Evaluation of the European Commission’s proposal to set aside emission allowances

27-11-2012 | Publication

A set-aside of CO2 allowances would reduce the current oversupply in the European Emissions Trading System (ETS). This would result in temporary higher CO2 prices. However, a literature study has shown that the impact of the European Commission’s proposal on CO2 prices is likely to be limited, because the total amount of allowances up to 2020 would remain unchanged. However, the proposal sends out a signal to investors that the functioning of the ETS is a priority for politicians, and increases the likelihood of further reforms. Any negative impact of back loading on ETS companies in the Netherlands is likely to be limited.

European Emissions Trading System oversupplied with emission allowances

The functioning of the EU Emissions Trading System (ETS) is under discussion, as current market prices of the allowances that permit the emission of CO2 are far below expectations. Although emission reductions are currently achieved at low costs, the current price of around eight euros per tonne of CO2 is considered too low to stimulate investments in low-carbon technologies. Such investments are necessary for deep emission reductions in the long run. The main explanation for the low CO2 price is the economic stagnation in the European Union since the end of 2008. This stagnation caused emission levels to be much lower than expected, while the supply of allowances remained unchanged. This resulted in a vast oversupply of allowances which is likely to persist during the entire trading period up to 2020. To address this oversupply, the European Commission (EC) has proposed to reduce the amount of auctioned allowances in the years 2013 to 2015 (temporary set-aside) and increase the allowances again by the same amount in the following years, up to 2020 (back loading). PBL was asked by the Dutch Ministry of Infrastructure and the Environment to assess the impact of the EC proposal on the CO2 price in the EU ETS and its effects on Dutch ETS companies.

CO2 prices temporarily higher in case of substantial back loading

The impact of back loading allowances on the carbon price is likely to be limited, mainly because the total amount of allowances up to 2020 will remain unchanged. Only when a substantial amount of allowances are back loaded, a significant impact on the carbon price can be expected in the short term. The CO2 price would decreases from 2016 onwards, as supply increases again. The CO2 price may end up slightly higher by 2020, as the adoption of back loading will be considered a signal that structural ETS reform, such as cancellation of allowances, is more likely to be adopted, as well. Not adopting the EC proposal may result in a further decline in CO2 price.

Proposal considered as a signal for further ETS reform

Back loading probably will have no impact on investments in low-carbon technologies. Although carbon prices would increase, temporarily, the increase would be much too low to stimulate investments in low-carbon technologies. Moreover, investors may face some additional uncertainty as long as the current proposal is not transparent enough for them; for example, because criteria on repetition and quantification are unclear. However, investors also seem to regard the intervention in the form of back loading as an important indication that politicians take seriously the necessity of an appropriate ETS price signal for long-term investment in low-carbon technologies. They see adoption of the proposal as a signal that structural reforms (to be announced later in 2012) are more likely to be accepted.

Negative impact of back loading on ETS companies is likely to be limited

Although the carbon price is likely to rise, temporarily, when a substantial number of allowances are back loaded, the negative impact on ETS companies, including those in the Netherlands, is probably limited. As power producers, in principal, no longer receive any free allowances, higher CO2 prices may temporarily increase their production costs, especially over the 2013–2015 period. However, power producers can pass all of the costs of allowances on to consumers (including industry), so the negative impact for the energy sector is expected to be limited. Industrial companies in the Netherlands, however, can use the surplus of allowances, accumulated over the 2008–2012 period, to compensate for an increased scarcity of allowances. Also, they will continue to receive most allowances for free up to 2015 (the carbon-leakage-sensitive industry even receives all allowances for free up to 2020). As far as industrial companies are able to pass the costs of a temporarily higher CO2 price and higher electricity bills on to consumers, this temporary rise could even increase the profits generated by the allocation of free allowances (‘windfall profits’) in the short term. Although aircraft operators are expected to be short on allowances, the impact of back loading is likely to be limited. Costs to acquire allowances will rise only temporarily and decline in the subsequent years up to 2020.