The European Union’s Emissions Trading Scheme (EU ETS) is designed to reduce greenhouse gas emissions in Europe in a cost-effective manner. It is based on the cap-and-trade approach where a carbon market is created on which emission allowances are auctioned. Although today auctioning does not cover the totality of the emission allowances in the EU, it represents the main allocation principle. To create the carbon market and allow auctioning to happen, the European legislators have put in place a system classically involving an auction platform, a monitoring, reporting and verification system, as well as rules regarding transparency and market abuse. This system results in a carbon price which is key to the current structure of the EU climate and energy policy and is a matter of interest for a series of stakeholders. The course will look into the structure and functioning of auctioning under the EU ETS and bring some practical perspectives based on experience before reflecting on the expected evolution of the system.

1. AUCTIONING OF EMISSION ALLOWANCES
UNDER THE EU ETS
SUSTAINABLE EUROPEAN ENERGY & CLIMATE POLICY 6.2
25th March 2016

2. Session contents:
• Introduction
• Principles of auctioning
• Technical provisions
• Perspectives

3. INTRODUCTION
• European Union Emissions Trading Scheme (EU ETS)

4. THE EU ETS DIRECTIVE
• Cornerstone of EU climate policy and main
decarbonisation instrument
• Principle: put a price on carbon

5. SNAPSHOT OF THE SYSTEM
• Objective: reduce GHG emissions + incentivise low carbon technologies
• Design:
 Limit on overall emissions from emitting industry sectors, reduced each year
= cap
 Within this limit, companies can buy and sell emission allowances as needed
= trade
 The carbon price is determined through the balance of supply and demand
of emission allowances
 N.B. Participation is mandatory for sectors covered by the EU ETS Directive
• Scope: more than 11,000 power stations and manufacturing plants in the 28 EU
Member States + Iceland, Liechtenstein and Norway; aviation operators flying
within and between most of these countries
 In total, around 45% of total EU emissions are capped by the EU ETS

6. EU CARBON MARKET
• Trade of EU allowances (EUAs): right to emit 1 tonne of CO2 equivalent
• Default allocation method: auctioning of EUAs
 At the end of a year the participants must return an allowance for every
tonne of CO2eq. they emit during that year
 If a participant has insufficient allowances, there are 2 options: reduce
emissions or buy more allowances on the market
 Exception: free allocation (proportion of the allowances given to certain
participants for free, e.g. in sectors where there is considered to be a
potential risk, if they pay the full cost of all the pollution allowances they
need, that production and pollution could shift to countries with less
ambitious emissions reduction action, a.k.a. the risk of carbon leakage)

7. AUCTIONING -> TRADE
• In 2013, over 40% of the allowances were auctioned
• Share to increase until 2020
Source: European Commission’s Carbon Market Report 2015
43.30%
42.80%
42.20%
56.70%
57.20%
57.80%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
2013
2014
2015
Repartition free allocation vs. auctioning
Free allocation Auctioning

8. EVOLUTION ALONG THE WAY
• EU ETS Phase 1:
 2005-2007
 Learning by doing
 5% of allowances to be auctioned
• EU ETS Phase 2:
 2008-2012
 ETS enlarged to the EEA + aviation
 10% of allowances to be auctioned (in reality only 4% were)
• EU ETS Phase 3:
 2013-2020
 EU-wide cap on emissions
 >50% of allowances auctioned

9. PRINCIPLES OF AUCTIONING
• Legislation in force
• Main actors

10. LEGISLATION IN FORCE
• EU ETS Directive 2003/87/EC adopted on 13th October 2003
 Amended several times; last reform adopted in 2009
 Article 10 deals with auctioning
 “Member States shall auction all allowances which are not allocated free of
charge” and inform the Commission on the use of the revenues thereof
• Auctioning Regulation 1031/2010 adopted on 12th November 2010
 Also amended since 2010
 Rules on the timing, administration and other aspects of the auctioning of
allowances under the EU ETS Directive
 Chapter III: annual volumes of general allowances to be auctioned and
timing and frequency of auctions

11. ROLE OF MEMBER STATES
• Allowances to be auctioned are distributed among the
Member States (Annex I to the Auctioning Regulation)
 The allowances’ property transits to them
 Each Member State must ensure that its share is auctioned
• Distribution rules (Article 10(2), EU ETS Directive):
 88% of historical share of verified emissions in 2005 or on the basis of the
average of 2005-2007 (the highest is chosen)
 10% for certain Member States for solidarity and growth (Article 10c of the
EU ETS Directive)
 2% “bonus” for Member States with emissions at least 20% below the Kyoto
Protocol base-year for emissions in 2005
• Political acceptance is crucial: distribution of allowances for auctioning ensures
distribution of revenues among Member States (burden sharing for EU ETS
sectors)

12. SECTORS COVERED BY THE EU ETS DIRECTIVE
• Power industry with ≥20MW thermal rated input
• Manufacturing industry:
 Energy intensive industries with ≥20MW
thermal rated input, oil refineries, coke
ovens, iron and steel, cement clinker, glass,
lime, bricks, ceramics, pulp, paper and board,
aluminium, petrochemicals, ammonia, nitric,
adipic, glyoxal and glyoxylic acid production
 CO2 capture, transport in pipelines and
geological storage of CO2
 Aviation

13. SHARE OF EU GHG EMISSIONS PER SECTOR (2012)
Source: EEA, EU greenhouse gas inventory, 2014 submission
33%
27%
20%
10%
7%
3%
0%
Energy supply
Energy use
Transport
Agriculture
Industrial processes
Waste
Solvents and other

14. AUCTIONING SECTORS AS FROM PHASE 3
• Power sector: 100% auctioning
 Holds the biggest share of emissions under the EU ETS
 Can pass-through carbon costs (indirect emissions + windfall profits)
 Exception: modernization of the power sector in some Member States
(Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Lithuania, Poland and
Romania) which allows them to give a decreasing number of free
allowances to existing power plants for a transitional period until 2019
(derogation under Article 10c of the EU ETS Directive )
• Manufacturing sectors: share of free allocation (up to a certain level);
the rest of their emissions is subject to auctioning
• In practice at the beginning of phase 3: still limited participation to auctions

15. AUCTIONING VS. FREE ALLOCATION IN PHASE 3
43.30%
42.80%
42.20%
56.70%
57.20%
57.80%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
2013
2014
2015
Repartition free allocation vs. auctioning
Free allocation Auctioning
Source: European Commission’s Carbon Market Report 2015

16. TECHNICAL PROVISIONS
• Auction platforms
• Auction format
• Union Registry
• Monitoring, Reporting and Verification
• Market oversight
• NER300 programme
• Use of revenues

17. AUCTION PLATFORMS (1)
• Phase 3: principle of common auction platform
 25 Member States are using it
 Germany, UK and Poland opted out: parallel action platforms or
arrangements
 EEA-EFTA States auction on the common auction platform as well
• In practice, two auction platforms are in place:
 European Energy Exchange (EEX) in Leipzig
(common platform for the large majority of
countries participating in the EU ETS)
 ICE Futures Europe (ICE) in London (UK's platform)

18. AUCTION PLATFORMS (2)
• EEX:
 Selected by the European Commission
through procurement procedure in 2011
 Contract until August 2016
 Open to buyers anywhere in the EU and the EEA-EFTA (ETS operators or
other bodies holding an authorisation – e.g. financial institutions)
 In practice, also used by Germany and Poland
• ICE: only for UK
• Auctions through the internet; calendars published by the platforms
• Auctions on the basis of the volume of allowances to be auctioned by Member
States, through an auctioneer per Member State
 Around 700 millions EUAs to be auctioned in 2016
 Lots of at least 500 allowances
• Auctioning Regulation: an independent monitor must be appointed;
not done yet

19. AUCTION FORMAT
• Single-round, sealed bid, uniform price auction
• During a single bidding window of the auction, bidders can place any number of
bids, each specifying the number of allowances they would like to buy at a given
price
• The bidding window is open for at least two hours
• Directly following the closure of the bidding window, the auction platform
determines and publishes the clearing price: demand for allowances equals the
number of allowances offered for sale in the auction concerned
• Successful bidders are the ones who have placed bids for allowances at or above
the clearing price (all successful bidders pay the same price, regardless of the
price they specified in their bids)

20. UNION REGISTRY
• Emissions accounting system: monitoring,
verification and recording of emissions
at plant level
• Commission Regulation (EU) 389/2013
of 2nd May 2013 establishing a Union
Registry: ensures the tracking of
allowances
• Single registry operated and maintained
by the European Commission + national
registry administrators in all 31
countries participating in the EU ETS (point of contact)
• Secure web-based application

21. MONITORING, REPORTING AND VERIFICATION
• Commission Regulation (EU) 601/2012 of 21st June 2012
(general MRV) and Commission Regulation (EU) 600/2012
of 21st June 2012 (accreditation of verifiers)
• Compulsory monitoring, reporting and verification measures
under the EU ETS
 Businesses must monitor and report their EU ETS emissions for each
calendar year and have their emission reports checked by an accredited
verifier
 Emissions shall be monitored either by calculation or on the basis of
measurement
• Enforcement:
 Installations report each year by 30th April
 At the end of each year, plant operators surrender allowances to cover
actual emissions of the year
 Sanctions for non-compliance (financial penalties)

22. MARKET OVERSIGHT
• The legal nature of emission allowances and their fiscal treatment are not
defined at EU level
• The auctioned product may or may not be a financial instrument in the meaning
of the EU regulatory framework for markets in financial instruments
• The lion's share of transactions in emission allowances is in the form of
derivatives (futures, forwards, options, swaps), which are already subject to EU
financial markets regulation
• Additional regulation applies:
 Market Abuse Directive 2003/6/EC of
28th January 2003 (MAD): applies to
behaviour and transactions of any bidder
in the EU ETS auctions
 Markets in Financial Instruments Directive 2014/65/EU of 15th May 2014
(MiFID), currently being reviewed (MiFID2): from January 2017, all emission
allowances will be classified as financial instruments

23. NER300 PROGRAMME
• The European Commission is also involved in the auctioning of emission
allowances through the NER300 programme (Article 10a8 of the EU ETS
Directive)
 Programme aimed at promoting low-carbon technologies
 Up to 300 million allowances in the new entrants' reserve (NER)
were available until end 2015 to help stimulate the construction and
operation of CCS or renewable energies commercial demonstration
projects in the territory of the EU
 Reserve dependent on the carbon price: around 2 bn € raised
• The financial support is gathered through the European Investment Bank
(EIB)
• If not sold, the NER300 allowances are to be distributed among the
Member States

24. USE OF THE AUCTIONING REVENUES
• At least 50 % of auctioning revenues or the equivalent in financial value
of these revenues should be used by Member States for climate and
energy related purposes (Article 10 (3) of the EU ETS Directive)
• In practice:
 In 2013, the total revenues for the EU reached
€3.6 bn (European Commission’s report on
progress towards achieving the Kyoto and EU 2020 objectives, 2014)
 The total revenues generated from the auctions between 2012 and
June 2015 exceeded € 8.9 bn (Report on the functioning of the
European carbon market, November 2015)
 Reported use by Member States: 87% of the 2012-2015 revenues
for climate and energy related purposes (ib.id.)
 N.B. “climate and energy related purposes” is a rather large
and undefined category

25. EU AUCTION MARKET IN PRACTICE
0% 20% 40% 60% 80% 100%
2014
2015
2016 (forecast)
2017 (forecast)
2018 (forecast)
EU auction market volume (Mt)
EUAs auction EUAs exchange traded EUAs OTC
EUAs options EUAs aviation
0% 20% 40% 60% 80% 100%
2014
2015
2016 (forecast)
EU auction market value (€ mln)
EUAs auction EUAs exchange traded
EUAs OTC EUAs option
EUAs aviation
Source: Climate Observer, January 2016

26. PERSPECTIVES
• The central role of carbon price
• EU ETS beyond 2020
• Developments at international level

27. CARBON PRICE
• Carbon price plays a central role in the EU ETS: expected to both reduce
emissions and support low carbon investments
• European Commission’s logic: a higher carbon price is needed to
stimulate low carbon investments and reduce emissions…
• European Parliament’s logic: … for instance through enhanced energy
efficiency
• Member States’ logic: it also brings more revenues

28. CARBON PRICE EVOLUTION
Source: Business Spectator

29. OTHER CHALLENGES OF THE EU ETS
• Low flexibility
• Surplus of allowances -> low prices
• Credibility of the system harmed (quick fixes; long term objectives)
Source: European Commission

30. STRUCTURAL REFORM OF THE EU ETS
• Back-loading Decision
 Commission Regulation (EU) 176/2014 of 25th February 2014
 The Commission postponed the auctioning of 900 million allowances from
2013-2015 until 2019-2020 to allow demand to pick up
 Temporary measure only (at least originally)
• Market Stability Reserve
 Commission Decision 2015/1814 of 9th October 2015
 More structural measure
 Aims both at addressing the surplus of emission allowances that has built up
and at improving the system's resilience to major shocks by adjusting the
supply of allowances to be auctioned
 Incorporates the backloaded allowances (therefore backloading is definitive)
 Operational from 2019
 Challenged in court by Poland in January 2016…

31. EU ETS POST-2020
• Legislative proposal published by the European Commission on 15th July
2015: review of the EU ETS Directive for the period 2021-2030
 Fixed auctioning share: 57%
 Modernisation fund: auctioning of 310 millions allowances
43%
57%
• Expected amendment of Auctioning Regulation to follow
6267
7674
853
680 310
Structure total allocation quantity Phase 4 (mln EUAs)
Free allocation to industry Auctioning 90% based on verified emissions
Auctioning 10% redistribution Article 10c (max.)
Modernisation fund 2%

32. TOWARDS A GLOBAL CARBON MARKET?
Source: Carbon Pricing Watch 2015, World Bank

33. INTERNATIONAL LEVEL
• Is a global carbon market possible any time soon?
• The Paris Agreement contains progress in this direction
• However disparity among the instruments used around the world
remains: the EU ETS setup based on auctioning is far from being global
 Quebec’s ETS is the most similar to the EU ETS with 100% auctioning
for the power sector
 There is a limited auctioning share in California’s ETS (around 10%)
 Auctioning will start in 2018 in the Korean ETS at a 3% level
 The 7 ETS pilots in China are mainly based on free allocation
• Linkages with other ETS-like systems are a possible first step

34. THANK YOU!
Iva Ganev
ganev@euroalliages.be