Lessons learned from EU Emissions Trading Scheme (ETS) Dina Kruger Director, Climate Change Division Office of Atmospheric Programs U.S. Environmental Protection Agency NARUC WINTER MEETING Joint ERE-Electricity Committee Session February 19, 2008

Overview Background on EU Climate Policy EU Emission Trading Scheme (ETS) Lessons learned from “Trial period” of ETS Looking forward

European Union (EU) Within EU Original 15 EU Member States have 23 countries have Kyoto targets as “Annex B” parties, Malta and Cyprus do not have targets Original 15 EU Member States have Collective Kyoto target of (8% below 1990 levels), but Differentiated responsibilities under the EU Burden Sharing Agreement

Emissions and GDP in 2005 EU emissions are 40% below US emissions while GDP is about 10% higher than US GDP EU emissions are approximately 42% lower than US emission in 2005, while EU-27 economy is larger than US EU intensity is lower than US Emissions data is from respective inventories GDP data is from IMF World Economic Outlook Database

EU Burden Sharing Agreement

EU Climate Change Policy Overall EU Goal: Reducing its overall emissions to at least 20% below 1990 levels by 2020 EU is using a portfolio of policies to meet goal across all sectors through the EU Climate Change Program (ECCP) Cross-cutting cap and trade Regulation Incentives Voluntary approaches Updated goals and binding measures for ECCP portfolio announced January 23, 2008: Energy supply measures: increase share of renewable energy to 20% by 2020 Energy demand measures: 20% reduction in energy consumption through energy efficiency Transportation, buildings, agriculture: reduce emissions 10% below 2005 levels Commitments by car makers to reduce CO2 emissions rate from new passenger cars by 25% below 1995 levels by 2008/2009 Increase share of sustainable biofuels to 10% of overall petrol and diesel consumption Improved EU ETS European commission established ECCP in 2000 -it was/is designed as a multistakeholder consultative process bringing together all relevant players (commission, national experts, industry and NGO community). The European Commission unveiled its ambitious proposals to fight climate change and promote renewable energy in line with EU commitments agreed in March of last year. The main thrust of these commitments is a 20% below 1990 cut in greenhouse gas emissions by 2020, with a promise to step up to 30% under an international agreement; and a 20% of energy use through renewables by 2020. The European Council invited the Commission to submit a proposal for a new comprehensive Renewables Directive on the use and promotion of renewable resources. Currently 27 member states operate 27 different national support schemes, including trading green certificates, imposing electricity taxes and providing feed-in tariffs. (NOTE APPROVAL ON PLAN TO TAKE 1-3 years, IN GENERAL there is “POLITICAL WILL” TO ACHIEVE AGREEMENT QUICKLY) SUMMARY ON JANUARY 23 PROPOSAL; Existing ETS directive 2003/87/EC (ETS Directive) established a framework for the purchase and sale of allowances to meet EU member states greenhouse gas emissions caps. First trading period 1/1/05-12/31/07; 2nd trading period coincides with first commitment period of Kyoto: 1/1/08-12/31/12. BROADLY, January 23, 2008 Proposal: strengthen, expand, improve ETS post 2012; reduction of 20% by 2020 compared with 1990 levels and 30% if a international agreement is reached; and the following features: -singe EU-wide cap instead of 27 national caps (the annual declining cap will continue beyond the end of the third trading phase (2013-2020) -More allowances auctioned (estimated 60% by 2013, rising to 100% over time) -Commission will issue harmonized rules governing free allocation of emissions -New industries covered including petrochemicals, aluminum, ammonia, and new gases including N20 and PFCs; and CCS will be covered -Member states can use CDM credits from emission reduction project in certain Kyoto-approved countries UNTIL a future global climate change agreement has been reached, up to 3% of the emissions of each Member State NOT covered by the ETS Directive Once there is an international agreement, Member States should only accept ER credits from countries which have ratified that agreement and are subject to a common approach. -overall target of 20% renewable energy by 2020 (e.g., UK 15% renewable energy consumed within its borders; France 23%, etc.) -Member states required to ensure 10% of energy consumed in transport sector renewable (biofuels) by 2020 Finally, commissions proposals are likely to impose a significant cost burden on business, and at the same time provide significant investment opportunities. The President, Jose Manuel Barroso indicated increased costs may put European businesses at a competitive disadvantage to businesses in non-EU countries. A global climate change agreement should address that imbalance, however, in its absence, or if countries such as the US do not agree to it, Barroso stated carbon tariffs may be imposed on their imports into the EU. Significantly more stringent approach than the existing one. Key to proposals have been increased trading opportunities, particularly within the EU, for allowances under the ETS and guarantees of origin to meet renewable energy targets. Such opportunities are likely to foster more trade between Member States and, where they exist, break down barriers to help achieve the challenging targets proposed by the commission. The Commission has raised the stakes for businesses throughout Europe and internationally but it remains to be seen whether they are up to the challenge. Source: Point Carbon, European Climate Change Program, http://ec.europa.eu/environment/climat/eccp.htm

EU Emissions Trading Scheme (ETS) EU ETS currently addresses nearly 50% of all CO2 emissions (~40% of total annual GHG emissions) EU Directive currently outlines provisions for initial trading periods “Trial” period (2005-2007) First commitment period (2008-2012) Proposed amendment for third period (2013-2020) with commitment for subsequent phases Based on 2005 emissions, ETS addresses nearly 50% of all CO2 emissions and 40% of total GHGs (including CO2) Non-capped sectors in initial trading periods: Transportation Buildings Some sectors such as chemicals could be added as opt-ins in period 2, but will be part of phase 3.

EU Emissions Trading Scheme (ETS) 2005-2007: Trial Period Cap: set by member states, 2.2 billion allowances issued annually Covers only CO2 emissions Coverage: combustion and process emissions from electricity generation and selected industries Energy activities, mineral oil refineries, coke ovens (installations with “rated thermal input” ≥ 20 MW) Production and processing of ferrous metals Minerals industry (includes cement, glass, ceramics, lime) Pulp and paper production Point of regulation Downstream Allocation Approaches 95% of allowances must be allocated freely, 5% can be auctioned Compliance and penalties Penalties 1st period = €40/excess ton CO2 2008-2012: Kyoto Commitment Period Cap: set by member states, 2.083 billion allowances annually Also covers only CO2. but other gases are opt-ins 90% of allowances must be allocated freely, 10% can be auctioned Penalties 2nd period = €100/excess ton CO2 Use of Kyoto mechanisms (% of CDM credits allowed to be set by member states) qualitative limitations – no nuclear and sinks credits quantitative limitations – in phase 2 credit import is limited to 10% of the Member state’s total allowances Now entering Kyoto commitment Period. CDM/JI threshold of 10% is in someways a “rule of thumb” and final decisions are determined by the commission. Netherlands “opt-in” of N2O sources – Nitric Acid installations An application for an opt-in for the N2O emissions from nitric acid production will be made under article 24 of the Directive. This will affect three installations. Separate emission capacities will be set up for N2O. The quantity of emission capacity per year is 1.4 megatons of CO2 equivalents for the existing installations. In addition, there is approximately 0.3 megatons available for new entrants and there is a limited quantity of allowances for legal proceedings.

Prices and Volumes General factors contributing to price volatility: Fuel prices Weather Policy developments Current Phase II price is around 20 euros Price volatility is also due to overallocation. Price dropped in May 06 after first verification period.

Evaluating Emissions Trading Does it meet the environmental goal? Are caps achieved? Is monitoring accurate? Does the market work efficiently? Sufficient sources for a liquid market? Long-term certainty for investment planning? Is it a workable program administratively? Is the cap stringent enough to meet goals? Usually Based on current and projected emissions, cost benefit analysis.

“Trial” Period Design and Implementation Lessons Lesson 1: Need high quality emissions data to set environmental goals Phase 1 caps based on limited data Phase 2 caps take advantage of better data Complementary policies needed for non-capped sectors Lesson 2: Consistency and predictability are important Large variability in allocation method among member states Failure to credit plant shutdowns creates perverse incentives Lesson 3: Keep scope manageable and consider contribution to emissions Inclusive of largest emitters and sufficient sources for trading, but Large number of small installations included ~36% of total installations, responsible for ~ 0.7% of emissions 7.5% of total installations, responsible for ~60% of emissions Third phase of ETS will allow small installations < 25MW and emitting <10,000 tons to opt out

“Trial” Period Design and Implementation Lessons Lesson 4: Need to have flexibility and provide long term-certainty Sources did not have temporal flexibility due to lack of banking between phases Phase 3: Trading extended to (2013-2020) for long-term investment certainty Banking will be allowed between Phase 2 and 3 Lesson 5: Program implementation should be efficient Infrastructure for transfer of CDM credits not in place Monitoring protocols clear, but not all reporting is electronic Initial release of monitoring data not coordinated Role of third-party verifiers affects timing of data submissions Lesson 6: Transparency is important for credibility Functioning registry system to track allowances and ownership, but allowance transfers are not public data Annual reporting (quarterly reporting in U.S.) Note on registries: As a signatory to the Kyoto Protocol in its own right, the Community is also obliged to maintain a registry. This is the Community Registry, which is distinct from the registries of Member States. Allowances issued from 1 January 2013 onwards will be held in the Community registry instead of in national registries. EU ETS is looking to harmonize program design across all participating countries…

EU Climate Policy Looking Forward Further improvements to EU ETS Single EU-wide cap instead of 27 national caps Average 1.846 billion metric tons CO2/year Increasing share of auctioning (full auctioning of power sector allowances in 2013) Community-wide new entrant reserve (5% of cap) Expanding to include other sectors and gases Aviation Aluminum (PFCs) and Chemicals (N2O) Recognize carbon capture and storage (CCS) Domestic Offsets? Linking Phase 2: Norway, Iceland, and Liechtenstein International Carbon Action Partnership (ICAP) Discussions with the Northeast Regional Greenhouse Gas Initiative (RGGI), California, Australia, New Zealand and Canadian Provinces With global agreement, EU will commit to 30% below 1990 levels by 2020 EU/Community-level cap. Countries will not prepare NAPs – EC to harmonize allocation rules across member states. Phase 3 Cap is nearly 16% below phase 1 avg. cap, 11% below phase 2. Increasing share of allowances will be auctioned starting with 100% auctioning power sector. For installations in other sectors, a gradual transition is appropriate, starting with free allocation at a level of 80% of their share in the total quantity of allowances to be issued, decreasing by equal amounts each year, arriving at zero free allocation by 2020. It is estimated that around 60% of the total number of allowances will be auctioned in 2013, and this proportion will increase in later years. at least 20% of the proceeds from the auctioning of allowances should be used to reduce greenhouse gas emissions, to adapt to the impacts of climate change, to fund research and development for reducing emissions and adaptation, to develop renewable energies to meet the EU’s commitment to using 20% renewable energies by 2020, to meet the commitment of the Community to increase energy efficiency by 20% by 2020, for the capture and geological storage of greenhouse gases, to contribute to the Global Energy Efficiency and Renewable Energy Fund20, for measures to avoid deforestation and facilitate adaptation in developing countries, and for addressing social aspects such as possible increases in electricity prices in lower and middle income households. New entrant allocation from reserve should “mirror allocation to existing installations” Note on offsets: The Commission is proposing that projects in EU Member States which reduce greenhouse gas emissions not covered by the ETS could issue credits. These 'domestic offset credits' would need to be managed according to common EU provisions set up by the Commission in order to be tradable throughout the system. Such provisions will be adopted only for projects that cannot be realized through inclusion in the ETS. The provisions will seek to ensure that domestic credits do not result in double-counting of emission reductions or impede other policy measures to reduce emissions not covered by the ETS, and that they are based on simple, easily administered rules.

For more information Thank you! Point Carbon: www.pointcarbon.com Caisse desDepots: http://www.caissedesdepots.fr/ EU ETS: http://ec.europa.eu/environment/climat/emission.htm Thank you! Dina Kruger Director, Climate Change Division Office of Atmospheric Programs kruger.dina@epa.gov www.epa.gov/climatechange