The EU Emissions Trading System (EU ETS) is at a critical juncture as it navigates a path towards achieving a net-zero Europe by 2050. Amidst this transformation, the proposal to create the European Central Carbon Bank (ECCB) has sparked a range of criticisms. Some critics have raised valid concerns about the feasibility, necessity, governance, and potential drawbacks of such an institution. Robert Jeszke and Sebastian Lizak at the Centre for Climate and Energy Analyses (CAKE) – a Polish think tank – address some of these concerns and highlight the compelling arguments in favour of establishing the ECCB within the EU ETS framework. There will always be risks related to the pace of technological development hitting their targets, supply chains from outside the EU, and the availability of materials essential for rapid transformation. Against this background the existing Market Stability Reserve (MSR) and Article 29a are not sufficient to deliver price stability and predictability for European CO2 allowances (EUAs). This is what the ECCB can be designed to do as the EU ETS expands and evolves, say the authors.
ECCB vs existing EU ETS framework
Critics of the ECCB question the rationale for the existence of this institution in light of the existing EU ETS market mechanisms, such as the MSR and Article 29a of the EU ETS Directive, suggesting that these mechanisms merely need modifications. In response to this criticism, it’s important to recall the primary objective of establishing the MSR. This mechanism was introduced to eliminate a massive surplus of CO2 allowances in the market which arose following the economic crisis in 2007-2008 due to the excessive number of CER units allowed into the EU ETS market.
By 2040, the situation will have changed dramatically – the system will face a significant shortage of CO2 allowances, and the MSR reserve will not contain enough allowances to stabilise the market. This is largely due to the “invalidation mechanism”, which in 2023 nearly depleted the entire reserve of allowances (invalidating 2.5 billion out of 3 billion allowances). Thus, EU lawmakers could only modify other MSR parameters, like MSR thresholds, claiming this to be the evolution of the MSR. However, this will not address the predicted problems of 2040, when there will be a need to release additional EUAs to the market.
Another issue is that the MSR reserve mechanism has struggled to cope with the significant price volatility observed in recent years. This was not the intended purpose of creating this mechanism. Price volatility was supposed to be addressed by the mechanism in Article 29a of the EU ETS directive. However, despite a sharp increase in prices, particularly between 2020 and 2022, this mechanism did not work as intended. It has been recently improved in the revised EU ETS directive, but in our view it may still not be effective enough in the future. Even if this mechanism finally operates effectively, its limitations (it can only be activated once a year) means it would not be responsive enough to mitigate frequent market volatility.
The future EU ETS needs to be flexible, capable of handling high volatility, and ensuring proper liquidity in the CO2 market. In our opinion, all these goals could be achieved by the ECCB.
ECCB: addressing feasibility concerns and governance Issues
Some experts raise doubts about the feasibility of creating a centralised regulatory body, citing the immense scale and complexity of the EU ETS. They argue that effectively implementing and managing the ECCB could prove challenging. While introducing the ECCB will indeed be a significant challenge, it’s worth recalling that the concept of the ECCB is not without precedent. The EU has a history of successfully implementing complex regulatory bodies, such as the European Central Bank (ECB), responsible for EU monetary policy and ensuring price stability. Other examples of significant central banks include the USA Federal Reserve (FED), the Bank of Japan, and the Bank of China. Within the framework of the EU ETS, the creation of an institution analogous in character and competence to these central banks is seen as a mechanism with the potential to enhance the efficiency of carbon markets and facilitate the global transition to a low-carbon economy.
Feasibility concerns can be addressed through careful planning and collaboration, especially given the urgency of the period post-2030, the ongoing debate on the 2040 target, and the imperative to achieve net zero by 2050. The lack of clarity on governance can be resolved through comprehensive discussions and negotiations among EU Member States. By involving key stakeholders and drawing from principles of central bank governance, it is possible to establish clear guidelines and decision-making processes for the institution.
Balancing dual functionality: ensuring market stability and managing Carbon Removal Units
Another argument raised in the discussion about the ECCB is questioning its dual functionality – ensuring market stability post-2030 and managing carbon removal units. Experts also have doubts about whether replacing the Market Stability Reserve (MSR) with the ECCB is a reasonable step. In response, it is worth indicating that the need for the ECCB arises from the evolving landscape of the EU ETS.
As the market moves toward a net-zero Europe by 2050, and with no allowances expected to be available for purchase on the market by 2040, new challenges and uncertainties will emerge. These include extending the EU ETS to new sectors, integrating the new ETS2 for road transport and buildings into the existing EU ETS, operating within an increasingly limited market, shifts in hedging strategies, and the effects of the Carbon Border Adjustment Mechanism (CBAM) implementation.
Our CAKE simulations suggest that the inclusion of new sectors into the EU ETS will lead to an increase in marginal emission abatement costs within the trading system, due to more expensive reduction options available in sectors not currently covered by the EU ETS. For example, the price of CO2 emission in the EU ETS can reach EUR 440 in 2050 under the Fit for 55 scenario or even EUR 1,000 if the EU ETS covers all sectors of the economy (One ETS scenario). It is reasonable to expect a significant increase in EUA prices compared to their current levels. From our research perspective, we argue that the establishment of the ECCB could play a pivotal role in effectively managing the evolving dynamics within the European CO2 market. Specifically, this institution could adeptly manage demand and supply volumes, thereby mitigating the potential adverse impacts of price volatility.
In light of these considerations, the necessity of the Market Stability Reserve (MSR) becomes subject to scrutiny, particularly given apprehensions about its capacity to release an adequate number of EUA allowances into the market. The recent MSR review indicates that there will be a fixed supply of only 400 million EUA allowances available to market participants. This quantity may fall short of meeting the market’s requirements, potentially exacerbating price instability.
Navigating uncertainties: integrating removals and ensuring adaptability of the ECCB
Critics contend that there are significant uncertainties surrounding the integration of removals into the market, suggesting that such decisions should be made through EU policy-making processes rather than by the ECCB. Indeed, these uncertainties are especially valid in the context of nature-based solutions where implementation costs, variability in opportunity costs, and challenges with permanence and practical issues are key concerns. Decisions regarding the inclusion of removals, and the specific types of removals in the EU ETS, will be made through standard legislative processes. However, any addition of removal units to the market will need to be monitored. Therefore, the ECCB must provide the necessary flexibility to adapt to changing circumstances.
The bank can be designed to work in tandem with evolving EU policy, providing expertise and insights to address uncertainties, ensuring that decisions related to removals are made collaboratively and in alignment with broader climate objectives. We agree that it is essential to carefully consider the types and volumes of carbon removals that could be available for participants in the EU ETS. However, these challenges should be addressed through strict rules regarding quality criteria, baselines, standards and certifications for removals, rather than by the ECCB itself.
The role of this institution is to safeguard the stability of the EU ETS, the market, and the overall climate architecture. The ECCB could have the capacity to acquire carbon removals from both European and even potentially in the future, global markets. It could then inject these units into the EU ETS when the carbon prices exceeds a certain trigger as demand materialises. In this way, the ECCB could serve as a liquidity provider, ensuring the continued functioning of the EU ETS. Moreover, through upfront purchases and by allowing the build-up of a reserve of removals, it also creates greater certainty for the providers of removal credits, particularly if the purchasing proceeds according to a specified schedule and pre-announced volumes.
Setting price targets: the ECCB’s role in market control and addressing price volatility
Some experts question the necessity of setting appropriate price targets for CO2 allowances without full visibility on the costs of emission abatement. They argue that this could lead to market distortions and investment uncertainties, undermining the effectiveness of the EU ETS.
Indeed, setting an appropriate price target without comprehensive insight into the costs of emission abatement can be challenging. However, this is precisely one of the problems that we intend to address. We have no guarantee that the assumed technological progress and the rate of efficiency in different sectors of the economy will align with expectations, that the supply chain will remain stable, and so on. We aim to prevent the EU ETS market from reverting to uncontrolled allowance price behaviour. This is increasingly crucial as we see a growing number of EU policies aimed directly or indirectly at decarbonising the EU economy. For instance, the introduction of another ETS2 system raises questions about the behaviour of the new market we are creating, to which we currently do not have definitive answers.
Challenges related to EUA price targets can be addressed by conducting thorough economic assessments and leveraging expert input. The ECCB could have mechanisms in place to regularly review and adjust price targets based on data and market conditions, thereby mitigating the risk of price distortions. The role of the ECCB would be to control the market and safeguard situations where technological progress fails to deliver fast enough reductions, leading to soaring carbon prices. Simultaneously, cheaper options could arise from sectors not covered by the ETS through sinks and removals. Smoothing out price development behaviour would provide EU ETS participants and Member States with greater stability and room for necessary long-term investments.
Therefore, the ECCB can be viewed as an instrument designed to uphold stability and liquidity in the CO2 market and could be tasked with overseeing the EU ETS as a whole. This becomes particularly pertinent in a scenario of limited market resources, where the anticipated scarcity of EUAs by the end of the 2030s is expected to introduce vulnerabilities into the market. In such circumstances, the ECCB could play a crucial role in ensuring price stability in strategically important sectors of the EU ETS. It is imperative to proactively address the anticipated price volatility that will coincide with the depletion of EUAs, and the ECCB is well-positioned to effectively manage this challenge.
Enhancing policy predictability: transparent decision-making within the ECCB
Critics also argue that delegating important decisions to the ECCB could reduce policy predictability and certainty, essential features of the EU ETS design. This can be mitigated by establishing a well-designed ECCB, which can enhance policy predictability by providing clear guidelines and stability to market participants. Its transparent decision-making process, based on principles of central bank governance, can provide market participants with confidence in the long-term viability of the EU ETS, ultimately contributing to greater predictability.
Up to this point, every mechanism aimed at stabilising and protecting the European CO2 market from the risks of abuse and speculative activities has not guaranteed right timing and effectiveness (the good example is Article 29a of the EU ETS Directive) or left room for interpretation in terms of their operational methods (similar measures designed to secure price levels in ETS2). The bank guarantees and commits to ongoing and effective market oversight. In an era of uncertainty surrounding fuel supplies and their prices, this can have a destabilising impact on price behaviour within the EU ETS. As the costs of CO2 emissions rise, this could also discourage the adoption of climate policies within the EU.
While there is scepticism about the actual likelihood of establishing the ECCB in the short term, momentum for addressing climate change is increasing globally. The short-term likelihood may be uncertain, but the need for effective climate policy is undeniable. As the EU ETS evolves and more stakeholders recognise the benefits of the ECCB, political support may grow rapidly over time. Discussing emission reduction levels for 2040 will be challenging, given the expected dramatic increase in the costs of reduction. This is accompanied by risks related to the pace of technological development, supply chains from outside the EU, and the availability of materials essential for rapid transformation.
The European Commission (EC) also recognises this, indicating that the current focus should be on improving the management of the transformation process and concentrating on the implementation of the massive commitments and plans arising from the Fit for 55 package. This will be a key element in ongoing efforts. Governance is now the ‘sweet spot’ for taking further steps in implementing additional elements of climate policy, such as incorporating removals into the EU ETS. The ECCB concept is not merely a tool – it is a solution designed not only to provide a clear vision of what the EU ETS could look like after 2030, but also to ensure the continued existence of the EU ETS beyond 2030.
In conclusion, the establishment of the ECCB is a forward-looking proposal aimed at addressing the complex challenges of the EU ETS beyond 2030. While criticisms are valid, they can be mitigated through careful planning, transparent governance, and adaptation to changing circumstances. As the urgency to combat climate change intensifies, exploring innovative solutions is essential, and the ECCB can play a vital role in achieving a sustainable, net-zero future.
Robert Jeszke is CEO of the Centre for Climate and Energy Analyses (CAKE) in the National Centre for Emission Management (KOBiZE), part of the Institute of Environmental Protection – National Research Institute
Sebastian Lizak is an expert in the Centre for Climate and Energy Analyses (CAKE) in the National Centre for Emission Management (KOBiZE), part of the Institute of Environmental Protection – National Research Institute