Raiding the reserve that underpins the EU’s Emissions Trading System to reduce the European Union’s dependence on Russian gas is short-sighted and destructive, especially as far better solutions exist.
The Market Stability Reserve (MSR) is an important element of the EU Emissions Trading System. It has proven effective in supporting the carbon price, and helped end a period of very low confidence (and carbon prices) in the EU ETS by actively sucking surplus pollution permits out of the market. From 2023 onwards, it will also ‘retire’ (i.e. delete or cancel) emission allowances held in the reserve.
However, the European Commission now risks undermining the MSR and scaling back the progress it has helped achieve. The EU executive has proposed to plunder the MSR to sell some of the allowances it contains to finance the REPowerEU plan. But the MSR is not a cookie jar that can be dipped into at whim – it is a critical component of the EU ETS that needs to be protected from raiders.
REPowerEU seeks to reduce the impact of Russia’s invasion of Ukraine by saving energy, lowering the EU’s dependence on Russian gas, diversifying the bloc’s energy sources and accelerating the green transition. While worthy policy goals, the way the Commission proposes to fund the initiative is incredibly problematic. The Commission intends to raise €20 billion by selling about 250 million allowances currently held in the MSR, which will damage the EU carbon market in several ways.
First, it would raise the amount of pollution allowed under the EU ETS by 116 to 144 million tonnes of carbon dioxide equivalent (CO2e) by 2030; undermining climate action during this critical decade for tackling the climate breakdown.
Second, carbon prices would be depressed, reducing auctioning revenues that currently go to the member states or are used to fund climate-friendly innovation in the EU. At best, this would be a zero-sum game where member states receive funds through REPowerEU that they would otherwise have received directly from auctioning. At worst, it would deplete EU ETS revenues for years to come. As an early warning signal of what could come,the EU carbon price tumbled by nearly 15% in the days following the publication of the Commission’s proposal.
These two factors would reduce the incentives for industry to decarbonise. Industrial emissions declined by a paltry 1.3% between 2013 and 2019 (the last pre-COVID year). Lower carbon prices and a higher EU ETS cap would only further slow down the necessary transition to a climate-friendly industrial sector.
Moreover, dipping into the EU ETS solely to fill coffers would set a risky precedent that could trigger future raiding parties. This would transform the MSR from a tool for safeguarding market stability into a piggy bank to be smashed open at whim. This would fundamentally alter the perceived role of the MSR, and its impact on confidence in the EU ETS – undermining carbon prices in the mid-to-long term as well. Moreover, it would set an unacceptable precedent of prioritising revenue raising over the environmental impact of climate policy.
To amplify the injury caused, REPowerEU also plans to invest around €11.5 billion in fossil gas and oil infrastructure. This would cause even more planet-heating emissions, increase the EUs dependence on fossil fuels, create stranded assets and lock us into new fossil fuel infrastructure.
There is still time to ensure that REPowerEU does not undermine the EU carbon market and deepen our dependence on fossil fuels. The mistakes in the proposed set-up of REPowerEU can and must be rectified by the EU institutions.
Revenues must not be raised using the MSR. Instead, the EU should raise the capital it needs to finance REPowerEU by auctioning some of the free pollution permits given away to industry, potentially in combination with some of the allowances earmarked for auctioning or the Innovation Fund. In addition, investments in fossil fuels must be explicitly excluded from REPowerEU to avoid the risk of short-term fixes causing long-term damage.
Moreover, the REPowerEU plan cannot be kept separate from the ongoing trilogue negotiations on the reform of the EU ETS. Attempts to undermine the integrity of the EU carbon market should be taken seriously, and if needed the negotiators should add measures to prevent the potential damage to the MSR done by REPowerEU. Instead, negotiators should focus on shoring up and strengthening the EU ETS, including the MSR itself.
It is possible and necessary to come up with solutions that tackle the current energy crunch and combat the climate emergency simultaneously, instead of seeking short-term elusive gains and the price of deeper long-term pain.
For more details, see our Life ETX briefing ‘Don’t pillage the MSR‘