The Emissions Trading System reform is in Committee Stage, and a dark comedy has begun. Many of the measures proposed in the Environment (ENVI) committee draft (by Ian Duncan MEP) ironically act against the environment, condemning the EU to an inadequate response to the size of the challenge for the foreseeable future, and undermining the EU’s promises in the freshly signed Paris Agreement. This is pushing the EU citizens towards irreversible climate change, rather than protecting them from it.

Tiering: a red herring

The current debate is dominated by much talk around the carbon leakage criteria and what different industrial sectors can hope to benefit from the EU ETS in the next decade. The idea that the EU ETS was designed to put a price on otherwise unaccounted for GHG externalities, seems to have been completely forgotten in the midst of concerns around how to best maximize free allocation – which does nothing but to perpetuate the unaccounted externalities, and windfall profits to some of the world’s largest businesses.
Focusing the discussion on tiering or specific 0.1 differences in thresholds is rearranging the deckchairs on the Titanic. In the absence of more fundamental measures, the EU ETS is likely to remain with an ineffective price of just a handful of Euros, regardless of which tiering option is chosen. Under the current proposals, by 2030 the ETS will have been active for a quarter of a century with only a couple of years of an appropriate carbon price;. An awfully long time for a regulatory mechanism to be given a chance to work properly.

Focus on the surplus

In as much as they differ, both the Environment and Industry (ITRE) committee proposals miss out on the main point: the cap is too loose. Tiering and access to R&D and modernisation funds only become relevant in the context of a tight scheme in line with reality and with science. The Market Stability Reserve (MSR) reform won’t provide this, and neither will the current proposals.


In a dark humoured break with tradition, the normally conservative  ITRE committee draft opinion (by Frederick Federley MEP) places us slightly closer to the lifeboats than the draft from the normally more environmentally ambitious ENVI committee, a point confirmed by price outlooks from analysts at PointCarbon
The ENVI draft strives to increase innovation by carrying over allowances from Phase III (which has the opposite effect as it would de facto lower the value of these allowances), whereas the ITRE draft opinion takes these allowances from the cap of Phase IV. The latter is clearly the more ambitious option, since there should be no carry over of any allowances from Phase III if we want to have any realistic carbon price before 2030
Both documents reference Paris. And yet, referencing Paris is not enough to make a document Paris compatible. Including 5 year reviews it is a mere technicality meant to align different review processes and does not give the ETS the jump in ambition it needs as soon as possible.

Changing the LRF, introducing tiering

The fact that the Linear Reduction Factor (LRF) in both drafts is still at 2.2% is outrageous, and deeply incompatible with the increased ambition committed to just 6 months ago in Paris. An LRF of 2.8% would barely put the EU on a good track, while research has even suggested that an LRF of 4.2% would be appropriate for the goals in the Paris Agreement to be reached.
Both proposals support the introduction of more targeted tiering, which is a progressive move from away from the binary approach of the Commission. However, both of the proposals seek to maximize the distribution of allowances to be distributed, not leaving a sufficient buffer against the Cross Sectoral Correction Factor (CSCF) towards the end of the Phase IV.
In this context, Sandbag prefers the ITRE proposal, with its emphasis on the temporary dimension of free allocation and on the need for increased innovation and with a smaller distance between the categories, avoiding loopholes. Furthermore, getting rid of the category of free riders who although not exposed to ‘carbon leakage’ would still get 30% seems to make most economic and environmental sense.

Controlling indirect cost compensation

The ITRE draft makes a great step in the direction of preventing a low to irrelevant carbon price being locked in into the next decade, via its proposal to withhold compensation for indirect costs through state aid if the carbon price is below €15. If the price rests below €15 for more than two consecutive years, indirect cost compensation by Member States would no longer be allowed. Furthermore, of the price is on average between 15-25 Euros for 2 years, then 50%compensation is allowed. If a significant carbon price is in place however, meaning a price over 25 euros/tonne, then full compensation is allowed.

Accessing the 10c funds

Criteria on how to manage the 10c funds is changed by both proposals, with the ITRE draft completely abandoning the min. 10 mil threshold requirement, on the justification that such a threshold is arbitrary and with ENVI increasing it to 20 mil. Interestingly enough, the ENVI draft claims projects eligible to also be those below 10 mil, in addition to those over 20 mil, which clearly seems discriminatory from an internal market point of view to all those which would fall in between. These two categories are more arbitrary than the existence of a single threshold. But again, this is only about who gets what seats on the great sinking deck.

Small emitters

Another important reason why Sandbag finds the ITRE draft opinion to be more fit for purpose than ENVI’s is that the first recommends the inclusion of small emitters into the scheme. This means that small emitters and potential innovation drivers have access to the market of allowances. The ENVI drafts suggests the opposite should happen and “remove up to 5.6% of ETS emissions”, which without an equivalent reduction in the cap would weaken the proposal.

Trade intensity

The criteria for what actually trade intensity means needs to be upgraded to reflect both export intensity and import intensity, in correlation to carbon pricing, which both of the drafts fail to do. This risks having the perverse effect of incentivizing carbon import, as opposed to carbon leakage, as shown by Sandbag’s previous research on the cement sector.
We welcome the fact that both proposals ask for the Commission to look into the dynamic interactions between additional policies and their consequence on the accumulation of ‘hot air’ under the EU ETS. This recommendation is in line with Sandbag’s findings presented in the report “The ETS in context”. The ETS can never drive decarbonisation alone; and we absolutely must have a mechanism that takes into account the impact of supplementary policies on the number of Allowances.
Furthermore, Sandbag finds it appropriate that both drafts talk of introducing more dynamic allocation in free allocation. The change that this triggers in cessation rules make this the single most progressive novelty both drafts bring to the table. However, even more dynamic allocation won’t be sufficient to remove the crippling ETS surplus.

Taking the narrow view

It is mind-narrowing and dangerous for the debate got lost in these small details, missing the big picture. This is not to say that the details are unimportant. A small but fatal flaw can destroy the whole scheme – but unless we address the bigger questions, the whole scheme will be dysfunctional from year I of Phase IV anyway.
What was once designed to be the EU’s main climate policy, is now being transformed into EU’s trade and industrial policy. That this is happening half a year following the Agreement in Paris, when the EU committed to “limit the temperature increase to 1.5°C”, is darkly comic. Needless to say, the current targets, linear reduction factor and baseline for the ETS are far from being compatible with a 2 degrees scenario, let alone the new international ambition.
The dark humour in this situation can only amuse us in so far as we disregard scientific evidence or we overlook the resources mobilised by the EU in its climate diplomacy coming up to the COP21
It is high time for the EU’s elected officials, the Members of the European Parliament, remember that they are accountable to the citizens of the EU and that they must serve their interests above all else.

Winners and losers?

Any discussion about ‘winners and losers’ of the energy transition seems to forget that this is not about winning – but rather about avoiding catastrophic loses. It is a positive thing that in doing so Europe can also win as a result of low-carbon innovation. A tighter EU ETS would indeed pave the way to more jobs, more growth and everything else the EU so badly needs at the moment, while it would simultaneously help to mitigate climate change. Talk about a win-win situation? With the current drafts in the EP we seem to be instead looking at a lose–lose situation.
In short, both drafts paint a grim future for the EU’s climate ambition, in their stubbornness to overlook the main problems plaguing this scheme: the massive discrepancy between the trajectory and actual emissions levels, the persistently insignificant carbon price, which the MSR won’t fix, a situation which only further reduces the revenues available for innovation and modernization under the EU ETS. This scheme will get reduced to a little more than an accounting mechanism, which incidentally hands out private assets free of charge to industry, with the drive in reductions is coming from other sectorial policies.
Sandbag is profoundly disappointed with the lack of ambition and disconnect from reality in both schemes, as reflected by the lack of interest of adjusting the cap to real emission levels, and warns the lawmakers involved in this process that they might just end up being on the wrong side of history.

Image by Jeffrey on Flickr, used under a Creative Commons non-commercial license