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Long road ahead for carbon market reform

Amid an energy crisis, Russian gas cut-offs, and worsening climate change, EU negotiators face the mammoth task of overhauling Europe’s core emission reduction tool, the emissions trading scheme (ETS)

By: EBR - Posted: Monday, July 25, 2022

“There is an agreement in Parliament. There’s an agreement in Council, but in some areas, these agreements do not overlap yet,” EU climate chief Frans Timmermans told journalists on 14 July.
“There is an agreement in Parliament. There’s an agreement in Council, but in some areas, these agreements do not overlap yet,” EU climate chief Frans Timmermans told journalists on 14 July.

by Kira Taylor

Amid an energy crisis, Russian gas cut-offs, and worsening climate change, EU negotiators face the mammoth task of overhauling Europe’s core emission reduction tool, the emissions trading scheme (ETS).

In June, EU countries and the European Parliament decided their respective positions on the carbon market reform, tabled by the European Commission in 2021. Now the three must thrash out the details in meetings called ‘trilogues’.

But it is far easier said than done.

“There is an agreement in Parliament. There’s an agreement in Council, but in some areas, these agreements do not overlap yet,” EU climate chief Frans Timmermans told journalists on 14 July.

“We need to make sure that, for instance, on the reform of the emissions trading system, we bring the two co-legislators closer together so that we can come up with a common conclusion – I think that is the most thorny issue,” he added.

There are “many points” where the Parliament and Council agree in principle, the lead ETS negotiator Peter Liese said after the first trilogue in July. For instance, both want to expand the carbon price to the maritime sector, but the details are yet to be worked out.

“There are too many issues to speak about red lines now. The main point is that no institution should have the belief that the deal is done and the other side just needs to agree,” Liese told EURACTIV.

Even the overall emissions reductions target for ETS sectors has to be negotiated, with the Commission and EU countries aiming for 61% and the European Parliament wanting 63%.

Liese expects at least four more trilogues. While a deal before COP27 in November would be ideal, he said it is more realistic to expect one by the end of the year.

Phasing out free allowances

A major source of contention is how quickly to phase out free permits to pollute, meant to mitigate the impact of the carbon price and prevent companies from leaving Europe for places where it is cheaper to emit.

The idea is to gradually replace these with the carbon border adjustment mechanism (CBAM)., which would put a price on carbon-intensive goods entering the bloc.

The hardest topic to negotiate will be the speed of the phase-out, the lead CBAM negotiator, Dutch MEP Mohammed Chahim, told EURACTIV.

EU countries and the European Parliament have a similar stance when it comes to starting the phase-out, with EU countries wanting a start date of 2026 and Parliament aiming for 2027.

However, the positions differ drastically past 2030. Parliamentary lawmakers want free allowances to finish in 2032 while EU countries want a much slower phase-out ending in 2035.

Industry and environmentalists are both watching the debate closely. Industry is concerned about the impact of a quick phase-out, given the newness of the carbon border levy. If it fails, they fear being undercut by cheaper, more carbon-intensive products from outside the bloc.

“As the steel sector, we were supporting the idea of the CBAM from the beginning, but always conditional on a cautious testing and a cautious interaction with the free allocation and the current measures,” Adolfo Aiello, deputy director general at the steel industry group EUROFER, told EURACTIV.

A slow phase-out is also favoured by industry group BusinessEurope.

Markus J. Beyrer, director general at BusinessEurope, said they “need to see first whether this new instrument [CBAM] works before we give up the little protection we have for the energy-intensive sectors which are under heavy competition”.

But Sam van den Plas from Carbon Market Watch argues delaying the phase-out decreases the incentive to decarbonise and prevents money from going to the Innovation Fund that finances clean technology.

Six billion free allowances are expected to be handed out between 2021 and 2030, but according to van der Plas, “If you hand them out for free, you are not auctioning them, so it’s forgone revenues to member states, it’s foregone financial means which are available to help decarbonise.”

While he is aware of the industry’s challenges, he says there is no evidence the carbon price leads to measurable shifts in import/ export patterns or investments going out of Europe.

Protecting exports

Another controversial topic is how EU industry can competitively trade outside the bloc once free allowances are removed. The industry is concerned it will face a high carbon price its non-EU competitors will not have to shoulder.

“I think that both the Parliament and Council acknowledge that we have to find the solution there but how that solution would look like is still a bit vague. I think we will depend a lot on the creativity of the European Commission,” said Chahim.

The European Parliament wants to keep free allowances for exports. However, there are concerns this could break international trading rules, set out by the World Trade Organisation.

But Aiello said the answer was simple: “If you want to have an ambitious climate policy, you cannot have an overly cautious trade policy.”

Many other issues are still to be negotiated, for instance, what happens to the money raised by the levy.

And, while the Parliament and Council agree on the sectors covered by CBAM, the European Parliament wants to include indirect emissions in the calculation of a product’s carbon intensiveness, whereas the Commission and EU countries want to include that later.

Other topics may be easier to agree. For instance, the Parliament wants to have a centralised authority to implement the carbon border levy and the Council wants what Chahim calls a “hybrid approach”.

“I think both in the core are exactly the same,” he told EURACTIV, adding he does not expect much debate on this.

Negotiating through a crisis

Much has happened since the carbon market reform was tabled, including the energy crisis and war in Ukraine. Asked whether these will impact negotiations, Liese said the European Parliament’s position already reflects them.

He pointed to rebasing, the system which brings the number of permits in the ETS in line with actual emissions. The Parliament has a lower ambition until 2026 and then a steeper curve to overcompensate.

“We will allow some breathing space for everybody and then we don’t only catch up but increase the ambition, so in 2030, we will be more ambitious,” explained Liese.

However, van der Plas was unconvinced, saying rebasing is a short-term measure and every year without it slows down ambition.

The next trilogue meeting is after the summer break, with several more expected after.

*first published in: www.euractiv.com

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