Structural reform of the European carbon market
The European Commission is taking action to address the surplus of emission allowances that has built up in the EU emissions trading system (EU ETS), largely as a result of the economic crisis.
Since 2009 the EU ETS has experienced a growing surplus of allowances and international credits compared to emissions which has significantly weakened the carbon price signal.
Surplus of almost 2 billion allowances
At the start of phase 3 in 2013 the surplus stood at almost two billion allowances, double its level in early 2012. This increase was due to several factors: record use of international credits, auctioning of phase 2 allowances and remaining allowances in the new entrant reserve, early auctioning of phase 3 allowances, and sales of phase 3 allowances to generate funds for the NER300 programme.
Without action, structural surplus will persist for most of phase 3
While the rapid build-up is expected to end from 2014, it is not anticipated that the overall surplus will decline significantly during phase 3. Potentially there will be a structural surplus in most of phase 3 of around 2 billion allowances. This risks undermining the orderly function of the carbon market. Moreover, if these imbalances are not addressed they will profoundly affect the ability of the EU ETS to meet more demanding emission reduction targets in future phases in a cost-effective manner.
The Commission is taking action on two fronts.
‘Back-loading’ of auctions in phase 3
As a short-term measure, the Commission is postponing the auctioning of 900 million allowances until 2019-2020 to allow demand to pick up. This ‘back-loading’ of auctions is being implemented through an amendment to the EU ETS Auctioning Regulation.
Back-loading does not reduce the overall number of allowances to be auctioned during phase 3, only the distribution of auctions over the period. In 2014 the auction volume will be reduced by 400 million allowances, in 2015 by 300 million, and in 2016 by 200 million.
The proportionate impact assessment demonstrates that back-loading can rebalance supply and demand in the short term and reduce price volatility without any significant impacts on competitiveness. It can also strengthen government revenues early in phase 3.
The amendment was adopted by the Commission following approval by the EU Climate Change Committee and scrutiny by the European Parliament and Council.
The Parliament and Council had cleared the way for adoption of the amendment by approving, in December 2013, an amendment to the ETS Directive which clarifies that the timing of auctions may be changed to ensure the orderly functioning of the carbon market.
Proposal for market stability reserve
As back-loading is only a temporary measure, a sustainable solution to the imbalance between supply and demand requires structural changes to the EU ETS. The Commission proposes to establish a market stability reserve at the beginning of the next trading period in 2021.
The reserve would both address the surplus of emission allowances that has built up and improve the system's resilience to major shocks by automatically adjusting the supply of allowances to be auctioned. It would operate entirely according to pre-defined rules which would leave no discretion to the Commission or Member States in its implementation.
The legislative proposal , put forward in January 2014 at the same time as the framework for climate and energy policies up to 2030, requires approval by the Council and the European Parliament to become law.
Efforts to address the market imbalance would also be helped by an increase in the annual linear reduction factor which determines the EU ETS cap. To achieve the target of a 40% reduction in EU greenhouse gas emissions below 1990 leveIs by 2030, set out in its 2030 framework for climate and energy policy, the Commission proposes an increase in the linear reduction factor to 2.2% per year from 2021, compared with 1.74% currently.
Debate and public consultation on structural measures
The debate on structural measures was launched by the first report on the state of the European carbon market , published in November 2012, in which the Commission identified six options for correcting the surplus.
A formal stakeholder consultation ran from December 2012 until the end of February 2013; see all contributions. The Commission organised two consultation meetings, in March and April 2013, which each focused on three of the options identified. The second consultation meeting also looked at possible additional options supported by several stakeholders in the online consultation, including the stability reserve to render auction supply more flexible. In October 2013 DG CLIMA hosted a panel of experts to discuss technical aspects related to the creation of a stability reserve.