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ENVI adopts bullish carbon market reform proposal

The Environment Committee (ENVI) has approved MEP Ian Duncan's proposal for the reform of the EU Emissions Trading System (EU ETS) Phase IV. The proposal received 53 votes in favour, 5 against, and 7 abstentions, marking a significant step forward. Covering various aspects of the EU ETS, including carbon leakage, auction share of allowances, and the Modernisation fund, the comprehensive proposal sets out the committee's position.

In collaboration with Trevor Sikorski, Head of Carbon and Gas Research at Energy Aspects, we analyse the key reform proposals and their potential impacts on EU Allowance (EUA) prices.

Linear Reduction Factor (LRF) Increase: The LRF is set to rise from the original 2.2% to 2.4%. This adjustment would result in an annual cap reduction increase of 4.5 million tonnes (Mt), with a minimal impact on prices—adding an estimated €1.5 to average Phase IV prices. The proposal also includes provisions for the cancellation of an additional 200Mt, dependent on the activation of the Cross Sectoral Correction Factor.

Enhanced Market Stability Reserve (MSR) Withdrawal Rate: The adopted proposal suggests increasing the MSR withdrawal rate from the current 12% per year to 24% in 2019, 2020, 2021, and 2022. Energy Aspects' price forecasts indicate an increase from €5.50 to €8.2 in 2019 and from €8 to €24 in 2020. Average Phase IV prices are also revised upwards from €30 to €36. These accelerated withdrawal rates would exhaust the MSR by 2022, earlier than the projected 2026.

MSR Cancellation: The cancellation of 800Mt of EUAs from the MSR in 2021 would not have an immediate impact on the EU ETS. However, the effect would be felt post-2030 when the MSR injects EUAs into the market, depleting its reserves sooner than expected.

Changes to Carbon Leakage List: The proposal suggests removing the cement sector from the carbon leakage list, subject to the implementation of a system that requires importers outside Europe to surrender allowances for the carbon content of their goods. Sectors covered by this system would no longer receive free allocation.

Alignment of Aviation Emissions: The proposal aims to bring aviation emissions in line with the rest of the EU ETS. Currently, aviation has a static cap and free allocations, unlike other sectors. Under the ENVI proposal, the aviation cap would fall under the LRF, and the auction share would increase to 50%. This would lead to reduced allocation and higher EU Aviation Allowance (EUAA) prices, which are closely linked to EUA prices.

Inclusion of Shipping in EU ETS: If the International Maritime Organization (IMO) fails to deliver a global deal by 2021, shipping will be included in the EU ETS from 2023, mirroring the inclusion of aviation. EU politicians will require assurance that adequate measures are being taken globally.

Reduced Allocations: Installations not covered by the carbon leakage list would see their allocations fall to zero, except for the district heating sector, which would still receive 30% of its benchmarked free allocation. In cases where the Cross Sectoral Correction Factor is activated, up to 5% of the auction share may be transferred to free allocations to protect carbon-leakage-exposed companies.

Member State Allowance Cancellation: Member states would have the authority to cancel allowances if national policies are detrimental to the EU ETS. Examples include the UK's carbon floor price and renewable subsidies across multiple member states that reduce demand for EUAs outside the EU ETS.

What Was Not Included?

Tiered Leakage List: The proposed tiered leakage list was replaced with the existing binary approach, increasing the risk of triggering the Cross Sectoral Correction Factor.

Cap Rebasement: There were calls for the cap to be rebased using 2020 actual emissions data to address the issue of oversupply. Currently, cumulative emissions are 10% below the cap.

Next Steps

While the proposal still faces a long path to becoming EU legislation, the majority obtained in the ENVI Committee vote provides a promising start. The proposal will undergo a parliamentary vote, likely in February 2017. Although attempts to dampen the proposal are anticipated, achieving a majority vote in parliament would strengthen MEP Ian Duncan's position when presenting the proposal to member states. Recent changes in voting rules also make it more challenging for member states to form a blocking minority and impede the proposal's progress.


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