Emissions of a Nuclear Exit
Tags: Climate Action, Renewable Energy, Nuclear Energy

Impact of the Cancellation Policy in the Market Stability Reserve on the Effective Emissions of a Nuclear Exit in Belgium

(The below article appeared first in Dutch on LinkedIn.)

It is well known and recently reconfirmed that, by 2025, Belgium is planning to exit nuclear power — which delivers a major share of the Belgian power generation: with 6 GW of installed capacity, it delivers more than 40% of all domestic electricity if operational.

In order to achieve this transition, the Belgian government plans to auction a capacity remuneration to trigger the investment of 2.5 to 3.2 GW of gas-fired power plants. The idea behind this has always been two-fold:

By installing flexible gas power plants, it would be easier to further develop renewable energy within Belgium from a market and grid perspective.

The carbon emissions linked to the switch to gas, which are estimated to be 2.5 to 3.5 MtCO₂ per year, would be compensated within the European Emissions Trading Scheme.

One of the questions often raised is whether the latter explanation stands strong: “are the emissions related to a nuclear exit compensated within the emission trading scheme?”

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The EU ETS ‘Waterbed Effect’

The European Emissions Trading Scheme (EU ETS) is often seen as the flagship of European climate policy and is based on a simple principle:

For every tonne of CO₂ emitted in the European electricity sector, the energy-intensive industries, and the aviation sector, the emitting party must submit one emission allowance (or ‘EUA’), and the number of allowances manually put into circulation is regulated by the European Commission.

The EU ETS is a strong mechanism because of three aspects:

First , the total allowances (and hence emissions) within the system are finite by definition: year after year, Europe puts fewer and fewer allowances into circulation and moves towards zero allowances in 2050.

, the total allowances (and hence emissions) within the system are finite by definition: year after year, Europe puts fewer and fewer allowances into circulation and moves towards zero allowances in 2050. Second , the emissions trading system covers a significant part of total European emissions: at its start-up in 2005–2007, more than 12 000 industrial installations are covered by the EU ETS, initially corresponding to 2.3 GtCO₂ annually or 40% of total emissions in Europe.

, the emissions trading system covers a significant part of total European emissions: at its start-up in 2005–2007, more than 12 000 industrial installations are covered by the EU ETS, initially corresponding to 2.3 GtCO₂ annually or 40% of total emissions in Europe. Third, the trade and banking of allowances should result in a cost-efficient energy transition at the European level — realizing the cheapest emission reductions first and the most expensive ones last.

Trading of allowances can take many forms: some companies or sectors receive free allowances, others have to buy their allowances at official auctions or may choose to trade them among themselves.

Emission allowances also do not have an expiry date either. This means allowances can be banked for later use, and that the total number of allowances put into circulation will also equal the final emissions. Temporary surpluses, e.g. due to economic stagnation or an accelerated roll-out of renewables, thus initially only affect when emissions would occur and who would emit — not the number of emissions. Hence, we say the Waterbed Effect applies: each measure that results in 1 tCO₂ of emissions takes 1 allowance out of rotation, which reduces everyone else’s possibility of emitting by 1 tCO₂.

Since 2015–2019, however, this picture looks slightly different.

In the first decade of EU ETS, the actual emissions were significantly lower than the allowances put into circulation. Surpluses accumulated, and the price stagnated at around €6 per allowance.

In order to make the EU ETS a strong mechanism again, two things were changed:

The annual linear reduction factor (LRF) in the number of allowances put into circulation was increased. A market stability reserve (MSR) was set up to accommodate historical non-auctioned or allocated allowances and annual surpluses.

The tightening of the annual reduction factor from 1.7% to 2.2% reduces the number of allowances issued in 2031 to 1.2 GtCO₂, or 57% of the number in 2005. The resulting cumulative number of allowances that will be put into circulation after 2018 is thus reduced to 43.8 GtCO₂.

Furthermore, the market stability reserve seeks to stabilize emissions trading in two ways:

If there is an excess of allowances in circulation, each year a proportion of the allowances that are to be auctioned will not be auctioned but placed in the reserve. In this way, the impact of historical surpluses on the market price is gradually eliminated.

When there is a scarcity of allowances in circulation, allowances that were previously withdrawn from circulation are put back into circulation and auctioned.

To this end, Europe makes an annual inventory of the total number of allowances in circulation (TNAC). As long as the number of allowances in circulation exceeds 833 MtCO₂, a total of 24% of this number is removed from circulation in the following two years. After 2024, this will be reduced to 12%. If the total number of allowances in circulation falls below 400 MtCO₂, rights are taken out of the reserve again and put back into circulation.

At the beginning of 2020, there were still 1385 million allowances in circulation and 333 million allowances have been placed in the market stability reserve. One year earlier, the TNAC was 1655 million allowances and 397 million had been transferred. On top of that, allowances that were not auctioned or allocated yet have also been placed in the reserve. As such, a total of 1600 million EUA have already been allocated to the reserve.

The tightened LRF and the MSR will ensure a more stable supply of allowances, a higher carbon price and a 16% reduction in total cumulative allowances. However, both measures do not affect the Waterbed Effect.

The MSR Cancellation policy

However, the introduction of the MSR came with an important, additional detail:

From 2023 onwards, the market stability reserve may not contain more rights than the number of allowances that have been put into circulation in the previous year.

This means that if the market stability reserve becomes too large, allowances will be permanently withdrawn from circulation and destroyed.

This measure means that the Waterbed Principle of EU ETS is no longer certain: there is a possibility of reducing the total, effective emissions with the EU ETS sectors below the foreseen total number of allowances and thus below the cumulative ceiling of 43.8 GtCO₂. It is said that ‘the waterbed leaks’.

The principle works as follows:

The longer it takes to bring the total number of allowances in circulation below 833 MtCO₂, the greater the market stability reserve will become and the more allowances will have to be permanently destroyed based on the MSR cancellation policy.

The faster the total number of allowances in circulation drops below 833 MtCO₂, the smaller the reserve, and the fewer allowances will be permanently destroyed.

Recent simulations (Bruninckx et al. 2019, 2020) show that 3 to 16 GtCO₂ of allowances could be destroyed through this cancellation policy, depending on e.g. the evolution of mitigating costs, renewable energy targets, or a European nuclear phase-out. This means that final cumulative emissions under the ETS could end up between 28 and 41 GtCO₂. In other words, if appropriate policies are put in place, within the current rules of EU ETS, the total emissions within the ETS could be reduced further by 5 to 35%.

In this context, it is worth noting that — as written above — today’s market stability reserve is already bigger than the number of allowances put into circulation annually and that the number of allowances in circulation is still a long way from 833 MtCO₂.

In a simplified way, under the current rules, this would mean the following:

Any additional allowance that is placed in the market stability reserve will eventually end up being destroyed.

Therefore, a one-off saving of 1 tonne of CO₂ under ETS that is achieved today, e.g. through a one-off event like COVID-19, would result in an effective saving of about 1 tonne of CO₂ because it would mean that, eventually, 1 additional allowance will be transferred to the reserve, and 1 additional allowance will be destroyed within the reserve.

Contrary, a one-off additional emission of 1 tonne of CO₂ under ETS today, will in principle never be offset elsewhere.

For measures that have a long-term effect, such as the structural replacement of nuclear power stations by gas-fired power stations as proposed in Belgium, there is greater uncertainty: In such context, it becomes important whén the limit of 833 MtCO₂ will be reached. The same simulations of Bruninckx et al. show (depending on the flanking policy) that this can take anywhere between 3 to 30 years — and reference simulations point to the latter.

Belgian nuclear exit

The notion above could mean two things for the resulting emissions of the Belgian nuclear exit:

if the limit of 833 MtCO₂ is reached before 2025, i.e. the moment of the nuclear exit in Belgium, then the emissions associated with the structural switch to gas-fired power plants will be fully compensated within ETS.

if the limit of 833 MtCO₂ is not reached before 2025, only a partial offset will take place: Approximately only 95% of the emissions would be offset if the limit is reached by 2030, only 60% would be compensated if the limit is not reached before 2040, and 20% is offset if it is not reached until 2050.

Hence, since the reference simulations in Bruninckx et al. point towards 2050, it seems unlikely that the emissions related to the planned Belgian nuclear exit in 2025 will be structurally compensated with EU ETS.

The uncertainty related to this is, however, very big — i.e. uncertainty linked to at which year the waterbed will be sealed, but also linked to the planned changes within the EU ETS such as a further increase in the annual reduction factor and a possible expansion of sectors.