NOU 2000: 1 A Quota System for Greenhouse Gases (Summary)

A Quota System for Greenhouse Gases

Letter to the ministry

To the Ministry of Environment

"The Quota Commission" was appointed by Royal Decree on 23 October 1998 to draw up a national trading system for greenhouse gases using quotas and based on the Kyoto Protocol. The Commission herewith presents its recommendations.

Oslo, 17 December 1999

Eva Birkeland,
Chair

Nina Bjerkedal
Øystein Dahle
Cathrine Hagem

Gerd Halmø
Anders Haugestad
Michael Hoel

Peer Stiansen
Bent Fester Sunde
Ingun Hagesveen Weltzien
Lars Erik Aamot

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Anne Beate Tangen
Åse Bøe
Kjersti Flåthen
Mette Møglestue
Line Vogt
Vebjørn Wiken

1 Introduction

The threat posed by major climate change as the result of human activity is perhaps the greatest environmental challenge the world has ever faced. The UN Framework Convention on Climate Change was adopted in Rio in May 1992 and entered into force two years later. In December 1997 a Protocol under the Climate Convention was adopted: the Kyoto Protocol.

The Kyoto Protocol is an important first step towards fullfilling the Convention's objective: to stabilise greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system. The aim of the Protocol is to reduce emissions of the most important greenhouse gases to at least five per cent below 1990 levels within the period covered by the agreement, 2008-2012. Norway's commitment under the Protocol is that its greenhouse gas emissions during the period 2008-2012 will not be more than one per cent higher than in 1990.

The Protocol builds on important principles such as burden-sharing (differentiated commitments) among countries, and cost-effectiveness in fulfilling commitments irrespective of country, industrial sector or the greenhouse gases themselves. A key element in this context is the so-called Kyoto mechanisms, which enable industrial countries to trade emission quotas and creates various forms of cooperation among the industrial countries themselves (joint implementation projects, JI) or between industrial and developing countries (the clean development mechanism, CDM).

The macroeconomic calculations carried out in connection with the Government White Paper no. 29 (1997-98) on implementation of the Kyoto Protocol, indicate that the total cost to the national economy could be trebled if Norway were to choose only cost-effective domestic measures for reducing emissions instead of free use of the Kyoto mechanisms.

Norway has been one of the countries concerned to set up an effective system for using the Kyoto mechanisms, not only in order to comply with the existing Protocol, but also because these principles will be an important basis for future rounds of negotiations. In the international process, regulations and guidelines for using the Kyoto mechanisms are to be adopted at the sixth Conference of the Parties to the Convention in November 2000. In parallel with this process, a number of countries, including Norway, have set to work evaluating national systems for quota trading, and ways in which national policy instruments can be linked to the Kyoto mechanisms. "The Quota Commission" was appointed by Royal Decree on 23 October 1998. Its mandate was to draw up a national trading system for greenhouse gases using quotas and based on the Kyoto Protocol.

The total cost to the Norwegian economy of meeting the Kyoto commitments is largely conditional on how both the Kyoto mechanisms and the national instruments are framed. Current climate change policy, in which CO2 taxes are the basic instrument, is characterized by big differences in the pricing of greenhouse gas emissions in different sectors of the Norwegian economy. This means that some sectors, such as petroleum and private transport, have adapted to relatively high CO2 taxes. As a result, measures taken in these sectors have been significantly more expensive than in others, a development which is likely to restrict severely any short-term prospects for further reductions at a realistic cost.

This sheltering of high-emission industries has been justified by fears that unilateral Norwegian measures affecting these companies could lead to redundancies and to the expatriation of Norwegian industrial companies operating in competitive markets. Some of these companies are based in the regions, in localities with a single source of commercial activity, where the potential for establishing alternative businesses can be limited, at least in the short term. Some companies in Norway will continue to compete with companies in countries which have not assumed quantitative commitments under the Kyoto Protocol. There is also uncertainty as to the strength of the measures that might be applied to competing companies in countries which have such commitments under the protocol. At the same time it is hard to see how pursuing an ambitious policy on climate change, in Norway and other countries, can fail to have long-term consequences for the industrial and commercial structure.

One of the most difficult challenges facing the Commission has involved precisely this apportioning of emission reductions among various sectors in the Norwegian economy. Shaping a quota system that will bring about a cost-effective fulfilment of Norway's Kyoto commitments will at the same time exert great pressure for change in the most greenhouse gas-intensive industries, notably the refineries, the metallurgical industries and chemical raw materials producers. Failing great technological advances, we must expect some of the high-emission industries to become unprofitable and to be closed down or expatriated. At the same time, new investment in these sectors could become less attractive. Such policies will therefore encourage a commercial sector in Norway that is less greenhouse gas-intensive. If this leads to increased production and therefore emissions from foreign industries, e.g. energy-intensive companies using high-carbon fuel or operating at lower energy efficiency, there will be a risk that global emissions could increase in response to the changes in Norway's commercial structure.

A central concern of the Commission has been the criteria for the allocation of quotas. Selling the quotas at market prices and allocating quotas unconditionally and free of charge will ensure that emission reductions are cost-effective. As we have seen, however, such measures are also likely to give rise to incentives for change in the commercial sector. Discussions on quota allocation have also taken account of the effect of free quotas in terms of lost income which otherwise would have contributed to reductions in taxes and surcharges, with reduced efficiency in the utilization of resources in the Norwegian economy as a consequence.

In its proceedings the Quota Commission has stressed the need to address the political choices facing the nation in devising the policy instruments, including the quota system, for fulfilling the Kyoto commitments. In some cases the Commission has thought it appropriate to make concrete recommendations. In those cases where the Commission has made no such recommendations, it has concentrated on making clear the consequences of the various courses of action discussed.

This chapter outlines the proceedings and recommendation of the Commission.

By and large the chapter follows the organization and approach of parts III and IV of the report as follows:

*Considerations in evaluating the role of the Commission, defining

its mandate, and implementation

*Main features of the quota (the emissions certificate)

*Scope of the system (which emissions should be included)

*Selection of legal entities subject to regulation by quotas

*Allocation of quotas

*Liquidity and organization of the quota market

*Application of the Kyoto mechanisms

*Phasing-in the quota system

*Reporting, controls and sanctions

*Legislative framework for the quota system

2 Some main considerations in evaluating the role of the Commission, defining its mandate, and implementation

The Quota Commission was established in accordance with decisions taken in the Storting during discussions of the Proposition to the Storting no. 54 (1997-98) on green taxes, and Government White Paper no. 29 (1997-98) on Norwegian implementation of the Kyoto Protocol. The mandate of the Commission, which is set by Government, also comprises the parliamentary guidelines worked out during discussions of Proposition. 54, cf. as contained in the Parliamentary Committee's paper Innst. S. nr. 247 (1997-98).

The Commission thought it appropriate, at an early stage in its deliberations, to discuss central policy goals and other considerations in the framing of a quota system, and to interpret key points in its mandate. The Commission infers that its deliberations and proposals for a quota system and other measures are based on the assumption that the main goal of the system is to fulfil Norway's commitments to limit emissions under the Kyoto Protocol. It is further assumed that cost-effectiveness and capacity to ensure that commitments are met are primary considerations in the formulation of environmental policy instruments, including a quota system. The mandate also emphasizes other considerations; and in some areas conflicts could arise as a result of these varying points of emphasis. This is apparent, inter alia, in assessments of how the quotas should be allocated.

The Commission has aimed to keep within the terms of its mandate and to avoid discussing or issuing recommendations on related political issues. The Kyoto Protocol has not yet entered into force, and some of the elements in the Protocol still remain unclear. In its deliberations the Commission has assumed that the Protocol will come into force and that a regulatory framework for utilization of the Kyoto mechanisms will be established. The Commission points out, however, various implications of introducing a domestic quota system independently of the Kyoto agreement.

One of the most controversial themes in the debate on climate change is the proposal by the EU to limit the Parties' use of the Kyoto mechanisms. Any wide-ranging discussion of this issue is beyond the mandate of the Commission; but the Commission calls attention to the consequences for the Norwegian economy of implementing the proposal, and the implications for the development of the Norwegian quota system. Neither has the Commission addressed the issue of establishing a Nordic quota market regardless of whether the Kyoto Protocol comes into force, but looks at a number of issues that will need to be dealt with in that event.

The Commission notes the paragraph in the mandate which states: "The Commission is requested to consider how the quota system can be adjusted if necessary to take account of possibly more restrictive international commitments on emissions after the end of the existing commitment period."

The Commission has carried out this aspect of its mandate by proposing a robust system which can readily accommodate new emission sources, and which enables the Government to meet more restrictive targets by reducing its allocation of quotas in accordance with any post-Kyoto agreements.

The Commission has received numerous written submissions from members of its advisory group of stakeholders. These recommendations have been taken into account in the Commission's deliberations.

Members of the Commission representing the various ministries wish to emphasize that the mandate of the Commission does not include all the issues the Government will have to deal with in the further political process. These individuals have served as expert members of the Commission and have not sought to express the political opinions of the Government or its members.

3 What is a quota?

The Commission assumes that the quotas are to be allocated and traded as emission certificates, and that the national authorities are to issue those certificates which have not been bought internationally. The emission certificates are of economic value because each confers the right to release emissions of a given volume of greenhouse gases.

In order to ensure efficient trading, the quota should be as far as possible a standardized and well-defined product. The Commission recommends that the quotas be measured in tonnes CO2 equivalents, and that the quota certificates be issued in whole tonnes.

The quotas can be issued by the authorities as rights to release emissions of greenhouse gases according to the face value of each quota certificate. Quotas can also be bought on the international market, in the sense that one Party to the Protocol will transfer some of its assigned amount to an entity in another country. Additionally, the quotas can be built up through emission reduction measures in other countries via the joint implementation mechanisms (JI) and the clean development mechanism (CDM), or through investment in Norwegian sources which are not regulated by quotas.

The Commission favours unrestricted use of the quotas during the commitment period: in other words, use of the emission certificates should not be confined to a specific year. The Commission further advises that banking of quotas for later use from one commitment period to another should be allowed, but not the use of quotas which have not yet been allocated ("borrowing"). This implies that enterprises regulated through the quota system must deliver emission certificates to the authorities for all emissions released during each accounting period. The Commission also recommends that trading of allocated quotas should be unrestricted, except for any quotas that might be allocated free of charge on condition that they can be utilized only by one specific enterprise. In that case, the implication is that the owner cannot sell the quotas, nor can the quotas be used e.g. in another company in the same group.

The Commission advises consideration of whether it might be appropriate to make the necessary adjustments in current regulations to make greenhouse gas quotas/emission certificates subject to securities legislation, and to bring trade in quotas between the various enterprises under the authority of the Central Securities Depository (VPS). It is also to be expected that a market in quota derivatives will develop.

Derivatives in commodities are not currently subject to securities laws, but a public commission has proposed that commodity derivatives be classified as financial instruments and regulated under securities legislation. (See NOU 1999:29 On commodity derivatives.) If the proposal is accepted, the case for regulating quota derivatives as commodity derivatives should be examined. If that event, a well established system of registration and control could be applied to any trade in such derivatives. Any such considerations must allow for international trade in the quotas.

4 Which point sources should be covered by a quota system?

The Commission states as its point of departure that fulfilling Norway's Kyoto commitments as efficiently and cost-effectively as possible requires that as many gases and sources as possible are covered by the quota system. The need for equal treatment of all polluters/emitters strengthens the case for the most comprehensive system.

The Commission recommends the most comprehensive system possible, to include, where technically feasible, all sources subject to regulation by quotas.

In some circumstances, however, covering all greenhouse gases from all sources may be unacceptably costly and impractical in the short term. If quota liability is to be imposed on a particular source, there must be some practical method of assigning responsibility to a legal entity. This in turn calls for appropriate assessment, reporting and control systems addressing the same entity. For some sources the cost of establishing such systems may be unacceptably high, and imposing liability for quotas on those sources would therefore be inappropriate. The emissions concerned might therefore be regulated by other measures, or remain unregulated.

Any measures for controlling greenhouse gas emissions (in this case a quota system) should be framed in such a way as to encourage measures for emission reduction that are warranted from a national economic point of view. Greenhouse gas emissions can be cut both by reducing activities which cause emissions and by technological advances in reducing emissions at source.

For most emissions from sources in Norway, it should be possible to build into the quota system encouragement for both courses of action. For administrative simplicity and to reduce the costs of the quota system, it could be appropriate to design the system for some sources with incentives only for reducing levels of activity. Other measures can be taken to encourage technological initiatives, such as requiring use of a particular technology, or applying standards of performance.

In designing an overall policy on mitigating climate change, including decisions as to which sources should be included in a quota system, considerations of lowest possible system costs must be weighed against the need for cost-effective measures.

There are two central criteria for deciding whether a point source is suitable for inclusion in the quota system. The first is whether regulating emissions from a particular source by quotas will create incentives for the responsible legal entity to reduce emissions. The second is how expensive it will be to regulate those emissions through a quota system (the system costs). Availability of methods and corresponding costs for inventories will affect both incentives and system costs and could be decisive in setting levels for choosing whether regulation by quotas should occur upstream or downstream.

The Commission notes that if all greenhouse gases from all point sources considered suitable for regulation by quotas are included, the system will be able to accommodate almost 90 per cent of greenhouse gas emissions (based on Norwegian emission levels in 1997). All emissions, which can be allocated to an entity with a reasonable degree of certainty and at reasonable cost, would then be covered by the quota system. For some of these sources, inclusion in the system will require further developments in methodology. Greenhouse gas emissions, which are not yet considered suitable, are:

*N2O and CH4 from combustion

*CO2 from agricultural liming and from solvents

*CH4 from agriculture

*N2O from agriculture

*HFCs/PFCs used as substitutes for CFCs and halons

*SF6 other than from magnesium production

The Commission recommends more work on methods for calculating emissions, etc., with the aim of bringing the remaining emissions into the system. For emissions, which cannot reasonably be assigned to a specific legal entity, the Commission recommends the use of other regulatory measures with a view to fulfilling Norway's commitments as cost-effectively as possible. The Commission also suggests that the creation of quotas might be made possible by implementing emission reduction measures for sources, which are not regulated by quotas. Such an arrangement could function as a safety valve and help encourage cost-effective measures, which are not facilitated by ordinary regulatory mechanisms.

The Commission believes that carbon sequestration in forests should be included in the quota system, but there are questions of practical implementation to be considered once the international framework conditions are in place.

5 Selection of legal entities subject to regulation by quotas

The Commission states as its point of departure that regulation by quotas should be imposed directly on sources that cause pollution. Considerations of effective utilization of resources imply that regulation by quotas should be applied in such a way that incentives are created for the polluter to reduce emissions as cost-effectively as possible, and to develop new technology which will cut costs by limiting emissions in future. This can be particularly important in cases where the emissions are not only dependent on quantities of fossil fuels or other commodities produced and/or consumed, but also to a large extent on which technology is involved.

The Commission emphasizes that the simplest possible system requires that regulation by quotas be imposed at producer level for CO2 emissions from mobile sources and from some stationary sources. For these emissions, regulation at producer level will not create weaker incentives for reducing emissions than regulation at consumer level, because the volume of emissions from a particular commodity is not dependent on technology. For those process emissions which are recommended for inclusion in the system, regulation by quotas should be imposed at the end-user level in cases where the processes originate with major industrial companies. For process emissions stemming from a series of small sources, e.g. emissions of N2O from commercial fertilizers, regulation by quotas should be imposed on retailers or importers in order to avoid unacceptably high system costs.

The Commission notes that good reporting and verification routines must be established in order to ensure that a particular source is not made liable for regulation by quotas for the same emissions more than once. Large land-based industrial companies would have to distinguish between emissions associated with processes, for which they would be required to deliver quotas to the authorities, and emissions associated with stationary combustion of oil, for which the oil companies would be responsible. This arrangement, moreover, would be entirely consistent with current tax regulations, and implementation is assumed to be administratively uncomplicated.

The Commission has also discussed an alternative method of imposing quota obligations for emissions of CO2 from stationary and mobile sources which allows a degree of choice as to which entity is to be regulated by quotas. In other words, either the producer/importer or the end-user can comply with the quota obligation. The point is that any emissions of CO2 will be covered by a quota before the end-user receives the petroleum product. Such voluntary regulation by quotas will make it possible for ia. local authorities to take part in quota trading.

Further attempts to define which entities should be regulated by quotas should start with the principle in the Pollution Control Act that the owner of the source of pollution concerned is accountable for any release of pollutants, for which concession must be sought and certain conditions met. In a group of companies, it is common practice to link the concession to one individual plant or site. In a quota system this would also be the natural basis for reporting and controlling emissions. In many cases emissions of greenhouse gases are closely associated with other types of emissions for which licences are required. It would be useful if the same companies reported various emissions while committing themselves to complying with the terms of the licence and regulation by quotas.

6 Allocation of quotas

Under the Kyoto Protocol, Norway is committed to quantitative limits, in the form of a national emissions quota, on the volume of greenhouse gases which can be released during the period 2008-2012. With a quota price of 125 kroner per tonne CO2 the market value of Norway's aggregate quota allocated for the Kyoto commitment period will be about 33 billion kroner. The Government can sell quotas, allocate quotas free of charge ("free quotas"), allocate quotas to enterprises which carry out joint implementation projects, and/or retain quotas in order to cover emissions which are not regulated under the quota system. Which method of allocation is chosen will have a considerable bearing on the costs of fulfilling Norway's commitments on emissions. The method of allocation can also mean substantial advantages for some enterprises, in particular for those which are allocated free quotas compared with those which are not.

The Commission is confident that a comprehensive quota system featuring sale of all quotas will ensure that Norway fulfils its Kyoto commitments at lowest possible cost. The Commission therefore states as its point of departure that in principle the quotas should be sold. Possible grounds for rejecting this principle are discussed in chapter 7. Both the sale of quotas and unconditional allocation free of charge will encourage cost-effective measures in all sectors. The sale of quotas will also be a source of income for the state. This income can be used to reduce other, less efficient taxes or surcharges and so enhance the profitability of the collective resource use in the Norwegian economy.

Sale of quotas by the state can take different forms. If a well-functioning international market in quotas exists, it will be appropriate and efficient for the state to sell quotas directly in the market. However, it is uncertain whether such a market will have been established by the time the Norwegian government starts selling quotas. In that case, the Commission believes the state should sell the quotas by auction.

Direct sales and auctions in a well-functioning market will be largely self-correcting for cost-effectiveness and will ensure that the quantitative target is met. This type of allocation will also create cost-effective incentives to reduce emissions over time. However, the sale of quotas will not ensure that other considerations are met, such as avoidance of plant closures, maintaining the competitiveness of Norwegian industry, etc.

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The details of the auction process are important. The Commission recommends that auction procedures be drawn up with the help of experts who can offer both theoretical knowledge and practical experience of the field. In addition to cost-effective emission reductions, the auction process should guarantee transparency, accessibility and consistency. It should also prevent abuse of market power and price manipulation while delivering efficient market pricing of quotas and income to the state.

The Commission proposes that the quotas be auctioned gradually, but that a relatively large number of quotas be auctioned early. In the interests of avoiding uncertainty in the market, the amount of quotas at each auction should be fixed well in advance. When the first auction is held it might also be advisable to hold it in stages, so that price information acquired at one stage will be available for later stages and subsequent auctions. Frequent auctions in the early phase will help all concerned to gain experience of the process as well as price information.

The Commission recommends that auctions be open to all wishing to participate: foreign as well as domestic, and including those not regulated by quotas.

Working out and implementing a strategy for managing the assets (publicly held at the outset) represented by the quotas will be a demanding task, with considerable implications for public finance. It is worth considering whether to establish a special administrative body for the purpose, following guidelines drawn up by the political authorities. In any case, the question of how to set feasible targets for risk and results will have to be addressed in order to keep a running total of current assets and liabilities.

In accordance with its mandate, the Commission has considered several alternative criteria for allocating quotas, in this case by auction and by allocation free of charge. The latter involves allotting a given number of emission certificates to a company at no cost. The Commission has discussed some possible grounds for allocating free quotas, as follows:

*Competitiveness of Norwegian companies

*Restructuring of industry, including closures

*Carbon leakage

*Implications for regional development

*Potential inefficiencies in the capital market

The Commission has illustrated the consequences of allocating free quotas to enterprises with emissions currently not subject to CO2-taxation, corresponding to 70 per cent of emissions at 1990 levels. The Commission has also, in the light of a proposal by the Confederation of Norwegian Business and Industry (NHO), looked at the consequences of allocating free quotas corresponding to 95 per cent of 1990 emission levels.

Given the current state of knowledge, and methods for calculating greenhouse gases, the sum of all quotas allocated free of charge (equal to 70 per cent of untaxed greenhouse gas emissions from the industrial sector in 1990) would correspond to 12 million tonnes CO2 equivalents per year and 60 million tones for the whole of the Kyoto period. This in turn represents about 22 per cent of the volume of greenhouse gases Norway can release under its Kyoto commitments. With a quota price of 125 kroner per tonne CO2 equivalents, these enterprises would in effect be receiving economic compensation of 1.5 billion kroner annually and 7.5 billion kroner for the Kyoto period -- or roughly 80,000 kroner for each employee.

Chapter 13 looks in detail at the consequences for specific industries, regions and income distribution. One main conclusion is that there are wide differences in the effects of a quota system on the various greenhouse gas-intensive industries. The quota costs can be especially high in relation to earnings in the ferro-alloy, carbide, refining and cement Industries. These businesses employ about 5,200, representing 0.2 per cent of jobs in Norway. The markets for ferro-alloys and carbides are global, and the scope for recovering increased costs through product prices is probably limited. For oil refineries and the cement industry, which primarily compete in European markets, increasing product prices could be somewhat easier. This will depend on the relative stringency of regulations applied to companies in other countries and in Norway, a very uncertain factor.

Which businesses survive will also depend on other circumstances, including developments in the electicity markets. It is therefore possible that some companies will close down regardless of whether a quota system is introduced. Some of these businesses operate in areas where they are the main source of commercial activity. Allocating free quotas to industry, corresponding to 70 per cent of untaxed emissions in 1990 will be a strong counterbalance to the commercial and regional effects of a quota system, provided that the free quotas are exploited by those plants that receive quotas.

The Commission accepts that the allocation of free quotas to certain businesses, commercial sectors or branches of industry can probably be seen as state support, which is subject to the general prohibition in article 61 no. 1 of the EEA agreement (see Bugge/Løvold: "Legal issues related to the implementation of a tradable quota system for greenhouse gases", University of Oslo, 1999, in Norwegian). For other sectors, the assumption is that the quota system is based on payment for quotas. However, there remains a possibility that such a measure will after all be acceptable, as it is covered by the potential exemptions from the prohibition mentioned in article 61 no. 3, in particular b) and c). The condition would presumably be that the "grandfathering" was a temporary regulation, aimed at making it possible for enterprises to adapt to measures for meeting Kyoto commitments.

The Commission stresses that the system must in any case be notified to ESA for decision on whether the regulation can be accepted under the exemption rules. The Commission also notes that trade in emission quotas for greenhouse gases is a new mechanism which is under consideration by a number of countries, including those in the EU, and that the various legal implications must be expected to evolve over time. A quota system that includes allocation of free quotas is being introduced in Denmark, for example, with regulation by quotas from 2000; and the way this system is handled in the various EU institutions should be instructive.

The Commission, taking its mandate as the point of departure, assumes that any allocation of free quotas will be limited to emissions of greenhouse gases in industrial activities currently not subject to CO2 taxes. Emissions from enterprises currently in operation and not subject to CO2 taxes, and which the Commission finds it reasonable to define as industrial activities, include process emissions from production of primary aluminium, magnesium, steel, ferro-alloys, carbides and fertilizers, and oil and gas terminals; emissions from the use of gas in refineries, gas terminals and petrochemicals, and both process and combustion emissions from the production of cement and leca (a composite building material).

The Commission notes that the coastal fisheries fleet is also not subject to CO2 taxes and the Storting has asked the Government to include these sources in the quota system currently under preparation (cf. Recommendation to the Storting no. 247 [1997-98]). The wood processing and herring meal industries are currently subject to half the prevailing rate of CO2 tax. It is worth considering whether to allocate free quotas to these enterprises, possibly with a proportional share of free quotas for those paying half. The Commission has also explored the effects of allocation of free quotas to the wood processing and herring meal industries.

A majority of the Commission (members Birkeland, Bjerkedal, Hagem, Haugestad, Hoel and Weltzien) recommend "that all concerned pay full market price for emission quotas in line with the polluter pays principle. Free quotas should not be allocated to any industrial sector. The majority believes that the benefits achieved by allocating free quotas are disproportionately small in relation to the increased costs which would be imposed on the rest of the economy. Allocating free quotas would also increase the difficulty of meeting more ambitious climate targets in future and would be of little help in lessening the adverse effects of necessary restructuring in the commercial sector.

The polluter pays principle is central to environmental policy. The price of pollution includes both the cost to the polluter of reducing his own emissions and the cost to society of the pollutant emissions which continue to be released. The costs to society of these persistent emissions are represented in this case by the face-value of the quota. When the polluter himself must pay, he is motivated to reduce his emissions, and to develop more environment-friendly technology. Free quotas allocated to industrial sectors are incompatible with the polluter pays principle.

Through the Kyoto agreement greenhouse gases have become a scarce resource, a commodity. A price must be paid for using it. As with any other commodity, this one must be available to those who are able and willing to pay for it, so as to be utilized where it will generate the highest possible value to society. Allocating free quotas for greenhouse gases would, over time, weaken possibilities for economic growth.

Free quotas would obstruct some changes in the commercial sector that would make industry less greenhouse gas-intensive, which in turn would prevent the implementation of cost-effective measures for reducing the emissions, so that the costs to the Norwegian economy of meeting its Kyoto commitments would be unnecessarily high.

Postponing necessary changes now will only heighten the need for change in the future, when Norway is likely to face more stringent requirements and higher compliance costs.

An ambitious climate policy demands cost-effective measures. Measures that increase the costs of meeting environment targets, such as the allocation of free quotas, will make it more difficult and even more costly to set more ambitious targets in future.

Norway could become one of the first nations to implement a quota system for greenhouse gas emissions. If that system incorporates a comprehensive range of exemptions, it will send unfortunate signals to other countries. Norway has been a trailblazer in the search for cost-effective solutions during negotiations on an international climate regime. The majority is of the view that this cost-effective and innovative approach should also be taken at national level. The right signals from Norway could stimulate other countries to restrict the sheltering of particular enterprises from emissions regulation. This in turn would help reduce the collective costs to these countries of fulfilling their Kyoto commitments, while encouraging them to accept more stringent regulation during subsequent commitment periods.

Free quotas will also lead to loss of state income and loss of efficiency in the economy, as other taxes and surcharges are increased, or expenditure in other social sectors is reduced. Allocating free quotas covering 70 per cent of emissions at 1990 levels which are currently not subject to taxation corresponds to about 12 million tonnes CO2 equivalents annually. Assuming the Commission's quota price of 125 kroner per tonne CO2, the free quotas represent an annual total of 1.5 billion kroner.

Allocating free quotas to industrial sectors is not a very efficient way of achieving relevant political aims. The Commission submits analyses of the effects on individual sectors and businesses of universal payment for quotas on the one hand and allocation of free quotas on the other. Notwithstanding the uncertainty of the results, the analyses suggest that in some sectors free quotas will not be required in order to maintain production, while in others they will probably not prevent closures, even if free quotas are allocated for all emissions. In some sectors other factors such as developments in the price of power can influence profitability at least as much as the cost of quotas.

Statistics Norway has calculated that free quotas equivalent to 70 per cent of untaxed emissions at 1990 levels will reduce job losses in the affected industries by about 1000 man-years in the long term. In the light of these calculations the annual value of free quotas, estimated at about 1.5 billion kroner, works out as a very costly and inefficient expedient for maintaining production and employment in the favoured industrial sectors.

The alternative to using free quotas, which would contribute to freezing the current industrial structure, is to take advantage of the existing administrative apparatus in Norway to alleviate the need for restructuring and to stimulate new activities. Norway also has a well developed system of job-creation incentives and welfare regulations guaranteeing personal income. The majority recommendation is that measures other than free quotas be considered if it is thought desirable to offset the consequences of a cost-effective quota system.

A cost-effective implementation of the quota system will probably lead to some increase in emissions in countries which have not committed themselves to reducing them (so-called carbon leakage). Carbon leakage is a result of the fact that developing countries have not undertaken such commitments. The scope for pursuing an ambitious climate policy after the first commitment period will depend on whether and to what extent these countries assume such commitments. The prospects for tackling the climate problem will rise and fall accordingly, because it is in these countries, on present trends, that the highest rise in greenhouse gas emissions is likely to occur. Trying to limit the problem of carbon leakage by allocating free quotas will have little effect. The problem must be solved more efficiently through international negotiations."

Commission members Dahle og Halmø recommend that "free allocation of quotas be offered in the context of a practical implementation of the system for those industrial sectors which are currently exempt from CO2 taxes. The justification for free allocation is recognition that socio-economic theory and practical reality are not always ideally adapted.

There is no disagreement on the basic principle that the polluter must pay. In most cases, however, this principle implies that the costs assumed by polluting enterprises for reducing emissions are passed on to the customers via the sales prices of the products. This is seen as legitimate because consumer demand for the products is the ultimate reason for the pollution. For those parts of the Norwegian industry that only have domestic competitors this principle works well. In order to function as well for industries exposed to international competition, at home or abroad, unilateral Norwegian initiatives must not appreciably undermine their competitiveness: in international terms, there must be "a level playing field", so that industry operating in international markets is not burdened by costs which distort competition. This principle is not new. The very fact that the Norwegian process industries have encountere demanding competitive conditions in their export markets has over time led to restructuring, modernizing and increased efficiency in the commercial structure; this suggests that existing industries in competitive markets have little margin for absorbing costs which are not faced by their international competitors.

Commission members Dahle and Halmø are therefore of the opinion that free quotas represent a necessary flexibility as a temporary measure until other countries introduce similar emission costs. These members do not dispute the principle that carbon emissions must entail a cost in order to create the necessary incentives for technical solutions that will help reduce carbon emissions.

The views of these members derive in part from the EU's comprehensive efforts to establish a carbon tax in the first half of the nineties. The aim of this process was to have member states impose a tax equivalent to 10 dollars per barrel (oil equivalent) before the year 2000, but with exemptions for industries exposed to competition from other geographic regions.

Free quotas would probably delay a number of important long-term structural changes; but the priority in government strategy must be to seek solutions - via international negotiations - which will introduce carbon costs simultaneously for the various industries worldwide.

From a legal point of view, the polluter pays principle should not hinder the allocation of free quotas to particular sectors or companies.

Commission members Dahle and Halmø put emphasis on maintaining a national industrial infrastructure in the multi-billion class: highly efficient and environment-friendly in many cases, and often located in regions where the industrial structure is less than robust. A decline in production in Norway will not necessarily reduce demand for the products. Transferring production to other Annex B countries (industrialised countries) will be possible in many cases because a number of countries can take measures at relatively low cost in other sectors in order to compensate for increased production. In that respect, Norway is untypical. Alternatively, transferring production (of aluminium, ferro-alloys, etc.) to non-Annex B countries is clearly a case of carbon leakage.

Up to this point, these members have argued that free quotas should be part of the quota system. Regarding the size of the free quotas, the mandate suggests allocations covering 70 per cent of emissions in 1990, i.e. emissions reductions of ca. 30 per cent. As the industries concerned have already implemented investments in efficiency in line with their most efficient European competitors, a further 30 per cent improvement lies far beyond their reach, both technically and financially. As the Norwegian commitments under the Kyoto Protocol are a one per cent increase in emissions relative to 1990 levels, an unreasonable expectation arises that industries operating in competitive conditions will contribute substantially more than their logical share at this stage. These members therefore recommend free quotas covering 95 per cent of emissions by these industries in 1990.

Commission members Dahle and Halmø basically subscribe to the view, as expressed in the mandate, that free quotas should not be allocated to new enterprises. All concerned in start-ups will be in no doubt as to society's growing will to impose increasing costs on greenhouse gas emissions, and all investment decisions must be made in this context. If the economic projections do not look sufficiently robust to cope with anticipated costs, even with an unfavourable application of policies and measures internationally, the project should be postponed. However, a flexible approach to this principle should be possible.

Finally, these members note that the Norwegian Kyoto commitments must naturally be fulfilled. In order to meet these targets there are several sectors in which emission reductions are more easily achieved, from a technical point of view, than in the process industries: the transport sector, for example, which releases about the same volume of emissions."

Commission members Stiansen, Sunde and Aamot believe "that it will be basically a political issue as to which enterprises should be allocated free quotas and how great a share of free quotas they should be given. These members have not considered it part of their mandate to take a position on whether free quotas should be allocated. The Commission has not looked at all the considerations which could be relevant to such a position. The decision on how quotas are to be allocated will affect the finances of the enterprises concerned and can therefore have future consequences for the business structure. This in turn will affect efforts to maintain regional policies, in terms of employment and commercial activity, together with the extent of adverse environmental repercussions as the result of carbon leakage. Political aims in these areas can be influenced, with varying degrees of precision, by the allocation of free quotas.

The Commission has, as instructed in its mandate, discussed free allocation of quotas to industrial enterprises accounting for 70 per cent of emissions at 1990 levels which are currently not subject to taxation. In addition the Commission has looked at the consequences of 95 per cent free allocations as per the recommendation of the Confederation of Norwegian Business and Industry (NHO). Allocation of quotas via sale/auction has also been considered. The Commission has sought to elucidate the social effects of the various forms of allocation as specified in the mandate. Other mechanisms for meeting these aims targets have not been considered."

The Commission has also discussed the distribution of free quotas among various enterprises, if free quotas are to be allocated. There are several ways to arrange this. The Commission has discussed the following four principal ways of allocating free quotas:

a)(A) Unconditional allocation based on historic emissions

b)(B) As A, except that the free quotas cannot be traded (i.e., free quotas = B quotas)

c)(C) Allocation based on historic emissions, conditional on avoiding closure of the enterprises concerned, or maintaining minimum production

d)(D) Allocation according to the level of activity within the enterprise.

The Commission is of the view that in any case some of the quotas will be allocated as non-tradable B quotas. The Commission further proposes that allocation be based on a specified historic base period, for example that each individual enterprise be permitted to choose between 1990 and 1998. New enterprises, which would have released no emissions during the base period, would not be allocated quotas. The total number of quotas would be set in proportion to emissions in the base year.

A majority in the Commission (members Birkeland, Bjerkedal, Hagem, Haugestad, Hoel and Weltzien) "emphasize that any free allocation of quotas must be of some benefit in moderating or postponing restructuring or closures. These members consider allocation form B the best for this purpose. This form of allocation can be made relatively simple to administer; it will also create incentives for enterprises to implement emission reduction measures which will not necessitate substantial retrenchment or closures. These members recommend that all free quotas should be non-tradable."

Commission members Dahle, Halmø, Stiansen, Sunde and Aamot take the view that "an unqualified variant of allocation form B will not be able to create strong enough incentives for implementing emission reductions in the enterprise concerned. All in all, these members recommend combining the allocation of free tradable quotas (A) and non-tradable quotas (B). This solution would stimulate enterprises to implement environmental improvements in their own businesses because it would free quotas for sale. The non-tradable quotas would strengthen the enterprise economically and lessen the threat of closure. This combined form would be administratively straightforward and not susceptible to lobbying".

7 Liquidity and organization of the quota market

The organization of the secondary market must ensure that the Government has the access to information and the control it needs for Norway to meet its commitments. Efficiency in quota trading and a reasonable overview of price developments are also required.

Emission certificates will be suitable both for trading via a commodities exchange and for bilateral, decentralized trading. It is an absolute requirement that the method of trading chosen must ensure that Kyoto targets are met. In this context, this means that the authorities must have a complete overview of the buying and selling of quotas, both among domestic enterprises and where foreign enterprises are involved. The need for cost-effective emission reduction means that all enterprises should trade at the same price at any given time. Trading should be open and accessible to all enterprises wishing to trade in the market, and efforts should be made to ensure that these conditions also apply to the secondary market.

Irrespective of the method of trading, a register must be set up to record ownership of the individual quotas. This can probably be done through the Norwegian Central Securities Depository (VPS), or through a dedicated register performing a function for quotas analogous to that of VPS for securities trading. Such a register must also record the initial allocation. Work is proceeding in the climate negotiations to set up a regulatory framework for such registers in the context of the Kyoto mechanisms, and it is important that national and international regulations be compatible.

A commodities exchange, whether operating in Norway or abroad, would create a central and accessible marketplace, ensuring that the ruling market price for quotas was publicly available, and that all involved would know where to turn if they wanted to deal in quotas. A commodities exchange will normally have clearly defined trading rules and routines for resolving disputes quickly - an important consideration for efficient trading. Even in the absence of a commodities exchange, a number of brokers would be likely to specialize in quota trading, so that enterprises wishing to trade would have little trouble finding their own middleman. Quota prices would not necessarily be accessible to the public at all times, but keeping track of prices is unlikely to be difficult: brokers would have an incentive to ensure accessibility.

The Commission is confident that the market can be left to itself to find the most suitable form of trading. In a free international market, quota exchanges will probably spring up spontaneously together with a number of active brokers, who will see to it that the market functions effectively with ample price information. The Commission therefore advises the Government not to set up a quota exchange. This assumes that limitations to the use of the Kyoto mechanisms are not introduced.

If a free international market has not been established, it may be necessary to consider whether the authorities should take a more active role in the creation of a secondary market. However, this should be seen in the light of what limitations might affect such a market, and how the Government might wish to deal with them.

In the interests of an efficient quota market, which also means limiting the risk of exploitation of market power, the market should be open to all entities wishing to trade, Norwegian and foreign alike. The Commission proposes that the market should also be open to participants who are not regulated by quota. This means that private individuals and organizations, as well as professional traders, should be able to buy quotas. If the market is open to participants who are under no obligation to hold or surrender quotas, the market will be that much larger and the potential for abuse of market power that much less, with corresponding gains in efficiency.

The Commission notes one factor which could create uncertainty in the market: the possibility of reassessment of emissions due to revisions in the methods for estimating the emissions (recalculations), so that enterprises would have to procure more quotas than those working from earlier calculations. The Commission sees a good case for government action to avoid frequent recalculations of the various emissions in order to prevent this uncertainty, in the market and among enterprises regulated by quotas. However, this must be considered in the light of the aim that the volume of quotas should correspond as far as possible to the actual volume of emissions. The Commission considers that recalculation should be ruled out for the period 2008-2012 unless an international decision is taken to reassess during the commitment period. The Commission also considers that those enterprises regulated by quotas should bear the risk of reassessment of emissions.

8 Use of the Kyoto mechanisms

There is a great deal of interest, both national and international, in the Kyoto mechanisms. The Commission does not see it as its task to consider how these mechanisms should be developed internationally. However, it is the opinion of the Commission that the Norwegian authorities should not set more stringent requirements for Norway's use of these mechanisms than are agreed in international negotiations. Such unilateral restrictions would increase the costs to the Norwegian economy of fulfilling its Kyoto commitments without markedly mitigating any of the potentially adverse side-effects of the Kyoto mechanisms.

International trade in quotas will mean that a market for greenhouse gas quotas is established, and with it a market price for emissions of greenhouse gases. As the costs of measures vary widely from one country to another, and from region to region, an international quota system will present opportunities to reduce emissions at somewhat lower cost than (for example) in Norway.

In the national climate debate, international trade in quotas has been perceived as an opportunity to buy oneself out of international commitments, and has therefore been experienced as a moral issue. The Commission thinks it must be desirable to be able to finance emission reductions in countries where the costs of such reductions are lower than in Norway, if the respective countries are interested in such an arrangement. A self-imposed restriction on the use of the Kyoto mechanisms would increase costs in Norway. Higher costs reflect lower cost-effectiveness globally, which again can make it more demanding for Norway to take on more ambitious commitments in the period after 2008-2012.

The Commission recommends that in an international system, where there are no limitations on the exploitation of the Kyoto mechanisms by the countries which are Parties to the Protocol, all concerned should make direct use of the Kyoto mechanisms, assuming the development of a secure system of controls.

The Commission has also considered a situation where restrictions might be imposed on the various countries' access to use of the Kyoto mechanisms. In such a situation there are grounds for supposing that other international groupings than the EU would choose to establish a "bubble"-style cooperative arrangement. Another possibility, if restrictions are imposed on use of the Kyoto mechanisms, is that the state would auction/sell the rights to take advantage of quota trading, CDM and JI projects, on the Norwegian market. This would avoid the costs associated with establishing, running and controlling a system where the enterprises, under tighter guidelines, can take advantage of the mechanisms.

The Commission notes the need for a well developed control system, both national and international, to enable private entities to exploit the Kyoto mechanisms. International work on such a system is in progress, and Norway naturally awaits developments with a view to adapting any national system to international regulations. From a Norwegian point of view, it is important that the national control system ensures that all quotas in circulation are accepted within the international trading system.

9 Phasing-in the quota system

Phasing-in - introducing - the quota system would involve four stages: formal adoption of the system, compulsory reporting, allocation of quotas and effective regulation by quotas.

The Commission notes that in the interests of transparency for producers and consumers, and in particular for enterprises which must take a long-term view in making their investment decisions, the key elements of the quota system should be firmly in place as soon as possible. This should also help minimize the costs involved in adjusting to the system.

The Commission has taken a number of factors into account in considering the time-frame for allocation of quotas and imposition of regulation by quotas. These factors include cost-effectiveness and efficiency in reaching Norway's Kyoto commitments; state income, and the need to limit costs to the government and the enterprises concerned.

In its discussions of the phasing-in period, the Commission has assumed above all that the main reason for regulating emissions through the quota system during the first commitment period and any subsequent periods is to use a policy instrument that will ensure compliance with a quantitative commitment. The Commission does not see that the need to fulfil the Kyoto commitments requires a comprehensive quota system with statutory regulation by quotas before 2008. The decisive criterion for introducing the quota system at an earlier stage should be whether the government feels the need for other climate policy instruments independent of the Kyoto commitment. In any case, the decision to adopt a quota system must be taken after consideration of alternative policy instruments. Please note the comment on this issue by Commission members Bjerkedal, Hagem, Hoel and Weltzien in chapter 12.3.

In its consideration of when the quotas should be allocated, the Commission accepts that it might be helpful if the enterprises concerned could gain some experience of primary and secondary trading in quota certificates before the start of the Kyoto period. Early allocation of quotas can be of some help here. In any case the question should be examined more closely, e.g. in the light of what other countries are doing, developments in the international quota and derivatives markets, and recognizing the state's interest in asset management related to Norway’s assigned amount under the Kyoto Protocol.

It might, however, be advisable to make an early start on improving current emission reporting and control routines for those enterprises on which the authorities might wish to impose regulation by quotas. An early trial run for these routines would not only be educational, but would also help improve the quality of Norway's own reporting of greenhouse gas emissions internationally.

The regulations establishing the key elements of the quota system should be enacted as soon s possible. In particular, the regulations for reporting and control routines should be in place well before 2008 if we are to gain any useful experience.

In its mandate to the Commission the Government asks it to investigate a quota system for fulfilling the Kyoto commitments. In view of the wide-ranging political debate concerning an early or independent quota system, the Commission wishes to call attention to certain aspects of introducing a national quota system as a supplement to, or substitute for, climate policy instruments currently in use, regardless of whether the Kyoto Protocol comes into force. The Commission has only briefly looked at issues the authorities must take into account in considering such a system.

10 Reporting, controls and sanctions

Within a quota system it is important to build up a reporting and control system capable

of ensuring that enterprises regulated by quotas are assessed and charged for emissions that are estimated in accordance with Norwegian government requirements and decisions of the Parties to the United Nations Framework Convention on Climate Change. The reporting and control system should also ensure that such enterprises can produce the necessary quotas for their emissions.

In the first phase the authorities will have to develop a standard methodology for calculating and measuring greenhouse gas emissions at the level where regulation by quota is applied. Establishing such a methodology will help enterprises regulated by quotas make arrangements for their own internal control and reporting routines.

Based on a standard methodology, the government should develop a standard format for reporting emissions. The format should contain the necessary information for the regulatory authorities or a third party to be able to reconstruct the emission figures. The Quota Commission recommends that an annual surrender of quotas to the state be required of all enterprises regulated by the system. This process, to be finalized by a fixed date, would show quotas corresponding to the previous year's emissions.

The first link in the control system would be the internal control and reporting procedures of the enterprise regulated by quotas in accordance with the requirements of the standard methodology and reporting format. There are various actions the regulatory authority could take after receiving a report. To begin with, there will be a need for a preliminary inspection to see that the report complies with the reporting format. If the report deviates from the standard methodology or contains flaws in the data, these should be drawn to the attention of the enterprise which filed the report.

The next step would be to draw up a comparison of aggregate reported emissions with other national statistical sources. Spot checks of enterprises regulated by quotas might also be useful. Any control system would also have to consider the need for recalculations. The final, crucial, task of any control operation would be to ensure that emissions quotas were produced corresponding with the emissions. The regulatory authorities would then check the validity of the quotas and ownership against the national register of quotas.

As a further guarantee of the system's reliability in an international context, independent systems audits could be carried out for the entire national reporting and control system.

The use of sanctions could be necessary in cases involving inadequate surrender of emission quotas, failure to meet deadlines for reporting emissions, incorrect information on e.g. emission figures, etc. The effect of the sanctions on compliance will depend on the stage at which the sanctions apply and on the strength of the official response. In general, the effect of the sanctions should be to make those concerned aware that it does not pay to take the risk of failing to meet the requirements of the quota system. A holistic approach to the compliance mechanisms will help ensure a well-functioning quota system.

The recommendation of the commission is that a provision for surcharges be drawn up. The penalties should reflect the principle that companies in non-compliance should not benefit from having avoided paying interest on capital needed for purchasing quotas in time, or from any fall in the price of quotas since the deadline for surrendering them.

11 The legal framework for the quota system

A system for trading emission quotas is a new instrument in Norwegian environmental policy. None of the major administrative or environmental legislation has been drawn up with a quota system in mind. For this reason the Commission has thought it important to consider how existing legislation could be applied to the various elements in a quota system. The question is dealt with in Bugge/Løvold, 1999. Their report shows that introducing a quota system will require new statutes. It also also discusses how the regulations for the quota system can be reflected in related regulations.

The Commission will not make concrete proposals for new legislation or regulations for controlling the quota system. However, in chapter 15 the Commission has discussed how regulations should be framed in relation to the various elements of a quota system: the obligation to surrender emission quotas, identification of entities which should be subject to regulation by quotas, and procedures for fulfilling the various requirements. There is a further need for regulations concerning the form of the emission certificate, procedures for allocating emissions quotas, and trading in the secondary market, as well as controls and sanctions.

Clearly the quota system must be based on formal legislation. The Commission sees two reasonable alternatives: to frame a specific law on the quota system, or to incorporate provisions for a quota system as a separate chapter in the Pollution Control Act of 13 March 1981 no. 6. The Commission has no view on which alternative should be chosen.

During the deliberations of the Commission, the question has arisen whether some aspects of the quota system should be considered as a tax or surcharge in the context of the Constitution paragraph 75 a. On this point the Storting's view will be decisive. The Commission advises that considerations of transparency for enterprises regulated by quotas dictate that the main elements in the quota system, including the most important provisions for any allocation of free quotas, must be regulated and firmly rooted in law with a view to keeping the regulations stable over time.

The Commission has not gone thorough through the division of legal authority among the various administrative sectors. The numerous interests involved in the quota system are so powerful and broadly based that it would be natural for important decisions to be taken by the King in Council.

12 Summary of the recommendations and proposals of the Commission

*The Commission recommends that an extensive national quota system be introduced with regulation by quotas from 2008.

*All emissions suitable for regulation by quotas should be included in the system. The Commission is of the view that the following emissions are not suitable for the time being, but that their inclusion should be considered and/or actively sought: N2O og CH4 from combustion, CO2 from agricultural liming and from solvents, CH4 and N2O from agriculture, HFCs/PFCs as substitutes for CFCs and halons, and SF6 other than from magnesium production

*The Commission notes that if all greenhouse gases from all point sources considered suitable for regulation by quotas in a quota system are included, the system (based on Norwegian emission levels in 1997) will be able to accommodate almost 90 per cent of collective greenhouse gas emissions

13 Allocations

*A majority of the Commission (members Birkeland, Bjerkedal, Hagem, Haugestad, Hoel and Weltzien) recommend "that all concerned pay full market price for emission quotas in line with the principle that the polluter pays. Free quotas should not be allocated to any industrial sector."

*Commission members Dahle and Halmø recommend that "free allocation of quotas should be an option for practical implementation of aspects of the system in those sectors of industry which are currently exempted from CO2 taxes. These members are keen to maintain a national industrial infrastructure in the multi-billion class: highly efficient and environment-friendly in many cases, and in many others, in regions where the industrial structure is less than robust, as a crucial support."

*Commission members Stiansen, Sunde and Aamot believe "that it will be basically a political issue to consider which enterprises should be allocated free quotas and how great a share of free quotas they should be given. These members have not considered it part of their mandate to take a position on whether free quotas should be allocated."

*The Commission recommends that those quotas to be sold by the state be sold directly in the market, if a well-functioning market exists. If not, then the quotas should be auctioned. The precise method of auction should be worked out after the final decisions on the shape of the quota system have been taken.

*The Commission has discussed the following four principal forms of allocation of free quotas: (A) ((*?))Unconditional allocation based on historic emissions. (B) As A, except that the free quotas cannot be traded (i.e., free quotas = B quotas). (C) Allocation based on historic emissions, conditional on avoiding closure of the enterprises concerned or maintaining minimum production levels. (D) Allocation according to the activity level of the enterprise.

*The Commission is of the view that if any quotas are allocated free of charge, at least some of these quotas should be allocated as non-tradable B quotas. The Commission further proposes that allocation be based on a specified historic base period, for example that each individual enterprise can choose between 1990 and 1998. New enterprises, which would have had no emissions during the base period, would not be allocated quotas. The total number of quotas would be set in proportion to emissions in the base year.

*The majority, Commission members Birkeland, Bjerkedal, Hagem, Haugestad, Hoel and Weltzien, recommend that "all quotas allocated free of charge should be non-tradable quotas (B quotas)".

*Commission members Dahle, Halmø, Stiansen, Sunde and Aamot take the view that "an unqualified variant of allocation form B will be unable tocreate strong enough incentives for implementing emission reductions in the enterprise concerned. These members are in favour of strengthening such incentives by combining the allocation of free tradable quotas (A) and non-tradable quotas (B)."

Characteristics of "the quota" (the emission certificate)

*The Commission recommends that the quotas be allocated and traded as emission certificates conferring the right to allow emissions of a given volume of CO2 equivalents.

*The Commission recommends that regulation by quotas be imposed in part on the producer, in part on the sales or import chain, and in part on the end-user.

*The Commission recommends that all enterprises regulated by quota be required to by a fixed date to surrender quotas for the previous year's emissions.

• The quotas are not to be tied to a specific year so that they can be used at any time after regulation by quotas has taken effect.

The market for greenhouse gas quotas and use of the Kyoto mechanisms

* The Commission takes the view that the market can be left to itself to find the most suitable form of trading.

*The Commission recommends that in an international system, where there are no limitations on the exploitation of the Kyoto mechanisms by the countries which are Parties to the agreement, all concerned should make direct use of the Kyoto mechanisms, assuming the development of a secure system of controls.

*If any limitation were to be imposed on use of the Kyoto mechanisms, the Commission notes the that the state could auction/sell the rights to take advantage of quota trading, CDM and JI projects, on the Norwegian market.

The regulatory framework for the quota system

*The Commission recommends that regulations establishing the key elements of the quota system should be enacted as soon s possible. Further work is required in legislation and regulatory provisions for regulating the quota system. In particular, the regulations for reporting and control routines should be in place well before 2008 if we are to gain any useful experience.

*The Commission recommends a system of reporting, controls and sanctions that ensures compliance.

*The Commission recommends consideration of the advisability of setting up a regulatory body to supervise the management of the assets represented by the quotas, following guidelines drawn up by the political authorities.

NOU 2000: 1 (In Norwegian)