France wants to modify the EU carbon market’s Market Stability Reserve to introduce a “soft collar” for allowance prices because it says existing reforms fall short, a senior French government source told Carbon Pulse.

The country is circulating an informal proposal to other EU member states and stakeholders that outlines how existing measures and upcoming post-2020 structural reforms to the 11-year old scheme could be reworked to implement a “corridor” for EU Allowance prices.

The source said the non-paper is intended to force EU lawmakers to face up to the reality that something further needs to be done to address low carbon prices, which remain depressed by a years-old surplus despite several rescue measures.

“There’s an issue with the credibility of the EU ETS and a recognition that we need to do something more about carbon prices, because they currently provide little incentive to invest in low-carbon technologies,” the source said, speaking on condition of anonymity.

According to the proposal, dated Feb. 2016 and seen by Carbon Pulse, the low prices have also increased the cost of support mechanisms for renewables, while decreasing the EUA auction revenues available to fund the transition to a low-carbon economy, which has prompted some governments to look at supplementary unilateral actions.

“The feeling we have right now is there is an elephant in the room, a common recognition when we’re having discussions with working parties that something is not working properly,” the source added.

“This is especially evident when we’re talking about carbon leakage with a €5 carbon price. There’s a gap between these discussions and reality at the moment.”

As a result, France wants to introduce in government EUA auctions both a reserve price and a ceiling price some 3-6 times that level, forming a corridor that rises annually along a predetermined trajectory to provide a degree of certainty for ETS participants, investors, and governments.

“The price corridor could easily be set up based on the Market Stability Reserve, and would not have a significant impact on member state auction revenues. Moreover, to avoid impacts on the competitiveness, the implementation of this soft price collar would be done in conjunction with maintaining improved and strengthened provisions to fight against a potential risk of carbon leakage,” the proposal said.

“The idea of a price corridor has been taken up by [French Environment] Minister [Segolene] Royal, who has shown a personal interest in this matter.  We want to discuss this at EU level now,” the source said.

“She considers it to be one of the main priorities in terms of the follow-up from COP-21, and feels it would help strengthen the way carbon pricing is developed in Europe and worldwide.”

Royal has included the EUA price corridor as part of a four-part plan that France is advocating in the wake of the Paris climate talks.

In addition, Royal wants the 28-nation bloc to encourage other countries to introduce a price on carbon, to integrate their own carbon taxes on sectors outside the ETS similar to the one passed by France last summer, and to ensure 100% free allowance allocations target only the EU industries most vulnerable to carbon leakage.

**Click here to download France’s non-paper proposal**

PRICED IN

The EU has in recent years approved two separate mechanisms to tackle the hefty oversupply of allowances, an almost decade-old glut that has knocked prices from a high of €30 in 2008 to single digits.

“EU carbon prices have collapsed since beginning of the year, and member states are facing some problems in how to explain that in light of Backloading and the MSR,” the French government source said.

Market participants say EUAs have tumbled by around 40% since the end of 2015 due to a number of bearish factors including speculative positioning, changing utility hedging patterns, and unseasonably warm weather.

The crash has all but erased the sizeable gains posted in the past two years on the back of approval of both supply-cutting mechanisms.

Backloading removes 900 million allowances from the market between 2014 and 2016, and those allowances will be placed in the MSR, which starts in 2019 and sucks up 12% of the scheme’s surplus annually as long as the glut is in excess of 833 million tonnes.

A senior European Commission official earlier this month said the bloc’s executive will not propose further measures to address scheme’s the oversupply before 2020, insisting that the MSR needs a chance to work before its first review in 2022.

“Many analysts say both measures have now been priced in, so if that’s the case and we’re still at €5, then there’s clearly an issue and we can’t wait any longer for the MSR to kick in,” the source added, citing analyst estimates that the current EUA oversupply won’t be fully absorbed by the reserve until the late 2020s.

PUT A COLLAR ON IT

France’s plan would see the MSR modified to withdraw or reintroduce allowances based on EUA price triggers, rather than the supply-based rules passed by lawmakers last year.

Auctions that clear below the floor price would cause quotas in subsequent sales to be reduced or for those sales to be cancelled altogether, with those units going into the MSR. Meanwhile, auction prices above the ceiling would see EUAs taken from the MSR to increase future sale quotas.

The source said this would ensure the mechanism is more reactive to EUA prices than is the MSR in its current agreed format, which removes a number of allowances from the market based on the previous year’s oversupply.

According to France’s proposal, such a soft price collar would also “reduce volatility from adverse expectations of future emissions and improve the predictability of the carbon price, creating a strong incentive in favour of low-carbon investments while securing revenues for member states.”

The concept is akin to measures integrated in North America’s RGGI and WCI markets, where the auctions have floor prices and additional allowance sales from a special reserve ‘safety valve’ system are triggered by high prices.

As to where minimum and maximum prices should initially be set, the French source said the levels informally discussed by lawmakers during the MSR’s negotiations and impact assessment could be a benchmark.

“For the floor price, there was a consensus to get around €10 in 2016, increasing to around €30 in 2030 … [And] for the ceiling, we want to avoid it being too low as we still want to let the market play,” the source said, adding that France remained open to discussing the specific details of such a plan.

“With the MSR discussions, there were quite a few fantasies [from opponents] as to its impact on prices, that they would soar to €100. With a price collar, we would know what we’d get, prompting fewer fears.”

POLITICAL APPETITE

“It’s also to give governments certainty, because if the ETS revenues aren’t there then planning can be difficult and they have to be drawn from other programmes,” the source said.

“But there needs to be political appetite for this, and while we’re trying to have this discussion to create that appetite, we also don’t want to put back into harm’s way what we have already accomplished with the MSR.”

The source said the idea has garnered some initial support from some NGOs as well as the French power sector, which is mainly nuclear-based and would benefit from higher carbon prices, while also piquing the interest of a few member states as well as some corners of the EU’s executive.

“There are ongoing, high-level discussions about more direct measures regarding ‘command and control’ for carbon prices, including in the European Commission,” the source added.

“When you go higher up in the political landscape, [EU climate commissioner Miguel Arias] Canete is not necessarily reluctant, and this idea is circulating in [Commission President Jean-Claude] Juncker’s cabinet, which has also looked at applying monetary policy to carbon prices.”

While the notion of price management in the EU ETS has long been taboo for many lawmakers including the scheme’s main architects, DG Climat – the European Commission’s climate department – who have preferred to set the scheme’s emissions cap and let the market freely determine the price, the source said France had not yet received any negative feedback over its draft plan.

“I have the feeling that we’re not at the same point as we were at the start of discussions over the [post-2020] structural reforms.”

COMPLEMENTARY MEASURES

France also wants any efforts to support and guide EUA prices to be accompanied by complementary measures in the post-2020 structural reforms, in order to offset the impact on sectors vulnerable to foreign competition.

“We need to address carbon leakage, and this is best done through a tiered approach with 100% for most exposed industries,” the source said.

France, along with the UK, recently floated a separate proposal to divide the allocation of post-2020 allowances into four different tiers, wider than the Commission’s proposed two, in more efficient target-exposed sectors.

And along with a soft collar for carbon prices, France is also calling for:

– A “more harmonised and more effective” system of compensation for indirect EU ETS costs. France said it would make a more detailed proposal for this in a separate non-paper to come.

– The establishment of a ‘carbon inclusion mechanism’, starting with the cement sector, that would require importers of goods manufactured outside Europe to buy EUAs.

– An acceleration of the implementation of the EU’s innovation fund.

France also thinks its plan will help improve the EU ETS by dissuading countries from introducing supplementary unilateral measures such as the UK’s carbon price floor, which effectively acts as a top-up tax on EUA prices for emitters and now stands at around £18/tonne, or almost five times current EU carbon prices.

“The UK carbon price floor is doing harm to the EU ETS.  Every time a country implements an additional measure, it reduces emissions domestically, increases the [EUA] surplus, and leads to emissions elsewhere.”

“If more and more countries are doing that because the carbon price is too low, what would be the place for the ETS in the end?” the source asked, noting as well that carbon prices would then decrease, auction revenues would dry up, and initiatives like the EU’s innovation things would go unfunded.

The Dutch government, current holders of the EU’s rotating presidency, last month said carbon pricing would be on the agenda for the Apr. 14-15 informal Environment Council meeting, which would give Royal an opportunity to further discuss France’s proposal with other member states ahead of the June 20 EU Council meeting.

By Mike Szabo – mike@carbon-pulse.com

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