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Reform Options for the European Emissions Trading System (EU ETS)

Euro-CASE convened in Brussels on 24-25 September to inform about the policy paper on reform option of the European Emission Trading System (EU ETS) and present it to relevant European decision makers.
  

reform1Ottmar Edenhofer, Co-Chair of the Euro-CASE Energy Platform and Deputy Director and Chief Economist of the Potsdam Institute for Climate Impact Research (PIK) and responsible for the report “Reform Options for the European Emissions Trading System“ met with Jos Delbeke, Director-General for Climate Action, European Commission and Ivo Belet, MEP and rapporteur for the EU-ETS to present the Euro-CASE reform proposal in detail. Both were grateful for the scientific contribution of the Academies. The report was also sent to over 1500 stakeholders, among them the Commissioners for Energy and Climate Action and persons associated with the topic in the European Institutions.
Ottmar Edenhofer emphasised that a reform of the EU ETS is urgently needed to tackle the climate challenge. “In its present form the system does not incentivize the required investments in climate-friendly technologies,” he said. Without a far-reaching reform the EU ETS could fail and endanger European cohesion in climate policy.
Euro-CASE welcomes the efforts of the European Commission to reform the EU ETS. Instead of a Market Stability Reserve the reform proposal suggests to implement a price collar for the CO2 price with lower and upper boundaries to solve the problems related to the long-term steering effects of the current EU ETS. The price collar is likely to reinforce the long-term credibility and reliability of the price signal and to help stabilizing investors’ expectation.reform2
The Euro-CASE Policy Position Paper also proposes to integrate the heat and transport sector into the system which so far is limited to the power sector and some industries. In addition, it contains recommendations for a targeted innovation policy and proposes to address carbon leakage through tailor-made trade policies and to increase the coalition of countries included in the carbon pricing.
The Euro-CASE recommendations are launched at a time when the political framework for the energy and climate policies for the period beyond 2020 is being negotiated between the European Parliament and Council. The discussions are based on the communication “A policy framework for climate and energy in the period from 2020 to 2030” put forward by the European Commission in January 2014.

    
  

Download the Euro-CASE Policy Position Paper 'Reform Options for the European Emissions Trading System (EU ETS)'

 

Executive summary

The central pillar of European climate policy, the European Emissions Trading System (EU ETS), is currently questioned in its ability to deliver its objectives as the allowance price is persistently low at around 5€ / tCO2. The cap was met and emissions actually declined in recent years, ensuring the environmental effectiveness of the scheme. However, the low price may affect the long-term cost-effectiveness of the instrument by reducing the incentive for investment and deployment of low carbon technologies. Consequently, no significant increase in the EU ETS allowance price is expected before 2020, and probably not beyond, without reform. While the reasons for the price decline are controversial, empirical analysis shows that only a small proportion of price fluctuations can be explained by factors such as the economic crisis, renewable deployment or international offsets. Therefore, it is likely that political factors and regulatory uncertainty have played a key role in the price decline. As a consequence, any reform of the EU ETS has to deliver a mechanism that reduces such uncertainty and stabilizes expectations of market participants. The Market Stability Reserve as proposed by the EU Commission is unlikely to address the problem of the low price, and the uncertainty of future price development remains substantial. The ability of the Market Stability Reserve to deliver long-term cost-effectiveness is thus questionable.
The key element of the alternative reform proposal by Euro-CASE is to set a price collar in the EU ETS with lower and upper boundaries. This is likely to reinforce the long-term credibility and reliability of the price signal. In addition, a price for the GHG emissions not covered by the EU ETS has to be set. If additional market failures prevent the market from functioning efficiently, specific policy instruments related to innovation and technology diffusion should be implemented in addition to carbon pricing. Carbon leakage could be addressed through tailor-made trade policies. In parallel, increasing the coalition of countries included in the carbon pricing should remain a priority. This reform package would bring the EU ETS back to life. At the same time, it would avoid a relapse into national climate and energy policies across Europe, which could result in much higher costs and inefficiencies. The following seven theses present a comprehensive reform proposal of the EU ETS.
 

  • 1. Pricing carbon is essential for climate policy.
  • 2. The EU ETS is a market where scarcity is governed by political decisions and thus expectations of market participants about future political decisions are critical.
  • 3. In view of the low EU allowance price since early 2013, the key concern regarding EU ETS performance is dynamic efficiency.
  • 4. There are several reform options for the EU ETS which can be broadly categorized as instruments addressing either the price directly or the supply of permits. Another dimension is institutional and pertains to the degree of delegation embodied in a reform proposal.
  • 5. The Market Stability Reserve (MSR) proposed by the Commission does not address the problem of long-term cost-effectiveness and price uncertainty.
  • 6. Instead of a narrow reform of the EU ETS, a fully-fledged reform addressing several aspects of carbon pricing is required.
  • 7. The political feasibility of implementing a reform package might be limited.
      

Download the Euro-CASE Policy Position Paper 'Reform Options for the European Emissions Trading System (EU ETS)'