The climate change and renewable energy package includes a directive to amend the current EU Emissions Trading Scheme (ETS) Directive. The amendments will introduce a number of important changes to the EU ETS that will take effect from Phase III (2013-2020) of the scheme, and provide a clearer sense of the future of the scheme. The main changes include a declining emissions cap, increased auctioning of allowances and longer trading phases. The increase in auctioning will be introduced more slowly than was proposed by the European Commission when it announced the climate and energy package in January 2008.

Expansion to new activities and gases

The Directive will expand the EU ETS to cover new activities and gases, including:

  • carbon dioxide emissions from the petrochemicals, ammonia and aluminium sectors;
  • nitrous oxide emissions from the production of nitric, adipic and glyocalic acid; and
  • perfluorocarbon emissions from the aluminium sector.  

Although much of the attention on Phase III has surrounded its expansion, the new Directive confirms that the EU ETS will continue to be focused on large energy-intensive sectors.

Harmonisation and centralisation

A number of measures will be introduced to harmonise and centralise the operation of the scheme:

  • allocations of allowances will be made centrally rather than by Member States under National Allocation Plans (NAPs) - this is intended to reduce competitive distortions within sectors resulting from different rules being adopted by Member States with regard to allocation;
  • administration of the New Entrant Reserve (equivalent to 5% of total annual allowances to be awarded) will be centralised; and  
  • records relating to allowances, and trading in allowances, will be held in a central register rather than in national registries.  

Decreases to the allowance cap

In relation to the EU-wide cap on emissions allowances:

  • from 2013, the cap will decrease year on year by 1.74% of the Phase II cap from the total amount of 1.974 billion allowances in 2013 to 1.720 billion in 2020 (equivalent to an overall reduction of 21% in allowances available by 2020 compared to 2005);
  • beyond 2020, the cap will continue to decrease by 1.74% per year, but this rate of reduction may be revised by 2025; and  
  • allowances issued from 2013 onwards can be banked for use in any subsequent phase of the scheme.  

A move to compulsory auctioning

A major change will be a shift away from allocating allowances to operators free of charge, to a process involving the compulsory auctioning of allowances:

  • free allocations of allowances will be phased out progressively, with 20% of available allowances being auctioned in 2013, increasing to 70% in 2020, with a view to the full quota of allowances being auctioned in 2027;
  • no allowances will be allocated free of charge to electricity generators as of 2013 (except for district heating schemes, high-efficiency combined heat and power schemes, and where eligible Member States have opted to derogate from this rule); and  
  • Member States will conduct auctions, with 90% of the allowances to be auctioned being given to Member States in proportion to their verified emissions for 2005, and the remaining 10% of allowances being given to Member States with lower per capita income.  

Extension to cover Carbon Capture and Storage (CCS)

The EU ETS will be extended to cover the capture, transport and storage of carbon dioxide. However, in order to support the development of CCS, operators will not need to surrender any allowances for carbon dioxide that is permanently stored in a licensed CCS facility. (For further information please see oure-bulletin on the CCS Directive).

Phase III is open to Kyoto Project Credits

With regard to credits generated by Clean Development Mechanism (CDM) and Joint Implementation (JI) projects:

  • the Directive extends the ability to use credits generated by CDM and JI projects issued in respect of emission reductions occurring before 2013 or generated by projects established before 2013 into Phase III of the EU ETS;
  • credits may be exchanged by Member States for EU ETS allowances at any time up to 31 March 2015;  
  • the total amount of credits used may not exceed 50% of total emissions reductions below 2005 levels during the period from 2008 to 2020; and  
  • in the event that an international agreement is reached to succeed the Kyoto Protocol, triggering an increase in the EU reduction target beyond the current target of 20% by 2020, Member States would be allowed to use additional CDM and JI credits to meet half of the additional emissions reduction required.  

Some significant changes from the Commission's original proposals

The main changes from the original proposal announced by the Commission in January 2008 (and reported in our bulletin of 29 January 2008) are:

  • Auctioning: The rate of increase in the level of auctioning is lower than that originally proposed by the Commission. The Commission had called for 100% of allowances to be auctioned by 2020.
  • Exemptions: The option available to Member States to exempt small installations has been extended to cover all small installations regardless of sector or the nature of the activity undertaken. The emissions threshold below which an installation is classified as "small" has been raised from 10,000 to 25,000 tonnes of carbon dioxide emitted per year. In addition, in the case of combustion installations, the capacity threshold has been raised from 25 MW to 35 MW. Member States have also been given the option of excluding hospitals from the exemptions.  
  • Distribution of allowances: In addition to the distribution of 10% of allowances for auctioning to Member States with a lower per capita income, a further provision has been added to allow a redistribution of 2% of auctioned allowances to take into account Member States which, in 2005, had achieved greenhouse gas emissions reductions of at least 20% compared to 1990 levels (the twelve "new" Member States and Greece and Portugal will benefit from this measure).  
  • Derogation from rules for electricity generators: In order to assist Member States with less developed generating infrastructure and economies, certain Member States may opt to derogate from the rule preventing the allocation of allowances to electricity generators free of charge. This option will only be available where certain conditions relating to the interconnectivity of the electricity grid, the share of fossil fuels in electricity generation, and GDP per capita are fulfilled. Even if the option is exercised, 30% of the allowances available for electricity generators must be auctioned in 2013, rising progressively to 100% by 2020, and the Member State must invest in energy infrastructure, clean technologies and energy diversification an amount equal to the market value of the free allocation. In addition, free allocations can only be made for emissions from installations that are operational or under construction no later than the end of 2008.  
  • Auctioning revenues: The recommended proportion of auction revenues which Member States should use to fight climate change, and alleviate the social consequences of moving towards a low-carbon economy has been raised from 20% to 50%. The proceeds from auctioning 300 million allowances reserved for new entrants to the EU ETS will be used to support renewable energy projects and up to 12 CCS demonstration projects.  
  • Carbon leakage criteria: More detail has been included in the Directive on the criteria that will be used to determine sectors exposed to a significant risk of "carbon leakage" (such as the relocation of manufacturing or other activities covered by the scheme outside the EU where similar emission reduction constraints have not been imposed). The Commission will identify those sectors that will face significantly increased production costs, ie, costs comprising (more than 5% of its gross value added) and international competition (more than 10% non-EU imports and exports). The publication of the Commission's list of affected sectors has been brought forward to 31 December 2009. By June 2010, the Commission will review carbon leakage generally in light of any international agreement that is reached which may substantially reduce the risk of carbon leakage. The Commission has stated that this could involve maintaining or adjusting the proportion of allowances received free of charge by sectors deemed to be at risk of carbon leakage.  
  • Compensation for increased electricity costs: Member States may compensate certain installations for EU ETS costs passed on to them through higher electricity prices if these costs might otherwise expose them to the risk of carbon leakage. The Commission will amend its guidelines on state aid for environmental protection to allow this compensation to be granted.