Linking emissions trading systems - Energy and Climate Change Committee Contents

4  The EU Emissions Trading System

22. The EU Emissions Trading System (EU ETS) is the world's first and currently largest emissions trading system covering 11,000 power stations and industrial plants in 31 countries. Proposals to include aviation have been made and will be implemented if the International Civil Aviation Organisation (ICAO) do not come forward with robust plans to cut emissions from aircraft.[80] It covers around 45% of the EU's greenhouse gas emissions. Launched in 2005, the first 'learning by doing' phase lasted until the end of 2007. The second phase ran from 2008 until 2012 and coincided with the first commitment period of the Kyoto Protocol (see chapter 5). The third and current phase will run from 2013 to 2020. This phase represents a significant departure form phase one and two, firstly because it includes a single EU-wide cap on emissions and secondly involves the use of auctioning, rather than providing allowances to participants for free, as the default method for allocating allowances.[81]

23. The EU ETS has demonstrated that an international market in carbon emission allowances can operate effectively. This achievement constitutes a significant measure of success. Martin Pibworth, Managing Director of Wholesale at SSE, described it as "pioneering".[82] David Hone said that it was a "very well-functioning system".[83] This view was supported by the European Commission and the Government. The Parliamentary Under-Secretary of State told us "it is doing very well in having a leading role in providing a structure that works".[84] Despite this, most stakeholders think it has failed to incentivise emissions reductions and decarbonisation of the economy, principally because the carbon price achieved has not been high enough to influence investment decisions. Dirk Forrister said this was because the market was "awash" with over 2 billion surplus allowances following the 2008 financial crisis which has led to a reduction in economic output and subsequently the demand for allowances.[85] Lord Stern said that the "ludicrously low" prices in the EU ETS were having no impact on emissions.[86] The Parliamentary Under-Secretary of State summed up its performance; "it is like a school report, good in parts; more to do".[87]

24. In January 2012, we published a report on the EU ETS and argued it was "going through a period of difficulty as tumbling prices have watered down the incentive for investment in low-carbon options".[88] We put forward a number of proposals for short term fixes and long term flexibility to reinvigorate the trading system. We recommended action to increase the price of carbon by removing a significant volume of EU allowances and tightening the cap. We concluded that "if this can be achieved, the EU ETS can continue to be a significant force in promoting international action on climate change".[89] Three years on, very little has changed. Respondents to this inquiry were overwhelmingly supportive of reforming the EU ETS.[90] Reform could help it play a more prominent role as the central driver for EU decarbonisation.[91] Lord Stern told us that "making the ETS work well is fundamental" and if carbon went back to a more sensible price in Europe it "would create a very powerful signal worldwide".[92] The Prime Minister agreed that reform of the EU ETS was "essential" and that it was "essential that Britain lead this process of reform".[93]

25. Today there are two main proposals on the table to reform the EU ETS. The first involves postponing the auctioning of 900 million allowances. By temporarily 'back-loading' these allowances the European Commission hopes demand will increase and drive up the price of carbon.[94] The second involves long term structural change to address the ongoing imbalance between the supply and demand of allowances.[95] The Commission proposed introducing a market stability reserve (MSR) at the beginning of the next trading period in 2021.[96] Mr Forrister described how the MSR might work in practice:

    I think of it as being the allowance equivalent of a strategic petroleum reserve. It would be a reserve where excess credits are kept aside and brought to market in times when you are fearful about price spikes because the supplies are getting too tight. Conversely, you would withhold credits from auction in times when you felt like the market had plenty of liquidity and plenty of allowances in circulation.[97]

26. While some businesses would have preferred the permanent removal of allowances from the system, most businesses including EDF Energy, SSE and Shell, supported the introduction of the MSR as the best solution currently on the table.[98] Miles Austin asserted that "if we do not get the MSR in place the EU ETS will become internationally irrelevant".[99] Some went further arguing that the need for reform was so great that the MSR should be introduced in 2017 rather than 2021 as originally proposed by the Commission.[100] The Government supported the proposal to introduce the MSR earlier and the Commission made it clear that it would not stand in the way if the European Parliament and Council wish to apply the reserve earlier.[101] It may be difficult to get agreement, however, because some industries and countries are unhappy about the introduction of the MSR or any mechanism to remove allowances, raise the price of carbon and thereby impact on EU competitiveness.[102] As discussed in chapter 2 both the Government and the Commission were confident that these concerns were unfounded.[103]

27. The EU has played, and will continue to play an important role in promoting emissions trading and in eventually linking different systems.[104] Dr Denny Ellerman suggested that "although little noted as such, the EU ETS is the world's first and only multinational cap-and-trade system".[105] Damien Meadows said that "the provisions in the law are quite open for linking".[106] The EU ETS Directive provides for the possibility to link the EU ETS with other compatible systems.[107] The Commission set out some of the conditions which would need to be met:

    Compatibility in the EU ETS context has been understood to mean that robust registries, monitoring, reporting and verification systems, as well as enforcement systems are in place. [A prospective system] should also have a similar ambition level, including similar (qualitative and quantitative) limits on the use of international (and domestic) offsets. The key will be to ensure that the systems have the same basic environmental integrity and that a tonne of CO2 in one system is a tonne in the other system.[108]

The Parliamentary Under-Secretary of State said that the Government wanted to ensure the EU ETS would "widen" and that "linking must be the goal".[109] The Government and others were clear however that the EU ETS would need to be reformed in order to make the EU a credible partner before linking could be considered.[110] Mr Meadows agreed that once the EU ETS was reformed other systems might express more interest in linking.[111] In the meantime countries continue to learn from the experience of the EU ETS, something we heard strongly and frequently expressed during our visit to China.[112]

28. The issue of surplus allowances in the EU Emissions Trading System (EU ETS) must be addressed urgently. We recommend that the Government focus on getting agreement in the European Parliament and Council to implement the market stability reserve (MSR) at the earlier date of 2017 rather than in 2021, as originally proposed by the European Commission. Once it has been reformed the credibility of the EU ETS will increase along with the prospects of linking it to other systems in future.

80   European Commission, 'Reducing emissions from aviation,' accessed on 10 February 2015 Back

81   European Commission, 'The EU Emissions Trading System (EU ETS),' accessed on 10 February 2015 Back

82   Q41 (Mr Pibworth) Back

83   Q154 (Mr Hone), Q165 (Mr Hone) Back

84   Q179 (Mr Meadows), Q195 (Ms Rudd) Back

85   Q25 (Mr Forrister), Q114 (Sir David) Back

86   Q41 (Mr Pibworth), Qq165-166 (Mr Hone), Q179 (Mr Meadows), Q195 (Ms Rudd), Oral evidence taken on 26 November 2014, HC (2014-15) 666, Q30 (Professor Lord Stern) Back

87   Q195 (Ms Rudd) Back

88   Energy and Climate Change Committee, The EU Emissions Trading System, Tenth Report of Session 2010-2012 (17 January 2012), p47 Back

89   As above Back

90   LTS 005 (DECC), LTS 009 (EDF Energy), LTS 011 (SSE) Back

91   Q25 (Mr Forrister), Q41 (Mr Pibworth), Q46 (Mr Pibworth), Qq95-96 (Sir David), Q167 (Mr Hone), Q179 (Mr Meadows), Q197 (Ms Rudd), Oral evidence taken on 26 November 2014, HC (2014-15) 666, Q30 (Professor Lord Stern) Back

92   Oral evidence taken on 26 November 2014, HC (2014-15) 666, Q30 (Professor Lord Stern) Back

93   Oral evidence taken before the Liaison Committee on 16 December 2014, HC (2014-15) 887, Q4 (Mr Cameron) Back

94   Q167 (Mr Hone) Back

95   Q25 (Mr Forrister), Q28 (Dr Taschini),  Back

96   Q179 (Mr Meadows), European Commission, 'Structural reform of the European carbon market,' accessed on 10 February 2015 Back

97   Q25 (Mr Forrister) Back

98   Q49 (Mr Austin), Qq168-170 (Mr Hone), LTS 009 (EDF Energy), LTS 009 (SSE) Back

99   Q63 (Mr Austin) Back

100   Qq47-49 (Mr Pibworth, Mr Austin), Q197 (Ms Rudd)  Back

101   Q114 (Sir David), Q180 (Mr Meadows), Q197 (Ms Rudd) Back

102   Qq48-49 (Dr Leese), Q197 (Ms Rudd) Back

103   Q45 (Mr Pibworth), Qq186-187 (Mr Meadows), Q195 (Ms Rudd), Q200 (Ms Rudd) Back

104   Q184 (Mr Meadows) Back

105   LTS 007 (A. Denny Ellerman) Back

106   Q183 (Mr Meadows) Back

107   LTS 016 (IETA) Back

108   LTS 017 (EU Commission) Back

109   Q198 (Ms Rudd) Back

110   Qq45-46 (Mr Pibworth), Q198 (Ms Rudd, Mr van Heyningen).  Back

111   Q185 (Mr Meadows) Back

112   Q183 (Mr Meadows), LTS 007 (A. Denny Ellerman) Back

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Prepared 17 February 2015