Market liquidity needs to be restored.
With the current EU ETS parameters, the supply of CO2 allowances on the primary market will end around 2040. The Market Stability Reserve (MSR) will be empty by that time and will not be able to mitigate supply constraints, which will probably occur due to economic recovery after the end of the war in Ukraine, the increase in EU defence capabilities and insufficient supply of decarbonized gases to replace natural gas.
Therefore, to prevent a market squeeze, the EU ETS revision should, in the first place, substantially reform the MSR parameters. The already presented proposal to abolish the invalidation of allowances by the MSR is the right move, but more needs to be done. The current Total Number of Allowances in Circulation (TNAC) indicator is static and does not reflect the number of allowances held in speculative long-term positions. We suggest introducing a dynamic TNAC to better reflect market circumstances. We also recommend lowering the Linear Reduction Factor to reach climate neutrality by 2050, instead of the current 2040 target. What is more, peaking units, which ensure system stability and adequacy, should be exempted from the obligation to surrender allowances. International carbon credits should also be integrated with the EU ETS.
A focus on affordability and investments is also needed. Further decarbonization of power systems is becoming more challenging, as the remaining emissions are more costly and difficult to abate. The EU ETS auction revenues (estimated at €1.5 trillion by 2050) are expected to cover only 11 percent of the sector’s total investment needs. Since the whole economy benefits from energy infrastructure, initiatives such as the recently announced €30 billion ETS Investment Booster should support the energy sector. It is also of the utmost importance to maintain the Modernisation Fund in the post-2030 framework, which needs to be continued at the level of 4.5 percent of the total pool of allowances. Furthermore, the standard and additional allocation of free allowances for the district heating sector should continue after 2030.
Key message
The real test of the next EU ETS reform is not whether it drives decarbonization, but whether it can do so without driving industry away. Decarbonization has to strengthen the competitiveness of the entire EU, not only selected sectors, companies or member states. It should not be only for first movers, but for the entire European industry.