EU Commission unveils carbon market reform proposal

20 July 2015

The EU plans to introduce new rules governing its carbon market to come into effect at the end of the decade.

The European Commission has presented a much-anticipated legislative proposal geared towards revising the 28-nation bloc’s carbon market for the post-2020 period in order to help meet its 2030 climate and energy goals. The proposal envisages an increased annual decline in the number of emissions allowances available, further development of carbon leakage rules, and a revision of free allowance allocations.

The proposal also outlines several new support mechanisms designed to help industry and power sectors move towards a low carbon growth model. This includes the establishment of an “Innovation Fund” to boost cleaner technologies and a “Modernisation Fund” to scale up investments in upgrading the power sector as well as increasing energy efficiency in poorer EU member states.

In addition the revision presents three new possible areas where member states could deploy the funds generated by the auction of emissions allowances, including climate finance for vulnerable third countries, mentioned in the context of a landmark UN meet scheduled for December where almost 200 nations are hoping to adopt a new universal climate deal. Other new areas are indirect cost compensation and the promotion of skill formation and reallocation of labour affected by the transition of jobs in a decarbonising economy.

 “My message to our global partners ahead of the Paris climate conference: the EU stands by its international commitments,” said EU Commissioner for climate and energy Miguel Arias Cañete in a press release. “And my message to investors, businesses and industry: invest in clean energy; it's here to stay and continue to grow.

The Commission’s legislative proposal will now be considered by the European Parliament and Council for consideration and eventual adoption. Stakeholders are invited to give their views on the proposal over the next eight weeks.

Securing emissions cuts

EU leaders last October reached a political agreement on a 2030 climate and energy policy framework, envisaging a binding 40 percent greenhouse gas emissions reduction target shared across the bloc’s 28 member states, accompanied by binding renewable and indicative energy efficiency goals.

The EU later converted the emissions target into its “intended nationally determined contribution” (INDC) to the UN climate talks. Countries have agreed that individual climate action plans will form the basis of the first-ever global emissions-cutting deal to enter into force at the end of the decade.

Under the October deal, EU chiefs said that 43 percent of the emissions reduction target would be met using sectors covered by the EU’s Emissions Trade System (ETS), as the carbon market is known. The European Council conclusions also set the annual reduction in emissions allowances at 2.2 percent from 2021 onwards, a figure enshrined in the Commission’s proposal, compared with the current rate of 1.74 percent.

The EU’s ETS was set up in 2005 as part of the bloc’s effort to cut climate warming emissions in a cost-effective manner. The “cap-and-trade” system works by putting a limit on overall emissions from high-emitting industry sectors, which is subsequently tightened each year. A certain amount of emissions allowances are auctioned annually and others are allocated. Companies can then buy and sell allowances within the limit according to their needs.

The EU’s carbon market is currently the world’s largest and covers around 45 percent of the bloc’s total emissions. However, the scheme has struggled to operate effectively in recent years with a glut of allowances causing permit prices to slump, thereby dis-incentivising mitigation actions. A number of stakeholders and governments around the world interested in setting up similar schemes will likely be closely monitoring the EU ETS reform process.  

EU institutions also recently reached a deal on a new market stability reserve (MSR), in motion from January 2019, to help buffer permit supply and prices in the carbon market. The MSR will work by removing excess allowances based on set “trigger” thresholds to be placed in a reserve and then fed back to the market when there are too few allowances. Under the agreement, any unallocated allowances at the end of the decade are to be placed in the mechanism rather than being re-auctioned. (See BioRes, 9 July 2015)

Free allocation

From 2021, as per current rules, 57 percent of EU ETS allowances will be auctioned while the remainder will be allocated to industries for free. However, the Commission’s revisions propose adopting a tiered system for the free allowances, which would see the 177 industrial sectors currently granted all of their allowances dropping to 50. The remainder would receive allowances to cover 30 percent of their emissions.

The new rules envisage better flexibility in the allocation rules in order to account for factory production increases or decreases. The EU executive also envisages regularly updating benchmark values – used to influence allocation according to efficiency – and to capture technology progress in different sectors.

A system of free ETS allowance allocation was set up in the face of concerns that tougher unilateral EU action on emissions, compared with other regions and countries, would result in “carbon leakage” whereby industry and associated emissions move overseas to more climate lenient jurisdictions. EU officials said last week that the 50 sectors still receiving the full free allocation allowance would be those considered most at risk.

Some industry representatives, meanwhile, expressed concern that the European Commission’s proposed revisions were too harsh given the need to trade and attract investment in a global marketplace.

“The Commission’s proposal is failing to safeguard the competitiveness of European industries,” said Markus Beyrer, Director General of European business association BUSINESSEUROPE. “By unnecessarily reducing the volume of free emissions allowances so drastically, it raises the risk of investment leakage, exposing our industries to unfair competition from countries without comparable climate efforts.”

The planned revisions could result in a carbon price of around €25, according to some analysts. EU ETS permit prices currently hover around €7.50 per tonne of carbon dioxide equivalent emissions emitted. Carbon prices around the world presently range from between around US$7-100.

“How to share the free allocation among different industry sectors will likely be the most controversial issue in the legislative process,” market analysts at Thomson Reuters Point Carbon told reporters, pinning their colours on €17 carbon price in 2020, rising to €30 in 2030.

Some environmental groups on the other hand, reacted coldly to the Commission’s proposal, suggesting it was a missed opportunity. “This proposal fails to show how the EU ETS will ensure that Europe’s largest polluters pay for a meaningful carbon price for their carbon pollution,” said Geneviève Pons, director of WWF’s European policy office.

Some experts, meanwhile, have suggested that the current system of free allocation could amount to a trade distorting subsidy.

Low carbon support

The Commission’s proposal would see the profits from some 400 million allowances – worth around €10 billion – poured into the new innovation fund so support investments in renewable energy, carbon capture and storage, and low carbon innovation in energy intensive industries.

A further 50 million unallocated allowances from 2013-2020 would also be set aside to enable to innovation fund to start before 2021. The Commission also proposes using a further 250 million of these unallocated allowances to support new entrants and significant increases in production. In addition, two percent of the total allowances, would be set aside to establish the separate, so-called modernisation fund.

Some environmental groups hit out at the proposal suggesting that it would weakened the newly-agreed MSR’s stabilising effect.

“This proposal is a step backwards in curbing the oversupply of allowances on the market,” said Damien Morris, head of policy at environmental advocacy group Sandbag. “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.”

ICTSD reporting; “Takeaways and reactions to the post-2020 EU ETS reform proposals,” CARBON PULSE, 15 July 2015.  

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