A tale of two surpluses

A tale of two surpluses

Report: A tale of two surpluses

This report considers MSR cancellation options for Phase 4 of the ETS.

A combination of elements from the European Parliament and Council ETS positions, if maintained in trialogues, would leave the Emissions Trading System in better shape – though still with further to go to guarantee cost-effective emissions reductions.

  • The persistent surplus in the EU ETS is composed of two main elements – the surplus available to the market and surplus which has not yet been released. The bulk of the latter will be transferred to the MSR from 2019.
  • The two elements of the surplus affect the price signal generated by the system in different ways, therefore any changes to the rules will lead to different price impacts.
  • The Council position on annual cancellation from the Market Stability Reserve (MSR) is a particularly positive proposal, especially combined with doubling the MSR withdrawal rate. These changes would initially increase the speed with which the MSR takes allowances from the market during Phase 4 (up to 2030), supporting an increased carbon price. Under base emissions the reform theoretically removes the surplus on the market by the early 2030s, but in reality this outcome isn’t certain; it will depend on the level of actual emissions.
  • However, these changes are only part of the solution. With a current surplus in circulation of 1.7 billion tonnes in the EU ETS, we still forecast a surplus available to the market of over 1 billion tonnes in 2025. And in a “low emissions” scenario (e.g. if coal plants close more quickly than expected) the reforms will not remove the surplus on the market by the end of Phase 4, carrying a surplus of over 2Bt into the 2030s.
  • No amendments currently on the table address the impact on the market surplus of overlapping policies for power sector emission reductions, despite the potentially large cancellation of allowances stored in the MSR. We therefore believe that the withdrawal rate of the MSR should be increased beyond 24% for the whole period 2021-2030.
  • Most importantly, the changes would represent only a temporary fix to a structural problem, which requires a structural response. The disconnect between the cap and real emissions is the main reason why the EU ETS is not delivering its intended price signal, failing to drive the emission cuts taking place.

We continue to believe that the best solution is to remove surplus from the market quickly by readjusting the starting point of the Phase IV cap to reflect  the real-world level of emissions. The European institutions have correctly decided to link the Effort Sharing Regulation to real emissions; the same should be done for the ETS. It’s a simple question of taking stock: we can’t expect the EU to land in 2040 using emissions estimates from 2007, and this exercise will have to be done periodically.