Draft proposals will see more allowances removed from the market and fewer auctioned off in future

MEPs have backed plans to boost the European carbon price by mopping up a chronic surplus of allowances in the EU emissions trading system.

The draft proposals will see more of the existing allowances in circulation removed from the market and fewer new allowances auctioned off in future. 

Speaking yesterday, the MEP leading the reforms, Ian Duncan, said: “Today’s vote marks a major step forward towards meeting our ambitious climate change targets. Parliament has voted through ambitious measures to fulfil our Paris agreement obligations, and we have sent a strong signal to the European Council that we are serious about the fight to stop global warming.”

The EU emissions trading system (EU ETS) has been plagued by a long-running glut of carbon allowances due to reduced economic activity, and therefore lower emissions, in the wake of the 2008 financial crisis.

Over the past three years the European Commission has postponed the auction of 900 million allowances – a process known as backloading – as a short-term measure to chip away at the surplus. 400 million allowances were backloaded in 2014, 300 million in 2015 and 200 million last year. The backloaded allowances will be transferred to a market stability reserve (MSR), which will be created in 2018 and become operational the year after.  

Under the latest proposals to reform the EU ETS the annual capacity of the MSR to absorb excess allowances will be doubled from 12 per cent of the total number in circulation to 24 per cent. 800 million allowances will be removed from the MSR and cancelled by the start of 2021.

The annual reduction in the number of allowances auctioned off each year will increase from 1.74 per cent to 2.2 per cent. MEPs said the figure will be kept under review with a view to increasing it to 2.4 per cent by 2024 at the earliest.

A modernisation fund to support energy system upgrades in poorer members and an innovation fund to support decarbonisation efforts will be also be set up and financed using the proceeds from auctions. MEPs have furthermore proposed creating a “just transition fund” – again funded by auction revenues – to help with the loss and creation of jobs as members decarbonise their economies.

The European Parliament voted to approve the draft measures by a margin of 379 to 263 with 57 abstentions. MEPs will now enter into negotiations with the president of the European Council on the final shape of the legislation before it is returned to the parliament.

The surplus of EU ETS allowances has resulted in very low prices on the European carbon market – at the time of publication they were trading at less than €5 per tonne of carbon dioxide (/tCO2).

This has, in turn, led to a large gulf between the carbon price in Britain and the rest of the EU following the instruction of a carbon price floor in the UK in 2013. The carbon price floor is currently set to rise to £32/tCO2 in 2020 and £75/tCO2 in 2030.

In March 2014, the government responded to the disparity by capping the rate of the carbon price support – the levy on fossil fuels which makes up the difference between the EU ETS price and the carbon price floor – at £18/tCO2 from 2016/17 to 2019/20. 

The chancellor Philip Hammond announced that the cap will remain in place until 2020/21 in his autumn statement in November but gave no indication as to what would happen beyond then.

It also remains unclear whether the government wants to stay part of the EU ETS following the UK’s departure from the EU.

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