The linking Directive allows companies to use Kyoto credits to meet their caps under the EU ETS. Credits generated under the Clean Development Mechanism can be used in the first phase of the scheme, while both CDM and Joint Implementation projects are eligible in the second phase from 2008-12.
In the summer, the Environment Department (DEFRA) suggested that it might impose either qualitative or quantitative restrictions on the use of CDM credits in the first phase of the ETS (ENDS Report 365, pp 41-42).
The first concern was that a large quantity of imported credits could undermine the drive to reduce emissions in the UK. The second was that projects to abate non-CO2 gases are dominating the CDM - and that an influx of credits from such sources would clash with the UK's domestic target, which is focused on CO2 abatement.
However, the idea met with a hostile reaction from business - which wants to maximise access to cheap abatement opportunities - as well as from the emissions trading community.
The Government has now decided not to impose any restrictions for the first phase of the scheme, which runs to the end of 2007. The only constraints will be on the use of credits from nuclear facilities, land use change and forestry, and as specified by the Directive.
The picture is likely to change in the second phase of the scheme however. Firstly, the Directive requires member states to set mandatory limits on the use of project credits in accordance with the principle set out in the Protocol that imported credits should be "supplemental" to domestic action. These limits will need to be spelled out by next summer, when national allocation plans are due to be submitted to the European Commission. Secondly, DEFRA says that the questions around the impact of credits from non-CO2 gases on national CO2 targets are still being considered as part of the review of its climate change programme.
The decision to allow unlimited access to CDM credits in the first phase is driven by the view that few other member states are planning restrictions. It also reflects official expectations that the market will be able to supply only a fairly limited quantity before 2008.
Research for DEFRA by Ecofys suggests that the global supply of CDM credits will be approximately 90 million tonnes over the first phase of the ETS - compared to a notional shortfall of 47 million tonnes in the UK's allocation plan. Overall demand from European companies is likely to exceed the available supply of credits by a considerable margin, even before competition from governments and other buyers is taken into account.
At present, the forward price for CDM credits is around €6-12 per tonne. It is reasonable to expect the price to rise to reflect the shortfall in supply, and also in recognition of the fact that CDM credits, unlike EU allowances, can be carried over into the second phase of the ETS. However, an international transaction log to allow formal transfer of CDM credits is not expected to be in place until 2007.
Even so, CDM credits are currently cheaper than the EU allowance price of €20-24 per tonne. DEFRA remains confident that allowance prices will fall to around €10-15 per tonne by the end of the first phase "as the market matures".
The financial benefit to British industry of allowing unrestricted use of CDM credits depends on the future price differential with EU allowances. DEFRA says that if the differential stays at around €13 per tonne, the total cost saving would be around €208 million - but this falls to just €32 million at a cost differential of €2.
The regulations allowed the UK to meet the 13 November deadline for transposing the Directive. Most other member states have missed the deadline.
The regulations also set out procedures for approval of CDM and JI projects. DEFRA will act as the UK's national authority. It will have powers to seek further information and to require independent verification of any information provided. It has issued supporting guidance on the procedures for both regimes.2
- Regulations on treatment of late entrants:DEFRA is also consulting on another amendment to the ETS regulations to establish a process for handling "late" installations.3
More than 1,000 installations in the UK now have greenhouse gas permits, and are included in the national allocation plan published in May.
However, DEFRA estimates that perhaps 50-100 installations have not yet applied for a permit and are failing to comply with the regulations. Most are thought to be small combustion plants with annual CO2 emissions of less than 10,000 tonnes.
The Government set aside a small part of the new entrant reserve, some 1.5 million tonnes, to issue free to late applicants. The regulations give force to the provisions for sharing out this reserve. Those who applied for permits before 31 August will be allocated 90% of their historic emissions, and those applying after 1 September will receive just 75%. No free allowances will be granted to late entrants joining the scheme after February 2007.
The proposed regulations also cover a range of consequential matters such as surrender of permits, the power to delay issue of allowances, registry charges and a charging scheme for offshore installations.
DEFRA is also proposing to take new powers giving it access to verified information under the ETS. It hopes that the shift to verified data collected under the scheme will improve the accuracy of its reporting of the UK's national emissions inventory, as required under the Kyoto Protocol.