International Agreements and Cooperation Examples: European Union Emission Trading Scheme

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The European Union Emission Trading Scheme is the focal point of EU climate policy thus far.  It is the largest multinational emissions trading system in the world, covering more than 10,000 installations and 40 percent of EU carbon emissions.  Emissions are monitored and calculated on an annual basis, and extra credits are tradable.  The goal is to reduce emissions substantially and efficiently.

Begun in 2005, the ETS has been gradually revised over time to improve its functioning.  An important early concern involved over-allocation—giving away too many permits for free, thus undermining the price of emission credits and thus the environmental benefits of the scheme.

Going forward, a primary issue is whether and how to integrate the unilateral approach of the EU ETS with other future regional or global trading regimes.  This area is in constant flux, as a successor agreement to the Kyoto Protocol is not yet in place, and so it is unclear how the ETS will interact with the uncertain international regime.  There are concerns with potential regulatory overlap (which would create unnecessary costs and undermine efficiency), so compatibility is desirable. 

More generally, there are concerns about the effect of the ETS on EU competitiveness.  Since many of Europe’s developed rivals have not embraced similarly stringent emission limits, the relative impact of carbon prices on EU firms (as compared to less-regulated peers in other countries) is a major issue.  The ETS thus far has had varying impacts both within and between countries depending on the industrial/manufacturing concentration of the economy.  This issue is intertwined with the general threat of carbon leakage, which would undermine both ETS pricing and the environmental benefits of EU policy.

Other issues include: (1) the effect of regulatory uncertainty (and especially fluctuating permit prices) on EU businesses; (2) how the unilateral action of the EU effects the stability and ambition of international climate negotiations; (3) the relative costs and benefits of auctioning versus free allocation of emission permits; (4) whether and how the ETS can be supplemented or replaced by a carbon tax (applicable to the entire economy, as opposed to sectors like the ETS); and (5) the interaction between EU and national climate policies.