Although most observers have reacted positively to the Commission’s January 2014 package of proposals on 2030 climate targets, from a business perspective, there are too many areas where delays are threatening, writes Jesse Scott, Head of the Environment and Sustainable Development Policy Unit of Eurelectric, the European association of electricity producers. ”Many crucial questions have not yet been answered”, notes Scott – most of all when it comes to the EU Emission Trading Scheme (ETS). She also points out that the Commission’s proposals on how to ensure renewables growth and how to create a harmonised internal energy market are “carefully vague”, though she adds that this may well be deliberate: the spring and summer of 2014 will see the conclusion of six separate legal exercises that could have a profound effect on the future of the EU’s energy market. “By autumn the baseline for energy policy discussions between EU member states and the Commission may look rather different than it does today.”
Most observers have been pleasantly surprised by the European Commission’s January 2014 package of proposals on 2030 climate targets and on the EU Emissions Trading System. The Commission analysis shows once and for all that emissions can be decoupled from economic growth. It recommends -40% EU domestic greenhouse gas emissions relative to 1990, a binding target at EU-level for renewables, and a simpler, more European, more market-based approach to decarbonisation than the current 20/20/20 package.
So far, so good. But these proposals are only the first step in a long process towards the adoption of implementing legislation, and underneath the strong headlines, many crucial questions have not yet been answered.
Some of those questions are about policy gaps. Energy savings and efficiency, carbon capture and storage, and low-carbon transport all seem to have been postponed to rather uncertain ‘reviews’ which are likely – by intention? – to span the change-over to a new College of Commissioners in autumn 2014. The two most important open questions, however, are political. First, when will the key decisions be taken? Doubts about timing are crucial both to Europe’s role in the international climate negotiations, and to the future of the EU ETS. Secondly, will Member States accept the Commission’s idea of a ‘new European governance’? This issue of governance is central for renewables in electricity generation and to the future of the internal energy market itself.
EU leaders meeting in the European Council on 20-21 March are unlikely to conclude anything definite on 2030. Instead the goal should be to have leaders endorse the -40% in May or June, in time to contribute to UN Secretary-General’s Ban Ki Moon’s global climate summit in September. A rapid decision-making process during the first half of 2014 could also facilitate the necessary domestic deals. Germany, France, Britain and the other members of the so-called “Green Growth Group” will need to find a compromise with Poland and the so-called Visegrad Group (Poland, Czech Republic, Hungary, Slovakia), but despite extensive diplomatic efforts it is hard to imagine what this can be if limited to climate. So the deal needs to be wider, encompassing other EU policies and national interests. Summer 2014 offers a once-in-five-years opportunity for a grand bargain to include the allocation of top EU jobs.
Part of the difficulty is that carbon prices are not a smooth continuum: there is a threshold for impact.
Meanwhile, the EU ETS has been failing since 2010, suffering from three distinct problems, which together make it unfit for purpose. First, the current ETS cap set by the 1.74% annual linear reduction factor is not coherent with the EU 2050 emissions goal: the solution would be a new, stronger linear factor. Second, the ETS struggles from being a unique type of market in which supply is fixed and has no flexibility to adjust to changes in demand. A supply adjustment or reservation mechanism in the auction timetable could be a solution here, although this problem is also linked to the over-lapping impact of the EU 2020 renewables and energy efficiency targets. And thirdly, the ETS has built up an overwhelming surplus of EUAs (emission allowances) that is likely to total 2-2.5 billion by 2020 (out of total 18 billion EUAs in the period three cap). The solution to this fatal supply-demand imbalance would be the cancellation – or ‘set-aside’ – of at least 1 billion EUAs within the next one or two years. At best, the hard-fought ETS back-loading decision of of 2012-13 which will remove allowances from the market in 2014-18 but re-inject them in 2019-20 can only temporarily mitigate the second of these problems.
Timing is money
For the fourth ETS trading period, from 2021 onwards, the Commission’s January proposals now offer an annual ETS linear factor of 2.2%, combined with a market stability reserve mechanism which would provide a predictable and permanent means to back-load auctions, and which would, other things being equal, probably slowly eat into the surplus. To the Commission, these reforms may seem to be quite substantial, and three years may seem a reasonable period in which to study, consult, and prepare. But businesses see things differently. They have a clear-cut test for ETS reform: will there be an impact on operations or investments, and will it come soon enough to shape tomorrow’s decisions?
Part of the difficulty is that carbon prices are not a smooth continuum: there is a threshold for impact. For the ETS to become relevant to power plant operations, companies would need to see a price trending upwards towards €40 (the threshold for coal-to-gas switching at current commodity prices). To drive capital investment in power generation, something approaching €30 would be needed for onshore wind investments without additional subsidies. These higher price perspectives are unlikely to be seen while the EUA surplus persists. Meanwhile, in practice, today’s €6 carbon price is barely different from the €2 ‘junk bond’ of a year ago. In short, timing is money. It makes all the difference whether companies can expect a meaningful carbon price signal from 2014, or from 2021, or only in the late 2020s. And every policy delay brings a delay in business decisions.
Measured by this standard, the Commission’s proposals are still too little, too late. And frankly, they are puzzling too: the ETS back-loading will be ‘re-loaded’ in 2019 and 2020, but the market stability reserve is proposed to come into effect only from 2021: so back-load, then re-load, then reserve? This zigzag is not a recipe for market confidence. Similarly, the 2.2% linear factor may be too weak (Sanjeev Kumar, an ETS expert at NGO Change Partnership, calculates that it should be 2.6%). And meanwhile the only senior European politicians talking about a set-aside are German Federal Environment Minister Barbara Hendricks and UK Secretary of State for Energy and Climate Change Ed Davey.
These proposals are a challenge to the very principle of national control of the energy mix.
This picture should be of serious concern also for business sectors which are not low-carbon leaders or enthusiasts, because the alternatives to an effective ETS are national carbon price floors/taxes or national/EU emissions performance standards. Even companies which opposed the back-loading might – on reflection – prefer the flexibility and lower-cost of a carbon market to these policies. Moreover, such policies would be unlikely to encompass free allocation plans or extensive exemptions. Haggling for another three years over the market stability reserve start date and a set-aside will not help any business interest.
Seen from the perspective of member states, however, it may be that the Commission’s carefully vague statements about renewable energy support and about governance matter more than any climate policy goals, target numbers, or dates. In abstract terms, the Commission could have chosen among four possible approaches to a 2030 renewables target. Option one would have been a continuation of the 2020 model of an EU level target which is implemented through 28 national targets and ‘push’ support schemes. Option two would be an EU level target, implemented not nationally but through harmonised European support schemes. Option three would be an EU level target which does not have its own policy instrument, but is implemented through the carbon price ‘pull’ signal and some limited ‘push’ schemes for innovative or immature technologies. Or option four would have been no renewables target at all. The Commission has made clear that it intends to focus on options two and three only, with a preference for option three.
They argue that today’s national renewables support schemes ‘address regional specificities but at the same time can hinder market integration’ and that the -40% greenhouse gas target ‘should by itself encourage’ renewables growth to 27% of energy consumption by 2030. Therefore ‘different national support schemes need to be rationalised to become more coherent and to comply with competition and state aid rules to avoid market distortions and ensure cost-effectiveness’. Further, the Commission has announced that it intends to create a new ‘consolidated’ governance framework of ‘simplified and streamlined national energy plans’ by which member states will report to Brussels on emissions, infrastructure, taxes and support schemes, and their procedures for consulting with neighbouring countries ahead of major policy decisions. The Commission says it will ‘prepare guidance’ later in the year.
These proposals are a challenge to the very principle of national control of the energy mix. In the Commission analysis – a view shared by much of business – opening and harmonising a competitive European internal energy market is an urgent imperative. Not least, this could help mitigate Europe’s energy costs and support competitiveness. But energy price dis-convergence between member states during 2011-13 shows definitively that the goal of ‘completing’ a harmonised internal energy by 2014 through market law ‘software’ cannot survive interaction with 28 different national energy policy ‘hardwares’. The internal energy market is fragmenting. And this is a problem whose potential for harm goes beyond energy policy: retreat from the project to harmonise energy markets would also contradict the European mission as a whole – allowing a virus to spread in the market DNA of European integration.
These three different institutions, three different responsibilities, and three different time perspectives make EU climate and energy policy negotiation resemble a nine-dimensional game of chess.
Looked at on its own, the brief outline of ‘new governance’ could mean anything or nothing: another toothless grumble from Brussels, similar to many previous communications from DG Energy to member states? But alongside the 2030 process, spring-summer 2014 will see the conclusion of six important legal exercises affecting the relationship between national energy policies (Article 194 of the Treaty on the Functioning of the European Union) and EU internal market, competition, and state aid law (much of the rest of the EU Treaty). In Brussels, DG Competition will finalise new Environment and Energy State Aid Guidelines for 2015-20. It will also consult on an updated definition of which market distortions qualify as a state aid. And it will decide (probably) the first phase of the Hinkley Point nuclear plant state aid application, and rule on industrial exemptions from the German EEG renewables feed-in tariff law. In Luxembourg, the European Court of Justice will reach judgement in the Aalands Vindkraft market access case (the Essent case on the privatisation of energy infrastructure judged in November 2013 is also important). And in Berlin, the federal government is revising the EEG law. By the autumn, the baseline for energy policy discussions between EU member states and the Commission may look rather different than it does today.
To this extent, the Commission’s 2030 renewables strategy is to reassert the principle that any market distortion must be limited to what is ‘necessary, proportionate, and transitional’ – and to move slowly, step by step, through an examination of member states’ responses to the 27% proposal as they take on board the results of the DG Competition and ECJ processes. It is surely too soon to guess exactly what compromise policy framework may result, but even first steps are important and will bear watching closely.
One more observation: climate and energy policy debates (especially the Commission’s work) are frequently presented as a ‘trilemma’ attempt to balance sustainability, security, affordability. But the 2030 proposals are making clear that there is another kind of EU trilemma problem – in political decision-making. The Commission has responsibility for market rules, and is inclined to think long-term, planning policy directions ten or fifteen years ahead. Meanwhile the member states have (the main) responsibility for the national energy mix, and tend to work with shorter-term policy debates linked to national electoral cycles. And then there are the businesses – not just the power sector, or heavy industry, or technology companies, but crucially also their equity and bond investors – which are responsible for investments, but must balance multi-decade forward planning about assets with quarterly returns to shareholders. These three different institutions, three different responsibilities, and three different time perspectives make EU climate and energy policy negotiation resemble a nine-dimensional game of chess.
Jesse Scott is Head of the Environment and Sustainable Development Policy Unit of Eurelectric. The views expressed here are those of the author alone, and do not necessarily represent the views of Eurelectric members.