The EU's emissions trading system (EU ETS) has long grappled with a large surplus of emission allowances, which means that the carbon dioxide price is not sufficiently high to stimulate the market into adapting the energy system in line with the objectives of the Paris Agreement. According to a new study undertaken by the Pöyry consultancy on behalf of Vattenfall, the Finnish company Fortum and the Norwegian company Statkraft, the surplus is largely due to the EU's member states setting their own targets, which is affecting emissions. This is something that the EU system as it is currently designed is not really capable of managing.
"We are positive towards many of the reforms that are currently being implemented in the EU ETS Directive. In particular those measures which have the aim of removing a significant proportion of the surplus of emission allowances which has built up in the market up to now," says Erik Filipsson, Policy Advisor at Vattenfall.
Mechanism currently lacking
However, what is currently lacking is a forward-looking solution and a built-in mechanism which directly regulates the number of emission allowances in relation to the climate initiatives being implemented at national level. Erik Filipsson provides an example:
"Let's say that a country decides to shut down a number of coal-fired power plants. With the current system, the amount of carbon dioxide which would then be reduced locally, would have no direct effect on the amount of carbon dioxide that can be emitted in the emissions trading system. It means that the number of emissions allowances in circulation is too high and results in the price of emission allowances falling and no longer having the controlling effect intended. This means, paradoxically, that a less ambitious EU country can increase its emissions as a result of other countries' efforts, as long as the jointly set EU objectives are achieved."
Propose automatic regulation
The mechanism which Vattenfall and the two other Nordic power companies are now proposing automatically regulates the amount of emission allowances in relation to the real amount of emissions.
"As soon as a country reduces its emissions, this has to be reported centrally, and an equivalent amount of emission allowances removed from future auctions. In this way, the national measures also have an effect on the climate overall, and it avoids other policy instruments undermining EU ETS, so the cost per emission allowance becomes a real incentive to invest in climate-smart energy," Erik Filipsson says.