Killing carbon: Ten years of the EU ETS

When its carbon price fell to record lows last year, Europe's emissions trading scheme became more of a compliance formality than investment driver. But a planned re-calibration should see it driving decarbonisation again soon.

Shell blog

This month the EU Emissions Trading System is 10 years old – which in itself is quite an achievement as there were those at the start who said it wouldn’t last and any number of people over the years who have claimed that it doesn’t work, is broken and hasn’t delivered.

Yet it stays with us, continues to be the bedrock of the EU policy framework to manage CO2 emissions and despite issues along the way, is now likely to receive a significant overhaul in time for 2020 when a new global deal on climate change should kick-in.

The ETS started life as a relatively short draft Directive (EU ETS Draft Directive 2001) back in 2001 and has expanded since then with appendages such as the linkage Directive and the 2008 Energy and Climate package (e.g. NER300) and will likely expand again with the proposed addition of the Market Stability Reserve.

But the simple concept of a finite and declining pool of allowances being allocated, traded and then surrendered as CO2 is emitted has remained and despite various other issues over the years the ETS has done this consistently and almost faultlessly year in and year out. The mechanics of the system have never been a problem.

The one issue that has plagued the ETS has been the price – from some arguing it was too high at the start to many now concerned (including me) that the surplus of allowances and consequent low price has stopped all direct investment in emission reduction projects.

10 Years of the EU ETS

With investment as a goal, the heyday of the system was 2007-2008 when Phase II was underway and confidence was rising that a long term carbon price signal had emerged in Europe to guide decarbonisation efforts going forward. There was plenty of evidence that this was really the case. Fuel switching to gas was gathering pace, innovative projects were being considered in many industrial facilities and when the European Parliament agreed the NER300, some 20 CCS (carbon capture and storage) projects were initially tabled with the Commission for consideration. After all, at a CO2 price of ~€30 (~$42 in AUD today) that meant ~€9 billion ($12.7 billion) of project funding and sufficient support for the operational cost of CCS. But as the price fell to a low of <€4 ($5.6) in April-May 2013, everything evaporated. The ETS became more of a compliance formality than an investment driver.

Last week I participated in a lunchtime seminar on the Future of the ETS held within the European Parliament in Strasbourg, France. Unlike some lunchtime events I have attended over the years, this one was packed, with standing room only. There is real and genuine interest among many MEPs (Members of the European Parliament) to reform this instrument and return the CO2 price to its rightful position as the key market signal to drive change in the energy system. After all, there are plenty of good reasons to do this, starting with the most important reason of all – it’s the most economically effective way of doing the job.

The seminar focused primarily on the proposed Market Stability Reserve (MSR), which is an intended pool of allowances that can be drawn on in the event of excessive tightness in the allowance supply/demand balance or added to when a surplus prevails. The conceptual design of this mechanism now seems to be largely agreed, but the operating parameters are still being negotiated between Member States. Most importantly is the question of a “first fill” of allowances and the intended start date of the process. Given the significant surplus that now exists, it makes sense to do the “first fill” with the 900 million allowances withheld from auctioning under the backloading initiative and to start the MSR much earlier than 2021 (i.e. 2017) so that it can continue to absorb the current overhang.

Recalibrating the EU ETS and having it fit for purpose as other countries implement their UNFCCC INDCs (Intended Nationally Determined Contributions) to also reduce emissions will offer the EU a true competitive advantage in a challenging global economy. It will allow the EU to achieve similar or even greater reductions than others, but at lower cost.

David Hone is the climate change adviser for oil and gas multinational Royal Dutch Shell. Originally published on Shell's blog. Reproduced with permission.