Those of you with a close interest in carbon markets will know that there is currently a debate in Brussels over how to reform the EU Emissions Trading Scheme (EU ETS), the world’s largest carbon trading system. This debate started last year when the European Commission proposed to ‘backload’ 900 million allowances, a measure the European Parliament approved in December.
At the time I wrote that whilst backloading was welcome it was only the first step in the reform process, with much more still to do before the structural flaw within the EU ETS – namely that there is no link between the supply and demand of allowances, which has resulted in a massive surplus – is resolved.
The analogy I used, which still holds true today, is that the reform process is like fixing a burst water pipe: backloading has stopped the water flowing temporarily, but further measures are needed to fix the leak permanently, and to mop up the spillage.
I proposed three additional measures which I thought could achieve this, outlined below. The first two are needed to fix the ‘leak’ by addressing the structural oversupply, and the third is needed to mop up the ‘spillage’ of surplus allowances:
1. Link the rate at which the ETS cap tightens to the EU’s carbon reduction target for 2030, and its expected target for 2050.
2. Introduce a Market Stability Reserve (MSR), which was previously known as a Supply Adjustment Mechanism. The MSR tackles the root cause of the problem of future surplus allowances build-up by limiting the volume coming onto the market at times of surplus and returning allowances at times of shortage. This introduces a vital link between the supply of allowances and demand.
3. Either cancel the two billion surplus allowances in the system; or place them in the MSR.
Since the start of 2014 the debate in Brussels has focused on measures two and three above and recently member states have been giving their opinions on which reforms would be best, with the UK Government publishing its views last month. Its headline message was that surplus allowances need to be cancelled before 2020, as the current two billion surplus is depressing the carbon signal for investors now and is likely to increase costs in the future.
I agree with this analysis, and would actually go further by saying that the current carbon price signal is meaningless in terms of encouraging carbon optimisation, and will continue to be so far into the next decade without reform. As I’ve outlined cancellation, or another way of dealing with the surplus, is a vital part of the reform program – so SSE fully supports the UK government’s position here.
However whilst this stance is very welcome, the UK hasn’t yet commented on the legislative proposal for one of the other key components of reform – the market stability reserve, or MSR.
The current proposal is for the MSR to begin from 2021. However, given that reform is necessary sooner rather than later, I’m not sure why we need to wait for so long. Others, including the German government, share this view and have called for the MSR to be introduced in 2017.
The European Parliament will consider the MSR shortly, but if MEPs are to vote for an early introduction then it needs to have broad-based support.
I therefore feel the UK should join with the German government and signal its support for the early introduction of the MSR. The UK Government has shown real leadership on an ambitious Climate and Energy Package for 2030 so its support would give momentum to the reform agenda. It would also send a clear and positive message that a robust European carbon price can be achieved in this decade, and demonstrate active political and economic leadership.
Martin Pibworth is Managing Director, Wholesale, at SSE