European Trading System Reform
The EU emissions trading system (EU ETS) is a cornerstone of the European Union’s policy to address climate change and it represents a key tool for reducing GHG emissions cost-effectively. However, the scheme has been witnessing severe challenges. To address them, the European Commission has approved a range of measures.
The EU’s emissions trading scheme (EU ETS) was launched in 2005 to promote the reduction of GHG emissions in a costeffective and economically efficient way. It works on a “cap and trade” principle. A cap, set by the EU, is set on the total amount of certain GHG that can be emitted by the industries, power plants and other installations in the system. The cap is reduced over time so that total allowed emissions gradually decreases. Within the cap, companies receive or buy emission allowances which they can trade as needed.
However, in recent years, weak demand for allowances, largely due to the economic crisis, has led to a surplus of allowances, which has depressed the carbon price.
To address the problem, the EU Commission has introduced two mechanisms: backloading in 2014 and the Market Stability Reserve in 2015.
The Backloading was implemented through an amendment to the EU ETS Auctioning Regulation which entered in force on February 2014. It has been designed as a short-term mechanism that consists on postponing the auctioning of allowances. In particular, the auction volume has been reduced by 900 million allowances (400 million in 2014, 300 million in 2015 and 200 million in 2016). By such, the backloading is aimed at rebalancing supply and demand in the short term, and reducing price variations.
The Market Stability Reserve (MSR) is a long-term, structural measure approved by the European Parliament of 7 July 2015 and by the Council on 6 October 2015. The MSR aims at reducing the historical surplus of allowances and improving the resilience of the EU ETS by adjusting the supply of allowances to be auctioned. The scheme will start operating in 2019 and is expected to put Europe on the right track to achieve its ambition to cut greenhouse gas emissions by 40% in 2030 compared to 1990 levels.
In accordance with the MSR, when in a given year the total emission allowances exceeds a certain threshold, a percentage of allowances will be automatically withdrawn from the market and placed into the reserve. In the opposite case, allowances will be returned from the reserve to the market.
Under the scheme, backloaded allowances (900 million postponed allowances withdrawn from the market at least until 2019), will be placed in the reserve when in starts in 2019. Unallocated allowances from the period 2013- 2020 will be also added in the reserve as soon as in 2020.
For the period 2021-2030, market imbalances would also be addressed by a faster reduction of the annual emissions cap. The European Commission is proposing reducing the overall number of allowances by 2.2% each year compared to the current figure of 1.74%.