Better management of allowances required for EU Emissions Trading System

Posted on 6 Mar 2012 in

The European Union should permanently remove, instead of just delaying the sale of, 900 million allowances from the Emissions Trading System, and should implement price ceilings and floors, according to a report published today (6 March 2013) by the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science.

In a submission to a consultation by the European Commission about reform of the European Union Emissions Trading System (EU ETS), Dr Luca Taschini warns that “the price of carbon in the EU ETS has fallen to a level that could damage not just Europe’s low-carbon ambitions, but also the credibility of the ETS itself”.

The report points out that although the fall in the carbon price has been created by a surplus of allowances and international credits for greenhouse gas emissions within the ETS, current plans, to be voted on by the European Parliament in April, to “backload” 900 million allowances, by delaying their sale until a later date, cannot guarantee a sustained increase in price and the orderly functioning of the ETS. It suggests that only the removal of the allowances from Phase 3 of the ETS, which extends until 2020, is “the only market intervention in the short term that would be credible”.

However, the report also indicates that the permanent removal of allowances alone is “insufficient” to solve the structural imbalance between the demand for emissions allowances and their supply. Instead, the European Union should introduce a new institution to manage the price of carbon within the ETS beyond 2020. The report suggests that the Commission could “mandate an independent authority to manage allowance supply, as central banks do in interest markets, by buying and selling volume into the allowance market”. However, this may not be consistent with the fundamental principle of the ETS, which is intended to gradually reduce the quantity of allowances.

The report recommends therefore that the Commission should design a “rule-based mechanism that adjusts the supply of allowances by depleting or replenishing an allowances reserve”, which could “function without setting specific target prices”. The supply of reserve allowances would be triggered by a floor and ceiling set for the price of carbon within the ETS.

But the report also acknowledges that the new mechanism will create a trade-off. It states: “The more the supply of allowances adjust to accommodate changes in allowance demand, the more seamlessly compliance insurance is provided. But this makes it more likely, other things being equal, that the regulated industries will forego abatement investments to the detriment of future economic stability.”

Notes to Editors

  1. The Grantham Research Institute on Climate Change and the Environment was launched at the London School of Economics and Political Science in October 2008. It is funded by The Grantham Foundation for the Protection of the Environment and the Global Green Growth Institute.
  2. The Centre for Climate Change Economics and Policy is hosted by the University of Leeds and the London School of Economics and Political Science, and funded by the UK Economic and Social Research Council and Munich Re.