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EU Carbon Market Hit by Brexit, But Reform Carries On

Brexit carry on photo Tom MalavodaWill the reform of the failing EU Emissions Trading System (ETS) be a casualty of Brexit, now that its British rapporteur will be replaced, possibly by a Polish colleague? As the EUEnergy App shows, greenhouse gas emissions in Europe have gone down drastically since 1990. But not thanks to the EU ETS. What is more, in the coming years much greater emissions cuts are needed, and the carbon market is expected to deliver these, with or without the UK. Sonja van Renssen reports on how policymakers in Brussels are trying to reconnect the ETS to what is going on in the real world.

The MEP leading the reform of the EU Emission Trading Scheme (ETS) – the world’s largest carbon market – has become one of the first Brexit casualties. But Brexit or no Brexit, the reform of the ETS must carry on. It even seems likely that the UK will continue to be part of it, given its pro-market history and the fact that non-EU members such as Norway participate. Ian Duncan, the Conservative Tory MEP from Scotland who has so far led the file at the European Parliament, said at a debate in Brussels on 20 June: “The energy question is bigger than the EU, bigger than Europe. It’s a global question and we shouldn’t look at it solely through [the lens of] a regional entity.”

What is clear already is that none of this helps Europe get to a meaningful carbon price any time soon

That said, he had his resignation letter ready and duly handed it over on 24 June, the day after the UK referendum. “I believe it would be sensible for the dossier to be taken forward by a member who can steer the important reforms to their conclusion,” it reads. On the fateful day itself Duncan tweeted “Nothing lasts forever…” with a photo of his parliamentary badge being removed from its plastic holder. Both Duncan and other sources in the Parliament have suggested that a Polish MEP within Duncan’s right of centre ECR group will take over the file. Duncan says in his letter that the incoming rapporteur should be given latitude to re-examine the report and propose changes.

Poland in charge

These changes could yet be substantial: Poland is renowned for its scepticism of EU climate policy after all, and the country’s government was calling for a new EU Treaty that gives more power to member states (and less to the European Commission) ahead of a summit of heads and state and government in Brussels on 28-29 June.

Yet all is far from settled. Duncan’s resignation has yet to be accepted and there were reports last week that he would consider staying on – if asked to do so, which he deemed unlikely. The Parliament is meeting this week to decide what to do. What is clear already is that none of this helps Europe get to a meaningful carbon price any time soon. The EU ETS reforms risk severe delays as Brussels scrambles to cope with the fallout of Brexit while the anti-EU sentiment sweeping across the continent hardly makes the case for a more ambitious European climate policy. In the meantime, the EU carbon price fell to a new two-year low of €4.28 a tonne at the end of last week.

The EU will have to get its act together for Europe to have a shot at living up to its Paris commitment to help keep global warming to “well below” 2 degrees (never mind 1.5 degrees).  Even before the UK referendum, the EU carbon price was  still limping along at a paltry €5-6 a tonne and the latest renewables investment figures for Europe actually show a decrease compared to previous years. Where is the low-carbon investment signal that Paris supposedly delivered?

Reality on the ground

A look at Europe’s actual emissions reveals that Europe is actually already well beyond its 20% greenhouse gas emission reduction target for 2020. It has cut emissions by no less than 24.4% since 1990, according to new figures from the European Environment Agency (EEA) released on 21 June. It has also progressively decoupled GDP from emissions, reported the EEA, with an increase in GDP of about 47% over the same period. The agency attributes the decrease in emissions since 1990 to more renewables and energy efficiency, less carbon-intensive fuels in the energy mix, structural changes in the economy and the recession.

The EU ETS reforms risk severe delays as Brussels scrambles to cope with the fallout of Brexit while the anti-EU sentiment sweeping across the continent hardly makes the case for a more ambitious European climate policy

The EUEnergy App, developed by Shell and Energy Post, shows, based on Eurostat data, that the decoupling of GDP and emissions has proceeded largely independently of the economic downturn. It is moreover at its most impressive in some Eastern European countries – Poland has grown its GDP by 12 times while it is emitting 62% less CO2 per unit of GDP. The data also shows that the power sector and industry have dominated not only emissions, but also their reduction. Transport, in third place, is the only sector whose emissions are still going up. Luxembourg is the EU’s worst per capita emitter – consistently emitting 2-3 times the EU average – due to its transport sector and fuel export business.

EU Energy App Poland

EUEnergy App shows Polish carbon emissions have declined while GDP has risen (Eurostat data)

The data also show a declining but still substantial role for fossil fuels in the European energy mix. Oil has always been most important. Gas has taken over second place from coal, but is on a downward trend today due at least in part to a weak carbon price. Renewables have nearly tripled their share of the energy mix, it’s true, but even green champion Germany still consumed over a quarter of all the coal used in Europe in 2013 – just as it did back in 1990. Coal still drove 44% of German electricity production in 2013 (albeit down from well over half in 1990) and a third of Danish power production (down from 90% in 1990).

EUEnergy App German electricity mix

EUEnergy App shows coal is still dominant in German electricity mix (Eurostat data)

That low-carbon signal

This has led some to call for an active EU policy to phase out coal, but for others, including the European Commission, that remains the job of the EU ETS. The scheme covers more than 11,000 energy and manufacturing installations and with that about half of Europe’s greenhouse gas emissions. Note that the UK is Europe’s second largest emitter after Germany. If it does withdraw from the scheme, that will have an impact on demand and supply, as well as the reform itself – the UK has been a leading proponent of tightening up the scheme to boost the carbon price.

The fact is that the pace of emission cuts will become more demanding if the EU wants to stay on track to at least a 40% cut by 2030 and an 80-95% cut by 2050 (that’s before 1.5 degrees is taken into account). It will need to do more in the next decade than it has done in the past three decades and the carbon market is expected to deliver the bulk of these cuts.

Where is the low-carbon investment signal that Paris supposedly delivered?

To this end, the Commission has succeeded in convincing member states and MEPs to back two changes to the EU ETS already. First, “backloading” – which delayed the sale of 900 million carbon allowances into the market – and second, the “market stability reserve” – which will absorb these 900 million orphans and manage the flow of allowances to and from the market from 2019 according to a pre-set formula, to protect it from external shocks. What legislators in Brussels are discussing now is a much deeper “structural reform” that would enable the EU ETS to finally play its role as flagship EU climate policy.

Re-setting the baseline

“The most important thing is that the EU ETS is brought in line with the Paris deal,” says Femke de Jong, EU Policy Director at Carbon Market Watch, a Brussels-based NGO. She argues that the rate at which the Commission proposes to tighten the scheme’s emissions cap after 2020 – at 2.2% per year – is inadequate to get to an 80% economy-wide emission cut by 2050. That would require 2.4% at least. Never mind going for a 95% cut in emissions, which is ultimately what Paris may require of Europe.

Some member states and MEPs believe that the reform needs to look at more measures to boost the carbon price. In the Council of Ministers, France has put the issue squarely on the table with a proposal to introduce a carbon price floor. This has not garnered support, but it has triggered the question of whether the reform proposals go far enough. There are already several other ideas out there among legislators for more that could be done. These focus on regulating the volume of carbon allowances on the market, not the carbon price.

“The most important thing is that the EU ETS is brought in line with the Paris deal”

Most simply, the rate of cap decline could be increased. France supported an increase from 2.2% to 2.4% at the last environment council on 20 June.

A second solution could be to raise the rate at which the market stability reserve removes allowances from the system. This is currently set at 12% of the total number of allowances in circulation. Why not double it, for example?

A third option, introduced by rapporteur Ian Duncan, is for the Commission to do more to limit the impact of renewables and energy efficiency policies on the EU ETS and to let member states remove allowances for power plants that are shutting down early “due to national measures”.

An interesting new suggestion from Germany is that old and dirty plants could have to surrender more than one allowance per tonne of CO2. This opens up the door to a different carbon price for different installations – and a distinction between the power sector and industrial manufacturing. Some industry representatives have long argued that the EU ETS should be split in two because industry is exposed to international competition and runs the risk of carbon leakage, while the power sector doesn’t.

Other stakeholders have other ideas. De Jong proposes to re-set the baseline for emissions cuts, for example. “It matters where you start counting,” she explains. In practice, the EU is likely to be at 30% below 1990 emissions in 2020, according to UK-based NGO Sandbag. It predicts that EU ETS emissions will be 38% below 2005 levels, compared to a target of 43% for 2030. Hence, De Jong proposes that the EU moves the baseline for emission reductions from 2005 to close to 2020. “Basically, the idea is to eliminate the future build-up of surplus allowances. Without changing the baseline, you risk that… EU ETS caps will continue to be set above actual emissions,” she explains. The move could take two billion carbon allowances out of the system. That’s ten times as many as changing the rate of cap decline from 2.2% to 2.4%.

Several political groups in the European Parliament are considering this idea, including the Greens and the Liberals. But for others, it is too radical and goes beyond the remit of the guidance for EU ETS reform given by European heads of state and government in October 2014.

An interesting new suggestion from Germany is that old and dirty plants could have to surrender more than one allowance per tonne of CO2

Meanwhile, the European Chemical Industry Council (CEFIC) has led a cross-industry effort to convince the Commission that “real” data should also guide the discussion over handing out free allowances to compensate for the risk of carbon leakage. At a meeting with the Commission, a handful of member states, market analysts, NGOs and other stakeholders on 21 June, CEFIC led the sharing of 2014 production data and forecasts from 12 industrial sectors. The goal is to demonstrate that accurate, up-to-date information exists and can be used to distribute free carbon allowances. It is possible that “every best performer gets what he needs” say industry representatives, with no need for the controversial tiering system proposed by Duncan that scales down the carbon leakage risk – and free allowance entitlement – for some.

System change

The debates over carbon leakage and ambition have only just started. Can the EU ETS become Europe’s flagship climate policy after so many years in the doldrums? “Strengthening the ETS is always a good idea,” said Jonathan Gaventa, Director at think-tank E3G, at a debate in Brussels on 22 June, “but the stronger price will mainly affect more short-term operational decisions rather than the longer term investment decisions for big capital-intensive infrastructure… because the uncertainty over that time horizon is always going to be too high for a politically administrated measure like the ETS.” He believes policymakers in Brussels are starting to realise it is “much more looking at a system transition rather than a price to get us to decarbonisation”.

Maybe so. Duncan himself said on 20 June that the EU has been very successful at reducing emissions, just not through the EU ETS. At the same time, he writes in his resignation letter that he believes the scheme “when working well, will make a real difference”. As for all other EU affairs, Brexit casts a shadow over the EU ETS reform, in particular because its pragmatic rapporteur is looking like a direct casualty. But neither the reform, nor the scheme itself, is going away and whatever other policies may sit around it, the EU ETS is a central part of EU climate and energy policy. It will have to be recalibrated to a post-Paris world.

EUEnergy App: your guide on EU energy data  from Energy Post and Shell

The EUEnergy App provides users with statistics on EU and national greenhouse gas emissions, energy and electricity mixes, renewables, gas infrastructure and electricity prices, from 1990 till the present day. All in an easy-to-use and interactive format. The EUEnergy App was introduced in December last year for Apple and in May this year for Android. It will be updated every year with the latest data from Eurostat. You can download it here.

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