A well-functioning Emissions Trading System (ETS) and meaningful carbon price signal are poised to spur sustainable investments in power generation. Ensuring proper functioning requires addressing both the long and short-term supply of emission allowances. It also means making the two major mechanisms of the EU ETS the two pillars of carbon neutrality. These mechanisms are the linear reduction factor, which sets the trajectory of decarbonisation, and the market stability reserve, which controls the supply and demand of allowances.
These measures are essential to ensure the European Green Deal’s success in achieving climate neutrality by 2050, while stimulating economic growth.
ETS CAP GEARED TO NET ZERO WELL BEFORE 2050
The ETS trajectory needs to be revisited and aligned with possibly increased EU 2030 greenhouse gas reduction targets. The overall cap on the total volume of carbon dioxide emissions, known as the linear reduction factor, is currently set to decline annually at a 2.2% rate — insufficient to reach increasingly ambitious climate targets.
Timing is essential in this debate. If the linear reduction factor is adjusted upwards now, the reduction of emissions will be gradual. If it comes later, however, the adjustment needed will be higher. Any delay increases the risks of a steep and disruptive removal process in a short timeframe.
The speed and scale of emissions reduction throughout the whole economy is also highly and directly dependent on the burden sharing between ETS and non-ETS sectors, such as road transport and maritime. This proves how much each industry needs to contribute to overall decarbonisation goals.
Currently, fewer than 45% of all EU greenhouse gas emissions are covered by the ETS. This number will plunge in the coming years due to the increased decarbonisation of the power sector. The role played by the ETS in the decarbonisation of electricity proves undeniably that a meaningful carbon price on all sectors is needed if we are serious about climate neutrality.
MARKET RESILIENCE FOR A STABLE PRICE TRAJECTORY
A surplus of allowances in the ETS undermines the proper functioning of the carbon market in the short and medium term.
A stable and meaningful ETS price trajectory over the next decade can be ensured through the update of the design parameters, namely the intake rate and thresholds of the market stability reserve. The 2021 review must sediment the reserve’s ability to ensure prompt reaction to past and future sources of market imbalances, and continue to bring a meaningful carbon price.
A steep change in demand for allowances, triggered by a large volume of coal plant closures in a single year, raises concerns about this mechanism’s ability to manage large removals in the short term. Member states will need to execute voluntary cancellations of those allowances corresponding to the closure of coal plants in order to maintain sufficient scarcity in the ETS.
FUNDING THE TRANSITION
Compliance with more ambitious measures would bring about higher investment needs and potentially additional operational costs associated with the purchase of allowances. This would require earmarking of a significant percentage of EU ETS revenues for the transformation of energy generation, especially in the case of countries with high carbon intensity and low GDP per capita levels.
Currently, EU member states are encouraged, but not required, to do so. It is now essential to leverage ETS generated funding into clean power generation projects. As Europe takes global leadership in addressing climate change, European industry must be able to compete, while knowing that investing in decarbonisation efforts is a no-regret decision.
ALL EMITTING SECTORS NEED TO CONTRIBUTE
Progress in emissions reduction has been observably slower for sectors outside the ETS. All sectors must contribute to the achievement of climate targets. And that means putting a meaningful price on carbon.
In this sense, sectors which are not exposed to a CO2 price, like maritime, or have an insufficient CO2 price — such as individual heating in some member states — should be addressed. This means either extending the scope of the ETS or applying other carbon pricing measures, using the most efficient tool for each sector.
At a global level, the number of operational ETS schemes had grown to 21 as of January 2020. Many other jurisdictions, such Ukraine, Serbia and the other eight Contracting Parties to the Energy Community Treaty, are also looking into putting a price on carbon. This approach appears, in particular, to be a logical alternative at the EU’s borders, where countries are working on developing an EU-proof carbon pricing mechanism, which allows a potential extension of the EU internal energy market.
The path to reaching climate neutrality by 2050 requires ample policy solutions that preserve both the environmental integrity and the competitiveness of European industries. This is why the Green Deal should promote mechanisms that make domestic industries more carbon efficient and, at the same time, encourage third parties to become more climate friendly. An active European role in climate diplomacy is essential and should be reflected in all relevant debates with international partners.
The views expressed in this opinion are those of the author and do not necessarily reflect the position of FORESIGHT Climate & Energy
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