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Persistent surplus risks stymieing EU ETS reform, finds research from Sandbag

The latest data analysis from think tank Sandbag shows that the reforms being widely considered for the EU ETS are unlikely to be effective drivers of decarbonisation, as they will fail to deal with the surplus of emissions allowances (EUAs) within the system. 

Using an in-house modelling tool calculating the ETS’ supply and demand, Sandbag’s modelling shows that an EUA surplus could continue to exist throughout Phase IV of the EU’s emissions trading system, hypothetically allowing for an increase in CO2 emissions that could leave emissions up to 66% higher than the cap in 2030. 

Surplus allowances have long dampened the carbon price effect of the EU ETS, persisting despite progress made under the Market Stability Reserve (MSR). A slower-than-expected recovery during 2021 could further exacerbate the surplus and further incentivise polluters to exceed the cap in later years. Sandbag’s estimates show that over 1,300 million extra EUAs could be available to emitters for use above the Phase IV cap, the equivalent of one and a half year’s emissions.  

Adrien Assous, Sandbag’s Delegated Director, said, “A cap that can be repeatedly exceeded by huge amounts can’t be called a capThe revised EU ETS needs ensure that its cap will not be undermined by the existing surplus of EUAs, otherwise it creates a risk that Europe will fail to reach its overall target.” 

Not only would the surplus hinder emission reductions, but it could even allow industry emissions to stagnate. Using a maximum emissions pathway, Sandbag’s modelling shows that, due to the surplus, enough EUAs would be available to allow ETS-sectors to emit far more than would be compatible with a 55% or 65% overall emission reduction target for 2030. While the ‘maximum emissions pathway’ is not a forecast of emissions, it illustrates how the EUA surplus undermines the cap, regardless of the ambition of the target on which this cap is based. 

Julie Ducasse, Data and Policy Analyst at Sandbag, said “While a lot of attention is focused on the figure of the 2030 targets, our modelling shows that the actual target is rendered less ambitious by the EUA surplus. Unlike the highly politicised debate about overall targets, measures to improve the EU ETS such as reducing the surplus are less controversial, but equally as important.” 

In order to dramatically reduce the surplus, Sandbag recommends a reduction of the MSR lower threshold to zero and of the higher threshold to no more than 100m allowances. In addition, in order to prevent any sustained excess emissions, no allowances should be released from the MSR or any reserve if the previous year’s emissions exceeded the cap. 

The results of Sandbag’s modelling are displayed through the EU ETS Simulator on their websiteMore interactive graphs and other information will be added to the Simulator in the run-up to the Commission’s legislative proposal on the EU ETS in June, to aid all interested stakeholders in visualising the implications of different policy options.

Notes

  1. Sandbag is a not-for-profit climate change think tank which uses data analysis to build evidence-based climate policies. They focus on EU policies such as the EU ETS and decarbonisation in emissions-intensive industrial sectors.
  2. The ETS Simulator displaying the modelling results is available on Sandbag’s website here:https://sandbag.be/index.php/euets-simulator/ 
  3. The EUA surplus is made of the allowances in excess of those needed by installations and airlines to cover their verified emissions. Surplus EUAs (will) come from various reserves: unused allowances not yet transferred to MSR, allowances not allocated early in Phase IV, the New Entrants Reserve, allowances to be carried over from Phase III by Greece and allowances released by the MSR.
  4. In a scenario where the overall 2030 reduction target is 55%,but no other structural changes are made to the EU ETS, the maximum emissions pathway exceeds the cap by 46%. In a scenario where the overall 2030 reduction target is 65%, keeping the other parameters equal, the maximum emissions pathway exceeds the cap by 66%. These pathways represent the worst-case combination of policy options for both targets.
  5. The current MSR thresholds of 833 million and 400 million allowances were instituted based on the hedging needs of electricity utilities. However, this design was remiss, as hedging does not require that the EUAs are available when the contract is made, but merely at a future date when the EUAs are exchanged. Keeping a surplus in the name of utilities hedging creates a rolling artificial supply, which will not be needed because this hedging activity will stop, either suddenly a few years before the end of the EU ETS or gradually as electricity production becomes fully decarbonised.