Further thoughts on an EU ETS set-aside

After a post-recession recovery to some €17, EU-debt driven jitters have hit the EU ETS and in recent days it has fallen close to €10 per tone of CO2. Some market watchers have praised this as indicative of a system which is responsive to the underlying condition of the economy as a whole, but the reality for investors and energy companies trying to develop low emission projects and strategies is a much more challenging business environment. Does this mean that the ETS is reacting as it should or failing to do it’s job?

There is no doubt that the ETS will deliver on its part of the EU 2020 goal to reduce emissions by 20% across the economy as a whole, so in that sense we should consider it to be a success. But arguably the system has a more important goal, namely the delivery of a power sector heading towards zero emissions – a fundamental part of an economy intent in reducing emissions by at least 80%. This means that the ETS should be driving fuel switching, encouraging the development of CCS and supporting the resurgent nuclear industry. At the moment it is struggling to do any of these things.

A few weeks back I put forward a case for setting aside allowances in Phase III of the ETS as a means of supporting the price. The first airing of this idea at the EU Council of Ministers wasn’t a great success, but it has appeared again within the recently proposed Directive on Energy Efficiency, although this time specifically linked with the impact of that particular Directive:

“. . . . . including recalibrating the emissions trading system by setting aside a corresponding number of allowances from the part to be auctioned during the period 2013 to 2020, should a corresponding political decision be taken.”

So it would appear that the notion of recalibration is alive, although its implementation in practice remains somewhat distant. In thinking further about the case for correction, it is worth looking back to a document which started much of the thinking about measurement and reporting on emission reduction pledges, the WRI / WBCSD Greenhouse Gas Protocol.

The Protocol has now been used by companies for over ten years as a guide for measuring and reporting on corporate emissions. It sets out the rules for the scope of a measured system and guides the user on correcting the baseline when changes occur. This latter practice ensures that emission reductions are real and constitute actual environmental improvement rather than simply being a result of a change in structure of the company reporting its emissions.

The issue of real environmental improvement now faces the EU ETS. The 2020 target now looks as if it will be met largely because of the result of a macro economic shock to the system. The recession has had the effect of changing the shape and structure of the covered sector, to the extent that compliance with the target is now almost a given. As noted above, reductions from major projects and real change will be limited.

This is where the GHG Protocol comes in. If the Protocol was the complete guide to managing this system, it would potentially call for a change in the original baseline emissions as a result of the changes seen in Europe over recent years. The only way of implementing such a change in the ETS is to withdraw or set aside some of the allowances in the system.

The challenge remains to provide a clear quantification of this, a task much more complex for the ETS than a company correction to its baseline. Current estimates argue for something over one billion allowances being removed from Phase III, although in the case of the ETS any actual set aside number will be as much a political agreement as anything else.

A correction will support the carbon price and more importantly give confidence to investors that the Commission is prepared to stand behind the market it has created, ensuring that it is the investment driver for emissions reduction in Europe and not just an annual compliance mechanism.