European Parliament adopts draft reform of carbon market

The European Parliament on Wednesday (15 February) adopted draft reforms of the EU's carbon market post-2020 that aim to balance greater cuts in greenhouse gases with protection for energy-intensive industries.

The European Union’s Emission Trading System (ETS), a cap-and-trade permit system to regulate industry pollution, has suffered from excess supply since the financial crisis, depressing its prices and heightening the need for reform.

But politicians and EU nations are divided over how best to fix the complex system, with industry and environment groups lobbying hard on opposing sides.

Reform efforts have also been overshadowed by Britain’s decision to quit the bloc, raising fears it would also leave the EU’s scheme, hammering prices.

The draft, adopted by 379-263 votes, rejected a more environmentally ambitious proposal for the faster removal of surplus carbon permits from the ETS – sparking criticism from climate campaigners.

Instead, it sticks with the EU executive’s proposal for the cap on emissions to fall by 2.2% per year – the so-called linear reduction factor – until at least 2024.

The Climate Action Network said it “betrayed the spirit” of the Paris accord to slow global warming, while Dutch green lawmaker Bas Eickhout said provisions to protect industry showed “the lobbyists have won out in the end.”

The Paris Agreement caps global warming at no more than two degrees above industrial levels.

But leading policymakers called it the best compromise possible in tough talks. EU lawmakers will now enter negotiations with representatives of the bloc’s 28 governments to hammer out the final legislation.

“I am delighted that the European Parliament has endorsed these reforms.  This agreement puts us on course to achieving our Paris Agreement obligations and sends a strong signal to the European Council that we are serious about tackling climate change,” said Ian Duncan, a UK Conservative and lead MEP on the bill.

The benchmark European carbon contract fell by about 2% following the vote, hovering around €5 a tonne, but Thomson Reuters carbon analysts said the market reaction would be short-lived.

“The Parliament position significantly tightens the market balance,” said Hege Fjellheim, an analyst at Thomson Reuters.

Carbon leakage

The cap-and-trade system is the EU’s key tool to meet its goal of a 43% cut in greenhouse gases from industries and power plants covered by the market compared with 2005.

It aims to send a policy signal to encourage their investment in renewables and low-carbon electricity production.

In a bid to shore up prices, the Parliament’s proposal doubles the rate at which the scheme’s Market Stability Reserve (MSR) soaks up excess allowances to 24% per year from 2019. It also cancels 800 million carbon allowances from the MSR in 2021.

To minimise the risk of industry moving abroad to escape climate regulation, the draft allows for the share of allowances auctioned to be reduced by up to 5% to cushion against the impact of a cap on overall allocations, known as the cross-sectoral correction factor.

The cement industry, which some lawmakers had pushed to exclude from free allowances, will remain on the list of installations receiving handouts.

The deal drew mixed reactions from other industries. The steel, metal and chemical sectors welcomed the step towards adopting the long-awaited reforms but said they hoped for more safeguards for their competitiveness in continuing talks.

The shipping industry protested its inclusion under the scheme from 2023 in the draft proposal, which also calls for reforms to tighten emission controls on aviation, including reducing the emissions cap and the number of free allowances.

However, lawmakers leading the reform have said the two provisions are likely to be traded away in upcoming negotiations with member states.

Bill Hemmings, aviation and shipping policy director at Transport & Environment, said, “This crossparty proposal will end the anomaly of shipping being the only sector in Europe not contributing to the EU’s 2030 emissions reduction target.

“EU governments must follow Parliament’s lead and agree that ship CO2 emissions must go in the EU ETS if the International Maritime Organisation (IMO) does not act.”

But the European Community Shipowners Associations said that global rules brokered by the IMO would be a better option.

EU ETS: A background

The EU’s Emissions Trading System is the world’s biggest scheme for trading emissions allowances. Regulated businesses measure and report their carbon emissions, handing in one allowance for each tonne they release. Companies can trade allowances as an incentive for them to reduce their emissions. Countries can also sell permits to the market.

The European Commission has proposed a series of reforms to the ETS.

Pollution credits were grossly over allocated by several countries during the 2005 initial implementation phase of the ETS, forcing down carbon prices and undermining the scheme’s credibility, which prompted the EU to toughen up the system. Carbon prices have since remained stubbornly low at under €8 a tonne.

The proposed reform proposes tightening the screw on heavy polluters by restricting the amount of pollution credits available in the period 2021-2030.

Under the Commission proposal, 57% of allocations will be auctioned by member states, the same as in the current trading period (2013-2020). They are estimated to be worth €225 billion. 43% (6.3 billion allowances) will go to industry in free allocations, worth an estimated €160 billion. Those will be divided out, with the most efficient companies being prioritised. So the best performing companies will still get the benefit of free allowances.

177 sectors currently qualify for free permits. About 100 will drop off the list for 2021-2030. They are likely to be those that qualified because of their trade intensity rather than their emissions intensity.

The list will stay the same for ten years, rather than the five years of the previous trading period. This will make it more stable and give greater investor certainty. The new system will take into account production increases and decreases more effectively, and adjust the amount of free allowances accordingly. A number will be set aside for new and growing installations.

James Crisp,

This article first appeared on EurActiv, an edie content partner

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