EU carbon market blurred by volatile prices and speculation, Greens warn

The current carbon price is volatile, meaning the flawed market system must be addressed if it is to continue being high and incentivising decarbonisation in European industry [Daina le Lardic / EP]

The EU needs to tackle design flaws and speculation on its carbon market to ensure the price of emissions remains high and becomes a more effective tool to drive decarbonisation, according to a report by the Greens in the European Parliament.

The carbon price on the EU emissions trading scheme (ETS) has risen sharply over the past year, reaching heights that weren’t expected until the end of the decade.

But while a high price for emitting climate-warming carbon is good, the volatility of the CO2 price on the carbon market needs to be addressed or there are risks of jeopardising the decarbonisation effort, according to Marie Toussaint, a Green lawmaker in the energy committee and group co-president Philippe Lamberts.

“Although the EU ETS is the cornerstone of the EU’s policy to combat climate change, it has contributed far too little to greenhouse gas emission reductions in the sectors covered since its inception in 2005,” Toussaint and Lamberts write in a foreword to a new report on the EU carbon market.

“Unless the European Parliament and the Council agree to tackle the structural flaws of the EU carbon market, our common future could therefore be seriously compromised,” they warn.

An independent report commissioned by the lawmakers found design flaws on the EU carbon market mean it is not fit for purpose, despite the EU lauding it as a key instrument to drive reductions in emissions. According to the European Commission, “since the EU ETS was introduced in 2005, emissions have been cut by 42.8% in the main sectors covered: power and heat generation and energy-intensive industrial installations.”

But flaws in the design of the EU carbon market have undermined its effectiveness, according to the report by Frédéric Hache, former financial market professional, independent consultant and director of the Green Finance Observatory.

Those include a surplus of emissions allowances in the first phases of the market’s launch, free pollution permits given to companies in order to prevent them from leaving Europe, and a lack of precautions against speculation.

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With its proposed reform of the EU Emissions Trading Scheme (EU ETS), the European Commission is bringing carbon pricing policies to new areas such as shipping, road transport, and buildings. However, it is the fate of industry and ordinary people that is getting all the political attention.

Speculation and a blurred price signal

According to Hache’s report, the two tools in the ETS that drive decarbonisation – the price signal and the cap on allowances available – are flawed and create uncertainty.

For instance, he warns that the price signal, which aims to incentivise investments in low-carbon technology, is blurred by volatile prices and speculation.

“A high price without the expectation that prices will remain high will do little to incentivise a change in behaviour and technology,” Hache warns.

“A strong and stable carbon price signal is essential for the EU ETS to be truly effective. Without the expectation of a future scarcity of allowances, energy-intensive industrial sectors will not be encouraged to switch to cleaner technologies,” write Toussaint and Lamberts in their foreword.

The other incentive to decarbonise – the cap of emission allowances – is also flawed because of the excess of carbon allowances on the market, according to Hache. He points out that, between 2013 and 2019, verified emissions were on average about 220 million allowances lower than the nominal cap. And the closure of coal power plants and uptake of renewables will likely continue this trend.

“The extremely high volatility of carbon prices in the EU ETS, coupled with the vast excess of carbon allowances, thus entirely explain its failure to meaningfully contribute to climate change mitigation,” he writes.

However, tackling these issues must be done carefully, say Toussaint and Lamberts. They warn that, if the EU focuses only on curbing speculation, there is a risk that the price will drop and further undermine the ETS’s goal.

Instead, they argue that policymakers should move in stages, first making drastic cuts to the allowance surplus and then curbing speculation.

An insufficient revision

In July 2021, the European Commission put forward a proposal to revise the EU carbon market. There are some positive points in the revision, says Hache, including the progressive reduction of allowances on the market (via the Linear Reduction Factor) and the inclusion of the maritime sector in the carbon price.

But Hache warns the revision “fails to address in a timely fashion the enormous surplus of allowances in the system”, leaves free allowances in the system for another 14 years and fails to address speculation and limit price volatility.

Also, the Commission proposal saw no change to the Market Stability Reserve, introduced in 2019 to address the surplus on the market, which currently amounts to 1.5 billion allowances. The reserve does this by withholding a certain number of allowances from the market and injecting these if needed.

And Peter Liese, the German lawmaker who is leading the revision of the EU ETS in the European Parliament, has not made any attempts to increase the ambition of the Market Stability Reserve or the linear reduction factor, which would help tackle the excess of allowances, Hache said.

This was confirmed by Liese when he presented his report on the ETS in January. “I think the Commission, in general, has made a good proposal when it comes to ambition,” he told journalists at a press briefing about his report.

Liese also introduced a “bonus-malus system” to incentivise decarbonisation which rewards best performing companies with extra emission allowances while penalising worst performers by requiring them to introduce climate plans before they can receive their allowances.

That was met with scepticism from his fellow lawmakers, who feel like there is a lack of ambition in his report. “He is definitely too slow on phasing out free allocations, too slow on innovation and too slow on CBAM,” Swedish lawmaker for Renew Europe Emma Wiesner told EURACTIV.

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[Edited by Frédéric Simon]

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