The European Commission has moved to close a potentially massive loophole in the MSR reform in what appears to be a draft of the EU ETS post-2020 proposal leaked on Wednesday, giving a slightly bullish EUA price outlook and tightening free allocations to industry.

The undated draft text was leaked and posted on the website of environmental campaigners Change Partnership, providing more clues as to what key changes to the bloc’s carbon market the European Commission is pushing for.

The Commission is aiming to publish its final proposal on July 15, despite warning that it could be delayed until September.  This will then kickstart a lawmaking process that could last two years or more.

While the MSR is due to withhold around 1.6 billion EUAs from the market by the end of the decade, lawmakers left a potential loophole by not fully deciding on the fate of an estimated 700 million allowances unallocated in Phase 3 (2013-2020).

In the MSR deal, lawmakers said 50 million should be used to help fund innovative low-carbon projects but asked the Commission to consider whether any more of those allowances should be used to address carbon leakage, meaning they could be sold back into the market.

The draft, which sources said was as much as two weeks old, said at least 250 million of those unallocated EUAs should be put into a different reserve for new entrants to the scheme.

“This goes some way to closing the loophole as those allowances will be held for new entrants, not sold on the market,” said Haege Fjellheim, an analyst at Thomson Reuters Point Carbon.

Strict rules already apply for allocating from this reserve to companies providing evidence they are building new or expanded installations.

It will “effectively act as an insurance policy for industry should activity surge,” BNEF analyst Jerry van Houten told Bloomberg News.

SLIGHTLY BULLISH

Fjellheim said this was slightly bullish for EUAs because Point Carbon had assumed in its most recent price forecast that 350 million of the approximately 700 million unallocated EUAs would be sold. They said not selling any could add as much as €2 to their price forecast of €25 in 2026.

Environmental campaigners Carbon Market Watch said the draft proposal still undermined the MSR because it did not prevent the units from returning to market altogether, meaning the current ETS surplus could be used as an extra free allocation to big-emitting industries.

“In the MSR those pollution permits would not come back to market before 2030, in the new entrants reserve they will. So it undermines the EU 2030 emission target,” said Femke de Jong of Carbon Market Watch.

AUCTION SHARE

Although the post-2020 ETS proposal is expected to deepen the market’s annual cap reduction from 1.74% to 2.2%, the main focus of the final text will be on how industries will keep receiving free allowances.

The Commission also appeared to propose that 57% of all allowances in Phase 4 (2021-2030) are auctioned, with 55% ringfenced for member state governments and 2% earmarked for a modernisation fund for industry.

It adds that any EUAs not allocated for free to industry in a given year should go in a type of buffer for use by those companies in future years, rather than being put up for sale.

As well, allowances given up by shuttered or partially closed plants be put in the new entrants reserve rather than be auctioned.

These measures seem to address EU leaders’ guidance from last October’s 2030 climate deal to ensure better alignment of allocation levels with changing production levels in different industrial sectors.

“Rather than meaning industry can get all the free EUAs they need, its increasingly clear the Commission is tightening the rules and all industries will receive less free allocation than today,” said Point Carbon’s Fjellheim.

FREE ALLOCATION

Current rules allocate to industries the vast amount of their required carbon allowances for free, but according to the leaked text the Commission is considering changing how the units are given out.

The draft suggests the Commission wants to stagger the allocation, with higher amounts of free allowances awarded to sectors deemed more vulnerable to carbon leakage.

Under this approach, a group of related industrial sectors deemed more vulnerable would receive 100% of their allowances for free up to a benchmark, while another group seen to be less at risk would get 30%.

The two-tiered allocation is simpler than the four-tiers the Commission was previously considering, according to a draft impact assessment leaked last month.

The leaked text also shows the Commission intends to tighten the benchmark values that help determine the share of free allocations within each industry sector “to avoid windfall profits and reflect technological progress”.

By Ben Garside and Mike Szabo – ben@carbon-pulse.com