Emissions trading jigsaw takes shape

The rush towards an EU-wide market in carbon emissions involving up to 17,000 installations is gathering pace. However, the UK's draft national allocation plan has been delayed until January amid high-level debate over the stringency of the overall cap. Meanwhile, guidance from the European Commission has set out how operators should monitor and report greenhouse gas emissions - and the Commission is also calling on Member States to make new entrants buy all their allowances from the market.

Europe is hurtling towards the onset of greenhouse gas emissions trading on 1 January 2005 (ENDS Report 341, pp 18-22 ). Member States were supposed to transpose the Directive into national legislation by the end of December - and national allocation plans are due to be submitted to the Commission by the end of March, or slightly later for the accession states.

By late December, the picture was still in a state of flux. The UK - generally held to be in the vanguard on emissions trading - is now not expected to issue a draft allocation plan until mid-January.

The slippage - not surprising in light of the complexities involved - means that the consultation process on this far-reaching initiative will be highly compressed.

One uncertainty was resolved by the pre-Budget report, which confirmed that climate change levy discounts will be extended to all installations with caps under the trading scheme. This removes a major incentive for companies under climate change agreements to opt out of the EU scheme (see pp 26-28 ).

But by mid-December the Government had still to reach agreement on the most important single question - the stringency of the overall cap.

Environment Secretary Margaret Beckett is understood to favour using the UK's domestic 20% CO2 reduction target for 2010 as the basis for allocation. In contrast, the Department of Trade and Industry, concerned over the impact on British industry's competitiveness, is pushing for a 15% national reduction in CO2 as the yardstick.

Environmental groups argue that a stringent cap is vital to deliver the Government's wider aspirations on climate change. They also argue that a generous cap which allows industry to export surplus allowances could undermine delivery of the UK's national greenhouse gas targets - and may result in a perverse situation where the Government is forced to buy credits from overseas to ensure that businesses do not trade it out of compliance.

Most businesses, with the exception of the renewable energy sector, have argued for a weak cap based on the UK's relatively undemanding Kyoto Protocol target. However, Scottish Power has broken ranks by expressing support for the Government's 20% CO2 target, provided this "does not result in distortion" in relation to the mandatory target under the Protocol.

Fred Dinning, Scottish Power's corporate environment director, told ENDS that "we are very strongly supportive of the Government's backing for renewables and a low-carbon economy. The allocation plan should be set in a way that takes all these aspirational targets into play." ENDS understands that the company's position was taken after strong pressure from its stakeholder environment forum.

Progress elsewhere in Europe is also at a critical stage. According to information collated by the European Commission, most Member States were aiming to issue draft plans in December or January. No country had done so as of mid-December.

The Commission has also published its latest estimates of the number of installations expected to come under the scheme (see table). The total in existing Member States is now put at 13-14,000 - with Germany, France, the UK and Italy set to dominate the market. A further 2,500 or so installations in accession states are also expected to join the scheme.

Some analysts warn that the planned 2005 launch date is now at risk. In a report issued in December, Deutsche Bank said there is "limited time available for solving massive problems in the initial allocation of credits." The bank expects the greatest challenge to be in harmonising the various national allocation plans.

Member States are keeping a close eye on each others' choice of allocation methodology. There is considerable scope for market distortions - and the European Commission will face a tall order in sifting the draft plans for overly generous allocations which could constitute illegal state aid.

One key area of potential distortion is the treatment of new entrants. There are two basic options - new entrants could be required to buy all their allowances from the market, or could be given them free from a pool held back by Governments.

Manufacturing industry prefers the latter approach because it would reduce perceived barriers to entry. However, it would open a can of worms in defining what is meant by a new entrant. For example, would increases in production capacity at an existing factory be treated in the same way as a new greenfield facility?

ENDS understands that the Commission's guidance on national allocation plans, due to be published by the end of December, will give strong support to making new entrants buy allowances. However, France has already decided to hold back a pool of free allowances - and other Member States may feel strong pressure to follow suit so as not to lose out in the competition for new industrial investment.

The Commission was also expected to issue another important guidance document by the end of December, dealing with monitoring and reporting requirements.

ENDS has seen a near-final draft of this Decision, which sets out a range of "tiered" methodologies for each industry sector. In general, the Commission expects operators to use the most accurate tier unless it can convince the competent authority that this "is technically not feasible or will lead to unreasonably high costs." There is some limited scope to apply less stringent standards to minor sources on a site accounting for less than 5% of total emissions.

The Commission has also eased off on the standards of accuracy which it expects operators to achieve. For large emitters using natural gas, uncertainties of less than 2.5% are expected. However, smaller sources using variable fuels such as coal or waste, or with significant process emissions of CO2, may be allowed uncertainties of 10% or more. Third party verifiers will have a key role in ensuring that methodologies are correctly selected and applied.

The Decision also makes clear that biomass fuels will be zero-rated. An illustrative list of such "carbon neutral" fuels includes wood wastes, sewage sludge, biofuels - and, more controversially, landfill gas and the biomass fraction of paper, cardboard, municipal waste and industrial waste.

The cement and lime industries have failed in their bid to ensure that other waste fuels, such as tyres and solvent-based wastes, are classed as carbon neutral (ENDS Report 346, pp 5-6 ). The classifications could have a significant impact on the economics of various waste fuels and disposal options.

Back in the UK, DEFRA has issued guidance to operators to help determine whether they are covered by the scheme, including its controversial interpretation of the Directive's definition of "combustion installations" (ENDS Report 345, p 5 ).1 The Environment Agency has also fleshed out its guidance on how to apply for greenhouse gas permits (ENDS Report 344, p 43 ).2

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