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Set aside allowances An EU ETS intervention worth the risk? Daniel Engström Stenson Christofer Sköld FORES Policy Paper 2012:1
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Set aside allowances - An EU ETS intervention worth the risk? FORES Policy Paper 2012:1

Oct 26, 2014

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In 2012 countless articles were written aboutdeclarations and wordings of resolutions at the great UNSummit on sustainable development in Rio de Janeiro.Meanwhile hardly anything was publicized about agigantic, immediate move in real life climate policy, theplan to strike out of three-quarters of a year’s carbonemission in the entire European Union, through the so-called “set-aside” on the EU ETS carbon market.
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Page 1: Set aside allowances - An EU ETS intervention worth the risk? FORES Policy Paper 2012:1

Set aside allowances An EU ETS intervention worth the risk? Daniel Engström Stenson Christofer Sköld FORES Policy Paper 2012:1

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About FORES FORES - Forum for Reforms, Entrepreneurship and Sustainability - is an independent research foundation and think tank devoted to evidence-based research mainly centred on environmental economics, migration, structural economic reforms and foreign policy. We engage academics and experts to propose concrete policy proposals and endeavour to bring facts and research to the broader public. FORES functions as a link between civil society, entrepreneurs, policymakers and academia, producing research papers, policy briefs and books, and hosting seminars and policy debates. FORES is based in Stockholm, Sweden, and governed by an independent board of directors and a research board composed of respected academics. Our work is based on broad principles of liberal democracy and the rights of each person to shape her or his own lives. C o n t a c t s : Martin Ådahl Director FORES, [email protected], +46 730 88 52 61 Daniel Engström Stenson Programme manager environmental policies, [email protected], +46 730 88 52 63 www.fores.se

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Summary ...................................................................................................... 4  Foreword...................................................................................................... 7  1.  Introduction ........................................................................................... 9  2.  Set  aside  –  risks  and  benefits........................................................12  Reasons  behind  the  current  low  price.....................................12  Is  set-­‐aside  a  price  control  mechanism  or  an  emission  control  mechanism?.........................................................................14  How  many  allowances  to  set-­‐aside? .........................................16  Price  effects  from  set-­‐aside  –  affecting  state  and  business  revenues................................................................................................17  What  to  do  with  the  set-­‐aside  allowances?............................21  Cancel  allowances .......................................................................22  Return  of  allowances  to  the  market ....................................23  Return  at  a  given  date................................................................23  Return  at  a  given  price  level ...................................................25  

3.  Preferred  Policy  Options ................................................................27  Appendix. ...................................................................................................29  A  supporting  measure:  Scraping  auctioned  allowances  equal  to  the  amount  of  banked  allowances. ..........................29  

References .................................................................................................32  

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Summary

● In order to deal with the large surplus of emission rights in the EU ETS it has been proposed that a number of allowances could be set aside from the auction, later to be returned or cancelled.

● A set-aside is only a second best option, if it not possible to reach an agreement on EU moving to a 30 percent reduction target to 2020. An agreement on 30 percent creates more predictability than the set-aside. To achieve real predictability and long term price effects EU also has to agree on long-term targets after 2020, leading up to 2050.

● Current low prices are not only a cyclical result of the recession, but partly or even mainly the result of a structural oversupply of emission allowances and additional EU measures on energy efficiency that have led to a surplus and unexpectedly cheap allowances.

● Essentially a low emissions price signals that emission reductions are cheap, and that there is ample scope for more reductions at a modest cost. Hence, emission reductions should be the prime aim of a set aside.

● The number of allowance set-aside matters. The surplus from phase II of the ETS that is likely to be carried over to phase III is approximately 700 million allowances. Any set-aside should at least significantly exceed this.

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● In order for she set-aside to be an emission reducing mechanism, which is preferable, allowances needs to be retired (the allowances cancelled). If allowances are not cancelled, a set aside is nothing more than a price control mechanism, at best. A set-aside of 1.4 billion may, according to estimates, result in an allowance price around €17 that would create a significant (one third) increase in revenues from emission auctioning, and could contribute to the European public finances. For business with a surplus of allowances, it will also bring more revenues.

● The rules governing the set-aside must be clear and well-defined. This paper concludes that the most efficient and most feasible ways to make a quick correction of the EU ETS by using a setting-aside mechanism would be, in order of preference:

1. Set-aside at least 1.4 billion allowances with

clear guidelines to cancel them. In this option, setting aside means withdrawing the set-aside permanently after opening up the directive during Phase III.

2. Set-aside at least 1.4 billion allowances, with a view to return them during phase III, if the price rises above €50. The non-returned allowances could be cancelled at the end of phase III. If the low price turns out to be the result of the recession, the release of the set-

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aside would then soften the price increase as economic activity picks up.

3. Set-aside at least 1.4 billion allowances, keep them outside the system no matter what during phase III with a view to return them to the market after 2020, should the price rise above €50.

A set aside with no strict guidelines on if and when allowances are to be returned is to prefer over non-action, but it comes with a risk. If the decision on what to do with the set-aside allowances is procrastinated, it runs the risk of leading to further uncertainties, without neither pushing the price or reducing emissions.

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Foreword In 2012 countless articles were written about declarations and wordings of resolutions at the great UN Summit on sustainable development in Rio de Janeiro. Meanwhile hardly anything was publicized about a gigantic, immediate move in real life climate policy, the plan to strike out of three-quarters of a year’s carbon emission in the entire European Union, through the so-called “set-aside” on the EU ETS carbon market. There are similarities with the fable in “Parkinson’s Law about Triviality” about the company discussing the bike shed for an hour, and the go-ahead for a nuclear plant in five minutes. Complexity makes debaters chafe. However the basic principle in this case is simple: It has been much easier and thus much cheaper than expected to make the planned reductions of carbon emissions in Europe. Thus the emission price on the EU carbon emissions market is only a quarter or a fifth of what was expected. Given this, it is possible to change the plans, and reduce the decided emissions in a one-off, last minute decision, just before the next period of trades 2013-2020 is fixed, a so-called set-aside. The issue is whether this reduction of emissions should be permanent or just temporary and if the emissions taken away should be returned later, for example if and when the price of emissions goes up. The question is also how big this set-aside should be. The devil is in the details as always, notably there is an

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interesting connection to the scrambling for revenues during the euro debt crisis. Our hope is that this policy brief can explain some of these details, and bring as rational as possible policy advice as we can muster with the help of our emissions markets expert group. Martin Ådahl, Director FORES

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1. Introduction1 At the current stage, there is an evident surplus of emission allowances in the EU ETS. The emission trading think tank Sandbag has estimated that almost 700 million unused allowances will be carried over to phase III. 2 The Deutsche Bank has projected that the surplus will decline from almost 2.5 billion EUAs in 2013, and still be around 1.2 billion in 2020,3 while the Commission has estimated that by the end of 2020 the carried over surplus allowances may be as many as 2.4 billion.4 By then, other EU policies, on energy efficiency and renewable energy, are expected to deliver greater reductions than the economy-wide EU ETS. The oversupply of allowances has led to a price per ton (EUA) that is far below expectations. During 2012 the price has not climbed above €10, far from the €40 initially projected by the Commission.5 This indicates that reaching the current reduction target is cheaper than expected, and there is room to tighten the cap

1 Valuable contributions were given by the emission market expert group of FORES, notably Åsa Löfgren, associate professor University of Gothenburg, Lars Zetteberg, Swedish Environmental Research Institute, and Christina Olsen-Lund PhD Environmental Law, University of Gothenburg 2 Sandbag (2011) 3 Commodities now (2012) 4 European Commission (2012) 5 Vertis (2012), Climate Strategies (2012)

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significantly. To tighten the cap of the EU ETS by moving from the current 20% reduction target for 2020, to a 30% reduction target6 would be the rational decision from an environmental and economic point of view and should be the main option. It would create predictability and follows the basic logic of the EU ETS that the price is to be determined under a set cap. This has however met with the opposition of a few EU member states, most notably Poland. As a second best option, a so called set-aside has been proposed by the Parliament7 and the Commission8 and has also been discussed by energy and environment ministers during the spring of 2012.9 The idea behind the set-aside is to remove a number of allowances, with a view to return them into the system at a later point. This would temporarily compensate for the carry over of allowances from phase II to phase III, and increase the price of EUAs. Linked to the set-aside is also the possibility of cancelling the set-aside allowances and thereby in practice lower emissions. The most commonly proposed number of allowances for a set-aside is 1.4

6 Within the current 20% target, the sectors included in the EU ETS is bound to reduce its emissions by 21% compared to the emissions at 2005, the start of the scheme. In a 30% reduction scenario, the EU ETS will reduce its emissions by 34%. 7 European Parliament Environment Committee (2011) and European Parliament Industry Committee (2012) 8 European Commission (2011) 9 Reuters (2012)

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billion, which stems from Commission calculations that such a set-aside would be equal in terms of emissions 2013-2020 to moving to 30% (with a 25% domestic EU reduction). A 1.4 billion set-aside is roughly equivalent to 15% of the total number of allowances to be sold on auction during phase III (2013-2020), or three-fourths of the total allowances for one year.10 At first sight this appears to be a rational “quick and dirty” way around resistance towards a stricter target, but it would be an intervention which impacts market behaviour and in the longer run may also have and impact on the credibility of the entire emission trading scheme. This paper will highlight some of the major possible impacts and discuss what should be the rationale behind a set-aside. It should be noted, that the discussion on the set aside is to be seen in absence of a long-term target for the EU ETS. Should the EU member states agree on ambitious and credible post 2020-targets, these would have also short-term effects on EUA prices. A steepening trajectory for the EU ETS cap would increase the incentives for businesses to use the current surplus of allowances to bank them, which would stimulate demand and hence increase the price.

10 European Commission (2011)

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2. Set aside – risks and benefits

Reasons behind the current low price Generally, the carbon price in an emission trading market reflects the supply and demand of allowances. While the supply is determined by the regulatory setting for the amount and allocation of allowances (the cap), the demand for EUAs is determined by the amount of emissions that firms need to cover. The demand in turn depends on factors like weather conditions, price on natural gas, oil and coal, change in the GDP, energy efficiency and the availability of renewable energy. 11 It is often claimed that the current low price is primarily the effect of reduced demand, stemming from the financial crisis and low economic activity. However, it is likely that other factors have contributed to lower demand. Maydybura and Andrew show that about half of the changes in price of carbon is explained by price in natural gas, oil and coal, change in GDP, fluctuations in weather and the onset of the global financial crisis. 12 Gronwald and Ketterer conclude that demand-side fundamentals do not seem to provide a full explanation of the EUA price development.13

11 Gronwald, M. and Kettterer, J (2012) 12 Maydybura, A. and Andrew, Brian (2012) 13 Gronwald, M. and Ketterer, J (2012)

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Many have instead pointed to other factors affecting demand (energy efficiency, renewable energy etc) as well as decisions by the regulator (the Commission and member states) as the prime price drivers. 14 Reasonably both the supply and different aspects of the demand side have contributed to the current price levels. Most of cap-and-trade-markets, such as the US SO2 scheme, the RGGI emissions market in the North Eastern USA and the Phase I of EU ETS saw patterns of a high initial price that decreased over time as businesses adapt to the new scheme, regardless of the business cycle.15 Hence, the economic downturn probably does not give the full explanation of the falling price during the EU ETS phase II. The current low price is instead likely to be the result of an over-allocation, stemming from a combination of factors: the original negotiations which did not sufficiently take into account strong macroeconomic conditions at the outset, relative fuel prices, the influence of Europe’s complementary targets on energy efficiency and renewable energy and technological trends. In sum, there are large uncertainties in regards to energy forecasts and the estimates of the demand of allowances.

14 See Maydubura and Brian (2012), Gronwald and Ketterer (2011)Zhang (2011) 15 Climate Strategies (2012)

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Is set-aside a price control mechanism or an emission control mechanism? A fundamental question is whether the set-aside measure should be used as a price control mechanism or an emission control mechanism. The question also relates to the broader question of the aim of the emission trading scheme – is it to reduce emissions in a cost-effective manner, to establish a price signal that helps stimulate investments in carbon-free techniques, or a combination thereof?16 According to the directive, the EU ETS is established “in order promote reduction of green house gas emissions in a cost-effective and economically efficient manner”.17 But since the price decreased dramatically during the beginning of the economic downturn in 2008, many have come to the conclusion that the low price and price volatility have a negative impact on carbon free investments and therefore need to be regulated. One proposal is a price collar, where a “central bank” such as the Commission regulates the supply of allowances to make sure that the price stays within a predefined range. This is believed to promote predictability and improved cost-efficiency. 18 A price collar benefits predictability, but seem to be in opposition to the fundamental idea behind a carbon

16 For further discussion, see Rob Stavins (2012) 17 European Parliament and Council (2009) 18 See Gronwald and Ketterer (2012) and Frankhauser et al (2011)

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market: politicians decide an acceptable level of emissions, and under that cap the market will find the cheapest reductions. A low price means that reaching the target is cheap. Essentially this is a good thing, signalling cost-efficiency of measures to reduce emissions. It shows that lowering emission to the level set by decision-makers has been significantly cheaper than expected. Using a price collar might mean that emissions exceed or fall short of the pre-decided level.19 But the current low price is also an indicator that the cap is set too high, and implies that there is room for tightening the cap. In the case of the EU ETS the cap is set at a level that does not correspond to the Union’s additional climate policies, in particular the targets for renewable energy, and that overestimates the demand of emission allowances. If a set-aside is used as a temporary price control mechanism, as a way of smoothing the price curve, it will have no direct impact on EU emissions. The only regulator of total emissions in the ETS is the total available amount of emissions. Changing the timeline of when to make emission rights available, such as a rescheduling of the auction time line, will if no further actions are taken only spread the emissions differently over years.

19 Chevallier (2012)

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How many allowances to set-aside? The 1.4 billion allowances often mentioned as a set aside stems from a Commission working paper on moving beyond 20%, and has stuck in the debate. Deutsche Bank has proposed a 1.2 billion set aside, while think-tank Sandbag advocate a 3.1 billion set aside to cover for current and future surplus.20 A leaked version of Commission Road Map 2050 included numbers of 500-800 million allowances, in order to cover for excess allowances banked in Phase II and forwarded to phase II.21 A set-aside of 1.4 billion allowances would according to estimates by Neuhoff et. al. reduce the volume of unused allowances enough to avoid a situation where the surplus is so big that available allowances becomes subject to speculative investments rather than a way for businesses to cover for emissions and risks of future higher prices.22 To drive the price, it is likely that the number of set-aside allowances need to be substantial. It should at least cover the allowances carried over from the second to the third phase (likely to be around 700 million), in order to at least create a deficit at the end of one year during the phase. A smaller set-aside would result in continued surplus of allowances even if the entire set-aside took place in year one. Hence the price effect is likely to be

20 Commodities now (2012) and Sandbag (2012b) 21 European Commission (2011) 22 Neuhoff (2012)

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small, in the absence of a clear and ambitious post 2020-target.

Price effects from set-aside – affecting state and business revenues The exact price effects of a set-aside are difficult to project. But there are estimates that give an indication. A Point Carbon survey in February found an average estimate of €17/ton CO2.23 Climate Strategies calculates that if 1 billion allowances were to be withdrawn from the scheme, the price would rise from €10 to €20. Another calculation from Climate Strategies states that a 1.4 billion set-aside (being cancelled or not used until post 2020) would in continued economic downturn lead to a price between €8 and €20, depending on the development of renewable energy. In a scenario with high economic growth, the price would range from €20, in the scenario with high share of renewables, to €32, in the scenario with a low share of renewables. This indicates that the prices would most likely remain within the price range experienced 2008-2012, even after a 1.4 billion set-aside. 24 Strongly related to the price are the revenues from the auction of EUAs. According to Commission estimates a 1.4 billion set-aside would increase the revenues from the

23 see Sandbag (2012a) 24 Climate Strategies (2012)

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auction by a third. The price increase is hence estimated to more than compensate in terms of revenues for the set-aside allowances not being sold. 25 Therefore, to reduce the amount of emission rights could also be seen as an opportunity for governments to increase revenues in times of economic crisis. For the period 2013-2020, Climate Strategies estimate the additional revenues in a set aside scenario (again 1.4 billion allowances) to range from 68 billion Euros if the EUA price stays at €8, to 271 billion in a high economic growth scenario where the prices reaches €32. The increased income may thus have a significant impact on the present European debt restructuring and be an incentive to keep set-aside allowances outside the scheme. FORES has in a previous policy brief highlighted that an economy wide carbon price of 20 US dollar would cover a significant share of many European states’ increased government debt during the financial crisis.26 By using the estimates from Climate Strategies above, table 1 below show the estimated revenues for some of the EU states under different price levels, after being shared according to the formula set by the Commission.27

25 European Commission (2011) 26 Stavlöt, Ulrika (2011) 27 European Commission (2010)

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T a b l e 1 S t a t e R e v e n u e s f r o m E U A a u c t i o n Country Revenues

(€) from auction with a €8 EUA price 2013-2020

Revenues (€) from auction with a €17 EUA price 2013-2020

Revenues (€) from auction with a €32 EUA price 2013-2020

Denmark 829 million 1.74 bn 3.3 bn Germany 13.3 bn 27.8 bn 53 bn Greece 2.3 bn 4.8 bn 9.2 bn Italy 6.4 bn 13.5 bn 25.4 bn Poland 8.3 bn 17.5 bn 33 bn Romania 3.3 bn 7 bn 13.2 bn Spain 5.73 bn 12.1 bn 22.9 bn Sweden 590 million 1.24 bn 2.35 bn

In addition, businesses with a current surplus of allowances are set to gain increased revenues from a set aside. When the number of allowances on auction decreases, businesses will be able to sell their surplus allowances to a higher price compared to the current situation. Table 2 show the total revenues to businesses in Sweden and Poland, should they sell their entire surplus built up during 2008-2011.

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T a b l e 2 V a l u e o f E U A S u r p l u s 2 0 0 8 - 2 0 1 1 Country Total

surplus EUA price €8

EUA price €17

EUA price €32

Poland 17, 9 millions

143 millions

304 millions

572 millions

Sweden 8,1 millions

65 millions

138 millions

260 millions

Although the calculations are rough and based on the assumption that none of the surplus allowances have been re-sold since 2008,28 they give an indication that several businesses have a clear gain to make from an increased carbon price. The preliminary allocation of allowances to Swedish businesses for 2013-2020 compared to emissions in 2011 indicates even larger revenues in the future. The preliminary accumulated surplus over the period reaches 58 million allowances, worth €989 million at a €17 EUA price, double the value compared to current price levels. Using surplus allowances to increase capital is not new to business in the EU ETS. During 2008 and 2009, when production fell as a result of the economic downturn, businesses frequently sold their excess allocation in order to generate extra funds in a tighter credit environment.29

28 Estimates by Neuhoff (2012) indicates that industrial emitters retained half of the emission allowances received for free 2008-2011. 29 World Bank (2009)

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What to do with the set-aside allowances? The answer to the question of whether the set-aside should be seen as a price control or emission control mechanism will help answering a second critical question - what to do with the set-aside allowances? This will also affect the prices and hence the public revenues discussed in previous section. Only if the set-aside allowances (or a share of them) are not returned to the market do the options lead to actual European emission cuts. In practice, this mean there are two different options.

1. Cancel the allowances. 2. A conditioned return of the allowances to the

market a. at a given price level b. at a given date (spread over a number of years)

In alternative 1, it is essential to have a guarantee that the set-aside is in effect a withdrawal of allowances. If such a guarantee is not possible, options concerning the return of allowance will have to be considered. A set-aside risks to create insecurity in the market, since it might be perceived as an ad hoc price floor, used by politicians when markets do not live up to expectations (which may in turn vary over time). This kind of uncertainty should ultimately be avoided.30 Another area 30 Maydybura and Andrew (2011)

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of uncertainty is what happens to set aside allowances, since it is crucial for long term carbon price expectations.31 If there are no clear guidelines on how, when or if the set-aside allowances are to be returned, the price is likely to be determined by actors assumptions of how large shares of the set-aside will be returned, and when. If businesses assume that the entire set-aside will be returned, they will probably be able to adjust their trading over time, with the help of banked emissions, so that the effect on today’s price would be small, if any. Should a short-term price bump occur, the price is likely to drop once the allowances are returned.

Cancel allowances While the decision to set-aside a number of allowances can be done without opening the directive, a decision during the period of 2013-2020 to cancel allowances would most likely require an opening of the directive, since it would violate the current trajectory of an annual decrease of emissions by 1.74.32 Steepening the trajectory will be necessary at some point, since the current trajectory will not lead to the Commission Roadmap 2050 target of 80% reduced emissions by 2050, and opening the directive to remove allowances could be seen as a way to bring forward the necessary discussion on post-2020 targets for the ETS.33 However, some have argued that it would be possible to decide before 2013 to set aside and

31 Neuhoff (2012) 32 Client Earth (2011) 33 Sandbag (2011)

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withdraw allowances without opening the directive, since it would not intervene with the 1.74% linear decline.34 In practice a set-aside followed by cancelled allowances would be a one-off reducing the number of emission allowances. Thus, the set-aside option has the best environmental impact and interrupts the market the least.

Return of allowances to the market The term set aside implies that the allowances can or should be returned. In order for the set aside with a return to have any real impact on emissions, and probably also on the price levels, the return should be conditional. A conditional return would create the predictability that a set aside without clear rules of return would miss, and is probably the second best option after the cancelling of allowances. The return could be conditioned to a date or a price level.

Return at a given date One option for return would be to set a given date on which the set-aside allowances would be returned to the market at a steady rate. Since Phase III will be oversupplied partly by the carried over allowances from Phase II, a rational option would be to let the set-aside

34 Client Earth (2011)

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allowances stay outside the system for the entire Phase III, and leave them to be part of the discussion on the post 2020 ETS. On the one hand, this would mean that the current oversupply is corrected for and that the rules to 2020 become clear. On the other hand, it could mean an increase in the cap from 2021, unless the negotiations on post-2020 ETS mean that the set-aside allowances are, in practice, cancelled. Under this same headline there is also a proposal by the Commission to change the auction timeline. The proposal intends to create a back-loading of allowances sold on auction, meaning less allowances will be auctioned in the early years of phase III, and that more allowances will be sold towards the end. The details of the proposal are yet to be made public, but along what has previously been argued in this paper, the price effect is likely to be small, if any. Since the price is to a large extent driven by expectations on future scarcities,35 the knowledge that the number of allowances will increase towards the end of the period will likely mean that banked allowances will be used to cover medium term shortages. In order for the rescheduled auction timeline to be a consistent price driver, a deeper trajectory for the post-2020 ETS is likely to be necessary.

35 Gronwald and Ketterer (2011)

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Return at a given price level In the directive, there is already a price control mechanism. If the price on EUAs during six consecutive months is three times higher than the average price during the two preceding years, the Commission has the option to take action to lower the price by either rescheduling the auctioning of allowances, or by granting member states to use allowances originally reserved for new entrants.36 Along the same lines it would be possible to decide that the Commission will return the set-aside allowances at a predestined price level. This would in practice function as price ceiling, for as long as the set-aside lasts at that given price. A €50 price ceiling would be fair but reasonably low, given that the Commission initial projections stated an expected price of EUA to €40.37 It is also close to the median of estimates for a sustainable global carbon price given by the Stern review and other long-term evaluations. As previously mentioned, the current low price is likely to be the result of a combination of factors, not only an effect of the recession, as is sometimes argued. It is therefore unlikely that a set-aside alone would drive the price above previous levels, that is above €30-35 a ton.

36 European Parliament and Council (2009) 37 Climate Strategies (2012)

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Nevertheless, if an economic boom drastically increased the demand for allowances, driving the price above €50, the set-aside allowances would be returned to the market, acting as a safety valve for cyclical effects. However our informed guess is that this is not likely the price would actually reach €50.

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3. Preferred Policy Options The set-aside mechanism is probably the best short-term intervention on the EU ETS in absence of a move to 30% reduction target and ambitious post 2020-targets. Most important, it provides an opportunity to actually reduce the EU emissions and give decision makers a chance to correct for the structural over allocation during 2008-2012. But is also likely to be the most market-dynamic tool to stabilize the price level. It is therefore preferable to alternatives such as a reserve price or price collars. But a set-aside implemented in the wrong manner risks have a damaging effect on the credibility of the EU ETS, and it is important to keep in mind that less intervention is generally better and that the most efficient action would be to set a stricter EU ETS cap and agree on the long term targets. Therefore, any decision on a set-aside should be clear on whether this sets a precedence for future intervention, or if this is a one time intervention due to the extraordinary circumstances of previous over-allocation and the economic crisis (and the inability to reach 30%). Making clear it as an exceptional one-off intervention is in itself important. This paper concludes that the most efficient and most feasible way to make a quick correction of the EU ETS by using a setting aside mechanism would be, in order of preference:

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1. Set-aside at least 1.4 billion allowances with clear guidelines to cancel them. In this option, setting aside means withdrawing allowances, if needed after opening up the directive during Phase III. 2. Set-aside at least 1.4 billion allowances, with a view to return them during phase III, if the price rises above €50. The non-returned allowances could be cancelled at the end of phase III. 3. Set-aside at least 1.4 billion allowances, keep them outside the system during phase III with a view to return them to the market after 2020, should the price rise above €50. 4. Set-aside at least 1.4 billion allowances without conditions for return. It is to prefer over non-action, but comes with a risk. If the decision on what to do with the set-aside allowances is procrastinated, it runs the risk of leading to further uncertainties, without neither pushing the price or reducing emissions.

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Appendix. A supporting measure: Scraping auctioned allowances equal to the amount of banked allowances. Another proposal, related to the discussion on setting aside and withdrawing allowances, is to withdraw from auctioning a number of allowances equal to the surplus from the previous phase or year. 38 In practice this would for the beginning of phase III mean that once the businesses have reported their surplus of allowances (estimated to 500-800 million according to the Commission) form the second phase, the Commission will withdraw the same amount from the auctioning of Phase III. This would have the effect that the amount of allowances for Phase III would be in accordance with the directive. Businesses would still be able to bank allowances and carry them over to next phase, and the intervention would not change the rules for companies with already banked allowances. This would lead to actual reduced emissions, while the only notable difference for actors in the scheme would be that actors in need of allowances would buy them from companies with a surplus from previous phase. This would in practice mean that the cap is corrected in

38 See Sandbag (2012a)

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retrospect to match actual emissions. This could either be a one-off intervention, or used as permanent feature of scheme, to correct for over-allocation.

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