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The EU Emissions Trading Scheme

Introduction

The EU Emissions Trading Scheme (EU ETS) is one of the main policies being introduced across Europe to tackle emissions of carbon dioxide and other greenhouse gases and combat the serious threat of climate change.

The scheme is due to start in 2005, establishing the world’s largest market in greenhouse gas (GHG) emissions. The first phase of the EU ETS will run from 1st January 2005 to 31 December 2007, with a second phase from 1st January 2008 to 31st December 2012. The second phase coincides with the first Kyoto Commitment Period. Further 5-year periods are expected subsequently.

In the UK, up to 2,000 installations, or sites, are set to participate in this market and collectively they emit about half of the economy’s carbon dioxide emissions.

For more information on the EU ETS, please visit http://www.dti.gov.uk/energy/sepn/euets.shtml or http://www.defra.gov.uk/environment/climatechange/trading/eu/index.htm.

Sectors included in the scheme

The scheme is mandatory for those installations (sites) carrying out activities in sectors covered the EU ETS Directive. In the first phase (2005 – 2007) the scheme is limited to CO2 emissions. The regulated sectors are: 

Energy activities
Combustion installations
Oil refineries
Coke ovens

Production and processing of ferrous metals
Iron and steel production

Mineral industries
Glass manufacturing
Cement clinker and lime production
Brick and tile manufacturing
Ceramic products

Other activities
Pulp
Paper

Operation of the EU ETS

The EU ETS will operate on a "cap and trade" basis. EU Member State governments are required to set an emissions cap for each of the installations covered by the scheme. Each installation will then be allocated allowances for the particular commitment period in question. The number of allowances allocated to each installation for any given period will be set down in a document called the National Allocation Plan (NAP).

Each installation involved in the EU ETS must carefully monitor its emissions every year. It will then need to surrender a number of EU emission allowances equal to the number of tonnes of carbon dioxide emitted for that year. These surrendered allowances will then be cancelled. Therefore the installation has to ensure that there are sufficient allowances in its account to cover the emissions for that year.

There are three routes an installation can employ to ensure that the allowances it holds match its emissions:

reduce the installation’s own annual emissions to the number of allowances allocated for that year;

reduce annual emissions to below the cap and either sell the excess allowances to another company or “bank” them for future use;

if the annual emissions are above the allowances allocated, the company owning the installation may buy allowances from the market to cover the difference.

The price will depend on the supply of, and demand for, carbon allowances within the Europe wide carbon trading market.

If an installation is not able to surrender sufficient allowances to cover its annual emissions by the reconciliation date, it will be financially penalised, and the amount of the deficit in allowances will be carried over to the following year. The fine for non-compliance in the first phase is 40 Euros/tonne CO2, and it rises to 100 Euros/tonne CO2 for the second phase.

Allowances that can be used for compliance are called European Allowance Units (EAUs). In addition to this, carbon credits from international climate change projects (Certified Emission Reductions from CDM projects and Emission Reduction Units from Joint Implementation projects) can be used.

Using JI and CDM credits

The European Directive regarding the introduction of overseas project-based credits into the EU ETS, the “Linking Directive”, was approved by the European Parliament in April 2004 and will enter into force in September 2004. This Directive allows companies that participate in the EU ETS to use carbon credits from international climate change projects (generated from Clean Development Mechanism and Joint Implementation projects) for compliance.

Individual Member States will decide whether or not they will place a limit on the number of credits that can be used by companies in their countries that participate in the scheme.

Companies will be able to use credits from CDM projects (CERs) for compliance from 2005 onwards, and credits from JI projects (ERUs) from 2008 onwards.

If CDM or JI credits are acceptable under the Kyoto rules, they will also be allowable for EU ETS compliance, with the following exceptions:

Credits from large dam projects;

Credits from forestry projects (sinks);

Credits from projects in the same country (known as unilateral JI or domestic projects) in sectors outside the EU ETS.

These are all excluded from the first phase of the EU ETS, but this exemption will be reviewed in 2006 to determine whether or not they will be included in the second phase of the EU ETS (2008-2012).

Credits from CDM and JI projects are expected to be cheaper than EU allowances, so allowing them into the EU ETS may make it less expensive for participating companies to meet their targets than it would otherwise have been.