No guarantee is given that the operation of the EU ETS, as originally established (the supply of emission allowances including), will remain unchanged or can be modified only at the end of a trading period.
The divide of the EU ETS operating rules into trading periods originated in the need to align the EU ETS with the expiry dates laid down in the relevant international instruments (Kyoto Protocol etc.).
However, it can be of utmost importance for the carbon and energy markets’ trading models and strategies, to determine whether the EU ETS rules within the trading period are stable and predictable or there is a possibility of a regulatory free-ride in this regard at any time.
Four trading periods of the EU ETS were designed so far: the two, which are concluded and settled (2005 - 2007 and 2008 - 2012), the one that is ongoing (2013 - 2020) and the future (2021 - 2030).
In this context it is useful to observe that the European Court of Justice in the recent judgment of 21 June 2018, (Republic of Poland v European Parliament and Council of the European Union, Case C-5/16) undertook an extensive reasoning to prove that the availability of emission allowances can, in principle, be changed during a trading period as a result of legislative or regulatory actions.
Among the Court’s arguments are such that:
- the EU ETS, as the principal instrument of the European Union’s climate policy, is a permanent instrument that is not limited in time and that produces its effects beyond either individual or collective trading periods;
- the EU ETS is a complex scheme and the EU legislature has the power to have recourse to a step-by-step approach in the light of the experience gained where it is called on to restructure it (judgment of 16 December 2008, Arcelor Atlantique et Lorraine and Others, C‑127/07, EU:C:2008:728, paragraph 57);
Moreover, the Court listed some legislative and regulatory interventions that already influenced the EUA’s availability within trading period:
- Article 1(9) of Directive 2009/29, which amended Article 9 of Directive 2003/87, started the annual linear reduction of allowances during the second trading period (from 2008 to 2012)’);
- Article 1 of Decision No 1359/2013/EU of the European Parliament and of the Council of 17 December 2013 amending Directive 2003/87 clarifying provisions on the timing of auctions of greenhouse gas allowances (OJ 2013 L 343, p. 1), which amended Article 10(4) of Directive 2003/87, provides that ‘where an assessment shows for the individual industrial sectors that no significant impact on sectors or subsectors exposed to a significant risk of carbon leakage is to be expected, the Commission may, in exceptional circumstances, adapt the timetable for the period referred to in Article 13(1) beginning on 1 January 2013 so as to ensure the orderly functioning of the market’;
- Article 1 of Commission Regulation No 176/2014 provided for a reduction during the period 2014-2016 in the volume of allowances to be auctioned in each given year.
In conclusion, according to the said judgment of 21 June 2018, the divide of the EU ETS rules into trading periods cannot prevent the legislature from intervening, if it becomes apparent that the EU ETS no longer is capable of achieving the aims for which it was established.
Hence, the risk factor to be included in any energy or carbon market trading strategy is that the EU ETS rules (i.e. EUAs supply side) may change not only at the end of a trading period, but anytime in between.
A logical consequence of the above conclusion is also that it is difficult to predict with precision possible carbon price caps based on estimated supply - as the legislature and regulatory actions are in this regard, in principle, unpredictable.
That said, it is, however, regrettable, such important issues were not clearly declared at the EU ETS’s ignition.
Given that the scheme was launched in 2005 we learn about such important facets after more than a decade.
To me, this part of the Court’s considerations re-establishes the entire philosophy on which, I previously presumed, the EU ETS was built.
I used to think that trading phases of the EU ETS were designed to give market participants certainty that during respective periods market rules and, consequently, the EUAs’ availability, will not be changed.
After reading the Court’s reasoning I must admit, I was entirely wrong.
But okay, if we learned already that the EU ETS rules can fluctuate at any time at any political wish, maybe it’s time to clearly also conclude that all these declarations about the scheme stability, at least within trading phases, where all rubbish.
As always, there will be winners and losers on occasion of the Court’s determination.
But, when the Court has just manifestly thrown away all this systemic stability, maybe there is also time to became conscious that the political pendulum can change its direction - at any time.
So far it was steadily restricting the EU ETS supply side but can anybody be sure, the upcoming European Parliament‘s election won’t make a u-turn?
What is the recommendable solution, then?
To me, the EUETS can be, as the Court said “a step-by-step approach in the light of the experience gained”, but within the trading phases the rules influencing the supply and demand balance should remain stable.
This seems to be a balanced and rational compromise between the system necessary adaptations and evolution and the business needs, which necessitate at least the minimum scope of predictability and legal certainty to carry out business viably.
Consider that the trading phases can be longer or shorter, as the needs be, nobody mandated the EU institutions to set up trading phases so long as 8 to 10 years (the third and fourth trading periods, respectively).
But if they have been shaped this way, I think it operates self-restricting, when it comes to the legislature.
In the opposite case, dividing the EU ETS into the trading phases would become, practically, meaningless.
One more reflection comes to mind when reading the Court’s reasoning in this case - watch out and read carefully all impact assessments attached to the yearly reports on the state of the European carbon market - if you neglect this even once, it may entirely ruin all your business, and it will be your fault only.
This is exactly what the Court said:
“[...] the public became aware of a serious dysfunction in the ETS with regard to its ability to create a price signal at the very latest upon the publication of the report on the state of the European carbon market in 2012. That report contained two types of measure intended to solve the problems identified, namely, first, a review of the auction timetable as a short-term measure and, second, the adoption of structural measures divided into six options, including the option permanently to withdraw a certain quantity of allowances during the third trading period of the ETS.
In the light of the foregoing, it must be found that a prudent and circumspect economic operator could not expect that the legislative context at issue would remain unchanged and that the institutions concerned would take no measures in order to remedy the ETS’s structural imbalance prior to 2020.”
What is the simplest conclusion of the whole mess? If you carry out business in-between carbon, energy and financial markets, be “prudent and circumspect economic operator” and follow closely all EU ETS regulatory developments.
And do not neglect the political side...