The European Emission Trading Scheme (EU ETS) is a core part of EU climate change policy and every year installations covered by the system must acquire and surrender allowances equal to their verified emissions. It operates in 28 EU countries and three EEA-EFTA states (European Economic Area—European Free Trade Association: Iceland, Liechtenstein and Norway). It covers around 45% of the EU’s greenhouse gas emissions and includes over 11,000 heavy energy-using installations in power generation and manufacturing industries.
The EU ETS established a carbon market in which emissions allowances have a value. There are three main approaches to allocate allowances to incumbents: (1) allocation according to historic emissions (minus required savings) or grandfathering; (2) allocation according to benchmarks (e.g., determined on the basis of the 10% best or Best Available Technology); (3) auctioning.
To mitigate the risk that the cost associated with these allowances could competitively disadvantage EU industry relative to those that are not subject to the same carbon pricing, many of the allowances are issued to them for free. For the 1st and 2nd trading period (Phase I of the EU ETS: 2005–2007; Phase II: 2008–2012), free allocation was based on national allocation plans (NAPs) and grandfathering. This decentralized approach was criticized because it creates substantial differences in allocations across countries that could cause competitive distortions. The decentralized approach also adds complexity to the scheme and thereby increases transaction cost [1
]. Further criticism related to large allocation surpluses and insufficient incentives to reduce emissions [2
Major revisions to strengthen the EU ETS were therefore undertaken for Phase III (2013–2020), especially with respect to allowance allocation [3
]. The following changes are especially important:
The move to a single Union-wide cap instead of national caps standardised the approach to improve the harmonisation of ambition between Member States and therefore the level of allocation to their industries.
Auctioning has become the default method for allowance distribution, reducing the number of allowances that are provided for free. Theoretically auctioning of allowances is preferred since it avoids rent seeking behavior in decision about distribution of allocations. Further, auctioning is consistent with the polluter pays principle which likely increases the perceived fairness of the auction’s outcome [2
]. However, in practice auctioning shares so far remained low except in the electricity sector because of concerns over carbon leakage. Free allocation is considered as second best to protect leakage exposed industries [4
Harmonised rules for free allocation based on benchmarks (for products and fall-back approaches for heat and fuels) standardised the approach for installations within each sector or subsector. The product benchmarks have been defined based on the 10% best performing installations. The benchmark-based allocation rewards efficient installations that will receive a relatively complete endowment with certificates to cover their emissions while installations with a relatively poor emission performance will face a deficit in allocations compared to emissions.
These revisions are likely to have had an impact on industries covered by the system. Relative to the previous allocation method (based mainly on historic emissions-based grandfathering under national caps), the new approach affects the distribution of value of free allowances between installations within and across sectors. Good practice in low emission production is in principle rewarded in preference to higher carbon intensity operations because the allocation is independent of an installation’s actual emissions (at least as long as over-allocation is avoided). Installations operating nearer to the benchmark will receive a greater proportion of their allowances for free.
As a key instrument to reduce greenhouse gas (GHG) emissions the EU ETS has been evaluated both from an ex-ante and an ex-post perspective, with the first dominating the early years of the EU ETS, naturally. Ex-post analysis has been carried out on various aspects such as:
Effectiveness of the EU ETS in reducing GHG emissions which is the primary objective of an emission trading scheme [5
Cost efficiency in reducing GHG emissions [10
Carbon leakage effects and impacts on economic performance, competitiveness [8
Impacts on employment, investment and productivity [12
Innovation impacts [7
Interaction with other policy instruments [16
Methodological aspects with respect to evaluating the EU ETS [7
With respect to the effectiveness of the ETS to reduce GHG emissions, the difficulty resides in the need to separate impacts of other factors than the EU ETS (e.g., the economic crisis from EU ETS, specific energy policies such as for renewables and energy efficiency, structural changes due to globalisation) from the impacts of the policy itself. A number of studies conclude on a substantial reduction of 100–200 million tonnes of CO2
]. However, the distinction of what is due to the before mentioned effects and the EU ETS is difficult to make, especially in a case of low carbon prices and over-allocation as was the period for most of the lifetime of the EU ETS so far. Further, these studies do not have a specific look to the manufacturing sector.
Particularly interesting is the question whether the EU ETS has not only led to a reduction of activity levels but also to the reduction of specific emissions [8
]. While both effects contribute to the effectiveness of emission trading (the first, by putting pressure on carbon-intensive activities, the second, by triggering process innovations), it is the second effect, which is most desirable from a policy maker perspective, as it may contribute to enhancing competitiveness and innovation in the economy. So far, there was little investigation from a bottom-up perspective (i.e., at the level of individual industrial production processes) on changes of specific emissions. The present paper contributes to closing this gap. Some research has been carried out on individual industrial branches in the past, but mainly with a focus of carbon leakage [11
This paper focuses on the following two key research questions:
How do allocations compare with actual installation verified emissions? The purpose of this analysis is to determine at detailed sector and country level, the evolution from Phase I/II (which have been characterised by large over-allocation) to Phase III.
How do actual verified emissions of installations compare with benchmark values? For that purpose, we focus in an exemplary manner on four important products: cement clinker, pig iron production, ammonia production and the production of nitric acid (as an important emitter of nitrous oxide N2O, a powerful greenhouse gas).
To examine the first research question we investigated the ratios “Allocation 2008/Verified Emissions 2008” and “allocation 2013/average allocation Phase II”. The first ratio measures whether there was over-allocation of free allowances at the beginning of Phase II (starting in 2008), while the second measures in how far this has been corrected in the allocation of Phase III (starting in 2013).
The second research question, the analysis of benchmark values relative to actual performance involves the construction of sector specific emission intensities (emissions divided by production volume), using mostly publically available production data. The specific emission intensity values are compared with the benchmarks [3
] for the four case studies. The hypothesis to be verified was that the changes in allocation rules for Phase III may have influenced specific emissions, bearing in mind that emissions in Phase III are only available for 2013 to 2017 so far, though Phase III changes may have had impacts before its start (see the discussion on nitric acid in the results section). We therefore also include the time period from 2005–2012 in the analysis. The research comprised two principal elements. First, the available data and information were analysed to identify preliminary findings and indications. Second, interviews were carried out with selected sector and country representatives to gather further insights and information to inform the analysis.
4.1. Discussion of Results for the Comparison of Allocation with Actual Emissions
The analysis indicates that even at the beginning of the second trading period, when the economic crisis had not yet had a strong effect on emissions, substantial surplus in allocation over verified emissions existed. Several other analyses came to similar results: For the first trading period [29
] found high relative over-allocation in new member states, while at the contrary, under-allocation mostly occurred in Ireland, Italy, Spain, and the UK. The allocation based on historical emissions was criticized for not providing adequate incentives to increase emission efficiency. It was further vulnerable to strategically inflating emissions. Large inter-country difference in free allocation persisted in the 2nd trading period [2
] have substantiated the often formulated critique on the lacking harmonization of allocation based on decentralized national allocation plans for 1st and 2nd trading period. The question is then: did the move to benchmark-based allocation increase the harmonization of allocations across Europe?
According the results in answer of the first research question, the new allocation rules had a substantial effect on the allocation towards installations in the sample. Overall, allocation for the selected sectors decreased by 20% in 2013 compared to 2008. The allocation change varies at sector level and by country:
Allocation changes at sectoral: At the aggregate level, i.e., comparing the sum of allocations 2008–2013 per sector, allocation decreased in all but two sectors. On average the changed allocation contributed to the reduction of a surplus in allocations compared to verified emissions. While the ratio of allocation to verified emissions was larger than 1 in all but three sectors, the ratio was smaller than one in all but six sectors in 2013. For three sectors, in particular cement, the allocation to verified emissions ratio is larger in 2013 than in 2008 (see discussion below).
Allocation changes at country level: In 2008, in 23 out of 27 countries allocation exceeded verified emissions. Even though allocations decreased in most countries, still in more than half of the countries, allocations exceed verified emissions in 2013. However, changes are quite disperse within the countries in particular driven by the heterogeneity of changes observed at sectoral level.
Allocation changes and verified emissions for country-sector pairs: Looking at the heterogeneity of the allocation changes, the subsequent question is whether the changes contributed to reducing allocation surpluses that existed in 2008 and achieved a more harmonized allocation. The analysis of allocation/verified emission ratios for country-sector pairs shows that for the majority of country sector pairs, the ratio of Allocation 2013 to Average 2nd trading period was smaller than one while the ratio of allocations to verified emission in 2008 was larger than one. This can be interpreted as a correction of a potential historical over-allocation with the new allocation rules for the third trading period. The findings indicate that the benchmark-based allocation contributed to harmonizing allocation by reducing allocation more strongly for installations which have been over-allocated in the past.
Overall, with the move to Phase III the basis has been improved for the EU ETS to provide incentives to implement low carbon technology. Specific discussion items relate to specific products/issues:
Cement: Previous analysis has found that for the cement sector installation emissions in 2012 clustered around capacity thresholds [30
]. This indicates that installations’ operators reduced production and strategically exploited the rules for capacity changes to optimize their allocation situation. This effect contributes to explaining that despite decreased allocation, the cement sector has a higher allocation surplus over verified emissions in 2013 than in 2008. Notably, this is likely not related to improvements in operational efficiency. On the contrary, operating several plants at reduced capacity instead of closing one and operating the other at full capacity leads to decreased efficiency. Furthermore, the ambition to retain certain clinker production levels to meet the threshold may have led to increase clinker ratios in cement production.
Fertilisers and nitrogen compounds: The allocation increase in 2013 compared to 2008 at sector level for 20.15 Manufacture of fertilisers and nitrogen compounds (20.15) and 20.11 is driven by very high allocation changes in some installations. The median shows that most of the installations considered faced a decrease in allocation even though lower than in the other sectors. The installations with the largest allocation rise also had substantial changes in verified emissions from 2008 to 2013 which most likely relates to the changed scope of the EU ETS in its third trading period: Installations from the fertilizer sector only entered the EU ETS in 2013, but some installations have been liable to emissions trading before as thermal installations with a rated capacity of above 20 MW. Due to the low number of observations in the fertilizer sector particular effects from single installations have a stronger impact on the overall sector results.
Pulp/paper: The treatment of cross-boundary heat flows probably strongly affected allocation in the paper sector in which combined heat and power installations are very common. For the paper sector in the Scandinavian countries numerous installations received an increased allocation in 2013 compared to the 2nd trading period even though allocations exceeded verified emissions in 2008. There are two explanatory factors: (a) Scandinavian paper mills are often integrated mills using a high share of biomass inputs and waste from the pulping process. Those mills are better off compared to stand-alone paper production under benchmark based allocation; (b) under allocation based on historical emissions, these installations will have had relatively low allocations compared to mills using less biomass and/or stand-alone mill because they have fewer emissions.
4.2. Discussion of Results for the Impacts of Benchmarks for Allocation on Verified Emissions
In all of the four case studies, data issues are a challenge, notably for achieving s similar set of data, both for emission and production data. The EUTL only provides emission data. Hence, the comparison with the benchmarks is not straightforward, given that they are defined in terms of specific emissions (per tonne of product). A reduction in emissions per se may not be linked to an improvement in carbon efficiency but may be linked to changes in production, instead. Care had therefore to be taken to design an approach with a set of production data as close as possible to emission data. Further, plants not producing through the whole period falsify the picture as they may increase specific emissions due to low capacity use; those data had to be taken out from the analysis. Further, the benchmarks have been set in relation to sub-installations which are not identified in EUTL either and their shares had to be extracted from a previous data sets at the time when the benchmarks were established. Finally, economic recession such as in 2009 and the years onwards, has a strong impact on specific emissions due to low capacity use, and hence may drive specific emissions up. This discussion shows that such type of analysis would largely benefit, if the EUTL data would be complemented through suitable production information, at least in index form.
The results from the four product analyses can be summarized in Table 4
5. Conclusions and Outlook
Our analysis shows the allocation process for Phase III has largely improved the incentives for low-carbon technology uptake by reducing over-allocation though for a number of country-sector pairs some over-allocation remains. On the other hand, the evidence from the four case studies (cement clinker, pig iron, ammonia and nitric acid), which together represent around 40% of industrial emissions under the EU ETS, indicates that there was little impact so far, from the EU ETS on the evolution of specific carbon emissions, hence no substantial uptake of low-carbon technology in those production processes. Exception is the nitric acid process where, however, most of the change occurred before 2013. This change has, nevertheless, certainly benefitted from the introduction and discussion of the benchmarks around the period 2008/2009, anticipating the introduction of the benchmarks in 2013. The industrial process has benefitted from the fact that an important GHG reduction technology was available and could be taken up by a large number of companies in the ETS in a reasonable time frame.
This raises the question of how such alternatives can be developed for other sectors such as cement clinker, iron steel and other large emitters under the EU ETS. Such processes are in different stages of development as evidenced by the discussion around the Innovation Fund [14
] to be set up for Phase IV of the EU ETS, i.e., starting 2020. The rising carbon prices—in recent weeks around 16 Euro/tonne CO2
was reached, after seven years of low prices at 5–6 Euro/tonne CO2
—will reinvigorate companies’ interest in bringing forward innovative low-carbon production processes. The over-supply in Phase III will rapidly disappear in Phase IV, in particular also through the reserve features developed for the period after 2020. This will increase pressure on politics to exempt carbon-intensive productions by increasing free allocation with the competitiveness and carbon leakage argument. However, with the now operating ETS in South Korea (start in 2015; price levels at 17,18 Euro/tonne CO2
) and China (the national scheme has started in 2018), this debate gets more subtle and the pressure increases to develop for competitiveness reasons the first low-carbon processes for the production of crude steel, cement etc. Otherwise, increasingly also substitution by other, less carbon-intensive, materials, less subject to carbon price, will occur over time.