Opinion: Reform of EU emissions trading system likely to fail

The EU has declared the Emissions Trading System (ETS) to be its key tool for cutting industrial emissions. However, the price for CO2 allowances has been dropping for years, reaching a low point of 3€/tonne in 2013. As a result, the EU now seeks to “fix” the current ETS - albeit by neglecting its own legal principles.

The ETS works on the “cap and trade” principle, a market-based system that deliberately avoids the use of price regulation. A cap is set on the total amount of certain greenhouse gases that can be emitted by factories, power plants and other installations falling within the system. The cap is then reduced over time, so that total emissions fall.

Companies receive or buy emissions allowances, to cover their actual emissions (where such emissions exceed their designated cap).

Originally, the EU used a price of 30€/tonne for its calculations. However, due in particular to a significant surplus of allowances, the price still fluctuates above and below this figure by around 7€/tonne. Critics therefore say that the ETS has failed its mission, but the EU is forced to stick with it, having no other system to turn to.

Market stability reserve

The European Commission has thus proposed an instrument, which will stabilise the price of the C02 tonne, the so-called “market stability reserve”.

From 2021 onwards, a certain number of emissions allowances for auctioning shall be taken from the market in order to reduce the number of allowances in circulation.

Now, the environmental committee of the European Parliament has not only announced its support for the market stability reserve, but also proposed two relevant amendments.

First, the committee favours implementation by the end of 2018, rather than 2021. Second, it wishes to transfer certain allowances, which have already been set-aside (“back-loaded”) and should be released to the market in 2019/2020, directly to the market stability reserve.

EU law and principles

Whilst the committee doubtless made such proposals with good intentions, the transfer of the “back-loaded” allowances to the market stability reserve before the end of the ongoing trading period (end of 2020) would conflict with EU law and principles.

First, if the already “back-loaded” allowances are not released to the market in the ongoing trading period, this is likely to conflict with the principle of legal certainty. Market participants will have developed legitimate expectations regarding their release in the last two years of the ongoing period.

Second, and of greater legal concern, is that the approach will also result in decreasing the ETS cap of the ongoing trading period and therefore increase the 20 percent CO2 emissions reduction target by 2020 - agreed by the European Council back in 2007.

The quantity of the “back-loaded” allowances equates to six per cent of the total allowances under the cap in the period 2013 to 2020. Therefore, the EU would be changing the reduction target through the backdoor, without any underlying political decision by the heads of the member states (European Council).

Third, the approach conflicts with the principle of proportionality. It is neither proven that the market stability reserve will actually eliminate the surplus and that the price will rise, nor does the assessment include potentially "less restrictive means", which might be sufficient to achieve the EU’s target of greater climate protection.

Member States' competencies

Likewise, there are significant concerns that the commission seeks to encroach on member states’ competencies.

As laid down in primary law, a special legislative procedure requiring unanimity in the Council must be used to pass EU measures that will affect member states’ energy mixes. However, the commission’s proposals ignore this requirement, as they suggest the use of the ordinary procedure whereby the Council can act by simple majority.

The committee of the permanent representatives of the governments (Coreper) will make its decision this week, on Wednesday (25 March). The Council, parliament and commission will then meet to develop a final text.

Hopefully, the EU institutions will heed these legal concerns before they vote for an instrument that clearly conflicts with established EU principles.

If not, the measure could be subject to legal action - in particular by member states, whose energy mixes or domestic industries would heavily be affected by the market stability reserve.

Rather than fixing the ETS, the proposed reform of the ETS may instead turn into a headache for the EU.

Wolf Friedrich Spieth is partner and co-head of the low carbon energy group at Freshfields Bruckhaus Deringer in Berlin