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What do the recession and energy efficiency have in common?

Both are making EU policy makers think twice about releasing the planned volumes of emissions allowances within the EU Emissions Trading Scheme (EU ETS).

The European Commission’s 2050 Low Carbon Roadmap raised the possibility of ‘setting-aside’ a number of EU Allowances, the permits that are required by heavy polluters in the EU ETS. 

Setting-aside allowances means removing them either temporarily or permanently from the system. This mechanism can be used to re-balance the system when an unforeseen event changes demand for allowances and their price in the trading scheme.

Set-asides have been suggested a number of times by different stakeholders over the past six months: most notably in response to the recession, which unexpectedly reduced emissions across Europe due to a decrease in production, but also in response to new energy efficiency policies.

Set-aside due to the recession

A draft of the EU 2050 Low Carbon Roadmap made public in February said that the recession reduced demand for permits by around 500–800 MtCO2 (million tonnes of carbon dioxide or equivalent greenhouse gas). A World Bank report on the state of the carbon market put that figure at 1280 MtCO2. 

Despite this change in demand for permits, a recent Sandbag report shows that they system is still in deficit overall by 1.1 GtCO2e. In other words, it is projected that between now and 2020 the system will reduce emissions 1.1 GtCO2e below what they would have been without the EU ETS. 

Commentators and policy makers however have suggested that setting-aside some EU Allowances. 

The main reason for the suggestion is that setting-aside allowances will help provide long-term support for carbon prices. Bloomberg New Energy Finance predict that under a scenario where 650 million allowances are set aside until after 2020, carbon prices would be 23% higher on average over Phase III of the EU ETS, which runs from 2013-2020.  

A set-aside would also increase low carbon investment in the near term and get emission reductions back on track, avoiding sharper and more costly adjustments near the end of Phase III.

The final version of the 2050 Roadmap also mentioned the possible need to set-aside allowances; however it lacked any reference to the figure of 500 – 800 million allowances that was mentioned in the draft. Instead it said that ‘appropriate measures need to be considered, 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’. 

Impact of improved energy efficiency

The 2050 Roadmap raised another reason for potential set-aside of allowances: new energy efficiency legislation. This legislation is expected to significantly reduce emissions across Europe by requiring public bodies to renovate 3% of their buildings every year from 2014. 

Such policies did not exist when the emission cap on the EU ETS was set and so their impact on emissions was not considered. 

Without a tighter emissions cap, greater energy efficiency on its own will fail to reduce the overall level of emissions in the EU, since the cap is fixed and allowances given up by power companies will be bought by other polluting industries. Setting-aside the number of allowances equal to the energy savings would overcome that issue.  

Carbon Retirement highlighted this problem in our report ‘Maximising the efficiency of the CRC’  when we reported how the Carbon Reduction Commitment (a UK energy efficiency scheme) could undermine the effectiveness of the EU ETS. Our report suggested the overlap be eradicated by removing or “retiring” a number of allowances out of the UK allocation, a number equal to the emission reductions achieved by CRC participants. 

No numbers have been given at this stage as to how European energy efficiency schemes might affect demand for EU Allowances. But the European Commission has said that it needs to be closely monitored and that set-aside could be used to re-calibrate the system. 

Alternatives to set-aside

One way to reduce the number of permits without the need for set-aside would be to further reduce the number of CDM credits that can be used for compliance in the EU ETS. This would create a greater need for carbon reduction within European industry and would have a similar effect to setting-aside allowances.

Alternatively, and with similar likely effects, the EU could increase their target for emissions reduction from a 20% reduction by 2020 to a 30% reduction by 2020.  Climate Commissioner Connie Hedegaard has already published a paper on the move to a more ambitious target, stating that due to the recession, the cost of moving to such a target has been considerably reduced. 

A clear policy is needed

The need for the EC to set out a clear policy on set-aside has become all the more pressing in recent weeks as lack of certainty on the supply of allowances has created some volatility and criticisms from EU ETS participants and their brokers.

A clear policy on set-aside will create help drive up the price of allowances and will help to achieve both increased investment in emissions abatement technology and faster emissions reductions across Europe.

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