Is the EU ETS now obsolete


In the wake of the European Parliament’s ‘no’ vote to backloading of allowances, we ask international players in the power sector if the European Union Emissions Trading Scheme (EU ETS) is now redundant as a tool to cut emissions and encourage low-carbon technologies?

Matti Rautkivi, General Manager, Wartsila Power Plants

Has the EU ETS really driven decarbonisation of the energy sector within the EU? No, it hasn’t. Low-carbon technologies – wind, solar and the latest nuclear plants – require additional support schemes, such as feed-in-tariffs.

Secondly, over generous free allocations, combined with the economic recession in Europe, has led to an oversupply of allowances. This has caused prices to drop to levels below 5 EUR/t, at which point it makes sense to run even old coal plants having very high CO2 emissions.

In 2012, electricity generated by coal increased all across Europe, while gas gen’ation faced negative spark spreads. Simultaneously, we are building more and more intermittent renewable generation capacity, which requires flexible generation to balance the inherent variability of renewables. In the current situation, this flexibility is provided by old part loaded coal plants, instead of flexible gas generation, which would be the perfect match with intermittent renewable generation. Politicians have realized this awkward situation, whereby decarbonisation activities actually increase CO2 emissions, at least temporarily. To change this perverse situation with the help of the EU ETS, the carbon allowance price should be around 30 EUR/t.

On April 16, the European Parliament rejected the Backloading proposal by 334 to 315 votes, so it appears that there is not enough political will to fix the design failures of EU ETS in the current economic turmoil. Consequently, it is likely that member states will try to fix the situation at the individual country level by implementing national schemes, such as the UK’s Carbon Price Floor. The obvious drawback of these national “carbon tax” schemes is the market distortion between the EU countries. Nevertheless, it seems to be “the least harmful approach”, while the EU is looking for consensus and direction for its energy policy.

Europe can’t turn the EU ETS into being an effective tool for cutting emission alone, since increasing electricity prices initiate an immediate debate on carbon leakage. Therefore, a global price for carbon is needed and all the main players, including the USA and China, must take part in this agreement. This raises another question: Why would, for example, the US implement a carbon trading system, since it has already been able to cut emissions with the help of cheap gas, which has enabled the rapid transition from coal to gas?

The vision of the EU ETS and global carbon pricing as a tool for reducing emissions is a tempting one. Unfortunately, it seems to be neither very effective nor politically acceptable as a tool for decarbonisation, at least in the current economic situation.

Ben Warren, Environmental Finance Leader at Ernst & Young

The EU-ETS was once the largest and most established carbon trading scheme. It was seen as the leading force for carbon markets globally and the bastion driving European policy. It now paints a rather glum picture – painting carbon trading as being in a state of disarray and suffering from massive oversupply. The recent EU vote against the backlogging proposal meant to stem this oversupply has moved carbon prices to hover around the €3/tonne mark. This is far too low to have any meaningful impact on carbon usage or decision making. The mechanism in its current state looks extremely unlikely to have any meaningful impact on decarbonisation. Professor Tom Burke is a little more optimistic saying, “The decision on the ETS sent the wrong signal, but it is likely that some form of agreement will be made and the ETS will recover”. However, for now this is now left to individual member states under their national policies, albeit within the context of Europe-wide targets.

Most people argue that a globally linked cap and collared carbon market would be the most efficient, fairest, most transparent way to incentivise the transition to a low-carbon economy. We are perhaps now further away than we were ten years ago.

Harald Thaler and Jonathan Robinson, Frost & Sullivan

We feel that the impact of the EU ETS on low-carbon investments is effectively nil.

The system has now for some years completely failed to penalise coal-burning plants. It has been plagued by an oversupply of carbon permits for a long time, with the price for a tonne of carbon dropping from €30 at one stage to around €3 in 2013. The European Commission had proposed in late 2012 to withhold some of the carbon permits that were due to come onto the market between 2013 and 2015. This “backloading” proposal, however, was defeated in a crucial vote in the European Parliament in April 2013, leaving the entire scheme in complete disarray, since this measure was supposed to be the predecessor of a more fundamental cancelling of permits.

power plant

While major utilities were generally in favour of the backloading proposal as a way of boosting the cost of carbon to encourage low-carbon technologies, large energy users and some key coal consuming countries such as Poland lobbied hard to defeat the proposal, arguing that the low price of carbon is merely a reflection of Europe’s economic realities of economic stagnation and recession.

Effectively, the EU ETS has now become largely irrelevant as a way to encourage investments in renewables and nuclear power, so coal generation is the direct beneficiary. The oversupply of permits will continue for the rest of the decade, thus continuing to fail to penalise coal and other high-carbon energy sources. A prolonged period of high coal burn, as well as future investments in gas-based generation, will thus make it all but impossible for the EU to attain its long-term 2050 target to decarbonise the power sector by reducing emissions by 80 percent below 1990 levels. If a price floor can be agreed upon by member states, that could make a significant difference and return some bite to the EU ETS, but this looks like an extremely long way off.o boost investments in gas generation in 2013.

The European Parliament’s ‘No’ to intervention in the EU ETS on 16 April led many market participants and observers to conclude that carbon prices will remain at very low levels for a long time.

It quickly became clear that several MEPs had in fact pushed the wrong voting button, and statements from “pro-backloaders” indicate that although the battle was lost, the war is not yet over. Nonetheless, this fighting spirit cannot in itself dispel the genuine and strong opposition to political intervention in the carbon market.

As market watchers delve into the usual speculations over what MEPs and member states need to do for backloading to become a reality, the more important question to ask today is whether the EU ETS is dead. Can it survive what will likely be several years of low prices for EU Allowances? The answer is the EU ETS will indeed survive, both politically in terms of support, and materially, in terms of continued demand for carbon allowances. To the extent that the EU ETS’s primary purpose is to secure emission abatement, it does deliver.

The EU is well on track to reach its target of a 20% reduction on 1990 levels by 2020. If the current political gridlock continues to block any adjustments to the regulatory framework, the ETS Directive stipulates that by default the cap (the overall emissions ceiling) will be reduced annually by a factor of 1.74 per cent.

Power generators, who represent more than half of the covered emissions, still need to buy allowances every year that the system is in place, to compensate for the output from their coal and gas power stations.

The accumulated oversupply of carbon permits – some 2000 million tonnes – is less than utilities need to cover two years of generation (they surrender approximately 1100 million tonnes per year). If they were to stop buying, they would soon run out of allowances.

A more detailed answer is more nuanced, however. A carbon price of €3 or less does little to incentivise green investments.

Instead big utilities such as RWE and Vattenfall have recently increased their new coal power capacity, in what seems to be a bet on cheap coal and carbon for many years to come. The recent rejection of backloading shows that, against a backdrop of slow growth, a narrow majority of European decision makers have focussed their attention on keeping the electricity bills of households and factories down to a minimum. Climate change is no longer top of the agenda.

At international level, the perceived failure of the EU ETS also poses a serious threat to Europe’s claim to be leading the way in global climate mitigation. A rough comparison with other carbon markets (without taking into account different rules for allocation, credit use, etc.) shows that Californian and Australian emitters are currently paying €11 and €17 respectively for their allowances, much higher than the European price of €3.

If this situation should drag on, it could increase the political appetite for more ambitious climate targets in Europe, including a more permanent fix for the oversupplied carbon market.

Giles Dickson, Vice-President, Environmental Policy and Government Affairs, Alstom

Is the EU ETS now obsolete? Absolutely not.

It is true the ETS is not functioning effectively today. With a supply/demand mismatch of around 2bn allowances, it is not functioning as a proper market. And with a CO2 price of €3-4, it is failing to deliver either of its two objectives. It is failing (a) to incentivise urgently-needed investments in low-carbon technology and infrastructure. And it is failing (b) to deliver cost-effective emissions reductions because, in the absence of a CO2 price signal for investment, EU Member States are having to subsidise the deployment of low-deployment technologies more than they would wish.

However, there is no doubt that the EU ETS remains the ‘best bet’ as the policy instrument to cut emissions and drive investment in low-carbon technologies. As a market-based instrument it stimulates investments where they make most economic sense – where they will cost least. With a variable CO2 price it helps to even out costs over the economic cycle. It is technology-neutral and allows economic forces to pick winners. And, crucially, it is an EU-wide instrument that gives a single consistent price signal to investors all over Europe. Tax-based incentives, which by definition in Europe would be national, would not offer these advantages.

What is needed now is reform to let the ETS fulfil its role. Most urgently, the EU needs to tackle the huge surplus of allowances by endorsing the European Commission’s proposal to ‘backload’ the auctioning of 900m EUAs. This will restore the necessary minimum of market confidence to shore up the ETS before the EU can agree more structural reforms. The latter should probably entail permanent withdrawal of the backloaded allowances and require steeper annual reductions in the ETS cap than the current 1.74%. Structural reform measures need to be agreed as soon as possible to give operators and investors in the power sector certainty about their operating environment up to 2030 and beyond.

Jill Duggan, Policy Director, Doosan Power Systems

On 16th April a plenary session of the European Parliament voted on an obscure proposal to ‘backload’ allowances in the EU Emissions Trading System. The proposal was to withhold 900 million carbon allowances from auction in the next few years to stem the drop in the European Carbon Allowance Price. The allowances would then be allowed back into the system when demand had picked up or bigger structural reforms had been made.

The proposal was narrowly defeated, but it is not dead – the changes can be made through a committee of Member State officials. Nor has the ETS been ‘holed below the water line’ as The Economist said. But to continue and be restored as the cornerstone of EU climate policy it will need industry’s support.

Industry and business still prefer Emissions Trading to regulation – as it provides access to least-cost emissions reductions, allows companies to choose their compliance strategy and gives certainty on the environmental outcome. But at around €3 a tonne it cannot make any impact in the board room, nor on immediate investment decisions.

The alternatives to emissions trading are far less industry-friendly. Those who advocate a tax severely underestimate the difficulty in getting a single tax agreed across Europe. And in the absence of a strong carbon price we are already seeing a patchwork of differing regulations spring up across Europe, creating new competitive distortions within the single market. Countries are rolling out different carbon price floors, which do nothing to reduce the overall emissions in Europe but provide tax revenues to treasuries.

The EU ETS is alive, its breathing is shallow, but it could yet make a full recovery. It is in the interests of industry to make sure it does. It is not a question of the ETS or nothing, but of something very much worse.

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