Studies show that global warming can only be combated by heavily reducing greenhouse gases. How will the EU Emission Trading Scheme adapt itself after Phases I and II and still impose ambitious targets?
What? The emission trading (ETS) system, the cornerstone of the EU's climate policy, is based on the principle of 'cap-and-trade'. This principle imposes a limit on the volume of greenhouse gases that can be emitted each year by certain power plants and installations. The system attributes emission "allowances" (permits) to ETS companies (see hereunder) for trade on the market. Such allowance gives the holder the right to emit 1 ton of CO2. Each year companies have to submit allowances linked to the amount of CO2 emitted, subject to fines in case of non-compliance.
Who? The EU ETS system, launched in 2005, now covers approximately 12 000 plants and manufacturing installations in the industrial sectors across 27 Member States plus Norway, Liechtenstein, Iceland and Croatia. The sectors involved include power generation, iron, steel, cement, oil, lime, glass, ceramics, pulp and paper. This covers around 45 % of the EU's greenhouse gas emissions.
How? The ETS system has been developed in three phases:
- 2005-2007: Phase I - "Learning by doing" - EU ETS becomes the biggest carbon market, but prices have been very volatile due to over-allocation of EU allowances by the Member States and ever-changing carbon dioxide regulation.
- 2008-2012: Phase II - As a consequence of the recession and decreased industrial production, a surplus of unused allowances appears.
- 2013-2020: Phase III - Instead of national caps for Phases I and II, the Phase III introduces a single EU-wide cap on emissions (reduction by 1,74% each year). Phase III introduces a progressive shift towards auctioning of allowances instead of cost-free allocation.
Issues
When Phase III started on the 1st of January 2013 there was a surplus of almost two billion allowances, which is the double of the level reached early 2012.
Although this fast build-up is expected to end by 2014, the European Commission argued that it is not anticipated that the overall surplus will decline during Phase III. Potentially, according to the Commission, there will be a structural surplus in this period of around 2 billion allowances.
Although the ETS system was scheduled to apply as of 1st January 2013, on the national level, specific legislation is still needed today in order to implement the ETS directive on the particularities of Phase III (such as carbon leakage, the auctioning mechanism, etc.).
Attention should also be paid to the upcoming judgement of the ECJ in the Case C-203/12 where Advocate General Paolo Mengozzi already delivered his opinion on the 16th of May 2013 stating that fines for non-delivery of carbon credits should be proportionate. An ECJ decision following this opinion could undermine the sanctioning regime linked to the ETS system as companies might be more attracted to paying 'proportionate' fines than buying allowances on the market.
Overcoming crisis and restoring confidence
The above described problems risk undermining the aims of the system. If not properly addressed, imbalances are expected to affect the ability of the EU ETS to meet more demanding emission reduction targets in future.
These concerns made the European Commission take initiatives in a twofold way.
Initiative 1: Back-loading
The Commission first sought for solutions within the short term and proposed an amendment to the ETS Directive in June 2012 in order to postpone (or back-load) the auctioning of 900 million emission allowances from the years 2013-2015 to 2019-2020. This measure aims to rebalance supply and demand and to reduce price volatility.
This initiative has not been happily welcomed by parts of the industry. Lobbying organizations developed arguments on the fact that high energy prices will undermine the EU's efforts to promote growth, jobs and competitiveness. Furthermore it was argued that European industry is already under pressure of the shale gas and oil revolution in the United States. Other groups lobbied for a "yes to back loading" from the MEP's, and argued that it was crucial to withhold the carbon credits from the next round of the cap and trade system.
As a result of the plenary vote of the European Parliament on 16 April 2013, the proposal was rejected. With 334 votes against 315 and with more than 60 abstentions, the Commissions' proposal returned to the parliamentary committee (ENVI) and is forecasted to plenary session for first reading on the 2nd of July 2013. It will be interesting to see at that time which amendments are needed to provide a green light for the back-loading proposal.
Initiative 2: Structural reform
In accordance with Article 10(5) and 29 of the EU ETS Directive, the Commission published in November 2012 its first report on the state of the European carbon market. In this Report six possibilities are being explored on how to overcome the challenges of the carbon market:
- Increasing the EU's greenhouse gas emissions reduction target for 2020 from 20% to 30% under 1990 levels;
- Retrieving a certain number of Phase III allowances permanently;
- Revising upwards the 1.74% annual reduction in the number of allowances;
- Bringing more sectors into the EU ETS;
- Limiting access to international credits;
- Introducing discretionary price management mechanisms such as price management reserves.
Together with this report the Commission has launched a formal stakeholder consultation on solutions to the surplus with meetings in March and April 2013.
Conclusion
Both for the proposal of back-loading as for the initiative supporting a structural reform of the EU ETS, things are moving slowly. After the European Councils' Summit on 22-23 of May 2013, Commission President Barroso acknowledged that the pace of implementation has been too slow in both policy fields that have been under discussion (tax and energy, also related to climate policy). Furthermore, according to Europ' Energies (the energy magazine), recent indiscretions of some MEP's arguing in favor of a reduction strategy on short term, led to a new degree of optimism which translated into a noticeable increase of the CO2 price (at the end of May a price of 3,95 Euros/ EUA was reached).
However, industry requires previsibility and stability to develop their strategies, embedded in clear and consistent market regulations. The recent months have not proven to go along this line in the EU ETS. One can hope, both for economic reasons as for climate change combating, that Barroso's voice will be heard in the European Parliament.
