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European Union - Emission Trading System (EU ETS)

To understand EU ETS, we must understand a few aspects related to climate change. The following few paragraphs deal with the issue of climate change and the subsequent paragraphs deal with the EU ETS.

As per Intergovenmental Panel on Climate Change (IPCC), human activities are estimated to have caused approximiately 1⁰C of global warming above pre-industrial levels (1890s). The range is between 0.8 and 1.2. Global warming due to humans is likely to reach 1.5⁰C between 2030 and 2052. If it reaches this level, the following will be the impact.

General Impact

• Increase in mean temperature in most land and sea (oceans)
• Hot extremes in most inhabited regions
• Heavy precipitation in several regions
• Probability of drought and precipitation deficits in some regions
• Impact on livelihoods, health and well-being, ecosystem and species, service, infrastructure
• Impact on social, economical and cultural assets

Impact on Oceans (Seas)

• By the year 2010, 1 meter increase in mean sea levels
• Salt water intrusion
• Floating and damange to infrastructure
• Marince ice sheet instability in Antartica
• Irreversible loss of Greenland ice-sheet
• Ice-free Artic once per decade
• Loss of about 3 million tonnes of fish catch annually/

Impact on Land

• 18% of insects, 16% of plants and 8% of vertebrates may be lost.
• Risk of forest fires and spread of invasive species

So what is the solution?

Under the UNFCC (United Nations Framework Convention on Climate Change) many countries have agreed to the adoption of the following protocols.

• Kyoto Protocol of 1997; and
• Paris Agreement of 2015

The parties to these agreements have committed themselves to reduce the greenhouse gases as per the recommendations made by the IPCC (Intergovernental Panel on Climate Change).

Under the Paris Agreement (2015), 196 countries came together to commit themselves to reduce greenhouse gas emissions and to limit global warming due to human activity to below 1.5⁰C.

Procedure for Solution

Every nation which is a signatory to the Paris Agreement is required to prepare, communicate and maintain "Nationally Determined Contributions (NDCs)"" that it intends to achieve. Countries are free to find their own ways to meet the targets.

Methods available to countries to meet targets

1. Command and Control approach
A standard command and control approach may mandate a standard limit per installation, but provide little flexibility to companies as to where and how emission reductions take place.


2. Tax System
A tax system does not guarantee that the CHG emissions reduction target will be achieved in a multi-national system. It is very difficult to authorities to determine the right price of carbon and hence may under or over charge companies.


3. Cap and Trade System
A cap and trade system may be beneficiial because it provides certainity about quantity (it is easy to ascertain the overall quantity of carbon emissions for a period of time). It is cost effective as well as trading will reveal the true price. The revenue received from allocation of auctioning of carbon credits gives a source of revenue to governments. It also minimises risk to member state budgets as the member states will not need to purchase additional international units to meet their commitments under Kyoto Protocol.

Some Key Terms

Greenhouse gases
They are those that absorb and emit infrared radiation in the wavelength range emitted by Earth.

• Water vapour (H₂O)
• Carbon Dioxide (CO₂)
• Methane (CH₄)
• Nitrous Oxide (N₂O)
• Ozone (O₃)
• Chlorofluorocarbons (CFCs)
• Hydrofluorocarbons (including HCFCs and HFCs)

Non-greenhouse gases

• Nitrogen (N₂)
• Oxygen (O₂)
• Argon (Ar)

EU ETS

The EU ETS is a "Cap and Trade" system. It caps the total volume of Greenhouse Gases (GHG) emissions responsible for around 50% of EU GHG emissions. It is the first and the largest emissions trading system in the world. It covers roughly 11,000 power stations and industrial units.

Phases
The EU ETS is implemented in phases. The first phase which started in 2005 and ended in 2007 was a pilot project. The second phase which started in 2008 and ended in 2012 is for compliance with the 1st commitment under Kyoto Protocol, the third phase which started in 2013 and will end in 2020 is for compliance with the 2nd commitment of Kyoto Protocol, and the fourth phase which will start in 2021 will be an additional commitment undertaken by the EU.

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The EU ETS is an environment law and, therefore, falls within European powers. The decisions about the EU ETS are made at the European level rather than at Member State level. They key institutions involved for the law are the European Parliament (the elected representatives of European citizens), the European Commission (Europe's civil service), and the European Council (the representatives of member governments in Europe's decision making).

EU Emissions Target

The international community has agreed that global warming should be kept below a 2⁰C increase, as compared to the temperature in pre-industrial times (1890s). The following are the EU targets that need to be met by 2020, also known as ("20-20-20" target):

• A reduction in EU greenhouse gas emissions of at least 20% below 1990 levels.
• 20% reduction of EU energy consumption to come from renewable resources.
• A 20% reduction in primary energy use compared with projected levels to be achieved by improving energy efficiency.

EU Targets to be met by 2050

• Reduce GHG emissions by 80~90% compared to 1990 levels, in order to keep climate change below 2⁰c.
• Creation of NER300 Fund. The fund is created to provide financial support for innovative renewable energy technology and Carbon capture and storage projects.
• To manage risk of carbon leakage by providing additional free emission allowances; and funding member states

How does the ETS work?

The system caps the overall emissions of all participants in the system. Emission allowances are provided to participants in the system. Allowances are rights to emit GHG emissions. Each allowance is a right to emit 1 tonne of CO₂. The level of cap determines the total number of allowances available in the whole system. The cap is designed to decrease annually from 2013 by 1.74% per year. Some allowances are given for free, while others are auctioned.

Let's say 100 allowances each were given to firm A and B. 100 allowances means the right to emit 100 tonnes of CO₂ annually. If firm A emits 90 tonnes in a particular year while firm B emits 110 tonnes, we have a situation where firm A has surplus of 10 emission allowances while firm B has deficit of 10 emission allowances. Firm B can buy 10 emissions from firm A through a bilateral deal (OTC market) or buy them from an exchange where emissions are listed and traded (such as European Energy Exchange - EEX and ICE, London).

Products Available

• Cash
• Forwards
• Futures
• Options
• Swaps (Exchange of EU ETS for Kyoto Carbon Credits (KCC) or vice-versa)

Phases and Inclusions

Key Features	Phase 1 (2005-2007)	Phase 2 (2008-2012)	Phase 3 (2013-2020)
Geography	EU 27	EU 27 + Norway, Iceland, Liechtenstein	EU 27 + Norway, Iceland, Liechtenstein Croatia from 01.01.2013 Aviation from 01.04.2014
Sectors	Power stations and other combustible plants >= 20MW Oil refineries Coke ovens Iron and Steel plants Cement clinker Glass Lime Bricks Ceramics Pulp Paper and Board	Same as Phase 1 + Aviation from 2012	Same as Phase 1 + Aluminium Petrochemicals Aviation from 01.01.2014 Ammonia Nitric, Adipic, Glyoxlic acid production, CO2 capture, transport in pipelines and geographical storage of CO2.
GHGs	CO2	CO2, N2O emissions via opt-in	CO2, N2O, PFC from aluminium production
Cap	2058 million tCO2	1859 million tCO2	2084 million tCO2 in 2013, decreasing in a linear way by 38 million tCO2 per year.
Eligible Trading Units (ETUs)	European Union Allowances (EUAs)	EUAs, CERs and ERUs Not eligble: Credits from forestry and large hydropower.	EUAs, CERs, ERUs, Not eligible: CERs and ERUs from forestry, HFC, N20 or large hydropower projects. Note: CERs from projects registered after 2012 must be from Least Developed Countries.

Key Features of the EU ETS

• Free allowances
• Auctions
• Monitoring
• Reporting
• Verification
• Registries
• Market Oversight

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