Saving the EU emissions trading scheme may mean abandoning key principles
- 06 Mar 2013, 15:40
- Mat Hope
Credit: Yanni Koutsomitis
The EU emissions trading scheme has been
struggling to stay afloat, and the
latest attempt to save it has stalled in the European Parliament. New
research suggests a fundamental rethink - and abandoning some of
its key principles - is needed to save the scheme.
A new report from the London School of Economics
(LSE) says the EU needs to be more active in influencing supply and
demand in the emissions trading scheme (ETS). It produced the
proposal in response to a European Commission consultation on long
term structural reforms to the scheme. The commission is looking at
ways to prevent the carbon price hitting January's record low of below 3 euros in the future. We take a look
at the proposals trying to reboot the scheme.
Companies buy and sell permits to emit carbon dioxide
under the ETS. Each permit allows participants to emit a tonne of
carbon dioxide. If they emit less than their permits allow, they
can sell the excess for a profit. The scheme is meant to reward
those that cut their emissions, and it relies on a shortage of
But the ETS has a real problem with oversupply. There
are currently too many permits in the system which means that
polluters don't need to cut their emissions and the price of
permits has slid to record lows.
The oversupply is largely due to the
economic slowdown since 2008. Energy
demand is low, so power plants - one of the main sources of
emissions in the system - don't need all their permits. This means
there is a significant surplus of permits that gets larger every
year. As the table below shows, since 2009 there has always been
less demand than supply:
Source: European Commission,
The state of the carbon market 2012
The European Parliament is currently considering a
proposal to withhold 900 million permits from the market between
2013 and 2015 - known as backloading.
But the plan has hit a snag. While the environment
committee voted to approve the plan in mid-February, it failed
to get enough votes within the committee to take the plan straight
to the European Council. This means the whole parliament will now
vote on the plan - and it is not at all certain it will get
enough votes to go through.
Even if MEPs do accept the plan - and the council
also gives it a thumbs-up - backloading is generally accepted as
only a temporary fix. The permits would be released back into the
market in 2019 and 2020 - increasing the supply once again,
regardless of the level of demand.
Reuters Point Carbon has said if the
permits are not cancelled, then prices could remain between €8 and
€10 per tonne between 2013 and 2015, later collapsing to €6 in 2020
when the permits are reintroduced. Sarah Deblock from the
International Emissions Trading Association previously told us backloading simply
doesn't work as a "standalone measure".
Recognising the need for longer term reform, the
European Commission has come up with a
shortlist of measures that could be
implemented to breathe fresh life into the ETS - from reducing the
overall number of permits, to extending the scheme to other
sectors, or setting up new mechanisms to manage the carbon
new report from LSE says the last of these is the key. It
argues that without a way to control the balance of supply and
demand in the system any other reforms remain vulnerable to large
economic changes of the sort that hit the ETS after 2009.
The report says:
"A key lesson we have learnt from the
past is that the absence of institutional rules permitting
adjustments of the cap in the face of new information contributed
to the need to invoke overlapping, potentially less-efficient,
It suggests the EU needs to find new ways to respond
when demand significantly peaks or dips due to outside influences
like economic booms or crashes.
One option would be for the EU to set up a new
institution which holds a permits reserve. It would then act like a
central bank for the ETS - buying and selling permits into the
system as demand shifts.
Alternatively, the EU could set a price 'ceiling' and
'floor'. The price ceiling would be set at a level which the EU
deems harmful to economic productivity. If the carbon price got
that high, more permits would be supplied to bring the price down.
The price floor would be set at a level below which the ETS stops
reducing emissions effectively. If the carbon price got that low,
the EU would remove some permits to bring the price back up.
Both of these mechanisms would match supply and
demand, making sure there isn't always a large surplus - as is
currently the case.
LSE isn't the only one to suggest controlling supply
offers a remedy. Trade association the
Climate Markets and Investment
Association proposes that if participants don't use a
certain number of surplus permits within three years, an equal
number should be removed permanently from later supply. It says
this would ensure emissions were reduced on average for any
consecutive three years.
But not everyone is happy with the idea of the EU
interfering in the market.
Coal industry representative the
European Association for Coal and
Lignite warns "any interference through the set aside of
allowances or backloading of allowance auctioning will discredit
the ETS" as it won't be seen "as an efficient market-based
mechanism, but as a scheme subject to political manipulation". It
argues the reforms are contrary to founding principles of the ETS
as an emissions trading market.
So debates around the reforms are not just about
making the market work effectively, but the politics behind how it
The LSE report acknowledges that regulating the
supply of permits "would be difficult to reconcile with the
fundamental principles of an emissions trading system".
Implementing the reforms means the EU playing a much greater role
in influencing how the carbon market functions. Nonetheless it
argues the tradeoff is worthwhile to save the scheme.
The EU faces stark choices over how it is going to
keep the ETS going, and positions within the European Parliament
appear to be hardening. But allowing the scheme to limp on as it is
at the moment could damage the EU's ability to manage its carbon
emissions. The future is uncertain for the EU's flagship climate
policy - and the controversy over backloading looks likely to just
be the start.