Carbon market participants want the EU to be able to adjust the supply of emissions allowances when a surplus is building up, they have said as the European Commission gears up to overhaul the EU emissions trading system (EU ETS).
This kind of flexible mechanism or carbon reserve would avoid discretionary interventions to fix the supply/demand mismatch in the EU ETS, such as the current proposal to back-load allowances in the face of the current supply glut.
However, a key EU official has cast doubts on how a carbon reserve could be put into practice.
The large oversupply in the scheme - which has pressured prices to record lows - stems from the fact that industry was allocated a quota of free EU allowances on the basis of pre-recession benchmarks. This led them to build up a surplus of permits in phase II of the ETS after production levels plunged on the back of the low demand.
The International Emission Trading Association (IETA) is urging the Commission to consider basing the free allocation of allowances on ongoing production data, rather than on historical production levels.
As part of the mechanism, if output was falling from a plant, its earmarked EUAs would instead be put into a reserve and only released in cases of higher industrial activity, IETA said in response to an EU consultation on possible structural reform the ETS (see EDCM 10 December 2012).
"Such a scheme could prevent any future interventions from the Commission and would be based on a clear, transparent formula known in advance," said Sarah Deblock, IETA's EU policy director, at Argus European Emission Markets conference in Amsterdam on Thursday.
Critics of the Commission's proposal to back-load some 900m EUAs at the end of phase III are often citing its discretionary nature as a basis for opposing it.
The European Commission, however, said IETA's suggestion could mean reopening the European treaty.
"I don't think this is an idea which is completely out the remit of the six options that the Commission has put on the table for discussion," said Peter Zapfel, head of policy coordination at the Commission DG climate action, at the conference.
Yet he added: "It's probably quite easy to outline some of the channel principles of such mechanism, but it gets extremely difficult if you think how operationally you are going to do it. We don't think the creation of a carbon bank is going have much future in Europe... It would need a change of the European treaty and I don't see any change coming up any time soon."
Link to surplus
Italian power incumbent Enel also backs more flexibility in the free allocation, but said this should be linked to any surplus of allowances that might be building up, rather than to a fall in production at plants receiving free credits.
Linking the free allocation to real production could make intensity targets difficult, the company argues.
Enel's head of carbon regulation and climate change Giovanni Bertolino told ICIS at the conference that future caps should be instead linked to surplus.
Enel's proposed mechanism would lower the cap on emissions via a reduction in auctions volumes when overall supply gets higher than a pre-established threshold. Withdrawn allowances would be put into a reserve to be later gradually reinjected into the market as soon as the surplus would be reabsorbed by the market.
"Such mechanism will allow managing annual supply according to a clear and predictable rule-based approach, avoiding private and political pressures," Enel said.
Industry has it say
The idea of flexibility found support among industrials as well.
"The idea of a dynamic cap where if you are less busy it gets ex-post adjusted and if you are more busy there is an ex-post adjustment the other way is definitely a discussion we would like to have," steel major Tata Steel's head of public affairs Tim Morris said at the conference.
According to cement producer Holcim's CO2 business senior manager Carsten Schirmeisen, free allocation and auction volumes would need to be adjusted to economic developments, reflecting larger or smaller needs for compliance purpose.
In particular, the company suggested the allocation should be based on actual production levels in a system with free allowances - but it also asked for a carbon levy to be imposed to importers of the system switched to full auctioning.
Industrial surplus allowances holders have recently reported in their annual results that they sold EUAs in 2012, in sign that long-awaited industrial selling might have already kicked off, adding to the ETS oversupply and further pressuring prices.
Holcim realised revenues of Swiss francs (Swfr) 62m (€51m) from the sale of EUAs in 2012 (see EDCM 27 February 2013). Arcelor Mittal generated $0.2bn from the sale of carbon credits for its business in 2012 (see EDCM 6 February 2013).
"I'm guessing the reason why people sold large amounts of CO2 is because they are in a difficult financial environment," Tata Steel's Morris said. "We are at an unsustainable all-time low in terms of how busy we are." Silvia Molteni