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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 
(II)

COMMITTEE ON ENERGY AND NATURAL RESOURCES 

JEFF BINGAMAN, New Mexico, Chairman

DANIEL K. AKAKA, Hawaii 

BYRON L. DORGAN, North Dakota 

RON WYDEN, Oregon 

TIM JOHNSON, South Dakota 

MARY L. LANDRIEU, Louisiana 

MARIA CANTWELL, Washington 

KEN SALAZAR, Colorado 

ROBERT MENENDEZ, New Jersey 

BLANCHE L. LINCOLN, Arkansas 

BERNARD SANDERS, Vermont 

JON TESTER, Montana 

PETE V. DOMENICI, New Mexico 

LARRY E. CRAIG, Idaho 

CRAIG THOMAS, Wyoming 

LISA MURKOWSKI, Alaska 

RICHARD BURR, North Carolina 

JIM DEMINT, South Carolina 

BOB CORKER, Tennessee 

JEFF SESSIONS, Alabama 

GORDON H. SMITH, Oregon 

JIM BUNNING, Kentucky 

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 
(III)

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

(1)

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 SDG50, 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 capand-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. 
2

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 
3

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-andtrade 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 
4

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-andtrade 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-andtrade 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 emis-
5

sions. 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 
6

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 longlived. 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. 
7

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 
8

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 
9

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. 
10

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 
11

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 Im-
12

plementation 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 
13

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 leastcost 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 ac-
14

count 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 
15

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-andtrade 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 
16

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 
17

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 capand-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. 
18

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 
19

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? Ninetyfive—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. 
20

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. 
21

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 
22

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 
23

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. 
24

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 
25

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——
26

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 indus-
27

try. 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? 
28

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 
29

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 genera-
30

tion 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 
31

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.] 

(33)

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 
34

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 overthe-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. 
35

• 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 
36

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. 
37

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 emis-
38

sions 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; 
39

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 nationstates 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-andcontrol’’ 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 
40

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.

Æ