After a lengthy trialogue session that concluded after 3:00 a.m. CET, an agreement on the Phase IV reform package for the EU ETS was finally reached. The reform package outlines the rules that will govern the EU ETS from 2021 to 2030 and will have significant implications for all EU ETS installations. The key reforms that are expected to have a substantial impact on installations and the market are as follows:
Doubled MSR Withdrawal Rate: The Market Stability Reserve (MSR) will withdraw 24% of the calculated market surplus during the first five years of its existence (2019-2023). This will likely result in the removal of over 400Mt of allowances from auctions in 2019 and 2020. Analysts predict that this will lead to an increase in prices, with many forecasting prices reaching €20 by the end of Phase III and the European Commission projecting average prices of €25 in Phase IV.
Increased Linear Reduction Factor: The Linear Reduction Factor will be raised to 2.2%, causing the overall cap to decline at a faster rate. As the share of allowances available through auctions increases, this will negatively impact the total number of allowances available for free allocation.
Minimum Benchmark Improvement Rates: Minimum benchmark improvement rates will lead to arbitrary reductions in free allocation for all installations. The minimum reduction will be 0.2%, while the highest reduction will be 1.6% per annum. These improvement rates will be retroactively applied to 2008, potentially resulting in a reduction of up to 24% in the benchmark rate used to calculate free allocation during the first half of Phase IV.
Changes to Carbon Leakage List: The carbon leakage list will undergo changes, causing many sectors to be removed from the list. Although the overall emissions affected are relatively small, certain industries may experience significant decreases in their free allocation.
Auction Flexibility Mechanism: The auction flexibility mechanism (3%) will provide some relief for installations, as the Cross Sectoral Correction Factor is less likely to negatively impact free allocations.
Automatic Allowance Cancellations: Starting from 2024, allowance cancellations will occur automatically if the number of allowances held in the MSR exceeds the total number of allowances auctioned in the previous year. This could result in a large-scale cancellation of approximately 2Bt in 2024 and expedite the exhaustion of allowances in the MSR.
Voluntary EUA Cancellations: Member States may use voluntary EUA cancellations to offset any national climate and energy policies that lead to a substantial decline in EUA demand.
The provisional agreement will now undergo final ratification by the European Parliament and the Council as the last step of the EU legislative process. While there is a possibility for further changes, it is uncommon in practice. The Phase IV reforms, along with the ongoing Brexit negotiations, significantly increase carbon risk for most installations across Europe. Decreasing free allocations combined with rising prices will result in significant changes in compliance costs. For an update on the EU ETS and to understand the carbon risks your company may face, please contact the Redshaw Advisors team at +44 203 637 1055 or via email at info@redshawadvisors.com.
