CO2 Emissions - Moving from an Environmental Issue to an Economic Variable and the Implications for the German Chemical Businesses

TABLE OF CONTENTS

PREFACE

ABBREVIATIONS AND GLOSSARY

1 INTRODUCTION

2 PROVISION OF POLICY CONTEXT
2.1 Kyoto Protocol
2.2 Kyoto’s market-based mechanisms
2.2.1 Emissions Trading
2.2.2 Clean Development Mechanism (CDM) and Joint Implementation (JI)

3 EMISSIONS TRADING
3.1 EU ETS – EU Emissions Trading Scheme
3.2 How CDM and JI fit in
3.3 How do businesses get involved?
3.4 Implications for German chemical businesses
3.5 Status

4 NATIONAL ALLOCATION PLANS (NAP)
4.1 NAP Details
4.1.1 Reduction or Compliance Factor (CF)
4.1.2 Allocations Methods for existing installations
4.1.3 Sector differentiation
4.1.4 New Entrants
4.1.5 Closure rules
4.1.6 Reserve
4.1.7 Special treatment
4.1.8 Early action
4.1.9 Special rules for CHP installations
4.2 Critics and controversies of the German NAP
4.2.1 Distortions generated by allocations methods for existing installations
4.2.2 Critics on sector differentiation
4.2.3 Critics on new entrants
4.2.4 Critics on closure rules
4.2.5 Critics on reserve
4.2.6 Critics on special treatment
4.2.7 Critics on early action
4.2.8 Critics on special rules for CHP installations
4.2.9 Other distortions and critics

5 DEVELOPMENTS ON THE EU TRADING PLATFORMS BEING SET UP FOR CO2 CREDITS
5.1 Introduction to the EU ETS trading platforms
5.2 Legal nature of allowances
5.3 Connection to other markets
5.4 Lessons learned by the EU ETS experience
5.5 Implications for German chemical businesses

6 RELATIONSHIP BETWEEN CO2 EMISSIONS TRADING AND THE ENERGY (ELECTRICITY) PRICES
6.1 Historical evidence
6.2 Expected future development
6.3 Implications for German chemical businesses

7 INFLUENCE OF THE EMISSION CREDITS ON INVESTMENT DECISIONS
7.1 Implementation of new technologies based on CO2 allowances
7.2 Shareholder capital investment
7.3 Implications for German chemical businesses, which one stands to gain or lose in terms of new investments?

8 THE CONSEQUENCES OF THE US NOT PARTICIPATING IN THE KYOTO AGREEMENT
8.1 Will the EU ETS succeed or fail without the US?
8.2 Consequences for the German chemical industry

9 CONTROVERSIES INHERENT IN THE SYSTEM
9.1 Controversies discovered

10 CONCLUSIONS AND RECOMMENDATIONS
10.1 On track with its emissions reductions?
10.2 Conclusions
10.3 What is expected from the future?
10.4 General Recommendations
10.5 Recommendations to German chemical businesses
10.6 A short reflexion

11 APPENDICES
11.1 Appendix A – Project Proposal
11.2 Appendix B - Figures
11.3 Appendix C - Tables
11.4 Appendix D: NAP I (& II) of GERMANY
11.4.1 Macro-level plan - allocation quantities
11.4.2 Micro-level plan (allocation rules and criteria)
11.5 Appendix E – Questionnaire on CO2 emissions trading

12 BIBLIOGRAPHY

PREFACE

The topic of this management project was selected due to several reasons. First, the CO2 emissions trading scheme in Europe is very new and not much is known about its implications and consequences yet. Interest by companies, investors and the public in general is growing quickly. Second, knowledge about emissions trading can be useful to any firm, thus it was considered to be valuable asset to acquire. Last but not least, how an environmental issue is related to economic decisions and becomes part of firms’ overall corporate planning captured the attention of the author.

The biggest difficulty encountered was the lack of information and contact to experts in the beginning of the project. Little literature on the progress of the EU ETS exists, since it started its operation only a few months ago, on January 1, 2005. Most of the information had to be drawn from news articles published on the internet or reports issued by authorities.

Later on, the author met Patrick Graichen who works for the Bundesministerium für Umwelt, Naturschutz und Reaktorensicherheit (German Environmental Ministry) and was involved with setting up the first National Allocation Plan (NAP) for Germany and Jürgen Nolde who is involved in implementing the policy in a German chemical company and also participated in several national and international forums related to the topic. Both of them could provide the author with useful insights and background information during the interviews conducted.

As the author started getting acquainted with the subject, it was easier to find and understand the relevant information. In addition, most of the useful information only started to become available after the 30th of June, when the German NAP II for the second period (2008-2012) was published. This made the time for writing the report rather short. In fact, emissions trading in Europe is still developing and ongoing as this management project is being written.

Additional information was gathered by a survey conducted by the author. This survey consisted of a questionnaire sent out by email to various representatives of the German chemical industry involved with dealing with CO2 emissions. The idea was to discover the implications that the EU ETS poses on the German chemical industry .

The content of the management project also deviated somewhat from what was the original intention. This work was thought to focus on three of the biggest CO2 emitting countries, Germany, France and Spain, covering three different scenarios. The three of them together contribute significantly to the total share in EU allowances (37.9%), but have quite a different Kyoto-target. While in Germany a major reduction is targeted (-21%), France is neutral (0%) and Spain is allowed to increase its CO2 emissions by +15% compared to 1990 levels (see Table 11-1). However, when these guidelines were established in 1994, the current emissions at that time vs. 1990 were –16% for Germany, +30% for Spain and somewhat over the target for France (Graichen 2006).

Therefore comparing the 1994 versus 1990 emissions and the Kyoto-targets, the conclusion was that the large majority of the EU-15 countries do need to reduce CO2 emissions to achieve their Kyoto-targets. Therefore only one scenario became relevant; that of having to reduce emissions. Thus the report focuses mainly on Germany, since this scenario is in principal similar to the other countries.

In addition, the German chemical industry was analysed under a different point of view than initially thought. There is no such ‘chemical sector’ that is specifically addressed by the EU ETS. The chemical industry is covered depending on the type and scale of the polluting installations it has on site and can therefore belong to and be treated as two different sectors (industrial and energy).

Also the structure of the report deviated somewhat from the project proposal submitted end of April 2006. Investments and new technologies were found to be very closely related and were therefore treated in a single chapter; whereas for the details of the National Allocation Plans which are important for understanding the controversies of the system, a new chapter was created.

All in all, the CO2 emissions trading in Europe was indeed found to be a very interesting topic to deal with, with all its controversies and pitfalls, and potentials to develop. CO2 emissions trading in Europe is just at its start and has a rather uncertain but hopefully bright future. It was great fun to work on this report while a large knowledge was acquired in the process.

The author would like to thank Patrick Graichen and especially Jürgen Nolde for the time they took for the interviews and for the information provided on the topic.

Peter Roberts, the author’s supervisor, deserves the author’s sincere appreciation for all the support, useful guidance, and the thorough and detailed feedback provided during the development of the report. This guidance was very much appreciated.

LIST OF TABLES

Table 2-1: The Kyoto Protocol

Table 2-2: Comparison between IET and the EU ETS (Schafhausen 2006a)

Table 2-3: Timeframe on NAP II (Eutech 2006)

Table 3-1: Five ways in which the EU ETS differs from previous emission trading systems (Grubb and Neuhoff 2006)

Table 3-2: Emissions Budget for both EU ETS periods for Germany (Schafhausen 2006b)

Table 3-3: Application of flexible Kyoto mechanisms in Germany (Schafhausen 2006b)

Table 3-4: Effect on marginal costs; Results, Effect of EU ETS and UK policy measures, percentage change (based on Smale et al 2006)

Table 3-5: Installations per sector in Germany (Schafhausen 2006c). Only installations with emissions higher than 25000 tons of CO2 per year are considered.

Table 3-6: Is the German industry reducing emissions or rebalancing using the NAP? Based on first data obtained relevant to the first trading period (2005-2007) (Schafhausen 2006c)

Table 4-1: Total allocation and scope of application (DEHSt 2005b)

Table 4-2: Allocation rules and criteria for Germany (DEHSt 2005b, BMU 2004 and BMU 2006b)

Table 4-3: Effect of allocation on power sectors incumbent (adapted from Neuhoff et al 2006)

Table 5-1: Volumes transacted and corresponding values on the main carbon allowance markets for the EU ETS, NSW (New South Wales), CCX (Chicago Climate Exchange) and the UK ETS (Capoor and Ambrosi 2006)

Table 5-2: Overview of the different European CO2 trading platforms and their associated costs (CO2-Handel.de 2006b)

Table 7-1: Calculation of compliance costs (Reinaud 2004)

Table 7-2: Characteristics of winners in terms of new investments / innovation

Table 7-3: Characteristics of losers in terms of new investments / innovation 62 not ratifying the Kyoto Protocol. (adapted from Carraro 2002)

Table 8-2: Consequences for the German chemical industry because of the US not participating in the Kyoto Protocol

Table 9-1: Summary of the German NAP controversies

Table 10-1: General recommendations (EEA 2006 and Schafhausen 2006c)

Table 10-2: Recommendations given to the German chemical businesses

Table 11-1: Summary information per Member State for the 2005-2007 trading period (indicative table based on national allocation plans approved by the European Commission) (European Union 2006).

Table 11-2: Historic and estimated GDP growth rates and carbon intensity trends (European Commission 2003b). Historically (1990-2000) carbon intensity reductions have balanced or even outweighed economic growth, which means that GHG emissions remained stable or declined. This trend is likely to continue (European Commission 2005)

Table 11-3: Key indicators for the EU Energy system. Index (1990 = 100) (European Commission 2003a)

Table 11-4: Auctioning in the EU ETS – key findings (Hepburn et al 2006)

Table 11-5: Calculation of response rate from the questionnaire

LIST OF FIGURES

Figure 3-1: ETS in Germany, a four level approach (Matthes 2004)

Figure 3-2: Number of allocations and total allocations according to activity (adapted from DEHSt 2005a)

Figure 3-3: The (German) reality of the ETS. Small and large installations (Matthes 2004)

Figure 3-4: Other sectors to be included in the EU ET, response by all stakeholders (McKinsey and Ecofys 2005)

Figure 4-1: Importance of EU ETS topics (McKinsey and Ecofys 2005)

Figure 5-1: Breakdown of CDM and JI credits purchases for compliance along the nature of buyer (volume in million tons CO2) (Capoor and Ambrosi 2006)

Figure 6-1: CO2 price and fuel-switch theory (Mysterud 2005)

Figure 6-2: Marginal cost (price) duration curve. Pass-through of CO2 opportunity costs for different load periods (at a price of € 20/tCO2) (Sijm et al 2006)

Figure 7-1: EU ETS, architecture and actors influencing innovation potential (Pontoglio 2006)

Figure 7-2: EU ETS impact on innovation (McKinsey & Ecofys 2005)

Figure 7-3: Energy industry: regression of SAM Sustainability Score against Return on Equity (DJSI Newsletter 2005)

Figure 7-4: Price-in of CO2 in current (left-hand side) and future (right-hand side) marginal pricing decisions according to companies (McKinsey and Ecofys 2005)

Figure 7-5: Long-term decision making affected by the EU ETS by companies (McKinsey and Ecofys 2005)

Figure 10-1: Uncertainty of emission projections from installations covered by the EU ETS. The chart shows best estimates of total CO2 emissions from EU ETS sectors in 2003 and 2005 (connected by dotted line), compared to allocations (flat line 2005– 2007), and two estimates of 2005 emissions provided by market analysts in the months leading up to the release of the verified emission data. The shaded area indicates a plausible range of uncertainty in emission projections for the phase I period at the time of initial allocation decisions (Grubb and Neuhoff 2006)

Figure 11-1 Participation in the Kyoto Protocol, where green indicates countries that have signed and ratified the treaty and yellow stands for states that have signed and hope to ratify the treaty. Australia and the United States have signed but, currently, decline to ratify it (in red). None participating countries are indicated in grey (wikipedia 2006)

Figure 11-2: Carbon emissions from various global regions during the period 1800-2000 (wikipedia 2006)

Figure 11-3: Overview of the German CO2 emissions trading regulation (wikipedia 2006)

Figure 11-4: Off-peak power prices versus fuel/CO2 costs in Germany (year-ahead, 2004-2005) (Sijm et al 2006)

Figure 11-5: Coal price corrected price increase for electricity (3-4 pm) depicted as dots and their 40day moving average (volatile dark blue line) and the evolution of the CO2 price (pink line). Price increase of electricity (3-4pm) for each day relative to the pre- ETS year 2004 (Sijm et al 2006)

Figure 11-6: EU ETS windfall profits – conceptual framework (Frontier Economics 2006). This framework allows for the possibility that the ETS alters the merit order, which then would have substantial changes in the volume of generation by each plant and hence different quantities of fuel used as well as the different quantise sold by each generator, with and without the ETS. However, the merit order has not been affected by the ETS so far and therefore the shaded area may be ignored

Figure 11-7: If the allocation of allowances (the vertical lines) is stringent, more abatement will be needed and relatively expensive abatement projects will be worthwhile (shown through the marginal cost of abatement across participating sectors as a whole). As a consequence, the demand for allowances (and their price) will be higher than if the governments are generous in their allocation of allowances. The point where the marginal abatement cost curve of all participating firms intersects the vertical line of the stock of allowances determines the equilibrium price of an allowance (Frontier Economics 2006).

Figure 11-8: Carbon intensity improvement by sector in EU (% difference from 1990 levels) (European Commission 2003a)

Figure 11-9: Questionnaire responses I

Figure 11-10: Questionnaire responses II

Figure 11-11: Questionnaire responses III

Figure 11-12: Questionnaire responses IV

ABBREVIATIONS AND GLOSSARY

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1 INTRODUCTION

Under the Kyoto Protocol, the European Union (EU) has introduced an Emissions Trading Scheme (ETS) in January 2005 in order to set economic limits to an environmental concern, global warming. Under this Agreement, the EU has committed reducing its CO2 emissions by 8% below the 1990 levels.

Since then, 12.000 large industrial plants in the EU have been able to buy and sell permits to release carbon dioxide (CO2) into the atmosphere. Therefore trading with CO2 emissions has become another economical variable that is being considered by business now.

At the moment there is still a considerable amount of uncertainty about long-term development of the ETS and its effects on business.

This report intends to provide an overview on the current situation, focus on the German chemical industry, how it is affected in the short term and what can be expected from the future.

In more detail, the following issues will be examined in the various chapters:

After covering the policy context, emissions trading and national allocation plans in chapters 2, 3 and 4, the behaviour of the developments on the trading platforms being set up for CO2 credits in Europe is investigated. Do they behave like the stock markets? Implications for German chemical industries are discussed in chapter 5.

The relationship between CO2 emissions trading and the energy (electricity) prices and energy availability / supply is covered in chapter 6.

Emission credits are influencing investment decisions around the world. What kind of chemical business sector in Germany stands to gain or lose in terms of new investments is analysed in chapter 7.

Possible consequences of the US as a big industrial country and the largest contributor of CO2 emissions not participating in the Kyoto Agreement will also be examined; this in chapter 8.

The ETS is very complex and has consequences on many different issues which in return are interrelated. This can lead to controversies that are highlighted as being discovered during the course of the report, see chapters 4 and 9.

In the end, the thorough investigation on the subject of CO2 emissions trading leads to some guidelines and recommendation for the chemical business sector within Germany, covered in chapter 10.

2 PROVISION OF POLICY CONTEXT

2.1 Kyoto Protocol

The United Nations Framework Convention on Climate Change (UNFCCC)¹ and its Kyoto Protocol provide the international framework for combating climate change. Building on the UNFCCC framework, the Protocol sets legally binding limits on greenhouse gas emissions. The objective is "the stabilisation of greenhouse gas (GHG) concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system" (UNFCCC 1994).

The Kyoto Protocol is underwritten by governments and is governed by global legislation enacted under the UN’s aegis. It now covers more than 163 countries globally and over 65% of global GHG emissions (Table 2-1).

Governments are separated into two general categories: developed countries, referred to as Annex I countries (who have accepted strict GHG emission reduction obligations); and developing countries, referred to as Non-Annex I countries (who have no GHG emission reduction obligations). More details on participating countries in

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Figure 11-1.

Industrialised countries are required to reduce their emissions of six greenhouse gases [carbon dioxide (CO2), which is the most important one, methane (CH4), nitrous oxide (N20), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulphur hexafluoride (SF6)] by around 5% below the 1990 level during the first Kyoto Protocol ‘commitment period’ from 2008 to 2012. The EU-15 reduction target as a group is at 8% below 1990 levels during the first commitment period. This target is shared between the 15 Member States (MS) under a legally binding burden-sharing agreement, which sets an individual emissions target for each MS (see Table 11-1). If the group doesn’t comply with the target, then each MS will be held to its target under the EU's burden-sharing agreement, and the EU as a whole will be in non-compliance.

Parties who fail to meet their emissions target, are required it to make up the difference in the second commitment period (after 2012), with an additional 30% penalty. They must also develop a compliance action plan, setting out the actions that it will take to meet the target and the timetable for doing so. In addition, their eligibility to ‘sell’ under the Protocol’s international emissions trading system will be suspended.

When setting each country’s emissions target and the number of allowances permitted, the actual emissions (in 1994) were compared to the baseline (1990). In addition CO2 emissions per capita² and the GDP³ (Table 11-2) of each country were considered (Graichen 2006).

Annex 2 of the EU NAP II guidelines (European Commission 2005) establishes that:

“allowances shall be consistent with the assessments of actual and projected progress towards fulfilling the MS commitments” and “with the (technical) potential of activities covered by the scheme”.

Therefore comparing the 1994 versus 1990 emissions and the Kyoto-targets, the conclusion is that the large majority of the EU15 country’s needs to reduce its CO2 emissions to achieve the Kyoto-targets.

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Table 2-1: The Kyoto Protocol

2.2 Kyoto’s market-based mechanisms

The Kyoto Protocol envisages three innovative market-based mechanisms, known as the Kyoto flexible mechanisms: Emissions Trading between governments with Kyoto targets, the Clean Development Mechanism and Joint Implementation.

These allow industrialised countries to meet their targets cost-effectively by trading emission allowances between themselves and gaining credits for emission-curbing projects abroad. The rationale behind these three mechanisms is that greenhouse gas (GHG) emissions are a global problem and that the place where reductions are achieved is irrelevant in scientific terms. In this way, reductions can be made where costs are lowest.

The ETS was introduced in order to attach a cost to CO2 emissions and thus reduce the level of emissions to a desired target. In order to make an environmental issue operational it was tied to economics which is much more effective for companies. CDM and JIs were introduced later for three main reasons:

- The cost of complying with Kyoto is prohibitive for many Annex I countries (especially those countries with highly efficient, low GHG polluting industries, and high prevailing environmental standards). Certain MS otherwise would not be able to comply. Kyoto therefore allows these countries to purchase Carbon Credits instead of reducing GHG emissions domestically; and,
- This is seen as a means of encouraging Non-Annex I developing economies to reduce GHG emissions since doing so is now economically viable because of the sale of Carbon Credits (wikipedia 2006).
- In addition it is argued that it doesn’t matter where CO2 emissions are reduced, all of them contribute to global warming.

2.2.1 Emissions Trading

Kyoto enables a group of several Annex I countries to join together to create a so-called ‘bubble’, or a cluster of countries that is given an overall emissions cap and is treated as a single entity for compliance purposes. The EU elected to be treated as such a group, and created the EU Emissions Trading Scheme (ETS) as a market-within-a-market. The ETS’s currency is an EUA (EU Allowance). All 25 EU Member States (MS) are covered and it is the first multi-national emissions trading scheme in the world.

The differences between the International Emissions Trading and the EU ETS can be found in the comparison Table 2-2 unten:

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Table 2-2: Comparison between IET and the EU ETS (Schafhausen 2006a)

For the EU ETS, the first trading period is between 2005 and 2007, although a forward market has existed since 2003. This first phase is considered more of an experimental and learning phase. The second EU ETS trading period ranges from 2008-2012 and coincides with the first Kyoto commitment period.

Each country with Kyoto targets is assigned a fixed maximum amount of emissions that it may emit over a commitment period to comply with its target. In either system, trading is based on the principal that the party (country or company) emitting less can sell the unused quota to others that emit more. This allows reductions to take place where they are cheapest, reducing compliance costs.

Under the EU ETS, the Commission has approved the allocation of about 6.57 billion allowances to more than 11,400 installations for the first trading period, 2005 to 2007. Almost a quarter of the allowances are allocated to German installations (499 million/year). The information on allowances for second trading period will become available by the end of 2006 after the European Commission has reviewed and approved all National Allocation Plans (NAP) (see Table 2-3).

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Table 2-3: Timeframe on NAP II (Eutech 2006)

2.2.2 Clean Development Mechanism (CDM) and Joint Implementation (JI)

Next to the EU ETS, the most important sources of credits are the Clean Development Mechanism (CDM) and the Joint Implementation (JI) mechanism. Both of these allow the creation of new Carbon Credits by developing emission reduction projects in Non-Annex I countries (in the case of CDM) and in Annex I countries (in the case of JI). CDM projects produce Certified Emission Reductions (CERs), and JI projects produce Emission Reduction Units (ERUs). CERs are valid for meeting EU ETS obligations as of 2005, but only if constructed in 2000 or later (Graichen 2006), and ERUs will become similarly valid from 2008 (wikipedia 2006).

Both, CDM and JI allow industrialised countries to achieve part of their emission reduction commitments by conducting emission-reducing projects abroad and counting the reductions achieved toward their own commitments.

The CDM and JI mechanisms are thought to directly support and promote sustainable development in countries that need it most⁵. CDM projects provide an opportunity for channelling private capital and technology investment from developed to developing countries. The two mechanisms are expected to lower compliance costs, transfer advanced technologies to developing countries and foster cooperation between countries with Kyoto targets.

A condition for the issue of credits in respect of the reductions achieved is that the projects result in real, measurable and long-term climate change benefits that are additional to what would have happened without the projects. Therefore, under the aegis of the UN, Kyoto established the Vienna-based Clean Development Mechanism Executive Board to assess and approve projects (‘CDM Projects’) in Non-Annex I economies prior to awarding CERs, not that business-as-usual (BAU) projects are awarded with credits.

NGOs however consider that emissions should be reduced in the place where they are produced and not where they are cheapest⁶ and argue against CDM and JI projects (CAN 2006).

3 EMISSIONS TRADING

3.1 EU ETS – EU Emissions Trading Scheme

Emissions trading systems as economic incentives to address environmental concerns are complementary to regulations and control systems. Emissions-trading as an economic concept has already existed for several decades and has minimised abatement costs in various pollution reduction regimes (CO2e.com 2001). Built on this experience and many years of economic research (Grubb and Neuhoff 2006) the EU ETS sets an unprecedented landmark by being the world’s largest international trading system in place today in terms of economic coverage.

The EU ETS differentiates itself from the former schemes in various ways; the most important ones are listed in Table 3-1 unten. (Distortions resulting thereof are treated separately in sections 4.2 and 9).

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Table 3-1: Five ways in which the EU ETS differs from previous emission trading systems (Grubb and Neuhoff 2006)

The EU ETS marks a paradigm shift in European environmental policies engaging with the private sector in searching for the most cost-effective solutions to a global problem (Dimas 2006 and European Union 2006).

Each country has its own competent authorities for setting the guidelines and monitoring the emissions trading. In Germany, the climate change policy is the responsibility of the BMU (Federal Ministry of the Environment, Nature Conservation and Nuclear Safety). The BMU sets out the NAPs, laws and regulations needed for implementation. In addition, the BMU provides the technical and legal oversight for the German emissions trading authority DEHSt (Deutsche Emissionshandelsstelle). Tasks of the DEHSt include the allocation and issuance of emissions allowances, supervision and oversight, maintaining the German national register as well as reporting at national and international level. Under the TEHG (German Greenhouse Gas Emissions Allowance Trading Act), the licensing and monitoring of emissions from installations subject to emissions reduction shall be carried out by the authorities designated in the various laws of the individual federal states (Schafhausen 2006c). (Also see Figure 11-3)

National targets are listed in the individual NAPs which also include the targets for the individual installations. Under the scheme, companies that emit less than the number of allowances they receive can sell the surplus to companies that have problems staying within their limits, or for which emissions reduction measures are more expensive than buying allowances on the market. Any company may also increase its emissions above the level of its allowances by acquiring more allowances from the market. By setting relatively high fines⁷, the EU hopes to encourage moving to lower GHG emissions.

As shown in the table unten, CO2 emissions covered under the ETS amount almost 60% of the total CO2 emitted.

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Table 3-2: Emissions Budget for both EU ETS periods for Germany (Schafhausen 2006b)

All areas need to reduce emissions to achieve the Kyoto target, not only the industry sectors covered by the EU ETS.

3.2 How CDM and JI fit in

The EU Emissions Trading Scheme is linked to CDM and JI as discussed in 2.2.2. Several Annex I countries including Germany, are actively promoting government carbon funds and supporting multilateral carbon funds intent on purchasing Carbon Credits from Non-Annex I countries. These government organisations are working closely with their major utility, energy, oil & gas and chemicals conglomerates to try to acquire as many GHG Certificates as cheaply as possible (wikipedia 2006).

The objectives of the Annex I and Non-Annex I countries are quite different. The former entities want Carbon Credits as cheaply as possible, whilst the latter entities want to maximise the value of Carbon Credits generated from their domestic GHG Projects (wikipedia 2006). Precisely this is part of trading, and how demand and supply will drive prices, more in chapter 5.

For multinational firms the use of CDM and JI comes in very useful. Any reduction performed in any one country can be shifted towards an installation in other countries up to a certain percentage fixed in the NAPs (provided that they are both covered by the Kyoto protocol⁸). This allows international companies to transfer credits among installations to wherever it is economically more sound.

In this respect, the flexible Kyoto mechanisms are working. When considering however how many companies have applied for either CDM or JI projects, then the number is still very small. Approved so far are only 2 out of 112 projects (see table unten). From the survey conducted by the author on the German chemical businesses (section 11.5), none of the respondents has filed for such a project, but half of them possibly consider getting involved with the flexible mechanisms over the next 5 years.

Apart from gaining experience it might indicate that in the medium term (5-10 years) companies will find it more difficult to reduce emissions ‘at home’, and therefore will look to take advantage of investing abroad, usually at a much lower cost.

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Table 3-3: Application of flexible Kyoto mechanisms in Germany (Schafhausen 2006b)

3.3 How do businesses get involved?

Under the EU scheme, EU Member States have set limits on CO2 emissions almost 11,500 energy-intensive plants (steel factories, power plants, oil refineries, paper mills, and glass and cement installations), which together account for almost half of the EU's CO2 emissions. They have done this by issuing emission allowances to the companies, which determine how much CO2 the plants are allowed to emit during a first 2005-2007 trading period (European Union 2006)⁹. Results for the second round of allocations, for the 2008-2012 trading period, will become available towards the end of 2006 (Table 2-3).

[...]

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¹ All abbreviations and technical expressions can be found in the glossary on page xi.

² Higher emissions per capita suggested the application of a stricter target

³ The higher the GDP, the lower the emissions should be because newer technology should be affortable and employed. Also see Table 11-3 for future developments

⁴ There are several reasons for focussing only on CO2 emissions in the EU ETS. First, it is the most important one in terms of percentage contributed. Second, the additional bureaucracy required for including all GHG was considered to be too large to justify the benefits associated. Third, the main affected parties would be the chemical industry which seem to have lobbied strongly and last, the EU ETS was based on a consensus approach where so far only for the CO2 was agreed upon.

⁵ However, the carbon market however still largely bypasses Africa as well as countries of Central Asia and the Pacific (Capoor 2006).

⁶ The cost of reducing CO2 emissions is $ 1 to 4 / tn of CO2 in developing countries versus $ 15 to 100 / tn of CO2 in Annex I countries. (The World Bank 2006)

⁷ MS that fail to meet their obligations are subject to fines starting at €40/ton of CO2 in 2005, and rising to €100/ton in 2008. Slightly higher compared to the cost of reducing CO2 levels (€15 to € 100 per ton of CO2 emitted)

⁸ The German NAP II establishes a maximum of 12% of total allowances to be originated from the linking mechanisms

⁹ One allowance is valid for one ton of CO2 emissions