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The EU CO2 Emissions Trading Scheme

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					The EU CO2 Emissions Trading Scheme
A. Denny Ellerman Center for Energy and Environmental Policy Research

Massachusetts Institute of Technology

New Directions in Regulation Seminar JFK School, Harvard University October 22, 2007
Massachusetts Institute of Technology
Center for Energy and Environmental Policy Research

MIT CEEEPR

Topics
• Market Development
• 2005-06 Results: Over-allocation? • Allocation choices • Broader Implications

MIT CEEEPR

The EU ETS
• 27-state multinational CO2 trading system • Classic cap-and-trade covering large sources
– About 45% of EU CO2 emissions

• Hybrid implementation of Kyoto Protocol
– Trading and non-trading sectors – Decentralized cap within a cap with CDM linkage

• 2005-07 trial period, 2008-12 second period, and post 2012 periods
MIT CEEEPR

The EUA Market
• Mostly futures trading in front contract
– Also, spot but 10-15% of total volume

• OTC market initially, but exchanges developed quickly and account for 30-40% of volume
– US allowance markets all OTC

• An EUA is a downloaded AAU, but non-EU AAUs are not acceptable; CERs/ERUs are.
– Also any linked systems: probably Norway
MIT CEEEPR

Monthly EUA Trading Volumes
December 2004 - September 2007
180,000,000 160,000,000 140,000,000 120,000,000 100,000,000 80,000,000 60,000,000 40,000,000 20,000,000 0
05 06 07 5 5 6 6 04 05 05 06 06 7 05 06 ct 0 Ap r0 Ap r0 ct 0 Au g Au g Ap r0 b b b c c c 07 Ju n Au g
MIT CEEEPR

n

De

De

n

De

Fe

Fe

OTC

Exchanges

Fe

Ju

Ju

O

O

07

EUA Prices
Jan 2005 - Present
€ 35

2005
€ 30 € 25 € 20 € 15 € 10 €5

2006

2007

Euros

Dec 07 €0
1/7/2005 4/7/2005 7/7/2005 10/7/2005 1/7/2006 4/7/2006

Dec 08
10/7/2006 1/7/2007 4/7/2007 7/7/2007 10/7/2007

7/7/2006

Weekly observations

MIT CEEEPR

Three Prominent Features
• Higher than expected initial prices
– Energy price relations – Adverse weather – Institutional features

• Sharp adjustment upon revelation of lower than expected emissions
– All prior information was speculative – Similar response in US SO2 program

• End-of-period price separation
MIT CEEEPR

Temporal Trading: An Important Pricing Feature
• Unrestricted intra-period banking and borrowing, but none between trial and subsequent periods • Explains 1st and 2nd period price separation in 2007 • Inter-period banking expected from 2008-12 on
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(20%) 100% 20% 40% 60% 80% 0%
1/7/2005 2/7/2005 3/7/2005 4/7/2005 5/7/2005 6/7/2005 7/7/2005 8/7/2005 9/7/2005 10/7/2005 11/7/2005 12/7/2005 1/7/2006 2/7/2006 3/7/2006 4/7/2006 5/7/2006 6/7/2006 7/7/2006 8/7/2006 9/7/2006 10/7/2006 11/7/2006 12/7/2006 1/7/2007 2/7/2007 3/7/2007 4/7/2007 5/7/2007 6/7/2007 7/7/2007 8/7/2007 9/7/2007 10/7/2007 11/7/2007 12/7/2007

Temporal Restriction Does Affect Prices

07-08 Difference 1st Term Difference

MIT CEEEPR

Linked to a Complicated International Market
Kyoto Parties in Deficit (Japan, Canada, NZ) Non-Annex I Kyoto Parties (China, India, Brazil, etc.) CERs

Kyoto Parties with Surplus AAUs (Russia, E Europe) Non-ETS Sectors (Gov’t responsibility) (AAUs remain as such)

Subject to supplementarity limits

ETS Sectors (Private Responsibility) (AAUs converted to EUAs)

EU Kyoto AAUs

MIT CEEEPR

Topics
• Market Development
• 2005-06 Results: Over-allocation? • Allocation choices • Broader Implications

MIT CEEEPR

The Aggregate EU25 Short/Long Position

2005

Sum of Shorts 183 Mt 8.8%

Net 79 Mt 3.8%

Sum of Longs 262 Mt 12.6%

2006

Sum of Shorts 224 Mt 11.0%

Net 35 Mt 1.7%

Sum of Longs 259 Mt 12.7%

-300

-200

-100

0

100

200

300

400

Million tons-CO2/EUAs Gross Short Net Long Gross Long

MIT CEEEPR

Average Member State Positions, 2005 and 2006
Poland France Germany Czech Republic Netherlands Finland Lithuania Estonia Slovakia Hungary Belgium Sweden Denmark Portugal Latvia Luxembourg Greece Cyprus Slovenia Austria Ireland Spain Italy Great Britain -80

Net Long Net Short

Gross Long Gross Short

-60

-40

-20 Mt CO2

0

20

40

60

MIT CEEEPR

Average Member State Positions As % of Allocation, 2005 and 2006
EU Total Lithuania Estonia Latvia Luxembourg Slovakia France Czech Sweden Hungary Poland Finland Netherlands Belgium Denmark Cyprus Portugal Germany Slovenia Greece Austria Spain Italy Ireland Great Britain -30% -20% -10% 0% 10% 20% 30%

Net Long Gross Long Net Short Gross Short

40%

50%
MIT CEEEPR

Average 05-06 Positions by Sector
Power and Heat Iron and Steel Cement and Lime Refineries Pulp and Paper Ceramics, Bricks and Tile Coke ovens Glass Metal ore -200 -150 -100 -50 0 Mt CO2 50 100 150 200

Net Long Gross Long Net Short Gross Short

MIT CEEEPR

EU ETS: Over-allocation
• Not an issue until first data release • Muddled concept; conflated with being long • With inter-period banking constraint, sure to be either long or short • Concept also used to imply no abatement; data are showing abatement • Inherently difficult problem of ensuring shortage with ambition is modest; ex post rarely coincides with ex ante
MIT CEEEPR

Topics
• Market Development
• 2005-06 Results: Over-allocation? • Allocation choices • Broader Implications

MIT CEEEPR

Allocation in the EU ETS
• Delegation to member states to decide total and distribution with  95% grandfathered • Member state decisions subject to review by the European Commission
– In practice, limited to the proposed totals, and – No ex post adjustment or quota management

• Huge data problems at installation level • Extended discussion between industry and government on data and allocation principles
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What Choices were Made?
• Allocations based on recent emissions
– Benchmarking proved infeasible

• Shortage allocated to the power sector
– More abatement possibilities & no competitive problems

• Very little auctioning (4 MSs & 0.13% of total) • New entrant and closure provisions
– Potentially distorting effects but ubiquitous
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Principles or Politics?
• Near universal disapproval of grandfathering, yet always chosen
– Is there more than just politics & lobbying?

• Unacknowledged social norms?
– Lockean prior use and squatter rights – EU variant: production conveys the right

• A convergence of fairness and expediency?
– Allowances permit Coasian separation of efficiency and equity – Assign rights to mitigate financial impact of the change in prices and rules
MIT CEEEPR

NAP2 Differences
• More auctioning: 11 MS’s,  3% of total • Some increase in benchmarking, but still little • Substantially lower caps
– Based on aggregate 2005 Verified emissions – All East European MS’ suing in ECJ – Wide variation among MSs (-19% in Denmark to +33% in Lithuania (relative to 2005 emissions)

• Updating at micro level only in East Europe
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Evolution of Auctioning in the EU ETS
Member State Denmark Hungary Lithuania Ireland Percent of Cap Auctioned 2005-07 5.0% 2.5% 1.5% 0.75% 2008-12 0% 4.3% 2.9% 0.5%

Austria Belgium
Germany Italy Luxembourg Netherlands Poland UK EU Total

0% 0%
0% 0% 0% 0% 0% 0% 0.13%

1.2% 0.3%
8.8% 5.8% 4.8% 4.3% 0.9% 7.0%  3.1%
MIT CEEEPR

NAP2 (2008-12) vs. NAP1 (2005-07)
% Relation to 1st Period Total % Relation to 2005 Emissions

EU 15
EU10 EU25

- 11.4%
- 12.8% - 11.7%

- 6.1%
+ 5.5% - 3.9%
MIT CEEEPR

NAP2 Totals in Relation to NAP1 and 2005
40% Lthuania 30% Slovakia 20% Latvia Netherlands Malta Estonia Hungary -35% -30% Luxembourg -25% France -20% Finland Germany Italy Denmark Spain -20% -15% Poland Czech R Belgium -5% 10% Cyprus 0% 0% -10% Ireland 5% Sweden Portugal

In Relation to 2005 Emissions

EU25

-10% Greece Austria

UK Slovenia

-30% In Relation to NAP1 Total

MIT CEEEPR

Topics
• Market Development
• 2005-06 Results: Over-allocation? • Allocation choices • Broader Implications

MIT CEEEPR

The Next Steps for the ETS
• The East European challenge in NAP2 • Expanding the scope: Aviation proposed • The ETS (post-2012) Review: Dec 07
– An EU-set cap? -20% from 1990 – Much higher auctioning share? – More harmonized allocations?

• Maintaining a credible price
– Overlapping mandates (i.e., renewables) – International market linkage (CERs, greened AAUs)
MIT CEEEPR

The EU ETS as Prototype
• A multinational trading system with a uniform price on carbon throughout the EU • The east/west parallel to the global north/south divide
– Differing criteria for EU15 and Accession-10 – Differing responsibilities for non-covered emissions

• What made all 25 join up?
– The European idea? – Or the benefits of the club?
MIT CEEEPR

The Geopolitical Importance of the EU ETS
• The Fact on the Ground • The Pioneering Example
– Learning experience for those who follow – The subtle influence on the American debate

• The €20/tonne incentive and the CDM
– Attracting interest from those outside – Influencing Chinese and Indian preferences
MIT CEEEPR

The Challenges Ahead
• Continuing the EU ETS and keeping it open • Avoiding trans-Atlantic acrimony in global environmental diplomacy
– First step is linking EU and US systems

• Developing combination of community and interest that will attract others (as in the EU) • Finding a multinational institution to coordinate and negotiate accession/membership
MIT CEEEPR


				
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Description: Denny Ellerman Center for Energy and Environmental Policy Research Massachusetts Institute of Technology New Directions in Regulation Seminar JFK School, Harvard University October 22, 2007
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