Policy Exchange , London 28.10.2014

1. Policy Exchange , London 28.10.2014 • The future of the ETS in Europe’s climate strategy • Karsten Neuhoff

2. The future of the ETS in Europe’s climate strategy • What role plays ETS as European climate policy evolves? • Should the ETS remain the centrepiece of European climate policy? How should it fit with other policy instruments, such as the Renewables Directive? • What reforms are needed to keep the ETS relevant? Should policymakers worry about a low carbon price?

3. Best practice frontier 1 What role plays ETS as European climate policy evolves? Attention Price Target “Satisficing” behaviour “Transforming” behaviour “Optimising” behaviour “Business-as-usual” innovation Real-world individual and organisational decision-making Innovation & evolution of complex systems Resource Use / Energy & Emissions Accelerated low-carbon innovation Purely carbon-price-driven innovation Economic Output / Consumption Source: Grubb, Hourcade & Neuhoff (2014): Planetary Economics, Energy, Climate Change and the three domains of sustainable development. Routledge.

4. 2 How should EU ETS it fit with other policy instruments, such as the Renewables Directive? In 2013 70% of solar deployment was outside of Europe. Source: Neuhoff et al. (2014): Staying with the Leaders: Europe’s path to a low carbon economy. www.climatestrategies.org. DIW Berlin Calculations based on REN 21, 2013; EPIA, 2014; Clean Energy Regulator, 2014.

5. 2 Securing a long-term economic energy supply & JobsComparison of European fossil fuel bill and capital costs for renewables By 2013, annualised capital costs for renewable generation to replace fossil fuels have declined to a level of the fossil fuel expenditures Illustration excluding system cost! DIW Berlin Calculations based on BP Statistical Review of World Energy; Energy Statistics for the EU-27; Bundesverband Solarwirtschaft e. V.; IEA; European Wind Energy Association.

6. 3 What reforms are needed for EU ETS to support an efficient abatement pathway? Surplus Banking capacity Rate ofannualspotpriceincrease Slopeofforward pricecurve Need for Market Stability Reserve (Early+ linked to back- loading) Speculation at returnrequirementsofspeculators (> 10-15%) Risk-freearibtrage at costofcarriage (3-5% offeredbybanks) Accumulatedsurplus spot price increase with slope of forward curve Hedging If accumulated surplus exceeds hedging demand: Price falls until low enough allow annual price increases that attract speculators High rate of annual price increases not reflected in forward curve -> inconsistency undermines credibility of EU ETS -> strategic investments are miss-guided by low spot price (ignoring future scarcity)

7. What reforms are needed for leakage protection post 2020 with long-term perspective? Ensure leakage protection also for scenarios with differences on climate policy ambition and emphasis on carbon pricing across regions While supporting investment in innovation and modernization opportunities in energy intensive industries 3 Free allowanceallocationasleakageprotectionprovides limited incentivesforinvestments. Sectorneedstobeableto pass mitigationandcarboncoststoconsumers. Source: Climate Strategies – The Steel Report – www.climatestrategies.org

8. Leakage protection with inclusion of consumption can focus on energy/carbon intensive materials allocation of mitigation and carbon costs of steel, cement, (perhaps aluminium and cooper) is essential for credible investment perspective coverage of competing materials avoids distortions focus on few materials limits administrative efforts and complexity 3 Industrial activities with the highest cost increase from carbon pricing, and their contribution to UK GDP, assumed carbon price increase 20 €/t CO2, electricity price increase 10 €/MWh.

9. The future of the ETS in Europe’s climate strategy • What role plays ETS as European climate policy evolves? • Should the ETS remain the centrepiece of European climate policy? How should it fit with other policy instruments, such as the Renewables Directive? • What reforms are needed to keep the ETS relevant? Should policymakers worry about a low carbon price?