Early EU carbon market reform paramount – UK study

Early implementation of planned reforms to fix the EU carbon market is much more important than the details of those reforms, according to a report produced for the UK’s Department of Energy and Climate Change (DECC).

Rapid reforms are needed to tackle the “myopia of firms” who risk getting locked in to a high-carbon path, says the  report published by DECC yesterday. Early reform is the single biggest factor in correcting the problems faced by the carbon market, it adds.

The EU emissions trading scheme (ETS) is central to EU efforts to tackle climate change. But it has been suffering from  chronically low prices that are insufficient to drive needed low-carbon investments, potentially leaving firms facing higher costs later on if they are forced to retire high-carbon technology early.

The European Commission has  proposed to bring in ETS reforms from 2021 in an effort to tackle these low prices, which are the result of a massive surplus of credits on the market. The surplus is over two billion carbon credits, according to the commission, and  some groups expect it to grow significantly by 2020.

The commission’s reforms would introduce a market stability reserve (MSR) to reduce the size of the carbon credit surplus at set trigger points. It hopes this would reduce price volatility and help push market participants onto a more cost-effective decarbonisation pathway, with early investment in low-carbon technology.

The planned reserve, starting in 2021, would work like this:

• If the surplus of credits exceeds a trigger point of 833 million allowances, 12 per cent of the surplus is put into a ‘reserve’ – basically a central bank for carbon credits.

• If the surplus gets below 400 million, the reserve puts 100 million credits back into the market at the next auction.

The reserve should be introduced much sooner, in 2017, according to the UK, France and Germany among others, such as the International Energy Agency. They now have support for this position from a study looking at a range of options for the proposed market stability reserve.

The report, prepared for DECC by consultants Ecofys, considers different ways to trigger the reserve into action. It looks at the commission’s proposed surplus credit volume trigger as well as other options, such as a “price corridor” setting maximum and minimum carbon prices.

Different surplus volume triggers or price triggers would have an impact on the effectiveness of the reserve, the Ecofys study finds. ETS participants told the study’s authors that these details would have a big impact on their response to the reforms. But the technical arguments for modifying the commission’s proposed trigger points are limited, Ecofys says.

Any discussion of these details is likely to involve lengthy negotiations with other EU member states and would end in political compromise, limiting the beneficial impact. There is “little to be gained” from opening this debate, the Ecofys report says. The commission’s initial proposals appear to already represent a “sensible political compromise”.

Instead of tweaking these details, bringing the planned reforms in early would have the largest impact, its modelling results suggest. Early reform would have the added benefit of greater certainty for market participants, who are already expecting reforms.

Lessons from other commodity markets show that reform is a continuous learning experience, Ecofys says, showing the importance of a planned review of the reserve. It says this review needs to look at indicators of success such as how often the reserve is triggered and the flow of low-carbon investments.

A majority of member states and the European Parliament must agree to the proposed ETS reforms before they can be implemented. Two key parliamentary committees will vote on the plans in late January and late February before a plenary vote of the whole parliament scheduled for July.

After that, member state representatives in the European Council must also give their seal of approval. All this means the UK faces an uphill struggle to push its position, despite the support of France and Germany.

Fixing the ETS is hugely important for EU climate efforts in both practical and symbolic terms. It isn’t just EU carbon targets that could be at risk. The rapidly developing global embrace of carbon markets could be threatened, too.

Main image: Aerial view of Berlin skyline and Spree river in beautiful evening light at sunset in summer, Germany.