Climate Change: The European Union's Emissions Trading System (EU-ETS)

Publication Date: July 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Environment

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Abstract:

The European Union's (EU's) Emissions Trading System (ETS) is a cornerstone of the EU's efforts to meet its obligation under the Kyoto Protocol. It covers more than 11,500 energy intensive facilities across the 25 EU member countries, including oil refineries, powerplants over 20 megawatts (MW) in capacity, coke ovens, and iron and steel plants, along with cement, glass, lime, brick, ceramics, and pulp and paper installations. Covered entities emit about 45% of the EU's carbon dioxide emissions. The trading program does not cover emissions of non-CO2 greenhouse gases, which account for about 20% of the EU's total greenhouse gas emissions. The first trading period began January 1, 2005. A second trading period is scheduled to begin in 2008, with a third one planned for 2013. In deciding on its trading program, the European Commission (EC) adopted a "learning-by-doing" approach to prepare the EU for the Kyoto Protocol's emission limitations. The EU does not have major experience with emissions trading, and the EC felt that an initial program beginning in 2005 would give the EU practical familiarity in operating such a system.

At first glance, it would appear that the EU may have little difficulty meeting its Kyoto Protocol requirements during the second trading period. The anticipated deficit between the second trading period for the original 15 Member States can be covered by trading with the 10 newer Member States that anticipate a surplus. Also, credits are likely to be available through Joint Implementation (JI) and Clean Development Mechanism (CDM) projects sanctioned under the Protocol.

However, there are other considerations. The availability of surplus credits created via JI and CDM is restricted by the EC requirement that such credits be "supplemental" to a country's domestic efforts. Each country is to spell out what "supplemental" means in its National Allocation Plans (NAPs) for the second trading period. Individual countries are likely to define that term differently -- restricting allowance trades and purchases in some countries.

Another consideration is the overall commitment of the Kyoto Protocol. As noted earlier, the ETS covers only a percentage of the overall greenhouse gas emissions in the various Member States of the EU. Some sectors not covered by the ETS may grow faster than sectors covered by it, creating difficulties for compliance. In particular, the transportation area is already a source of concern.

A final consideration for the ETS is its suitability for directing long-term investment toward a low-carbon future -- the ultimate goal of any climate change program. It is too early to tell whether the ETS's market signal and individual countries' NAPs will move investment in the appropriate direction. The early signs are not particularly encouraging, with the 2005-2008 NAPs producing an overallocation of allowances and one major Member State (Germany) attempting to direct its second NAP toward carbon-intensive, coal-fired electric-generating facilities rather than low-carbon alternatives. Reluctance by countries to redirect their NAPs and an inconsistent price signal from the ETS make the long-term effect of the ETS uncertain.