European Commission proposes 'market stability' mechanism for carbon trading as part of 2030 climate change reforms

Out-Law News | 27 Jan 2014 | 9:43 am | 3 min. read

Automatic adjustments to the EU's supply of tradable emissions allowances could be introduced from 2021, improving the system's resilience to "major shocks" as well as addressing the surplus of allowances created by the economic downturn.

The 'market stability reserve', proposed by the European Commission, would be introduced at the beginning of the next phase of the EU Emissions Trading System (EU ETS). It would be governed by "pre-defined rules", leaving the Commission and EU member states with no discretion over the way in which it was implemented.

"The proposed 'market stability reserve' mechanism is a further step in the right direction to make sure that the EU ETS has long-term measures in place to resolve the structural imbalance between the supply and demand for allowances that is expected to last for at least a decade or longer, following on from the temporary 'backloading' of allowances that was approved back in December," said environment and energy law expert Eluned Watson of Pinsent Masons, the law firm behind Out-Law.com.

"The proposed structural reform shows that the Commission has taken on board the need for deeper reforms and recognises that the 'backloading' measure is only temporary and will not resolve the existing imbalances on its own. It is hoped that the structural reform proposed by the market stability reserve will complement the existing EU ETS regime and guarantee a more balanced and resilient market, with a carbon price that is properly driven by mid- and long-term emissions reductions," she said.

Proposals allowing the Commission to 'backload' up to 900 million allowances that would otherwise have been made available for auction between 2013 and 2015 until 2019 and 2020 as a temporary measure, pending longer-term structural reform, were recently approved by EU member states.

The Commission's legislative proposal emerged alongside an updated draft framework on energy and climate change, which will now be debated by member states and the European Parliament. The package includes a target to reduce greenhouse gas (GHG) emissions by 40% below 1990 levels by 2030, by which time the EU would also have to generate at least 27% of its energy needs through renewable sources. The new framework does not set national renewable energy generation targets, which the Commission said would give member states the "flexibility" to transform their energy supply systems "in a way that is adapted to national preferences and circumstances".

The proposals are intended to update the EU's existing 2020 targets ahead of global negotiations in 2015. EU member states had previously agreed to cut emissions and energy use by 20% against 1990 levels by 2020, by which time 20% of their energy generation needs should come from renewable sources.

"Climate action is central for the future of our planet, while a truly European energy policy is key for our competitiveness," said José Manuel Barroso, Commission President. "An ambitious 40% greenhouse reduction target for 2030 is the most cost-effective milestone in our path towards a low-carbon economy. And the renewables target of at least 27% is an important signal: to give stability to investors, boost green jobs and support our security of supply."

As proposed by the Commission, the EU ETS market stability reserve would begin operating as part of Phase 4 of the scheme, starting in 2021. Up to 12% of allowances in circulation could be placed in the reserve using an automatic mechanism determined according to the total number of allowances in circulation that are not already needed for compliance needs. The total number of allowances in circulation in the previous year would be published in May of each year in order to ensure transparency and allow the market to prepare.

Allowances would only be placed in the reserve if the total number of allowances in circulation was greater than 100 million allowances, and 100 allowances would automatically be released when the total number of allowances in circulation in a given year fell [below?] 400 million. Further safeguards would apply to ensure allowances were released if the carbon price rose for more than six consecutive months to more than three times the average carbon price during the two preceding years.

Environment and energy law expert Eluned Watson said that the proposal was "quite a complicated mechanism", and that "further scrutiny will be required on whether the structural reforms really have the teeth to secure the objective of reducing the imbalance between supply and demand of allowances".

"The proposals still need to be agreed by the European Council and Parliament, and so the final form of the mechanism is still subject to change going forward," she said.

UK Energy Secretary Ed Davey said that the 2030 package was "a step in the right direction towards an ambitious emissions reduction target for Europe", but reiterated the Government's desire for a tougher 50% target. He added that the UK remained "concerned" about any proposed renewable energy generation target "especially as the debate within Parliament and the British green movement has moved on to technology neutral options like a decarbonisation target as the most cost effective and practical way to revive the EU ETS and deliver more emissions reductions at least cost".