With a weaker EUETS other policies must be stronger

The recent vote in the European Parliament and continuing discussions in Council make it clear that the EUETS is likely to remain weak for many years.  In this context, other climate change policies in Europe will need to be strengthened if Europe is to make a smooth and successful transition to a prosperous low carbon economy. 

The EUETS looks likely to continue with low prices and a large surplus for at least the next 10 years, and probably beyond …

The EUETS has been running a surplus since its early years.  This trend continued last year.  On preliminary estimates for 2016 emissions were around 11% below the cap.  By 2020 (the end of Phase 3 of the EUETS) the cumulative surplus of allowances will have reached nearly 4 billion tonnes, the equivalent of more than two complete years of emissions.  A little over half of this will be in the Market Stability Reserve (MSR), with the rest available to the market (see Chart 1).

Chart 1:  The surplus will have grown to nearly four billion allowances by 2020

capture

Source: Sandbag

Furthermore, there does not look likely to be any scarcity of emissions in Phase 4, which runs to 2030.  Total emissions over Phase 4 (2021-2030) look likely to be below the total cap (and perhaps greatly below) even with little abatement due to the carbon price (see Chart 2a).  The reason for this is that emissions start well below the cap – indeed emissions are already below the cap for 2020[1].  Consequently it takes a while for the cap to fall below emissions (see Chart 2b).  Indeed, the cap may not fall below emissions until after 2030, especially if there are significant reductions in generation of electricity from coal, which currently accounts for 40% of all emissions under the EUETS.  This type of case is illustrated by the low emissions scenario in the charts.

Chart 2a: There is no scarcity on average during Phase 4, and perhaps a large surplus

chart-2a

Source: Sandbag

Chart 2b: Emissions compared with the cap for Phase 4

chart-2b

Source: Sandbag

The reforms recently voted on by the European parliament do not significantly affect this situation …

The measures passed in the European Parliament last week include a doubling of the rate of transfer from the MSR for four years, so removing surplus allowances from the market more quickly.  This is welcome, but does not have much effect.  The surplus available to the market is so large that by the time it has been largely moved to the MSR the slower rate has had a chance to largely catch up (see Chart 3).  In both cases a substantial surplus persists for most of the decade even under the Base emissions case.

Chart 3: Effect of the MSR withdrawal rate

chart-4

Note:  This analysis assumes all allowances are allocated.  In practice some allowances may remain unallocated.   Source: Sandbag

The decision to cancel 800 million allowances from the MSR is also welcome.  Indeed much more cancellation will be required in future, and ideally the size of the MSR should be limited, for example to a billion tonnes.  However without further reform this will only have an effect in the very long term.  The MSR will be so large by the end of Phase 4 that allowances will take several decades to return at the maximum allowed rate of 100 million per annum (see Chart 4).  The 800 million allowances due to be cancelled would anyway have returned only in the about the 2050s.  They thus have almost no effect on the market over the next decade and a half.

Chart 4: Cancelled allowances from the MSR would anyway only return after decades

chart-5

 Source: Sandbag

As a result the EUETS seems likely to remain weak for the foreseeable future…

With such an oversupply of allowances the price seems likely to remain weak.  How weak is impossible to say, but the price has not perceptibly moved as a result of the recent vote in the ENVI committee and the Parliament.  Prices have remained at around €5/tonne, and the forward curve currently shows prices essentially flat at this level to 2020.  It is also hard to see scarcity of allowances being sufficient to drive substantial abatement for several years beyond 2020, and perhaps much longer.

This implies that the EUETS will fail to deliver adequate or efficient signals for either short term abatement or longer term investment in low carbon technologies. The EUETS looks likely to become mainly a backstop mechanism and an accounting and MRV framework, rather than the primary driver of action many wish it to be.

This in turns requires other policies to provide most of the incentives to decarbonise if low cost abatement opportunities are to be realised now, and if the European economy is to be put on track for a prosperous low carbon future.

The weakness of the EUETS is likely to represent a marked shift in climate policy in the EU …

The continuing weakness of the EUETS is likely to trigger a range of actions.  Some of these may be at the EU level but many are likely to be at the national level.  They are likely to include some mix of the following:

  • National carbon pricing initiatives, perhaps along the lines of UK carbon price floor and similar measures proposed in France, with perhaps groups of countries adopting similar or even co-ordinated policies.
  • Additional restrictions on coal plant, including closure in some cases.
  • Assistance with selected low carbon technologies, including CCS, for industry, especially as low EUA prices are likely to mean that the EUETS’ Innovation Fund will not be worth very much.
  • Emissions performance standards for certain sectors.
  • Continuing emphasis on energy efficiency and renewables.

This in turn risks further weaken the EUETS unless opportunities are taken to fix it in future.  Indeed it risks a reinforcing feedback of weaker price signals from the EUETS leading to more additional actions, leading to yet weaker price signals, and so forth unless action is taken.  Action to correct the EUETS and avoid this is certainly desirable, but now looks unlikely on any substantial scale for at least the next several years.

There is another possibility that might emerge.  One of the changes in the current package allows Member States to cancel allowances rather than auction them.  It is possible that a group of larger Member States could collaborate and cancel substantial number of allowances.  Such an approach would be to be most effective once the MSR has absorbed more of the current surplus.  This could lead to a group of Member States doing what Parliament has been unable to do, and Council appears unlikely to do.  This may not be a model of Europe wide decision making, but may be the as good a chance as any for the EUETS to succeed.

Yet such action by multiple Member States at a large scale still seems distant, and may never occur.  The priority must be to put in place other policies which help put the EU on track to meeting its long term decarbonisation goals, and which work towards delivering the Paris Agreement commitments.

Adam Whitmore – 24th February 2016

Notes:

This post is in part adapted from a talk I gave at the Dutch PermRep in Brussels on 7th February, modified to take account of the subsequent vote in the Parliament.

Thanks to Boris Lagadinov and others at Sandbag for providing the charts for this post.  Further material can be found on the Sandbag website.

[1] Emissions in 2016 were 1754Mt (preliminary estimate) compared with the 2020 cap of 1816Mt.

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