The EU ETS reform, and what does this mean for the carbon markets?

Early Thursday morning, EU institutions reached a final agreement on the reform of the bloc’s carbon market for the period 2021 to 2030. Covering around 40% of EU’s greenhouse gas emissions from the energy, industry and aviation sectors, the EU Emissions Trading System (ETS) is currently the largest cap and trade carbon market in the world. But with a notorious oversupply of pollution permits that has kept carbon prices hovering around 5-7 EUR/tCO2e for the past five years, the ETS has long been the region’s problem child. ECO remains disappointed at the new agreement.

 

A real reform of the system would have simultaneously slashed the enormous allowance glut, sent a strong decarbonisation signal to energy and industry, and made sure that auction revenues go to sustainable and clean technology. The success of the reform has to be judged on the delivery on all of these aspects.

 

It is now clear that the reform will not bring the scheme in line with the Paris Agreement climate goals or with mid-century decarbonization.  However, the EU did make some small improvements with regard to the permit surplus: For the first time, some unused allowances will not be released to the market and could be cancelled, potentially leading to a reduction of 2-3 billion allowances in the long term.

 

The EU will still not have a ‘Paris-friendly’ carbon price. Even optimistic projections only show 25-30 EUR/tCO2e in 2030, but depending on coal phase-outs, it could be below 6 EUR/tCO2e  (lower than today).

 

With regard to decarbonising the European industry, the reform failed to overcome the current flaws. Energy-intensive industries such as steel, cement and aluminum will still receive all of their allowances for free until 2030. EU institutions have obviously caved in to industrial lobbying. This failure to provide clear decarbonisation incentives not only curbs these sectors’ drive to innovate and ridicules the polluter pays principle (a basic principle enshrined in the EU treaties, Commissioner Arias Cañete!), but also subsidizes the industries to the tune of more than €160 billion.

 

Further, regarding the funds that the ETS generates through the auctioning of pollution permits, the EU has failed to prevent them from subsidizing coal.

 

What does this mean for the UNFCCC? It depends on what the EU wants to do with its carbon market internationally. It’s certainly not a model to be followed! Does it want to sell its hot air to other countries? Perhaps,to the International Civil Aviation Industry? How does this fit in with the UNFCCC markets under Article 6? These are all open questions, but the EU needs to fix its market to get a real carbon price before mixing it up with others.

 

The EU has three more opportunities to fix this. Firstly, the surplus will be revisited in 2022 with a review of the Market Stability Reserve, the key means of ensuring scarcity in the market and hence a more robust price. Secondly, governments can unilaterally cancel some of their emissions rights and, if just the progressive countries come together to do so, the EU’s overall GHG reduction target can increase significantly from -40% by 2030, to inject confidence into the Talanoa Dialogue. Thirdly, the European Commission will come forward with an updated 2050 strategy which will conclude that the -40% 2030 target is insufficient and set the agenda for a higher target. All three opportunities must be discussed openly here in COP 23 , to ensure that the EU meets the Paris Agreement’s targets.

 

 

 

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