November 14, 2017
BRUSSELS INSIDER #1 by Clare Taylor
It’s definitive now: the ETS won’t do it (alone)
November 14, 2017
On 9 November, an initial final agreement between the European Parliament, European Council and European Commission was reached on the reform of the EU Emissions Trading System (ETS), inaugurating a fourth phase of emissions trading that extends the scheme to 2030. Climate campaigners are disappointed. They have lost their faith in the ETS as “flagship” climate policy instrument. “The bottom line is that the ETS alone will fail to decarbonize.”
The ETS puts a cap on the carbon dioxide (CO2) emitted by more than 11,000 installations in the power sector and energy intensive industry, covering 40% of EU greenhouse gas emissions, through a market-based cap-and-trade system. It is the first major EU climate law to be updated and agreed for the period after 2020, as part of the 2030 climate and energy package, and Europe’s implementation of the Paris Agreement.
In theory, a cap-and-trade system works by setting a total limit on emissions (the ‘cap’) that declines each year in order to reach the agreed [Paris] climate goals. Emission permits equaling the cap are auctioned each year to the installations that are covered by the system, and revenues are recycled back into further climate action to create a virtuous cycle.
That’s the theory. But in practice, many observers believe that Europe’s ETS isn’t working. Femke de Jong, EU policy director at not-for profit environmental organisation Carbon Market Watch, explains: “There are three main reasons why the EU ETS has not worked so far. Firstly, the cap is set above actual emissions, secondly, the annual reduction of the cap is not fast enough to reach the agreed Paris climate goals, and thirdly, allowances are not auctioned but given away for free, to around half of the total installations.”
According to Sam Van den plas, senior policy officer at World Wildlife Fund (WWF): “The ETS framework has a lot of the elements – including annual compliance checks, monitoring, reporting, verification, fines for non-compliance – needed for sound environmental policy. What is regrettable is the way in which the parameters are set; it doesn’t put Europe on track to reduce emissions to meet the targets set out in the Paris agreement.”
Key elements of the latest ETS reform relate to the speed of required emissions reductions, the number of free pollution permits given to industry installations and to energy producers, and the use of revenues from auctioned permits. “Some of these parameters stand out as deeply problematic,” says Van den plas.
Firstly, policymakers adopted a revised Linear Reduction Factor (LRF), which lowers the cap by decreasing the number of allowances issued, of 2.2% per year. This represents low ambition: even Europe’s electricity producers’ industry association Eurelectric, which would like to see the ETS as the only EU climate policy, advocates for a 2.4% LRF, saying that this is necessary to “place the European economy on a cost-effective pathway towards accelerating its decarbonisation up to 2050.”
De Jong agrees: “The EU ETS emission reduction trajectory is currently not in line with the low-end of the EU’s 2050 objective, let alone with the Paris climate goals. It needs to be updated to reflect the Paris ambition.” She sees the next opportunity for reform “following the 2018 UNFCCC Facilitative Dialogue, where Parties will take stock of the progress made so far towards meeting the Paris climate goals, and possibly increase their climate contributions to close the emissions gap.”
In a further move to tackle what Eurelectric refers to as “the toxic oversupply of allowances”, policymakers agreed to annually cancel excess emission allowances from 2023 onwards, which could lead to a cancellation of up to three billion allowances by 2030.
However, again the reforms do not go far enough: according to Carbon Market Watch figures, this cancellation of allowances will raise the carbon price to around €20/tonne in 2020, and around €30/tonne in 2030. According to Carbon Market Watch and other analysts, carbon prices would have to be at least €40/tonne rising to €100 / tonne by 2030 to have the desired effect of triggering clean investment flows.
Nonetheless, there are signs of progress in carbon pricing at national level: following the precedent set by the UK, the Dutch government has announced a rising carbon floor price for its electricity sector, reaching €43 by 2030. Portugal will implement a new tax on coal fired electricity generation and French President Macron has also called for a ‘significant minimum carbon price’ to boost investments in the energy transition. However, at the European level, the EU ETS reforms mean that “for at least five years, there will be a massive overhang in allowances – and the low carbon price will be a reality for years to come,” says Van den plas.
Furthermore, the reforms fail to tackle the most serious reputational issue affecting the ETS: free allowances allocated to energy intensive industrial sectors, and a derogation known as article 10c under which free emission permits can be given to energy producers in lower income member states.
Under the current reform, energy intensive industrial sectors will continue to receive free allowances – about 6.5 billion ETS emissions permits up to 2030. In turn, this reduces EU Member States’ ETS auctioning revenues by more than €160 billion. De Jong comments: “Heavy industry will continue to receive free permits to pollute, rather than having to pay for its pollution. The amount of pollution subsidies in the form of free allowances is over ten times higher than the amount spent under the EU ETS on low-carbon innovation.”
Policymakers also failed to adopt robust rules on a provision known as Article 10c, which allows ten lower income countries to allocate free emission permits to electricity generators until 2019, under the condition that they invest at least the equivalent monetary value of the free allowances in the modernisation and diversification of their energy systems and which will be extended until 2030. According to Carbon Market Watch, this provision has been misused, “with 86% of free allowances issued to lignite and hard coal plants representing coal subsidies of up to €12 billion by 2020.”
No silver bullet
With all of this, many find it difficult to understand how the ETS qualifies as “the flagship policy mechanism to achieve the EU’s emission reductions from around half the economy,” as stated in EU legislation – and how it will successfully decarbonize Europe’s power sector and energy intensive industries.
For campaigners, the focus has shifted to other policy instruments. “Our first and foremost priority is the rest of the energy and climate package – especially, the Renewable Energy Directive, the Energy Performance of Buildings Directive, the Energy Efficiency Directive. We have to get serious about the targets here, because the ETS will not be the silver bullet,” says Van den plas.
Echoing this, De Jong says: “carbon pricing will never be the silver bullet to tackle climate change, it is rather one solution in a broader climate toolbox, and requires companion policies, such as feed-in tariffs and efficiency measures, to overcome market failures and be truly effective.”
This is bad news for energy companies, which have long lobbied in Brussels to get the ETS accepted as the single climate policy instrument. This looks very unlikely now.
“It would be most dangerous to treat the ETS as a silver bullet,” says Tomas Wyns, a researcher at the University of Brussels Institute for European Studies, in an interview with Energy Post. Wyns’ European and international climate policy research focuses on the design of the EU ETS, and post 2020 industrial and innovation policy.
“The bottom line is that the ETS alone will fail to decarbonize – because of the low carbon price, but also because of the significant risk for industry,” says Wyns. Pointing to the modest reductions in industrial emissions in recent years, according to Wyns, much more radical policy action is needed for further reductions.
“For deep decarbonization, we need to redesign processes, products and business models – but these come with huge business risk,” he says.
To take one example, the chemical industry has already halved its energy intensity and greenhouse gas emissions since 1990, but producing chemicals remains one of the most energy intensive industrial processes. A report published by CEFIC (the European Chemical Industry Council) in July explores how the chemical industry can become carbon neutral by 2050, and finds that “many promising low-carbon technologies are available at a relatively advanced stage of development”, but “investment, raw material and energy challenges” must be overcome for large scale implementation in Europe.
“EU ETS needs to be embedded inside a [low carbon] mission-oriented EU industrial policy”, says Wyns, alongside a suite of policy instruments to promote circular economy and resource efficiency, supported by investment into research and development.
At least some billions of investment will come from the new ETS Innovation Fund, financed via 450 million emission allowances, and which will be in business by 2021, “to support innovative demonstration projects in renewable energy, carbon capture and storage, and low-carbon innovation in energy-intensive industries.”
Hopefully this will help address some of the shortfalls of the EU ETS ambitions to date. “The steel and chemical industries don’t yet have a decarbonization plan. They are seeking to claim allowances and focusing on short term economic issues, instead of the long-term abatement options. Technically, there is an awful lot of work to be done to make the currently dysfunctional ETS a cornerstone of climate policy,” says Van den Plas.
Industry and power producers welcome ETS reform
Business and power producers greeted the EU ETS reform positively. The International Emissions Trading Association (IETA), a non-profit organization serving business involved in carbon markets, welcomed the reform. “Today’s agreement is a welcome boost to market fundamentals and adds momentum to the UN climate negotiations which are underway in Bonn,” said IETA’s CEO and President Dirk Forrister in a press release. “It sends a strong signal that the EU is serious about its leadership role in the international climate policy arena and in helping make the Paris Agreement a success.”
European electricity producers industry association Eurelectric also welcomed the EU ETS reform: according to a press release. “Investors across Europe have received the much needed legal clarity that will enable them to take better informed decisions on low-carbon investments,” said Eurelectric Secretary General, Kristian Ruby. “The deal sends a timely message of EU climate leadership that coincides with the ongoing COP23 climate conference in Bonn. It also restores confidence in the long-term functioning of the EU ETS,” he added.