The European Union’s Emissions Trading Scheme (EU ETS) is the cornerstone of the EU’s climate policy and a genuine triumph of European collaboration on climate change. Yet after the scheme’s early success, which led to a steadily growing carbon price which reached €28 a tonne of CO2 in 2008, it is now failing, with the carbon price reaching a low of €3 euro few months ago.
The main reason the EU ETS is failing is that the European economy hasn’t behaved as it was expected to (or as it was hoped it would). Weak economic performance in recent years has meant that carbon emissions have been lower than anticipated. In turn, that has led to an oversupply of carbon allowances on the market.
This problem is exacerbated each year as more and more carbon allowances are released, flooding an already saturated market. The issue is that the amount of carbon that is coming onto the market is entirely de-linked from external factors, including what the economy is doing.
It could be argued that the market is working properly, as the EU ETS is limiting carbon emissions to the agreed carbon cap. However, this is storing up problems for the future as the low carbon price is not providing a signal to investors to invest in lower carbon alternatives – locking us in to high carbon infrastructure.
No one knows this more than the electricity sector. A low carbon price coupled with cheap fuel from America has meant that coal (which emits twice as much carbon as gas) presently accounts for a proportion of electricity generation not seen in the UK since 1996. In the longer term, a low carbon price is not providing certainty to developers and manufacturers of low-carbon technologies that there will be sufficient demand for their goods and services to provide a return on new investments.
There is a consensus that structural reform of the EU ETS is required, but there has been little detail on what that should be and how that could be achieved. We are in favour of an intervention which can limit carbon emissions through the EU ETS while also providing a robust carbon price signal that can help drive investment decisions to decarbonise at the lowest possible cost.
To meet these aims, we have been advocating an Automated Supply Adjustment Mechanism with a Strategic Reserve (ASAMSR, please send better names on the back of a postcard) that will link the availability of carbon allowances to the amount being released to the market. This mechanism would involve excess allowances being held in a ‘strategic reserve’, providing scarcity in the market to improve the robustness of the carbon price, but importantly having an available reserve at times of market stress. For those that like finer detail, our proposal can be viewed in more detail in a discussion paper here.
The good news is that the European Commission has indicated it will bring forward proposals for such a mechanism by the end of the year. However, there is a still a debate to be had around how allowances are restricted and then returned to the market, and the discussion in Brussels will likely focus on these trigger mechanisms.
It was encouraging to see that on the back of these developments, the carbon market had a small bump of €2, a positive sign that the market is seeing light at the end of a rocky period for the EU ETS. Although structural reform will not be a quick fix, as it may take several years to implement, it’s something that is needed.
There is a nearer term debate around what to do with the excess allowances now. Phrases like ‘back-loading’, ‘linear reduction rates’ and ‘cancellations’ will all be well known to those with an interest in the EU ETS debate. These ideas, which we support, will be included as part of the debate around the EU’s 2030 Climate and Energy Package that is currently being developed, to ensure the overall aims of carbon emission targets are interlinked with the EU ETS.
Meanwhile on structural EU ETS reform, we’re going to continue to work closely with policymakers in Brussels to ensure that the EU ETS is linked to external factors, to prevent a similar collapse in the carbon market. This will help to deliver a carbon price that will drive fuel switching and investments in low carbon electricity generation, in the near and long term.
I’ll keep you updated as it progresses.