When COVID-19 met the EU ETS
The EU carbon market prices are plummeting as a result of the economic shutdown, underlining the need to strengthen the scheme to better sustain similar shocks in the future. No efforts should be spared to stop the spread of the coronavirus pandemic, and it will be critical to ensure that European climate policies are not weakened and stimulus packages also support the EU Green Deal.
The coronavirus epidemic is being felt across the world. Governments are rightly taking unprecedented measures to enforce social distancing, the only way to slow down the spread of the virus.
The widespread lockdown measures have led to an economic slowdown which, together with market speculation, has sent the carbon price under the EU Emissions Trading System (EU ETS) in a nosedive.
As of 25 March, the price has dropped by almost 40% to a near two-year low just above €15/ton CO2.
Up until two weeks ago, the EU ETS price was around 25 euros per tonne. The higher price has helped drive the coal phase-out, a key goal for Europe. As of now, the current price drop has not revived coal power generation, however, the profitability of lignite plants has unfortunately already improved.
The price drop, of course, also means reduced revenues to member states coming from the auctioning of emission allowances.
As a side note, a Polish government representative has proposed to scrap the entire EU carbon market as a response to the coronavirus epidemic. The motive for this is unclear to us, seen that the Polish government made €2.2 billion in auctioning revenues last year and one would think that even the reduced revenues would still be welcome for all affected economies.
A lower carbon price means less exposure to the carbon price signal to incentivize emission reductions. This is especially important for large polluting industrial sectors (steel, chemicals, cement) and the aviation sector. The negative economic impact on these sectors is (partially) offset by lower carbon prices. This means that any requests by the biggest polluters for even more pollution subsidies are mostly unfounded and should at the very least be carefully assessed.
Are the current tools enough to avoid a total price crash?
The EU ETS Market Stability Reserve (MSR) has been absorbing excess allowances off the market since the beginning of 2019, which is the main reason for the 25€ price until last week. It will continue to take out the surplus and cancel those permits later. However, the MSR was designed to handle past oversupply accumulated over the years. It is not fit for purpose to deal with current or future surplus (linked to e.g. the Covid-19, financial downturn, coming coal plant closures…).
The MSR will, therefore, need to be strengthened in the context of the EU Climate Law implementation and the upcoming review of the EU carbon market rules. This means increasing the intake rate to 36% from 2024 onwards, adopting a declining threshold and by setting an automatic cancellation for allowances held in the MSR for more than five years. In addition, the pace at which the pollution permits are reduced annually, the ETS linear reduction factor (LRF), needs to be raised to at least 4.2% in order to decarbonize the power and industry sector by 2040 the latest.
Such improvements were foreseen to be included in legislative proposals next year. Considering the current volatile situation on the market, the EU Commission should aim to speed up this process if carbon prices do not recover in the medium term.
In the meantime, EU governments can help strengthen the system by cancelling surplus allowances as power plants are closed down, as provided for in the EU ETS directive. Furthermore, implementing either national or regional carbon floor prices would be an ideal measure to strengthen the EU ETS and provide the necessary incentives to phase out coal.
The Green Deal just got that much more important
Some airlines are already saying that plans to levy green taxes on aviation should be postponed. It shows how those benefiting from the current unsustainable and polluting economic model are wasting no time to use the health crisis as an excuse to weaken Europe’s climate action. This is self-serving, opportunistic and irresponsible.
While emissions are temporarily dropping, they are likely to bounce back as soon as economic activities pick up again. Drawing lessons from the past, our governments should do what they didn’t do after the 2008 financial crash: they should make sure that stimulus packages support the green transition instead of propping up the biggest polluters and keeping dependence on fossil fuels locked in.
A climate-friendly Europe is also a healthier Europe and more resilient to deal with crises like the covid-19. Our leaders should keep this in mind as they plan for the post-pandemic economic relief measures and make sure that Europe’s determination to avoid a climate breakdown becomes stronger, not weaker.