The European Union Emissions Trading System (EU ETS) : A Short Introduction

02.02.2018

The EU ETS: A Short Introduction

The European Union Emissions Trading System (EU-ETS) has become a landmark environmental policy representing the world’s first and largest greenhouse gas (GHG) trading program. It covers around 12,000 installations over the span of 25 member countries and six industrial sectors.

It must be noted that the EU-ETS is in itself an opportunity to gain critical insights into the workings and achievements of such market-based environmental programs. In other words it is self-learning and self-regulating. Important lessons are derived from actual experiences with emissions trading and include the real cost of emission reduction, the implications of sector competitiveness, and the development of new technologies.

Over the past two decades emission trading has emerged as a relatively successful environmental policy tool, the advantage being for firms to flexibly choose how to meet their targets, rather than using predetermined standards such as command-and-control policies. As a working idea, emission sources with low-cost reduction opportunities may over-comply their reduction targets and thus sell their additional allowances to sources where reductions would be more difficult, or costly. This leads to the lowest overall cost and the most economically viable solution.

Emission trading is particularly relevant to efforts made towards the mitigation of climate change given that both carbon dioxide and other greenhouse gases have the same effect whether or not they are emitted, and compliance costs will greatly differ depending on the source. There is thus a significant scope of trading and real opportunity for considerable gains. Past data from the United States and other countries have shown that a well-designed and well-implemented emission trading program can reduce environmental policy costs by 50%.  

In order to reach cost-effective environmental goals, a certain range of implementation issues had to be resolved, and in particular, the drafting of a new regulatory system to supervise the ETS. This specific process continues to generate debate on the long-term and short-term economic and political consequences.

The history of the EU ETS begins in 1992 with 180 countries signing the United Nations Framework Convention on Climate Change (UNFCCC) that featured goals meant to ‘stabilize atmospheric GHG concentration back to safe levels.’ Past the preliminary negotiations that fell under this agreement, the Kyoto Protocol was signed in 1997 committing certain industrialized nations to an average decrease of 5.2% in GHG emissions, compared to 1990 levels, by the first commitment period being 2008-2012 (or more commonly referred to as Phase II.)

With ratification from the European nations, Canada, Japan, New Zealand, and soon thereafter Russia, the Kyoto Protocol officially went into effect on Feb 16, 2005 and signified the beginning of Phase I which would last from 2005 to 2007. Under the Kyoto Protocol the existing 15 European Union nations agreed to meet a collective reduction of 8% in GHG emissions, which was later referred to as the EU-15 ‘bubble’.

By the year 2000, many of the European countries showed difficulty in reducing emissions; at the exception of the United Kingdom and a very effective structural switch from coal to natural gas, and Germany with the modernization of the post-communist Eastern region. The EU ETS was then enacted as a policy measure meant to help the European Union reach the Kyoto targets. Although significant progress could be measured in reducing GHG emissions, the overall result was still biased by the fortuitous reductions coming from Germany and the United Kingdom, and levels in other EU nations had increased.

With the ascension of ten new member countries in May 2004 from Central and Eastern Europe, and whose aggregated emissions were already considerably lower than their own Kyoto targets due to regional economic restructuring, the taking shape of the EU ETS then included 25 member countries. The inclusion of new countries in the system strengthened the importance of emission trading given that it increased the diversity of emission reduction options, and with it, the gains of trading.

It should be noted, however, that the EU ETS symbolizes only one in a panel of policy measures designed for emission reduction. Specifically, only the electricity and several other industrial sectors are covered under the ETS. Moreover, as the European Union economy continues to expand so will the upward pressure on GHG emissions; and as the economy grows in individual countries, their available emission allowances will reduce, and this realization portrays a major incentive for the implementation of the EU ETS as a cost-effective policy.

This white paper was compiled by SAGA Commodities.              
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