For the last couple of years, the European carbon market has failed to provide a signal for decarbonisation with carbon prices hovering around 5 euros for a tonne of CO2. To address this, earlier this year, the European Commission proposed to reform the EU’s Emissions Trading System (EU ETS) in order to provide a more meaningful carbon price. It is now up to the European Parliament and the Member States to take this proposal forward and make it more effective.
The main problem is the large surplus of more than 2 billion emission allowances that has built up in the EU ETS and is mostly due to the overgenerous use of international offsets. As a result of this enormous oversupply of emission allowances, the price for these pollution permits has dropped so significantly that the EU ETS no longer facilitates the transition towards a renewable and efficient economy. This could lock Europe into carbon-intensive infrastructure for years to come.
The reform of Europe’s carbon market aims to address this imbalance between the supply of and demand for pollution permits. Under the Commission’s proposal, emission allowances would automatically be put into the so-called Market Stability Reserve when there is a large oversupply and released back into the market when allowances are scarcer. The reserve would start operating from 2021.
Although the Market Stability Reserve is a necessary first step to making the EU ETS an effective pollution control instrument, the proposal by the Commission is too little, too late. In order to address the current problems of the low carbon price and oversupply of pollution permits, the Market Stability Reserve needs to be enacted at the earliest possible date, which is July 2016.
Furthermore, the current proposal does not prevent close to 1.7 billion allowances from flooding an already oversupplied market. Not only will the 900 million back-loaded allowances return to the market, but large volumes of additional allowances will likely be auctioned in 2020. The Market Stability Reserve merely attempts to smoothen out the manner in which these allowances come back into the EU ETS. According to modelling by Thomson Reuters Point Carbon, this will result in an unstable carbon price. By contrast, permanently cancelling these allowances is a structural solution that will lead to a more stable and predictable carbon price according to the same analysis.
The Market Stability Reserve should also restrict the amount of surplus allowances from transforming into future ‘rights to pollute’ to help ensure that the EU ETS does not cancel out the greenhouse gas reductions from other existing and future policies. The Commission’s proposal fails to do this as the surplus allowances that are placed in the reserve will be released into the market at some point in the future. If no limit is placed on the amount of allowances that the Market Stability Reserve can store over time, the overachievement of EU’s current weak climate ambition will further weaken climate action after 2020.
It is now in the hands of the European Parliament to make the Market Stability Reserve more effective in achieving its objective of stabilizing carbon prices. The Parliament’s lead draftsperson, Yvo Belet, will steer this process with a vote in the environment committee on 23 or 24 February 2015. It is high time that the world’s largest carbon market starts rewarding efficient companies while making the polluters pay!