10 Years of EU Emissions Trading – and Beyond

© Dirk Vorderstrasse/flickr (CC BY 2.0)

2015 marked the ten year anniversary of the EU greenhouse gas emissions trading system, or ETS - an occasion on which to reflect on how far the program has come and focus on how to improve the program for the future. Presently, the EU ETS is under review. This overhaul is necessary because in October 2014 Heads of State and Government have tightened the reduction objective for the fourth trading period (2021 – 2030). Emissions trading as market-based and technology-neutral approach continues to be the “right” instrument for cost-efficient climate protection. The BDI therefore supports this review of the EU ETS as long as effective precautions are taken to protect our companies’ international competitiveness also in the future.

The ETS was introduced across the EU on January 1, 2005. The program covers approximately 12,000 installations in 31 countries, equating to roughly 45 % of the EU’s total greenhouse gas emissions. Since January 1, 2012 the aviation sector has also been included under the ETS. However, while this extension of the ETS was done in the hopes of encompassing all flights taking off from and landing on EU territory, the decision was met with strong protest from other nations, including China, Russia, and the United States. As a result, for the time being only intra-European flights are covered under the program.

 

January 1, 2013 marked the beginning of the third trading period (2013-2020) of the ETS. This trading period is governed by markedly different rules than those governing the second trading period, from 2008 - 2012. These new rules are based on a 2009 amending directive, which set an extremely sharp emissions reduction commitment effective in 2013: a 21 % reduction in greenhouse gas emissions by 2020 from 2005 levels. Additionally, since 2013 as a matter of law emissions allowances have mainly been allocated by auction, marking an end to the previous period in which certificates were given out by governments at no cost.

 

The overall viability of the ETS system is impacted by Europe’s ongoing economic and financial crisis. A sluggish economy has resulted in occasionally extreme slumps in production, and thus decreases in emissions subject to the ETS. However, as the allocation amounts (aka the ‘cap’) were established under law in advance of and irrespective of actual production and emissions levels, the amount of allowances cannot be adjusted to reflect this reality. This has resulted in a surplus of allowances and a drop in allowance price in response to imbalance between supply and demand. Thus, the instrument ETS as such works as expected: a drop in demand entails lower prices.

 

The resulting relatively low CO2 price prompted calls for political intervention on the grounds that the ETS has not produced the intended effect of steering the transition to a low carbon economy. Such intervention, including calls to implement price raising measures, are not supported by the BDI. The BDI has always strongly opposed attempts at price control, as doing so would undermine the rationale of the instrument, which is explicitly designed for volume control.

 

That said, it must be acknowledged that the ongoing oversupply in the ETS is incompatible with the basic principles of emissions trading, which by definition is predicated on and indeed only works with a shortage of allowances. A so-called Market Stability Reserve (MSR) has been devised in the meantime to re-establish a certain scarcity in the market. This MSR is to control the total number of allowances in circulation as of 1 January 2019. Transfers in and out of the reserve would make the CO2 market more resistant to severe demand shocks. Furthermore, such a remedy should help establish greenhouse gas emissions reduction as the key objective and the market-based ETS as key instrument, goals the BDI has long advocated for.

 

In July 2015, the European Commission presented its legislative proposal for ETS reform with respect to the fourth trading period, to begin in 2021. The proposal stipulates a significantly increased contribution to overall EU emissions reductions from installations subject to the ETS, as it includes an emissions reduction target of 43 % by 2030 as compared to 2005. Given the current and future challenges the ETS incumbents have to face, the BDI insists that when it comes to a going beyond 2020 a thorough public debate and discussion is needed. In particular, the international context in which European climate policy takes place should be taken into account, as well as consistency and coherence in climate and energy policy. The BDI will continue to constructively engage in this debate on the structural adjustments to the EU ETS for future trading periods.