IEEJ: November 2004

Outline of the EU Emissions Trading Scheme and Analysisof the Impact of Its Introduction♦
Tadashi Ishizaka*
Introduction
European countries centered around the EU have been implementing various measures against global warming for
more than a decade, such as carbon tax, self-action, voluntary agreements, use of the Kyoto Mechanism, and emissions
trading. In Japan, additional policies and measures are also under consideration toward review of the Guideline for Measures
to Prevent Global Warming. These policy measures taken by the EU can be thought to offer various suggestions forpolicymaking in Japan.
A series of policies in the EU has been implemented with the aim of reducing greenhouse gas emissions “within”
the EU, but the EU’s activities may also have various impacts on countries “outside” the EU. In particular, the EU Emissions
Trading Scheme (EUETS1) that is scheduled to be introduced in January 2005 may influence the environment for investmentin projects related to an international framework, the Kyoto Mechanism, and the distribution of Kyoto credits (such as CERs
and ERUs2). Japan therefore must also pay attention to the characteristics and functions of the scheme.
Thus, this report analyzes the impact of the EU Emissions Trading Scheme (EUETS) on Japan and other countries
outside the EU while organizing the noteworthy institutional aspects of the scheme.

1．

Background of the Introduction of the EU Emissions Trading Scheme (EUETS)

Policy measures against
global warming taken by countries
within the EU started with theintroduction of a carbon tax by
Scandinavian countries in the
beginning of the 1990s. Various
policy measures have been promoted
thereafter, such as voluntary action /agreement,
emissionstrading
schemes in Denmark and the United
Kingdom, and the schemes forpurchasing Kyoto credits including
ERUPT and CERUPT 3 in the
Netherlands (see Figure 1-1).

Figure 1-1 Genealogy of EU’s Global Warming-Related Policies
UNFCCC

COP3

Carbon Tax

Germany, Italy, and U.K.

Scandinavian countries

Linkage; Denmark

Voluntary action / agreement
Germany, etc.

Linkage; U.K.

Establishment of anagreement; Germany

Domestic emissions trading
Denmark
EUETS: 2005

Kyoto Mechanism
The Netherlands

Proposal of a common
carbon tax

Directive on Energy Taxation
Renewable Energy Directive, CHP Directive,
Directive on Energy Saving, etc.

♦
*
1
2

3

This report was prepared on the basis of the contents reported at the 389th Forum on Research Works of the Institute of Energy
Economics, JAPAN (IEEJ) held on July 26, 2004.
Senior Researcher, Environment/Energy Conservation Group, Environment/Technology Unit, The Institute of Energy Economics,
JAPAN
EUETS: EU Emissions Trading Scheme
CER: Certified Emission Reduction: Credits from CDM projects
ERU: Emission Reduction Unit: Credits from JI projects
CDM: Clean Development Mechanism: Mechanism in which developed countries (Annex I Parties) implement greenhouse gas
reduction projects for developing countries (non-Annex I Parties) and emission reductions are issued as credits and are split by parties
concerned.
JI: Joint Implementation: Mechanism in which developed countries (Annex I Parties) implement greenhouse gas reduction projects, andemission reductions are issued as credits and are split by parties concerned.
ERUPT: Emission Reduction Unit-Procurement Tender
CERUPT: Certified Emission Reduction Unit-Procurement TenderIEEJ: November 2004
On the other hand, a common carbon tax in the EU was examined in 1992-1997 as a unified EU policy. However,EU members could not achieve coordination, and consequently, only the minimum energy tax rate to be ensured by all
members was stipulated. Although common frameworks within the region, such as renewable energy, CHP (combined heatand power), and promotion of energy savings, have been proposed and implemented, the EU as a whole has to take further
additional measures to achieve Kyoto Protocol targets (see Figure 1-2). In such circumstances, discussions have been held on
the introduction of the EUETS. Seen from the past background, this scheme is considered to have been proposed as analternative to a common carbon tax.
Figure 1-2 Actual Greenhouse Gas Emissions in the EU and Prospect Thereof
1990=100
105

99.5

100
97.7

Upward revision(95.3)

95

92.8

Kyoto target
90

Upward revision(87.6)

85
1990

1995

2000

2005

2010

Existing policies (Prospect by assessment in 2000)
Existing policies (Prospect by assessment in 2001)

Additional policies (Prospect by assessment in 2000)
Additional policies (Prospect by assessment in 2001)

Actual performance

Kyoto target(Source) EEA (European Environment Agency), Greenhouse gas emission trends and projections in Europe, 2002 and 2003

2．

Characteristics of the EUETSThe EU Emissions Trading Directive4 was adopted in July 2003, and the Linking Directive,5 which stipulates aframework that makes it possible to use Kyoto credits (such as CERs and ERUs) in the EUETS, was adopted in September 13
2004. The EUETS will be in a trial period for the first phase of three years (2005-2007) and thereafter will be implemented inunits of five years. The second phase (2008-2012) overlaps the first commitment period of the Kyoto Protocol.

45

EU Emissions Trading Directive (2003/87/EC) adopted on July 22, 2003
“establishing a scheme for greenhouse gas allowance trading within the Community and amending Council Directive 96/61/EC”
http://europa.eu.int/eur-lex/pri/en/oj/dat/2003/l_275/l_27520031025en00320046.pdf
Draft Linking DirectiveFirst draft of the European Commission (COM (2003)403final) on July 23, 2003:“amending the Directive establishing a scheme for greenhouse gas allowance trading within the Community, in respect of the Kyoto
Protocol's project mechanisms”
http://europa.eu.int/eur-lex/en/com/pdf/2003/com2003_0403en01.pdf
Proposed amendments adopted by the First Reading of the European Parliament on April 20, 2004:“European Parliament legislative resolution on the proposal for a European Parliament and Council directive amending the Directive
establishing a scheme for greenhouse gas allowance trading within the Community, in respect of the Kyoto Protocol's projectmechanisms (COM (2003) 403 – C5-0355/2003 – 2003/0173(COD))”
http://www2.europarl.eu.int/omk/sipade2?PUBREF=-//EP//TEXT+TA+P5-TA-2004-0303+0+DOC+XML+V0//EN&LEVEL=3&NA
V=X
Complement to the EU deliberation process: Draft laws and ordinances prepared by the European Commission are deliberated at theEuropean Parliament and the Council of the European Union. If a document adopted by the Parliament is not approved by the Councilof the European Union at the first deliberation (First Reading), the second deliberation (Second Reading) will be held.

IEEJ: November 2004

Figure 2-1 Position of the EUETS and Comparison with the Kyoto Protocol

Country’s compliance scheme

CER

EUA

Allowance/credits possessedby an installation operator asa result of initial allocation/issuance/trading

AAU

ERU

Emission from one
installation

CER

Others(residential &commercial,transportation,
etc.)

ERU

<EUETS>(Some)
industrial/
energysectors

RMU

Total emission by a country

Allowance/credits possessedby a country as a result of initial
allocation/issuance/ trading<Kyoto Protocol>

A scheme similar to the Kyoto
Protocol is established at the
installation level for (some)industrial/energy sectors

The position of the EUETS can be summarized as follows in comparison with the Kyoto Protocol (see Figure 2-1).
The Kyoto Protocol is a scheme that requires “countries” to hold the actual emissions below the total of the Assigned AmountUnits (AAUs6), which are allocated initially, and credits (CERs, ERUs, and RMUs7). On the other hand, the EUETS
establishes a similar scheme for each “installation” possessed by operators in (some) industrial and energy sectors with respect
to each country’s emissions. On this occasion, allowance initially allocated is different from the AAUs, but common8 credits
with those of the Kyoto Protocol are used.
The institutional characteristics of the EUETS are summarized below.

2-1 Participating Countries
Countries participating in the EUETS are the 25 EU member countries including the 10 countries that have newly
acceded to the EU since May 2004 (in addition, Norway is planning to participate in the scheme in the form of linking with its
own emissions trading scheme). This means that 249 out of 38 Annex B Parties with a numerical target of the Kyoto Protocol
participate in the EUETS (see Figure 2-2). The emissions from these countries account for about 50% of those from Annex B
Parties (see Table 2-1), excluding the countries that have withdrawn from the Kyoto Protocol, namely, the United States andAustralia. The only major countries that are not included in the EUETS are Japan, Canada, Russia, and the Ukraine. Thus, theintroduction and implementation of the EUETS is expected to have a significant impact on the international emission credit
market, depending on the market players and the scale.

6
7
8
9

AAU: Assigned Amount Unit: Allowance assigned to countries under the Kyoto Protocol.
RMU: Removal Unit: Removal by sink activities in developed countries (Annex I Parties).
To be precise, there are credits that cannot be used in the EUETS (forest sinks and so on).
Cyprus and Malta do not have a numerical target of the Kyoto Protocol.

IEEJ: November 2004
2-2 Setting of Allowance
The method of allocating initial allowance is one called “cap-and-trade” (see Figure 2-3). First of all, policymakers
decide total possible emissions (cap) and allocation to each emitter, and then, emitters trade allowance to achieve the target.
This method is different from “baseline and credit” in which differences (reduction) from “emissions forecasted” in the casewhere emission reduction measures are not implemented are converted to credits.
Figure 2-2 Countries Participating in the Scheme

Table 2-1 Emission Shares of Countries Participatingin the Scheme

Countries having a numerical target for the Kyoto Protocol(Annex B Parties)

Actual emissions from Annex B Parties

EU
Austria
Belgium
Denmark
FinlandFranceGermany
GreeceIreland
Italy
Luxembourg
The Netherlands
Portugal
Spain
SwedenU.K.
Czech Republic
Estonia
Hungary
LatviaLithuania
PolandSlovakia
Slovenia

Norway

Japan

U.S.

CanadaAustralia

Switzerland
Iceland(Monaco)(Liechtenstein)*The above
two countries
have
expressed
withdrawal
from theKyoto
Protocol.

15 conventional EU countries

Countries
participatingin the EUETS(Russia)
UkraineRomania
Bulgaria(Croatia)

4,094

42%

8 new EU countries

720

7%

Norway

58

1%

4,872

50%

Russia

2,007

20%

Japan

1,382

14%

Canada737

8%

Ukraine458

5%

Others (excluding the U.S. and Australia)

362

4%

Total

9,817

100%

U.S.

7,021

Total of the EUETSNew ZealandAustralia* Countries inparentheses have
yet to ratify the
Kyoto Protocol.

Total GHG
emissions
Percent[Mt/CO2] distribution(2000)

498

Cyprus
Malta

Figure 2-3 Cap and Trade10
11[Selling of emission credits]
Sell excess reductions of 10
tons as emission credits
Emission (t)It is also another characteristic that this cap is
not prepared by the European Commission but is preparedindividually by each member state as a National
Allocation Plan (NAP).10 Although there are guidelines
for formulating a NAP, each member can decide the cap
on its own initiative unless it conflicts with the State Aidrules11 (however, the European Commission has vetopower in examination). Despite that the EUETS is theEU’s uniform policy, binding allowances are set by thesovereignty of each member state, therefore, this scheme
requires coordination at the European Commission formaintaining fairness in economic burden among
members.
The control subjects for which an allowance(cap) is set are about 13,300 sites (prospect as of October
21, 2004), which are large stationary emission sources in

Excess
１０トンのemissions
不遵守
of 10
tons

Maximumemissions
排出上限
(Cap)

Excess１０トンのreductions
超過達成
of 10 tons

Control subject A

Control subject B[Payment]
Purchase emission credits forthe excess emissions of 10 tons

Article 9 of the Directive.
State Aid rules: These rules prohibit aiding a country that distorts fair market competition. The authority of judgment belongs to theEuropean Commission. This means, here, allocating an unreasonably large amount of valuable allowance to a specific subject.

IEEJ: November 2004
the industrial and energy sectors. Thereby, about half of CO2 emissions in the EU are covered. Specifically, the subjects
include installations with a rated thermal input exceeding 20 MW, oil refineries, coke ovens, iron production and processing
sectors, mineral sectors (glass, cement, and ceramics), and others (paper and pulp).12
What should be noted here is the fact that for electricity, allowance is allocated not for emissions from consumers
but those from power plants (this is called direct allocation: see Figure 2-4). This means that reduction in power consumption
is not directly regarded as emission reduction by consumers. The act of reducing CO2 emission through reduction in power
consumption is brought by an indirect effect, that is, a rise in the consumer price of electricity. This is a contrast to the fact that
reduction in power consumption by consumers is appreciated as CO2 emission reductions under the U.K. emissions trading
scheme and in the Nippon Keidanren’s voluntary-action plan.
Figure 2-4 Direct and Indirect Allocation
Government
Allowance

Cost increase

Electricity producer

Electricity price increase
Power consumption
reduction

Final consumer<Direct allocation>

Allowance

Electricity producer
Power consumption
converted to CO2
Final consumer CO2 reduction(Power consumption reduction)<Indirect allocation>

2-3 Relations with the Kyoto Protocol
The allowance used is unique to the EUETS, called “EU Allowance (EUA),”13 and AAUs allocated to thegovernment under the Kyoto Protocol are not directly traded in the EUETS.
This unique allowance is adopted not only for a technical reason, i.e. the trading scheme will be implemented from2005 before the first commitment period of the Kyoto Protocol starts in 2008 and will also be implemented regardless ofwhether the Kyoto Protocol goes into effect, but also for the reason of avoiding companies’ directly trading AAUs to prevent
AAUs from flowing out to Japan and other countries and from flowing in from Russia and other countries. Incidentally,anyone can participate in trading.14 This is possibly because of expectation that traders’ participation will increase the market
liquidity. Due to this, it is considered possible for Japanese companies to open accounts and participate in trading.

12
13
14

Annex I to the Directive.
EUA is the common name, and it is called “Allowance” in the Directive.
Article 19(2) of the Directive. Detailed requirements for participation are now in preparation (as of August 2004), but it is expected that
simple requirements only are required, such as having an address within the EU.

IEEJ: November 2004

Figure 2-5 Relations between EUA Trading and AAUs under the Kyoto Protocol<Trading between EU member countries>
EU
countryA

Some form of
adjustment＝

Government

AAU<Trading with non-EU countries>

EU
countryBEU
countryA

Government

Government

Non-EUCountryC

AAU

Government
EUA

EUA

PrivateDepending on
the agreement

PrivateTrading

PrivatePrivateTrading

In
terms
of
relations with the allowance

Figure 2-6 Choosing JI projects

Actualemissions

under the Kyoto Protocol,
EUA
the Directive also stipulates
that transfers of EUAs by theprivate sector to another
EUA
country within the EU will
involvecorresponding
EmissionadjustmentsofAAUs
reduction!
Sell excess EUA
possessedbyrelevant
15
Two options forcountries (see Figure 2-5).
EUA
selling excess
From this, it can safely be
EUA
ERU
Canceled
understood that EUAs areequivalent to AAUs at least
within the EU. On the otherEUA
hand, the Directive stipulates
that the EUETS shall belinkedwithemissions
Cancel excess EUA
trading schemes of non-EU
and file an application
countries after conclusion of
as a JI projectamutualrecognition
16
agreement. To put it the other way around, it must be noted that even if the Japanese government and companies purchase
EUAs, AAUs will not be transferred to them, unless a mutual recognition agreement is concluded. The Directive does notinclude any specific descriptions about mutual recognition agreements, and all details thereof are left to future negotiations.
At installations subject to the EUETS, it is possible to choose to cancel allocated EUAs and issue ERUs from JI
17
projects (see Figure 2-6). Therefore, Japan may implement JI projects in Central and Eastern Europe with large room for

15
16
17

Recital (10) and Article 19(3) of the Directive.
Recital (18) and Article 25 of the Directive.
Article 11b(2)-(4) of the draft Linking Directive. In the original text proposed by the European Commission, it was not allowed to
implement JI projects at installations subject to the EUETS (excluding those that have already been started), but it has come to be
admitted at the stage of passing amendments by the European Parliament.

IEEJ: November 2004
emission reductions. Although this is “institutionally” possible, caution must be given as to whether it is actually possible. This
point is to be mentioned later.

2-4 Use of the Kyoto Mechanism (Linking)
Under the EUETS, it is possible to use Kyoto credits (CERs and ERUs) for compliance (linking). The EUETS is
also characterized by the fact that such linking will be implemented regardless of whether the Kyoto Protocol goes into
effect.18 Thereby, operators within the EU are given a clear incentive to invest in CDM/JI projects. As a result, these operators
have the effect of encouraging the consideration and implementation of CDM/JI projects. In addition, this will also function to
reduce operators’ risk because investments in CDM/JI projects will not be wasted even if the Kyoto Protocol does not go into
effect.
This linking can be used only for CERs from the first phase of the EUETS (2005-2007) before the firstcommitment period of the Kyoto Protocol. Incidentally, the Directive stipulates that CERs used in the first phase should becancelled.19

2-5 Others
Other than the above, what are stipulated under the EUETS are maximum allowances subject to auction at the timeof allocation, penalty for breach, inclusion of additional activities, installations, and gases (opt-in), temporary exclusion(opt-out), integration of subject installations (pooling), and subjects to the linking scheme. The outline thereof is summarizedin Table 2-2.
Table 2-2 Other Characteristics of the EUETSFirst phase: 2005-2007

Second phase: 2008-2012[Article 10 of the Directive]

At least 95%（＝Auction is permitted up to 5%)

Banking [Article 13 of the Directive]

No provisions regarding carry-over of allowances to the next phase: left to each country’s discretion

Penalties [Article 16 of the

EUR 40 for each ton of CO2 + carry-over of excess
emissions to the next phase

EUR 100 for each ton of CO2 + carry-over of excess
emissions to the next phase

Inclusion of additional
activities, installments, andgases
Opt-in [Article 24 of the Directive]

The scheme may be applied to installations with a
rated thermal input not exceeding 20 MW, which do
not have to be subject to the scheme.

The scheme may be applied to sectors that are now
not subject to the scheme.

Temporary exclusion
Opt-out [Article 27 of the Directive]

Installations may be excluded from the scheme if as aresult of national policies, they can reduce emissions
as much as would be the case if they were subject tothe EUETS.

Exclusion is not permitted.

Pooling

Operators of subject installations carrying out the same activity may form a pool (jointly become one subject tothe scheme). Operators participating in a pool nominate a trustee.

Allocation free of charge

Directive][Article 28 of the Directive]

Credits excepted from subject
to linking [Article 11a(3) and
Article 11b(5) of the draft Link ing
Directive]

Credits issued as a result ofdomestic reduction projects

Sinks
Nuclear facilites (stipulated only for the first andsecond phases)(Large-scale hydroelectric power … obligation toclearly specify impact)

There is room for issue of EUAs in respect of
reductions resulting from domestic reduction projects(in transportation/civilian sectors, etc.)−*No quantitative regulations
Obligation to prepare an NAP, and obligation to report
every two years[Article 30(3) of the draft Link ing
Directive]

18
19

There is room for sinks’ returning to subject to linking.
[Article 30(o) of the Link ing Directive]−[Article 30(n) of the draft Link ing
Directive]

Supplementarity of linking

At least 90%（＝Auction is permitted up to 10%)

Article 11a(1) and (1a) of the draft Linking Directive.
Article 11a(1a) of the draft Linking Directive.

IEEJ: November 2004

3．

Present Trends over EUETS

3-1 Trends of National Allocation Plans (NAPs) for the First Phase
National Action Plans (NAPs) for the first phase were prepared with the due date set for March 31, 2004 (May 1
for the ten new members), but most member countries were rather in arrear (see Table 3-1). This is partly because there was
not much time from the adoption of the Directive in July 2003 to the due date. In addition, elections and the political situation(Spain and France) as well as delay in collection of data by installation (Greece, Italy, and major nations in Central and Eastern
Europe) also seem to have affected preparation of NAPs. As of October 20 2004, the European Commission has approved
NAPs of 16 countries.
Allocations set in NAPs are generally recognized as being not challenging in terms of numerical targets, except
those prepared by the United Kingdom and some others (see Table 3-2 for major countries’ NAPs). The U.K.’s NAP was
prepared in anticipation of a higher domestic target (-20%) than the Kyoto Protocol target (-12.5%), so numerical targets arechallenging. Some of other countries, however, admit increase from the current emission level. This fact shows how it ispolitically difficult to set allowances (cap) for operators. It also clearly shows that all countries position the first phase as the“practice period for the trading scheme.”
Methods of allocation also differ depending on the country (see Table 3-3). In countries that have their own national
climate change programme, a NAP is prepared on the basis of the plan in some cases while it is formulated out of nothing inother cases. In addition, countries that formulate a NAP out of nothing formulate it on the basis of emissions forecast. Thus,
there are many countries, which cannot be completely said to be necessarily showing a clear path to achievement of Kyoto
Protocol targets. In addition, there are countries that make various exceptions, like Germany. In this manner, there are an
extremely wide variety of options of allocation methods (see Table 3-4).

Table 3-1 Progress of Preparation of a NAP for the First Phase in Each Country
Countries that
submitted a draft
to the EU (On time)

Countries that submitted a draft to the EU(After the due date)

Countries that havenot submitted adraft to the EU

15 conventional
members

Austria*
Denmark
Finland *Germany*
Ireland

Belgium
France *Italy
Luxembourg
The Netherlands

Portugal
Spain
SwedenU.K.*

Greece10 new members

LatviaSlovenia

Czech Republic
CyprusEstonia
Hungary

Lithuania
Malta
PolandSlovakia(Note) Progress as of October 20, 2004
The submission due date is March 31 for the 15 conventional members and May 1 for the 10 new members.
The NAPs of countries written in red and underlined were approved by the European Commission. The next chance
for approval will be in September.
* The NAPs of Austria, Finland, France, Germany, and the United Kingdom were approved subject to amendment.

IEEJ: November 2004
Table 3-2 Characteristics of Major Countries’ NAPs for the First Phase (1) Allocation
Major
Countries

Total allocation(cap)*①[Mt-CO2]

Total GHG
emissions ②
In 2000 [Mt-CO2]

Content①/②

No. of subject
installations

U.K.

245

659

37%

1,078

15% reduction compared to 1990 in2010

Germany

499

993

50%

2.419

0.4% reduction compared to 20002002

France

155

547

28%

About 1,390

2.4% reduction compared to emissions
forecast

Italy

241

539

45%

About 2,000

7% increase compared to 2000

The
Netherlands

95

224

43%

333

4% reduction compared to 2001-2002

Poland

286

376

76%

1,166

20% increase compared to 1999-2002

Slovakia

31

50

62%

209

About 2,170

About 4,800

45%

About 13,300

EU in total**

Challenging level of total allocation

19% increase compared to 2001

(Source) Prepared based on each country’s NAP (As of October 20, 2004; the same applies to Tables 3-3 and 3-4 below)
Figures in ② are from the Interim Report of the Global Environment Subcommittee, Environment Committee,
Industrial Structure Council (July 2003).
(Note) The NAPs of countries written in red and underlined were approved by the European Commission. (The same
applies to Tables 3-3 and 3-4 below.)*The total allocation ① is the annual average in the first phase (2005-2007).
**The total allocation for the entire EU does not include allocations in some countries for which numeric values are
not clear, so the total allocation at this time is smaller than the actual total.

Table 3-3 Characteristics of Major Countries’ NAPs for the First Phase (2) Methods of Allocation
Major
countries

Method of determining
total allocation (cap)Method of allocation to eachsectorSpecial provisions for allocation

U.K.

Based on the CCP, *1 and in
anticipation of reduction effects ofthe ETS

Based on the CCP, and reductions by the
ETS are allocated to the electric power
sectorGermany

Following the trend towardachieving the Kyoto target
Not direct trend

Emission standard in 2000-2002

FranceForecasted based on emissions per unit production (basic unit calculated basedon emissions in 1998-2001 is multiplied by production forecast)Emphasizing that emissions per capita are small and thus there is little room forreduction.

Italy

Based on the National Research
Programme (PNR). Emissions in2010 did not meet the Kyoto target.

In consideration of emission standard in2000 and future growth

Reserve for new installations is set with respect toeach sector. *3

The
Netherlands

Middle of values set in thebenchmark covenants and those
forecasted by a research institute

Based on emission standard in 20012002, in consideration of future growthdepending on the sector, differences in
reduction rates depending on whether anagreement has been concluded

Separate assessment for electricity
Special provisions for process emissions

PolandFollowing the trend towardachieving the Kyoto target

Based on standard in 1999-2002(excluding minimum year), and inconsideration of future growth andimprovement of emissions per unit
production

Separate assessment for electricity and cement
plant
Bonus allowances are available for early action
and cogeneration.

Slovakia

Based on emissions forecast

Based on standard in 1998-2002 forsmall-scale installations, and inconsideration of future growth

Individual negotiations for large-scale installations

Replacement during the first phase is treated not
as cancellation and new allocation but as diversion.
An integrated target is set for an integrated plant,such as a steel plant.
The ex-post adjustment system is available. *2Special provisions for process emissions andcogeneration(Notes) *1 CCP: Climate Change Programme*2 The European Commission issued an order to amend.
*3 Reserve for new installations: Allowances saved in advance to be allocated to installations that are newly operated
during the implementation period.
*4 BAT: Best Available TechniqueIEEJ: November 2004

Table 3-4 Characteristics of Major Countries’ NAPs for the First Phase (2) Options for Allocation
Major
countries

U.K.

Rate ofreserve fornewinstallations
7.7%

Germany

0.9%

Considerationof early action

Banking*3

Exclusion (Opt-out)
Additional application(Opt-in)Put to auction△*2

Not allowed

Opt-out is allowed.

Canceled○*1

Not allowed

Opt-in is available.

Allowed?

−Handling of residual
reserve for new
installations

France3.0%

Canceled

△ *2

Italy

16.2%

Sell Off△ *2

Not allowed−

The
Netherlands

2.6%

To be determined (inthe original plan,
reallocated to existing
installations)*4○*1

Not allowed

Opt-out is set at the
government’s discretion.

Poland

3.1%

Put to auction○ *1

Allowed *5

Opt-out is available.

Slovakia

2.0%?

Put to auction

△ *2

Not
mentioned−(Notes) *1 ○ for early action: Favorable treatment is given to those who implement early action, by using appropriate
adjustment factors at the time of allocation to sectors or installations. Bonus allowance is available in Poland.
*2 △ for early action: Early action is indirectly taken into consideration through several-year study of actual emissions,which are used as standards for allocation to sectors and installations. This gives some clemency to those who
implement early action, but it cannot be necessarily said that favorable treatment is given to them.
*3 Banking: Banking of EUAs. Banking is available for CERs and ERUs, which are used as credits, within the scopeof the Kyoto Mechanism.
*4 The European Commission has a policy of not allowing reallocation to existing installations.
*5 Allowed only emission reduction by new capital investment.

3-2 Points to Be Noted toward the Second Phase
The second phase overlaps the first commitment period of the Kyoto Protocol, and is thus considered to be theperiod of actual implementation that aims at full-fledged emission reductions. Attention will focus on what adjustments andsettings will be made in allocation for the second phase that is scheduled in 2006, following the fact that formulated NAPs
generally ended in setting not challenging numeric values and conditions in the first phase, as mentioned above. The impact of
the Kyoto Mechanism on the international market will also attract attention. Specific key points are as follows.
・ Challenging level of initial allocation (how much reductions are urged the industrial/energy sectors to achieve in
anticipation of achieving the Kyoto Protocol target)
・ Degree of freedom in using Kyoto credits (this must be described in a NAP: for example, how to conduct quantitative
restrictions associated with supplementarity20)
・ Degree of freedom of compliance rules (propriety of banking21 that also has impact on the next commitment period of
the Kyoto Protocol)
・ As another relevant trend, the supply and demand of Kyoto credits (the number of projects, and demand trends
including those outside the EU)
20

21

Supplementarity: The Marrakech Accords to the Kyoto Protocol (Decision 15 and draft decision on the Kyoto Mechanism) advocatesthat the use of the Kyoto Mechanism (acquisition of credits, and emissions trading) should be supplemental to domestic emission
reductions. However, it does not clarify how much use is supplemental. (From the very beginning, the Netherlands plans to deal with one
half of excess emissions by the Kyoto Mechanism.)
Banking: Mechanism for carrying over allowances to the next commitment period.

IEEJ: November 2004
4．

Impact on Countries outside the EU and Direction of the EUETSThis part considers the impact of the introduction of the EUETS on Japan and other countries outside the EU fromthe viewpoint o f the characteristics of the scheme. Considerations are also given to the impact of the future direction of the
EUETS, especially the direction of market expansion, on countries outside the EU.

4-1 Impact ①: Implementation of JI projects in Central and Eastern European Countries
In the original Linking Directive drafted by the European Commission, there was a clause that prohibits
implementing a JI project for an installation subject to the EUETS. Therefore, Japan with the intention of promoting JI
projects in Central and Eastern European countries had expressed concern for a period of time. In the end, this provision wasdeleted when the European Parliament passed the amended directive in April. There are thus no provisions constraining theimplementation of JI projects.
However, the final draft Linking Directive contains a provision stipulating that the baseline22 of a JI project mustcomply with the acquis communautaire.23 Under ordinary circumstances, a JI project can be implemented at each country’s
discretion (in the case of the first track24), but this provision is considered to mean that the eligibility of a JI project isdetermined not at each country’s discretion but based on rules set by the European Commission. It must be noted that there
remains a risk of restrictions being put on the operations of projects in the future if the EU tightens eligibility determination.

4-2 Impact ②: Environment Surrounding the Kyoto Mechanism
The Linking Directive will give installation owners who have the obligation to comply with the EUETS an
incentive to acquire Kyoto credits (CERs and ERUs).
In this scheme, credits held in the national register by operators who possess and operate installations are subject to25
linking, and participants in trading who do not have the said obligation cannot convert CERs or ERUs into EUAs for the
purpose of selling. Consequently, the scheme is expected to further accelerate investment in CDM/JI projects and purchase of
CERs and ERUs by installation owners with the said obligation rather than those by traders for profit.
In addition, since the EUA market is relatively likely to have higher liquidity compared to the CER and ERU
markets at this time, operators may have an incentive to convert CERs and ERUs into EUAs at an early stage.
Moreover, the “irreversibility” of the Linking Directive also needs attention. Since the Linking Directive does notinclude a provision stipulating the conversion of EUAs into CERs and ERUs to use, there is concern that CERs and ERUs areconverted into EUAs in a unilateral way. In fact, EUAs can be converted into ERUs by choosing JI projects (mentioned
above), and “de facto reversibility” thus exists. Therefore, the scheme is not necessarily “irreversible” from the institutionalview, and it thus cannot be said that the EUETS hinders the distribution of Kyoto credits in the private sector. On the other
hand, operators may not be able to freely implement JI projects in which EUAs are converted into ERUs (this process
corresponds to the said “reversibility”) due to the provision for the baseline of a JI project (mentioned above).
As above, the EUETS is expected to encourage installation owners with the obligation to comply with the EUETS
to invest in CDM/JI projects and purchase Kyoto credits and thereby to cause the situation where Kyoto credits, once acquired,hardly flow out to the EU. As a result of this, it may become more difficult for Japan and other countries to ensure inexpensive
CDM/JI projects or purchase credits in the future (however, actual movements will also depend on the supply and demand of
EUAs, demand of Japan, Canada, and other countries for Kyoto credits, and prices thereof).

4-3 Direction: Meaning of Expansion of the EUETS Market

22
23
24

25

Baseline: Forecast of emissions that would have arisen if a relevant JI project did not exist.
Article 11b(1) of the Linking Directive.
First track: If a host country of a JI project satisfies certain conditions (for example, preparation of a national registry necessary for credit
management, and annual submission of the national inventory report), it can approve a methodology for the project and issue ERUs on
its own. Countries that do not satisfy the conditions have to take approval procedures by the “Article 6 Supervisory Committee,” which
will be established under the United Nations Framework Convention on Climate Change (UNFCCC). This is called the second track.
Article 11a(1) and (1a) of the draft Linking Directive.

IEEJ: November 2004
The EUETS Directive provides for linking the market with other countries’ domestic emissions trading schemes,
and indicates that the market will expand to outside the EU. In a general sense, the meaning of expansion of the emission
credit market is the provision of opportunities for more cost-effective emission reductions, and this is also advocated in the
Directive.26 However, attention must be given to the fact that the meaning of expansion of the EUETS market includes manyother important elements.
The first element is the expansion of opportunities to use Kyoto credits. As mentioned above, incentives to acquire
Kyoto credits have been increasing among EU member countries due to the existence of the Linking Directive. If a EU
member country carries forward market expansion (market link) to Japan, Canada, or another country after ensuring credits,credits possessors will have more chances to sell credits.
The second element is the enclosure of countries with large room for emission reductions. As mentioned above, it
is possible from the institutional view to access Central and Eastern Europe through JI projects, but there remains the risk ofactual restrictions. From the EU’s standpoint, this means that inexpensive JI projects can be developed not under the JI scheme
but under the EUETS. Since the EUETS is a scheme to adjust AAUs along with the transfer of EUAs, it will eventually
become possible to acquire AAUs at an extremely low price. An interesting fact is that in terms of actual greenhouse gas
emissions as of 2000, while emissions exceeding Kyoto targets of the 15 conventional EU member countries amounted toabout 240 million tons of CO2, excess reductions by the 10 new EU member countries amounted to almost the same as theexcess emissions (see Figure 4-1). In addition, if the EUETS is expanded not only to the 10 new EU member countries but
also to the Ukraine and Russia, such opportunity will further increase.

Figure 4-1 Emissions and Reductions Exceeding Kyoto Targets
1,500(As of 2000: Major countries)

450

500
238
57

e

a

Uk
ra
in

Ru
ss
i

Ro
m
an
ia

EU

-240

Bu
lg
ar
ia

s
co
un
tr i
e

es

co
un
tri

-165

10

ne
w

EU

-200

15

-1,500(Note)

Ca
na
da

Ja
pa
n

)
.S
.

-500

-1,000(Source)

125

0
(U

AAUs allocated - Emissions in 2000
[1 million tons of CO2/year]

1,024
1,000

-1,285Prepared based on the Interim Report of the Global Environment Subcommittee, Environment Committee,
Industrial Structure Council (July 2003) and others.
Major Kyoto Protocol Annex B Parties that are not on this graph: Croatia (+1), (Australia (-48)), New Zealand(-8), Norway (-7), Switzerland (-5), and Iceland (0).

Attention also has to be paid to new business chances inherent in the EUETS. If the EUETS becomes a de facto
worldwide standard for emissions trading, many business chances, such as the installation and management of monitoring
systems, certification businesses, the development and management of registries, and transaction businesses throughinducement of market places, will roll in EUETS participants. In addition, since the EUETS precedes preparations for
implementing the Kyoto Mechanism, the Kyoto Mechanism may be operated in the same manner as the EUETS.
26

Recital (18) of the Directive.

IEEJ: November 2004
As mentioned above, the expansion of the market subject to the EUETS means the expansion of various strategic
options for the EU. It must be noted that the EUETS may give EU member countries and EUETS participants advantage overmeasures against global warming taken by Japan and other countries, depending on the future direction.

5．

Conclusion

It is expected that the EUETS will encourage operators in the EU to invest in CDM/JI projects and purchase Kyoto
credits and that such credits will hardly flow out of the EU. In addition, options for EU strategies for measures against global
warming have been diversifying due to the EUETS, and there is thus an increasing possibility that the EU will take theinitiative in global-level measures against global warming, including the Kyoto Protocol.
To achieve the Kyoto target with high economic efficiency in such circumstances, Japan has to make politicalcoordination in relation to the rules of the EUETS (including rules which will be set in the future) accordingly, includingintergovernmental efforts to create a road map for cases where operators wish to implement JI projects in the EU (for example,
conclusion of a memorandum of understanding (MoU)) and consultations to eliminate those which can become obstacles tothe international use of the Kyoto Mechanism as stipulated in the Kyoto Protocol. At the same time, Japan also has to makeefforts to enhance the certainty of credits that are achieved by the Kyoto Mechanism, through active promotion of excavationof inexpensive CDM/JI projects.
Contact: report@tky.ieej.or.jp