Linking regional emissions trading schemes with the EU ETS Peter Zaman UK Emissions Trading Group DTI Conference Centre 20 February 2007

Linking regional emissions trading schemes with the EU ETS 1 Linking vs Global Kyoto Linking not as ideal as global harmonised approach between parties under the UNFCCC Harmonisation benefits greater consistency predictability lower transaction costs But reality Tough to get large emitting States to agree to binding caps Possibly the only available alternative to Kyoto Policy concern – message could be interpreted as anti-Kyoto

Linking regional emissions trading schemes with the EU ETS 2 Benefits of Linking International trade is better than scenario of no international trade Larger market, greater liquidity drives allocation of resources towards least cost abatement more efficiently Greater range of abatement opportunities = reduced carbon cost Effective linking leads towards a single global price for carbon

Linking regional emissions trading schemes with the EU ETS 3 Managing the Linking Issues Issues depend on whether linking occurs with Kyoto or without Kyoto scenario Minimal harmonisation required to avoid distortions arising from linking schemes with different designs Linking will create winners and losers Linking removes a national government’s assurance that the emission reduction will occur within its own boundaries

Linking regional emissions trading schemes with the EU ETS 4 Some Basic Design Features Mandatory Compliance e.g. EU ETS Voluntary Compliance e.g. JVETS Cap & Trade e.g. RGGI Baseline e.g. NSW Down stream i.e. catches at point of emissions Up stream i.e. catches at point of utilisation Free AllocationAuctioning AbsoluteRelative

Linking regional emissions trading schemes with the EU ETS 5 Technical Issues to Address All units should equate to 1 tonne CO 2 e Registry interface Supplemental transaction logs Common data exchange standards

Linking regional emissions trading schemes with the EU ETS 6 Legal Issues to Address Art. 25 of the EU ETS Directive will have to be amended (currently restricts linking to Kyoto signatory ‘countries’ only) Art. 300 of the Treaty of Rome requires the agreement counterparty to be a ‘State’ Requirements of a ‘State’ include capacity to enter into relations with other States Do NSW, California, RGGI have capacity to sign linking agreements with EU ETS?

Linking regional emissions trading schemes with the EU ETS 7 With Kyoto Scenario – Fungibility of Trading Units Linking schemes where units are not fully fungible in both schemes will lead to over- supply of allowances Correlation between EU ETS Kyoto targets and external schemes’ allowances requires an AAU to back-up the non-EU allowance. This provides common basis for trading

Linking regional emissions trading schemes with the EU ETS 8 With Kyoto Scenario - Banking and non-Banking Schemes Restriction on banking in a scheme could be circumvented by parties swapping allowances for existing period with allowances for subsequent period in different schemes This causes distortion as banked allowances would not be converted to AAU backed allowances Solution – harmonised rules on banking

Linking regional emissions trading schemes with the EU ETS 9 With Kyoto Scenario – Compliance Framework – Mandatory vs Voluntary EU ETS has cost for borrowing as well as penalty Differences in penalty rates will not cause a problem so long as penalty is sufficient to ensure parties do not simply default and opt out of scheme altogether Similar models with different penalties will work because price of allowances is not directly linked to the penalty Linkage with voluntary schemes difficult since uncertainty will arise in compliance commitment where carbon prices become too uncertain

Linking regional emissions trading schemes with the EU ETS 10 With Kyoto Scenario – Compliance Framework – Penalty vs Price Caps Fixed penalty is payable for allowances that are not surrendered, but no requirement to make up shortfall in future compliance year If market price rises above the price cap, government could either offer further allowances or financially compensate the companies Price differential would have to be maintained artificially but end result could be to split the market once the carbon price rises above the price cap

Linking regional emissions trading schemes with the EU ETS 11 Other with Kyoto Issues Sector and gas coverage: Care must be taken to avoid double-counting when linking schemes based on direct emissions with schemes that include indirect emissions Allocation method: Different allocation methodology can lead to distortion of incentives Monitoring and reporting provisions: May not be a problem as long as differences do not undermine recognition of other schemes’ units

Linking regional emissions trading schemes with the EU ETS 12 Without Kyoto Scenario – Fungibility of Trading Units It is essential to put in place a system of mutual recognition of credits between the different emissions trading schemes Essential to agree to recognise different countries’ emission commitments This is necessary to maintain the environmental effectiveness of trading between two schemes

Linking regional emissions trading schemes with the EU ETS 13 Without Kyoto Scenario – Compliance Framework – Relative vs Absolute Targets If relative emissions trading scheme has no national emissions targets, increases in emissions may not be offset by emissions reductions elsewhere A direct effect of linking could be to increase overall emissions from a relative scheme Possible solutions could include: (i) introducing an exchange rate to adjust for relative allowance values and (ii) tightening the allocation in the absolute scheme.

Linking regional emissions trading schemes with the EU ETS 14 Other Without Kyoto Issues Stringency of scheme: If stringency of linking scheme so low that more allowances are allocated than business-as-usual case, then linking could undermine the environmental performance of the combined scheme Monitoring and reporting provisions: Any differences in two schemes may not matter so long as they do not undermine the recognition of other schemes’ units

Linking regional emissions trading schemes with the EU ETS 15 Conclusions Tier 1 harmonisation Fungibility and mutual recognition of units Technical compatibility (registries, STL, data flow) Recognition of respective emission targets Rules on banking Rules to avoid double counting in sector and gas coverage Tier 2 harmonisation Monitoring, reporting and verification Maintaining certain levels of stringency Managing absolute vs relative target discrepancies

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