Earlier this week, the European Commission (Commission) released its proposal to “backload” auction volumes to tackle the potential surplus of European Union Allowances (EUAs) at the beginning of Phase III of the EU Emissions Trading Scheme (EU ETS). The proposal has been submitted to the EU Climate Change Committee (Committee) and takes the form of a draft amendment (Amendment) to Article 1 of the EU ETS Auctioning Regulation (Commission Regulation (EU) 1031/2010) (Auctioning Rules). The hope is that this step will strengthen the EU ETS and in particular, the price of EUAs during the early years of Phase III which will ultimately be supported by other structural reforms in the longer term.

For further background on the EU ETS and its relationship to the Australian carbon market, see our recent legal update “The EU-ETS – A primer for Australian Companies”.

What is the backloading proposal?

The Commission’s proposal is to withhold 900 million EUAs from the Phase III auction timetable between 2013 to 2015. The withholding will occur in the following sequence:

  • 400 million EUAs in 2013
  • 300 million EUAs in 2014, and
  • 200 million EUAs in 2015.

The EUAs will then be reintroduced for auction in 2019 and 2020, in the amounts of 300 million and 600 million respectively.

Commission Report

The backloading proposal formed part of a report from the Commission to the European Parliament and the Council, dealing with the state of the European carbon market (Report). The Report notes that primarily due to the financial crisis in 2008, but also as a consequence of the increased number of international units1 , the supply of allowances has increased and has resulted in a surplus when compared to demand. The supply demand equation is illustrated in the following table.

Click here to see Table.

Source: Community Independent Transaction Log (CITL), compliance data 2011 as published on 2 May 2012, European Commission

This equation has had an obvious impact on the price of EUAs, which can be see in the graph below.

Click here to see Diagram

The expectation is that the surplus could be over 1.5 billion EUAs, and as high as 2 billion EUAs, by the commencement of Phase III.

Other possible structural reforms

The Report notes that the backloading proposal will not ultimately remove the possible 2 billion allowance surplus which will be present in Phase III, and accordingly there is a need for further structural measures.  Six options have been identified:

  •  Increase the EU reduction target to 30% in 2020
  •  Retire EUAs from Phase III on a permanent basis
  •  Revise the linear reduction factor currently set at 1.74%
  •  Expand the scope of the EU ETS to other sectors
  •  Limit access to international credits
  •  Introduce price management mechanisms, such as a price floor or a price management reserve.

What next?

The Commission has invited the Climate Change Committee to provide an opinion on the draft Amendment to the Auctioning Rules by the end of this year and the European Parliament and the Council of the European Union (representing the Member States) (Council) have been invited to adopt the backloading proposal by an amendment to the EU ETS Directive.

In terms of the longer term structural reforms, the Commission proposes to commence a formal stakeholder consultation process.

Why is the backloading proposal important?

It will be important for Australian companies, especially liable entities under the Carbon Pricing Mechanism (CPM), to monitor the progress of the Commission’s proposal and other longer term structural reforms to the EU ETS. Commentary suggests that the withholding of 900 million EUAs from the early years of Phase III of the EU ETS is anticipated to push up the price of EUAs2 , although reports on the likely impact on the EUA price are mixed.

Any increase in the EUA price is particularly relevant to liable entities under the CPM in light of the decision by the Federal Government and the Commission to link the CPM and EU ETS, which will allow liable entities to surrender EUAs (from 2015) to fulfil up to 50 per cent of their compliance obligations under the CPM.

Assuming that the linking of the CPM and EU ETS comes into effect, and if the impact of the backloading proposal is to increase the price of EUA’s as predicted, it would be prudent for liable entities under the CPM to consider their carbon strategy in relation to potentially purchasing EUAs now in order to minimise compliance costs in the future (ie post 2015).