The current climate protection strategy as it is laid out in the National Allocation Plans (NAPs) for the European Emissions Trading Scheme (ETS). The multi-regional, multi-sectoral CGE-model DART is used to simulate the effects of the current policies in the year 2012 when the Kyoto targets need to be met. Different scenarios are simulated in order to highlight the effects of the grandfathering of permits to energy-intensive installations, the use of the project-based mechanisms (CDM and JI), and the restriction imposed by the supplementarity criterion.

1. INTRODUCTION

The European Emissions Trading Scheme (ETS) for CO2 is one of the major components of the European climate strategy for reaching the European Kyoto targets. The ETS that started in January 2005 covers facilities for electricity generation, the production and processing of ferrous and non-ferrous metals, energy intensive activities in the mineral industry and the pulp, paper and board production. These installations are responsible for around 45% of the European CO2-emissions. Besides trading emission allowances within the trading scheme, a linking between the ETS and the two flexible project mechanisms "Clean Development Mechanism" (CDM) and "Joint Implementation" (JI) has been established. This allows European facilities covered by the ETS to carry out emission-curbing projects in other Annex I countries (JI) and non-Annex I countries (CDM) and to convert the credits earned into emission allowances under the ETS.

While the ETS guarantees that the emission targets in the ETS sectors are achieved at minimal costs, the efficiency of the overall climate strategy of the EU as well as the efficiency at the level of the European Member States depends crucially on the climate policies introduced outside the ETS. The current system is thus a hybrid system of which the efficiency properties are quite unclear. There are broadly three policy types through which the reduction of greenhouse gas emissions in the Member States can be achieved in order to meet the Kyoto-targets:

1. Domestic CO2-emission reductions for the energy intensive installations in the ETS

2. Domestic reductions of CO2-emissions in the sectors not covered by the ETS and reductions of other greenhouse gases (domestic reductions outside the ETS)

3. Emission reductions abroad--mainly through CDM and JI since it is not clear whether international emissions trading will take place within the 1st Kyoto commitment period from 2008-2012.

The third option can be used by firms covered by the ETS as well as by those governments, which have set domestic targets not sufficient to meet the emissions limits of the European Burden Sharing Agreement in the Kyoto Protocol.

The allocation of permits to the ETS is determined in the so-called National Allocation Plans (NAPs), which each member state has to prepare before the beginning of an ETS trading period. For the first trading period from 2005-2007, the final NAPs for all of the EU25 countries are since June 2005 accepted by the European Commission and made public. The NAPs as well as some government programs contain information on the planned government purchase of CDM and JI credits. Some NAPs also indicate the targets for the ETS sectors until 2012. Given this information it is possible to determine how the different EU member states plan to achieve their Kyoto targets in terms of domestic reductions in and outside the ETS and reductions abroad.

Existing simulation studies are based on hypothetical allowance allocations to the ETS and ignore the possibility of using CDM and JI credits within the ETS and by European governments. In contrast, the objective of this paper is to examine the implications of the current NAPs under different assumptions about the use and availability of CDM and JI credits using the DART model (Klepper et al. 2003). DART is a computable general equilibrium model designed for the analysis of international climate policies and calibrated for the enlarged EU. With DART it is possible to simulate the ETS, the CDM and JI market and the domestic action under different assumptions about the functioning of these three markets. Since the Kyoto targets are not binding for the former accession countries, except Slovenia, the focus will be on the EU15.

The paper proceeds as follows. In section 2, we derive the current climate strategy towards the Kyoto targets of the different EU Member States and provide some information on the ETS and the market for CDM and JI. Section 3 and 4 present the DART model, our simulation studies and interpret the simulation results. Section 5 summarizes the findings and draws some conclusions.

2. REACHING THE EUROPEAN KYOTO TARGETS

In this section, we summarize the information available on how the former EU15-countries plan to meet the Kyoto targets by making use of the three options described in the introduction: trading in the ETS, emissions reduction in the Non-ETS sectors and in GHGs other than CO2, and through purchases of CDM and JI credits. In addition, we give an overview over the potential market for CDM and JI credits and discuss the issue of hot-air.

2.1 The European Climate Strategies

In the Kyoto Protocol from 1997, the EU agreed to cut their overall GHG-emissions relative to the 1990 level by 8% in the period from 2008-2012. In 1998, this target was differentiated between the different member states in the so-called Burden Sharing Agreement giving cohesion member states, such as Spain, Portugal, Ireland and Greece, a lighter burden, compared to richer member states. The (former) accession countries that joined the EU in May 2004 and the countries that are scheduled to join in 2007 are not part of the Burden Sharing Agreement but have their own Kyoto targets.

Since the signing of the Kyoto Protocol, greenhouse gas (GHG) emissions have risen in most of the EU15 Countries, and only few of the countries (Sweden, Great Britain, France and Germany) appear to be on track to fulfill their commitments. With the exception of Slovenia, in all of the (former) accession countries emissions fell drastically since 1990 due to the economic break down of their economies. For these countries, the question is not how and where to reduce emissions, but rather, how much of the excess emission rights (hot-air) they decide to sell on the European ETS market.

The national climate strategies of the EU member states are summarized in the National Allocation Plans (NAP). The NAPs contain information in different detail and with differing time horizons. Table A1 in the Appendix summarizes the relevant information concerning the allocation to the ETS sectors, the emissions of these sectors and the use of CDM and JI. With the help of official data on GHG-emissions, it is possible to derive or estimate the emissions of the ETS and non-ETS sectors in 2002, the allocation to the ETS in 2007, the planned use of CDM and JI and the remaining reductions that have to be achieved to reach the Kyoto targets. Four countries have also indicated the allocation to the ETS in 2012. Germany, the UK, and the Netherlands plan to reduce the ETS-emissions by 1.5 to 2.5% from 2007 to 2012. In Denmark, the reduction is even set to almost 20%.

Figure 1 shows for each of the EU15 states the emission reductions that are necessary to reach the Kyoto target relative to 2002 emissions. All numbers are in megatons of CO2 equivalent (Mt CO2e). The dark part of the bars indicates the reduction (or increase) of the CO2-emissions of the ETS sectors according to the allowance allocation in the NAPs. Where available, these data are for 2012. In most cases, information is only available until 2007. The striped bars show those reductions that are officially planned to be obtained through CDM and JI projects. These reductions will only be relevant for the first Kyoto commitment period from 2008-12, which also is the second trading period of the ETS. The light bars show the difference between the Kyoto targets and the reductions from the ETS and the state run project mechanisms. These reductions will need to be realized in the sectors other then the ETS installations and with gases not covered by the ETS. This residual can be influenced, of course, if the allocation of allowances in the second ETS trading period or the CDM and JI credits are adjusted accordingly.

Figure 1

According to the numbers shown in Figure 1 only France, the UK and Sweden already meet their Kyoto target in 2002. The UK plans to reduce emissions in the ETS even further, which leaves room for rising emissions in the non-ETS sectors. Even though most countries have to reduce emissions considerably for meeting their Kyoto targets, Portugal, Finland, Denmark, Austria, the Netherlands and Italy allocate allowances to ETS sectors that surpass emissions in 2002. In the remaining countries, emission reductions in the ETS sector also play a minor role given the overall Kyoto target. Only Belgium plans to achieve a major part (about one third) of the reductions necessary for the Kyoto target within the ETS. CDM and JI are also of relatively little importance in most countries. Italy, the Netherlands and Spain plan to make use of these mechanisms most strongly. CDM and JI are also part of the climate strategy in Belgium, Denmark and Ireland. Given these reduction plans, the major burden for domestic reductions falls on the sectors outside the ETS in almost all countries.

Even though the last NAPs for the first trading period have been finalized in June of 2005, the European Emissions Trading Scheme has started in January 2005. There is some evidence that it can indeed generate considerable cost savings (Criqui and Kitous 2003, Klepper and Peterson 2004, Svendson and Vesterdal 2003). Trading prices have started at 8.5[euro]/tCO2 and have meanwhile gone well beyond 20[euro]/tCO2. (1) On the other hand, there are estimates for the shadow taxes needed to achieve the necessary...