EU throws open the door to Kyoto credits

The European Parliament and Council of Ministers have agreed the so-called "linking" Directive which will allow companies under the EU emissions trading scheme to buy credits from overseas projects. To the fury of environmental groups and delight of industry bodies, the Directive sets no fixed cap on the use of project credits.

Over the last three months, the focus of EU climate change policy has been the production of national allocation plans setting out how many allowances Member States will grant to their industries.

Only five of the 15 Member States - Germany, Finland, Denmark, Austria and Ireland - submitted plans by the deadline of 31 March. Even the UK, previously seen as a leader in the field (ENDS Report 348, pp 18-22 ), delayed its plan until the end of April.

So far, the picture is one of generous allocation for the first phase of the trading scheme from 2005-7 - prompting a slump in traded prices from €13 to €7-8/tCO2.

The agreement on the linking Directive increases the likelihood that allowances will not be in short supply and that prices will remain low.

The Directive was proposed last summer (ENDS Report 343, pp 48-49 ) and has been approved with remarkable speed. The urgency stemmed from the imminent onset of EU trading in January and the need to finalise a deal before the European Parliament dissolved for elections.

The Parliament approved the deal on 20 April. Pressure to reach an agreement meant that it gave ground on many potential sticking points.

The Directive allows credits from the Kyoto Protocol's "clean development mechanism" (CDM) and "joint implementation" (JI) programme to be used in the EU trading scheme. As expected, it permits CDM and JI credits to be used regardless of whether the Protocol comes into force (ENDS Report 349, pp 59-60 ). It also allows credits from CDM projects to be used in the trading scheme's first phase.

The move should revive interest in the CDM and JI, which has stalled because of ongoing doubts over whether Russia will ratify the Protocol. Dutch MEP Alexander de Roo, who led negotiations for the Parliament, said: "To prevent the Kyoto Protocol process from failing, the EU has taken the initiative of creating a parallel Kyoto process."

The move to allow CDM credits from 2005 may have little immediate effect on the market. According to a new analysis by Point Carbon, the supply of credits is likely to be about 2.7 million tonnes of CO2 equivalent in 2005, rising to 9.8 million in 2007.

Supply is expected to increase significantly in the Kyoto compliance period of 2008-12 - but companies under the trading scheme will then be competing with national governments. In the EU alone, Austria, Belgium, Denmark, Ireland, Italy and the Netherlands have already announced plans to buy around 23mtCO2e annually in order to help meet their Kyoto targets.

The main points in the agreement on the final text are:

  • Cap on credits: The European Commission originally proposed a review if imported credits reached 6% of the total quantity of allowances, with a view to setting a ceiling at 8%.

    The idea of a cap was to protect the principle, set out in the Protocol, that credits should be "supplementary" to emission reductions achieved domestically. The EU had argued previously that credits should not account for more than 50% of each country's effort to meet its target under the Protocol.

    However, the idea of a cap has been scrapped in the face of strong opposition from industry and concerns over its practical implementation. The Directive now leaves it to Member States to decide what overall limit to set on the use of imported credits. The limit will be applied as a percentage of each installation's allocation under the national allocation plan.

    Each Member State's use of credits must "be consistent with the relevant supplementarity obligations under the Kyoto Protocol". A report must be submitted to the Commission every two years on the relative balance between domestic action and use of the project mechanisms - with provision for the Commission to make more binding proposals if supplementarity at EU level appears to be at risk.

    The decision may be particularly problematic for the Dutch Government, which has long planned to meet half of its total national target through imported credits. On the face of it, this leaves no room for Dutch companies to use imported credits.

    Climate Action Network Europe, a coalition of environmental groups, claimed that by allowing "unlimited volumes of cheap credits" into the market the Directive "may be the death-knell for domestic emission cuts among EU industry." It called for urgent action at Member State level to agree a "strict and harmonised cap" on the use of project credits.

    Industry bodies were pleased with the move. The UK's Chemical Industries Association said it "will help the scheme to be implemented without burdening its players with excessive costs" - but claimed that the potential for Member States to introduce their own caps was "likely to put upward pressure on the price of carbon".

  • Project types: Firms will not be allowed to use credits from "sinks" such as reforestation projects. Some Member States had been pushing for sinks credits to be allowed in the EU scheme, pointing to last year's agreement on rules for such projects under the Protocol.

    The Commission will reconsider the eligibility of sinks projects in a review in 2006. This will be based on an assessment of the risk of non-permanence, and of potential risks arising from the use of genetically modified organisms and invasive alien species.

    Environmental groups had been pushing for large hydroelectric projects to be excluded, and for smaller projects to be required to meet criteria drawn up by the World Commission on Dams.

    The final Directive says that hydropower projects over 20MW should "respect" the criteria. The European Commission will also monitor the environmental and social effects of large projects over 500MW, with a view to possibly prohibiting them in the 2006 review.

    In line with the Protocol, credits from nuclear power projects will not be eligible at least until 2012. MEPs failed in an attempt to rule out nuclear power beyond that date.

  • Domestic projects: Some Member States had wanted domestic emission reduction projects, in sectors outside the scope of the trading scheme, to be eligible for carbon credits. The Directive rules this out for the time being - but says the Commission may revive it in the 2006 review.

    The UK tried to set up a project mechanism to feed into its own domestic emissions trading scheme (ENDS Report 328, pp 26-28 ). However, plans have been quietly shelved - not least because of the problems of double-counting and demonstrating "additionality" in a crowded policy environment.

  • Links with other trading schemes: The Parliament was keen to develop links between the EU carbon market and the growing number of regional trading schemes in countries which have not ratified Kyoto. The deal leaves open the possibility of mutual recognition of mandatory schemes with absolute emissions caps, but only once the Protocol enters into force.

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