The UK government has today called for major reforms to improve the emissions ‘cap and trade’ system put in place by the European Union to tackle climate change.

The EU Emission Trading System (ETS) has since 2005 given companies from heavy industries and the power sector the flexibility to decide whether to invest in carbon abatement or to purchase emission allowances to comply.

But with a current surplus of more than two billion allowances, the UK’s Department of Energy and Climate Change (DECC) has said that the system “is not stimulating the low-carbon investment needed now to meet long-term targets”.

In a statement it said: “Various factors, such as the economic downturn and an insufficiently ambitious target for 2020, have resulted in a lower than expected demand for allowances, and therefore a weak price signal for low-carbon investment.”

In a policy paper published today called UK Vision for Phase IV of the EU ETS, DECC has set out a series of reforms which it said are needed “to strengthen the ETS so that it helps businesses to deliver future emissions reductions cost-effectively, fosters investment in innovative low-carbon technologies, and protects the competitiveness of UK industries in the transition to a global low-carbon economy”.

There are three key reforms in the paper:

Cancellation of surplus allowances before 2020. DECC said this will “help restore the balance between supply and demand, and put the system back on track once and for all”.

“If not tackled, the surplus will continue to depress the carbon price, delaying the low-carbon investment that is needed now to meet our emissions reduction targets cost-effectively. The UK government is considering the potential of the Market Stability Reserve to address this problem, a mechanism proposed by the European Commission in January.

Revision of free allowances provisions. DECC stated that while the system of free emission allowances, which are designed for certain businesses to stay competitive during the transition to a low-carbon economy, “must continue to protect those who need support most to adjust over the long term”, it added that “as the amount of free allowances available within the cap continues to fall after 2020, allocation must be based on robust evidence and target the sectors that are genuinely at risk of losing competitiveness”.

Cutting unnecessary red tape to strike a better balance between fairness, cost-efficiency and simplicity. As an example, DECC said that compliance and administrative costs “could be reduced by ensuring that small sources of emissions are treated proportionately”.

UK Energy Secretary Ed Davey said: “The UK is asking for bold and comprehensive reforms to restore the ability of the EU’s Emission Trading System to drive cost-effective emission reduction and low carbon investment.

“A glut of emission allowances on the carbon market has thrown the system off course. This is delaying the low-carbon investment that countries need now to meet long term targets, and thwarting the economic growth that these investments will bring.”