Focus: Attention shifts to phase IV proposal after carbon reform deal

Silvia Molteni

07-May-2015

After an informal deal on the carbon market reform was reached, the ball is back in the European Commission’s court as it prepares to roll out a new proposal, which could alter supply dynamics in phase III and phase IV of the EU emissions trading system (ETS).

The agreement between the European Parliament and the Council of the EU on Tuesday addressed major design features of the market stability reserve reform. The two institutions agreed it should start in 2019 and it should absorb some of the pre-existing oversupply (see EDCM 5 May 2015).

Specifically, 900m EU allowances (EUAs) whose auctioning has been postponed to the end of the phase as part of back-loading and permits that would have remained unallocated by the end of phase III (2020) will now be transferred directly to the reserve rather than be sold.

However, other points were left for the European Commission to decide in a proposal on the revision of the EU ETS rules that will govern the scheme from 2021 onwards, expected to be published mid-year.

Use of unallocated allowances

In the reform deal, which still needs to be approved by the parliament and EU countries, the two bodies agreed than the use of unallocated EUAs will be decided on at a later stage. The fact that some of the allowances transferred to the reserve could be used means that they could find a way out of the reserve buffer outside of the standard rules for release of allowances.

“We kept it pretty open in the legal texts. We asked the commission to review the use of unallocated allowances. It’s up to the commission to come forward with proposals if and how to use them. In the Commission’s declaration they indicate that they could use them for carbon leakage. So this is also deliberately vague,” Gerben Jan Gerbrandy, one of the EU politicians that was involved in negotiations on the reserve design features, said on Wednesday.

“How these unallocated allowances would be used for carbon leakage is up for the commission to consider, so that is not clear yet,” said a source from the office of Bas Eickhout, another lawmaker involved in negotiations.

A diplomatic source which took part in the negotiations on the council side said that a group of countries was pushing to include in the reform a list of the possible uses of the unallocated allowances, rather than leaving this for later. For instance, Italy wanted such permits to be used for reimbursing industry for indirect carbon costs stemming from higher electricity prices. This is something that at the moment is left for countries to do with their own money, or not at all.

“The deal regarding the unallocated allowances opens the door for the commission to propose legislation to make these allowances available for industrial installations in the next trading period. These volumes could for example be part of the post-2020 carbon leakage reform,” said Philipp Ruf, lead EU carbon analyst at ICIS analytic branch Tschach Solutions.

Different uses of unallocated allowances would have a different market impact, even if the overall supply balance remains unchanged. If they were given out as additional free allocation to industry, they would be subject to the hedging or banking dynamics that will emerge later on. If, for instance, they were sold at auction to fund an indirect cost compensation scheme, they would become readily-available supply.

Phase III NER50?

A second issue left for the commission to decide is an innovation fund of up to 50m EUAs that is meant to bridge a gap between two financing schemes for low-carbon innovation.

Some 300m allowances have been sold to finance renewable and CCS projects before, and 400m are set to be sold in the next decade to finance low-carbon innovation in industrial production.

“The innovation fund will be considered in the context of the ETS review to provide a bridge between NER 300 and 400,” said the source at Eickhout’s office.

“It is again left to the Commission. But the timing is clear: ‘before 2021’,” said Gerbrandy.

The possible impact of this additional supply will obviously depend on how it comes to the market. “The impact of such a fund is highly dependent on the design. The key questions are: in which way are the 50m allowances monetised? Who is going to monetise them? What is the time frame of the monetisation?,“ Ruf said. silvia.molteni@icis.com

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