The European Parliament has passed a package of reforms to the EU Emissions Trading System (ETS) designed to boost the price of allowances and accelerate the pace of decarbonisation.
MEPs voted in favour of legislation covering phase four of the scheme (2021 to 2030) by a margin of 535 to 104, with 39 abstentions.
For much of its existence, a surplus of allowances has depressed prices. The reforms seek to rectify the issue by reducing the number of new allowances issued, increasing the rate at which surplus allowances can be removed from circulation and introducing a mechanism to completely cancel allowances.
As a short-term measure, the auctioning of 900 million was postponed during phase three (2013 to 2030), a process known as “backloading”. To solve the problem over the long run, a market stability reserve (MSR), due to become operational in January 2019, will be used to soak up excess allowances.
Allowances will be added to the MSR if the total number in circulation exceeds 833 million but will be released if the total falls below 400 million. The backloaded allowances will be transferred to the MSR towards the end of phase three.
As part of the latest reforms, the percentage of excess allowances which can be absorbed into the MSR in each auctioning year has been doubled from 12 per cent to 24 per cent for the first fours years of phase four.
A new mechanism will be introduced in 2024 to invalidate allowances in the MSR. If the number of allowances in the reserve exceeds the number auctioned in the previous year, the difference will be cancelled.
The annual reduction in the cap on the number of allowances issued each year – known as the linear reduction factor (LRF) – will also be increased from 1.74 per cent in phase three to 2.2 per cent during phase four.
Independent MEP and rapporteur Julie Girling, said: “The ETS remains the cornerstone of our EU policy to combat climate change. We have done our best to agree an ambitious update.
“The ETS has had many detractors over the years. We tackled many problems – from a carbon price that was clearly too low to make the market function to the extremely difficult issue of striking the balance between our environmental ambition and the protection of energy-intensive European industry.”
Pieter Willem-Lemmens, head of analysis at green think tank Sandbag, told Utility Week: “We welcome the limited strengthening of the system achieved, but in our view this reform is not enough. It does not put the ETS back at the helm of EU climate policy and it will not drive the investment needed for rapid least cost abatement.”
He said new mechanisms, such as a price floor or automatic adjustments to the annual cap on the number of allowances issued, are still needed to compensate for reduced economic activity following the 2008 financial crisis and to ensure the system is resilient to future shocks.
“They are also needed to respond to the impact of other abatement policies, such as those targeting renewables deployment and energy efficiency”, he added.
“The opportunity to rebase the cap’s trajectory right at the start of the new phase to take advantage of previous lower than expected emissions levels has been missed.”
Price of allowances over the last five years
Source: Bloomberg
The European carbon price has risen significantly over recent months in anticipation of the changes. Back in May, allowances were trading for less than €4.50 but they are now selling for more than €9.
The total carbon price paid by generators in Great Britain consists of both the EU carbon price plus a top-up known as the Carbon Price Support (CPS). As the CPS takes the form of a levy on fossil fuels for generation and the rate is set annually, the rising price of EU ETS allowances will affect generators in Great Britain over the short-term.
However, they will also be insulated from its impact over the medium-term after the government announced in its autumn budget statement that the total carbon price would be frozen until the planned phase out of coal generation, due to take place by 2025, is completed. The CPS rate had previously been frozen at around £18 per tonne to keep British businesses competitive with their European peers.
The fate of the carbon price over the long-run is less certain. The government has said the UK will remain part of the EU ETS for a two-year transition period following Brexit but it’s unclear what will happen afterwards.
You can read Utility Week’s post-budget guide the carbon price and the debate over its future here.