Fault Lines Emerge on World’s Biggest Carbon Market Overhaul

A planned reform of the European Union’s carbon market is already revealing tensions over how to turn the bloc’s ambitious climate-neutrality goal into reality.

Results of a public consultation published Thursday highlighted divisions between government, business and industry over how the EU’s 16-year-old Emissions Trading System should meet the region’s stricter climate goals for the coming decade. The almost 500 submissions will be taken into account by the European Commission when it drafts the biggest-ever overhaul of the market.

The revision of the EU ETS, due to be unveiled in June, is the first major test of the EU’s political resolve to drastically cut its greenhouse gases under the Green Deal. The ETS puts pollution limits on utilities, factories and airlines and is the cornerstone of Europe’s ambition to become the world’s first climate-neutral continent.

Sticking points in the submissions range from how and when to start limiting emission rights in the cap-and-trade system, to whether free permit allocations should end and how carbon border controls would work. The draft regulation will then be subject to negotiations between governments and lawmakers in a process that companies will try to influence.

Fault Lines Emerge on World’s Biggest Carbon Market Overhaul

Below are the key issues lawmakers will need to find a compromise on:

Deeper Cuts

A key revision will be the reduction of the number of emission permits in the 10-year period through 2030 to meet the EU’s headline pollution goal, which covers both the cap-and-trade program and sectors outside it. The consultation’s respondents are at odds on how much effort should be borne by the ETS.

The European Commission is considering several measures, ranging from a one-off reduction -- or rebasing -- of the total number of permits, to increasing the rate the overall emissions cap shrinks each year, known as the Linear Reduction Factor. Another option is adjusting the Market Stability Reserve, a mechanism that automatically controls the supply of emission allowances.

The policy option, or a mix of them, that the commission chooses will determine how quickly the supply of permits will decrease. Proposal highlights include:

  • Sweden’s Climate Ministry and Denmark’s Environment Ministry endorse strengthening the MSR. In addition to that, both back some form of rebasing and an increase in the LRF.
  • Electricite de France SA calls for a carbon price floor or corridor, a policy long urged by the French government that has never found widespread support.
  • Orsted AS, the offshore wind farm developer, advocates a reserve price for carbon permit auctions.
  • Eurofer, the European steel industry association, and the European Aluminium trade group both oppose rebasing.

Carbon Leakage

Most carbon emission rights in the EU are sold at auctions, but companies in industries prone to relocating their production outside of Europe get some permits for free. The overall number of free allowances is set to shrink in the coming years.

Countries such as Sweden argue that free allocation should be phased out as soon as possible. Energy-intensive industries defend the handouts, with European Aluminium warning against any type of reduction.

Carbon Border

The Commission is also planning to propose a levy on imports of some emissions-intensive products through the so-called Carbon Border Adjustment Mechanism, which was endorsed by numerous respondents. However, they differ on how such a levy should be designed. Energy-intensive industries want a border mechanism to complement free allocation, which the Commission has said is incompatible with World Trade Organization rules.

Carbon Removal Credits

A number of respondents, including Total SA, Royal Dutch Shell Plc, Orsted and Eurometaux, Europe’s metals industry association, urged measures to encourage investment in removing CO2, including the trade in carbon removal credits. The Commission last year started work on devising a carbon removal certification mechanism.

Contracts for Difference

Many companies, including French energy group Engie SA and chemical maker BASF SE, endorsed carbon contracts for difference, where clean-technology projects would be guaranteed a fixed carbon price when the ETS price is too low.

“New tools like CfDs are needed to assist EU industry not merely to just continue producing, but to invest in drastically reducing its emissions as the best protection against carbon leakage,” said German research group Agora Energiewende.

Fault Lines Emerge on World’s Biggest Carbon Market Overhaul

©2021 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.