By Yan Gu, Summer Intern

The European Parliament recently voted through a temporary plan to delay the auction of hundreds of millions of EU emission allowances (EUAs) for several years, in order to avoid flooding the market with new allowances while prices are near historic lows.  This decision allows what is known as the “back-loading” proposal to proceed to further negotiations with the European Council to reach a commonly approved text that could become law in the future.

The EU Emission Trading Scheme (EU ETS), established under a Directive of European Parliament and Council in 2005, has been the world’s largest market-based emission trading system designed to meet GHG emission reduction targets set by the Kyoto Protocol. Since 2009, however, the carbon market has experienced a significant imbalance between the supply and demand of emission allowances, largely due to the economic and financial crisis sweeping the entire world, but also to early over-allocation of allowances by national governments. There were up to two billion surplus of allowances as of the beginning of the EU ETS’s third phase of operation (running from 2013-2020), according to European Commission Directorate-General for Climate Action. As a result, the EUA price hit bottom: a record low of 2.63 euros a ton in April 2013, compared to its peak near 30 euros in July 2008. Prices this low fail to send the signal needed to stimulate investment into low carbon technologies and undermine the ETS’s ability to meet higher reduction goals in the long-term.

The back-loading regulation aims to help prop up this ailing market. While keeping the overall number of EUAs unchanged, the plan postpones the 900 million allowances scheduled for auction in 2013-2015 until 2019-2020. By doing so, the EU hopes that the price for EUAs will rebound, thereby at least temporarily restoring the ETS’s effectiveness in reducing emissions. The back-loading strategy was subjected to proportionate impact assessment, which found that “this magnitude of back-loading is likely to provide for temporary support to the price signal in 2013-2015 compared to prices at present.”

Recognizing the market imbalances, the Commission initially proposed to the European Parliament and Council an amendment to ETS Directive in July 2012 to clarify the scope of the Commission’s power on modifying the time of auctions of GHG allowances. This proposal, after one year’s debate, developed into the newly adopted decision of the Parliament (approved on July 3, 2013) that “the Commission may, in exceptional circumstances, adapt the timetable” and “shall make no more than one such adaptation for a maximum number of 900 million allowances”.

It should be noted that in April, the Members of European Parliament (MEP) voted, by 334 to 315 votes, against the back-loading plan of the same amount. The proposal was then sent to the European Parliament’s Environmental Committee for re-assessment. Stricter limits were added to the new version, providing that changes in auctioning schedule must be determined to present no “significant risk” of carbon leakage. The political rebirth of the back-loading regulation was attributed to leadership by the UK climate change minister, along with a group of ministers from other nations. In a joint announcement released on May 7, the ministers called for setting a timetable for adopting of the reform, urging that July 2013 would be the last time to come to a resolution on the back-loading proposals.

The back-loading decision is considered a necessary short-term remedy to save the carbon market. In the long run, more substantial “structural reform” is essential for EU to correct over-supply and revitalize the market. In the Commission’s first Carbon Market Report issued at the end of 2012, it proposed six potential structural measures to address the two billion surplus allowances (which will not ultimately be affected by temporary back-loading). Among the options presented are proposals to increase the stringency of the EU’s reduction targets in 2020, to permanently retire a number of surplus allowances, and/or to extend the scope of the ETS to additional sectors.

The European Commission has initiated active debate and consultation meetings based on the Report to explore these options for reform. The UK government allied 12 EU states in another joint statement prior to July’s back-loading vote, calling for the Commission to bring forward a legislative proposal for reforming EU ETS by the end of 2013 at the latest.

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