EU Lawmakers Approve Draft Plans for Post-2020 Carbon Market Reforms

16 February 2017

The European Parliament voted on Wednesday 15 February in favour of reforming the bloc’s flagship carbon market, paving the way for negotiations with the other EU institutions on finalising those changes for the 2021-2030 period.

Lawmakers signed off on the reform package with 379 votes in favour, 263 against, and 57 abstaining. However, some of the reforms were modified from an earlier version submitted by that chamber’s environment committee.

While the Parliament vote was an essential step for advancing the proposed changes, the legislative body must now begin negotiations with EU member states under the European Council as well as with the European Commission before the reforms can be finalised. Environment ministers under the Council are due to discuss the reforms at their upcoming meeting on 28 February.

The EU’s Emissions Trading System (EU ETS), as the carbon market is known, has been in place since 2005 and is currently the largest such cap-and-trade scheme in the world. The EU ETS covers around 45 percent of the bloc’s greenhouse gas emissions in all of its 28 member states, as well as Iceland, Liechtenstein, and Norway.

In its current form, the carbon market aims to slash greenhouse gas emissions from energy-intensive industries, ranging from power plants to air travel. Separately, the bloc is also considering a proposal to continue limiting the ETS’ aviation coverage to only those flights that take place entirely within the European Economic Area. (See Bridges Weekly, 9 February 2017)

EU officials: ETS reform crucial for Paris objectives

The process to reform the EU ETS for the post-2020 period dates back to July 2015, when the European Commission published its legislative proposal outlining its views on how to strengthen the scheme while also meeting the bloc’s climate and energy goals for 2030. These goals form part of its UN climate commitments. (See Bridges Weekly, 23 July 2015)

"Today’s landmark vote provides a clear outcome after more than a year of discussions in Parliament, and it demonstrates the European Union’s commitment to turning the Paris Agreement into reality through concrete action on the ground,” said EU Climate Action and Energy Commissioner Miguel Arias Cañete.

The Paris Agreement that Cañete was referring to is the landmark, global climate deal reached under the UN Framework Convention on Climate Change (UNFCCC) in December 2015, which has been in force since November of last year. (See Bridges Special Update, 6 November 2016)

Ian Duncan, the UK member of the European Parliament (MEP) who has served as the “rapporteur” of this reform package within the legislative chamber, welcomed the outcome while also urging EU member states to move promptly on the subject.

“By passing this report we will be reminding member states of the commitment they signed up to. We simply must deliver the ambitions of the Paris Agreement on climate change and do what is required for our planet. This is bigger than Brexit, bigger than Britain, bigger than the EU. We have to get it right,” said Duncan.

Climate watchers have similarly urged member states to take swift action on advancing the ETS reform process in order to keep the momentum going, particularly in light of the growing interest in countries as far-flung as Canada, China, and Mexico in adopting carbon pricing mechanisms.

“Europe needs to retain its place at the forefront of the climate battle by establishing the policy framework for the next phase in the 2020s – using the market to deliver the most cost-effective emissions reductions to meet Europe’s objectives,” said Dirk Forrister, the CEO of the International Emissions Trading Association (IETA), a business group advocating for an emissions trading framework at the international level.

ETS Phase 4

At stake during Wednesday’s vote in the European Parliament plenary was a hard-won compromise that made its way out of the legislative body’s environment committee (ENVI) last December.

The proposal adopted at the committee level last year included slashing the number of carbon credits being issued by a rate of 2.4 percent annually – in other words, strengthening what is known as the “linear reduction factor.” Currently, this annual limit on carbon allowances is lowered at a rate of 1.74 percent.

However, the 2.4 percent figure was then revised during Wednesday’s plenary vote back to 2.2 percent, which was the level proposed by the European Commission. EU lawmakers did say that this number could potentially be revised upward to 2.4 percent by 2024 or later, pending further scrutiny.

When it tabled its proposed ETS reforms nearly two years ago, the European Commission argued that a 2.2. percent linear reduction factor would be essential to meeting the bloc’s goals of cutting greenhouse gas emissions by 40 percent from 1990 levels by the year 2030. Some NGOs such as the UK-based Sandbag have suggested that a larger reduction factor would serve the EU better in meeting those objectives.

Other aspects of the ENVI proposal included changes to the “market stability reserve” (MSR), a system that is due to take effect from 1 January 2019 and aims to tackle the surplus of carbon allowances. This oversupply has long plagued the EU ETS, keeping carbon prices far below the level that many experts say is needed to spur low-carbon production and investment patterns. The plan for the market stability reserve was adopted in 2015. (See Bridges Weekly, 9 July 2015)

The ENVI committee has proposed that the MSR take in 24 percent of any surplus credits annually for its first four years – twice the level that was initially planned. Furthermore, they have suggested culling 800 credits from the reserve in 2021. Both of those were approved by the plenary on Wednesday.

Shipping emissions

The committee had also put forward a few provisions regarding shipping, a sector which currently falls outside the ETS. Specifically, the ENVI panel had backed creating a fund that would help provide for a series of shipping-related emissions reduction measures.
The plenary has signed off on this shipping fund, which would be financed by requiring that ship owners begin purchasing credits under the EU’s carbon market from the year 2023 onward or pay into the new system. This policy’s enactment would be contingent on the results of climate-related negotiations at the International Maritime Organization (IMO), with the fund to apply only if the international agency fails to reach a deal by that time.

The IMO is the UN body responsible for tackling issues relating to global shipping emissions. The agency reached an agreement last year on a mandatory system for monitoring the use of fuel in the sector, as well as deciding that they would finalise by 2023 a plan for cutting maritime emissions. However, past attempts to clinch an emissions reduction target have consistently struggled to advance, hinting at the difficulties in tackling the climate challenge in this sector. (See Bridges Weekly, 3 November 2016)

The move by the European Parliament was welcomed by some environmental groups, including the NGO Transport & Environment.

“This cross-party proposal will end the anomaly of shipping being the only sector in Europe not contributing to the 2030 emissions reduction target. EU governments must follow Parliament’s lead and agree that ship CO2 emissions must go in the EU ETS if the IMO does not act,” said Bill Hemmings, aviation and shipping policy director at Transport & Environment.

Cement border measure rejected

In the weeks leading to the Parliament’s vote, an ENVI committee proposal regarding the cement industry has increasingly become a lightning rod for debate, with potential implications for both trade and climate policy.

Under the ENVI committee proposal from December, producers of cement would no longer be allocated free permits under the EU ETS. To protect the EU cement sector from cheaper imports that face no domestic carbon costs, cement from foreign sources would be subject to an adjustment at the border by being required to pay a tax.

Proponents of such a move argue that cutting these free permits could yield significant ETS revenue that can support other climate-focused measures, among other benefits.

However, the full plenary ultimately rejected that suggestion on Wednesday – a move that was criticised by various environmental groups. Currently, cement is one of several industries that is allocated free permits, which it can then sell as needed.

“The border tax would have helped create a level playing field and make European cement industry a world leader in low-carbon technologies,” said Agnes Brandt, Senior EU Policy Officer at Carbon Market Watch, a Brussels-based NGO.

Several experts supporting the proposal have further pointed to the fact that cement faces limited international competition compared to other sectors like steel or chemicals, as very little of it is traded.

Trade-climate debate heats up abroad

The debate over such border measures is also taking place on the other side of the Atlantic, as a group of prominent US Republicans who refer to themselves as the “Climate Leadership Council” have put forward a climate strategy for a carbon tax, starting at US$40 per tonne, that would grow progressively over time.

The tax would be accompanied by a border carbon adjustment mechanism targeting both outgoing and incoming trade, which they say would “protect American competitiveness and punish free-riding by other nations, encouraging them to adopt carbon pricing of their own.” It would further be designed in a revenue-neutral way, rebating the tax revenue to Americans through “dividend checks, direct deposits, or contributions to their individual retirement accounts.”

Other aspects of their proposed plan would include cutting back on regulations, including the Clean Power Plan that was introduced under former US President Barack Obama, which they say should face an “outright repeal.”

However, whether such a proposal will make any headway under both a Republican-led Congress and White House remains to be seen, particularly in light of past high-profile failures to establish cap-and-trade schemes at the national level in the US as well as the attitudes expressed by many of the party’s lawmakers against the climate action efforts of the previous Obama Administration.

Moreover, some experts warn that the border carbon adjustment element may raise controversies at the WTO, suggesting that international trade rules and jurisprudence currently do not appear to provide sufficient clarity on the ability to distinguish products based on their carbon content.

ICTSD reporting; “Utility group apply pressure on EU ahead of ETS vote,” POWER ENGINEERING INTERNATIONAL, 10 February 2017; “MEPs set for crunch vote on EU carbon scheme,” EU OBSERVER, 13 February 2017; “The price is right? Crunch time for EU carbon market reform,” EURACTIV, 10 February 2017; “A Rare Republican Call to Climate Action,” THE NEW YORK TIMES, 13 February 2017; “Carbon market reform vote puts EU cement sector in the spotlight,” EURACTIV, 10 February 2017.

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