Carbon price floor: supporting the EU ETS

In its progress towards meeting its climate commitments under the Kyoto Protocol, the EU is on the right path to achieve its target of reducing greenhouse gas (GHG) emissions to 20% by 2020. In fact, 2016 data shows that GHG emissions were already 23% below the 1990 level. And, to be more specific, emissions from power plants or refineries covered by the EU Emissions Trading System (ETS) fell by 26% between 2005 and 2016, which is markedly more than the 23% reduction set as the 2020 target.

Further down the line, and in a next step outlined under the Paris Agreement, the EU and its Member States collectively committed to decreasing their emissions by at least 40% by 2030 from 1990 levels. Negotiations to this effect are currently underway under the fourth EU ETS Reform (Phase IV), with a raft of proposed legislation to meet the overarching 2030 targets. However, it seems that no progress is being made for the EU ETS to give the right signals that would oblige Member States to comply with the objectives it was initially set up for.

Thus, it comes as no surprise that some countries have already implemented a parallel mechanism (as is the case of the UK) or are considering putting one in place (like France or the Netherlands), to encourage the transition to a low carbon economy.

Such mechanism, a Carbon Price Floor, would deliver the right price signals to decarbonize electricity generation in Europe.

In view of the Paris Agreement, and with France, and also Germany, now having taken up the leading role to combat Climate Change, it is necessary that both countries establish a minimum CO2 price for the electricity sector and become a reference for other Member States to follow suit in this endeavour.

EU ETS

Being highly relevant for the EU´s climate commitment, the EU ETS has been successfully implemented, but can still be improved.

The System, which charges more than 11,000 companies for each ton of CO2 they emit, is effective in reducing GHG emissions from the sources covered, and provides the incentives to reduce emissions efficiently. However, its practical implementation is still faced with a few areas which deviate from this positive picture.

The biggest issue is the low carbon price brought about by the deep and prolonged economic crisis starting in 2008. The unexpected drop in demand of allowances led to a carbon price shock from which the EU ETS has not recovered yet (from EUR30 in 2008 to EUR8 per ton of CO2 in 2017). As a result, significant investments to phase out coal (the most polluting fuel), required for achieving the EU ETS´s long-term goal, are not taking place yet as they lack economic viability with the current CO2 prices.

The outlook for revising the EU ETS and the associated carbon price foreshadows only weakly effective action up to 2030. Proposals put forwards by the European Commission, the EU Parliament and Council for a revised ETS up to 2030 (Phase IV) are currently being discussed in tripartite negotiations. In addition, the current reform ignores the urgency to reduce emissions quickly and hands out billions in pollution subsidies, meaning that the EU carbon market will continue to fail at its task to spur green investments and phase out coal.

 

In light of the above, there is an urgent need to set up a solid complementary instrument effective enough to tackle coal-fired production. Such need could be met by means of setting up a Carbon Price Floor (CPF).

Carbon Price Floor (CPF)

There is growing momentum for carbon floor prices in Europe: following the UK precedent, the new Dutch government has announced a rising carbon floor price for its electricity sector, reaching EUR43/TnCO2 by 2030, and French President Macron has also called for a ‘significant minimum carbon price’ to boost investments in the energy transition.

UK:

In 2013 the UK set up a scheme, limited to power generation, in the form of an ex-post tax on electricity production. The tax was intended to compensate for the difference between prices on the EU ETS market and the floor price set by the UK government.

The Carbon Price Floor (CPF) taxes fossil fuels used to generate electricity via Carbon Price Support rates set under the Climate Change Levy. The price floor consists of two components which are paid for by energy generators in two different ways: (i) The EU ETS allowance price; and (ii) the Carbon Support Price (CPS), which tops up the EU ETS allowance prices, as projected by the government, to the carbon floor price target. All revenues from the CPF are retained by the Treasury.

When the CPF was first introduced, it was due to rise every year until 2020 to a price of GBP30/TnCO2. In its 2014 Budget, the government announced that the CPS component of the floor price was to be capped at a maximum of GBP18/TnCO2 (approx. EUR20/TnCO2), from 2016 to 2020, to limit the competitive disadvantage faced by business and reduce energy bills for consumers. This price freeze was extended to 2021 in its 2016 Budget. Eventually, the UK government confirmed in its 2017 Budget that the price support would continue until coal was phased out.

The additional costs of the CPF are ultimately borne by domestic and business consumers. Fears for the competitiveness of energy intensive industries led the government to introduce compensation measures aimed at alleviating the costs of the EU ETS and the CPF.

Since the implementation of the CPF there have been significant falls in coal electricity generation – the most carbon intensive energy source.

The share of coal in UK´s electricity generation mix has dropped from 50% in early 2013 to a record low of 2% in July 2017, with the most notorious year-on-year decrease observed between 2016 and 2017 (down 27.5%), and the UK seeing in April 2017 its first day without coal for its electricity production for the first time since the Industrial Revolution.

Currently, 9 coal-fired power plants with a total capacity of 14GW are in service in the UK. One is to shut down in 2018, and another one in 2019. By the beginning of 2025 (deadline set by the UK to complete its coal phase-out programme), only 1.3GW of coal capacity should remain online.

 

THE NETHERLANDS:

In October 2017, the Netherlands Prime Minister Mark Rutte announced that the incoming Dutch coalition government (the so-called Rutte III coalition, a four-party coalition which took over 200 days to negotiate after the elections in March 2017), was planning to introduce a CPF in the electricity sector. Under this proposal, a CPF of EUR18/TnCO2 would be imposed on companies starting in 2020, and then gradually rise to EUR43/TnCO2 by 2030. The mechanism to be used will be similar to that already used in the UK, i.e. an additional levy would be charged based on the difference between the EU ETS price and the price floor.

The proposal is part of a broader climate package by the new Dutch government to reduce CO2 emissions by 49% in 2030 compared to 1990 levels (with no specific targets announced for 2020 as yet) and incorporate national climate targets into domestic law (the only indication so far being a court ruling stipulating that the Dutch government must reduce GHGs by 25% compared to 1990 levels by 2020). In addition to the CPF, the government proposed to phase out coal generated power by 2030.

After a previous “coal tax” linked to plant efficiencies had already caused most Dutch coal units to close over recent years, the 5 remaining Dutch coal-fired power plants, with a combined capacity of over 4GW (including 3 of the most efficient coal plants in Europe, that were only completed in 2015) will be closed by 2030, a decision which is sending a dramatic signal to the electricity markets today that no investment in coal-fired plants in Europe is safe.

Coal´s share in the Dutch power mix dropped to 32% in 2016. However, overall CO2 emissions were down just 11% compared to 1990 levels, with the Netherlands still heavily depending on fossil-fuels for their power generation (note that gas power plants increased their share to 46% in the same year).

Rutte´s coalition government also agreed to buy emission allowances (EUAs) on the EU ETS market to make sure coal closures did not simply make it easier to pollute elsewhere. Finally, it announced that it would seek to agree stronger action with ‘likeminded’ countries in northwest Europe to minimise any disadvantage from tougher targets.

FRANCE:

France has been calling for a European CPF which would curb CO2 emissions, particularly from coal-powered generators, and increase investments in renewables and other cleaner sources of energy.

In the absence of a broader European initiative to strengthen carbon pricing, the previous government, led by President Francois Hollande, announced in May 2016 that it would unilaterally set a carbon price mechanism targeting both coal and gas-fired power plants in France, hoping the move would spur other countries to act. However, the plan was ultimately abandoned due to the pressure exercised by the various utilities affected, which threatened to close down their power plants by reason of the negative economic impact such mechanism would have on them at the time.

However, with a new government now in place, French environment minister Nicolas Hulot has announced that all coal-fired power plants in France would be closed by 2021, a decision which was also confirmed by President Emmanuel Macron during the One Planet Summit held in Paris in December 2017. There are still five, operated by EDF (Cordemais 4 & 5, and Le Havre 4) and Uniper (Emile Huchet 6 and Provence 5), amounting to a combined 3GW (2.3% of total installed capacity in France), with a production share of 2% in 2017.

In addition, President Macron has been openly calling for a Carbon Price Floor to be implemented at European level, with France reaching out to Germany in an effort to implement a common CPF, hoping the move would make other Member States act. The level of CPF suggested is that of EUR30/Tn CO2.

A series of studies based on modelling generation capacity in Europe converge towards the conclusion that a floor price between EUR20 and EUR30/TnCO2 (depending on the relative wholesale market prices of gas and coal) would tip the scales in favour of CCGTs generation over most, if not all, coal-fired plants. Figures from RTE indicate that the substitution would occur with a carbon price of EUR30/TnCO2. The Canfin-Grandjean-Mestrallet report recommends that the floor price be set initially between EUR20 and EUR30/TnCO2 in 2020.

GERMANY:

The weight of coal and lignite in the electricity mix in Germany, respectively 14% and 26%, and in the German economy is far greater than in France. Current installed coal capacity amounts to +46GW, and the share of coal in Germany´s electricity generation was 37% in 2017.

In an attempt to comply with EU and national emissions reduction targets and, more specifically, energy sector emissions, the German government decided in 2015 to gradually close a few lignite-fired power plants by 2021 (2.7GW) in the form of a kind of ‘capacity reserve’ as part of the new power market design. The remaining reductions would have to come from an array of smaller measures, mostly incentives for industry to invest in efficiency measures.

However, following September 2017 elections, Germany faces unprecedented difficulties in forming a new government – likely a coalition government again –  a situation which obviously has an impact on energy and climate policies. The next government will be faced with numerous challenges to make progress on Germany´s Energiewende and climate protection, such as phasing out coal-fired power production or lifting the cap on expanding renewable energy sources, with an important intermediate target for emissions reduction by the end of 2020.

The future role of coal in Germany will be crucial in this context. In the Jamaica talks in November 2017, Chancellor Merkel´s conservatives and the pro-business FDP proposed to retire up to 5GW coal capacity, while the environmentalist Green Party called for 8-10GW. A compromise between the parties envisaged the decommissioning of 7GW by 2020, the equivalent of Germany´s 15 most carbon-intensive coal plants.

The talks’ collapse ultimately scrapped this agreement but, in a surprise move, the SPD, which remained reluctant to enter a coalition, and which traditionally has close links with the coal industry, has recently announced that reaching the climate targets would have to go “hand in hand with an end to coal-fired power generation”, and that protecting coal workers’ economic interests had to be paramount for a just energy transition.

Hence, the future of coal-fired generation is now also likely to figure prominently in potential coalition talks between the Social Democrats and the conservatives. Plus, the coal exit commission proposed in Germany´s Climate Action Plan 2050 might start its work in 2018, according to German environment ministry.

Finally, and regarding the potential implementation of a CPF, only the Green Party made it one of its climate protection priorities in its pre-elections programme, followed by SPD´s rather vague ‘development of a common European “climate diplomacy” to push global energy transition’.

France and Germany: hand in hand?

With the closure of French coal-fired plant only some limited reduction of emissions will be achieved as French coal production will be replaced by other thermal facilities (from other coal-fired plants from abroad and/or CCGTs). But this closure launches a direct signal to Germany: if Germany really wants to contribute to Climate Change, the only way to proceed is to do away with their own coal/lignite-fired power plants.

To curtail the undesirable effects of such a measure and align it with a dynamic integration of the European power market, the phasing out of coal-fired generation must be approached in collaboration with adjacent countries.

Which raises the following question: with France and Germany facing major energy challenges, and given their historical and economic place in Europe, as well as in electricity production, it is of crucial importance to coordinate the energy transition trajectories of the two countries. This coordination could serve as a model to improve energy and climate governance in Europe. It is a question of jointly addressing the economic and social consequences of electricity generation, in addition to the evolution of the electricity mix in the two countries. Applying the same logic, it would also make sense for countries such as Belgium, the Netherlands and Luxembourg to adopt a similar plan.

But, how likely is France to convince Germany to establish a common CO2 price floor emitted by power utilities?

President Macron wants to revive a plan already turned down by Germany last year, when Hollande´s government unsuccessfully tried to convince its neighbour to agree on a common CPF.

This would make France more competitive relative to Germany due to the high share of low-carbon nuclear power in France (around 75%) and the high share of coal power in Germany (around 40%).

The compromise would obviously benefit EDF, who manages the whole French nuclear fleet and, together with Engie, would see the use of its gas-fired power plants increase significantly.

As for Germany itself, a CPF might hurt utilities RWE and Uniper, who have stated that it would lead to job losses because of their heavy reliance on lignite and coal to produce electricity.

And with Germany currently facing an uncertain political future, with ongoing potential coalition talks under way, the likelihood of achieving a compromise on a common CPF seems to be fading away. In fact, the latest round of coalition talks, this time between Merkel and the SPD, and which started on January 7th, seems to be pointing at a potential agreement to postpone the country´s 2020 target.  A set of measures would be introduced to close the gap as much as possible by that year, and then reach the initial objectives ‘by the early 2020s’.

Should this agreement eventually come through, Merkel would probably lose her status of ‘Climate Chancellor’, possibly leaving France to flagship Climate Change on its own, in which case it would have to reach out to other Member States to reach a consensus on a common CPF.

 

What is for certain, however, is that, regardless of whether France and Germany manage to reach an agreement on a common CPF, a proposal for a common CPF in the electricity sector must be framed within a coordinated approached among Member States concerned.

Michaela Sternhagen

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