Update on European Union Emissions Trading Scheme Trialogue discussions in progress
The ‘Fit for 55’ legislative package proposed by the European Commission in the summer of 2021 is likely to be the catalyst for the most meaningful reform of the European Union Emissions Trading Scheme since the programme began in 2005. A lot of progress had been made in getting to a final agreement, with the European Parliament having concluded its debates before the summer recess and the Council of European Union (chaired by Czech Republic) finalising its position around the same time. However, discussions between the three groups (The European Commission, Council of European Union and European Parliament) on ‘Fit for 55’ legislation has been slowed by concurrent REPowerEU discussions. REPowerEU is the European Commission’s plan to make Europe independent from Russian fossil fuels well before 2030, in light of Russia's invasion of Ukraine. Both REPowerEU and Fit for 55 should promote energy transition and decarbonisation and the therefore are pace and ambition in one initiative will have implications on the other.
Trialogue discussions on the ‘Fit for 55’ legislation between The European Commission, Council of European Union and European Parliament are currently taking place. There is a lot of hope that these discussion will be concluded before Christmas, while the current chair of the Council is in place (Czech Republic).
What’s been agreed and what’s next?
So far a number of things have been agreed :
1. A lower threshold for the cost containment mechanism (Article 29a)
2. No restriction of market access to “speculators”
Provisional agreement has been reached on :
1. 40% emission reduction by 2030 from 2005 in Effort Sharing Regulation (non-ETS sectors)
2. Provisional agreement on starting the phase-in of shipping into the ETS in 2024-26, later than the 2023 as originally proposed
3. Phasing out free EUAs for the aviation industry by 25% in 2024 and 50% in 2025 and completely by 2026. A total of 5 million allowances that were allotted to aviation companies will now go into an innovation fund. Only intra-EU aviation is covered by the EU ETS. In 2026, the EU will access if the International Civil Aviation Organization’s CORSIA is doing a good enough job at decarbonising the international aviation industry. If it isn’t they will seek to include international flights into the EU ETS.
Tentative agenda for remaining discussions :
1. December 14th 2022: Carbon Border Adjustment Mechanism
2. December 16th 2022: Revision of key formulas including overall cap, linear reduction factor and expansion of ETS to buildings and road transportation
3. December 19th: Social Climate Fund
Swift agreements will be useful
As we approach the final days of the calendar year, open interest and trading volumes on EUA futures tend to decline. Important news flow on days with lower-than-normal liquidity could have an outsized effect on price. Thus, it will be prudent for the trialogues to conclude swiftly. Moreover, it will be convenient to conclude before the (rotating) Presidency of Council of Europe switches to Sweden on January 1st 2023. With center-right Prime Minister Ulf Kristersson dependent on the far-right, Euroskeptic Sweden Democrats (SD) for his parliamentary mandate, some fear EU legislative processes could be slowed. However, if key agreements are made before the switch, it will be difficult for the Council to back out in the New Year.
Article 29a reform
Under Article 29a of the current Directive, if for more than six consecutive months, the allowance price is more than three times the average price of allowances during the two preceding years, the European Commission (EC) shall convene a meeting of the Climate Change Committee. As a second condition, the EC Climate Change Committee has to determine that the excessive price fluctuations do not correspond to market fundamentals. If both conditions are met, Article 29a is triggered, whereby the EC can release an appropriate number of Allowances from the Market Stability Reserve. To date, this has never happened.
The reform agreed is to lower the threshold to 2.4 times the average price of allowances during the two preceding years rather than 3x. This is less bearish for EUA prices than lowering to 2x as we were projecting in our last blog - Suspension of EU ETS unlikely. The current Article 29a doesn’t specify how many EAUs need to be released. The EC would need to decide on an appropriate number given the scale and circumstances of the misalignment with fundamentals. The reformed Article will involve 75 million allowances released automatically. While still less than the 100 million discussed earlier this year, removing the ‘second condition’ of judging if the price movement is out of line with fundamentals may in fact drive more instability in EUA pricing.
Had this reform been in place in 2021-2022, it still would not have triggered the release of additional EUAs, during this period of heightened price volatility, although it would have come close. If implemented in 2018, Article 29a would have likely been triggered.
Are we there yet?
Not everything in the Fit for 55 package has been agreed and even what has been a greed is not yet law. Any provisional agreement reached in trilogues is informal and has therefore to be approved by the formal procedures applicable within the Council and Parliament. In Parliament, the text of the provisional agreement has to be approved by a vote in committee after which it is confirmed in plenary.
