2020 is almost over and the European Union looks set to meet its emissions reduction targets, but the 2030 targets will most likely be increased. This is increasing the volatility of the emissions trading market, but is the price increase really supported?

Let us remember the targets of the EU

The Green Energy Package established by EU leaders in 2007 and incorporated into legislation in 2009 sets out the main objectives:

  • 20% reduction in greenhouse gas emissions (compared with 1990 levels).
  • 20% of renewable energy in the EU.
  • 20% improvement in energy efficiency.

All EU countries must also achieve a 10% share of renewable energy in their transport sector.

Key targets for 2030:

  • at least 40% reduction in greenhouse gas emissions (compared to 1990)
  • at least 32% share of renewable energy
  • at least 32.5% improvement in energy efficiency

Where do we stand in terms of reducing emissions?

With this treaty the European Union is trying to be at the forefront of sustainable economies and the transition as such.

Source: statistical pocketbook 2020

According to the latest EU report published on 9 September, “Statistical Pocketbook 2020“, the European Union will achieve a 20% reduction by 2020, although this achievement varies from country to country.

The graph above shows that the emission reduction targets for 2020 have already been practically achieved, which is why the focus is on 2030. By 2030, the objective so far was to reduce greenhouse gas emissions by 40% in relation to 1990 levels, and this objective is much more ambitious than that of 2020.

If we continue with the plans for 2050, the long-term goal was initially to achieve a low-carbon economy, but now it is more focused on leading the way to climate neutrality.

Source: European Environment Agency

What do the 2030 transition plans reveal?

Targets at EU level are often transformed into more ambitious ones at national level, so member states tend to make more aggressive policies in the fight against climate change, but this does not happen in all countries.

The latest report from Climate Action Network (CAN) Europe (the main coalition of European NGOs fighting dangerous climate change) shows that we risk falling into an unfair transition where there is a risk of rewarding climate laggards at the expense of countries with ambitious plans and commitment to the Paris agreement.

In particular, seven countries will still be producing with coal in 2030 and it is not surprising that we are starting from a decarbonisation with reductions over 1990 levels, where the former Iron Curtain countries were bringing in an obsolete and highly polluting industry.

The Just Transition Fund, which belongs to the EU’s Next Generation pillars, is endowed with EUR 40 billion, according to this report almost two thirds of which will go to these 7 countries that do not plan to end up with coal before 2030 (mainly Poland and Germany).

The new European deal: increasing the reduction of emissions from the 2030 targets to 55%.

We are still far from 2030 and asking whether the targets are easily achievable is complicated, yet the European Union intends to tighten its targets to 2030. The European Commission will probably finally approve in early October to increase the target for reducing greenhouse gas emissions to 55%.

This reduction is a bit ambiguous as according to Climate Action Network (CAN) Europe the Commission in its proposal is expected to change the sectors covered by this target. The current 2030 target does not cover emissions from all sectors; emissions from international shipping and removals from land use and forestry (LULOCF) are not included, according to this body LULOCF removals would reduce the target from 55% to 49% ceteris paribus. What the main coalition of NGOs fighting against climate change is saying is that 55% and 40% are not comparable as they would be based on different points of reference.

Even so, EUA prices shot up on 10 September when the European Parliament’s environment committee voted in favour of the EU’s 2030 emissions reduction target by 55%, although work had been underway since March to increase this target and it came as no surprise. The committee chairwoman acknowledged that this target was too much for some and not enough for others. Once approved by the Commission, the next step is to be negotiated between the Parliament and the Council of the EU.

Source: MTech

The above chart shows how the price of the December 20 emission rights contract skyrocketed on 10 September.

The roadmap was set out in the Annex to the European Commission’s Communication on the European Green Pact of 11/12/2019 and states

  • By March 2020: a proposal for a European “Climate Act” is ready, enshrining the objective of achieving climate neutrality by 2050.
  • By summer 2020: the Comprehensive Plan to raise the EU’s climate target for 2030 to at least 50% and towards 55% in a responsible manner.

We will have to wait until June 2021 for the following proposals : proposals to revise the relevant legislative measures to meet the increased climate ambition, followed by the revision of the Emissions Trading Scheme Directive, the Effort-Sharing Regulation, the Land Use, Land-Use Change and Forestry Regulation, the Energy Efficiency Directive, the Renewable Energy Directive and the CO2 emission performance standards for passenger cars and vans.

However, what possible changes to the EU ETS could be proposed?

The first option would be to implement the already reformed Phase 4 of the EU ETS which was completed in April 2018 with the MSR (Market Stability Reserve) and the free allocation reduction factor (from 1.7% to 2.2%). But this does not seem to support the new 2030 targets.

The second option could be the revision of the MSR in 2021. Recall that it was modified before it began to allow the AMS to absorb the US$900 million that had been temporarily withheld from the market in the 2014-2016 backloading episode. As part of the reforms it doubled from 12 to 24% to absorb more surplus supply. Obviously with COVID-19 this will require a reinforcement to extend this rate of extension.

The third would involve updating the 2030 objectives in June 2021. Ursula Von Der Leyen’s statements were a proposal and, to make it effective, we need to redefine the objectives. Amongst this revision is talk of significantly extending the ETS to maritime emissions, road transport and building – quite a statement of intent! The Commission will present legislative proposals for the 2030 target in June 2021. When would these targets come into force by 2030?

The fourth option would be to legislate for the achievement of the zero emission target for 2050 and the Green Deal, which involves reshaping the whole EU economy (how we consume, travel, build, etc). Also, only for the 2050 targets, we could assume that a net zero target would have a significant impact on the cap and would probably require the introduction of some kind of removal credit for CO2 emissions. Not only that, but we will have to look for the next level of reduction. Over the last 15 years, the EU ETS has worked almost exclusively to remove fossil fuels from power generation. It has been all about the energy sector, while industrial emissions have been protected through free allocation, indirect compensation, etc. The Commission’s legislative proposals for the Green Deal are many and quite intimidating. It should not be forgotten that between now and the end of next year we should expect a positive avalanche of proposals from Brussels.

In any case, the EU ETS will be modified and will provide the necessary price signal for the achievement of the existing or more ambitious targets already announced.

If the ETS directive is revised, and allowances are removed from auctioning, this effect should increase the price of the EUA, but not for the Dec 20 contract it is currently impacting on. As mentioned on other occasions, this price increase would mean a change in the variable cost indicator for traditional thermal power stations in relation to combined cycles. Therefore, the increase in demand will have a direct effect on the price of European gas markets and will make the cost of production of combined cycles even more expensive (due to the increase in the price of CO2 and gas itself), thereby having a negative effect on electricity prices, since the market continues to be marginal, and spot market prices are therefore set by the latest technology, and this effect is already being reflected in European electricity futures markets.

At present, speculative movements are increasing the volatility of this commodity, which in itself is very sensitive to variations in supply, and it is therefore possible that the cost of the December 20 emission rights is currently overvalued.

Even so, there is still a long way to go to set not so much targets as the 2030 roadmap and this continues to raise questions:

How do countries plan to adapt to the new target?

Will the EU need increased funding?

What will be the consequences in the end for the emissions trading market?

Marta Serrano | Energy Consultant

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