Setting the Cap: Experiences from EU Emissions Trading. 3rd Annual CEEM Conference Emissions Trading Getting Crucial Design Elements Right

Setting the Cap: Experiences from EU Emissions Trading 3rd Annual CEEM Conference Emissions Trading – Getting Crucial Design Elements Right 30th Novem...
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Setting the Cap: Experiences from EU Emissions Trading 3rd Annual CEEM Conference Emissions Trading – Getting Crucial Design Elements Right 30th November 2007 Australian Graduate School of Management, UNSW, Sydney

Joachim Schleich Fraunhofer Institute Systems and Innovation Research (ISI), Karlsruhe, Germany [email protected] Virginia Tech University, Blacksburg, USA

Outline 1. Environmental and legal boundary conditions for cap setting in EU ETS 2. Outcome and assessment of cap setting for phase 1 3. Outcome and assessment of cap setting for phase 2 4. Summary and outlook

Page 2

1. Background: EU-Kyoto Targets and Achievements

41.1% 41.1%

42.0% 42.0%

50%

22.5% 22.5%

25.8% 25.8%

26.0% 26.0% 17.0% 17.0%

DTT 2004 domestic

-8.0%

-8.0%

-8.0% -7.2% -7.2%

-8.0%

-6.0%

-8.0%

-8.0%

-6.0%

-8.0%

-8.0%

Romania

Bulgaria

Slovenia

Slovakia

Poland

Lithuania

Latvia

Hungary

Estonia

Czech Republic

UK

-34.0%

Spain

Sweden

Portugal

Netherlands

Luxembourg

9.3% 1.3% 1.3%

-22.9%

-13.6%

-28.0% -28.4%

Italy

Ireland

Greece

Germany

France

Finland

Denmark

Belgium

Austria

-40%

BS-Target

-12.5%

-4.0%

1.2%

7.7% 4.0%

8.8% -6.0% -8.3%

-6.5% -14.9%

-10.1% -3.6%

-18.5%

-3.5% -3.5% -21.0%

-14.5% -11.1%

-13.0%

-17.2%

-28.6%

-30%

-21.0% -19.6% -12.8%

-7.5% -7.9% -3.1%

0% -10%

1.1% 1.1%

0.0%

10%

0.0% 1.4% 1.4%

13.0%

20%

15.0%

25.0%

30%

-20%

27.0%

40%

37.3% 37.3%

50.5% 50.5%

60%

52.4% 52.4%

Kyoto burden sharing target (BS) and distance-to-target (DTT) in 2004

Most EU 15 States are far from reaching their Kyoto-Targets; most new EU MS will easily reach their Kyoto targets Without New MS, EU would not be on target to reach Kyoto-Target (~ minus 8%)

DTT 2004 with KM

Page 3

1. Background: Overview of EU ETS • • • • •

Cap-and-trade type scheme for large installations in energy & industry Operates in Phases: Phase 1 (2005-2007), Phase 2 (2008-2012) etc. Banking between Phase 1 and Phase 2 not possible but unlimited afterwards Links to credits from JI and CDM projects established Allocation rules given by EU Emissions Trading Directive: Auction share at most 5% in Phase 1 and 10% in Phase 2 • National Allocation Plans (NAPs) for each phase: - MS set ET-budgets (Macro) and rules on installation level (Micro) - need to be approved by EU Commission - had to be based on objective and transparent criteria, including those listed in Annex III - NAP Guidance Papers by European Commision für Phase 1 and Phase 2; - BUT: no bindings rules existed for cap setting for Phase Page 4

1. Allocation Criteria Consistency with (1) Burden-Sharing Agreement & national climate program (2) Assessments of historic and projected emissions development to achieve required targets (3) Potential to reduce emissions, including technical potential (4) Other EU legislative and policy instruments (5) Non-discrimination between companies or sectors Information on (6) Treatment of new entrants (7) Whether & how early action is accounted for (8) How clean technologies are taken into account (9) How public was included in process (10) How competition from outside the EU is accounted for (11) List of installations with intended allocation (*) Limit on company use of credits from JI and CDM-Projects Page 5

1. How to Split the Pie – Appropriate Size of ET Budget? EU ETS is a partial system (energy (> 20 MWth) & industry sector) Approaches for splitting emission budges b/w trading and non-trading sectors include • Economic efficiency (equal marginal cost) • Equal burden (equal additional cost) • Grandfathering (equal shares) • Emission projections

Page 6

1. ETS Share on CO2-Emissions in EU Member States ETS-Share on CO2-Emissions 80% 70% 60% 50% 40% 30% 20% 10%

Au st Be ria lg iu Cz m ec Cy pr h Re u s pu De blic nm a Es rk to n Fi ia nl an Fr d a G nce er m a G ny re e Hu ce ng ar Ire y la nd Ita ly La t vi Li a t Lu hua xe ni m a bo ur g Ne M a th lta er la nd Po s la Po nd rtu Sl ga l ov a Sl kia ov en ia Sp a Un i S ite we n d Ki d en ng do m

0%

Page 7

1. Cap setting in EU ETS: Outcome of Phase 1 Most EU 15 MS chose two-step approach (Step 1: Define ET-budget; Step 2: allocation to individual installations plus compliance factor); but: top-down approach problematic because data from energy balances did not reflect coverage in EU ETS Most EU 10 MS chose one-step approach (allocation to individual installations without compliance factors) Size of ET-budgets in most EU 15 MS based on: • • • • •

emission projections existing Voluntary Agreements, reduction potentials as determined in national climate strategy economic efficiency only in a few MS mostly: intense dialogue between governments and industry

Most MS apply tighter budgets for power sector than for other sectors European Commission was rather lenient w.r.t size of ET-budgets Page 8

2. Stringency of Cap in Phase 1 46.0 17.2%

19.3%

20% 0.4 4.6%

5.2

5.7% 0.1

7.2% 14.5 14.9% 4.1 24.6% 4.2 13.9% 1.2 29.9% 6.9

0.4

3.0

0.5 1.3%

Allocation surplus : ~100 Mio. EUAs in 2005 (~5%) (Kettner et al. 2007)

30%

10%

Reasons: inflated projections in most MS (Grupp and Ferrario 2006)

0%

-20% -30% -40%

Excess allocation or abatement? Abatement: 50-100 Mio. t CO2e (Buchner and

Ellerman 2006)

Au

st

B e ri a lg D e iu m nm a Fi rk nl an Fr d a G n ce er m a G ny re ec Ir e e la nd Lu x e It a l y m N e bo t h u rg er la Po nds rtu ga Sp l S w a in ed en UK Cz ec C y p h R e ru s pu b Es lic to H u n ia ng ar La y L i t v ia th ua ni a M al P o ta la Sl nd ov ak S l ia ov en ia

-40.0

40%

-10%

-36.4

-30.0

50%

-17.7%

-20.0

13.3%

19.4% 6.1 7.1% 0.6 -16.4%

-10.0

-10.8 -6.3%

0.0

4.2%

3.0 5.1% 10.8

10.0

-1.0 -3.0%

MtCO 2 e/a

20.0

-0.1 -0.2% -3.2

30.0

11.6

29.0%

40.0

Overallocation in 2005 (in %)

25.9% 19.1 12.7% 21.0

Overallocation in 2005?

-8.8 -4.1%

50.0

60%

51.1%

60.0

Source: Betz, R., Rogge, K, Schleich, J (2006): EU Emission Trading: An Early Analysis of National Allocation Plans for 2008-2012, Climate Policy.6 (4), 361-394.

Empirical evidence still scarce

Page 9

2. Effect of Cap on Prices for EUAs in Phase 1 • Drop in price for EUA once allocation surplus became known; • Price drops to zero because of ban on banking from Phase 1 to Phase 2

Page 10

3. Stringency of Caps in Phase 2 1- ET-budget phase 2 (COM decision)/Emissions 2005

19.4% -1.6%

13.2%

31.7% -6.8% -6.8%

-3.7%

Slovenia

Slovakia

Romania

-38.9%

-24.1% Malta

Poland

Lithuania

-51.5% Latvia

Hungary

Estonia

Czech Republic

UK

Cyprus

Spain

Sweden

Portugal

Netherlands

Luxembourg

Italy

Ireland

Greece

France

Germany

Finland

Denmark

Belgium

Austria

-70%

Bulgaria

14.8% 10.0% -15.9%

-10.0%

-1.5%

4.8% -23.2% -23.2%

8.8%

33.1%

42.6% 18.8%

17.6%

-50%

-7.1%

-6.1%

-0.7% -6.1% -24.5% -20.7% -30.9% -31.3%

-30%

-10.1% -5.9% -4.3% -11.0% -2.7% -12.3% -6.0% -7.5% -17.7% -25.7%

-10%

-3.9% -10.8% -3.8% -12.3% -10.3% -10.3%

10%

4.0%

12.3% 7.5%

30%

-23.0%

50%

22.5%

? ET-budget 2 (COM) - VET 2005 EU-15: -232.6 Mt CO2e/a (-15.8%) ? ET-budget 2 (COM) - VET 2005 EU-10: -19.3 Mt CO2e/a (-4.0%) ? ET-budget 2 (COM) - VET 2005 EU-25: -251.9 Mt CO2e/a (-12.9 %)

54.7%

70%

24.0%

1- ET-budget phase 2/Emissions 2005

Notified CAP • Implied only small reductions, in particular in new MS EC cut CAPs • Formulabased • by 10.5% (on avge) Approved CAP • Much more ambitious

Page 11

3. Overview on Stringency of Caps in Phase 2 Mt CO2 e/a

-383.2

JI/CDM Companies

EU-15 -232.6

-251.9

EU-15 -206.0

-271.9

-328.5

-450

Page 12

-350

EU-15 -211.7

-250

EU-12 -19.3

EU-12 -65.9

EU-12 -116.8

-150

EU-12 51.3

-50

EU-15 331.9

Implied reduction requirements compared to

383.2

• Verified emissions in 2005: 12.9% • Cap 1: 13.1% • Projections: 15.8%

VET 2005

Cap 1

Projection 2010

50

150

250

350

450

Use of CDM/JI credits: Abatement in ET sectors low ?

3. Economic Efficiency of Cap How should the pie be split at the macro level ? Theory • Marginal abatement costs in trading and non-trading sectors should be equal (prior to trading) Implication • Since marginal abatement costs tend to be lower in ET-sector it should contribute more than in proportion to emission reductions necessary to meet Kyoto/Burden-Sharing targets Reality • From Phase 1 (and notified NAP 2): most ET-budgets are too large compared to cost-efficient split; reduction burden for other sectors too high Corollary • Without EC intervention costs to achieve emission targets would have been higher in most MS Page 13

4. Summary and Outlook Historic cap setting in EU ETS • Cap in Phase 1 was too lenient; result of a) lobbying by industry ; b) poor data availability; c) European Commission's strategy to rather be soft on cap in Phase 1 than risk start of EU ETS • Tendency by governments to purchase CDM/JI credits to allow for more generous ETbudget • Intervention by EC at macro level "saved" environmental effectiveness, efficiency and possibly existence of ETS;(Forward price for Phase 2 currently around 25/t) • Generous use of ERUs/CERs casts doubt on extent to which ETS will lead to abatement efforts within ET sectors Future cap setting in EU ETS • Centralized (and possibly differentiated) at EU level or at level of Member States? • Centralized approach to "split pie" based on projections or marginal costs would require "accepted parameters" • Impact of other regulations such as renewable targets for MS needs to be recognized • Length of phase 3: debate on 5-years vs. 8 years; Perceived tradeoff between flexibility and investment security Page 14

Literature Betz, R.; Eichhammer, W. & Schleich, J. (2004). Designing National Allocation Plans for EU Emissions Trading – A First Analysis of the Outcomes. Energy & Environment, 15, 375-425. Betz, R., Rogge, K. & Schleich, J. (2006). EU Emissions Trading: An early analysis of national allocation plans for 2008-2012. Climate Policy, 6, 361-394. Ellerman, A.D. & Buchner, B. (2006). Over-Allocation or abatement? A preliminary analysis of the 2005 Emissions Data, 139.2006, November 2006, FEEM Working Paper Nota Di Lavoro: FEEM. Grubb, M. & Ferrario, F (2006). False confidences: forecasting errors and emission caps in CO2 trading systems. Climate Policy, 6, 495–501. Kettner, C., Köppl, A. Schleicher, S. & Thenius, G. (2007). Stringency and distribution in the EU Emissions Trading Scheme – the 2005 Evidence. Nota di Lavora 22.2007 Fondazione Eni Enrico Mattei. Rogge, K., Schleich, J. & Betz, R. (2006). An Early Assessment of National Allocation Plans for Phase 2 of EU Emission Trading, 01/06, Fraunhofer ISI Working Papers Sustainability and Innovation, Karlsruhe: Fraunhofer ISI. Retrieved on 1 August, 2007 (http://www.isi.fhg.de/n/Projekte/pdf/NAP2_assessment.pdf) Schleich, J., Betz, R. & Rogge, K. (2007): EU Emission Trading – Better Job Second Time Around? Working Paper Sustainability and Innovation Nr. S 2/2007, Fraunhofer ISI, Karlsruhe (http://www.isi.fhg.de/e/working%20papers/working-paper_eu-emission-trading.pdf) Page 15

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