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CARBON COPIES: THE UNITED STATES, EU ETS AND LINKAGE
by
Benjamin Higham
A thesis submitted in conformity with the requirements For the degree of Master of Law
Graduate Department of Law University of Toronto
Copyright by Benjamin Higham 2009
Carbon Copies: The United States, EU ETS and Linkage
Benjamin Higham
Master of Laws
Graduate Department of Law University of Toronto
2009
Abstract
Although many nations have recognized the need to protect the Earth’s climate,
human activities are continuing to result in a change in greenhouse gas levels that
threaten to result in a detrimental change in the Earth’s climate in terms of ongoing
human life. The EU ETS has been developed and implemented in Europe as a key tool
to meet the goals set by the Kyoto Protocol. Much political debate has arisen in recent
years regarding the implementation of a carbon-trading regime in the United States.
Many commentators have recognized that the success of any proposed carbon regime will
be determined by how well it is tailored to fit certain economic realities in the United
States. However, the adequacy of proposed carbon trading frameworks with regard to
potential linkage to existing systems, namely the EU ETS, raises additional
considerations. My study seeks to expose these considerations for debate and determine
whether existing political considerations in the United States are adequate for the
establishment of future linkages or whether further measures are required.
ii
Table of Contents
I.
II.
A.
B.
Purpose and Scope of the Article
Overview of Climate Change Science and Law
Climate Science
International Law 1.United Nations Framework Convention on Climate Change 2.Kyoto Protocol 3.International Adoption and Compliance
Cap-and-Trade Primer 1.The Cap 2.The Trade
Broad Coverage
Linkage
The European Union Emissions Trading System
A. The European Model 1.Overview 2.The Market 3.Compliance and Enforcement
Domestic EU ETS issues
1. 2. 3.
C.
IV.
A.
1. 2. 3.
National Caps – What Went Wrong? Domestic Lobbying Looking Forward
Summary of Part III
A Comparison of the EU ETS, the Dingell-Boucher Draft and the Waxman-Markey Bill
The United States
US Administrative Intent Existing Federal Regulatory Approach Dingell-Boucher and Waxman-Markey Legislation
1
3
3
4 4 5 6
7 7 8
10
12
14
14 14 17 21
23
24 25 26
26
28
29
29 30 32
C.
D.
E.
III.
B.
iii
i.
ii.
iii.
iv. v.
vi. vii. viii. ix.
B.
V.
A.
B.
Implementation Plan a.Implementation and Linkage Scope a.Scope and Linkage Currency of the U.S. ETS a.Currency and Linkage National Registry Allowance Allocation a.Allocation and Linkage Trading Monitoring and Reporting Compliance Pre-emption
33 35 36 39 40 42 43 45 47 48 50 50 51
52
53
53
55 55 57 57
59
60
61
Summary of Part IV
Conclusions on Linkage
Linkage Generally
Linkage Suggestions 1.Allocations 2.Price Control – Borrowing 3.Enforcement
Summary of Part V
Conclusion
Bibliography
C.
VI.
VII.
iv
1
PART I Purpose and Scope of the Article
While many nations have recognized the need to act on global climate change by
implementing legislation to mandate reductions of greenhouse gas emissions, for various
reasons, the United States has delayed its participation in these efforts. Now, four year
after the Kyoto Protocol came into force and the EU ETS was commenced, the U.S.
Congress has taken its first steps toward delivering climate change legislation. While the
linkage of any U.S. carbon trading scheme to the EU ETS may offer economic
advantages, there will be serious compatibility issues that must be addressed in order for
these advantages to be realized. This paper presents these administrative concerns and
identifies areas where aspects of proposed legislation should be improved in order to
address these concerns.
This paper is structured as follows. Part II presents the prevailing view of global
climate change and discusses the legal backdrop. Part III has two primary objectives.
The first objective is to provide a detailed explanation of the EU ETS and the structural
mechanisms by which it is implemented. The second objective is to explain the causes
and effects of problems arising during the first phase of implementation. Part IV has three
primary objectives. The first objective is to describe the effect of the Massachusetts v.
EPA decision on the U.S. regulatory power to regulate CO2, and the importance of
legislative action. The second objective is to describe the Dingell-Boucher Draft
legislation recently released for discussion in the House of Representatives and then
access the similarities and differences of this proposal with the European approach
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discussed in Part III. The third objective is to describe the ways in which Waxman-
Markey Bill recently passed in the House of Representatives builds on the Dingell-
Boucher Draft. Part V conducts a preliminary assessment of the compatibility of the
proposed Dingell-Boucher Draft and Waxman-Markey Bill with the existing European
scheme with regards to the implementation of linkage between the systems. Part VI
concludes the article.
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PART II Overview of Climate Change Science and Law
Despite dire warnings in recent years from respected members of the scientific
community, many nations remain standing at the sidelines of global climate change
policy development. The European Union, however, has committed itself to an
environmental undertaking that is certainly unmatched by any other collective effort. This
undertaking, known as the European Union Emission Trading Scheme (EU ETS),
resembles established market mechanisms. While the European concept of emissions
trading appears to be straightforward. It becomes clear, however, in the course of further
analysis of its implementation, that in order to succeed the European model requires
consideration and reconciliation of disparate national interests. In effect, nations must
not only work together, but also in order to realize the shared long term objective of
collective emission reduction they must sometimes implement climate legislation that is
not in their direct national interest.
A. Climate Science
In support of their position, critics of the theory of global climate change offer the
undisputed fact that the natural processes occurring on our planet have, for millions of
years, resulted in the emission of greenhouse gasses. Intelligent minds differ, however,
when assessing whether our relatively recent industrialization, resulting in increased
greenhouse gas emissions over the natural baseline, will result in a detrimental change in
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4
the Earth’s climate in terms of ongoing human life.1
Scientists issuing global climate warnings have undertaken much scientific work
to support their allegations. The World Meteorological Organization (WMO) is a prime
contributor to such a debate. Most recently, WMO provided a comment stating that the
collective scientific research of its members supports the conclusion that greenhouse gas
emissions have and are expected to continue to increase global temperatures.2 Although
some comment that warming may bring certain benefits to colder regions of the planet,
the WMO suggests that warming introduces collateral “reasons for concern” that will
detrimentally offset these benefits.3
B.
1.
Climate Change Law and Policy
International Law
Entering into force in 1994, the United Nations Framework Convention on
Climate Change4 (UNFCCC) is not legally binding on its signatories. Despite limits on
its enforceability, it is well worthy of note and indeed represents the legal philosophy and
underpinnings of ongoing attempts "to achieve stabilization of greenhouse gas
1 See Intergovernmental Panel on Climate Change, Fourth Assessment Report, Climate Change 2007: Synthesis Report, Summary for Policymakers, online: IPCC http://www.ipcc.ch/pdf/assessmentreport/ ar4/syr/ar4_syr_spm.pdf [Climate Change 2007] 2“The long-term upward trend of global warming, mostly driven by greenhouse gas emissions, is continuing. Global temperatures in 2008 are expected to be above the long-term average. The decade from 1998 to 2007 has been the warmest on record, and the global average surface temperature has risen by 0.74C since the beginning of the 20th Century”. See World Meteorological Organization, Info Note No. 44, online: WMO <http://www.wmo.int/pages/mediacentre/info_notes/info_44_en.html> 3Heightened risks to unique and threatened systems (ecosystems and communities); risks of extreme weather events (droughts, floods, and heat waves); distribution of impacts and vulnerabilities (economically disadvantaged and elderly will be more effected by climate change); aggregate impacts (net economic costs of impacts of increased warming are projected to increase over time); and risks of large scale singularities (global warming over many centuries would lead to sea level rise). See Climate Change 2007, supra note 1 4United Nations Framework Convention on Climate Change, “U.N. Doc. A/AC 237/18”, online: U.N. <http://unfccc.int/essential_background/convention/background/items/1349.php> [UNFCCC]
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concentrations in the atmosphere at a low enough level to prevent dangerous
anthropogenic interference with the climate system."5
While the UNFCCC does not provide mandatory limits or contain enforcement
provisions,6 some member industrialized and developed nations have openly expressed
concerns with the differential treatment of developing nations under the Convention.7
Despite these concerns, ratification and implementation of the UNFCCC framework
serves as the inevitable jumping off point for the discussion of the EU climate model.
UNFCCC’s importance in this regard is clearly evidenced by its provision of the more
widely recognized “protocols”, which establish binding reductions of national emissions
of greenhouse gases.
2. Kyoto Protocol
The Kyoto Protocol is likely one of the first pavlovian responses in the mind of a
typical person at the mention of climate change. The Kyoto Protocol has been a
somewhat globally contentious attempt to implement the policies of the UNFCCC. It is
also the motivator for the European climate regime discussed in the next part.
5 6 UNFCCC, supra note 4 at art 2 Article 4 sets out a number of non-binding commitments such as, “[d]evelop, periodically update, publish … national inventories of anthropogenic emissions by sources and removals by sinks of all greenhouse gases” and “[f]ormulate, implement, publish and regularly update national and … regional programmes containing measures to mitigate climate change by addressing anthropogenic emissions by sources and removals by sinks of all greenhouse gasses”. See ibid note 4, at art. 4 7For example the preamble to the UNFCCC states that “[t]he largest share of historical and current global emissions of greenhouse gases has originated in developed countries, that per capita emissions in developing countries are still relatively low and that the share of global emissions originating in developing countries are still relatively low and that the share of global emissions originating in developing counties will grow to meet their social and developmental needs.” See UNFCCC, supra note 4, at preamble
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By way of summary, the Kyoto Protocol, which entered into force in February
2005, commits industrialized countries to the reduction of greenhouse gas emissions8 by
an average of 5.2 percent9 from 1990 base year levels during the years 2008-2012.10
While there is more than one method of calculating the baseline from which these
reductions can be realized, Kyoto and resulting emissions reduction schemes seeking to
promote compliance with it, facilitate certainty by pegging all reduction targets on the
1990 base year, with ascertainable emission data.
3. International Adoption and Compliance
As mentioned, ratification of the Kyoto Protocol has proven to be a contentious
matter. While both the problem of climate change and its global nature have been
recognized, adoption of the protocol was plagued by national protectionism and a failure
to act. Some nations, such as Canada, signed on but will not meet their commitments.
Others, such as America, led the way with “alternate” approaches, discussed in Part IV.
Industrial nations who are signatories to the Kyoto Protocol are not required by
the agreement to implement any specific domestic policies.11 They are free to pursue
reductions in greenhouse gas emissions in accordance with their national circumstances.12
In recognition of the difficulty of such efforts, the Kyoto Protocol details three “flexible
8 Carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, hydrofluorocarbons, and perfluorocarbons: See Kyoto Protocol to the United Nations Framework Convention on Climate Change, U.N. Doc. FCCC/CP/197/L.7/Add. Annex A (Dec. 10, 1997), online: U.N. <http://unfccc.int/essential_background /kyoto_protocol/items/1678.php> [Kyoto Protocol] 9The EU is required to reduce emissions by 8 percent: ibid. at art. 3.7 10ibid. at art. 3.1 & Annex B 11ibid. at art. 2 12ibid.
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mechanisms” that industrialized nations may choose to employ to reduce greenhouse gas
emissions. Of the flexible mechanisms, the most well known and the topic of the
remainder of this article is “emissions trading”.13 The other two are the “clean
development mechanism”14 which creates tradable credits through investment in
emission reduction projects in developing countries15 and “joint implementation”16 which
creates tradable credits through investment in emission reduction projects located in a
developed member nation other than the nation of the entity seeking creation of the
credit.17
C. Cap-and-Trade Primer
In order to assess an emissions trading scheme, such as the EU ETS, or the
compatibility of multiple schemes, a basic comprehension of the types of undertakings
that comprise these systems is helpful. This section presents a general explanation of
these undertakings – capping emissions of CO2 and trading the right to emit CO2.
1. The Cap
When an emission trading regime is undertaken and a corresponding market is to
be relied on, the establishment of a scarce cap and corresponding pool of allowances is
fundamental. A cap represents a collective limit imposed by a state or several states that
13 14 Kyoto Protocol, supra note 8, at art 17 Kyoto Protocol, supra note 8, at art 12 15U.N., United Nations Convention on Climate Change, “clean development mechanism”, online: U.N. <http://unfccc.int/kyoto_protocol/mechanisms/clean_development_mechanism/items/2718.php> 16Kyoto Protocol, supra note 8, at art 6 17U.N., United Nations Convention on Climate Change, Kyoto Protocol, online: <http://unfccc.int/ kyoto_protocol/mechanisms/joint_implementation/items/1674.php>
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restricts the overall CO2 emissions by members within the designated region.18 In
circumstances where multiple autonomous or semi-autonomous nations or states
contribute to a single cap, the total emissions reductions under the cap are usually
realized through parallel commitments to reduce emissions.19 In the case of the EU,
discussed in Part III, its member states have historically set their own emission limits
thereby creating the regional cap.20 In the US proposal, discussed later in Part IV, the
proponents envision a national cap that is distributed from the national level down, rather
than the bottom up approach in the EU.
In all emission trading regimes, overall caps are divided into tradable allowances
that are distributed to domestic entities.21 Each allowance can be visualized as a tradable
unit of the cap. It is common for an allowance to represent the right to emit one tonne of
CO2 or its equivalent during a specific period of time.22
2. The Trade
In the face of stiff penalties for failure to comply, emitters that find themselves
potentially releasing more of any particular greenhouse gas than permissible under their
permit, must choose between reducing emissions or purchasing allocations from other
18 Shapiro, S & Cheatham, C, “The Green Building Guide to Waxman-Markey”, Reuters, (26 June 2009), online: Reuters < http://www.reuters.com/article/gwmBuildings/idUS216473327920090626> 19See IHS, “FAQ on EU Emissions Trading and National Allocation Plans for 2008-2012”, online: <http://engineers.ihs.com/news/2006/eu-en-emissions-trading-faq-11-06.htm> 20See for a general discussion of the emission allocations: European Commission, online: Europa <http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/06/2> 21Grubb, M. “The Economics of the Kyoto Protocol” World Economics, volume 4, number 3, (July- September 2003), p. 148, online: World Economics <www.ieta.org/ieta/www/pages/getfile.php?doc ID=129> 22ibid.
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emitters covered under the regime or a linked regime.23 Fortunately, this results in the
creation of a market framework that incentivizes trading between emitters.24 Depending
on the regime, trading platforms often facilitate both direct and brokered trades and
exchanges.
When evaluating the benefits associated with a trade, each party to the trade
determines its position based in part on its own cost of compliance.25 As every individual
facility represents a different set of emission parameters, it follows that no two emitters
will incur the same cost per allocation of ‘actual’ reduction.26 For instance, the actual
cost per tonne of emission reductions in a U.K. manufacturing facility may be 50 Euros
while the same reductions implemented in another facility, even in the same sector, may
cost more. Such abatement cost heterogeneity facilitates market conditions by
encouraging emitters with low cost of compliance to lower emissions by investing in
abatement technologies, reducing output, or employing other control mechanisms.27
Emitters who lower their emissions can then sell surplus allowances to market
participants with a higher costs of compliance.28
The essence of cap-and-trade is its facilitation of reductions that are motivated by
the opportunity to sell excess allotments on the market at a price higher than the cost
23 See generally Thomson, V., “Early Observations on the European Union’s Greenhouse Gas Emission Trading Scheme: Insights for United States Policymakers” University of Virginia (19 April 2006), online: Pew Climate < www.pewclimate.org/.../Early_Observations_on_EUETS_Thomson.pdf> 24ibid. 25EU, “Greenhouse gas emission allowance trading scheme”, online: Europa < http://europa.eu/legislation_ summaries/energy/european_energy_policy/l28012_en.htm> 26Jaffe, J. and Stavins R., “Linkage of Tradable Permit Systems in International Climate Policy Architecture”, The Harvard Project on International Climate Agreements, Discussion Paper 08-07, September, online: Harvard <belfercenter.ksg.harvard.edu/.../linkage_of_tradable_permit_systems_in_ international_climate_policy_architecture.html> 27See EU, Emission Trading System (EU ETS), online: Environment <http://ec.europa.eu/environment/ climat/emission/citl_en.htm> 28Worldwatch Institute, State of the World 2009: Into a Warming World, (Washington, D.C.: Norton, W. W. & Company, Inc., 2009) at 104, online: Worldwatch <www.worldwatch.org/sow09>
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incurred to realize the emission reduction.29 In all regimes, there must be a liquid market
that pairs sellers with emitters who require additional allotments for compliance. It
follows, that such a system will contain emitters with a higher cost of compliance. With
high and low cost of compliance emitters entering the market for profit and to reduce
costs, emitters are free to make compliance decisions based on whether it is more cost
effective to reduce emissions or purchase carbon allocations at market price.30 Economic
theory supports the conclusion that the overall result of such an emission reduction
strategy is increased efficiency so long as a country’s national circumstances, sector
characteristics, and the strategies interaction with other policies allow emission
reductions to take place where they are cheaper.31
D. Broad Coverage
Although cap-and-trade can be an effective tool when appropriately implemented,
governments are not limited to carbon trading as a means of addressing climate change.
Other price mechanisms, such as carbon taxes, exist. A carbon tax differs from carbon
trading in that it allows government to directly establish the price of a quantity of
carbon.32 A carbon tax can be levied upstream at the source of the carbon rather than at
the point of consumption, where the administrative burden increases. A significant
29 30 See supra note 28 ibid. 31Stern, N. (2006): The Economics of Climate Change: The Stern Review; Cambridge University Press, New York, New York, ch. 15, <http://www.hm-treasury.gov.uk/ independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm> [Stern Report]. See also Stern Review: The Economics of Climate Change Executive Summary; HM Treasury, online: < http://www.hm-treasury.gov.uk/d/Executive_Summary.pdf> 32Doelle, M, “Global Carbon Trading and Climate Change Mitigation in Canada: Options for the Use of the Kyoto Mechanisms” in Bernstein et al, eds., A Globally Integrated Climate Policy for Canada (Toronto: University of Toronto Press, 2007) p 179
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benefit of a carbon tax is that it can catch uses that could not be efficiently covered by
cap-and-trade, such as cars and domestic uses.33 This approach results in less certain
emission reductions, as compared with carbon trading where the total quantity of
emissions reductions is controlled directly.34
Efficiency implications, however, do not exist in a vacuum. For instance, national
policies “cannot be based on generalized notions of markets and governments, but must
be based on how institutions and individuals actually operate”.35 As a result, efficiency
implications are difficult to determine. This is compounded where “abatement costs
and/or benefits are uncertain, picking a carbon tax (price) can lead to the “wrong” level of
emissions reduction, while choosing a quantity can result in a mistake about the
forecasted” permit price.36
In 2006 the British government released a comprehensive study, the Stern Review
on the Economics of Climate Change [Stern Report]37, which addressed, in part, the
difficulty of determining implement efficiency. The Stern Report suggests that each
country should use the appropriate mix of taxes, trading, spending and regulation as
necessary to reach its emission reduction target.38 The Stern Report states that:
33 “Putting a Price on Carbon: An Emissions Cap or A Tax?” Opinion, Yale Environment 360, (07 May 2009) online: Yale Environment 360 <http://www. e360.yale.edu/content/feature.msp?id=2148> 34ibid. 35Green, A, “Bringing Institutions and Individuals into Climate Policy for Canada” in Bernstein et al, eds., A Globally Integrated Climate Policy for Canada (University of Toronto Press, 2007) p. 247 [Green] 36Weitzman, M.L., 1974 “Prices vs Quantities,” The Review of Economic Studies 41(October): 477-91, cited in van Kooten, G.C., 2003, “Smoke and Mirrors: The Kyoto Protocol and Beyond, Canadian Public Policy” 29: 397-415, online: University of Victoria <http://web.uvic.ca/~kooten/REPA/WorkingPaper2003 -04.pdf> 37 Stern Report, supra note 31 38House of Commons, “Stern Review: the implications for Treasury policy: Government Response to the Committee's Fourth Report of Session 2007–08” (22 April 2008), online: House of Commons <
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[t]he choice of policy tool will depend on countries’ national
circumstances, on the characteristics of particular sectors, and on the
interaction between climate-change policy and other policies. Policies also
have important differences in their consequences for the distribution of
costs across individuals, and their impact on the public finances. Taxation
has the advantage of delivering a steady flow of revenue, while, in the
case of trading, increasing the use of auctioning is likely to have strong
benefits for efficiency, for distribution and for the public finances. Some
administrations may choose to focus on trading initiatives, others on
taxation or regulation, and others on a mix of policies. And their choices may vary across sectors. 39
While the choice of instruments is difficult, in order to reduce global emissions, national
and regional policies should include a mix of carbon taxes, trading and/or regulations.40
E. Linkage
Linking exists where a carbon trading “system’s regulatory authority allows
regulated entities to use emission allowances or emission reduction credits from another
system to meet their domestic compliance obligations.”41 When all linked systems are
functioning properly, allowance trading between systems facilitates higher-cost
reductions in one system to be replaced by lower-cost reductions in another system.
http://www.publications.parliament.uk/pa/cm200708/cmselect/cmtreasy/495/495.pdf> 39Stern Review: The Economics of Climate Change Executive Summary; HM Treasury, p 18, online: < http://www.hm-treasury.gov.uk/d/Executive_Summary.pdf> 40Green, supra note 35 41Jaffe, J & Stavins, R, “Linkage of Tradable Permit Systems in International Climate Policy Architecture”, (Harvard Project on Int’l Climate Agreements, Discussion Paper 08-07, 2008) 7, online: Harvard – Belfer Center for Science and International Affairs <http://belfercenter.ksg.harvard.edu/ publication/18580/linkage_of_tradable_permit_systems_in_international_climate_policy_architecture.html > [Jaffe & Stavins], cited in Driesen, D.M. "Linkage and Multilevel Governance." 19 Duke J Comp & Int'l L 389, online: Duke Journal of Comparative and International Law < http://www.law.duke. edu/journals/djcil/> [Driessen]
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Thus, larger linked markets can facilitate greater cost savings that a smaller unlinked
market.42 While these cost savings serve as an incentive to link, carbon trading program
administrators must also consider the resulting concerns, including increased
complexity43 and most notably the impact global emissions and national control have
over allowance prices.44 For instance, administrators must pierce the veil of cost savings
to determine whether linkage is facilitating the “evasion of pollution control obligations or
simply control[ing] cost differentials between states.” 45
A noted climate commentator recently concluded that less focus should be placed
on linking different systems and more of a focus should be placed on innovations and
emission reduction maximization.46 The commentator believes that while well-designed
trading programs can contribute to lowering global carbon emissions, in order to
maximize reductions, governments must focus their efforts on encouraging development
and use of advanced technology in developing nations.47 However, as another
commentator has pointed out, even if linkage does not encourage the technology
development, in-kind side payments arising from linkage benefits poor countries by
providing resources to help manage the negative effects of climate change.48
42 Wiener, J.B., “Global Environmental Regulation: Instrument Choice in Legal Context”, 108 YALE L.J. 677, 701-04 (1999), cited in Driessen, supra note 41 at 391 43Driessen, supra note 41 at 391 44Jaffe & Stavins, supra note 41 at 1 45Driessen, supra note 41 at 396 46ibid at 411 47ibid at 409 48Wiener, J, “Think Globally, Act Globally: The Limits of Local Climate Policies”, Duke Law School Legal Studies, Research Paper Series, Research Paper No. 158 (May 2007), fn 53, online: Duke Law School <http://lsr.nellco.org/cgi/viewcontent.cgi?article=1093&context=duke/fs>
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PART III
The European Union Emission Trading System
In 2003, the EU sought to meet its collective obligations under the Kyoto Protocol
by creating an emissions trading regime from the ground up.49 Known as the EU ETS,
the scheme has matured to facilitate market-based trading of CO2, by reliance on the cap-
and-trade model discussed in Part II. This part undertakes to provide a comprehensive
presentation of the EU ETS regime in order to adequately facilitate a subsequent
comparison of proposed U.S. emissions legislation.
A.
1.
The European Model
Overview
Phase I of the implementation of the EU ETS commenced in January of 2005 and
closed at the end of 2007. This phase represented the first of several distinct phases.50 By
design, the initial phase was non-binding, or a “learning phase”. Undertaking this phase
allowed stakeholders to implement the scheme without exposure to possibly significant
49 EC, Commission Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC [2003], online: <http://ec.europa.eu/environment/climat/ emission/implementation_en.htm> [2003/87/EC] 50UK Dept. of Environment, “Early days of EU Emissions Trading System and the Response of Government and Business” (2008), online: UK Dept. of Environment <http://www.delkor.ec.europa.eu/ home/newsevents/events/document_files/Session2/Session23%2520Duggan.pdf>
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legal and financial consequences that resulted from embedded efficiency issues and a
lack of emissions data.51
Running parallel with the Kyoto compliance period, Phase II commenced on
January 1, 2008 and will close in 2012.52 As compliance with the EU ETS is now
mandatory, allotments from the prior non-binding phase were not carried forward.
Discussed in greater detail later in this part, this measure was necessary in order to avoid
an inevitable market dilution that would have occurred as a result of known over
allocation.53
Phase III is scheduled to begin in January of 2013. At the present time, the
European Commission is reviewing proposed changes and undertaking amendments.54
For example, the European Parliament recently amended the establishing directive55 to
include aviation after 2013, expanding the scope of the EU ETS.56 Lessons learned by
the Commission are reflected in the January 2008 proposed revisions to the scheme.57
As discussed, the implementation directive establishes the structure of the EU
ETS. Annex 1, of that same directive, lays out the regulatory reach of the EU ETS, or its
scope.58 In laying out this reach, Annex 1 specifically includes CO2 by reference within
51 Frauendorfer, “Clean Valuation with regard to EU Emission Trading” (2008), p.3, online: U.N. <http://www.finance.unisg.ch/org/finance/web.nsf/SysWebRessources/WP84/%24FILE/WP84.pdf> 52ibid at 2; 2003/87/EC, supra note 49 53Regulations prohibited the carrying over of emission rights between Phase I and II. Ibid at 3 54Defra, Dept. for Environment Food and Rural Affairs, “Phase III”, online: <http://www.defra.gov.uk/environment/climatechange/trading/eu/operators/phase-3.htm>. 552003/87/EC, supra note 49 56Amended on July 8, 2008. European Parliament, “Air pollution: including aviation activities in the scheme for greenhouse gas emission allowance trading within the Community (amend. Directive 2003/87/EC)”, online: EP <http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//TEXT+TA+P6- TA-2008 0333+0+DOC+XML+V0//EN&language=EN> 57The E.U. intends to move from free allocation to auctioning: 2003/87/EC, supra note 49 at art 10 582003/87/EC, supra note 49
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its regulatory scope. 59 While the scope of Phase I was limited to the regulation of CO2
to simplify data and technology requirements, member states could voluntarily include
other greenhouse gases in their Phase II NAP’s.60
Compliance with the EU ETS, and implementation, is mandatory for all of the 27
EU member nations. Within their national boarders members are required to regulate
activities that produce a threshold amount of CO2. For instance, energy production
generally emits large amounts of CO2. If an energy installation has a critical mass
combustion capacity of 20 MW or greater the facility is included and must be regulated
by the member state in which it is situated. Of course, the regulation of CO2 is more
comprehensive than the regulation of energy facilities alone. 61
Annex I establishes the scope of the installations by specific reference to
categories of activities. In addition to the above, these categories include: mineral oil
refineries and coke ovens; production and processing of ferrous metals, such as metal ore
roasting and sintering and pig iron and steel including continuous casting; mineral
industry, such as cement clinkers, lime, glass (including fiber), bricks, ceramics; other
activities, such as industrial plants producing pulp, paper and board. 62
59 60 The Kyoto Protocol covers seven different greenhouse gases. See, Kyoto Protocol supra note 7 Ramakrishnan, J, “EU ETS”, International Environmental Science Center, online: IESC <http://www.internationalprofs.org/iesc/eu-ets.html> 61The main changes are the following: one EU-wide cap; annual cap will decrease along a linear trend line; larger share of allowances will be auctioned; harmonised rules governing free allocation; aluminium and ammonia producers will be included; so will nitrous oxide and perfluorocarbons; Member States will be allowed to exclude small installations from the scope of the system. See EC, Questions and Answers on the Commission's proposal to revise the EU Emissions Trading System, MEMO/08/35, 23 January 2008, online: EC <http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/35&format= HTML&aged=0&language=EN&guiLanguage=en> 622003/87/EC, supra note 49
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In Phase II, the EU ETS scope was expanded to incorporate certain CO2 emitting
installations not previously included. For example, installations that were granted opt-out
status during Phase I are now included. Also, Phase II grew to include additional sectors
that were not previously included and expanded the scope for certain facilities that were
already included. The majority of these changes affected installations that involved:
gypsum, rock wool, carbon black, petrochemical crackers, glass, offshore, and integrated
steelworks.63
Recent estimates place the total number of covered installations at around 10,500,
which includes installations in the E.U. as well as installations in Iceland, Liechtenstein
and Norway.64 While the EU ETS has experienced significant volatility in terms of the
price of credits, in 2007, its value was estimated to be 50 billion euros based on
prevailing market prices.65 In 2008, the EU ETS experienced continued growth and now
accounts for 70 percent of global trades.66
2. The Market
The market is largely a digital one. The EU has chosen to facilitate the transfer of
allocations as digital currency, rather than on paper.67 Known as European Union
63 Defra, “Final Methodology Guidance”, online: Defra <http://www.environment-agency.gov.uk/ commondata/acrobat/amrules_2070949.pdf. For definitions of new installations, online: <http://ec.europa.eu/environment/climat/emission/pdf/etsworkinggroup/2007_03_08/5a.pdf> 64See EU, Environment Website, online: <http://ec.europa.eu/environment/climat/emission/citl_en.htm> 65Ieta, “Market Developments in the EU ETS: An Exchange’s viewpoint”, online: Ieta <http://www.ieta.org/ieta/www/pages/gƒetfile.php%3FdocID%3D1338> 66In the first half of 2008, the value of the world market was estimated to be 38 billion euros. Mark Milner, “Pollution: Value of global carbon trading is nearly double last year’s figure at 30bn”, The Guardian”, July 9, 2008, online: Guardian <http://www.guardian.co.uk/environment/2008/jul/09/carbonemissions. carboncapturestorage#> 67See for a general discussion of the form of emission allocations: European Commission, Environment website, online: EC <http://ec.europa.eu/environment/climat/emission/index_en.htm>
18
Allowances (EUAs), each allowance entitles the holder the right to emit one tonne of CO2.68
The Kyoto Protocol creates two additional currencies, the CER69 and ERU.70 Each is
created via the CDM and JI mechanisms respectively. 71 Although the EUA is the only type
of credit currently traded in the EU ETS, CERs will be traded in the not so distant future.72
Credits must be stored. 73 By way of Decision 16/CP.10,74 the EU Commission
granted each member state the authority to create an independent national registry.75
These registries are tasked with facilitating storing, trading and authenticating EUAs. In
order to ensure a sound market, registries are required to employ data exchange
standards76 that govern the issuance, holding, transfer, and cancellations credits.77 Once a
trade is closed, registries are responsible for “settling” emissions trades. This is perhaps
one of the most important tasks; the registry removes credits from a seller’s account and
68 European Commission, “EU emissions trading — an open scheme promoting global innovation”, online: EC <http://ec.europa.eu/environment/climat/pdf/emission_trading2_en.pdf> 69CERs are generated by climate-friendly, sustainable development projects in developing countries. They can be used by developed country Governments and companies to meet their reduction commitments under the Kyoto Protocol. See UNFCCC, First emission credits issued under the Kyoto Protocol, online: UNFCCC <http://cdm.unfccc.int/CDMNews/issues/issues/I_WJHSF1N67JGAORWII2BKVAI8O74B5A/ viewnewsitem.html> 70An ERU represents one tonne of CO2-equivalent greenhouse gas emissions reductions achieved through a Joint Implementation project. It can be used to meet an Annex B Party’s emission commitment or as the unit of trade in greenhouse gas emissions trading systems. See UNFCCC, A Glossary of Climate Change & Forestry, online: UNFCC <http://unfcccbali.org/unfccc/component/option,com_glossary/Itemid, 99/func,view/catid,31/term,Emissions+Reduction+Unit,+or+ERU/> 71Kyoto Protocol supra note 8 72Carbon Finance, “ITL link, EU ETS review key for 2008 prices”, online: Carbon Finance <http://www.carbon-financeonline.com/index.cfm?section=lead&action=view&id=10948&linkref=cnews> 73UNFCCC, “Registry Systems under the Kyoto Protocol”, online: U.N. <http://unfccc.int/kyoto_protocol/ registry systems/items/2723.php> 74EC, Commission Decision16/CP.10, (Issues relating to registry systems under Art. 7(4) of the Kyoto Protocol) in FCCC/CP/2005/3/Add.3; See also EC, Commission Regulation of 21 December 2004 for a standardized and secured system of registries pursuant to Directive 2003/87/EC and Decision 280/2004/EC 75United Nations Convention on Climate Change, “Registry Systems under the Kyoto Protocol”, online: U.N. <http://unfccc.int/kyoto_protocol/registry_systems/items/2723.php> 76UNFCCC, “Data Exchange Standards for Registry Systems Under the Kyoto Protocol” (2006), online: U.N. <http://unfccc.int/files/kyoto_mechanisms/registry_systems/application/pdf/des_techspec_v1_1.pdf> 77As well as credits from JI and CDM flexible mechanism projects under Kyoto: See supra note 8
19
delivers those credits to the buyer’s account.78 This action is fundamental to any market,
but, as will be discussed, the integrity of the design of this particular process is
instrumental when contemplating cross regime trading.
Also instrumental to the facilitation of trading is the ability of each national
registry to communicate with every other registry. The UNFCCC created and manages
the International Transaction Log (ITL) as an administrative system link. The ITL is
utilized in every transaction, verifying and monitoring to ensure that the trade is in
compliance with the Kyoto rules.79 If a transaction is not compliant, the registries must
terminate the transaction.
Just as the 27 EU Member States participating in the EU ETS must create their
own national registry, each Member State is tasked with the development of its own
National Allocation Plan (NAP) that must be in harmony with the overall EU cap. While
the scope of EU ETS is limited to certain national economic sectors, for the purposes of
the NAP, when Member States calculate their overall cap they must include emissions
from all emitters.80
The creation of a NAP is often a complicated undertaking, compounded in part by
the fact that allocation mistakes can have serious consequences with regard to the overall
integrity of the EU ETS. The importance of the NAP in implementing Kyoto is clearly
78 National registries contain accounts that function similar to those in traditional financial banks. Accounts are created by businesses operating in sectors that are included in the scheme, as well as for individuals or non-governmental organizations that are authorized by a domestic government to hold and trade EUAs. See generally, supra note 73 79UNFCCC, “International Transaction Log –ITL”, online: UNFCCC <http://unfccc.int/kyoto_protocol/ registry_systems/itl/items/4065.php> 80Both trading and non-trading sectors must be included. For example, non-trading sectors include household, commercial, agriculture, fisheries, and transport: See EC, “Impact Assessment” (27 February 2008), online: EC < http://ec.europa.eu/energy/renewables/doc/sec_2008_85-2_ia_annex.pdf>
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evident by its objectives, namely considering the amount of CO2 emissions from all
sectors in relation to a determination of how many allowances to allocate to trading
sectors. As one might imagine, since drafters of the NAP must further allocate
allowances specific to every facility in each sector the process is often fraught with
political wrangling.81
In order to counter this internal political pressure and other concerns, prior to each
phase, it is required that each NAP be submitted to the European Commission for
approval. In order to ensure transparency, assessment is based on 12 criteria set out in
Annex III of the ET directive.82 In its assessment, the Commission must insure that the
quantity and the method of allowance allocation conform to the 12 criteria83 and the EU
Treaty.84 In addition, the NAP must avoid discrimination between companies and sectors,
plan for new entrants, and make early reduction credits available. Following review the
Commission has the authority to approve, reject, request additional information, or
require changes to the NAP before a final decision issued.85
EU participants have several choices when planning and selecting a trading method.
81 82 See 2003/87/EC, supra note 49 See Annex III to Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC. 83“[T]he proposed total quantity of allowances must be in line with a member state’s Kyoto Protocol target … member states [must] assess emissions developments and potentials for reductions in all sectors.” See IHS, “FAQ on EU Emissions Trading and National Allocation Plans for 2008-2012”, online: <http://engineers.ihs.com/news/2006/eu-en-emissions-trading-faq-11-06.htm> 84EC, Commission Communication COM(2003)830 of January 2004 on guidance to assist Member States in the implementation of the criteria listed in Annex III to Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, online: <http://www.epa.ie/downloads/advice/air/climate%20change/name,13125,en.html>; See also, Commission Communication COM(2005)703 of 22 December 2005 on further guidance on allocation plans for the 2008 to 2012 trading period of the EU Emission Trading Scheme, online: <http://ec.europa.eu/environment/climat/emission/2nd_phase_ep.htm> 85EC, Council Directive 2003/87/EC, 2003 O.J. (L 275/32) (EC) p. 9; See further Europa, “Questions & Answers on national allocation plans for 2008-2012”, Press Release - 9 January 2006, online: <http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/06/2&format=HTML&aged=0&langua ge=EN&guiLanguage=en>
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Similar to other trading that occurs with regard to traditional commodities, participants
may choose to trade:
Privately, moving allowances between operators within a company and
across national borders.
Over the counter, using a broker to privately match buyers and sellers.
Trading on the spot market of one of Europe's climate exchanges (the
most liquid being the European Climate Exchange). Like any other
financial instrument, trading consists of matching buyers and sellers
between members of the exchange and then settling by depositing an
allowance in exchange for the agreed financial consideration. Much like a
stock market, companies and private individuals can trade through brokers who are listed on the exchange.86
No matter what method is relied on, as in other markets, the price of a credit is
determined by supply and demand economics.87
3. Compliance and Enforcement
The permitting and subsequent monitoring of listed instillations occurs at the
national regulator level. The permitting process is commenced with the submission of a
permit application.88 An applicant must provide a monitoring plan that provides specific
technical details on the process by which the instillation will measure and report
86 See online: Open Carbon World <http://www.opencarbonworld.com/wiki/european-union-emission- trading-scheme.html> 87Although not yet developed to be fully accessible, the spot trading market will grow and provide liquidity once financial and delivery risks are lowered. See European Federation of Energy Traders, “June 2005 EFET Position on the EU ETS Review”, online: EFET <http://www.efet.org/Download.asp%3FFile %3D677> 88See Environment UK, “ETS1Application and Guidance”, online: UK <http://www.environment- agency.gov.uk/commondata/105385/ets_app_guide_624838.pdf>
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emissions.89 In addition to this, an applicant must draft its submitted monitoring and
reporting plans according to EU guidelines.90
Once a permit has been issued, instillations must commission verified emissions
reports. A private and independent accredited verifier must cross check emission data for
errors, omissions and consistency with the instillations monitoring and reporting plan.
Once submitted, the report is crosschecked against the emission data contained in the
registry and a verification opinion is sent to the Member State regulator.
As discussed above, the EU ETS is a flexible mechanism created in order to
facilitate Member States’ overall compliance with the Kyoto Protocol. In order to ensure
compliance, the EU ETS sets clear timetables for the surrender of allocations by covered
installations. In order to be determined in compliance, instillations must annually
surrender to the registry a quantity of EUAs equivalent to the actual verified amount of
CO2 emissions produced in that year.91 Failure to do so, results in the imposition of a
fine for each additional tonne of CO2 emissions.92 In addition, the names of installations
determined to be in non-compliance are published and, the following year, they must
purchase an amount of EUAs equivalent to the deficit.93
89 EU, “Phase 2 Monitoring Plan and Guidance”, online: UK <https://www.og.berr.gov.uk/environment/ MRplantemplate.xls> 90EU, Commission Decision of 29/01/2004, establishing guidelines for the monitoring and reporting of greenhouse gas emissions, adopted in regards to Article 14 of Directive 2003/87/EC of the European Parliament and of the Council; Commission Decision of 18/06/2007 to establishing guidelines for the monitoring and reporting of greenhouse gas emissions pursuant to Directive 2003/87/EC of the European Parliament and of the Council, online: <http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2007 :229:0001:0085:EN:PDF> 91EU, Commission Decision of 18 July 2007 C (2007/589/EC) establishing guidelines for the monitoring and reporting of greenhouse gas emissions pursuant to Directive 2003/87/EC of the European Parliament and of the Council (notified under document number C(2007) 3416). 92Under the EU-ETS the penalty was 40 euros per missing allowance under Phase I and 100 euros under Phase II. 93EEA, “Technical report No 2/2006, Application of the emissions trading directive by EU Member
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B. Domestic EU ETS issues
In order to meet the goals set by Kyoto, the Member States of the EU ETS must
have finely calibrated caps that are not too low, nor too high. These caps determine the
number of EAUs available on the European carbon market. According to free market
theory, when there is a larger supply of an item relative to the demand the price will fall,
of course the opposite result is true when there is a scarcity relative to demand. As
applied to the EU ETS, a larger cap results in over-allocation of EUAs. Excess EUAs, in
turn, result in the price of EUA sinking to levels where it is financially advantageous for
emitters to purchase EUAs and continue emitting without reduction, or perhaps increase
emissions.
As the EU ETS is presently structured similarly to the fiefdoms of old Europe,
there are several possible factors that could result in over-allocation. As it turns out, such
factors were realized, namely a ‘race to the bottom’ among Member States and
information failures with regard to emission data. It is widely accepted that the liquidity
of the EU ETS was indeed compromised.
Since January 1, 2005 the price of carbon in the EU has taken a wild ride.
Looking back commentators are in wide agreement that over-allocation occurred.94 It is
States”, http://reports.eea.europa.eu/technical_report_2006_2/en. This report provides an overview of all the unique penalty provisions in place in the 27 Member States. 94Review of the Independent Community Transaction Log containing EU Emission Trading Scheme’s 2005 verified emissions revealed the over-allocations in the following amounts: Belgium (3.5 Mt); Czech Republic (14 Mt); Denmark (11 Mt); Estonia (4 Mt); Finland (11.5 Mt); France (19 Mt); Germany (25 Mt); Hungary (4 Mt); Latvia (1 Mt); Lithuania (7 Mt); Netherlands (6 Mt); Slovak Republic (5 Mt); and Sweden (3 Mt): Carbon Market Data, Press Release, 2 June 2006, online: <http://www.carbonmarketdata.com/page s/Press%2520release%2520CMD%2520%2520EU%2520ETS%2520%25202%2520June%25202006.pdf>
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widely accepted that the drop in the EUA spot price that occurred at the Phase I midpoint
supports this conclusion.95
As discussed, Phase I was intentionally designed as a trial run. In accordance with
this, over-allocated EUAs obtained during Phase I could not be banked for use in Phase
II. This method of containment seems to have been effective, since the price of carbon
has risen. The lessons learned are valuable and applicable to any similar emission trading
system. The likely causes should be addressed before a trading scheme is put into place
in any other jurisdiction, especially if some form of cross jurisdictional exchange of
credits is contemplated.
1. National Caps – What Went Wrong?
The balance of power in terms of establishing the national cap was clearly in
favour of the Member States. When drafting its NAP, a Member State was free to start
high and, subject to review, work its calculations downward. The incentive is clear,
Member States that were successful in securing a larger cap were free to over-allocate
credits to its domestic industries. This in turn has obvious benefits when domestic
industries compete with companies in other Member States that did not secure this
advantage. A type of ‘green’ trade war emerges. This effect can be seriously
compounded if a company receiving surplus credits is able to sell these credits on the
market for windfall profits.
95 The spot price fell from over 30.00 euros to less than 1.00 euro between April 1, 2006 and 2007. Thompson, B., “Latest Developments in the EU ETS”, Carbon Expo, Cologne, 2 May 2007, online: <http://www.ieta.org/ieta/www/pages/getfile.php%3FdocID%3D2294>
25
Any emissions trading system, where there are competing national or regional
interests, must account for the likelihood or perhaps inevitability of a ‘race to the
bottom’. In the present case, Phase I caps in the EU did not create the scarcity necessary
to establish market liquidity. Market failure also occurred, as discussed in the next
section, as a result of the ‘wait and see’ practice of Member States who did not want to be
the first to make large emission cuts.
2. Domestic Lobbying
In sync with the desire on the part of Member States to maximize the national cap,
each nation’s domestic industry has strong motivations to avoid or minimize its
compliance obligations. It will come as no surprise then that many industries sought to
influence the national decision making process. In fact, efforts to lobby government and
apply other forms of political pressure in order to receive larger allocations of national
caps made news headlines in Europe.96
The most notable example of such lobbying efforts took place in Germany. When
Germany was undertaking to draft its NAP in order to comply with Phase I of the EU
ETS, German steelmakers cried foul, arguing that essentially that the science relied on
was flawed. These challenges were not taken lightly. In fact, German Chancellor
Schroeder had to personally intervene.97 It should come as no surprise then, that
Germany was not considered as progressive in terms of its national cap. Germany was
96 See generally Karlseng, T.H., “Decreasing German Climate Ambitiousness”, FNI Report 8/2006, online: FNI < http://www.fni.no/doc&pdf/FNI-R0806.pdf> 97Pew Center, “The European Union Emission Trading Scheme (EU ETS) Insights and Opportunities”, p. 12, online: Pew <http://www.pewclimate.org/docUploads/EU-ETS%2520White%2520Paper.pdf>
26
not the only country to be effected, however, as the French government also experienced
strong lobbying efforts domestically.98
3. Looking Forward
Now that Phase II is underway, it is clear that the EU Commission has increased
its willingness to regulate and demand that changes be made where Member States have
failed to plan for a sufficient Phase II cap.99 While it is likely that some of the national
issue discussed above will be resolved by transparency, access to information, and
through old fashioned shame, a strong EU-wide regulator will likely be necessary to
overcome these forces. In line with this foreseeable centralization of power, it is likely
that in the near future the EU Commission will reassess the bottom up, patchwork
method of creating a EU cap. In the future, the EU Commission will push for a EU cap
that is distributed rather than requested.
C. Summary of Part III
The analysis in this Part provides necessary background and further substance to
an understanding of the implementation of the EU ETS. In order to explain how the
system operates, a walk through of the mechanism in the context of an analysis of
national, EU and global issues and discretion put flesh on the bones of an otherwise
skeletal scheme.
98 99 See supra note 96 See further Europa, “Emissions trading: Commission decides on first set of national allocation plans for the 2008-2012 trading period”, Press Release - 29 November 2006, online: Europa <http://europa.eu/rapid/ pressReleasesAction.do?reference=IP/06/1650>
27
With Phase II now underway, it will be interesting to see if the lessons learned
will be put into play. The EU Commission got off to an ambitious start by demanding
that most Member States tighten up their Phase II NAPs before being approved.
Although it is too early to make a final determination, if the price of carbon in the EU
continues to fall to below 15 euros it may become clear that the necessary scarcity and
related issues have not been realized. If that is the case, in the coming years the market
may lose confidence.
Looking forward, the EU Commission is now undertaking to make serious
revisions of the EU ETS prior to the commencement of Phase III in 2013. With new
rules due this year, many participants are eager for change. Part V of this paper discusses
one particular type of change, potential linkage to a developing U.S. system.
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PART IV A Comparison of the EU ETS, the Dingell-Boucher Draft and the Waxman-Markey Bill
In the midst of a global economic downturn, further implementation of the EU’s
‘grand experiment’ with cap-and-trade by North American nations is believed by some to
be risky business. Despite this implementation risk, such policies have resulted in EU
member states realizing competitive advantages over delayed participants, such as the
United States.100 Although a signatory to the UNFCCC, the record of the U.S. on
combating climate change has clearly demonstrated a lack of ambition. This section
presents a brief overview of the April 2007, United States Supreme Court decision
Massachusetts v EPA101 and a subsequent draft legislative proposal and bill to reduce
GHG emissions, known as the Dingell-Boucher Legislation Discussion Draft102 [Dingell-
Boucher Draft] and the American Clean Energy and Security Act of 2009103 [Waxman-
Markey Bill] respectively. With regards to the analysis of the proposed U.S. legislation,
the commentary provides a comparative analysis of the climate mechanism discussed in
Part III, the EU ETS, as well as providing significant consideration of foreseeable issues
arising from attempts to link the EU and proposed U.S. emission trading schemes in the
future.
10 0 See e.g. World Wildlife Fund, “EU ETS, Competitiveness and Employment”, online: WWF <http://www.wwf.fi/wwf/www/uploads/pdf/clearingthemist_summary.pdf> 10 1Massachusetts, et al, Petitioners v. Environmental Protection Agency, et al (2007), 549 U.S. 497, 127 S. Ct 1438 [EPA] 10 2Dingell-Boucher Legislation Discussion Draft, House Committee on Energy and Commerce, online: <http://energycommerce.house.gov>; See also, online: <http://www.instituteforenergyresearch.org/wp- content/uploads/2008/10/dingell-boucher-draft-cap-and-trade-bill.pdf> [Dingell-Boucher] 10 3American Clean Energy and Security Act of 2009, H.R.2454 [Waxman-Markey Bill]
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29
A. The United States
Greenhouse gas reduction initiatives both proposed and implemented have
emerged on both the national and sub-national level in the United States. While the
scope of this paper is limited to background on the Massachusetts v. EPA104 decision, the
proposed Dingell-Boucher Draft and the Waxman-Markey Bill the reader is encouraged
to consider this federal proposal alongside sub-national plans already implemented.105
1. US Administrative Intent
On the federal level, despite several well-intentioned efforts by senior
politicians106 to introduce federal cap-and-trade legislation in Congress, there has been
little progress made on this issue up to this point in time. The previous administrative
regime, in attempting to fulfill UNFCCC obligations, relied primarily on voluntary
initiatives that resulted in limited success.107 The current administration has yet to act
decisively on the issue of greenhouse gas intensity reduction, through cap-and-trade or
another policy.108 Unlike its predecessor, however, the current administration may chose
to act and create a federal legal requirement to reduce GHG gasses. When and if the
current government does act on climate change, it must choose one of two paths to create
10 4 10 5 EPA, supra note 101 See Western Climate Initiative, online: WCI <http://www.westernclimateinitative.org/>; Regional Greenhouse Gas Initiative, online: RGGI <http://www.rggi.org/> 10 6S.2191, the Lieberman-Warner Climate Security Act, December 5, 2007 10 7Climate VISION (Voluntary Innovative Sector Initiatives: Opportunities Now) administered through the Department of Energy’s policy and international program, online: Climate Vision <http://climatevision.gov/> 10 8The legislation includes a cap-and-trade global warming reduction plan designed to reduce economy- wide greenhouse gas emissions 17 percent by 2020. For the Bill to become law, a similar version must next pass the Senate: See supra note 103
30
a national program, namely: the existing Supreme Court sanctioned regulatory approach
or by working with Congress to enact new, comprehensive cap-and-trade legislation.
2. Existing Federal Regulatory Approach
As mentioned above, the U.S. federal government has yet to adopt climate change
legislation. Despite this, the current Administration has the existing authority to create a
national regulatory greenhouse gas reduction initiative, and possibly implement a cap-
and-trade policy. 109 Many commentators have remarked that the Supreme Court’s 2007
decision in Massachusetts v. EPA110 not only introduced important administrative law
changes,111 but also of potentially greater significance in the context of global climate
change, decided that the federal Environmental Protection Agency (EPA) has the existing
authority to regulate CO2 under the Clean Air Act.112
The Supreme Court remanded the matter back to the Agency to decide whether
CO2 causes or contributes to climate change.113 If it is indeed established in the
affirmative,114 Section 202(a)(1) of the reviewed legislation requires that:
10 9 Broder, J.M., “E.P.A. expected to Regulate Carbon Dioxide” The New York Times (18 February 2009), online: The New York Times: Environment <http://www.nytimes.com/2009/02/science/ earth/19epa.html>, quoting: Rep. John Dingell as saying that the regulation of CO2 by the E.P.A. under the Clean Air Act, as it stands, would set off a “glorious mess” that would resonate throughout the economy; and Senator John Barrasso likewise as warned Lisa P. Jackson (the new E.P.A. administrator) that the use of the Act to regulate carbon “a disaster waiting to happen.” 11 0EPA, supra note 101 11 1See e.g. Freeman, J., and Vermeule, A., “Massachusetts v. EPA: From Politics to Expertise” (Aug 2007), online: ssrn <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1008906> 11 2Clean Air Act (CAA), 40 U.S.C. ‘7401-7671q [CAA] 11 3EPA, supra note 101 at 26 11 4On April 22, 2009, the EPA proposed an “endangerment finding” for emissions of GHGs: See EPA, Proposed Endangerment and Cause or Contribute Findings for Greenhouse Gases under the Clean Air Act, online: EPA <http://www.epa.gov/climatechange/endangerment.html>
31
The Administrator shall by regulation prescribe […] standards applicable
to the emission of any air pollutant from any class or classes of new motor
vehicles or new motor vehicle engines, which in his judgement causes, or
contribute to, air pollution which may reasonably be anticipated to
endanger public health or welfare.115
Although the EPA has not yet promulgated CO2 regulations under the Clean Air
Act,116 it recently issued a proposed finding stating, “[i]n both magnitude and
probability, climate change is an enormous problem. The greenhouse gases that
are responsible for it endanger public health and welfare within the meaning of
the Clean Air Act.”117
Once the EPA asserts its jurisdiction to regulate CO2 under Section 202, a
domino effect will ripple across similar Sections of the Clean Air Act.118 For instance, the
Administrator would be compelled to list CO2 as a pollutant under Section 108119 and
next establish National Ambient Air Quality Standards for CO2 under Section 109.120
While the complete regulatory implications of establishing a climate policy from
judicial construction are outside of the scope of this essay, suffice it to say, it is likely that
11 5 11 6 42 U.S.C. § 7521(a)(1) ibid. 11 7EPA, News Release, “EPA Finds Greenhouse Gases Pose Threat to Public Health, Welfare / Proposed Finding Comes in Response to 2007 Supreme Court Ruling”, (April 17 2009), online: EPA < http://yosemite.epa.gov/opa/admpress.nsf/0/0EF7DF675805295D8525759B00566924> 11 8CAA, supra note 111 11 942 U.S.C. § 7408 12 042 U.S.C. § 7409
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the current Administration will choose to supplement this route with new legislative
action that is tailored to the specific U.S. contribution to climate change.121
3. Dingell-Boucher and Waxman-Markey Legislation
Many commentators believed that the Dingell-Boucher Draft122 announced on
October 7, 2008 in the House of Representatives, by Representatives John Dingell123 of
Michigan, Chairman of the House Committee on Energy and Commerce, and
Representative Rick Boucher124 of Virginia, Chairman of the House Subcommittee on
Energy and Air Quality, represented the likely future legislative approach to addressing
greenhouse gas emission reduction in the United States. Part of the reason for this belief
was that the draft proposed to amend the existing Clean Air Act125, discussed above,
rather than attempt to create a standalone legislative regime from scratch. Another reason
was that the bill sets targets via hard caps, and boasts a CO2 emission reduction target of
80% below 2005 levels by 2050.126 The Dingell-Boucher Draft stimulated discussion.127
This discussion influenced the May 15, 2009, introduction and June 26, 2009, passage of
Rep. Henry Waxman128, Chairman of the House Committee on Energy and Commerce,
and Rep. Edward Markey129, Chairman of the Subcommittee on Energy and
Environment, climate change and clean energy bill entitled “American Clean Energy and
12 1 President Obama and Administrator Jackson have repeatedly indicated their preference for legislation action to address climate change: See supra note 116 12 2Dingell-Boucher, supra note 102 12 3Congressman John Dingell, online: <http://www.house.gov/dingell/> 12 4Congressman Rick Boucher, online: <http://www.boucher.house.gov/> 12 5CAA, supra note 111 12 6Dingell-Boucher, supra note 73 at s. 711(e)(1) 12 7Memoranda from Rick Boucher, Chairman Subcommittee on Energy and Air Quality and John D. Dingell, Chairman Committee on Energy and Commerce (7 October 2008) U.S. House of Representatives [Executive Summary] 12 8Representative Henry A. Waxman, online: < http://waxman.house.gov> 12 9Representative Edward Markey, online: < http://markey.house.gov>
33
Security Act of 2009”, or the Waxman-Markey Bill.130 The Dingell-Boucher Draft
provided a solid framework and a clear direction. As discussed below, the Waxman-
Markey Bill borrowed from the Dingell-Boucher Draft and addressed some unresolved
issues.
i. Implementation Plan
Like the EU ETS, the Dingell-Boucher Draft anticipates implementation in
distinct phases.131 A Dingell-Boucher cap-and-trade program would commence on 2012
and continue until 2050.132 The first distinct phase would begin with the 2012
commencement and run until 2017.133 As in the European model, its first phase
contemplates economic integration concerns. However, unlike the “learning phase”
which was conducted as trial by error, the Dingell-Boucher Draft plan would start by
implementing a binding and enforceable cap that would sanction increases in issuances of
allowances between 2012 and 2017 before beginning a steady decline each year
thereafter.134 For instance, the Dingell-Boucher Draft contemplates the following CO2
emission timeline: 4.987 billion tons in 2012; (increased to) 6.167 billion tons in 2017;
5.796 billion tons in 2020; 4.617 billion in 2025; 3.436 in 2030; 2.335 in 2040; and 1.233
billion in 2050.135 It is important to note, however, that increases in the early part of the
first phase were not included as “breathing room” for covered entities. Rather, the
130 13 1 Waxman-Markey, supra note 103 Dingell-Boucher, supra note 102 at s. 711(e)(1) 13 2ibid. 13 3Dingell-Boucher, supra note 102 at s. 712(b) 13 4Pew Center on Global Climate Change, Statement, “Summary of the Dingell-Boucher Discussion Draft”, (7 October 2008), online: Pew Center <http://www.pewclimate.org/statement/dingell-boucher/10- 07-08> [Pew Center] 13 5ibid.
34
drafters contemplated the need for additional allocations as various emitters were to be
brought with the scope of the trading regime in these years. For instance, natural gas
LCD emitters would not be initially included in the draft scheme.136 For this purpose,
although the creation of allocations would increase the cap, the act of bringing these
entities into the regulatory scheme would result in an overall reduction of the business as
usual emissions of this carbon heavy industry, thereby lowering overall global emissions.
Like the Dingell-Boucher Draft, the Waxman-Markey Bill establishes an
economy wide cap-and-trade program that commences in 2012 and starts with binding
and enforceable cap calculated from the 2005 baseline. The Waxman-Markey Bill,
however, contemplates greater up front reductions than those that would be made under
the Dinger-Boucher Draft. For instance, in 2012 the cap starts 3% below the baseline,
17% below by 2020, and 83% below by 2050.137
As discussed in Part III, banking of Phase I allocations was not permitted under
the EU ETS scheme. The U.S. proposed legislation took a different, and more flexible,
approach to this issue. Both the Dingell-Boucher Draft and Waxman-Markey Bill
contemplate full banking of allowances.138 Unlike in the EU, the use of banking will
result in pressure on the U.S. regulator to correctly determine the appropriate cap.
However, banking under the Dingell-Boucher Draft is subject to an overriding authority
on the part of the EPA to create limiting restrictions.139 For instance under the Dingell-
Boucher proposal, if over allocation of credits occurs early on the regulator would be
13 6 13 7 Dingell-Boucher, supra note 102 at s. 712(b)(2) Waxman-Markey, supra note 103 at s. 702(1) 13 8ibid 13 9Dingell-Boucher, supra note 102 at s. 715
35
forced to correct market dilution as these credits migrate to subsequent phases. EPA
authority to modify allowance rights must be approached with caution, since the exercise
of these rights would likely undermine liquidity and trust in the market.
a. Implementation and Linkage
The Dingell-Boucher Draft and Waxman-Markey Bill both propose an allowance
system that is different from the EU ETS in one significant respect, the use of future
allowances. Both propose that a U.S. covered entity may satisfy up to 15 percent of its
compliance obligations by borrowing allowances to be allocated in up to five future years
in order to meet current compliance obligations.140 On this issue, it is important to be
aware that the European Parliament, Policy Department Economic and Scientific Policy,
recently commented that “linking a system without borrowing to a regime that allows
borrowing may require restrictive provisions to be taken so as to maintain the
environmental effectiveness of the linked trading scheme.”141 For instance, the note
contemplates borrowing ‘excess’ credits from other emitters rather than their own future
allocations. On this issue, legislators must carefully balance the historic U.S. carbon
emission legislative precept to “not significantly harm”142 to the U.S. economy with
compliance with emission reduction requirements imposed by the EU as a condition of
participation and the likely economic benefits that might result as a consequence of
14 0 14 1 Dingell-Boucher, supra note 102 at s. 715(2); Waxman-Markey, supra note 103 at s. 725 EC, Policy Department Economic and Scientific Policy, Implications of Linking the EU ETS with other Emissions Trading Schemes, (2007), online: EP <http://www. Europart.europa.eu/activities/committees/ studies/download.do?file=19802> [Implications of Linking] 14 2For example: in 1997 the Senate unanimously passed a non-binding resolution stating that it would not ratify an international climate agreement (such as Kyoto) that would “do serious harm” and, second, not require developing nations to participate. See S. Res. 98, introduced by Senate Robert Byrd (D-WV) and Chuck Hagel (R-NE) passed on July 35, 1997
36
linkage with the EU ETS. Although the exact conditions are not yet known, how this can
be done remains unclear since participation will inevitably have economic costs for the
U.S. 143
ii. Scope
Implementation of either the Dingell-Boucher Draft or Waxman-Markey Bill will
establish a cap-and-trade program that, like the EU ETS, results in the creation of an
economy-wide market for carbon that monetizes emissions. Like other similar schemes,
these proposals seek to establish a regime that has a dual effect of incentivizing carbon
reduction by emitters and the development of carbon reduction technologies.
Both proposed schemes would cover 85 percent or more of the U.S. economy’s
GHG emissions, which is significantly more ambitious than the EU scheme’s historical
coverage of 46 percent of CO2 emissions.144 However, in the short term, the Dingell-
Boucher scheme’s reduction goal is much more back loaded that the EU ETS’s
commitment. For instance, the proposed scheme pegs reduction goals to the 2005 base
year with a higher emission baseline. In addition, the draft contemplates only a six
percent reduction by 2020 from 2005 emission levels. While this represents a significant
move away from ‘business as usual’ in the U.S., the reductions will not match the
reductions of CO2 emitted if the EU goal of 20 percent by 2020 is realized.
14 3 National Center For Policy Analysis, News Release, No. 617, “Capping C02 Emissions, Boosting Energy Costs”, (14 May 2008), online: NCPA < http://www.ncpa.org/pub/ba617> 14 4Point Carbon, Press Release, (12 May 2006), online: Point Carbon <http://www.pointcarbon.com/wimages/Press release Point Carbon 12 May 2006 1.pdf>
37
Unlike the Dingell-Boucher Draft, the Waxman-Markey Bill matches the 2020
EU 20 percent reduction goal on its face.145 While the Waxman-Markey Bill proposes a
goal of 20 percent, which is significantly tighter than the 6 percent Dingell-Boucher goal,
the reduction is also pegged to the 2005 baseline rather than the lower 1990 EU baseline.
The Waxman-Markey Bill maintains a scope comparable to the Dingell-Boucher Draft,
foreseeing the capture of 85 percent of US GHG emissions.146 If passed by the Senate in
its current form the Waxman-Markey Bill could result in a reduction of CO2 that is at
least 14 percent greater than the forecasted reduction under the Dingell-Boucher Bill in
2020.
As in Annex 1 of the EU ETS, the Dingell-Boucher Draft specifically captures ‘low
hanging fruit’. For instance, large direct emitters and other installations that significantly
contribute to U.S. emissions are specifically included in the draft scheme. By 2013, the
proposed scope of the Dingell-Boucher scheme would encompass the following GHG
emitting entities: 1) electric generators, 2) producers and importers of fossil-based fuels,
emitting more than 25,000 tons of GHG annually, 3) producers and importers of other bulk
gasses, and 4) geologic sequestration sites.147 In 2014, larger industrial facilities emitting
more than 25,000 tons of GHG annually are scheduled for inclusion.148 For example,
facilities in high emitting sectors such as aluminum, chemical, petroleum, iron and steel,
concrete, and pulp and paper industries are listed.149 Lastly, as proposed, between 2017 and
2021 emissions resulting from the domestic combustion of natural gas would be included in
the scope. The Dingell-Boucher proposal would implement staggered inclusion, based on
14 5 14 6 Waxman-Markey, supra note 103 at s. 702 EPA, “EPA Analysis of the Waxman-Markey Discussion Draft: The American Clean Energy and Security Act of 2009” (20 April 2009), online: EPA < http://www.epa.gov/climatechange/economics/pdfs/WaxmanMarkeyExecutiveSummary.pdf> 14 7Dingell-Boucher, supra note 102 at ss. 700(8) and 712; See also Pew Center, supra note 133 14 8ibid. 14 9ibid at 712
38
the overall delivery volume, at the distribution level by requiring distributors delivering more
than 46, 000 cubic feet of gas to participate in the scheme.150
In the Dingell-Boucher Draft’s executive summary, the drafters explain that the
EPA would be granted authority to establish emission standards for industries emitting less
than 25,000 tons per year.151 The EPA would initially consider standards for “nonroad
engine, transportation fuel, and aircraft standards ” and motor vehicle standards.152 As the
Dingell-Boucher Draft is written the U.S. climate regime would cast a wide net over smaller
point sources that comprise a larger share of net U.S. emissions than large emitters. For
example, the Draft’s statutory language specifically instructs the EPA to list smaller sources
that, in addition to covered large emitters, will comprise 95 percent of industrial
emissions.153 This proposal would cover a significantly greater share of total U.S. GHG
emissions than the share covered by the EU ETS scheme.154 In terms of smaller emitters, a
recent EC proposal may take the EU in the opposite direction of the U.S. by removing
installations from the scheme that emit low amounts of CO2.155
The Waxman-Markey Bill is remarkably similar to the Dingell-Boucher Draft in
terms of the scope of covered entities, capturing facilities emitting 25, 000 tonnes of GHG
annually.156 As in the Dingell-Boucher Draft, the compliance period commences in 2012 for
most covered entities, in 2014 large industrial sources and in 2016 for Local Distribution
15 0 Dingell-Boucher, supra note 102 at s.712; According to the Pew Center the draft incorrectly states the natural gas distribution threshold as 460,000 cubic feet: See Pew Center supra note 86. 15 1Executive Summary, supra note 126 15 2Alliance to Save Energy, “Summary of Dingell-Boucher Discussion Draft”, (October 2008), online: <http://www.ase.org> 15 3Dingell-Boucher, supra note 102 at s. 811 15 4The EU ETS covers 50 percent of European CO2 emissions and 40 percent of European GHG emissions: See EC, Questions and Answers on the Commission’s proposal to revise the EU Emission Trading Scheme, (23 January 2008) MEMO/08/35 15 5Ibid. The Commission has proposed allowing Member States to remove installations with a rated thermal input below 25MW whose reported emissions were lover than 10,000 tonnes of CO2 equivalent in each of the three years preceding the year of application. 15 6Waxman-Markey, supra note 103 at s. 700(12)
39
Companies of natural gas, a year earlier than in the Dingell-Boucher Draft.157 Also, the
Waxman-Markey Bill grants powers to the EPA to establish emission performance
standards for smaller stationary sources not caught by the 25,000 tonne cap.158 This
provision is not as broad as under the Dingell-Boucher Draft, since it does include moving
sources such as motor vehicles and aircraft. 159
a. Scope and Linkage
While the Dingell-Boucher Draft lacks aggressive ‘early’ emission reductions like
those imposed by the EU ETS on its constituents, it provides compensation for this by not
only ensuring that an absolute cap is in place, as opposed to an intensity based approach,
but also by implementing an approach that is more comprehensive in scope. The
Waxman-Markey Bill improves on the Draft by increasing early reduction requirements.
Despite differences between the percentage reductions made by the U.S. legislation and
the EU, both of the proposed U.S. proposals are designed to regulate almost twice the
total volume of annual emissions as compared to the EU ETS.
With varied government actors and ambitions, it is unlikely that the scopes of the
two enormous schemes will match each other in inclusions of covered entities. While
this possible reality could have many economic effects, perhaps the most troubling to the
EU may be the transfer of wealth that could result. Since a larger U.S. scope could result
in a greater number of allowances with lower abatement costs, more payments would be
15 7 15 8 Waxman-Markey, supra note 103 at s. 721(e) ibid at s. 811 15 9Dingell-Boucher, supra at s. 811
40
made for U.S. allowances than for EU allowances. 160 As a result of this, “it is probably a
political precondition for linking that all sides demonstrate efforts to establish
comparable caps.”161
As mentioned, the Waxman-Markey Bill requires covered emitters to make
greater emission reductions between 2013 and 2020 than the Dingell-Boucher Draft
does.162 If passed by the Senate in its current form, the scope of the proposed U.S.
scheme will be greater than was contemplated under the Dingell-Boucher Draft. If this is
the case, then further expansion could result in an even greater number of payments being
made by Europeans for a larger pool of U.S. allocations. It is possible that the inflow of
these funds could incentivize U.S. companies, rather than their EU counterparts, to invest
in abatement technology that creates real emission reductions. The effect of this may
have a political impact on linkage, since euros would fund U.S. capital development.
iii. Currency of the U.S. ETS
The GHG emission allowance, as contemplated by the Dingell-Boucher Draft, is a
comprehensive approach to GHG reduction. The reason for this is that each allowance
entitles the holder the right to emit one tonne of CO2 or equivalent GHG.163 In this
respect, the U.S. approach would be substantially broader than that of the Europeans,
since allocations there are limited to trades in CO2 emissions.
16 0 European Parliament, Options and Implications of Linking the EU ETS with other Emissions Trading Schemes, p19, Policy Department Economic and Scientific Policy, p. 20, online: EP < http://www.europarl. europa.eu/activities/committees/studies/download.do?file=19802> 16 1Implications of Linking, supra note 91 16 2Waxman-Markey, supra note 103 at s. 702 16 3Dingell-Boucher, supra note 60 at s. 700(13)
41
The Dingell-Boucher Draft is more progressive in another regard, the use of
offsets. While the EU ETS is only beginning to integrate credits created via the Kyoto’s
CDM and JI flexible mechanisms, the Dingell-Boucher Draft envisions significant use of
both domestic and international offsets to satisfy a U.S. covered emitters compliance
burden.164 It is worthy to note that the worldwide Kyoto credit market will benefit from
the U.S. markets involvement and demand for these units. In exchange, unlike the
“reduction at home” approach taken by Europe in the early years, the U.S. economy
would benefit from the purchase of an abundance of less expensive credits created in
emerging economies. This involvement is likely to please U.S. politicians who, in the
past, have lamented over Kyoto’s seeming free pass to developing economies. Yet it is
uncertain whether these same players will be concerned by the flow of U.S. dollars
overseas to meet domestic emission reduction obligations.
The Waxman-Markey Bill creates allowances identical to those contemplated by
the Dingell-Boucher Draft.165 As for the use of offset credits, the Waxman-Markey Bill
also allows covered entities to partially demonstrate compliance with their use. The Bill
provides an equation166 that calculates the permissible level offsets to be 27% to 31% of
the total obligation until 2025, increasing every year to over 60% by 2050. 167 On the issue
of offsets, the Waxman-Markey Bill goes further than the Dingell-Boucher Draft by
16 4 Dingell-Boucher, supra note 102 at ss. 712(c), 741-750, 761-764; for instance, 2013-2017 5% of compliance may be met with any combination of domestic and international offsets; 2018-2020 15% of compliance may be met with any combination of domestic and international offsets; 2021-2024 30% of compliance may be met with a equal amount of domestic and international offsets; 2025- future 35% of compliance may be met with a 20%/15% mix of domestic and international offsets. 16 5Waxman-Markey, supra note 103 at s. 712 16 6The percent of offsets is computed by dividing 2 billion by the sum of 2 billion plus the prior year’s cap: ibid at s. 722(c) 16 7Congressional Research Service, Summary of Waxman-Markey Draft Greenhouse Gas Legislation (14 May 2009), p.20, online: CRS < http://lugar.senate.gov/services/pdf_crs/Summary_of_Waxman Markey.pdf>
42
limiting the use of domestic and international offsets to a maximum of split of 50/50 of
the total percent allowed in each year.168 The Waxman-Markey Bill is more conservative
that its predecessor in this area, as the Bill requires the presentation of 1.25 offset credits
for each 1 emission allowance due.169
a. Currency and Linkage
Depending on what position the European Commission ultimately decides to take
with regards to carbon offsets in the coming years, any U.S. sanction of the use of
domestic and international offsets could pose a significant challenge to linkage of the two
systems. Although the EU ETS was recently revised to allow post 2012 participants to
satisfy up to 50% of target through the purchase of international offset credits,170 the
issue remains in play as the types of allowable offsets are not equal in nature. For
example, both the Dingell-Boucher Draft and Waxman-Markey Bill contemplate the
inclusion of domestic forestry offsets.171 The European Counsel recently revisited this
issue, determining that forestry offsets should not be included in the next stage of EU
ETS.172
16 8 16 9 Waxman-Markey, supra note 103 at s. 712 ibid. 17 0EC, Press Release, Climate change: Commission welcomes final adoption of Europe’s climate and energy package (17 December 2008), online: Europa<http://europa.eu/rapid/pressReleasesAction.do?reference=IP/08/1998&format=HTML&aged=08la nguage=EN&guiLanguage=en> 17 1Dingell-Boucher, supra note 102 at s.742(b); Waxman-Markey, supra note 103 at Title V 17 2EU, Press Release, “Questions and Answers on the revised EU Emissions Trading System Press Release MEMO/08/796” (17 December 2008), <http://europa.eu/rapid/pressReleaseAction.do?reference=MEMO /08/796&format=HTML&aged=0&language=EN$guiLanguage=en>
43
The Europeans will likely require some form of mediation on the issue, so as to
avoid the trade of these offsets from crossing over. Such measures may include a
prohibition being placed on U.S. companies selling surplus credits in the EU, if they
chose to make use of non EU approved offsets to meet their permit requirements. In
doing so, the integrity of the EU ETS would not be compromised by the sale of U.S.
credits that would not have been available had it not been for the use of these offsets.
Tracing the sale of these credits across several transactions involving multiple parties
would be difficult and could ultimately have the same effect as above, namely market
dilution in the EU scheme. In addition, the EU will likely require that any U.S. use of
offsets will not result in the creation of incentives to generate CO2. These areas will be
of special concern when contemplating linkage.173
iv. National Registry
Both Dingell-Boucher Draft and Waxman-Markey Bill require the creation of a
Federal GHG registry within one year of either’s enactment into U.S. law.174 Each
delegates the task of establishing the registry and issuing accompanying regulations to the
EPA Administer. In carrying out this mandate, the Administrator must draft regulations
that compel covered entities to submit to the EPA data on: “(i) greenhouse gas emissions
in the United States; (ii) the production and manufacture in the United States, and
17 3 17 4 See e.g., Mukerjee, M., "A Mechanism of Hot Air", Scientific American (June 2009), pp. 9-10
Dingell-Boucher, supra note 102 at s 703; Waxman-Markey, supra note 103 at s. 713
44
importation into the United States, of fuels and other products the uses of which result in
greenhouse gas emissions; and (iii) the sequestration of greenhouse gases.”175
In addition to reporting requirements, these sections go on to require the formation
and implementation of various protocols, practices, procedures, and publications by the
EPA necessary to regulate the Federal GHG registry. It is interesting to note, that both
require that the Administrator rely on GHG emission data collected by the Climate
Registry. Established in 2007, the Climate Registry is a nonprofit partnership that now
includes registered members form thirty-nine U.S. states and the District of Columbia,
seven Canadian provinces and territories, six Mexican states, and three tribal nations.
Climate Registry reporters register their organizations entire GHG emissions for
facilities, corporations and operations in U.S., Canada and Mexico.
The Climate Registry recently finalized of its General Reporting Protocol, “which
gives guidance on how to inventory greenhouse gas emissions for participation in the
Registry.”176 While standardization of reporting methodologies is necessary to ensure the
accuracy of data, allowing this Registry data collected on a voluntary basis may be risky,
considering the potential for miscalculation or lack of stringent oversight. Computer
programmers are fond of the phase “garbage in garbage out”. It will be interesting to see
if the Climate Registry data is sufficiently groomed to represent a value added approach
to the formulation of the initial national cap. In light of the informational problems that
developed during Phase I of the EU ETS, the Europeans would be wise to view the U.S.
17 5 17 6 Dingell-Boucher, supra note 102 at s 703; Waxman-Markey, supra note 103 at s. 713 Climate Registry, General Reporting Protocol, (May 2008), Climate Registry online: <http://www.theclimateregistry.org/downloads/GRP.pdf>
45
reliance on this type of soft data as incomplete. In turn, any approach toward linkage
should mandate caution out of concern for dual market dilution if credits are over
allocated in the U.S. during the first phase. Failure to ‘wait and see’ could easily frustrate
the realization of gains made in Europe and negate any benefits associated with linking
the two systems.
Discussed in more detail below, the EPA’s recent announcement of its intention
to create a national GHG registry demonstrates a clear ambition on the part of the Agency
to be in position to implement and support Congressional cap-and-trade legislation in the
near future. Such an ambition is not only necessary for the success of such a proposal,
but also serves to drive the legislative process forward where in the past it has languished.
Much of this may be attributed to the recent political regime change in the U.S., and
perhaps an increased desire on the part of the American public to reenter the international
policy stage in a more positive, holistic way.
v. Allowance Allocation
As in the EU ETS scheme, participants in the U.S. will share a CO2 emissions
cap.177 The U.S. cap is comprised of allowances, like the EU, but unlike the EU, the
authority to issue and distribute allowances would be vested federally in the EPA rather
than collectively in the Member States.178 Rather than adopt ad hoc state-by-state
approach, consolidation of authority at the federal level will facilitate an annual linear
17 7 17 8 Dingell-Boucher, supra note 102 at s. 711; Waxman-Markey, supra note 103 at s. 721 The Commission recently proposed setting a single EU-wide cap post 2012, rather than allowing member states to determine the total quantity to be allocated and how. See: EC, Questions and Answers on the Commission’s proposal to revise the EU Emission Trading Scheme, (23 January 2008) MEMO/08/35, online: Europa <http://europa.eu/rapid/pressReleaseAction.do?reference=MEMO/08/796&format= HTML&aged=0&language=EN$guiLanguage=en>
46
decrease of allowances. A cursory review of the U.S. proposals relieves doubt that the
framers learned valuable lessons from the market failures that resulted early on during the
European allocations.
At this time, neither the Dingell-Boucher Draft nor the Waxman-Markey Bill
contains details on the issue of allocation.179 Neither has chosen a method of allocation.
Rather than putting forward a single emission allocation proposal, the Dingell-Boucher
Draft contains descriptions of four different allocation options and requests comments.180
The Dingell-Boucher Draft Executive Summary clearly frames the proposed options: 1)
allocation of allowances without charge to covered sectors; 2 & 3) reduced allowances to
be provided without charge to and provide varying auction allowance amounts with
revenues funding adaptation programs; and 4) allocation of allowances entirely by way of
auction with the majority of revenue being rebated to U.S. consumers. The Dingell-
Boucher drafters included a provision to encourage Congressional reauthorization. The
provision would mandate auctioning of all allowance and distribution of the proceeds to
taxpayers if reauthorization is not successfully completed prior to 2026.181
Unique to the Waxman-Markey Bill is that it mandates that the EPA create a
“strategic reserve” to be created by the holding back of a percentage of allowances each
year.182 From this, on a quarterly basis, the EPA will make available allowances for
auction, with a reserve price that is 100% above the current market price.183 Unsold
17 9 18 0 Dingell-Boucher, supra note 102 at s. 721; Waxman-Markey, supra note 103 at ss. 711 & 782 Dingell-Boucher, supra note 102 at s. 721 (options A-D) 18 1ibid. 18 2Waxman-Markey, supra note 103 at s. 726 18 3Waxman-Markey, supra note 103 at s. 726
47
allocations accumulate in the reserve.184 The proceeds of the auction will be used to
purchase forestry offsets to replenish the reserve.185
a. Allocation and Linkage
Although the Dingell-Boucher Draft and the Waxman-Markey Bill have not taken
firm positions on the anticipated method of general allocation, this issue may not be as
controlling on the issue of linkage as it may first appear. If fact, “[d]ifferences in the way
allowances are distributed to the companies covered by ETS usually have no impact on
the system’s environmental effectiveness since this is solely determined by the overall
cap.” 186 Thus, “[b]eyond an initial transfer of wealth in the case of free allocation, the
method of initial distribution should not affect the competitiveness of the entities.”187 As
a result, no matter what method of allocation the U.S. legislature ultimately passes by
legislation, the economic effect will be limited to the U.S. economy. In turn, the choice
of allocation methodologies will not compromise the EU ETS. As such, whatever
method is chosen, linkage will not be prevented.
While the particular decision may not result in an economic bar to linkage, there
may certainly be political barriers to consider. As discussed, varying obligations between
similar industries operating in different jurisdictions inevitably results in lobbying
pressures as a result of perceived trade competition issues. Therefore, it would be
difficult to imagine the linking of a U.S. emission scheme that allocated credits in a
18 4 18 5 Waxman-Markey, supra note 103 at s. 726 ibid. 18 6Options and Implications of Linking the EU ETS with other Emissions Trading Schemes, p19, Policy Department Economic and Scientific Policy 18 7ibid.
48
manner that is inconsistent with its counterpart. As such, if linkage is a U.S. objective, it
would be wise for the legislature to monitor proposed and realized allocation
amendments to the EU ETS.
Overall, the U.S. may elect to employ a different allocation method than the free
allocation method implemented during Phase I and II of the EU ETS. This could be moot,
however, as the EU Commission is also contemplating implementing options 2 & 3
above. Despite the lack of economic necessity, the best course of action in the U.S. is
clearly to foster a coordinated approach, as the result would generate greater similarities
between the two schemes in the future.
vi. Trading
Neither the Dingell-Boucher Draft nor the Waxman-Markey Bill establishes a
regulated framework to facilitate the trade of emission allowances. This approach, also
taken by the Europeans, is well suited for the development of market mechanisms that
grow freely with demand. The Draft specifically states that, “the lawful holder of an
emission allowance may, without restriction, sell exchange, transfer, hold for
compliance.”188 As discussed with regards to the EU ETS policy, participants will have
several choices when planning and selecting a trading method.
Although the Dingell-Boucher Draft contemplates an anything goes approach in
terms of transaction methods, the ‘place’ where such transactions occur must be
registered with Federal Energy Regulatory Commission (“FERC”) and approved as a
18 8 Dingell-Boucher, supra note 102 at s.714; Waxman-Markey, supra note 103 at 724
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“carbon trading facility”. Such a facility is contemplated as being an entity “in which
multiple participants may execute or trade agreements, contracts, or transactions
involving a regulated instrument by accepting bids and offers made by other participants
that are open to multiple participants in the faculty or system.”189 The Draft goes on to
specify that such facilities may become ‘registered’ if they are able to demonstrate that
they are prepared to prevent market manipulation, ensure fair and equitable trading,
establish and enforce rules governing trading and financial integrity, must establish and
be capable of enforcing its own disciplinary procedures, and, lastly, the facility must
ensure its own ability, as well as the publics ability, to access information relating to
trading and trades.190 It is also very likely that under both the Dingell-Boucher Draft and
the Waxman-Markey Bill all brokers, dealers and traders would be regulated by FERC.191
Since the EU ETS, Dingell-Boucher Draft and Waxman-Markey Bill take near
identical positions in terms of trading, concerns regarding trading are premature. What
must be considered, however, is how the trading systems sync together despite their
similarities. Issues of foreign authentication, deposit, hold times after a deal closes, and
other elements may result in the realization of latent issues in the future. Although
having the potential to be significant, at this early stage such concerns cannot be
addressed in this article.
18 9 19 0 Dingell-Boucher, supra note 102 at s. 402(16) ibid, at s. 405(a)(2) 19 1ibid. at s. 405(b); The Federal Energy Regulatory Commissions will be charged with the regulation of the cash market in allowances and offsets: Waxman-Markey, supra note 103 at 761
50
vii. Monitoring and Reporting
As discussed, the scope of the Dingell-Boucher Draft and the Waxman-Markey
Bill specifically capture emission sources emitting 25,000 tonnes of GHG annually.192
Although plans have not been finalized, the public comment period recently closed on a
draft EPA regulation that seeks to establish a national annual reporting requirement
commencing in 2010 for GHG emitters or producers or importers of fossil fuels.193 The
proposed regulatory disclosure requirements closely maps on to the covered entities
thresholds framed by both pieces of proposed cap-and-trade legislation. For instance,
under the proposed regulation, the EPA would require annual submissions from faculties
that emit the equivalent of 25,000 metric tonnes or more of GHG equivalent.194 Whether
this draft regulation is a harbinger of a U.S. cap-and-trade program only time will tell. A
strict comparison of the EU and U.S. approaches reveals greater similarities than
differences in terms of the threshold for monitoring. Currently, the U.S. proposals lack
sufficient detail to undertake a point by point comparison. Suffice it to say, what has been
put forward in the U.S. is perhaps more progressive in nature. For instance, as discussed,
in both the proposed Draft and the Bill the EPA has been granted greater authority to draft
legislation catching smaller emitters.195
viii. Compliance
Under the Dingell-Boucher Draft, a new statutory office named the Office of
Carbon Market Oversight would be established within FERC.196 If created, this office
19 2 19 3 Dingell-Boucher, supra note 102 at ss. 700(8) and 712; Waxman-Markey, supra note 103 at 700(12) Environmental Protection Agency, Proposed Mandatory Greenhouse Gas Reporting Rule (10 March 2009), online: EPA <http://www.epa.gov/climatechange/emissions/ghgrulemaking.html> 19 4ibid. 19 5Waxman-Markey, supra note 103 at s. 811 196 Dingell-Boucher, supra note 102
51
would have administrative authority over the U.S. carbon market separate and distinct
from FERC and its Chairman. This authority would include regulatory authority over
issued credits, allowances and their derivatives.
Although the Waxman-Markey Bill does not create an independent office within
FERC, like the Dingell-Boucher Draft, the Bill grants FERC the authority to regulate the
carbon market.197 The Waxman-Boucher Bill takes a different approach on derivatives
by directing the President to delegate regulatory authority over this market to the
appropriate agency.198 If the Bill gains traction in the Senate this year, FERC will likely
follow the EPA’s lead and begin breaking ground on its own regulatory obligations.
ix. Pre-emption
The EU ETS was the first cap-and-trade regime to be put in place in Europe. As
such, it occupied the field and was unchallenged by competing regimes. The same cannot
be said in North America. Despite the hard work that has been done, the Dingell-Boucher
Draft and Waxman-Markey Bill intend to occupy the field in much the same way as the
EU ETS. While the Dingell-Boucher Draft will pre-empt all other trading programs
permanently199, the Waxman-Markey Bill initially limits the period of pre-emption to the
first five years of implementation. 200
19 7 19 8 Waxman-Markey, supra note 103 at s. 761 ibid. 19 9Dingell-Boucher, supra note 102 at s. 707 20 0Waxman-Markey, supra note 103 at s. 861
52
B. Summary of Part IV
While the current Administration has the authority under the Clean Air Act to
regulate CO2 emissions in the U.S., most agree that such an approach would not provide
a strong framework for a national emissions trading scheme. On the other hand, many of
the Dingell-Boucher Draft and Waxman Market Bill weaknesses, such as borrowing and
forestry offsets, discussed further in Part V, are perhaps political chips necessary to
commence the legislative ball rolling. The U.S. legislation represents an important step
toward not only a national approach, but also a multi-national GHG approach by
facilitating linking with the EU ETS.
53
PART V
Conclusions on Linkage
In Part IV, the comparative analysis put forward focused on similarities and
differences of the approaches taken by the EU ETS and anticipated by the Dingell-
Boucher and Waxman-Markey emission regimes. While special attention was paid in
Part IV to the identification of area of concern in terms of linkage of future linkage of
these schemes, Part V will provide more thorough analysis of the obstacles and what can
be done to ensure compatibility in the years ahead.
A. Linkage Generally
It is without doubt that if the U.S. adopts any emission reduction scheme there
will be a major push domestically to work with other international players toward the
common goal of avoiding catastrophic climate change. That being said, any U.S.
legislative action should, at the drafting stage, look toward overcoming obstacles to
linkage in order to facilitate the transfer of allowances between schemes. Internalization
of such an objective not only externalizes a shared goal, it facilitates attainment of the
goal by dramatically improving liquidity and reducing each system’s economic costs
associated with its implementation. Although the U.S. prefers not to have its domestic
policy dictated, the potential for a ‘win-win’ should significantly motivate the legislature
and relieve some concerns regarding effects on the domestic economy. So long as each
scheme’s rules remains substantially similar, for instance if neither allows its allocation
pool to be a conduit for cheaper ‘hot air’ credits which create surplus credits that are sold
53
54
for profit to participants in the linked scheme, the environmental outcome will not be
frustrated and market efficiency will prevail because emission allocations will be
exchanged on par.
If the U.S. legislative approach focuses on the reduction of GHG globally, not
only nationally, then drafters should look toward the EU. The EU has higher institutional
learning based on its early efforts, and its participants have had several years to
internalize the inevitability of compliance. In fact, this advance notice may facilitate
lower costs of compliance that may be passed on to U.S. covered emitters seeking short-
term purchases while emission reduction technologies develop and are ultimately
implemented. In short, the inchoate U.S. trading market would likely benefit from
linking to a market the size of the EU ETS.
Discussed in Part II, the Stern Report suggests that each country should use the
appropriate mix of taxes, trading, spending and regulation as necessary to reach its
emission reduction target 201 Following the Stern Report, as the U.S. moves toward
enacting a cap-and-trade regime, drafters should not solely determine the national
emission reductions that will be included in its scope, but also what portion of the overall
cap could be reduced in a more efficient or beneficial manner with other mechanisms.
For instance, does the U.S. want to encourage green technological improvements by
employing a carbon tax regime that establishes a fixed price for carbon? However, when
other types of regimes work “alongside emissions trading (tax, environmental, exchange
20 1 Stern Report, supra note 31
55
regulation, corporate governance)” they “should be examined for potential distortions on
the link, which could lead to welfare losses exceeding welfare gains from linking”.202
B. Linkage Suggestions
Based on the comparisons of the EU ETS with the Dingell-Boucher Draft and
Waxman-Markey Bill, in Part IV, the following suggestions should be considered by the
legislature when moving forward.
1. Allocations
The first matter to be considered by a legislative drafter of an emission reduction
regime is – “what are we going to trade?” If the U.S. anticipates linking with the EU
ETS, then it has correctly relied on the established EU standard of an allocation being
equivalent to one tonne of CO2 or other equivalent volume of GHG.
If the US chooses to proceed with the Dingell-Boucher Draft or the Waxman-
Markey Bill, the scheme will cover not only CO2, but also other GHG. Such a position
represents a noble ambition to take the lead globally, since currently the EU ETS covers
CO2 alone. Given timeframe considerations and genuine concerns regarding potential
administrative lag time as the system gets up and running, the drafters may find current
20 2 Chapman, J., “Linking a US Greenhouse Gas Cap-and-Trade System to the EU ETS” (2009) Itn’l Law Seminar, online: wordpress < works.bepress.com/james_chapman/1/>
56
proposals including other GHG advantageous, since Phase III EU ETS coverage will be
expanded to include to other gasses into the scheme. 203
While U.S. and EU ETS emission allocations may be roughly equivalent in terms
of the volume of CO2, the use and types of offsets available under the schemes is not. As
discussed above, the U.S. plans allow its covered entities to use a greater percentage of
offsets relative to emission allocations and, furthermore, more sources of offsets are
contemplated. Specifically, the U.S. legislature is contemplating domestic forestry
offsets, a type of offset that was only recently rejected by the European Commission.
The Europeans voiced their opposition after the first U.S. draft was released. When
approving the Waxman-Markey Bill, the U.S. legislature seemed to disregard these
concerns by allowing changes to several provisions that increased “the use of offsets,
especially domestic ones, and consequently lower the cost of the program”.204 Without
an agreement between the governments, the inclusion of domestic forestry credits in the
U.S. could enter the U.S. cap and allow U.S. allocations to be exported into the EU ETS.
Participants in the EU ETS would likely object, since the European Counsel has refused
to allow these offsets because of reliability concerns.
Before legislation is enacted, it would be wise for the current U.S. administration
to discuss the use of offsets further. While offsets are a valuable tool in the toolbox for
20 3 Coverage will be extended for Phase III of the EU ETS to include other sectors and GHG emissions, including CO2 emissions from petrochemicals, ammonia and aluminium and nitrous oxide emissions from the production of perfluorocarbons from the aluminium sector: See “The Waxman-Markey Bill and the EU Emissions Trading Scheme: The Basics” McDermott Newsletters (22 May 2009) online: McDermott < http://www.mwe.com/index.cfm/fuseaction/publications.nldetail/object_id/84e2f069-9d58-4fd1-8a7d- d8efdcd7f313.cfm> 20 4EPA, “Ways in Which Revisions to the American Clean Energy and Security Act Change the Projected Economic Impacts of the Bill” (17 May 2009), online: EPA <http://www.epa.gov/climatechange /economics/pdfs/EPAMemoonHR2454.pdf>
57
mitigating the cost of compliance, they are not the only tool. Even in this modest
economy, the U.S. legislature has a large purse and may choose to spend on programs to
lower national emissions and create jobs rather than rely on offsets.
2. Price Control – Borrowing
While both pieces of legislation do not contemplate a price cap, which would
likely severely obstruct linkage with the EU, a U.S. scheme will likely permit borrowing
to meet obligations.205 The delay of emission reduction by a covered entity is not seen as
a best practice by environmental commentators. It is understood that emitters may either
not comply in the future or complain that the cost of compliance has become too great
and the regulator should offer a solution. The European Parliament recently released a
note addressing, among other issues, the issue of borrowing in an emission trading
scheme in the context of linking.206 In that note the authors suggests that if one system
allows borrowing and another does not, a condition for linking should be a restrictive
provision such as, “to allow purchases for the scheme with borrowing only after its
compliance period has been completed and only from companies that did not borrow, i.e.
to allow only ex-post purchases of surplus allowances.”207 The reason for such a
restriction is that emitters should not play the market, selling allocations in year one in an
attempt to, deliberate or not, profit from a lower price subsequent to the sale. Such a
transaction would resemble a short sale of securities.
20 5 20 6 Dingell-Boucher, supra note 102 at s. 715(2) Implications of Linking, supra note 141 20 7ibid.
58
There should be discussion between the EU and U.S. if the legislature intends to
allow borrowing. While such borrowing may provide economic insurance, it may be
unnecessary given both the added liquidity brought about by linking and the relatively
low historical price of allocations. When drafting a final bill, the legislature should
consider dropping borrowing provisions. Rather, it should focus its legislative eye on
improvements to provisions supporting and funding mitigation technologies such as
carbon capture and storage and energy efficiency. In doing so, the legislature will better
prepare the U.S. economy and increase competitiveness with our global partners.
3. Enforcement
While it is too early in the legislative process to comment on the administration of
enforcement, it is fair to comment that the proposed legislative penalties for
noncompliance provisions show their teeth.208 How this is carried forward will
ultimately effect the EU position on liking to the regime, with perhaps more weight than
any other single factor. Indeed, the EU will likely wait for any U.S. regime to be up and
running to have time to measure not only the penalties themselves, but also how well the
Administrator enforces the sanctions for non-compliance. In all likelihood, as the
legislation will likely come with legislative support and fall within the new
administrations mandate, it will be enforced. That being said, so long as the final
penalties and sanctions are at least as stringent as those in the EU, the Commission could
favour approval of linkage on this basis.
20 8 Dingell-Boucher, supra note 102 at s. 713
59
C. Summary of Part V
At present, the U.S legislative proposals are at odds with the EU ETS in several
respects. In some respects, the proposals are miles ahead of the EU ETS, for example by
the inclusion of GHGs other than CO2. However, other aspects, such as the use of
banking, fall short of the EU ETS mandate. It is without a doubt that the U.S. legislature
should be encouraged to draft legislation that is compatible with the EU ETS. The
benefits of a single price control provision should be weighed against the anticipated
benefits in liquidity and flexibility that could result as a consequence of linking. It is also
important to consider where both schemes are ultimately headed and how long it will take
to reach a common objective.
60
PART VI Conclusion
The U.S. legislature must draft with a pen contemplating events that might not
occur until years in the future. Over the last decade the pace of climate change science
and the government response has regrettably both increased and failed to keep up with
the realities as they come into our collective view. Various government reports
concerning the effects and proposed approached are issued weekly, if not by the day.
Suffice it to say, information presented by this paper, timely as it may be, will likely be
out of date by the end of this year. It is tremendously difficult for any legislature to
govern effectively. Addressing climate change on the legislative level will be one of the
greatest challenges of any government dedicating itself to the task.
If it is accepted that we must act to address global climate change, then we must
act globally. The ‘go it alone’ approach that was presented by the United States during
the first half of the century is not compatible with a global effort. It is without a doubt
that the legislature must ensure that the U.S. economy remains strong enough to provide
for their constituents. Future action must be tempered by such a concern, not dictated.
If the U.S. legislature undertakes to enact legislation based on current proposals,
negotiation with the European Union should take place prior to enactment. Linkage
issues and potential solutions should be identified in advance. If the United States and
Europe accomplish this objective, it is likely that the rest of the world will follow. If that
is the case, the U.S. will be part of a global solution to a global problem.
60
61
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