Documents considered by the Committee on 25 April 2017 Contents

21EU Emissions Trading System 2021–2030

Committee’s assessment

Politically important

Committee’s decision

Cleared from scrutiny (by Resolution of the House on 13/12/2016); further information requested; drawn to the attention of the Business, Energy and Industrial Strategy Committee

Document details

Proposal for a Directive amending Directive 2003/87/EC to enhance cost-effective emission reductions and low-carbon investments

Legal base

Article 192(1) TFEU, Ordinary Legislative Procedure, QMV


Business, Energy and Industrial Strategy

Document Number

(37003), 11065/15 + ADDs 1–3, COM(15) 337

Summary and Committee’s conclusions

21.1The EU Emissions Trading System (ETS) is seen as a central component of efforts to meet carbon dioxide reduction targets in a cost-effective and technologically neutral way. Companies can either buy allowances giving the right to emit carbon dioxide or they can take action to reduce carbon dioxide and sell allowances to others. There is a fixed limit on the amount of allowances available, reducing over time. Some allowances are auctioned and some allowances are available free.

21.2In July 2015 the Commission put forward a proposal for a Directive which would set out the arrangements to apply in Phase IV (from 2021 to 2030). Details are below.

21.3The proposal was first considered by the Committee on 16 September 2015 and debated in European Committee on 12 December 2016, after which the document was cleared from scrutiny.78 During that debate, the Minister of State for Climate Change and Industry (Nick Hurd) made it clear that no decision had been taken on the UK’s future engagement in the EU ETS but that—regardless of future UK participation—a strong EU ETS was in the UK’s national interest.

21.4The Minister has now written to update the Committee on progress in both the European Parliament and Council. The respective positions are set out in detail below. Negotiations between the institutions began on 4 April and may continue into the second half of 2017.

21.5In summary, both institutions support changes designed to strengthen the carbon price signal. While both institutions support measures designed to protect those industries at risk of carbon leakage,79 their approaches differ in the extent to which they divert funds from national budgets. Furthermore, the European Parliament wishes to impose stricter emissions requirements for access to the Modernisation Fund for projects in lower income Member States. The aim is to avoid the provision of this funding source to coal-fired power stations. The Council text is significantly less stringent in this respect.

21.6The Minister’s summary of the respective positions of the European Parliament and Council is helpful. We note that there are similarities between the two positions but that the European Parliament’s opening position is more ambitious than that of the Council.

21.7We are aware that the Government is yet to take a decision on the UK’s participation in the Emissions Trading System (ETS) once the UK has withdrawn from the European Union. As the EU ETS involves reciprocal arrangements, the default position in the absence of a negotiated agreement on future engagement would be non-participation. Now that Article 50 has been triggered, we expect the Government to have either arrived at a position or be close to that stage. We ask that, when the Minister next writes to us with an update, he include information on the UK’s approach to the EU ETS post-Brexit.

21.8We report these latest developments to the House and draw them specifically to the attention of the Business, Energy and Industrial Strategy Committee, which is undertaking an inquiry into the implications for energy and climate change of the UK’s withdrawal from the EU.

Full details of the documents

Proposal for a Directive amending Directive 2003/87/EC to enhance cost-effective emission reductions and low-carbon investments: (37003), 11065/15 + ADDs 1–3, COM(15) 337.


21.9In 2014, the European Council agreed a 2030 policy framework for climate and energy, which included a binding target to reduce overall EU greenhouse gas emissions by at least 40% compared with 1990 levels, and it also took the view that, in order to achieve this target cost-effectively, the sectors covered by the EU ETS would have to reduce their emissions by 43% compared with 2005 (with a corresponding reduction of 30% from other sectors).

21.10The Commission accordingly put forward these proposals relating to Phase IV of the ETS from 2021 to 2030, including:

21.11Further details on the proposals were set out in our Report of 16 September 2015.80 In that Report, we concluded that the document was significant and had no hesitation in recommending it for debate in European Committee A. The document was drawn to the attention of the then Energy and Climate Change Committee.

21.12The debate took place on 12 December 2016, at which the point the document was cleared from scrutiny. The Minister wrote again on 27 January 2017 explaining that a General Approach was not agreed—as had been anticipated—in December 2016 but that one was expected in February 2017.

Minister’s letter of 21 March 2017

21.13The Minister explains that the European Parliament (EP) agreed its position on 15 February and the Council agreed its position (General Approach) on 28 February. The respective positions struck on the UK’s key areas of interest are set out below.

Strengthening the carbon price signal

21.14The EP position includes a measure that would double (from 12% to 24%) the rate at which the Market Stability Reserve (MSR)81 removes allowances from the market until the first review, which must take place within the first three years of the operation of the MSR, thereby reducing the current surplus of allowances more quickly than would otherwise have happened. It also cancels 800 million surplus allowances, with the possibility of cancelling 200 million more if they are not used.

21.15The Council position includes a near term provision to double the MSR extraction rate for the first five years of the operation of the MSR (until the end of 2023). Also agreed was a long-term measure starting in 2024 to make surplus allowances held in the MSR that exceed the previous year’s auctioning volume invalid, effectively removing them from the system. This proposal is subject to review by 2021, but in combination these two measures, says the Minister, would reduce significantly the oversupply of allowances that has built up over the past decade.

Protection for industrial sectors at risk of carbon leakage

21.16The EP has proposed a conditional 5% move in the split between auctioned and freely allocated allowances in favour of free allocation. This reduction in the auctioning share would only be triggered in the event that there are not enough free allowances to fully allocate allowances to industrial sectors on the carbon leakage list. This would minimise the risk of having to introduce a uniform reduction in free allocation to all sectors through the application of the “Cross Sectoral Correction Factor.” The EP position also includes an exemption from the correction factor for certain sectors deemed to be at a very high risk of carbon leakage.

21.17The Council agreed on a 2% conditional shift in the split between auctioned and freely allocated allowances, in favour of free allocation. As with the EP position, this shift would only be triggered if needed to avoid the application of a universal correction factor.

Measures to provide compensation to industry for the indirect costs of the EU ETS

21.18The EP proposes to establish a mandatory EU-wide central fund for compensation to industry. The Council agreed additional reporting requirements for Member States which choose to provide such compensation, and a recommendation that they should seek to limit compensation paid from auctioning revenues to 25% of their total auctioning revenue. Compensation from other funding sources is unaffected.

Modernisation Fund for lower income Member States,

21.19The EP position enforces robust project criteria (including an emissions performance standard of 450 grams of CO2 per kilowatt-hour) that would ensure that projects funded through the mechanism would contribute to long-term climate goals. There is language in the Council stipulating that projects should be in line with long term climate goals, but the governance mechanisms do not guarantee this.

Measures to simplify the system and reduce administrative burdens

21.20The EP proposes to raise the small emitter opt-out threshold to certain installations emitting 50,000 tonnes of CO2 per year and the option for Member States to exclude installations emitting less than 5,000 tonnes of CO2 per year entirely from the EU ETS. In the Council position, there is an additional opportunity for installations to join the small emitter-opt-out during the next Phase and Member States are required to report more frequently on functioning of schemes. There is also a provision for further simplification options to reduce administrative burdens in more detail in implementing legislation.

Concluding comments

21.21The Minister considers that the agreement struck in Council is a good outcome for the UK, and largely reflects the UK’s priorities for the negotiation:

“The strengthening measures especially are in line with our long-held position that the allowance surplus must be tackled, and should help drive a strong low carbon investment signal throughout Phase IV, underpinning the EU’s climate efforts and levelling the playing field between the carbon price in the UK and the rest of the EU.”

21.22On carbon leakage, the Minister says:

“One absence from either position is a tiered approach to protecting industrial sectors most at risk of carbon leakage, which the UK had supported throughout the negotiation. The carbon leakage proposals we previously advocated were to strike an effective balance between environmental ambition and protecting the competitiveness of European industry. The proposal for a conditional increase in the proportion of free allowances—while not our preferred option—will help to strike the same balance.”

21.23The Minister explains that the next stage of the process will be for the Council, European Parliament and Commission to negotiate together. He says that the UK will continue to engage to ensure that the final deal is in line with UK priorities and he hopes that agreement can be reached before the end of 2017. The Minister plans to write again when the negotiations progress sufficiently to warrant an update.

Previous Committee Reports

Fourth Report HC 324-iv (2015–16), chapter 1 (16 September 2015).

78 See Votes and Proceedings, 13 December 2016.

79 Generally energy-intensive industries, such as cement and steel, which might re-locate to countries which have a weaker (and therefore cheaper) regulation of emissions, thus simply transferring the emissions elsewhere rather than reducing them.

80 Fourth Report HC 324-iv (2015–16), chapter 1 (16 September 2015)

81 From 1 January 2019, 12% of the allowances in circulation will be placed in a reserve each year if the number of allowances in circulation two years earlier exceeds 833 million. Allowances in the reserve will be carried over from one year to the next, and 100 million allowances will be released when there are fewer than 400 million allowances in circulation, or in case of a strong rise in the price of EU emission allowances.

27 April 2017