Follow-Up Meetings Advance EU ETS Reform Package
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Today, the EU Council held a meeting to finalize their view on the ETS reform package. We are still awaiting the outcome, though once it is released, we will provide a summary of their position. Some believe that the state members are leaning more toward the original proposal provided by the Commission, which is less ambitious than the version just passed by Parliament. We have detailed below the revised package approved by Parliament last week.
Recap of Parliament’s view:
- Set a 2030 emissions reduction goal tighter at 63% below 1990 levels
- One-off reductions in permit supply of 70mt in 2024 and 50mt in 2026
- CBAM (Carbon Border Adjustment Mechanism) starts in 2027 with a corresponding reduction in free allowances
- Clarity on restrictions for speculative access to physical allowances
- Article 29a: tightened price control mechanism
On Wednesday the European Parliament adopted its report on the “For for 55” reform package for the EU Emissions Trading System, as well as on the proposed Carbon Border Adjustment Mechanism. Note that nothing is completely finalized but the first steps of Parliament’s approval is key to moving the package forward.
The report contains the assembly’s proposed amendments to the full legislative proposal, which was first tabled by the Commission last year.
This week’s vote was the second attempt by the legislature to agree its position on the ETS reform package, after a first vote ended in chaos, with lawmakers on both the left and right opposing a slate of amendments that had been discussed by the assembly’s environment committee.
Parliament has now opted to set a 2030 emissions reduction goal of slightly more than 63% below 1990 levels, which higher than the Commission’s initial 61% proposed cut but less than the 67% that Parliament itself debated two weeks earlier. As a slight improvement, the more aggressive target means more upside pressure for the market.
The annual cap on emissions would decline each year by 4.4% in 2024, and by 4.5% from 2025, instead of the 4.2% suggested by the environment committee earlier this month. A steeper reduction in the cap results in a tightening of supply, which could be bullish for carbon prices.
Analysts have calculated that Parliament’s updated amendments to the bill would give an emissions cap of 12.278 billion tonnes by 2030, or 6 million tonnes less than the first iteration of the committee file.
Additionally, amendments to the Carbon Border Adjustment Mechanism (CBAM) proposal were passed by parliament, mainly dealing with the phase-out of free EUA allocation to European industry.
The CBAM would require importers of raw materials from countries without equivalent carbon prices to pay a shadow price of carbon – linked to the EUA price. The CBAM would initially apply to imports of such products as steel, cement, chemicals, and plastics.
By adding a cost of carbon to imported materials, the EU hopes to create a level playing field between EU producers and their foreign competitors. As a result, the free issuance of EUAs to European industrial installations would no longer be necessary, and so free EUAs would be phased out between 2026 and 2032.
The end of free EUAs for industry would bring those companies to the market, some of them for the first time, and this would add to demand in the market, potentially pushing prices higher.
The assembly also voted to make changes to the market’s price control system – known as Article 29a. Under current rules, the Commission would inject more allowances into the market if, for six months, prices rose more than three times higher than the preceding two-year average.
The new proposed rules would reduce the price multiple to two, making it potentially easier for the mechanism to be triggered. However, this amendment essentially leaves the market dynamics relatively unchanged. Instead of injecting more allowances from a special reserve, the Commission brings forward volume from subsequent auctions, and thus is able to maintain the overall cap on supply. The impact of advancing supply (rather than introducing new supply) simply tightens the market and would be reflected in a steeper price curve – which in turn would filter back to prompt prices through the cost of carry.
New revisions to Article 29a provide clearer direction for officials compared to the open-ended provisions previously laid out (which was never activated despite several significant price hikes).
Despite its disapproval among market experts, the Parliament also passed amendments that would prevent non-compliance entities (i.e. speculators and investors) from accessing the emissions registry or owning physical EUAs.
The general opinion among the trading community is that the proposed amendments are unlikely to impact trading in the derivatives markets since financial investors rarely hold the underlying asset. Traders will, however, be watching for a reaction from major market-makers on the futures exchanges, since many of them do hold physical EUAs as a hedge against futures positions.
The next step in legislation is for the European Council, representing member state governments, to agree its position on the reforms. It’s not yet clear whether central and eastern countries and their western counterparts will agree on all elements of the package, with differences over the CBAM and some elements of the EU ETS reform package said to be difficult to resolve.
Once the Council has agreed on a position, negotiations between the Council, Parliament and Commission will take place over the rest of the year to develop a compromise package acceptable to all the co-legislators. This process is expected to take much of the rest of 2022.
We will continue to provide updates as we closely watch developments in this ever-expanding market.