In 2021, the EU's emissions trading system, EU ETS, will enter a new phase. A review of the EU ETS directive for this fourth trading period, which will run until 2030, is currently being negotiated. The aim is that the new directive will be adopted by the first quarter of 2017.
Although the emissions trading system is intended to be the cornerstone of the EU's climate policy and that it is crucial if Europe's CO2 emissions are to be cost-effectively reduced in line with the long-term targets, the system is not working properly. This is mainly due to the surplus of allowances which has upset the balance within the system and lead to a sustained weak CO2 price signal.
In December 2015, a global climate agreement was signed at the COP21 summit in Paris with the overall objective of limiting global warming to well below 2°C and pursuing efforts to limit it to 1.5°C.
"We believe that now that the ETS directive is up for review, we should take into consideration what was agreed in the Paris Agreement and adapt the EU climate policy accordingly as soon as possible. The changes which the European Parliament is currently proposing in the form of amendments to the EU Commission's legislative proposal from last summer are still based on the ambition level that the EU agreed in 2014, which is to reduce the GHG emissions by 40% until 2030. We believe that with the Paris Agreement in place, this target is somewhat outdated and that we should aim higher with the EU ETS. This is motivated also in the light of the EU's existing decarbonisation target for 2050, although it will probably take a few years until the EU has formally adopted a new, higher 2030 target reflecting the Paris ambition," says Erik Filipsson.
The number of allowances supplied in the EU ETS is reduced annually at a rate which is determined by a linear reduction factor specified in the directive.
The current rate in the directive reduces the number of allowances by 1.74% per year. The EU Commission has proposed that the rate should be increased to 2.2% from 2021.
Erik Filipsson explains that Vattenfall is proposing a linear reduction factor of at least 2.6%.
"This is based on, among other things, the fact that we have an EU-wide decarbonisation target for reducing the greenhouse gas emissions by 80-95% until 2050. To better reflect the recently adopted global climate ambitions, we believe that the EU should at least position itself at the higher end of its current climate target for 2050 when it sets the target for the EU ETS policy. This would require a linear reduction factor of 2.6%."
"Looking ahead, the CO2 reduction path in the EU ETS must probably be even steeper than that. In a few years’ time, the EU will have to adopt a new climate target for 2030 which is in line with the global 1.5°C target and, as a result, the linear reduction factor will have to be further increased also beyond 3%. There are some parties in the debate, amongst others NGOs, who maintain that it should be set a 4.2%. One thing we can say for sure is that the EU Commission's proposal is inadequate," says Erik Filipsson.
According to Filipsson, one of the positive developments in the EU negotiations so far is that there appears to be a growing recognition of the negative impacts which overlapping national policies have on the EU ETS. This is evident, for example, in the European Parliament's draft position, which the rapporteur Ian Duncan presented in May.
"The more the system has been questioned, the more the EU member states have started to introduce national policies which are directed at exactly the same emissions which are already regulated by the EU ETS directive. We believe that the impact which these interventions have on the operation and efficiency of the EU ETS policy must be properly quantified and accounted for."
The impact of these overlapping policies is often that certain countries, mainly in Western Europe, reduce their CO2 emissions locally, but in terms of the EU and the system as a whole, the main effect is that they give rise to an even greater surplus of allowances in the system and further weakens the international CO2 price signal. Thereby it may also lead to higher CO2 emissions in other countries and sectors under the pre-defined EU ETS allowance cap.
"In order to mitigate these problems, the European Parliament's rapporteur has proposed that the member states should be required to report every second year what impacts their measures have and then the number of allowances which are auctioned by member states can be adjusted and instead introduced into the Market Stability Reserve (MSR) that will be established in 2019. On this particular aspect, the rapporteur is to a large extent in line with our way of thinking," says Erik Filipsson, who also adds that much negotiations remain before a solution to the problem is agreed.
"Totally at odds"
Filipsson explains that there are other aspects of the EU Commission's legislative proposal which Vattenfall finds problematic. These include the proposal that 250 million allowances should be taken out of the Market Stability Reserve (MSR) when a reserve is created for new entrants prior to Phase IV.
"It's normal to set aside a special reserve for new installations which are expected to come online during the trading period, primarily in the industry sectors. But the usual and most logical approach would be to take these allowances from the emissions cap which is decided for the period 2021-2030 rather than depleting the new MSR. We believe that taking 250 million allowances out of the MSR, instead of taking them from the Phase IV allowance cap, is totally at odds with the rationale behind the introduction of an MSR and the general strive to achieve a healthier market balance in the EU ETS."
“Strengthening must be a priority”
Two of the most commonly debated issues within the EU ETS negotiations are the protection of industries which are regarded as being exposed to the risk of carbon leakage, and the setting up of new EU funds aimed at supporting, for example, new innovative technologies in renewable energy, CCS and certain industrial processes.
"We clearly support the idea behind the Innovation Fund, but in order to generate the revenues you have to sell the 400 million carbon allowances which have been set aside for this purpose. If they are suddenly sold en masse or far too early, this could counteract many of the other things that we are striving for. Therefore, we have put forward a joint proposal, in conjunction with Statkraft and Fortum, whereby they shouldn't be sold until 2023 at earliest. This would avoid undermining the purpose of the MSR and make sure that allowances are not taken away with one hand and given back with the other at the same time. Also, there is reason to believe that a later sale of these allowances would generate more revenues, to be used for supporting climate projects across the EU,", says Filipsson.
"In our view, the reforms elaborated by the EU commission and the European Parliament so far are not sufficient to rectify the problems which the EU ETS is grappling with at present. More focus must be put on the long-term ambition level and further measures to address the surplus of allowances in the system. If we don't manage to strengthen the CO2 price, there won't be any significant need for a comprehensive carbon leakage regime anyway, nor will there be as many resources in the EU-wide funds as they are fully dependent on what the auctioning of allowances bring in."