Avoiding A Carbon Crash

EXECUTIVE SUMMARY:

12 European countries have committed to closing down coal-fired power plants over the coming years. In order to do their part in limiting the global temperature rise to 1.5°C above pre-industrial levels, all EU countries will have to follow on this path and phase out coal by 2030. While this is an urgent and needed measure, it could also have a significant negative impact on European climate action by weakening the EU Emissions Trading System (EU ETS).

One of Europe’s main climate tools, the EU ETS caps greenhouse gas emissions from Europe’s industry, power and aviation sectors. Without further action, countries could continue to auction pollution permits for power plants which are no longer in use. This could lead to 2.22 billion excess permits (representing 2220Mt CO2e) entering the EU carbon market between 2021 and 2030. By 2040, this ‘coal bubble’ will have grown to 6.18 billion permits. This is likely to send ETS prices crashing, following last year’s recovery after a decade of ineffective price levels.

The EU ETS Market Stability Reserve (MSR) recently began to absorb excess allowances off the market which is the main reason for the recent price hikes. However, the MSR alone will not be sufficient to deal with the new surplus that follows from coal plant closures. The MSR should, therefore, be significantly strengthened through the legislative reform process set to take place by 2021.

The latest EU ETS reform gives governments the possibility to unilaterally cancel emission allowances as coal power plants are taken off the grid. Together with strengthening the MSR, this will be key to ensure that the coal phase-out does not lead to another massive surplus flooding the market, thereby depressing the price and reducing the incentive to cut pollution.

Finally, the EU ETS alone will not set sufficient incentives for a full fuel switch from coal and lignite to gas, let alone a transition to 100% renewable energy which should be the ultimate objective for the European power sector. In order to drive a rapid phase-out of coal while at the same time ensuring the effectiveness of Europe’s carbon market, EU Member States should agree to significantly strengthen the market stability reserve, cancel the surplus allowances resulting from the coal phase-out, and adopt complementary policies to phase out all fossil fuels from the European power sector.

Key policy recommendations:

The EU Commission should propose to:

• Increase the MSR intake rate to 36% from 2024 onwards

• Adopt a declining threshold for the MSR to improve its effectiveness

• Set an automatic cancellation for allowances held in the MSR for more than five years

• Broaden the scope of article 12.4 of the revised ETS directive to allow national cancellation of allowances reflecting the closure of any ETS installation

• Increase the Linear Reduction Factor (LRF) to 4.2%

EU Member States should:

• Adopt a coal phase-out plan to stop burning coal and lignite for electricity by 2030

• Commit to cancelling allowances in line with the closure of power plants