COMMENT: What next for the EU ETS?

Published 06:00 on August 29, 2018  /  Last updated at 15:23 on September 7, 2018  / Ben Garside /  Contributed Content, EMEA, EU ETS, Other Content

Sanjeev Kumar of PR consultancy Burson-Marsteller sets out four EU carbon market reforms that should be on Brussels’ agenda to ensure effective operation based on clear market fundamentals.

By Sanjeev Kumar, director – energy and environment, Burson-Marsteller

Moves are afoot from among some Council members to explore reforms to EU climate legislation on established commitments as well as the Emissions Trading System (EU ETS), the EU’s flagship climate instrument.

The European Commission has already started the process to identify long-term climate strategies to 2050, while Climate Commissioner Miguel Arias Canete is indicating more than -45% emission reductions by 2030 will be achieved after agreement of the Energy Efficiency and Renewable Energy Directives, up from the current 2030 target of -40% under 1990 levels.

Meanwhile, the 2018 ‘Facilitative Dialogue’ (Decision 1/CP.21, paragraph 20) is the first instance in which signatories to the Paris Agreement will have an opportunity to increase their emission reduction targets. This will be repeated in at the ‘Global Stocktakes’ (Article 14(1)) that take place every five years from 2023, meaning EU legislators will have a very busy agenda in the new mandate.

Even though EUA prices have started to become relevant in recent months, rising from below €6 in early 2017 to a 10-year high of €21.79 this week, considerable surplus and structural hinderances remain, impacting on the effective operation of the market based on clear market fundamentals.

Four reforms presented below could impact this and are thought to be integral to the Market Stability Reserve (MSR) review scheduled for 2021, even though the last two are outside the scope of the MSR.

These reforms under discussion are:

  1. MSR thresholds – The 833 Mt upper threshold to the MSR was agreed in 2017 before governments accelerated closure of fossil-fired electricity generator portfolios. The Netherlands agreed to closing all coal-fired plants by 2030 and has brought forward closure of two old coal plants to 2024; the UK made a similar pledge by 2025; France by 2021; whilst Germany, the largest coal-fired polluter, established a Commission to outline how it will close coal capacity in a socially responsible manner. These make the 833 Mt threshold – anchored on consumption by large coal-fired power generators – suboptimal, especially when increased targets for renewables are factored alongside coal phase-out actions. A downward adjustment is required to the 833 Mt threshold to reflect these new circumstances.
  2. Extending lifetime of the 24% MSR removal rate – The 24% removal rate will be in place from 2019-2024. This means 76% of the annual ETS surplus, which lowers the carbon price at which clean technology investments are made, will remain in the market and increase to 88% after 2024. Additional measures would be required to remove the surplus either by focusing on the MSR removal rate and/or increasing the Linear Reduction Factor (LRF). The 24% removal rate could be extended to 2030 to maintain the agreed direction, or increased to 33%, which would reduce the rate of total surplus removal from four years to three. It could also be increased to 50%, which would remove the total surplus in two years.
  3. ETS closure rules – The ETS surplus will increase as polluting installations permanently close. However, allowances continue to be generated either for distribution to manufacturing industry or auction. These influence market effectiveness by permitting ‘hot air’ to remain in the system, which subsequently lowers the carbon price investment signal. An option would be to adjust the total volume of allowances in each calendar year that are available for auctioning and distribution. This reduces future build-up of surplus, and maintain confidence in a robust carbon price.
  4. Aligning the LRF – Analysis by consultancy Ecofys indicates the 2.2% LRF agreed in 2017 delivers a -71% emission reduction on ETS emissions by 2050, which is below the EU’s agreed overall -80% GHG by 2050 target. A 2.4% LRF is compatible with the -80% target, while 2.7% is needed to meet the EUs upper-range 2050 target of -95%. Note, these ranges do not comply with the 1.5C temperature increase target outlined in the Paris Agreement.