A major legislative reform process has just been completed. Nevertheless, there clearly remains a gap between the state of ETS (even with the current reforms) and what’s necessary to achieve cost-effective pathways to a prosperous low carbon European economy consistent with the EU’s international climate change obligations.
The report’s five main recommendations are below:
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(Published 7th Dec 2017)
The EU ETS should be retained, but requires further substantial reform to become effective
However recent reforms have failed to adequately address the fundamental problems with the EU ETS. A process of continuing substantial reform in the coming years is needed to turn the EU ETS into a more effective policy instrument, and so enhance its credibility within the EU and restore the EU’s leadership internationally.
Reforms leave the ETS with a continuing enormous surplus (blue bars)
-assuming emissions reductions continue at a similar rate
Current caps and long-term targets need to be revised in light of the Paris Agreement
The level of emissions allowed in 2050 is currently uncertain by a factor of four, and this is too wide a gap for effective system design. The EU’s overall emissions target of 80-95% reduction by 2050 needs to be clarified to a single, specific emissions reduction target.
To reflect the objectives of the Paris Agreement a single, stringent long term target needs to be accompanied by a rapid path down towards this target, consistent with early peaking of global emissions, the need to severely limit cumulative emissions, and to achieve net zero emissions in the second half of this century.
The milestones for ETS reform
Complementary measures will continue to be necessary
The UK’s power sector carbon tax has rapidly reduced emissions from coal
New mechanisms are needed to make the ETS resilient to unexpected events
Adjusting supply of allowances in response to price by introducing an auction reserve price to provide a price floor would improve the economic efficiency of the EU ETS by creating more efficient price signals and stimulating investment. Similar measures have worked well elsewhere and there is every reason to suppose they would do so in the EU ETS. It is essential as part of this that the auction reserve price is at an adequate and increasing level.
The measures to improve the Market Stability Reserve (MSR) agreed in the latest reforms are welcome, especially the provisions to limit its size. Further MSR reform should include reducing thresholds. The rate of transfer, currently set at 24% for the next five years, should be further increased and extended.
A five year ratchet mechanism could bring down the ETS surplus
– by adjusting the ETS cap to actual emissions
Continuing reform of auction revenue and carbon leakage protections
Uses of the revenue raised by auctioning of allowances should be reviewed. There are several worthwhile uses for revenue. These include furthering emissions abatement, for example through supporting the development of new technologies and promoting energy efficiency for low income household. There are also strong arguments for using funds for adaptation, for compensating those adversely affected by climate change, and for distributing revenue directly to citizens.
As emissions continue to reduce, the advantages of expanding sectoral coverage of the EU ETS in the long term are likely to increase, and sectoral coverage should be reviewed in future. Other systems, notably in California, have shown that broad sectoral coverage can be easily implemented and can operate effectively.