EU achievement with carbon trading

January 2008 marked the end of the first trading period for the European Union's emissions trading system (EU ETS). We take stock and think about what the system has achieved so far. It is also time to ponder on the influence it is having on the rest of the world. Says Stavros Dimas, European Commissioner

The European Union has always been at the forefront in the battle on climate change. In the summer of 2001, only months after the United States said it did not intend to ratify the Kyoto Protocol, European leaders agreed to go ahead and ratify anyway. All EU Member States did so in May 2002. EU leaders also expressed their commitment to fulfilling the Protocol's targets whether or not it entered into force. This did finally happen on February 16, 2005 after Russia ratified, thanks in large part to the leadership shown at the time by the European Union.

In March 2007, EU leaders reaffirmed their leadership when they confirmed the European Union's objective of reducing its emissions of greenhouse gases by 30 percent by 2020 as part of a post-2012 global reduction agreement. Were no such agreement to be reached, Europe's leaders pledged their commitment to unilaterally reduce emissions of greenhouse gases by 20 percent. On the same occasion they argued that one of the most important instruments the EU has at its disposal is its emissions trading system.

Having their own binding Kyoto targets, individual Member States could have chosen to devise their own policies for delivering on their commitments. But they found it preferable to work together rather than follow a purely national approach. In coming up with the most cost-effective way to meet EU targets it was believed that a common system for reducing the emissions of the EU's biggest greenhouse gas emitters would be through a market-based instrument where emissions could be traded. The idea of emissions trading was a novelty in the European Union because of its results-orientated approach. Unlike other instruments that would have imposed a particular type of technology or set stringent limits on how much could be emitted, emissions trading allows companies to decide for themselves how to meet their commitments.

The biggest emissions trading system in the world
The EU ETS is the world's first multi-country emissions trading system and its largest company-based system. Today it comprises some 10,500 energy-intensive industrial installations and power plants covering more than 45 percent of all CO2 emissions in the 27 EU Member States. In all but a few respects the EU ETS has turned into a success from the start, despite the fact that there was an over allocation of certificates during the first phase. The system began its operations as scheduled on January 1, 2005. Allowances were issued, the electronic registries that record these allowances went on-line, a large number of private companies entered the carbon market and emitters began to carefully monitor their emissions. Initially, the companies that became involved in carbon trading originated from sectors such as power generation familiar with commodity trading.

The trading of carbon emissions has increased from year to year. In 2005, its first year, more than 250 million allowances were traded for a value of about €5bn. In 2006 more than 800 million allowances were traded, and in 2007 this volume was reached after only seven months of trading.

The emissions trading system has served as the launch pad of the international carbon market, where it now represents some 80 percent of worldwide sales of CO2.

Serving as a role model for trading systems around the globe
It is in large part because emissions trading is working well in Europe that a carbon market can be envisaged as a solid building block for any future international climate agreement after 2012. But the European emissions trading system should also be made attractive so that non-EU countries want to link up to it. Such links would be beneficial for European industry as it would expand the range of abatement opportunities and reduce overall compliance costs.

To achieve significant cuts in worldwide emissions a global carbon market must be set up. We must build up a liquid and truly global carbon market with a single carbon price. The EU is encouraged by plans to set up cap-and-trade emissions trading schemes for CO2 in Australia, New Zealand, Switzerland, California and the north-eastern US states and by the interest shown in other US states and Canadian provinces. The creation in October 2007 of the International Carbon Action Partnership (ICAP), of which the EU European Commission and EU Member States are founder members, will help to link it to other compatible trading systems in the future. Through ICAP, public authorities that have cap-and-trade emissions trading schemes, or are committed to setting them up, will share experience and best practice.

Spurring clean development projects in emerging economies
Without officially being linked to other systems the EU ETS has already gone international. It allows those companies with installations in the system to use credits from Joint Implementation (JI) and the Clean Development Mechanism (CDM) under the Kyoto Protocol to fulfil their obligations up to certain limits. The EU ETS is the main driver of the CDM market. This market involves some 168 countries and transactions are valued at about €3.8 billion with European buyers having an 86% market share of the primary CDM and JI market. This demand originates mainly from the private sector with some demand from national governments.

Importing JI/CDM credits undoubtedly allows short-term economic benefits and lower carbon prices. But the unrestricted use of these credits to ensure compliance under the EU ETS is counterproductive. It delays the inevitable efforts needed to move the EU towards a low-carbon economy and prevents EU companies from taking advantage of market opportunities to develop low-carbon technologies. And it also jeopardises the European Union's ability to meet its long-term emissions reduction targets.

A balance is therefore needed between the short-term economic benefits of importing JI/CDM credits and the need to move towards a low-carbon economy in the medium term, a need which requires major technological advances spurred on by sustainable carbon prices.

The Commission has carried out an extensive review of the European Union's Emissions Trading System and will propose in 2008 new rules for the third trading period starting in 2013. These new rules reflect an in-depth analysis of how the system could be improved so as to increase its predictability and harmonise the allocation of allowances to avoid market distortions. I am confident that the lessons learned from past experience with carbon trading have led to a more robust European emissions trading system that will allow the European Union and the world to reduce greenhouse gas emissions in the most efficient way with as little cost to the economy and society as possible.