Box 113 Key elements of the European Commissions proposals for Phase 3 of the EU ETS

• Phase 3 to last from 2013 to 2020, with the cap declining by 1.7 per cent each year. Emissions in 2020 to be capped at 1720 MtCO2 -approximately 21 per cent below 2005 emissions and 11 per cent below the Phase 2 cap.

• The cap to be tightened upon the conclusion of a future international agreement on climate change that includes ambitious targets for developed countries.

• Full auctioning of allowances from 2013 for electricity generation and oil refineries. In other sectors, 80 per cent of allowances to be freely allocated in 2013, declining to zero in 2020.

• Auctioned allowances to be distributed to member states according to share of 2005 emissions, but some redistributed to lower income member states. Remaining allowances freely allocated on the basis of harmonised, sector-specific benchmarks. At least 20 per cent of auction revenues to be invested in climate-friendly projects at home or abroad.

• Commission to investigate the impacts on vulnerable sectors and, if necessary, introduce mitigating measures such as additional free allocation.

• Scheme expanded to include other sectors (aluminium, ammonia, petrochemicals) and gases (nitrous oxide, perfluorocarbon), but many smaller installations excluded.

• JI and CDM credits from Phase 2 allowed to be banked into Phase 3. Rules on future credit imports subject to an international agreement on climate change.

• Scope for linking with other schemes, including provisions for adjustment of targets.

The proposals have been broadly welcomed by both business and environmental groups, although the former remain concerned about the impacts on competitiveness while the latter argue that the 20 per cent target is insufficient. The latter is certainly true when judged against the latest climate science, but the Phase 3 proposals now form part of the EU's international negotiating strategy on climate change. Developing countries may have an interest in a tighter Phase 3 cap since it would create a market for CDM credits. However, since the current proposals increase market uncertainty, they are likely to have a negative effect on CDM investment in the short term.

In practice, the post-Kyoto negotiation process could be delayed and the final agreement could be relatively weak. In these circumstances, the EU ETS could still drive global abatement through linking to and encouraging the development of other trading schemes (Figure 11.3). But the resulting carbon price is unlikely to be sufficient to encourage innovation and investment in low carbon technologies on the scale

Existing links Possible links

Import of credits from JI and CDM projects

Bilateral linking to cap and trade schemes in other Annex 1 countries

'greened' AAU: from Internation Emissions Tradi

Import of

'greened' AAU: from Internation Emissions Tradi

Import of

One-way linking to cap & trade schemes in the US and Australia

Expansion of scope to include other sectors

Figure 11.3 The EU ETS as the potential hub of the emerging global carbon market

Source: Author

Expansion of scope to include other sectors

One-way linking to cap & trade schemes in the US and Australia

Import of credits from expanded CDM - e.g. sector based

One-way linking to schemes for international aviation and shipping

Figure 11.3 The EU ETS as the potential hub of the emerging global carbon market

Source: Author required. Hence, while the success of the international climate negotiations depends in part on the EU ETS, the future success of the EU ETS depends to a greater extent on the outcome of those negotiations.

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