(The author is a Reuters market analyst. The views expressed are his own.)
By Gerard Wynn
LONDON Nov 14 After a renewed crisis, the European Union is embarking on a marathon reform of its carbon market for rather small gains, and may find more success by focusing on its next trading cycle after 2020.
The market, which has all but collapsed for the second time in its brief existence, accounts for half the bloc's greenhouse gas emissions and is the main tool for meeting climate change targets.
To fix the problem, in the wake of the worst recession in half a century and an enduring eurozone crisis the EU executive, the European Commission, is trying to boost carbon prices.
That would add up to a rise in power prices too - currently a popular bugbear across the EU, in sharp contrast to the United States, where prices are plunging thanks to a boom in unpolitically correct shale gas production.
The Commission worries that if it does nothing, prices will otherwise likely to fall to near zero, given a glut of EU allowances (EUAs) expected to grow to the equivalent of one year's emissions under the scheme (see Chart 1).
It detailed this week two steps for reform.
The first, relatively simple measure is to delay the sale of EUAs, briefly halving the surplus, and makes sense although it is not guaranteed member state approval.
It announced on Wednesday options for a second step of deeper, structural reforms which would take longer and face stiffer opposition, and included cancelling allowances permanently.
If successful, the reforms may achieve a modest revival in carbon prices to around 12-15 euros.
That would prevent the market stalling altogether but fail to drive significant emissions cuts given a sharp fall in coal prices, now too cheap for cleaner-burning gas to compete.
The Commission, however, strangely missed any reference to an overhaul of the market's next trading cycle, from 2021-2030, including a 2030 emissions target.
Such a target would avoid short-term hiatus from attempted reforms opposed at least by Poland; fits with an international schedule of climate negotiations; will have to be addressed anyway, preferably sooner than later; could address deeper reforms including a floor price; and would equally impact prices before 2020 as a result of forward hedging by utilities.
The case for nearer term reform is undermined by a eurozone crisis which has already driven deep cuts in emissions (see Chart 2) and which makes the prospect of a small hike in power prices, as a result of higher carbon prices, less palatable.
Chart 1: link.reuters.com/myj93t
Chart 2: link.reuters.com/nyj93t
Chart 3: link.reuters.com/pyj93t
The Commission is taking a two-step approach because it views the first as less controversial and legally simpler, meaning it can get the process underway.
That first step, announced on Monday, is a draft amendment to the EU ETS Auctioning Regulation which would delay the auction of some 900 million EU allowances (EUAs) to 2019-20, originally due in 2013-15.
There are complications: some member states have not given explicit backing pending clarity on plans for a deeper overhaul, as the Commission said in its "Impact Assessment" on Monday:
"Member States seem to agree factually with the Commission's analysis showing a rapid build-up of the surplus. Opinions on if and how this should be addressed are not conclusive."
Amendment of the regulation requires approval by a Climate Change Committee (CCC) of member state experts at a meeting on Dec 13 or thereabouts plus a three-month scrutiny period.
The Commission is also seeking a "mini-amendment" of the emissions trading Directive, requiring a full parliament vote probably in April.
The CCC vote needs a qualified majority vote, a technical EU term which refers to the different voting powers held by different member states.
As Chart 3 shows, Poland has said it is opposed and has 27 votes; it needs to muster another 64 to block progress at this first hurdle.
The parliament vote requires a simple majority.
The back-loading proposal does not affect the overall volume of allowances to be auctioned in phase three of the market, from 2013-2020, only their distribution over the eight-year period.
On Wednesday, the Commission announced options for the second leg of its reform.
Options included: cancelling surplus EUAs; a tougher EU-wide carbon emissions target in 2020; steeper annual emissions reductions in the carbon market; limits on imports of carbon offsets; and a price floor.
The proposals need analysis and will require intensive canvassing of member states, followed by detailed draft amendments to existing law, and finally a decision process which will take two years or more.
The Commission is only considering reforms before 2020.
But it already has a mandate to review the ambition of its carbon market in the 2020s, through annual reductions called the "linear factor".
As the emissions trading directive says: "The Commission shall review the linear factor and submit a proposal, where appropriate, to the European Parliament and to the Council as from 2020, with a view to the adoption of a decision by 2025."
An Impact Assessment accompanying the Commission's "Energy Roadmap", published last December, has already suggested a 2030 target which can provide an emissions trajectory:
"In 2030, energy-related CO2 emissions are between 38-41 percent lower (than 1990 levels), and total GHG (greenhouse gas) emissions reductions are lower by 40-41 percent," it said.
Agreement on such a target fits with an international schedule where the EU must decide a negotiating position for the climax of U.N. talks on a new global climate deal in 2015.
And it could impact prices before 2020 as a result of utility hedging where power generators sell electricity and hedge their carbon emissions up to three years ahead.
While the Commission's proposals would prevent its flagship carbon market from stalling altogether, it could alternatively focus on a longer term overhaul, which may fit better with its existing mandate and so require less brinkmanship, and avoid a focus which raises power prices and emissions cuts now, neither a near-term priority. (Reporting by Gerard Wynn; editing by Patrick Graham)