As of February 2006 161 countries had ratified the 1997 Kyoto Protocol, which entered into force on February 16, 2005 (United Nations 2006). The Protocol signifies broad international agreement that the developed nations should take the lead in reducing greenhouse gas emissions, the bulk of which have been emitted from the industrialized world.

The European Union’s leadership in the climate change arena was evident before the Protocol formally went into force. In 2000 the European Union (E.U.) initiated the comprehensive European Climate Change Program. A cornerstone of this program is the Greenhouse Gas Emission Trading Scheme, or the E.T.S. (European Union 2003), which was launched in 2005 and is the most ambitious emissions trading system ever established.

This paper describes how the E.T.S. is working thus far and it also asks what U.S. policymakers can learn from the E.T.S.’s early implementation as they develop climate change policies in the United States. The greenhouse gas reduction plans implemented across the E.U. necessarily vary because each Member State’s regulatory, historical, political, and economic circumstances are unique and because each country has a different emissions goal under the E.U.’s climate change burden-sharing agreement. These sundry approaches offer a diverse range of experiences to draw on as U.S. policymakers try to craft greenhouse gas regulatory schemes at the state, regional, and national levels.

Any evaluation of the E.T.S. must be regarded as preliminary as it went into effect little more than a year ago. Still, the E.U.’s policies represent the most ambitious effort in the world to address climate change and, as such, it makes sense for U.S. policymakers at all governmental levels to understand the practical details of the European experience to date. And to the extent that U.S. policymakers would like to link domestic market-based programs with trading opportunities elsewhere in the world, it helps to appreciate the ways in which the design of domestic programs can facilitate or hinder that end.

This paper is organized as follows: (a) background on the European Climate Change Program; (b) general observations about the E.T.S.; (c) E.T.S. National Allocation Plans; (d) allowance trading in the E.T.S.; and (e) linking the E.T.S. with projects and programs outside of the E.U. Many sub-topics are treated within these broader categories, including but not limited to: the use of so-called “project-based” mechanisms (the Clean Development Mechanism and Joint Implementation); costs and benefits of greenhouse gas reductions; allowance price caps; non-E.T.S. greenhouse gas reduction measures; competitive effects; and, centralized vs. decentralized government control.

This research is supported by, and it has been completed in collaboration with, the Pew Center on Global Climate Change. The author acknowledges the invaluable support of Patrick J. Roach, who provided expert research assistance and whose thoughtful, knowledgeable input has greatly enriched all aspects of this work. Appendix A lists the E.T.S. experts who provided interviews, information, and/or comments. Without their gracious help this paper would not have been possible. Pew Center staff provided insightful questions and comments.

This paper does not give a detailed overview of the E.T.S. Readers seeking more background information on how the program works may consult either the Pew Center’s recent paper on this topic (Pew Center on Global Climate Change 2005) or the European Commission’s internet sites on the European Climate Change Program and the E.T.S.