The EU emissions trading system (EU ETS) was launched in 2005 as the world’s first international company-level ‘cap-and trade’ system for reducing emissions of carbon dioxide (CO2) cost-effectively. This section covers the first two trading periods of the EU ETS, the rules for which differed in important respects from those of the current third trading period.
The first and second trading periods were governed by the 2003 Emissions Trading Directive as amended by the 2004 ‘Linking Directive’, which recognised the use in the EU ETS of a limited amount of emission credits from the Kyoto Protocol’s project mechanisms, the Clean Development Mechanism (CDM) and Joint Implementation (JI) mechanism.
In the first two phases, the cap on allowances was set at national level through national allocation plans (NAPs).
Phase one was a three-year pilot period of ‘learning by doing’ to prepare for phase two, when the EU ETS would need to function effectively to help ensure the EU and Member States met their Kyoto Protocol emission targets.
In phase one the EU ETS covered only CO2 emissions from power generators and energy-intensive industrial sectors. Almost all allowances were given to businesses free of charge. The penalty for non-compliance was €40 per tonne.
Phase one succeeded in establishing a price for carbon, free trade in emission allowances across the EU and the necessary infrastructure for monitoring, reporting and verifying actual emissions from the businesses covered.
In the absence of reliable emissions data, phase one caps were set on the basis of best guesses. In practice, the total allocation of EU ETS allowances exceeded demand by a sizeable margin and in 2007 the price of phase one allowances fell to zero (phase one allowances could not be banked for use in phase two).
The generation of veriﬁed annual emissions data from the installations participating in the pilot phase ﬁlled this important information gap and created a solid basis for setting national caps for phase two.
The three EEA-EFTA states – Iceland, Liechtenstein and Norway – joined the EU ETS at the start of phase two. At the same time, the scope of the system was marginally widened through the inclusion of nitrous oxide emissions from the production of nitric acid by a number of Member States.
The proportion of general allowances given away for free fell slightly to at least 90%. The penalty for non-compliance was increased to €100 per tonne. Several Member States held auctions during phase two.
Businesses were allowed to buy CDM and JI credits (except for those from nuclear facilities and agricultural and forestry activities) totalling around 1.4 billion tonnes of CO2-equivalent. This possibility enlarged the range of cost-effective emission mitigation options available to businesses. The EU ETS became the biggest source of demand for such credits, making it the main driver of the international carbon market and the main provider of clean energy investment in developing countries and economies in transition.
Phase two coincided with the first commitment period of the Kyoto Protocol, which required the EU and Member States to meet their emission targets.
On the basis of the veriﬁed emissions reported during phase one, the European Commission tightened the cap by cutting the total volume of emission allowances by some 6.5% compared with the 2005 level. However, the economic crisis that began in late 2008 depressed emissions, and thus demand for allowances, by an even greater margin. This led to a large and growing surplus of unused allowances and credits which weighed heavily on the carbon price throughout the second trading period.
The aviation sector was brought into the EU ETS on 1 January 2012 through legislation adopted in 2008. For 2012 the cap on aviation allowances was 3% lower than aviation emissions in the 2004-2006 reference period. In order to strengthen momentum towards agreement on a global market-based measure to address aviation emissions, however, the Commission in November 2012 made a proposal to defer the application of the EU ETS to flights into and out of Europe during 2012.
From the launch of the EU ETS in January 2005, national registries ensured the accurate accounting of all allowances issued. This task was taken over during 2012 by the single Union registry operated by the Commission, which also covers the three EEA-EFTA states. From 2012 the Union registry includes accounts for aircraft operators.
During phase two the national and Union registries recorded:
The Community Independent Transaction Log (CITL) automatically checked, recorded and authorised all transactions that took place between accounts in national registries. When the Union registry was fully activitated, the CITL was succeeded by the European Union Transaction Log (EUTL), which performs the same functions today.
The market in emission allowances developed strongly from the start. In 2005, the EU ETS's first year of operation, some 321 million allowances, with a value of US $7.9 billion, were traded. Trading volume rose to 1.1 billion allowances in 2006 and 2.1 billion (worth $49.1 billion) in 2007, according to the World Bank’s annual Carbon Market Reports.
The EU ETS remained the main driver of the international carbon market during phase two. Trading volume in EU allowances jumped from 3.1 billion in 2008 to 6.3 billion in 2009 and 6.8 billion in 2010 (when EU allowances accounted for 84% of the value of the total carbon market). In 2011, 7.9 billion allowances were traded, with a value of $147.9 billion.
Daily trading volumes exceeded 40 million allowances in early 2009, touched 60 million in early 2011 and exceeded 70 million in mid-2011, data compiled by Bloomberg New Energy Finance and London Energy Brokers Association show.
Daily trading volumes in EU emission allowances (in millions)
Source: Bloomberg New Energy Finance and London Energy Brokers Association. Data from six exchanges are used in this assessment: Bluenext, Climex, European Energy Exchange, Green Exchange, Intercontinental Exchange and Nord Pool.