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Four magic potions for the EU’s carbon market

In July 2015, the European Commission presented a legislative proposal to revise the EU’s Emissions Trading System (ETS) in order to implement the EU’s 2030 target of at least 40% domestic emission reductions. Although the proposal suggests a few improvements it fails to introduce much needed provisions that improve the mitigation potential of the EU ETS. A new Carbon Market Watch policy brief recommends four magic potions to turn the EU ETS into an effective climate mitigation tool.

  1. Disappearing spell: Remove poisonous pollution permits

The EU ETS is burdened by an oversupply of about two billion carbon allowances, equivalent to more than twice the emissions of Germany, as a result of an inadequate 2020 climate target and high imports of international offset credits. Without action, this large surplus of pollution permits will dilute the necessary efforts in the 2030 package. Casting a disappearing spell on the EU ETS to empty the Market Stability Reserve in 2020 will permanently remove two billion surplus poisonous pollution permits from the EU’s carbon market and goes some way in helping the EU ETS recover its force.

  1. Linear reduction booster: Adopt a steeper trajectory to inject early mitigation action

Once the problem of looming pollution permits is out of the way, the EU policymakers can turn towards incentivizing early action. The proposed linear reduction factor by which the EU ETS cap is reduced each year is set too low to reap the benefits of early action to reach the 2050 decarbonisation objective cost-effectively. A booster should be added to the carbon market so as to avoid delaying efforts until after 2030 by increasing the linear reduction factor to at least 2.6%.

  1. Shrinking tonic: Limit the surplus in the reserve to account for technological progress

The rapid decline in costs resulted in a faster uptake of renewables than expected, which meant that the EU ETS targets have been outpaced by actual emission reductions. The EU’s carbon market is hence in need of a shrinking tonic to keep the EU ETS targets to keep pace with technological progress. Currently the Market Stability Reserve can hold an unlimited amount of surplus pollution permits. Shrinking the reserve to a maximum of one billion allowances ensures that allowances are automatically removed when the ceiling is reached and thereby makes certain that the EU ETS targets are adjusted as new and cheaper low-carbon technologies become available.

  1. Review elixir: Revise EU’s climate targets every five years

Finally, the proposed 10-year trading periods will carve the EU’s ambition level in stone until 2030, locking down ambition for the next fifteen years. What we need is some review elixir in order to turn the EU ETS into a flexible climate instrument that is more responsive to market developments such as technological and economic changes. Revising EU’s climate targets every 5 years and adopting five year trading periods in the EU ETS will increase the ability of regulators to adapt the system to changing circumstances.

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