EU Narrows Down Carbon-Market Overhaul Options, Climate Action Commissioner Says

By Ewa Krukowska and Mathew Carr

The European Union's regulatory arm is winnowing down the options for a long-term overhaul of the world's biggest carbon market and aims to make a decision in the coming months, EU Climate Action Commissioner Connie Hedegaard said.

The European Commission has floated several scenarios to help curb a record glut of emission permits and boost the price of carbon in the bloc's €54 billion ($72 billion) Emissions Trading System, where prices slumped to an all-time low in April.

“We're now narrowing down the options and we will propose something in the autumn,” Hedegaard said in an interview in Brussels Aug. 27.

Among the tools the Commission is considering is a flexibility mechanism that would link the supply of carbon permits with the European Union's industrial activity, Jos Delbeke, director-general for climate at the Brussels-based Commission, said in May.

The idea of an automatic supply-adjustment tool is getting prominence in the climate department, according to a person familiar with that matter who declined to be identified, citing policy. The climate department is drafting measures to overhaul the carbon market, which then need approval from the commissioners.

Carbon Market

The concept of a flexibility mechanism was floated in the public consultations on the overhaul among governments, traders, and industry by groups including the International Emissions Trading Association and Tschach Solutions, a market analysis firm.

It adds to six scenarios sketched out by the Commission in a November report on the carbon market, including a tighter climate goal, cancellation of carbon permits, mechanisms to support emission prices, and limits on imported credits.

The ETS needs a mechanism that allows stricter emission reduction targets while avoiding excessive price increases, according to Ingo Tschach, managing director at Tschach Solutions.

One option would be to “adapt on a yearly or quarterly basis auction volumes based on past economic growth,” Tschach said by telephone Aug. 28. “It's very easy to explain. It's probably easiest to agree on.”

IETA proposed a “dynamic allowance reserve” or a free allocation of permits based on actual output. Any such mechanism should be operated in a transparent, independent, and predictable manner and should be triggered by “quantitative thresholds, not price levels,” the lobby said in its consultation paper.

Economic Crisis

The European cap-and-trade program imposes pollution limits on about 12,000 manufacturing companies and utilities in the region, including Germany's largest utility EON SE and steelmaker ArcelorMittal. The system, in which caps were set before the economic crisis, doesn't allow any price floors or ceilings. After the slump reduced industrial production and cut into demand for pollution rights, the surplus of permits rose to around 2 billion metric tons last year, a level almost matching the annual supply, according to the Commission.

But linking carbon supply with a measure of economic activity presents “conceptual and practical problems,” according to Trevor Sikorski, an analyst at Energy Aspects Ltd. in London.

“Such a plan presupposes there's a right price for carbon,” he said, adding that the European Union should set the emission reduction target and let the market set the price.

The Commission has said current carbon prices are too low to stimulate investment in low-emissions technology.

Backloading Measure

To help boost prices before an overhaul of the market is enacted, the Commission last year proposed a short-term fix known as backloading. The emergency plan, which was supported by the European Parliament in July and is awaiting a verdict from national governments, would delay auctions of some permits, alleviating the record glut (36 INER 948, 7/17/13).

Negotiations between the Parliament and member states about the final wording of the backloading measure will start after Sept. 22 elections in Germany, Hedegaard said Aug. 27. The government in Germany, the biggest European economy, remains undecided whether to back the plan, with Economy Minister Philipp Roesler opposing carbon-market intervention and Environment Minister Peter Altmaier advocating a move to help prices rebound.

“The backloading in itself will never re-establish the price that would give the strong signal that we need; that was also never expected, it was never intended to,” Hedegaard said. “It was intended only to stabilize the situation while we were discussing the more far-reaching things, the more structural options.”