The EU ETS: From Two Perspectives A. Denny Ellerman Massachusetts Institute of Technology EPRI Global Climate Change Research Seminar Washington, D.C. May 20, 2009
The Two Perspectives A Single-state Cap & Trade System Highly decentralized, like US NOx Program 1 st CO 2 and largest cap-and-trade system Many lessons for US or other systems A Multinational (Global?) System Member states are sovereign nations Large differences among member states Many lessons for potential global system
The EU ETS in Brief A partial system CO 2 only; large stationary sources Successive compliance periods: 2005-2007, 2008-2012, post-2012 National Allocation Plans Decentralized allocation/ cap-setting Interesting and novel rules for banking and borrowing Free allocation and limited offsets
EU ETS: Results Infrastructure in place to limit GHGs Sophisticated CO 2 market Only uniform price in the EU Incorporated into business decisions World-wide impact on projects Modest abatement & little to no trade impact No transforming technological innovation
Despite Great Odds A new and unfamiliar regulatory instrument Little experience and some hostility to emissions trading Rushed implementation Very poor data on installations and ETS emissions
Economic Impact Is Imperceptible No visible macro-economic effect De-industrialization of Europe?? No visible trade impact either Also little effect, but short-term only Why? CO 2 is but one price among many All others as important now as before True for long-term investment, also?
Borrowing Worked without Abuse Only cap-and-trade system with unrestricted year-ahead borrowing Used by many in 2005-06 (16% to 30% of ~3000 shorts) An alternative compliance option that reduced demand when prices were high All paid back in 2007
Evidence of Borrowing in the UK Millions EUAs 80 70 60 Net short Net imports Borrowing Carried over borrowing Why? 50 40 30 20 10 70 % 42 % 0 2005 2006 2007
4/7/2009 35 30 25 20 15 10 5 0 EUA Prices: Data and Design Matter! 2005 2006 2007 2008 Ph2 Price Why? Dec07 Price MIT Joint Program 4/7/2005 7/7/2005 10/7/2005 1/7/2006 4/7/2006 7/7/2006 10/7/2006 1/7/2007 4/7/2007 7/7/2007 10/7/2007 1/7/2008 4/7/2008 7/7/2008 10/7/2008 1/7/2009 Weekly observations 1/7/2005
Post-2012 Changes EU-wide cap set in legislation Rapid phase-out of free allocation Electric utilities: full auctioning 2013 on for EU15, Eastern Europe by 2020 Industry: Largely free allocation on trade grounds ~60% auctioning in 2013 to 100% by 2027 (in theory) Harmonized benchmarks for residual free allocation
Other Lessons Largely confirms US experience with cap-and-trade Markets emerge effortlessly Agents internalize price in decisions Emissions reduced with few other effects Unexpected forms of abatement Allocation is a big deal Good data needed for cap-setting Expanding coverage is not easy
Now, The Multinational Perspective The EU is neither a strong federation nor homogeneous The Commission, Directives, and Treaties East-West and North-South divides Non-problems Institutional readiness Cross-border financial transfers Global system would likely resemble the highly decentralized 1 st period
Trial Periods & Limited Sector Scope Trial periods would be useful for all Resolves infrastructure and data issues Reassures existing systems about integrity Partial coverage first? Not the ideal, but more important/realistic Major reductions are in electricity sector Inclusion of industrial sectors deals with trade and leakage issues
Defining a Center The indispensable role of the EU Commission Dealing with cap inflation: special powers Educating and facilitating An adventitious and available institution Subsequent centralization an EU phenomenon? What could serve on a global scale? Players only and limited delegations
Club Benefits Varying commitments and sincerity of commitments and yet all belong. Why? The broader benefits of the EU Part of the package; no variable geometry Another fortunate, almost accidental feature What will serve on a global stage? Linkage is the essence of diplomacy Many dimensions possible
Stringency, Differentiation & Harmonization A broad then deep strategy All inclusive, non-demanding beginning Increasing differentiation with greater stringency Participation of the less committed in decisions The new problem of harmonization Equality vs. differentiation The EU solution: auctioning harmonizes all Differentiate through auction rights
Differentiation in the 1.6 1.5 EU ETS in 2020 Latvia 1.4 Lithuania 1.3 2020 vs. 2005VE 1.2 1.1 1.0 0.9 0.8 0.7 Rom ania Bulgaria Poland Hungary Estonia Slovakia Czech Rep Malta Slovenia Cyprus Greece Portugal Spain Sweden Italy Belgium Per Capita GDP in 2005 (000 US$, PPP basis) Luxembourg Germany Ireland France Finland, UK Austria, Denm ark, 0.6 N th l d $0 $10 $20 $30 $40 $50 $60 $70 $80
The EU ETS: A Global Prototype? Pre-existing institutions made it a lot easier for the EU ETS But technical competence, politically astute implementation & accident were important Do we build the global institutions, or can they arise out of bottom-up, bilateral deals? Challenges are not unique to trading regimes