The European Union Emissions Trading System: Insights and Observations

The European Union Emissions Trading System (EU-ETS) is a landmark environmental policy, representing the world's first large-scale greenhouse gas (GHG) trading program, covering around 12,000 installations in 25 countries and 6 major industrial sectors. The EU-ETS offers an opportunity for critical insights into the design and implementation of a market-based environmental program of such size and complexity. In addition, key lessons based on actual experiences of emissions trading will include the cost of emissions reductions, the implications on competitiveness of sectors and firms, and the development of new technologies and efficiency opportunities.

This analysis discusses the background to the EU-ETS in the context of ongoing emission abatement efforts and policy initiatives to meet EU-25 member state targets under the Kyoto Protocol. The key elements of the EU-ETS are detailed, focusing on its timetable, sectoral coverage, methodology for distributing emission allowances, provisions for banking, opt-outs, opt-ins and pooling mechanisms, the procedures for monitoring and verification, and the compliance mechanisms.

The paper then turns to the current status of the EU-ETS, focusing on the ongoing national allocation plans, and discussing key remaining uncertainties, namely the readiness of all parties to trade, linkages to other trading programs, availability and use of project-based allowances, the impact of Russian emission credits, strategies of new Central and Eastern European member states, the compliance role of governments, progress in emissions reductions from sectors outside the EU-ETS, and finally the importance of expectations of future targets and prices.

This paper concludes with early conclusions from this first large-scale GHG emissions trading program. The EU-ETS is up and running with significant trading volumes; it looks set to deliver real (vs. BAU) but modest reductions; these reductions are focused on the power sector; and ongoing concerns remain regarding detrimental impacts on industry competitiveness and the impact of higher electricity prices. Key remaining challenges include the remaining implementation issues of this novel trading system, and to retain political support for the EU-ETS in the years ahead. Key insights from the EU-ETS will include the price, traded volume and cost-savings from GHG trading, the longer term implications of the EU-ETS for technology development and the progression of global climate change policies, and direct lessons for U.S. policy makers as they debate domestic GHG trading