The European emissions trade directive

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The EU emission trading approach is outlined in a European Commission directive now well on its way through the legislative process, Com(2001)581. It covers six greenhouse-gases with CO2 being the most important. In December, the Council of Ministers approved the directive in principle, leaving a series of important details to be sorted out with the EU parliament. It seems there will be no going back and the first phase is to start in 2005 and last until 2008.

Under phase one, individual European governments will issue emissions allowances, for free, to all the industries and activities defined by the directive. Combined, they represent 46% of all the EU's CO2 emissions. The penalty for non compliance will be EUR 40/tonne CO2. In phase two (2008- 2012), which runs parallel to the budget period of the Kyoto protocol, the further reduction of emission allowances has yet to be defined, but the penalty will be EUR 100/tonne CO2 for non compliance.

All installations subject to the directive will need a permit in which the technical details of the installation are defined and the way in which the emissions are measured. Installations need to hold allowances which entitle the holder to emit a corresponding quantity of CO2. In the initial phase, member states will allocate most probably 100% of allowances to participating installations free of charge. There are plans to auction off 10% of allowances in 2005.

The exact method of allocation will be defined by each member state. Most probably a reference date, such as 2002, will be chosen as basis. Whether the full emission volume of the reference year is allocated or just part of it is still open. Between 2005 and 2007, the yearly allowances will remain constant. The approach within the second period is less clear. Whether a (reduced) fixed emission volume per year is chosen or a volume which decreases year by year is still to be decided.

Allowances are tradable. A plant is entitled to emit more than its allocated allowances when it finds another company which uses less allowances than allocated and is, therefore, able to sell its excess allowances. This is the key element of ET: emissions reductions will then be made wherever in the European community it is cheapest to make them.

The Commission expects allowance prices between EUR 20 and EUR 30 for a tonne of CO2; other market players like the Swiss-Finnish Electrowatt-Ekono AG expect a price range of EUR 10-20/tonne of CO2, and the Danish government says it will use EUR 16/tonne of CO2 as a marker price. First forwards on EU allowances are trading between EUR 5-7/tonne CO2. The upper price limit is defined by the penalties which apply in case of non-compliance.

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