Carbon trading in the European Union reached a new low on Tuesday, with the news that the European Parliament rejected a proposal heralded as a short-term “fix” for the European Emissions Trading System (ETS) by a narrow margin of 19 votes.

The measure, known as “back-loading” and dreamed up by the European Commission in an effort to boost dwindling carbon prices, would have seen 900 million permits temporarily removed from trading in ETS until later on in the decade – and potentially reinvigorated the beleaguered system before a more permanent solution was agreed.

At the time of writing, carbon prices were hovering at the €3/tonne mark, a far cry from the €18 price that ETS carbon permits, or EUAs, commanded back in May 2011. In fact, EUAs have had 90% of their value wiped out over the past five years. In essence, the ETS’ problem lies in the fact that there is chronic oversupply of permits in the market, by as much as 2 billion EUAs.

In part, this is due to the on-going economic slump in the EU, which has seen a steep decline in energy demand, and emissions. The EU has already reduced its emissions by 17% - not far from its 20% by 2020 target – without enforcing the shut-down of a single coal-fired power station. Meanwhile the oversupply was exacerbated by over-allocation to member states, as well as the ETS’ linkage with other carbon offset schemes, such as the Clean Development Mechanism (CDM).

So why was the back-loading measure defeated? Clearly there were many in favour, but, as European Parliament rapporteur Matthias Groote complained after the vote, many MEPs are simply against European-set targets in principle, while there was strong feeling that interference in the market-based ETS would invite more interference later.

For Chris Norton, partner in UK-based law firm Hogan Lovells and an expert in the ETS, the problem with back-loading was always that it was a temporary fix, which could have made things worse once the market was flooded with the suspended allowances at the end of the decade. “It didn’t have any element of removing allowances from the market,” he says. “It was being done as quick fix because they didn’t want to go through the whole legislative rigmarole of getting the Directive changed, so it didn’t have that that structural reform which is what it needs.”

The defeat was nonetheless slammed by environmental and renewables advocates alike - the European Renewable Energy Council (EREC) raged that the vote had rendered the ETS “impotent”. But what was the impact on renewables? According to Rémi Gruet, senior regulatory affairs advisor on climate change for the European Wind Energy Association (EWEA), the vote’s significance lies not so much in the effect it will have on the investment in renewables, but the signals it gives out to investors.

“So far the carbon price is already so low that the direct impact of the ETS on our industry is very limited,” he tells Renewable Energy Focus. “We can’t say today that it’s affecting private investment, because that the moment that’s just not happening.

“But what [back-loading] could have done is give a very strong political signal, that we do want carbon pricing, that we are not going to give up on that idea, and that we are not going to give up on the instrument to implement that idea.”
Gruet’s chief concern is that the defeat will trigger a swathe of investment in coal fired power stations, a concern echoed by Josche Muth, secretary general of the EREC, who points out that the EU saw the first net increase in coal-fired power generation this year since the ETS began.

“If there is no price signal that it is costly to go into polluting technologies and will remain so in the future then yes we will see investment into coal fired power plants,” he says.

However, Norton believes these fears are unfounded. “There are other regulations in the EU, such as the Industrial Emissions Directive, which requires a lot of coal-fired power stations to close down by 2017 unless they have put in quite costly abatement equipment to turn it into clean coal,” he says. “So from that perspective I don’t think there will be much change.”

However, he is agreed with Gruet and Muth on one point, that vote has sent a clear political signal from the EU: “The signal to market coming from this decision is that the EU as a whole is more concerned about economics now than environment,” he says.

So the question is: what now? According to Gruet, if left unchecked, the oversupply will last at least until 2030, which will keep carbon prices critically low until that time and potentially wither away the ETS as an emissions reduction tool. Something, he says, needs to be done.

Certainly, the back-loading advocates hope that the measure is not dead. As the Parliamentary vote did not garner enough “no” votes to kill the proposal completely, it is now back with Parliament’s Environment Committee for further discussion. It is possible that it could be reintroduced to Parliament with a compromise solution, with a caveat to placate the market fundamentalists who fear on-going political meddling.

“This could be addressed by saying this is a one-off, due to exceptional circumstances,” says Muth. “Nobody could have forecasted the economic recession. It wasn’t modelled in. We can say back-loading is not a green light to do this any and every time but we see an urgent need to do it in order to steer investment. That might be a possibility for those who rejected it, to say yes we can agree to it.”

But Norton does not believe that back-loading will see the light of day again, and the Commission will now have to look at the other six options that it considered earlier on. Among these options are plans to fundamentally restructure the ETS via legislation, including the cancellation of permits completely adjust the emissions cap to reflect the differing economic circumstances, although Norton warns that the Commission will experience “significant push-back” from coal-dependent Eastern European states, as well as the newly nuclear-free Germany.

“If they’re going to go for anything they’re going to go for a more permanent fix, but I don’t think that’s going to happen any time soon,” he says.