ENVI adopts bullish carbon market reform proposal

The Environment Committee have adopted the proposal put forward by MEP Ian Duncan on the EU ETS Phase IV reform. It was voted through with 53 votes for, 5 against and 7 abstentions. The lengthy proposal provides a position on all aspects of the EU ETS such as indirect carbon costs, auction share of allowances, carbon leakage, management of the Modernisation fund and use of auction revenue, amongst others.

With the help of Trevor Sikorski, head of Carbon and Gas research at Energy Aspects, we analyse the impacts of the main reform proposals adopted and their impacts on the EUA price.

1) Linear Reduction Factor increased to 2.4% from the original proposal of 2.2%. According to Energy Aspects this would increase the cap reduction by 4.5Mt each year but only have a minimal impact on prices, adding €1.5 to average Phase IV prices. There are also provisions for the cancellation of an additional 200Mt but this is dependant on whether or not the Cross Sectoral Correction Factor has been triggered.
2) Increased MSR withdrawal rate. Under today’s adopted proposal the MSR withdrawal rate will increase from 12% each year to 24% in 2019, 2020, 2021 and 2022. Energy Aspects price forecasts would increase from €5.50 to €8.2 in 2019 and from €8 to €24 in 2020. Average prices for Phase IV are also revised upwards from €30 to €36. The new withdrawal rates would see the MSR finish withdrawing allowances from the market in 2022 rather than the projected 2026.
3) Cancellation of 800Mt EUA from the MSR in 2021 would have no real immediate impact on the EU ETS. The impact would be felt later, post 2030, when the MSR is injecting EUAs into the market and is exhausted of EUAs sooner than it otherwise would have been.
4) Cement sector to be removed from the carbon leakage list, among others, if the EU-ETS can put in place a system that requires importers from outside Europe to surrender allowances to cover the carbon content of their goods. Once implemented, any sector covered would receive no free allocation.
5) Aviation emissions brought in line with the rest of the EU ETS. Currently the aviation cap and free allocations are static rather than decreasing like the rest of the EU ETS . Additionally, only 15% of allowances are auctioned while 82% are given away for free. Under the ENVI proposal this will change with the cap brought under the LRF and the auction share going to 50%. Airlines face the prospect of greatly reduced allocation and markedly higher EUAA prices which are intrinsically linked to EUA prices.
6) Shipping to be included in the EU ETS from 2023 if the International Maritime Organisation (IMO) does not deliver a global deal by 2021. Much like the inclusion of aviation in the EU ETS, any potential IMO global market mechanism will need to satisfy politicians in Europe that enough is being done.
7) Allocations fall to zero for installations not covered by the carbon leakage list. The exception is the district heating sector which will still receive 30% of their benchmarked free allocation. To help protect free allocations for carbon-leakage exposed companies, up to 5% of the auction share may be transferred to free allocations if the Cross Sectoral Correction Factor is triggered.
8) Member states can cancel allowances in the event national policies are detrimental to the EU ETS. Examples of this include the carbon floor price in the UK and renewable subsidies across numerous Member States which have reduced demand for EUAs with policies outside of the EU ETS.

What did not make the cut?

1. Tiered leakage list scraped in favour of the current binary approach. This heightens the risk of the Cross Sectoral Correction Factor being triggered.
2. No rebasing of the cap. There have been calls for the cap to rebased to 2020 actual emissions data to avoid the on-going issue of over supply from one year to the next. Currently, cumulative emissions are 10% below the cap.

Next steps?

The proposal still has a long road ahead until it becomes EU legislation but the majority reached in today’s vote gives it good start going into a parliament vote, likely in February 2017. Moves to dampen the proposal are likely however if MEP Ian Duncan can achieve a majority vote in parliament it would strengthen his hand before he goes to member states with the proposal. The recent changes in voting rules also make it harder for member states to form a blocking minority and impede the path of the proposal.