The EU CO2 Emissions Trading Scheme

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 MIT CEEEPR (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 MIT CEEEPR 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 MIT CEEEPR 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 MIT CEEEPR 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