By Sanjeev Kumar, founder, Change Partnership

After eleven years of operation, the EU ETS is still in a dire predicament. MEP Ian Duncan, lead legislator on the EU ETS reform in the European Parliament, last September stated “it’s not going anywhere, that’s evident.  It’s not driving forward innovation, it’s not driving forward change, [and] it’s not delivering against our ultimate climate change targets.”

That was before the EU carbon price collapsed even further to €5.  Investment bank Barclays’ latest report, titled “2 degrees of separation”, estimates the carbon price will remain at €5 by 2030.  Now the EU ETS is being used by unscrupulous policy makers to undermine other, more successful legislation on renewables and energy savings – which have delivered investments, jobs and economic growth – by seeking to abandon those efforts in favour of the carbon price.

Governments have been forced to opt for domestic measures to help stimulate investment in the absence of the EU ETS.  Sometimes, this has led to a more costly approach to decarbonisation, for example as seen with the UK carbon price floor – a tax paid on the difference between what the UK government expects from ETS allowances and the actual price. Germany has had to rely on its Energiewende programme to drive through its energy system transformation.

The main problem with the European carbon market has been and remains a crippling surplus and massive giveaway of free pollution rights. The cause is an institutional inability to correct market failure and respond to changing circumstances in a timely way, in essence a ‘too little, too late’ response.

This has delayed sustainable investment and innovation for over a decade.  And unless drastic action is taken, the EU will be locked into long-term insignificance.  This is because even with the application of the Market Stability Reserve and the introduction of a 2.2% linear reduction factor on the scheme’s Phase 4 emissions cap, the surplus is expected to continue beyond 2030, according to the European Commission’s assessment.

The most obvious solution is to temporarily suspend allowance banking between Phase 3 (2013-2020) and Phase 4 (2021-2030).  This timely strategy would have an immediate effect on the surplus and on carbon prices, while also bringing more predictability and transparency to the market.  Real scarcity would finally arrive in 2021.

What’s more, the precedent already exists for this move. In 2011, the commission banned the use of Clean Development Mechanisms credits with low environmental integrity from the EU ETS.

But some market fundamentalists may see the suspension of banking as being too radical.  To address their concerns, a compromise might be to only permit 50% of allowances to be banked across periods.

This too, would substantially improve the plight of the EU ETS. Its impact would be twofold:

Firstly, EUA prices would fall in the short term as companies sell off their allowances to 2020. The impact would hardly be dramatic given the low and falling carbon price today. In fact, it is a manageable price to pay for an outcome that would finally restore credibility and a robust investment signal.

Secondly, the prospect that allowances cannot be banked will finally stimulate polluting companies to bring forward investments in facilities to ensure that they reduce their risk with a genuine market taking effect.  Innovation to reduce process emissions and identifying alternative means of production get welcome added impetus.  In addition, a robust carbon price will provide more substantial capitalisation for the proposed Innovation Fund and will help create a pipeline of projects to benefit from it.

Unless the EU ETS is fixed, and fixed quickly, the bloc’s flagship policy will sink.  The commission’s proposal fails to address these core problems, so the baton now passes to the European Parliament and Council to rectify this situation.

Sanjeev Kumar is a climate and energy political campaigner as well as the founder of Brussels-based Change Partnership, an independent not-for-profit think-tank seeking to solve the politics of transition to a clean, secure and prosperous climate. It delivers these aims by creating innovative policy and political solutions, as well as organising decision-makers in governments, business and civil society to ensure real change is achieved.