There is a long way to go to reform the EU carbon market

Georgi Velev

Against the backdrop of an energy crisis, a shutdown of Russian gas supplies and worsening climate change, EU negotiators are facing the daunting task of revising Europe's main emissions-cutting tool: the Emissions Trading Scheme (ETS).

In June, EU countries and the European Parliament gave their views on the carbon market reform brought by the European Commission in 2021. The three are now due to discuss the details in meetings called "trilogues". But that's much easier said than done. This was commented by the European publication Euractiv.

"There is an agreement in the parliament. There is an agreement in the Council, but in some areas these agreements still do not overlap," the EU's first climate vice-president, Frans Timmermans, recently shared. "We need to make sure that, for example, on the reform of the emissions trading system, we bring the two co-legislators together so that we can reach a common conclusion - I think that is the most difficult issue," he added.

There are "many points" on which Parliament and the Council agree in principle, lead ETS negotiator Peter Lise said after the first tripartite meeting in July. For example, both want to extend the carbon price to the marine sector, but the details are not yet worked out. "There are too many problems to talk about red lines now. The main point is that no institution has to believe that a deal is done and the other party just has to agree," Lise believes.

Even the overall emissions reduction target for ETS sectors needs to be agreed, with the Commission and EU states aiming for 61% and the European Parliament asking for 63%. Lise expects at least four more trilogies. While hammering out a deal before COP27 in November would be ideal, he said it was more realistic to expect one by the end of the year.

Phasing out of free allowances

A major source of contention is how quickly to phase out free pollution permits designed to cushion the impact of a carbon price and prevent companies from leaving Europe for places where it is cheaper to emit greenhouse gases. The idea is to gradually replace them with the Carbon Border Adjustment Mechanism (CBAM), which will put a price on carbon-intensive goods entering the EU.

The most difficult topic for negotiations will be the speed of the gradual removal of free quorums, the lead negotiator for CBAM, the Dutch MEP Mohamed Sahim, was categorical.

EU countries and the European Parliament have a similar position when it comes to starting the phase-out, with EU countries wanting a start date of 2026 and Parliament aiming for 2027. However, positions diverge dramatically after 2030. MEPs are pushing for the free quotas to end in 2032, while EU countries want a much slower phase-out ending in 2035.

Industry and environmentalists are watching the debate closely. Industry is concerned about the impact of a rapid removal of quotas, given the newness of the carbon border tax. If it fails, they fear they will be undercut by cheaper, more carbon-intensive products imported from outside the community.

"As a steel sector, we have supported the idea of ​​CBAM from the beginning, but it will always depend on cautious testing and careful interaction with the free allocation and current measures," explains Adolfo Aiello, deputy director general of the steel industry group EUROFER.

The slow removal of quotas is also supported by the industry group BusinessEurope. Markus J. Beyrer, director general of BusinessEurope, said that "they must first see if this new tool [CBAM] works before we give up the little protection we have for energy-intensive sectors that are under strong competition."

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

Six billion free allowances are expected to be given out between 2021 and 2030, but according to van der Plass, "If you give them away for free, you don't auction them, so that's lost revenue for member states, that's lost financial funds available to help decarbonise.'

While he is aware of the industry's challenges, he says there is no evidence that a carbon price is leading to measurable changes in import/export patterns or investment leaving Europe.

Export protection

Another point of contention is how EU industry can trade its goods competitively outside the bloc once free quotas are removed. The industry is concerned that it will face a high carbon price that its non-EU competitors will not have to bear.

"I think both the Parliament and the Council recognize that we have to find the solution there, but it's still a bit unclear what that solution will look like. I think we will depend a lot on the creativity of the European Commission", believes Shahim.

The European Parliament wants to keep free export quotas. However, there are concerns that this could violate international trade rules set by the World Trade Organization.

But Aiello said the answer is simple: “If you want to have an ambitious climate policy, you can't have an overly cautious trade policy.” Many other issues still need to be agreed, such as what happens to the money raised through this fee.

And while Parliament and Council agree on the sectors covered by CBAM, the European Parliament wants to include indirect emissions in the calculation of the carbon intensity of the product, the Commission and EU countries want to include it at a later stage.

Other topics may be easier to agree on. For example, Parliament wants to have a centralized authority to enforce the carbon border tax, and the Council wants what Shahim calls a "hybrid approach". "I think both are fundamentally the same," he told the publication, adding that he doesn't expect much debate on the matter.

Negotiations in times of crisis

Many things have happened since the introduction of carbon market reform, including the energy crisis and the war in Ukraine. Asked whether this would affect the negotiations, Lise said the European Parliament's position already reflected them. He pointed to rebasing, the system that aligns the number of permits in the ETS with actual emissions. Parliament has a lower ambition until 2026 and a steeper overcompensation curve thereafter.

"We're going to give everyone a little bit of breathing room and then we're not only going to catch up, but we're going to increase the ambition, so in 2030 we're going to be more ambitious," Lise explained.

But Van der Plas was unconvinced, saying rebasing was a short-term measure and every year without it slowed down the EU's ambitions. The next tripartite meeting is after the summer break. It will not be the last, as several more are expected after it.