CEPS policy paper March 21, 2016 Andrei Marcu & Milan Elkerbout - PowerPoint PPT Presentation

EU ETS Phase 4 revision: CEPS policy paper March 21, 2016 Andrei Marcu & Milan Elkerbout 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 1

Background • Phase 4 revision as the capping stone of a long reform process • Backloading; Market Stability Reserve  addressing price? • Phase 4 revision  addressing cost? • Next step: MSR review in 2022? • Needs to confirm (or re-establish?) EU ETS as the central pillar of EU climate policy • Be the main driver of GHG emission reductions • Ensure cost-efficiency both in short and long run • Support innovation that is necessary to reach long-term goals 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 2

Background The current revision talks take place in a different environment compared to when the EC proposal was released in July 2015 • Paris Agreement adopted • Higher long-term ambition than the pathways which led to the 2030 Framework • 5-yr review cycles – which will lead to updated commitments over time both for the EU and for other countries • High volatility in EU carbon market • Multi-year ascend in the run-up to Paris came to abrupt end in early 2016, with EUA prices dropping below 5 EUR; back to 2013 levels • In April: ETS emission data for 2015 to be released; some indication that ETS emission may have increased YoY 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 3

Impact of the Paris Agreement The Paris Agreement formulates a new long-term goal: “ Holding the increase in the global average temperature to well below 2 °C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5 ° C” [Art 2(1a)] • “Well below 2C” and “Pursue efforts [for] 1.5C” are new elements that go beyond the long term goals on which the 2050 Roadmap, 2030 Framework Communication as well as the 2014 EUCO Conclusions and the EC’s ETS proposal are predicated. • Overall EU ambition set by EUCO – MS in the Council have divergent views on what needs to happen with the EU’s ‘at least - 40%’ goal by 2030 • EUCO requires unanimity • EU ETS revision requires co-decision and QMV  changes to LRF? 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 4

Impact of the Paris Agreement Other key elements of the Paris Agreement • “[…] achieve a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases in the second half of this century” [Art 4(1)]  Implies that attention to carbon sinks will be required • Art 6 of P.A. – Sustainable Development Mechanism • Introduces an option for international carbon markets • EU 2030 ambition currently wholly domestic • International credits could make increased ambition more attractive 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 5

When is the EU ETS ‘fit for purpose’? 1. Provide a LRF that would re-assure stakeholders that the EU ETS is providing all the necessary contribution to reach its decarbonisation goal for 2050 2. Revisit the provisions for addressing the risk of carbon leakage in light of decreasing overall allocation – make sure that there is enough free allocation for those that truly need it, by identifying those that need less, or are not truly at risk. 3. Ensure flexibility on the supply for free allocation 4. Provide additional tools to complement the EU ETS, as needed. This is especially true to make the whole EU ETS complex forward looking. In this respect special care and attention should be given to provisions that would encourage and catalyse innovation. 5. Does it provide an effective and credible contribution to the implementation of the EU’s new obligations and commitments under the Paris Agreement? 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 6

Linear Reduction Factor • The LRF will drive the ambition of the EU ETS – the proposed value of 2.2 would lower the cap annually by 48 million allowances (up from 38 million under the current LRF) • Having a LRF based on a fixed quantity by which the cap is lowered every year indeed leads to a constant, gradual decrease in allowances available, but it also implies that the effort required will increase relatively speaking as time moves on • A LRF of 2.2 is not consistent with the EU’s long -term ambition • 2.2 LRF does not lead to the 90% emission reductions (compared to 2005) in ETS sectors by 2050 that is consistent with a pathway to -80% by 2050 [as noted in the ETS proposal I.A.] • 2.2 LRF scenario presumed lower targets for RE/EE when it was analysed for the 2030 Framework • This is notwithstanding the outcome of Paris 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 7

Linear Reduction Factor Governance of the LRF • Currently the LRF value is explicitly included in an Article in the main ETS Directive • 2.2 LRF directly taken from EUCO Conclusions • Any value of the LRF should take into account the targets for RE and EE • Overlapping policies: extra reductions triggered by more RE or EE would be undone if the cap is not adjusted commensurately • Is it optimal to require co-decision to make changes to the LRF, or should there be some kind of delegated act procedure applicable? • Paris Agreement review cycles create the possibility that there will be pressure to increase ambition mid-trading period. • Given how a LRF increases the relative required effort over time, it may be considered not to wait until after 2030 to increase it as by then, as the current EUA surplus may serve as a ‘cushion’ which may not exist in the future 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 8

Market balance (Mt) under different LRF scenarios 2000 1800 Carbon market balance (Mt) 1600 1400 1200 1000 800 600 400 200 Source: Thomson Reuters 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Linear reduction factor (LRF) 2.2% LRF 2.5% LRF 2.75%

Nominal EUA prices ( € /t) under different LRF scenarios 35 30 25 EUA price ( € /t) 20 15 10 5 Source: Thomson Reuters 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Linear reduction factor (LRF) 2.2% LRF 2.5%

Auctioning Share The EC’s proposal states: “From 2021 onwards, the share of allowances to be auctioned by Member States shall be 57% ” The EUCO Conclusions state: “…without reducing the share of allowances to be auctioned ” • How much for free allocation? • Funds still need to be subtracted (NER, Innovation Fund) • What happens to ‘unused’ allowances if free allocation quantities are lower than expected? • Wording “shall be at least 57%” could have been considered • Alternatively: fixing free allocation share at X%, while allowing carry-over of such earmarked allowances to subsequent trading periods 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 11

Free allocation The quantity of free allowances an installation will receive from one year to the next depends on 3 elements: • Benchmark provisions • Carbon leakage criteria • Production/activity level rules • These elements interact with each other, and will need to be considered in unison: significant changes to one set of provisions may relieve the need to 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 12

Free allocation: benchmarks • Flat-rate reductions imply that all sectors will receive fewer free allowances due to the benchmark updates • Standard annual flat-rate of 1%, but 0.5% or 1.5% also possible • Some sectoral differentiation • Minimum of 10% • Maximum of 30% • Annual flat-rate reduction also have as a consequence that it reduces the impact of a potential Cross-sectoral Correction Factor (CSCF) as the BM-reductions simply achieve a similar effect • Using flat-rates instead of updating all benchmarks clearly prioritizes administrative simplicity over accuracy • Fallback approaches to benchmarks should be avoided as much as possible  more product benchmarks • Investment and technology cycles may differ considerably across sectors; the proposed system only allows for limited differentiation to account for this 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 13

Free allocation: carbon leakage criteria • New combined criteria of trade intensity and emission intensity • Cuts down on # of sectors (about 50) • Does not cut down substantially share of emissions covered • Criteria used are proxies for carbon leakage risk but not perfect • Ignores pass-through rates 3/21/2016 Centre for European Policy Studies (CEPS) • Place du Congrès 1, 1000 Brussels, Belgium www.ceps.eu 14