The EU's Emissions Trading System (ETS) risks suffering a "lost decade" unless policymakers bring forward plans to combat the oversupply of allowances dogging the market, Climate Change Capital (CCC) has warned.
As part of a proposed 2030 environment package that would overhaul the ETS, the European Commission wants to introduce a market stability reserve (MSR) to automatically withhold 12% of allowances in circulation each year, only releasing them if the circulation falls below a certain level.
The Commission has proposed that the MSR starts operating in 2021, but a white paper – written by Martin Schoenberg, head of policy at environmental asset management and advisory group CCC, and seen by Environmental Finance – argues that the MSR should be brought in four years earlier, or crucial investments in low-carbon infrastructure will be delayed to the mid- to late 2020s.
The paper also argues that the 900 million allowances set to be temporarily withheld from the market to prop up prices in an initiative known as 'backloading', should not be returned to market in 2019 and 2020 as currently planned. Instead, they should be placed directly into the MSR in order to restore investor confidence in the beleaguered market.
Prices in the EU ETS have slumped to below €5 ($6.80) in the past year from around €30 in 2008 due to the glut of EUAs in circulation as a result of the sharp decline in industrial activity since the financial crisis. The current surplus has been estimated at just over 2 billion allowances. Prices have in recent days pushed beyond €7 as EU ministers this week approved plans to fast-track backloading.
"Before major investment decisions in the power sector are made based on the ETS, the price needs to reach a significant level and stay there for a prolonged period of time," the paper argues. "The ETS needs to go through a period of success before its credibility is restored. If this period of success is only started in 2021, the ETS will miss the opportunity to make an impact on most of the power sector investments that will shape the success or failure of the EU to reach the 2030 greenhouse gas target."
The paper goes on to warn that if carbon prices do not recover sufficiently, high-carbon energy assets will continue to be built, which will then become 'stranded' when the carbon price reaches "significant, abatement-grade levels in the mid- to late 2020s".
"The further we push a high carbon price into the future, the further we delay transforming our power sector and the more capital we waste on high-carbon assets," the white paper adds.
There have been calls for the formation of a 'carbon central bank' to regulate supplies of allowances, but the paper argues that an MSR would be more effective because it will provide more predictability to market participants, whereas the actions of a central bank would be discretionary.
"The ETS has been rendered nearly irrelevant due to its fixed cap, the significant surplus of allowances in the system, and the resulting inability to deal with large demand shocks," the white paper says. "This needs to change, because the ETS has the potential to become the primary driver of decarbonisation in the EU and therefore, through its design, ensure the most cost-effective route to decarbonisation. Re-establishing the EU ETS as a successful instrument of climate policy will also drive the introduction of carbon markets across the world."
Peter Cripps