Understanding the proposed revision of the EU ETS Thomas Bernheim DG Environment Unit C.2 European Commission

Objectives of EU ETS revision  Ensure a cost-effective contribution of the EU ETS to achieving the 20% GHG reduction for 2020, and to a 30% reduction reached in an international climate agreement  Improvement of the EU ETS based on experience so far  Enhance predictability and certainty for long-term emission reductions  Contribute to developing the international carbon market and encouraging action globally

Overview  Key elements of the Commission’s proposal –Scope –Targets / cap setting –Allocation methods –International aspect –Monitoring, reporting, verification  Next steps and key messages

Scope  Harmonised coverage of large industrial emitters: extension e.g. to chemical sectors and aluminium  Extension to other GHGs: nitrous oxide (fertilisers), perfluorocarbons (aluminium)  Extension to Carbon Capture & Storage (CCS)  Leading to new abatement opportunities, lower overall costs, and higher efficiency  Potential opt-out of smallest emitters if equivalent emission reduction measures are in place (e.g. tax)  Possibility introduced for Community-level projects

Summary of scope effects MtCO2 In % of NAP2 No of installations Extended scope Streamlining – 2.5n.a. New sectors and gases Up to 97Up to 4.6 n.a. Potentially excluded installations Up to 5000 Net effect – 6.3

GHG Target

Cap setting  A single EU-wide cap rather than 27 caps proposed by Member States  CO 2 allowances available in 2020 (based on current scope): 1720 Mt –- 21% compared to 2005 emissions  Linear decrease –predictable trend-line to 2020 and beyond (annual decrease by 1.74%) –Possible review by 2025 at the latest  Automatic adjustment to greater reduction foreseen in international agreement  Aviation being included, building on December’s Council political agreement

Cap setting -20% -30% 2083 Mtyr Gradient: -1.74%

Figures on the Cap  Figures based on –NAP 2 decisions of the Commission –ETS scope as applicable in Phase 2 To be adjusted for: –Opt-ins in Phase 2 –Extended scope in Phase 3 –Inclusion of aviation –Inclusion of Norway, Liechtenstein, Iceland

Allocation principles  Harmonised allocation rules to ensure a level playing field across the EU: –No distortion of competition –No state aid risks for operators  Auctioning as the general rule with transitional free allocation  In terms of allocation rules, three categories of operators: –No free allocation (i.e. full auctioning) –Partial free allocation –Up to 100% free allocation  European Commission to report on carbon leakage by 2011 and make any appropriate proposal: - To review free allocation levels and/or - To introduce system to neutralise distortive effects  Binding sectoral agreements to be taken into account  In conformity with principles of UNFCCC and WTO

Auctioning  Basic principle for allocation is auctioning: –Eliminates ‘windfall’ profits –Simplest and most transparent allocation system –Level playing field for new entrants and incumbents  Full auctioning for sectors able to pass on costs: –Power sector  Auctioning on the basis of harmonised rules ensuring –Transparency and non-discrimination –Full access for SMEs

Auctioning and earmarking  Range of economic situations in Member States means relatively more auctioning rights to MS with lower GDP/capita to balance high investment costs –90% of the auctioning cap is distributed according to the MS share of 2005 Verified Emissions –10% distributed to MS with GDP/cap below 120% of EU average –This distribution takes into account GDP per capita and expected growth rates  Auctions must be non-discriminatory, open to everybody and will be carried out by Member States on the basis of harmonised rules  20% of auction revenues should be used for combating climate change and promoting renewable energies

Transitional free allocation  Transitional free allocation to industry –in 2013, 80% of allocations for free of quantities determined in accordance with Community-wide rules –Annual reduction of free quantity  Phased out by 2020 for “normal industry”  Community-wide rules, e.g. benchmarking, for free allocation to be determined taking into account most efficient techniques, substitutes, alternative production processes, use of biomass and CCS  No free allocation for electricity production

Higher free allocations  Installations in sectors which are seen, on analysis, to be exposed to a significant risk of carbon leakage  Can receive up to 100% free allocation of the quantity of allowances determined under the general Community-wide rules  Sectors to be determined at the latest in 2010, taking into account inter alia ability to pass on costs without losing market share to non-EU competitors

New entrants reserve  5 % of total quantity of allowances  Equal treatment of existing and new installations  Capacity extensions not considered to be new entrants  Implementing rules to be adopted under comitology.  Sufficient size is important for avoiding carbon leakage, in particular for fast growing economies  Remainder to be auctioned

Key international aspects of the EU ETS revision  EU’s overall objective: to limit global warming to 2° C above pre-industrial levels  EU wants an international agreement on achieving these levels of emission reductions  This will require contributions from developed countries and major emitting developing countries  Climate / energy package provides incentives for others to join an international agreement

Linking  Currently, EU ETS covers 30 countries including Norway, Iceland and Liechtenstein  Linking agreements can be concluded with any other third country listed in Annex B to the Kyoto Protocol which have ratified the Protocol  In revision, Commission proposes to enable EU ETS to also link with other mandatory emission trading system capping absolute emissions: –with any third country, or –in sub-federal and regional systems  Different types of linking arrangements foreseen: –Treaty arrangements –Agreements to link systems e.g. through politically binding MoU –Reciprocal commitments applied through domestic systems

Joint Implementation and the Clean Development Mechanism  Links EU ETS with projects in around 150 other countries that have ratified Kyoto Protocol, by providing for companies to use JI/CDM credits for compliance in EU ETS  Revision proposal gives certainty on the potential for companies to use JI/ CDM, whether or not there is an international agreement following Kyoto  Clear need to differentiate between EU’s independent 20% commitment to reduce GHG emission, and the contribution that the EU will make under an international agreement where others are also contributing, e.g. –JI/CDM are an incentive for third countries to join international agreement –Demand for CDM only from the EU would reduce market-based incentive to increase energy efficiency, investment in low carbon technologies –EU’s renewables target would become more expensive if EU ETS not contributing to its achievement

JI/ CDM use without international agreement  Revision proposal ensures that: –JI/CDM credits can be used up to 2020, by enabling these to be exchanged for allowances –JI projects can continue beyond 2012, by enabling bilateral/ multilateral agreements with third countries  In a -20% scenario, certainly is given for a total 1.4 billion tons for (one third of reduction effort over the period) to: –Credits for reductions in the period from project types which were accepted by all Member States –Credits for reductions from from such projects set up in the period –In addition, credits from such projects from in any of the 50 Least Developed Countries –And credits from any bilateral/ multilateral agreements with third countries

JI/ CDM use without international agreement  In addition, climate/ energy package also provides for Member States to use CDM in respect of non-ETS emissions: –To enhance the equitable geographical distribution –To enhance achievement of international agreement on climate change –Up to 3% annually of their non-ETS emissions –Corresponding to 700 Mt demand from Member States, in a situation without international agreement

JI/ CDM once international agreement  Once an international agreement is concluded, the EU ETS will automatically increase the use of credits (JI/CDM/other) by 50% of the additional reduction effort under that agreement  Member States’ use of JI/CDM/other credits will also increase by 50% of the additional non-ETS reduction effort under that agreement  This provides a clear incentive for third countries to join international agreement

Monitoring & Reporting, Verification & Accreditation, Compliance  More harmonised rules through Regulations on –monitoring and reporting of emissions by operators –verification of reports and accreditation of verifiers (including mutual recognition)  Non-compliance penalties (€100/ tonne CO 2 ) to increase by inflation rate to maintain deterrent effect  To enhance reliability and thus international credibility of the EU ETS

Next steps  Adoption by Council and Parliament aimed for by Spring 2009  Comitology procedure to start after entry in force of revised Directive  Preparatory work already started: various pilot studies being undertaken by MS and Commission  Exposed sectors to be determined by 30 June 2010 at the latest  Community-wide rules to be adopted by 30 June 2011 at the latest  Implementation by MS by 30 September 2011 at the latest  Issuance of first year allocations by 28 February 2013 at the latest

Key messages  The ETS is the cornerstone of the EU’s market based-strategy to reduce greenhouse gases cost- effectively  Essential elements of the ETS review: –Fully harmonised approach –Ambitious cap to ensure real emissions reductions –Improvement taking into account past experience  Open and transparent process for implementation