[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 23.1.2008

SEC(2007) 52

COMMISSION STAFF WORKING DOCUMENT

Accompanying document to the Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Directive 2003/87/EC so as to improve and extend the EU greenhouse gas emission allowance trading system Impact Assessment

{COM(2008) 16 final}{SEC(2008) 53}

TABLE OF CONTENTS

1. Procedural Issues and Consultation of Interested Parties 7

2. Identification of overall objectives, lessons learnt and assessment criteria 8

2.1. Overall Objectives 8

2.2. Lessons learnt and experience gathered 12

2.3. Identification of Assessment Criteria 15

3. Scope of the Directive 17

3.1. Streamlining the current scope 17

3.1.1. Identification of Problems 17

3.1.2. Identification of Objectives 18

3.1.3. Policy Options and Screening 18

3.1.4. Impacts – Comparing the Options 20

3.1.5. Compliance of Options with Objectives 22

3.2. Cost-effectiveness as regards small installations 23

3.2.1. Identification of Problems 23

3.2.2. Identification of Objectives 24

3.2.3. Policy Options and Screening 25

3.2.4. Impacts – Comparing the Options 27

3.2.5. Alternative Instruments 28

3.2.6. Compliance of Options with Objectives 29

3.3. Inclusion of new sectors and gases 32

3.3.1. Identification of Problems 32

3.3.2. Identification of Objectives 33

3.3.3. Policy Options and Screening 34

3.3.4. Impacts on sectors through inclusion in EU ETS 37

3.3.5. Compliance of options with objectives - summary on inclusion of other sectors and gases 46

3.4. Overview of trade-offs emerging from options on streamlining the scope, increasing cost-effectiveness as regards small installations and inclusion of new sectors and gases 47

3.5. Carbon capture and storage 49

3.5.1. Identification of Problems 49

3.5.2. Identification of Objective 49

3.5.3. Policy Options and Screening 49

3.5.4. Impacts – Comparing the Options 50

3.5.5. Compliance of options with objectives 52

3.6. Transport 53

3.6.1. Road Transport 53

3.6.2. Shipping 55

3.7. Land use, land use change and forestry (LULUCF) 56

3.7.1. Identification of key issues 56

3.7.2. Identification of Options 57

3.7.3. Assessment of Options 58

3.7.4. Compliance of options with objectives 61

4. Robust Compliance and Enforcement 62

4.1. Monitoring and reporting 62

4.1.1. Identification of Problems 62

4.1.2. Identification of Objectives 63

4.1.3. Policy Options and Screening 63

4.1.4. Impacts – Comparing the Options 65

4.1.5. Compliance of Options with Objectives 70

4.2. Verification and Accreditation of Verifiers 71

4.2.1. Identification of Problems 71

4.2.2. Identification of Objectives 71

4.2.3. Policy Options and Screening 72

4.2.4. Impacts – Comparing the Options 74

4.3. Improving cost-effectiveness: 79

4.3.1. Identification of Problems 79

4.3.2. Identification of Objectives 79

4.3.3. Policy Options and Screening 80

4.3.4. Impact of Options 80

4.3.5. Compliance of Options with Objectives 82

4.4. Compliance and enforcement 83

4.4.1. Identification of Problems 83

4.4.2. Identification of Objectives 83

4.4.3. Policy Options and Screening 83

4.4.4. Impacts – Comparing the Options 84

4.4.5. Compliance of Options with Objectives 87

4.5. Registries 87

4.5.1. Identification of Problems 87

4.5.2. Identification of Objectives 88

4.5.3. Policy Options and Screening 88

4.5.4. Impact of Options 88

4.5.5. Compliance of Options with Objectives 89

5. Further Harmonisation and Increased Predictability 90

5.1. Identification of Problems 90

5.1.1. Problems as regards cap setting 90

5.1.2. Problems as regards allocation 91

5.2. Identification of objectives 93

5.2.1. Objectives as regards cap setting 93

5.2.2. Objectives as regards allocation 94

5.3. Cap-setting: level of harmonisation 95

5.3.1. Policy Options and Screening 95

5.3.2. Impacts – Comparing the options 96

5.3.3. Comparing the options with the objectives 97

5.4. Cap-setting: level of the cap 98

5.4.1. Policy options and screening 98

5.4.2. Impacts – Comparing the Options 99

5.4.3. Compliance with Objectives 101

5.5. Cap-setting: design options to increase predictability 101

5.5.1. Policy options and screening: 101

5.5.2. Impacts – Comparing the Options 103

5.5.3. Compliance of Options with Objectives 103

5.6. Allocation: auctioning versus allocation for free 104

5.6.1. Policy Options and Screening: auctioning vs allocations for free 104

5.6.2. Impacts – Comparing the Options as regards auctioning and allocation for free – Competitiveness and carbon leakage 106

5.6.3. Compliance of Options with Objectives 117

5.7. Allocation methods for any remaining allowances allocated for free 120

5.7.1. Options and screening as regards any remaining allocations for free 120

5.7.2. Impacts – comparing of options for allocating for free 122

5.7.3. Compliance of Options with Objectives 123

5.8. Allocation: new entrants 124

5.8.1. Policy Options and Screening 124

5.8.2. Impacts – Comparing the Options 125

5.8.3. Compliance of Options with Objectives 126

5.9. Allocation: closure rules 127

5.9.1. Policy Options and Screening 127

5.9.2. Impacts – comparing the options 128

5.9.3. Compliance of Options with Objectives 129

6. Linking with Emission Trading Systems in Third Countries, and Appropriate Means to Involve Developing Countries and Countries in Economic Transition 130

6.1. Linking to other systems 130

6.1.1. Introduction 130

6.1.2. Identification of Problems 131

6.1.3. Identification of Objectives 132

6.1.4. Criteria for assessing the potential for linking 132

6.1.5. Developing Criteria for linking with other systems 133

6.1.6. Compliance of options with objectives 135

6.2. Use of offsets 137

6.2.1. Entitlements 137

6.2.2. Standards 144

6.2.3. Additional projects into the EU ETS 150

6.2.4. Transition and predictability 153

7. Conclusions – the Preferred Options 160

7.1. Scope 160

7.1.1. Streamlining the current scope 160

7.1.2. Cost-effectiveness as regards small installations 161

7.1.3. Inclusion of other sectors and gases 161

7.1.4. Carbon capture and storage 161

7.1.5. Transport 162

7.1.6. Land use, land use change and forestry (LULUCF) 162

7.2. Monitoring, Reporting, Verification 162

7.3. Further Harmonisation and increased predictability 163

7.3.1. Cap-setting: level of harmonisation 163

7.3.2. Cap-setting: level of the cap 163

7.3.3. Cap-setting: design options to increase predictability 163

7.3.4. Allocation: auctioning versus allocation for free 163

7.3.5. Allocation methods for any remaining allocations for free 163

7.3.6. Allocation: new entrants 163

7.3.7. Allocation: closure rules 164

7.4. Linking and JI/CDM 164

7.4.1. Linking to other emission trading systems 164

7.4.2. Use of offsets 164

8. Overall Assessment of Administrative Costs 166

9. Monitoring and Evaluation 173

Annex 1: ECCP Report 174

Annex 2: Summary of stakeholder contributions submitted to the Commission 226

Annex 3: Description of the E3ME model 232

Annex 5: Table representing the outcome of screening of sectors emitting non-CO2 GHG for inclusion in the EU ETS 247

Annex 6: Overview of refineries and chemicals sector and potential sector boundaries 248

Annex 7: List of References 249

Annex 8: Abbreviations 254

PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES

On 13 October 2003, the European Parliament and the Council adopted Directive 2003/87/EC of the European Parliament and of the Council establishing a system for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC[1] (the Emissions Trading Directive). It has been amended by Directive 2004/101/EC of the European Parliament and of the Council of 27 October 2004 amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Community, in respect of the Kyoto Protocol’s project mechanisms[2]. The European Union Emissions Trading System (EU ETS), became effective as from 1 January 2005.

Recognising the first phase as a learning period[3] and bearing in mind Article 30 of the ET (Emissions Trading) Directive foreseeing the Commission drawing up a report on the application of the ET Directive, the Commission launched a survey among participants and stakeholders of the EU ETS. The survey was conducted between June and September 2005 and involved 517 companies, government bodies, industry associations, market intermediaries and NGOs. Almost 60% of the stakeholders addressed responded. The results of the survey, albeit conducted very soon after the start of the EU ETS, indicated that there are important areas for improvement of the overall design of the system, but did not derive any clear recommendations on where to go. The results of the survey are published and available on the website dedicated to the review of the EU ETS[4].

Article 30 of the ET Directive contains a list of issues for the Commission to consider when drawing up the report on the application of the ET Directive. In responding to Article 30 of the ET Directive, the Commission adopted a Communication[5] (the Review Communication), where it identified growing consensus on the key strategic issues for review, and that, as more experience and evaluation is needed to determine solutions on these issues, it would be premature for the Commission to make legislative proposals at this stage. Therefore, the Commission decided to consult further by means of a separate Working Group on the Review of the EU ETS within the framework of the European Climate Change Programme (ECCP).

In the Review Communication, the Commission also identified the four main topics of the review, namely: (1) scope, (2) robust compliance and enforcement, (3) further harmonisation and increased predictability and (4) linking with emissions trading systems in third countries, and appropriate means to involve developing countries and countries in economic transition. Each of these topics has been dealt with extensively at a dedicated meeting of the above Working Group[6], which, consequently, met four times between March and June 2007. The presentations given at these meetings are available from the EU ETS review website[7], the final reports of these meetings reflecting their outcome are annexed to this document (Annex 1). These reports represent a major input to the review of the ET Directive. Furthermore, the Commission services have established a functional mailbox on the EU ETS review website, in order to allow all interested parties to submit their view on the review of the EU ETS to the Commission. Annex 2 contains a summary of these views as well as a list of parties which have submitted their view.

Seven Commission interservice meetings have been held on 28 February, 7 March, 12 April, 8 May, 8 June, 11 July and 31 July 2007, in order to discuss the outcome of the ECCP meetings and the issues to be examined in the framework of this impact assessment. One meeting was exclusively devoted to the work carried out by ENTEC for this impact assessment.

Identification of overall objectives, lessons learnt and assessment criteria

Overall Objectives

Fighting climate change is one of the most urgent challenges of mankind[8]. The latest IPCC reports[9] provided strong evidence on the likelihood and impact of climate change for overall life on earth highlighting the urgency of effective action. Only a couple of months earlier, Sir Jonathan Stern had published his report[10], in which he confirmed the Commission's stance and pinpointed the costs of action and non-action in combating climate change. His conclusion was simple and clear: the benefits of strong early action considerably outweigh the costs.

The European Commission has taken this message seriously. On 10 January 2007, it adopted a new energy and climate change strategy including the Communication “Limiting Global Climate Change to 2 degrees Celsius”[11]. The Commission’s central proposal is that, under a future global agreement, the group of developed countries should cut their emissions of CO2 and other greenhouse gases responsible for warming the planet to 30% below 1990 levels by 2020 and that the EU should take the lead by committing autonomously to reduce its own emissions by at least 20% by 2020. In the longer term, worldwide emissions need to be cut by up to half of 1990 levels by 2050.

The European Council, held on 8-9 March 2007 in Brussels, endorsed these objectives[12]. It also acknowledged the “central role of emission trading in the EU's long-term strategy for reducing greenhouse gas emissions” and underlined

that the European Union Emissions Trading System (EU ETS) is and will remain one of the most important instruments for the EU's contribution towards achieving the significant emissions reductions which are necessary to meet the strategic objective of limiting the global average temperature increase to not more than 2 degrees C above pre-industrial levels.

Against this background, three overall objectives should be aimed at in the framework of the review of the EU ETS:

First overall objective :

Fully exploiting the potential of the EU ETS to contribute to the EU's overall GHG reduction commitments in an economically efficient manner.

The European Council, held on 8-9 March 2007 in Brussels, endorsed

an EU objective of a 30% reduction in greenhouse gas emissions by 2020 compared to 1990 as its contribution to a global and comprehensive agreement for the period beyond 2012, provided that other developed countries commit themselves to comparable emission reductions and economically more advanced developing countries to contributing adequately according to their responsibilities and respective capabilities.

and that

until a global and comprehensive post-2012 agreement is concluded, and without prejudice to its position in international climate negotiations, the EU makes a firm independent commitment to achieve at least a 20% reduction of greenhouse gas emissions by 2020 compared to 1990.

In the longer term, the European Council envisages reducing GHG of all developed countries by 60 to 80% by 2050 compared to 1990[13].

Compared to the Kyoto objectives of reducing GHG emissions by 8% from 1990 levels, the new targets are further reaching and underline the need to make use of all instruments available. While the EU ETS should not be considered a panacea to achieve emission reduction targets across all economic sectors of the EU, it offers a huge potential to trigger emission reductions in a number of economic sectors in a cost-effective manner.

Implementing the above emission reduction targets will lead to the necessary gradual restructuring of the European economy towards a less carbon-intensive industry implying the introduction of less carbon intensive products and processes in the medium and longer term. Reinforced research and development efforts should take place in parallel, in order to maintain Europe’s industrial base and competence. They are going to prepare the ground for new products and markets that can be expected to evolve as a consequence of a stringent policy to combat climate change.

Since climate change is a global problem, other countries are expected to follow the European path and commit themselves to the necessary GHG reduction targets. Implementing its objectives, Europe will gain first mover advantages on these markets in the middle and the longer term. This can already be observed in some Member States, where the renewable energy industry is acquiring an increasing market share in, for example, the US and China.

Against this background, it should be noted that the basis of Europe's economic welfare is likely to be more and more made up by technological achievements in line with the needs of less-carbon intensive economic activities. They may increasingly determine Europe's competitive position on the global market. For this reason, starting the restructuring now will not only reduce the costs of climate change, but will also ensure Europe’s welfare and competitiveness tomorrow.

In the light of these further reaching objectives, the synergies with relevant aspects of other, very important objectives of the European Union should be taken into account:

- Competitiveness and the Lisbon objectives: The Spring 2006 European Council has identified energy and climate change as one of the four priority areas for more growth and jobs[14]. It has been acknowledged that the action against climate change and their costs will bring major opportunities for growth and employment through investment and producing and disseminating new eco-efficient technologies. Fully exploiting the potential of the EU ETS as a cost-effective instrument to tap the potential for emissions reductions while stimulating innovation is fully in line with the Lisbon strategy and its objectives.

- Sustainable development[15]: The needs of the present generation should be met without compromising the ability of future generations to meet their own needs. It represents an overarching objective of the EU set out in the Treaty. A key of objective of the renewed sustainable development strategy of the EU is to promote a prosperous, innovative, knowledge-rich, competitive and eco-efficient economy, which provides high living standards and full and high-quality employment throughout the European Union. In this respect, the polluter-pays-principle is a policy guiding principle. It aims at ensuring that prices reflect the real costs to society of consumption and production activities and that polluters pay for the damage they cause to the environment.

- Cohesion and fairness: In line with the Conclusions of the European Council of March 2007, the national circumstances of Member States should be taken into account in contributing to the climate policy objectives, in order to reflect fairness and transparency.

Second overall objective:

Refining and improving the EU ETS in the light of experience gathered

Experience gathered during the first years of its operation suggests that there is potential to reinforce economic efficiency of the system to the benefit of the European economy. In a number of areas identified in the Review Communication[16] improvements can be achieved by taking the experience of the private and public sector over the first years of the EU ETS into account. This would allow fully exploiting the potential of the EU ETS.

Third overall objective:

Contributing to transforming Europe into a low greenhouse-gas-emitting economy and creating the right incentives for forward looking low carbon investment decisions by reinforcing a clear, undistorted and long-term carbon price signal.

In its conclusions of 20 February 2007, the Council emphasised[17]

that the EU is committed to transforming Europe into a highly energy efficient and low greenhouse-gas-emitting economy

and called on the Commission to

review Directive 2003/87/EC in good time and bring forward proposals which create the right incentives for forward-looking, low-carbon investment decisions

These stipulations of the Council fully correspond to the objectives identified above. In addition, they highlight the need for a clear, undistorted and long-term carbon price signal as an indispensable feature of the EU ETS.

Such a carbon price signal would help achieving the European Council's 20% renewable target, bring about the necessary incentives for forward-looking, low-carbon investments including CCS and would provide correct incentives for our partners internationally to contribute appropriately to emission reduction. A clear, undistorted and long-term carbon price signal would represent a strong incentive to reward low or no-greenhouse gas emitting technologies conveying price signals along the whole chain of supply and demand from production and generation down to the consumer, as the costs of the allowances will be reflected in the final product offered to consumers. This way, consumers will be made increasingly aware of the costs of emitting greenhouse gases and as a consequence, demand is gradually expected to shift away from more carbon intensive products to less carbon intensive products.

The pressure emerging from a clear, undistorted and long-term carbon price signal to restructure the economy towards a less carbon intensive economy is thought to arrive from two different angles:

- On the supply side, the price of allowances under the EU ETS, will gradually rise with a more and more tightening cap designed to achieve the ambitious, but indispensable emission reduction targets. On condition that the necessary regulatory framework is set right, electricity generators and producers of carbon intensive products will factor in the price of the allowances, which are becoming genuine production costs. In order to minimise this kind of production costs, operators will in the short-term exploit existing potential to realise efficiency gains, as long as it is economic to do so (allowance price). In the medium and longer term, however, they will increasingly turn to less carbon-intensive technologies and investment, as otherwise they face the risk of losing their competitive position on the market and thus market shares.

- On the demand side, consumers will be made increasingly aware of the costs of carbon intensive products, which compared to less carbon intensive products will appear as more expensive and thus less competitive. Consumers’ natural desire to turn to cheaper products on homogenous markets will trigger demand for less carbon intensive products, thus reinforcing the trend towards decarbonised production.

A clear and undistorted carbon price signal is necessary to ensure dynamic efficiency, which is needed, in order to establish a constant incentive in terms of innovation and R&D to move towards a less-carbon intensive economy.

This mechanism is already laid down in the overall design of the EU ETS, but may need to be reinforced and more pronounced in the light of the new emission targets. It may, among other things, also affect allocation methods, as some methods might be more promising in this respect than others. So far, the EU ETS mainly focused the identification of least cost abatement measures. As a consequence, companies complied either through making the necessary investments to comply or through buying more allowances. In order to give a clear and undistorted, long-term carbon price signal, and thus to ensure dynamic efficiency, the costs incurred by emitting GHG would need to be reflected too, i.e. from the first tonne emitted. This happened already in a number of sectors of the EU ETS, albeit in a slightly different manner: So far, these costs have been taken into account as opportunity costs and passed on to the consumers, where possible. Conveying a clear, undistorted, long-term carbon price signal as a fundamental prerequisite of ensuring dynamic efficiency in the EU ETS would require these costs to be accounted as genuine production costs[18] rather than opportunity costs.

For those sectors already passing opportunity costs to their customers, the difference in terms of consumer prices would be marginal, if there is any at all[19]. Sectors that do not have the possibility to pass through carbon costs on the grounds of international competition for the supply of the same product may justify the application of transitional measures.

Lessons learnt and experience gathered

When considering the role of the EU ETS in achieving these objectives, lessons learnt and experience gathered so far have to be taken into account.

The EU ETS is the largest emission trading system in the world. It comprises 27 states under a common framework to reduce GHG emissions in an economically efficient manner and in this respect, is unprecedented in the world. Its first phase from 2005 – 2007 was driven by the wish to create the critical mass for a liquid and well functioning carbon market, which appeared most promising by focusing on CO2 emitting sectors and establishing the necessary infrastructure for trading and MRV. As such, the positive results of the first trading phase were that:

- the first two compliance cycles have been successfully carried out, thereby establishing overall credibility of the EU ETS based on sound and reliable procedures and infrastructure to monitor, report and verify emissions from the installations under the EU ETS.

- free trade of allowances across all parties participating in the EU ETS has been achieved and a real market trading allowances has evolved. As can be seen from figure 2.1, traded volumes were steeply rising and exceeded 100 million of allowances traded on a monthly basis almost each month in 2007.

- it allowed very valuable insight in the functioning of carbon markets; without the EU ETS being established in 2005 the EU (authorities and companies) would be much worse off in terms of complying with its Kyoto commitments at least cost;

- due to its size – the EU ETS comprises around 10500 installations from the power and various industrial sectors accounting for approximately 41%[20] of total EU GHG emissions – it offers new opportunities to implement CO2 abatement measures in a cost-effective manner across the EU;

- already in 2006, the EU ETS globally accounted for around 81% of the global carbon market in terms of value and 67% in terms of volume.

Figure 2.1: Monthly volumes traded in the EU ETS

[pic]

Source: Point Carbon

The first trading period was always intended to be a "learning-by-doing" phase for all parties involved. The problems that occurred provided valuable lessons on how a carbon market functions and have been taken into account to the extent possible in the NAP assessment for the 2nd trading period. They are also being thoroughly considered for the post-2012 period with a view to identifying appropriate and effective solutions:

- While emissions trading can only exploit its environmental strength and justification, if scarcity on the allowance market is maintained, the lack of verified emission data when setting up the NAPs for the 1st trading period enabled Member States to support their own industry by relying on overoptimistic projections justifying the issuance of more allowances than would be allowed to ensure scarcity on the market. Since this behaviour pattern could be observed in almost all Member States, the environmental effectiveness of the system was put in question – to the detriment of its overall efficiency and thus to the detriment of the overall economy of the EU.

- Lack of a level playing field for operators in the EU ETS resulted in different levels of ambition of the ETS sector in Member States and subsequently different level of ambitions for sectors and installation allocation. As a consequence, distortions of competition between Member States' trading sectors and also within sectors occurred entailing a perception of unfairness.

- Member States have applied widely differing allocation methods entailing among other things fuel specific benchmarks, which have caused a range of distortions and thus did also not comply with the requirement of economic efficiency.

- Furthermore, undue distributional effects to those sectors occurred that were able to pass through the market value of the allowances in the form of opportunity costs thus increasing operating profits for the companies concerned.

- The approval of NAPs turned out to be a long lasting, cumbersome and complex process creating a lot of uncertainty on the market with respect to the overall cap of the EU ETS.

Once such data became available in April 2006, it triggered a halving the allowance price within a couple of days. The swift correction of the market price of allowances demonstrated convincingly that the carbon market is working. The resulting low level of phase I prices indeed was not likely in itself to trigger additional or new abatement measures.

Figure 2.2: Price developments of EU ETS allowances

[pic]

Source: Point Carbon

In its assessment of the National Allocation Plans for the 2nd trading period, the European Commission developed a robust approach[21] that has been equally applied to all Member States. It was designed to ensure necessary scarcity on the market and to warrant that Member States respect Kyoto targets of the EU and its Member States. On the basis of the experience with NAP I, the Commission had already issued a 2nd guidance document[22] with a view to achieving a more consistent approach on the national allocation plans. Verified emission data provided a reliable basis for the NAP II assessment and showed that the necessary infrastructure requirements for a well functioning carbon market are in place.

Following the approval of 27 Member States NAPs , the overall cap for the 2nd trading period will amount to 2082.68 million tons of CO2. Taking into account the enlarged scope of the EU ETS in the 2nd trading period[23], the EU ETS will deliver emission reductions of 6.5% in the 2nd trading period compared to 2005 verified emissions.

Against this background, the EU ETS is bringing about the environmental benefits it is supposed to.

Identification of Assessment Criteria

In accordance with the Impact Assessment Guidelines of the European Commission, the options to be assessed will first be screened against the following criteria:

- Effectiveness : the extent to which options can be expected to achieve the objective of the proposal

- Efficiency : the extent to which objectives can be achieved for a given level of resources/at least costs

- Consistency : the extent to which options are likely to limit trade offs across the economic, social and environmental domain

Following the screening, the assessment is mainly based on the following criteria and their respective interpretation:

Environmental effectiveness : Expanding the coverage/scope of the EU ETS would increase its environmental effectiveness provided that the overall cap is not undermined, i.e. there is no carbon leakage. Furthermore, the integrity of the cap is a crucial element of the EU ETS as a cap-and-trade system, since it does not only determine the level of environmental benefit, but also represents the guarantee that the environmental effectiveness of the EU ETS is ensured. For these reasons, the options considered will be assessed whether they contribute to the integrity of the cap or not and whether the coverage of the EU ETS will be affected. The criteria are also closely linked to the overall objectives set out above. The global dimension of climate change also has to be borne in mind when considering the environmental effectiveness of the different options in question. The need to promote and foster sustainable development is crucial in this respect.

Economic efficiency : The EU ETS is designed as a system that allows meeting a certain emission reduction objective at least cost, i.e. the costs incurred by implementing the objective should not be higher than necessary across the whole EU. Thus, the options considered will be assessed against their ability whether they contribute to achieving the objective in question as well as the overall objectives at least cost. An increased scope of the EU ETS is likely to enhance its economic efficiency, since more sectors/gases/installations would be able to benefit from the flexibility offered by emission trading without compromising the overall environmental objectives. This presupposes a well functioning allowance market including the necessary transparency of the market, which also constitute relevant elements to be borne in mind. In the light of the long term emission reduction objectives indicated by the European Council in March 2007[24], the options should also promote, or at least not hinder, further reaching emission reduction objectives to be achieved in the long term. Incorporating an undistorted, clear and strong carbon price signal reflecting the cost of carbon in the economy is important to ensure least cost measures to be identified. Such a signal would also convey the necessary incentives to establish dynamic efficiency in terms of innovation, research and development. These elements will also have to be considered when assessing the options under consideration.

Administrative costs : For the purpose of the impact assessment, administrative costs are defined as the costs incurred by operators and regulators to establish and maintain the system. Administrative costs may, where appropriate, include transaction costs of operators, but do not include compliance costs incurred by operators under the EU ETS. Compliance costs are incurred where operators have to buy or sell (negative compliance costs) allowances in order to surrender the corresponding amount of allowances in line with their verified emissions. A summary of the administrative cost assessment is available in chapter 8.

Competition and internal market : Where appropriate, the options will also be assessed in terms of their compatibility with a well functioning internal market ensuring competition between market participants without any distortion.

Employment : The renewed Lisbon Strategy is refocused on growth and jobs. The regulatory framework in the EU should contribute to achieving growth and jobs, while continuing to take into account the social and environmental objectives and the benefits for citizens and national administrations. The options considered will therefore also be assessed, where appropriate and relevant, against their impact on employment.

If case may be and relevant, other criteria will be applied as well, such as impact on consumers, environmental side effects etc. In some cases, the application of all assessment criteria to the options under consideration does not seem to be applicable. In these cases, the grounds will be briefly explained and the assessment criteria applied will be introduced.

Most of the assessment criteria must be seen in the light of the overall objectives, as set out above: environmental effectiveness and economic efficiency are crucial elements to feature in the options chosen, as they may best guarantee that the EU ETS results in the expected outcome, i.e. achieving a certain reduction of emissions at least cost. Achieving the new emission reduction targets, the need to fully exploit the potential of emissions trading and the stepwise transformation of the EU into a low carbon economy through a revised EU ETS would broadly depend on how much these criteria can be enforced. Bearing in mind the requirements of better regulation, administrative burden at both EU and Member State level should be kept to the minimum required to achieve the overall and specific objectives. Finally, competition and internal market requirements go hand in hand with economic efficiency.

Scope of the Directive

Streamlining the current scope

Identification of Problems

The scope of the EU ETS Directive is defined in Article 2(1):

“This Directive shall apply to emissions from the activities listed in Annex I and greenhouse gases listed in Annex II.”

Annex I lists a number of activities carried out in certain installations including combustion installation and certain industrial plants. In phase I of the EU ETS, different interpretations of combustion installations were used by Member States leading to differences in the coverage of similar installations under the EU ETS. As a result, competitive distortions on the internal market of the EU occurred due to the fact that some Member States have included a certain type of installations, while others had not.

Three different interpretations of the “combustion installations” were applied in the 1st phase:

- a narrow interpretation including only those combustion installations that produce electricity, heat or steam and supply that to third parties

- a medium interpretation including all combustion installations that produce electricity, heat or steam, with the purpose of energy production, including those that are process-integrated, e.g. a steam plant integrated in e.g. chemical industry is included, but certain process furnaces, such as crackers in the petrochemical industry were excluded.

- a broad interpretation including all combustion installations that produce electricity, heat or steam, whether or not their main purpose is not energy production, e.g. the production of ethylene or ammonia (e.g. naphta crackers or ammonia plants).

In its second guidance document (EC 2005a), the Commission made clear that it considered the broad interpretation as the appropriate one to be applied when setting up the NAP for the 2nd trading period. In close cooperation with Member States through the Climate Change Committee[25], the Commission established a priority list on installations that should be included in the EU ETS in the 2nd trading period, while others were left to the discretion of Member States.

So-called process emissions[26] represent a major issue in this respect, as they have not been consistently included in the EU ETS by all Member States.

Following the agreement in the Climate Change Committee, practically all Member States included the priority list installations in their NAPs. Some Member States apply a broad interpretation as advocated by the Commission, while others applied the medium interpretation plus priority list or stay somewhere between this and the broad interpretation. As a result, the following problems persist:

- competitive distortions accruing from the different interpretation of the notion “combustion installation” continue to exist in the 2nd trading period also highlighting the absence of a level playing field on the internal market;

- incomplete coverage of so-called process emissions, i.e. emissions that do not derive from combustion processes, but represent the major part of emission in some industrial sectors/accruing from both energy production for third parties as well as the supply of energy for a production process with and without using an energy transfer medium; as a consequence, the environmental effectiveness of the system is compromised;

- lack of legal certainty concerning the scope of the Directive.

Identification of Objectives

In the light of the above problems, the following objectives can be identified:

- Ensuring a consistent application of the scope of the Directive across Member States resulting in the elimination of currently existing competitive distortions and creation of a level playing field for all sectors included in the EU ETS.

- This should also bring about full legal certainty on the scope to Member States and entities operating the installations included in the EU ETS.

- Process emissions should be covered as much consistently and completely as possible.

Policy Options and Screening

The current situation concerning the scope of the Directive has been described above. In order to improve it and to achieve the objectives identified, the following options are considered bringing about substantial changes compared to the current situation:

1. Option 3.1: Codifying a broad interpretation of combustion installation by defining more precisely the scope of the Directive. A definition of combustion installation would be introduced implying that all installations combusting fuel are included, irrespective of the purpose of fuel combustion. Energy production for third parties as well as the supply of energy for a production process with and without using an energy transfer medium would be covered. Such an approach would aim to effectively codify the broad combustion interpretation (as has already happened to some degree under Phase II)and would provide for a consistent coverage of process emissions, so that any ambiguity about whether process emissions associated with a ‘combustion installation’ should be included is removed.

2. Option 3.2 : Activity list: Defining the scope of the Directive in Annex I by extending the list of all covered activities, including the power sector by means of more precise definitions and moving away from the notion of “combustion installations” with a view to also including process emissions from relevant activities. Activities not explicitly included in this list would therefore be excluded from the system.

3. Option 3.3: Economic classification: Defining the scope of the Directive in Annex I by sectors using a 3 or 4 digit ISIC (International Standard Industrial Classification of all economic activity)[27] or alternative (e.g. CPC) code delivering the same or a similar scope as an approach based on combustion installations.

In accordance with the Impact Assessment Guidelines of the European Commission, screening the proposed options against the criteria[28] of

- Effectiveness: the extent to which options can be expected to achieve the objective of the proposal

- Efficiency: the extent to which objectives can be achieved for a given level of resources/at least costs

- Consistency: the extent to which options are likely to limit trade offs across the economic, social and environmental domain

leads to the following results:

- Effectiveness : With respect to a consistent application of the scope of the Directive, option 3.1 would effectively codify the guidance of the Commission for the 2nd period and build upon the work undertaken in the Climate Change Committee. It would provide legal clarity and benefit from the discussions between the Commission and the Member States held in the past with a view to streamlining the scope of the Directive. However, a full and consistent inclusion of process emissions can not be achieved by following this option alone. Option 3.2 has the potential to arrive at a consistent application of the Directive provided that a common understanding on the activities covered can be ensured. As it is likely that a broad list of activities would need to be agreed, in order to maintain the current environmental effectiveness of the system and avoid ambiguity, a consistent application of the Directive might be more difficult to achieve compared to option 3.1. On the other hand, the issue of process emissions would be solved, since the kind of emissions would not matter anymore. Option 3.3 would be likely to bring some ambiguities partly due to the existing level of disaggregation, which may capture activities currently not foreseen for inclusion in the system, partly due to operators which would fall under several codes. Another serious issue would be the fact that the various international codes (ISIC, CPC) cannot be legally enforced, definitions of categories would be necessary, in order to determine which operator falls under which category. Like option 2, process emissions would automatically be covered.

- Efficiency : Achieving the objectives at lowest costs compared to the current situation is best ensured by option 3.1, as it is largely a clarification and partly a continuation of current practice, but with enhanced legal clarity. For this reason, administrative costs for public authorities would not differ much to the current situation. This might be different for option 3.2 and 3.3, which would require some further efforts for all public authorities involved to ensure common understanding of the activity list or the codes respectively.

- Consistency : None of the options is likely to have any negative impact on any other Community policies, while options 3.1 and 3.2 might contribute to improving competition on the internal market.

All three options also have to be seen in the light of other outstanding issues in the review of the EU ETS, such as the cost effectiveness for small installations. All three options entail the potential to increase the number of small installations in the system although there are no concrete numbers available due to lack of data. They also would offer the potential to eliminate existing distortions of competition, however, option 3.2 and 3.3 may risk creating new problems.

The following table summarises these considerations:

Option | Effectiveness | Efficiency | Consistency | Result |

3.1: Codifying broad interpretation | √/0 | 0 | √/0 | Retained |

3.2: Activity list | √/0 | - | √/0 | Retained |

3.3: Economic classification | - | - | 0 | Discarded |

√ meeting the screening criteria, 0 neutral, - not meeting the screening criteria, |

Option 3 is discarded on the grounds that it scores worse compared to options 1 and 2.

Impacts – Comparing the Options

The assessment criteria are applied as set out above, but supplemented by some .

Environmental effectiveness : Both selected options will result in an expansion of the EU ETS, as they will cover more installations than under the current scope. It will increase environmental effectiveness of the system bringing another 40-50 MtCO2 under the EU ETS. Legal clarity of the scope across all Member States, however, seems to be indispensable, in order to ensure an increased and consistent coverage of the system. Again both options provide useful elements in that respect, but none of them would allow a sufficient solution on a stand alone basis: Codifying a broad interpretation through implementation of option 3.1 is likely to encompass all kind of combustion installations, however, without necessarily capture all process emissions emerging from specific activities. This could result in compromising the environmental effectiveness of the system. In order to provide full legal clarity to Member States, it might also be recommendable to set up a definition of combustion installation that comprises all relevant technical apparatuses the operation of which would result in GHG emissions.

By including a list of activities in Annex I of the Directive (Options 3.2.), process emissions from certain activities could be effectively captured. However, the list of activities to be included is likely to become very long and thus difficult to handle and to implement in practice.

In terms of environmental effectiveness, option 1 might be preferable, because it brings a currently ambiguous situation to an end. It would include more installations in the EU ETS including larger ones, which so far are left to the discretion of Member States[29]. On the other hand, option 3.2 represents a more tailor made approach, as it would exclude everything not explicitly mentioned and thus is likely to result in a large list of activities to be covered to ensure a comparable coverage to option 1. It also means involving a risk that imperfections in coverage under a large list of covered activities could be exploited.

An important consideration is the capability of both options to capture process emissions. Process emissions are not defined in the Directive due to, among other things, the diversity of industrial processes rendering any definition of process emissions very complex, most likely incomplete and subject to legal challenges. For the sake of environmental integrity, however, it does not matter whether emissions are released to the atmosphere as a consequence of combustion for the purpose of generating electricity and/or heat or as a consequence of another chemical process. For this reason, emissions accruing from both combustion and processes are intended to be covered by the Directive.

The current approach of the Directive to deal with emissions from both combustion and processes is based on two pillars and comprises combustion emissions (resulting from combustion activities in all listed activities) and a list of activities that especially exhibit CO2 from processes. This list allows avoiding a definition of process emission, as it does not matter whether emissions from these activities are generated by combustion or processes.

Economic efficiency: This criterion does not seem relevant in this respect.

Administrative costs : It is not possible to accurately indicate the number of new installations captured by the implementation of one of the said options, until Member States have scrutinised the respective sectors. For this reason, it is also not possible to indicate an absolute number of administrative costs incurred by the two options. There is also a wide range of estimated administrative costs for operators varying from €2000 to €15.000 per year and authorities lying between €3.000 and €10.000 per site and year (ENTEC 2007b). However, as an illustrative indication only , extrapolating from the UK expansion figures to the total EU number of Phase I installations and verified 2006 emissions could lead to an inclusion of approximately 1500-2000 additional installations and 40-50 MtCO2 under option 1[30]. Based on a range of €5000-€25000 per installation per year (covering both operators’ and regulators annual costs but excluding one-off costs) this would add administrative costs of very approximately €7.5-50 million / year at EU level compared to the current situation. (ENTEC 2007b).

However, it is expected that the overall level of these administrative costs will decrease due to both the new monitoring and reporting guidelines designed, among other things, to relief the burden of administrative costs to small operators, and due to increased experience acquired from the 1st and 2nd phase[31]. The final costs of the options at stake must also be seen in the light of the solution identified to increase the cost-effectiveness of small operators (see below).

Competition and impacts on consumer : Both options would contribute to creating a level playing field for installations within their specific sector across the internal market. As a consequence, competition on the internal market between competing products will be reinforced by ensuring a more complete coverage of these products and potential market distortions will be eliminated. For instance, gypsum, which is a competitor to cement and lime in the construction industry, is only included in some Member States, but not in all, while the cement and lime industry are participating in the EU ETS throughout the EU. Consumers might therefore benefit from reinforced competition, although the impacts are not expected to be very pronounced.

Impacts on employment, health, innovation and research : Generally, impacts on all these criteria are considered to be very minor due to the relatively small number of companies concerned. Positive effects on innovation and research might be strengthened with more complete sectors facing a carbon price signal.

Table 3.1.4. Summary of the impact of options in relation to relevant problems and objectives

3.2: activity list | 0/+ | 0 | - | + | 0 |

+ positive effect, 0 neutral/no or negligible effect, - negative effect

Compliance of Options with Objectives

In the following, it is evaluated to which extent the options assessed would comply with the objectives defined:

- Consistent application of the scope : Codifying one of the two options is expected to ensure a consistent application of the scope eliminating existing competitive distortions to a considerable extent. However, it cannot be excluded that implementing option 3.2 would ensue new inconsistencies and competitive distortions, since the list of activities required might not address the full range of competitive relations on the market.

- Full legal certainty on the scope: Both options would provide legal clarity for Member States. However, this might be more efficient in the event that option 3.1 is implemented, as its scope and implementation had been extensively discussed in the Climate Change Committee[32]. Option 3.2 might in some cases decrease a Member States’ coverage of emissions, if it has already rigorously implemented the broad interpretation of combustion installation, since the option specifically requires the exclusion of any non-mentioned activities. However, given that only few Member States pursued this interpretation under Phase I (of the 15 Member States surveyed under the Ecofys (2006) work the Netherlands, Ireland and Belgium (Wallonia) used the broad interpretation) the effect might be limited.

- Consistent and most complete coverage of process emissions : While option 3.1 would not necessarily capture process emissions to an extent which can be expected from an activity based approach, a new and broader definition of "combustion installation" covering all possible technical apparatus the operation of which would release emissions might offset this drawback to a considerable extent. Emissions not captured by this approach (i.e. using a technical apparatus not included in the definition of "combustion installation") are supposed to be small, but could be addressed through a list of activities supplementing what is covered under option 3.1. The most consistent and most complete coverage of process emissions can therefore be achieved by a combination of option 3.1 and 3.2.

Cost-effectiveness as regards small installations

Identification of Problems

Currently, there are approximately 10800 installations included in the EU ETS in accordance with

- the capacity thresholds laid down in Annex I of the Directive

- the aggregation clause

- opt-in of Member States

Installations within the EU ETS represent a large range of emitters with annual emissions varying from less than 5000 tCO2 (ca. 3.000 installations) to more than 5.000.000 tCO2 (ca. 70 installations). The contribution of small and large emitters to the overall emissions covered by the EU ETS is very uneven: the largest 7% of installations in the EU ETS represent 60% of total emissions, while the smallest 14% of installations only account for 0.14% (Ecofys 2007a). The disproportionate relation between the number of installations and their contribution to the overall emissions under the EU ETS points to higher transactions costs[33] per ton emitted for small installations. The cost-benefit ratio for including small emitters may therefore appear unbalanced, i.e. the costs are higher compared to the benefits of their participation. For this reason, there might be a need to ensure or improve the cost-effectiveness as regards small installations, as indicated by the Commission in its second NAP guidance document (EC 2005a).

An exclusion of small emitters from the EU ETS on the grounds of cost-effectiveness cannot mean, however, that these installations do not need to contribute to the overall emission reduction targets of the EU. It would just mean that there would need to be other more cost-effective measures to ensure the same objective. It is also important to bear in mind that the entry-into-force of the new Monitoring and Reporting Guidelines adopted by the Commission in July 2007[34] (see also below) is likely already to bring about considerable improvements in this respect.

The table below provides an overview of the number of installations and their share in total emissions.

[pic]

Source: Ecofys 2007a

Identification of Objectives

- Improving cost-effectiveness to small emitters through identification of an appropriate threshold to include/exclude installations in/from the EU ETS. Installations excluded must be subject to alternative, equivalent measures, since all parties have to contribute to emission reductions. The overall issue should also be seen in the context of including new sectors and gases and must not diminish the overall environmental effectiveness and integrity of the EU ETS, i.e. the share of GHG emissions covered by the system.

Policy Options and Screening

A number of options have been identified, in order to increase cost-effectiveness of the EU ETS for small emitters[35]:

4. Option 3.4: Emissions threshold only: inclusion of installations based on a minimum threshold for annual emissions or exclusion based on a threshold for maximum emissions. This could be a threshold of 10kt CO2 or 25ktCO2 / annum.

5. Option 3.5: Production threshold only: specifying production thresholds instead of capacity thresholds. This option entails the replacement of capacity data with annual production data.

6. Option 3.6: Combination of capacity and emissions threshold: introducing a combination of capacity thresholds and emission thresholds. This option entails keeping the 20 MW capacity threshold whilst additionally adding either a 10 kt CO2 or 25 kt CO2/year emissions threshold.

7. Option 3.7: MS opt-out: introducing a specific and conditional opt-out provision for small installations covered by the ETS, where equivalent measures are in place. Under this option MSs would be allowed the flexibility of giving special treatment to small installations provided that they could demonstrate that the installations were subject to ‘equivalent environment effort’. The final decision would rest with the EC (role of approving MS proposals), or a supervisory role could be foreseen at Community level. Certain measures will automatically qualify.

8. Option 3.8: Introducing a change of the aggregation clause :

9. Option 3.8a: Aggregation capacity threshold: formalised minimum threshold for the application of the aggregation clause. Under this option only combustion installations with a capacity of over 3 MW each would be counted towards the 20 MW threshold as part of the aggregation rule. This would lead to the removal from the system of sites with a large number of very small sources, the costs of monitoring for which are high compared to annual emissions.

10. Option 3.8b: Multiple of aggregation threshold : Inclusion in the ETS only if application of the aggregation clause sums up to a multiple (e.g. 150%, 200%) of the capacity threshold, but keep all installations in the system if the threshold is reached by a single unit. Under this option, the aggregation rule would apply only if the total capacity of all installations on a single site aggregates to 30 MW or 40 MW. This provision would lead to the exclusion of sites that include a number of small installations adding up to a total of 20 MW. Such installations are likely to have proportionately higher monitoring and verification costs due to the complexity ensuing from large numbers of units per site.

11. Option 3.9 Installation-type exclusions: adding a list of installations to Annex I that should be excluded from the scope of the Directive. This could be installations such as combustion units of hospitals-, universities and nuclear back-up equipment.

12. Option 3.10 Alternative instruments: under this option measures for small installations alternative to EU ETS inclusion are assessed, and their impacts contrasted with the ETS in general and with the specific options above. The alternatives considered are energy taxation and CO2 taxation.

Screening the options leads to the following results:

- Effectiveness : With the exception of option 3.4 and 3.5, all other options would be effective in that they remove a number of small installations from the scope of the EU ETS. Opposed to this, option 3.4 and 3.5 would cast doubts on their effectiveness: an emission threshold only, as proposed in option 3.4, might also capture installations below 20 MW under certain circumstances (e. g. coal fired combustion with a high load factor), but would exclude installations used only temporary or as back-up or emergency facilities. A production threshold (option 3.5) does not seem to be feasible due to the lack of relevant production figures. Therefore, its effectiveness cannot be decided.

- Efficiency : A number of options could be implemented without incurring new costs compared to the current situation (options 3.6 if the current capacity threshold is maintained, options 3.8a and b). The efficiency of option 3.7 would depend on the concrete provisions in Member States and at the EU level to allow the opt-out, while option 3.9 may require some research, in order to establish a complete list of installations to be excluded including their definition (e.g. definition of back-up unit). Option 3.4 is considered less efficient than the current situation, as it would require keeping the current MRV requirements and supplement them with those installations that are below to the emissions threshold. Similarly, option 3.6 would not relieve operators of the excluded installations from monitoring emissions (including verification of reports). Option 3.5 seems technically very difficult, as the definition of production levels targeting specific emission levels would generally be very difficult resulting in increasing costs for both operators and regulators.

- Consistency : Most options do not create a problem. Option 3.7, however, would require some Commission scrutiny and either approval or some degree of oversight of opt-out applications, in order to avoid competitive distortions coming up. Option 3.9 may imply some gaming with definitions resulting in unwanted exclusion of installations and thus compromising the environmental effectiveness of the system.

The following table summarises these considerations:

Option | Effectiveness | Efficiency | Consistency | Result |

3.4: Emission threshold | - | - | √ | Discarded |

3.5: Production threshold | - | - | √ | Discarded |

3.6: Combination of capacity and emission | √ | 0 | √ | Retained |

3.7: Opt-out | √ | √ | 0 | Retained |

3.8a: Aggregation capacity threshold | √ | √ | √ | Retained |

3.8b: Multiple of aggregation threshold | √ | √ | √ | Retained |

3.9: Installation type exclusion | √ | - | - | Retained |

√ meeting the screening criteria, 0 neutral, - not meeting the screening criteria, |

Options 3.4 and 3.5 are therefore discarded and will not be further pursued. Since option 3.9 might be effective, it is retained at this stage, although it scores as bad as options 3.4 and 3.5.

Impacts – Comparing the Options

Based on the information available from ENTEC 2007b, the impacts of the different options on various impact areas can be described as follows:

Environmental effectiveness : Option 3.6 with an emission threshold of 10ktCO2/yr would cut down the overall emission coverage by 15MtCO2/yr or 0.75% or, in the event of an emission threshold of 25ktCO2/yr by 50MtCO2/yr or 2.5%. Option 3.8a would lead to less than 1MtCO2 or the exclusion of 0.05%. As for options 3.8b and 3.9, the level of emissions excluded is unknown, but may be higher than under option 3.6, as in particular some moderate or medium sized emitters (40MW limit may lead to emitters in the range of 50-100ktCO2/yr) may be concerned. It is worth noting that a combination of options 3.6 and 3.7 is likely to deliver the best environmental effectiveness: small installations would be excluded on request of Member States (opt-out) provided adequate alternative measures are in place. Such an approach would raise the cost-effectiveness of the EU ETS without compromising its environmental effectiveness.

Economic efficiency: This criterion is not considered relevant.

Administrative costs : under the current situation, there is a large range of administrative costs incurred by operators included in the EU ETS varying from €2.000 to €15.000 per installation and year depending on the size and complexity of the installation concerned. Due to the new MRG and a learning-by-doing effect, administrative costs for small emitters are likely to be at the lower end. Option 3.6 (and also option 3.7 if combined with option 3.6) may reduce the annual overall amount of administrative costs by approximately €8 – 60 million or €13 – 95 million in the case of 10kt or 25kt emission threshold. However, due to the fact that continued monitoring of emissions remains necessary (in order to prove the emission threshold is not reached), part of these savings will be offset. A smaller reduction of costs, possibly in the order of €2 – 12 million, can be expected from option 3.8a, however, these savings would be net, because further monitoring would not be required. While the overall amount of cost reductions emerging from the other options are unknown, since the number of small installations excluded would be unknown, the savings per installation are likely to be higher than under option 3.6.Costs incurred by regulators under the current system vary from €3.000 to €10.000 per installation and year. Option 3.6 would bring about the highest reduction of these costs, in the order of approximately €12.6 – 40 million and €20 – 60 million respectively. The same observations as above would apply to the regulatory costs. Impact on competitiveness, competition and internal market : transaction costs per ton of CO2 are considerably higher for small installations than for their larger counterparts. In the form of administrative costs they amount to €0.5 – 3/tCO2 for small and medium sized emitters dropping to less than €0.01/tCO2 for the largest emitters. This means that in an extreme case, a small emitter incurs 300 times higher administrative or transaction costs per ton of CO2 than the large emitters. While such an extreme case is not likely to have any effect in reality, because the emitters concerned may not be in the same sector, it points to potential distortions of competition between different operators in a given sector. On condition that an alternative system would require equivalent environmental efforts from the operators excluded, option 3.6 would result in an improvement compared to the current situation, as competitiveness of small operators might be strengthened without resulting in competitive distortions on the internal market. This would also go for option 3.8a, albeit to a smaller extent, and 3.8b. No impact on competitiveness and the internal market is likely to accrue from option 3.9, because many sites excluded might be in the public sector. Option 3.7 may lead to competitive distortions between ETS and non-ETS installations, unless the Commission is put in the position to assess the impacts on the basis of information provided by Member States. Employment : The sector most concerned might be the verification business. Impacts for other sectors are negligible.

Table 3.1.4. Summary of the impact of options in relation to relevant problems and objectives

3.7: Opt-out | + | 0 | + | -/0 | 0 |

3.8a: Aggrega-tion capacity threshold | + | 0 | + | + | 0 |

3.8b: Multiple of aggregation threshold | + | 0 | + | 0/+ | 0 |

3.9: installation type exclusion | 0/+ | 0 | + | 0 | 0 |

+ positive effect, 0 neutral/no or negligible effect, - negative effect

Alternative Instruments

In the light of the EU's climate change policy in general and the emission reduction targets in particular, all emitters of GHG irrespective of their size have to contribute to these policy objectives. Usually, operators often referred to as small emitters can be characterised as compliance companies in the sense that they strive for compliance within the EU ETS, but do not have the potential to fully exploit commercial opportunities emerging from emissions trading. While their administrative costs per ton of emission are thought to be disproportionately high compared to larger emitters, there may be alternative instruments available which might be more cost-effective for small emitters than is emissions trading. For this reason, a qualitative analysis of alternative measures is presented in the following. Two instruments, a CO2 tax and an energy tax, have been included in this analysis. Their impacts on the assessment criteria are briefly compared with the respective impacts to be observed in the EU ETS:

- Cost-effectiveness of emissions reduction : in theory, a CO2 tax could be as cost-effective as the ETS in terms of emissions reductions. In practice, however, it is difficult to determine the appropriate tax level to achieve the desired reduction of emissions. An energy tax will not lead to cost-effective emission reductions, since it is not directly based on the level of emissions produced but rather energy consumed.

- Administrative costs to emitters are expected to decrease significantly in the event of both CO2 tax and energy tax, although in the case of the former, costs from monitoring emissions will not disappear.

- Production costs to emitters (emissions trading with little auctioning): In theory, a CO2 tax could be set to provide an equivalent impact, but it is difficult to implement due to fluctuating ETS allowance price and level of free allocation. Compared to the EU ETS, a CO2 tax would impact on production costs from the first ton emitted, possibly reinforcing incentives to reduce emissions, while under emission trading with free allocation this might not necessarily be the case in practice. A CO2 tax, however, would provide more certainty to the emitting companies. Setting an impact equivalent to the ETS, but based on an energy tax might be even more difficult, since an energy tax is not differentiated by carbon intensity.

- Innovation and research : A CO2 tax potentially provides greater long term price certainty and dynamic efficiency, unless the ETS cap is tightened over time. While an energy tax is similar to a CO2 tax in this respect, the lack of carbon differentiation reduces incentives to innovate.

- Budget effects on public authorities : A CO2 tax, and to a smaller extent also an energy tax, would lead to revenue increases for the state budget, as long as allowances are allocated for free under the ETS. Auctioning would provide similar impacts.

- Administrative costs of public authorities : Regulator's costs could decrease in particular with an energy tax due to simplified monitoring and verification requirements. This is, however, unlikely to be the case with a CO2 tax. Provided equivalent tax systems are already in place, implementation costs would only increase slightly.

- Functioning of the internal market : Harmonisation of CO2 and energy taxes at EU level may be problematic. Non-harmonised tax rates may lead to competitive distortions between Member States and also between ETS and non-ETS installations.

- Direct and indirect employment effects may be marginal to negligible in all cases.

Compliance of Options with Objectives

On the basis of the above analysis, a combination of options 3.6, 3.7 and 3.8a score best and would comply most with the objective to increase cost-effectiveness to small emitters. They would bring about considerable overall reductions of administrative costs to both operators and regulators and would, on condition that exclusion of small operators is made conditional to the existence of alternative measures in Member States, lead to an improvement of the competitiveness of small operators without distorting competition or the well functioning of the internal market.

In order to decide which emission threshold should be applied, the following considerations should be taken into account:

- Excluding installations from the scope of the system means by definition reducing its environmental effectiveness.

- This would only be justifiable, if operators excluded would be subject to equivalent measures undertaken at national level ensuring that they contribute their appropriate share to the overall reduction efforts of the EU.

- As set out above, the objective is to increase cost-effectiveness to small emitters through identification of an appropriate threshold. Since small emitters are usually compliance companies, i.e. they do not trade allowances, but ensure that the number of allowances surrendered complies with their emissions, cost-effectiveness is mainly a matter of administrative costs[36].

- Consequently, the threshold should be chosen, in order to allow the maximum gain in terms of reduction of administrative costs for each ton excluded from the system.

Against this background, table 3.2.6 demonstrates that choosing a threshold of 10.000 tonnes brings about the best relative ratio between a "ton lost vs. reduction of administrative costs".

Table 3.2.6: Comparison of a 10.000 and 25.000 tonnes threshold for optional exclusion of small installations with respect to the reduction of administrative costs

No | Subject | 10.000 tonnes/yr | 25.000 tonnes/yr |

1 | Number of installations | 4200 | 6300 |

2 | Emissions excluded from the EU ETS* | 15 mio t | 50 mio t |

3 | Emissions excluded from the EU ETS in % of NAP II allocation | 0.7 | 2.4 |

4 | Administrative costs on average** - per regulator/yr - per operator/yr | € 6500 € 8500 |

5 | Total administrative costs on average per installation/yr | € 15000 |

6 | Overall reduction of administrative costs*** | € 63 mio | € 94.5 mio |

7 | Reduction of administrative costs per tonne excluded**** | € 4.2 | € 1.89 |

Legend and explanations:

* estimates from ENTEC 2007b

** average of administrative costs for operators ranging between € 2000 and € 15.000 and for regulators ranging between € 3000 and € 10.000

*** [5]*[1]

****[6]/[2]

Source: ENTEC 2007b, PWC

As can be seen from row 7 in table 3.2.6, the reduction of administrative costs per tonne excluded amounts to €4.2 in the case of a 10.000 tonnes threshold, while the corresponding figure for a threshold of 25.000 tonnes would only be €1.89. This means that in the former case the gain or economisation of administrative costs is 222% higher per tonne than in the latter. Against this background, the variant with 10.000 tonnes looks much more promising in terms of striking the right balance between reducing the scope of the EU ETS and improving the cost-effectiveness of small installations.

This result is not surprising, as is demonstrated by figure X below. The graph, which is based on figures from the European Environment Agency and using the same administrative cost indications and method as above, confirms that indeed an emission threshold of 10.000 tonnes scores much better than that of 25.000 tonnes.

Figure 3.2.6: Gains in administrative cost reduction per tonne excluded

[pic]

Source: EEA 2006a and own calculations

For any of the other options, compliance with the objective could only be assumed to a lesser extent, if at all:

- Option 3.8b could potentially lead to a quite high level of emissions excluded from the system and would not comply with the overall objective to fully exploit the potential of the EU ETS to contribute to the EU's overall GHG reduction commitments in an economically efficient manner.

- This would also hold for option 3.9.

The issue should also be considered in the context and in connection with options accruing from section 3.1 and 3.3. An overview is provided in section 3.4.

With respect to alternative instruments, a CO2 tax might be preferable to the EU ETS in the case of small emitters excluded from the EU ETS.

Inclusion of new sectors and gases

Identification of Problems

The first trading period of the EU ETS from 2005 – 2007 was very much designed as a learning-by-doing phase. It focussed on creating the critical mass for a liquid trading market and establishing the necessary monitoring, reporting and verification infrastructure. For this reason, the Directive focussed, like all successful applications of cap-and-trade systems in various environmental domains have done, mainly on large stationary sources and only on CO2 emitters, while in principle it covers all greenhouse gases (see Annex II of the Directive).

Based on available NAP II decisions and relevant GHG monitoring reports submitted to the UNFCCC[37], the EU ETS covers a share of 37% of total GHG emissions of the European Union. This means that the balance of GHG emissions is subject to no measures or measures, which are most likely, less cost-effective. Expanding its coverage by inclusion of new sectors and gases would have two effects:

- it would enhance the environmental effectiveness of the system, since it would cover a larger share of total EU GHG emissions;

- it would introduce new and additional abatement opportunities to the system, thereby offering a higher abatement potential and lower abatement costs[38], which may ultimately lead to lower allowance prices. It would thus render the system more efficient.

The question of whether new sectors and gases can be included would depend on whether certain criteria can be met. This would first and above all apply to criteria assessing the monitoring, reporting and verification (MRV) requirements, as the implementation of robust MRV must be considered a "conditio sine qua non" for the inclusion of new sectors and gases. Otherwise, the environmental integrity of the EU ETS would be jeopardised.

Experience gathered so far has enabled the Commission to revise the initial monitoring and reporting guidelines (MRG) with a view to both improving the monitoring, reporting and verification process and making the rules clearer and more cost-effective[39]. The new rules may also lay the ground to include new CO2 emitting sectors.

Some Member States have announced their intention to make use of Article 24 of the EU ETS Directive with a view to opting in N2O. The Commission is currently elaborating the necessary MRG for N2O, which enables a Community-wide inclusion of N2O and might be used as an example for the inclusion of other sectors and gases.

When deciding on the inclusion of new sectors and gases, the objective of contributing to transforming Europe into a low greenhouse-gas-emitting economy entailing the need for reinforcing a clear, undistorted and long-term carbon price signal has to be taken into account. While the potential and costs of abatement may also play a role in this respect, its non-availability must not constitute a reason not to include a given sector within the EU ETS. Otherwise, emergence of a non-distorted carbon price signal may be slowed down and thus jeopardise dynamic efficiency, which is an indispensable requirement to achieve the above mentioned objective. In this context, it is worth recalling the reference of the Presidency conclusions of the European Council in June 2007 to emission reduction targets by 2050.[40]

In the event that inclusion of a sector in the EU ETS should raise serious problems with respect to international competitiveness of this sector, measures related to other elements of the EU ETS are thought to remedy these problems.

In the light of the above, there is reason to believe that further efficiency gains for the system as a whole could be achieved by the inclusion of new sectors and gases.

Identification of Objectives

- Enhancing the environmental effectiveness of the EU ETS by including new sectors in the EU ETS either emitting CO2 or other GHG, which would also help to reduce the climate change impacts of these sectors. The role of a clear, un-distorted, long-term carbon price signal, however, has to be taken into account as well as the fact that the availability of reduction potential should not play a role in the longer run, as there are already sectors included in the EU ETS with a limited reduction potential. A harmonised approach across Europe including robust MRV rules, clear legal definitions, recognizing technology and the international dimension (i.e. international competitiveness and the ability to pass or not pass through costs) should also be taken into account. However, the matter of international competitiveness as such should not constitute a reason not to include a sector, as long as alternative means are available to address the issue.

- Reduce existing intra-EU competitive distortions between competing products/sectors

Criteria designed to reach these objectives are considered to represent the criteria to be used when deciding on inclusion of new sectors and gases, as requested by the Council[41].

Policy Options and Screening

Criteria for inclusion of new sectors and gases

In line with the requirements to ensure effectiveness, efficiency and consistency of the policy options, the following criteria will be applied in the screening process:

- Significance of the source

- The share of the source in EU GHG emissions. However, it is important to note that this criterion does not necessarily preclude smaller sources, if their inclusion would comply with the overall objectives of the review, in particular the need to reinforce an undistorted carbon price signal. Furthermore, it would need proof if it was technically feasible to bring them into the system as the most cost-effective way to achieve emissions reductions relative to alternative measures outside of ETS;

- The trend of the sector/GHG in the EU25[42], because fast growing sources of emissions mean that they will be more significant in later years if not adequately controlled.

- Feasibility to monitor the emissions

- Achievable level of uncertainty (low <10%, medium 10-20%, high >20%), which is important for the environmental effectiveness of the system as well as the functioning of the allowance market in relation to the number of allowances needed for compliance. This is best achieved where similarly robust levels of accuracy are available across all participating installations.

- Data collection: above if it is not possible to easily collect information on emissions this could undermine the environmental effectiveness of the system as well as the functioning of the allowance market.

- Installation boundaries: where it is difficult to define them, it is not clear what emissions are covered by the system, potentially impacting upon its environmental integrity.

- Proportionality of transaction costs

- Number and size of emitters: smaller more complex emitters can be subject to disproportionate administrative burden under the ETS and hence reducing emissions from sectors, which contain a large number of them, may be more cost-effectively achieved via alternative measures outside of the ETS. This issue, however, has already been addressed under section 3.3.2.

- Complexity of MRV requirements: Where complexity is high this will entail higher administrative costs and hence emissions reductions may be achieved in a more cost-effective via alternative measures.

- Interaction with existing policies and regulation

- Existing regulation: If the source is subject to sufficient emissions reductions under alternative measures then there is little need to bring it within the scope of EU ETS as they could entail a double burden.

- Competition: If there is competition with sectors already covered, there is a desire to bring the sector into the system to reduce competitive distortions between those who are currently subject to a carbon price within the system and those outside who are not.

- Compliance costs

- Abatement availability: in general, if would be preferred to include sectors with a large amount of remaining abatement potential as the mechanism under the ETS provides a cost-effective way of unlocking this. However, sectors with small remaining potential should not be precluded purely because of this due to the desire to provide a clear long-term carbon price across as much of the EU economy as possible.

The level of abatement costs may not strictly represent a criterion for exclusion or inclusion, but may be considered more for information on the likely response of the sector (e.g. net buyer or seller) within the system: Given that sectors are still assumed to be subject to alternative emissions reduction measures outside of ETS and that abatement costs only help determine the carbon price within the system itself (with all participants exposed to the same marginal price of CO2) the level of abatement costs should not be an essential criterion on the inclusion or exclusion of a given sector.

Options to include CO2 sectors not yet included in the EU ETS and result of screening

Annex 5 provides a table indicating the results of the screening exercise against the criteria mentioned above. Consequently, the following sectors emitting CO2 are considered further for inclusion in the EU ETS:

- Petrochemicals and other chemicals: Some CO2 emissions are already included via combustion installations and the explicit types of activity mentioned in the Phase II NAP guidance[43]. However, due to the complexity of the sector further examination surrounding a more formal inclusion under Annex I is warranted.

- Ammonia production: This is technically part of the chemicals sector, but because of its reasonably clear installation boundary and high level of process emissions, this ‘sector’ is examined separately in terms of the potential for a more formal inclusion under Annex I.

- Aluminium production: Direct CO2 emissions associated with primary aluminium production are only covered via combustion installations if auto-generation is used. However, this is only estimated to be around 3% of the sector’s energy consumption in the EU, primarily because production uses electricity rather than heat and steam and there is no inherent benefit to having electricity generation on-site as opposed to importing it from a dedicated producer. Process emissions of both CO2 and PFCs (the latter of which are not effectively impacted on by the F-gas regulation) from primary aluminium production are significant and would need to be formally included in Annex I of the Directive.

There are some sectors, which are already covered to some degree or which will be covered automatically in a move to a broad interpretation of combustion – and for which more explicit coverage is not needed within Annex I:

- Food and drink (CO 2 ) This sector generally contains a large number of small sources, some of which are brought into the system via the definition of combustion installation, if they are above the 20MW threshold. In addition, the move to a broad interpretation of combustion will bring in a greater number of types of installation in this sector, again provided that the thresholds are met. Given the negligible process emissions and the fact that most significant sources are captured via combustion installations in Annex I of the Directive this sector is not considered further.

- Production of rockwool and oil/gas flaring – are already included in the EU ETS, as they were explicitly required by the additional NAP 2 guidance. They would be covered by a broad interpretation of combustion installation.

- Gyspum (CO 2 ) This sector has already been included by some MSs in Phase II and is automatically covered by the move to a broad interpretation of combustion installation (where the relevant thresholds are met). Given the negligible process emissions there is no need to bring this sector in more explicitly under annex I.

A CO2 emitting sector not yet covered and not deemed suitable for inclusion at this stage is:

- Waste incineration (CO 2 ) : This sector is already covered by both the Waste Incineration Directive and IPPC as there is a need for careful control of other pollutants from waste incineration. In addition, MRV requirements are likely to be complex due to the high variability in the composition of the waste stream.

Options to include other GHG emissions

Annex 6 provides a table indicating the results of the screening exercise against the criteria mentioned above. Consequently, the following sectors emitting other GHG are considered further for inclusion in the EU ETS:

- Nitric acid and adipic acid production (N2O) as it is a non-CO2 greenhouse gas the sector would need to be formally included as a separate Annex I activity under the Directive. Following an opt-in request furthermore the inclusion of N2O from the production of glyoxalic acid and glyoxal should be considered.

The following sectors are not deemed suitable for inclusion:

- Natural gas distribution (CH 4 ): High levels of uncertainty and difficulties in defining the installation mean there are technical issues with bringing this sector into the system. In addition, the choice of abatement options is limited, and so other direct regulatory measures may be more appropriate.

- Semiconductors (PFCs): The F-Gas Regulation (842/2006) already tightly covers the use of PFCs in the semiconductor industry, and it is also subject to a worldwide voluntary agreement. Hence inclusion under ETS would impose a double burden.

- Magnesium foundries (SF 6 ): Under the F-Gas Regulation (842/2006), the use of sulphur hexafluoride (above 850kg per year) in magnesium foundries will be prohibited from 1 January 2008. Hence it is already tightly covered by existing regulation and inclusion under ETS would impose a double burden.

Coalmine methane (CH4) is already effectively captured by the EU ETS where it is used as a fuel in combustion installations (>20 MW). The remaining emissions are more appropriately considered as domestic offset projects and hence are examined in chapter 6.

Impacts on sectors through inclusion in EU ETS

Some general remarks

The following analysis is carried out sector by sector due to specificities of sectors. It is also based on the assumption that the screening process (see above) has proven the overall feasibility of including the sector from a technical point of view (i.e. possibility of MRV, reasonable complexity etc).

Against this background, specific features of the various sectors will be looked at with a view to determining the impacts possibly accruing from their inclusion in the EU ETS. The assessment criteria applied are environmental effectiveness, economic efficiency, administrative costs, competition and competitiveness and employment. Potential impacts on competitiveness of the sectors concerned may depend on the degree of allocating allowances for free and on the effectiveness of other measures to address potential competitiveness concerns. This as well as other aspects related to the matter of competitiveness are discussed in more detail in section 5.6. For this reason, and in order to avoid duplication, only some specific aspects are mentioned in this section, while general considerations are presented in chapter 5.

CO2 emissions from petrochemicals production and other chemicals

General remarks: This paper refers to the “chemical sector”[44] when a broader view is needed than only petrochemicals. However, as this chapter explains, it is possible to focus mainly on petrochemicals. Most chemical processes need significant energy input (at least for starting the reaction) and as a consequence, combustion installations can be found in most chemical production plants. However, respective considerations are already addressed in chapter 3.1. In the current chapter only chemicals are considered where significant process emissions occur and which therefore would not necessarily be covered under the activity “combustion installation”. As a result of a first screening, relevant[45] chemicals productions can be summarized under the heading “petrochemicals”, as the only other chemicals sector coming out of the screening is ammonia synthesis, which is treated separately (see chapter 3.3.4.3.). In order to roughly define the petrochemicals sector, it is useful to classify organic chemical sectors into

- upstream mineral oil refineries

- mid-stream petrochemical processes, which can be divided into a narrow petrochemical sector and a wider petrochemical sector and

- downstream other chemicals, often referred to as “large volume organic chemicals” (LVOC)

Annex 7 contains an illustration of this division of the chemicals sector. Of the named sectors, mineral oil refineries are not further discussed, as they are already covered by the current scope of the directive (through Annex I). Furthermore, carbon black production and emissions from crackers are covered for inclusion in the ETS by the NAP II guidance. All other combustion installations in the chemicals sector with a capacity of 20 MW and more are already included in the EU ETS or at least will be under the broad scope (see chapter 3.1.). A broad interpretation of combustion would also add a number of further activities to the scope of the EU ETS[46]

Table 3.3.4.2.A

Share | MtCO2 |

narrow petrochemicals | 66% | 87 |

wider petrochemicals | 9% | 12 |

other chemicals | 25% | 33 |

total | 100% | 132 |

Source: ENTEC 2007b

Environmental effectiveness : Due to the complexity of the chemical processes concerned in combination with a lack of data, it is not possible to accurately indicate the emissions that would be captured by including the chemical sector in the EU ETS on top of a consistent application of a broad interpretation of combustion installation. The following figure is based on information provided by ENTEC 2007b.

Figure 3.3.4.2.A

[pic]

Source: ENTEC 2007b

Although the figures must be strongly caveated due to the fact that they are based on UK data extrapolated to the EU, the figure shows that the bulk of emissions from the chemical sector would already be covered through the inclusion of crackers in Phase II and under a broad interpretation of combustion installation. Only 9-17% of total emissions from the chemical sector amounting to approximately 11 – 22 MtCO2 might not be included, but would mainly consist of small emitters with less than 20 MW rated thermal capacity. However, for the sake of legal clarity, it would nevertheless be useful to include the chemicals sector in Annex I of the Directive. In order to target the large emitters, this inclusion should preferably aim at petrochemical production processes, as a broad definition of combustion installations would cover the rest of the chemical industry, while ensuring through the 20MW threshold that the smallest emitters stay outside the ETS.

Economic efficiency : Reduction or abatement potential might amount to 20% of the sector’s total emission, however at relatively high cost as many lower cost abatement measures have already been taken to help reduce energy costs.

Competition and competitiveness : While the inclusion of petrochemical crackers within Phase II has helped to sort out some competitive distortions on the internal market, including the chemical sector more widely would also help reduce competitive distortions with installations producing similar materials on sites already covered by the EU ETS (e.g. petrochemical installations inside refineries).

With respect to the competitive situation with non-EU competitors, modelling[47] suggests that whilst there may be some impact on the chemical sector, it is not likely to be too significant at an aggregate level. This is in line with another study, which looked at the chemical sector in one Member State[48] and according to which the impact of inclusion of the chemicals sector in the EU ETS on operator profitability and competitiveness appears relatively limited[49].

Administrative costs : Since petrochemical installations tend to be large and are already extensively monitored (IPPC and LCP Directive), the overall administrative burden accruing from inclusion in the EU ETS should not be disproportionate. Consistent coverage of the sector may even remove some regulatory complication.

While monitoring and reporting requirements of the sector may create some additional burden to public authorities, the overall approach to be applied in this respect will not be different from the approaches used in other ETS sectors.

Employment : So far, there is no evidence that negative employment effects would occur which can be attributed to the inclusion of the chemicals sector in the EU ETS.

Ammonia

Environmental effectiveness : The estimated share of emissions released from the production of ammonia amounts to approximately 2.25% of GHG emissions covered by the EU ETS in phase II. It roughly corresponds to 45 Mt CO2 and is split between emissions from combustion (appr. 15 MtCO2) and process emissions (30 MtCO2). It is worth noting that a broad interpretation of combustion installation, as discussed in section 3.1 would include the combustion share of ammonia related emissions, but not necessarily the process emissions. Increasing the environmental effectiveness of the EU ETS, but also because there are considerable possibilities to shift parts of the energy input (and thus the emissions) between the combustion part and the reaction part of the installation, the regulatory clarity and the avoidance of possible “cheating” (i.e. optimize the combustion/process shift after allocation and consider it emission reduction) demands the inclusion of the whole emissions.

Economic efficiency : The results of the screening exercise (see Annex 5) showed that emissions from ammonia production would be well suited for inclusion in the EU ETS: low uncertainty in terms of monitoring the emissions, good data collection possibilities, clearly defined installation boundaries (only in the case of full inclusion instead of combustion only), good abilities to identify the operators and easy verification possibilities are promising in this respect. In addition, the small number of companies, which all operate large plants, low complexity of MRV matters also support this finding as does the medium to high abatement potential.

The main abatement techniques for ammonia production are related to process changes. 23% of the CO2 emissions in ammonia production can be reduced across both combustion and process emissions[50]. Total abatement costs are referred to as “reasonable”.

Administrative costs : Costs for operators in terms of MRG would not be excessive due to the relatively low complexity of the process and the high level of existing regulation. There are generally large plants with about 76% of production based in Germany, Netherlands, France, Belgium and the UK. Costs for public authorities are considered to be similar to other sectors with large and less complex installations, i.e. relatively low.

Competition and competitiveness : In the Netherlands, ammonia producers were initially included, but have been opted out, as other EU-based competitors were not included in the system. Inclusion at EU level would therefore be beneficial for the functioning of the internal market and remove currently existing competitive distortions emerging from an inconsistent interpretation of combustion in Member States.

With respect to the competitive situation in comparison with non-EU competitors, it has to be noted that there are competitive advantages of non-EU competitors located in Russia and the Middle-East due to access to cheaper natural gas. Imports of ammonia from outside the EU rose from 12% in 2005 to 17% in 2006 (ENTEC 2007b). High gas prices have caused several ammonia plants in the EU to shut down. However, in the longer term, increasing demand from Asia may alleviate the competitive pressure on European producers. Also costs of logistics (handling and transportation of the product for imports from outside the EU) play already an important role[51] and may, in the longer term, partially offset competitive advantages of non-EU producers[52]. Against this background, it cannot be fully excluded that, in the short term, EU ammonia producers may have to cope with increasing competitive pressure from non-EU producers, if included in the EU ETS. In the longer term, however, additional pressure accruing from inclusion in the EU ETS may decrease, thus providing a more level-playing field like competition between EU and non-EU producers.

Employment : Bearing in mind competitive advantages of external production sites (cheap energy prices, almost no transportation costs for energy) and continuing demand from emerging economies in Asia, negative effects on employment cannot be fully excluded in the future, however, can most likely not be attributed to the carbon constraint accruing from the EU ETS, but to a whole bunch of considerations, among which the EU ETS may figure, but not very prominently.

Aluminium (CO2 and PFC emissions)

Aluminium contains a number of desired properties and is therefore widely used in transportation, packaging and the construction industries, as it combines light weight with high strength. Carbon fibres and other