General description. Kyoto Commitment Period I (Phase I)

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1 Title of the measure: CH2 Swiss emissions trading scheme CH ETS (Schweizer Emissionshandelssystem / Système suisse d échange de quotas d émission / Sistema svizzero di scambio di quote di emissioni) General description In 2008, in conjunction with the CO 2 levy, Switzerland introduced its first emissions trading scheme (CH ETS), which enables a cost-effective reduction of emissions. The Swiss ETS covers only around 50 installations from energy intensive industries and is, measured in covered emissions, the smallest emissions trading system worldwide (SFAO 2017b, p. 2). The participation in the ETS is mandatory for large and greenhouse-gas intensive companies, whereas medium-sized companies may participate voluntarily. However, independent of their size, all companies that participate in the ETS are exempted from the CO 2 levy (see MURE measure Emission Reduction Target Agreements) (FOEN 2015b; SFAO 2017b). The ETS is based on a cap-and-trade principle, thus the quantity of emission allowances is limited. The total quantity of emission allowances, which represents the cap, is determined in advance and the allocated allowances can be traded. The first commitment period of the ETS was from 2008 to Since 2013, the revised CO 2 Act and the corresponding CO 2 Ordinance are in place and regulate the second commitment period from 2013 to It is foreseen by the Swiss Federal Council that the Swiss ETS and the EU ETS are linked in the future. The technical negotiations have been finalized, however, ratification is still pending in the Swiss Parliament. The linking of the two system requires that Switzerland includes aircraft operators and gas-fired combined-cycle power plants in the ETS (Swiss Confederation 2018, p. 90). Kyoto Commitment Period I (Phase I) The first commitment period lasted from 2008 to Companies were incentivised to participate voluntarily in the ETS by being exempted from the CO 2 levy as a result. Companies received freely allocated allowances according to agreed emissions reduction targets, which were negotiated on the basis of technological potential of economic viability measures to reduce greenhouse gas emissions within the company (see MURE measure Emission Reduction Target). Around 450 companies participated voluntarily in the scheme and accepted emissions targets. The commitment was considered fulfilled if they surrender the quantity of emissions allowances required to offset their effective CO 2 emissions by 1 June 2013.As can be seen from Table 1, freely allocated allowances were higher than the obligations based on emissions, which means that the scheme was in total over allocated. Trading volumes have been negligible, apart from the transfers of the surplus to the Climate Cent Foundation (predecessor of KliK à see MURE Compensation of CO 2 Emissions). Table 1: Phase I allocation and banking of emission allowances. Usually refers to CHUs Total Phase I Total free Allocation 3'259'764 3'309'016 3'337'581 3'162'554 3'454'474 16'523'389 Total Auctioning Total Obligation 2'783'715 2'571'092 2'844'033 2'671'779 2'592'567 13'463'186 Over allocation 476' ' ' ' '907 3'060'203 % Total Allocation 15% 22% 15% 16% 25% 19% Total Surrendered CHU1 2'787'942 2'572'990 2'833'520 2'701'072 2'126'128 13'021'652 Total Surrendered CHU2 Total Surrendered CERs 1'292 2'850 2'682 19' ' '773 Total Surrendered ERUs '679 69'679

2 Total Over allocation 477' ' ' '584 1'321'047 3'615'655 % of Total Allocation 15% 22% 15% 16% 38% 22% Total Over allocation by Phase II companies 181' ' ' ' '133 1'361'124 Total Use CERs & ERUs ' ' '306 Total potential banking by 147' '628 85'121 16' ' Phase II companies (Betz, Leu & Schleiniger 2015) Second commitment period (Phase II) The second commitment period started in 2013 and lasts until Since 2013, the rules for the ETS have been aligned with the European Emissions Trading Scheme (EU ETS) with the aim to link both systems in the future (Swiss Confederation 2018, p. 90). Under the CO 2 Act, large emitters with a total thermal input of their combustion installations of 20 MW or higher are required to participate in the emissions trading scheme (ETS), while medium-sized companies may participate voluntarily. In other sectors, specific thresholds based on production capacity (e.g. paper and paperboard production with a production capacity of over 20 tonnes per day) are also used as a criterion for mandatory participation in the ETS. For sectors that typically include companies with large installations, no threshold has been set (e.g. mineral oil refining). These companies are required to participate in the ETS, regardless of their production capacity (see Figure 1 and Appendix I). Installed combustion capacity > 20 MW or acitivity according to the Appendix 6 of the CO 2 Ordinance yes Emissions < 25'000 tons of CO 2 eq in each of the previous three years no Installed capacity between 10 and 20 MW and acitivity according to the Appendix 7 of the CO 2 Ordinance yes no yes no Opting out of the ETS possible Mandatory participation in the ETS Voluntarily participation in the ETS possible (Opting in) Dispensation from the CO 2 levy possible without participation in the ETS Figure 1: Scheme of the participation decision in the ETS 1. 1 Opting out of the ETS:

3 Zero companies have voluntarily opted-in so far, thus, the number of participating companies is much smaller in Phase II. The number of covered installations has been reduced from 450 to around 55 installations or 35 companies in Phase II (see Table 2), but the coverage of emissions has increased by more than 40% from an average of 3.1 million ton CO 2 per year in Phase I to 5.3 million tons CO 2 per year in Phase II (based on allocation). This increase in emissions, in conjunction with a 90% lower number of companies covered, is due to the fact that more emissions intensive companies (e.g. refineries, cement and combustion installations from communes for district heating) have been regulated in Phase II. 2 (FOEN 2016). Table 2: Number of companies, sector affiliation and allocation in the CH ETS (Swiss Confederation n.d. as of September 2017) Sector Number of ETS companies Allocation (in tons CO 2 ) Cement, rocks and soils Chemicals / Pharmaceuticals Refineries Paper Metal processing District heating Others ETS cap and reduction path The Federal Office for the Environment (FOEN) determines the quantity of the annually available emission allowances. This quantity represents a cap, as it defines the maximum amount of emissions for all companies that participate in the trading system. One emission allowance entitles to an emission of one ton of CO 2. The quantity available is reduced step-wise by the same absolute amount every year (1.74% of the 2010 level). This approach has been applied to determine the caps for the period of 2013 to 2020 and in 2013 the cap was set at 5.63 million tons of CO 2. From the cap, a fixed amount of 5% is deducted and held back as reserve in every year in case new installations enter the trading system or existing installations significantly increase their capacity. Thus, only 95% of the maximum emission allowances are available. In case no new installations enter the system, the amount held back is auctioned by the FOEN in the next year (Swiss Federal Audit Office [SFAO] 2017, p. 20). Allocation of emission allowances In general, the allocation of emission allowances is determined by using product-benchmarks. These benchmarks define the amount of emission allowances that are allocated for every produced unit. The benchmarks are defined by taking the average of the emissions of the 10 most energy efficient installations per sector (EU-wide). The sum of all emission allowances allocated must not exceed the cap minus the reserve. As this was the case in 2013, the allocations were cut in a linear manner and multiplied by a crosssectoral correction factor. In order to ensure the same competitive conditions that exist in the EU, the Swiss ETS harmonized its allocation rules, which are based on the same benchmarks of emissions performance as in the EU ETS (SFAO 2017a, p ). Companies that exceed their specific threshold but had total emissions below 25,000 tons of CO2 equivalent each year in the last three years may submit a request to the FOEN to opt out of the ETS. If the emissions of these companies subsequently exceed the threshold of 25,000 tons of CO2 equivalent during a year, they will again be required to participate in the ETS in the following year. Opting in the ETS: Medium-sized companies in energy and trade-intensive economic sectors may voluntarily participate in the ETS (opt-in). The threshold for these companies to opt in is a total installed rated thermal input, i.e. the sum of the rated thermal inputs of the company's various installations of 10 MW or higher. The decision to participate is made once at the beginning of the commitment period and remains valid until The cement sector has been covered in Phase I by cemsuisse, the Swiss association of cement producing companies, but not all companies and installations were covered, therefore, the mandatory coverage has increased the covered emissions substantially and Holcim became the biggest player in the Swiss ETS.

4 Table 3: Main features, allocation, obligation and surrendering of emission allowances in the Swiss ETS (Swiss Confederation n.d. as of April 2018). Year Cap 5'632'864 5'529'455 5'426'045 5'322'635 5'219'225 5'115'815 5'012'405 4'908'996 Reserve (5% of the Cap) 281' ' ' ' ' ' ' '450 Auction Amount Free of Charge Allocation CHU2 5'400'506 5'254'632 5'136'033 4'758'943 4'519' Obligation 5'510'716 5'444'991 4'665'132 4'773' Scarcity (Obligation- 110' Allocation) Total Surrendering 5'470'405 5'477'708 4'656'085 4'772' Surrendered CHU 28' Surrendered CHU2 4'198'836 5'080'110 4'640'788 4'693' Surrendered CERs 1'242' '598 15'297 67' The amount of emission allowances allocated for free depends on the risk of leakage, which defines the risk that a company moves production out of Switzerland due to the high financial burden of CO 2 costs. Therefore, some allowances are allocated free of charge and others are auctioned by the FOEN. At present, a majority of the companies are rated as high-risk of leakage and thus receive their allocation for free (SFAO 2017a, p ). The free-of-charge allocation is calculated per sub-installation for each year of participation in the ETS, according to the following formula: Allocation i = benchmark activity level carbon leakage factor i correction factor i The activity level is either the average of production in or , depending if a company did already participate in Phase I. The carbon leakage factor does not apply if a company is part of a sector defined as high risk of leakage, which is the case for most of the manufacturing companies covered. However, the factor may apply for some of the waste incineration companies or district heating plants. The correction factor is defined in the CO 2 regulation and ensures that the sum of calculated allocations per company in Switzerland is equal to the cap set for the ETS-sector. Activity level: based on the corresponding benchmark. Carbon leakage factor: adjustment factor which corresponds to the risk of relocating abroad due to the costs of CO 2 (carbon leakage). Correction factor: Assures that the total quantities of allowances do not exceed the maximum quantity of emission allowances available in the ETS (see Table 3 and Table 4). Table 4: Adoption and reduction factor for Swiss allocation formula. Year Carbon leakage factor CH correction factor 99.91% 98.55% 97.17% 95.78% 94.38% 92.96% 91.54% 90.09% EU ETS correction factor 94.27% 92.64% 90.98% 89.30% 87.61% 85.90% 84.17% 82.44%

5 Emission allowances auctions Emission allowances which have not been allocated for free are auctioned off by the FOEN. In addition, unused units of the reserve (5% of the yearly cap) are also auctioned. Auctions may be carried out several times a year and participation is limited to ETS companies. In the auctions, every bidder places his bid with price and quantity of the required emission allowances (FOEN 2015a). Table 5 shows that the auction prices in the Swiss ETS are moving in compliance with the trading prices in the EU ETS. Table 5: Evolution of the auction prices per emission allowance in the Swiss ETS. Date Price CHF Price (CHF) Evolution of Auction Prices CH-ETS Time Monitoring by companies in the emissions trading system Under the CO 2 Act, ETS companies must submit annually, latest by 31 March of each year a monitoring report based on the monitoring plan. These are recorded in a monitoring system. The FOEN may require that the monitoring reports be verified by an independent third party (FOEN 2015a). Use of international emissions reduction units (certificates) ETS companies can use certificates for specific emission reductions achieved abroad like CERs and ERUs (see Table 3). However, the quantity of such certificates that they can use for compliance is limited. Their certificates must be issued according to the rules of the Kyoto Protocol and meet the quality criteria set out in the CO 2 Ordinance (FOEN 2015a). Factors which have an impact on the CH ETS in Phase II One of the amendments in Phase II is the introduction of auctioning of unused units of a new entrant reserve. The reserve consists of 5% of the cap. The withholding of 5% of allocation results in an average underallocation of installations of around 2000 tons of CO 2 (see Figure 2). Most of the installations belonging to manufacturing industries are, however, long. Whereas combined heat and power producing installations such as, for example, airport Zurich or refineries, e.g. Tamoil, which closed down in 2017, are underallocated. The high amount of emission allowances allocated free of charge in combination with the currently low prices per unit provide little incentive for companies to implement reduction measures. In addition, the closing of the third-largest CO 2 emitter in Switzerland (Tamoil refinery) intensifies these effects as there is a sufficient amount of allowances available in the current period. With the close down of Tamoil, the CO 2 emissions of all other participant in the ETS are already today below the target level in 2020 (SFAO 2017a, p. 3, 24).

6 Units of Allowances (Tons of CO2) Swiss Emissions Trading Registry: Boxplots of Allowances 2013 Allowances Distributed 102'292 = Mean = Median = Outliers Units of Allowances per one ton of CO Allowances Surrendered 104'293 = Mean = Median = Outliers Units of Allowances per one ton of CO Allocation Position = Mean = Median = Outliers -2'001 Figure 2: Individual and average allocation position CH ETS Phase II Source: Swiss Emissions Trading Registry [ N = 55 ] The overall scarcity of the scheme depends not only on the allocation and emissions in Phase II, but also on two other factors that will have a major impact. First, the carry-over of national CHUs and international units like Certified Emissions Reductions (CERs) and Emissions Reduction Units (ERUs) from Phase I into Phase II. For international units, rules apply that limit the banking to a level of CERs and ERUs (Art. 139 section 3 CO 2 ordinance). 3 Based on the registry information, the maximum of bankable CHU1 and CERs/ERUs from Phase I is estimated to be around 1.6 million units for installations, which were covered in both phases (see Table 1). However, most of the installations have made use of the opportunity to sell their surplus from Phase I to the Climate Cent Foundation (predecessor of KliK see MURE measure Compensation of CO 2 -Emissions) at a price of CHF 50 per CHU1 (Climate Cent 2013), therefore, it is assumed that most of the surplus has not been transferred into Phase II. Secondly, the possibility to use additional international emissions reduction units reduces, the pressure of national emission cutbacks. Again, limits for international units apply which are determined in Art. 48 (CO 2 - Ordninance) as follows: first, for installations that already participated in Phase I a maximum of 11% of the allocated CHU1 in can be used for compliance in both phases. Thus, used CERs and ERUs in Phase I have to be subtracted from the total eligible amount in Phase II. Secondly, installations which have only participated since Phase II are allowed to make use of 4,5 % CERs and ERUs of their actual greenhouse gas emissions in 2013 to In Figure 3, the overall scarcity is estimated, taking both inter-temporal and international flexibility into account. As mentioned above, the banking from Phase I to Phase II may be much lower, given the sales to Climate Cent Foundation. Nevertheless, there seems to be no overall scarcity in the Swiss ETS in Phase II, just by accounting for the potential use of international emissions reduction units. 3 Based Article 3, paragraph 13 of the Kyoto Protocol there is no banking restriction for Assigned Amount Units and a limit of 2.5% of the assigned amount for CERs and ERUs. RMUs cannot be carried over.

7 Estimated scarcity Swiss ETS, Phase II, Units of allowances (in tons of CO2-eq) Cap Banking CHU1s (Phase I) Potential use of CERs & ERUs (Phase II) Emissions 2013 = 5.4 million CHUs Source: Swiss Federal Office for the Environment FOEN, own calculation Figure 3: Estimated Scarcity Swiss ETS Phase II (without the close down of Tamoil). Benefits of Linking the Swiss and EU emissions trading schemes The Swiss government believes that both environmental policy and the economy benefit from linking the two systems because: in a larger market, there is greater potential to reduce emissions at a lower cost a larger and more established market is more liquid and leads to stable prices Switzerland's small market hinders trade and price formation European and Swiss emissions allowances would equally fulfil the statutory requirements Swiss companies could operate in the same emissions market as their business partners in the EU Impact evaluation (methods and results) Most research regarding the Swiss ETS estimates the effects of linking with the EU ETS based either on computable general equilibrium models (Voehringer 2012) or by qualitative analysis by Oberauner and Krysiak, (2008). There seems to be a lack of empirical ex-post evaluation of phase I and phase II of the Swiss ETS. Ecoplan (2016) analysed the impact of a linking between the Swiss and the EU ETS on behalf of the FOEN by using a multiple-country-general-equilibrium model. With a linking, Swiss companies could benefit from an increasing planning security, as there are less price uncertainties because of more participating actors. Additionally, the EU is able to reduce emissions more cost-effectively than Switzerland and there are no alternatives to linking. In a recently published report, the Swiss Federal Audit Office (SFAO 2017a) criticised a series of regulatory shortcomings which call the impact of the ETS into question. The most important shortcomings are: (i) The high number of emissions allowances allocated free of charge and the currently low emission prices which do not create reduction incentives for the participants of the ETS. (ii) The eligibility of foreign emission certificates which leads to an excess supply. (iii) Planning uncertainties due to the possible linking between the Swiss and EU ETS, as well as uncertainty about the transferal of unused emission allowances to the new commitment period. The Swiss Federal Audit Office recommends appropriate control mechanism to

8 respond to over- or undersupply and suggests that unused emission allowances are removed from the system. Given the small volumes of the Swiss ETS as well as the international exposure of most of the ETS companies they support the linking between the Swiss and the EU ETS. Should this linking not be realized, alternatives to the Swiss ETS need to be examined. Summary of climate policies and measures Name of policy or measure Estimate of mitigation impact, by gas (for a particular year, not cumulative, in million tonnes CO 2 equivalent) Year Emissions trading 1.0 n.a. n.a. n.a. n.e scheme (cap and trade) n.a.: not applicable n.e.: not estimated (Swiss Confederation 2016). The mitigation impact after 2020 is estimated to an additional reduction of 1.0 million tons of CO 2 (The Federal Council 2017, p. 97). Interaction of measures CO 2 Levy, Emission Reduction Target Agreements Historical data First trading period Allocation and Surrendering Obligation [Commitment Period ] Units of Allowances (Tons of CO2) Allocation Surrendering Obligation Source: Swiss Emissions Trading Registry [ N = 445 ]

9 Second trading period , Years 2013 & 2014 Allocation, Surrendering Obligation, Surrendered Units [Commitment Years ] Commitment Year 2013 Surrendered Units: Surrendered CHU Surrendered CHU2 Surrendered CER Commitment Year 2014 Units of Allowances (Tons of CO2) Units of Allowances (Tons of CO2) Allocation Obligation Surrendered Allocation Obligation Surrendered Source: Swiss Emissions Trading Registry [ N = 55 ], Own Calculation Units of Allowances (Tons of CO2) Allocation Position (= Allocation - Obligation) per Installation [Commitment Years ] Commitment Year 2013 [Mean Position: -2204] Units of Allowances (Tons of CO2) Commitment Year 2014 [Mean Position: -3577] Source: Swiss Emissions Trading Registry [ N = 55 ], Own Calculation

10 Appendix I: Companies obliged to participate in the ETS according to annex 6 of the CO 2 Ordinance 1. Combustion of fossil or partial fossil fuels with a total rated thermal input of over 20 MW; excluded is the combustion of fossil or partial fossil fuels in fixed installations whose main function is the disposal of municipal waste in accordance with Article 3 paragraph 1 of the Technical Ordinance on Waste of 10 December ; 2. Refining of mineral oil; 3. Production of coke; 4. Roasting or sintering, including palletisation, of metal ore, including sulphide ore; 5. Production of pig iron or steel (primary or secondary fusion) including continuous casting, with a capacity of over 2.5 tonnes per hour; 6. Production or processing of ferrous metals including ferro-alloys in which combustion units with a total rated thermal input of over 20 MW are operated; 7. Production of primary aluminium; 8. Production of secondary aluminium in which combustion units with a total rated thermal input of over 20 MW are operated; 9. Production or processing of non-ferrous metals, including production of alloys, refining, foundry casting, etc., in which combustion units with a total rated thermal input (including fuels used as reducing agents) of over 20 MW are operated; 10. Production of cement clinker in rotary kilns with an installed production capacity of over 500 tonnes per day or in other furnaces with a production capacity of over 50 tonnes per day; 11. Production of lime or calcination of dolomite or magnesite in rotary kilns or in other furnaces with an installed production capacity of over 50 tonnes per day; 12. Manufacture of glass including glass fibre with a melting capacity of over20 tonnes per day; 13. Manufacture of ceramic products by firing, in particular roofing tiles, bricks, refractory bricks, tiles, stoneware or porcelain, with an installed production capacity of over 75 tonnes per day; 14. Manufacture of mineral wool insulation material using glass, rock or slag with a melting capacity of over 20 tonnes per day; 15. Drying or calcination of gypsum or production of plaster boards and other gypsum products in which combustion units with a total rated thermal input of over 20 MW are operated; 16. Production of pulp from timber or other fibrous materials; 17. Production of paper or cardboard with an installed production capacity of over 20 tonnes per day; 18. Production of carbon black involving the carbonisation of organic substances such as oils, tars, cracker and distillation residues, where combustion units with a total rated thermal input of over 20 MW are operated; 19. Production of nitric acid; 20. Production of adipic acid; 21. Production of glyoxal and glyoxylic acid; 22. Production of ammonia; 23. Production of bulk organic chemicals by cracking, reforming, partial or full oxidation or by similar processes, with an installed production capacity of over 100 tonnes per day; 24. Production of hydrogen (H2) and synthesis gas by reforming or partial oxidation with an installed production capacity of over 25 tonnes per day; 25. Production of soda ash (Na2CO3) and sodium bicarbonate (NaHCO3).

11 Appendix II: Product Benchmarks according to annex 9 of the CO 2 Ordinance Product benchmark (number of emission Product allowances per tonne of manufactured products) Iron ore sinter Hot metal Pre-bake anodes Aluminium Grey cement clinker White cement clinker Lime Dolomite lime Sintered dolomite Float glass Bottles and containers made of clear glass Bottles and containers made of coloured glass Products made of continuous glass fibre Facing bricks Paving bricks Roofing tiles Spray-dried powder Gypsum Dried secondary gypsum Short-fibre sulphate pulp 0.12 Long-fibre sulphate pulp 0.06 Sulphite pulp, thermo-mechanical and mechanical pulp 0.02 Pulp made of recycled paper Newsprint paper Uncoated fine paper Coated fine paper Tissue paper Test liner and fluting Uncoated paperboard Coated paperboard Nitric acid Adipic acid 2.79 Vinyl chloride monomer (VCM) Phenol/ acetone S-pvc E-pvc Soda ash Refinery products Carbon steel obtained using the electric arc process High-alloy steel obtained using the electric arc process Cast iron Mineral wool Gypsum paperboard Industrial soot («Carbon Black») Ammonia Steam cracking Aromatics Styrene Hydrogen 8.85 Synthetic gas Ethylene oxide and ethylene glycol 0.512

12 References Betz, R., Leu, T., & Schleiniger R. (2015). Disentangling the Effects of Swiss Energy and Climate Policies, CREST Working Paper. Ecoplan (2016). Auswirkungen eines EHS-Linkings Schweiz-EU für den stationären Berich. Aktualisierung für den Betrachtungszeitraum 2021 bis Bern: FOEN. Federal Office for the Environment [FOEN] (2015a). Emission trading scheme (ETS): information for ETS companies. Available at: (Accessed: ). FOEN (2015b). Swiss emissions trading scheme (ETS). Available at: (Accessed: ). FOEN (2016). Emissions trading scheme (ETS) step by step. Available at: (Accessed: ). Krysiak, F., & Oberauner, I. (2010). Environmental policy à la carte. Journal of Environmental Economics and Management, 60(3), p Swiss Federal Audit Office [SFAO] (2017a). Evaluation der Lenkungswirkung des Emissionshandelssystems. Bundesamt für Umwelt. Bern: SFAO. SFAO (2017b). Evaluation of incentive effect of emissions trading scheme Federal Office for the Environment. Key Facts. Bern: SFAO. Swiss Confederation (2016). Switzerland s Second Biennial Report under the UNFCCC. Bern: Federal Office for the Environment. Swiss Confederation (2018). Switzerland s seventh national communication and third biennial report under the UNFCCC. Bern: Swiss Federal Office for the Environment. Swiss Confederation (n.d.). Emissions Trading Register. Available at: EN=71f3396a1461ee6ee3dad ff (Accessed: ). The Federal Council (2017). Botschaft zur Totalrevision des CO 2 -Gesetzes nach Bern: Swiss Confederation. Vöhringer, F. (2012). Linking the Swiss Emissions Trading System with the EU ETS: Economic Effects of Regulatory Design Alternatives. Swiss Journal of Economics and Statistics, 148(2), p