January 1st, 2005, was a groundbreaking day in the history of man's fight to mitigate climate change. That day marked the opening of the first international trading system for CO2 emissions in the world.
In an effort to meet targets set by the Kyoto Protocol, the Emissions Trading Scheme was created on 25th October, 2003. This directive provided for the establishment of a 'Community-wide gas emissions allowance trading scheme as of 2005.'
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The EU ETS is a cap-and-trade system that covers over 11,500 energy-intensive installations across the EU, representing close to half of Europe's emissions of CO2. Participants include combustion plants, oil refineries, coke ovens, iron and steel plants, and various factories.
Countries are allocated permits, at least 95% of which must be grandfathered or freely given away for the 2005-2007 period. Similarly, at least 90% of the permits for the 2008-2012 period must be grandfathered. Each permit allows the holder to emit one ton of CO2 equivalent.
To stay within the limit, the participant can cut emissions or purchase unused allowances from other, more efficient enterprises. At the end of the year, each country is required to report their emissions levels and the number of surrendered permits.
If a company fails to surrender sufficient permits to cover their emissions, a fine of 40 will be levied for every excess ton of CO2 emitted in the 2005-2007 trading period and 100 per excess ton for the 2008-2012 trading period.
Participation is mandatory for installations that fall under certain criteria. It is incumbent upon the participants to decide how and where to trade allowances. Firms have the option to trade directly with each other or to trade via a broker, bank or other allowance market intermediary.
Trading is carried out on an international basis, facilitated by an electronic registry system that records the ownership of emission allowances. This system is separate from trading activity as not all trades result in a change of ownership. However, in cases where a change in ownership does occur, the registry system records a transfer of allowances between accounts.
Thus, the registry system is 'similar to a banking system which tracks the ownership of money in accounts, but does not track the deals made which are the cause of the money changing hands.'
Each Member State of the is responsible for creating a National Allocation Plan (NAP) that determines how many permits each participant will receive. This allocation is governed by twelve criteria that are set out in the Directive.
The challenge is to balance the allocation such that the number of permits is limited enough to create scarcity so that a market can develop, but sufficient so that operations of the affected sectors are not too severely inhibited.
Source: Commission of the European Communities
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