Carbon trading has a pivotal role in European energy policy

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of PLC.

In order to re-establish confidence in Europe’s power sector as an actor in the European quest to cut carbon emissions, a few conditions need to be met. These include concrete intermediate reduction targets and an emissions trading scheme capable of delivering a clear CO2 price signal, writes Giuseppe Montesano.

Giuseppe Montesano is head of European regulation for the Italian energy company.

"Recently there have been a number of international and European commitments for ambitiously reducing emissions to combat climate change.

One important example is the 2009 declaration binding Europe’s power sector to carbon-neutrality by 2050, signed by 61 CEOs representing companies supplying over 70% of EU power generation under the aegis of the region’s power industry association EURELECTRIC.

This commitment highlights just how substantial the power sector’s contribution to reducing carbon intensity across economies can be. The European Commission’s Energy Roadmap 2050 also acknowledges the key role to be played by the sector in the transition to a low-carbon economy.

The Roadmap’s goals and policy objectives represent a huge challenge for Europe, in terms of both implementation and funding. In fact, the International Energy Agency has estimated that €3 trillion will be needed by 2035 to build new energy infrastructure and reinforce Europe’s energy mix, all amid the current cycle of low demand and regulatory uncertainty which threatens new investments.

In order to re-establish confidence in Europe’s power sector, as well as deliver carbon emissions reductions, three conditions must be met. First, a stable long-term framework for the development of the EU energy market must be drawn out. Then, concrete intermediate CO2 emission-reduction targets must also be put in place for 2030, as 2020 is already right around the corner. Finally, a well established market instrument like the ETS, capable of delivering a clear CO2 price signal, must also be set in place.

Unfortunately, these conditions are not being met at the moment. Europe’s Third Energy Package has not yet been implemented and market reforms are still sitting on the agenda of numerous debates across Europe. The ETS has, in principle, a long-term perspective, but in practice, targets beyond 2020 are in a sort of limbo, while the bearish trend of prices is threatening the credibility of the ETS.

Many power companies, including Enel, believe that the ETS remains the most effective instrument to reduce emissions and should be confirmed as the cornerstone of EU climate policy. In order to do so, credibility must be urgently restored to the system. This can come about by acting through a long-term perspective, and by introducing more flexibility to adapt to short-term contingencies under a clearly defined set of rules. This includes aligning the emissions reduction trajectory to the EU’s commitment for 2050, revising the post-2020 targets accordingly, as well as introducing mechanisms to mitigate the effects of economic cycles and limit excessive CO2 price sensitivity.

A signal that produces an immediate effect on market equilibrium and price forecasts is necessary to promote short-term mitigation initiatives, as well as provide adequate predictability for investment planning. CO2 prices currently are not determined by structural demand drivers such as marginal abatement costs or compliance obligations, as one would expect. Instead they reflect market volatility and regulatory uncertainty on long-term policy objectives and possible short-term interventions.

However, structural adjustments will require a relatively long time to implement making timely and coherent intervention with a long-term perspective all the more necessary to provide an immediate response to the market, producing immediate tangible effects on carbon prices, restoring trust in the ETS and fostering expectations for future policy actions.

EU Climate Commissioner Connie Hedegaard’s recent reference to a back loading of auction volumes scheduled for Phase III is a suitable option. Such a measure would buy time while longer-term decisions on the ETS can mature according to EU institutional processes. A “do nothing” scenario, on the contrary, would increase the risk of policy fragmentation at the EU level, with likely counterproductive effects in terms of cost efficiency. Using the ETS as the cornerstone of EU climate policies should mean avoiding overlaps with other policies and targets, which would reduce, rather than reinforce, the effectiveness and cost-efficiency of the ETS.

There are also ways to optimise policies for CO2 reduction by coordinating systems for the development of renewables and energy efficiency within the ETS. Finally, while recalling the three necessary conditions mentioned earlier (stable frameworks, clear targets and market instruments), let me conclude that these will also be able to stimulate the innovation which is essential to sustain the EU’s industrial and environmental leadership."