Potential future action to align EU emissions targets with Paris accord may render all coal and lignite plants unprofitable
LONDON, April 26 – EU carbon prices are set to double by 2021 and could quadruple to €55 a tonne by 2030 if the European Commission ultimately legislates to align the bloc’s current emissions targets with the Paris climate agreement, finds a new report by Carbon Tracker released today.
Carbon Clampdown: Closing the gap to a Paris compliant EU-ETS, warns that, in order to put EU emissions on a path consistent with international climate targets, the price of traded carbon allowances, known as EUAs, would have to rise to levels that would make even the most efficient coal and lignite power plants unprofitable.
The first assessment of the impact of action to bring the world’s largest carbon market into line with the 2015 Paris Agreement has been written by Mark Lewis, a leading authority on carbon markets, who joined Carbon Tracker this month as Head of Research from Barclays, where he was Head of European Utilities. Previously, he was Head of Carbon Research at Deutsche Bank over 2007-13.
Mark Lewis said: “Carbon pricing won’t be sufficient on its own to achieve the Paris goal of limiting warming to well below 2˚C, but it does have a vital role to play: Carbon prices put a value on the limited amount of CO2 we can store in the atmosphere if we are to avoid catastrophic climate change. The space left for increased concentrations of greenhouse gases is the ultimate scarce resource, and it is imperative that it be priced accordingly.”
EU governments last month formally requested the European Commission to draw up a proposal for a long-term emissions reduction strategy in line with the Paris Agreement within a year. This sets in train a process that could potentially lead to a cap on the number of allowances dealt on the EU Emissions Trading System (EU ETS) aligned with the objective of keeping global warming “well below 2C”.
Reforms to the EU ETS have already seen the price of carbon allowances triple, from a low of €4.38 per tonne in May 2017 to €13.82 per tonne in April 2018, making them the world’s best performing energy commodity in the last year.
The report finds prices are on course for €25-€30 per tonne by 2020-21 as reforms squeeze out surplus supply. But it also finds that the EU would need to implement a much tighter squeeze and drive prices still higher in order to align the EU-wide 2030-emissions target — and hence the EU-ETS cap — with the Paris Agreement.
The EU currently aims to cut emissions by 40% against 1990 levels by 2030, but Carbon Tracker calculates that this would need to rise to 55% to align with the Paris Agreement.
Mark Lewis said: “Life is set to get much tougher for EU coal generators. Higher carbon prices will eat further into operating margins that have already been severely eroded by the growth of renewables, forcing less efficient coal plants off the grid altogether. Under a Paris-compliant EU-ETS cap the shock to coal would be even greater, forcing all coal and lignite plants – even the most efficient – either off the grid or to the margin.”
The report finds that under a Paris-compliant cap for the EU-ETS, carbon prices would need to average €45-€55/tonne for a sustained period to drive coal and lignite power plants out of the market and keep emissions in line with the Paris Agreement, which seeks to limit temperature rise well below 2˚C of warming versus pre-industrial times.
This is likely to see a major switch from coal to gas in Italy, Spain, Germany and the Netherlands (the UK has largely already achieved this switch owing to its higher domestic carbon-support price). High carbon prices are also likely to accelerate the development of large-scale energy storage, smart grids and demand-side response, where energy users shift consumption away from peak periods.
The EU-ETS is a cap-and-trade system, covering energy intensive industries responsible for half the EU’s emissions as well as aviation. It sets a cap on carbon emissions which is reduced over time.
Companies receive allowances to cover their carbon emissions, which they can also buy and sell. As the number of allowances is reduced over time, either demand must fall or prices must rise in order incentivise action to cut emissions and switch to cleaner fuels.
However, prices plunged following the 2009 global financial crisis and subsequent recession, when a massive over-supply built up. By the end of 2016 there was a 1.7 billion tonne surplus of allowances in the market — almost the same as the 1.75 billion tonnes of annual emissions covered by the scheme.
In response the EU is introducing a mechanism to create the biggest supply squeeze the EU ETS has ever seen: from January 2019 a new Market Stability Reserve will cancel 24% of the surplus each year up to 2023 and 12% thereafter.
The price of carbon allowances is already rising in anticipation of its impact. The report forecasts that they could reach €15 a tonne in the second half of 2018, €20 in 2019 and €25-30 in 2020-21 as the supply squeeze really starts to bite.
Carbon Tracker expects the Market Stability Reserve to remove three gigatonnes of allowances by 2023 – equivalent to nearly two years’ worth of current emissions in the ETS. As the market surplus is cut sharply by the MSR, the supply gap will need to be met by actual reductions in emissions from high-carbon infrastructure.
But in order to align the EU ETS with the Paris Agreement an extra 1.6 gigatonnes of allowances would have to be squeezed out of the market, forcing a much greater switch to clean energy.
Carbon Tracker finds that the Market Stability Reserve will have the equivalent effect of reducing the EU ETS cap on annual emissions by 2.65% a year from 2020 to 2030, from 1.8 to 1.2 gigatonnes. However, to align with the Paris Agreement action must be taken to reduce the EU ETS cap by 4% a year to just over 0.943 gigatonnes in 2030.
Carbon Tracker modelled the impact of aligning the EU ETS with a “well below 2C” climate target using both a top-down approach based on a recent report by the Netherlands Environment Assessment Agency, and a bottom-up approach based on the International Energy Agency’s Sustainable Development Scenario. Both of these approaches align with the objectives of the Paris Agreement.
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 An EU-wide target of -55% versus 1990 levels is based on a study by the Netherlands Environment Assessment Agency published in October 2017. Carbon Tracker calculates that it would require the EU-ETS to reduce emissions by 60% from 2005 levels by 2030 compared with the reduction of 43% versus 2005 that the EU-ETS must achieve under the current EU-wide target of -40% versus 1990.
 In addition to the 1.7bn surplus in the market there are a further 900m EUAs that were withheld from the auctions over 2014-16, and the CTI report estimates that a further 800m allowances will end up in the MSR in 2020 owing to plant closures and unused allowances in the new Entrants’ Reserve. Adding all of these together means that the total surplus of EUAs by 2030 will exceed 3 billion.