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

EU ETS state of play Compliance with targets (cap & trade), but consistently low prices Phase 1 – 2005-2007 Phase 2 – 2008-2012 Phase 3 – 2013-2020 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?

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

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

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

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

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

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

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 2021-2030

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

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

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

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

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

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

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.

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 2020 the existing cap would be an upper limit.

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.

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

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