Solving the Wrong Variable
My speech to the Carbon Pricing Leadership Coalition High Level Forum on the proposal for a Carbon Collar
The EU Emissions Trading System doesn’t work, at least not as it was intended to work. A symptom of this is a carbon price of around €6 per tonne; an irritant but not a serious driver of innovation or of change.
I will talk shortly about the proposal of the French Government for a ‘soft collar’ (a so much more enticing name than a carbon corridor). Before I don the collar, I should take a moment to explore the problem.
Why doesn't the market work?
In a single word: oversupply. There are simply too many allowances. When the ETS was launched back in 2005, with an initial carbon price that rose to €35, I might add - no one foresaw the single largest global economic contraction in over 80 years. Economists, eh? Suddenly there were plenty of allowances. None of the original ETS architects had anticipated such global contraction, so no prevision was made to address the problem.
Aside from ‘events’, there was another suite of factors creating oversupply: the EU (and certain member states) have instituted a number of policies each of which have been successful in driving energy switching and emission reduction. In my constituency of Scotland, the last coal-fired power station closed in March, in no small part due to the industrial emissions directive. At its peak, Longannet, the third largest coal-fired power station in Europe was emitting more than 10 million tonnes of carbon annually. Now it isn’t. Since the ETS began in 2005, the UK as a whole has reduced its carbon emissions (and therefore its demand for allowances) by 28%. And in this, the UK is not alone, the overlapping policies adopted at Member State and EU level (which sit alongside the ETS) have reduced overall emissions by 24%.
So what’s the answer?
Eventually it was conceded that the market alone could not solve the problem, and so was born the ‘Market Stability Reserve,’ a noble attempt to dry up the all too saturated market. I was one of the Parliament’s negotiators on the proposal. The motto for the negotiations could well have been, ‘make haste slowly'. The Commission proposed a start date of 2021. The Parliament eventually compromised on 2019. And the extraordinary surfeit of allowances would not be cancelled (not even gradually over time) they would be saved in a big vault for a rainy day when they could be returned to the market. So we have a saturated market until at least 2019, and no guarantee it won’t saturate again.
We’ll always have Paris
The UN Climate Change accord, signed in Paris, represents a paradigm shift. However, there is a gulf between rhetoric and reality that is worth considering. The EU, and its Member States, founding members of the High Ambition Coalition - have signed the accord. However, ratification is another question entirely. It will take time to corral the member states. Indeed there is every prospect that the Paris Accord will come into force without the ratification of the EU.
The coming reform of the Emission Trading System
I sit in the third largest Group in the European Parliament. It is a third the size of the centre-right EPP, and half the size of the Socialist Group. Given the make-up of my group, I can call upon about half the MEPs - on a good day - to support my position. In truth my power extends only as far as the ambitions and desires of my colleagues in larger groups and of course, ultimately, upon compromise with the European Council. And so my report has been drafted by compromise and consensus.
One important point became clear early on: whilst there is agreement on the need to raise ambition, there is little appetite (and certainly not the votes) to raise the ambition of the Linear Reduction Factor (LRF) (not yet anyway).
There was however a consensus on addressing the supply side of the equation. Something has to be done to reduce the volume of allowances in the market. And that brings me to the ‘triple lock of ambition’ - a set of levers that if used well will adjust the price of carbon, not through artificial price inflation - which is a symptom not a cause of the problem - but by tackling the oversupply. Let me spell out the locks:
Lock one: Allow member states to retire the surplus emissions that result from the success of national policies. The UK, whose coal-fired power stations produce 75 million tonnes of CO2 each year, will fully decarbonise by 2025. Other EU nations are marching in step. The UK is a Paris signatory with a high climate ambition. My proposal would allow such states to march ahead of the pack. Subsidiarity and empowerment wrapped in one.
Lock two: The EU has a number of (successful) emissions reduction policies which depress the ETS price. Under my proposal, each year the Commission must determine the impact of these overlapping measures on the carbon price and adjust the ETS, either through retirement of allowances, full cancelation or structural reform. Real time reform of the ETS, driven by market reality. For example, the Renewables Efficiency Directive and the Energy Efficiency Directive will reduce demand for allowances by 700 million tonnes of CO2 by the start of Phase IV. Removing these allowances would raise ambition by more than the proposed 26% increase in the LRF (compared with Phase III).
Lock Three: The UN will conduct its first global stock stake of climate ambitions in 2023. I propose that the EU recalibrate its ETS at this point. The EU has many policies it could adjust, but this clause will mean that adjustment of the ETS is embedded in law. Bear in mind that the review comes only 24 months into Phase IV. Real change in real time, based upon a clear analysis of where the EU is in terms of emissions reduction.
Each of these locks addresses the issue of volume of allowances. It empowers both the EU and the ‘high ambition coalition’ Member States to reduce the allowances in the market, without recourse to a further back loading mechanism or through the imposition of a steep linear reduction factor (which doesn't seem to have the votes).
The French ‘soft collar’ and the problem of solving for the wrong variable.
The price is a symptom of the failure of the ETS, not a cause. The cause, as I outlined above, is over-supply.
Having read the French non-paper let me make some observations:
The paper states that, ‘several carbon markets in the world have right from the start set up a ‘minimum floor carbon price’.’ Indeed. Unfortunately, the EU wasn’t one of them. The EU therefore has to address a very specific issue, namely the oversupply of allowances, a challenge which none of the other schemes have had to deal with. Price alone cannot address the over-supply.
The declaration that the imposition of a carbon floor and an annual ratchet ‘will lead to a price of €30 per tonne by 2030,’ is disingenuous. The market isn’t being led, the price is being set. This is about as far from a market-driven price as it is possible to be.
The statement that, ‘if the floor price is close to the current projected path of price developments, it is likely that few auctions will be cancelled,’ is just plain odd. Given that the only driver of the price increase is the floor price, it invariably will be set just where it is predicted to be. (Unless of course something else intervenes to dry up the allowances).
A British politician once described himself as an optimist, but an optimist who always carried an umbrella. I have taken that approach to heart as I developed the triple lock. I believe that they address the oversupply issue, empower member states to embrace a high ambition pathway, and compel the Commission to do something about the (successful) overlapping climate change policies.
My political group in the European Parliament is too small for me to drive through all of these reforms. They will survive only if MEPs believe that they will address the challenge of climate change, whilst affording the necessary protection to industry.