Achieving 1.5°C warming goal requires rapid reform of EU carbon market

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Because time is short and political capital is a limited resource, policymakers should carefully weigh the relative merits of different options to maximise the climate impact of the ETS reform, argue Mari Pantsar and Outi Haanperä. [Sitra]

To deliver quick results, the European Commission should focus on two measures when revising the EU Emissions Trading Scheme: strengthening the cap and enhancing the Market Stability Reserve (MSR), write Mari Pantsar and Outi Haanperä.

Mari Pantsar is the director for carbon-neutral circular economy at Sitra, the Finnish Innovation Fund. Outi Haanperä is a leading specialist at Sitra.

The new President of the European Commission, Ursula von den Leyen, pledged to increase the EU’s 2030 emission reduction target from 40% to at least 50% from 1990 levels, with the possibility to push this to 55%.

More information about the targets, and the measures to achieve them, were outlined in the European Green New Deal communication in December.

We all know the coming decade is crucial in the fight against global warming. European Union leaders, with the exception of Poland, have agreed a ‘net-zero’ greenhouse gas emissions target by 2050 at their December summit. Updating the EU 2030 climate target is a logical consequence and doing so would meet the request by the international community to update the Nationally Determined Contributions (NDC) by 2020.

The current pledges under the Paris Agreement are not compatible with the 1.5-degree warming target and therefore all parties to the Agreement, including the EU, need to increase their emission reduction efforts.

Any plan to increase EU climate ambition shifts the focus to the EU Emission Trading Scheme (EU ETS). Although the system has effectively reduced emissions – under the stationary ETS, emissions decreased by 29% since 2005 compared to a 10% decrease in sectors covered by the Effort Sharing Regulation (ESR) – the system still dramatically falls short of its potential to help the EU meet its Paris climate targets.

The big question is how to Paris-proof the EU ETS.

A recent study by the Finnish Innovation Fund Sitra and the Öko Institut looks at how the ETS objectives should be altered under a scenario where the EU’s emission reduction target is increased from the current 40% to either 55% or 60% by 2030, compared to the 1990 levels.

As a consequence of the EU’s more ambitious emission reduction target, emissions within the scope of the EU ETS should be reduced by 61-65% compared to 2005 levels. The current target is a 43% reduction from the 2005 levels.

The important question now is how to best close the gap between the current target and the more ambitious target. How to evaluate different measures, abundant in the literature, to enhance the EU ETS?

We argue the chosen measures should maximise the emission reductions by 2030 while minimising the administrative effort associated with implementing the measures. The study assesses both the actual emission reduction potential of the individual measures, as well as their practicality when it comes to implementation, such as the associated legislative process required to implement the measure.

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Our analysis suggests that the emission reduction potential and the practicality of the measures vary significantly. Therefore, the Commission should focus on two measures when revising the EU ETS: strengthening the cap and enhancing the Market Stability Reserve (MSR).

The former ensures that the number of emission allowances entering the market is aligned with the enhanced emission reduction target whereas the latter addresses the surplus of emission allowances.

The surplus of emission allowances, currently amounting to approximately 1.7 billion allowances, threatens the stability of the system and therefore needs to be tackled properly.

If we want to reduce emissions in the ETS sector faster, we must reduce the amount of emission allowances put into circulation. Importantly, early action pays off both from a political and climate perspective:

The earlier changes are adopted, the smaller are the changes needed for key parameters such as the linear reduction factor, and the lower the cumulative emissions to the atmosphere.

A stronger MSR would be able to absorb the current and expected surplus of emission allowances. It is notable that without enhancing the MSR, even meeting the current target is at risk because of the surplus of allowances building up again in the next decade.

Our study recommends that the MSR continue to take in allowances at the higher rate after 2023. Also, the thresholds determining whether the MSR takes in or releases allowances should decrease at the same rate as the cap.

The future of the EU ETS is not only in the hands of the European Commission, but the Member States can play a significant role, too. Implementing a regional carbon price floor and cancelling surplus allowances resulting from coal-fired power plants closures will not only reduce emissions, it is also relatively easy to implement. This is because they only depend on national decision making in the participating member states.

The emission reduction potential of the other measures, such as extending the scope of the EU ETS, is much more limited. Therefore, European policymakers should carefully weigh the relative merits of different options to maximise the impact of the proposed interventions.

Because political capital is a limited resource, we should use it wisely in the coming decade, which will be pivotal in the fight against global warming.

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The Emissions Trading Scheme (ETS) is not a good instrument to cut road transport emissions because it will raise petrol prices and fuel popular discontent, as seen in the past with the ‘Gilets Jaunes’ protests, writes William Todts. Road emissions …

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