Supply of Additional Credits

In general CERs are cheaper than EUAs, even though the price of CERs reacts very similarly to those of EUAs, (especially) from 2008 on. The main reason, why CERs are not as expensive as EUAs, is uncertainty. During Phase I it was uncertain when the infrastructure for the CERs was going to be ready. Also the overall supply level of CERs was unknown. These additional uncertainty factors had a lowering effect on the CER prices, since fewer market participants were willing to invest in such a highly uncertain asset. Still, offering this additional, slightly cheaper emission permit, in turn, has a lowering effect on the price of the EUAs. With the infrastructure in place and trading experiences gained, the prices of EUAs and of CERs (and from 2008 also from ERUs) are expected to assimilate more and more – with the EUAs remaining slightly higher, as the use of CERs has been limited (starting in Phase II) according to the percentage fixed in the NAPs of each Member State. Broadening the market has a positive effect for the participants. A larger market is more stable and thus reduces price volatility. With higher market liquidity, uncertainty for the players is reduced. Higher market confidence makes long-term investment decisions easier.

Ireland, Finland and the Netherlands rely on these flexible mechanisms of the Kyoto Protocol to a substantial degree. The European Commission therefore limited the share of CDM and JI credits made available to the Member States, since a high percentage relocates the measures against climate change to other countries, all the while not guaranteeing the success of the projects.

During Phase I linkage did not play a central role. At first, there was demand for CERs until the end of April 2006, but no supply. When there was finally supply in the end of 2007, there was no more demand. CDM and JI projects have a year- long lead time. The “Linkage Directive” was only issued in 2004; too short for projects to be chosen, approved and certified. Also, the registry link that finally enabled the use of CERs was not in place until 2007. The ITL, that supervises trades from all Kyoto Flexibility Mechanisms (Emission trading credits – EUAs, JI credits – ERUs and CDM credits – CERs) linked to the CITL (which only supervises the EUAs, thus making the use of CER credits, even though it would

have been allowed, impossible until then) on November 14, 2007. At that time, the EUA price was already down to zero and with it the demand to purchase additional credits. Thus, no project based credits were surrendered 2005-2007. CERs finally became available in the end of 2007. As CERs are credits from outside the system, they do not fall under the banking restrictions. At that time EUAs for Phase II had a value of around EUR 20, while Phase I EUAs had none. Thus, all CERs that could have been used in Phase I were banked for Phase II. The amount that can be banked is limited to 2.5 per cent of the Member State’s Kyoto target for CERs and 2.5 per cent for ERUs.

The high demand in the beginning of the first trading phase showed that CERs would become increasingly important in the near future. The European Commission has added a twelfth criterion to its Annex III of the “Emission Directive”, that have to be taken into account for the development of the Phase II NAPs, concerning the supplementary of CDM and JI credits and published new guidelines on how the Annex III criteria were to be interpreted. The European Commission (2006a) limited the overall amount of CDM and JI credits, deciding that no more than “half of the effort undertaken by a Member State, taking into account government purchases, is made through the Kyoto flexible mechanisms” and elaborate on the calculation of the exact amount, that in “practical terms the Commission assesses consistency with supplementary obligations based on the following formulae:

A = base year emissions – emissions allowed under Kyoto target B = greenhouse gas emissions in 2004 - emissions allowed under Kyoto target

C = projected emissions in 2010 – emissions allowed under Kyoto target D = 50% of Max (A, B, C) – annual average government purchase of Kyoto units

Maximum allowed limit (in %) = (D/annual average cap) or 10%”

This means that Member States may, additionally to their domestic measures, buy 50 per cent project based credits. If the government buys many credits, fewer are available for the private sector. To avoid that the government excludes the private sector completely from the additional credit system, the European Commission

decided that installations were allowed to use flexmex credits by up to 10 per cent in addition to the allowances they were allocated. If an installation wants to use more than the 10 per cent limit, the Commission, upon deciding if increasing the limit is reasonable, takes into account the Member State’s “path to Kyoto”. The reason for the European Commission’s decision to limit the level of allowed CERs and ERUs is obvious. If there was no limit, the Member States would import as many credits as they needed to cover their entire shortage. Without shortage the price for EUAs would be too low to encourage abatement.

Table 10 lists the project-based credit limits as stated in the NAPs of the individual Member States for Phase II.

Point Carbon analysed that with the present solution the import of credits “will not be enough to cover the entire short in the EU ETS [because …] the limits are per installation level. Thus for the full import potential to be realised, each installation across the EU ETS would have to submit imported credit for compliance. With so many diverse installations (and companies) across all sectors and countries, there is reason to believe that the full import will not be realised.” (Point Carbon 2007) Of course the credits will reduce the need for internal abatement, but not to the extent it would have without the limit.

Table 10 Credit limits of the Member States in Phase II, all in Mt/year33