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Table of Content

Table of Content ......................................................................................................... 11. Introduction ............................................................................................................. 22. The Implementation of Emission trading ................................................................. 3

2.1. Phase 1: 2005 end of 2007 ........................................................................... 42.2. Phase 2: 2008 end of 2012 ........................................................................... 4

3. Further plans for the future ..................................................................................... 53.1. Phase 3: 2013 end of 2020 ........................................................................... 53.2. After Kyoto ....................................................................................................... 6

4. The Carbon Market ................................................................................................. 65. Data on Emission Allowances ................................................................................ 96. The East- West comparison ................................................................................. 107. Conclusion ............................................................................................................ 11Reference List .......................................................................................................... 12

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1. Introduction

During the last decade of the 20th century the development of the industry in

European countries and other large countries in the world has taken a drastic

negative impact on the environment and the world climate. In 1997 at the Kyoto

Conference it was decided that the industrialized countries should reduce their

greenhouse gas emissions by 5.2 % in comparison to their emissions in 1990. In

2005 the protocol came into force and the industrialized countries are now faced with

the reduction goal until 2012.

As the European industrialized countries are among the highest polluters in the world

the EU decided to take steps towards a reduction of CO2 emissions. Therefore the

Emission Trading Scheme (ETS) was introduced for the European member states. It

is a cost effective way to reduce the greenhouse gas emissions as only 0.1 % of the

EUs GDP have to be invested. This number is very low in comparison to costs of

other measures to reduce greenhouse gases (GHG) by 5.2 % (Grubb et al, 2008).

ETS works as a cap and trade system, which means that an overall limit (cap) for

CO2 emissions has been set by the EU. At the same time emission allowances

(EUA) covering CO2 emissions are handed out and can be obtained by companies.

Whereas the price of CO2 is a function of supply and demand as in any other free

market. The companies or industrial sites have the choice between buying

allowances from others if their emissions exceed the allowed amount or, if they are

not willing or able to acquire additional allowances, they have to adapt the amount

produced to the allowed emission limits. The third option is to invest into new cleaner

technology, which at first is more expensive but in the long run would allow a

company to produce more effective at reduced emissions. Therefore the ETS forces

the emitters to deal with the costs of emissions by themselves.

ETS seems to be a flexible and relatively cheap measure to reduce CO2 emissions.

The following essay will show the implementation of the system in the EU and the

future plans for ETS. There will also be a brief analysis of the first results of ETS and

a comparison of the Eastern and Western European countries and their compliances

with ETS limits

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norm that member states made realistic estimations and plans are accepted right

away. If they are not accepted the related country has make further adjustments to its

NAP. After the acceptance of the NAP the first trading period started in 2005. This so

called Phase 1 lasted until the end of 2007.

2.1. Phase 1: 2005 end of 2007

This first phase was seen as a pilot orlearning by doing phase as this period was

needed to establish the ETS mechanisms and also get an impression of how realistic

the allowance estimations have been to make further adjustments for the following

periods. During this phase the necessary infrastructure was established so that

monitoring, of the participating companies was possible. A reporting system was

introduced where the industrial sites have to provide annual reports to the authorities,

also actual emission verification was covered so that at the end of the first phase for

the first time there was complete information on the amount of CO2 emissions

allowing provision of a more exact amount of allowances for the second phase. With

the introduction of the allowances the carbon market was established.

Even though 95 % of the allowances were handed out for free in this phase scarcity

was created due to the limitation of these, whereas the other 5 % were auctioned to

the highest bidders (European Commission, 2008).

2.2. Phase 2: 2008 end of 2012

This phase is seen as the crucial phase of the whole scheme. With 5 years it is much

longer than the first phase. Before the start all participating states again had to

submit NAPs for the next 5 years. This time the allowance caps have been tightened

according to the results of the actual emissions during the first phase so that CO2

emissions are reduced by 6.5 %, this is important as the deadline of the first Kyoto

Protocol target is in 2012. Also the number of participating countries has increased,

not only the new EU member states joined the ETS during phase one but now also

non EU members Norway, Liechtenstein and Iceland. Not only the participating

countries have increased but also other greenhouse gases like nitrous oxides are

now covered by allowances and therefore controlled under the ETS. In comparison tothe previous phase only 90 % of the allowances were handed out for free and 10 %

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this time were auctioned, this and the reduced cap put a higher pressure on the CO2

price.

As can be seen the changes taken in the second phase are very important

contribution to a further reduction GHGs (European Commission, 2008).

3. Further plans for the future

Initial steps for the time after the first Kyoto target in 2012 have already been taken, it

is important to further improve the ETS as by 2020 last Kyoto target is due. The EU is

committed to reduce its emissions by 20 % in comparison to 1990. An important

change for the future will be that there will not be any NAPs anymore. These will be

replaced by one central allocation plan set up by the EU covering industrial sites

included in the ETS. This is an important step as it will make a more objective

approach towards the allocation of allowances possible, as many countries tried to

set the caps as high as possible so the industry is not weakened. It makes it also

easier for the EU to implement more drastic reductions. It was decided that until 2020

there will be a yearly constant reduction of emission allowances by 1.74 % leading to

a 21 % reduction by 2020 in comparison to 2005. After the EU allocation plan in 2012

the third phase will begin (European Commission, 2008).

3.1. Phase 3: 2013 end of 2020

Precise changes for this phase will be seen later on during the second phase, when it

becomes more obvious which parts of the scheme can still be improved (Grubb et al.,

2009). But general plans are already made up for the eight year long third phase.

Further industrial sectors will be included. The two most important will be the aviation

sector and carbon capture and storage facilities. Also steps towards a full auctioning

of allowances will be undertaken (European Parliament, 2009). In 2013 at least 50 %

of the allowances will be auctioned, with a greater cap reduction this may make CO2

even more expensive, maybe forcing companies to chose installing clean

technologies for production rather than buying expensive allowances. Which would

be more in compliance with the polluter pays principle. The power generation sector

will have to buy all its allowances. For other sectors the auctioned percentage willincrease from year to year reaching a 70 % allowance auctioning by 2020. Also

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further greenhouse gases, like perfuorocarbon will be included in the scheme

(European Commission, 2008).

3.2. After Kyoto

Even though the Kyoto Protocol only sets targets until the year 2020 the ETS sets

further goals beyond this decisive year. It is planned that until 2027 all greenhouse

gas emissions are covered by the ETS and that 100 % of allowances will be

auctioned, a complete auctioning will have a significant influence on the clean

technology development and on the GHG reduction. Even though some sectors,

where competitiveness is judged as being at risk due to complete auctioning, may

still get free allowances (European Commission, 2008).

4. The Carbon Market

At the centre of the ETS stands a financial market made up of carbon emission

allowances, the carbon market. The limited number of allowances creates the

scarcity needed for developing a market and the price is determined by supply and

demand. Trading periods are restricted to the phases 1, 2, 3. This means that

allowances are issued annually but have validity for every year within the period.

Each installation gets a specific amount of allowances. Not every installation is able

to cut its emission as set and thus gets the opportunity to buy extra allowances of

installations which have allowances left. A surplus of allowances from a firm can be

due to innovative environmental policy and investment into modern technology which

optimizes the manufacturing and engineering processes.

Carbon allowances can be traded privately and from one single person (which does

not necessarily need to be a participant of the ETS) to another or between

companies directly, via brokers, banks or other market agents (Ellermann and

Joskov, 2008). The carbon market acts hereby as an official platform for trading

emissions. Since a trade volume of over three billion EUAs has been recorded in

2008 the system states a high business potential (European Commission, 2009).

This upwards trend in sales volume can be clearly seen in figure 1: Traded volumes

of EU allowances.

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Figure 1: Traded volumes of EU allowances Source: ec.europa.eu

The diagram represents all organized exchanges via the market excluding direct

trade. It can be seen that the overall positive trend in sales volumes increases

significantly since 2008 with implementing the second phase. The diagram shows low

exchange behaviour during the first phase from 2005 until 2008. This was caused by

the fact that the allowance cap was not tight enough and had only minimal influences

on emission behaviour. But since the cap for emission tensed up with the second

phase the need for additional allowances and trade increased considerably. In the

beginning of each year every installation has to evaluate how much allowances it will

consume and whether it has to buy additional ones, it can sell surplus allowances or

hold back for other business strategies. Finally the ups and downs in the curve reflect

the transaction behaviour of the industry (European Commission, 2009).

Closely related to the trade volume is the price of one tonne of CO2 since the price is

a function of supply and demand.

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Figure 2: Price of EU allowances Source: ec.europa.eu

Figure 2 presents the development of the price of EU allowances. The curve shows

the price during the trial period from 2005- 2007 and the beginning of the second

trading period 2008. Its trend is upwards until a distinctive 44% fall in April 2006 and

a steady ongoing decline of prices until March 2007.In the beginning of the emission trading era the new introduced system brought

uncertainty on side of the installations whether the allowances given would be

sufficient to cover the process emissions. Thus the demand for additional certificates

increased which pushed the prices upward for the first months. The precursor for the

following strong decline was a report on emissions in 2005 which pointed out that the

actual emissions where clearly below the expected level (Murray, 2006). Knowledge

about the miscalculation, lead to the sharp fall in demand for allowances and with it

the price. The prices kept on falling continually because there was only a short time

left in the trading period to work off the unexpected surplus. Since March 2007 the

prices started slowly to rise until the end of the trial period. The second period started

with a decline in price since every member did not want to do the same mistake

again like in the beginning of the trial phase. Everyone was careful with buying and

tested how far their own allowances covered their needs. But since the cap now was

tightened the trade got pushed on and demand and price increased. This trend

stopped with the evolving economic crises July 2008. The installations had to cut

back in production, which lead to lower emission rates and decreasing demand. In

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2009 the prices reached its all time low. Low prices for oil and gas and the

expectations that economic recession will lead to a reduced energy demand

(Nature Publishing Group, 2010) were the reason for this development. Nevertheless

these extreme fluctuations in demand indicate either that the cap is not at its lowest

limit or that the installations invest preferably into low emitting processes and

innovative technology.

5. Data on Emission Allowances

To have a detailed look on the cap settings and actual consumption of each member

state we take the table of figure 3 into account shown below.

Figure 3: EU members emission allowances Source: ec.europa.eu

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The first column shows the first cap set. Germany is the country with the most

allowances, followed by the UK and Poland. Poland is expected to have an important

economic rise which is why they got so many allowances. The second column

displays the actual emitted tonnes of CO2 in 2005. Obviously the cap has been so

loose that the majority of the countries stayed easily below the limit. But still the sum

of the actual emissions in 2005 layed below the allowance limit. Moving on to the

second phase the countries had to evaluate and forecast their CO2 emissions and

record that in their national allocation plan. These numbers are shown in the third

column. Interesting to see here is that the majority of the countries calculated their

emission levels even higher than the very loose cap of the first period. Following the

thought: better too much than too less. Very striking is the case of Poland which

estimated its emissions excessively higher than even approved before. Only a few

expected to reduce their emissions. But with the actual cap set for the second period,

shown in column 4 the countries got taken back to reality. The levels from period 1 to

2 where drastically decreased about 10%. Almost every member state got fewer

allowances than in the first period but still often more than they actually emitted in the

previous years. This can be discovered when comparing column 2 and 4.

But still there is an enforced reduction and when looking at columns 2 and 4 there will

be at least a reduction of approximately 3%. Following this table big emission

reducers are France, Spain and Italy but also Poland and Czech Republic are forced

to noticeably reduce CO2 emission.

6. The East- West comparison

Comparing the data from the table of figure 3 one finds a controverse aspect:

Concentrating on the western and eastern part of Europe one recognizes that the

western countries have 3.6 times as much allowances than the eastern part and

actually emit 4 times as much more CO2 (shown in figure 4).

Figure 4: values assessed on data from Figure 3

386.22515.11367.65443.2Eastern Europe

1473.051539,411543.011614.6Western Europe

Cap allowed2008-2012

Proposed cap2008-2012

2005 verifiedemissions

1st periodcap

(all numbers in millions)

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The national allocation plans of the countries for the second phase show two

completely opposing approaches and intentions. Whereby the western countries see

their responsibility in emission reduction and set their proposal already below their

confirmed emissions, the eastern part asked for a clearly higher permission than

even allowed in the trial period, justifying their proposal by their estimated enormous

(too high) GDP growth. Also the strategy of stocking allowances to sell them at

beneficial market terms to reduce their emission costs as far as possible could be the

reason for such high estimations.

With the second phase coming into force the western countries were forced to reduce

their emissions below their verified emissions of 2005 and their proposal. Finally they

showed good will but it turned out that it still does not meet the necessary effort

towards the Kyoto targets. The eastern part on the other side is allowed to emit a little

bit more than their verified emissions of 2005 but still far below their proposed value.

The higher rate of allowances was seen as necessary regarding the expected GDP

growth.

7. Conclusion

Considering the history of the ETS one recognizes positive processes and results but

also negative developments and space for improvement.

Positive results were an emission reduction by 2.5% already after the first imperfect

phase. That is partially based on the improvements on scope and allocation

undertaken to meet the EU targets. Another optimistic fact is the cost effectiveness of

the system proven by the low impact on the GDP. In the end emission trading puts a

price on each tonne of CO2 emission and thus rises the attention to action against

this additional cost (Grubb et al.,2009). Putting back the positive aspects it is to

criticize that the reduction is very slow and could have been pushed more by lower

surplus of emission allowances and tighter caps. Another critical development is the

price decline below expected values which hinders the incentive to allocation and

new technology and promotes just additionally allowances buying. However the

market will adjust itself and the whole system is a noticeable step forward in

environmental orientated processing and development.

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Reference List

Ellermann A and Joskov P., 2008. The European Unions emission trading system in

perspective, PEW Center on Global Climate Change, Massachusetts Institute

of Technology

European Commission, 2009. EU action against climate change: The EU Emission

Trading Scheme, Office for Official Publications of the European Communities,

Luxembourg from ec.europa.eu

European Parliament, 2009. Climate change package 2020: the EUs emission

trading systems 3rd phase, from europarl.europa.eu

Grubb M., Brewer T.L. et al., 2009. Climate policy and industrial competitiveness:

Ten insights from Europe on the EU emission trading system, G/M/F,

Washington DC

Murray I., 2006. EU market crashes In Environment & Climate News (July 2006), The

Heartland Institute from http://www.heartland.org/policybot/results/19336/

EU_Carbon_Market_Crashes.html

Nature Publishing Group, 2010. Prices plummet in carbon market, Nature Publishing

Group/Macmillan Publishers from www.nature.com/news/2009/090120/full/

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