Diplomats in Brussels have struck a deal to reform the EU’s emissions trading system, giving a boost to efforts to reduce emissions across the 28-nation bloc.
The move will remove carbon permits from the market, making it more expensive to pollute within the EU, in the hope it will drive investment towards low-carbon alternatives.
The EU’s emissions trading system (ETS) is the cornerstone of the region’s climate policy.
The system is designed to reduce emissions across the region as cost efficiently as possible, by allowing industries covered by the scheme to buy and sell the right to pollute. Each allowance gives the owner the right to emit one tonne of CO2.
The idea is that gradually tightening the cap on the number of allowances available to industries will cut emissions while driving investment and innovation towards low-carbon alternatives.
But the reality to date has been that the number of allowances available has outstripped demand, making allowances cheaper and, therefore, decreasing the financial imperative for polluters to switch to clean energy.
EU statistics released on Monday showed there was still a surplus of more than two billion permits in 2014.
The EU has attempted to address the problem of permit oversupply before.
In 2013, a decision was taken to “backload” allowances. This delayed the release of 900 million allowances, set to be auctioned between 2014 and 2016, to 2019 and 2020.
But this was a short-term solution to a long-term problem. It did not permanently reduce the number of allowances on the market, and threatened another price crash when they flooded onto the market at the end of the decade.
The solution that policymakers have offered is called a “market stability reserve”. It is intended to tackle the surplus in a more sustainable fashion.
This means that, as from 1 January 2019, these 900 million backloaded allowances, along with unallocated allowances, will be placed into a reserve, rather than released onto the market.
In addition to this, the deal means 8% of allowances currently in circulation will be placed into the reserve between January and September 2019. From then on, 12% of surplus allowances would be placed into the reserve every year, at a rate of 1% a month.
This will take place as long as the surplus is higher than 833 million allowances. Meanwhile, if the surplus drops below 400 million, the EU will release 100 million back onto the market – although the current oversupply means this remains a “very distant prospect”, Damien Morris, head of policy at UK-based campaign group Sandbag,* tells Carbon Brief.
Why it matters
The reforms have been welcomed by market watchers, many of whom have said it is a key step in rekindling the EU’s beleaguered trading scheme.
The agreement, which was struck after three-way talks between the European Council, Parliament and Commission, is more ambitious than an initial proposal from the Commission, which wanted the reserve to begin in 2021. Parliament voted in February that the reserve should be in operation by 31 December 2018.
In the absence of an effective ETS, carbon cuts across the EU have been driven by targets for energy efficiency and renewables, as well as its headline 20% emissions reductions target. Last year, the EU set a new target to reduce emissions at least 40% by 2030, from a 1990 baseline.
With the market stability reserve in play, the EU’s carbon market could have a more important role in driving cuts, explains Sandbag’s Morris. He tells Carbon Brief:
“What’s important to say is without the market stability reserve there will be no impetus for the carbon market to reduce emissions under the 2030 target. So many spare allowances have built up and emissions are so far below the cap, that the traded sector could meet its obligations up to 2030 without making any further emissions reductions.”
A lower supply of carbon permits will help to push up the carbon price. Preliminary forecasts by market analysts ICIS suggest that, with the market stability reserve in force, the carbon price could increase to â?¬30 by 2020 and to around â?¬40 by 2030. Today, the price hovers around â?¬7.
Yann Andreassen, a carbon markets analyst with ICIS, tells Carbon Brief:
“If you wait and don’t have any MSR at some point you’re going to have to abate emissions very quickly in order to meet your long-term target, so the MSR is a way to spread out that cost and not keep all the abatement for the end, when you’re about to have to reach your target.”
While the decision of the three EU bodies marks a turning point in the fortunes of the EU’s carbon market, it is not the end of the legislative road. To become official, the text must be adopted by the EU’s parliamentary environment committee, before being passed to a full plenary vote. After that, it must be accepted by national ministers at the Council of the European Union.
This could happen as soon as July, says Andreassen. He tells Carbon Brief that there are still chances it could be rejected, but that there is “a high likelihood it will go smoothly”.
These adjustments have been long-awaited by carbon market watchers. With this success under their belt, attention will shift towards a review of how the ETS will work between 2021 and 2030, which will require further details to be ironed out, including compensation for carbon leakage.
As it stands, the reforms have the potential to turn the EU’s carbon market into a functioning part of its efforts to reduce greenhouse gas emissions.
Main image: Flags of European countries against the blue sky.
* Sandbag and Carbon Brief both receive funding from the European Climate Foundation.
Expert analysis directly to your inbox.