Emissions trading is a market-based scheme used to control emissions of carbon dioxide and other greenhouse gases by providing economic incentives for achieving reductions in these emissions. Emissions trading is a relatively new phenomenon, yet there has been rapid growth in its volume and complexity.
Companies under the trading system are given credits or allowances which represent the right to emit a specific amount. The total amount of allowances distributed cannot exceed a cap, limiting total emissions to that level. Companies that emit beyond their allowances must buy allowances from those who emit less or face heavy penalties. The buyer pays for polluting, while the seller is rewarded for having reduced emissions. Companies that can easily reduce emissions will do so and those for which it is more expensive will buy credits.
EU Emissions Trading Scheme (ETS)
The EU Emissions Trading Scheme (ETS) is one of the policies introduced across the EU to reduce emissions of carbon dioxide and other greenhouse gases, in an effort to combat the serious threat of climate change. The operation of ETS is governed by Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowances trading within the Community as amended by Directive 2004/101/EC. These Directives were transposed into Irish law through the European Communities (Greenhouse Gas Emission Trading) Regulations 2004 to 2005 and the Kyoto Protocol Flexible Mechanisms Regulations. The ETS came into operation on 1 January 2005. The first phase of the scheme ran from 2005-2007 and the second phase runs from 2008 to 2012 to coincide with the first Kyoto commitment period.
ETS works on a "cap and trade" basis whereby all EU member states are required to set a limit or cap on the amount of a pollutant that can be emitted for all installations covered by the scheme. Each installation is allocated allowances for the particular commitment period with the number of allowances allocated to each installation for any given period being determined on the basis of a national allocation plan. The national allocation plan determines the total quality of carbon dioxide emissions that member states grant to companies located in that state which can then be sold or bought by the companies themselves. The idea is that member states limit carbon dioxide emissions from the energy and industrial sectors through the allocation of allowances, thereby creating scarcity, so that a functioning market can develop later and overall emissions are then reduced. Each year the installations must return enough emissions allowances to the relevant regulator to cover their actual emissions which in turn encourages emissions reduction.
Ireland's National Allocation Plan
On 4 March 2008, following the European Commission's acceptance on 5 February 2008 of the final draft of Ireland's National Allocation Plan for 2008-2012, the Environmental Protection Agency published the Final Allocation Decision on the aforementioned Plan. This document fixes the allocation of greenhouse gas emission allowances which will be made under the Emissions Trading Directive to Ireland's major greenhouse gas emitters for the period 2008 to 2012. These fixed allocations will be issued to installations on an annual basis over the five year period. Ireland's National Allocation Plan for 2008-2012 provides for an assignment of allowances among Irish installations participating in the scheme, of which there are just over 100 out of an EU-wide total of more than 11,400 installations. These installations include all fossil fuel power generation facilities and large industrial energy users such as cement manufacture, paper and pulp manufacture and food processing. Collectively, these installations would account for an estimated 35% of forecast emissions for the Kyoto commitment period, had the ETS not been introduced.
The ETS is a cornerstone in the fight against climate change. It is the first international trading system for carbon dioxide emissions in the world. It is important to point out that ETS does not imply new environmental targets rather it is intended to allow for more cost effective compliance with existing targets under the Kyoto Protocol by allowing participating companies to buy or sell emission allowances.
Carbon Trading
The European Commission has not stipulated on what price allowances should be rather the price is function of supply and demand. Companies with commitments may trade allowances directly with each other, or they may buy or sell via a broker, bank or other allowance market intermediary. A carbon trading market has now started to form. Market intermediaries quote prices for allowances offered or bid for. The European Commission will not intervene in the allowance market. Of course if distortions occur, competition law would be applicable as with any other market.
Due to the risk that international competition could result in "carbon leakage" (the relocation of carbon intensive industry to less regulated jurisdictions) the European Commission intends to assess and determine the exposed sectors and such sectors will receive 100% of their allowances for free.
Electronic Registry System
Provision is also made for an electronic registry system that keeps track of the ownership of emission allowances as they are exchanged within the market. In Ireland the Environmental Protection Agency is responsible for establishing and maintaining a national emission trading registry. This registry system is separate from trading activity - not all trades result in changes of allowances but where a trade culminates in a change of ownership, there is a transfer of allowances between accounts in the registry system. The registry operates in the same way that a banking system keeps track of ownership of money in accounts but does not track the deals made in the goods and services markets, which are the cause of the money changing hands. Therefore the registry system is not a marketplace but rather the way in which allowances are traded is a decision made by the participants in the market.
Climate and Energy Package
In December 2008, the European Parliament voted in favour of the European Commission's proposed climate and energy package which is intended to help Europe transform into a low-carbon economy and increase energy security.
In line with the European Commission's proposals in January 2008, agreement was reached on legally binding targets so that by 2020 there would be a cut in greenhouse gas emissions by 20%, a 20% share for renewable energy would be established and energy efficiency would be improved by 20%. The package also contains a choice to go further and commit to a 30% cut in the event of a satisfactory international agreement being reached. Included in the package were significant changes to the existing ETS. The improvements mean that from 2013 an emissions cap will be set at EU level and cut each year to reach a 21% cut in 2020.
Therefore under the ETS, from 2013, member states will no longer prepare a national allocation plan. In place of that there will be one EU-wide cap on emission allowances which will decrease along a linear trend line. The agreement will increase the level of auctioning in the system. Whereas there is an option for transitional free allowances that most member states could apply for, the power generation sector will have to buy allowances so a greater proportion of allowances will be auctioned which will limit perceived windfalls arising from free allocation from a sector that has proven itself capable of passing costs through to customers.
Industry installations not subject to carbon leakage will be required to buy 20% of allowances in 2013, rising to 70% in 2020 and 100% in 2027. Operators at risk of carbon leakage that invest in the most efficient technologies will receive allowances for free in accordance with a benchmark based on best available technology.
The revised ETS allows for the use of offset credits from outside the EU, but this amount remains below half of the reduction effort in order to ensure a sufficient level of emission reductions inside the EU. These measures will need to be technically implemented and procedures provided for auctions, determining the benchmarks for free allocations and preparing regulations on reporting. Further adjustments will also be required in light of any further international agreements on climate change.
It is clear that the above proposals entail a major change from the previous framework and will create significant and far-reaching challenges for government, industry and consumers.
