EU countries gear up for tough talks on CO2 market reforms

Prague (Platts)--28 Feb 2017 733 am EST/1233 GMT

* EU Environment Council seeking common position Tuesday
* Four countries seeking limit to allowance validity
* Legislation to shape long-term carbon price dynamic

EU member state representatives on Tuesday were gearing up for tough negotiations on proposed reforms to the EU Emissions Trading System for the post-2020 period, as ministers were set to gather in Brussels in a bid to find a common position.

At stake is the future of Europe's flagship emissions cap-and-trade system, with ministers and lawmakers seeking to find the right balance between environmental ambition and protection for emissions-intensive industries.

Battle lines are forming around a few key elements, including the extent of free allocation of carbon allowances for industries exposed to carbon leakage -- the risk of moving operations to avoid carbon costs -- and the functioning of a market stability reserve to hold surplus allowances which aims to re-balance supply with underlying demand.

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A group of four countries -- France, Luxembourg, Netherlands and Sweden -- have called for a measure to be included that would make CO2 allowances invalid if they have been in the reserve for more than five years, if the volume held in the reserve is greater than 500 million mt of CO2 equivalent.

"The purpose of the proposal is to provide for a long term measure to strengthen the price signal in the EU ETS, whilst providing for predictability and stability for the markets," the four countries said in an EU Council document dated February 24.

"The proposal would help to ensure that allowances that are placed in the MSR will only be used in accordance with the objectives and purposes of the MSR and that they will not be used as an additional bank of allowances that can be placed back on the market. The proposal will thus help to address the surplus of allowances in a long term perspective," the countries said.

The EU Parliament on February 15 backed a raft of proposed post-2020 reforms to the EU ETS, and the EU Council now must decide its position before three-way trilogue talks can begin between the parliament, council and European Commission.

The proposed reforms are expected to help reduce a long-running surplus of allowances over time, in a predictable and transparent rule-based system that is expected to send carbon prices higher over the long term.

Higher carbon prices would be expected to make cleaner-burning natural gas relatively more attractive than coal for power generation as well as providing a relative cost advantage for other low carbon energy and industrial processes.

Under existing legislation, the MSR is set to start withdrawing surplus carbon allowances from January 2019. Thus far, carbon leakage has not materialized in a significant way, but many of Europe's industries are concerned that a regulatory push to drive carbon prices higher could make carbon leakage a reality, and are therefore looking to secure protection before that happens, in the form of extra free allowances.

Geneva-based industry group, the International Emissions Trading Association on Monday called on EU ministers to strengthen the EU ETS while protecting industry's competitiveness.

IETA said it backs the proposed doubling of the intake rate for the MSR to 24% per year for a maximum of five years and a "moderate" decrease in the share of allowances to be auctioned -- up to 5% -- in the case that a correction factor needs to be applied that would claw back free allowances from industry.

IETA also backed adequate compensation for indirect costs arising from the EU ETS and the provision of free allowances to only those sectors that are at risk of carbon leakage.

The group also said it backs "close monitoring of the functioning of the EU ETS, including interactions with other Union climate and energy policies."

"Doubling the Market Stability Reserve's withdrawal rate for a maximum of five years must go hand-in-hand with up to a 5 percentage point increase in free allocation available to sectors at risk of carbon leakage as well as with compensation for indirect costs handled through coordinated arrangements at Union level," said Julia Michalak, IETA's EU Policy Director, in a statement Monday.

IETA CEO Dirk Forrister said the current EU carbon market reform occurs at an important time, when many other jurisdictions -- from China to Canada, California, Mexico and Korea -- are developing their own market-based systems to contribute to global emissions reductions under the 2015 Paris Agreement.

"The reforms will shape the EU ETS for the next decade, when we expect market mechanisms to become the main pricing tool countries use to deliver their climate objectives. This reform will help improve the EU market's readiness for the future of globally linked carbon mechanisms," said Forrister.

Tuesday's EU environment ministers meeting was set to include discussion on the EU ETS reforms at 0810 GMT and in an additional session at 1415 GMT, according to the Council's schedule.

The EU Parliament and Council are expected to reach an informal agreement on a common text for the proposed legislation as soon as May to June, and a common text could be adopted by the council in September to October -- potentially entering into force by January 2018.

--Frank Watson,
--Edited by Geetha Narayanasamy,

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