At a time in which global debate rages over the post-2012 carbon framework, the European Union (EU) is undertaking a number of reforms to strengthen and expand their commitment to address EU greenhouse gas emissions, including expanding the EU emissions trading scheme (ETS).

The EU reforms strengthen the EU ETS through the expansion to sectors previously not covered, including global aviation. These reforms take place in a broader context of international political and economic debate regarding the shape of the post-2012 emissions reduction framework.

The shape of the post-2012 framework will have an immediate and significant impact not only on currently or imminently operating emissions trading schemes (such as the EU ETS and the Australian ETS), but also on the rapidly growing global carbon market.

2012 marks the end of the first commitment period - not the end of Kyoto

Although it has been widely publicised that the Kyoto Protocol expires in 2012, such commentary is misleading. The importance of the year 2012 is simply that the first (of potentially many) commitment periods under Kyoto ends.

The Kyoto Protocol, which has been in force since February 2005, was created under the auspices of an earlier, 1994 global agreement - the United Nations Framework Convention on Climate Change. The Kyoto Protocol’s first commitment period started on 1 January 2008 and lasts until the end of 2012. During the first commitment period, countries listed in Annex B to the Protocol accepted obligations to limit their carbon emissions (as against 1990 levels). It is whether there will be future commitment periods, how and on who they will operate, as well as the detail of the obligations to be contained in any later commitment periods agreed to, that is the subject of contemporary debate.

With the future of the Kyoto regime in the throes of global political negotiations (most prominently at last December’s Bali Conference and most recently in Ghana in August) the scope of possible outcomes range from mild tinkering of the commitment numbers, to a large scale replacement by a fundamentally different regime (see for example submissions made by Japan). What is currently considered the most likely outcome is a building upon and broadening evolution of the Kyoto Protocol infrastructure, with or without a second commitment period (2013 to 2017).

Emissions Trading Schemes are the Kyoto Protocol in action

The Kyoto Protocol provides for three market-based mechanisms for countries to meet their emissions reductions target:

• Emissions trading;
• Clean development mechanisms (CDM) and
• Joint implementation (JI) projects.

With the future of the Kyoto Protocol uncertain post-2012, the future of the emissions trading schemes that link or seek to link to it (eg the EU ETS and the imminent Australian ETS) is also under a cloud of uncertainty.

While the current schemes are here to stay, the content, operation and global impacts of them will be affected by the outcome of the negotiations. Moreover, the post-2012 carbon framework may extend the obligations to reduce emissions to new frontiers - such as the USA and the developing world.

China’s October White Paper

Insights into China’s latest position on climate change, crucial to a long-term global climate change solution, were revealed in a recently released Government White Paper. The China State Council’s China’s Policies and Actions for Addressing Climate Change proposes to ‘address climate change within the framework of sustainable development.’ Key policies China seeks to implement include:

• Further developing renewable energy
• Developing a recycling economy, and
• Enhancing public awareness to foster a social environment conducive to addressing climate change.

EU ETS pushes ahead with reform

Notwithstanding this global uncertainty, and the need to overcome considerable practical and political difficulties, the EU is pushing ahead with its plan to expand and strengthen the EU ETS. The EU ETS, which has been operating since 2005, has largely focused on stationary sources to date. However, the most high profile of the recent amendments is the proposed inclusion of aviation from 2011. Debate continues over the possible future inclusion of shipping.

The recent financial turbulence global and EU markets are encountering may temper the resolve for reform - for example, in light of the economic crisis EU negotiators recently mooted a three-year delay until 2015 on proposed obligations on car makers to reduce the carbon dioxide emissions of their new vehicles.

Aviation and Maritime Emissions

The Kyoto Protocol mandated the International Maritime Organisation (IMO) and the International Civil Aviation Organisation (ICAO) - as opposed to individual nation states - with the task of reducing their industries’ emissions. While international groups canvas responses to reduce emissions, the EU will unilaterally impose obligations on the aviation industry and has threatened to do so in relation to shipping. Both EU actions have global implications.

Aviation’s imminent inclusion: Global reach of carbon market irrespective of home jurisdiction

The imminent inclusion of aviation under the EU ETS will mark the first truly global industry to be subject to legally enforceable emissions permit trading (as opposed to the current voluntary market).

Key features of the EU proposal include:

• all intra-EU flights will be covered from 2011
• all flights to/from an EU airport will be covered from 2012
• over-flights will be exempt
• the reductions are separate from Kyoto commitments
• emissions allowances will be specific to aviation and will not be able to be traded to non-aviation sectors, although the aviation sectors’ use of CERs and ERUs (up to 15% of allowances to be surrendered) will be allowed
• the allowance surrender obligations will fall on aircraft operators, and where they are not identifiable, the aircraft owners, which creates a potential carbon risk impact for aircraft lessors and insurers
• penalties will be €100/tonne for insufficient allowances, and importantly
• the scheme will cover all aircraft - irrespective of their home jurisdiction.

One key issue yet to be addressed is, how will non-stop and single/multi-stop journeys over the same route be treated (eg a journey from Hong Kong to London, via Dubai compared to Hong Kong to London direct), to ensure equality of competition for overseas carriers.

Shipping: Wallowing in the waters

Shipping’s lack of advances in relation to greenhouse gas reductions is in part attributable to the greater challenges shipping throws up (for example the laws of the sea and the complex and well entrenched laws surrounding flags of convenience). The IMO has recently made progress towards developing a mandatory regime to control greenhouse gas emissions (most recently in a June 2008 meeting in Oslo), through, for example, the development of a mandatory CO₂ Design Index for new ships. Once finalised, the index will serve as a fuel-efficiency tool at the design stage of ships, enabling the fuel efficiency of different ship designs to be compared.

Hanging over the IMO deliberations is the growing political momentum for shipping’s inclusion in the EU ETS - in the absence of any action by the IMO, it is likely shipping will soon become another EU ETS covered sector.

A global or regional maritime solution will see significant worldwide implications on (among others) shipping lines, owners, operators, exporters, importers and insurers, and would focus international trade’s attention on carbon risk.

Significant times ahead

The outcome of the ongoing Kyoto Protocol negotiations, combined with EU ETS, ICAO and IMO reform moves, will have a significant impact on many global businesses, not least of which includes the aviation and shipping sectors.