Detailed guide: EU Emissions Trading System – the future of the System

By HM Government

The UK believes the EU ETS, the world’s largest cap and trade system, should remain the cornerstone of EU energy and climate change policy. The centrality of the EU ETS in delivering the objectives of the 2030 framework was highlighted by the European Council in March 2014.

The UK’s vision for the future of the EU ETS:

The UK’s vision for the future of the EU ETS is is for a system that

  • Delivers EU emissions reductions consistent with meeting the long-term EU objective of reducing greenhouse gas emissions by 80%-95% by 2050 at least cost, including a 2030 emissions reduction target of 40% moving to 50% in the event of an ambitious global deal, including by driving investment in the low carbon economy.
  • Is designed in such a way that energy-intensive industries remain competitive during the transition to a global low-carbon economy, adequately protecting them from the risk of carbon leakage so that they can adjust over the longer term.
  • Demonstrates global leadership through delivery of an effective and economically efficient emissions trading scheme, ready to link with all suitable ETSs as the foundation of a global carbon market.

The EU ETS market currently has a surplus of around 2 billion allowances (equivalent to a year’s worth of allowances under the EU ETS cap) which, if not tackled, is expected to depress the signal for low-carbon investment for at least a decade, and is likely to increase the overall costs of meeting our future emissions reduction targets. Commission analysis shows that even with a tightened cap in Phase IV to deliver a 40% GHG target in 2030, the surplus will reduce slowly and will remain at over 2bn allowances in 2030. Any further access to project credits within the cap will prolong the surplus.

The surplus is the result of a combination of factors, which include:

  • An unanticipated shock – the economic recession;
  • A weak 2020 target out of line with a least cost pathway to achieve 2050 emissions reduction goals; and
  • Access to project credits within the EU ETS cap.

In order to achieve the UK’s vision for the EU ETS, strengthening and reform of the System required. Currently, there are two EU ETS reform tracks:

  • Market stability reserve (MSR): urgent reform to address the 2 billion surplus of allowances in the system, strengthen the investment signal and to improve the resilience of the EU ETS ; and
  • EU ETS Phase IV: wider post-2020 reform of the EU ETS including ensuring carbon leakage provisions are extended post-2020 and are focused on those sectors which evidence demonstrates are at most risk of carbon leakage, to ensure that they receive the support they require.

DECC has been keen to involve a wide range of interested parties to inform the focus of our future work in this area – see engagement and evidence section below.

Market Stability Reserve

The UK supports implementation of a strengthened Market Stability Reserve (MSR).

The proposal

In January 2014 the European Commission published a legislative proposal to introduce an MSR.

The proposed MSR would start in 2021, the beginning of Phase IV of the EU ETS. The mechanism would establish a set of rules for adjusting the volume of auctioned allowances (the rules would not impact on levels of free allocation to industry), with the aim of making supply responsive to changing circumstances, as in ordinary markets. When the available number of allowances in the market was above an upper threshold of 833million, allowances would be removed from the market and placed in to a reserve; if the number of allowances was below a lower threshold of 400 million or if there was a strong increase in prices, then allowances would be returned from the reserve to the market. An additional provision would partially smooth the peak in supply of allowances (primarily from the return of backloaded allowances) in 2019-20.

Further details on the Commission’s proposal can be found on the European Commission’s website.

UK’s position on the MSR

The UK supports an MSR that is strengthened and introduced earlier so it can fully tackle the damaging surplus, provide a credible, stable low carbon investment signal and ensure Europe can meet its GHG emissions reduction obligations more cost effectively.

By allowing supply to adapt to changing circumstances, as it does in ordinary markets, a rules-based MSR reduces the risk of future ad-hoc interventions and minimises uncertainty for operators.

The UK supports the introduction of a strengthened Market Stability Reserve (MSR) and calls for:

  • implementation by 2017, to urgently address the surplus;
  • backloaded allowances to be cancelled and/or enhancement of the proposed mechanism to smooth auction volumes so that backloaded allowances are placed into the reserve. This will ensure sensible, stable development of auction volumes between phases; and
  • amendments to ensure allowances are retained in the reserve under ‘business as usual circumstances’, so they remain available to provide protection against insufficient liquidity and prices rising too quickly should these occur in the future.

Further information on the UK Government’s view is set out in our policy paper

Please contact the DECC EU ETS team at eu.ets@decc.gsi.gov.uk if you would like to comment on the UK’s position on the MSR or contribute your views to further policy development on more detailed elements of the MSR.

UK Vision for EU ETS Phase 4 (from 2021)

On 16 July 2014 the Government published the UK’s Vision for Phase IV of the EU ETS in a blueprint which sets out the basis for the UK’s continued support for the EU ETS and outlines the priority areas for future reform: tackling the surplus of allowances, protecting sectors at risk of competitive disadvantage and improving efficiency while cutting unnecessary red tape.

Please contact the DECC EU ETS team if you would like to contribute your comments and ideas about the future of the EU ETS at eu.ets@decc.gsi.gov.uk

Engagement and evidence gathering

To expand our evidence base on how the EU ETS should be reformed, DECC has hosted two informal stakeholder meetings on the future of the EU ETS. These events brought together interested parties from a variety of sectors to discuss and explore possible options for reform of the EU ETS. Details of each of the events are available below.

The first meeting was held in April 2013 and discussed the broad direction for the future of the EU ETS. The report is published on the GOV.UK website.

The second event in January 2014 also adressed the overall picture but then had a particular focus on the MSR:

To fill an evidence gap in this area and to inform the Government’s position on structural reform in the EU ETS, DECC commissioned a research project on approaches to cap-setting and the importance of price certainty in the EU ETS.

The report was produced by Ecofys UK Ltd. and Oxford Energy Associates and peer reviewed by: Dr. Herman Vollebergh (Erasmus University, Rotterdam)

Source:: Detailed guide: EU Emissions Trading System – the future of the System