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Carbon price crash shows "urgent" reform needed to EU emissions trading, says expert

The "dramatic drop" in the EU carbon price and permits under the EU's emissions trading scheme (EU ETS) reinforces the need for "urgent" reform of the system, an expert has said.30 Jan 2013

Eluned Watson of Pinsent Masons, the law firm behind Out-Law.com, was commenting as prices fell to a record low of €2.81 a tonne after the European Parliament voted against plans to 'backload' carbon auctions under the third phase of the EU ETS to address falling demand. Although prices later rallied to just under €5 a tonne, EU Commissioner for Climate Action Connie Hedegaard described it as a "final wake-up call" for the scheme.

As announced last month, the Commission has proposed transferring some 900 million allowances that would otherwise have been made available for auction between 2013 and 2015 under the third phase of the EU ETS to later in the same period. By doing so, it hopes to address the build-up in allowances caused by reduced industrial activity during the economic downturn.

Watson, an environmental law expert with Pinsent Masons, acknowledged that the proposal was not a "fix all solution" for the struggling scheme. However, she said that it was "disappointing" that the Commision's proposal to backload allowances  had been "met with resistance at such an early stage" by the European Parliament.

"The dramatic drop in the EU carbon price reinforces the fact that urgent action is required, backed by clear legislative support, to structurally reform the EU ETS and to rebalance the supply and demand of allowances in the EU ETS market," she said. "Although the backloading proposal is very much a 'quick fix', reactionary measure, it is clear that longer term structural reform will take time, with changes unlikely to be in place until 2017 at the earliest."

"It is hoped that more decisive votes are forthcoming in the environment committee in February and the Plenary session in March to push through the proposal. Although not a 'fix all' solution, it is clear that such urgent measures are required to prevent further price drops, to provide greater certainty to industry on the carbon price and overall to make sure that the EU ETS remains an effective mechanism to promote reductions in greenhouse gas emissions and to drive investment in a wide range of low carbon technologies," she said.

Under the EU ETS there is a cap on greenhouse gas emissions from prescribed energy intensive installations. Installations must purchase greenhouse gas emissions allowances, called European Union Allowances (EUAs),  representing the right to emit or discharge a specific volume of emissions in line with national allocation plans. Operators of installations must hold EUAs equal to, or more than, total emissions at the end of the EU ETS year and those with excess allowances can 'bank' allowances or trade with those who need to buy more allowances to comply with emissions limits.

The EU ETS began in 2005 and was the first major emissions trading scheme in the world. The  third phase begins on 1 January 2013 and runs until 2020. The EU ETS covers more than 11,000 factories, power stations and other installations with a net heat excess of 20MW per year. It currently operates in all 27 EU member states as well as Iceland, Norway and Liechtenstein and is set to fully link up with a future Australian emissions trading scheme by 2018.

"Few would disagree that the ETS is the most cost-efficient tool in EU climate politics. If in doubt, look at all the big economies now following the EU example by establishing similar ETS systems: Australia, Korea, California, China," Commissioner Hedegaard said shortly after the European Parliament's vote.

"We have presented a proposal for back-loading (the short term response) and options for the more structural initiatives. Everyone knows that the political discourse over the structural options will take time. The recent events show that something has to be done urgently. I can therefore only appeal to the governments and the European Parliament to act responsibly and support the back-loading," she said.

Failure to agree reforms at a European level would lead to "a re-nationalisation of climate tools" rather than a "level playing field" for European companies, she warned.

In its first report on the carbon market (12-page / 225KB PDF), published last month, the Commission proposed six longer-term structural changes to the EU ETS. These could include increasing the EU's carbon reduction target from the current 20% to 30% by 2020, the permanent cancellation of a number of allowances or extending the scheme to cover additional sectors.