Phase III of the European Union Emissions Trading Scheme (EU ETS) started in 2013 and ends in 2020. Among the most significant changes in Phase III is an increase in the Linear Reduction Factor to 1.74% per year to ensure the EU will achieve the 20% greenhouse gas reduction targets set. In addition to this, the European Commission (EC) has determined a secondary cap for aviation which is a sector newly included in the EU ETS since 2012.
Phase III also sees a shift in the allocation methodology from grandfathering to more auctioning. Phase I & II were characterised by near full free allocation and little or no auctioning of allowances. In Phase III free allocation will decrease at a faster rate than the cap as more allowances are auctioned. In 2013 over 40% of the allowances were auctioned with this figure rising to ~57% by the end of the phase. The total auction volume will be split as follows; 88% of the auction volumes are distributed to member states on the basis of their 2005 emissions, 10% is shared between the least wealthy EU member states and 2% function as Kyoto bonus.
Electricity generators become the exception to the norm in Phase III as they receive no free allocation unless the country of origin has a GDP below 60% of EU average, in which case they are entitled to a derogation volume. The derogation volume is intended to help the power sector in these countries cope more easily with the costs of making the transition to less carbon-intensive electricity generation.
A New Entrants’ Reserve (NER) will also operate with the purpose of providing new installations and installations that increase capacity with free allocation. It is a pool of allowances set aside that will amount to approximately 5% of the total amount of allowances for Phase III of the EU ETS (2013-2020).
Phase III has also seen the intra-phase introduction of backloading which is a structural reform aimed at alleviating some of the oversupply that has dogged the market and led to low prices. Backloading withdraws 900mt from the auction volumes between 2014 and 2016 and originally would have added them to the auctioning pot in 2019 and 2020. Backloading was a short term fix aimed at easing immediate supply pressure and has to an extent, been superseded by the Market Stability Reserve (MSR) which is a structural reform due to start in 2019. The backloaded auction volumes will now go straight into the MSR rather than coming to market in 2019 & 2020.