EU Emissions Data for 2005
The last month has seen a period of volatility and increased activity in the carbon emissions trade, as a result of the premature release of the 2005 EU emissions data for installations covered by the EU Emissions Trading Scheme (EU ETS).
The 2005 EU emissions data (the 2005 Data) was due to be published on 15.5.06. However at the end of April four EU member states released their emissions data early, triggering a dramatic fall in price - primarily for first phase EU ETS allowances. To add to the confusion, the 2005 Data was then - accidentally – prematurely published on 12.5.06. Verification of the 2005 Data then followed on Monday 15.5.06.
The 2005 Data records that companies in the EU ETS emitted 1785.3 million tonnes of carbon dioxide in 2005. The annual average allocation of allowances for 2005 was 1,829.5 million, leaving a theoretical surplus of 44.1 million tonnes in the first year.
Although most EU countries are well within their targets, some, notably the UK, have exceeded their quota for carbon dioxide emissions last year. This has led to the UK government questioning the actions of other EU countries in setting caps on carbon dioxide emissions that are too loose. Environment and climate change minister Ian Pearson said he would be taking the issue up with the EC. The French and Finnish governments have also called on industry and government to overhaul the EU ETS, calling for quarterly reporting of verified emissions and a looser link between carbon and electricity prices.
Background to EU ETS
The United Nations Framework Convention on Climate Change (UNFCCC) is aimed at minimising the effect of climate change. Under the Kyoto Protocol, countries are provided with targets to reduce or stabilise their emissions by 2012. Countries are permitted to use a trading system to meet their emissions targets.
There are also other mechanisms in place to help reduce emissions. These include the Clean Development Mechanism (CDM), a mechanism for project-based emission reduction activities in developing countries. Certificates are generated through the CDM from projects that lead to certifiable emissions reductions (CERs) that would otherwise not occur. Another is Joint Implementation (JI), a mechanism for the transfer of emissions permits from one Annex B country to another. JI generates Emission Reduction Units (ERUs) on the basis of emission reduction projects leading again to quantifiable emissions reductions.
The EU ETS, the world’s largest carbon trading regime, is designed to help EU member states meet their Kyoto Protocol commitments to reduce greenhouse gas emissions.
The EU Emissions Trading Directive 2003/87/EC was implemented in the UK by the Greenhouse Gas Emissions Trading Scheme Regulations 2005 (the Regulations), which came into force on 21.4.05.
The EU ETS Directive was amended by Directive 2004/101/EC in October 2004 to provide for linking to the Kyoto Project Mechanisms (ie CDMs and JIs) and the use of credits from this (ie CERs and ERUs) for compliance.
Each EU country has reduction targets established in the Kyoto Protocol. Member states set a cap, and installations that emit less carbon dioxide can sell their allocation to others. The EU ETS has three phases: the initial trading period 2005 2007 covering three years from 1.1.05; the second phase 2008-2012 and beyond Kyoto from 2012 onwards.
At the time of publication of the 2005 Data, four of the 25 EU states, Cyprus, Luxembourg, Malta and Poland had not yet connected to the Community International Transaction Log, although these countries are expected to connect soon. A significant price move is anticipated when Poland does connect.
The Carbon Price
The carbon price is the price of an allowance to emit one metric ton of carbon dioxide – the only greenhouse gas covered by the EU ETS at the moment. These allowances have been traded since January 2005 on the futures market and, since February 2005, spot trading has also taken place.
Factors affecting the market price include political and regulatory issues, market fundamentals i.e. supply and demand, and also factors such as the weather: more power will be consumed and carbon dioxide produced if the weather is cold and dry in the winter, and hot and dry in the summer.
Since the publication of the 2005 Data, after an initial downturn, the general view seemed to be that the figures were bullish and prices climbed steadily, although by 30.5.06 there had been four successive days when prices had fallen, reportedly in anticipation of the release of figures by Poland and perhaps because of the reported surpluses.
Many countries, which are now preparing their national allocation plan for the second phase, from 2008-2012, have indicated that they intend to increase their allowance. For example (1) the Netherlands is to increase its national allocation plan, including the amount reserved for new entrants, from 95.5 million tonnes in the first phase to 99.2 million tonnes in the second phase, while more than doubling the amount of installations included in the scheme; and (2) Poland aims to increase the annual allocation under the EU ETS by 20 million tonnes, according to the draft national allocation plan for the 2008-12 period.
However, the second phase also brings new areas of industry into the scheme. There are no temporary exclusions – all carbon dioxide emissions from installations carrying out an activity defined in Annex I of the Directive will be included.
It remains to be seen whether the aircraft industry, one of the main emitters of carbon dioxide, will be covered by the scheme. Although the EU announced its intention in September 2005 to bring aviation into the scheme, and member states may unilaterally include other sectors, for example, aviation, in the second period, it is unclear whether any will do so.
It has also been suggested that other pollutants should be added to the scheme, as carbon dioxide is only one of the six greenhouse gases covered by the Kyoto treaty.
If countries do in fact reduce their emissions (the stated aim of the Kyoto Protocol) but are granted the increased allowances they are seeking in their National Allocation Plans for next year, there could be an even greater surplus next year. Suggestions by, eg DEFRA, that there should be an auction of allowances, if indeed this goes ahead, may be the only way to cap this otherwise lucrative trade in a commodity that exists only because of its limited supply.
The Commission is due to report on its review of the EU ETS to consider the role of international obligations, harmonisation of allocation including the use of auctioning, the registry and penalties. However, even if any changes are adopted they will only take effect in phase three.
It seems inevitable, however, that the trading system will have to undergo a certain amount of change if the EU is to meet its collective Kyoto target of getting greenhouse gas emissions 8% below 1990 levels by 2012.
It is also inevitable with a scheme of this nature that there are teething issues that need to be addressed. Clearly a more formal and accurate system for reporting of information needs to be developed to avoid a re-occurrence of the events of last month. Similarly, achieving greater consistency between the member states on various matters such as the establishment of caps will need to be addressed.
It will be interesting to see how the EU ETS market reacts to the future developments mentioned above.
How Does This Affect You?
The trading of carbon allowances is important because it is a mandatory scheme for the sectors covered – installations within the sectors will have no choice but to ensure that they trade as efficiently as possible. The sectors covered will grow and industry will face a much tougher regime, which will drive the demand for allowances and create a liquid market.
As far as concerns the global carbon market, the EU ETS is only one method of meeting Kyoto targets. Others include procurement programmes aimed at purchasing CERs from CDM Projects and ERUs from JI projects. If countries base their allocation plans on an interaction with the projects market then real reductions in emissions can be made whilst still reducing allocations.
Although the EU ETS is currently the most commoditised sector of the global market, this is likely to change in the future although probably not in the near future.
What is clear is that the global carbon market is continuing to develop quickly and it is important to be aware of new developments particularly as regards 2012 and beyond.