[Senate Hearing 110-72]
[From the U.S. Government Publishing Office]
S. Hrg. 110-72
EU EMISSIONS
=======================================================================
ROUNDTABLE
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
TO
DISCUSS THE PROGRESS OF THE EUROPEAN UNION'S EMISSIONS TRADING SCHEME
AND TO RECEIVE INFORMATION ON LESSONS LEARNED FOR POLICYMAKERS WHO WANT
TO BETTER UNDERSTAND HOW A MARKET-BASED TRADING PROGRAM COULD OPERATE
EFFICIENTLY AND EFFECTIVELY IN THE UNITED STATES
__________
MARCH 26, 2007
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota LARRY E. CRAIG, Idaho
RON WYDEN, Oregon CRAIG THOMAS, Wyoming
TIM JOHNSON, South Dakota LISA MURKOWSKI, Alaska
MARY L. LANDRIEU, Louisiana RICHARD BURR, North Carolina
MARIA CANTWELL, Washington JIM DeMINT, South Carolina
KEN SALAZAR, Colorado BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Frank Macchiarola, Republican Staff Director
Judith K. Pensabene, Republican Chief Counsel
Jonathan Black, Professional Staff Member
Kathryn Clay, Republican Professional Staff Member
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 1
Caneill, Jean-Yves, Project Manager, Sustainable Development
Division, Electricite de France, Paris, France................. 12
Delbeke, Jos, Director, Climate Change and Air, Directorate-
General for Environment, European Union Commission, Brussels,
Belgium........................................................ 8
Domenici, Hon. Pete V., U.S. Senator from New Mexico............. 2
Edward, Garth, Trading Manager, Environmental Products, Shell
Oil, London, England........................................... 11
Ellerman, Denny, Senior Lecturer, Sloan School of Management,
Massachusetts Institute of Technology, Cambridge, MA........... 15
Kopp, Raymond, Senior Fellow and Director, Climate and Technology
Policy Program, Resources for the Future....................... 4
Salazar, Hon. Ken, U.S. Senator from Colorado.................... 3
Vanderborght, Bruno, Vice President, Climate Protection, Holcim
Cement, Zurich, Switzerland.................................... 14
Wold, Per-Otto, Founding Partner and CEO, Point Carbon, Oslo,
Norway......................................................... 10
APPENDIX
Responses to additional questions................................ 33
EU EMISSIONS
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MONDAY, MARCH 26, 2007
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 2:07 p.m., in
room SD-G50, Dirksen Senate Office Building, Hon. Jeff
Bingaman, chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW
MEXICO
The Chairman. All right, why don't we go ahead and get
started? Nearly a decade ago, over 100 countries negotiated the
Kyoto Protocol, an international treaty to address the
challenge of climate change. While the United States did not
ratify the treaty, many others did. Many have moved forward on
their commitments under that treaty. The program put in place
by the European Union to establish a market-based cap-and-trade
program is one of the most significant endeavors being
undertaken on climate change today. The EU's emission trading
scheme began in early 2005 and its second phase will begin this
next year.
A few weeks ago, EU Environmental Ministers expressed
support for an ambitious post-Kyoto reduction target of a 20
percent--I believe that's below 1990 levels, as I recall
reading those reports--below 1990 level reduction in greenhouse
gas emissions by 2020. The EU is to be commended for its
ambition and leadership on the issue, but we've not had
sufficient clarity here in the United States about what is
truly being done in the European Union. There is a lot of
confusion and even misinformation about the EU's program, and I
hope that we'll be able to address some of those important
issues here today and gain a better understanding of that
program.
The lessons learned by the EU are extremely valuable for
policymakers in this country at this time. There are a number
of cap-and-trade proposals in Congress right now, including one
that Senator Specter and I are working on. It's important that
we learn from the EU about their experiences with the cap-and-
trade program and as a result, try to create an effective
program here that builds on what has been learned in Europe.
To that end, we welcome the six experts on the EU Emissions
Trading System that are here today. Let me just briefly
introduce the names of these individuals, and then I'll call on
Senator Domenici for his comments. But first, let me just
indicate who is here.
Jos Delbeke is Director for Climate Change and Air of the
European Commission's Directorate-General for Environment. In
this capacity, he oversees the implementation of the European
Union's Emission Trading Scheme and other clean air programs.
Mr. Per-Otto Wold is a founding partner of Point Carbon,
which is a world-leading provider of independent news analysis
and consulting services for European and global power, gas, and
carbon markets.
Mr. Garth Edward is Shell's Trading Manager for
environmental markets. Mr. Jean-Yves Caneill is a Project
Manager at Electricite de France and Dr. Bruno Vanderborght is
the Vice President of Environmental Strategy for Holcim, a
leading global cement group that is based in Switzerland. Dr.
Denny Ellerman is Senior Lecturer with the Sloan School of
Management at MIT.
Today's roundtable will be much less formal than a hearing.
After a brief background presentation on this EU Emissions
Trading System by a scholar from the Resources for the Future,
Raymond Kopp, panelists will be given about 5 minutes each to
summarize their thoughts and make the main points that they
think we need to be aware of, and what was done right and what
was done wrong in the EU system to date.
Following the opening remarks, senators will have the
opportunity to ask questions and make comments. We will not
have any time limits on those questions or the give-and-take.
The hope is that senators who seek recognition, ask their
questions, and then we will take the discussion wherever it
leads from there on.
But I thank you all for being here and let me now defer to
Senator Domenici for any opening comment that he has.
STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM NEW
MEXICO
Senator Domenici. Hello, everyone. It's good to be with
you. I met with some of the people from the Union that are not
on the panel, Senator Bingaman, but are experts in their own
rights, and I had a little extra time in my office this
morning, so I had to chance to visit with them. That was very
good for me and I appreciate them. They are here and I thank
them for their time.
I do want to say that I'm not prepared to give an opening
set of remarks because I was of the opinion that we were not
going to. That doesn't mean that I am offended. Your opening
statements never offend me, whatever it is that you choose to
say.
On the other hand, I think that you should not be misled.
The implication, if any, that American legislators look at
Europe and think that you are doing quite well--if that's what
the good Senator, my colleague from New Mexico said--I think
that's a little of an overstatement. I don't think that there
is a majority, or anything like a majority, of legislators that
think the European community is doing really well or that we
can model something off of them that might work in America.
There are a few things we could learn. The most important
thing is that you are off and running; you're trying something.
I guess Americans would have to admit that. Beyond that, then,
we'd go to work on what? That's probably why this was a good
meeting today because you might think it is decided that
Senator Domenici is deciding not to participate; not at all.
But I don't think that I want to spend a lot of time when you
are here. I think it is most important that you spend a lot of
time and tell us why you're here and what you think, even to
the extent that you tell us what you think we are doing or not
doing that we ought to do and why. I think that would be good
for any of you who are here. Don't think you can't tell us
quite openly today that you think we are--whatever nice words
you use. I love to hear you talk so I hope you will. I love
your use of the language. I wish we talked like you.
But in any event, if you could tell us what we ought to be
doing that is better, that would sure be helpful. What you are
doing that's wrong, if you have some opening observations in
that regard, would be very helpful also.
Now, that's about enough for now and thank you, Senator
Bingaman and again, thanks to all of you and let's have a good
afternoon.
The Chairman. Thank you very much. Senator Salazar wanted
to just make a short statement. Let me call on him at this
point.
STATEMENT OF HON. KEN SALAZAR, U.S. SENATOR
FROM COLORADO
Senator Salazar. Thank you very much, Senator Bingaman. Let
me just say that I think this committee, over the last 2 years
in the 109th Congress, did a lot of great work, in part because
we almost unanimously passed the Energy Policy Act of 2005. We
have a lot of work that we continue to do this year on new
technologies, on renewable energy and a whole host of other
things that obviously impact climate change and global warming.
I'm one of those members of this committee that is looking
for some guidance in terms of what it is that we ought to do,
with respect to the issue of global warming. We have,
obviously, the Kyoto Protocols that have been out there that
many countries signed up for. We have other legislation that
has been proposed, including the McCain-Lieberman legislation
from several years ago. We have Senator Bingaman, and I think
Senator Specter and others, who are working on another package.
The House of Representatives, I think, is poised to pass some
kind of a global warming cap-and-trade system, perhaps by
August. At the end of the day, the one thing that I know fully
really are two things.
The first is that I believe that the scientific community
has said, loud and clear, is that global warming is a major
issue that does, in fact, threaten civilization, and we need to
do something about it. I agree with that conclusion. Second of
all, that there are a number of different approaches out there
on how we should approach this issue of global warming. I think
for us, in this committee and in this Senate, it is very
important to learn from the European Union, since you have
already embarked upon a program that is trying to deal with the
issue. So I'm very much looking forward to the discussion this
afternoon, to learn what has worked, what hasn't worked, and
what kind of guidance you might give us as we struggle with
this very, very difficult issue. Thank you, Senator Bingaman.
The Chairman. Thank you. We have six distinguished
witnesses here. Let me just call on each of you to, as I
indicated before, take about 5 minutes to give us your views,
the main points that you think we need to be aware of before we
get into questions.
Before we do that, I'm going to have Dr. Kopp, who is the
Senior Fellow and Director of the Climate and Technology Policy
Program for Resources for the Future, give us sort of an
overview of the European Emissions Trading System. Let me just
mention also, and I guess this is by way of introduction, Dr.
Delbeke. I'm informed that yesterday was the 50th anniversary
of the Treaty of Rome and that was the Treaty that made--that
was responsible for forming the European economic community and
what was the foundation for today's European Union. So
congratulations for 50 years of success with that effort.
Dr. Kopp, why don't you go right ahead?
STATEMENT OF RAYMOND KOPP, SENIOR FELLOW AND DIRECTOR, CLIMATE
AND TECHNOLOGY POLICY PROGRAM, RESOURCES FOR THE FUTURE
Mr. Kopp. Thank you, Senator Bingaman and members of the
committee.
Thank you very much for this opportunity to speak. Let me
say, Resources for the Future is a nonpartisan, non-advocacy
research institution in Washington, DC and any opinions I
express today, please don't hold against my colleagues or the
institution. It does not take positions.
The purpose of my remarks is to provide a brief
introduction to the European Union Emissions Trading Scheme,
which goes under the acronym, EU ETS, which I'm sure you will
hear more and more about.
I also want to discuss some lessons that one might draw
from the EU experience. The EU ETS is an emissions allowance
cap-and-trade system, similar in many respects to the current
system used to control sulfur dioxide and the provisions of the
Clean Air Act.
All cap-and-trade systems establish a cap on annual
emissions, identify those entities whose emissions will be
regulated, and set a few rules. In most contexts, one allowance
is required for each ton of emissions and allowances are
usually freely transferable. Allowances can be initially
distributed in the market through free allocation based on some
metric or another, or sold through an auction. The key question
each system must address is whether allowances that are not
used in the current year may be banked for subsequent years.
So let's turn to the structure of the EU ETS. It began
operation in January 2005 and includes 27 countries of the
European Union. The program is run in two phases. Phase I from
2005 to 2007 was intended to be a trial period to work the bugs
out of the system. However, in all respects, it is a mandatory
and binding cap-and-trade system. Phase II from 2008 to 2012
coincides with the Kyoto commitment period.
Specifications regarding future phases have yet to be
established, but the program is intended to run indefinitely.
The cap covers only carbon dioxide--that's CO2,
although other greenhouse gases may be added in the future. The
EU ETS is not an economy-wide cap-and-trade system; rather it
regulates downstream approximately 12,000 emissions sources,
accounting for half of EU emissions. Covered sources include
iron and steel, cement, glass, ceramics, pulp and paper,
electric power and refineries. Transport is not included in the
system, although the EU will include air transport in 2011.
Each country submitted for approval plans for the
allocation of allowances for Phase I. The European Commission
is in the process of finalizing allocation plans for Phase II,
which by the way, is 2008 to 2012. Allocation plans describe
three decisions each country must make. First, how much of a
country's Kyoto target is assigned to the sectors participating
in the trading scheme and by implication, the remainder of the
target must be met by sectors outside the scheme--for example,
transportation.
Second, how much of the cap will be assigned to each
sector, determining how much of the burden and cost individual
sectors will have to bear, and finally, third, how the sector
allocation is further divided among individual companies.
Phase I rules allowed countries to auction an upper limit
of 5 percent of the allowances. Only Denmark chose to put up
for sale 5 percent; the remainder being allocated gratis. More
auctioning is likely to occur in Phase II, where the upper
limit on auctioning has been expanded to 10 percent.
Emission sources covered by the EU ETS may satisfy their
commitments by surrendering allowances in an amount equal to
their emissions, or may supplement their EU ETS allowances with
credits available under the Kyoto Protocol Rules, including
joint implementation and clean development mechanism credits.
As a result, the price and availability of these Kyoto credits
will have a bearing on the price of EU allowances.
Let me turn now to the market itself. Early in Phase I,
allowance trades were handled by brokers outside of formal
exchanges. Currently, about half the trading volume occurs on
exchanges and the other half over the counter. In 2005, about
$8 billion of trades took place. At the end of 2006, this had
grown to about $27 billion. Trades in the worldwide carbon
market for 2006 are perhaps on the order of about $30 billion.
So the EU ETS has the lion's share of those trades.
The current spot price for a Phase I allowance is currently
=1, about $1.30, and this is for Phase I. But the price for
Phase II allowances, as reflected in the Futures market, is
today =16.35, or about $21.75 per ton of carbon dioxide.
There are several lessons one can draw from the EU ETS.
These lessons can be placed in context by considering three
features of the cap-and-trade system that are important when
evaluating policy effectiveness.
First, cap-and-trade systems establish a new class of
asset--the emissions allowance--and these assets have immediate
value once the system is established. Therefore, allocation of
allowances is an allocation of wealth. Second, cap-and-trade
emission reduction policies impose a cost on society, and once
the initial allocation of allowances is made, the distribution
of the cost will be determined by the market, not by government
policy. Third, the spot price is a visible signal regarding the
current cost of greenhouse gas reductions, while the future
price reflects expectations regarding future cost, and takes
into account expectations regarding government policy decisions
and the future cost of abatement, which is, as we know, closely
linked to the availability of new technology.
So turning to the lessons, the performance of a cap-and-
trade market hinges on accurate monitoring, reporting and
enforcement. At the outset of the ETS in Phase I, many nations
lacked reliable data reporting systems, which in part,
contributed to some extraordinary price volatility. The lesson
we draw from this is quite simple: inclusion of sectors and
sources should be preconditioned by the development of strong
monitoring and accounting systems.
Second, the ability of governments to distribute the
economic burden a cap-and-trade system will impose on the
economy is greatest during the allocation stage, and
importantly, the manner in which permits are allocated can
alter economic incentives, leading to a variety of unintended
consequences. The lesson here is rather obvious. Think very
carefully about the allocation and keep the allocation rules as
simple and as transparent as possible.
Third, allowances are assets that have significant value.
Allowances that have fixed lives, like those in Phase I, must
have asset values that go to zero at their terminal points.
This raises difficult asset management issues for those
required to hold allowances, and once again, here the lesson is
rather obvious: develop effective banking rules, or at least
short-term overlapping rules, from one phase to the next, that
in some sense limits this price volatility at the close of
these periods.
Fourth, near-term investments in technology needed to
radically lower greenhouse gas emissions are likely confined to
the energy sector, where these investments tend to be large and
very long-lived. Allowance prices are intended to incentivize
these investments and must have as little political uncertainty
as possible. At the current time in the European Union, there
is considerable uncertainty concerning the level of emission
reductions the EU governments will actually require post-2012.
The lesson again, fairly obvious: governments need to be as
clear as possible about emission reduction targets. The
commitment periods need to be as long as possible and certainly
longer than the Kyoto periods. Allowance banking is an absolute
requirement.
Mr. Chairman, thank you for this opportunity to speak.
[The prepared statement of Dr. Kopp follows:]
Prepared Statement of Raymond Kopp, Senior Fellow and Director, Climate
and Technology Policy Program, Resources for the Future
the european union emissions trading scheme (eu-ets): a brief overview
by Dallas Burtraw and Raymond Kopp
CAP AND TRADE--A QUICK TUTORIAL
EU ETS is an emission allowance cap-and-trade system. All such
systems establish a cap on annual emissions (or if banking is allowed,
on the annual allocation of emission allowances), identify those
entities whose emissions will be regulated, and set a few rules. In
most contexts, one allowance is required for each ton of emission.
Allowances are usually freely transferable, although in some programs
constraints on trading have been imposed. Allowances can be initially
distributed in the market through free allocation based on some metric
or another, or sold through an auction. A key question is whether
allowances that are not used in the year they are issued can be banked
for use in a subsequent year.
EU ETS STRUCTURE
The EU ETS began in January 2005 and includes the 27
countries of the European Union.
The program is run in two phases. Phase 1 from 2005-2007 was
intended to be a trial period to work the bugs out of the
system; however, in all respects, it is a real cap-and-trade
system. Phase 2 (2008-2012) coincides with the Kyoto commitment
period.
The cap covers only carbon dioxide (CO2),
although other greenhouse gases (GHGs) may be added in the
future. (CO2 accounts for 80% of all GHGs.)
About 12,000 CO2 emissions sources are covered by
the cap, accounting for some 40% of all EU CO2
emissions. Covered emissions sources include iron and steel;
cement, glass, and ceramics; pulp and paper; and energy
(electric power generation and refineries).
Transport is not currently included in the system, although
the EU will include air transport in the EU ETS in 2011.
Each country submitted a National Allocation Plan (NAP) for
approval for Phase 1. The European Commission is in the process
of finalizing NAPs for Phase 2. NAPs describe three decisions
each country must make.
--How much of a country's Kyoto target is assigned to the sectors
participating in the trading system (by implication, the
remainder of the target must be met by sectors outside the
system--for example, transport). The EU offers strong
guidelines and regulatory oversight to require that at
least the major sources such as those listed above be
included in the program.
--How much of the cap will be assigned to each sector--determining
how much of the burden and cost sectors will have to bear.
--How the sector allocation is then further subdivided among
individual companies.
EU ETS rules allow countries to auction an upper bound of 5%
of the allowances, only Denmark chose to auction the full 5%,
the remainder being allocated gratis. More auctioning is likely
to occur in Phase 2.
Emissions sources covered by the EU ETS may satisfy their
commitments by surrendering allowances in an amount equal to
their emissions or may supplement the EU-ETS allowances with JI
(Joint Implementation) and CDM (Clean Development Mechanism)
credits (which are generated by undertaking CO2
reduction projects outside the European Union in accordance
with Kyoto Protocol rules.)
As a result, the price and availability of CDM credits will
have bearing on the price of EU allowances.
eu ets market performance
Early in Phase 1, allowance trades were handled by brokers
outside of formal exchanges. Currently about half the trading
volume occurs on exchanges and the other percent over the
counter.
In 2005 about 8 billion dollars of trades took place in the
EU ETS. By the end of 2006, this is thought to have grown to
25-27 billion. Trades in the worldwide carbon market for 2006
may be on the order of 30 billion dollars--with the lion's
share owing to the EU ETS.
Prices March 20, 2007:
--The current spot price is =1.00, $1.33.
--The December 08 Future price (Phase 2) is =15.60, $20.75.
LESSONS LEARNED
There are three features of a cap-and-trade system that are
important when evaluating its policy effectiveness.
1. Cap-and-trade systems establish a new class of asset--the
emissions allowance--and these assets will have immediate value
once the system is established; therefore, initial allocation
of allowances is an allocation of wealth.
2. Cap-and-trade emissions-reduction policies impose a cost
on society, and once the initial allocation is made, the
distribution of that cost will be determined by the market, not
government policy.
3. The allowance prices are visible signals regarding the
current cost of CO2 reductions (the spot price) and
expectations regarding the future cost (futures prices). These
expectations take into account expectations regarding the
policy decisions determining the required reductions and the
future cost of abatement--closely linked to abatement
technology.
The performance of the market hinges on accurate monitoring,
reporting and enforcement. At the outset of the ETS in Phase 1, many
nations lacked reliable data reporting systems, which contributed to
the extraordinary price volatility.
Lesson.--Inclusion of sectors and sources should be
preconditioned by the development of strong monitoring and
accounting systems.
The ability of government to distribute the economic burden a cap-
and-trade system will impose on the economy is greatest during the
allowance allocation stage.
Lesson.--Think twice, allocate once.
Allowances are assets that can have significant value. Allowances
that have fixed lives, like Phase 1 of the EU ETS, must have asset
values that go to zero at their terminal points. This raises difficult
issues of asset management for those required to hold allowances.
Lesson.--Develop banking rules, or least short-term
overlapping rules.
Investments in technology needed to radically lower GHG emissions
are likely confined to the energy sector, where they tend to be large
and very long lived. In that case, allowance prices are intended to
incentivize these investments and must have as little non-market
uncertainty as possible. At the current time in the European Union,
there is considerable uncertainty concerning the level of emissions
reductions required post 2012.
Lesson.--Governments need to be as clear as possible about
emissions-reduction targets, the ``commitment'' periods need to
be as long as feasible--certainly longer than Kyoto periods,
and banking is required.
The Chairman. Thank you very much. I think that gives us
some sort of parameters and general outline of what it is we're
talking about and I think that's very useful. Dr. Jos Delbeke,
I introduced earlier as the EU Commission Director for Climate
Change and Air and the European Commission's Director General
for Environment. Jos, thank you for being here, and go right
ahead.
STATEMENT OF JOS DELBEKE, DIRECTOR, CLIMATE CHANGE AND AIR,
DIRECTORATE-GENERAL FOR ENVIRONMENT, EUROPEAN UNION COMMISSION,
BRUSSELS, BELGIUM
Mr. Delbeke. Thank you very much, Senator. I would like to
highlight three points in my introduction. The first is that
the EU ETS is the pillar of the EU's policy to reduce
greenhouse gas emissions. It is the pillar to live up to our
commitments of the Kyoto Protocol, and that is -8 percent for
the EU as a whole. We differentiate internally that percentage.
Now, the EU ETS covers all major industrial emitters. That
ETS system has created an active market for carbon allowances
through which one price is being defined for all 27 member
states.
The market volume of those allowances in 2006 was
approximately $24 billion for the 27 member states of the EU.
That unique price across Europe has indeed attracted the
attention of CEOs and Board of Directors in our companies, and
those companies now look seriously and pragmatically at
emissions reductions. There are good indications that the low-
hanging fruit, as we call it, the lowest cost emission
reductions, are being reaped. In short, my first point would be
that the EU ETS is working because it is cost-effective and it
is environmentally effective.
My second point would be that the EU ETS started in 2005
and we have now a rather young history of only 27 months.
That's not very long, but what we learned in that period--and
we called that first period a learning-by-doing period--is that
today we have the basic infrastructure in place that we need to
live up to our Kyoto Protocol commitments. That is, in time for
the start of that first period under the Kyoto Protocol, which
is the first of January, 2008. So what we learned was in what
we commonly call the ``pre-Kyoto'' period.
That infrastructure that we have in place now is first a
coherent and verified database of the emissions of all
industrial installations covered. We had to start without such
a verified and coherent database, and this resulted in a
relative over-allocation. In fact, only 2 percent was over-
allocated, but that over-allocation nevertheless was there and
led to a rather sharp fall in prices as we have it today.
That problem is now addressed because those days, and even
today, the European Commission took positions on the so-called
National Allocation Plans for the member states. We see that
the forward prices have picked up and today, the forward price
that was indicated is around $20, $23.
We have a coherent, verified database. We have also an
electronic registry in place, which is the backbone of a
trading market. We have a coherent system of monitoring,
reporting and verification. Member states and the commission
have learned a lot about how to handle market sensitive
information, such as the data release and the data of real
emissions as they are verified.
We have learned how to do this because emissions trading is
very new to Europe's environment policy. We never did that and
we learned, in fact, all our experience came from the United
States and the sulfur trading scheme that has been successfully
put up.
My third point that I would like to make is: what kind of
message emerges from our experience? The strongest message that
we would see as the regulator in the European Commission is
keep the system simple. Because that gives a maximum of clarity
and a maximum of certainty to all those involved--in
particular, the private sector companies.
A simple system for us is a mandatory system that covers
all major emitters, and we are extending that scope gradually.
It is also a system that has absolute caps, because everybody
knows before the trading starts what the name of the game is.
We have not chosen for reasons of simplicity, for price
management, so we are not going to price caps. We are not going
into price floors. We leave the market to determine the price
and we go for much more harmonized allocation methodologies,
because the allocation before the period starts was very much
in the hands of the member states, and that led to too-wide
variation in the way that was being done.
Our conclusion was that it is absolutely essential to have
clear incentives to all private sector players, to leave it to
the companies to make or buy decisions, and to minimize every
interventionist inference to the absolute minimum. That
creates, in our view, strong incentives for the deployment of
new technologies in our companies. We also thought that keeping
the system simple would create the best guarantee for extending
the system internationally, either through offset mechanisms
like we have in the Kyoto Protocol, or also through linking
with other regional schemes.
Keeping the system as simple as possible and the
interference of the public authorities as minimal as possible
has been a very strong guidance in the setup of the EU ETS.
Thank you very much.
The Chairman. Thank you very much. I appreciate that
excellent testimony. Mr. Per-Otto Wold is the founding partner
and CEO of Point Carbon. Thank you very much, and thanks for
your help in getting this roundtable organized.
STATEMENT OF PER-OTTO WOLD, FOUNDING PARTNER AND CEO, POINT
CARBON, OSLO, NORWAY
Mr. Wold. Thank you, Chairman Bingaman, Senator Domenici
and members of the committee. Thank you for the opportunity to
appear before you here today. As requested by your invitation,
my statement focuses on Point Carbon's experience and analysis
of the EU ETS and other developments relating to the emerging
carbon markets. Overall, we would argue that the EU ETS is a
qualified success, although we clearly recognize the need for
improvements with regard to market design and other issues.
With regard to achievements and what has been done right,
we first acknowledge that the EU ETS has led to price discovery
and the PAN-European price on carbon has been established.
Organizations across Europe are now factoring in the cost of
carbon in their business decisions. According to a recent Point
Carbon survey, 65 percent of respondents covered under the EU
ETS have now initiated internal abatement measures as a direct
result of the EU ETS, and this is up 18 percent from last
year's survey.
The EU ETS has put a cost----
The Chairman. What percent did you say have now----
Mr. Wold. Sixty-five percent of the respondents.
The Chairman. All right.
Mr. Wold. The EU ETS has put a cost on emissions and a
value on reductions. Second, the expected demand from Phase II
of the EU ETS, lasting from 2008 to 2012, is widely seen as the
key driver for investments in projects aimed at reducing
emissions in 128 developing countries and countries with
economies in transition.
According to Point Carbon's estimates, investments in
projects under the Clean Development mechanism and joint
implementation will deliver real verified emission reductions
in the range of 2 billion metric tons of CO2
equivalent emissions by 2012, around 400 million metric tons
per year. This corresponds to approximately 6 percent of total
greenhouse gas emission in the United States in 2005.
Third, we argue that market efficiency is satisfactory and
comparable to what was seen in the USS 2002 trading program.
Almost as important, there are no perceived information
asymmetries between the participants. Point Carbon estimates
that more than 1 billion metric tons were traded in the EU ETS
alone in 2006, with a financial value of more than US$24
billion. The turnover was 50 percent, measured as the ratio of
traded volumes to the total quantity of allowances allocated.
It is comparable to what was seen in the second year of the USS
2002 program. We forecast that traded volumes will double again
in 2007.
As mentioned, experience has also highlighted a number of
areas where there is scope for improvement. First and
importantly, it is critical to get the baseline right. The
release of verified emission figures for the year 2005 showed
that emissions were around 5 percent below allocated
allowances. Although it is likely that some of this is due to
actual emission reductions, Point Carbon's analysis suggests
that governments in most countries allocated more than what was
needed for compliance. Still, it is important to recognize that
the EU ETS has produced a consistent set of verified emissions
data, which future allocations can be assessed against.
Second, unauthorized leaks of verified emission figures for
2005 in several countries created information asymmetries and
undue opportunities for some business market participants. This
has highlighted the need for strict rules and procedures for
handling of price-sensitive information along the lines that is
common in more mature financial markets.
This concludes my opening statement and I'd like to take
questions.
The Chairman. Thank you very much. Mr. Garth Edward, we're
glad to have you here again. Thank you.
STATEMENT OF GARTH EDWARD, TRADING MANAGER, ENVIRONMENTAL
PRODUCTS, SHELL OIL, LONDON, ENGLAND
Mr. Edward. Thank you, sir. Good afternoon, Senators and
thanks again for the opportunity to make this submission. I'll
be speaking from the perspective of a trading manager for
Shell, so not on the legislative side, but from the
practitioning side.
I'd like to emphasize that Shell believes the EU Trading
System has delivered important results in the first 2 years of
operation. I think there are three important results to
highlight.
First, I'm going to say that the legislative foundations
have been laid--clearly this is the case. More than 10,000
installations across 27 countries are now covered by formal
emissions trading laws, from Ireland to Estonia, from Greece to
Slovakia. That covers also cement, metals, refining companies.
They all now monitor, verify, and report their emissions. A
registry system is in place and every year, governments ensure
and enforce that these companies hold a volume of allowances at
least equal to their verified emissions--the first significant
step forward.
Second, we believe that the point of an emissions trading
system is to give companies the necessary information to allow
us to allocate capital in the most effective way to deliver the
required environmental results by implementing projects,
investments in clean technologies, and so on. This means that
we need a price to plug into operational decisions and project
plans and investment strategies. The EU Emissions Trading
system has clearly delivered this price information and it has
not been subject to any price controls.
The market is deep and liquid. Approximately $50 million
per day of allowances trade through several exchanges and
brokerage houses, and the forward curve extends out to 2012,
which is comparable with oil or gas or power markets. For
companies like Shell, this is the critical information that
helps us reduce emissions in the most effective way.
The third major step forward has been that the EU Emissions
Trading system has driven the development of international
market mechanisms. The Clean Development Mechanism and Joint
Implementation are what they are known under in the Kyoto
Protocol. Shell supports an international approach to emissions
trading and notes the strong success of these mechanisms in
implementing a wide range of environmental technologies, such
as wind, biomass, landfill gas capture, flare reduction, energy
efficiency and so on, in more than 120 developing countries.
These projects are expected to reduce on the order of 480
million tons of CO2 per annum and will flow
approximately $6.5 billion per year to less-developed
countries. We note that these international mechanisms finance
the transfer of new technology, and they also improve local
employment and local environmental standards in developing
countries.
But like any school report, there is always room for
improvement. For the first phase of allocations, 2005 to 2007
in the EU, annual emissions were capped at an average 2.09
billion tons of CO2. As verified data have been
published, we can see that this cap actually resulted in an
annual surplus of about 150 million allowances more than
emissions, as Mr. Delbeke has already alluded to.
Supply has therefore exceeded demand and consequently, the
market for Phase I allowances now trades around $1. It is clear
though that the next round of allocations for 2008 to 2012 are
being tightened based on this experience. The information is
there and the allocations and the policies are being adjusted.
Current projections are that cuts of about 335 million tons
of CO2 per annum against business-as-usual will be
necessary to steer EU member states on a course to meet their
Kyoto targets. The Commission is confident that this is the way
things will go.
In order for companies to deliver these results, the
European Commission, however, must focus on working with the
United Nations to overcome infrastructure delays and to ensure
that all registries are operational and connected to the
international markets. This is the way that we'll be able to
deploy capital in the most effective way to fund emission
reductions at the lowest possible cost. Thank you.
The Chairman. Thank you very much. Next is Dr. Jean-Yves
Caneill, who is with Electricite de France. We're glad to have
you here.
STATEMENT OF JEAN-YVES CANEILL, PROJECT MANAGER, SUSTAINABLE
DEVELOPMENT DIVISION, ELECTRICITE DE FRANCE, PARIS, FRANCE
Mr. Caneill. Thank you very much, Senator Bingaman and
Senator Domenici. I'm quite honored, and also my company, to
have been invited to testify before the U.S. Senate with the
objective to share with you our views on this instrument that
was implemented in Europe early in 2005, the EU ETS.
We've been quite involved in the early days on the
definition of that instrument as we contributed to organize the
so-called GETS experiments in 1999 and 2000, which is the
Reopen Electricity Association of the start of the first
discussion in Europe on the emission trading issue.
As a large electric utility group, we have faced different
issues in the past years and questions on the effect of ETS on
the power prices and its impact on large consumers, on the
relevance of ETS to do the work is intended for.
So I would like to stress shortly here some of the factors
I consider as key for price development of an emission trading
instrument in the future that can be taken forward by any new
system which might come on board, including the revision of the
EU ETS. This started to be discussed some weeks ago and in line
with my analogies of what is wrong and what is right that I've
provided before.
What I will be shortly developing is quite in line with one
of the lessons of the simulations we did in 2000. Investments
reduce emissions, not trading. Emission trading helped to find
the least-cost ways to do them. Therefore, as I will talk on
the electricity sector, the timeframe-related questions will be
very important.
So I'd like to make three points. The first one, a long
time framework has to be considered. Actors need to get
predictability in the rules in order to shape their investment
decisions in the right way, and looking in the electricity
sector, a period of 30 years probably is relevant. The
allocation process for allowances might be revisited along this
timeframe, which is long, but each allocation period will to be
at least something like 10 years.
Second, concerning the definition of targets, it is
necessary to state something. We have to get a system working
and safe for delivering environmental integrity, given the
economy reality check. If a cap-and-trade system is going to be
implemented, attention has to be paid to the available
technologies today and to the future technologies, which are
not existing yet.
So the targets have to be set appropriately to the sectors
with realistic trajectories for the constraint, taking into
account the capital stock turnover of the sector and the
investment cycles.
Last point--the devil is in the details, and what we have
learned from the first period calls for the following
requirements at least progressively, in the allocation process:
move as soon as possible to appropriate rules for new projects
or new installations. So the rules should be as soon as
possible, as soon as we can, no free allocation for these new
projects. This is the only one which is economically sound for
giving the incentive for investments in the right technologies,
taking into account the CO2 cost and the full cost
of technologies, or in our language of electricity, the long-
term marginal costs.
In the same time, installations, which could have been
given allowance for free at the beginning, with a
grandfathering approach, could continue to receive part of them
for free, but with a clear indication that they will have to
deliver reductions over time to incentives then for future
investments. So different methods could be proposed to address
these so-called compliance factors in an organized manner,
taking into account the age of the installations or use of
benchmarking approaches.
In summary, if we give long-term visibility in the
framework, realistic trajectories for the targets over time and
proper allocation processes are related to the inclusion of the
environmental--in the fuel costs, I think we can build the
basis of an appropriate framework for taking the right
decisions without putting too much stress to the economy.
Linking more systems together, taking into account the role of
offset projects, domestic as well as developing countries, and
bringing progressively more sectors and gas in the economy
could help to build a new international regime at the end of
the day. So I thank you very much for this opportunity to
speak.
The Chairman. Thank you very much. Let me--before you
start, Dr. Vanderborght, let me just see if some of the
members--I know Senator Salazar is going to have to go the
Senate floor, I'm informed. Does anybody else have a need to
run out, if they want to ask a question before we hear from our
final two witnesses?
If not, I guess Dr. Vanderborght, why don't you go ahead?
Then Dr. Ellerman, and then we'll open up the discussion.
STATEMENT OF BRUNO VANDERBORGHT, VICE PRESIDENT OF CLIMATE
PROTECTION, HOLCIM CEMENT, ZURICH, SWITZERLAND
Mr. Vanderborght. Thank you very much, Senators Bingaman
and Domenici. I will talk from the perspective of a large
global cement producer, CO2 and energy-intensive
producer with about 15 percent of our emissions in European
Union, 15 percent in the United States and 60 percent, the
fastest growing in developing countries. So for us, climate
change and trade issues at a global level is really the core of
our interests.
Going to what is--going well with the European Emissions
Trading System, we have to recognize that it is a remarkable
political and business achievement. In a very short time, all
the legislation, all the regulations are in place in European
Union and implemented by all 27 member states.
The monitoring, reporting, and verification of emissions
gives us a very sound information basis for building of future
reductions. Knowing what we do and knowing what we can do in
the future really is of critical importance with this
monitoring and reporting.
The CO2 emissions trading market functions in a
competitive environment. All the tools and methodologies work
well and we have a good price indication. This has, as a
result, that CO2 emission reductions and energy
saving is now very firmly on the radar screen of the CEO, the
Executive Committees and the Board of Directors of major energy
companies, and that is really the most important driver for
change--attention by the top management of the companies.
It also has an influence on our investment decisions in
Europe, in the United States, and in developing countries. Now,
we may not forget that this is not an emissions trading system.
It is an emissions allowance cap-and-trade system and for the
energy-intensive industry, the cap on our emissions, the
obligation to reduce our emissions is of absolute key
importance and is more important than the trading aspects of
the allowances.
Here we have some room for improvement of the European
system. The current allowance allocation is based on absolute
emissions from the past and that is extrapolated to the future,
meaning that the more you polluted in the past, the more you
have the right to pollute in the future. Early action is
punished. The absolute cap based on historic emissions and
lower allocation to new investments freezes market change and
does not provide a real incentive for innovation in new
investments. It is future investments which will reduce the
emissions.
Also, the time perspective that we have at this moment is
insufficiently long: 2012 is for a short time and even 2020 is
for a medium time.
All these counterproductive rules in setting the allowance
allocation has as a result that there is very intense lobbying
in different directions from different industry beliefs, all
trying to get as much as possible free allowances to start, and
this does not help the credibility and the efficiency of the
system.
So our most important recommendation for improvement of a
system which is already good, but our most important
recommendation is to simplify the allowance allocation. We need
a long-term, simple long-term target. Long-term means 2030,
2040. Based on CO2 efficiency performance, so
CO2 intensity of our products multiplied by real
production to have an absolute cap-and-trade system.
Having a long-term target, we need a predictable path from
current performance to the decreasing long-term target. That
will provide us sufficient incentives to improve our emissions
through investments in Europe, the United States, and
developing countries. Thank you for your attention.
The Chairman. Thank you very much. Our final witness here
is Dr. Denny Ellerman, who is with the Sloan School of
Management at MIT. We're very glad to have you here. Go right
ahead.
STATEMENT OF A. DENNY ELLERMAN, SENIOR LECTURER, MASSACHUSETTS
INSTITUTE OF TECHNOLOGY, CAMBRIDGE, MA
Mr. Ellerman. Thank you, Senator Bingaman, Senator Domenici
and fellow Senators of the committee for this opportunity to
testify before you.
I speak to you as a student of emission trading systems and
of the European trading system in particular. My prepared
remarks about what is right and wrong with the European trading
scheme are contained in the discussion packet that you have
received, and I thought what I do with my allotted time here is
to provide an outside perspective at my noting two
circumstances in the implementation of the EU ETS that
distinguishes it from what might occur in the United States.
These are: first, the very different Federal structure of
the European Union, and second, the great haste with which the
EU ETS was implemented.
Senator Domenici. Mr. Chairman, Mr. Chairman.
The Chairman. Yes, go ahead.
Senator Domenici. I wondered if I might just interrupt for
one moment and just make an observation for our English
visitors. I think since we are going to soon talk with you, our
British visitors, I think it might be well that you listen
attentively, because this witness may, in fact, be one that has
done more homework than we have, your American inquisitors,
because he has just indicated what he is and we are not that.
To the extent that we can tell you we have worked hard and
studied, we are not students of what has occurred in your
countries collectively. You are, maybe but he is for certain.
And that should be noted by you because that to us, is very
important. Thank you, Mr. Chairman.
Mr. Ellerman. These two circumstances are important because
much of what is criticized about the European Emission Trading
System results from these circumstances rather than from the
inherent characteristics of the cap-and-trade mechanism that
has been adopted in Europe and that is under consideration by
the U.S. Senate.
Let me expand briefly upon each of these circumstances. The
relationship between the member states of the European Union in
Brussels is very different from that between the States of the
American Union and Washington. The constituent elements of the
European Union are sovereign states that have ceded some
authority to Brussels, but they retain a degree of sovereignty
that Texas, California or New York, for example, could not
aspire to attain.
The result for the EU ETS is a highly decentralized form of
implementation and the consequent differences among the member
states, especially as it concerns allocation, have been
strongly criticized. But much of that criticism presumes a
political reality that while desirable, does not presently
exist. The stronger Federal structure of the United States
should allow Congress to avoid many of these problems, although
regional differences will, of course, still have to be
resolved.
The second circumstance, the haste with which the EUS was
implemented can best be appreciated by comparison with the U.S.
SO2 Emission Trading Program, which was, in its
time, also a first of its kind. The latter, the SO2
system, was proposed in April 1989. It was signed into law in
November 1990. In the intervening 18 months, Congress decided
all of the major features of the SO2 system,
including notably, the cap and the allocations. EPA then had 4
years to issue what were largely technical implementing
regulations and to establish the registries through which
trading would occur.
In Europe, the comparable authorizing legislation was
proposed in mid-2001 and approved by the member states at the
EU level 2 years later, in mid-1983. In the remaining 18 months
before the system was to begin operation, the member states
were to determine the caps, allocate allowances, issue the
implementing regulations and set up the registries. When the
system started on January 1, 2005, many of the caps and
allocations had been completed, but not all. Most of the
implementing regulations still had to be put in place and only
one registry was operating at the start. Now all of that has
been resolved, as you have heard, and these problems have been
worked out.
It's important to understand that the underlying reason for
this rushed and somewhat ragged implementation was the desire
to conduct a 3-year trial period to work out the problems prior
to the start of the trading period that really counted with
respect to the Kyoto Protocol. In effect, the EU adopted what
you could see as sort of a boot camp approach, that there is
going to be some unpleasant experiences, but the subjects will
be better off after they've been through it.
This was, in my judgment--I think this was a good judgment
on their part, given the circumstances, but I would stress that
it is a circumstance that I do not think applies to the United
States. Thank you for your attention.
The Chairman. Thank you very much. Let me just start with a
question, and then I'll call on Senator Domenici for any
questions he has, and then we'll open it up to any other
Senator.
Dr. Delbeke, I think you highlighted the fact that one of
the accomplishments is that you now have in place a coherent
and verified database on emissions, as I understood what you
said. To the extent that we are seriously considering putting
in place a cap-and-trade system in this country, I would assume
we would need something comparable. We would need good
information about where the emissions are, the extent of the
emissions in order to be able to set up an allocation system.
I'd be interested in any more you could say on the subject of
what's involved in putting that together, that kind of a
database and the length of time it took to accomplish it.
Mr. Delbeke. Thank you, Senator Bingaman. I think indeed,
it is absolutely necessary to have a good database. I think
that the experience we had over the last 2 years underlines
that. Now, there is a bit of choice in this. You can either go
ahead as we did and take a risk. Good hindsight; we didn't know
what precisely the risk was we were taking. We were rather
confident that the database we were working on based on the
best data around, et cetera, was a good one. But that is one of
the lessons that we learned, that the other way around would be
to start first in building up a coherent and solid database,
and then go into capping decisions and into the trading itself.
Now for Europe, and I guess as well for the United States,
the construction of these databases builds a lot on existing
regulations, I would assume. That means that major polluters
like power stations or cement kilns or petrochemical
installations are already subject to procedures on which a lot
of information is available. The only thing that was not
available in Europe was a knowledge about the precise emissions
of greenhouse gases. We knew a lot about NOX and
SOX and PM10 and all kinds of other
emissions and these charges, but not about greenhouse gas
emissions. So we started with best guesses, and now we know
much better, because what we did was not create an obligation
to the public authorities to create a database, but we took the
analogy of the financial markets. We asked companies themselves
to make a report about their emissions and to have every year
such a report made and verified by a third party.
We are in a very different political structure, as was
outlined by Professor Ellerman, and I think that explains as
well that we could not have gone as fast as we did if we would
have had to wait for the 27 member states and the
administrations, which are very different in quality and in
capability to have that solid and verified database made. So we
asked, as an analogy, to the financial markets, to ask the
companies to do it themselves, to ask for an independent
verifier to check the bills, so to speak, and there is what we
have every year now by April, May, every year, we will have a
verified database about the real emissions release on
greenhouse gases. Thank you.
The Chairman. Thank you very much.
Senator Domenici.
Senator Domenici. Thank you very much, Mr. Chairman. Let me
see if I can make sure we clarify a couple of things for the
record. If I'm wrong, please just tell me I'm wrong, but from
what I understand, the cap that you have is very loose. By
that, I mean the price of carbon is very cheap and you couldn't
have that as your permanent level and have a program, is that
correct? I see nodding of the heads but we're in a forum where
we need somebody saying yes. Let's do it this way. Since none
of you have said no, I assume you all said yes. That's fair
enough, that's the way we do it around here sometimes.
All right. Now having said that--oh, you wanted to comment?
Mr. Ellerman. Senator, yes. I guess I'd make one comment. I
think there is general agreement that the cap is loose. I mean,
how loose is a difficult question to address, and I think a
distinction must be drawn between the first period price now,
which is quite low, and the second period price in starting
2008, which is =16, a fairly high level, and that results from
design features, namely the lack of ability to bank from the
first period into the second period. So you've created this--
what are now very low prices. They will disappear on December
31 of this year.
Senator Domenici. Thank you very much. The fact that I said
a while back that you were our expert should not be taken
literally. You don't have to answer everything I say.
[Laughter.]
Senator Domenici. In any event, that was well taken and we
needed that. Now let me make sure that everybody else--we
understand a few other things here in America as you talk.
Your agreement among yourselves--that does not include any
outsiders like China or India or any comparable countries, is
that correct? Please, Mr. Delbeke.
Mr. Delbeke. Thank you, Senator. It does not include in the
emissions trading the link, the formal link with other
emissions trading systems in the world simply because they do
not exist.
Senator Domenici. Yes.
Mr. Delbeke. But the ETS directive, the regulation itself,
foresees such a linkage. But that will have to be subject to a
separate decision made by the legislature.
The other element is that the ETS system is open for
credits from other parts of the world; that these credits are
created through the Kyoto Protocol. They are so-called credits
from the Clean Development mechanism and from Joint
Implementation schemes and these credits are, in fact,
generated by projects--offsets--projects that are being
undertaken, to a large extent in China, but also in Brazil and
other parts of the world. These credits can be brought into the
European scheme and have a value to comply--compliance possibly
of companies to use these credits. Thank you.
Senator Domenici. Well, I think that's a good answer, but I
think that we should make it very clear that--what you're
really saying is you have some provisions whereby one might
conclude that under certain circumstances, all things being
right, you might have one of these countries join, right? But
it's obvious to me that they are not overtly speaking as if
they would like this, and it would seem to me that for you to
come here and imply that there is, is a misstatement, that
they're not interested at this point. They're not interested
even in entering into an agreement with the United States in a
major way, and we're one of the trading partners that they
ought to be most worried about, because they sell us too much
in comparison to what they buy. That has a big impact, one way
or another, or will have, depending upon what happens to this
program.
I want to make two other points and then I'll let you
comment further. I want to make for the record another point.
Constantly, it is said the United States--and they reply that
President Bush--turned down the Kyoto Agreement. I think it
should be fair here, although not discussed as such; the
President did not turn down the Kyoto Agreement. The Senate of
the United States turned down that agreement by a vote of 95--
was that the vote? Ninety-five--97 to zero, and the resolution
said to the President, don't bother to send it to us because
we're not interested in voting on it. So then we got involved
in a Presidential campaign and everybody forgot that and they
said the President of the United States is the one that turned
down Kyoto. Well, not so. The U.S. Senate, Democratic and
Republican did.
The last question--last observation and/or question to you
all--there is a big difference between what you are doing and
what the distinguished chairman, Senator Bingaman, my colleague
from New Mexico is doing. He is distinguished, and he is
working very hard to try to get cap-and-trade language that
might get him a sufficient number of votes to get it out of
committee, for which I applaud him. I haven't yet said that
I'll go beyond that and vote with him. That's two different
things--you can laud your colleague without agreeing with
everything they say. I know that, too.
On the other hand, he does his differently. The taxing
point for you is downwind, right? You tax at the end of the
emissions scheme and he taxes at the upper end, right? So you
would be taxing the coal mine that emits coal, from which coal
comes and is put into the scheme. You would tax it right there.
We understand the European communities are living under a
system that does what? Stay with the coal mine. What happens?
They mine the coal and then when do they tax it?
The Chairman. I think the witnesses can answer better. My
understanding is, what we're proposing is to regulate the
carbon as far as we can, when it comes into the economy, very
much upstream. As I understand the European system, you
regulate further down at the place where the emission is
actually made into the atmosphere. Is that a fair statement?
Senator Domenici. Is that a fair statement, sir?
Mr. Delbeke. I think indeed that's a very fair statement,
and perhaps it is explained by the following, why the European
system follows the downstream approach, and that is that the
system does not incorporate transport. Because we have a
tradition in Europe of dealing with transports through a
combination of direct regulation, the technical regulation and
taxation, and we didn't want to change that system because we
found it was effective in having energy-efficient cars and
transport systems in place.
May I perhaps take the opportunity of replying also or
making a comment to the question on whether we expect other
states to join or to link up with the European system, which is
quite different. We expect, for example, Norway or Iceland to
join the system. That means they are going to be a complete
part of the system and will accept the system entirely as it
stands. We are looking for other states to link up with our
system, which means that it is not necessary that those who
want to link up with the EU ETS have to have exactly the same
regulatory context. There may be differences. I think the less
differences there are, the easier that will be. But it is a
possibility that is foreseen by the legislature that we can
link up with states like the United States, which is frequently
debated in Europe, and with Canada, where there is an active
debate going on, even with States like California, who also are
investigating our system. So linking is different from joining,
but both possibilities exist. Thank you.
Senator Domenici. Thank you very much. Senator Bingaman,
I'm going to yield now and I'll wait and ask questions at a
later date, when the Senators have finished.
The Chairman. I know Dr. Vanderborght had some thoughts on
this issue of how to bring China and India or the extent of
their involvement since they do business in those countries.
Mr. Vanderborght. Yes, thank you, Senator Bingaman. Indeed,
as I said in the introduction, we have about 60 percent of our
emissions in developing countries and it is especially growing
in Asian countries. The business opportunities that have been
created by the European Emissions Trading System are
significant. We have fairly regular contacts with our Asian
operations and I can tell you that the interest of Asian
companies to engage in the CDM projects and to effectively
reduce their CO2 emissions and energy consumption is
very real and significant. I am rather positive of engaging,
after 2012, the developing countries, if we could move to a
system which rewards efficiency instead of only basing on
absolute emissions.
I would also like to take the opportunity, Senator
Bingaman, on commenting on the previous question on monitoring
and reporting. As it has been discussed, very good quality of
information is essential for a successful emissions trading
system. So I would recommend to the United States to start as
early as possible with mandatory monitoring reporting and
verification. I insist on the word mandatory, because we know
from experience that limiting ourselves to a voluntary
monitoring and reporting system does not provide reliable
information, because it will be essentially the leading
companies which will participate to a voluntary system, so you
will get an over-optimistic view of the real emissions. Whereas
we demand that you have the whole industry, and then you will
get much more accurate view of the emissions.
Adding to what we do in Europe--in Europe, the monitoring,
reporting and verification is only on absolute emissions. It is
important to also have information in that system on
performance, because only having absolute emissions allows you
to build allowance allocation grandfathering, but does not
provide you the necessary information to have an allowance
allocation on benchmarking or performance, and that is the key
for success in the future.
The Chairman. Let me see if other Senators--Senator Corker,
did you have a question?
Senator Corker. Yes, sir, I do. I have several questions,
thank you. Thank you for this great hearing. I appreciate it.
It seems to me that if you were going to have one of these
systems, that the method that Europe has--not to be critical
versus the upstream method that has been proposed--is one that
would cause CEOs to actually make decisions as to how they're
going to create steel. It seems to me that that's the level at
which you'd want those decisions made, versus it coming out of
a mine or coming out of another place. It seems to me that the
upstream approach is more of a carbon tax than it is an actual
trading system. I see people nodding here so I'm going to move
on.
The level at which you're trading now, the $16: is that a
level that really creates enough pain for people to invest in
technology, or is that a rate that is a fair rate, or is that
still way below what causes people to actually make investments
in technology?
Mr. Edward. The bulk of emission reductions in the EU are
made, actually, by coal-to-gas fuel switching and power
stations, and any price will start to change the dispatch of
power plants and start to change away from coal into gas. It's
certainly the case that prices of =16 or $24 or whatever, will
start to change those dispatch decisions.
Senator Corker. I'll ask one more question. I came from a
business where there was an adage that said, ``Bought right,
half sold.'' In other words, the deal you made on the front end
was where at least half the value if not all of it was made.
The allocation of these credits--I just sit here and think
about all the governmental relations people we have here in
Washington and all the industries. I can't possibly imagine
trading the allocation process. You can create one that would
actually be fair. I mean, it just seems to me it would be very
difficult, and I'd like for you to educate me on this because
this seems to be the most perplexing piece to me. In that you
have people who have been good actors, meaning they've invested
heavily, let's say over the last 20 years to reduce emissions.
Then you have people that have been really bad actors. They're
just blowing coal out and certainly have paid no attention to
that. So you have that discrepancy, and then you have the issue
of new industries that don't even exist today and how are they
allocated credits? I'd love to understand that if I could.
Dr. Caneill. Yes, I'd like to respond to that question.
This is really the key thing for the future, as I've been
trying to state in my initial statement. Looking at the prices
we have today, any price has an influence in the electricity
sector on the varied order of the plans you are using for
delivering the electricity. So when you reach some prices, you
can displace coal-to-gas, for instance, and depending on the
price of the fuels, you will have a requirement for the pseudo
price in order to change the married order. But you cannot go
very much with that because you have existing plans. So you
have some limitation. The real thing to implement is a system
that allows the people to take the right signal for the
investment.
So in the future, I need to know what the price signal is
that I need to change my investment decision from a coal-
powered plant or to a gas-powered plant or to equip in the
future, a coal-powered plant with--so it is important to have
the right price signal introducing the full cost of the
technologies. So this is very different from the shorter
marginal costs of appropriation. I need to have a signal for
real investment.
Senator Corker. But that's not really the question I'm
asking. I'm talking about setting it up on the front end and
allocating the caps--I mean, it just seems to me that that is a
huge undertaking and that smart people--the smart companies are
going to make all the money on the front end, if you will, in
the allocation process, and create tremendous wealth there. I'm
just wondering if you all might know how to overcome that.
Mr. Edward. I was just going to come back and say, of
course we recognize the point that initial allocations
establish winners and losers in the game. Typically, it's
spoken both academically and in the marketplace. There are
three basic methods by which you can do an allocation. Either
you can grandfather, based on historical emission levels or you
can issue allocations against some kind of benchmarking level,
or you can auction. They all have different merits, different
drawbacks, different kinds of political achievability and so
on.
Grandfathering in the EU context, had the merits of being
able to get the system going in reasonably short order. It's
clear that as we move into the next round of national
allocation plans, there are now other kinds of allocation being
considered, to answer some of the questions that you just
referred to, to do with equity of allocation and so on. So it
may be that you have a starting point, which is politically
achievable and then that there is some kind of transition to
other better, more accurate systems, which can be established
on the back of real information rather than initial reports. So
I think it is a kind dynamic process.
Mr. Delbeke. If I just may complete the argument that was
made, because European Commission had to scrutinize all these
national allocation plans that the member states were serving
up to the Commission, and in fact, we had a double assessment.
The first is a macroeconomic assessment, so what turns out to
be the optimal amount for a member state and there is to be
taken into account that every single member state has a
separate commitment under the Kyoto Protocol that is legally
binding. So that already explains the degree of scarcity for
every single member state and within that, we have a very
different pattern in the European Union of member states
industrializing heavily, like the new member states, or member
states like the U.K., for example, who are rapidly moving to a
service economy. So we use economic indicators to differentiate
in the approach in order to make sure that what is being given
to companies is fitting together with the Kyoto Protocol, but
also the sound economic conditions internally into the EU.
That's the macro--the top-down approach, and that is being
complimented with the bottom-up approach, which is sector-by-
sector at the member state level.
Now there is one element I would like to draw your
attention to, and you explicitly mentioned that, what with new
entrance. The European regulation is silent on what to do with
new entrants. But the member states have all separately
invented one element that is the new entrant reserve. So when
new investments are being done, the new investor can ask,
according to certain conditions, to the member state, to have a
set of free allowances, and this new entrants reserve is
increasingly managed by technological/benchmarking criteria.
One of the big debates we are going to have for the future is
whether we should not forget about the new entrants reserve,
once the system is up and running, that it would not be normal
that a new entrant is going or is forced to buy a number of
allowances on the market--or the alternative is to have a more
harmonized use of the new entrant reserve so as to avoid
distortions creeping in, not only in system installations but
also with the new investors coming into the market. Thank you.
Mr. Ellerman. May I add a comment? Let me step back a
moment to address your issue about allocation. I think first it
must be observed that allocation has been solved in a number of
programs in the United States as it has in Europe and this is
always the tough issue. It's never easy. The underlying issue
is who is going to get the rights to emit that are now being
restricted which, in most cases, were freely exercised prior to
the policy that is being adopted? This is faced by any
environmental constraint, however imposed, and the main
difference that makes allocations so difficult in cap-and-trade
programs is that the assignment of these rights is explicit and
transparent.
It is fundamentally issues of equity on who should receive
these rights. In my view those are best resolved in legislative
processes whose main job is to resolve issues of equity almost
in any laws that you pass. I think in this case, if you want to
step back, the major contending principles that we observe here
is sort of prior use claim, if you wish, an ecological squatter
claim. There are lots of institutions in our society that
recognize prior use. There are parties who are exercising this
right freely. It's now being restricted. They will continue to
exercise that right, and they assert a claim, but there are
counterclaims to that. Those counterclaims are essentially what
you could characterize as higher social purposes to which the
revenues--the scarcity rents being created by these systems
inevitably and by any environmental constraint--could be
dedicated through auctions such as new technology or return to
citizens. I mean, there is a whole series--reduce other taxes--
of other uses and purposes.
But I think to step back broadly, it is a problem that has
been solved. It is difficult. It is probably one of the most
difficult aspects of setting up any system--deciding who gets
these rights that we are now going to limit. Thank you.
The Chairman. Senator Domenici had one question he wanted
to clarify, and then he's going to have leave and then Senator
Lincoln had some questions.
Senator Domenici. Thank you, Senator Lincoln, because I
certainly have had more than enough time and I would not want
to deny you a chance. I must go to the office now, and so I
just have a question because I'm confused about this price of
the--how much it is per ton? I understand you've been using =16
a ton. But that's not the price now. That's a future price,
right? So my friend from Tennessee who was asking about the
price at =16 per ton--let's make sure we know that's not the
price now. That's a future price. They've got a much cheaper
price now. But I don't quite understand why. Does it have to do
with what we talked about a while ago, that you have that too
loose a cap and have done that on purpose? If so, what's the
purpose? Why is that? You both look so eager.
Mr. Wold. In essence, there are two main prices in the
market. There is a price for Phase I, which is the 2005 to 2007
price and then there is a price for Phase II, which goes from
2008 to 2012. They are basically two different products and the
supply and demand in those two products are different. The
supply for the Phase I is surpassing the demand, hence the
price is very low, around $1, around =1.
Then when we get into Phase II, with the allocation plans
being decided on currently, the caps are stricter, so the
supply is less and the expected demand is expected to be higher
than the current supply, and hence, the price is around =16 to
=17 at today's levels.
Mr. Delbeke. There may be a question why we have in the
European system, this strong separation between the first
period and January 1, 2008 period that is going to start. The
real history is the Kyoto Protocol. We were preparing ourselves
for the Kyoto Protocol. We know that longer periods would
prevent these price differences and in the future, we will have
longer periods and we will have also a possibility to bank
allowances from one period to the other. But for the learning-
by-doing period, this first period we have until the end of
this year. We decided to have a kind of rupture, a difference
between the two, and so all those who have the surplus
allowances can use them to comply with the objectives they have
to comply with, but the value of those has faded down to close
to nil and that will be absolutely different as of January 1,
2008, where we expect the price level in the order of magnitude
of over =16.
So it is more a historical reason. That is, that we did not
have any trading system. We wanted to start. We wanted to learn
it and we wanted to be ready for Kyoto and that is January 1,
2008. Thank you.
Senator Domenici. Thank you very much. I don't know if you
had a comment, the American Scholar, on the program? All right.
Thank you, Senator Bingaman.
The Chairman. Thank you very much.
Senator Lincoln.
Senator Lincoln. Thank you, Mr. Chairman and I certainly
appreciate your leadership as well as Senator Domenici's
leadership on this issue. You've given us a great opportunity
thus far and I know that will continue to really have the in-
depth conversation we need, to make sure that whatever plan we
come up with is going to be appropriate for us to help reach
the goals that we've set for ourselves. So I want to thank you
for that.
We are enormously grateful to you all for your time and
energy and enthusiasm to come and visit with us about what it
is we do need to move forward on and what has worked for you
and what hasn't. I don't know who it was but I thought I heard
someone say that the reason for the split in those phases was
that in the early phase, it was giving the opportunity of
investment for infrastructure that was necessary in order to be
able to get to the second phase. I understand the economics
you've presented in terms of why those credits are more
expensive later on. But it seemed as if there was maybe not a
time of investment in terms of infrastructure that was
necessary from the industry side of things to be able to get to
that point.
I'm not sure if I was understanding you, Dr. Caneill,
correctly in that the credits present more certainty than the
auction, maybe. Is that some of what you were trying to say in
terms of the differences when we were talking about the auction
and the credits? I believe it was Dr. Kopp that mentioned the
auctioning of credits. You said that Denmark had actually
chosen to do some of the auctioning in Phase I. Was that the
only country to do that? But you indicated that more countries
would be likely to do that in Phase II and I'm just kind of
wondering why that auction mechanism creates a more attractive
approach in Phase II as opposed to Phase I? Almost all of my
questions go back to the issue of the two phases that you've
created from 2005 to 2007 and then beginning in January when
you move into the next phase.
So the question to all of you would be that if you had it
to do over again, would you still create a market with two
phases? As I think Dr. Delbeke just mentioned the banking of
those credits and being able to move those banked credits
across the phases. If that's the case, what is the advantage of
doing two phases? If you can bank those credits and use them
across the division, that hard division line that you have,
what are the advantages of having two phases? Anybody?
Dr. Caneill. I can start to try to respond to your question
about creating an auction. In fact, what was underlying what I
said on the treatment of the present installation, the
incumbents, which are at the start of the scheme and the ones
which will appear on the way, the newcomers, the new projects.
Those should be treated differently and that appeal for a
certain degree of auction in the system at a point. So in the
European system, the possibility was given to the member states
to have a certain percentage of auction in the allocation. But
it was not used by most of the countries in the first phase. In
the second phase, some countries have indicated that they will
have a certain percentage of auction on the board in the limits
of the directive today, which is 10 percent in the second
phase.
But what I said on the dynamics of the allocation: the way
you are treating those who were before the scheme is starting
who discovered that there is a new regulation, and the ones
which will come in some years, where the regulation will be
there. They know that there is a regulation, so there should be
some auction process in the system in order to give the right
economy signal to those access. So I think it is not
contradictory. I think if you design a system over time with
more auction, you don't need to have 100 percent auction at the
beginning. But giving the sign that the auction will be
progressively increased in the future, this is quite compatible
with the economy signal you have to give to the actors which
build new installations.
Senator Lincoln. Is there a reason why Denmark participated
in Phase I with the auction? I mean, is it something about how
they produce their----
Mr. Delbeke. Well, on auctioning, we have in the first
phase, four member states that went into auctioning and for the
second phase, we expect half of the member states going into
auctioning, with more significant percentages. So auctioning is
becoming more popular. I think that one of the reasons is that
when you are not auctioning, you are giving out the allowances
for free. So politically, that becomes a very difficult
process. The more you give for free, the more that people are
interested to get for free. So allocation problems are being
avoided to a large extent, in going to auctioning. Of course,
the other side is that auctioning gives some revenues. Some
member states may find that interesting, also for the purpose
of reduction of emissions for stimulating new technologies in
the renewable energy sector, et cetera.
I just wanted to come back as well on the two phases. I do
not want to complicate further but in fact, there are three
phases in the EU ETS. That is, the phase we have now, coming to
an end at the end of the year. Then we have the Kyoto period,
which is from January 1 of next year until December 31, 2012.
Then the third period is going to be after 2012, presumably
running until 2020. Given that our heads of state have taken
decisions on emission reductions in that time perspective, that
is going to be the perspective in which we are going to work as
of now. The perspective is 2020.
Banking will be allowed between Phase II and Phase III. So
I can see that now that we have better data, we will have the
market developing, driving to emission reductions, those who
want to save emissions reductions, who will store their
allowance and use them in the third period. In my view, they
will certainly be allowed to do that.
In the first period, between period 1 and 2, that is not
allowed, because we were in a learning-by-doing period and that
monitoring and reporting problems that we had seemed to
indicate that that was a wise decision. Whether we would do it
exactly the same way, I don't know, but I would assume that
with what we know now, that people would say when you start,
make sure that you have first a solid database of monitoring of
verified data. That is not what we heard when we started and we
were developing the legislation, but with hindsight, I'm sure
that would be a very important element in the debate today. So
we solved it historically through the learning-by-doing phase,
but perhaps people would then say, let's monitor and verify
first, and then go into the real transactions and trading.
Thank you.
Mr. Ellerman. Senator, let me try to address your question
about Denmark. I say this to report the results of actually a
series of studies and a book that is about to come out, of
which I was one of the co-editors. It's on allocation in the
European Commission Trading System, and Denmark was one of the
countries that we did study, and how they went about allocating
their allowances. As Dr. Kopp had said, it was the only country
that chose to allocate the full 5 percent. There were three
other member states who chose to auction varying amounts that
were 2.5 percent, 1.5 percent and .075 percent.
The Danish reason for doing so is interesting in that it
was essentially competitive considerations on the part of the
power industry. It gets a little complicated, because many of
the inner-country differences in allocation are created by
what's called the European Burden Sharing Agreement, whereby
the overall burden for Europe is allocated among the various
member states. And the fact of that agreement is that Denmark
had a much tougher target than say, Germany, with whom Danish
generators competed. They felt and they wanted to provide a
signal to people to auction more because they felt they would
be less disadvantaged by auctioning than if they were
grandfathering, because they would get less because of
Denmark's more strict limits under the Burden Sharing
Agreement.
It is also interesting to note that in the second round,
Denmark has chosen to auction no allowances. So they've moved;
whereas there are more countries auctioning and most have gone
from a lower number to a higher number and such, Denmark has
done the reverse. Others here may have more of a feel for that
or reasons for that, I'm not sure. I suspect it has to do with
Denmark made a very severe cut in their total cap in the second
period and it's probably easier to take allowances away from
the auction than it is from the parties to whom they're given.
Mr. Kopp. Senator, can I just? One comment again, on
auctioning versus grandfathering, and this is strictly just an
economic argument. Dr. Delbeke has already pointed out some of
the important political considerations. When you allocate
gratis permits--that is, for free, whether they are based on
past emissions or on the basis of past output or on the basis
of an updating procedure, where you're looking at future
behavior and allocating emissions on the basis of an efficiency
standard or an output standard, you bear the risk of changing
economic incentives in ways that may not be fully recognized.
You're going to be changing incentives for firms' investment
behavior. Certainly output-based updating is one of those
things that, in some sense, artificially keeps the price of
electricity low, if its in the case of an electricity sector,
expands output and raises the social cost of attaining any
particular cap.
At auction, on the other hand, is one of those things that
really maintains the incentives in their right place. You
cannot go wrong by auctioning. I think you can bring 100
economists in here, and while economists agree on very few
things, I think if you all pose them the same question, if you
had the choice between auctioning and some sort of gratis
allocation, which is the cleanest, most transparent, most
economically efficient way to go, it would be auctioning.
It also has the benefits of generating revenue that if you
recycled it through the tax system, you could expand the
economy, you could use it for a variety of different purposes.
But setting that aside, it's really one of those mechanisms
that tries to leave the incentives essentially unchanged and
reduce your susceptibility to a lot of unintended consequences,
which will prevail with a lot of gratis-type allocation schemes
that have interesting little tweaks to them, but really change
incentives for future behavior.
Senator Lincoln. Thank you, Dr. Kopp. Thank you again, Mr.
Chairman.
The Chairman. Senator Sessions, did you have some
questions?
Senator Sessions. Thank you, Mr. Chairman. I don't think
that we're dealing with a small matter. I think this is a very
big matter and one that deserves very serious thought if we
were to head in the line of a major cap-and-trade system that
Europe has done. Mr. Chairman, I'm not sure I know the full
answers at this point either, but I think there is some
simplicity in your approach.
I think that to alter an old phrase, ``Oh, what a tangled
web we create, when we first start to regulate.'' Regulations
beget regulations like the tax code. People figure ways to get
around it. You close that off. It grows and it becomes an
exceedingly complex thing requiring, if it has integrity,
monitoring and so forth.
I think in talking about our trip to the moon, Norman
Mailer said, ``There's a razor's edge between a hero's endeavor
and vain glory.'' Being heroic is one thing but creating
something that is not going to work for us is another.
Now with regard to CO2. There are other issues
that relate to CO2. Relevant issues for a nation
that are important to them--for example, pollution. Pollution
is not controlled, I understand, with the trading system in
Europe--particulates or other matters that are pollutants. But
pollution isn't a relevant issue for a nation to desire and it
can be important for the world because it can be worldwide-
distributed.
Also, the national security of a nation--its ability to
sustain itself even if hostile forces were to deprive it of
energy sources worldwide: I couldn't help but think the
transfer from coal to gas for Europe makes Europe more
dependent on Russia.
Then there is another factor. I do not think it should be
our goal to raise prices. I think our goal would be to reduce
emissions and our goal would be to have a healthy economy,
which requires, where possible, reducing costs, not increasing
costs of basic energy.
So those are factors to me. I see a weakness here in the
sense that the trading system would focus on one issue,
CO2, and not other issues that may be more relevant
or as relevant to the Nation that's adopting the system. Would
anyone want to comment on that?
Mr. Delbeke. Thank you very much, Senator, for your
comments. I think that it is very important to underline that
perhaps one of the most important drivers for the Europeans to
decide on this cap-and-trade system was not to prescribe the
technology or the way we would reduce our emissions. So we
leave it to the companies, the entrepreneurs in their companies
to decide how to do it. So some will switch from coal to gas.
Others will improve their energy efficiency. Others will
elaborate and build further on their nuclear installations.
Renewable energy sources will be driven into the market. We
see that as a very important element. And also through simple--
sometimes, very simple--managerial decisions, energy efficiency
and carbon reductions can be realized, the so-called low-
hanging fruit.
So we are not prescribing to anybody how to realize those
efforts. Further, we don't know, we in the public
administration, how to do it in the companies, but having a
price signal makes it beneficial for the companies to look at
these things. They all come up with very different answers and
very creative answers, because the scope for emission
reductions is scattered all over the value chain, also in very
different economic sectors.
Senator Sessions. But my question to you would be: simply I
guess, yes or no? It focuses simply on CO2
emissions, is that correct?
Mr. Delbeke. It now focuses on CO2. It will
incorporate in the immediate future, in the next 5 years, all
greenhouse gases. So also methane, NTO and the fluorinated
gases.
The Chairman. Let me just clarify. Now, Europe has done the
same thing we have done in this country though, with regard to
other pollutants. That is, we've adopted the Clean Air Act,
which is direct regulation to try to control other pollutions.
EPA does that. But that does not cover greenhouse gas emissions
in this country or in Europe. So that's why Europe decided on
this other cap-and-trade approach to deal with the greenhouse
gases, is that correct?
Mr. Delbeke. That's absolutely correct, Senator, yes.
The Chairman. Excuse me for the interruption.
Senator Sessions. Well, that's important, but I guess if
you can get two or three benefits from the same regulation,
that would be preferable to just getting one benefit. As we
write it, I think that's a matter we ought to think about.
I'm thinking about France also, Dr. Caneill. You have a
strong commitment to nuclear power. First, do you feel like
France was adequately recognized for its major CO2
savings as a result of having done that previously? That's just
a brief response to that. Second, if a power company were to
decide to build a nuclear power plant, when would they get any
credits? Would it be as you noted when the investment is made?
I believe it may be vendor-brought--suggested. Is it when the
investment that you want or it is some time in the distant
future? Because one of the difficulties in a nuclear power
plant would be the up-front cost. How does it work now?
Dr. Caneill. Thank you very much, Senator Sessions, for
these questions. So I will try to answer them and try to come
back on your previous question as well.
On the nuclear power side and our commitment in France, you
asked first if we were recognized of our previous commitment,
early commitment in nuclear generation in France. So the first
thing I would respond is that when France designed its nuclear
power program that started many years ago, the carbon issue,
the climate issue was not on board. So we didn't build these
nuclear power plants for solving the CO2 problem.
However, when Europe----
Senator Sessions. If every nation had done what France had
done in Europe, you'd be far ahead today, would you not?
Dr. Caneill. Yes, okay, you're right. But the concern at
the time was more national security of supply than the climate
issue, which was not on board at this time. So, when Europe
divided the -8 percent that Dr. Jos Delbeke mentioned at the
beginning, the Kyoto commitment--this number has been divided
between the different European countries, it was 15 at this
time. So the targets that France got in this agreement was
stabilization of emissions from 1990 up to 2012. So we can say
that the fact that the generation in France is mostly nuclear
has been recognized in the Burden Sharing Agreement.
So now for the future, if we are building a new nuclear
power plant we get credits for that. Along with what I've
developed before, we will not get credits. If I would get
credits for building a nuclear power plant and taking as a
baseline of coal power plants, so I would add emissions in the
environment. So the important thing is to ensure that the
price, pseudo price, I will see on the market is sufficiently
stable, in order that I can secure this investment in the long
term. This was the reason I prone in my development that we
need a long-term signal. We need a safe trajectory in order to
have development of the price that allows an actor to take a
decision on such an investment.
Senator Sessions. Briefly, but so therefore the benefit
from the credit that would occur would be over the long term.
It would not help finance the building of the plant up front.
Is that correct?
Dr. Caneill. You cannot build the finance with something
you received, but when you decide the finance of your
investment, you are taking into account the avoidance of
CO2 and the fact that you will not have to buy any
CO2 allowances in the future. So I think if you make
the economic calculation, you can take that somewhat into
account.
So I'd like to just come back shortly on your first
question. I think the two things you were mentioning, the
national security of supply and financing and also the
increasing of the price, are two issues that are important. You
asked if the EU ETS was addressing directly these concerns.
I would say the EU ETS is addressing an environmental
problem, which is this CO2 emission reductions. So
we have to be careful what we want, that the system is
addressing directly too many questions. We can come up with
distortions of the rules in order to try to adapt the system in
order to have the national security of supply concern and the
price allotment. So if a country has a national security supply
of energy question, it has to be addressed appropriately with
right measures, and try to study what will be the interaction
with CO2 regulation for the prices now.
Yes, it is for sure that in the long term the
CO2 allowance prices will have an influence on the
electricity price. We saw that in the short-term in the first
phase. If you have a price signal of the market for
CO2, it will be taken directly in the short-term
economy of the electricity generation, because you cannot store
electricity. You have to produce electricity every second. So
the price issue is important.
What is important to ensure that you develop the constraint
with the base trajectory in order that the development price
can be afforded by the economy. We have to build something like
a safety valve--not directly a safety valve of the price, but
you could do it correctly by designing the target and the
constraint over time, in order that this price can be afforded
by the economy.
Senator Sessions. Mr. Chairman, I would just note that I
think nuclear power is three stars. It reduces pollution, it
increases our national security, and makes us less dependent on
foreign sources. It is, I believe, will prove, and is now
proving, to be less expensive than any other source. So we
could simply enhance nuclear power perhaps and get more--as
much benefit as anything else that we might do.
Or we might emphasize the production of natural gas, which
we have offshore and other places in large amounts, which in
itself would be a major move for our country that would also
reduce pollution and keep our wealth at home and reduce our
dependence on foreign energy. So there are things other than a
massive, complex cap-and-trade system, that I don't doubt can
work and every regulator I've seen that's been a part of a
regulated system usually likes it, and figured if they just had
a little more regulation, they could make it even fairer and
less of a problem.
So I think we should be open to this issue. I think
CO2 does represent a potential threat to our
environment and I'm glad you had this hearing, but I do believe
that we should be cautious as we go forward. Thank you.
The Chairman. All right, thank you very much. Let me just
ask if any of you have last-minute points you wanted to make
that you think were obviously missing here. There are probably
so many you don't know where to start. But yes, let me call on
Dr. Vanderborght for a final comment from him.
Mr. Vanderborght. Yes, thank you, Senator Bingaman. I would
have been happy to be able to comment on the question of
Senator Corker about the short-term interest and winners and
losers. It's for sure that when you will discuss allowance
allocation, you will be lobbied by all industry sectors and
lobbying will go in all directions. It is also clear those who
have not taken the necessary actions until now, that they will
prefer grandfathering, while those companies who have an
efficient production at this moment, will prefer the other
allowance allocation based on benchmarking. So you will be
faced with tremendous lobbying in all directions.
Then I would give the legislators maybe three pieces of
advice. The first being that make the difference between
lobbying for short-term vested interests and the long-term
objective of climate change being long-term, reducing the
emissions through investments.
Second, if society wants to reduce emissions, then at the
same time, foster economic and social growth, there is only
possibility, and that is improving the efficiency of our
products and of our consumption. So the core of the incentives
to industry should be efficiency. So when thinking about
lobbying, think about including efficiency of production of
products and consumption into the system. Last but not least,
the allowance allocations should be simple, objective and
transparent. Thank you.
The Chairman. Well, I think all those are very good points
and I appreciate that very much. Let me just go ahead, since
we're to the 4 o'clock hour, I'll just conclude the roundtable
discussion. I thank all of you for coming. I think it has been
very useful to hear your comments. As you can see, there is a
lot that we need to learn about what Europe has experienced,
and hopefully incorporate that knowledge and information into
anything we're able to do here in this country. I think this
roundtable has helped us to do that. So thank you all very much
and again, thank you for coming.
[Whereupon, at 4 o'clock p.m., the roundtable was
adjourned.]
APPENDIX
Responses to Additional Questions
----------
Carbon Dioxide Trading in the European Union
The European Union Emissions Trading Scheme (EU-ETS) is the world's
largest tradable permit system for carbon dioxide and the cornerstone
of the EU's strategy to meet its Kyoto emission target. The first phase
the program began more than two years ago, in January 2005, and will be
followed by a second phase commencing in January 2008.
This discussion will provide an overview of the trading system and
will focus on lessons that have a bearing on the design of a
CO2 trading system for the United States.
Participants were asked two questions: ``What was done right in the
EU Emissions Trading Scheme?'' and ``What was done wrong in the EU
Emissions Trading Scheme?'' Participants answered each question in one
page or less. Background on the EU-ETS and the responses are compiled
here.
Responses of Jos A. Delbeke
RIGHT
A mandatory cap-and-trade system was put in place, based on
absolute emissions levels determined in advance. It is a multi-
sector scheme covering installations that are major emitters
across the 27 countries that are members of the European Union.
Today, the system covers some 45% of total CO2
emissions. In 2006 the volume of allowances traded over-the-
counter and at exchanges is reported at some =18 billion
[approx. $24 billion (rates March 19, 2007)]. By giving large
installations flexibility, it engages them in finding least
cost approaches to reducing greenhouse gas emissions and can
spur innovation.
Harmonised emissions monitoring and reporting requirements
were set, building on work carried out in this area by
industry.
The private sector was used for verifying greenhouse gas
emissions.
Stringent penalties were set for non-compliance, to ensure
that the environmental integrity of the system is maintained
(from 2008, =100/tonne plus making up any shortfall).
A straight-forward and secure electronic allowance transfer
system was set up, enabling companies to transfer allowances
across the EU. The Commission is considering licensing this
system, developed with U.S. expertise, to third countries and
regions to ensure that the global carbon market develops
smoothly at the technical level.
Market operation was left up to the market. The private
sector quickly developed services (trading platforms, daily
price quotes) needed for smooth operation of the allowance
market. There is no `price-cap'. The market is allowed to
function freely, setting the right signal to invest in cleaner
technology and efficiency improvements to meet the target
(cap). Price-caps would inhibit the linking of emission trading
schemes to form a global carbon market.
As from the start-up period 2005-07, the EU ETS is open to
least-cost global emission reductions, by accepting--with
qualitative and quantitative safeguards--most types of credits
generated from project-mechanisms in 169 countries worldwide
under the Kyoto Protocol, and by foreseeing linking to
emissions trading systems in other developed countries that
have ratified the Protocol. The Commission is currently
considering widening its linking provisions to include links to
systems in other countries and regions.
The system was set up for an unlimited duration. The initial
3-year learning period has proven to be extremely valuable to
put in place and fine-tune the infrastructure needed for a
trading system and for the collection of sound and verified
data on which 2008-12 will be based. The learning period means
that both regulators and companies are much better prepared for
the trading period 2008-12.
WRONG
The lead-time from the entry into force of the Directive
(October 2003) to the start of the system (January 2005) was
too short.
When setting caps for the 2005-07 start-up period, with
hindsight, the EU had insufficient historic emissions and other
data for participating installations. As a result, some Member
States based their allocations on projections and estimates
rather than actual emissions. The resulting inaccuracies
resulted in insufficiently ambitious levels for emission
reductions, and a significant drop in the market price for
allowances when this became apparent. This shortcoming is now
corrected for the second period running from 2008-12.
Auctioning was limited to 5% of allowances. As a
consequence, Member States which wished to auction a higher
proportion were not able to. The limit on auctioning is raised
to 10% for the second period running from 2008-12, and no limit
is set beyond then.
Despite commonly agreed criteria for allocation, Member
States proposed caps that varied widely in stringency. The
Commission needed to take corrective action for most national
plans. This shortcoming should be overcome through greater
harmonisation in terms of setting caps from 2013 onwards.
Differing national approaches were taken in respect of the
EU ETS's scope in the 2005-07 start-up period, resulting in
some combustion installations being covered in some Member
States and not others (e.g. crackers). This shortcoming has
been overcome by a common approach being agreed between the
Commission and Member States on the precise scope.
Not all significant emitters were initially included in the
EU ETS. This shortcoming is being addressed during the 2008-12
period through unilateral extension of the EU ETS by Belgium,
France and the Netherlands to other greenhouse gases
(N2O), and by the UK to carbon capture and storage
installations. From 2011, the Commission has proposed to
include aviation, where this is not covered by other States'
emissions trading schemes. Further extensions are under
consideration.
Relatively small installations were included whose emissions
might more appropriately be addressed through alternative
policies. This potential shortcoming has been addressed by
simplifying the EU's monitoring and reporting rules for small
installations. From 2013 onwards, the Commission is considering
whether further action is needed, for example through enabling
small installations to be `opted-out' of the EU ETS if they are
covered by alternative policies.
______
Responses of Per-Otto Wold
RIGHT
Financial Market Efficiency
A trusted market-wide price on carbon was established
quickly and distributed widely in the market.
The market price responded from the start to changes in
supply and demand, with fuel prices influencing supply and
weather influencing both supply and demand.
A market with reasonable liquidity has been established.
More than 1,000 million metric tons were traded in the EU ETS
in 2006, for a value of =18bn ($23bn). The market turnover,
measured as the ratio of traded volume to the total number of
allowances allocated, has been about 50%. Point Carbon
estimates trading volume will further double in 2007.
Infrastructure for international emissions trading is in
place and functioning. This includes registries, accredited
verifiers, market places (exchanges and over-the-counter) and
other market intermediaries, such as information providers,
project developers and financial institutions.
Environmental Effectiveness
The cost of carbon has been absorbed as part of operational
decisions for thousands of installations across the European
Union. By early 2007, companies participating in the EU ETS had
to a large degree (65%) initiated internal abatement measures
(Point Carbon survey--Carbon 2007). This compares to 18% in a
similar survey a year earlier.
The EU ETS has been a key driving force behind investments
in project-based mechanisms (CDM/JI) in 128 countries and a
range of project types. Point Carbon estimates that investments
in CDM/JI projects will provide reductions totaling more than 2
billion metric tons of CO2 equivalent emissions by
2012.
The start of the EU ETS produced a consistent set of
verified emission data across more than 10,000 installations in
25 countries. The European Commission made ``extensive'' use of
2005 data in assessing allocation plans for Phase II.
Policy Efficiency
The EU ETS represents the first international emissions
trading scheme to date. Lessons learned from the ``test phase''
(2005-2007) are providing valuable experience for stakeholders
ahead of the start of the first commitment period under the
Kyoto Protocol, from 2008-2012.
Although uncertainties prevail with regards to international
framework conditions for the post-2012 period, the EU ETS
Directive secures the continuation of the EU ETS beyond 2012,
which is critical for investor confidence.
The EU ETS Directive provides an opportunity for linking to
other national or regional emissions trading schemes (U.S.,
Japan, Canada and Australia). Along with the indirect links via
offset markets (CDM/JI), this provides a path for convergence
and towards a truly global carbon market.
WRONG
Financial Market Efficiency
The timing of demand and supply is important, but was not
fully understood:
--The demand from utilities, which were generally under-allocated,
was present from the beginning of the market. Utilities
manage their current and future combined exposure to
carbon, fuel and electricity risks on a daily basis;
--The supply from companies in energy-intensive sectors, who were
generally over-allocated, typically came to market later
and episodically.
The difference in timing of demand and supply largely
explains why prices increased above =30/t in April 2006,
despite the market being fundamentally oversupplied.
The unauthorized leaks of market sensitive verified emission
figures for 2005 created information asymmetries and ``undue''
opportunities for some market participants.
The implementation of registries was delayed in many
countries, most notably Poland and Italy, likely preventing
market access and impairing liquidity.
Environmental Effectiveness
The release of verified emission figures in April/May 2006
showed that the market was over allocated by about 5% (100 Mt)
in 2005. Although some abatement is likely to have taken place
due to high carbon and energy prices, the long position is in
our view largely explained by over-allocation and lack of
consistent, historical data.
Uncertainties about Phase II (2008-2012) and the post-2012
period have made investments in more energy-efficient capital
stock uncertain.
Regulatory Risk and Policy Efficiency
A number of factors are specific to the EU and its principle
of subsidiarity and are therefore more unlikely to carry over
to the United States:
--Distributed responsibilities for allocation processes at national
level led to countries opting for favorable allocation to
domestic industries.
--Lack of harmonization in monitoring, reporting and verification
procedures.
--Different rules and procedures for treatment of new entrants.
Grandfathering penalizes early action.
The EU ETS extends beyond 2012, but there is a lack of
clarity about rules due to ongoing review process and
international negotiations.
Distributional Issues
Free allocation by grandfathering has created windfall
profits for utilities.
The principle of opportunity costs was not fully understood
or anticipated amongst policymakers:
--The pass through of the cost of carbon into power prices is seen
by many as unduly favoring the power industry and thus a
challenge for the integrity of the scheme. This pass
through was, however, anticipated in a few countries,
notably the UK, as highlighted in their National Allocation
Plans;
--Perception of fairness will affect the support for and
sustainability of the EU ETS and international emissions
trading.
______
Responses of Garth Edward
RIGHT
Coverage.--10,365 installations in the electricity, cement,
metals, and refining sectors are covered by the EU-ETS
Directive and the relevant national legislation.
Registries.--Each installation is connected to one of the 27
national registries which then communicate through the
Community Independent Transaction Log. These registries are
operational and provide the basic infrastructure for assessing
compliance as well as operating the market. Registries enable
allowances to be issued to companies, transferred between
companies, stored, and redeemed for annual compliance.
Compliance.--Verified emission statements have been obtained
and submitted by companies in line with the reporting and
compliance timelines. Essentially all installations have
demonstrated annual compliance by holding a volume of
allowances on their registry accounts that is equal or larger
than their verified emissions statement.
Establishment of a market price.--Significant trading takes
place with a daily market turnover in the EU-ETS of
approximately USD$50m. Approximately 50% of volume transacts on
exchanges such as Nordpool, Powernext and the ECX. While the
balance of trading activity takes place through brokers. The
forward curve extends from spot out to 2012 and this provides a
long term price signal comparable to oil or power markets. This
price signal is integrated into electricity dispatch decisions
across the EU with companies deciding to run gas or coal plant
on the margin depending on the price of allowances.
Development of the international Clean Development Mechanism
(CDM) and Joint Implementation (JI) markets.--The demand
generated by the EU-ETS has driven the quick development of
international project credit markets. CDM now has 517
registered projects with a projected flow 2008-12 of 761m CERs.
At an average of USD$13.3 this represents a capital flow from
rich to developing countries of USD$10.11bn up to 2012. A
further 3,831 projects are in the UN approval process
representing another 2,147m CERs and USD$26.7bn. This pipeline
is being added to daily. JI (Joint Implementation) is picking
up speed now as we approach 2008 and 271m Emission Reduction
Units (worth approx USD$3.59bn) will be generated from projects
currently undertaking approval with the UN. This pipeline will
be added to considerably over the coming year as Russia and
Ukraine build the necessary institutions. In summary we can say
that CDM/JI will flow approx USD$6.65bn per year into
developing countries from now till 2012. Alongside this flows
technology transfer, improved local employment, and better
local environmental quality.
WRONG
Delays in infrastructure.--Some governments were late in
establishing their registries which meant that issuance of
allowances were delayed and some installations were held off of
the market.
Delay in connecting to the UN International Transaction
Log.--The EC has not yet connected to the ITL which means that
the Certified Emission Reduction (CER) credits flowing from CDM
projects cannot be physically imported and used for compliance.
Auctions.--Some EU Governments have chosen to auction EU
Allowances, either as part of their primary allocation process
or as a distribution method for surplus allowances left in New
Entrant Reserves (e.g. UK, Ireland, Hungary, Denmark). These
auctions have been frequently delayed as governments have found
that auctions require significant logistical organization.
Inconsistent allocation methodologies across the Member
States.--This meant that the definitions of installations were
different, monitoring and verification guidelines were
different and baseline periods were different. As a result, the
same kind of installation (refinery, power plant, cement plant
etc) would have very different allocations depending on its
jurisdiction.
______
Responses of Jean-Yves Caneill
RIGHT
Setting the scene.--Implementation of the EU Emissions Trading
Scheme (hereafter EU ETS) was proposed after about three years
discussion (that involved all stakeholders), which started in 1999, and
continued to its final adoption. Although we can consider that this
time duration is short for the implementation of a new economic
instrument, it was done in a way, that made industry and power sector,
faced with the reality of the carbon constraint. The EU ETS allowed
immediately for the setting of a single allowance price for
CO2 throughout EU in early 2005 when it started effectively.
Simplicity.--Making a decision to consider ``direct emissions'' and
not base the ETS on ``indirect emissions'' was also a wise decision to
take, although discussed strongly at the beginning among the different
stakeholders. Including both would have complicated too much the design
at the and simplicity of the approach was an essential feature for
having a prompt start of the scheme. This does not mean that one cannot
make more complex the scheme over time, but it should have to be done
cautiously and in a progressive manner.
Learning by doing.--It was clear at the beginning that use of such
an instrument was very new for European actors, and such, the fact that
a learning phase was proposed (the years 2005/2007) was important. This
allowed different constituencies to discover the instrument, its
potential advantages, as well as its difficulties. In a sense the
period has largely been used to monitor accurately the perimeter of
action that was defined, and perhaps a recommendation one can take from
that experimental phase is that it is worthwhile to start by the
monitoring and assessment of the perimeter covered by the ETS
regulation, before starting the allocation process and the real
trading.
Reducing the costs.--As soon as the ETS Directive was adopted,
Commission prepared the so called ``linking directive'' devoted to
allow actors to use credits generated by the CDM and JI mechanisms,
allowing more flexibility for complying with the environmental
objectives. Although there was a lot of discussion on the way these
mechanisms should supplement actions ``done at home'', one can consider
this achievement as an important one in the design of the economic
instrument itself. It allowed to embed the EU ETS system in a larger
perspective, in line with the international agreements, recognizing in
the same time, that reducing the costs of compliance was an integral
part of the process.
Monitoring emissions.--Articulation of the flow of information
between the company, national and EU levels, as far as the building of
the CO2 emission registries, have been an important piece of
the functioning of the scheme. Together with the monitoring, reporting
and verification procedures that were put in place, these features
helped to build the necessary framework for gathering the necessary
data to monitor compliance, and allowing transparency requirements for
future allowance distribution process.
WRONG
The EU Emissions Trading System is a regulation that has been
adopted through a compromise between the Commission, the EU Council and
the EU Parliament. Although some of the features discussed hereafter
were not part of the first proposals discussed, some of them were part
of the compromise and it is worthwhile to mention them, as they seem to
me critical for the design of a well functioning emissions market.
Length of the commitment period.--The relevant time frame of the EU
ETS regulation had two major drawbacks: first the overall time frame
was too short, second the period was decomposed in a trial period and
the commitment period corresponding to the international agreement.
Although one can understand that the trial period was necessary to
start the system, the margins that were led to the EU Member States in
deciding some implementation rules led to counteractive proposals,
namely: no banking provisions from period 1 to period 2, except for two
countries (that are now in the process to abandon it), re-opening of
the discussion of the distribution of allowances between the two
periods. One can discuss the reasons for this status of play, but it is
important that in any future design, actors get a stronger visibility
and predictability: longer time frame and predictability of the rules.
As a matter of fact it is important to favor right conditions for
future new investments.
New entrants and closures rules.--EU ETS directive specified that
these provisions should be defined by the Member States in their
national allocation plans. This led to different treatments of
installations over EU, and behavior that could lead in the long term to
non appropriate decisions as far as the reduction of emissions are
concerned. For instance, very often an installation which is going to
be closed has to give back allowances non used (in an emissions trading
system, keeping the allowances non used is an incentive to close an old
installation and build a new one); a new installation should get
allowances for free (on the basis of a new entrant reserve), often on
the basis of its needs. These provisions were decided by Member States,
because of the short time frame, and to avoid disputes based on
competition arguments between incumbents and newcomers. However in the
future, and on the basis on longer allocation periods, incumbents
should be given the signal that they have to reduce their emissions on
the long term (in the case they get free allocation, they should get
less over time), and new projects (and/or new entrants) should have to
pay their allowances, in order that CO2 signal appears in
the full investment cost, for taking appropriate decisions aligned with
the environmental goal.
Reflecting the costs in the operations.--Many factors concurred to
the fact that spot electricity prices reflected immediately the
CO2 price that appeared on the market. Although quite
normal, this feature was not enough recognized by the actors at the
start of the scheme and generated strong misunderstanding. Inherent
volatility of the carbon price due to imbalances of allocation between
the industry and the power sector, and differences of behavior between
the two communities in front of this new market, led to a significant
increase of the power prices. To alleviate this situation, one should
pay strong attention to the realism of the targets set to the different
sectors over time (in line with the investment cycles) and proper and
harmonized allocation rules, especially to the new entrants.
______
Responses of Bruno Vanderborght
RIGHT
The objective of the EU Emissions Trading System is to reduce
CO2 emissions from industry in a cost efficient way while
fostering economic development and employment.
The EU ETS may form a solid foundation to this end:
1. The necessary European legislation and regulations are in
place and implemented by all Member States;
2. Monitoring, reporting and verification of emissions
provides reliable quantitative historical information;
3. The CO2 market systems and tools are in place
and operate in a competitive environment;
4. The CO2 emissions trading market functions;
5. Reducing CO2 emissions and improving energy
efficiency are now firmly embedded in business strategies and
risk management.
WRONG
Despite this solid foundation, the EU ETS building is not yet
completed, therefore not yet sufficiently delivering to its objectives.
The main deficiencies are not so much related to the Emissions
Trading Directive but rather to the method of allocation of emission
allowances.
1. Allowance allocation based on absolute historical
emissions by installations rewards pollution and punishes
efficiency and early action;
2. There is no predictability for the medium-and long-term
objective;
3. The international coverage is too small;
4. An absolute cap based on historical emissions and lower
allocation to new installations freeze market share and inhibit
innovation, investment and growth of economy;
5. The counterproductive allocation method causes intense
lobbying, undue distortion of competition between sectors and
companies and affects the credibility of the system.
What we need to make the ETS an effective and efficient system is:
1. A clear, simple, long-term (i.e. 2030) objective for each
industrial sector, equitable to the technical and economic
potential to reduce emissions;
2. Based on CO2 or energy efficiency performance,
i.e. CO2 emission per unit of output;
3. With a predictable path from current performance to the
long-term objective;
4. With linking to similar CO2 performance
objectives and market systems in countries with developed and
emerging industrial economies.
The global and regional burden sharing should be based on an
international sectoral rather than on a national approach.
______
Responses of A. Denny Ellerman
RIGHT
1. An Initially Modest but Effective Constraint.--The most
important achievement of the EU Emissions Trading Scheme (EU
ETS) is that a constraint and a price have been placed on about
half of the CO2 emissions from a region of the world
that accounts for a significant fraction of global economic
activity (about 10% of global CO2 emissions). The
initial ambition is modest, but the real achievement is putting
in place a policy structure that can deliver the CO2
emissions reductions that may be required. From the perspective
of global climate policy, this is only a start but it is the
most significant and promising development to date in a domain
where grand ambition has often thwarted achievable result.
2. A Multinational Trading System.--This achievement is the
more impressive in that it has been adopted by all 27 members
of the European Union despite significant differences among the
member states in economic circumstance and commitment to
climate policy. The federal structure of the EU is far weaker
than that of the U.S. and the differences among the EU's
constituent nation-states are far greater than those among U.S.
states. In fact, the East-West axis in Europe bears many
similarities to the global North-South divide. As such, the EU
ETS is a proto-type multinational trading system from which
many lessons can be drawn concerning what attracts
participating nations and how participation affects economic
and environmental performance.
3. A Replicable Approach.--In placing a constraint on
CO2 emissions, the EU has chosen an instrument, cap-
and-trade, that is more likely to propagate to other nations
and thus to create a global regime for controlling greenhouse
gas emissions than other instruments, such as taxes or assorted
other policies and measures. The cap-and-trade approach is more
promising because it allows the issues of equity and efficiency
created by a CO2 constraint to be dealt with
separately at global and national levels and because the trade
in the financial instruments thereby created closely resembles
existing investment flows and trade in goods, services, and
capital. This is not to say that propagation will be easy; only
that it will be easier than by any other approach.
4. Openness to Equivalent External Credits.--In placing a
price on a significant fraction of EU CO2 (and
greenhouse gas) emissions, the EU has recognized the essential
equivalence of emission reductions in any part of the world
through the linkage provisions of the EU ETS. This openness to
equivalent external credits has provided a great impetus to
project-based emission reductions in key developing economies,
such as China, India, and Brazil, through the Clean Development
Mechanism. In addition to familiarizing these nations with the
requirements and institutions of emissions trading (and thus of
what will ultimately be required of them), this openness to
external credits provides the means for indirect linkage and
eventual formal mutual recognition among the independently
developed, ``bottom-up,'' national trading systems that may
emerge.
WRONG
1. An Incomplete Cap.--The EU has chosen to apply the cap-
and-trade approach to large stationary sources and to adopt
other policy measures to deal with CO2 emissions
from mobile and small stationary sources. While multiple
instruments can in theory be equivalent in cost, they rarely
are in practice so that their use is inevitably inefficient.
Even worse, alternative ``command-and-control'' measures have a
tendency to overpromise and to under-deliver thereby adding
ineffectiveness to inefficiency. Consumers who bear the
ultimate burden of CO2 limitation are unlikely to
prefer to pay more for the abatement measures associated with
their driving than for those affecting the electricity they
consume at home, or vice versa.
2. Repeated, Sequential Cap-setting and Allocation.--In
conformity with the Kyoto Protocol, the EU ETS has been set up
in discrete commitment or trading periods in which the cap for
the next five (or x) years is decided along the way. For
instance, the cap for 2008-12 is currently being decided and
the cap beyond 2012 is unknown. While there is not much doubt
that the system will continue, this circumstance has created
considerable uncertainty about longer term reduction
requirements with consequent effects on investment. Also, the
possibility that future allocations would be based on current
period emissions may lead some firms to abate less than they
would otherwise. A better approach would be to establish a
longer term cap or schedule that is subject to review but
which, barring later adjustment, would be the operational
default.
3. New entrant and closure provisions.--A novel feature of
the EU ETS is the set of provisions whereby new installations
are endowed with free allowances from a new entrant set-aside
and closed facilities forfeit allowances granted to them. While
perhaps understandable from an equity standpoint, these
provisions distort long-term investment decisions and create
over-capacity. Older facilities that would otherwise be closed
(and which are usually inefficient) are kept open if the value
of the allowance endowment is greater than the losses incurred
by continuing production at the minimally acceptable level.
Endowing new facilities with a free allocation compensates the
investor for all or most of the carbon costs that will be
incurred and thereby keeps the investment criteria largely what
they were prior to the start of the program. In addition, both
provisions will tend to create excess capacity in the affected
industry.
4. Limit on Banking.--The carry-over of unused allowances
from the 2005-07 period into the 2008-12 period is prohibited
and this provision has created a significant price disparity
between 07 and 08 allowances that will lead to strange
abatement behavior around the turn of the year as firms and
traders arbitrage this price difference. Aside from this
restriction, the EU ETS does allow complete intra-period
banking and borrowing. This has resulted in very stable price
relationships among years in each trading period and efficient
abatement within these periods.