1. The EU ETS in the 2020s - Status of Phase 4 reform and overlap with other policies
Presentation to British Institute of Energy Economics
Climate and Energy Seminar
08 February 2017

2. EU ETS state of play
Compliance with targets (cap & trade), but consistently low prices
Phase 1 –
Phase 2 –
Phase 3 –
Structural reform – backloading as temporary measure, then the MSR as the permanent fix to surplus
Latest chapter – Phase 4 of the ETS starting in 2021
EC proposal released Jul15
Ordinary legislative procedure (co-decision)
EP Committee (ENVI) vote Dec16
EP Plenary vote Feb17
Trilogues – Mar-May17?
Council decision Jun17?

3. Market Stability Reserve – the one structural reform
To start in 2019 – reduces auctioning volumes in a given year by 12% of surplus from previous year
Min 100 Mt annual withdrawal so effectively withdraws when surplus above 833Mt (100/0.12)
Lower surplus limit of 400Mt below which allowances begin to return
Fixed return rate of 100Mt annually

4. Preliminary data shows emissions in 2016 down 49Mt compared to LRF of 38Mt - structural surplus above 3Bt for the first time
Emissions have been consistently below the cap
Structural surplus in ETS

5. Reductions to date due to power sector policies – no incentive for economy wide decarbonization due to persistent surplus and low price

6. Price history – alternatively driven by regulatory changes and other commodity markets rather than system supply & demand
Recession leads to fall in emissions, market realizes surplus will last…
COM Energy Efficiency Proposal
Commodity markets fall led by oil
Initial rejection of backloading by EP Plenary

7. Emissions continue to be below the cap during the rest of Phase 3 …

8. …so the total surplus will be 3.8-4.4 billion tonnes by 2020 …

9. With current EC proposals annual surpluses will be generated until late in Phase 4 and possibly throughout …
Sandbag estimates of renewables generation & power demand to 2020
Base emissions scenario then EU Reference Scenario for the period

10. Emissions in Phase 4 are likely to be below the cumulative cap (without the existing surplus) even if the EUETS itself leads to little abatement
We consider it unlikely that emissions will be above our base case

11. By 2030 the MSR will contain 3-5 billion tonnes with some surplus still available to market
Consequences of large MSR are to destabilize the market by creating uncertainty about what will happen to such large volumes –total is a quarter to half of cumulative Phase 4 cap
At current rates of release, all MSR volumes would only return to market around 2070

12. Doubling MSR deduction rate for four years has little effect by 2030 because the surplus persists through Phase 4
Increasing the rate at which allowances are placed in the MSR does not change the fundamental supply-demand balance by the end of the period …
Price effect may increase surplus slightly by lowering demand, but this effect is likely small

13. Cancellation of 800Mt from MSR becomes relevant in 2050s
Cancellation will not have an impact because the MSR will contain 3.7 – 5.4Bt by 2030 and it only returns 100Mt/yr. Effect will be felt in 30 years

14. Increasing the LRF to 2.4% has only a minor impact on the market before 2030
The cumulative surplus in 2030 is reduced by 242Mt during Phase 4 (3-5% of cumulative surplus in 2020, 1.6% of cumulative cap for Phase 4). In 2030, the cap difference is 44Mt.
Assuming the same rates, the cumulative cap difference is over 2Bt by 2050

15. Emissions in Phase 4 are likely to be below the cumulative cap (without the existing surplus) even if the EUETS itself leads to little abatement
39Mt due to MSR rate change
234Mt due to MSR rate change
We consider it unlikely that emissions will be above our base case

16. Rebasing the cap has immediate impact from 2021, because it addresses the surplus at source
A surplus is no longer being generated in Phase 4 and the existing surplus will immediately start decreasing
*Forecast 2020 emissions used as the new cap starting point
Increasing the LRF in addition to rebasing further increases stringency.

17. Because rebasing aligns to actual emissions it is robust to different outcomes over the remainder of Phase 3
If emissions fall faster or slower than anticipated to 2020, rebasing would still ensure that the surplus does not continue to grow throughout Phase 4
*Forecast 2020 emissions used as the new cap starting point
In the highly unlikely case of emissions above the cap in the existing cap would be an upper limit.

18. Price impact is moderate
Price impact is moderate. Even with rebasing prices, reach the expected Ph 3 level of €30/t only around 2030.
Note: Price scenarios are indicative only, based on analysis of the supply demand balance and abatement cost assumptions. They are for the purposes of comparing reform options only.

19. Weak ETS is likely to lead to more “overlapping” action, but this may still reduce cumulative emissions
A weak ETS, with prices too low to stimulate necessary investment, is likely to lead to more actions by Member States (or the EU) concerned about appropriate long term trajectories
The traditional view is that such “overlapping” policies do not decrease cumulative emissions, which are fixed by the cap
However the surplus means that this view is unlikely to hold in practice
Additional actions increase the surplus
The majority of this is absorbed into the MSR
This is likely to lead to reduced emissions over time, either because further volumes are cancelled from the MSR, or because they enable tighter caps (especially as they would take several decades to return)
These factors apply to some extent even without a surplus

20. Conclusions
Emissions expected to continue declining
ETS design not robust enough to avoid another decade of irrelevant prices
Proposal includes sensible small steps to fix system, but unlikely to restore scarcity before end of 2020s
More policy overlap likely as prices stay depressed until surplus is removed while MS try to comply with long term trajectory