The European Union’s (EU) Emissions Trading Scheme (ETS) is a cornerstone of the EU’s
efforts to meet its obligation under the Kyoto Protocol. It covers more than 10,000 energy
intensive facilities across the 27 EU Member countries; covered entities emit about 45% of the
EU’s carbon dioxide emissions. A “Phase 1” trading period began January 1, 2005. A second,
Phase 2, trading period began in 2008, covering the period of the Kyoto Protocol. A Phase 3 will
begin in 2013 designed to reduce emissions by 21% from 2005 levels.

Several positive results from the Phase 1 “learning by doing” exercise assisted the ETS in making
the Phase 2 process run more smoothly, including: (1) greatly improving emissions data, (2)
encouraging development of the Kyoto Protocol’s project-based mechanisms—Clean
Development Mechanism (CDM) and Joint Implementation (JI), and (3) influencing corporate
behavior to begin pricing in the value of allowances in decision-making, particularly in the
electric utility sector.

However, several issues that arose during the first phase were not resolved as the ETS moved into
Phase 2, including allocation schemes and new entrant reserves, and others. A more
comprehensive and coordinated response by the EU has been made for Phase 3 with harmonized
and coordinated rules being developed by the European Commission.