As promised, here is part two of the school paper I wrote on the European Union Emissions Trading System (EU ETS). It includes an overview of the EU's political framework and an introduction to how the system works.
In case you missed part one, here it is.
Institutional Framework of the European UnionIn case you missed part one, here it is.
Before expanding on the details of the EU ETS, let’s take a look at how the European Union is governed, how laws are generated and implemented, and some of the key stakeholders involved.
The decision making body of the European Union is the European Council. They make many of the final legislative and budget-related decisions. The Council consists of prime ministers, chancellors, and presidents from the twenty eight member nations. Larger nations get more votes than the smaller nations, similar to the electoral college in the United States.
In addition to the Council, there is a Council Secretariat. Besides providing content expertise, it serves as a decision-making facilitator. However, they assist more in the foreign policy realm and help to influence the policy agenda and the implementation of EU foreign policies.
Then there is the European Parliament. The Parliament is essentially a suggestion-maker. But do not let that term fool you. Their calls to the European Council for a tough stance on climate change and carbon emissions have been heeded.
The Parliament is made up of elected representatives from the twenty eight member nations, and representation is proportional, like the U.S. House of Representatives. They ask tough questions and are provided with detailed information about proposed laws, called “directives." The Parliament may have little power over legislation or budget matters, but as I stated earlier, they have plenty of influence.
The European Commission is the primary administrative enforcer of directives in the European Union. The Commission also proposes directives, which go before the European Council for approval. When the Council approves a directive, each member nation is responsible for developing its own legislation, or action plan, to enforce the directive. It is a decentralized system of enforcement, with individual nations maintaining their judicial and procedural autonomy. This makes the member nations and their leaders important stakeholders in the development and enforcement of the EU ETS.
With Regards to Energy and the Environment
Furthermore, the Commission is divided into thirteen Directorates General. The Directorates General of concern here are the Directorate General for the Environment and the Directorate General for Energy and Transport. Their purpose is to assist the member nations with implementing their own energy and environmental laws to comply with those approved by the Council.
Since member nations are responsible for crafting their own legislation to meet the environmental standards of the European Union, they have the option of exceeding the requirements set by the Council by enforcing tougher laws. Unfortunately, under the EU ETS, there is very little incentive to do so.
On the plus side, the European Union is a strong advocate for Best Management Practices (BMPs) for reducing pollution. New polluters are required to have the latest and greatest pollution control technologies and utilize BMPs during operations. There is also accountability, with European Union directives that hold polluters (who beyond any doubt polluted illegally) liable for the cleanup costs of illegal pollution.
The European Union also uses taxes to encourage conservation and efficiency. By heavily taxing pollutant emissions, the EU is leading the way in reducing greenhouse gas emissions and mitigating climate change. This helps to make up for the exclusion of some polluting sectors (e.g. transportation) from EU ETS requirements. More on that later...
The System
After ratifying the Kyoto Protocol in 2002, the European Union committed to reducing greenhouse gas emissions to 8% below 1990 levels by 2012 and to at least 20% below 1990 levels by 2020. To achieve this goal, European leaders launched the European Union Emission Trading System (EU ETS) in January 2005. It is a system of tradable allowances and is designed to reduce greenhouse gas emissions in an economically friendly manner.
The directive divides the EU ETS into three phases. Phase I was a relatively unsuccessful three-year pilot phase from 2005 to 2007. Phase II was from 2008 to 2012 and corresponded with the Kyoto Protocol’s reporting period. Phase III began in 2013 and is ongoing. Allowances handed out for each phase can only be used or traded within that phase. As a result of over-allocation during the first phase, pollution allowances were restricted during the second phase. During the third phase, the majority of permits will be auctioned rather than allocated freely.
From the EU Climate Action Website:
The 2013 cap for emissions from power stations and other fixed installations in the 28 EU Member States and the three EEA-EFTA states was set at 2,084,301,856 allowances. During phase 3 of the EU ETS (2013-2020), this cap decreases each year by 1.74% of the average total quantity of allowances issued annually in 2008-2012. In absolute terms this means the number of general allowances will be reduced annually by 38,264,246. Thanks to the decreasing cap, in 2020 emissions from fixed installations will be 21% lower than in 2005.
The ETS directive says that member nations must develop a National Allocation Plan (NAP) for each phase. The NAP includes the total number of allowances that the member nation intends to hand out for that period and how it plans to allocate them. NAPs are a good indicator of the extent to which member nations rely on the ETS to achieve their target. Member nations must submit their action plan, including the total number of allowances they plan to hand out, to the European Commission. It is then accepted as is, modified, or rejected according to criteria in Annex III of the directive.
This gives member nations a high degree of freedom in determining the amount of allowances to allocate to national ETS installations (the same way the U.S. EPA gives states a great deal of freedom in how they will achieve certain environmental restrictions or targets). Total reduction targets for the continent were established by adding each member nation’s commitment to the Kyoto protocol. The sum of allowances that each member nation assigns to polluters within their country determines the overall EU ETS cap.
After figuring out the total amount of emissions allowed for the ETS sectors, which account for only about 45 percent of the EU’s total carbon dioxide emissions, they could then figure out the amount of emissions the ETS sectors are legally required to reduce. This, in turn, also determined the burden that each member state would share. The burden is then further divided by allocating emission rights between different polluters within the individual member states.
The fundamental objectives of the EU ETS are free allocation of permits, efficiency of emission abatement, and what is known as competitive neutrality. Competitive neutrality simply means that there should be a level playing field in mixed markets, which contain state-owned companies, private firms, and third party organizations.