EU:ETS tightens its grip on polluters

February 21 2023 saw a remarkably unpublicised, but nonetheless landmark, moment in the battle against climate change. For the first time, the European Union’s carbon price climbed above €100 a tonne for the first time.
That means the price of carbon credits within the showpiece EU emissions trading scheme (EU:ETS) has risen fivefold in the past three years. Prices have accelerated by 20 per cent in the initial weeks of this year, as the EU has tightened rules to make the system more onerous for polluters. Carbon is at last at a price at which companies will start looking more seriously at investing in more expensive consumption reduction technologies. The emissions caps of the companies concerned, nearly 12,000 installations in Europe, have been calculated to be 60 per cent lower than their 2005 level.
Almost 18 years after its launch, the EU:ETS is finally achieving what its progenitors always claimed for it. Having been heavily involved in its design, I recall that all our calculations were based upon a working hypothesis of around €34 per tonne. Which indeed is how the trade price went initially.
But by the time the great financial collapse of 2008 was occurring, the price of allowances had plummeted down to as low as €5 per tonne. Indeed, I recall even hearing anecdotally about some industries, desperate for liquidity, selling off to electricity generators what had become at that point perceived as surplus assets, for just a couple of euros.
Prices climbed again. But not by much. Even at the start of this decade, trades were taking place at only around €20. After all, it was as recently as November 2018 that the UK Parliament voted to give the Treasury permission to replace the EU:ETS with a new domestic Carbon Emissions tax set at a maximum of £16 per tonne of carbon emitted from power stations and industrial sites.
That tax was superseded by the whimsical decision by the Johnson government to set up a clone system. Unsurprisingly called the UK:ETS. To date it effectively has mirrored its counterpart, itself now covering 31 European countries – and acting as an inspiration to similar (albeit smaller) emissions trading schemes operating in parts of China, in the Pacific north-west of the USA, in Australia, and now in Indonesia.
Companies that couldn’t afford to hedge last year seem to be coming back to the European market, ahead of the April deadline to account for 2022 emissions. Industries that almost shut down completely last year are buying permits again now that energy is cheap enough for them to operate.
The rules are set to tighten further. A planned overhaul of the EU:ETS will, in 2024-2027, increase the rate at which the pollution cap shrinks each year to 4.3 per cent from 2.2 per cent now. The so-called Linear Reduction Factor (LRF) will then accelerate to 4.4 per cent from 2028.
On top of the LRF, the bloc will reduce the number of allowances by 90m in 2024 and 27m in 2026. By the end of the decade, the two together will translate into a 62 per cent drop in the pollution limit by the end of this decade from our initial 2005 level.
The shrinking caps and increasing price of pollution are well designed to accelerate the shift to clean technologies. However, these record-high prices have renewed calls from energy-intensive companies for interventions by governments to keep their costs in check. Hence, the UK government’s new proposals to offer support to 300 energy-intensive companies by “reducing the network charges that industrial users pay for their supply of electricity; cutting costs associated with maintaining generating capacity; and looking at whether to increase exemptions on costs arising from renewable energy obligations from 85 per cent to 100 per cent.”
At present, with its Carbon Border Adjustment Mechanism (CBAM) the EU is concentrating upon introducing penalties for imported goods in these vulnerable sectors from countries without any comparable additions to reflect carbon emission externalities.
Due to begin in 2025, the chances are that the UK will perforce endorse a similar scheme. Whether the UK:ETS will expand as swiftly into other energy using areas already earmarked within the EU scheme – maritime, non-European aviation, surface transport, even buildings – is not yet clear. But recent history does suggest this will indeed occur, albeit in all probability later and less effectively.
The UK has made it plain that its own climate policy will be more rather than less ambitious than those adopted by all other European countries. Under the terms of the Brexit agreement, we have also agreed not to diverge from EU policies that might provide a significant trading distortion advantage.
So I am prepared to bet that, shortly after 2025, we will have introduced a very similar carbon border “tax” to the CBAM. See if I am not right.