Expert View: What Next For The EU ETS?

17 Apr 2013, 17:00 Sarah Deblock and Bryony Worthington The European Parliament yesterday rejected backloading, a plan to withhold emissions permits from the European Emissions Trading Scheme (ETS) to combat oversupply in the market. So can the ETS recover? Two experts give their views. Without backloading, ETS reform may be undermined Sarah Deblock, policy director for European affairs for the International Emissions Trading Association Backloading is not new. First known as the set-aside proposal, the European Parliament originally proposed it as a solution to address oversupply in the market around two years ago. So why has the parliament now rejected backloading? In recent months, MEPs’ positions across the political spectrum have fractured. Yesterday, nearly 70 per cent of MEPs in the influential right-of-centre EPP group, 86 per cent of the European Conservatives and Reformists, and 40 per cent of the liberal ALDE group rejected the proposal. Just 19 votes out of a total of 754 swung the decision. The result has hurt political confidence in the emissions trading scheme. However, while the vote failed to provide a clear political commitment to the proposal for addressing the current oversupply in the EU ETS, it has also led to public assurances of those MEPs who believe in emissions trading and the need for structural reform, but who do not see backloading as being a necessary part of this process. Many of those MEPs opposed to backloading viewed it as a short term measure only, and did not support that type of market intervention. Therefore, as additional information emerges, most MEPs would argue that their opposition to the backloading proposal is not to be interpreted as opposition to the EU ETS. Moreover a majority of the anti-backloading camp is publicly supportive of reform. But although structural reform is likely to happen with or without backloading, it will be much harder to restructure the ETS if nothing is introduced to make the market more efficient. Backloading is also a way to buy time to avoid the carbon price collapsing further. Without it, the price of permits is likely to start rising and falling depending on speculation over political developments rather than market signals. And if MEPs begin new discussions on long-term structural reform in a context in which the ETS is working inefficiently, the discussions could get sidetracked from redesigning the scheme long-term in favour of a short-term fix. More time is needed for a meaningful reform so that the carbon market can automatically adjust when the economy takes a turn for better or worse. What’s worse, the political situation in Europe is likely to delay ETS reform. With the European elections taking place in May 2014, the new commission is not expected to be formally in place before early 2015. Once a new legislative proposal for reform materialises, it’s likely to take another year or two to get through the European Parliament and European Council. This delay means that without backloading, the ETS is likely to run inefficiently until at least 2016. This will increase the temptation for governments to implement alternative instruments like carbon taxes, even though most politicians would agree that an EU-wide policy instrument such as the EU ETS is more desirable than a patchwork of 27 different national policies. The time has now come to make a strong political commitment to the existing scheme, to acknowledge its difficulties, and to discuss the options on the table for reform. The outcome will also have an effect on the emissions trading schemes that are developing worldwide. Recent examples include Australia, California and the north-Eastern US states, which are starting to look to link to other carbon markets. Progress is also noticeable in the developing world in China, South Korea, Kazakhstan, and Chile. The EU ETS is the biggest emissions trading scheme in the world, and as it is facing challenges, all eyes are on Europe to see how it will address these difficulties. Member states must clarify their position to move the debate forward. The ETS will limp along, but Europe will pay for the delay to reform Bryony Worthington , director and founder of cap and trade campaign organisation Sandbag With the European Parliament’s vote against backloading, the future of the ETS in Europe the short term looks pretty bleak. The carbon price – already at rock bottom – has fallen by close to half. The immediate implications of this are that carbon auctions may struggle to go ahead if bids fail to meet reserve prices. EU member states that have been banking on incomes from carbon auctions to fund public services or supporting green policies will find they have a hole in their finances. This could prompt countries to follow the UK’s lead and introduce carbon taxes to compensate. If policies across Europe start to splinter, it will lead to distortions in trade – and that’s bad for business. The low prices also mean Europe’s most efficient businesses are no longer rewarded for doing the right thing, and those that rely on revenue from selling surplus permits will lose a potential lifeline. In the medium term, it is possible that a more ambitious proposal than the current ETS could emerge from one of the European institutions. A number of MEPs abstained, while several who rejected backloading have said they support fixing the ETS – just not through this measure. Both may support a different approach if one can be agreed. If nothing emerges ahead of the next parliamentary elections in May next year, it will be two years or more before anything can be done at an EU level. In the long term, the ETS will simply carry on regardless – there is nothing in the legislation that can cause it to cease. Prices will inevitably rise in around 10 years as industrial permit surpluses dry up, free allocations disappear and carbon offsetting provisions run out. Sadly for the EU, to sit around doing very little for the rest of the decade would lead to loss of investment. It would also send a very bad signal to other governments.   For this reason, it seems likely the European Commission will now shift its focus to deciding climate targets for 2030. If targets come in at the same time as changes to the ETS, they could speed up a rise in the carbon price.