After adopting the Market Stability Reserve (MSR) in 2015, the European Parliament and Council are now embarking on a new legislative road to reform the EU ETS from 2021. To support the policy process, ICIS Tschach Solutions has released a white paper to share with stakeholders the results of its analysis of the European Commission’s proposal for the Post-2020 EU ETS reform.
Tschach Solutions' analysts conclude that the Commission´s proposal is a step in the right direction for the improvement of the free allocation system but that some provisions have room for optimisation. Philipp Ruf, Lead Analyst – EU Carbon Markets, comments that "a key finding of our analysis is that the European Commission´s proposal would result in the Cross-Sectoral-Correction-Factor (CSCF) not being triggered during Phase 4. This was a critical element that the Commission´s wanted to achieve through its new proposal. And this is achieved mainly through revised approaches for the benchmark and historical activity levels". The CSCF refers to the annual correction applied to allocation volumes in years when allocation volumes exceed the maximum possible amount earmarked for allocation.
Another key element brought forward by the Commission is the accommodation of increase in production levels with higher free allocation allowances. According to Ruf, “Historically, industrials have been hit with a downward correction with falling production levels but no upward adjustment with increasing levels. In theory, this new provision goes in the right direction by not impending industry growth but the devil in the details here. If the current rules for the downward adjustment would be applied to the new upward one, the threshold would require a 50% increase in production levels – that´s in our opinion unrealistically too high if the aim of the Commission is for the lion share of participants to be able to qualify for this”.
The Commission also proposes 1% decreasing benchmarks. On this point, Ruf states "There are many angles to consider here. On the one side, the proposed benchmark adjustment goes against the current principle that the 10% most efficient installations are the basis for the benchmarks. The flat-rate approach breaks with this principle and sets instead artificial benchmarks. On the other side, the decreasing provision creates incentives for industrials to make long term low carbon investments in order to reach the flat-rate adjusted benchmarks. In addition, flat-rate decreasing benchmarks is a lot easier administratively compared with having an EU ETS wide benchmark collection. Key to consider in this discussion is also that a flat-rate approach which treats all sectors indiscriminately the same might also decrease benchmarks below the technological possibilities of the 10% most efficient installations in this sector. Such a result would challenge the original aim of the free allocation system to fully shield carbon leakage exposed sectors and provide them with technological achievable benchmarks."
In addition to the benchmark, a second element of the free allocation equation, namely the history activity level, must be handled with care. According to the Tschach modelling, the lion share of EU ETS sectors will experience growth up to 2030 below pre-crisis levels. In that context, the paper warns of a potential uneven regional playing field. On that point, Ruf states "the proposed two historic activity level baseline will help make use of more updated data. But you are still dealing with historic rather than actual data. Taking into account the regional granularities in terms of industrial growth that means you could see a scenario where regions, after years of low growth during the historic activity baseline periods, make a late recovery only to see their free allocation volumes based on outdated low growth levels".
According to Ruf, this issue could very well be solved by the other Commission's proposal to accommodate increase in production with higher free allocation volumes. "We see that provision adding a dynamic feature to the system, allowing it to amend free allocation for the next year according to actual data. To some degree, that would be a sort of a light version of dynamic allocation without the hassle of ex-post adjustments".
Finally, the paper touches upon the 57% auction and 43% free allocation that was agreed by the EU Council in its 2030 framework. While policymakers are likely to discuss the validity of the cap composition, Tschach analysts in their report state that the Council's decision alongside the Commission´s reform proposal guarantee enough free allocation for the EU industry during 2020-2030. On that point, Ruf states "at the end of the day, the question is, does the cap composition alongside the proposed rules provide sufficient free allocation allowances during Phase 4 to ensure EU industrials' needs? According to our analysis, the answer is yes."
On 15 July 2015, the European Commission published a legislative proposal to reform the EU ETS Post-2020. To become legislation, the proposal will have to be approved by both the European Parliament and the Council of the EU. On the Council side, the Working Party on Environment (WPE), the technical group of the Environment Council, has already started discussing the file. On the Parliament side, the Conference of Presidents agreed on the ENVI/ITRE's shared responsibilities in January and the discussions in committees are to kick start on 18 February with ENVI's public hearing.
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