The European Union is testing the waters for a sweeping overhaul of the world’s biggest carbon market that is set to drive up prices and extend the system to cover ships.
The European Commission is drafting a law to align the EU Emissions Trading System with the Green Deal’s objective of reaching climate neutrality by 2050 and opened a public consultation on the measures on Friday. The process sheds some light on the scenarios the EU regulatory arm is considering to strengthen the cap-and-trade program, where prices more than tripled over the past three years.
The measures could include new financial instruments to support innovative technologies. For the existing system, policy makers are seeking feedback on a one-off reduction in the EU ETS pollution cap and increasing the pace at which emission limits shrink every year. They also are weighing cancellation of CO2 permits in a special reserve, strengthening the reserve and an early application of a tighter emissions cap, for example in 2023 rather than later. Those measures would tighten supply in the system.
“The most decisive thing the Commission could do would be to go for a one-off reduction in the cap in, say, 2023, as that would make the market realize that things need to get serious already now, today,” said Mark Lewis, global head of sustainability research at BNP Paribas.
The challenge for the EU is to design the complex reform in a way that puts the carbon market in sync with a proposed stricter carbon-reduction goal for 2030 while ensuring the bloc’s businesses remain competitive with their rivals abroad. The commission wants to accelerate emission cuts across the economy to at least 55% by the end of the next decade from 1990 levels. The current target is to lower them by 40%.
Started 15 years ago, the EU carbon market is the region’s flagship climate policy tool and covers about 45% of its greenhouse gas emissions. It imposes gradually shrinking pollution limits on almost 12,000 facilities owned by utilities and manufacturers and also covers CO2 discharges from airlines.
Under the existing climate goal for 2030, emissions from companies in the EU ETS will shrink by 43% compared with 2005 levels. The new headline target of 55% would require a 63% cut in sectors currently included in the carbon market.
To reach that level, a “big one-off reduction in the cap” in 2023 could be accompanied by increasing the rate at which the annual pollution limit in the program shrinks each year, according to Lewis. The so-called Linear Reduction Factor is 1.74% in the eight-year trading period through the end of this year and will rise to 2.2% from next year.
For Lewis, the second-best option would be to maintain for longer than planned tougher parameters of the Market Stability Reserve, a mechanism designed to alleviate the supply of surplus permits. The MSR absorbs 24% of carbon allowances in circulation each year until 2023, falling then to 12%. The commission is analyzing a scenario of keeping the higher rate beyond 2023 while also asking for feedback on sticking to the current regulation, lowering the rate or increasing it further.
Keeping the 24% rate until 2030 would be consistent with the stricter climate target the EU is seeking and would translate into a 65% cut in emissions from sectors covered by the CO2 market compared with 2005 levels, Lewis said.
The commission is also seeking opinions on whether the current provision on canceling permits in the MSR should be maintained. That would mean limiting the number of CO2 permits in the reserve to a level no higher than the auction volumes in previous year. Holdings above that level would lose their validity within the system.
Investors, national governments, experts, individuals and non-governmental organizations have until Feb. 5 to submit their feedback. The commission plans to propose a law to overhaul the carbon market in June.
As part of the revision, the EU is also drafting a plan to put a price on emissions from shipping, an ever-growing source of pollution. Options include extending the carbon market to cover maritime transport, setting up a specific emissions trading system for shipping or introducing a tax at the EU level.
While the commission had already signaled it will consider including “at least intra-EU” maritime transport in its carbon market, it’s also seeking feedback on whether voyages between Europe and ports outside the region should be addressed by carbon pricing.
“As carbon pricing will not be able to address all barriers to the deployment of low and zero emissions solutions, a basket of other complementary policy actions at EU level are needed to trigger further investments in clean energy technologies and infrastructure,” the commission said, signaling it will look into laws on mobility, transport fuels and energy taxes to ensure synergies.