The reform of the European carbon market: an attempt to rescue a controversial system

By Oriane Renette

Launched in 2005, the carbon market – also called the European Union Emissions Trading System (EU-ETS) – has become the most symbolic tool of the European Union in its fight against global warming. It also represents an object of intense political negotiations. At the COP 21 in Paris, the EU made a commitment to reduce its carbon emissions by 40% compared to 1990 by 2030. To fulfill this commitment, the European institutions struggled to find an agreement on the latest reform of the its carbon market, covering the period 2021-2030.

A pollution market 

Based on the “polluter pays” principle, the carbon market aims at regulating greenhouse gas emissions (mainly CO2, but not only) through a system of cap levels. This ceiling decreases from year to year. A quota is one tonne of CO2. Companies buy at auction (or in some cases receive for free) permits which they can then freely sell to others according to their needs. This flexible approach allows them to reduce their emissions at low cost. The European carbon market currently concerns more than 11,000 power stations and industrial sites and 2.2 billion tonnes of carbon.

Tackling the shortcomings of the system

An excess of allowances, due among other reasons to the economic crisis of 2008, resulted in an extremely low carbon price (5 Euros / tonne) and, consequently, in a lower incentive to reduce emissions. The Commission proposed to freeze the quotas and to create a reserve stability. These proposals were made shortly before the 2014 elections. Without being a major issue, reducing carbon emissions was an objective announced in most of the European parties’ manifestos.

This agreement shows that the EU is serious in its climate leadership.” Julie Girling, rapporteur.

Six rounds of negotiations

In 2015, the Commission headed by Jean-Claude Juncker presented its proposal. The draft revision was far from unanimous. In February 2017, the European Parliament and the Council each defined their position on the dossier. At first glance, inconsistent. The institutions therefore began negotiations to find a common understanding on the main blocking points. In total, six trilogues took place leading to an informal agreement between the two co-legislators.  Adopted by the Parliament on Tuesday 6 February 2018 by a very large majority (535 MEPs voted in favor,  the reform provides for a faster reduction of greenhouse gas emissions in the European Union. The new agreement sets an annual cap of allowances available on the market of 2.2% from 2021 (against 1.74% previously). A decrease that will be even more demanding from 2024. In addition, the stability reserve capacity of the market will be doubled. This mechanism will make it possible to eliminate the excess of quotas on the market and thus to ensure a higher carbon price…

This reform is also the result of discussions and concessions within the Council. The first proposal met great disparities in the votes. France, Sweden and the Netherlands pushed for a more ambitious proposal. Germany and Italy were divided as they seek to protect their industries. Eastern countries were against increasing cuts. Poland, whose industry relies heavily on coal, has distinguished itself by its fierce opposition to the proposal. The Council finally gave its formal agreement on the reform on 27 February.

Protection of the environment and European industries: a delicate balance

The continuation of this delicate balance has led the European institutions to take measures to protect European industries from “carbon leakage”, i.e. to relocate production to third countries where emission limits are less stringent or non-existent. Companies facing this risk of relocation are given a number of free allowances.

In addition, to support countries in the transition to a low-carbon economy, two European funds have also been introduced. They are intended to promote innovation and modernisation of the industrial and energy sectors by 2020. They will, among other things, support the lowest-income member states in their transition.

Published in the EU’s Official Journal on 19 March, the Directive will come into force 20 days after this publication.