A watershed moment for Europe's ETS

On April 16, the EU Parliament will take a vote on the so-called ‘backloading’ proposal to delay the issuing of EU emissions permits. The outcome of the coming vote is unclear.

If the measure gets passed, markets will take this as a sign there is political resolve to reform the EU ETS and breathe more ambition into the scheme. If not, then EU ETS prices are likely to collapse further than they already have.

It is unusual to refer such a detailed issue of policy to the Parliament. And unusually the parliament doesn’t seem to be split along the usual bloc or national lines, making it difficult to predict the outcome. At the German government’s emissions trading conference in Berlin, delegates are trading rumours about the numbers in the EU Parliament. Most think the vote will be very close.

The next question is what will happen to the EU carbon price. Presumably it will rise if the vote is in the affirmative, perhaps a lot. And it is bound to fall further if the proposal is rejected. It could be a watershed.

There is no purely economic reason why the backloading proposal should affect the price much. This is because backloading simply means that the release of 900 million permits will be deferred from 2013-15 to 2019-20. Permits are already bankable, so it would make no difference to the amount of permits available between now and 2020.

But it makes a big difference to the market’s perception of political resolve to change the settings of the EU ETS to support the price. The economic slump means energy use and emissions have been subdued, doing much of the work that the carbon price would otherwise have needed to do. In each of the last few years, more permits were issued than needed to cover emissions.

The cap, or amount of permits, meanwhile is fixed in legislation, declining by 1.74 per cent per year irrespective of economic conditions. Continued to 2050, this would take EU emissions to 80 per cent below 1990 levels.

Changing the cap is what is now under discussion. Proposals for structural reform of the EU ETS are swirling around, from a ‘rolling caps’ system akin to Australia’s, to handing permit supply decisions to an independent agency, or introducing a price floor.

All of these proposals would result in fewer permits being issued in future years. A shift to a 30 per cent reduction target for 2020 would have a similar effect, as it would imply tightening the annual percentage reduction. A one-off option would be to cancel an amount of permits, rather than just postponing their release.

Structural reform of the EU ETS is not likely to be decided anytime soon. The decision-making process among the 31 nation states in the EU ETS is tortuous. Don’t expect any major changes until well after the next EU Parliament and EU Commission are in place, both coming in during 2014.

Meanwhile, if the EU Parliament votes against backloading on April 16, then markets will interpret this as a sign that there is little appetite or ability for EU member states collectively to strengthen ambition for the EU ETS. If so, then permits will be going very, very cheap. If backloading gets the thumbs-up, then the permit price will probably hang in there.