EU May Weigh Carbon Price Support, Offset Limit, Draft Shows

The European Union may consider introducing mechanisms to support carbon prices and limit the use of offsets in its emissions trading system after 2020 to strengthen the market, according to a draft EU document.

Other options for the 27-nation bloc to strengthen the world’s biggest cap-and-trade program are tightening the EU emissions-reduction target, canceling a number of carbon permits to alleviate an oversupply and expansion of the system into new industries, according to the draft report on the state of the European carbon market obtained by Bloomberg News.

The report, which floats various scenarios for the EU emissions trading system, or the ETS, is currently being considered by the European Commission and will be sent next month to the bloc’s member states and the European Parliament. The commission, the bloc’s regulatory arm in Brussels, wants policy makers to start talks about a long-term overhaul of the ETS after emission prices plunged to a record low in April.

“The options for structural measures outlined in the report should be discussed and explored without delay,” according to the document.

EU carbon permits for December dropped 0.1 percent to 7.90 euros a metric ton on the ICE Futures Europe exchange as of 10:52 a.m. in London. The contract extended its decline to 28 percent in the past year as the financial crisis hurt industrial production and cut demand from industry for pollution rights, boosting a glut of allowances to almost half of the average annual pollution limit in the system.

Limit Supply

The long-term measures to improve the ETS will complement a short-term plan by the commission to limit the supply of carbon allowances at auctions in 2013-2015 to help prices recover, the report said. The strategy, known as backloading, includes a draft measure to delay sales of an as-yet unspecified number of permits and a one-sentence amendment to the EU emissions trading law to reassert the commission’s right to decide about the timing of auctions.

The commission will officially submit next month the backloading proposal with a specific number of permits to be delayed and will invite representatives of national governments in the EU Climate Change Committee to vote on the measure before the end of this year, according to the draft report on the carbon market.

To “eliminate any uncertainty” about postponing some permits at auctions, the European Parliament and national governments should “urgently adopt the proposed mini-amendment to the EU ETS directive that would clarify expressly the relevant provision,” the commission said in the draft report.

Structural Surplus

While backloading would allow for a “more stable” functioning of the carbon market in its next trading period starting in 2013 and known as Phase 3, it will not address the structural surplus of allowances, according to the report. To do so the EU will need to enact measures that would affect “more profoundly and permanently the balance between supply and demand,” the commission said. The scenarios to be floated by the commission would not constitute legislative proposals.

One of the options could be increasing the EU target to reduce emissions to 30 percent in 2020 compared with 1990 levels from the current 20 percent, according to the report. To tighten the goal to that level the EU would need to remove 1.4 billion allowances from the market, the draft showed. A revision of the current EU law would require support by national governments and the Parliament.

New Decision

Another option would be cancelling permits through a new decision by the parliament and member states, without changing the existing law, the commission said in the draft. That would affect allowances to be auctioned while leaving free allocation to companies in the ETS intact, the report showed.

“The measure could be effective in addressing the overall supply-demand imbalance over Phase 3 but it would not address the framework after 2020,” according to the commission. Removing permits would ensure that the ETS drives innovation and contributes to renewables and energy efficiency objectives, the draft said.

The third potential option included in the draft report is a revision of the 1.74 percent linear reduction factor by which pollution caps in the ETS fall annually from 2013. While the EU law envisages a review of the factor as of 2020, with a decision to be adopted by 2025, the change could be brought forward, according to the commission. Any potential change, which would not only address the imbalance in the next trading period but also affect the supply of allowances after 2020, would need approval by governments and the Parliament.

Tougher Rules

The ETS could also be strengthened by expanding into new sectors or tougher rules on imports of carbon offsets in Phase 4 to initially allow “for no or much more limited access to international credits,” the draft report showed.

“Short-term demand shocks could be contained through the remaining surplus in the EU ETS, and do not require per definition a large amount of international credits,” according to the commission. “Additional flexibility could be foreseen, for instance by creating an automatic system that allows an increase in access to international credits under certain circumstances, such as a strong and sustained price increase.”

The sixth scenario floated by the commission in the draft document includes two mechanisms to temporarily support the price of allowances: a carbon price floor and a price management reserve. Under the latter an amount of permits could be put in a reserve if a decline in demand would lead to “an excessive price decrease,” the commission said.

These mechanisms would “alter the nature of the EU ETS as a quantity-based mechanism,” according to the draft. “They carry a downside in that the carbon price may become primarily a product of administrative and political decisions (or expectations about them), rather than a result of the interplay of market supply and demand.”

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