The EU Emissions Trading System is facing a future of tighter supply as the EU's legislative bodies move forward on reforms that aim to curb a long running surplus of carbon allowances. While the system remains oversupplied in the short-term, carbon prices could be poised for future growth if the reform proposals pass into law.
Frank Watson, managing editor, European emissions, examines the background to proceedings and assesses the latest developments, allowing for three-way talks to commence between the parliament, Council and European Commission.
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EU ministers agree position on post-2020 carbon market reforms
Video Transcript
EU ministers agree on post-2020 ETS reforms
By Frank Watson
Welcome to the Snapshot a series that examines the factors driving and shaping global commodity markets today.
On February 28, the EU Environment Council - representing the EU member states - voted in favor of reforms to the EU Emissions Trading System that will take effect after 2020. That follows a plenary vote by the EU Parliament on February 15.
EU Environment ministers back post-2020 carbon market reforms
Approval is needed from both institutions in order for the proposed legislation to pass into law. The latest developments mean three-way talks can begin between the parliament, Council and European Commission.
Crucially, both the parliament and council have now backed a 2.2% per year decline in the CO2 cap from 2021-2030 and stronger measures for the Market Stability Reserve – a set-aside that will withdraw surplus carbon allowances from the market each year starting in 2019.
EU carbon allowance prices for December 2017 delivery jumped by 13% to almost 6 euros a ton the day after the EU Council’s agreement, which went further than the parliament’s version.
If the stronger measures are passed into law, we think the Market Stability Reserve is a game-changer for Europe’s cap-and-trade system, because for the first time, it will reconnect supply with underlying demand.
In the past, the accumulative surplus of allowances has reached 2.2 billion tons of CO2 equivalent – more than a year’s worth of CO2 emissions across the 28-member system – keeping carbon prices depressed.
The Market Stability Reserve completely changes that underlying dynamic, because it will institutionalize a much smaller market surplus of 400 million to 833 million tons of allowances. The withdrawal or release of allowances from the reserve will happen automatically, irrespective of underlying demand-side factors.
This is likely to eliminate very low and very high carbon prices because a fixed lower and upper limit on the surplus suggests a lower and upper limit on the price.
Under the effects of the MSR, the surplus will eventually fall within the 400 to 833 million ton range, and we think this could happen by around 2022, assuming that the proposed 24% per year intake rate for the MSR is agreed in the final legislation.
Looking back at the net surplus and comparing it to historical prices, we can see that when the surplus was at about the same level as that implied in future by the MSR, the price moved in a range of roughly 10 and 17 euros per ton.
Therefore, we think it is possible that prices move into a similar range once the MSR has reduced the surplus by the early 2020s. That suggests an increase from today’s price of around 5-and-a half euros per ton, over the long term.
Until next time on the Snapshot, we’ll keep an eye on the market.