysis of ETS allowance prices during Phase 1 suggests the most important variables in determining allowance price changes were oil and natural gas price changes. This apparent linkage between allowance price changes and price changes in two commodities markets raises the possibility of market manipulation, particularly with the inclusion of financial instruments such as options and futures contracts. Congress may ultimately be asked to consider whether the Securities and Exchange Commission, Federal Energy Regulatory Commission, the Commodities Futures Trading Commission, or other body should have enhanced regulatory and oversight authority over such instruments.
The European Union's (EU) Emissions Trading Scheme (ETS) is a cornerstone of the EU's efforts to meet its obligation under the Kyoto Protocol. It covers more than 10,000 energy intensive facilities across the 27 EU Member countries; covered entities emit about 45% of the EU's carbon dioxide emissions. A "Phase 1" trading period began January 1, 2005. A second, Phase 2, trading period began in 2008, covering the period of the Kyoto Protocol, with a Phase 3 proposed for 2013.
Several positives resulting from the Phase 1 "learning by doing" exercise assisted the ETS in making the Phase 2 process run more smoothly, including: (1) greatly improving emissions data, (2) encouraging development of the Kyoto Protocol's project-based mechanisms—Clean Development Mechanism (CDM) and Joint Implementation (JI), and (3) influencing corporate behavior to begin pricing in the value of allowances in decision-making, particularly in the electric utility sector.
However, several issues that arose during the first phase were not resolved as the ETS moved into Phase 2, including allocation schemes, shutdown credits and new entrant reserves, and others. In addition, the expansion of the EU and the implementation of the directives linking the ETS to the Kyoto Protocol project-based mechanisms created new issues to which Phase 2 had to respond. A more comprehensive response to these issues is envisioned for Phase 3.
The United States is not a party to Kyoto. However, almost four years of carbon emissions trading has given the EU valuable experience in designing and operating a greenhouse gas trading system. This experience may provide some insight into cap-and-trade design issues currently being debated in the United States.
The U.S. requires only electric utilities to monitor CO2. The EU-ETS experience suggests that expanding similar requirements to all facilities covered under a cap-and-trade scheme would be pivotal for developing allocation systems, reduction targets, and enforcement provisions. In the U.S. debate on comprehensive versus sector-specific reduction programs, the EU-ETS experience suggests that adding sectors to a trading scheme once established may be a slow, contentious process. As with most EU industries, most U.S. industry groups either oppose auctions outright or want them to be supplemental to a base free allocation. The EU-ETS experience suggests Congress may want to consider specifying any auction requirement if it wishes to incorporate market economics more fully into compliance decisions. EU-ETS analysis suggests the most important variables in determining Phase 1 allowance price changes were oil and natural gas price changes; this apparent linkage raises possible market manipulation issues, particularly with the inclusion of financial instruments such as options and futures contracts. Congress may consider whether the government needs enhanced regulatory and oversight authority over such instruments.