European emissions trading and the flexible mechanisms of the Kyoto Protocol
Source: FutureCamp GmbH, July 2007

Note: Futher information about EU ETS and CDM is available by clicking on the relevant options in the menu at the lefthand side of this page.

Only countries and not companies are obligated to reduce their emissions under Kyoto Protocol and EU Burden Sharing Agreement. From 2005 on, EU emissions trading determined reduction obligations relevant for installations, which on country level are further passed into various installations. The amount of the allocated emission credits depends on the type of an industrial sector and the size of the installation, respectively the amount of emitted GHG (Greenhouse Gases).

The basic idea behind emissions trading is plain and simple: For each installation, a total amount of CO₂ allowances is defined for the entire period. The state issues a predefined amount of tradable certificates ("allowances") to the companies, where each certificate authorizes to emit one ton of CO₂ during a specified period (e.g. 2005 to 2007 or 2008 to 2012). The state gradually reduces the amount of allocated certificates, therewith reducing the emission of climate relevant gases.

Altogether for the first crediting period 2005-2007 in 25 European Union member states there were allocated 2.1 billion t CO₂ per year. Additionally installations from Bulgaria and Romania from 2007 on are also covered by the scheme, which may bring further 153.8 million t CO₂ per year to the scheme, if the European Commission in the submitted form accepts both plans.

Regarding the so far allocated emission rights, almost all member states allocated them 100 % free of cost. Allocation was based on historical emission data as well as on benchmarking. There are relevant country-specific differences particularly regarding the design of new entry reserves and special allocation rules (e.g. early action).

Currently the National Allocation Plans for the second crediting period are in the approval process, where so far (25.06.07) 22 NAPs were already adopted. In most cases the assigned amounts needed to be shortened in regard to the amount proposed in notified drafts, as well as the maximum overall amount of the Kyoto project credits (CERs and ERUs) to be used by operators for compliance purposes.

EU Emissions Trading enables the companies to participate in climate protection projects within two flexible mechanisms: Clean Development Mechanism (CDM) and Joint Implementation (JI).

The basic principles are determined by the EU Linking Directive, Directive 2004/101/EC (27 October 2004), which serves as an amendment to the Emission Trading Directive with the objective of incorporation of the climate protection projects, JI and CDM, into European Emission Trading.

By means of the Clean Development Mechanism, projects in developing countries that contribute to emission reductions (e.g., replacement of obsolete power plants in Africa) receive financial support. A project developer can be a company or a country and the project can be either placed in industrialized and/or in the developing country. Project developers, by generation of emission reduction credits, can either use the credits for their own emission-reduction obligations or sell such certificates on the market.

The first CDM project was acknowledged at the end 2004, and there were over 700 projects registered by June 2007.

Joint Implementation (JI) is a similar mechanism, however it is applied to projects within industrialized countries. The emission reductions generated by JI also can be used to comply with own compliances or can be sold.

As mentioned above, JI projects can be already implemented, however the emission credits can only be generated from 2008 onwards.

Emission trading offers the companies with emission obligations a lot of flexibility with regard to CO₂ avoidance they can decide how, where, when and whether they wish to implement CO₂ reduction measures. In order not to exceed their own emission budgets (caps), they can reduce the CO₂ emissions in their own installations, as well as they can purchase allowances on the market or generate certificates by implementing climate projects. Ultimately, the decision will extensively depend on the cost-effectiveness of the avoidance option, although other factors also have considerable impact, e.g. risk management and marketing aspects.

Any company that is able to reduce its emissions so cost effectively that a credit surplus remains can sell the excess certificates. On the other hand, it might make sense for a company to purchase additional credits instead of reducing its own emissions, especially if the additional allowances would cost less than the emission reduction of the same amount within the company.

The cost of allowances depends on the ratio of the credits supply and demand on the market. Trading can take place bilaterally or on the market. In all cases each transaction is passed to account in the emissions register of the participating countries and companies.