Emission Allowance Supply Management in the EU ETS

The steering mechanism of the ETS has been significantly reduced in recent years due to oversupply and consequent low price of allowances. In essence, the reasons behind this are the complicated and distortive energy and climate policy architecture that is based on multiple targets and overlapping implementation mechanisms as well as the inflexibility of the supply-side of the EU ETS system. The EU ETS as currently designed has proved inadequate to deal with large economic shocks while preserving the pursuit of long-term greenhouse reduction goals.

Setting 2030 climate targets remains the number one priority in reinforcing the EU ETS system. Bringing the system back into balance and restoring its credibility is vital for its functioning. Structural reform addressing the issue is necessary for the ETS to maintain its position as the leading instrument of the EU climate policy.

A key success factor of the ETS is the scarcity of allowances that needs to be maintained. An allowance supply adjustment mechanism (ASAM) has the potential to provide an optimal market balance of supply and demand by introducing flexibility in the supply side and to manage the impact of major economic swings. The mechanism would automatically, based on pre-determined rules, adjust the supply of allowances in cases of significant changes in economic development (or other causes of demand variations). This mechanism would react on excessive structural surplus or deficit of allowances and enhance the elasticity of supply over the short term while leaving the overall long-term drivers in place.

The key challenges in the designing of the mechanism include definition of the optimal surplus band, the timing and frequency of the adjustments, the allowance reserve size and trajectory, and the handling of the cumulated surplus from phase 2. The governance model of the mechanism must be addressed as well.

A thorough discussion on ASAM in the context of the EU 2030 target setting, backloading of allowances during 2013-2020 and the structural changes to be planned for the ETS pre- and/or post-2020 is recommended.