Last week, in conjunction with the Queensland Resources Council, Minter Ellison hosted a presentation by one of the world's leading carbon market experts. Her topic was the European Union's Emissions Trading Scheme (EU ETS) and what Australia can learn from it in the context of the current debate around a carbon pricing mechanism for this country.

Jill Duggan works for the EU. She has designed, implemented, managed and analysed carbon markets, was the UK's representative on the International Carbon Action Partnership, has advised the Western Climate Initiative in the US, and provided expert testimony to a US Congressional Committee. 

We have prepared this brief overview of Ms Duggan's presentation and of the panel discussion that followed it. There is much food for thought here, and we would be delighted to receive your comments and thoughts.

The EU ETS in brief

The EU ETS is the largest emissions trading scheme in the world. Launched on 1 January 2005, it is the cornerstone of the EU's policy to combat climate change in a cost-effective and flexible way. 

The scheme encompasses approximately 11,500 regulated entities across 30 nations (including the 27 member states of the EU as well as Norway, Iceland and Liechtenstein). It is designed to regulate emissions-intensive industries, including the energy sector and various industrial plants. Because of its broad jurisdictional and sectoral reach, in 2010 the EU ETS captured about 40 per cent of the total greenhouse gases emitted in the EU.

It uses a broad-based 'cap-and-trade' approach – setting a 'cap' (or limit) on the total amount of regulated greenhouse gases that can be emitted by regulated entities. This cap is reduced at regular intervals to ensure that the EU remains on target to achieve a 20 per cent reduction in its total greenhouse gas emissions by 2020, based on 1990 levels. 

Within the predetermined cap, companies receive emission allowances (or permits), which they can sell to or buy from one another as needed on a secondary market. This constitutes the 'trade' aspect of the scheme.

What Australia can learn from the EU ETS

In the seven years it has been operating, the EU ETS has been 'adjusted' a number of times to improve its environmental integrity, administration and economic efficiency. These changes have been possible because the scheme is designed to have three phases (phase 1: 2005-2007; phase 2: 2008-2012; phase 3: 2013-2020). 

The benefit of this phased approach it that administrators can review and, where necessary, amend design deficiencies – and then introduce these changes at the beginning of the next phase.

A number of key 'lessons learned' during the initial stages of the EU ETS are particularly relevant in the context of the national debate about designing a domestic carbon pricing mechanism for Australia. They include the following:

Certainty and simplicity: Entities that may be caught by an ETS, and the broader economy, need certainty. An ETS should be designed in such a way that it provides this. Based on the EU ETS experience, certainty can be promoted by:

• simplicity: keep the design of the ETS simple and easy to understand, particularly for liable entities. Governments must resist calls by individual lobby groups to build in multiple exemptions or varied treatments;

• stability: once the scheme is up and running, amendments should be kept to a minimum, especially if these could affect the liability or compliance obligations of liable entities;

• consistency: political upheaval and industry pressures should not be allowed to affect the ETS. It needs to be designed to operate in a consistent and stable manner for the long term.

Monitoring, verification and reporting:An ETS should cover only those installations and greenhouse gases that can be monitored accurately. It should have a robust emissions monitoring, reporting and verification regime that is consistent with other international regimes, to facilitate linkages with those schemes and trading. 

Australia already has the National Greenhouse and Energy Reporting Scheme, which compels regulated entities to monitor and report on their energy use and greenhouse gas emissions. NGERS was designed to be largely compatible with corresponding obligations under the EU ETS.

Distribution of permits:The most economically efficient way of distributing emissions permits is through large scale auctioning of permits.  Revenue generated from the auctions is then available to invest in other climate change-reducing initiatives. 

That said, the process of auctioning permits must be considered in light of the potential negative impact on Australia's emissions-intensive trade exposed industries. In addition, the potential for 'carbon leakage' should also be considered – this is where one country produces more emissions as a result of another country introducing carbon reduction policies.  In considering which method of permit allocation is most appropriate, it is useful to note that the EU is projected to meet its 2012 Kyoto Protocol target – of 8 per cent greenhouse gas emission reduction below 1990 levels – even though permits issued during the first two phases of the EU ETS were allocated free of charge.

Use of offsets:An ETS must encourage domestic reduction of emissions while also targeting carbon-intensive energy production.  Because of this, the use of offsets should be considered carefully.

While offsets are important to global efforts to reduce greenhouse gas emissions, the goal must be domestic long-term emissions reduction and the transition to new technologies. Therefore, some form of limit on the use of offsets to meet emissions liability will be needed.

Jill Duggan recently joined the European Commission as an expert on carbon markets.  She has had a distinguished career: in 2003, she took over management of the United Kingdom’s early Emissions Trading System and two years later was appointed cross-Government policy lead for the UK for the 2008-2012 phase of the European Union’s Emissions Trading Scheme.  She led the UK’s work on international emissions trading and linking, was a founding member of and the UK's representative on the International Carbon Action Partnership, has advised the Western Climate Initiative in the US, was a Senior Visiting Fellow at the World Resources Institute, and has given expert testimony to a US Congressional Committee.  She has also been an expert advisor to various governments in Europe on designing and implementing emissions trading schemes.

Following her presentation, Ms Duggan was joined by Michael Roche (CEO, Queensland Resources Council), Alex Zapantis (Manager, Climate Change–External Relations, Rio Tinto Coal Australia) and Kellie Caught (Acting Head of Climate Change Policy, World Wildlife Fund) for a discussion on the EU ETS and the design of the proposed carbon pricing scheme in Australia.

For further information please contact

Scott Singleton, Partner
T: +61 7 3119 6173

Allison Warburton, Partner
T: +61 7 3119 6209