Green Paper on greenhouse gas emissions trading within the European Union

Dear Mr. Delbeke,

We refer to the Green Paper COM(2000)87 dated 8 March 2000 and its invitation to submit reactions and opinions. We further refer to previous contacts with the Commission on the issue of emissions trading, which has also been an item for discussion between the Minister for the Environment and her Nordic and other European colleagues, as well as Commissioner Wallstrøm.

Norway welcomes the Green Paper as a very constructive and interesting contribution to developing emissions trading as an appropriate measure to reduce greenhouse gas emissions. We hope it will lead to intensified efforts among the stakeholders both inside and outside the EU member states to make emissions trading a practical and effective vehicle for i.a. complying with the Kyoto Protocol. In order to make emissions trading feasible, we see a need for considerable "technical" preparations, awareness raising and the necessary political will to take decisions on a pragmatic and flexible basis.

As you are well aware, Norway is currently developing a national emissions trading system, and our process necessarily addresses most of the same issues and appears in several respects quite similar to the process within the European Union. The Norwegian Parliament (the Storting) decided in 1998 to set up a Quota Commission to discuss a national quota system as a part of the Norwegian strategy to implement the Kyoto Protocol. The Quota Commission published its report in December 1999 (see English summary on www.miljo.no). There was a public hearing until 30 April 2000, entailing responses from more than 40 stakeholders in the process. The Government is currently preparing a White Paper, which we intend to present to the Norwegian Parliament in spring 2001, pending the outcome of COP 6. In parallel we are developing the necessary legislation for submission to the Parliament following its discussion of the White Paper.

Our comments on the Green Paper will to a large extent be based on the discussions in the Quota Commission’s report, as well as some observations from the subsequent process both in Norway and in the European Union.

We have noted with satisfaction the references on page 16 in the Green Paper to the need to "take account of the particular status of non-EU countries in the European Economic Area, that may have their own emissions trading schemes or wish to be included in the Community scheme", … "and the possibilities of joining or enlarging the Community system through mutual recognition could be further explored."

Under the Kyoto Protocol, it is our aim that the emissions trading system should cover as many Annex B Parties as possible, and that it should also utilise the other Kyoto mechanisms Joint Implementation and the Clean Development Mechanism. A broad system would generally ensure a more effective and efficient market, with more effective market institutions and less possibilities to use market power. Thus, we are positive to cooperate with the EU Member States and the Commission, as well as others, in developing such a system and exploring the possibilities referred to in the Green Paper.

The Community’s regulations on inter alia state support are applied in Norway through the application of the EEA agreement. In the event that a quota system, or elements of it, is considered relevant for the EEA agreement, it will be necessary to develop our emissions trading scheme in close contact with the relevant authorities.

Emissions trading is seen as an instrument that could give more room for flexibility regarding economic burden while delivering an environmental result in a more cost-effective way than today’s application of policies and measures. In the following we would like to concentrate on some of the main issues raised in the Green Paper and in the report of the Norwegian Quota Commission.

Coverage of sectors and gases.

Our comments on the coverage relate to the questions 1 – 4 in the Green Paper. The Green Paper advocates a fairly narrow system, at least to begin with, covering only CO ₂ from mainly major point sources in electricity and industrial production. This would include about 45 % of the EU CO ₂ emissions. The fraction of CO ₂ , as well as of all greenhouse gas emissions from such sources in Norway would be less than 30 %, since we at present have practically no emissions from electricity generation. In contrast the Norwegian Quota Commission has argued that the system should be as comprehensive as possible and could, based on the 1997 inventories, cover 90 % of the Norwegian greenhouse gas emissions. The widest possible coverage of the trading system should ensure that the environmental result is achieved with a high degree of certainty and at a minimum cost, which is relevant to the Green Paper’s question 7 and 8.

Such wide coverage would require improved and more disaggregated emission inventories for several source categories in Norway, to enable the necessary control mechanisms to function in the system. We note that different countries at present have different inventory systems, and that for some it could require a substantial effort over some time to produce inventories that could support a comprehensive quota system. This might be an important argument for accepting varying coverage in different countries participating in the system.

In exercising flexibility regarding the scope of participation in the EU system, one would avoid a ‘lowest common denominator’- system. Allowing individual Member States to include more sectors in their domestic trading schemes than what is covered by a Community scheme might be a way to improve the system’s cost-effectiveness. Such flexibility might also be useful if the Community system is to be compatible with an international trading system among the Annex B countries.

Allocation of quotas and the issue of state support.

The polluter pays principle is a central element in both European and Norwegian environmental policy. In our view, the polluter pays principle should as far as possible be adopted for emissions of greenhouse gases. Both the Quota Commission's report and the

hearing show that there are different views as regards whether or not to allocate quotas free of charge ("grandfathering"). Our comments here are relevant for the Green Paper’s questions 1– 4 and 6.

A majority in the Norwegian Quota Commission recommends that all concerned pay full market price for emission quotas in line with the polluter pays principle. An ambitious climate policy demands cost-effective measures. Measures that increase the costs of meeting environment targets, such as the allocation of free quotas, will make it more difficult and even more costly to set more ambitious targets in the future. The majority believes that the benefits achieved by allocating free quotas are disproportionately small in relation to the increased costs which would be imposed on the rest of the economy.

Important stakeholders, as for instance the Confederation of Norwegian Business and Industry, are advocating that parts of the industry should get quotas free of charge. Generally, inclusion in a quota system of an activity/industry that is presently exempt from economic policies and measures such as taxes, implies increased economic burdens on this activity/industry, even if a portion of the quotas is allocated free of charge. This is important to bear in mind when the issue of "grandfathering" will be considered in the context of state support regulations.

We have noted that there is a separate process to revise the Community guidelines for state aid for environmental protection, and that emissions trading systems for greenhouse gases have been brought up in that context. We see it as important that these guidelines will be compatible with a well functioning, cost effective and politically acceptable quota system.

The Norwegian government has so far not taken a position on the matter of "grandfathering", but we would like to make a few observations. Generally, accepting "grandfathering" would make it more costly to reach a national target than if all polluters initially faced the same price on their emissions. However, those who believe there is a case for "grandfathering" are often afraid that the quotas system would otherwise worsen the industries’ competitive position, and that there could be leakage effects that could substantially reduce the environmental effects from the domestic trading system in a situation where the industry in other countries do not have to bear similar costs.

Firstly, we note that sale of all quotas would meet the requirement to create equal competitive conditions for industry inside the quota system. Still, exclusion of some sectors, sources or gases, from the system, could generally give the exempted activities the same advantages as if they had been given enough quotas free of charge to cover their emissions, given that the exempted activities do not have to implement other measures entailing costs. Thus, the coverage of the system is clearly linked to the question on "grandfathering". A broad system which covers as many sectors as possible and where emitters have to pay the same price for the quotas would be in line with the polluter pays principle.

Secondly, the case for allocating quotas free of charge could be different for different sectors depending on their competitive position. Some industries compete on a domestic market, others on a regional one (i.a. Nordic or European), and some against industries located in developing countries that do not have quantitative commitments to reduce greenhouse gases. The Norwegian Quota Commission carried out analysis for different industries that showed quite different effects from payment for quotas, and this analysis has been widely commented in the hearing process.

Thirdly, the way in which allocation of quotas free of charge could be carried out merits careful consideration. The Quota Commission investigated this issue as far as its time limitation permitted. It recommended an allocation based on historical emissions as a simple and practical way. It’s worth noting that this recommendation was also similar to the recommendation from the Confederation of Norwegian Business and Industry, carried out through a comprehensive process among its members.

The Quota Commission gave much attention to whether or not quotas allocated through "grandfathering" should be tradable. It was noted that fully tradable quotas contribute to a cost-effective reduction of emissions. However, a majority held the view that firms should not be able to sell quotas directly acquired through "grandfathering". Thus, they recommended that if the quota system includes "grandfathering", quotas allocated this way should not be tradable.

Since the publication of the report, we have seen that the EU Commission has approved the Danish system for emissions trading to come into effect next year. We have noted, however, that it has demanded that new entrants to the Danish electricity market should also be given quotas free of charge based on objective and non-discriminatory criteria. We are not aware that there has been a subsequent further specification or application of such criteria. The Quota Commission argued that, as far as it was able to conclude given the limited time available, alternative ways of allocating quotas, such as normative allocation on the basis of unit of production, appeared complicated and possibly impractical, or they could have other deficiencies compared with using the historical emissions as basis. In the longer term, when the system could become a tool to comply with the Kyoto Protocol commitments, we would also emphasize the need to keep the total amount of quotas under control.

The Quota Commission’s mandate furthermore explicitly stated that new entrants to the market should not be given quotas free of charge. The Quota Commission pointed out that this could constitute a competitive disadvantage for such enterprises, but did not discuss the issue in depth. However, some of the members of the Quota Commission argue that new entrants to the market will know well in advance (when the introduction of the quota system is decided on in Parliament) that there will be a cost attached to the emission of greenhouse gases. They will therefore have the opportunity to take this into consideration when deciding on whether or not to undertake investments to enter the markets. Also, the question of giving new entrants quotas free of charge or not should be considered in light of the period such quotas are granted for entities that are already in the market. If the amount of quotas free of charge to such entities decline over the period 2008-2012, and reach zero by the end of it, the competitive disadvantage for new entrants would be smaller.

How the European Community will solve the issue of allocation could have substantial consequences for non-members as well. If the Community, or some of its Member States, chooses to allocate quotas free of charge to their industry, this could obviously create additional arguments for "grandfathering" also in Norway and other countries.

Phasing in the system

Turning to what the Commission has called "a learning-by-doing" approach, we recognize that this strategy could have several advantages - not least due to the many scientific and practical problems at this stage, and the different starting points among the Member States. The suggested step-by-step approach might also increase the system’s legitimacy among key actors in the industry. Although the Norwegian Quota Commission has chosen a somewhat different recommendation, suggesting a broad system to be introduced by 2008, it has clearly recognised that introducing certain elements of the system early would be important to create the right incentives to the industry and to gain some early experience e.g. with regulations for reporting and control routines. However, it should be possible to introduce a broad system for those countries that have the technical capabilities and prefer to do so already in an initial phase. Here we would note that in Norway the stakeholders already have shown a general acceptance regarding the establishment of a broad quota system to comply with the Kyoto Protocol.

The Green Paper suggests that the EU system could start in 2005. Before 2008 there are no quantitative commitments under the Kyoto Protocol, and consequently no compliance regime addressing such commitments. The Quota Commission concluded that if the purpose was solely using emissions trading to comply with the Kyoto Protocol, it would not be necessary to establish the effective regulation by quotas before 2008. The Quota Commission did not address an early system as an alternative to the present set of policies and measures. It noted, however, that a number of issues would have to be dealt with in such an event; notably setting a ceiling for the emissions. There will also be a need to address the market structure and develop a compliance regime for the period up to 2008. These issues are relevant to the Green Paper’s questions 5 and 10. Such a system would also have to be established in the absence of the Kyoto mechanisms. In the hearing process the industry has expressed interest in an early start with voluntary participation in the system, while it has expressed reservations regarding a mandatory system before 2008.

Other issues

The technical issues related to emissions trading are fairly similar for both the EU and Norway. We would like to point to the extensive work that has been carried out by the Norwegian Quota Commission also on issues that we are only briefly addressing in this letter, which we hope could be useful in the further EU process. The Quota Commission’s report discusses the organisation of the secondary market for emission quotas. The market institutions and many of the actors on that market could be the same in Norway and in a European market.

For several sources of emissions it is possible to choose different legal entities as responsible for holding quotas. Regarding fuels, one would have to choose between an upstream and a downstream system. In other sectors, the choice could be between plant or company levels. Within a broad international system it appears possible with different solutions for different countries also on this aspect of the system. Still this is an issue that needs further attention both at the domestic and international level.

The Norwegian Government has to work further on how the quota system could be integrated in our domestic legislation. Obviously, such legislation must be compatible with our application of the relevant EU regulations through the EEA agreement, such as the IPPC-, mineral oil- and various waste directives. We assume that there could be a need to address these directives also from the Community’s side to make sure that they are compatible with the establishment of a broad international trading system. It is stated in the mandate of the Norwegian Quota Commission that "the Storting has decided that emissions subject to regulation through quotas should not be taxed or regulated by the Pollution Control Act."

The Quota Commission started to address the issues of reporting, control and sanctions. Here there is a considerable need to take the work further, which the government is currently doing. We believe there could be advantages in comparing notes internationally in the process.

It is important that countries are developing national emissions trading systems that, when the Kyoto Protocol enters into force, are compatible with the full use of the Kyoto mechanisms from the first commitment period. Such systems for emissions trading would depend on involving legal entities in the use of the Kyoto mechanisms to be efficient. This issue has been given little attention in the Green Paper.

As you are aware, we have for many years been working closely with our Nordic colleagues in exploring flexible means of implementing commitments to reduce greenhouse gases, and at present we are looking at ways to make the Baltic region a testing ground for the Kyoto mechanisms. This work must be coordinated with the efforts of the EU countries’ and the Commission to develop emissions trading.

Finally, we will once again emphasize our keen interest in continuing the close dialogue with the EU Commission as well as the EU member states on this issue.

Yours sincerely,

Eldrid Nordbø

Director General

Copy: The Interministerial Group on Climate Change and Acid Rain Issues (KLISUR)

The Norwegian Delegation to the EU