Explanatory Memorandum to COM(2008)16 - Amendment of Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading system of the EC - Main contents
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| dossier | COM(2008)16 - Amendment of Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading system of the EC. |
|---|---|
| source | COM(2008)16  |
| date | 23-01-2008 |
On 1 January 2005, the European Emission Trading System (EU ETS) started operation. It represents the spearhead and “one of the most important instruments”[1] of EU climate policy due to its ability to achieve absolute emission reductions in an economically efficient manner.
The 1st phase of the EU ETS (2005 to 2007) successfully established free trade of emission allowances across the EU, set up the necessary infrastructure for monitoring, reporting, verification including registries and has so far successfully concluded two compliance cycles. It developed into the world’s largest single carbon market accounting for 67% in terms of volume and 81% in terms of value of the global carbon market i and also worked as the driver of the global credit market and in that triggered investments in emission reduction projects today indirectly linking 147 countries to the EU ETS through JI/CDM projects.
However, the environmental outcome of the 1st phase of the EU ETS could have been more significant but was limited due to excessive allocation of allowances in some Member States and some sectors, which must mainly be attributed to reliance on projections and a lack of verified emission data. Once such data became available, it swiftly corrected the market price of allowances demonstrating convincingly that the carbon market is working.
The principles and mechanisms resulting in problems during the 1st trading period recurred in most 2nd phase National Allocation Plans (NAP) of Member States. However, thanks to verified emission data and experience gathered, the Commission could much better ensure that national allocation plans result in real emission reductions. Approved NAP decisions show an absolute emission reduction of 6.5% compared to 2005 verified emissions, thus ensuring that the EU ETS, designed as a cap-and-trade system, will deliver real emission reductions. However, experience of the 1st period and the NAP assessment of the 2nd period gave strong reason to believe that the overall functioning of the EU ETS could be improved in a number of aspects.
Against this background and responding to Article 30 of the EU ETS Directive i, the Commission, in November 2006, issued a Communication “Building a global carbon market – Report pursuant to Article 30 of Directive 2003/87/EC”[4], where it identified the main subjects to be reviewed with a view to streamlining the EU ETS.
In March 2007, the European Council endorsed an EU objective of a 30% reduction in greenhouse gas emissions (GHG) by 2020 provided that other developed countries would commit themselves to comparable emission reductions and economically more advanced developing countries contribute adequately according to their responsibilities and respective capabilities. The Council also made a firm independent commitment of at least a 20% reduction of GHG emissions by 2020, irrespective of any international agreement. In the longer term, by 2050, the European Council reaffirmed that developed countries should collectively reduce their emissions by 60% to 80% by 2050 compared to 1990 i.
Against this background and with a view to enhancing the certainty and predictability of the emissions trading system, the Directive should provide for automatic and predictable adjustments upon the conclusion of a future international agreement. They should increase the level of contribution of the EU ETS to achieving the reduction of 30% and should concern the allocation mechanism, the adjustment of the EU-wide cap, the use of credits from JI/CDM and potentially additional types of credits and/or mechanisms foreseen under the agreement.
In its conclusions of 20 February 2007, the Council emphasised the EU commitment of transforming Europe into a highly energy efficient and low greenhouse-gas-emitting economy. It also called on the Commission to “bring forward proposals which create the right incentives for forward-looking, low-carbon investment decisions”[6].
All these elements have been discussed in the framework of the European Climate Change Program (ECCP) Working Group on Emissions Trading, which met four times for eight days between March and June 2007. The outcome of these meetings provided major input to the review of the EU ETS Directive i. The provisions of the proposed amendments to the EU ETS Directive are guided by three overall objectives to be achieved:
1. Fully exploiting the potential of the EU ETS to contribute to the EU's overall greenhouse gas reduction commitments in an economically efficient manner.
2. Refining and improving the EU ETS in the light of experience gathered.
3. Contributing to transforming Europe into a low greenhouse-gas-emitting economy and creating the right incentives for forward looking low carbon investment decisions by reinforcing a clear, undistorted and long-term carbon price signal.
Contents
Streamlining and increasing the scope of the EU ETS…
Codifying the interpretation of combustion installation set out in the 2nd NAP guidance document of the Commission would end the inconsistent application of the scope of the Directive and would broadly reflect the approach taken by the Commission in the assessment of the National Allocation Plans in the 2nd period. In combination with an explicit definition of 'combustion installation', which encompasses all stationary combustion apparatuses, the operation of which would result in the release of greenhouse gases, it would provide the necessary legal and technical clarity for a consistent application of the Directive. An explicit list of activities, also in Annex I of the Directive, should supplement this approach, in order to clarify the coverage of process emissions possibly not clearly addressed by codification of the above interpretation of combustion installation. New sectors and gases, currently not covered by the EU ETS (see below), should also be covered by the activity list.
Expanding the coverage of the EU ETS by inclusion of new sectors and gases would enhance the environmental effectiveness of the system and would introduce new and additional abatement opportunities to the system, thereby offering a higher abatement potential and potentially lower abatement costs i.
The level of abatement potential or costs may not strictly represent a criterion for including a certain sector in the EU ETS, since there are already sectors included the abatement potential of which might be limited, but which include considerable GHG emission sources. Furthermore, it is important to highlight the need to attach an economic value to the emission of GHG. This has to be seen in the light of the new emission reduction objectives set by the European Council. They will only be achieved, if forward-looking, low-carbon investments are triggered by the necessary economic signals emerging from a clear and undistorted carbon price applicable to as many industrial sectors as possible.
For these reasons, CO2 emissions from petrochemicals, ammonia and aluminium should be included in the EU ETS. This also goes for N2O emissions from the production of nitric, adipic and glyoxalic acid production and PFC emissions from the aluminium sector, all of which can be measured and verified with sufficient accuracy.
Inclusion of these sectors and gases would increase the coverage of the EU ETS by up to roughly estimated 100 MtCO2 or up to 4.6% of Phase II allowances. In combination with streamlining the scope of the EU ETS through a codified interpretation of combustion installation, overall coverage of the EU ETS would roughly increase by up to 140 to 150 MtCO2 or 6.6 to 7.1% compared to Phase II allowances i.
The emissions trading system should only be extended to emissions which are capable of being monitored, reported and verified with the same level of accuracy as applies under the monitoring, reporting and verification requirements currently applicable under the Directive. This is the case for shipping, which is not included in this proposal but might be included at a later stage following a full fledged dedicated impact assessment. It is not the case for emissions from agriculture or forestry, although the EU ETS considers the combustion of biomass to be emission-neutral. The European Parliament and the Council have endorsed the use of proceeds from auctioning of allowances within the EU ETS to be used for reducing emissions, in particular by avoiding deforestation i.
In addition, expansion of the scope will be further facilitated by enabling the Commission, in its approval of an application for unilateral inclusion of additional activities and gases not listed in Annex I of the Directive to authorise other Member States to also undertake the inclusion of such additional activities and gases.
… while potentially lowering its overall costs through allowing alternative measures for small emitters…
Since the contribution of small and large emitters to the overall emissions covered by the EU ETS is uneven: the largest 7% of installations represent 60% of total emissions, while the 1 400 smallest installations (approximately 14%) only account for 0.14%. For this reason, the cost-effectiveness of small installations' contributions to emission reductions might be improved. While the currently applicable threshold of 20 MW of rated thermal input for combustion installations will be maintained, it should be combined with an emission threshold of 10 000 tCO2/yr (but excluding emissions from biomass), as long as their rated thermal input does not exceed 25 MW. This means that combustion installations with a rated thermal input of more than 20 MW, but less than 25 MW and an annual emission of less than 10 000 tonnes of carbon dioxide in each of the three years preceding the year of application, can be excluded from the EU ETS, if
1. as a matter of fairness, and in order to ensure that the internal market will not be distorted, there are measures (such as taxation) in place that will achieve an equivalent contribution of installations excluded from the system to the overall emission reduction objectives;
2. Member States apply to the Commission for excluding installations and continuing such measures and monitoring, and the Commission does not object within a period of six months.
The threshold of 10 000 tonnes of carbon dioxide offers, in relative terms, the maximum gain in terms of reduction of administrative costs for each tonne (potentially) excluded from the system. This would lead to saving administrative costs under the EU ETS in the order of € 4.2 for each tonne excluded with unknown administrative costs to equivalent administrative measures. Around 4 200 installations could be opted out accounting for approximately 0.70% of total ETS emissions.
A change of the aggregation rule, in line with the second guidance document of the Commission, resulting in excluding installations with less than 3 MW rated thermal input from the scope of the aggregation clause may lead to the exclusion of another (roughly estimated) 800 very small installations, currently covered under the system.
… with new opportunities offered by Carbon Capture and Storage …
In view of the long-term potential for emissions reductions from CCS, and pending the entry into force of Directive 2008/xx/EC on the geological storage of carbon dioxide, installations undertaking the capture, transport and geological storage of greenhouse gases should be included in the Community system. While Article 24 offers the appropriate legal framework for unilateral inclusion of such installations pending the entry into force of the said Directive, activities concerning capture, transport and geological storage of greenhouse gas emissions should be explicitly mentioned in Annex I of the Directive, in order to provide clarity.
With a view to providing the necessary incentives for geological storage of emissions, there would be no need to surrender allowances for emissions stored. However, no free allocation should be given for capture, transport or storage of greenhouse gas emissions.
… but without replacing other transport measures…
Although greenhouse gas emissions from road transport and shipping, are still increasing, more detailed analysis including a comprehensive cost-benefit analysis is necessary, in order to allow the Commission to decide on whether emissions trading is the most appropriate means to deal with these issues. Emissions from road transport and shipping are therefore not included in this proposal.
Improvements of monitoring and reporting rules…
Experience with monitoring and reporting so far showed some degree of divergence of Member States' practices. In order to improve overall performance of the monitoring and reporting system across the EU, a regulation adopted through comitology should replace the current guidelines.
… in combination with harmonised rules for verification and accreditation …
The current Directive and its Annexes only regulate some fundamental requirements and aspects of the verification process. As a consequence, verification practices in Member States differ and may not necessarily ensure the level playing field required to maintain the overall credibility of verification. A regulation adopted through comitology should provide common requirements for verification, in order to guarantee a certain level of quality of the verification process, while further improvements should be enabled through amendments to Annexes IV and V of the Directive.
This regulation should also enable Community-wide accreditation for verifiers for the benefit of the internal market.
… and updated compliance provisions …
In order to ensure that the penalties for non-compliance remain sufficiently high to ensure that the market functions properly, the excess emissions penalty should be indexed to the annual inflation rate of the Eurozone. This provision would ensure the deterrent effect of the current provision without having to review it frequently.
… increases confidence in and credibility of the EU ETS…
Monitoring, reporting and verification play a fundamental role for the functioning and overall credibility of the EU ETS, inside and outside the EU. Its environmental effectiveness and integrity and thus its overall reputation and acceptance depends to a large extent on a robust, reliable and trustworthy monitoring, reporting and verification system that ensures a sufficient degree of accuracy of the respective level of emissions of each installation covered by the system.
Against this background, potentially higher administrative costs in the short-term accruing from a regulation for the Commission seem to be justified, as administrative costs in the longer term would be much lower. In addition, it would provide greater certainty, transparency and reliability with respect to the actual emission levels and thus enhance the trust of the market in the system. In the longer term, these benefits are expected to largely offset any short-term higher administrative costs and indeed will reduce overall costs for monitoring, reporting and verification for operators and national authorities, once electronic tools play a more important role.
… with a simple and robust registry system
Allowances must be transferable between persons within the Community without any restriction. For this reason and due to the technical, political and administrative risks related to the current registry system and in the light of the uncertainty concerning the future development of the UN registry system, EU ETS allowances issued from 1 January 2013 onwards should be held in the Community registry. As well as simplifying the system, this is also necessary to ensure that the EU ETS can link to other emissions trading systems in third countries and administrative entities.
An EU-wide cap ensures achieving the 20% reduction target and a linear reduction provides long-term predictability …
A system based on national cap-setting does not provide sufficient guarantees that the emission reduction objectives endorsed by the European Council in March 2007 will be achieved. Moreover, such a system is not likely to lead to minimise overall cost of emissions reductions than necessary. Therefore, in order to achieve these objectives, an EU-wide cap should be determined in the Directive.
It also provides a long-term perspective and increased predictability, which is required for long-term investments in efficient abatement. This can be best achieved by an 8-year trading period until 2020 and a linear reduction of the cap that continues the reduction path beyond 2020, thereby giving a clear message to investors.
The level of the EU-wide cap for the EU ETS needs to be cost-effective and consistent with the EU's commitment of an overall reduction in emissions of 20% by 2020. The linear reduction which is consistent with this principle amounts to 1.74% per year, arriving at a reduction of 21% below reported 2005 emissions. This path has been calculated by starting at the mid-point of the 2008-12 period average annual total quantity of allowances issued by Member States pursuant to Commission Decisions on Member States' national allocation plans for the period 2008-12.
… while auctioning is the basic principle for allocation subject to the need to avoid carbon leakage …
Auctioning best ensures efficiency of the ETS, transparency and simplicity of the system and avoids undesirable distributional effects. Auctioning also best complies with the polluter-pays principle and rewards early action to reduce emissions. For these reasons auctioning should be the basic principle for allocation. The efforts to be made by the European economy to reach the greenhouse gas reduction targets set for 2020 will, however, be more significant than those currently required by 2012 and in the absence of comparable constraints for industry in third countries, there may arise a risk of 'carbon leakage', i.e. relocation of greenhouse gas emitting activities from the EU to third countries and thereby increasing global emissions.
In this context, taking into account their ability to pass through opportunity costs, full auctioning should be the rule from 2013 onwards for the power sector and carbon capture and storage. In order to encourage a more efficient generation of electricity, electricity generators could however receive free allowances for heat delivered to district heating or industrial installations.
For installations in other sectors, a gradual transition is appropriate, starting with free allocation at a level of 80% of their share in the total quantity of allowances to be issued, decreasing by equal amounts each year, arriving at zero free allocation by 2020.
In the event that other developed countries and other major emitters of greenhouse gases do not participate in an international agreement that will achieve the objective of limiting global temperature increase to 2°C, certain energy-intensive sectors and sub-sectors in the Community subject to international competition could be exposed to the risk of carbon leakage. This could undermine the environmental integrity and benefit of actions by the Community. The European industry should receive a clear commitment that the Community will take appropriate action. The Commission will review the situation by June 2011 at the latest, consult with all relevant social partners, and, in the light of the outcome of the international negotiations, submit a report accompanied by appropriate proposals. In this context, the Commission will identify by 30 June 2010 which energy intensive sectors or sub-sectors are likely to be subject to carbon leakage. It will base its analysis on the assessment of the inability to pass through the cost of required allowances in product prices without significant loss of market share to installations outside the EU not taking comparable action to reduce emissions. Energy-intensive industries which are determined to be exposed to significant risk of carbon leakage could receive up to 100% of allowances free of charge or an effective carbon equalisation system could be introduced with a view to putting installations from the Community which are at a significant risk of carbon leakage and those from third countries on a comparable footing. Such a system could apply requirements to importers that would be no less favourable than those applicable to installations within the EU, for example by requiring the surrender of allowances. Any action taken would need to be in conformity with the principles of the UNFCCC, in particular the principle of common but differentiated responsibilities and respective capabilities, taking into account the particular situation of Least Developed Countries. It would also need to be in conformity with the international obligations of the Community including the WTO agreement.
Overall, it is estimated that, at least two thirds of the total quantity of allowances will be auctioned in 2013.
The Directive determines the shares of the total quantity of allowances that Member States will auction. The proposal foresees that 90% of the total quantity of allowances to be auctioned is distributed according to the relative share of 2005 emissions in the EU ETS i. For reasons of fairness and solidarity, and taking into account national circumstances, 10% of the total quantity of allowances to be auctioned should be redistributed from Member States with an average level of income per head that is more than 20% above the EU average. Redistribution is higher with low income levels per head and high growth prospects.
Auctioning of allowances should be carried out without distorting competition in the internal market and without distorting the allowances market. The Directive therefore provides a legal basis for a regulation on the design and execution of auctions.
Auctioning will generate significant revenues. In line with the precautionary principle laid down in Article 174 i of the Treaty establishing the European Community, a certain percentage of the proceeds from the auctioning of allowances should be used to reduce greenhouse gas emissions, to adapt to the impacts of climate change, to fund research and development for reducing emissions and adapting, to develop renewable energies to meet the EU's commitment to using 20% renewable energies by 2020, for the capture and geological storage of greenhouse gases, to contribute to the Global Energy Efficiency and Renewable Energy Fund, for measures to avoid deforestation and facilitate adaptation in developing countries, and for addressing social aspects such as possible increases in electricity prices in lower and middle incomes.
In December 2006, the Commission made a legislative proposal to reduce the climate impact attributable to aviation by including carbon dioxide emissions from aviation in the Community system for greenhouse gas emission allowance trading. While the Commission made clear in its impact assessment that the aviation industry was expected to be able to pass on, to a large extent or even in full, the costs of participating in the system to their customers, the Commission did not take a position on the appropriate percentage of allowances to be auctioned beyond 2012, stating instead that, for future periods, the percentage to be auctioned shall take into account the general review of this Directive. This review has now been completed Aviation should be treated as other industries which receive transitional free allocation rather than as electricity generators, which means that from 2013 onwards, 80% of allowances should be allocated for free in 2013, and thereafter the free allocation to aviation should decrease each year by equal amounts resulting in no free allocation in 2020. The Community and its Member States should continue to seek to reach an agreement on global measures to reduce greenhouse gas emissions from aviation.
…any transitional allocation for free, also for new entrants, is to be based on Community-wide rules …
In order to avoid distortions of competition, the transitional free allocation should be based on harmonised Community-wide rules. These rules should take account of the most greenhouse gas and energy efficient techniques, substitutes, alternative production processes, use of biomass and greenhouse gas capture and storage. Any such rules must avoid perverse incentives to increase emissions.
Installations that have closed shall no longer receive any allowances for free. The proposal foresees the creation of a Community-wide new entrants' reserve. Allocations from this reserve should mirror the allocation rules for existing installations.
5. LINKING WITH EMISSIONS TRADING SYSTEMS IN THIRD COUNTRIES, AND APPROPRIATE MEANS TO INVOLVE DEVELOPING COUNTRIES AND COUNTRIES IN ECONOMIC TRANSITION
Linking with other emission trading systems to build a global carbon market…
The EU ETS should be able to link to other mandatory emission trading systems capping absolute emissions in third countries or administrative entities by means of arrangements and agreements to provide for the recognition of allowances between the EU ETS and the emission trading system to be linked to the EU ETS.
In line with the conclusions of the European Council of March 2007, the EU is committed to reduce its greenhouse gas emissions by 30% in the event of an international agreement. The terms of such an agreement will affect the combined number of allowances available in the EU ETS linked with another emission trading systems. For this reason, enabling provisions must be foreseen to provide for the necessary adjustments, where needed and appropriate.
… which exists already in terms of project credits, but there is a need for harmonisation…
Project credits allow EU operators to meet obligations under the ETS by investing in projects to reduce emissions outside the EU. This can be an incentive for countries to come within an international agreement and a short term cost-efficient way for companies to meet their obligations.
Under the conditions for phase 2 around 1 400 million tonnes of credits are allowed to enter the EU ETS, or a yearly average of 280 million tonnes. Relative to 2005 emissions the estimated phase 2 cap represents a reduction of approximately 130 million tonnes. If full use of credits is made by operators, few domestic reductions would occur and in an extreme case emissions in the EU ETS could even increase making it more difficult to achieve the EU's overall 2020 reduction targets. Therefore, CDM credits up to the remainder of the level which they were allowed in the 2nd trading period (2008-12) should be allowed in the 3rd trading period. Accordingly, operators should be given certainty about their potential after 2013 to use them by requiring Member States to allow operators to exchange certain CERs issued in respect of emission reductions before 2012 for allowances valid from 2013 onwards. This should also apply to high quality CERs issued in respect of emission reductions from 2013 onwards from projects that have been established before 2013.
In order to ensure equal conditions of competition within the Community, the use of credits for emission reductions by operators within the Community emissions trading system should be harmonised. Upon the conclusion by the Community of a satisfactory international agreement, access to credits from projects in third countries should be increased in tandem with the increase in the level of emission reductions to be achieved through the EU emissions trading system (i.e. from 20% rising to 30%). In the absence of such agreement, providing for further use of CERs would undermine this incentive and make it more difficult to achieve the EU's objectives on increasing renewable energy use.
While ERUs cannot exist in respect of emissions reductions from 2013 onwards before the entry into force of a future international agreement on climate change, projects which generated ERUs beforehand could continue to be recognised through bilateral or multilateral agreements with third countries. Once a future international agreement on climate change has been reached, CDM credits shall only be accepted in the EU ETS from third countries that have ratified the international agreement. Provisions should be included to discourage free-riding by companies in States which have not concluded an international agreement, except where those companies are based in third countries or administrative entities which are linked to the EU emissions trading system.
The use of CERs should be consistent with the EU's goal of generating 20% of energy from renewable sources by 2020, and promoting energy efficiency, innovation and technological development. Where it is consistent with achieving these goals, the possibility should be foreseen to conclude agreements with third countries to trigger investments in these countries which bring about real, additional reductions in greenhouse gas emissions while stimulating innovation in European companies and technological development in third countries. Such agreements may be ratified by more than one country.
Projects that reduce greenhouse gas emissions in the Community should be allowed to issue allowances provided they comply with certain conditions necessary to safeguard the proper functioning of the EU ETS. Such conditions would encompass adoption of harmonised rules for these projects at Community level, exclude double-counting of emission reductions and any impediment of the scope of the Community emissions allowance trading system as well as the undertaking of other policy measures to reduce emissions not covered by the EU ETS. Finally, these projects must not entail a huge administrative burden, but should be based on simple, easily administered rules.
The requirement to submit national allocation plans will be superseded by this proposal when it enters into force. In the event that this were delayed, Member States are required, under the EU ETS as it stands, to draw up and submit national allocation plans by June 2011 for the period 2013-17. From 2013 onwards, the current Directive allows all allowances to be auctioned. Allocation for free would constitute state aid which must be justified under Article 87 and 88 of the EC Treaty. With a view to enhancing certainty and predictability, at this stage, the Commission considers that national allocation plans would only be acceptable, if the total quantity were to decrease at least in line with this proposal and free allocations proposed do not exceed the amount either set out in this proposal or developed under it.