a Status Report I. Introduction II. Emissions Trading Directive 1. EU ETS in a nutshell Ulrich Ellinghaus, Peter Ebsen and Hannes Schloemann*

Transcription

1 JEEPL EU Emissions Trading Scheme 3 The EU Emissions Trading Scheme (EU ETS): a Status Report Ulrich Ellinghaus, Peter Ebsen and Hannes Schloemann* I. Introduction From 1 January 2005 on greenhouse gas emissions in the EU, so far virtually unregulated, will be subject to limitations. At the same time, and for the first time in the EU, these limitations will be tradable. Instead of facing old-style command-and-control regulation, operators of greenhouse gas emitting installations will receive allowances which they can sell or buy, as the case may be, provided they ensure to hold enough allowances to pay for their actual emissions at the scheduled time. The EU Emissions Trading Scheme (EU ETS) is built on three main legal instruments. First, the Emissions Trading Directive 1 (ET Directive), which establishes the cap and trade system itself, including key rules on, e.g., covered installations, allocation of allowances, monitoring and trading. Second, the so-called Linking Directive 2, not yet adopted, which will allow for, and regulate, the introduction into the emissions trading scheme of emission reduction credits generated through specific projects * Dr. Ulrich Ellinghaus, Peter Ebsen (both Frankfurt) and Hannes Schloemann (Berlin) are lawyers with Baker & McKenzie LLP. 1 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, OJ L 275, pp Directive 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 Protocol s project mechanisms. The Linking Directive has been informally agreed upon by the European Parliament and the Council. The European Parliament has formally accepted it. Formal acceptance by the Council is pending. 3 Commission Regulation for a standardized and secured system of registries pursuant to Directive 2003/87/EC of the European Parliament and of the Council and Decision 280/2004/EC of the European Parliament and of the Council. The Climate Change Committee on 24 June 2004 agreed on the presumably final draft. 4 For the sake of brevity we will only touch in passing on other relevant instruments such as in particular the Burden Sharing Agreement between the EU 15 Member States under the Kyoto Protocol (now codified in Annex II of Council Decision No. 2002/358/EC of 25 April 2002 approving the Kyoto Protocol, OJ L 130, pp. 1-20), the Monitoring Decision (Decision No. 280/2004/EC of the European Parliament and the Council of 11 February 2004, OJ L 49, pp. 1-8) and the Monitoring Guidelines (Commission Decision of 29 January 2004, C(2004) 130 final). abroad that lead to emissions reductions. Third, the Registries Regulation 3, not yet adopted, which will provide rules for the establishment and operation of national electronic registries for the EU system s emission allowances in the Member States. The following overview will address these instruments in turn 4. At the time of writing developments are highly dynamic, as will generally be the case throughout 2004 in the run-up to the EU ETS start in The European Commission, e.g. has just issued its decisions on eight out of 16 National Allocation Plans (NAPs) that have already been submitted by Member States and similarly initiated infringement proceedings against some of the defaulting Member States. Member State governments are working under tight deadlines and high pressure to set up institutions and pass laws and regulations in preparation for a timely start of the scheme. Operators of covered installations, in turn, are preparing for their respective allocation of emissions allowances including possible legal challenges thereto and the trading of allowances. Notwithstanding these dynamics, the system s main parameters are now established and shall be discussed below. II. Emissions Trading Directive 1. EU ETS in a nutshell The Emissions Trading Directive establishes a scheme for greenhouse gas allowance (EU Allowance) trading in the European Community. As of 1 January 2005, operators of installations covered by this scheme will have to monitor the carbon dioxide (CO2) emissions of these installations and report them annually to the competent authorities. Beginning in 2006 operators of such installations will have to surrender EU Allowances on 30 April of each year in a number equivalent to the CO2 emissions of the respective installation in the previous year. The EU Allowances will be issued to the oper-

2 4 EU Emissions Trading Scheme JEEPL ators of covered installations free of charge. The EU Allowances can be freely traded within the EU and can be used for the purposes of surrendering them for the respective emissions of installations located in any of the Member States. 2. Main features of the EU ETS a. Covered installations Annex I of the ET Directive contains a list of categories of installations that will be covered by the EU ETS. These are combustion installations with a rated thermal input exceeding 20 MW, mineral oil refineries, coke ovens and installations for the production of certain products such as steel, cement, lime, glass, ceramics and paper. There is some disagreement among the different Member States and the European Commission with regard to the interpretation of Annex I of the ET Directive. As a result, the same type of installation may be covered by the EU ETS in one Member State and not be covered by the EU ETS in another Member State. b. Emissions monitoring/ reporting Operators of covered installations will have to monitor and report their installations CO2 emissions each year, beginning in The emission reports have to be verified by independent verifiers. The monitoring and reporting has to be carried out in accordance with the Monitoring and Reporting Guidelines issued by the European Commission in January c. Surrender of EU Allowances Operators of covered installations are required to surrender EU Allowances in a number equivalent to the CO2 emissions of their respective installations in the previous year. In case an operator does not comply with this requirement, he will be required to pay a penalty of EUR 40 (EUR 100 as of 2008) for each tonne of CO2 emitted by that installation for which he has not surrendered sufficient EU Allowances. However, this penalty will not free the operator from his obligations, as he still remains obliged to surrender the respective amount of EU Allowances for these emissions in the subsequent year. There may, however, be some differences in the way the penalty is applied and dealt with in the different Member States. For example, in some of the Member States the penalty might be tax deductible. This may create an incentive for operators to "shift" the burden of any (unavoidable) non-compliance sanctions to installations in Member States with the most favourable rules on the application of the penalty. d. Allocation Operators of covered installations will receive at least 95 % of the EU Allowances free of charge in the 1 st allocation period from 2005 to 2007 (90% in the 2 nd allocation period ). For each allocation period (three year period followed by five year periods , etc.), EU Allowances are allocated by the EU Member States in a three step procedure. 1. Member States develop National Allocation Plans (NAPs) containing the overall quantity of EU Allowances and the abstract allocation rules. The EU Commission may reject the NAPs if they do not comply with the requirements of the ET Directive, in particular its Annex III, or with EU Competition Law. 2. Member States decide on the actual allocation of EU Allowances to the individual installations in allocation decisions that have to be in conformity with the NAPs. 3. Each year the Member States competent authorities issue a share of the allocated EU Allowances to the operators of the covered installations. At the time of writing only about two-thirds of the Member States have submitted their NAPs to the European Commission (see below, II.3.). The submitted NAPs differ significantly as to the burden they place on the covered installations in the respective Member State and with respect to the rules for the allocation of the EU Allowances amongst the covered installations. The EU Commission has by and large accepted all of these NAPs. Only minor technical changes to some of them were requested (see below, II.3.). So far, none of the NAPs allows for the interperiod banking of EU Allowances from the 1 st allo- 5 Commission Decision of 29 January 2004 establishing guidelines for the monitoring and reporting of greenhouse gas emissions pursuant to Directive 2003/87/EC of the European Parliament and of the Council, C(2004) 130 final.

3 JEEPL EU Emissions Trading Scheme 5 cation period to the 2 nd allocation period 6. As a result, any EU Allowances issued for the 1 st allocation period that are not used by 30 April 2008 will be cancelled and become invalid. Interestingly, this may create some additional demand for certified emissions reductions (CERs) generated from socalled Clean Development Mechanism projects in third countries 7, as these can be used both in the 1 st and the 2 nd allocation period, thus unlike EU Allowances can be effectively banked across the allocation periods. e. Trading The EU Allowances can be traded freely within the EU and can be used for the emissions of installations in any of the Member States. Each Member State maintains an electronic registry accurately accounting for the issuance, holding, transfer and cancellation of EU Allowances. These registries will have to comply with the Registry Regulation adopted by the Emissions Trading Regulatory Committee of the EU Commission on 24 June 2004 (see below, IV.). Different standard or model contracts for trading EU Allowances are presently being developed by IETA 8, EFET 9 and ISDA 10. Companies can use these standard contracts to develop their own, tailor-made contracts which take into consideration their company specific purposes and country specific requirements. It is unlikely that there will be an organized stock exchange for EU Allowances in the near future. Nevertheless, there are different initiatives for semi-organized market-places for EU Allowances in Amsterdam, Leipzig, London, Paris and Vienna, and 6 According to Article 13 para. 2 of the ET Directive, it is in the discretion of the Member States to replace 1 st period EU Allowances with 2 nd period EU Allowances after the 1st allocation period. 7 We discuss these and their link with the EU ETS in more detail below, III.4. 8 International Emissions Trading Association. 9 European Federation of Energy Traders. 10 International Swaps and Derivatives Association. 11 Austria, Belgium, Denmark, Estonia, Finland, Germany, Ireland, Latvia, Lithuania, Luxembourg, Portugal, Slovak Republic, Slovenia, Sweden, The Netherlands, United Kingdom; the submitted NAPs can be downloaded from the EU Commission website: emission_plans.htm. 12 Cf. European Commission press release IP/04/862 of 7 July Pursuant to criterion 10 of Annex III The plan shall contain a list of the installations covered by this Directive with the quantities of allowances intended to be allocated to each. it is likely that there will be some cooperation between these initiatives. 3. National Allocation Plans As of 7 July 2004, only 16 Member States have submitted final NAPs to the EU Commission for review 11. The remaining 9 Member States are in non-compliance with the ET Directive, as they were required to submit the NAP by 31 March 2004 (EU 15) or by 1 May 2004 (10 New Member States). The EU Commission has initiated infringement procedures against some of these Member States, of which Greece and Italy have received first written warnings. On 7 July 2004, the European Commission accepted five of the submitted NAPs (Denmark, Ireland, The Netherlands, Slovenia, Sweden) without requiring any further changes. Three Member States Austria, Germany and the UK have been asked to change their NAPs 12. The main problem of the German and the Austrian NAPs is that they allow for ex-post adjustments to allocations, i.e. they allow for a redistribution of allowances among the participating companies during the period after allocation of allowances to operators. In the European Commission s view ex-post adjustments would disrupt the market and create uncertainty for companies. In the interpretation of the European Commission, this would also contravene criterion 10 of Annex III of the ET Directive 13. The UK NAP, in the Commission s view, did not contain sufficient information on the manner in which new entrants will be able to begin participating in the trading scheme. Furthermore, the list of installations, included in the UK S NAP did not include installations in Gibraltar. The amendments required by the European Commission are rather minor in scope. Remarkably, the Commission did not consider any of the NAPs to be too generous in allocating EU Allowances. Allocation for the trading period would have been considered excessive by the Commission if such allocation were to jeopardize the fulfilment of the Kyoto target of the Member State. As a consequence of the Commission s arguably lenient approach, EU Allowance trading during the first trading period from will not suffer, or benefit, from significant scarcity.

4 6 EU Emissions Trading Scheme JEEPL III. Linking Directive The ET Directive will be amended by the socalled Linking Directive 14. The Linking Directive will enable Member States to allow for the use of project-based emissions credits instead of (or in addition to) EU Allowances within the EU ETS. As of 2005 the Member States may allow the operators of covered installations to use Certified Emissions Reductions (CER), i.e. emissions reduction credits from Clean Development Mechanism (CDM) projects. As of 2008 Member States may also allow the use of Emissions Reduction Units (ERU), i.e. credits from Joint Implementation (JI) projects. 1. Clean Development Mechanism (CDM) and Certified Emissions Reductions (CER) The Clean Development Mechanism (CDM) is one of the two project mechanisms established by the Kyoto Protocol 15. Under the CDM, participants of projects in developing countries, which lead to quantifiable reductions of greenhouse gas emissions, can receive emission credits, so-called CERs. The CERs are issued by the CDM Executive Board, an international body created under the Kyoto Protocol, once the project has gone through the so-called CDM-project-cycle. In order to receive CERs, 1. project participants must develop a Project Design Document (PDD), 2. a Designated Operational Entity (DOE) must validate the project activity, 3. the project must be registered with the CDM Executive Board, 4. the project participants must monitor the project in accordance with the Monitoring Plan, 5. a DOE must verify and certify the emission reductions achieved by the project and 6. the CDM Executive Board must issue CERs to the accounts held in an electronic registry that will be created and maintained by the CDM Executive Board. Countries that have agreed to quantified greenhouse gas emission limitation and reduction commitments under the Kyoto Protocol ( Annex I countries, i.e. industrialized countries) can use CERs to comply with their Kyoto targets. The CDM has evolved out of an international agreement (the Kyoto Protocol) between sovereign states but has created a type of project (the CDM project) and a trading market for project commodities (CERs) which private entities are eligible to participate in Joint Implementation and Emission Reduction Units The other project mechanism of the Kyoto Protocol is JI 17. As of 2008, operators of JI projects can receive emissions credits, that is ERUs. In contrast to CDM projects JI projects are carried out in countries with an emissions reduction target under the Kyoto Protocol. As a consequence, unlike CDM, which creates credits from countries that fall outside of the scope of the reduction targets of the Kyoto Protocol (and thereby arguably dilutes the system), JI is a mechanism to transfer emission credits (so-called Assigned Amount Units AAUs under the Kyoto Protocol) from one country with an emission reduction target to another such country. A country that accepts and hosts a JI project looses an AAU for every ERU that is issued to the JI project operator. As JI projects can be carried out within the EU, Member States have to ensure that installations covered by the EU ETS do not receive EU Allowances and ERUs for the same emission reduction activities ( double counting ) 18. The European Commission is set to adopt detailed provisions for the avoidance of double counting prior to Restrictions on the use of CERs/ERUs in the EU ETS The Linking Directive excludes certain project credits (CERs or ERUs) from use in the EU ETS, name- 14 See footnote 2 above. 15 Art. 12 of the Kyoto Protocol and Decision 17/ CP.7 Marrakech Accords CDM Modalities. 16 The legal issues of the CDM are explained in detail in the Legal Issues Guidebook to the Clean Development Mechanism that has been authored by Baker & McKenzie LLP for the UNEP project CD4CDM. The Legal Issues Guidebook to the CDM and other information to the CDM can be downloaded from the CD4CDM website: 17 Art. 6 of the Kyoto Protocol. 18 Art. 11 (ter) paras. 2-4 of the amended ET Directive. 19 Art. 11 (ter) para. 7 of the ET Directive.

5 JEEPL EU Emissions Trading Scheme 7 ly credits derived from nuclear power projects (which are anyway excluded from the CDM) and credits from land use, land-use change and forestry (LULUCF) activities 20. Apart from these limitations there are no further restrictions on the use of CERs in the EU ETS in the 1 st allocation period ( ). In the 2 nd and subsequent allocation periods, however, operators will only be able to use a limited amount of CERs to fulfil their EU ETS obligations. The limitation will be a percentage of the allocation to each installation. The Member States will specify the percentage in their respective NAPs. Each Member States has discretion as to the percentage of EU ETS obligations for the installations in the Member State that may be covered by CERs. In theory, a Member State could even choose a percentage of 100, thereby not limiting the use of CERs. The only restrictions to the Member States when specifying the percentage is that the total use of ERUs and CERs shall be consistent with the relevant supplementarity obligations under the Kyoto Protocol and the UNFCCC and the decisions adopted thereunder 21. This restriction does not impose a limitation to the individual Member States but only to the European Union as a whole. As a consequence, the EU Commission shall, if appropriate, make legislative or other proposals to complement provisions by Member States to ensure that the use of the project mechanisms is supplemental to domestic action within the European Community Impacts of the Linking Directive The Linking Directive increases the overall amount of emissions credits (allowances and credits) available to operators of installations covered by the EU 20 Art. 11 (bis) para. 3 lit. (b) of the amended ET Directive. 21 Art. 30 para. 3 of the amended ET Directive. 22 Art. 30 para. 3 of the amended ET Directive. 23 This is different from the earlier two yearly compliance dates during the first period. On 30 April 2006, operators of covered installations may use the EU Allowances that have been issued for 2005 and 2006 to cover the emissions for On 30 April 2007, operators of covered installations may use the remaining EU Allowances that have been issued for 2005, 2006 and 2007 to cover the emissions for On 30 April 2008 the operators of covered installations will not be able to use the EU Allowances issued for the year 2008, as these are 2 nd period EU Allowances. ETS, as operators may use CERs and ERUs in addition to EU Allowances. While the demand remains the same (amount of tonnes of CO2 emitted in the 1 st allocation period by all installations covered by the EU ETS), the supply is increased (amount of EU Allowances allocated by all Member States for the 1 st allocation period plus amount of CERs available by 30 April 2008). As a consequence, the price for EU Allowances is expected to be lower with the Linking Directive than it would have been without it. While this arguably dilutes the scheme s cap-and-trade logic (which requires a closed system), the inclusion of Kyoto Protocol project credits serves both the political purpose to encourage JI and CDM type investment and provides a welcome oiling of the system in its crucial first steps. As indicated, the inclusion of CERs in particular may play a significant systemic role. CERs can be used for emissions both of the 1 st allocation period and of the 2 nd allocation period. It may well be an advisable strategy for operators of covered installations to acquire a buffer of CERs before 30 April A certain stock of CERs at that time could help hedge against the risk of uncertainty of the specific amount of 1 st period EU Allowances required by operators by 30 April Furthermore, it could mitigate the risk of uncertainty of the price development of 1 st period EU Allowances before that date. Both an extreme rise of the 1st period EU Allowance prices and an extreme fall of these prices before 30 April 2008 are possible scenarios resulting from the fact that 1 st period EU Allowances that have not been used could loose their value at that date, but at the same time compliance (through surrendering of EU Allowances) could only be achieved by using such 1 st period Allowances 23. As a consequence, CERs are in fact more valuable than 1st period EU Allowances. However, this does not yet seem to be reflected in the present market prices of CERs and 1 st period EU Allowances (as indicated by advance sales). The operators of installations that are covered by the EU ETS compete for available CERs (and later ERUs) with Annex I countries and with some of the Member States. A number of Member States are planning to increase the amount of greenhouse gas emissions that may be emitted in the respective Member States under the Burden Sharing Agreement by Acquiring CERs and ERUs. Carrying out these plans will become more

6 8 EU Emissions Trading Scheme JEEPL expensive if the prices for CERs rise as a result of the Linking Directive. IV. Registries Regulation In general the Registries Regulation 24 lays down the rules for the EC registry and national electronic registries for EU Allowances. It ensures that all of the national registries are compatible and that EU Allowances can be transferred freely from one national registry to another. The Member States have to establish national registries in the form of standardized electronic databases by 30 September These registries have to incorporate the hardware and software set out in the Registries Regulation and conform to the functional and technical specifications required by the Registries Regulation 25. Member States may establish their national registries in a consolidated manner together with other Member States or the Community provided that each registry remains distinct. 1. Transactions The EU Allowances for the 1 st allocation period are created when the registry administrators issue them into the Party holding accounts, i.e., accounts held by the Member States 26. At that moment, each of the EU Allowances is assigned a unique unit identification code by the registry administrator. The EU Allowances for the 2 nd and subsequent allocation periods are created when the registry administrator converts Assigned Amount Units (AAU) held in the Party holding account into EU Allowances 27. The registry administrator issues the EU Allowances within the meaning of the ET Directive to the operators by transferring them from the party holding account to the operator holding accounts 28. The operators can perform transactions of EU Allowances to any other operator holding account or to any person holding account in any registry by requesting the registry administrator to transfer the EU Allowances. Person holding accounts are accounts held by persons who are not operators of installations covered by the EU ETS 29. Operators can surrender EU Allowances for installations by requesting the registry administrator to transfer them to the Party holding account of the relevant Member State and enter the number of transferred allowances into the section of the respective surrendered allowance table 30. The registry administrators will cancel the EU Allowances for the 1 st allocation period by transferring them from the party holding account to the retirement account 31. They will cancel the EU Allowances for the 2 nd and subsequent allocation periods by converting them into AAUs and transferring a number of Kyoto units of the type specified by the competent authority from the Party holding account to the retirement account of the relevant period Account holder/registry administrator relationship Each Member State designates a registry administrator who operates and maintains the national registry 33. The registry administrator may require operators and applicants for person holding accounts to agree to comply with reasonable terms and conditions addressing the issues set out in Annex V 34. Any fees charged by the registry administrator to account holders shall be reasonable. Registry managers shall not charge account holders for transactions of EU Allowances 35. All information held in the national registries, including the holdings of all accounts and all transactions made, shall be considered confidential. Information held in the registries may not be used without prior consent of the relevant account holder except to operate and maintain the registries in accordance with the provisions of the Registries Regulation. The registry administrator shall only per- 24 See footnote 3 above. In the following we refer to the final draft agreed upon by Climate Change Committee on 24 June Art. 3 of the Registries Regulation. 26 Art. 39 of the Registries Regulation. 27 Art. 45 of the Registries Regulation. 28 Art. 40 and 45 of the Registries Regulation. 29 Art. 49 of the Registries Regulation. 30 Art. 52 of the Registries Regulation. 31 Art. 58 of the Registries Regulation. 32 Art. 59 of the Registries Regulation. 33 Art. 8 of the Registries Regulation. 34 Art. 15 and 19 of the Registries Regulation. 35 Art. 74 in connection with Art. 49 of the Registries Regulation.

7 JEEPL EU Emissions Trading Scheme 9 form processes where necessary to carry out their function 36. Registry administrators are required to make certain information listed in Annex XVI Registries Regulation publicly available. This information includes the amount of EU Allowances issued to the installations within the meaning of the ET Directive and the amount of verified emissions of each installation. Registry administrators shall not release additional information held in the registries 37. V. Outlook Against the background of 16 submitted NAPs of Member States it appears now all but certain that the operation of the EU ETS will in fact start on 1 January 2005 in the majority of the 36 Art. 10 of the Registries Regulation. 37 Art. 9 of the Registries Regulation. Member States, including the Member States with the highest absolut emissions. However, given that the Registries Regulation has been adopted by the Climate Change Committee only recently (24 June 2004) and Member States and the Commission are still in the process of developing the software for the registries, a major uncertainty is whether the registries system will be operational in time. Due to the relatively generous NAPs of most of the Member States, there will probably not be a large scarcity of 1st period EU Allowances. This may well result in low prices for 1st period EU Allowances. As a consequence, the EU ETS may not have an overly large impact on operators and their business decisions in the years Nevertheless, a European wide emissions trading system will be put in place, and it will ensure that Member States and their operators will be prepared when it comes to actually reducing CO2 emissions to a larger extent in the Kyoto commitment period and beyond.