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pb_2013_02_.pdf

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 YOU'D BETTER BETON THE ETS
bruegel
policy brief 
ISSUE
2013/ 
02
APRIL 2013
by
Georg Zachmann
Research Fellow at Bruegel
 georg.zachmann@bruegel.org
POLICY CHALLENGE
The ETS must be stabilised by reinforcing the credibility of the system so thatthe use of existing low-carbon alternatives (for example burning gas instead of coal) is incentivised and investment in low-carbon assets is ensured. Further-more, failure to reinvigorate the ETS might compromise the cost-effective syn-chronisation of European decarbonisation efforts across sectors andcountries. To restore credibility and to ensure long-term commitment to theETS, the European Investment Bank should auction guarantees on the futureemission allowance price.This will reduce the riskfor low-carbon invest-ments and enable stabili-sation of the ETS until acompromise is found onstructural measures to re-inforce it in order toachieve the EU's long-termdecarbonisation targets.
Evolution of the EU carbon price since 2008
THE ISSUE
The European Union's emissions trading system (ETS), introducedin 2005, is the centerpiece of EU decarbonisation efforts and the biggestemissions trading scheme in the world. After a peak in May 2008, the price of ETS carbon allowances started to collapse, and industry, civil society andpolicymakers began to think about how to ‘repair the ETS’. However, the ETS isan effective and efficient tool to mitigate greenhouse gas emissions, andalthough prices have not been stable, it has evolved to cover more sectors andgreenhouse gases, and to become more robust and less distorting. Prices aredepressed because of an interplay of fundamental factors and a lack of confidence in the system.
Source: Datastream. Price per EU emission allowance.
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5
0
 
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      p      o        l        i      c     y        b      r        i      e        f
02
YOU'D BETTER BET ON THE ETS
THE EUROPEAN UNION'S EMIS-SIONS TRADING SYSTEM
(ETS) hashad a bumpy start. In particular,after a peak in May 2008, theprice of tradeable emission al-lowances has collapsed for vari-ous reasons (see section 3). Thiscollapse has resulted in calls fromindustry, civil society and policy-makers to ‘fix’ the ETS. But is itreally broken? Despite its prob-lems, the ETS has significantlyevolved to cover more sectors,more countries and more green-house gases. The allocation of al-lowances has become lessdistorting. The treatment of emis-sion rights from outside the EUhas become stricter. Fraud hasbeen made more difficult. The ETSentered its third phase, at the be-ginning of 2013, as a moremature system.
1THE ETS WORKS
The ETS is a classical cap-and-trade system specifying a cap forannual greenhouse gas emis-sions and allocating a correspon-ding amount of allowances tocompanies covered by thescheme. By definition, as this caphas decreased, emissions havealso been reduced. Excluding thecountries that have entered thescheme since 2005 (Bulgaria andRomania joined in 2007 andNorway has participated since2008) greenhouse gas emissionsfrom ETS participating installa-tions declined by about 14 per-cent between 2005 and 2012(Figure 1).Significant emission reductionswere achieved by the tighteningup of the system between the firstand second trading periods(2005-07 and 2008-12) (Abrell
etal
, 2011). A year-on-year emis-sion reduction of 3.6 percent ap-pears to be due to the tighteningof the system. It is not explainedby reductions in firm outputcaused by changing economicconditions and reduced produc-tion in Europe (Table 1).In addition, there is evidence thatsignificant emission reductionsalready took place before thestart of the ETS in order to complywith the system from the begin-ning (Ellerman and Buchner,2006; Brewer
et al
, 200
9
; Eller-man
et al
, 2010). Consequently,the ETS has been able to achieveits purpose – stimulating addi-tional emission reductions.The instrument of carbon tradingwas chosen in order to allowdifferentiation of carbonabatement efforts in differentsectors. And indeed, differentsectors exhibited differentemission-reduction strategies(Figure 2). This is good news. It isin line with the hypothesis thatdifferent sectors have differentmarginal abatement costs, andthe ETS is able to induce thecheapest carbon reductions.Table 2 shows that non-metallicminerals and basic metals wereresponsible for the main part of the emission reductions ob-served during the shift from thefirst to the second trading periods,while there has been no signifi-cant additional effect for theenergy and paper sectors (Abrell
et al
, 2011).We conclude that the ETS is achiev-ing its aim of keeping emissions inthe sectors that it covers under thecap. As the number of allocated al-lowances is irresistibly decliningby 37 million EU allowances(EUAs) each year, emissions willhave to continue to decline.
Spain Poland Italy United
K
ingdom
G
ermany Others
2005 2006 2007 2008 200
9
2010 2011 2012
25002000150010005000
Source: Bruegel based on CITL.
Figure 1: Country-level verified ETS emissions, million tonnes CO2
Table 1: Relative change in the growth rate of emissions between(2005-05) and (2007-08)
Reductions caused by the shift to the second period-3.6%**Control variablesChanges in turnover1
9
.1%***Changes in employment0.07%
Source: Abrell
et al
(2011). Note: significance: ** at 5% and *** at 1%.
 
YOU'D BETTER BET ON THE ETS
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03
1. Seewww.eea.europa.eu/data-and-maps/data/data-viewers/emissions-trading-viewer.2. Seewww.entsoe.eu/data/data-portal/production/.3. Trotignon (2011).4. The national new en-trants reserves wereset up to distribute freeallowances to newcarbon-emitting instal-lations in order to notput them at a disadvan-tage compared to exist-ing installations thatobtained allowances forfree in the secondphase of the ETS. Not allof the reserved al-lowances were used.5. Article 10(a) 8 of therevised Emissions Trad-ing Directive200
9
 /2
9
 /EC containsthe provision to setaside 300 million al-lowances for subsidis-ing innovative cleanenergy installations.6. European Commis-sion (2012).7. The relative impor-tance of the four factorsfor the surplus is diffi-cult to disentangle. Anupper bound for thecontributions of the in-dividual factors be-tween 2008 and 2012is in the range of 500million tonnes from therecession, 1420mtonnes from interna-tional credits, 200m
2THE SURPLUS
Since 2008, more EUAs havebeen issued each year than wereused
1
, leading to a substantialstock of allowances in circulation.Several fundamental factors areresponsible for this surplus. First,industrial production in Europewas strongly affected by the
G
reat Recession’. While produc-tion grew between 2003 and2007 by almost three percent peryear, it decreased by almost twopercent per year between 2008and 2012. In turn, demand for al-lowances substantially de-creased. Assuming an annualdecline of the allowance demandof five percent compared to thebaseline, the annual demand re-duction from 2008 to 2012 wouldbe more than 100 million tonnes.Second, the ETS is only one of several instruments of Europeanclimate policy. Energy efficiencypolicies and renewable energypromotion also lead to carbon re-ductions. Meeting the EU 20 per-cent energy efficiency target andthe 20 percent renewables targetreduces the need for fossil-fueledelectricity generation – thelargest contributor to emissionscovered by the ETS. The produc-tion of electricity from solar andwind in the EU doubled from 105TWh (terawatt hours) in 2008 to214 TWh in 2012
2
.Third, emission reductions fromoutside the EU are allowed intothe ETS in the form of additionalcredits. In the ETS second phase,EU legislation allowed 1,420 mil-lion tonnes (ie 284 million tonnesper year) of carbon reductionsfrom outside the ETS to be usedinstead of European emission al-lowances
3
. This option has beenwidely used, also because noother country or region has al-lowed such a generous monetisa-tion of foreign emissionreductions.Fourth, according to the EuropeanCommission (2012), some addi-tional 500 million allowancesfrom three exceptional sourceshave been brought to the marketin 2012/2013: 1). Unused al-lowances from the second phasenational new entrants reserves
4
were auctioned at the end of thesecond phase. 2). The EuropeanInvestment Bank is selling a fixedamount of third-phase al-lowances in order to fund anumber of carbon capture andstorage and innovative renew-ables projects (NER300 pro-gramme)
5
. 3). Some third-phaseallowances have been auctionedearly in order to avoid the scarcitythat was feared at the time the cli-mate package was negotiated in2008/200
9
.As emission allowances not usedin the second trading period(2008-12) can also be held overand used in the third tradingperiod, a surplus of 
“well over 1.5billion allowances, and even aslarge as 2 billion allowances” 
might have accumulated at thestart of the third phase
6, 7
.
3THE EMISSION PRICE SLUMP
A temporary surplus of allowances is not necessarily aproblem for the ETS. As thesystem is to run indefinitely witha constantly decreasing annual
Table 2: Relative change in the growth rate of emissions between (2005-06) and (2007-08) by sector
Pulp & paperNon-metallic mineralsBasic metalsElectricity & heatReductions caused by shift to the 2nd period-2.
9
%-8.7%***-
9
.5%*-0.1%ControlvariablesChanges in turnover15.4%**2
9
.
9
%***8.
9
%13.6%**Changes in employment-6.2%-4.6%
9
.
9
%1.2%
Source: Abrell
et al
(2011). Note: significance: * at 10%, ** at 5 % and *** at 1%.
OtherOil
 
refineries
 
(
-
28%)Metal
 
ore
 
(
-
4%)Iron
 
&
 
steel
 
(
-
52%)Ce
ment
 
clinker
 
(
-
38%)
G
lass
 
(
+
34%)Ceramic
 
products
 
(
+
141%)Pulp
 
&
 
paper
 
(
+
23%)Combustion
 
installations
 
(
-
10%)Coke
 
o
v
ens
 
(
-
26%)
A
ircraft
 
operators
2005 2006 2007 2008 200
9
2010 2011 2012
25002000150010005000
Source: Bruegel based on CITL. Note: million tonnes of CO2.
Figure 2: Sector-level verified emissions (reductions 2005-12 in brackets)

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