The EU's Emissions Trading System (ETS) covers more than 10,000 energy-intensive facilities across the 27 EU Member countries, including oil refineries, powerplants over 20 megawatts (MW) in capacity, coke ovens, and iron and steel plants, along with cement, glass, lime, brick, ceramics, and pulp and paper installations. These covered entities emit about 40%-45% of the EU's total greenhouse gas emissions, and almost two-thirds of them are combustion installations. A Phase 2 trading period began January 1, 2008, covering the period of the Kyoto Protocol, and a Phase 3 has been finalized to begin in 2013. The European Commission (EC) believes that the Phase 1 "learning by doing" exercise prepared the community for the difficult task of achieving the reduction requirements of the Kyoto Protocol. Several positive results from the Phase 1 experience 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 remained contentious as the ETS implemented Phase 2, including allocation (including use of auctions and reliance on model projections), new entrant reserves, and others. NAPs are central to the EU's effort to achieve its Kyoto obligations under Phase 2. However, through five 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 allocation systems, reduction targets, and enforcement provisions. 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 EU, 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.
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. A Phase 3 will begin in 2013 designed to reduce emissions by 21% from 2005 levels.
Several positive results 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 implemented Phase 2, including allocation schemes and new entrant reserves, and others. A more comprehensive and coordinated response has been designed for Phase 3 with harmonized and coordinated rules being developed by the European Commission.
The United States is not a party to the Kyoto Protocol. However, six 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 as the United States debates the issue and some states and regions implement their own programs.
The EU-ETS experience illustrates the importance of having reliable emissions data for all facilities covered under a cap-and-trade scheme; data that are pivotal for developing allocation systems, reduction targets, and enforcement provisions. In the United States debate continues 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 and/or states 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. The EU will examine the matter in preparation for Phase 3. Congress may consider whether the government currently has sufficient regulatory and oversight authority over such instruments.