The European Commission published its post-2020 ETS review proposal on Wednesday, after it was adopted at a morning meeting.

The legislative proposal was published as part of a package of measures including a seperate legislative proposal for energy labeling for appliances, a consultation on the electricity market design aimed at helping deploy renewables and a communication aimed at getting households to use energy more efficiently.

The ETS proposal, published in full on the Commission website, must be agreed by a majority of member states and the bloc’s parliament in a process that could take at least two years.

It sets out law to implement the ETS portion of an agreement struck last October when EU leaders set a 2030 target to cut greenhouse gas emissions at least 40% under 1990 levels. Proposals on non-ETS sectors and land use are expected early next year.

In that unusually detailed guidance, the leaders agreed many provisions including that ETS sectors should make a 43% cut under 2005 levels, a move that the Commission proposed will deepen the market’s annual cap reduction from 1.74% to 2.2%.

Click here for key takeaways and selected reactions to the proposal

MSR LOOPHOLE?

While much of the proposal focuses on changes to how allowances are handed out to industry, one outstanding issue that could have a direct carbon price implication is what the Commission proposes to do with unallocated allowances from ETS Phase 3 (2013-2020).

Under the already agreed MSR reform some 1.6 billion Phase 3 EUAs are due to be withheld from the market, but lawmakers left a potential loophole by not fully deciding on the fate of part of that volume – an estimated 700 million unallocated EUAs.

The MSR deal said 50 million should be sold before 2021 as part of a new Innovation Fund to help low-carbon industrial and energy projects, but it left the Commission to consider whether any more should be used to address carbon leakage, meaning they could be sold back into the market.

Today’s proposal was consistent with an earlier leaked draft, which called for at least 250 million of the unallocated Phase 3 EUAs to be put in a different reserve for new entrants to the scheme post-2020.

This goes some way to closing the loophole as those allowances will not be sold on the market, and only allocated to companies providing evidence they are building new or expanded installations.

Thomson Reuters Point Carbon analysts have said the move is slightly bullish for EUAs as they had previously assumed some 350 million unallocated EUAs would be sold. Not selling any could add as much as €2 to their previous EUA price forecast of €25 in 2026.

The decision also appears to go against the Commission’s own impact assessment (p. 226) which found that cancelling the unallocated allowances would be a better option.

Environmental campaigners Carbon Market Watch said the draft proposal 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 next decade.

“Since otherwise these 250 million allowances would have been prohibited from flooding the EU ETS before 2030, while they are now allowed to return to the EU ETS before that time, this undermines the EU’s 2030 climate ambition,” said Femke de Jong of Carbon Market Watch.

SURPRISE POT

The Commission surprised observers by proposing that another pot of unallocated Phase 3 EUAs not previously captured under the MSR be put into the Phase 4 new entrants reserve.

This pot of allowances, estimated to stand at 145 million by 2020, will be left over from allocations initially assigned to the few factories deemed not exposed to carbon leakage but later cut when regulators applied the so-called cross sectoral reduction factor across all industries to keep below the overall cap.

Without further legislative changes these allowances would all be auctioned in 2020 but environmental groups said it wasn’t clear if lawmakers were fully aware of them when they agreed to the MSR, which was brought in to help curb the market’s massive oversupply and adopted only last week in the EU Parliament.

“The nasty surprise for environmentalists is that we were cheated out of some of the ‘unallocated’ allowances we thought had been placed in the MSR… We should be carving allowances for innovation and new entrants out of the new Phase 4 carbon budget, not pillaging the MSR for these,” said Damien Morris of Sandbag.

LIMITED PRICE IMPACT

EU carbon prices rose slightly following the publication of the proposal, with the benchmark Dec-15 futures contract ending the day up 3 cents at €7.77 on ICE Futures Europe.

“Today’s proposal does not drastically change the outlook for the overall supply of allowances but rather reshuffles the amount of free allocation vs. auctioning.  We now expect European carbon prices reaching €17 in 2020, rising to €30 in 2030”, said Emil Dimantchev, a senior analyst at Thomson Reuters.

The analysts noted that the proposal confirms the leaders’ stance in the 2030 agreement that no additional use of international carbon credits be allowed for the 2021-2030 period.

NO RINGFENCED FOREIGN CLIMATE AID

Sources had told Carbon Pulse that up until days before the final publication, EU officials had been considering ringfencing revenue to be raised from auctioning a small portion of post-2020 EUAs for foreign climate aid.

Today’s proposal had no such provision, which development group Oxfam had said would have gone a long way to assure developing nations that the EU was making good on its international climate finance commitments.

Instead, the proposal merely recommended that member states do so, but left the decision up to them.

“It will be on Member States to devote part of these revenues from the emissions trading scheme to support climate mitigation actions in third countries, including development countries,” the Commission said in a statement.

“By failing to make the sale of pollution permits pay for clean development and climate adaptation abroad, the European Commission has lost an opportunity to restore its international climate leadership, and leaves the people most impacted by climate change without additional support,” said Oxfam’s Lies Craeynest.

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

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