pClimate Action iStockEU ETS Handbook 1/138 Contents Using the guide 3 What is the EU ETS 4 Benefits of cap-and-trade 5 History of the EU ETS 7 EU legislative structure and the EU ETS 9 How does the EU ETS contribute to meeting the EU’s climate policy goals 12 How does the EU ETS contribute to a competitive economy 14 How does the EU ETS work 16 Main EU ETS features over the years 18 Design structure 20 What GHG emissions does the EU ETS cover 20 What is the cap on GHG emissions 22 How are allowances allocated 24 How allocation has evolved 26 Auctioning in the EU ETS 28 Auctioning bodies and venues 29 Distribution of auctioning rights 31 Auctioning in practice 32 Use of auction revenues 35 Transitional free allocation for modernisation of the power sector Article 10c 36 NER300 fund for demonstration projects 38 Free allocation in the EU ETS 40 Timing of determining free allocation 41 Free allocation shifts compliance costs 42 From national allocation to EU-wide allocation; NAPs to NIMs 43 Calculating free allocation using benchmarks 44 Limit on total free allocation Correction factors 46 What is a benchmark 47 The process of developing the benchmarks 48 Product benchmark curves and values 49 Product benchmark for free allocation 51 Fall-back approaches for free allocation 53 Historical Activity Level 55 Cross-boundary energy - Who should receive free allocation 56 Capacity changes/Changes in emissions 58 When is an installation a new entrant 59 Addressing the risk of carbon leakage 60 Addressing the risk of carbon leakage Compensation for direct emission costs 62 Assessing carbon leakage risk quantitative 63 Assessing carbon leakage risk qualitative 64 Addressing the risk of carbon leakage compensation for indirect emission costs 65 Carbon Leakage post-2020 66 Carbon leakage Links to more ination 67 Market oversight 69 What type of trades can take place 71 The Union registry 72 How does the Union registry work 75 The EU Transaction Log 77 2/138 Registry connections 78 Surrendering, retiring and transferring allowances 80 Importance of Monitoring, Reporting and Verification MRV 82 Underlying principles of MRV 83 What do MRV procedures look like 85 Monitoring approaches 86 The “Tier” system of the Monitoring and Reporting Regulation 87 Aviation 89 Reing the EU ETS structural options 92 Reing the EU ETS Market Stability Reserve 95 External links use of international credits 96 External links to other mechanisms emissions trading systems 98 Complying with the EU ETS 101 The EU ETS Compliance Cycle 101 Actors in the compliance cycle 102 What is the correct benchmark for my installation 103 Sub-installation boundaries 105 Are my sub-installations eligible for carbon leakage status 106 Attributing GHG emissions to different sub-installations 107 Cross-boundary heat flow and waste gas allocation 108 What level of free allocation is my installation entitled to 110 How does the Commission assess carbon leakage exposure 111 How do operators obtain allowances from auctions 112 What are the MRV requirements in the EU ETS 114 What are the key changes to the MRV requirements 115 MRV Who has responsibility for what 116 What do I need to know about monitoring plans 118 How do I report my annual emissions 119 What do I need to monitor and report 120 What is the verification process 122 How can verifiers obtain accreditation 124 Must the verifier make site visits 127 Timeline for verification 128 What is the Union registry for 129 Opening an account within the Union registry 130 How do I per transactions with emission allowances 131 Can I bank and borrow allowances 133 Penalties for non-compliance 134 Glossary 135 3/138 Using the guide This guide provides detailed ination about the EU Emissions Trading System EU ETS, including ination about how the system was designed and how it operates. This document is aimed at those who want to understand the EU ETS. Although it has been written for non-experts, this guide does not provide the underlying theory of market-based instruments and emissions trading systems in general. Some prior basic knowledge of the principles of an emissions trading system would be helpful when using this manual. see e.g. Hansjurgens 2010, “Emissions Trading for Climate Policy” or Ellerman et al. 2010, “Pricing Carbon The European Union Emissions Trading Scheme”. How to use this guide This guide can be read from start to finish, but can also be used as a reference for specific components of the EU ETS. Please refer to the Table of Contents to find the relevant sections of interest, and then click directly through to that part of the guide. DISCLAIMER The views expressed in this guide represent those of the authors and are not necessarily those of the European Commission. This cannot be used as a reference for legal interpretation of EU legislation on the EU ETS . The legal documents can be found at on the website of DG Climate Action CLIMA http//ec.europa.eu/clima/policies/ets/index_en.htm European Union, 2015 Reproduction is authorised provided the source is acknowledged4/138 What is the EU ETS The EU Emissions Trading System EU ETS is a ‘cap and trade’ system. It caps the total volume of GHG emissions from installations and aircraft operators responsible for around 50 of EU GHG emissions. The system allows trading of emission allowances so that the total emissions of the installations and aircraft operators stays within the cap and the least-cost measures can be taken up to reduce emissions see Benefits of cap-and-trade. The EU ETS is a major tool of the European Union in its efforts to meet emissions reductions targets now and into the future. The trading approach helps to combat climate change in a cost-effective and economically efficient manner. As the first and largest emissions trading system for reducing GHG emissions, the EU ETS covers more than 11,000 power stations and industrial plants in 31 countries, and flights between airports of participating countries. The system was first introduced in 2005, and has undergone several changes since then. The implementation of the system has been divided up into distinct trading periods over time, known as phases. The current phase of the EU ETS began in 2013 and will last until 2020. Links The European Commission’s welcome page on the EU ETS http//ec.europa.eu/clima/policies/ets/index_en.htm EC webpage EU ETS ‘Frequently Asked Questions’ http//ec.europa.eu/clima/policies/ets/faq_en.htm European Environment Agency EEA webpage http//www.eea.europa.eu/themes/climate Phase 1 2005-2007 Phase 2 2008-2012 Phase 3 2013-2020 Phase 4 and beyond from 2021 5/138 Benefits of cap-and-trade The EU chose a “cap-and-trade” structure as the best means of meeting the GHG emissions reduction target at least overall cost to participants and the economy as a whole. It allows a set environmental outcome to be achieved at lowest costs. A traditional command-and-control approach may mandate a standard limit per installation, but provides little flexibility to companies as to where or how emissions reductions take place. A tax does not guarantee that the GHG emissions reduction target will be achieved and in a multi-national system, agreement would be required across all countries on the right price for carbon. It is also very difficult to determine the “right price” to obtain the cut in emissions required without under- or overcharging companies. Trading allows companies in the system to determine what the least-cost option is for them to meet a fixed cap. The carbon price is then set by the market through trading and based on a wide range of factors. The flexibility of cap-and-trade combined with other key benefits played an important role in the choice of a cap-and-trade structure Certainty about quantity GHG emissions trading directly limits GHG emissions by setting a system cap that is designed to ensure compliance with the relevant commitment. There is certainty about the maximum quantity of GHG emissions for the period of time over which system caps are set. This is relevant for supporting the EU’s international objectives and obligations and achieving environmental goals. Cost-effectiveness Trading reveals the carbon price to meet the desired target. The flexibility that trading brings means that all firms face the same carbon price and ensures that emissions are cut where it costs least to do so. Revenue If GHG emissions allowances are auctioned, this creates a source of revenue for governments, at least 50 of which should be used to fund measures to tackle climate change in the EU or other Member States, as agreed by Heads of State and government for the EU ETS directive see Use of auction revenues. Minimising risk to Member State budgets The EU ETS provides certainty to emissions reduction from installations responsible for around 50 of EU emissions. This reduces the risk that Member States will need to purchase additional international units to meet their international commitments under the Kyoto Protocol. Links and references for further ination are provided below. Links EC webpage EU ETS FAQs http//ec.europa.eu/clima/policies/ets/faq_en.htm EC webpage EU ETS ‘Cap’ Explanation on what the EU ETS cap is and what it covers http//ec.europa.eu/clima/policies/ets/cap/index_en.htm EC webpage EU ETS Cap FAQ Questions and answers on what a cap is and what it covers in the EU ETS 6/138 http//ec.europa.eu/clima/policies/ets/cap/faq_en.htm EC webpage Monitoring and reporting of GHG emissions o The EU ETS perance on reducing emissions in Member States http//ec.europa.eu/clima/policies/g-gas/monitoring/documentation_en.htm o Factsheet “The EU ETS is delivering emission cuts” http//ec.europa.eu/clima/publications/docs/factsheet_ets_emissions_en.pdf Reports on the EU ETS perance by independent organisations, analysts and NGOs Abrell, J., Faye, A. N. and Zachmann, G. 2012, “Assessing the Impact of the EU ETS using Firm data analysis”, http//www.iadb.org/intal/intalcdi/PE/2012/10379a09.pdf Ellerman, A.D., Convery, F.J. and de Perthuis, C. 2010, “Pricing Carbon the European Union Emissions Trading Scheme”. Environmental Defense Fund 2012, “The EU Emissions Trading System Results and Lessons Learned”, http//www.edf.org/climate/eu-emissions-trading-system-report Liang et al. 2013, “Assessing the Effectiveness of the EU Emissions Trading System”, http//www.cccep.ac.uk/Publications/Working-papers/Papers/120-129/WP126-effectiveness- eu-emissions-trading-system.pdf Martin, R., Muls, M. and Wagner, U. 2012, “An Evidence Review of the EU Emissions Trading System, focussing on Effectiveness of the System in driving Industrial Abatement”, https//www.gov.uk/government/uploads/system/uploads/attachment_data/file/48449/5725- an-evidence-review-of-the-eu-emissions-trading-sys.pdf World Bank 2014, “State amp; Trends of Carbon Pricing 2014”, http//documents.worldbank.org/curated/en/2014/05/19572833/state-trends-carbon-pricing- 2014 7/138 History of the EU ETS The Kyoto Protocol to the UN Framework Convention for Climate Change UNFCCC was agreed upon in 1997 and set legally-binding GHG reduction targets, or caps, for 37 industrialised countries for the first commitment period 2008–2012. This led to the need for policy instruments to meet the Kyoto commitments. In March 2000 the European Commission presented a green paper on “Greenhouse gas emissions trading within the European Union” with some first ideas on the designs of the EU ETS. It served as a basis for numerous stakeholder discussions that helped shaped the EU ETS in the first phases. This led to the adoption of the EU ETS Directive in 2003 and the introduction of the EU ETS in 2005. The first phase of the EU ETS ran from 2005 to 2007 and was seen as the pilot phase. This phase was used to test price ation in the carbon market and to establish the necessary infrastructure for monitoring, reporting and verification of emissions. The cap was largely based on estimates as there was no reliable emission data available. The primary purpose of phase 1 was to ensure the EU ETS functioned effectively ahead of 2008, to ensure that it would allow the EU Member States to meet their commitments under the Kyoto Protocol. The so-called Linking Directive 1allowed businesses to use certain emission reduction units generated under the Kyoto Protocol mechanisms clean development mechanism CDM and joint implementation JI to meet their obligations under the EU ETS see External links Use of international credits. In the first phase businesses were only allowed to use units generated under the CDM for EU ETS compliance. The second phase of the EU ETS ran from 2008 to 2012, the same period as the first commitment period under the Kyoto Protocol. From 2008 businesses could also use emission reduction units generated under JI to fulfil their obligations under the EU ETS. This made the EU ETS the largest source of demand for CDM and JI emission reduction units. Towards the end of phase 2 the scope of the EU ETS was expanded by including aviation from 2012 see Aviation. The third phase of the EU ETS was shaped by the lessons learnt from the previous two phases. In particular, significant efforts were taken to improve the harmonisation of the scheme across the EU following a review of the EU ETS, agreed upon in 2008. The third phase runs from 2013 to 2020. This coincides with the Kyoto Protocol second commitment period, as agreed in Doha in December 2012. The EU is one of the jurisdictions that has committed to a target under the second commitment period and the EU ETS will be key in achieving the target. Nonetheless, the EU ETS is defined by EU legislation and operates independently of the actions of other countries or the UNFCCC, underlining the commitment of the EU to tackle climate change. The EU ETS does not have an end date and continues beyond phase 3. 1Directive 2004/101/EC of the European Parliament and of the Council amending Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading within the Community, in respect of the Kyoto Protocol39;s project mechanisms 8/138 Links United Nations Framework Convention on Climate Change UNFCCC webpage http//unfccc.int/2860.php Delbeke 2006, EU Environmental Law The EU Greenhouse Gas Emissions Trading Scheme, Claeys amp; Casteels EC webpage on the EU ETS 2005–2012 A brief summary and description of Phase 1 and 2 http//ec.europa.eu/clima/policies/ets/pre2013/index_en.htm The 2004 EU ETS Directive to amend the original EU ETS Directive to allow the use of Kyoto Protocol project credits Directive 2004/101/EC The 2008 EU ETS Directive to amend the original EU ETS Directive to include aviation in the EU ETS Directive 2008/101/EC 9/138 EU legislative structure and the EU ETS/p