COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a Decision of the European Parliament and of the Council concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and amending Directive 2003/87/EC
Date: 2014-01-22
Institutions: European Commission
Subjects: EU Emissions Trading Scheme, environmental statistics, greenhouse gas, reduction of gas emissions, reservation













EUR-Lex - 52014SC0017 - EN











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52014SC0017

COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a Decision of the European Parliament and of the Council concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and amending Directive 2003/87/EC /* SWD/2014/017 final */









Contents
1............ Procedural issues and consultation of
interested parties. 4
1.1......... Organisation and timing. 4
1.2......... Consultation and expertise. 4
1.3......... Subsidiarity. 6
1.4......... Opinion of the Impact Assessment Board. 6
2............ Policy context 7
3............ Lessons learnt from
the functioning of the EU ETS. 7
4............ Problem definition. 8
4.1......... Interaction with possible measures in the
context of the 2030 framework. 10
5............ Objectives. 11
5.1......... General objective. 11
5.2......... Specific objective. 11
5.3......... Operational objective. 11
6............ Policy options. 12
6.1......... Option 1: Retiring a number of allowances
in phase 3. 14
6.2......... Option 2: Market
stability reserve. 14
6.2.1...... Potential sources of supply flexibility. 15
6.2.2...... Functioning of the mechanism.. 16
6.2.3...... Triggers for feeding allowances into the
reserve and releasing them.. 17
6.2.4...... Size of the adjustment 23
6.2.5...... Timing. 24
6.2.6...... Other design aspects and characteristics of
a market stability reserve. 25
6.3......... Option 3: Combination of
a market stability reserve with permanent retirement 26
7............ Analysis of impacts. 26
7.1......... Market balance. 26
7.1.1...... Baseline scenario – Option 0. 29
7.1.2...... Permanent retirement options: Options 1a and
1b. 30
7.1.3...... Options for the market stability reserve. 31
7.1.4...... Option for a combination of a market
stability reserve with permanent retirement: Option 3  45
7.2......... Potential impact on
carbon price formation. 45
7.2.1...... Baseline option. 46
7.2.2...... Permanent retirement 46
7.2.3...... Market stability reserve. 46
7.2.4...... Combination of a permanent
retirement and a market stability reserve. 47
7.3......... Auction revenues. 48
7.4......... EU competitiveness
considerations. 48
7.4.1...... Potential direct cost for
energy-intensive sectors covered by the EU ETS. 50
7.4.2...... Potential indirect cost 52
7.5......... Social impacts. 52
7.6......... Environmental impacts. 54
8............ Comparison of options and conclusions. 54
9............ Monitoring and evaluation. 55
10.......... Annexes. 58
10.1....... Sensitivity analysis. 58
10.1.1.... Baseline scenario. 58
10.1.2.... 40% GHG emission reduction by
2030. 60
10.2....... Summary of the results of the stakeholder
consultation. 63
10.2.1.... Process. 63
10.2.2.... Distribution of replies to the online
consultation. 64
10.2.3.... EU remains the best instrument for achieving
the EU objective of an economy-wide 80-95% reduction  66
10.2.4.... Option (a): Increasing the EU reduction target to 30% in 2020. 67
10.2.5.... Option (b): Retiring a
number of allowances in phase 3. 67
10.2.6.... Option (c): Early revision
of the annual linear reduction factor 67
10.2.7.... Option (d): Extension of the
scope of the EU ETS to other sectors. 67
10.2.8.... Option (e): Use of access to
international credits. 68
10.2.9.... Option (f): Discretionary
price management mechanisms. 68
10.2.10.. Other proposals. 69
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT
Accompanying the document
Proposal for a Decision of the
European Parliament and of the Council
concerning
the establishment and operation of a market stability reserve for the Union
greenhouse gas emission trading scheme and amending Directive 2003/87/EC
1.           Procedural issues and consultation
of interested parties
1.1.        Organisation and timing
The preparation of the Impact Assessment
(IA) for the structural measures to strengthen the EU Emissions Trading System
(ETS) formally started in November 2012 with the adoption of a Report on the State
of the European Carbon Market in 2012 (from here on referred to as the Carbon
Market Report).[1]
As the work on the 2030 climate and energy framework plays a role in the assessment
of several options for the structural measures , the preparation of this IA was
combined with the preparation of the IA for the 2030 framework (from here on
referred to as the 2030 IA). 
An interservice group for the 2030
framework was established in February 2013 in view of preparing a Green Paper
on the matter.[2]
It continued to meet to steer the work on the IAs after the paper's adoption. Also
in relation to the options for structural measures, the group met three times:
(1)                   
On 16 July 2013 to discuss the first outline of
the 2030 IA, including the chapter on the EU ETS, and the lessons learnt;
(2)                   
On 23 September 2013 to discuss the results and
analysis of the information submitted by stakeholders on the options for
structural measures, first outline of this IA and the progress on the 2030 IA;
(3)                   
On 21 October 2013 to discuss the progress on
both IAs.
The final draft IA was submitted to the
group on 13 January 2014.
Directorate-General
for Climate Action (DG CLIMA) took the lead on this IA. The following services were
invited to the steering group: Secretariat-General; Legal Service; DG
Competition; DG Economic and Financial Affairs; DG Employment, Social Affairs
and Inclusion; DG Energy; DG Enterprise and Industry; DG Environment; DG Internal
Market and Services; DG Mobility and Transport; DG Research and Innovation; DG
Taxation and Customs Union and DG Trade.
1.2.        Consultation and expertise
The Carbon Market Report
served as a consultation document. It presents the adverse effects of the severe
supply-demand imbalance in the EU ETS and sets out a range of possible
structural measures to address it in a sustainable manner. 
The Commission launched an online
stakeholder consultation, which lasted until 28 February 2013. It did its best
to accept late submissions also. The consultation sought input on the expected
impacts of individual options, including on emission reductions, ability of the
EU ETS to meet the EU long-term target of an 80-95% reduction by 2050 in a
cost-effective manner, stakeholders' activities, and employment and households.
232 contributions from a broad spectrum of stakeholders were received. The
Commission's minimum consultation standards were met. In addition, two
dedicated full-day consultation meetings were organised on 1 March and 19 April
2013. As there appeared to be a growing view among stakeholders that the EU ETS
needs some kind of objective and rule-based mechanism to strengthen market stability
and increase the resilience to large-scale demand shocks, the Commission
organised on 2 October 2013 an expert meeting on this additional option. The main
findings of the public consultation are found in Box 1 and a comprehensive summary report in section
10.2. 
Box 1: Main findings
of the public consultation
 The public consultation showed that a large majority of stakeholders continued to hold the view that the EU ETS is the best instrument for achieving the EU objective of an economy-wide 80-95% reduction in greenhouse gas (GHG) emissions by 2050 within an internal market. Most stakeholders recognise that there is a large and growing surplus in the carbon market. Some thought that the Carbon Market Report puts forward the options because the carbon price signal does not generate enough revenue for Member States. Many regretted that the options set out in the Carbon Market Report were not explicitly linked to a clear process on the 2030 framework. Some stakeholders felt that the options appeared to concentrate on the short-term action and did not sufficiently address the underlying issues. According to some, there are significant differences between the economies of Central Europe and the rest of the EU. Functioning of the EU ETS: Stakeholders have mixed views on the extent to which the success of the EU ETS depends on a robust carbon price signal. Many argue that a significant carbon price is necessary so that the low-carbon investment results in a positive business case. Others emphasised that a low carbon price simply indicates that there is little need for additional abatement to meet the current target. Accordingly, views differ on the need for measures in the short-term. Preferred options: Most energy-intensive industries prefer no action before phase 4 (2021-2028). Other stakeholders supporting measures to be taken in phase 3 generally favour: Option (c) for an early revision of the linear reduction factor consistent with a 2030 target, if necessary accompanied by option (b) for a permanent retirement preceeding the application of a new factor (in phase 4 of the EU ETS) in order to swiftly implement the new factor and address the market imbalance well before 2020; Additional option that has emerged from the consultation for a rule-based reserve mechanism to render the auction supply more flexible. A volume-based mechanism based on verified emission data seems to be seen as the preferred choice.  Other options: Member States and stakeholders highlighted that other options are not expected to be implemented and thus not have a material impact much before 2020. Hence, they are seen to be considered more in the context of the 2030 framework. Some believed that the options offered in the Carbon Market Report were incomplete. However, apart from the flexible auction supply, hardly any tangible options relevant for addressing the market imbalance were proposed. Most other proposals rather concerned measures for addressing the risk of carbon leakage.  
 The European
Parliament has noted in a number of documents that further improvement of the
EU ETS is necessary. In its Resolution on the Roadmap for moving to competitive
low carbon economy in 2050, the European Parliament called on the Commission to
adopt measures to correct the failings of the EU ETS and allow it to function
as originally envisaged, which it reiterated in the Resolution on the Energy
Roadmap 2050. Also in the context of the agreement on the Energy Efficiency
Directive, it called on the Commission to examine options for action with a
view to adopting as soon as possible appropriate structural measures during
phase 3 (2013-2020). 
The European Council of 22 May 2013
underlined the importance of a well-functioning carbon market in the context of
the challenges for Europe's energy policy. 
In terms of external expertise, the
Commission contracted the National Technical University of Athens,
International Institute for Applied System Analysis and EuroCare to model
scenarios underpinning the sectoral analysis for the 2030 IA, some which are
also behind the analysis for this IA.[3] 

1.3.        Subsidiarity
The EU ETS is an EU policy instrument. Structural
measures can only be implemented through proposals by the Commission to amend
the Directive. Moreover, the EU ETS is a climate policy instrument. Articles
191 to 193 of the Treaty on the Functioning of the EU (TFEU) confirm and
further specify EU competencies in the area of climate change.    
1.4.        Opinion of the Impact
Assessment Board
The Impact Assessment Board of the
Commission assessed a draft version of the IA and issued its opinion on 6
December 2013. The Board issued a positive opinion and made several
recommendations and, in the light of them, the final IA:
·                        
Explains better in sections 2 and 4.1 how this
initiative fits within the overall improvements/revisions foreseen to the EU
ETS in the longer-term (after 2020) and its general coherence with the 2030
climate and energy framework;
·                        
Explains in section 3 the lessons learnt from
the functioning of the EU ETS so far;
·                        
Explains in section 2 the role of the EU ETS in
the future climate policy mix;
·                        
Clarifies in section 5.3 the objectives that
this initiative aims to achieve and how they take into account the need for
simplicity and predictability of the EU ETS legal framework;
·                        
Explains better in sections 4.1 and 6 why an
early revision of the linear reduction factor was discarded from further
analysis in this impact assessment;
·                        
In terms of impacts, it amends section 7.2
giving more context on the limitations to the assessment of impacts on the
carbon price. It also amends sections 7.4.2 and 7.5 giving more context on the magnitude
of impact on energy prices. It adds a new section 7.3 on auctioning revenue and
explains in section 6.2.3.2 whether any of the sub-options entail
administrative burden requiring additional information and data to be
collected. 
2.           Policy context
The GHG emission reduction target for 2020
for the sectors covered by the EU ETS is expected to be met. However, the
economic recession and the accelerated inflow of international credits have
created a surplus of more than 2 billion allowances since beginning of phase 2
(2008-2012). 
The Commission in July 2012 undertook steps
to consider changes to strengthen the EU ETS based on a two-step approach. As a
first step, the EU should slow down the increase in the supply-demand imbalance
by postponing (back-loading) part of the auction supply.[4] Back-loading has received
a favourable opinion from Member States in the Climate Change Committee in the comitology
process. While the measure is now under scrutiny by the European Parliament and
the Council, this Impact Assessment takes back-loading for a fact.
The structural measures should be
identified as a second step, to enable the EU ETS to address the imbalance in a
sustainable manner. With this in mind, the Commission proposed six options for
structural measures in the Carbon Market Report.
As outlined by stakeholders, as well as in
the Carbon Market Report, a properly functioning EU ETS plays a critical role
in driving investments in a wide range of low carbon technologies. If
unaddressed, the large imbalance in the EU ETS will impact its ability to do so
in the mid- and longer-term. The 2020 framework is but
an intermediate step towards a competitive and secure low carbon economy. As a
preparatory step for the 2030 framework, the Commission adopted the Green Paper
on 27 March 2013. The Green Paper highlights the need to assess the 2030
architecture for EU ETS on a number of elements: the level of the target and potential
revision of the linear reduction factor, the extension of the scope of the EU
ETS, access to international credits and how to continue avoiding the risk of
carbon leakage. Accordingly, the 2030 IA also assesses the options for
structural measures and the relevant components form the basis for this IA
specifically on the structural measures to address the large supply-demand
imbalance in the EU ETS rather than determine the ambition level for 2030. The
options considered in this report are not included in the baseline option for
the 2030 impact assessment.    
This IA also complements the assessments
already undertaken in the context of these steps: Staff Working Document on the
functioning of the EU ETS[5],
Impact Assessment on backloading[6]
and the Carbon Market Report.   
3.           Lessons learnt from the
functioning of the EU ETS
The EU ETS regulatory framework has been largely unchanged for the
first eight years of the functioning of the system. However, with the start of
phase 3 a significant number of architectural and regulatory changes have
kicked in 2013, as outlined in the 2012 Staff Working Document. The EU ETS has
produced since its start an EU-wide carbon price signal to incentivise daily
operational and strategic investment decisions delivering emissions reductions
across parts of the EU economy that are responsible for half the EU's GHG
emissions. 
On the demand side, verified emissions have
varied materially over the years. At the start of phase 2, it was expected that
the EU ETS cap would be ambitious. However, emissions experienced a very large
decrease, with the economic crisis having a considerable impact on industrial
production and electricity consumption. In contrast, on the supply side, the
annual use of international credits in the EU ETS has actually experienced a
significant increase. In 2008 only around 82 million international credits were
used for compliance, while this increased to over 500 million credits in 2012.
The effect of these two elements has been a strong driver for the large
imbalance. The drivers of the surplus and of carbon prices have been analysed
in the report Energy Economic Developments in Europe[7].  
There is clearly an interaction between the
EU ETS, and renewables and energy efficiency policies. However, this was
anticipated and taken into account when the 2020 package was prepared and
adopted. Specific measures to promote renewable electricity or lower
electricity consumption can reduce the carbon price. But they are also expected
to deliver additional benefits beyond GHG emission reductions, e.g. concerning
synergies with resource efficiency. 
The current imbalance is aggravated by this
mismatch between the supply of emission allowances, which is fixed due the
nature of the EU ETS as a cap-and-trade system (and was decided in more
favourable economic circumstances), and demand for them, which is flexible and
impacted by economic cycles, fossil fuel prices and other drivers.  
4.           Problem definition
At the start of phase 3, the EU ETS was
characterised by a surplus of around 2 billion allowances.[8] In the baseline
scenario[9],
this surplus is expected to be at the same level at the end of phase 3 in 2020
and around 1.5 billion at the end of the phase in 2028. In the reference
scenario[10],
it is expected to grow to more than 2.6 billion allowances by 2020 and gradually
decrease to around 2.1 billion by 2028, which means compared to today the
surplus at the end of phase 4 would be largely unchanged. If adopted, the recent proposal to change the coverage of
aviation under the EU ETS, limiting it to European regional airspace and
exempting certain flights from lower income countries with small shares in
global aviation[11],
would be expected only to further increase this overall surplus.  
The IA examines the issues related to the
magnitude of the existing structural surplus expected to remain in place for
many years and definitely beyond the end of phase 3. The aforementioned 2012 Staff
Working Document and backloading Impact Assessment include an analysis of the
surplus that materialised in phase 2 and how the transition from phase 2 to
phase 3 was expected to impact it. This IA therefore complements these earlier
analysis related to the exceptionally rapid build-up by the end of phase 2, due
to the transition into phase 3. Figure 1 provides an illustration of the historical and expected growth of
the surplus up to 2028 assuming an emission profile of the reference scenario
projections.[12]
  
Figure 1:
Historical and projected future profile of supply and demand up to 2028 
Costs of emission reductions are expected
to be the lower, the earlier the necessary long-term investments take place. Although
in a cap-and-trade system, such as the EU ETS, the agreed environmental
objective expressed in the cap, limiting total emissions for a given period, is
guaranteed, the cost-efficiency objective expressed in the total cost is also
of central importance. In principle a market functions well with a certain
level of surplus, as it provides a buffer to deal with factors leading to
normal fluctuations in the supply-demand balance. For this reason rational
economic behaviour results in stock-keeping. However, a large surplus is likely
to result in a prolonged downward pressure on the carbon price signal. This may
be good for the short-term competitiveness of some sectors but not for the EU
at large. The resulting carbon price signal is increasingly distorted and no
longer in line with the trend necessary to achieve the long-term decarbonisation
target in a cost-effective manner. 
A large surplus hence strongly confounds
the signal for investments, which are necessary for the transition towards a
low-carbon economy, including energy supply[13].
It is a problem as it is expected to result in locking the EU into high carbon
capital and investment, in particular considering the currently high gas to
coal price ratio.
The latest survey of EU ETS operators in early 2013 by Thomson Reuters Point Carbon
reconfirmed that the EU carbon price has become less important for investment
decisions. 20% of the operators surveyed said that EU ETS no longer has a
significant impact on emission reductions. Because of the risk of carbon
lock-in, the large surplus in turn risks putting the EU on a more expensive path
to meeting the long term targets. That is bad for the longer term
competitiveness of the EU. Put differently, the presence of a large surplus
reduces the dynamic efficiency of the market-based outcome and thus increases
overall costs when considered over the longer periods that are relevant for the
climate change challenge.  
As a short term measure to mitigate the
effects of this problem in the context of additional temporary imbalances
caused by regulatory changes linked to the transition to Phase 3, the
Commission proposed to back-load the auctioning of 900 million allowances in
the beginning of phase 3. Figure 2 provides an illustration of the supply and demand balance up to
2020 with back-loading. The analytical assumption generally used in this Impact
Assessment is that back-loading reduces the auctioning amounts by 400, 300 and
200 million allowances in 2014, 2015 and 2016 respectively. The return of these
allowances to the market remains the same as initially proposed, increasing the
auctioning amounts by 300 and 600 million allowances in 2019 and 2020
respectively. It should be emphasised, however, that back-loading and the
measures considered in this Impact Assessment pursue complementary objectives.  
Figure 2
demonstrates that to an extent back-loading can rebalance supply and demand in
the EU ETS in the transition into phase 3 compared to a situation without back-loading.
As already highlighted in the Carbon Market Report, however, back-loading leads
to a rebound in the surplus in 2019 and 2020 and hence does not affect the average
size of the structural surplus of around 2 billion allowances in phase 3 and 4,
peaking at 2.6 billion in 2020. It is the structural surplus, and
solutions for addressing it in a sustainable way and preventing from it
accumulating again in the future that are the focus of this Impact Assessment. 
Figure 2: Historical
and projected future profile of supply and demand up to 2028 with back-loading
4.1.        Interaction with possible
measures in the context of the 2030 framework
According to
stakeholders, the linear reduction factor should be strengthened after 2020
consistently with the GHG emission reduction target for 2030. This target is
still to be decided. If the target is decided fast enough to allow for an early
revision of the linear reduction factor ahead of 2020, this should lead to a
decline in the surplus. Nevertheless, the decline would only happen gradually.
For this reason, an early revision of the linear reduction factor is also
discarded from further analysis as an option that can address the large
imbalance in the short-term. 
If, as of phase 4, the linear reduction
factor would be increased to a level consistent with a 40% GHG emission
reduction by 2030, all scenarios leading to such a reduction still result in a surplus
of around 2.3 billion allowances or more by the end of phase 4 (see Figure 3) and even 2030[14]. Under this target,
there is also no demand in the EU ETS for international
credits as of 2021, given that they would only add to the already very large
surplus of allowances. This is also consistent with the current legislation
that provides for no additional entitlements created after 2020. If it was
allowed to meet a part of the effort through international credits, this would
be combined with a higher conditional target. Hence, this is not likely to have
a considerable effect on the surplus.     
Figure 3:
historical and projected future profile of supply and demand up to 2028 with
back-loading and a 40% GHG target for 2030
Concerning possible
revision of the EU ETS after 2020 to include additional sectors, it still
requires further assessment. A first qualitative analysis is taken up in the
2030 impact assessment. It shows that the degree of impact on the market
balance will depend on the overall cap under the enlarged scope. In any case,
however, an extension of the scope may, like the revision of the linear
reduction factor, lead only to a very gradual decline in the surplus.
5.           Objectives
5.1.        General objective
The general
objective of the EU is to achieve the climate objective of limiting global
average temperature increase to not more than 2 degrees Celsius above
pre-industrial level. The EU ETS, as the main policy instrument at the EU level
to reduce GHG emissions, has a central role to achieve the needed emissions
reductions up to 2050 in a cost-effective and economically efficient manner.   
5.2.        Specific objective
The specific objective is to restore the
functioning of the European carbon market in the short-term (and beyond) in a
context where auctioning of allowances has gained a significant role as of
phase 3 in bringing allowances in circulation. 
5.3.        Operational
objective
The operational objective is to ensure inter-temporal
efficiency[15]
of the carbon market in the short-term and beyond in a market setting
characterised by large-scale auctioning, taking into account the need for
simplicity and predictability. This requires addressing the structural surplus
expected to remain in place even with other possible measures after 2020 in the
context of the 2030 framework (i.e. revision of the linear reduction factor,
use of international credits, extension of the scope). It also requires increasing
the resilience of the EU ETS in the light of the severe economic recession and
other potential future large-scale events that may severely disturb the
supply-demand balance.
6.           Policy
options
The baseline option (option 0) includes
back-loading of 900 million allowances as outlined in section 4 and the
so-called reference scenario concerning the expected emissions. Consistently
with the 2030 impact assessment, the reference scenario is assumed as this is
the one that sees the fulfilment of all legally binding targets for 2020. A
detailed description of the policies and measures includes in the reference
scenario is available in the 2030 impact assessment.         
In terms of structural measures, the Carbon Market Report outlined a
shortlist of six options listed in Table 1. The report acknowledged that some
of the options would require considerably more analytical work, time to decide
upon and subsequently implement. This was also one of the considerations that
stakeholders took into account in their choice of preferred options. Out of
those, who supported action in phase 3, the preferred options seem to be: c)
early revision of the linear reduction factor to maintain the credibility of
the EU ETS in the long-term, ideally combined with b) retirement of allowances
to maintain the credibility of the EU ETS in the short term; a variant of
option f), which would not focus on the price for allowances but rather on the
supply of (auctioned) allowances. 
The 2030 IA includes a general assessment
of the impacts of those options that can only be implemented and have an impact
in the context of a 2030 framework ((c) early revision of the linear reduction
factor, (d) extension of the scope of the EU ETS to other sectors and (e) using
access to international credits). It confirms that, although all options may be
relevant as of phase 4, only a few have the potential to achieve the objective
of this IA, to improve the functioning of the EU ETS in the short-term. Option
a) of increasing the target is excluded from the focus of the 2030 IA based on
the clear stakeholder feedback. Option c) for a revision of the linear reduction
factor would be best implemented only after the decision on the 2030 GHG
emission reduction target. Even if revised before 2020, it would only create
scarcity and restore better aggregate balance in a gradual manner and is not
expected to significantly impact the surplus in the short-term. As regards
option d), the main limiting factor is the fact that the option requires
further analysis and would not directly affect the surplus. In relation to
option e), this would only impact the availability of international credits in
phase 4. It would not sufficiently change the availability of international
credits in the short-term, as more than two thirds of the amount allowed until
2020 is already used up. For more information, see the 2030 IA. 
Based on the screening
of the six options in terms of stakeholder views and assessment in the 2030 IA,
the focus of this more detailed assessment is on the options that could
realistically be implemented, and already restore the orderly functioning of
the EU ETS in the short-term: 
·                        
Option 1: Retirement of a number of allowances
in phase 3 (option b) in the Carbon Market Report);
·                        
Option 2: More flexible auction supply in the
form of a market stability reserve (additional option building on a variant of
option f) in the Carbon Market Report);
·                        
Option 3: Combination of a market stability
reserve with retirement of a limited number of allowances in phase 3 
Table 1:
Comparison of the options from the Carbon Market Report
   || Stakeholder views* || Potential effectiveness in improving the functioning of the European  carbon market in phase 3 
 a) Increasing the EU reduction target to 30% in 2020 || Very limited support || Not focus of the assessment Would have been accompanied by a reduction of auction supply over phase 3 by some 1.4 bn allowances. This might have the potential to improve market functioning in the short-term Reference emission projections for 2020 actually already come very close to levels associated with a 30% reduction target. This means that while the EU might not be ready to increase its target to 30%, the full achievement of other agreed targets can reduce emissions in the EU to the level in line with what would be required to achieve a step up to a 30% target 
 b) Retiring a number of allowances in phase 3 || Medium support || Retiring a number of allowances early on has the potential to create scarcity and improve market functioning in the short-term 
 c) Early revision of the annual linear reduction factor || Medium support || Limited potential to improve market functioning in the short-term But expected to have a positive impact in the mid- and long-term 
 d) Extension of the scope of the EU ETS to other sectors || Limited support (for phase 3) || Limited potential to improve market functioning in the short-term Assessment of administrative challenges and potential to improve market functioning as of phase 4 needs to be further investigated But potential other benefits, e.g. in terms of technology-neutral incentives across sectors 
 e) Use access to international credits || Limited support (for phase 3) || Very limited potential to sufficiently improve market functioning in the short-term Aggregate surrender of international credits has already used up more than two thirds of the amount allowed until 2020   
 f) Discretionary price management mechanisms || Very limited support for a mechanism focused on price || Not focus of the assessment EU ETS is an instrument based on volume not price 
 Additional option || Medium support for a mechanism focused on (auction) supply to address market imbalance  || Potential to improve market functioning in the short-term Most useful and simplest mechanism expected to be a reserve of allowances 
* Out of those supporting any measures in phase 3
6.1.        Option 1: Retiring a number
of allowances in phase 3 
The market imbalance can be reduced by
retiring some of the phase 3 allowances on a permanent basis. A permanent
retirement would indirectly increase the reduction target for 2020 and in turn
(partially) restore the ambition level of the 2008 climate and energy package.
However, as a self-contained measure, it would not directly impact the
framework after 2020. 
A retirement of a number of allowances
would reduce the auction supply, but unlike with backloading this auction
supply would not return to market and the allowances would be cancelled. It
would not affect the amount of free allocation on the basis of the National
Implementation Measures (NIMs) for phase 3.
This option would address the impact of the
economic crisis and complementary policies on the demand side, as well as of
the supply side drivers, notably the large inflow of international credits.    
For the purpose of
this assessment, an upper limit is put on the number of retired allowances that
is equal to the number required for the step up to a 30% overall GHG reduction
target in 2020, i.e. 1400 million allowances. However, under this option the
primary aim is not to increase the target to 30%, but rather to address the
market imbalance. This sub-option assumes that the permanent retirement starts
in 2014 and ends in 2020, with high amounts at the beginning (similar to
backloading) to correct the large existing surplus and low amounts of 100
million annually as of 2016.
Of course other amounts of retired
allowances could be conceived. As a sensitivity analysis, another sub-option
with a lower amount of 500 million allowances is assessed. This sub-option
assumes that first 900 million allowances are temporarily withdrawn from the
market through backloading, 500 million of these are permanently retired, while
the remaining 400 million allowances are returned at the end of phase 2.    
6.2.        Option
2: Market stability reserve
Contrary to a one-off measure to improve
the functioning of the market in light of the current severe economic
recession, such as a retirement of allowances, the objective of a permanent mechanism
is to increase the efficiency of the EU ETS and its resilience of in the light
of any future severe demand shocks. A discretionary price management mechanism
was among the options for structural measures to strengthen the EU ETS. Two
variations have been put forward in the Carbon Market Report: a price floor and
a price management reserve. Neither drew much support in the consultation on
the options by stakeholders, who generally highlighted that the EU ETS is an
instrument based on volume not on price.[16]
Price management would go against the central EU ETS principles and is
therefore opposed by most stakeholders. It can also be expected that agreeing
on the "right" price thresholds would be very contentious, if not
impossible. 
However, there is a broad agreement among
stakeholders that instead possible measures to be assessed should be i)
non-discretionary and rule-based to remove the need for future ad hoc intervention,
and ii) volume-based to allow for continued price discovery by the market,[17] and  neutral to the
overall cap[18].
A mechanism to adjust auction supply aims to address the mismatch between the
fixed auction supply and flexible demand by introducing flexibility also on the
supply-side in the short-term, without affecting the total long-term supply in
place. Keeping the supply flexibility within the cap is essential for a
mechanism design that is environmentally viable. Hence, some stakeholders[19] are proposing an idea
of a reserve of allowances.
Such a measure may also allow improving the
interaction with renewables and energy efficiency policies, and even reduce
uncertainty from international negotiations, by playing a helpful role in the
2030 framework and move between an unconditional and possible conditional GHG
target. 
6.2.1.     Potential sources of supply
flexibility
Although supply on the carbon market stems
from three sources – auctions, free allocation and international credits – the
main cause of supply rigidity is the auction supply. 
Contrary to the
allowance allocated for free, auctioned allowances translate immediately into
supply on the market. The Auctioning Regulation[20] provides for a rigid time
profile. The volume to be auctioned in each year should be equal to the difference
between the total amount of allowances under the cap (which declines in a linear
manner) and the amount of allowances handed out for free in that year (in line
with the benchmarks), i.e. cap minus free allocation for each year. This time
profile was decided back in 2010.  
The point in time when free allocation
translates into actual supply in the secondary market, on the other hand,
depends on the operators’ incentives to sell the allowances they have received.
If demand falls, so does the price and the operators are not incentivised to sell
allowances received, and may prefer to bank them into subsequent trading
periods, reacting in a flexible manner to changes in demand. The rules for free
allocation when there are capacity extensions and reductions as well as new
entrants and closures provide additional flexibility responding to changes in economic
activity. Some stakeholders advocate going further to full ex-post corrections
to free allocation based on actual output.[21]
While this may be relevant for the discussion on addressing the risk of carbon
leakage, it is not relevant in relation to the large supply-demand imbalance.[22] It should be noted
that moving to ex-post allocation would change the incentives for industry and
in particular would undermine the incentives for emissions reductions for
products and sectors with no specific product benchmarks and covered by
so-called fall-back allocation approaches. 
In relation to international credits, a
distinction needs to be made between the overall amount of credits allowed and
the annual distribution of this amount over the relevant period (currently for
2008-2020 combined). The annual inflows of international credits are in
principle able to react to changes in demand, but in 2011 and 2012 this was
rather counteracted by increased inflow of credits in reaction to a regulatory
change (disallowing the compliance use of industrial gas credits) that was
decided in early 2011 for implementation as of May 2013. The overall amount, on
the other hand, is fully fixed. Following the recession, the overall limit has
turned out to be rather generous. The combination of these two factors meant
that the use of international credits was one of the major drivers of the
surplus. As of phase 4, the default situation is that no additional
entitlements are created. Any further use of international credits in a 2030
framework needs to address how many could be used (quantity) and what type
could be used (quality). In terms of quantity, various solutions could be
envisaged to avoid large inflows in the future: 
·                        
To ensure a more stable flow of international
credits and avoid excessive inflows in an individual year triggered by events
like the forthcoming ban of some credit categories, an option would be to break
down the overall amount into annual amounts, which would act as annual limits
on the use of the international credits. At the same time, if that annual
amount was not used up to the full, the remaining amount would be lost, i.e. it
could not be added to the amounts for the subsequent years. Although it
expected that this may create an incentive to use up the annual amount, it
would create a more stable inflow of international credits and avoid
circumvention of any additional credit bans by increased use of international
credits in preceding years. 
·                        
Another option to align the supply / inflow of
international credits with demand is to define the allowed use in relation to
emissions rather than (free) allocations. This would allow for a higher amount
of inflows in times of higher emissions and vice versa.
·                        
To align the use of international credits with
its original purpose – cost containment – and prevent the overall amount being
too generous, another option would be to make the overall amount subject to
demonstrated need. For example, the default amount could start at zero or a low
level, but could be increased depending on a price trigger. This could be an
absolute trigger or a relative one, like the mechanism in Article 29a of the EU
ETS Directive[23].
However, as by the end of phase 2 the
aggregate surrender of international credits has used around two thirds of the
amount allowed over 2008-2020, changes to the remaining allowed supply for
phase 3 would not have sufficient impact. Curtailing the remaining credit
entitlements would furthermore disadvantage those installations that have so
far made a disproportionally limited use of the possibility to surrender
international credits with the intention to consume the entitlement in later
years. More flexibility could rather be considered for phase 4 and beyond, in
case it should be decided to allow for the use of more international credits
after 2020. The option therefore discussed and assessed in the 2030 IA. 
6.2.2.     Functioning of the mechanism 
As the purpose of
the mechanism is to make supply more flexible without affecting the cap, the
most obvious mechanism is establishing a reserve of auctioned allowances. The
auction supply and the size of the reserve would vary over time by:
·                        
Adding allowances to the reserve by deducting them
from future auction volumes with the aim of mitigating market instability due
to a large temporary surplus in the EU ETS;
·                        
Releasing allowances from the reserve and adding
them to future auction volumes with the aim of mitigating market instability
due to a large temporary deficit in the EU ETS.
To ensure that the cap is not affected, an
increase in the auction volume would only be possible, if there were allowances
in the reserve. A market stability reserve would work across trading period
boundaries. Allowances that would be in the reserve at the end of a trading
period would remain there for the following period. Key design aspects that
need to be decided for the establishment of a workable reserve are rules on when
to feed allowances into the reserve and when to release them (triggers), how
many allowances to feed into it and how many to release (size of the
adjustment) and over what time period any adjustment should be made (timing).
The design of such
a reserve would need to take careful account of the already accumulated large
surplus in the EU ETS and the proposed back-loading of part of the auction
volumes from the beginning of phase 3. Experience with implementing
back-loading could also provide valuable insight into the operational design
and / or review of a reserve with regard the impacts of withholding an amount
of allowances from the market on the behaviour of market participants. 
Given that a market stability reserve would
be purely rule-based and non-discretionary, existing institutional arrangements
for auctions (e.g. tasks performed by the Commission and auction platforms)
could most cost-effectively be used for implementation purposes.  
6.2.3.     Triggers for feeding
allowances into the reserve and releasing them 
Potential triggers can be grouped into
external indicator-based, price-based and volume-based. In terms of their
level, the basis for the adjustment should be expressed in a range rather than
one specific value, which should be continuously targeted, to ensure that the
rules kick in only in exceptional circumstances due to large demand shocks and
not on frequent basis in normal circumstances.
The mechanism could also be devised as a combination
of these triggers, e.g. a volume-based trigger for putting the allowances into
the reserve, but a price-based trigger for releasing allowances from the
reserve. 
6.2.3.1.  External indicator-based triggers 
Triggers based on external economic
activity indicators, such as gross domestic product (GDP) and industrial
production, would be most directly related to the underlying causes of
decreased demand for emission allowances due to economic shocks. There are limitations
in the suitability of macroeconomic indicators, such as the GDP, as the trends
in the EU ETS sectors may be prone to different cyclical swings than the wider
economy. So more targeted indicators related to industrial or electricity
production may be more appropriate. Changes to the size of the reserve could be
made if the indicators considerably deviated from a certain range or possibly
based on multi-year averages, e.g. if the GDP in year x deviates by 0.5 % from
the average GDP over the preceding three years or less. 
One could use
actual data from the previous year as soon as they become available, or
forecasts. In case of the latter, the more forward looking the forecast, the
less accurate it is likely to be. Hence, it may be advisable to use forecast
for only one year ahead. Still, any trigger based on forecasts will inherently
suffer from the disadvantage that forecasts can turn out to be inaccurate, as
was the case with the growth forecasts used for the Impact Assessment for the 2008
climate and energy package[24].
However, a trigger based on forecasts will have the advantage of potentially
kicking-in before the changes in the economic activity driving demand shocks
have happened, while an indicator based on actual data, which is available with
a time lag, will only kick-in after the event. The expert meeting on flexible
auction supply on 2 October 2013 showed an almost universal preference for the
use of actual verified data over forecasts.  
A major limitation of external
indicator-based triggers is that they are only able to capture changes in the
demand for emission allowances due to changes in the economic activity. They
are not able to capture changes in the demand due to possible other factors,
such as impact of complementary policies, such as the renewables and
energy-efficiency policies, which can reduce EU ETS emissions and demand for
allowances. They are also not able to capture changes on the supply side, such
as occurred in the transition from phase 2 and 3, and any big changes in the
inflow of international credits.
6.2.3.2.  Volume-based triggers
As the issue the
measure aims to address is market imbalance, which is expressed in cumulative
surplus, a volume-based trigger would be best designed having either a certain
stock of surplus (cumulative surplus) or flow of surplus (changes in cumulative
surplus) as a basis. A surplus-based mechanism would aim to maintain the
surplus within a pre-defined target range. A market may normally build up some
surplus to act as a buffer by providing sufficient liquidity in times of higher
demand. This liquidity is absorbed by hedging demand[25], currently mostly in
relation to forward electricity sales. However, too large a surplus affects the
stability of the carbon market and impedes the effectiveness of the system in
incentivising both short-term abatement, such as fuel switching from coal to
natural gas, as well as mid- and long-term investments in low carbon
technology. 
The most useful data source related to the
evolution of the surplus is actual data on verified emissions and the use of
international credits in the previous year. The use of forecasts is arguable
less appropriate here. The expert meeting showed a general agreement on this
point, that historical data should be used.   
Such a range could be expressed as an
absolute range or in relation to the auction quantities or the cap. As an
example for the relative range, the levels proposed by stakeholders so far are
in the order of magnitude of 40-50% of the annual cap. This means that allowances
should be added to auctions when the surplus falls below 40% of the annual cap;
and they should be deducted when the surplus exceeds 50% of the annual cap. As
the cap decreases, the absolute numbers would change year on year with a band that
tapers over time. This may have the disadvantage of going against the possibly increasing
trend in hedging needs by also sectors other than the power sector as the
amount of free allocation declines. The band could also be determined in
absolute levels, e.g. that allowances should be added to the auctions when
surplus falls below 400 million allowances and deducted from the auctions, when
it exceeds 1000 million allowances. Also in the case of a band expressed as a
share of the auctioning amount, the absolute numbers would change year on year,
but with a band that would increase over time. However, such a band may be
exposed to possible structural breaks in the transition from phase 3 into phase
4, if there were any changes in the free allocation rules, in particular in
terms allocation to sectors deemed to be exposed to a significant risk of
carbon leakage.      
Another aspect to
consider is whether to have a constant band or one where the upper level either
increases or decreases over time. One possibility would be a band that
increases over time so that the surplus is reduced faster at the beginning to
restore market balance. Such an approach may be better if an amount of auction
supply is not already temporarily removed from the market through back-loading.
However, back-loading already acts in a similar way, quickly reducing the
market imbalance from the start, so a lower band in the early years may not be
needed. The alternative would be a band that decreases over time so that the
surplus shrinks or grows in a step-wise and gradual way to prevent big changes
in the auction supply and possible large price effects. A band that is relative
to the cap already declines in line with the cap, however bigger differences in
the level of the band over time would probably be needed to avoid shock-therapy
in a situation where a large surplus has already built up.  
In terms of the width of the band, a
narrower band is expected to lead to more need for intervention than a broader
band. As a result, it is likely to lead to a higher number and frequency of
adjustments and in turn in less predictability as regards the auction volumes. A
broader band would result in a lower number and frequency of adjustments.   
Figure 4: Illustration of a supply-based adjustment
An alternative to
cumulative surplus as a basis for the trigger could be an annual change in the
surplus. For example, allowances could be put into the reserve if the annual
change in the surplus (increase or reduction) would exceed a certain amount.
Such an approach is expected to react quicker than an approach based on the
cumulative surplus, which may take a number of years of large annual changes to
reach it. 
An advantage of surplus-based triggers is
that they would not only address the impact of the economic crisis, but also
take into account the complementarity between the EU ETS and renewables and
energy efficiency policies, which in the future may trigger an additional
increase in the surplus in the EU ETS, as well as supply-side drivers, such as
large inflow of international credits.
Choosing
values for a volume-based trigger
A crucial issue is determining the upper
and lower ends of a volume-based target range, which would trigger putting
allowances into a reserve and releasing them. This warrants considering several
approaches to establish appropriate values for the target range. These are:
·                        
An analysis of typical hedging needs: Given the primary
purpose of a market surplus, typical hedging needs in relation to emission
allowances to cover forward sales should guide the decisions about the
appropriate level of the band. The hedging needs are for the time being mainly
related to the electricity sector, but to the extent that industry (e.g.
industry sectors not deemed to be exposed to a significant risk of carbon
leakage) may increasingly need to buy allowances on the market rather than
having their compliance needs covered by free allocation, total hedging needs
may grow too. Hence, a relative band expressed in relation to the cap, which
would decrease over time, may have the disadvantage of going against the
possible increasing trend in hedging needs. However, only a part of the power
sector's hedging behaviour is understood and published data on it far from
complete. No legal mandate is in place for power companies to regularly
disclose hedging positions beyond certain transactions. Moreover, hedging
behaviour may change over time. An option would be to put in place a reporting
requirement in terms of hedging data. However, experts acknowledged that there
is a risk of strategic behaviour by the reporting companies and little
possibility to verify the data. Apart from that, none of the options for a
market stability reserve requires additional information and data to be
collected.   
·                        
An analysis of the average stocks of allowances
in phase 2 and 3: Figure 5
compares the average monthly stocks of emission allowances in phases 2 and 3.
In phase 2, the majority of emission allowances (around 96%) was allocated for
free in one go at the end of February and was not surrendered until April the
following year. This means that for two months, there were twice as many
allowances in the market as "needed" in a year. In phase 3, with the
increasing role of auctioning, which gradually brings allowances in circulation
over the year, the average monthly stock of allowances is considerably lower. The
difference between the average stock of allowances in circulation in phase 2
and 3 could provide insights about the magnitude of the needed allowances in
circulation that still allows for orderly functioning of the market. This
difference is around 800 million allowances. 
Figure 5:
Comparison of monthly stocks of allowances in phase 2 and phase 3
 
Some stakeholders and experts have
submitted estimates of the amount of allowances covering power sectors forward
sales and an appropriate range, which show diverging views on the order of
magnitude:
·                        
In the expert meeting, a representative of
Bloomberg New Energy Finance mentioned a range of 1.2-1.3 billion allowances;
·                        
In the same meeting, a representative of ENEL,
proposed a surplus range of 762-956 million allowances[26];
·                        
Fortum proposes a range between 40-50% of the
following years cap (i.e. 810-1013 allowances at the start of phase 3 declining
to 704-880 allowances at the start of phase 4).[27]
There are mixed views on the whether there exists
a "right" range in the first place and whether the values matter.
Some experts argued that the values are essential, while others that they do
not matter that much because market participants may adjust their behaviour
anticipating the impact of the reserve. In any case, the risk of setting the
triggers at inappropriate levels could be mitigated by setting a broader range
or a declining range, with a higher upper level at the beginning, to allow for
a gradual reduction in the market imbalance and learning about the market
impacts along the way, which could inform a possible review of the trigger
levels. Putting a limit on the size of the annual adjustment can also prevent
possible risks of setting the triggers at unsuitable levels, such as responding
too strongly to changes in the demand. Furthermore, any excessive price
increases due to a too low range would be addressed by the existing safeguard
in article 29a of the Directive.    
6.2.3.3.  Price-based triggers
Price based triggers could be expressed in
absolute or relative terms. Absolute thresholds would act as a price corridor
with a price floor and price ceiling. A relative approach could function as the
existing mechanism in Article 29a of the EU ETS Directive. This provides for the
option to advance auction supply, if for more than six months the carbon price
is more than three times the average price during the two preceding years. As
this is about excessively high prices, the article could serve as the basis for
the return of allowances from the reserve to the market, with another trigger
determined for feeding the allowances into the reserve.   
Price-triggers are a theoretical
possibility, but obviously, this would be a price-focused mechanism with all
the aforementioned drawbacks, which elicited little interest and support among stakeholders.
They frequently pointed out that any price management mechanism would
fundamentally modify the EU ETS, as the system would no longer be a quantity-based,
market-based instrument for achieving emission reductions in a cost-effective
way.[28]
One of the main implications of the decision for a quantity-based instrument
over a price-based one is that the carbon price signal is not fixed by
policy-makers but revealed by the market. In the EU ETS, the carbon price
reflects the quantity of allowances and their relative scarcity and not the
other way around. With this in mind, stakeholders are asking for a mechanism
that complements and enhances the market, and preserves this price discovery.[29] In contrast, a
mechanism prescribing a certain price corridor runs counter to a market logic and
even substitutes it, by distorting the carbon price level that would otherwise
be revealed by the market.
Price-base triggers also suffer from the
drawback of being more at risk of manipulation and gaming. There are indications
that this risk is not material for volume- and in particular GDP-based
triggers, as low concentration of the carbon market considerably mitigates the
risk of gaming with a company attempting to influence the annual emissions, let
alone the GDP. However, given that the European carbon market is dominated by
derivatives (namely futures) a reserve with price triggers may be more prone to
cross-market gaming behaviour by market participants influencing price-setting.[30]       
As the external indicator-based triggers,
it would also require an additional step to determine how many allowances would
be deducted or added to the auctions if the price fell outside a certain price range.
Price-base triggers would be able to
address the impact of the economic crisis and complementary policies on the
demand side, as well as of the supply side drivers, notably the large inflow of
international credits.    
 
6.2.3.4.  Review of triggers 
The appropriateness of the triggers and
their levels, the size of the adjustment and the timing could be reviewed on a
regular basis. There seems to be a broad consensus among experts on the need
for a periodic review of the triggers, which should be well-signalled in
advance. 
In case of surplus-based triggers the
review could include the latest trends in hedging and in case of external indicator-based
triggers latest trends in production, sector shares in the GDP and emission
intensity. The triggers could be automatically updated by basing them on
rolling averages of related data, or they can be revised on a more ad-hoc basis
via the comitology process (e.g. once per trading period or every 4 years). 
There is a trade-off between certainty for
market operators and flexibility to incorporate "learning" by the
decision makers. The advantage of the review would be that there would be a
smaller regulatory risk of setting the triggers at the wrong levels and that it
would allow for learning.  The review would also allow for responding to any
changes in the market structure, notably continued transition from free
allocation for industrial sectors not deemed to be exposed to a significant
risk of carbon leakage. On the other hand, it has the drawback of potentially reducing
certainty. 
One possibility would be to create two
different types of trigger: the first type of trigger to determine when
allowances go into or out of the reserve, the second type of trigger to launch
a review of the first trigger for (moving allowances in or out of the reserve).
For example, a surplus-based trigger could determine whether allowances are put
into or taken out of the reserve, whereas price trends could be used as a
secondary check or second trigger to launch a review. In this case, if
excessive price changes occur even with a reserve, they could automatically result
in (or trigger) a review of trigger levels based on the cumulative surplus.
This second, review trigger could for example be along the lines of the formula
in the existing rule in article 29a of the ETS Directive.  
The Commission will monitor and evaluate
the functioning of the carbon market in its annual report as foreseen under
Article 10(5) of the EU ETS Directive. Any need for review of the triggers
could be evaluated and signalled in the context of this report. 
6.2.4.     Size of the adjustment
As the external indicator-based triggers
and price-based triggers would not be directly expressed in a number of
emission allowances, another aspect to be decided is the amount of allowances
put into the reserve or taken out of it, once a trigger is reached. A number of
options exist, which are outlined and discussed in the following sections.  
6.2.4.1.  Function of the distance from the trigger levels
The amounts could be determined as a
function of the difference between the upper / lower limit of the band. For
example, in the case of external indicator-based triggers the amount could be
expressed as X million allowances to be deducted from auction volumes for each
percentage point below the band, or X million allowances added for each
percentage point above the band. For a price-based system, the amount could be
expressed as X million allowances to be deducted from auction volumes for each
€ below a certain price, or X million allowances to be added for each € above a
certain price.  The main challenge that this approach poses is that without a
perfect knowledge of the emission intensity in case of external indicator-based
triggers, and price elasticity in the case of price-based triggers, which would
be required to determine such amounts, it is uncertain that the adjustments in
amounts of allowances auctioned would actually correspond to the changes in
economic activity or bring the price within a desired price corridor.
As the surplus-based triggers and related
band would be expressed directly in a number emission allowances, there would
in principle be no need for this additional step to determine the size of the
necessary adjustment. This could be automatically determined by the difference
between the size of the surplus and upper or lower limit of the band.  
The advantage of the size of the adjustment
depending on the distance from the triggers is in its flexibility in responding
to different levels of demand shocks. However, this model may act as
shock-therapy in terms of changes in supply. It would also provide less predictability
in terms of the size of the adjustment and the final auction volumes. Hence,
the adjustment could possibly be determined as a percentage of (as opposed to
100% of) the distance to the trigger level.   
6.2.4.2.  Fixed independently of the distance from the trigger
levels
Alternatively, for all three types of
triggers, the amount could also be determined simply as a certain fixed amount
to be deducted from the auction volumes or added to them, as soon as the
relevant triggers were reached, independent of the distance from the band. For
example, allowances should be put into the reserve or taken in instalments of
100 million allowances or X% of the annual auction supply, each time the
trigger to feed the reserve is reached. 
The adjustment could also be determined as
a percentage of the cumulative surplus (e.g. 10%). In absence of further demand
shocks, the imbalance and the absolute amount of the adjustment would decline
with every preceding adjustment. This would combine the ability of the reserve
to respond proportionally to the magnitude of the imbalance, and at the same
time to avoid the risk of unwanted impacts due to too large annual adjustments.
In this case, the upper level of the trigger could also implicitly be expressed
as minimum amount of adjustment. I.e. an adjustment putting allowances into the
reserve would happen unless the adjustment, determined as a percentage of the
cumulative surplus would fall under a certain absolute amount (e.g. 100 million
allowances). In this example, the implicit upper limit would be 1 billion
allowances[31].    

The advantage of pre-determined amounts is a
high degree of predictability in terms of changes to the expected auction
volumes and simplicity. The disadvantage is that the size of adjustments may
not immediately correspond to the size of the changes in demand. For example,
the size of such an adjustment may not be sufficient. However, the difference
could decline by additional adjustments in the same instalments over the
following years, building the reserve or depleting it in a gradual manner.  
6.2.4.3.  Limits on the size of the adjustment and the reserve  
If the size of the individual adjustments is
not fixed, it may be considered to put an upper limit on them in order to
ensure more gradual changes to the supply profile and for transparency reasons.
There was general agreement among the experts that limits on the size of the
annual adjustment are warranted.    
An upper limit may be less needed if the
triggers would start with a high surplus band to avoid large changes in the
auction supply in the situation when a large surplus has already built-up. The
auction supply available acts as an ultimate limit on the maximum adjustment
that can be done in the period in question. However, for example, it could also
be decided that the magnitude of the annual adjustment cannot exceed a certain
amount, for example 100 million allowances or tenth of the auction volume in
the relevant period. This would ensure that majority of the expected auction volume
would come to the market, in case the rules would lead to deductions from the
auction volumes. The benefit would be increased predictability of the minimum
and maximum levels of annual auction supply. The drawback would be that the
adjustments may not be sufficient to fully react adequately and timely to very
large demand shocks. 
A limit could be put on the maximum size of
the reserve, e.g. that it shall never be higher than a certain percentage of
the annual cap (this would be a different number every year) or a certain
absolute amount (this could remain constant). If the maximum size of the
reserve was reached, there could be two possible consequences. Either the
auction volumes would remain untouched in line with the default annual volumes
or the allowances exceeding the maximum limit (for a prolonged period) would be
cancelled. The advantage of the former is that it would ensure predictability
of the system in relation to the absolute cap, but the mechanism may no longer
be able to achieve its objective of making the EU ETS more resilient to shocks.
 Conversely, cancelling any excess allowances in the reserve may undermine principle
of neutrality of a market stability reserve in terms of the overall cap and the
predictability of the system in relation to the absolute cap, but it would
still maintain the ability of the mechanism to cope with prolonged periods of
surplus accumulation.  Reducing the cap would improve the environmental outcome
of the EU ETS and ensure predictability in terms of relevant ambition. It could
also play a helpful role in the context of the international negotiations and
move to the more ambitious conditional target. Reaching the maximum limit could
lead to an automatic cancellation of allowances or initiate a review of the cap
through ordinary legislative procedure. 
6.2.5.     Timing
Another design aspect concerns the timing
of any adjustments to the auction volumes. A number of alternatives could be
contemplated, to a degree also depending on the triggers chosen.  
The most obvious would be an annual
exercise, with the total volume deducted or added to the auction volumes to be
spread over 12 months. In any case, the period over which the adjustment is
spread should not exceed the length of the period of the exercise to avoid accumulation
of adjustments. I.e. if this was an annual exercise, and the volumes were
spread over more than 12 months, the adjustments in month 13 and onwards could
already overlap with possible adjustments stemming from following year's
exercise.  
If the trigger was surplus-based, the
necessary data for the previous year (year t-1) - verified emissions and use of
international credits - would become available in May of the current year (year
t). So the earliest possible timing of the adjustment could be the 2nd
half of the current year. This means that the initial auction calendar, which
determines in detail the dates and volumes of auctions throughout a year, for
year t would be determined without taking into account the possible
adjustments. Following the annual compliance period, the auction calendar(s)
for year t would be updated, reducing or increasing the volume for the
remainder of the year. Another possibility would be to adapt the period of the
auction calendar(s) so it more aligned with the compliance year, and runs from
May of year t until April of t+1, or 2nd half of year t until 1st
half of year t+1. 
Alternatively, the adjustment could be done
in the following year (year t+1). This way the auction calendar for year t
would not require any updates and the auction calendar for year t+1 could
already take into account the necessary adjustment from the start. However,
adjustments in supply would have a longer delay than in the case of adjustment
in the current year. On the other hand, they may provide more predictability to
the market as the size of the adjustment would be known several months in
advance before it is implemented.        
Similar timing options and considerations
apply also for the external indicator-based triggers, given the industrial and
production indicators for year t-1, would only be available in year t. As
mentioned, also forecasts could be used. For example, using the European
Economic Forecasts[32]
– autumn editions (published in November), the auction calendar for the
following year could already take into account the forecast for that year.
Currently, according to the Auctioning Regulation, knowing the auction calendar
for a year in advance[33]
has been decided as appropriate to ensure the necessarily level of
predictability. 
The calculations to check whether a trigger
has been reached and the adjustments could also be done on a less frequent
basis, e.g. every two years or half way through the trading period (i.e. every
four years). In general a more frequent exercise has the benefit of being able
to react more quickly to any significant changes in circumstances, but the
drawback of providing less predictability in terms of volumes to be auctioned.
A less frequent exercise risks requiring larger adjustments but the volumes for
the adjustment can be spread over a longer period.
6.2.6.     Other design aspects and
characteristics of a market stability reserve
The model of a market stability reserve has
a number of other possible advantages and aspects that could be conceived. One
is in terms of the use of allowances in the reserve. Some stakeholders proposed
ideas that could be relevant in this regards. For example, European Chemical
Industry Council (CEFIC) proposes that the new entrants reserve be transformed
into an "EU central reserve bank for efficient growth" – that e.g.
during the times of economic crisis, unused allowances can be put into a
reserve and dynamically reallocated to ETS sectors and the market in times of
economic recovery and growth according to agreed rules. Their recommendation
seems to be also about additional ex-post adjustments to the free allocation,
but some elements could be considered also for a reserve of only auctioned
allowances. The Confederation of European Paper Industries (CEPI) recommends
using the revenues from the EU ETS to help drive innovation. Taking into
account this input, possible uses of the allowances in the reserve could be
·                        
To replenish the new entrants reserve if it were
to be depleted based on the existing free allocation rules for significant capacity
extensions and new entrants;
·                        
To use some of the auction revenue from the
allowances released from the reserve to support the development of breakthrough
technologies for the sectors covered by the EU ETS. 
The latter could be based on the principles
laid down in the NER300 programme. In terms of governance, the European
Investment Bank (EIB) could act as a reserve-keeper.
The market stability reserve could also
have benefits in the context of international negotiations. A market stability
reserve could also allow predictable but quick changes to the EU ambition to
match more ambitious commitments by other regions and countries, by committing
to permanently retire an amount of allowances in the reserve. This way the EU
could credibly signal a possible higher ambition level to the international
community and this help advance the international negotiations.
6.3.        Option 3: Combination of a market stability reserve with
permanent retirement 
The market imbalance can also be reduced with
a combined approach, both establishing a market stability reserve and
permanently retiring a limited number of allowances. This would appear to be
consistent with the dual nature of the problem, which is on the one hand the
large surplus that the market is experiencing today (a "corrective"
element) and on the other hand possible re-emergence of imbalances in the
future due to large demand shocks (a "preventive" element). 
Contrary to the baseline option, one
possible way to implement a combined approach is to permanently retire
allowances towards the end of phase 3. Technically this could be done by means
of some back-loaded auction supply not being returned to the market. The
analytical assumption used is that 500 million allowances are permanently
retired. Regarding the design of the market stability reserve part, this option
will be based on the central option(s) that will appear from the pre-assessment
of different market stability reserve sub-options. The market stability reserve
applies as of 2017. This option would be able to address the impact of the
economic crisis and complementary policies on the demand side, as well as of
the supply side drivers, notably the large inflow of international credits.     

7.           Analysis
of impacts
7.1.        Market balance 
Table 2 represents two
sub-options for the permanent retirement in terms of the numbers of allowances
to be permanently retired, which will be assessed in relation to the their
impact on the market balance and expected price development. It illustrates
changes in the annual auction volumes compared to the baseline option 0, and
for ease of comparison also the combined net change due to back-loading and a
permanent retirement compared to the initial auction volumes.   
Table 2: Sub-options for a permanent retirement –
changes in auction volumes
 [mio allowances] || Total || 2013 || 2014 || 2015 || 2016 || 2017 || 2018 || 2019 || 2020 
 Large retirement Option 1a || Change compared to option 0 || -1400 || 0 || 0 || 0 || 0 || -125 || -125 || -425 || -725 
 Net change compared to initial auction volumes before back-loading || -1400 || 0 || -400 || -300 || -200 || -125 || -125 || -125 || -125 
 Small retirement Option 1b[34] || Change compared to option 0 || -500 || 0 || 0 || 0 || 0 || 0 || 0 || -167 || -333 
 Net change compared to initial auction volumes before back-loading || -500 || 0 || -400 || -300 || -200 || 0 || 0 || 133 || 267 
Table 3 below
represents 7 sub-options for the market stability reserve in terms of when and
how many allowances to put into the reserve and when and how many to release,
which will be assessed in relation to their impact on the market balance. All
sub-options for a market stability reserve include rules for the return of the
allowances to the market and are therefore cap-neutral. The options assume that
the adjustment is done on an annual basis. The options were chosen to assess
the differences in functioning of the reserve with different design elements.
Other combinations of elements would be possible, too.  
The first set of options focuses on the
surplus-based triggers (options 2a-2f), either in relation to the cumulative
surplus or change in the surplus. Different levels of the band are chosen in a
way to allow a sensitivity analysis in terms of impacts of different levels and
widths of the band. The majority of the options are focused on the surplus-based
triggers as they have the important benefit of being able to account for the
impact of complementary policies, such as renewables and energy efficiency
measures. As explained before, price-based triggers are not the focus of this
assessment.          
In general, two variants are assessed, one where
there is some kind of a safeguard to avoid large changes in the auction supply:
·                        
Under option 2b, an upper limit is put on the
size of the annual adjustment. 
·                        
Under option 2d the adjustment putting allowances
into the reserve is calculated as a 10% share of the cumulative surplus, unless
the adjustment would fall under 100 million allowances. Adjustments releasing
allowances from the reserve are determined as instalments of 100 million
allowances.[35]
·                        
Under option 2f the adjustment is limited to 50%
of the distance from the band.   
The limits at the same time de facto mimic
the impact of a fixed amount of the adjustment. For the purpose of this
analysis, two different levels of 100 million (limit and instalment in options
2b and 2d) and 200 million (instalment in option 2g) allowances are assessed,
as well as an adjustment at the level of 50% of the distance from the band.     
One option (option 2g) looks at a reserve
with an external indicator-based trigger, more specifically based on the GDP
growth forecasts published in the European Economic Forecast – autumn editions.
As the band is not directly expressed in emission allowances, external
indicator-based triggers in any case require an additional step of determining
the amount of allowances placed into / released from the reserve. Given the
difficulties of precisely translating the relation between the unit of GDP
growth into a number of allowances, the external-based trigger is only assessed
in combination with pre-determined adjustment amounts of 200 million
allowances. 
Table 3:
Sub-options for a market stability reserve
   || Option || Trigger || Adjustment amount 
 Relative narrow band & unlimited || 2a || Total surplus outside 40-50% of the cap || Distance from the band/unlimited 
 Relative narrow band & limited || 2b || Total surplus outside 40-50% of the cap || Distance from the band/limit of 100 mio allowances 
 Absolute broad band & unlimited || 2c || Total surplus outside 400-1000 mio allowances || Distance from the band/unlimited 
 Absolute broad band & limited || 2d || Total surplus outside 400-1000 mio allowances || 10% of cumulative surplus/instalment of 100 mio allowances 
 Annual change & unlimited || 2e || Annual change in surplus >100 mio allowances || Unlimited/ surplus change above 100 mio allowances 
 Annual change & 50% || 2f || Annual change in surplus >100 mio allowances || 50% of the surplus change above 100 mio allowances 
 GDP || 2g || GDP growth forecast outside 2-3% || Instalments of 200 mio allowances 
Different impacts of a market stability
reserve on the market balance can be expected when the market is faced with a
growing imbalance and when the market balance has been restored. Therefore, the
assessment is done in steps. Firstly, it assesses the impact of the reserve on
the supply-demand balance with a demand shock resulting from a severe recession,
using actual phase 2 data as a proxy. Obviously, only a very small amount of
allowances was auctioned in phase 2, but for the purpose of this illustration,
it is assumed that a similar share of auctioning would be available for any
adjustments as in phase 3. The relevant time period for this step is primarily phase
2, but the assessment is extended to show residual impacts on phase 3. This
part of the analysis assesses whether a market stability reserve would have
prevented the large imbalance that the EU ETS is experiencing today.
In a second step, the assessment will examine
what the impact of different options would be in the current situation, after
back-loading has been implemented and has to a certain extent already restored
market balance in 2014-2016[36].
The reserve would apply as of 2017. Backloaded allowances then return in 2019
and 2020. The relevant period for this step is primarily phase 3. However,
analysis is also extended to show impacts in phase 4. Obviously, for the
permanent retirement options we only perform the second step of the assessment.
This part of the analysis assesses whether the options would correct the large
imbalance that the EU ETS is experiencing today.
In a third step, the assessment will
examine what the impact of different options would be if they applied as of
phase 4, with the first adjustment in 2021. This follows the preference by a
number of stakeholders to implement structural measures as of phase 4, as after
back-loading this would otherwise result in multiple measures in the space of
few years and could impair certainty. So contrary to a permanent retirement,
these stakeholders could support flexible supply as of phase 4.[37]
Table 4 represents an option for the
combination of a market stability reserve with permanent retirement. The choice
of design features for the market stability reserve is informed by the
pre-assessment and comparisons of the market stability reserve sub-options in
section 7.1.3.4. 
Table 4: Sub-option
for the combination of a market stability reserve with
permanent retirement
   ||   || Amount of permanent retirement || Reserve triggers || Reserve adjustment amount 
 Retirement & reserve limited || 3 || 500 mio allowances || Total surplus outside 400-1000 mio allowances || 10% of cumulative surplus/Minimum limit or instalment of 100 mio allowances 
The scheduled
changes in the auction volumes related to the permanent retirement follow the profile
set out in Table 5. 
 Table 5: Changes in auction volumes related to the permanent retirement 
 [mio allowances] || Total || 2013 || 2014 || 2015 || 2016 || 2017 || 2018 || 2019 || 2020 
 Change compared to option 0 || -500 || 0 || 0 || 0 || 0 || 0 || 0 || -167 || -333 
 Net change compared to initial auction volumes before back-loading || -500 || 0 || -400 || -300 || -200 || 0 || 0 || 133 || 267 
7.1.1.     Baseline scenario – Option 0
Figure 6 represents
the annual deficit or surplus and the total cumulative surplus up in the
current situation without a reserve being put in place. It will serve as the
basis for comparison with options where a market stability reserve would have
been implemented as of 2008. Hence, for the purpose of this particular
simulation, it assumes no back-loading, as the market stability reserve would
have already been in place and able to address the intended aim of that measure
too. As there was only limited auctioning in phase 2, the illustrations show
the total annual volume of issued allowances, rather than only auction supply. 
Figure 6: Option
0 – Evolution of the surplus in phase 2 (and 3) without a market stability reserve
and without back-loading  
Figure 7 represents the annual deficit and
surplus and total cumulative surplus in the situation without a market
stability reserve, but where back-loading has been implemented. It will serve
as the basis for the second part of the analysis, comparing the impact of the market
stability reserve if it was to be implemented as of 2017.
All figures in
this section use the same data as Figure 1.    
Figure 7: Option
0 – Evolution of the surplus in phase 3 (and 4) without a market stability reserve,
but with back-loading 
7.1.2.     Permanent retirement
options: Options 1a and 1b
Figure 8  provides
a graphical presentation of the impacts in terms of market balance of a
permanent retirement in two different amounts. Option 1 in the total amount of
1.4 billion allowances would mean that all 900 million allowances foreseen to
be back-loaded are permanently retired plus an additional 500 million
permanently retired afterwards. Option 2 in the total amount of 500 million
allowances would mean that only that amount of back-loaded allowances are
permanently retired, with 400 million returned to the market.   
Figure 8:
Evolution of the surplus in phase 3 and 4 with a retirement -options 1a and 1b
The following observations can be made:
·                        
Both options are expected to reduce the surplus
early on. This seems to be more consistent with the objective of inter-temporal
efficiency than the baseline option 0.  
·                        
The core difference between the two options emerges
in the second half of the period. A lower amount of permanent retirement
decreases the stabilising effect of the measure. The option with a large
retirement (1a) continues to reduce the surplus until 2020 and is likely to
support the price in that period. Option with a small retirement (1b), however,
results in a rebound in the surplus as of 2016 and an additional expansion of
the surplus in 2020 when the back-loaded allowances, which were not permanently
retired, are returned to the market. This may result in a renewed downward
pressure on the carbon price signal.
7.1.3.     Options for the market
stability reserve
7.1.3.1.  Options with volume triggers based on the cumulative
surplus: Options 2a-2d
Impact of a market stability reserve if implemented
in phase 2
Figure 9 gives a
graphical presentation of the impacts in terms of market balance of a market
stability reserve with volume triggers based on the cumulative surplus if it
was already in place as of 2008. 
Options 2a and 2b assume a relative and
narrow band. Option 2a assumes a band with the total surplus within 40-50% of
the cap with an adjustment depending on the distance from the band (unlimited adjustment).
Option 2b assumes the same band, but limits the amount of the annual adjustment
to maximum 200 million allowances. Options 2c and 2d are based on an absolute and
broader band of 400 to 1000 million allowances, former with an unlimited
adjustment defined as the distance from the band. Option 2d has an annual
adjustment putting allowances into the reserve defined as 10% of the cumulative
surplus in the preceding year, unless the adjustment would fall below 100
million allowances. Adjustments releasing allowances from the reserve are
defined as instalments of 100 million allowances. 
The following observations can be made: 
·                        
None of the options would have prevented the
rapid accumulation of the surplus in 2011 and 2012;
·                        
However, they would have avoided a continued
growth of the surplus and reduced the market imbalance substantially and in
most cases early in phase 3 compared to the baseline option 0. Hence, they appear
to be more effective in ensuring the inter-temporal efficiency;
·                        
Impact of the size of the adjustment: 
·              
As they provide more flexibility in responding
to the shocks, options with variable adjustments (2a and 2c) lead to an early
and significant reduction in the market imbalance. However, they also lead to
significant changes to the initial auction volumes.   
·              
Options with a limit on the adjustment or the
adjustment defined as a percentage of the cumulative surplus (2b and 2d) lead
to a more gradual and predictable but smaller reduction in the market
imbalance. They lead to similar results in phase 3. Of course, the speed of the
reduction in the overall surplus will depend on the maximum amount of the
adjustment and the percentage of the cumulative surplus, respectively. The
higher the values, the quicker the reduction in the surplus would have been. In
this particular case, these options do not manage to bring the surplus within
the band until 2020 and adjustments reducing the annual auction amounts
continue to be needed until the early years of phase 4.   
·                        
As for the impact of the levels of the band, in
general, the narrower the band, the greater the need for interventions. While
there is little difference in the number of interventions putting allowances
into the reserve in phase 3, options with a narrower band (2a and 2b) would
require more interventions in different directions in phase 4 (first still putting
the allowances into reserve and shortly later releasing them from it). Options
with a narrower band (2a and 2b) result in higher reserve levels by 2020. 
Figure 9:
Evolution of the surplus in phase 2 and 3 under options 2a-2d if already
implemented in phase 2
Impact of a market stability reserve if
implemented in phase 3
Figure 10 provides
an illustration of the impacts of the same options, if they were implemented as
of 2017, after backloading, and the backloaded allowances would be returned to
the market in 2019 and 2020 as scheduled. The following observations can be
made:
·                        
While the options are expected to lead to a
rebound in the surplus at the end of phase 3, they would result in a gradual
decrease as of phase 4. The pattern of a decrease in the market imbalance,
followed by an increase and then a more gradual decrease may be inconsistent
with the objective of better inter-temporal efficiency.  
·                        
Levels of the band: A narrow band (2a and 2b)
leads to a higher number of adjustments, first putting allowances into the
reserve, followed by adjustments releasing them only a few years later.   
·                        
Size of the adjustment: Options without a limit
(2a and 2c) reduce the surplus faster as of phase 4. However, they result in
quite high variability in auction supply and surplus in the transition into
phase 4, with a spike at the end of phase 3 followed by a rapid drop early in
phase 4. The options with some kind of a limit (2b and 2d) are slower in reducing
the surplus as of phase 4, but results in most stable auction supply and more
gradual reduction in the surplus. However, option 2b does not manage to bring
the surplus within the band in phase 4 and requires an adjustment putting
allowances into the reserve from 2017 throughout phase 4.
Figure 10:
Evolution of the surplus in phase 3 and 4 under options 2a-2d if implemented as
of phase 3 
Impact of a
market stability reserve if implemented in phase 4
Figure 11 provides
an illustration of the impacts of the same options if they were to apply as of
phase 4. The following observations can be made:
·                        
Clearly, none of the options prevent the rebound
in the surplus following the return of the back-loaded allowances. Compared to
a situation where a reserve would be implemented as of 2017, the surplus in
2020 at the end of phase 3 is always higher. 
·                        
However, the options do correct for the expansion
of the surplus as of phase 4. As the surplus is higher by then, so are the
needed corrections. 
·                        
Levels of the band: Without a limit on the size
of the adjustment, a narrow band (2a) results in more interventions in opposite
directions, first putting allowances into the reserve and releasing them
towards the end of the phase. 
·                        
Size of the adjustment: Options without any
limit (2a and 2c) lead to very high adjustments at the beginning of phase 4,
resulting in no auction volumes for 2021 and nothing (2a) or very little (2c)
to be auctioned in 2022. However, they bring the surplus within the band in two
years. Options with limited adjustments (2b and 2d) result in a slower but much
more gradual reduction in the surplus, and ensure continuity of material
auction supply throughout the phase. However option 2b is not able to bring the
surplus within the band in phase 4 and requires adjustments putting allowances
into the reserve every year of phase 4.
Figure 11:
Evolution of the surplus in phase 3 and 4 under options 2a-2d if implemented as
of phase 4 
7.1.3.2.  Options
with volume triggers based on the change in surplus: Options 2e and 2f
Impact of a market stability reserve if implemented
in phase 2
Figure 12 provides
a graphical presentation of the impacts of the options with a trigger based on annual
changes in the surplus. Both options assume that allowances are put into the market
stability reserve if the cumulative surplus grows by at least 100 million
allowances in a year and released from it if the cumulative surplus contracts
by at least 100 million allowances. Again, the adjustment is determined as the
full annual change in surplus above 100 million allowances (2e) or 50% of that
amount (2f).
Screening both options leads to the following
observations:
·                        
These options start reacting somewhat faster to
the accumulation of the surplus and therefore result in a lower expansion of
the surplus in 2012 than in the baseline option 0. However, they do little to
reduce the surplus further as the market is more in balance, not triggering the
rules, which would require putting additional allowances into the market stability
reserve. So they are effective in improving the inter-temporal efficiency only
to a limited extent.  
·                        
Impact of the size of the adjustment: Option
with an unlimited adjustment (2e) would have led to a significant reduction in
the build-up of the surplus. Option with a lower adjustment at 50% of the
distance from the band would have resulted in a proportionately smaller
reduction in the size of the surplus. 
Figure 12:
Evolution of the surplus in phase 2 and 3 under options 2e and 2f if already
implemented in phase 2
Impact of a market stability reserve if
implemented in phase 3
While both options would not yet address
the surplus in a lasting manner in phase 3, they would to a certain extent
reduce the surplus shortly after its rebound at the end of phase 3. However, no
subsequent adjustment is expected to follow if no unexpected rapid annual
changes in the surplus would happen. Again, this means that the options lead to
only limited improvements in inter-temporal efficiency. 
The option without a limit on the size of
the annual adjustment (2e) would lead to double the reduction in the surplus
than the one with an adjustment at 50% of the distance from the band (2f).
However, it would lead to higher variability in the auction supply and surplus in
the transition to phase 4.[38] 

Figure 13: Evolution of the surplus in phase 3 and 4
under options 2e and 2f if implemented as of phase 3
Impact of
a market stability reserve if implemented in phase 4
Figure 14 provides an
illustration of the impact of the same options if they started to apply as of 2021.
They would be able to reduce the surplus, but to a lesser extent than if they
were implemented in 2017. While the options would be able to respond to further
shocks, they would not lead to any additional improvement in the total
structural surplus. 
Figure 14:
Evolution of the surplus in phase 3 and 4 under options 2e and 2f if
implemented as of phase 4
7.1.3.3.  Option with a trigger based on the GDP growth forecasts
Figure 15 provides
an illustration of the impact in terms of market balance of the option using
GDP growth as the external trigger. Where the GDP growth forecast is outside a
band of 2-3%, allowances would be put in the reserve in instalments of 100
million allowances. The figure shows how the market stability reserve would
have worked in the time of the crisis, until today, and assuming GDP growth
rates would stay within the band as of 2013. 
Figure 15:
Evolution of the surplus in phase 3 under option 2g if already implemented in
phase 2
The following observations can be made:
By relying on forecasts for GDP growth,
this option would have anticipated the major changes in the economic activity,
which have been in part responsible for the surplus. The adjustment could
already be made in the year for which the forecast applies, and hence their
timing aligned with timing of the forecasted drop in demand. However, this kind
of approach would not have been able to react to changes in the market balance
due to other factors, such as the increased supply of allowances in the
transition into phase 3 and due to return of back-loading, and record inflow of
international credits due to regulatory changes. Hence, the option would have
improved the inter-temporal efficiency, but to a limited extent. These options
may be able to react to changes in demand due to impacts of complementary
policies, if production trends in terms of overall output as well as fuel input
in power generation can be adequately captured. 
7.1.3.4.  Comparison of sub-options for
the market stability reserve
There are many possible combinations of
design elements and trigger levels for a market stability reserve. In this
section we compare the sub-options and define the most interesting option to be
assessed further in the next sections of the impact assessment, based on the
assessment of the design parameters in terms of their effectiveness in
addressing the market imbalance and other related criteria. Figure 16 provides a comparison of the
impacts of the various sub-options for a market stability reserve on the
surplus and the size of the reserve if they were already in place in phase 2.  
Figure 16: Comparison of the evolution of the
surplus and reserve under various sub-options for
market stability reserve if already implemented in phase 2
Figure 17 compares
the impacts of various sub-options if a market stability reserve was
implemented in phase 3. The comparison in terms of the surplus also included
the two permanent retirement options (1a and 2b) and two combined options (3a
and 3b). 
Figure 17:
Comparison of the evolution of the surplus and reserve under various sub-options
for market stability reserve if implemented as of phase 3
Figure 17 compares
the impact of various sub-options if they were implemented in phase 3. The
comparison of the impacts on the surplus also includes the two permanent
retirement options (1a and 1b). However, they are by definition not relevant
for the comparison in terms of the size of the reserve, as a permanent
retirement would not lead to one. 
Figure 18 compares
the impact of various sub-options if they were implemented in phase 4. For ease
of comparison the figure depicting the evolution of the surplus also include
the two permanent retirement options. However, they are not included in the
figure on the reserve, as they do no lead to any allowances being put into a
reserve.   
Figure 18: Comparison of the evolution of the
surplus and reserve under various sub-options for market stability reserve if
implemented as of phase 4     
The results of the assessment are shown in Table 6. The following summary explanation
can be given with respect to the scores given:
·                        
The surplus-based triggers get a better score as
regards their ability to capture changes in demand not only due to
macroeconomic changes, but also other factors such as impact of complementary
policies, as well as supply side factors such as changes in inflow of
international credits. 
·                        
Out of surplus-based triggers, those based on a
cumulative surplus are expected to perform better that those based on annual
changes in correcting the surplus. While triggers based on changes in the
balance may be more effective in preventing a market imbalance, they do not
lead to further reduction of the surplus after the market is more in balance.
·                        
Those surplus-based triggers with an absolute
band score better in relation to simplicity. Moreover, a relative band which
tapers off in line with the decreasing cap may perform poorly with an
increasing trend in hedging needs. 
·                        
A broader band gets a better score in terms of number
of needed adjustments. Such a reserve rule is expected to lead to lower amounts
and frequency of adjustments as well as lower variability in auction volumes.
In contrast, a narrower band is likely to lead to higher number of
interventions and in different directions, i.e. a number of adjustments putting
allowances into the market stability reserve only to be followed by release of
those allowances shortly after. 
·                        
Limited adjustments, either with an explicit
limit on the amount of adjustment or determined as a certain percentage of the
cumulative surplus, get a better score in terms of predictability. They also
lead to more continuity in terms of auctions, and gradual changes to the
surplus and market stability reserve. Unlimited adjustments get a better score
in terms of flexibility in addressing large and rapid fluctuations in the
market balance and generally restore the market balance more swiftly. However,
in situations with a large surplus, as the market is expected to experience by
the end of phase 3, they may lead to no auction supply coming to the market for
several years.     
For ease of comparison, a choice needs to
be made on the option(s) for a market stability reserve to be taken forward for
further analysis. Considering a combination of criteria, it is proposed to take
option 2d (with volume triggers, with a broad absolute surplus range between 400
and 1000 million allowances and an adjustment putting allowances into reserve
at the level of 10% of the surplus) as the central options for the market
stability reserve to be assessed further in terms of impacts other than on
market balance and compare to the permanent retirement options. This option has
an important advantage in terms of correcting the market imbalance in a gradual
way, predictability and simplicity. While it may not fully address the market
imbalance in phase 3, they start doing so soon after, at the beginning of phase
4.
Table 6: Comparison of
various sub-options for a market stability reserve 
 Option || Effectiveness in ensuring inter-temporal efficiency || Size of the reserve || Market stability || Capturing impact of other policies, supply shocks || Simplicity || Predictability 
 Preventing market imbalance: size of surplus (if in phase 2) || Restoring market balance: size of surplus || If in phase 2 || If in phase 3 || If in phase 4 || Number of adjustments* 
 If in phase 3 || If in phase 4 || If in phase 3 || If in phase 4 
 2013 || 2021 || 2028 || 2021 || 2028 || 2013 || 2021 || 2028 || 2021 || 2028 || 2017-2028 || 2021-2028 
 Relative narrow band & unlimited || 2a || 1.2 bn + || 900 mio ++ || 500 mio ++ || 1.7 bn + || 500 mio ++ || 1 bn   || 1.8 bn || 1.6 bn || 900 mio || 1.6 bn || 9 (6↑/3↓) -- || 5 (2↑/3↓) - || + || - || -- 
 Relative narrow band & limited || 2b || 2.1 bn 0 || 2.1 bn 0 || 900 mio ++ || 2.5bn 0 || 1.3 bn + || 100 mio || 500 mio || 1.2 bn || 100 mio || 800 mio || 12(12↑) -- || 8(8↑) - || + || - || + 
 Absolute broad band & unlimited || 2c || 1.2 bn + || 1bn ++ || 500 mio ++ || 1.7 bn + || 500 mio ++ || 1.1 bn || 1.6 bn || 1.6 bn || 900 mio || 1.6 bn || 5(5↑) - || 2(2↑) 0 || + || + || -- 
 Absolute broad band & limited || 2d || 2 bn 0 || 1.8 bn + || 700 mio ++ || 2.4 bn 0 || 800 mio ++ || 200 mio || 800 mio || 1.4 bn || 300 mio || 1.3 bn || 9(9↑) - || 7(7↑) - || + || + || + 
 Annual change & unlimited || 2e || 700 mio ++ || 1.8 bn + || 1.3 bn + || 2.1 bn 0 || 1.6 bn 0 || 1.6 bn || 800 mio || 800 mio || 500 mio || 500 mio || 2(2↑) 0 || 1(1↑) 0 || + || + || - 
 Annual change & 50% || 2f || 1.4 bn + || 2.2 bn 0 || 1.7 bn 0 || 2.4 bn 0 || 1.8 bn 0 || 800 mio || 400 mio || 400 mio || 300 mio || 300 mio || 2(2↑) 0 || 1(1↑) 0 || + || + || + 
 GDP || 2g || 1.2 bn + || n.a. || n.a. || n.a. || n.a. || 1 bn || n.a. || n.a. || n.a. || n.a. || n.a. || n.a. || - || - || + 
Key: ++ (very
positive/ decrease in surplus > 1bn), + (positive / decrease in surplus >
500 mio), - (negative), -- (very negative), 0 (neutral/decrease in surplus <
500 mio)
*Means annual
adjustments. E.g. back-loading as proposed equates to 5 adjustments (3deducting
allowances from auction volumes and 2 adding them). ↑(adjustment putting
allowances into the reserve), ↓ ( adjustment releasing allowances from
the reserve) 
7.1.4.     Option for a combination of a market stability reserve
with permanent retirement: Option 3
Figure 19 shows the
impacts of the option for a combination of a permanent retirement of 500
million allowances and market stability reserve with a broad band with an
adjustment putting allowances into a reserve defined as 10% of the surplus and releasing
them in instalments of 100 million allowances. The following observations can
be made: 
·                        
While the option leads to a rebound in the
surplus at the end of phase 3, it does reduce it compared to the baseline
option 0. It also keeps gradually decreasing the surplus in phase 4. This seems
to be more consistent with the objective of inter-temporal efficiency than the
baseline option 0.  
Figure 19: Evolution of the surplus in phase 3 and 4
with combined option 3
7.2.        Potential impact on carbon
price formation
One of the central issues is the price
impact. Modelling tools typically used by the Commission to assess the impact
of certain targets, be it GHG target or specific energy targets, are better
able to assess mid to longer term scarcities and price formation on the market,
and are less well equipped to look at interaction of the drivers and
uncertainties within short periods of time. A detailed assessment of the annual
magnitude of the price impacts, in particularly of options with a market
stability reserve element, cannot be made for a number of reasons (similar as
for back-loading[39]).
Their impact is hard to forecast as by definition it is very uncertain when a
mechanism built to apply in cases of large-demand shocks only will apply. This
assessment uses actual data from the period of the economic crisis as a proxy
because economic models are not good in capturing such unexpected large shocks.
Furthermore, if a measure reduces auction supply to such an extent that those
entities that are short of allowances (such as the power sector that as of
phase 3 no longer receives any free allocation) cannot buy sufficient amount of
allowances in auctions, then prices will be driven to an extent by the
financing needs of the entities that are holding surplus allowances (such as
industry sectors) and the price levels that incite industry or other surplus
owners to sell allowances. Prices will furthermore be influenced by the changes
in hedging-driven demand. A further uncertainty relates to the extent that the
market participants may adapt their behaviour to anticipate the impact of a
reserve. 
The exact impacts of a market stability
reserve will depend on how such a mechanism is designed. As this impact
assessment shows, there are many ways to do so. Obviously, this is probably one
of the reasons why there are hardly any analyses quantifying the price impacts
of a market stability reserve by stakeholders or private market analysts
available at time of the writing of this assessment.
Complementing the EU ETS rule set with a
market stability reserve is furthermore expected to increase confidence of
market operators that the market is more resilient to major shocks. This should
extend the time horizon and/or lower the discount rates of market operators
when taking investments and entering positions in the carbon market. Such
impacts on carbon price formation are not measurable with conventional economic
models used for impact assessments.
Acknowledging the issue of uncertainties
concerning the exact price impacts, a safeguard trigger for a release of allowances
from the reserve based on article 29a of the ETS Directive could be added as an
appropriate response to mitigate any risk of excessive upward price
fluctuations.
7.2.1.     Baseline option
In a situation without back-loading and any
structural measures, the carbon price in the reference scenario is expected to
be €5 in 2015 and €10 in 2020, while the surplus of allowances is projected to
continue growing to some 2.6 billion allowances in 2020 and only gradually
decrease afterwards. In case Member States would not take on additional
policies to achieve their renewables targets and not fully implement latest adopted
policies, emissions might be a bit higher, but baseline projections still
project a surplus of more than 2 billion allowances by 2020.
With back-loading of 900 million allowances
(baseline option 0), the market balance profile changes considerably,
decreasing the surplus early in phase 3. This is likely to support the carbon
price at the beginning of the phase compared to the situation without back-loading.
But if the remaining surplus is large enough, prices should in principle not
increase significantly beyond projections mentioned above. By 2019 at the
latest, when back-loaded allowances start returning to the market, this
supporting effect would be lost again.  
7.2.2.     Permanent retirement
The larger permanent retirement of 1.4
billion allowances (option 1a) would result in at least a similar price support
as back-loading in the early years of phase 3, but without a price rebound as
of 2019. The lower amount of a permanent retirement of 500 million allowances
(option 1b) would significantly reduce the price support effect of the measure,
with an expected repeated decline in the price at the end of phase 3. Impacts
on prices should be limited if a permanent retirement only decreased this
projected surplus to a limited extent. Even if a permanent retirement reduced
the surplus by 1.4 billion allowances, impacts should be lower than those
assessed in the 2010 Communication in the context of an increase in the EU
target to 30%[40].
7.2.3.     Market stability reserve
Prices can increase when a market stability
reserve builds up. Once the market stability reserve has built up, and the
surplus is more in line with the orderly functioning of the market, prices should
be more strongly driven by the actual cap and the extent to which emissions are
below or above the supply in a given time period. Any market stability reserve
that reduces the surplus to a level that supports the functioning of the market
would thus rather support the price signal and the gradual transition to lower
emissions, also in case of a higher ambition in the EU ETS as of phase 4 in the
context of a 2030 framework. This would in turn reduce the risk of too much
carbon intensive investment (or too little low-carbon investments) in the short
term, which increases costs and prices in the longer term.
A market stability reserve is likely to
smooth out the price pattern over time avoiding extremes. A market that is not
perfectly forward looking is expected to experience upward price pressures when
the supply and surplus decrease, and downward pressures when supply and surplus
increase. 
In such a market setting, the impact of a
market stability reserve that would temporarily be built-up, would in the
short-term be similar and not higher than that of a permanent retirement of
allowances of a similar amount than the amount in the reserve. Not higher
because, the market participants are nevertheless expected to take into account
that allowances will return to the market at a later point in time. 
At the end of phase 3, the price support of
the market stability reserve would be significantly lower than of a large
permanent retirement. Over the mid- and long-run, a market stability reserve
would by definition allow for more flexibility in the supply and lead to a
relative decline in the carbon price when allowances are released from the
reserve. 
All in all, the price impact of the reserve
should allow for a market to function better and reduce emissions in line with
the gradually decreasing long-term target. Price evolution may depend on the
expectations by market participants about whether the allowances are returned
into the market or cancelled after a certain period of time or if the reserve
exceeds a certain size. 
To be noted is that even if the linear
reduction factor was to be increased in order to achieve a 40% GHG reduction by
2030, the overall surplus remains large up to 2030 if emissions effectively
reduce by -40%, with a remaining surplus of around 2 billion or more by 2030
(see IA 2030). This represents a situation where the market would have to
continue to operate with rather high surpluses, be it shrinking ones, strongly
driven by longer term considerations with respect to scarcity and costs. If
long term considerations are not sufficient to create short-term demand and market
certainty, short-term carbon prices may actually be lower than projected, mid-
and long-term emissions higher and surplus lower than projected in the
scenarios with 40% GHG reductions, putting the achievement of a 40% 2030 GHG reduction
target at risk and resulting later on in the need for steeper reductions. Thus
also in the context of such an increased ambition level, a market stability reserve
that reduces the surplus to a level that supports the functioning of the
market, would thus rather support price development consistent with the gradual
transition to lower emissions.
7.2.4.     Combination of a permanent retirement and a market
stability reserve      
Prices are expected to increase in relative
terms towards the end of phase 3 due to a combined effect of a permanent
retirement of limited number of allowances and the market stability reserve
being built up. Hence, this is expected to provide more support than solely a
permanent retirement of the same amount would (option 1b). It is also likely to
have a higher impact than a similar market stability reserve alone would (e.g.
option 2d). However, the options would still result in some rebound of the
surplus at the end of phase 3 and hence have less of a price impact than the
large permanent retirement (option 1a).
In the mid- and long-term, the relative
price impacts compared to the baseline option are expected to be reversed due
to two effects. Directly, because prices may decline in relative terms when
allowances are released from the reserve. It is also expected to prevent
unnecessarily higher prices in the mid- and long-term as reducing the surplus
to a level that allows orderly functioning of the market and brings the price
more in line with a price signal consistent with achieving the necessary
emission reductions in the mid- and long-term, would reduce the risk of carbon
lock-in in the short-term. 
Among the options assessed, the option with
a larger amount of permanent retirement is expected to result in the highest
prices over phase 3 and 4. 
If there were any excessive price
increases, they would be addressed by the existing mechanism in Article 29a of
the EU ETS Directive, which could also be combined with triggers for a release
of allowances from a reserve in case of concerns about excessive price movements.
7.3.        Auction revenues
Given the uncertainties concerning exact
price impacts, in particular of options including a market stability reserve,
it is also difficult to assess with certainty the impacts on the auction
revenues. What is clear is that even with back-loading, with an average weak
carbon price signal in phase 3 and beyond, the EU ETS auction revenues for
Member States would continue to be considerably lower than anticipated. This
adds pressure on public finances and reduces another potential source of funds
available for climate purposes. Furthermore, weaker carbon price also means
that there is materially less auction revenue for distributional and solidarity
purposes for certain Member States. 
A quantitative analysis of a large
permanent retirement of 1.4 billion allowances has been taken up for the 2010
Communication on the option to move beyond a 20% reduction target. It suggested
that auction revenues might increase by around a third, because the carbon
price was expected to increase more than the reduction of allowances auctioned.
The detailed results by Member States can be found in the follow-up 2012 Staff
Working Document[41].
Member States opting for a temporary derogation from full auctioning for the
modernisation of the power sector may forego some of the revenue increase.
However, as half of the permanent retirement, as assumed in this impact
assessment, would happen in the same years as the return of back-loading
allowances the absolute changes compared to an average annual auction volume
may not be considerable. This risk is also mitigated by the fact that free
allocation for the power sector declines over the period, reaching zero in
2020. But of course, an increase in the carbon price would still increase the
value of the free allocation given to the electricity generators for those
Member States.
Similar considerations concerning the free
allocation for the power sector apply also for other options. However, this is
no longer relevant in phase 4, and not at all relevant for a market stability
reserve, if it was to be implemented after 2020 only.
7.4.        EU competitiveness
considerations 
Energy and climate policies have the
potential to drive demand and growth in the low carbon economy. But by not
rewarding investments and innovation flowing from deploying low-carbon
technologies clearly and early enough, the EU is expected to lose a competitive
advantage in those technologies. Instead, an unrepresentatively weak carbon
price that the EU ETS has experienced recently and that may remain at a fairly
low level well into phase 4, is expected to incentivise carbon lock-in, which
refers to construction of carbon-intensive capital, such as fossil fuel plants.
It is failing to encourage investment in new low-carbon capacity, e.g.
renewable power capacity. This would lead to higher costs in the mid- and
long-term and higher negative competitiveness impacts in the mid- and
long-term. 
Furthermore, not strengthening the EU ETS
is expected to lead to a disintegrated EU energy and climate policy, and a fragmented
internal market.[42]
Member States may increasingly pursue national solutions to compensate for the
weak carbon price signal, which would distort the EU-wide carbon price signal,
undermine the efficiency of Europe's climate policy and create additional costs
for the sectors covered by the EU ETS. 
In terms of the short-term impacts on the
sectors covered by the EU ETS, a distinction needs to be made between the impacts
on the energy-intensive industries and the electricity sector. A stronger
carbon price in the short-term, as a result of a structural measure, is
expected to decrease the uncertainty in the electricity sector, decreasing the
risk of insufficient investment. In addition to a positive impact on the penetration
of low carbon technologies, this would also have a positive impact on the
security of energy supply and hence overall competitiveness. 
For the energy-intensive industry, however,
a stronger carbon price in the short-term would mean higher direct and indirect
cost, possibly negatively affecting certain energy-intensive sectors, deemed to
be exposed to significant international competition and thus risk of carbon
leakage. Some energy-intensive industries note that this is the wrong moment to
explore measures that may increase the cost for these industries over the next
years.[43] 

The impacts of a permanent retirement or a
market stability reserve up to a level of 1.4 billion allowances in 2020 are likely
to remain within the carbon price levels and production changes already assessed
in the context of the 2010 Communication on the options to move beyond 20%
reductions[44].
Even with a market stability reserve of that size, the carbon price and
production changes are expected to be lower in the mid- and long-term as
allowances return to the market. Furthermore, the current reference scenario
projects lower prices than this analysis from 2010, even though the latter
already took into account the impact of the crisis. The impact of a permanent
retirement of 1.4 billion allowances on the output of the EU energy-intensive
industry by 2020 was assessed to be limited, as long as special measures
already taken for energy-intensive industry stayed in place.
Neither of the permanent retirement options
(1a and 1b) would exceed the amount of 1.4 billion allowances. Although a
market stability reserve would affect the supply in a similar manner by 2020,
the allowances would be released back to the market later on. The amount in the
reserve in the central market stability reserve option (2d), and all other
sub-options, is within the amounts of the permanent retirement assessed. 
The carbon price signal also has an impact
on the sectors outside the EU ETS. For example, the EU currently holds a
technological advantage in wind energy. A robust carbon price signal is
expected to give an equally robust signal to investors and maintain this
advantage. This is particularly important, as sectors with such a competitive
advantage are typically exporting sectors positively impact the EU trade
balance. Despite the current recession, the European wind power sector is
estimated to have exported €8.8 billion worth of goods and services in 2010,
while the EU’s trade deficit was €150 billion.[45]

Furthermore, a robust carbon price signal is also expected to
provide trade balance benefits by reducing the imports of fossil fuel energy. Additional
diversification of energy supply routes could improve competition on energy
markets and deliver significant mid- and long-term savings by investments in
renewables and energy efficiency. This reduces the vulnerability to growing
energy prices. This is of particular concern to energy-intensive industries.   

By having an impact on the carbon price
signal, a structural measure would also have an impact on the cost of
achievement of other targets, notably the renewables target. Increasing the
carbon price signal would lower the cost of renewables support schemes. 
7.4.1.     Potential direct cost for energy-intensive sectors
covered by the EU ETS
The options considered in this impact
assessment would affect the auction supply, not the level of free allocation.
However, they are expected to affect also the price signal and therefore the
value of allowances that an installation holds or needs to buy.
Similar to backloading, the market
stability reserve option is expected to impact the distribution of cost over
time, probably increasing the carbon price when allowances are put into a
reserve and decreasing it when they are released. In contrast, the permanent
retirement option is likely to lead to an increase in the carbon price, without
being followed by a relative decrease in the mid-term. In the longer-time
still, both options may decrease carbon prices in relative terms by avoiding or
reducing underinvestment in low carbon capacity in the short term. The
magnitude of the impact depends on the amount of the permanent retirement or
allowances put into a reserve, the higher the amounts, the bigger the expected
price impacts.      
This means that in the short-term, a market
stability reserve and a permanent retirement would increase the cost for those
installations that need to purchase allowances on the market but increase the
benefits for those that hold extra allowances. Given the continued free
allocation to industry and the existing large surplus of allowances allocated
for free in phase 2, installations are more likely to be net sellers of
allowances in the short-term. 
In terms of the extent of industrial surpluses
accumulating in phase 2, the verified emissions data show in aggregate a
surplus of free allowances in relation to emissions from industrial sectors
(excluding the power sector) reported of more than 34% or around 895 million
allowances.[46]
Some of this surplus may have already been sold by industry, in which case the
value of those allowances for industry would not be lost but now arise in the
form of money. Moreover, these are all estimates for industry as a whole, with
potential variations between sectors and individual installations.  
For phase 3, a total of some 6 billion
allowances will be allocated for free to industry or on average around 740
million annually.[47]
Table 7 gives an overview of
the estimates of potential emissions for industrial sectors that receive free
allocation using reported historical emissions in each year of phase 2 and 2005
as an example of a year with higher emissions as the basis for an estimate of
emissions in phase 3. It also lists the consequent estimates of deficits or
surpluses of free allowances on average annually and in total over phase 3. The
table shows that under most emission assumptions the expected financial impact
on industry is quite moderate.     
Table 7: Estimated
amount of allowances that industrial sectors would need to buy assuming various
emission levels (in million allowances)
 Based on historical emissions of year || 2005 || 2008 || 2009 || 2010 || 2011 || 2012 
 Estimated annual emissions || 885 || 873 || 755 || 790 || 778 || 754 
 Estimated annual deficit (-) or surplus (+) || -146 || -133 || -16 || -51 || -39 || -15 
 Estimated total deficit (-) or surplus (+) in phase 3 || -1.168 || -1.067 || -128 || -407 || -312 || -121 
 Estimated total deficit (-) or surplus (+) in phase 3 with existing surplus || -273 || -172 || 767 || 488 || 583 || 774 
Note: Takes into account the impact of the cross-sectoral correction
factor
Due to the continued impact of the crisis,
emission estimates for phase 3 based on the latest 2012 data are the lowest and
based on 2005 data the highest. Further free allocation will be available to
new entrants and for significant capacity extensions, while free allocation may
be reduced in the case of closures and significant capacity decreases. However,
the amounts are difficult to predict at this stage.  
If emissions in phase 3 were similar to
those in any year of phase 2, except for 2008, then continued free allocation is
still expected to result in a surplus over phase 3 taking into account the
existing surplus from phase 2. As mentioned, some of the industry surplus has
already been sold, but not all. But in this case, industry as a whole could see
benefits in phase 3 from a structural measure in the form of increased value of
their surplus.   
If emissions were
to be similar as in 2005 or 2008, then continued free allocation in addition to
the existing surplus would not be sufficient to cover all industry needs, which
would partly need to be covered by buying extra allowances on the market. In
this case, industry as a whole could see increased cost in phase 3 due to a
structural measure in the form of increased cost for purchasing allowances. 
As of phase 4, any deficit may actually
become cheaper to buy under the options with a market stability reserve, which
would see allowances being released from the reserve (by 2028 this would happen
under option 2a). 
Assuming that emissions were at the top end
of the range, industry would need to purchase 273 million allowances over phase
3. Every €1 increase in the carbon price would translate into a cost increase
of € 273 million. Assuming that emissions remained at the level of 2012,
industry would still have 774 million allowances allocated for free to sell on
the market or use for future compliance needs. Every €1 increase in the carbon
price would translate into a benefit of €774 million in the form of increased
value of the industry surplus. 
Table 8: Estimated amount of allowances that
individual sectors would need to buy in phase 3  
   || Estimated annual surplus (+) or deficit (-) in phase 3 
   || in million allowances || % compared to NIMs emissions 
 Extraction of crude petroleum and natural gas; service activities || -15 || -40% 
 Manufacture of pulp, paper and paper products || -2 || -6% 
 Manufacture of coke, refined petroleum products and nuclear fuel || -48 || -30% 
 Manufacture of chemicals, chemical products and man-made fibres || -79 || -38% 
 Manufacture of other non-metallic mineral products || -33 || -14% 
 Manufacture of basic metals || -8 || -4% 
Notes: The table assumes emissions in phase 3 are similar to the
emissions in the years chosen by installations for the free allocation. Obviously,
the emissions figures from the period chosen for the National Implementation
Measures (NIMs) are expected to be the highest among the possible reference
years, in some cases even higher than 2005 figures, which are typically the
highest emission figures, as shown in Table 7. Since the production of the majority of European
industrial installations is currently lower than in the reference years chosen
by installations, in comparison to most recent production and emissions data,
this is a very conservative estimate. Actual allocation is expected to be less
constraining as the table may suggest. Classification according to 2-digit NACE
codes. Includes sectors with emissions above 30 million tCO2 per
year.   
This assessment does not take into account
national policies, which complement the carbon price signal, and could
therefore in aggregate have the same cost impact as an increase in the carbon
price.   
Depending on the degree of pass-through of
carbon cost to consumers, impacts on industries may be (significantly) lower.
Changes in the carbon price signal have very different impacts on profitability
and in turn competitiveness depending on the level of the cost-pass through,
which among others depends on climate action taken by third countries. So
unsurprisingly, impacts on the energy-intensive sectors are responsive to the
assumptions on the ambition of climate policies in third countries, with impact
lowest in case of global action. The EU is working on getting an international
agreement to cut emissions signed by 2015. Meanwhile, many countries already
have national measures in place to reduce emissions over the next decade and
beyond.      
7.4.2.     Potential indirect cost
The report Energy Economic Developments in Europe has found
no statistically significant impact of the carbon price on electricity retail
prices[48].
But this may be due to the fairly weak carbon price observed over the recent
years and may change if the carbon price was to increase. The Commission
adopted State aid Guidelines which set the conditions under which Member States
may compensate part of the increased electricity costs due to the EU ETS. They
list the maximum regional CO2 emission factors for electricity
production in different geographic areas from 0.56 tCO2/MWh and 1.12
tCO2/MWh. With conservative assumptions, i.e. 100% carbon cost pass
through into electricity price, every €1 increase in the carbon price would
then translate into an increase in the electricity price between 0.56 €/MWh and
1.12€/MWh. These figures do not take into account expected lower cost pass
through in the Member States applying the derogation allowing transitional free
allocation for the modernisation of electricity generation.  In addition to the
emission factor, the relative change in the electricity cost depends on the
existing cost of electricity for EU industry. On average, this represents an
increase in the electricity cost of 0.8% for EU industry[49]. 
These estimates are based on current
emission factors of price-setting power plants. A robust carbon price signal is
expected to reduce fossil fuel combustion and the importance of fossil fuel-based
plants in electricity price setting. Hence, it is likely to reduce the
incremental cost of the EU ETS in the electricity price in the mid- and
long-term. 
7.5.        Social
impacts
The carbon price level has been far lower
than what was anticipated when the climate and energy package was adopted in
2008. In
relation to the electricity cost, a €1 increase in the carbon price may on
average translate into an increase of 0.5% compared to the current price for
households[50],
if the carbon price reached a level where it would start having a noticeable
impact on the electricity retail prices. Any increases in the electricity cost
may be mitigated by more efficient appliances. For lower and middle income
households, possible negative impacts could be alleviated, if part of the ETS
auction revenue is used for measures intended to increase energy efficiency and
insulation or to provide financial support in order to address social aspects
in these households, as specified in article 10(3) of the ETS Directive. Decarbonisation
policies also reduce emissions of PM2.5, SO2 and NOx.
So through the carbon price signal, a carbon market can have positive health
impacts by in short-term by improving air quality through encouraging fuel
switching from coal to gas and in the mid- and long-term by discouraging
financing new coal facilities. While several factors have driven the EU to use
more coal, the weak carbon price signal in the EU has contributed to many
consumers opting for coal over natural gas.  A stronger carbon price signal is
therefore expected to discourage fuel combustion, in particular coal, and have
positive health impacts as well as broader economic benefits. 
In terms of employment, the carbon market
can have impacts through changes in production and related jobs, and through
the possible use of auction revenue to reduce labour taxes. On the one hand, environment
and climate policies in general are expected to contribute to creating jobs
through investment in typically labour intensive sectors, such as energy
efficiency and renewable energy. Figures from the Communication "Towards a
job-rich recovery[51]"
indicate that, despite economic downturn, the green economy has seen a rise in
employment and remains strong. The 2030 impact assessment shows that when
auction revenue are recycled and if carbon pricing extended to all sectors, decarbonisation
policies can lead to an increase in employment of 0.2% or 430.000 net jobs
created by 2030. The United Nation Environment Program (UNEP) estimates that
compared to fossil-fuel power plants, renewable energy generates more jobs per
unit of installed capacity, per unit of power generated and per dollar
invested. The stronger the carbon price signal, the higher the employment benefits
in the green economy are expected to be. 
On the other hand, if leading to possible
production losses in certain energy-intensive industries deemed to be exposed
to a significant risk of carbon leakage, a carbon price signal can have impacts
on the jobs in those sectors. In this case, the stronger the carbon price, the
higher the risk of carbon leakage and possible job losses. 
Furthermore, there is still a large scope
to shift the tax burden away from labour especially on the low skilled workers.
Lowering tax burden on labour will create new jobs, as well as improve
cost-competitiveness and encourage entrepreneurship. EU ETS auction revenue can
be used for reducing the labour cost. However, there are limits on the amount
of auction revenues and hence possible trade-offs between the use of the
revenues for different purposes, depending on the overall amount. In case of
the market stability reserve option, there would be a trade-off between
government auction revenue that could be used for reducing labour cost and the
use of allowances released from the reserve, in case it was decided to use them
for financing low-carbon investment (e.g. along the lines of the NER300
programme). In that respect, the more allowances were put into a reserve, the
lower the possible government revenue that could counteract a decrease in the
labour cost could be. However, increased financing of low-carbon investment
could have positive second order effects on employment in the sectors concerned.   
   
7.6.        Environmental impacts
The environmental impact of the EU ETS in
terms of emissions in the sectors covered over a certain period of time is
determined by the cap. The options that entail a permanent retirement (1a,1b and
3) would therefore lead to more positive impacts in terms of emission
reductions that the market stability reserve options (2a-2g), unless it was
decided that the reserve is used to facilitate the step-up to a more ambitious
EU GHG target.  
In addition to the direct impacts on
emission reductions, a more stable and stronger carbon price signal should also
allow the ETS to better support the achievement of the renewables targets and
the further improvement of energy efficiency by 2020.
As mentioned, decarbonisation policies also
reduce emissions of PM2.5, SO2 and NOx. Hence,
a structural measure would also have positive impacts on air quality by
incentivising in fuel-switching from coal in power plants. The stronger the
carbon price signal, the more it drives energy efficiency and low-carbon energy
sources, reducing also the need for fuel combustion in the mid- and long-term. 
8.           Comparison of options and
conclusions
Table 9 compares
the options for a permanent retirement (1a and 1b), a market stability reserve
(specifically option 2d)[52]
and combination of a market stability reserve with permanent retirement (3) to
the baseline option 0 in terms of their effectiveness in achieving the
objective and coherence with other policy goals. The assessment has identified
important advantages of a structural measure being taken in the short-term. At
the start of phase 3, the EU ETS was characterised by a surplus of around 2
billion allowances, which is expected to grow further. Not addressing the
surplus is expected to result in a prolonged downward pressure on the carbon
price signal, which is expected to lead to carbon lock-in and raise the cost of
emission cuts needed in the future, reducing inter-temporal efficiency.  
A permanent retirement or a market
stability reserve will improve the market balance by addressing the surplus in
a more lasting manner than back-loading and, if implemented as of 2017,
avoiding another increase as of 2019, although a small retirement (option 1b)
alleviates a further surplus increase to a very limited, probably insufficient
extent. This option is expected to be only marginally more effective in
addressing the market imbalance and in turn improving the efficiency of the EU
ETS in the mid- and long-term than the baseline option.
A large retirement and a market stability
reserve are more likely to be effective in addressing the market balance in a
lasting manner. However, a permanent retirement does not increase the
resilience of the EU ETS to potential future large-scale events that may
severely disturb the market balance, while a market stability reserve does. Similarly,
a permanent retirement is able to capture the impacts of complementary
policies, such as energy-efficiency and renewables measures, on the demand for
emission allowances so far, but not any future impacts. A combination of the
two measures (options 3) - a market stability reserve and permanent retirement
- may both correct the existing market imbalance and prevent it from happening
again in the future. If the reserve is combined with a fairly low permanent
retirement it will still lead to a rebound in the surplus at the end of phase
3, however it will decrease it in the years that follow. However, this option
implies a measure taken in phase 3 and a permanent retirement.
By changing the auction volumes, the free
allocation given to the industry will not be affected. A structural measure is
likely to increase the carbon price signal in relative terms in the second half
of phase 3 compared to the baseline option. However, it may not necessarily
increase the carbon price in absolute terms, but rather prevent a price decline
when backloaded allowances would otherwise return to the market. The price
impact is expected to be the strongest for the large permanent retirement (1a),
probably followed by the combination of a market stability reserve with a
limited permanent retirement (3a and 3b) and market stability reserve alone
(2d) and only very limited and short-lived impact of the small retirement (1b).
Accordingly, the impacts on individual companies will be the strongest in case
of a large permanent retirement, both in terms of benefits for companies covered
by the EU ETS, which are net sellers of allowances in phase 3, and companies
relying on low-carbon investment, and cost in terms of net buyers of allowances
in phase 3. 
Similar considerations apply to other
impacts. The social impacts are also two-pronged. On the one hand, a stronger
carbon price can lead to additional jobs in sectors associated with green
economy. On the other hand, a stronger carbon price increases the risk of
carbon leakage and hence job losses in the sectors deemed to be exposed to this
risk. A stronger carbon price is also expected to lead to highest increase in
electricity prices in the short-term, as well as highest benefits in terms of
air quality and associated health impacts.
A permanent retirement has a clear
advantage over options that include a market stability reserve in terms of
simplicity, as also acknowledged by most stakeholders. 
9.           Monitoring and evaluation  
The Commission will continue to monitor and
evaluate the functioning of the carbon market in its annual Carbon Market
Report, as foreseen under Article 10(5) of the EU ETS Directive. This annual
report foresees the explicit monitoring of the functioning of the EU ETS
including the implementation of the auctions and would implicitly also cover
the impacts of any structural measures. This may be particularly relevant in
case of a market stability reserve and its review.  
   
Table 9: Comparison with baseline option 0 in terms
of effectiveness and coherence
   ||   || Effectiveness in improving the inter-temporal efficiency and resilience of the EU ETS || Coherence with other policy goals || Simplicity 
 Renewables and energy efficiency policies || Competitiveness || Social impacts || Environment 
 Large retirement || 1a || Considerable continued decline in the surplus, continued carbon price support and no rebound in the surplus and no decline in the carbon price signal in 2019-2020. But no improvement in market imbalance in case of future large-scale events. + || Captures impact complementary policies had so far, but not additional future impacts   + || Strong signal against the fragmentation of EU energy and climate policy. No decline and possible limited increase in the value of allowances for surplus holders and in cost for net buyers. No decline and possible limited increase in electricity cost. Opposite effects in the long-term.  Strong signal for low-carbon investment +/- || No decline and possible limited increase in electricity cost Limited employment impacts Strong signal against carbon-intensive fuel use and for health benefits +/- || Strong signal against high-carbon fuel use ++ || + 
 Small retirement || 1b || Considerable rebound in the surplus and decline in the carbon price signal in 2019-2020. No improvement in market imbalance in case of future large-scale events. 0 || Only partly captures impact of complementary policies had so far, no additional future impacts. 0 || Weak signal against the fragmentation of EU energy and climate policy. No reversal in the decline of value of allowances for surplus holders and no increase in cost for net buyers. No increase in electricity cost. Opposite effects in the long-term. Weak signal for low-carbon investment 0 || Decline in electricity cost Limited employment impacts Weak signal against carbon-intensive fuel use and for health benefits 0 || Weak signal against carbon-intensive fuel use 0 || + 
 Market stability reserve || 2(d) || If implemented in phase 3, continued decline in the surplus, followed by a partial rebound in 2019-2020. If implemented in phase 4, considerable rebound in surplus and limited support of the carbon price signal in 2019-2020, followed by decline in the surplus and price support as of phase 4. Increase in auction supply in the mid-term. Improvement in market-balance in case of future large-scale demand shocks + || Captures impact complementary policies had so far, as well as additional future impacts ++   || Moderate signal against the fragmentation of EU energy and climate policy Short-term decline or possible limited increase in the value of allowances for surplus holders and in cost for net buyers. Short-term decline or possible limited increase in electricity cost. Opposite effects in the mid-and long-term.  Improved certainty and moderate signal for low-carbon investment +/- || Short-term decline or possible limited increase in electricity cost. Limited employment impacts Moderate signal against carbon-intensive fuel use and for health benefits +/-   || Moderate signal against carbon-intensive fuel use + || - 
 Combination of a market stability reserve and permanent retirement || 3 || Partial rebound in the surplus and decline in the carbon price signal in 2019-2020, followed by decline in the surplus and price support as of phase 4 Increase in auction supply in the mid-term Improvement in market balance in case of future large-scale shocks + || Captures impact complementary policies had so far, as well as additional future impacts ++   || Moderate signal against the fragmentation of EU energy and climate policy Possible limited increase in the value of allowances for surplus holders and in cost for net buyers. Possible limited increase in electricity cost in the short-term. Opposite effects in the mid-and long-term.  Improved certainty and moderate signal for low-carbon investment +/- || Possible limited increase in electricity cost. Limited employment impacts Moderate signal against carbon-intensive fuel use and for health benefits +/- || Moderate signal against carbon-intensive fuel use + || - 
10.         Annexes
10.1.      Sensitivity analysis
10.1.1.   Baseline scenario
Baseline projections only project already
implemented policies, and do not achieve in all Member States all targets, for
example the renewables targets. Forecasted EU ETS emissions remain flat by 2020
and start slowly decreasing in phase 4. With higher emissions than in the
reference scenario, the expected surplus is lower but still around 2 billion in
2020 without any measures (option 0). 
Impact of options implemented in phase 3
Figure 20
illustrates the impact of various sub-options on the evolution of the surplus
based on baseline scenario emissions profile, if implemented in phase 3.     
Figure 20:
Evolution of the surplus assuming baseline scenario emissions with options
implemented in phase 3  
Figure 21 illustrates
the impact of the various market stability reserve sub-options in terms of size
of the reserve based on the baseline scenario emissions. Given the smaller
surplus, there is less need for adjustments putting allowances into the
reserve, resulting in an earlier stop to adjustments putting allowances into
the reserve and a smaller size of the reserve at its peak and to possible earlier
adjustments in the other direction, taking allowances from the reserve.   
Figure 21:
Evolution of the reserve under sub-options with a market stability reserve implemented
in phase 3 assuming baseline scenario emissions
Impact of a options
implemented in phase 4
Figure 22 and Figure 23 depict the impact of various
sub-options implemented in phase 4, assuming baseline scenario emissions. Again
the surplus is lower than with reference scenario emissions, however, still at
the level that requires some adjustments putting allowances into the reserve at
least at the beginning of phase 4. However, these adjustments are generally
lower and stop earlier.     
Figure 22:
Evolution of the surplus assuming baseline scenario emissions with options
implemented in phase 4
Figure 23:
Evolution of the reserve under sub-options with a market stability reserve
implemented in phase 4 assuming baseline scenario emissions
10.1.2.   40% GHG emission reduction by 2030
According the ETS Directive, the ETS cap
for stationary sources decreases linearly, with an annual amount equal to 1.74%
of the average annual allocation during phase 2 (excluding aviation), referred
to as the linear reduction factor[53]. The scenario with 40% GHG reductions and moderate
energy-efficiency and renewables policies up to 2030 achieves emission
reductions in the ETS of 43% by 2030 compared to 2005. Setting a cap at this
2030 emission level would require a change of the linear reduction factor. 
Impact of options
implemented in phase 3
Figure 24 shows the
impact of various sub-options, implemented in phase 3, on the evolution of the
surplus using the GHG 40% emission projections. Even if, as of phase 4, the
linear reduction factor would be increased to a level consistent with a 40% GHG
emission reduction by 2030, it would still result in a surplus well above 2
billion allowances by the end of phase 4 and even 2030[54].
Figure 24: Evolution of the surplus assuming 40% GHG
reduction emissions profile with options implemented in
phase 3
Figure 25 shows the
impact of various sub-options with a market stability reserve implemented in
phase 3 in terms of the size of the reserve using the GHG 40% emission
projections.
Figure 25: Evolution
of the reserve under sub-options with a market stability reserve implemented in
phase 3 assuming 40% GHG reduction emissions profile
Impact of options
implemented in phase 4
Figure 26 and Figure 27 show that even if the linear
reduction factor would be increased to a level consistent with a 40% reduction target
by 2030, it would still require adjustments putting allowances into a reserve
in order to reduce the surplus, otherwise still staying well above 2 billion by
end of phase 4.     
Figure 26:
Evolution of the surplus assuming 40% GHG reduction emissions profile with
options implemented in phase 4
Figure 27: Evolution of the reserve under
sub-options with a market stability reserve implemented in phase 4 assuming 40%
GHG reduction emissions profile 
10.2.      Summary of the results of the
stakeholder consultation
On 14 November 2012, the European
Commission adopted a Report on the State of the European Carbon Market in 2012
(Carbon Market Report).[55]
This document served as a consultation document for a twelve-week online
consultation on the options for structural measures to strengthen the EU Emissions
Trading System (ETS, which lasted until the end of February 2013, allowing
stakeholders, Member States and other EU institutions to express their views. 
The Carbon Market
Report gave an overview of the current functioning of the market with a large
and growing supply-demand imbalance of emissions allowances in the EU ETS,
followed by a non-exhaustive list of six options for structural measures:
(a)                   
Increasing the EU reduction target to 30% in
2020;
(b)                   
Retiring a number of allowances in phase 3;
(c)                   
Early revision of the annual linear reduction
factor;
(d)                  
Extension of the scope of the EU ETS to other
sectors;
(e)                   
Use of access to international credits;
(f)                    
Discretionary price management mechanisms.
The information
submitted to the consultation is a fundamental part of the impact assessment
and has been taken into due account in the Commission's preparations of more
concrete proposals for a structural measure.
This document summarises the responses to
the consultation. It is available on the webpage of the online consultation[56], together with the
individual contributions received.   
10.2.1.   Process
The online consultation lasted from 7
December 2012 to 28 February 2013. A dedicated webpage including the link to
the Carbon Market Report was created and announced on the centralised
"Your Voice in Europe" page. 
The following general groups replied to the
consultation: 
·                        
Organisations consisting of business
associations; trade unions; representatives of civil society; such as
non-governmental organisations (NGOs); organisations representing other
stakeholders groups; and individual companies;
·                        
Public authorities consisting of national and
sub-national authorities;
·                        
Citizens;
·                        
Stakeholders, who identified themselves as
organisations representing certain interests but could not be verified in the
EU Transparency Register. 
In addition, two dedicated full-day
consultation meetings were organised on 1 March and 19 April 2013 in Brussels.
An expert meeting on an additional option, which emerged from the consultation,
of a reserve mechanism to render the auction supply more flexible was organised
on 2 October 2013. The results of all meetings were taken into due
consideration together with the results of the online consultation in preparing
this summary.
Box 2: Consultation meetings
The Commission organised two full-day consultation
meetings to examine with the stakeholder community in detail the merits and
drawbacks of the six options set out in the Carbon Market Report. The agenda
was defined in a way to move forward the reflection on three options in each
meeting. In addition, the second meeting looked at possible additional options
supported by several stakeholders in the online consultation.
1st meeting on 1 March 2013
Welcome and introductory remarks were given by the
Commission and the Irish Government. The Commission also presented a summary of
the results of the online consultation. 
The first session was dedicated to option
(b) of retiring a number of allowances in phase 3. The panel was composed of a
representative of Centre for European Policy Studies (CEPS) acting as a lead
discussant, followed by representatives of BusinessEurope and International
Emissions Trading Association (IETA). 
The second session was dedicated to option (f) of
discretionary price management mechanisms. The panel was composed of a
representative of Bloomberg New Energy Finance (BNEF) acting as a lead
discussant, followed by representatives of Glass for Europe and Eurelectric.
The third session was dedicated to option
(a) of increasing the EU reduction target to 30% of 2020. The panel was
composed of a representative of University College Dublin acting as a lead
discussant, followed by representatives of Cembureau and The Prince of Wales's
EU Corporate Leaders Group on Climate Change.
A video recording is available at the
following webpage:
https://scic.ec.europa.eu/streaming/index.php?es=2&sessionno=4ecb679fd35dcfd0f0894c399590be1a
2nd meeting on 19 April 2013
Welcome and introductory remarks were given
by the Commission. 
The first session was dedicated to option
(c) of early revision of the linear reduction factor. The panel consisted of a
representative of Tschach Solutions acting as a lead discussant, followed by
representatives of Confederation of European Paper Industries (CEPI) and
Climate Action Network Europe (CAN-Europe). 
The second session was dedicated to option
(d) of extension of the scope of the Eu ETS to other sectors. The panel
consisted of a representative of Öko-Institute acting as a lead discussant,
followed by representatives of Europia and Department of Climate Change and
Energy Efficiency, Australia. 
The third session was dedicated to option
(e) of use of access to international credits. The panel consisted of a
representative of Center for Clean Air Policy Europe (CCAP Europe) acting as a
lead discussant, followed by representatives of Eurofer and European Trade
Union Confederation (ETUC).
The fourth session was dedicated to
additional options supported by stakeholders. The panel consisted of
representatives of Thomson Reuters Point Carbon and European Chemical Industry
Council (CEFIC).
The meeting also included an item on
competitiveness and risk of carbon leakage presented by the Commission. 
A video recording is available at the
following webpage:
https://scic.ec.europa.eu/streaming/index.php?es=2&sessionno=b607ba543ad05417b8507ee86c54fcb7        

10.2.2.    Distribution of replies to the online consultation
In total 232
responses were received. One stakeholder requested that their submission
remains confidential. 
The consultation
registered a strong participation by organisations, with around 66% of overall
replies from registered[57]
organisations and 23% from non-registered organisations. 8% replies came from
citizens and 3% from Member States and other public authorities (see Figure 28).
Figure 28: Replies
per affiliation
Concerning the
geographical distribution, European level organisations represent the highest
share of responses (22% of all replies). At Member State level, stakeholders
from the biggest Member States are also generally best represented: Poland
(11%), France (7%), United Kingdom (7%), Germany (6%) and The Netherlands (6%).
Among non-European countries, Norway represents the highest participation (3%).
Equally strong participation can also be noted from international organisations
with members from both EU and third countries (3%).
Figure 29:
Geographical distribution of replies
    
10.2.3.   EU remains the best instrument for achieving the EU
objective of an economy-wide 80-95% reduction
The public
consultation showed that a large majority of stakeholders continued to hold the
view that the EU ETS is the best instrument for the covered sectors to
contribute to achieving the EU objective of an economy-wide 80-95% reduction in
greenhouse gas emissions by 2050 within an internal market.
Stakeholders are
asking for a stable, predictable legislative framework, which they believe
necessary for business investment.  Utilities, gas companies, organisations in
the renewables sector, non-energy intensive companies, NGOs, academia, think
thanks and some Member States think that because of a large surplus of
allowances, the market does not work in every aspect in a satisfactory way.
Some energy-intensive industry organisations feel a structural reform of the EU
ETS first needs to bring a structural solution to EU's competitive position.
Nevertheless, stakeholders, including most industrial organisations, recognise
that there is a large and growing surplus in the carbon market. 
Some energy-intensive
industry organisations thought that the Carbon Market Report puts forward the
options because the carbon price signal does not generate enough revenue for
Member States. Many regretted that the options set out in the Carbon Market Report
were not explicitly linked to a clear process on the 2030 framework. Some
stakeholders felt that the options appeared to concentrate on the short-term
action and did not sufficiently address the underlying issues. According to
some, there are significant differences between the economies of Central Europe
and the rest of the EU.
Stakeholders have
mixed views on the extent to which the success of the EU ETS depends on a
robust carbon price signal. Many argue that a significant carbon price is
necessary so that the low-carbon investment results in a positive business
case. Others emphasised that a low carbon price simply indicates that there is
little need for additional abatement to meet the current target. Accordingly,
views differ on the need for measures in phase 3. 
10.2.4.   Option (a): Increasing the EU reduction target to 30% in
2020
It is frequently
pointed out that this option is not deployable fast enough and would hence have
too little impact in order to address quickly enough the surplus in the market.
Although the energy-intensive industry organisations support the conditional
position to increase the target in case other industrialised countries commit
to comparable emission reductions, they emphasise that only the EU, Australia,
Norway and Switzerland and a few other countries agreed to binding emission
reductions. 
Others, including
the organisations from the renewables sector, see the increase of the target
not only as a solution to the climate challange, ensuring that the EU policy
complies with the 25-40% domestic reductions needed in the industrialised
nations to keep global warming below 2°C, but also as a solution to economic
and energy crises. However, throughout the second consultation meeting, there
was a strong acknowledgement by the proponents of more ambitious action that
pursuing this option may use up all political capital for the negotiations on
the 2030 framework.    
10.2.5.   Option (b): Retiring a number of allowances in phase 3
Throughout the
consultation, there was a strong support by those advocating a measure in phase
3, for a permanent retirement of a number of allowances. Electricity companies
support this option as it addresses the problem in a direct manner. Similarly,
gas companies support a permanent retirement (of at least 1.2 billion
allowances) to reinforce the effect of back-loading, as the definition of a
emission reduction target for 2030 and consistent revision of the linear
reduction factor take time. The option is also seen as the simplest.  
The options also
seems attractive to the academia, however they highlight the possibly difficult
political process the option may require. Part of the some energy-intensive
industry representatives see it as only addressing the symptom – the surplus in
the EU ETS – but not the underlying problem.
10.2.6.   Option (c): Early revision of the annual linear reduction
factor
By some of the
energy-intensive industry organisations, this option is seen as having a double
negative effect on its competitiveness by higher scarcity of allowances leading
to higher carbon prices and by reducing the free allocation to industry. But
otherwise there is a broad consensus among other stakeholders that the revision
of the factor should be accelerated (to as early as 2014). 
Non
energy-intensive companies support the increase of the factor from 1.74% to
2.5%.
The NGOs agree that the current factor is not
consistent with the EU agreed long-term objective of 80-95% reduction by 2050.
However, most stakeholders believe that even an early revision of the factor
would not have a material impact on the imbalance in the market much before
2020. Hence, many stakeholders believe that the factor should be revised early
consistently with a 2030 GHG reduction target, and if necessary accompanied by
a permanent retirement to swiftly address the surplus.  
10.2.7.   Option (d): Extension of the scope of the EU ETS to other
sectors
Some stakeholders note that extension
to sectors, such as transport, including perhaps maritime, and households would
increase liquidity in the market. It is considered by many as consistent with
the goal of cost-effective economy-wide reductions.  
But specifically in terms of road
transport, part of the NGOs oppose its inclusion in the system, as would not
deliver economic benefits. There is also a general agreement that this option
will take longer to implement and is thus only relevant for post 2020. Many
replies also suggest that a thorough impact assessment must be made.   
10.2.8.   Option (e): Use of access to international credits 
Some stakeholders
see this option as not having a significant impact on the ability of the EU ETS
to meet the EU long-term target of 80-95% reduction in a cost-effective manner.
Other stakeholders oppose limiting the access to international credits. 
On the other
hand, some NGOs and citizens emphasise many concerns regarding their use in the
EU ETS. Some feel access to international credits should not only be limited
but not allowed altogether.  Outcome of the international negotiations is seen
as one of the principle considerations in terms of this option.  
10.2.9.   Option (f): Discretionary price management mechanisms
The vast majority
of stakeholders highlight that the process for determining the true economic
cost of abating greenhouse gas emissions is best determined through market
principles and not via discretionary price management. Still, a few
stakeholders, including project developers for international credits, would be
supportive of a creation of a mechanism, which creates a reserve to buy
allowances under a defined policy. A preferred choice that clearly emerges from
the online consultation to address part of the surplus due to the economic
crisis is to establish, not a price-based, but rather a volume-based
supply-management mechanism. 
Building on this,
an additional option of a reserve mechanism to render the auction supply more
flexible appeared at the 1st consultation meeting. Hence, the
Commission organised an expert meeting to explore this option further (see Box 3).   
Box 3: Expert
meeting on flexible auction supply
The Commission hosted a panel of experts on 2 October 2013 to
discuss technical aspects related to the possible creation of a reserve
mechanism to render auction supply in the EU ETS more flexible. The agenda was
focused five questions, which were defined in a way to encourage a structured
debate. Welcome remarks were given by the Commission and an introductory
presentation by a representative of Tschach Solutions/ICIS. The panel of experts
was comprised of experts from industry, power generation, finance, research,
market analysis, non-governmental organisations and Member States. They
participated in their personal capacity.  
The conclusions were as follows: 
A rule-based approach that makes auction supply more flexible is
seen as part of the necessary structural reform of the EU ETS. The general view
was that the objective behind more flexible auction supply is to improve
efficiency in the market. More precisely, the participants often referred to
inter-temporal efficiency, to address the current situation where the diluted
short-term carbon price signal is expected to be followed by an unnecessarily
higher price in the mid- and long-term, and possible higher cost in total.
There was some hesitation about the mechanism, primarily because of possible
data constraints to set the triggers at appropriate levels.
Three types of triggers were discussed: volume-based (e.g. based on
surplus), output-based (e.g. based on GDP) or price-based. There seems to be a
clear preference for volume-based triggers, specifically based on thresholds
related to the cumulative surplus of allowances. Unlike output-based triggers,
they can capture changes both in output as well as due to impact of other
policies delivering abatement (renewables and energy-efficiency). The triggers
should not be based on the carbon price.
In terms of data, the mechanism should be based on actual historical
data, such as verified emissions, and not on forecasts.  
Another important conclusion was that the mechanism should not be
overly complicated in general.
What is clear is that the trigger values should ensure that the
mechanism applies in cases of large market imbalances only, and not whenever
there is a minor surplus in the market. 
Regular review of the triggers is needed, but not too often to
ensure market certainty. Two concrete periods that were mentioned were every 5
years or once per 8-year trading period.
The mechanism should avoid unnecessarily further destabilising the market
by following large changes in the demand by large changes in the supply. Hence,
there should be limits on the amount of adjustment that is possible in a year. 
There seems to be a general preference for having the same
"mirror" rules apply for putting allowances into the reserve and
releasing them from the reserve. Nevertheless, some participants acknowledged
that there may also be good alternative approaches. 
10.2.10. Other proposals
By some
energy-intensive industry organisations, the options referred to in the report
were perceived as incomplete. However, apart from the additional option of
flexible auction supply, there were hardly any suitable options proposed to
address the supply-demand imbalance. Instead, most other proposals concerned
measures to address the risk of carbon leakage. Business organisations called
for:
·                        
Supporting industry with recycling of auction
revenue;
·                        
Adequate evidence-based support to sectors
deemed to be exposed;
·                        
Maintaining a stable carbon leakage status;
·                        
Forward looking industrial policy giving
priority to boosting research and innovation;
·                        
Indirect free allocation for electro-intensive
sector;
·                        
More achievable benchmarks, e.g. based on
weighted average of performance of EU installations;
·                        
Redesigning the EU ETS from a static to a
dynamic one, allocation to operators based on actual production.  
[1]               COM(2012) 652
[2]               COM(2013) 169
[3]               For additional information see Impact Assessment for
a 2030 climate and energy policy framework 
[4]               COM(2012) 416 and draft Commission Regulation:
http://ec.europa.eu/clima/policies/ets/reform/docs/2013_07_08_en.pdf

[5]               SWD(2012) 234
[6]               http://ec.europa.eu/clima/policies/ets/cap/auctioning/docs/swd_2012_xx2_en.pdf

[7]               Energy Economic Developments in Europe, European
Economy 1, 2014. European Commission 
[8]               Surplus is defined as the difference between the
cumulative amount of allowances available for compliance at the end of a given
year, and the cumulative amount of allowances effectively used for compliance
with the emissions up to that given year.  
[9]               Baseline scenario assumes full implementation of
existing policies without additional policies that would for instance still be
required to achieve the renewable energy targets for 2020. 
[10]             Reference scenario assumes full implementation of
existing policies, including the achievement of the renewable energy and greenhouse
gas reduction targets for 2020 and implementation of the Energy Efficiency
Directive. For additional information see Impact Assessment for a 2030 climate
and energy policy framework
[11]             COM(2013) 722 final
[12]             In line with the 2030 IA, the calculations assume an
emissions profile of the reference scenario.
[13]             E.g. see Energie-Nederland response to the consultation
on the options for structural measures
[14]             Figure 3 shows the surplus in a scenario with 40% GHG reductions and
moderate energy efficiency and renewables policies up to 2030. For additional
information see Impact Assessment for the 2030 climate and energy policy
framework. 
[15]             In the context of carbon markets, this refers to the
optimal balance between the carbon price signal and low-carbon investment that
is needed now, and those that will be needed in the future. 
[16]             E.g. see Eurelectric's and AFEP's responses to the
consultation on the options for structural measures
[17]             E.g. see Businesseurope recommendations for a 2030
framework for energy and climate policy, June 2013
[18]             International Emissions Trading Association (IETA). Initial
IETA reflections on the concept of an "Automatic Adjustment of Auction
Volumes" in the EU ETS. 2013
[19]             E.g. CEFIC, Enel and Fortum responses to the
consultation on the options for structural measures
[20]             Commission Regulation (EU) No
1031/2010
[21]             E.g. see CEFIC and IFIEC contributions to the
consultation on the options for structural measures
[22]             Presentation by Point Carbon and ensuing discussion at
the consultation meeting of 19 April 2013
[23]             
[24]             SEC(2008) 85/3
[25]          Hedging
is making an investment to decrease a risk of an adverse price movement in an
asset. It is widely used by companies in various sectors and markets for instance
in sectors heavily dependent on oil prices or exposed to foreign currency
risks. Typically power companies need to cover at least to some extent their forward
sales of electricity with allowances. 
[26]             Based on 80-100% % of the expected 2014 auction volume
[27]             http://www.fortum.com/SiteCollectionDocuments/Media/Fortum_ASAM_Pöyry_report_%20summary.pdf
[28]             E.g. see consultation contribution by Fertilisers
Europe
[29]             International Emissions Trading Association (IETA). Initial
IETA reflections on the concept of an "Automatic Adjustment of Auction
Volumes" in the EU ETS. 2013
[30]             Some of this behaviour may be captured and prohibited
by the market abuse rules applying to financial instruments. 
[31]             If 10% of cumulative surplus is above 100 million, this
means the 100% of cumulative surplus is at least 1 billion allowances. 
[32]             http://ec.europa.eu/economy_finance/publications/european_economy/forecasts/index_en.htm

[33]             Auctioning Regulation allows for subsequent changes to
a published auction calendar in a number of prescribed situations, most of
which are technical of nature (Article 14 of Auctioning Regulation). 
[34]             The assumption on how the remaining allowances return
to the market is aligned with the envisaged back-loading profile, with a third
of the amount returning in 2019 and the remaining two thirds in 2020. 
[35]             If the adjustments releasing allowances from the
reserve (meaning the cumulative surplus is below 400 million) were also defined
as a percentage of the cumulative surplus, they would by definition always be
lower than the minimum limit on the adjustment of 100 million allowances (as
they would always be lower than 10% of 400 million=40 million). Hence, the
limit needs be lifted on the adjustment releasing allowances from the reserve
or adjustment determined as a fixed instalment.  
[36]             Back-loading would have translated into reduced annual
auction volume in 2014-2016.
[37]             E.g. see consultation contribution by Cembureau
[38]             Although back-loading will translate into reduced
annual auction volumes and t in principle lead to annual changes in surplus
above the thresholds, those amounts are considered as foreseen adjustments that
are not counted in the calculations of next year's surplus. Otherwise, each
adjustment reducing auction volumes could potentially necessitate an adjustment
in the opposite direction the following year and so on. 
[39]             For more information see chapter 4.1 of the impact
assessment on backloading: http://ec.europa.eu/clima/policies/ets/cap/auctioning/docs/swd_2012_xx2_en.pdf

[40]             SEC(2010) 650
[41]             SWD(2012) 5 final
[42]             E.g. see response by Finnish Energy Industries to the
public consultation on the options for structural measures
[43]             E.g. see response by European Tyre and Rubber
Manufacturers' Association (ETRMA) to be public consultation on the options for
structural measures
[44]             SEC(2010) 650
[45]             Response by European Wind Energy Association (EWEA) to
the public consultation on the options for structural measures 
[46]             All stationary installations reported in the European
Union Transaction Log (EUTL) that do not have as activity code
"combustion". 
[47]             All installations not identified as "electricity
generators". Therefore, this does not include free allocation to
electricity generators pursuant the application of the derogation allowed under
article 10c of the EU ETS Directive. It also does not include free allocation
for heat to electricity generators. However, it does include free allocation
for cross-boundary heat flows that may not correspond to emissions in the industrial
sectors themselves. For those installations that have not yet reported
emissions in the EU ETS, estimates have been made based on other reporting
installations.  
[48]             Energy Economic Developments in Europe, European
Economy 1, 2014. European Commission
[49]             Ranging from 0.4%-1.7% at Member State level. Based on
a simple average of increases for EU Member States, hence not weighted average.
Source of electricity prices: http://www.energy.eu/,
reference month May 2013
[50]             Ranging from 0.2%-1.3% at Member State level. Based on
a simple average of increases for EU Member States, hence not weighted average.
Source of electricity prices: http://www.energy.eu/,
reference month May 2013  
[51]             COM(2012) 173 Final
[52]             Impacts of a market stability reserve will depend on
its design. As explained earlier, for the purpose of this comparison the
central options for a market stability reserve is based on sub-options 2c and
2d.  
[53]             To determine 2013 allocation, the linear factor is
applied starting from 2010 onwards.
[54]             For additional information see Impact Assessment for
the 2030 climate and energy policy framework. 
[55]             COM(2012) 652
[56]             http://ec.europa.eu/clima/consultations/articles/0017_en.htm 
[57]          In the
interests of transparency, the Commission asks organisations who wish to submit
comments in the context of public consultations to provide the Commission and
the public at large with information about whom and what they represent by
registering in the Transparency
Register and
subscribing to its Code of Conduct.