Climate and Emissions: European Parliament and EU Ministers move to reform the Emissions Trading System (ETS)
A review of the Emissions Trading Scheme is underway in the EU Council today (19.12.2016). The discussions in Council follow a last-minute compromise on the way forward secured in the European Parliament’s environment committee last Thursday. Final Plenary approval is needed in February 2017 for the formal negotiations between MEPS and Member States to get underway in the Spring for a deal to be found on the way forward. One of the key problems that the European Commission’s proposal seeks to address is the problem facing the ETS scheme with a surplus of allowances that has built up in recent years as a result of the slowdown from the 2009 economic and financial crisis (the recession led to more than anticipated emissions than anticipated) and high imports of international credits. Correspondingly, this has led to lower carbon prices and thus a weaker incentive to reduce emissions. The European Commission is now proposing to address this market weakness through a series of short- and long-term measures.
In the short term, the surplus risks undermining the orderly functioning of the carbon market. In the longer-term it could affect the ability of the ETS to meet more demanding emission reduction targets cost-effectively. The surplus amounted to around 2 billion allowances at the start of phase 3 and increased further to more than 2.1 billion in 2013. In 2015, it was reduced to around 1.78 billion as a consequence of back-loading. Without this, the surplus would have been almost 40% higher at the end of 2015. Back-loading is a short-term measure that the European Commission has used to postpone the auctioning of 900 million allowances until 2019-2020. Overall, back-loading of auction volumes does not reduce the overall number of allowances to be auctioned during phase 3, only the distribution of auctions over the period. The auction volumes have been reduced by
· 400 million allowances in 2014
· 300 million in 2015
· 200 million in 2016.
A European Commission impact assessment shows that back-loading can rebalance supply and demand in the short term and reduce price volatility without any significant impacts on competitiveness. Back-loading was implemented through an amendment to the EU ETS Auctioning Regulation, which entered into force on 27 February 2014.
As a longer-term solution, changes will be introduced to reform the ETS by establishing a market stability reserve as of 2018. The reserve will start operating in January 2019. The reserve will:
· address the current surplus of allowances
· improve the system's resilience to major shocks by adjusting the supply of allowances to be auctioned.
The 900 million allowances that were back-loaded in 2014-2016 will be transferred to the reserve rather than auctioned in 2019-2020. Unallocated allowances will also be transferred to the reserve. The exact amount will only be known in 2020. However, market analysts estimate that around 550 to 700 million allowances could remain unallocated by 2020 (see impact assessment accompanying the legislative proposal for the revision of the EU ETS). According to the Commission proposals, the new reserve will operate entirely according to pre-defined rules that leave no discretion to the Commission or Member States in its implementation. Efforts to address the market imbalance would also be helped by a faster reduction of the annual emissions cap.
During the vote of the Commission proposal, the European Parliament’s environment committee backed steeper emissions reductions in the EU’s carbon trading scheme after 2020. MEPs voted to increase the linear reduction factor, the rate at which the emissions cap under the emissions trading scheme (ETS) falls annually, to 2.4% from 2.2% proposed by the European Commission. After much compromise, the committee voted on a strengthening the Market Stability Reserve (MSR). MEP’s agreed to double the absorption rate of surplus allowances into the reserve for the first years of its operation and to cancel 800 million allowances from it. Experts recognised the importance of the deal on the table and recognise that should both Institutions agree this would effectively tighten the ETS market balance and support carbon prices both in the short and long term.