Linking domestic emissions trading schemes to the EU ETS

Technology Transfer and Investment Risk in International Emissions Trading

Work package 4

June 20, 2006 Dr. Urs Springer, Ecoplan

ECOPLAN 1

Overview

1. Aims and scope of work package 4 2. Approach 3. Emissions trading in Switzerland 4. Ready to link up? The Case of Norway < Natsource: ETS in North America and Japan > 5. Conclusions

ECOPLAN 2

1 Aims and scope of WP4

Objectives

 to describe the climate policy framework in Switzerland, Norway, Canada, and Japan;  to assess the potential and problems of linking these schemes to the EU ETS  to deliver data about early technology transfer trends related to Canada and Japan

ECOPLAN 3

1 Aims and scope of WP4

Status of work

   End of April: D2 completed and sent to partners for comments Beginning of May: Short paper submitted to

Climate Policy

External review (Norway: CICERO) and internal quality check (ZEW) completed  End of May:

D2 submitted

to Commission

ECOPLAN 4

1 Aims and scope of WP4

Key elements of the EU ETS

GHG covered Trading system Coverage Tradable units Trading periods Allocation Sanctions

CO 2 emissions from the combustion of fossil fuels Mandatory cap-and-trade system for large emitters in the energy sector and selected industrial sectors Mandatory system for large emitters in the energy and selected industrial sectors EU allowances (≠ AAUs), CERs and ERUs (excluding nuclear power and LULUCF projects) Phase 1: 2005 – 2007. Phase 2: 2008 – 2012 Responsibility of Member states (phase 1: mostly free allocation based on historical emissions) Penalty of EUR 40 (phase 1) and EUR 100 (phase 2) and obligation to cover deficit in subsequent period

ECOPLAN 5

2 Approach

Compatibility assessment

Sources Criteria 1) System design

a) Trading scheme b) System boundaries c) Currency d) Use of Kyoto mechanisms

2) Target and allocation

a) Kyoto target • Consistency • Progress b) Allocation • Reduction potential • Non-discrimination • New entrants c) Transparency

3) Compliance

a) Monitoring b) Sanctions

ECOPLAN Economic literature EU Commission:

Speeches and personal communication.

EU Commission:

Criteria for NAP evaluation (Annex III)

6

3 Emissions trading in Switzerland

Background



Kyoto target: -8%

 Current GHG emissions: about 1990 level  Projected gap in 2010: 5% 

CO 2 tax

on heating and process fuels. Rate (22 EUR / t CO 2 ) still to be approved by Parliament.

 Companies that conclude

voluntary agreements

with the government are excluded from the CO 2 tax.



Climate cent:

Levy on transport fuels (1 cent / liter). Revenues used for mitigation projects in Switzerland and abroad.

ECOPLAN 7

3 Emissions trading in Switzerland

Key features of proposed trading scheme

 Companies can be

exempt

from CO 2 tax if they take on voluntary targets. These targets are the basis for the (free) allocation of tradable allowances for the period 2008-12.

 Compliance options: – implement internal emission reduction measures – purchase allowances from other Swiss companies – purchase CERs or ERUs 

Sanctions:

Repayment of entire CO 2 tax plus interest.

 Monitoring of each installation, verification by government or private agencies.

ECOPLAN 8

3 Emissions trading in Switzerland

Linkage of Swiss and EU ETS

Transport

Switzerland

Households Industry

European Union

Energy and industry Other sectors Climate penny CO 2 tax CO 2 tax EU ETS Other policies ETS

Rest of the World

All sectors JI / CDM

ECOPLAN

Existing link Link to be established

9

3 Swiss and EU ETS: Assessment of compatibility

1) System design - sectoral coverage

• Energy activities (including refineries) • Aluminum • • Tourism Problem: Swiss refineries not covered

ECOPLAN 10

3 Swiss and EU ETS: Assessment of compatibility

1) System design – Currency, flexible mechanisms

 Currency – Main problem: „Hot air“ – In CH: No problem, since „hot air“ is banned  Use of Kyoto mechanisms – Nuclear projects: Explicitly excluded in EU, implicitly excluded in CH – LULUCF: Banned in EU, allowed in CH. But: Swiss rule to be adapted, if ban in EU maintained.

– GMO projects: Allowed in EU, banned in CH.

– Large hydro: Must follow international guidelines in EU, no restriction in CH.

 Overall: Only minor differences, no compatibility problems.

ECOPLAN 11

3 Swiss and EU ETS: Assessment of compatibility

2) Target and allocation

 Total allocation: In accordance with national target.

 Installation-level allocation – Cement industry: Allocation 45% above current emissions: Over-allocation!

– Energy agency umbrella agreement: -11.5% compared to 1990 => ambitious target.

– Other sectors: No signs of over-allocation.

=> NAP criterion regarding allocation only partially fulfilled (“taking reduction potential into account”).

 Allocation to new entrants (gas-fired power plants) not clear.

 Transparency: – Swiss voluntary agreements confidential, but will be published.

ECOPLAN 12

3 Swiss and EU ETS: Assessment of compatibility

3) Compliance

 Monitoring: – EU: Annual reports for all installations, independent verification – CH: Annual reports by companies, first report in 2008 for groups. No independent verification.

 Less strict in CH  Sanctions: – EU ETS: 40 EUR (phase 1) and 100 EUR (phase 2) plus surrendering of missing allowances.

– CH: Repayment of CO 2 tax since introduction plus interest – Problem: For EUA prices > CO 2 tax (EUR 22), the most profitable option is to

sell all allowances

and default (pay tax).

ECOPLAN 13

3 Swiss and EU ETS: Assessment of compatibility

Ex-post adjustments

 EU Commission: “Ex-post adjustments are incompatible with the legal framework and represent interventions that disrupt the market and create uncertainty for companies.”  Consequences: – Commission has disallowed intended ex-post adjustments in 13 NAPs.

– Proposed ex-post adjustment in Swiss ETS is likely to be a

major obstacle

to linkage.

ECOPLAN 14

3 Swiss and EU ETS: Result of compatibility assessment

Conclusions and policy recommendations

Conclusions

– Swiss ETS is, in principle,

compatible

with EU ETS.

– Some adaptations should be made to increase the chances of linkage.

Recommendations

1.

Refrain from implementing the

ex-post adjustment

of targets. 2.

Strengthen compliance regime by imposing

stricter sanctions

or

prevent over-selling.

3.

Renegotiate voluntary agreement with

cement

industry and aim for voluntary agreement with Swiss

refineries

. Define detailed rules for new entrants.

4.

Increase the

transparency

of the system (list of companies, independent verification of emission reports).

ECOPLAN 15

4 Ready to link up? The case of Norway

Background

  

Kyoto target: +1%

Current GHG emissions: +9.5% Booming petroleum industry, energy intensive industries 

CO 2 tax

for offshore oil, domestic and transport sectors (23-40 EUR/t). Reduced rate for pulp & paper industry.



Voluntary agreement

with energy intensive industries (target: 20% vs. 1990) 

Emissions trading scheme

along the lines of EU ETS

ECOPLAN 16

4 Ready to link up? The case of Norway

Emissions trading scheme

 System design –

Cap-and-trade

– First period: 2005-07, second period not yet defined  Coverage: – Same as EU ETS – But:

Installations liable to the CO2 tax

(offshore petroleum activities, pulp & paper) are

exempt

from the ETS.

 Allocation: – Free of charge – General rule: 95% of demonstrated need – 20.5 mill. t for 2005-07 allocated to 51 companies

ECOPLAN 17

4 Norwegian and EU ETS: Assessment of compatibility

1) System design – sectoral coverage

PIL VA

• Aluminium • Ferrosilicon • Carbides • Other metals • Mineral fertilizer

ETS Norway

• District heating • Energy production • Gas processing • Other minerals • Steel • Cement • Petrochem • Refineries (Pulp & paper)

CO 2 tax

• Pulp & paper • Transport • Offshore petroleum • Domestic heating     System design: Cap-and-trade => no problems Overlapping coverage: no problem Opt-out of offshore petroleum and pulp & paper: Likely to pose problem for phase 2 Restrictions on use of CERs and ERUs: Same as EU ETS

ECOPLAN 18

4 Norwegian and EU ETS: Assessment of compatibility

2) Target and allocation

 Allocation: – Installation level: Overall allocation factor 90.6%. => stricter than most European countries – Uncertainty regarding new gas-fired power plants (CCS required or not?).

– No guarantee for reaching Kyoto target due to narrow scope of Norwegian ETS (transport and petroleum activities not covered).

 Ex post adjustment of targets – Initial allocation can be changed for 2006/07 “if the conditions on which the allocation was based are changed significantly”.

– Modifications can only result in a reduction of the number of allowances issued to an installation, not an increase.

– Likely to be disapproved by the European Commission.

ECOPLAN 19

4 Norwegian and EU ETS: Assessment of compatibility

3) Compliance

 Monitoring – Annual reporting of emissions required.

– Verification by independent party only in special cases (EU ETS: mandatory).

 Sanctions – Fine (EUR 40) and obligation to surrender missing allowances in the subsequent year. Same as EU ETS.

ECOPLAN 20

4 Norwegian and EU ETS: Assessment of compatibility

EU vs. EFTA law

 ETS Norway supposed to be linked to the EU ETS through a linking agreement according to

Article 25

of the ET directive.

 EC: Norway, Liechtenstein and Iceland have to implement the Directive under the rules of the European Free Trade Association

EFTA

.

 Norway accepted, but Liechtenstein and Iceland have been reluctant to do so (even though they do not have any installations falling under the Directive).

=> linkage not yet established.

ECOPLAN 21

4 Norwegian and EU ETS: Result of compatibility assessment

Conclusions and policy recommendations



Conclusions

– ETS Norway is, in principle,

compatible

with EU ETS.

– The main compatibility problems are:  

Sectoral coverage

: Offshore petroleum and pulp & paper excluded.

Unclear treatment of plants (CCS).

new entrants

, particularly new gas-fired power 

Ex post adjustment

of targets allowed (only reduction of allocation). 

Recommendations

– Include offshore petroleum activities and pulp & paper industry in the scheme.

– Clarify treatment of new entrants.

– Refrain from applying ex post adjustment.

ECOPLAN 22

5 Summary and conclusions

What have we learned?

1. Linkage

between EU ETS and domestic schemes – Norway and Switzerland: Linkage likely and feasible. – Japan and North America: Linkage faces great challenges of legal, economic and technical nature.

2. Economic potential

– Significant benefits for Norway and Switzerland

,

but negligible efficiency gains for the EU.

– Japan and North America: Linkage would greatly expand the market and provide substantial benefits for all parties.

ECOPLAN 23

5 Summary and conclusions

What have we learned?

3. Main obstacles

– Price caps: Segment the market, reduce efficiency.

– Eligibility of tradable units: Probably impossible to maintain in practice.

– Voluntary nature of trading schemes: Sanctions for non-compliance?

4. Lessons for policy development

– Linkage requires that ETS have key elements in common => ETS should not be developed independently of each other – Path dependence: Once an instrument (e.g. carbon tax) is implemented, it is likely to remain in place even when new instruments are introduced

5. Outlook

– No global uniform carbon market in the near term – In the long term, better prospects for linkage of major markets

ECOPLAN 24

ECOPLAN

www.ecoplan.ch

25