The member states of the European Union (EU) have decided to meet their commitments under the Kyoto Protocol jointly—an option the Kyoto Protocol explicitly allows. A key feature to reach the reduction goal of the EU—lowering emissions to 92% in comparison to the “base year” 1990—is the European Emission Trading Scheme, or EU ETS. This scheme is currently by far the largest installation based cap-and-trade system for greenhouse gases in the world. It was created by the EU emissions trading directive, and applies the concept of emission trading as created by the Kyoto Protocol to the private sector installation level. Currently, the first trading period (2005–2007) of the EU ETS is approaching its end. The second trading period will last from 2008–2012, parallel to the Kyoto Protocol trading period. The lessons learned from the EU ETS trading activities will most likely have significant impact on the design of future U.S. cap-and-trade systems (see below). Important Features

The EU ETS covers installations from the power sector (combustion power generation installations ≥20MW) as well as installations from emission-intensive industry sectors (such as glass, cement, aluminum, and paper). Installation operators need to apply for certificates (EU allowances or EUAs) vis-à-vis their national member state authorities at the beginning of each trading period, and then receive an allocation of EUAs for their installation. The allocation rules are different in every member state, and based on National Allocation Plans (NAPs) which each member state prepares at its discretion, but on the basis of the provisions of the emissions trading directive. However, NAPs must be submitted to the EU commission prior to implementation. The EU commission ensures that the NAPs are in line with the emissions trading directive. After EU commission approval, the NAPs are implemented by national legislation. Allocation rules are tailored to the different sectors and installation types. In most member states, energy installations face tougher reduction goals then industrial installations. There are also usually different allocation methodologies for existing installations and newcomers. In the first trading period, allocations were mostly free. For the second trading period, many EU member states intend to use the option provided by the emissions trading directive to auction up to 10% of the EUAs.

Every year, the installation operators must report their emissions, and surrender the equivalent amount of EUAs. They are free to sell and buy EUAs at any point of time. All allocations, surrender and trading activities are executed through accounts in national registries which are linked through the Community Independent Transaction Log (CITL), which links all national registries in order to allow cross-border transactions throughout the EU. Accounts can also be held by individuals or companies to operating and installation, in order to allow the market participation of traders and therefore enhance trading activities.

Linking the EU ETS to Kyoto Protocol Project Mechanisms

Through the so-called linking directive, the European Union has established a link between the EU ETS and the tradable Kyoto Protocol “currencies” of CERs and ERUs (see above). Both can be used in order to meet individual compliance goals. The directive requires national legislation to limit the amount of CERs and ERUs that may be used to meet compliance goals. Due to this linkage, the EU ETS is an attractive platform for investors based outside the EU, as it is an important market place for CERs and ERUs as well. It is currently being discussed to what extent a linkage of the EU ETS to U.S. trading schemes is possible in the future.