5 Emissions Trading System: market stability
reserve
| (35755)
5654/14
+ ADDs 1-2
COM(14) 20
| Draft Decision concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and amending Directive 2003/87/EC
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| Legal base | Article 192(1) TFEU; co-decision; QMV
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| Document originated | 22 January 2014
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| Deposited in Parliament | 28 January 2014
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| Department | Energy and Climate Change
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| Basis of consideration | EM of 6 February 2014
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| Previous Committee Report | None; but see footnote
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| Discussion in Council | See para 5.14 below
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| Committee's assessment | Politically important
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| Committee's decision | Not cleared; further information awaited
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Background
5.1 In order to promote reductions of greenhouse
gas emissions in a cost-effective and economically efficient manner,
Directive 2003/87/EC established the EU's Emissions Trading System
(ETS). This came into operation on 1 January 2005, and obliges
Member States to grant to undertakings in certain areas a permit
covering emissions of carbon dioxide. It also required them to
establish for each of the first two trading periods (2005-07 and
2008-12) a national plan dealing with the total quantity of allowances
and their allocation: undertakings with a permit are then able
to emit quantities of carbon dioxide up to the permitted limits,
but have to surrender an allowance equal to their annual emissions.
The System's third phase (from 2013-20) incorporates a number
of fundamental changes, with the individual Member State allocation
caps having been replaced by an EU-wide cap on allowances (which
will decrease by 1.74% annually), and with auctioning having become
the default system of allocation.
5.2 The Directive requires the Commission to report
on the operation of the System, and the first such report in 2012[31]
noted that, at the start of the second trading period, it was
expected that the cap would be ambitious, but that the economic
crisis had radically reduced the level of emissions, resulting
in a surplus of 955 million allowances by the end of 2011 (which
in turn had had a major impact on the carbon price, which had
fallen to below €10 in the second half of 2011). It added
that, due largely to temporary elements directly related to the
transition to phase III, a continued rapid build-up amounting
to some 500 million allowances was to be expected by the end of
2013, resulting in a surplus at the start of phase III, which
could well be over 1.5 billion, or even 2 billion, allowances.
5.3 The Commission therefore proposed that the auctions
of a certain quantity of allowances planned for 2013, 2014 and
2015 should be postponed ("backloaded") until later
in phase III, by means of an amendment to the Auctioning Regulation.
However, it pointed out that this would not affect the structural
surplus, and it therefore went on to consider a number of structural
options — including increasing the EU reduction target to
30% in 2020; retiring a number of allowances in phase III; an
early revision of the 1.74% annual linear reduction factor; extension
of the scope of the system to other sectors; limiting access to
international credits; and discretionary price management mechanisms
— which it intended to explore with stakeholders without
delay by launching a formal consultation process.
The current proposal
5.4 Even though it has recently been agreed that
the auctioning of 900 million allowances in the early stage of
phase III should be postponed until 2019 and 2020, the Commission
says that, without a reform of the ETS, a surplus of two billion
allowances is expected to persist until 2030, even if the cap
is adjusted downward to deliver the 40% greenhouse gas target
which the Commission has proposed in its Communication[32]
on a 2030 Climate and Energy Package. As this will result in a
carbon price insufficient to stimulate the investment needed to
meet long-term emission reduction targets, the Commission has
suggested the establishment of a market stability reserve (which
emerged as a further structural option during the consultation
process referred to above).
5.5 It is envisaged that such a reserve could in
the short term help to address the current allowance surplus,
and also make the ETS more resilient to any potential future large-scale
event which might severely disturb the balance between supply
and demand by adjusting auction volumes to address the mismatch
between the largely fixed supply but flexible demand from fluctuating
emissions, without affecting the total long-term supply. More
specifically, as from the start of Phase IV of the ETS in 2021,
12% of the cumulative surplus in the market[33]
which would otherwise have been auctioned would be withheld annually
and placed into the Market Stability Reserve, unless the volume
to be withheld was below 100 million allowances.[34]
The proposal also stipulates that 100 million allowances in the
Reserve would be returned to the market if the total number of
allowances in circulation is below 400 million, or if the allowance
price for more than six consecutive months is more than three
times the average price of allowances on the European carbon market
during the two preceding years.
5.6 The proposal includes a requirement for the Commission
to review the orderly functioning of a market stability reserve
by 31 December 2026, paying particular attention to the percentages
determining the number of allowances to be held in a reserve,
and to submit a proposal, where appropriate, to the European Parliament
and the Council. It also includes a provision to smooth out the
peak in supply caused by the reintroduction to the market in 2020
of 600 million 'backloaded' allowances, as well as any other increases
to auction volumes at the end of Phase III such as the auctioning
of unused New Entrant Reserve allowances. This provision specifies
that, where average auction volumes in 2020 are more than 30%
higher than expected volumes in 2021 and 2022, the 2020 volume
should be reduced by two-thirds of the difference, with the reduced
amount then returned in even instalments across each of the years
2021 and 2022.
5.7 The Commission has published an accompanying
Assessment, which sets out in broad terms some possible impacts
of such a reserve. This shows that it would remove allowances
from the market in 2021, thereby reducing Member States' auction
volumes, with the resultant increase in the carbon price being
likely to increase the costs to firms of complying with the ETS,
whilst the effect on Member States' auction revenues would depend
on the balance between the magnitude of the change in auction
volumes and the corresponding impacts on price. The Impact Assessment
also refers to the mid to long-term operation of the reserve,
when at some point allowances would be likely to return back to
the market (and would thus be likely to lead to a fall in the
carbon price and a reduction in the costs to firms of complying
with the ETS). However, the Assessment does not estimate the impacts
on Member States' auction revenues of removing allowances from
the market from 2021 or returning them later.
The Government's view
5.8 In his Explanatory Memorandum of 6 February 2014,
the Minister of State at the Department for Energy and Climate
Change (Gregory Barker) says that the ETS is a central component
for delivering cost effective emissions reductions in the UK and
across the EU, and he points out that the UK has long called for
legislative proposals for its reform so as to address the surplus
of allowances in the system and strengthen the incentive it provides
for investment in low-carbon technology. He adds that the Government
is open to considering the potential for supply side flexibility
mechanisms (including a market stability reserve) to improve the
functioning of the system, but believes that such a mechanism
needs to be supported by robust analysis, based on clear and transparent
rules which maintain the integrity of the market, and respect
Member States' fiscal sovereignty. It therefore broadly welcomes
this proposal, and is undertaking detailed analysis of the specific
parameters put forward to assess its likely impacts.
5.9 The Minister notes that the supply of allowances
in the ETS market is currently determined many years in advance
and then remains fixed during each Phase, and he suggests that,
whilst this has provided emission reduction certainty, it has
not provided the certainty required to support decisions to invest
in low carbon technologies. In particular, a fixed supply means
that significant changes in the level of demand will result in
large price movements, the impacts of this currently being seen
with prices having dropped around 80% since the beginning of the
recession in August 2008, as a result of a large and persistent
surplus, arising from significantly reduced output and hence emissions.
5.10 The Minister also comments that this situation
has created pressure for ad hoc reforms to address high surplus
and low prices, with the proposals for back-loading and the negotiations
surrounding their implementation having added to the uncertainty
for market participants, and created a risky investment environment.
He suggests that the introduction of a market stability reserve
might, if properly designed, give a more stable investment signal
by providing a clear set of rules for the adjustment of supply
in response to unforeseen changes in demand, and he believes that,
if this could be achieved, it would remove a significant source
of policy uncertainty for investors and improve the resilience
of the ETS.
5.11 The Minister also makes a number of specific
observations, namely that:
· as stated, allowances would only be withheld
and placed in the reserve, or released from the reserve if predefined
rules were met, and this will ensure that the action of the mechanism
can be predicted by, and is transparent to, market participants;
· the proposal only allows a limited volume
of allowances to be withheld or released to the market each year,
which will smooth the impact of the mechanism on the market and
auction revenues, but the mechanism is not without risks, and
some market participants and academics have expressed concern
that, if the rules and thresholds were calibrated incorrectly,
the mechanism might be ineffective or could cause disorder in
the market and increase price volatility;
· the proposed mechanism does not appear
to go far enough to address the current surplus of two billion
allowances in the ETS, and the UK has therefore continued to call
for the permanent removal from the system, or cancellation, of
an ambitious volume.
5.12 The Minister says that the Government is continuing
its assessment of the impacts of the proposal, and whether it
can deliver on the potential benefits whilst appropriately managing
the risks, and that it will prepare an Impact Assessment in due
course. In the meantime, he comments that the market stability
reserve is likely to have some impact on UK revenues from the
auctioning of ETS allowances, but that this will depend on the
balance between reductions in overall auction volumes and the
resulting increase in price (and vice versa).
5.13 He concludes by saying that initial discussions
in Council working parties are expected to take place over the
coming weeks, but that, although the timetable for detailed discussions
is not yet clear, it is not expected that trilogue discussions
will progress significantly before the next Commission and European
Parliament are in place in late 2014.
Conclusion
5.14 Given the central role which the EU Emissions
Trading System plays in reducing greenhouse gas emissions in a
cost-effective and economically efficient way, we think it right
to draw to the attention of the House this proposal which seeks
to address the current imbalance between the level of emissions
and the number of available allowances. At the same time, whilst
we have noted the broad welcome which the Government has given
to the proposal, it has also flagged up a number of reservations,
and has said that it will be carrying out a detailed assessment
of the likely impact. We are therefore holding the document under
scrutiny, pending receipt of this further information.
31 (34430) 16537/12: see HC 86-xxv (2012-13), chapter
14 (19 December 2012). Back
32
(35754) 5644/14: see chapter 2 of this Report. Back
33
Defined as the number of allowances issued to EU ETS participants
since 1 January 2008 plus surrendered international credits less
total verified emissions for the same period. Allowances in the
market stability reserve are also deducted from the total. Back
34
Thus effectively setting a maximum surplus threshold of 833 million
above which allowances will be withheld from the market and added
to the reserve each year. Back
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