EU and UK experience: Lessons learned Martin Nesbit Deputy Director, Climate and Energy – Business and Transport UK Department for Environment, Food and Rural Affairs

Stern Review: “The economics of climate change” July 2005: UK Finance Minister commissions Nick Stern (former World Bank chief economist) to study economics of climate change October 2006: report publishedreport Key messages: Urgency - benefits of strong early action outweigh the costs Mitigation = investment Poorest countries and people will suffer earliest and most Growth v. tackling climate change is a false choice Prices need to reflect climate change impacts – either through taxes, regulation, or trading. Trading likely to be the best way of securing an international carbon price.

Cap and Trade – the UK Experience Voluntary cap and trade scheme covering all Kyoto gases (indirect emissions) Climate Change Agreements: energy-intensive firms commit to significant carbon reductions to secure a rebate from the UK’s carbon tax (climate change levy = CCL) Lessons learned: Valuable experience in mechanics of trading (registries, etc.) Limited value in voluntary schemes Importance of ensuring scarcity Behavioural effects can be more powerful than expected

European Union 25 countries in ETS 2 joined EU in 2007

European Union action: Emissions Trading Scheme (ETS) 1998: EU Member States agree share-out of EU 8% Kyoto reduction target. Shares range from -20% (Germany, Denmark), -12.5% (UK), to some states which are allowed to increase emissions. 2001: European Commission proposes legislation for ETS; Member States (Council) + European Parliament reach agreement in Why? Because emissions trading - - means emissions reductions take place where cost is lowest, thereby maximising action possible for a given level of economic cost; - provides certainty of the level of emissions reductions (through setting a cap on emissions levels). New approach to environmental legislation for Europe, to meet new global challenge of climate change. Most other policies (e.g. air quality, acid rain, water quality) use a combination of tough limit values, and environmental standards.

Key features of EU ETS “Cap and trade” scheme covering CO 2 emissions from combustion processes (approx 46% of EU CO 2 emissions) Phase 1 EU ETS ‘learning phase’ Phase 2 EU ETS ‘Kyoto Commitment Period’ 1 European Union Allowance (EUA) = 1 metric tonne of CO 2 Allowances freely tradable throughout 25 EU Member States Majority of allowances allocated for free - range of methods, including historical emissions, projected emissions, sector benchmarks etc Businesses can make limited use of Kyoto project credits

EU allowance prices: phase 1 ( ) and phase 2 ( )

Need real scarcity – over-allocation in phase 1 Price fluctuations are to be expected in a young system – but can create political uncertainty In a multi-state system, potential for competitive distortion Need good data as a basis for allocation decisions But also: A functioning market system was created to an ambitious timetable, with a high level of compliance in year 1 (99%+) Early evidence of behavioural impacts, including much higher level of boardroom attention Decisions on phase II allocation much stricter, because (a) better data now available (b) Kyoto targets Learning how to manage a trading system

EU emissions trading: Daily Volume Jan 05 – Feb 07

EU ETS Phase I ( ) Data for 2 nd year of operation (2006) due around May EU ETS Phase II ( ) Allocation plans now being finalised, following Commission announcement in November 2006, which included criteria for checking member state allocation plans. EU ETS Review (Post 2012) European Commission conducting Review of EU ETS, with changes being considered for post EU ETS now has widespread political endorsement, and will be used as a key long-term mechanism for reducing greenhouse gas emissions in Europe Important issues for review: sectoral coverage, auctioning, cap-setting, long- term predictability for businesses Future of EU ETS

Future levels of ambition, and linking with other schemes EU Member States agreed last week a unilateral commitment to reduce to 20% below 1990 levels by 2020; and are ready to reduce to 30% as part of a “global and comprehensive agreement”.agreed EU wants to “strengthen the EU ETS” and to “extend the global carbon market”. Current EU legislation restricts linking EU ETS only to schemes in developed countries that have ratified Kyoto Protocol (e.g. Canada, Japan, Switzerland). Unilateral recognition by other schemes still a possibility (e.g. US state and regional-level schemes). EU ETS Review will consider potential for future links to other greenhouse emissions trading schemes. Impact on incentives for countries not currently signed up to international action a key factor.

EU and UK experience: Lessons learned Martin Nesbit Deputy Director, Climate and Energy – Business and Transport UK Department for Environment, Food and Rural Affairs