2014 debate: structural reform of the carbon market

30 December 2013 15:13 Source:ICIS
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With back-loading becoming law and soon to be implemented, debate in 2014 surrounding the EU emissions trading system (ETS) will concern how to structurally reform the beleaguered scheme to avoid further price crashes.

During phase II of the ETS between 2008-2012, prices plummeted to record lows on the back of massive oversupply which built up because EU allowances (EUAs) were allocated to industry based on pre-recession benchmarks.

With carbon prices insufficient to drive green investment or to trigger a fuel switch from coal-fired to gas-fired electricity generation, the European Commission intervened.

The EU executive proposed back-loading to the end of phase III, which stretches 2013-2020, some of the auction volume scheduled to come to the market at the start of the period. It was meant to be a “quick fix” for the EU carbon market, but the measure proved to be highly controversial and the approval process stretched into months.

Now it has been legally clarified that the Commission can amend the auction calendar, and back-loading is expected to be implemented by the second quarter of 2014, debate is set to shift to structural reform.

A proposal, expected in January together with a policy paper on 2030 targets, might take the form of a discussion paper, but there are rumours that it could be a full legislative proposal.

Options

The following options are on the table:

• Creating a reserve mechanism to render the auction supply of emission allowances more flexible, under which excess EUAs would be put into reserve and made available again if demand rises.

• Permanently cancelling some EUAs.

• Increasing the linear reduction factor – the percentage by which carbon emissions need to be cut every year.

The Commission has already excluded four of six options it originally proposed after a public consultation: tightening the EU’s carbon-reduction cap from 20% to 30% below 1990 levels by 2020; including more carbon-intensive industries; reducing or banning the use of international carbon offset credits after 2020; and introducing discretionary price mechanisms such as a carbon-price floor or a price management reserve ( see EDCM 14 November 2012 ).

It also added an additional option – the flexible supply mechanism – after consulting stakeholders.

State of affairs

This last option has gained momentum, to the point that observers say it is the ain frontrunner, because it is the only one that does not affect the total cap of allowances during phase III ( see EDCM 6 December 2013 ).

The Commission said in October following a stakeholder meeting that there is a clear preference for a mechanism to work according to volume-based triggers – which would mean a certain amount of EUAs are put in a reserve when a cumulative surplus threshold is hit, and vice versa – as opposed than price-based triggers.

However there are not many details available over how such an option could work. Issues such as the start date, the possible extent of supply correction and governance are still up for debate. Support for the remaining options is mixed.

Clash

Germany and the UK – two of the biggest voters in the EU council – have clashed over whether emissions allowances should be permanently cancelled ( see EDCM 23 December 2013 ). The German government, which includes politicians with deep roots in a region dependent on CO2-intensive coal generation and heavy industry, already said it opposes permanent cancellation.

The flexible supply mechanism has therefore been put forward as a possible compromise between the UK and German views.

For others, however, introducing flexibility on the supply side could make trading more difficult, as future scarcity would become harder to judge and could reduce volumes in the market or alternatively increase the price ( see EDCM 2 September 2013 ).

The International Emissions Trading Association (IETA), which represents companies active in the market, said in a policy paper earlier this month that its members largely believe the introduction of flexibility in supply will improve the functioning of the EU ETS.

But the expected effectiveness “is closely linked to the type of triggers chosen, according to which the supply of allowances would fluctuate”, the paper said.

Eurelectric, the EU lobby group representing electricity generators, is in favour of an increase in the linear reduction factor. Silvia Molteni


By Silvia Molteni