```

[Senate Hearing 110-72]
[From the U.S. Government Publishing Office]

                                                         S. Hrg. 110-72
 
                              EU EMISSIONS

=======================================================================

                               ROUNDTABLE

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                                   TO

 DISCUSS THE PROGRESS OF THE EUROPEAN UNION'S EMISSIONS TRADING SCHEME 
AND TO RECEIVE INFORMATION ON LESSONS LEARNED FOR POLICYMAKERS WHO WANT 
 TO BETTER UNDERSTAND HOW A MARKET-BASED TRADING PROGRAM COULD OPERATE 
            EFFICIENTLY AND EFFECTIVELY IN THE UNITED STATES

                               __________

                             MARCH 26, 2007

                       Printed for the use of the
               Committee on Energy and Natural Resources

                                 ______

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               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman

DANIEL K. AKAKA, Hawaii              PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota        LARRY E. CRAIG, Idaho
RON WYDEN, Oregon                    CRAIG THOMAS, Wyoming
TIM JOHNSON, South Dakota            LISA MURKOWSKI, Alaska
MARY L. LANDRIEU, Louisiana          RICHARD BURR, North Carolina
MARIA CANTWELL, Washington           JIM DeMINT, South Carolina
KEN SALAZAR, Colorado                BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey          JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas         GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont             JIM BUNNING, Kentucky
JON TESTER, Montana                  MEL MARTINEZ, Florida

                    Robert M. Simon, Staff Director
                      Sam E. Fowler, Chief Counsel
              Frank Macchiarola, Republican Staff Director
             Judith K. Pensabene, Republican Chief Counsel
               Jonathan Black, Professional Staff Member
           Kathryn Clay, Republican Professional Staff Member

                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Bingaman, Hon. Jeff, U.S. Senator from New Mexico................     1
Caneill, Jean-Yves, Project Manager, Sustainable Development 
  Division, Electricite de France, Paris, France.................    12
Delbeke, Jos, Director, Climate Change and Air, Directorate-
  General for Environment, European Union Commission, Brussels, 
  Belgium........................................................     8
Domenici, Hon. Pete V., U.S. Senator from New Mexico.............     2
Edward, Garth, Trading Manager, Environmental Products, Shell 
  Oil, London, England...........................................    11
Ellerman, Denny, Senior Lecturer, Sloan School of Management, 
  Massachusetts Institute of Technology, Cambridge, MA...........    15
Kopp, Raymond, Senior Fellow and Director, Climate and Technology 
  Policy Program, Resources for the Future.......................     4
Salazar, Hon. Ken, U.S. Senator from Colorado....................     3
Vanderborght, Bruno, Vice President, Climate Protection, Holcim 
  Cement, Zurich, Switzerland....................................    14
Wold, Per-Otto, Founding Partner and CEO, Point Carbon, Oslo, 
  Norway.........................................................    10

                                APPENDIX

Responses to additional questions................................    33

                              EU EMISSIONS

                              ----------                              

                         MONDAY, MARCH 26, 2007

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:07 p.m., in 
room SD-G50, Dirksen Senate Office Building, Hon. Jeff 
Bingaman, chairman, presiding.

OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW 
                             MEXICO

    The Chairman. All right, why don't we go ahead and get 
started? Nearly a decade ago, over 100 countries negotiated the 
Kyoto Protocol, an international treaty to address the 
challenge of climate change. While the United States did not 
ratify the treaty, many others did. Many have moved forward on 
their commitments under that treaty. The program put in place 
by the European Union to establish a market-based cap-and-trade 
program is one of the most significant endeavors being 
undertaken on climate change today. The EU's emission trading 
scheme began in early 2005 and its second phase will begin this 
next year.
    A few weeks ago, EU Environmental Ministers expressed 
support for an ambitious post-Kyoto reduction target of a 20 
percent--I believe that's below 1990 levels, as I recall 
reading those reports--below 1990 level reduction in greenhouse 
gas emissions by 2020. The EU is to be commended for its 
ambition and leadership on the issue, but we've not had 
sufficient clarity here in the United States about what is 
truly being done in the European Union. There is a lot of 
confusion and even misinformation about the EU's program, and I 
hope that we'll be able to address some of those important 
issues here today and gain a better understanding of that 
program.
    The lessons learned by the EU are extremely valuable for 
policymakers in this country at this time. There are a number 
of cap-and-trade proposals in Congress right now, including one 
that Senator Specter and I are working on. It's important that 
we learn from the EU about their experiences with the cap-and-
trade program and as a result, try to create an effective 
program here that builds on what has been learned in Europe.
    To that end, we welcome the six experts on the EU Emissions 
Trading System that are here today. Let me just briefly 
introduce the names of these individuals, and then I'll call on 
Senator Domenici for his comments. But first, let me just 
indicate who is here.
    Jos Delbeke is Director for Climate Change and Air of the 
European Commission's Directorate-General for Environment. In 
this capacity, he oversees the implementation of the European 
Union's Emission Trading Scheme and other clean air programs.
    Mr. Per-Otto Wold is a founding partner of Point Carbon, 
which is a world-leading provider of independent news analysis 
and consulting services for European and global power, gas, and 
carbon markets.
    Mr. Garth Edward is Shell's Trading Manager for 
environmental markets. Mr. Jean-Yves Caneill is a Project 
Manager at Electricite de France and Dr. Bruno Vanderborght is 
the Vice President of Environmental Strategy for Holcim, a 
leading global cement group that is based in Switzerland. Dr. 
Denny Ellerman is Senior Lecturer with the Sloan School of 
Management at MIT.
    Today's roundtable will be much less formal than a hearing. 
After a brief background presentation on this EU Emissions 
Trading System by a scholar from the Resources for the Future, 
Raymond Kopp, panelists will be given about 5 minutes each to 
summarize their thoughts and make the main points that they 
think we need to be aware of, and what was done right and what 
was done wrong in the EU system to date.
    Following the opening remarks, senators will have the 
opportunity to ask questions and make comments. We will not 
have any time limits on those questions or the give-and-take. 
The hope is that senators who seek recognition, ask their 
questions, and then we will take the discussion wherever it 
leads from there on.
    But I thank you all for being here and let me now defer to 
Senator Domenici for any opening comment that he has.

   STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM NEW 
                             MEXICO

    Senator Domenici. Hello, everyone. It's good to be with 
you. I met with some of the people from the Union that are not 
on the panel, Senator Bingaman, but are experts in their own 
rights, and I had a little extra time in my office this 
morning, so I had to chance to visit with them. That was very 
good for me and I appreciate them. They are here and I thank 
them for their time.
    I do want to say that I'm not prepared to give an opening 
set of remarks because I was of the opinion that we were not 
going to. That doesn't mean that I am offended. Your opening 
statements never offend me, whatever it is that you choose to 
say.
    On the other hand, I think that you should not be misled. 
The implication, if any, that American legislators look at 
Europe and think that you are doing quite well--if that's what 
the good Senator, my colleague from New Mexico said--I think 
that's a little of an overstatement. I don't think that there 
is a majority, or anything like a majority, of legislators that 
think the European community is doing really well or that we 
can model something off of them that might work in America.
    There are a few things we could learn. The most important 
thing is that you are off and running; you're trying something. 
I guess Americans would have to admit that. Beyond that, then, 
we'd go to work on what? That's probably why this was a good 
meeting today because you might think it is decided that 
Senator Domenici is deciding not to participate; not at all. 
But I don't think that I want to spend a lot of time when you 
are here. I think it is most important that you spend a lot of 
time and tell us why you're here and what you think, even to 
the extent that you tell us what you think we are doing or not 
doing that we ought to do and why. I think that would be good 
for any of you who are here. Don't think you can't tell us 
quite openly today that you think we are--whatever nice words 
you use. I love to hear you talk so I hope you will. I love 
your use of the language. I wish we talked like you.
    But in any event, if you could tell us what we ought to be 
doing that is better, that would sure be helpful. What you are 
doing that's wrong, if you have some opening observations in 
that regard, would be very helpful also.
    Now, that's about enough for now and thank you, Senator 
Bingaman and again, thanks to all of you and let's have a good 
afternoon.
    The Chairman. Thank you very much. Senator Salazar wanted 
to just make a short statement. Let me call on him at this 
point.

          STATEMENT OF HON. KEN SALAZAR, U.S. SENATOR 
                         FROM COLORADO

    Senator Salazar. Thank you very much, Senator Bingaman. Let 
me just say that I think this committee, over the last 2 years 
in the 109th Congress, did a lot of great work, in part because 
we almost unanimously passed the Energy Policy Act of 2005. We 
have a lot of work that we continue to do this year on new 
technologies, on renewable energy and a whole host of other 
things that obviously impact climate change and global warming.
    I'm one of those members of this committee that is looking 
for some guidance in terms of what it is that we ought to do, 
with respect to the issue of global warming. We have, 
obviously, the Kyoto Protocols that have been out there that 
many countries signed up for. We have other legislation that 
has been proposed, including the McCain-Lieberman legislation 
from several years ago. We have Senator Bingaman, and I think 
Senator Specter and others, who are working on another package. 
The House of Representatives, I think, is poised to pass some 
kind of a global warming cap-and-trade system, perhaps by 
August. At the end of the day, the one thing that I know fully 
really are two things.
    The first is that I believe that the scientific community 
has said, loud and clear, is that global warming is a major 
issue that does, in fact, threaten civilization, and we need to 
do something about it. I agree with that conclusion. Second of 
all, that there are a number of different approaches out there 
on how we should approach this issue of global warming. I think 
for us, in this committee and in this Senate, it is very 
important to learn from the European Union, since you have 
already embarked upon a program that is trying to deal with the 
issue. So I'm very much looking forward to the discussion this 
afternoon, to learn what has worked, what hasn't worked, and 
what kind of guidance you might give us as we struggle with 
this very, very difficult issue. Thank you, Senator Bingaman.
    The Chairman. Thank you. We have six distinguished 
witnesses here. Let me just call on each of you to, as I 
indicated before, take about 5 minutes to give us your views, 
the main points that you think we need to be aware of before we 
get into questions.
    Before we do that, I'm going to have Dr. Kopp, who is the 
Senior Fellow and Director of the Climate and Technology Policy 
Program for Resources for the Future, give us sort of an 
overview of the European Emissions Trading System. Let me just 
mention also, and I guess this is by way of introduction, Dr. 
Delbeke. I'm informed that yesterday was the 50th anniversary 
of the Treaty of Rome and that was the Treaty that made--that 
was responsible for forming the European economic community and 
what was the foundation for today's European Union. So 
congratulations for 50 years of success with that effort.
    Dr. Kopp, why don't you go right ahead?

STATEMENT OF RAYMOND KOPP, SENIOR FELLOW AND DIRECTOR, CLIMATE 
    AND TECHNOLOGY POLICY PROGRAM, RESOURCES FOR THE FUTURE

    Mr. Kopp. Thank you, Senator Bingaman and members of the 
committee.
    Thank you very much for this opportunity to speak. Let me 
say, Resources for the Future is a nonpartisan, non-advocacy 
research institution in Washington, DC and any opinions I 
express today, please don't hold against my colleagues or the 
institution. It does not take positions.
    The purpose of my remarks is to provide a brief 
introduction to the European Union Emissions Trading Scheme, 
which goes under the acronym, EU ETS, which I'm sure you will 
hear more and more about.
    I also want to discuss some lessons that one might draw 
from the EU experience. The EU ETS is an emissions allowance 
cap-and-trade system, similar in many respects to the current 
system used to control sulfur dioxide and the provisions of the 
Clean Air Act.
    All cap-and-trade systems establish a cap on annual 
emissions, identify those entities whose emissions will be 
regulated, and set a few rules. In most contexts, one allowance 
is required for each ton of emissions and allowances are 
usually freely transferable. Allowances can be initially 
distributed in the market through free allocation based on some 
metric or another, or sold through an auction. The key question 
each system must address is whether allowances that are not 
used in the current year may be banked for subsequent years.
    So let's turn to the structure of the EU ETS. It began 
operation in January 2005 and includes 27 countries of the 
European Union. The program is run in two phases. Phase I from 
2005 to 2007 was intended to be a trial period to work the bugs 
out of the system. However, in all respects, it is a mandatory 
and binding cap-and-trade system. Phase II from 2008 to 2012 
coincides with the Kyoto commitment period.
    Specifications regarding future phases have yet to be 
established, but the program is intended to run indefinitely. 
The cap covers only carbon dioxide--that's CO2, 
although other greenhouse gases may be added in the future. The 
EU ETS is not an economy-wide cap-and-trade system; rather it 
regulates downstream approximately 12,000 emissions sources, 
accounting for half of EU emissions. Covered sources include 
iron and steel, cement, glass, ceramics, pulp and paper, 
electric power and refineries. Transport is not included in the 
system, although the EU will include air transport in 2011.
    Each country submitted for approval plans for the 
allocation of allowances for Phase I. The European Commission 
is in the process of finalizing allocation plans for Phase II, 
which by the way, is 2008 to 2012. Allocation plans describe 
three decisions each country must make. First, how much of a 
country's Kyoto target is assigned to the sectors participating 
in the trading scheme and by implication, the remainder of the 
target must be met by sectors outside the scheme--for example, 
transportation.
    Second, how much of the cap will be assigned to each 
sector, determining how much of the burden and cost individual 
sectors will have to bear, and finally, third, how the sector 
allocation is further divided among individual companies.
    Phase I rules allowed countries to auction an upper limit 
of 5 percent of the allowances. Only Denmark chose to put up 
for sale 5 percent; the remainder being allocated gratis. More 
auctioning is likely to occur in Phase II, where the upper 
limit on auctioning has been expanded to 10 percent.
    Emission sources covered by the EU ETS may satisfy their 
commitments by surrendering allowances in an amount equal to 
their emissions, or may supplement their EU ETS allowances with 
credits available under the Kyoto Protocol Rules, including 
joint implementation and clean development mechanism credits. 
As a result, the price and availability of these Kyoto credits 
will have a bearing on the price of EU allowances.
    Let me turn now to the market itself. Early in Phase I, 
allowance trades were handled by brokers outside of formal 
exchanges. Currently, about half the trading volume occurs on 
exchanges and the other half over the counter. In 2005, about 
$8 billion of trades took place. At the end of 2006, this had 
grown to about $27 billion. Trades in the worldwide carbon 
market for 2006 are perhaps on the order of about $30 billion. 
So the EU ETS has the lion's share of those trades.
    The current spot price for a Phase I allowance is currently 
=1, about $1.30, and this is for Phase I. But the price for 
Phase II allowances, as reflected in the Futures market, is 
today =16.35, or about $21.75 per ton of carbon dioxide.
    There are several lessons one can draw from the EU ETS. 
These lessons can be placed in context by considering three 
features of the cap-and-trade system that are important when 
evaluating policy effectiveness.
    First, cap-and-trade systems establish a new class of 
asset--the emissions allowance--and these assets have immediate 
value once the system is established. Therefore, allocation of 
allowances is an allocation of wealth. Second, cap-and-trade 
emission reduction policies impose a cost on society, and once 
the initial allocation of allowances is made, the distribution 
of the cost will be determined by the market, not by government 
policy. Third, the spot price is a visible signal regarding the 
current cost of greenhouse gas reductions, while the future 
price reflects expectations regarding future cost, and takes 
into account expectations regarding government policy decisions 
and the future cost of abatement, which is, as we know, closely 
linked to the availability of new technology.
    So turning to the lessons, the performance of a cap-and-
trade market hinges on accurate monitoring, reporting and 
enforcement. At the outset of the ETS in Phase I, many nations 
lacked reliable data reporting systems, which in part, 
contributed to some extraordinary price volatility. The lesson 
we draw from this is quite simple: inclusion of sectors and 
sources should be preconditioned by the development of strong 
monitoring and accounting systems.
    Second, the ability of governments to distribute the 
economic burden a cap-and-trade system will impose on the 
economy is greatest during the allocation stage, and 
importantly, the manner in which permits are allocated can 
alter economic incentives, leading to a variety of unintended 
consequences. The lesson here is rather obvious. Think very 
carefully about the allocation and keep the allocation rules as 
simple and as transparent as possible.
    Third, allowances are assets that have significant value. 
Allowances that have fixed lives, like those in Phase I, must 
have asset values that go to zero at their terminal points. 
This raises difficult asset management issues for those 
required to hold allowances, and once again, here the lesson is 
rather obvious: develop effective banking rules, or at least 
short-term overlapping rules, from one phase to the next, that 
in some sense limits this price volatility at the close of 
these periods.
    Fourth, near-term investments in technology needed to 
radically lower greenhouse gas emissions are likely confined to 
the energy sector, where these investments tend to be large and 
very long-lived. Allowance prices are intended to incentivize 
these investments and must have as little political uncertainty 
as possible. At the current time in the European Union, there 
is considerable uncertainty concerning the level of emission 
reductions the EU governments will actually require post-2012. 
The lesson again, fairly obvious: governments need to be as 
clear as possible about emission reduction targets. The 
commitment periods need to be as long as possible and certainly 
longer than the Kyoto periods. Allowance banking is an absolute 
requirement.
    Mr. Chairman, thank you for this opportunity to speak.
    [The prepared statement of Dr. Kopp follows:]
Prepared Statement of Raymond Kopp, Senior Fellow and Director, Climate 
        and Technology Policy Program, Resources for the Future
 the european union emissions trading scheme (eu-ets): a brief overview
by Dallas Burtraw and Raymond Kopp

                    CAP AND TRADE--A QUICK TUTORIAL

    EU ETS is an emission allowance cap-and-trade system. All such 
systems establish a cap on annual emissions (or if banking is allowed, 
on the annual allocation of emission allowances), identify those 
entities whose emissions will be regulated, and set a few rules. In 
most contexts, one allowance is required for each ton of emission. 
Allowances are usually freely transferable, although in some programs 
constraints on trading have been imposed. Allowances can be initially 
distributed in the market through free allocation based on some metric 
or another, or sold through an auction. A key question is whether 
allowances that are not used in the year they are issued can be banked 
for use in a subsequent year.

                            EU ETS STRUCTURE

   The EU ETS began in January 2005 and includes the 27 
        countries of the European Union.
   The program is run in two phases. Phase 1 from 2005-2007 was 
        intended to be a trial period to work the bugs out of the 
        system; however, in all respects, it is a real cap-and-trade 
        system. Phase 2 (2008-2012) coincides with the Kyoto commitment 
        period.
   The cap covers only carbon dioxide (CO2), 
        although other greenhouse gases (GHGs) may be added in the 
        future. (CO2 accounts for 80% of all GHGs.)
   About 12,000 CO2 emissions sources are covered by 
        the cap, accounting for some 40% of all EU CO2 
        emissions. Covered emissions sources include iron and steel; 
        cement, glass, and ceramics; pulp and paper; and energy 
        (electric power generation and refineries).
   Transport is not currently included in the system, although 
        the EU will include air transport in the EU ETS in 2011.
   Each country submitted a National Allocation Plan (NAP) for 
        approval for Phase 1. The European Commission is in the process 
        of finalizing NAPs for Phase 2. NAPs describe three decisions 
        each country must make.

    --How much of a country's Kyoto target is assigned to the sectors 
            participating in the trading system (by implication, the 
            remainder of the target must be met by sectors outside the 
            system--for example, transport). The EU offers strong 
            guidelines and regulatory oversight to require that at 
            least the major sources such as those listed above be 
            included in the program.
    --How much of the cap will be assigned to each sector--determining 
            how much of the burden and cost sectors will have to bear.
    --How the sector allocation is then further subdivided among 
            individual companies.

   EU ETS rules allow countries to auction an upper bound of 5% 
        of the allowances, only Denmark chose to auction the full 5%, 
        the remainder being allocated gratis. More auctioning is likely 
        to occur in Phase 2.
   Emissions sources covered by the EU ETS may satisfy their 
        commitments by surrendering allowances in an amount equal to 
        their emissions or may supplement the EU-ETS allowances with JI 
        (Joint Implementation) and CDM (Clean Development Mechanism) 
        credits (which are generated by undertaking CO2 
        reduction projects outside the European Union in accordance 
        with Kyoto Protocol rules.)
   As a result, the price and availability of CDM credits will 
        have bearing on the price of EU allowances.
                       eu ets market performance
   Early in Phase 1, allowance trades were handled by brokers 
        outside of formal exchanges. Currently about half the trading 
        volume occurs on exchanges and the other percent over the 
        counter.
   In 2005 about 8 billion dollars of trades took place in the 
        EU ETS. By the end of 2006, this is thought to have grown to 
        25-27 billion. Trades in the worldwide carbon market for 2006 
        may be on the order of 30 billion dollars--with the lion's 
        share owing to the EU ETS.
   Prices March 20, 2007:

    --The current spot price is =1.00, $1.33.
    --The December 08 Future price (Phase 2) is =15.60, $20.75.

                            LESSONS LEARNED

    There are three features of a cap-and-trade system that are 
important when evaluating its policy effectiveness.

          1. Cap-and-trade systems establish a new class of asset--the 
        emissions allowance--and these assets will have immediate value 
        once the system is established; therefore, initial allocation 
        of allowances is an allocation of wealth.
          2. Cap-and-trade emissions-reduction policies impose a cost 
        on society, and once the initial allocation is made, the 
        distribution of that cost will be determined by the market, not 
        government policy.
          3. The allowance prices are visible signals regarding the 
        current cost of CO2 reductions (the spot price) and 
        expectations regarding the future cost (futures prices). These 
        expectations take into account expectations regarding the 
        policy decisions determining the required reductions and the 
        future cost of abatement--closely linked to abatement 
        technology.

    The performance of the market hinges on accurate monitoring, 
reporting and enforcement. At the outset of the ETS in Phase 1, many 
nations lacked reliable data reporting systems, which contributed to 
the extraordinary price volatility.

   Lesson.--Inclusion of sectors and sources should be 
        preconditioned by the development of strong monitoring and 
        accounting systems.

    The ability of government to distribute the economic burden a cap-
and-trade system will impose on the economy is greatest during the 
allowance allocation stage.

   Lesson.--Think twice, allocate once.

    Allowances are assets that can have significant value. Allowances 
that have fixed lives, like Phase 1 of the EU ETS, must have asset 
values that go to zero at their terminal points. This raises difficult 
issues of asset management for those required to hold allowances.

   Lesson.--Develop banking rules, or least short-term 
        overlapping rules.

    Investments in technology needed to radically lower GHG emissions 
are likely confined to the energy sector, where they tend to be large 
and very long lived. In that case, allowance prices are intended to 
incentivize these investments and must have as little non-market 
uncertainty as possible. At the current time in the European Union, 
there is considerable uncertainty concerning the level of emissions 
reductions required post 2012.

   Lesson.--Governments need to be as clear as possible about 
        emissions-reduction targets, the ``commitment'' periods need to 
        be as long as feasible--certainly longer than Kyoto periods, 
        and banking is required.

    The Chairman. Thank you very much. I think that gives us 
some sort of parameters and general outline of what it is we're 
talking about and I think that's very useful. Dr. Jos Delbeke, 
I introduced earlier as the EU Commission Director for Climate 
Change and Air and the European Commission's Director General 
for Environment. Jos, thank you for being here, and go right 
ahead.

  STATEMENT OF JOS DELBEKE, DIRECTOR, CLIMATE CHANGE AND AIR, 
DIRECTORATE-GENERAL FOR ENVIRONMENT, EUROPEAN UNION COMMISSION, 
                       BRUSSELS, BELGIUM

    Mr. Delbeke. Thank you very much, Senator. I would like to 
highlight three points in my introduction. The first is that 
the EU ETS is the pillar of the EU's policy to reduce 
greenhouse gas emissions. It is the pillar to live up to our 
commitments of the Kyoto Protocol, and that is -8 percent for 
the EU as a whole. We differentiate internally that percentage.
    Now, the EU ETS covers all major industrial emitters. That 
ETS system has created an active market for carbon allowances 
through which one price is being defined for all 27 member 
states.
    The market volume of those allowances in 2006 was 
approximately $24 billion for the 27 member states of the EU. 
That unique price across Europe has indeed attracted the 
attention of CEOs and Board of Directors in our companies, and 
those companies now look seriously and pragmatically at 
emissions reductions. There are good indications that the low-
hanging fruit, as we call it, the lowest cost emission 
reductions, are being reaped. In short, my first point would be 
that the EU ETS is working because it is cost-effective and it 
is environmentally effective.
    My second point would be that the EU ETS started in 2005 
and we have now a rather young history of only 27 months. 
That's not very long, but what we learned in that period--and 
we called that first period a learning-by-doing period--is that 
today we have the basic infrastructure in place that we need to 
live up to our Kyoto Protocol commitments. That is, in time for 
the start of that first period under the Kyoto Protocol, which 
is the first of January, 2008. So what we learned was in what 
we commonly call the ``pre-Kyoto'' period.
    That infrastructure that we have in place now is first a 
coherent and verified database of the emissions of all 
industrial installations covered. We had to start without such 
a verified and coherent database, and this resulted in a 
relative over-allocation. In fact, only 2 percent was over-
allocated, but that over-allocation nevertheless was there and 
led to a rather sharp fall in prices as we have it today.
    That problem is now addressed because those days, and even 
today, the European Commission took positions on the so-called 
National Allocation Plans for the member states. We see that 
the forward prices have picked up and today, the forward price 
that was indicated is around $20, $23.
    We have a coherent, verified database. We have also an 
electronic registry in place, which is the backbone of a 
trading market. We have a coherent system of monitoring, 
reporting and verification. Member states and the commission 
have learned a lot about how to handle market sensitive 
information, such as the data release and the data of real 
emissions as they are verified.
    We have learned how to do this because emissions trading is 
very new to Europe's environment policy. We never did that and 
we learned, in fact, all our experience came from the United 
States and the sulfur trading scheme that has been successfully 
put up.
    My third point that I would like to make is: what kind of 
message emerges from our experience? The strongest message that 
we would see as the regulator in the European Commission is 
keep the system simple. Because that gives a maximum of clarity 
and a maximum of certainty to all those involved--in 
particular, the private sector companies.
    A simple system for us is a mandatory system that covers 
all major emitters, and we are extending that scope gradually. 
It is also a system that has absolute caps, because everybody 
knows before the trading starts what the name of the game is. 
We have not chosen for reasons of simplicity, for price 
management, so we are not going to price caps. We are not going 
into price floors. We leave the market to determine the price 
and we go for much more harmonized allocation methodologies, 
because the allocation before the period starts was very much 
in the hands of the member states, and that led to too-wide 
variation in the way that was being done.
    Our conclusion was that it is absolutely essential to have 
clear incentives to all private sector players, to leave it to 
the companies to make or buy decisions, and to minimize every 
interventionist inference to the absolute minimum. That 
creates, in our view, strong incentives for the deployment of 
new technologies in our companies. We also thought that keeping 
the system simple would create the best guarantee for extending 
the system internationally, either through offset mechanisms 
like we have in the Kyoto Protocol, or also through linking 
with other regional schemes.
    Keeping the system as simple as possible and the 
interference of the public authorities as minimal as possible 
has been a very strong guidance in the setup of the EU ETS. 
Thank you very much.
    The Chairman. Thank you very much. I appreciate that 
excellent testimony. Mr. Per-Otto Wold is the founding partner 
and CEO of Point Carbon. Thank you very much, and thanks for 
your help in getting this roundtable organized.

  STATEMENT OF PER-OTTO WOLD, FOUNDING PARTNER AND CEO, POINT 
                      CARBON, OSLO, NORWAY

    Mr. Wold. Thank you, Chairman Bingaman, Senator Domenici 
and members of the committee. Thank you for the opportunity to 
appear before you here today. As requested by your invitation, 
my statement focuses on Point Carbon's experience and analysis 
of the EU ETS and other developments relating to the emerging 
carbon markets. Overall, we would argue that the EU ETS is a 
qualified success, although we clearly recognize the need for 
improvements with regard to market design and other issues.
    With regard to achievements and what has been done right, 
we first acknowledge that the EU ETS has led to price discovery 
and the PAN-European price on carbon has been established. 
Organizations across Europe are now factoring in the cost of 
carbon in their business decisions. According to a recent Point 
Carbon survey, 65 percent of respondents covered under the EU 
ETS have now initiated internal abatement measures as a direct 
result of the EU ETS, and this is up 18 percent from last 
year's survey.
    The EU ETS has put a cost----
    The Chairman. What percent did you say have now----
    Mr. Wold. Sixty-five percent of the respondents.
    The Chairman. All right.
    Mr. Wold. The EU ETS has put a cost on emissions and a 
value on reductions. Second, the expected demand from Phase II 
of the EU ETS, lasting from 2008 to 2012, is widely seen as the 
key driver for investments in projects aimed at reducing 
emissions in 128 developing countries and countries with 
economies in transition.
    According to Point Carbon's estimates, investments in 
projects under the Clean Development mechanism and joint 
implementation will deliver real verified emission reductions 
in the range of 2 billion metric tons of CO2 
equivalent emissions by 2012, around 400 million metric tons 
per year. This corresponds to approximately 6 percent of total 
greenhouse gas emission in the United States in 2005.
    Third, we argue that market efficiency is satisfactory and 
comparable to what was seen in the USS 2002 trading program. 
Almost as important, there are no perceived information 
asymmetries between the participants. Point Carbon estimates 
that more than 1 billion metric tons were traded in the EU ETS 
alone in 2006, with a financial value of more than US$24 
billion. The turnover was 50 percent, measured as the ratio of 
traded volumes to the total quantity of allowances allocated. 
It is comparable to what was seen in the second year of the USS 
2002 program. We forecast that traded volumes will double again 
in 2007.
    As mentioned, experience has also highlighted a number of 
areas where there is scope for improvement. First and 
importantly, it is critical to get the baseline right. The 
release of verified emission figures for the year 2005 showed 
that emissions were around 5 percent below allocated 
allowances. Although it is likely that some of this is due to 
actual emission reductions, Point Carbon's analysis suggests 
that governments in most countries allocated more than what was 
needed for compliance. Still, it is important to recognize that 
the EU ETS has produced a consistent set of verified emissions 
data, which future allocations can be assessed against.
    Second, unauthorized leaks of verified emission figures for 
2005 in several countries created information asymmetries and 
undue opportunities for some business market participants. This 
has highlighted the need for strict rules and procedures for 
handling of price-sensitive information along the lines that is 
common in more mature financial markets.
    This concludes my opening statement and I'd like to take 
questions.
    The Chairman. Thank you very much. Mr. Garth Edward, we're 
glad to have you here again. Thank you.

   STATEMENT OF GARTH EDWARD, TRADING MANAGER, ENVIRONMENTAL 
              PRODUCTS, SHELL OIL, LONDON, ENGLAND

    Mr. Edward. Thank you, sir. Good afternoon, Senators and 
thanks again for the opportunity to make this submission. I'll 
be speaking from the perspective of a trading manager for 
Shell, so not on the legislative side, but from the 
practitioning side.
    I'd like to emphasize that Shell believes the EU Trading 
System has delivered important results in the first 2 years of 
operation. I think there are three important results to 
highlight.
    First, I'm going to say that the legislative foundations 
have been laid--clearly this is the case. More than 10,000 
installations across 27 countries are now covered by formal 
emissions trading laws, from Ireland to Estonia, from Greece to 
Slovakia. That covers also cement, metals, refining companies. 
They all now monitor, verify, and report their emissions. A 
registry system is in place and every year, governments ensure 
and enforce that these companies hold a volume of allowances at 
least equal to their verified emissions--the first significant 
step forward.
    Second, we believe that the point of an emissions trading 
system is to give companies the necessary information to allow 
us to allocate capital in the most effective way to deliver the 
required environmental results by implementing projects, 
investments in clean technologies, and so on. This means that 
we need a price to plug into operational decisions and project 
plans and investment strategies. The EU Emissions Trading 
system has clearly delivered this price information and it has 
not been subject to any price controls.
    The market is deep and liquid. Approximately $50 million 
per day of allowances trade through several exchanges and 
brokerage houses, and the forward curve extends out to 2012, 
which is comparable with oil or gas or power markets. For 
companies like Shell, this is the critical information that 
helps us reduce emissions in the most effective way.
    The third major step forward has been that the EU Emissions 
Trading system has driven the development of international 
market mechanisms. The Clean Development Mechanism and Joint 
Implementation are what they are known under in the Kyoto 
Protocol. Shell supports an international approach to emissions 
trading and notes the strong success of these mechanisms in 
implementing a wide range of environmental technologies, such 
as wind, biomass, landfill gas capture, flare reduction, energy 
efficiency and so on, in more than 120 developing countries.
    These projects are expected to reduce on the order of 480 
million tons of CO2 per annum and will flow 
approximately $6.5 billion per year to less-developed 
countries. We note that these international mechanisms finance 
the transfer of new technology, and they also improve local 
employment and local environmental standards in developing 
countries.
    But like any school report, there is always room for 
improvement. For the first phase of allocations, 2005 to 2007 
in the EU, annual emissions were capped at an average 2.09 
billion tons of CO2. As verified data have been 
published, we can see that this cap actually resulted in an 
annual surplus of about 150 million allowances more than 
emissions, as Mr. Delbeke has already alluded to.
    Supply has therefore exceeded demand and consequently, the 
market for Phase I allowances now trades around $1. It is clear 
though that the next round of allocations for 2008 to 2012 are 
being tightened based on this experience. The information is 
there and the allocations and the policies are being adjusted.
    Current projections are that cuts of about 335 million tons 
of CO2 per annum against business-as-usual will be 
necessary to steer EU member states on a course to meet their 
Kyoto targets. The Commission is confident that this is the way 
things will go.
    In order for companies to deliver these results, the 
European Commission, however, must focus on working with the 
United Nations to overcome infrastructure delays and to ensure 
that all registries are operational and connected to the 
international markets. This is the way that we'll be able to 
deploy capital in the most effective way to fund emission 
reductions at the lowest possible cost. Thank you.
    The Chairman. Thank you very much. Next is Dr. Jean-Yves 
Caneill, who is with Electricite de France. We're glad to have 
you here.

 STATEMENT OF JEAN-YVES CANEILL, PROJECT MANAGER, SUSTAINABLE 
   DEVELOPMENT DIVISION, ELECTRICITE DE FRANCE, PARIS, FRANCE

    Mr. Caneill. Thank you very much, Senator Bingaman and 
Senator Domenici. I'm quite honored, and also my company, to 
have been invited to testify before the U.S. Senate with the 
objective to share with you our views on this instrument that 
was implemented in Europe early in 2005, the EU ETS.
    We've been quite involved in the early days on the 
definition of that instrument as we contributed to organize the 
so-called GETS experiments in 1999 and 2000, which is the 
Reopen Electricity Association of the start of the first 
discussion in Europe on the emission trading issue.
    As a large electric utility group, we have faced different 
issues in the past years and questions on the effect of ETS on 
the power prices and its impact on large consumers, on the 
relevance of ETS to do the work is intended for.
    So I would like to stress shortly here some of the factors 
I consider as key for price development of an emission trading 
instrument in the future that can be taken forward by any new 
system which might come on board, including the revision of the 
EU ETS. This started to be discussed some weeks ago and in line 
with my analogies of what is wrong and what is right that I've 
provided before.
    What I will be shortly developing is quite in line with one 
of the lessons of the simulations we did in 2000. Investments 
reduce emissions, not trading. Emission trading helped to find 
the least-cost ways to do them. Therefore, as I will talk on 
the electricity sector, the timeframe-related questions will be 
very important.
    So I'd like to make three points. The first one, a long 
time framework has to be considered. Actors need to get 
predictability in the rules in order to shape their investment 
decisions in the right way, and looking in the electricity 
sector, a period of 30 years probably is relevant. The 
allocation process for allowances might be revisited along this 
timeframe, which is long, but each allocation period will to be 
at least something like 10 years.
    Second, concerning the definition of targets, it is 
necessary to state something. We have to get a system working 
and safe for delivering environmental integrity, given the 
economy reality check. If a cap-and-trade system is going to be 
implemented, attention has to be paid to the available 
technologies today and to the future technologies, which are 
not existing yet.
    So the targets have to be set appropriately to the sectors 
with realistic trajectories for the constraint, taking into 
account the capital stock turnover of the sector and the 
investment cycles.
    Last point--the devil is in the details, and what we have 
learned from the first period calls for the following 
requirements at least progressively, in the allocation process: 
move as soon as possible to appropriate rules for new projects 
or new installations. So the rules should be as soon as 
possible, as soon as we can, no free allocation for these new 
projects. This is the only one which is economically sound for 
giving the incentive for investments in the right technologies, 
taking into account the CO2 cost and the full cost 
of technologies, or in our language of electricity, the long-
term marginal costs.
    In the same time, installations, which could have been 
given allowance for free at the beginning, with a 
grandfathering approach, could continue to receive part of them 
for free, but with a clear indication that they will have to 
deliver reductions over time to incentives then for future 
investments. So different methods could be proposed to address 
these so-called compliance factors in an organized manner, 
taking into account the age of the installations or use of 
benchmarking approaches.
    In summary, if we give long-term visibility in the 
framework, realistic trajectories for the targets over time and 
proper allocation processes are related to the inclusion of the 
environmental--in the fuel costs, I think we can build the 
basis of an appropriate framework for taking the right 
decisions without putting too much stress to the economy. 
Linking more systems together, taking into account the role of 
offset projects, domestic as well as developing countries, and 
bringing progressively more sectors and gas in the economy 
could help to build a new international regime at the end of 
the day. So I thank you very much for this opportunity to 
speak.
    The Chairman. Thank you very much. Let me--before you 
start, Dr. Vanderborght, let me just see if some of the 
members--I know Senator Salazar is going to have to go the 
Senate floor, I'm informed. Does anybody else have a need to 
run out, if they want to ask a question before we hear from our 
final two witnesses?
    If not, I guess Dr. Vanderborght, why don't you go ahead? 
Then Dr. Ellerman, and then we'll open up the discussion.

  STATEMENT OF BRUNO VANDERBORGHT, VICE PRESIDENT OF CLIMATE 
         PROTECTION, HOLCIM CEMENT, ZURICH, SWITZERLAND

    Mr. Vanderborght. Thank you very much, Senators Bingaman 
and Domenici. I will talk from the perspective of a large 
global cement producer, CO2 and energy-intensive 
producer with about 15 percent of our emissions in European 
Union, 15 percent in the United States and 60 percent, the 
fastest growing in developing countries. So for us, climate 
change and trade issues at a global level is really the core of 
our interests.
    Going to what is--going well with the European Emissions 
Trading System, we have to recognize that it is a remarkable 
political and business achievement. In a very short time, all 
the legislation, all the regulations are in place in European 
Union and implemented by all 27 member states.
    The monitoring, reporting, and verification of emissions 
gives us a very sound information basis for building of future 
reductions. Knowing what we do and knowing what we can do in 
the future really is of critical importance with this 
monitoring and reporting.
    The CO2 emissions trading market functions in a 
competitive environment. All the tools and methodologies work 
well and we have a good price indication. This has, as a 
result, that CO2 emission reductions and energy 
saving is now very firmly on the radar screen of the CEO, the 
Executive Committees and the Board of Directors of major energy 
companies, and that is really the most important driver for 
change--attention by the top management of the companies.
    It also has an influence on our investment decisions in 
Europe, in the United States, and in developing countries. Now, 
we may not forget that this is not an emissions trading system. 
It is an emissions allowance cap-and-trade system and for the 
energy-intensive industry, the cap on our emissions, the 
obligation to reduce our emissions is of absolute key 
importance and is more important than the trading aspects of 
the allowances.
    Here we have some room for improvement of the European 
system. The current allowance allocation is based on absolute 
emissions from the past and that is extrapolated to the future, 
meaning that the more you polluted in the past, the more you 
have the right to pollute in the future. Early action is 
punished. The absolute cap based on historic emissions and 
lower allocation to new investments freezes market change and 
does not provide a real incentive for innovation in new 
investments. It is future investments which will reduce the 
emissions.
    Also, the time perspective that we have at this moment is 
insufficiently long: 2012 is for a short time and even 2020 is 
for a medium time.
    All these counterproductive rules in setting the allowance 
allocation has as a result that there is very intense lobbying 
in different directions from different industry beliefs, all 
trying to get as much as possible free allowances to start, and 
this does not help the credibility and the efficiency of the 
system.
    So our most important recommendation for improvement of a 
system which is already good, but our most important 
recommendation is to simplify the allowance allocation. We need 
a long-term, simple long-term target. Long-term means 2030, 
2040. Based on CO2 efficiency performance, so 
CO2 intensity of our products multiplied by real 
production to have an absolute cap-and-trade system.
    Having a long-term target, we need a predictable path from 
current performance to the decreasing long-term target. That 
will provide us sufficient incentives to improve our emissions 
through investments in Europe, the United States, and 
developing countries. Thank you for your attention.
    The Chairman. Thank you very much. Our final witness here 
is Dr. Denny Ellerman, who is with the Sloan School of 
Management at MIT. We're very glad to have you here. Go right 
ahead.

STATEMENT OF A. DENNY ELLERMAN, SENIOR LECTURER, MASSACHUSETTS 
             INSTITUTE OF TECHNOLOGY, CAMBRIDGE, MA

    Mr. Ellerman. Thank you, Senator Bingaman, Senator Domenici 
and fellow Senators of the committee for this opportunity to 
testify before you.
    I speak to you as a student of emission trading systems and 
of the European trading system in particular. My prepared 
remarks about what is right and wrong with the European trading 
scheme are contained in the discussion packet that you have 
received, and I thought what I do with my allotted time here is 
to provide an outside perspective at my noting two 
circumstances in the implementation of the EU ETS that 
distinguishes it from what might occur in the United States.
    These are: first, the very different Federal structure of 
the European Union, and second, the great haste with which the 
EU ETS was implemented.
    Senator Domenici. Mr. Chairman, Mr. Chairman.
    The Chairman. Yes, go ahead.
    Senator Domenici. I wondered if I might just interrupt for 
one moment and just make an observation for our English 
visitors. I think since we are going to soon talk with you, our 
British visitors, I think it might be well that you listen 
attentively, because this witness may, in fact, be one that has 
done more homework than we have, your American inquisitors, 
because he has just indicated what he is and we are not that. 
To the extent that we can tell you we have worked hard and 
studied, we are not students of what has occurred in your 
countries collectively. You are, maybe but he is for certain. 
And that should be noted by you because that to us, is very 
important. Thank you, Mr. Chairman.
    Mr. Ellerman. These two circumstances are important because 
much of what is criticized about the European Emission Trading 
System results from these circumstances rather than from the 
inherent characteristics of the cap-and-trade mechanism that 
has been adopted in Europe and that is under consideration by 
the U.S. Senate.
    Let me expand briefly upon each of these circumstances. The 
relationship between the member states of the European Union in 
Brussels is very different from that between the States of the 
American Union and Washington. The constituent elements of the 
European Union are sovereign states that have ceded some 
authority to Brussels, but they retain a degree of sovereignty 
that Texas, California or New York, for example, could not 
aspire to attain.
    The result for the EU ETS is a highly decentralized form of 
implementation and the consequent differences among the member 
states, especially as it concerns allocation, have been 
strongly criticized. But much of that criticism presumes a 
political reality that while desirable, does not presently 
exist. The stronger Federal structure of the United States 
should allow Congress to avoid many of these problems, although 
regional differences will, of course, still have to be 
resolved.
    The second circumstance, the haste with which the EUS was 
implemented can best be appreciated by comparison with the U.S. 
SO2 Emission Trading Program, which was, in its 
time, also a first of its kind. The latter, the SO2 
system, was proposed in April 1989. It was signed into law in 
November 1990. In the intervening 18 months, Congress decided 
all of the major features of the SO2 system, 
including notably, the cap and the allocations. EPA then had 4 
years to issue what were largely technical implementing 
regulations and to establish the registries through which 
trading would occur.
    In Europe, the comparable authorizing legislation was 
proposed in mid-2001 and approved by the member states at the 
EU level 2 years later, in mid-1983. In the remaining 18 months 
before the system was to begin operation, the member states 
were to determine the caps, allocate allowances, issue the 
implementing regulations and set up the registries. When the 
system started on January 1, 2005, many of the caps and 
allocations had been completed, but not all. Most of the 
implementing regulations still had to be put in place and only 
one registry was operating at the start. Now all of that has 
been resolved, as you have heard, and these problems have been 
worked out.
    It's important to understand that the underlying reason for 
this rushed and somewhat ragged implementation was the desire 
to conduct a 3-year trial period to work out the problems prior 
to the start of the trading period that really counted with 
respect to the Kyoto Protocol. In effect, the EU adopted what 
you could see as sort of a boot camp approach, that there is 
going to be some unpleasant experiences, but the subjects will 
be better off after they've been through it.
    This was, in my judgment--I think this was a good judgment 
on their part, given the circumstances, but I would stress that 
it is a circumstance that I do not think applies to the United 
States. Thank you for your attention.
    The Chairman. Thank you very much. Let me just start with a 
question, and then I'll call on Senator Domenici for any 
questions he has, and then we'll open it up to any other 
Senator.
    Dr. Delbeke, I think you highlighted the fact that one of 
the accomplishments is that you now have in place a coherent 
and verified database on emissions, as I understood what you 
said. To the extent that we are seriously considering putting 
in place a cap-and-trade system in this country, I would assume 
we would need something comparable. We would need good 
information about where the emissions are, the extent of the 
emissions in order to be able to set up an allocation system. 
I'd be interested in any more you could say on the subject of 
what's involved in putting that together, that kind of a 
database and the length of time it took to accomplish it.
    Mr. Delbeke. Thank you, Senator Bingaman. I think indeed, 
it is absolutely necessary to have a good database. I think 
that the experience we had over the last 2 years underlines 
that. Now, there is a bit of choice in this. You can either go 
ahead as we did and take a risk. Good hindsight; we didn't know 
what precisely the risk was we were taking. We were rather 
confident that the database we were working on based on the 
best data around, et cetera, was a good one. But that is one of 
the lessons that we learned, that the other way around would be 
to start first in building up a coherent and solid database, 
and then go into capping decisions and into the trading itself.
    Now for Europe, and I guess as well for the United States, 
the construction of these databases builds a lot on existing 
regulations, I would assume. That means that major polluters 
like power stations or cement kilns or petrochemical 
installations are already subject to procedures on which a lot 
of information is available. The only thing that was not 
available in Europe was a knowledge about the precise emissions 
of greenhouse gases. We knew a lot about NOX and 
SOX and PM10 and all kinds of other 
emissions and these charges, but not about greenhouse gas 
emissions. So we started with best guesses, and now we know 
much better, because what we did was not create an obligation 
to the public authorities to create a database, but we took the 
analogy of the financial markets. We asked companies themselves 
to make a report about their emissions and to have every year 
such a report made and verified by a third party.
    We are in a very different political structure, as was 
outlined by Professor Ellerman, and I think that explains as 
well that we could not have gone as fast as we did if we would 
have had to wait for the 27 member states and the 
administrations, which are very different in quality and in 
capability to have that solid and verified database made. So we 
asked, as an analogy, to the financial markets, to ask the 
companies to do it themselves, to ask for an independent 
verifier to check the bills, so to speak, and there is what we 
have every year now by April, May, every year, we will have a 
verified database about the real emissions release on 
greenhouse gases. Thank you.
    The Chairman. Thank you very much.
    Senator Domenici.
    Senator Domenici. Thank you very much, Mr. Chairman. Let me 
see if I can make sure we clarify a couple of things for the 
record. If I'm wrong, please just tell me I'm wrong, but from 
what I understand, the cap that you have is very loose. By 
that, I mean the price of carbon is very cheap and you couldn't 
have that as your permanent level and have a program, is that 
correct? I see nodding of the heads but we're in a forum where 
we need somebody saying yes. Let's do it this way. Since none 
of you have said no, I assume you all said yes. That's fair 
enough, that's the way we do it around here sometimes.
    All right. Now having said that--oh, you wanted to comment?
    Mr. Ellerman. Senator, yes. I guess I'd make one comment. I 
think there is general agreement that the cap is loose. I mean, 
how loose is a difficult question to address, and I think a 
distinction must be drawn between the first period price now, 
which is quite low, and the second period price in starting 
2008, which is =16, a fairly high level, and that results from 
design features, namely the lack of ability to bank from the 
first period into the second period. So you've created this--
what are now very low prices. They will disappear on December 
31 of this year.
    Senator Domenici. Thank you very much. The fact that I said 
a while back that you were our expert should not be taken 
literally. You don't have to answer everything I say.
    [Laughter.]
    Senator Domenici. In any event, that was well taken and we 
needed that. Now let me make sure that everybody else--we 
understand a few other things here in America as you talk.
    Your agreement among yourselves--that does not include any 
outsiders like China or India or any comparable countries, is 
that correct? Please, Mr. Delbeke.
    Mr. Delbeke. Thank you, Senator. It does not include in the 
emissions trading the link, the formal link with other 
emissions trading systems in the world simply because they do 
not exist.
    Senator Domenici. Yes.
    Mr. Delbeke. But the ETS directive, the regulation itself, 
foresees such a linkage. But that will have to be subject to a 
separate decision made by the legislature.
    The other element is that the ETS system is open for 
credits from other parts of the world; that these credits are 
created through the Kyoto Protocol. They are so-called credits 
from the Clean Development mechanism and from Joint 
Implementation schemes and these credits are, in fact, 
generated by projects--offsets--projects that are being 
undertaken, to a large extent in China, but also in Brazil and 
other parts of the world. These credits can be brought into the 
European scheme and have a value to comply--compliance possibly 
of companies to use these credits. Thank you.
    Senator Domenici. Well, I think that's a good answer, but I 
think that we should make it very clear that--what you're 
really saying is you have some provisions whereby one might 
conclude that under certain circumstances, all things being 
right, you might have one of these countries join, right? But 
it's obvious to me that they are not overtly speaking as if 
they would like this, and it would seem to me that for you to 
come here and imply that there is, is a misstatement, that 
they're not interested at this point. They're not interested 
even in entering into an agreement with the United States in a 
major way, and we're one of the trading partners that they 
ought to be most worried about, because they sell us too much 
in comparison to what they buy. That has a big impact, one way 
or another, or will have, depending upon what happens to this 
program.
    I want to make two other points and then I'll let you 
comment further. I want to make for the record another point. 
Constantly, it is said the United States--and they reply that 
President Bush--turned down the Kyoto Agreement. I think it 
should be fair here, although not discussed as such; the 
President did not turn down the Kyoto Agreement. The Senate of 
the United States turned down that agreement by a vote of 95--
was that the vote? Ninety-five--97 to zero, and the resolution 
said to the President, don't bother to send it to us because 
we're not interested in voting on it. So then we got involved 
in a Presidential campaign and everybody forgot that and they 
said the President of the United States is the one that turned 
down Kyoto. Well, not so. The U.S. Senate, Democratic and 
Republican did.
    The last question--last observation and/or question to you 
all--there is a big difference between what you are doing and 
what the distinguished chairman, Senator Bingaman, my colleague 
from New Mexico is doing. He is distinguished, and he is 
working very hard to try to get cap-and-trade language that 
might get him a sufficient number of votes to get it out of 
committee, for which I applaud him. I haven't yet said that 
I'll go beyond that and vote with him. That's two different 
things--you can laud your colleague without agreeing with 
everything they say. I know that, too.
    On the other hand, he does his differently. The taxing 
point for you is downwind, right? You tax at the end of the 
emissions scheme and he taxes at the upper end, right? So you 
would be taxing the coal mine that emits coal, from which coal 
comes and is put into the scheme. You would tax it right there. 
We understand the European communities are living under a 
system that does what? Stay with the coal mine. What happens? 
They mine the coal and then when do they tax it?
    The Chairman. I think the witnesses can answer better. My 
understanding is, what we're proposing is to regulate the 
carbon as far as we can, when it comes into the economy, very 
much upstream. As I understand the European system, you 
regulate further down at the place where the emission is 
actually made into the atmosphere. Is that a fair statement?
    Senator Domenici. Is that a fair statement, sir?
    Mr. Delbeke. I think indeed that's a very fair statement, 
and perhaps it is explained by the following, why the European 
system follows the downstream approach, and that is that the 
system does not incorporate transport. Because we have a 
tradition in Europe of dealing with transports through a 
combination of direct regulation, the technical regulation and 
taxation, and we didn't want to change that system because we 
found it was effective in having energy-efficient cars and 
transport systems in place.
    May I perhaps take the opportunity of replying also or 
making a comment to the question on whether we expect other 
states to join or to link up with the European system, which is 
quite different. We expect, for example, Norway or Iceland to 
join the system. That means they are going to be a complete 
part of the system and will accept the system entirely as it 
stands. We are looking for other states to link up with our 
system, which means that it is not necessary that those who 
want to link up with the EU ETS have to have exactly the same 
regulatory context. There may be differences. I think the less 
differences there are, the easier that will be. But it is a 
possibility that is foreseen by the legislature that we can 
link up with states like the United States, which is frequently 
debated in Europe, and with Canada, where there is an active 
debate going on, even with States like California, who also are 
investigating our system. So linking is different from joining, 
but both possibilities exist. Thank you.
    Senator Domenici. Thank you very much. Senator Bingaman, 
I'm going to yield now and I'll wait and ask questions at a 
later date, when the Senators have finished.
    The Chairman. I know Dr. Vanderborght had some thoughts on 
this issue of how to bring China and India or the extent of 
their involvement since they do business in those countries.
    Mr. Vanderborght. Yes, thank you, Senator Bingaman. Indeed, 
as I said in the introduction, we have about 60 percent of our 
emissions in developing countries and it is especially growing 
in Asian countries. The business opportunities that have been 
created by the European Emissions Trading System are 
significant. We have fairly regular contacts with our Asian 
operations and I can tell you that the interest of Asian 
companies to engage in the CDM projects and to effectively 
reduce their CO2 emissions and energy consumption is 
very real and significant. I am rather positive of engaging, 
after 2012, the developing countries, if we could move to a 
system which rewards efficiency instead of only basing on 
absolute emissions.
    I would also like to take the opportunity, Senator 
Bingaman, on commenting on the previous question on monitoring 
and reporting. As it has been discussed, very good quality of 
information is essential for a successful emissions trading 
system. So I would recommend to the United States to start as 
early as possible with mandatory monitoring reporting and 
verification. I insist on the word mandatory, because we know 
from experience that limiting ourselves to a voluntary 
monitoring and reporting system does not provide reliable 
information, because it will be essentially the leading 
companies which will participate to a voluntary system, so you 
will get an over-optimistic view of the real emissions. Whereas 
we demand that you have the whole industry, and then you will 
get much more accurate view of the emissions.
    Adding to what we do in Europe--in Europe, the monitoring, 
reporting and verification is only on absolute emissions. It is 
important to also have information in that system on 
performance, because only having absolute emissions allows you 
to build allowance allocation grandfathering, but does not 
provide you the necessary information to have an allowance 
allocation on benchmarking or performance, and that is the key 
for success in the future.
    The Chairman. Let me see if other Senators--Senator Corker, 
did you have a question?
    Senator Corker. Yes, sir, I do. I have several questions, 
thank you. Thank you for this great hearing. I appreciate it. 
It seems to me that if you were going to have one of these 
systems, that the method that Europe has--not to be critical 
versus the upstream method that has been proposed--is one that 
would cause CEOs to actually make decisions as to how they're 
going to create steel. It seems to me that that's the level at 
which you'd want those decisions made, versus it coming out of 
a mine or coming out of another place. It seems to me that the 
upstream approach is more of a carbon tax than it is an actual 
trading system. I see people nodding here so I'm going to move 
on.
    The level at which you're trading now, the $16: is that a 
level that really creates enough pain for people to invest in 
technology, or is that a rate that is a fair rate, or is that 
still way below what causes people to actually make investments 
in technology?
    Mr. Edward. The bulk of emission reductions in the EU are 
made, actually, by coal-to-gas fuel switching and power 
stations, and any price will start to change the dispatch of 
power plants and start to change away from coal into gas. It's 
certainly the case that prices of =16 or $24 or whatever, will 
start to change those dispatch decisions.
    Senator Corker. I'll ask one more question. I came from a 
business where there was an adage that said, ``Bought right, 
half sold.'' In other words, the deal you made on the front end 
was where at least half the value if not all of it was made. 
The allocation of these credits--I just sit here and think 
about all the governmental relations people we have here in 
Washington and all the industries. I can't possibly imagine 
trading the allocation process. You can create one that would 
actually be fair. I mean, it just seems to me it would be very 
difficult, and I'd like for you to educate me on this because 
this seems to be the most perplexing piece to me. In that you 
have people who have been good actors, meaning they've invested 
heavily, let's say over the last 20 years to reduce emissions. 
Then you have people that have been really bad actors. They're 
just blowing coal out and certainly have paid no attention to 
that. So you have that discrepancy, and then you have the issue 
of new industries that don't even exist today and how are they 
allocated credits? I'd love to understand that if I could.
    Dr. Caneill. Yes, I'd like to respond to that question. 
This is really the key thing for the future, as I've been 
trying to state in my initial statement. Looking at the prices 
we have today, any price has an influence in the electricity 
sector on the varied order of the plans you are using for 
delivering the electricity. So when you reach some prices, you 
can displace coal-to-gas, for instance, and depending on the 
price of the fuels, you will have a requirement for the pseudo 
price in order to change the married order. But you cannot go 
very much with that because you have existing plans. So you 
have some limitation. The real thing to implement is a system 
that allows the people to take the right signal for the 
investment.
    So in the future, I need to know what the price signal is 
that I need to change my investment decision from a coal-
powered plant or to a gas-powered plant or to equip in the 
future, a coal-powered plant with--so it is important to have 
the right price signal introducing the full cost of the 
technologies. So this is very different from the shorter 
marginal costs of appropriation. I need to have a signal for 
real investment.
    Senator Corker. But that's not really the question I'm 
asking. I'm talking about setting it up on the front end and 
allocating the caps--I mean, it just seems to me that that is a 
huge undertaking and that smart people--the smart companies are 
going to make all the money on the front end, if you will, in 
the allocation process, and create tremendous wealth there. I'm 
just wondering if you all might know how to overcome that.
    Mr. Edward. I was just going to come back and say, of 
course we recognize the point that initial allocations 
establish winners and losers in the game. Typically, it's 
spoken both academically and in the marketplace. There are 
three basic methods by which you can do an allocation. Either 
you can grandfather, based on historical emission levels or you 
can issue allocations against some kind of benchmarking level, 
or you can auction. They all have different merits, different 
drawbacks, different kinds of political achievability and so 
on.
    Grandfathering in the EU context, had the merits of being 
able to get the system going in reasonably short order. It's 
clear that as we move into the next round of national 
allocation plans, there are now other kinds of allocation being 
considered, to answer some of the questions that you just 
referred to, to do with equity of allocation and so on. So it 
may be that you have a starting point, which is politically 
achievable and then that there is some kind of transition to 
other better, more accurate systems, which can be established 
on the back of real information rather than initial reports. So 
I think it is a kind dynamic process.
    Mr. Delbeke. If I just may complete the argument that was 
made, because European Commission had to scrutinize all these 
national allocation plans that the member states were serving 
up to the Commission, and in fact, we had a double assessment. 
The first is a macroeconomic assessment, so what turns out to 
be the optimal amount for a member state and there is to be 
taken into account that every single member state has a 
separate commitment under the Kyoto Protocol that is legally 
binding. So that already explains the degree of scarcity for 
every single member state and within that, we have a very 
different pattern in the European Union of member states 
industrializing heavily, like the new member states, or member 
states like the U.K., for example, who are rapidly moving to a 
service economy. So we use economic indicators to differentiate 
in the approach in order to make sure that what is being given 
to companies is fitting together with the Kyoto Protocol, but 
also the sound economic conditions internally into the EU. 
That's the macro--the top-down approach, and that is being 
complimented with the bottom-up approach, which is sector-by-
sector at the member state level.
    Now there is one element I would like to draw your 
attention to, and you explicitly mentioned that, what with new 
entrance. The European regulation is silent on what to do with 
new entrants. But the member states have all separately 
invented one element that is the new entrant reserve. So when 
new investments are being done, the new investor can ask, 
according to certain conditions, to the member state, to have a 
set of free allowances, and this new entrants reserve is 
increasingly managed by technological/benchmarking criteria. 
One of the big debates we are going to have for the future is 
whether we should not forget about the new entrants reserve, 
once the system is up and running, that it would not be normal 
that a new entrant is going or is forced to buy a number of 
allowances on the market--or the alternative is to have a more 
harmonized use of the new entrant reserve so as to avoid 
distortions creeping in, not only in system installations but 
also with the new investors coming into the market. Thank you.
    Mr. Ellerman. May I add a comment? Let me step back a 
moment to address your issue about allocation. I think first it 
must be observed that allocation has been solved in a number of 
programs in the United States as it has in Europe and this is 
always the tough issue. It's never easy. The underlying issue 
is who is going to get the rights to emit that are now being 
restricted which, in most cases, were freely exercised prior to 
the policy that is being adopted? This is faced by any 
environmental constraint, however imposed, and the main 
difference that makes allocations so difficult in cap-and-trade 
programs is that the assignment of these rights is explicit and 
transparent.
    It is fundamentally issues of equity on who should receive 
these rights. In my view those are best resolved in legislative 
processes whose main job is to resolve issues of equity almost 
in any laws that you pass. I think in this case, if you want to 
step back, the major contending principles that we observe here 
is sort of prior use claim, if you wish, an ecological squatter 
claim. There are lots of institutions in our society that 
recognize prior use. There are parties who are exercising this 
right freely. It's now being restricted. They will continue to 
exercise that right, and they assert a claim, but there are 
counterclaims to that. Those counterclaims are essentially what 
you could characterize as higher social purposes to which the 
revenues--the scarcity rents being created by these systems 
inevitably and by any environmental constraint--could be 
dedicated through auctions such as new technology or return to 
citizens. I mean, there is a whole series--reduce other taxes--
of other uses and purposes.
    But I think to step back broadly, it is a problem that has 
been solved. It is difficult. It is probably one of the most 
difficult aspects of setting up any system--deciding who gets 
these rights that we are now going to limit. Thank you.
    The Chairman. Senator Domenici had one question he wanted 
to clarify, and then he's going to have leave and then Senator 
Lincoln had some questions.
    Senator Domenici. Thank you, Senator Lincoln, because I 
certainly have had more than enough time and I would not want 
to deny you a chance. I must go to the office now, and so I 
just have a question because I'm confused about this price of 
the--how much it is per ton? I understand you've been using =16 
a ton. But that's not the price now. That's a future price, 
right? So my friend from Tennessee who was asking about the 
price at =16 per ton--let's make sure we know that's not the 
price now. That's a future price. They've got a much cheaper 
price now. But I don't quite understand why. Does it have to do 
with what we talked about a while ago, that you have that too 
loose a cap and have done that on purpose? If so, what's the 
purpose? Why is that? You both look so eager.
    Mr. Wold. In essence, there are two main prices in the 
market. There is a price for Phase I, which is the 2005 to 2007 
price and then there is a price for Phase II, which goes from 
2008 to 2012. They are basically two different products and the 
supply and demand in those two products are different. The 
supply for the Phase I is surpassing the demand, hence the 
price is very low, around $1, around =1.
    Then when we get into Phase II, with the allocation plans 
being decided on currently, the caps are stricter, so the 
supply is less and the expected demand is expected to be higher 
than the current supply, and hence, the price is around =16 to 
=17 at today's levels.
    Mr. Delbeke. There may be a question why we have in the 
European system, this strong separation between the first 
period and January 1, 2008 period that is going to start. The 
real history is the Kyoto Protocol. We were preparing ourselves 
for the Kyoto Protocol. We know that longer periods would 
prevent these price differences and in the future, we will have 
longer periods and we will have also a possibility to bank 
allowances from one period to the other. But for the learning-
by-doing period, this first period we have until the end of 
this year. We decided to have a kind of rupture, a difference 
between the two, and so all those who have the surplus 
allowances can use them to comply with the objectives they have 
to comply with, but the value of those has faded down to close 
to nil and that will be absolutely different as of January 1, 
2008, where we expect the price level in the order of magnitude 
of over =16.
    So it is more a historical reason. That is, that we did not 
have any trading system. We wanted to start. We wanted to learn 
it and we wanted to be ready for Kyoto and that is January 1, 
2008. Thank you.
    Senator Domenici. Thank you very much. I don't know if you 
had a comment, the American Scholar, on the program? All right. 
Thank you, Senator Bingaman.
    The Chairman. Thank you very much.
    Senator Lincoln.
    Senator Lincoln. Thank you, Mr. Chairman and I certainly 
appreciate your leadership as well as Senator Domenici's 
leadership on this issue. You've given us a great opportunity 
thus far and I know that will continue to really have the in-
depth conversation we need, to make sure that whatever plan we 
come up with is going to be appropriate for us to help reach 
the goals that we've set for ourselves. So I want to thank you 
for that.
    We are enormously grateful to you all for your time and 
energy and enthusiasm to come and visit with us about what it 
is we do need to move forward on and what has worked for you 
and what hasn't. I don't know who it was but I thought I heard 
someone say that the reason for the split in those phases was 
that in the early phase, it was giving the opportunity of 
investment for infrastructure that was necessary in order to be 
able to get to the second phase. I understand the economics 
you've presented in terms of why those credits are more 
expensive later on. But it seemed as if there was maybe not a 
time of investment in terms of infrastructure that was 
necessary from the industry side of things to be able to get to 
that point.
    I'm not sure if I was understanding you, Dr. Caneill, 
correctly in that the credits present more certainty than the 
auction, maybe. Is that some of what you were trying to say in 
terms of the differences when we were talking about the auction 
and the credits? I believe it was Dr. Kopp that mentioned the 
auctioning of credits. You said that Denmark had actually 
chosen to do some of the auctioning in Phase I. Was that the 
only country to do that? But you indicated that more countries 
would be likely to do that in Phase II and I'm just kind of 
wondering why that auction mechanism creates a more attractive 
approach in Phase II as opposed to Phase I? Almost all of my 
questions go back to the issue of the two phases that you've 
created from 2005 to 2007 and then beginning in January when 
you move into the next phase.
    So the question to all of you would be that if you had it 
to do over again, would you still create a market with two 
phases? As I think Dr. Delbeke just mentioned the banking of 
those credits and being able to move those banked credits 
across the phases. If that's the case, what is the advantage of 
doing two phases? If you can bank those credits and use them 
across the division, that hard division line that you have, 
what are the advantages of having two phases? Anybody?
    Dr. Caneill. I can start to try to respond to your question 
about creating an auction. In fact, what was underlying what I 
said on the treatment of the present installation, the 
incumbents, which are at the start of the scheme and the ones 
which will appear on the way, the newcomers, the new projects. 
Those should be treated differently and that appeal for a 
certain degree of auction in the system at a point. So in the 
European system, the possibility was given to the member states 
to have a certain percentage of auction in the allocation. But 
it was not used by most of the countries in the first phase. In 
the second phase, some countries have indicated that they will 
have a certain percentage of auction on the board in the limits 
of the directive today, which is 10 percent in the second 
phase.
    But what I said on the dynamics of the allocation: the way 
you are treating those who were before the scheme is starting 
who discovered that there is a new regulation, and the ones 
which will come in some years, where the regulation will be 
there. They know that there is a regulation, so there should be 
some auction process in the system in order to give the right 
economy signal to those access. So I think it is not 
contradictory. I think if you design a system over time with 
more auction, you don't need to have 100 percent auction at the 
beginning. But giving the sign that the auction will be 
progressively increased in the future, this is quite compatible 
with the economy signal you have to give to the actors which 
build new installations.
    Senator Lincoln. Is there a reason why Denmark participated 
in Phase I with the auction? I mean, is it something about how 
they produce their----
    Mr. Delbeke. Well, on auctioning, we have in the first 
phase, four member states that went into auctioning and for the 
second phase, we expect half of the member states going into 
auctioning, with more significant percentages. So auctioning is 
becoming more popular. I think that one of the reasons is that 
when you are not auctioning, you are giving out the allowances 
for free. So politically, that becomes a very difficult 
process. The more you give for free, the more that people are 
interested to get for free. So allocation problems are being 
avoided to a large extent, in going to auctioning. Of course, 
the other side is that auctioning gives some revenues. Some 
member states may find that interesting, also for the purpose 
of reduction of emissions for stimulating new technologies in 
the renewable energy sector, et cetera.
    I just wanted to come back as well on the two phases. I do 
not want to complicate further but in fact, there are three 
phases in the EU ETS. That is, the phase we have now, coming to 
an end at the end of the year. Then we have the Kyoto period, 
which is from January 1 of next year until December 31, 2012. 
Then the third period is going to be after 2012, presumably 
running until 2020. Given that our heads of state have taken 
decisions on emission reductions in that time perspective, that 
is going to be the perspective in which we are going to work as 
of now. The perspective is 2020.
    Banking will be allowed between Phase II and Phase III. So 
I can see that now that we have better data, we will have the 
market developing, driving to emission reductions, those who 
want to save emissions reductions, who will store their 
allowance and use them in the third period. In my view, they 
will certainly be allowed to do that.
    In the first period, between period 1 and 2, that is not 
allowed, because we were in a learning-by-doing period and that 
monitoring and reporting problems that we had seemed to 
indicate that that was a wise decision. Whether we would do it 
exactly the same way, I don't know, but I would assume that 
with what we know now, that people would say when you start, 
make sure that you have first a solid database of monitoring of 
verified data. That is not what we heard when we started and we 
were developing the legislation, but with hindsight, I'm sure 
that would be a very important element in the debate today. So 
we solved it historically through the learning-by-doing phase, 
but perhaps people would then say, let's monitor and verify 
first, and then go into the real transactions and trading. 
Thank you.
    Mr. Ellerman. Senator, let me try to address your question 
about Denmark. I say this to report the results of actually a 
series of studies and a book that is about to come out, of 
which I was one of the co-editors. It's on allocation in the 
European Commission Trading System, and Denmark was one of the 
countries that we did study, and how they went about allocating 
their allowances. As Dr. Kopp had said, it was the only country 
that chose to allocate the full 5 percent. There were three 
other member states who chose to auction varying amounts that 
were 2.5 percent, 1.5 percent and .075 percent.
    The Danish reason for doing so is interesting in that it 
was essentially competitive considerations on the part of the 
power industry. It gets a little complicated, because many of 
the inner-country differences in allocation are created by 
what's called the European Burden Sharing Agreement, whereby 
the overall burden for Europe is allocated among the various 
member states. And the fact of that agreement is that Denmark 
had a much tougher target than say, Germany, with whom Danish 
generators competed. They felt and they wanted to provide a 
signal to people to auction more because they felt they would 
be less disadvantaged by auctioning than if they were 
grandfathering, because they would get less because of 
Denmark's more strict limits under the Burden Sharing 
Agreement.
    It is also interesting to note that in the second round, 
Denmark has chosen to auction no allowances. So they've moved; 
whereas there are more countries auctioning and most have gone 
from a lower number to a higher number and such, Denmark has 
done the reverse. Others here may have more of a feel for that 
or reasons for that, I'm not sure. I suspect it has to do with 
Denmark made a very severe cut in their total cap in the second 
period and it's probably easier to take allowances away from 
the auction than it is from the parties to whom they're given.
    Mr. Kopp. Senator, can I just? One comment again, on 
auctioning versus grandfathering, and this is strictly just an 
economic argument. Dr. Delbeke has already pointed out some of 
the important political considerations. When you allocate 
gratis permits--that is, for free, whether they are based on 
past emissions or on the basis of past output or on the basis 
of an updating procedure, where you're looking at future 
behavior and allocating emissions on the basis of an efficiency 
standard or an output standard, you bear the risk of changing 
economic incentives in ways that may not be fully recognized. 
You're going to be changing incentives for firms' investment 
behavior. Certainly output-based updating is one of those 
things that, in some sense, artificially keeps the price of 
electricity low, if its in the case of an electricity sector, 
expands output and raises the social cost of attaining any 
particular cap.
    At auction, on the other hand, is one of those things that 
really maintains the incentives in their right place. You 
cannot go wrong by auctioning. I think you can bring 100 
economists in here, and while economists agree on very few 
things, I think if you all pose them the same question, if you 
had the choice between auctioning and some sort of gratis 
allocation, which is the cleanest, most transparent, most 
economically efficient way to go, it would be auctioning.
    It also has the benefits of generating revenue that if you 
recycled it through the tax system, you could expand the 
economy, you could use it for a variety of different purposes. 
But setting that aside, it's really one of those mechanisms 
that tries to leave the incentives essentially unchanged and 
reduce your susceptibility to a lot of unintended consequences, 
which will prevail with a lot of gratis-type allocation schemes 
that have interesting little tweaks to them, but really change 
incentives for future behavior.
    Senator Lincoln. Thank you, Dr. Kopp. Thank you again, Mr. 
Chairman.
    The Chairman. Senator Sessions, did you have some 
questions?
    Senator Sessions. Thank you, Mr. Chairman. I don't think 
that we're dealing with a small matter. I think this is a very 
big matter and one that deserves very serious thought if we 
were to head in the line of a major cap-and-trade system that 
Europe has done. Mr. Chairman, I'm not sure I know the full 
answers at this point either, but I think there is some 
simplicity in your approach.
    I think that to alter an old phrase, ``Oh, what a tangled 
web we create, when we first start to regulate.'' Regulations 
beget regulations like the tax code. People figure ways to get 
around it. You close that off. It grows and it becomes an 
exceedingly complex thing requiring, if it has integrity, 
monitoring and so forth.
    I think in talking about our trip to the moon, Norman 
Mailer said, ``There's a razor's edge between a hero's endeavor 
and vain glory.'' Being heroic is one thing but creating 
something that is not going to work for us is another.
    Now with regard to CO2. There are other issues 
that relate to CO2. Relevant issues for a nation 
that are important to them--for example, pollution. Pollution 
is not controlled, I understand, with the trading system in 
Europe--particulates or other matters that are pollutants. But 
pollution isn't a relevant issue for a nation to desire and it 
can be important for the world because it can be worldwide-
distributed.
    Also, the national security of a nation--its ability to 
sustain itself even if hostile forces were to deprive it of 
energy sources worldwide: I couldn't help but think the 
transfer from coal to gas for Europe makes Europe more 
dependent on Russia.
    Then there is another factor. I do not think it should be 
our goal to raise prices. I think our goal would be to reduce 
emissions and our goal would be to have a healthy economy, 
which requires, where possible, reducing costs, not increasing 
costs of basic energy.
    So those are factors to me. I see a weakness here in the 
sense that the trading system would focus on one issue, 
CO2, and not other issues that may be more relevant 
or as relevant to the Nation that's adopting the system. Would 
anyone want to comment on that?
    Mr. Delbeke. Thank you very much, Senator, for your 
comments. I think that it is very important to underline that 
perhaps one of the most important drivers for the Europeans to 
decide on this cap-and-trade system was not to prescribe the 
technology or the way we would reduce our emissions. So we 
leave it to the companies, the entrepreneurs in their companies 
to decide how to do it. So some will switch from coal to gas. 
Others will improve their energy efficiency. Others will 
elaborate and build further on their nuclear installations.
    Renewable energy sources will be driven into the market. We 
see that as a very important element. And also through simple--
sometimes, very simple--managerial decisions, energy efficiency 
and carbon reductions can be realized, the so-called low-
hanging fruit.
    So we are not prescribing to anybody how to realize those 
efforts. Further, we don't know, we in the public 
administration, how to do it in the companies, but having a 
price signal makes it beneficial for the companies to look at 
these things. They all come up with very different answers and 
very creative answers, because the scope for emission 
reductions is scattered all over the value chain, also in very 
different economic sectors.
    Senator Sessions. But my question to you would be: simply I 
guess, yes or no? It focuses simply on CO2 
emissions, is that correct?
    Mr. Delbeke. It now focuses on CO2. It will 
incorporate in the immediate future, in the next 5 years, all 
greenhouse gases. So also methane, NTO and the fluorinated 
gases.
    The Chairman. Let me just clarify. Now, Europe has done the 
same thing we have done in this country though, with regard to 
other pollutants. That is, we've adopted the Clean Air Act, 
which is direct regulation to try to control other pollutions. 
EPA does that. But that does not cover greenhouse gas emissions 
in this country or in Europe. So that's why Europe decided on 
this other cap-and-trade approach to deal with the greenhouse 
gases, is that correct?
    Mr. Delbeke. That's absolutely correct, Senator, yes.
    The Chairman. Excuse me for the interruption.
    Senator Sessions. Well, that's important, but I guess if 
you can get two or three benefits from the same regulation, 
that would be preferable to just getting one benefit. As we 
write it, I think that's a matter we ought to think about.
    I'm thinking about France also, Dr. Caneill. You have a 
strong commitment to nuclear power. First, do you feel like 
France was adequately recognized for its major CO2 
savings as a result of having done that previously? That's just 
a brief response to that. Second, if a power company were to 
decide to build a nuclear power plant, when would they get any 
credits? Would it be as you noted when the investment is made? 
I believe it may be vendor-brought--suggested. Is it when the 
investment that you want or it is some time in the distant 
future? Because one of the difficulties in a nuclear power 
plant would be the up-front cost. How does it work now?
    Dr. Caneill. Thank you very much, Senator Sessions, for 
these questions. So I will try to answer them and try to come 
back on your previous question as well.
    On the nuclear power side and our commitment in France, you 
asked first if we were recognized of our previous commitment, 
early commitment in nuclear generation in France. So the first 
thing I would respond is that when France designed its nuclear 
power program that started many years ago, the carbon issue, 
the climate issue was not on board. So we didn't build these 
nuclear power plants for solving the CO2 problem. 
However, when Europe----
    Senator Sessions. If every nation had done what France had 
done in Europe, you'd be far ahead today, would you not?
    Dr. Caneill. Yes, okay, you're right. But the concern at 
the time was more national security of supply than the climate 
issue, which was not on board at this time. So, when Europe 
divided the -8 percent that Dr. Jos Delbeke mentioned at the 
beginning, the Kyoto commitment--this number has been divided 
between the different European countries, it was 15 at this 
time. So the targets that France got in this agreement was 
stabilization of emissions from 1990 up to 2012. So we can say 
that the fact that the generation in France is mostly nuclear 
has been recognized in the Burden Sharing Agreement.
    So now for the future, if we are building a new nuclear 
power plant we get credits for that. Along with what I've 
developed before, we will not get credits. If I would get 
credits for building a nuclear power plant and taking as a 
baseline of coal power plants, so I would add emissions in the 
environment. So the important thing is to ensure that the 
price, pseudo price, I will see on the market is sufficiently 
stable, in order that I can secure this investment in the long 
term. This was the reason I prone in my development that we 
need a long-term signal. We need a safe trajectory in order to 
have development of the price that allows an actor to take a 
decision on such an investment.
    Senator Sessions. Briefly, but so therefore the benefit 
from the credit that would occur would be over the long term. 
It would not help finance the building of the plant up front. 
Is that correct?
    Dr. Caneill. You cannot build the finance with something 
you received, but when you decide the finance of your 
investment, you are taking into account the avoidance of 
CO2 and the fact that you will not have to buy any 
CO2 allowances in the future. So I think if you make 
the economic calculation, you can take that somewhat into 
account.
    So I'd like to just come back shortly on your first 
question. I think the two things you were mentioning, the 
national security of supply and financing and also the 
increasing of the price, are two issues that are important. You 
asked if the EU ETS was addressing directly these concerns.
    I would say the EU ETS is addressing an environmental 
problem, which is this CO2 emission reductions. So 
we have to be careful what we want, that the system is 
addressing directly too many questions. We can come up with 
distortions of the rules in order to try to adapt the system in 
order to have the national security of supply concern and the 
price allotment. So if a country has a national security supply 
of energy question, it has to be addressed appropriately with 
right measures, and try to study what will be the interaction 
with CO2 regulation for the prices now.
    Yes, it is for sure that in the long term the 
CO2 allowance prices will have an influence on the 
electricity price. We saw that in the short-term in the first 
phase. If you have a price signal of the market for 
CO2, it will be taken directly in the short-term 
economy of the electricity generation, because you cannot store 
electricity. You have to produce electricity every second. So 
the price issue is important.
    What is important to ensure that you develop the constraint 
with the base trajectory in order that the development price 
can be afforded by the economy. We have to build something like 
a safety valve--not directly a safety valve of the price, but 
you could do it correctly by designing the target and the 
constraint over time, in order that this price can be afforded 
by the economy.
    Senator Sessions. Mr. Chairman, I would just note that I 
think nuclear power is three stars. It reduces pollution, it 
increases our national security, and makes us less dependent on 
foreign sources. It is, I believe, will prove, and is now 
proving, to be less expensive than any other source. So we 
could simply enhance nuclear power perhaps and get more--as 
much benefit as anything else that we might do.
    Or we might emphasize the production of natural gas, which 
we have offshore and other places in large amounts, which in 
itself would be a major move for our country that would also 
reduce pollution and keep our wealth at home and reduce our 
dependence on foreign energy. So there are things other than a 
massive, complex cap-and-trade system, that I don't doubt can 
work and every regulator I've seen that's been a part of a 
regulated system usually likes it, and figured if they just had 
a little more regulation, they could make it even fairer and 
less of a problem.
    So I think we should be open to this issue. I think 
CO2 does represent a potential threat to our 
environment and I'm glad you had this hearing, but I do believe 
that we should be cautious as we go forward. Thank you.
    The Chairman. All right, thank you very much. Let me just 
ask if any of you have last-minute points you wanted to make 
that you think were obviously missing here. There are probably 
so many you don't know where to start. But yes, let me call on 
Dr. Vanderborght for a final comment from him.
    Mr. Vanderborght. Yes, thank you, Senator Bingaman. I would 
have been happy to be able to comment on the question of 
Senator Corker about the short-term interest and winners and 
losers. It's for sure that when you will discuss allowance 
allocation, you will be lobbied by all industry sectors and 
lobbying will go in all directions. It is also clear those who 
have not taken the necessary actions until now, that they will 
prefer grandfathering, while those companies who have an 
efficient production at this moment, will prefer the other 
allowance allocation based on benchmarking. So you will be 
faced with tremendous lobbying in all directions.
    Then I would give the legislators maybe three pieces of 
advice. The first being that make the difference between 
lobbying for short-term vested interests and the long-term 
objective of climate change being long-term, reducing the 
emissions through investments.
    Second, if society wants to reduce emissions, then at the 
same time, foster economic and social growth, there is only 
possibility, and that is improving the efficiency of our 
products and of our consumption. So the core of the incentives 
to industry should be efficiency. So when thinking about 
lobbying, think about including efficiency of production of 
products and consumption into the system. Last but not least, 
the allowance allocations should be simple, objective and 
transparent. Thank you.
    The Chairman. Well, I think all those are very good points 
and I appreciate that very much. Let me just go ahead, since 
we're to the 4 o'clock hour, I'll just conclude the roundtable 
discussion. I thank all of you for coming. I think it has been 
very useful to hear your comments. As you can see, there is a 
lot that we need to learn about what Europe has experienced, 
and hopefully incorporate that knowledge and information into 
anything we're able to do here in this country. I think this 
roundtable has helped us to do that. So thank you all very much 
and again, thank you for coming.
    [Whereupon, at 4 o'clock p.m., the roundtable was 
adjourned.]
                                APPENDIX

                   Responses to Additional Questions

                              ----------                              

              Carbon Dioxide Trading in the European Union
    The European Union Emissions Trading Scheme (EU-ETS) is the world's 
largest tradable permit system for carbon dioxide and the cornerstone 
of the EU's strategy to meet its Kyoto emission target. The first phase 
the program began more than two years ago, in January 2005, and will be 
followed by a second phase commencing in January 2008.
    This discussion will provide an overview of the trading system and 
will focus on lessons that have a bearing on the design of a 
CO2 trading system for the United States.
    Participants were asked two questions: ``What was done right in the 
EU Emissions Trading Scheme?'' and ``What was done wrong in the EU 
Emissions Trading Scheme?'' Participants answered each question in one 
page or less. Background on the EU-ETS and the responses are compiled 
here.
                      Responses of Jos A. Delbeke

                                 RIGHT

   A mandatory cap-and-trade system was put in place, based on 
        absolute emissions levels determined in advance. It is a multi-
        sector scheme covering installations that are major emitters 
        across the 27 countries that are members of the European Union. 
        Today, the system covers some 45% of total CO2 
        emissions. In 2006 the volume of allowances traded over-the-
        counter and at exchanges is reported at some =18 billion 
        [approx. $24 billion (rates March 19, 2007)]. By giving large 
        installations flexibility, it engages them in finding least 
        cost approaches to reducing greenhouse gas emissions and can 
        spur innovation.
   Harmonised emissions monitoring and reporting requirements 
        were set, building on work carried out in this area by 
        industry.
   The private sector was used for verifying greenhouse gas 
        emissions.
   Stringent penalties were set for non-compliance, to ensure 
        that the environmental integrity of the system is maintained 
        (from 2008, =100/tonne plus making up any shortfall).
   A straight-forward and secure electronic allowance transfer 
        system was set up, enabling companies to transfer allowances 
        across the EU. The Commission is considering licensing this 
        system, developed with U.S. expertise, to third countries and 
        regions to ensure that the global carbon market develops 
        smoothly at the technical level.
   Market operation was left up to the market. The private 
        sector quickly developed services (trading platforms, daily 
        price quotes) needed for smooth operation of the allowance 
        market. There is no `price-cap'. The market is allowed to 
        function freely, setting the right signal to invest in cleaner 
        technology and efficiency improvements to meet the target 
        (cap). Price-caps would inhibit the linking of emission trading 
        schemes to form a global carbon market.
   As from the start-up period 2005-07, the EU ETS is open to 
        least-cost global emission reductions, by accepting--with 
        qualitative and quantitative safeguards--most types of credits 
        generated from project-mechanisms in 169 countries worldwide 
        under the Kyoto Protocol, and by foreseeing linking to 
        emissions trading systems in other developed countries that 
        have ratified the Protocol. The Commission is currently 
        considering widening its linking provisions to include links to 
        systems in other countries and regions.
   The system was set up for an unlimited duration. The initial 
        3-year learning period has proven to be extremely valuable to 
        put in place and fine-tune the infrastructure needed for a 
        trading system and for the collection of sound and verified 
        data on which 2008-12 will be based. The learning period means 
        that both regulators and companies are much better prepared for 
        the trading period 2008-12.

                                 WRONG

   The lead-time from the entry into force of the Directive 
        (October 2003) to the start of the system (January 2005) was 
        too short.
   When setting caps for the 2005-07 start-up period, with 
        hindsight, the EU had insufficient historic emissions and other 
        data for participating installations. As a result, some Member 
        States based their allocations on projections and estimates 
        rather than actual emissions. The resulting inaccuracies 
        resulted in insufficiently ambitious levels for emission 
        reductions, and a significant drop in the market price for 
        allowances when this became apparent. This shortcoming is now 
        corrected for the second period running from 2008-12.
   Auctioning was limited to 5% of allowances. As a 
        consequence, Member States which wished to auction a higher 
        proportion were not able to. The limit on auctioning is raised 
        to 10% for the second period running from 2008-12, and no limit 
        is set beyond then.
   Despite commonly agreed criteria for allocation, Member 
        States proposed caps that varied widely in stringency. The 
        Commission needed to take corrective action for most national 
        plans. This shortcoming should be overcome through greater 
        harmonisation in terms of setting caps from 2013 onwards.
   Differing national approaches were taken in respect of the 
        EU ETS's scope in the 2005-07 start-up period, resulting in 
        some combustion installations being covered in some Member 
        States and not others (e.g. crackers). This shortcoming has 
        been overcome by a common approach being agreed between the 
        Commission and Member States on the precise scope.
   Not all significant emitters were initially included in the 
        EU ETS. This shortcoming is being addressed during the 2008-12 
        period through unilateral extension of the EU ETS by Belgium, 
        France and the Netherlands to other greenhouse gases 
        (N2O), and by the UK to carbon capture and storage 
        installations. From 2011, the Commission has proposed to 
        include aviation, where this is not covered by other States' 
        emissions trading schemes. Further extensions are under 
        consideration.
   Relatively small installations were included whose emissions 
        might more appropriately be addressed through alternative 
        policies. This potential shortcoming has been addressed by 
        simplifying the EU's monitoring and reporting rules for small 
        installations. From 2013 onwards, the Commission is considering 
        whether further action is needed, for example through enabling 
        small installations to be `opted-out' of the EU ETS if they are 
        covered by alternative policies.
                                 ______
                                 
                       Responses of Per-Otto Wold

                                 RIGHT

Financial Market Efficiency
   A trusted market-wide price on carbon was established 
        quickly and distributed widely in the market.
   The market price responded from the start to changes in 
        supply and demand, with fuel prices influencing supply and 
        weather influencing both supply and demand.
   A market with reasonable liquidity has been established. 
        More than 1,000 million metric tons were traded in the EU ETS 
        in 2006, for a value of =18bn ($23bn). The market turnover, 
        measured as the ratio of traded volume to the total number of 
        allowances allocated, has been about 50%. Point Carbon 
        estimates trading volume will further double in 2007.
   Infrastructure for international emissions trading is in 
        place and functioning. This includes registries, accredited 
        verifiers, market places (exchanges and over-the-counter) and 
        other market intermediaries, such as information providers, 
        project developers and financial institutions.
Environmental Effectiveness
   The cost of carbon has been absorbed as part of operational 
        decisions for thousands of installations across the European 
        Union. By early 2007, companies participating in the EU ETS had 
        to a large degree (65%) initiated internal abatement measures 
        (Point Carbon survey--Carbon 2007). This compares to 18% in a 
        similar survey a year earlier.
   The EU ETS has been a key driving force behind investments 
        in project-based mechanisms (CDM/JI) in 128 countries and a 
        range of project types. Point Carbon estimates that investments 
        in CDM/JI projects will provide reductions totaling more than 2 
        billion metric tons of CO2 equivalent emissions by 
        2012.
   The start of the EU ETS produced a consistent set of 
        verified emission data across more than 10,000 installations in 
        25 countries. The European Commission made ``extensive'' use of 
        2005 data in assessing allocation plans for Phase II.
Policy Efficiency
   The EU ETS represents the first international emissions 
        trading scheme to date. Lessons learned from the ``test phase'' 
        (2005-2007) are providing valuable experience for stakeholders 
        ahead of the start of the first commitment period under the 
        Kyoto Protocol, from 2008-2012.
   Although uncertainties prevail with regards to international 
        framework conditions for the post-2012 period, the EU ETS 
        Directive secures the continuation of the EU ETS beyond 2012, 
        which is critical for investor confidence.
   The EU ETS Directive provides an opportunity for linking to 
        other national or regional emissions trading schemes (U.S., 
        Japan, Canada and Australia). Along with the indirect links via 
        offset markets (CDM/JI), this provides a path for convergence 
        and towards a truly global carbon market.

                                 WRONG

Financial Market Efficiency
   The timing of demand and supply is important, but was not 
        fully understood:

    --The demand from utilities, which were generally under-allocated, 
            was present from the beginning of the market. Utilities 
            manage their current and future combined exposure to 
            carbon, fuel and electricity risks on a daily basis;
    --The supply from companies in energy-intensive sectors, who were 
            generally over-allocated, typically came to market later 
            and episodically.

   The difference in timing of demand and supply largely 
        explains why prices increased above =30/t in April 2006, 
        despite the market being fundamentally oversupplied.
   The unauthorized leaks of market sensitive verified emission 
        figures for 2005 created information asymmetries and ``undue'' 
        opportunities for some market participants.
   The implementation of registries was delayed in many 
        countries, most notably Poland and Italy, likely preventing 
        market access and impairing liquidity.
Environmental Effectiveness
   The release of verified emission figures in April/May 2006 
        showed that the market was over allocated by about 5% (100 Mt) 
        in 2005. Although some abatement is likely to have taken place 
        due to high carbon and energy prices, the long position is in 
        our view largely explained by over-allocation and lack of 
        consistent, historical data.
   Uncertainties about Phase II (2008-2012) and the post-2012 
        period have made investments in more energy-efficient capital 
        stock uncertain.
Regulatory Risk and Policy Efficiency
   A number of factors are specific to the EU and its principle 
        of subsidiarity and are therefore more unlikely to carry over 
        to the United States:

    --Distributed responsibilities for allocation processes at national 
            level led to countries opting for favorable allocation to 
            domestic industries.
    --Lack of harmonization in monitoring, reporting and verification 
            procedures.
    --Different rules and procedures for treatment of new entrants.

   Grandfathering penalizes early action.
   The EU ETS extends beyond 2012, but there is a lack of 
        clarity about rules due to ongoing review process and 
        international negotiations.
Distributional Issues
   Free allocation by grandfathering has created windfall 
        profits for utilities.
   The principle of opportunity costs was not fully understood 
        or anticipated amongst policymakers:

    --The pass through of the cost of carbon into power prices is seen 
            by many as unduly favoring the power industry and thus a 
            challenge for the integrity of the scheme. This pass 
            through was, however, anticipated in a few countries, 
            notably the UK, as highlighted in their National Allocation 
            Plans;
    --Perception of fairness will affect the support for and 
            sustainability of the EU ETS and international emissions 
            trading.
                                 ______
                                 
                       Responses of Garth Edward

                                 RIGHT

   Coverage.--10,365 installations in the electricity, cement, 
        metals, and refining sectors are covered by the EU-ETS 
        Directive and the relevant national legislation.
   Registries.--Each installation is connected to one of the 27 
        national registries which then communicate through the 
        Community Independent Transaction Log. These registries are 
        operational and provide the basic infrastructure for assessing 
        compliance as well as operating the market. Registries enable 
        allowances to be issued to companies, transferred between 
        companies, stored, and redeemed for annual compliance.
   Compliance.--Verified emission statements have been obtained 
        and submitted by companies in line with the reporting and 
        compliance timelines. Essentially all installations have 
        demonstrated annual compliance by holding a volume of 
        allowances on their registry accounts that is equal or larger 
        than their verified emissions statement.
   Establishment of a market price.--Significant trading takes 
        place with a daily market turnover in the EU-ETS of 
        approximately USD$50m. Approximately 50% of volume transacts on 
        exchanges such as Nordpool, Powernext and the ECX. While the 
        balance of trading activity takes place through brokers. The 
        forward curve extends from spot out to 2012 and this provides a 
        long term price signal comparable to oil or power markets. This 
        price signal is integrated into electricity dispatch decisions 
        across the EU with companies deciding to run gas or coal plant 
        on the margin depending on the price of allowances.
   Development of the international Clean Development Mechanism 
        (CDM) and Joint Implementation (JI) markets.--The demand 
        generated by the EU-ETS has driven the quick development of 
        international project credit markets. CDM now has 517 
        registered projects with a projected flow 2008-12 of 761m CERs. 
        At an average of USD$13.3 this represents a capital flow from 
        rich to developing countries of USD$10.11bn up to 2012. A 
        further 3,831 projects are in the UN approval process 
        representing another 2,147m CERs and USD$26.7bn. This pipeline 
        is being added to daily. JI (Joint Implementation) is picking 
        up speed now as we approach 2008 and 271m Emission Reduction 
        Units (worth approx USD$3.59bn) will be generated from projects 
        currently undertaking approval with the UN. This pipeline will 
        be added to considerably over the coming year as Russia and 
        Ukraine build the necessary institutions. In summary we can say 
        that CDM/JI will flow approx USD$6.65bn per year into 
        developing countries from now till 2012. Alongside this flows 
        technology transfer, improved local employment, and better 
        local environmental quality.

                                 WRONG

   Delays in infrastructure.--Some governments were late in 
        establishing their registries which meant that issuance of 
        allowances were delayed and some installations were held off of 
        the market.
   Delay in connecting to the UN International Transaction 
        Log.--The EC has not yet connected to the ITL which means that 
        the Certified Emission Reduction (CER) credits flowing from CDM 
        projects cannot be physically imported and used for compliance.
   Auctions.--Some EU Governments have chosen to auction EU 
        Allowances, either as part of their primary allocation process 
        or as a distribution method for surplus allowances left in New 
        Entrant Reserves (e.g. UK, Ireland, Hungary, Denmark). These 
        auctions have been frequently delayed as governments have found 
        that auctions require significant logistical organization.
   Inconsistent allocation methodologies across the Member 
        States.--This meant that the definitions of installations were 
        different, monitoring and verification guidelines were 
        different and baseline periods were different. As a result, the 
        same kind of installation (refinery, power plant, cement plant 
        etc) would have very different allocations depending on its 
        jurisdiction.
                                 ______
                                 
                     Responses of Jean-Yves Caneill

                                 RIGHT

    Setting the scene.--Implementation of the EU Emissions Trading 
Scheme (hereafter EU ETS) was proposed after about three years 
discussion (that involved all stakeholders), which started in 1999, and 
continued to its final adoption. Although we can consider that this 
time duration is short for the implementation of a new economic 
instrument, it was done in a way, that made industry and power sector, 
faced with the reality of the carbon constraint. The EU ETS allowed 
immediately for the setting of a single allowance price for 
CO2 throughout EU in early 2005 when it started effectively.
    Simplicity.--Making a decision to consider ``direct emissions'' and 
not base the ETS on ``indirect emissions'' was also a wise decision to 
take, although discussed strongly at the beginning among the different 
stakeholders. Including both would have complicated too much the design 
at the and simplicity of the approach was an essential feature for 
having a prompt start of the scheme. This does not mean that one cannot 
make more complex the scheme over time, but it should have to be done 
cautiously and in a progressive manner.
    Learning by doing.--It was clear at the beginning that use of such 
an instrument was very new for European actors, and such, the fact that 
a learning phase was proposed (the years 2005/2007) was important. This 
allowed different constituencies to discover the instrument, its 
potential advantages, as well as its difficulties. In a sense the 
period has largely been used to monitor accurately the perimeter of 
action that was defined, and perhaps a recommendation one can take from 
that experimental phase is that it is worthwhile to start by the 
monitoring and assessment of the perimeter covered by the ETS 
regulation, before starting the allocation process and the real 
trading.
    Reducing the costs.--As soon as the ETS Directive was adopted, 
Commission prepared the so called ``linking directive'' devoted to 
allow actors to use credits generated by the CDM and JI mechanisms, 
allowing more flexibility for complying with the environmental 
objectives. Although there was a lot of discussion on the way these 
mechanisms should supplement actions ``done at home'', one can consider 
this achievement as an important one in the design of the economic 
instrument itself. It allowed to embed the EU ETS system in a larger 
perspective, in line with the international agreements, recognizing in 
the same time, that reducing the costs of compliance was an integral 
part of the process.
    Monitoring emissions.--Articulation of the flow of information 
between the company, national and EU levels, as far as the building of 
the CO2 emission registries, have been an important piece of 
the functioning of the scheme. Together with the monitoring, reporting 
and verification procedures that were put in place, these features 
helped to build the necessary framework for gathering the necessary 
data to monitor compliance, and allowing transparency requirements for 
future allowance distribution process.

                                 WRONG

    The EU Emissions Trading System is a regulation that has been 
adopted through a compromise between the Commission, the EU Council and 
the EU Parliament. Although some of the features discussed hereafter 
were not part of the first proposals discussed, some of them were part 
of the compromise and it is worthwhile to mention them, as they seem to 
me critical for the design of a well functioning emissions market.
    Length of the commitment period.--The relevant time frame of the EU 
ETS regulation had two major drawbacks: first the overall time frame 
was too short, second the period was decomposed in a trial period and 
the commitment period corresponding to the international agreement. 
Although one can understand that the trial period was necessary to 
start the system, the margins that were led to the EU Member States in 
deciding some implementation rules led to counteractive proposals, 
namely: no banking provisions from period 1 to period 2, except for two 
countries (that are now in the process to abandon it), re-opening of 
the discussion of the distribution of allowances between the two 
periods. One can discuss the reasons for this status of play, but it is 
important that in any future design, actors get a stronger visibility 
and predictability: longer time frame and predictability of the rules. 
As a matter of fact it is important to favor right conditions for 
future new investments.
    New entrants and closures rules.--EU ETS directive specified that 
these provisions should be defined by the Member States in their 
national allocation plans. This led to different treatments of 
installations over EU, and behavior that could lead in the long term to 
non appropriate decisions as far as the reduction of emissions are 
concerned. For instance, very often an installation which is going to 
be closed has to give back allowances non used (in an emissions trading 
system, keeping the allowances non used is an incentive to close an old 
installation and build a new one); a new installation should get 
allowances for free (on the basis of a new entrant reserve), often on 
the basis of its needs. These provisions were decided by Member States, 
because of the short time frame, and to avoid disputes based on 
competition arguments between incumbents and newcomers. However in the 
future, and on the basis on longer allocation periods, incumbents 
should be given the signal that they have to reduce their emissions on 
the long term (in the case they get free allocation, they should get 
less over time), and new projects (and/or new entrants) should have to 
pay their allowances, in order that CO2 signal appears in 
the full investment cost, for taking appropriate decisions aligned with 
the environmental goal.
    Reflecting the costs in the operations.--Many factors concurred to 
the fact that spot electricity prices reflected immediately the 
CO2 price that appeared on the market. Although quite 
normal, this feature was not enough recognized by the actors at the 
start of the scheme and generated strong misunderstanding. Inherent 
volatility of the carbon price due to imbalances of allocation between 
the industry and the power sector, and differences of behavior between 
the two communities in front of this new market, led to a significant 
increase of the power prices. To alleviate this situation, one should 
pay strong attention to the realism of the targets set to the different 
sectors over time (in line with the investment cycles) and proper and 
harmonized allocation rules, especially to the new entrants.
                                 ______
                                 
                    Responses of Bruno Vanderborght

                                 RIGHT

    The objective of the EU Emissions Trading System is to reduce 
CO2 emissions from industry in a cost efficient way while 
fostering economic development and employment.
    The EU ETS may form a solid foundation to this end:

          1. The necessary European legislation and regulations are in 
        place and implemented by all Member States;
          2. Monitoring, reporting and verification of emissions 
        provides reliable quantitative historical information;
          3. The CO2 market systems and tools are in place 
        and operate in a competitive environment;
          4. The CO2 emissions trading market functions;
          5. Reducing CO2 emissions and improving energy 
        efficiency are now firmly embedded in business strategies and 
        risk management.

                                 WRONG

    Despite this solid foundation, the EU ETS building is not yet 
completed, therefore not yet sufficiently delivering to its objectives.
    The main deficiencies are not so much related to the Emissions 
Trading Directive but rather to the method of allocation of emission 
allowances.

          1. Allowance allocation based on absolute historical 
        emissions by installations rewards pollution and punishes 
        efficiency and early action;
          2. There is no predictability for the medium-and long-term 
        objective;
          3. The international coverage is too small;
          4. An absolute cap based on historical emissions and lower 
        allocation to new installations freeze market share and inhibit 
        innovation, investment and growth of economy;
          5. The counterproductive allocation method causes intense 
        lobbying, undue distortion of competition between sectors and 
        companies and affects the credibility of the system.

    What we need to make the ETS an effective and efficient system is:

          1. A clear, simple, long-term (i.e. 2030) objective for each 
        industrial sector, equitable to the technical and economic 
        potential to reduce emissions;
          2. Based on CO2 or energy efficiency performance, 
        i.e. CO2 emission per unit of output;
          3. With a predictable path from current performance to the 
        long-term objective;
          4. With linking to similar CO2 performance 
        objectives and market systems in countries with developed and 
        emerging industrial economies.

    The global and regional burden sharing should be based on an 
international sectoral rather than on a national approach.
                                 ______
                                 
                     Responses of A. Denny Ellerman

                                 RIGHT

          1. An Initially Modest but Effective Constraint.--The most 
        important achievement of the EU Emissions Trading Scheme (EU 
        ETS) is that a constraint and a price have been placed on about 
        half of the CO2 emissions from a region of the world 
        that accounts for a significant fraction of global economic 
        activity (about 10% of global CO2 emissions). The 
        initial ambition is modest, but the real achievement is putting 
        in place a policy structure that can deliver the CO2 
        emissions reductions that may be required. From the perspective 
        of global climate policy, this is only a start but it is the 
        most significant and promising development to date in a domain 
        where grand ambition has often thwarted achievable result.
          2. A Multinational Trading System.--This achievement is the 
        more impressive in that it has been adopted by all 27 members 
        of the European Union despite significant differences among the 
        member states in economic circumstance and commitment to 
        climate policy. The federal structure of the EU is far weaker 
        than that of the U.S. and the differences among the EU's 
        constituent nation-states are far greater than those among U.S. 
        states. In fact, the East-West axis in Europe bears many 
        similarities to the global North-South divide. As such, the EU 
        ETS is a proto-type multinational trading system from which 
        many lessons can be drawn concerning what attracts 
        participating nations and how participation affects economic 
        and environmental performance.
          3. A Replicable Approach.--In placing a constraint on 
        CO2 emissions, the EU has chosen an instrument, cap-
        and-trade, that is more likely to propagate to other nations 
        and thus to create a global regime for controlling greenhouse 
        gas emissions than other instruments, such as taxes or assorted 
        other policies and measures. The cap-and-trade approach is more 
        promising because it allows the issues of equity and efficiency 
        created by a CO2 constraint to be dealt with 
        separately at global and national levels and because the trade 
        in the financial instruments thereby created closely resembles 
        existing investment flows and trade in goods, services, and 
        capital. This is not to say that propagation will be easy; only 
        that it will be easier than by any other approach.
          4. Openness to Equivalent External Credits.--In placing a 
        price on a significant fraction of EU CO2 (and 
        greenhouse gas) emissions, the EU has recognized the essential 
        equivalence of emission reductions in any part of the world 
        through the linkage provisions of the EU ETS. This openness to 
        equivalent external credits has provided a great impetus to 
        project-based emission reductions in key developing economies, 
        such as China, India, and Brazil, through the Clean Development 
        Mechanism. In addition to familiarizing these nations with the 
        requirements and institutions of emissions trading (and thus of 
        what will ultimately be required of them), this openness to 
        external credits provides the means for indirect linkage and 
        eventual formal mutual recognition among the independently 
        developed, ``bottom-up,'' national trading systems that may 
        emerge.

                                 WRONG

          1. An Incomplete Cap.--The EU has chosen to apply the cap-
        and-trade approach to large stationary sources and to adopt 
        other policy measures to deal with CO2 emissions 
        from mobile and small stationary sources. While multiple 
        instruments can in theory be equivalent in cost, they rarely 
        are in practice so that their use is inevitably inefficient. 
        Even worse, alternative ``command-and-control'' measures have a 
        tendency to overpromise and to under-deliver thereby adding 
        ineffectiveness to inefficiency. Consumers who bear the 
        ultimate burden of CO2 limitation are unlikely to 
        prefer to pay more for the abatement measures associated with 
        their driving than for those affecting the electricity they 
        consume at home, or vice versa.
          2. Repeated, Sequential Cap-setting and Allocation.--In 
        conformity with the Kyoto Protocol, the EU ETS has been set up 
        in discrete commitment or trading periods in which the cap for 
        the next five (or x) years is decided along the way. For 
        instance, the cap for 2008-12 is currently being decided and 
        the cap beyond 2012 is unknown. While there is not much doubt 
        that the system will continue, this circumstance has created 
        considerable uncertainty about longer term reduction 
        requirements with consequent effects on investment. Also, the 
        possibility that future allocations would be based on current 
        period emissions may lead some firms to abate less than they 
        would otherwise. A better approach would be to establish a 
        longer term cap or schedule that is subject to review but 
        which, barring later adjustment, would be the operational 
        default.
          3. New entrant and closure provisions.--A novel feature of 
        the EU ETS is the set of provisions whereby new installations 
        are endowed with free allowances from a new entrant set-aside 
        and closed facilities forfeit allowances granted to them. While 
        perhaps understandable from an equity standpoint, these 
        provisions distort long-term investment decisions and create 
        over-capacity. Older facilities that would otherwise be closed 
        (and which are usually inefficient) are kept open if the value 
        of the allowance endowment is greater than the losses incurred 
        by continuing production at the minimally acceptable level. 
        Endowing new facilities with a free allocation compensates the 
        investor for all or most of the carbon costs that will be 
        incurred and thereby keeps the investment criteria largely what 
        they were prior to the start of the program. In addition, both 
        provisions will tend to create excess capacity in the affected 
        industry.
          4. Limit on Banking.--The carry-over of unused allowances 
        from the 2005-07 period into the 2008-12 period is prohibited 
        and this provision has created a significant price disparity 
        between 07 and 08 allowances that will lead to strange 
        abatement behavior around the turn of the year as firms and 
        traders arbitrage this price difference. Aside from this 
        restriction, the EU ETS does allow complete intra-period 
        banking and borrowing. This has resulted in very stable price 
        relationships among years in each trading period and efficient 
        abatement within these periods.

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