There is still a long way to go for carbon market reform

There is still a long way to go for carbon market reform

In the context of the energy crisis, the interruption of Russian gas supplies and the worsening of climate change, European Union negotiators are faced with the daunting task of revising the main European tool for the reduction emissions, the emissions trading system (ETS).

In June, the Member States of the European Union (EU) and the European Parliament agreed on their respective positions on the reform of the carbon market, presented by the European Commission in 2021.

Now, the authorities have to work out the details during the “trilogues”. However, this is much easier said than done.

“There is an agreement in Parliament. There is an agreement in the Council, but on certain points, these agreements do not yet overlap”Frans Timmermans, the EU’s “climate gentleman”, told reporters on 14 July.

“We have to make sure that, for example, on the reform of the emissions trading system, we bring the two co-legislators together in order to reach a common conclusion — I think that is the most delicate question »he added.

It exists “many dots” which Parliament and Council agree in principle, said ETS lead negotiator Peter Liese after the first trialogue in July. For example, both want to extend the scope of the ETS to the maritime sector, but the details have yet to be worked out.

“There are too many questions to talk about red lines now. The bottom line is that no institution should have the belief that the deal is done and the other side just has to accept”Liese told EURACTIV.

Even the overall emissions reduction target for the sectors covered by the ETS has to be negotiated, with the Commission and EU Member States aiming for 61% and the European Parliament for 63%.

Mr Liese expects at least four more trialogues. If the ideal would be to reach an agreement before COP27 next November, it would be more realistic to hope for an agreement by the end of the year.

Gradual abolition of free pollution permits

One of the main sources of disagreement concerns the speed at which to phase out free pollution permits, intended to mitigate the impact of the price of carbon and to prevent companies from leaving Europe to locate where emissions are less expensive.

The idea is to gradually replace them with the Carbon Border Adjustment Mechanism (CBAM), which would set a price for carbon-intensive goods entering the EU.

The most difficult point to negotiate will be the speed of the phase-out, the MACF’s main negotiator, Dutch MEP Mohammed Chahim, told EURACTIV.

EU member states and the European Parliament have a similar position on the start of the phase-out, with states wanting a start date in 2026 and Parliament in 2027.

However, positions differ dramatically after 2030. Parliament lawmakers want free permits to end in 2032, while member states want a much slower phase-out, ending in 2035.

Industry and environmentalists are following this debate closely. Industry is concerned about the impact of a rapid phase-out, given the novelty of the carbon border tax. If this fails, they fear competition from cheaper, higher-carbon products from outside the European Union.

“We, the steel industry, supported the MACF idea from the start, but always on the condition that we do a careful test and exercise caution in interacting with the free allocation and the current measures,” Adolfo Aiello, deputy managing director of steel group EUROFER, told EURACTIV.

A slow phase-out is also favored by industry group BusinessEurope.

Markus J. Beyrer, Managing Director of BusinessEurope, said they “must first see if this new instrument [le MACF] works before giving up what little protection we have for energy-intensive sectors that are subject to strong competition”.

However, Sam van den Plas of Carbon Market Watch believes that delaying the phasing out of permits reduces the incentive to decarbonise and prevents money from reaching the Innovation Fund which is used to finance clean technologies.

Six billion free permits are expected to be distributed between 2021 and 2030, but according to Mr van der Plas, “if you distribute them for free, you are not auctioning them, these are lost revenues for the Member States, these are lost financial means that are available to help decarbonisation”.

Although he is aware of the challenges facing the sector, he says there is no evidence that the price of carbon is driving measurable changes in import and export patterns or investment outside Europe.

Protect exports

Another controversial issue is how European industry will be able to compete outside the European Union once free permits are phased out. The industry fears that it will face a high carbon price that its non-European competitors will not have to face.

“I think Parliament and the Council both recognize that we need to find a solution, but what form that solution will take is still a bit vague. I think we will depend a lot on the creativity of the European Commission”Mr. Chahim said.

The European Parliament wants to keep the free permits for exports. However, some fear that it violates International trade rules, set out by the World Trade Organization (WTO).

But according to Mr. Aiello, the answer is simple: “if you want to have an ambitious climate policy, you cannot have an overly cautious trade policy”.

Many other issues still need to be debated, for example, what will happen to the money raised by the tax.

And, if the Parliament and the Council agree on the sectors covered by the MACF, the European Parliament wants to include indirect emissions in the calculation of the carbon intensity of a product, while the Commission and the Member States of the EU want to include it later.

Other issues may be easier to resolve. For example, the Parliament wants to have a centralized authority to implement the carbon border tax, while the Council wants what Mr Chahim calls a “hybrid approach”.

“I think that, basically, the two are exactly the same”he told EURACTIV, adding that he does not expect a big debate on this point.

Negotiations in times of crisis

A lot has happened since the carbon market reform was introduced, including the energy crisis and the war in Ukraine. Asked whether these events will have an impact on the negotiations, Mr Liese replied that the position of the European Parliament already takes this into account.

He mentioned “rebasing”, a system that aligns the number of permits in the ETS with actual emissions. Parliament has a more modest ambition until 2026, then a steeper curve to compensate for the overcompensation.

“We’re going to give everyone a bit of a breather, and then we’re not just going to catch up, but we’re going to increase ambition, so that in 2030 we’ll be more ambitious”explained Mr. Liese.

However, Mr van der Plas was unconvinced, saying rebasing is a short-term measure and every year without rebasing slows ambition.

The next trilogue meeting will take place after the summer holidays, and several others are expected to follow.

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