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EU Proposes Tighter Control on Auction Timing in Bid to Increase Carbon Allowance Prices

Aug. 6, 2012
On July 25, the European Commission (Commission) presented its plans to bolster the Emissions Trading Scheme (ETS) by reducing the burden of surplus carbon allowances — and thereby encouraging higher carbon prices — through controlling the timing of allowance auctions. According to the press release (available here), the Commission has urged the European Union (EU) member states to make the necessary legal amendment implementing this change by the year’s end.

Background

As discussed in our June 21 alert, this spring the carbon allowance price in Europe fell to a record low of roughly €6 (US$7.50) per ton of carbon dioxide equivalent. Although the price has since risen back to approximately €7 (US$8.50), this is still far below the €20 – €50 levels widely considered necessary to spur investment in low-carbon technologies and processes or to discourage high emissions of greenhouse gases (GHGs).

Most attribute the low prices of ETS credits to the general slowdown of industry throughout the EU, which has caused covered entities to emit fewer GHGs and therefore require fewer ETS credits than anticipated. In addition, further downward price pressure may be a result of the linkages between the ETS market and carbon-credit systems outside the EU, including from the Kyoto Protocol-based Clean Development Mechanism, in which industry can purchase GHG offset credits for carbon-reducing projects in certain developing countries. Lastly, rapid expansion of renewable energy technologies through many EU states has created less demand for credits in the energy production sector.

The European Commission Proposal

Due to the low prices of ETS credits and low liquidity of the ETS market, the European Commission began review of the ETS program in mid-April. Following its review, it issued a Proposed Decision to clarify that the Commission Regulation on auctioning can be amended in order to alter the timing of auctions within the trading periods as a way to promote a healthier market through tighter control on allowance supply and the timing of allowance availability. Specifically, the Commission’s proposal would allow for early auctioning of 0.4 billion, 0.9 billion or 1.2 billion allowances in 2012 (the last year of the first trading period), with a corresponding reduction of the number of allowances included in the 2013 and 2014 auctions (part of the second trading period, which lasts until 2020).

The Commission anticipates that this back-loading of credits put up for auction will increase the price early in the next trading period (thereby jumpstarting the market) and reduce prices when the volumes are increased again after the first two years. As stated by EU Climate Action Commissioner Connie Hedegaard, “The EU ETS has a growing surplus of allowances built up over the last few years. It is not wise to deliberately continue to flood a market that is already oversupplied.”

Reactions to the Proposed Decision have been mixed, both among industry participants in the ETS program and among EU member states. BusinessEurope (a trade organization representing 20 million companies from 35 countries that aims to strengthen corporate competitiveness throughout the EU), as well as groups representing carbon-intensive industries such as cement and metal production, have criticized the Commission’s interference in the carbon market and argued that the new approach would encourage carbon “leakage” by forcing such industries to relocate in non-EU states. Meanwhile, a coalition of prominent energy companies (including GE, Shell, Alstom and several others) has voiced support for the proposal while environmentalist organizations have called for the EU to go even further in its efforts to drive carbon prices up.

In a similar vein, EU member states with more carbon-intensive industries (such as Poland, which relies heavily on coal) are opposed to the proposed decision while those that have a high integration of renewable sources (such as Germany and Spain) are more neutral.

Next Steps and Outlook

The Proposed Decision requires the approval of the EU member states as well as the European Parliament. Following the European Commission’s summer recess in August, the proposal will be analyzed and then debated by representatives from all member states at a meeting of the Climate Change Committee on Sept. 19. Later this year, the Commission will present its first report on the functioning of the carbon market, which could launch a debate on the deeper reform of the ETS system. Although many have claimed that low prices and a glut of allowances have rendered the ETS largely ineffectual in reducing actual CO2 emissions, there do not appear to be easy answers from the EU member states on how to address the concerns. If approved, the adjustment of the auction timetable likely represents a relatively minor tool to drive the market; whether the ETS system can succeed longer-term in the face of Europe’s struggling and volatile economy remains to be seen. 

Circular 230 Disclosure: Internal Revenue Service regulations provide that, for the purpose of avoiding certain penalties under the Internal Revenue Code, taxpayers may rely only on opinions of counsel that meet specific requirements set forth in the regulations, including a requirement that such opinions contain extensive factual and legal discussion and analysis. Any tax advice that may be contained herein does not constitute an opinion that meets the requirements of the regulations. Any such tax advice therefore cannot be used, and was not intended or written to be used, for the purpose of avoiding any federal tax penalties that the Internal Revenue Service may attempt to impose.

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