The EU emissions trading system – essential for the energy transition

The European Commission, Council and European Parliament agreed in November 2017 on a reform of the EU emissions trading system (ETS) for phase four (2021 - 2030). The German government succeeded in including its key objectives in the reform: price signals are to be strengthened in order to create incentives for climate-neutral technologies. Also, energy-intensive and emission-intensive industries are to continue to be protected against competition from other countries which do not have emissions trading systems. The ETS covers both industrial and energy-industry production processes.

Stronger price signals - cutting surpluses in emissions trading

The emission allowances price is an important indicator for the economy since it translates long-term European emission reduction targets into a price signal which companies can relate to, so that emissions can influence corporate decision-making. Recently, emissions trading has been the target of criticism due to the high surpluses of allowances and the resulting low prices on the allowances market. In 2016, there were around 1.7 billion allowances in circulation. The reform significantly boosts the price signals:

• The total volume of allowances available in a year in EU emissions trading (the “cap”) will be cut annually from 2021 by a linear reduction factor (LRF) of 2.2 percentage points, rather than the current rate of 1.74 percentage points.
• From 2019, 24% (rather than 12%, as originally intended) of the surpluses on the market are to be placed in the market stability reserve if the surpluses exceed a threshold of 833 million allowances.
• From 2023, the reserve will be restricted to a volume which corresponds to the amount auctioned in the EU’s ETS in the previous year. The quantity in the reserve exceeding this amount will be cancelled (probably more than 2 billion certificates) if the review scheduled to take place by then does not arrive at a different conclusion.

Further information can be found here (in german).

Strengthening the energy transition

The reform is of significance for the power plant sector. Since 2013, energy companies have needed to buy allowances for the emissions caused by their energy generation – only some of the allowances in the field of heat generation are allocated free of charge. Here, rising allowances prices will increase the economic pressure on carbon-intensive power plants, whose electricity will thus become more expensive in the medium term than lower-carbon power, e.g. from combined heat and power generation or gas-fired power plants.

The directive also permits the Member States to voluntarily cancel a certain quantity of allowances from their volumes up for auction if they take additional national measures to close down generation capacity. The intention here to ensure that the certificates no longer required in a Member State do not result in higher emissions in other Member States. The phrase used to describe this is the “waterbed effect”.

Also, it was decided in the reform that subsidies for coal-based projects should not generally be provided from the European “modernisation fund”. The modernisation fund aims to help eastern European Member States in particular with the modernisation of their energy systems.

Furthermore, the ETS is also very important for the national climate targets in the energy sector. Although the EU-wide instrument of emissions trading does not specifically aim to reduce emissions in individual sectors and countries (thus guaranteeing compliance with the national climate objectives), and does permit cross-border trading in emission rights, carbon pricing can create incentives for the reduction of emissions and thus help reach the national climate targets.

Carbon leakage and the competitiveness of energy-intensive industry

Whilst the Paris climate accord represents an important step towards the global coordination of efforts to mitigate climate change, it does not create a level global playing field for industry. This means that it remains necessary at European level to have rules to prevent a relocation of industrial production or upstream investment in plant and equipment into countries outside the EU which are not subject to emissions trading rules (i.e. to prevent “carbon leakage”.

Following the reform of emissions trading, European industry will continue to receive certificates free of charge under uniform EU allocation rules based on efficiency benchmarks in order to reduce the costs for the purchase of certificates to cover their in-house carbon emissions (direct carbon costs). Further to this, electricity-intensive companies in Germany receive electricity price compensation to compensate for the increased electricity costs caused by emissions trading (indirect carbon costs).

Further information can be found here (in german).