PGE: How to change EU ETS so that it supports the energy transition?

“With such serious price swings and allowance shortages as we have been seeing, the EU ETS – instead of motivating the producers of power and heat to invest in renewable energy sources – in fact slows these investments down,” said Wojciech Dąbrowski, president of the management board at PGE Polska Grupa Energetyczna. “We have been drawing attention for years to the need to adjust the EU’s energy policy to the specifics of each country. So that the energy transition can be implemented in a way that is just and smart. We currently need a reform of the ETS system and we as the industry are proposing to get rid of the speculative nature of this mechanism,” he added.

EU ETS needs reform and stronger oversight

The EU ETS market requires emitters (e.g. power plants, industrial facilities) to purchase and trade CO2 emission allowances on the primary and secondary market. A report by the European Securities and Markets Authority (ESMA) published on 28 March confirms that in recent years financial institutions made profits on the secondary market. They control a major volume of allowances and influence their price. In contrast to similar CO2 emission markets around the world  (e.g. New Zealand, South Korea), EU ETS does not limit the scope of operations by financial entities, which can treat the market as just another source of earnings. The growth in prices on the ETS market hits companies that need the allowances to operate. In 2021 alone, PGE spent nearly PLN 8.5 billion on the EU emission certificates. This is more than 10% of the overall amount that PGE Group intends to spend on investments to decarbonise the Group (including distribution grids) by 2030.

“The ETS market needs changes and better oversight. Many of the ESMA’s conclusions are similar to findings with the analysis by Compass Lexecon that we commissioned. The analysis pinpoints specific problems in the functioning of the ETS market along with possible corrective measures. We are expecting not only better oversight of the market and greater transparency but also, for example, a restriction of the role of financial institutions involved in speculations,” said Wojciech Dąbrowski. “The report by Compass Lexecon was drafted independently of the ESMA report and not in response to it. We want our voice in the ETS debate to be heard. Our aim is to propose concrete solutions that will help to adjust the mechanism so that it supports the energy transition rather than hampering it,” added Wojciech Dąbrowski.  

Key conclusions from Compass Lexecon analysis

“The analysis commissioned to Compass Lexecon clearly shows the need for the EU ETS system to be reformed, and the conclusions stated in the report should become a part of a wider debate on changes in CO2 emission allowance trading,” emphasised Wojciech Dąbrowski.

Conclusions from the report:

Some of the features of the EU ETS market may be conducive of greater speculation, which could have harmful effects for short- and long-term price stability. These include: inelastic supply, lack of a long-term political commitment to achieving climate targets by financial institutions and regulatory certainty as to the on-going reform of EU ETS. The ETS is also prone to speculative attacks, especially because of the existing Market Stability Reserve (MSR) mechanism.

The report identifies the following solutions that could alleviate the negative effects of speculation and lead to a wider improvement in the functioning of this market:

• Application of fixed measures to improve market monitoring and oversight.
• Introduction of measures intended to stabilise the price of emission allowances so as to reduce massive price swings, which we are currently observing on the market. These measures could include:
  • A reform of the Market Stability Reserve (MSR) by moving away from the total number of allowances in circulation (TNAC) mechanism in favour of a price threshold up to which allowances should be directed to the market. The price of CO2 emission allowances is a more reliable indicator of expected allowance shortages than the number in circulation (which could reflect the build-up of speculative positions rather than the lack of allowances on the market). Tying the supply to the price could potentially mitigate the risks associated with excessive speculation and could ultimately lead to a short-term reduction in price volatility.
  • Introduction of a substitute fee mechanism, the amount of which would reflect the cost of bringing innovative technologies to the market.
  • Reform of art. 29a of the ETS Directive toward a faster response to observed price shocks by moving away from price multiplicators in favour of introducing – as in the case of the proposed changes to MSR – a price threshold from which allowances are freed up on the market.
• Introduction of measures to compensate obligated entities without having to change the EU ETS market. These measures could include a tax on market turnover for entities that are not required to surrender allowances or do not act on behalf of such compliant entities.
• Introduction of temporary measures to limit or regulate financial trading in order to reduce short-term swings in the price of EUAs, particularly in periods of major political or regulatory uncertainty. Such measures may consist of taxation of certain transactions (to limit the value of speculative transactions), minimum holding period for emission allowances (to limit the value of short-term speculative transactions), introduction of individual or general position limits to limit the volumes of allowances traded by financial institutions (to limit the volume of speculative transactions).
• Introduction of additional compensation for CO2 emitters participating in the ETS market: e.g. through a tax on trading in the ETS market of financial entities which are not acting on behalf of emitters. This should of course not violate the aid rules, but would certainly be an effective incentive to invest in green energy.

Compass Lexecon is a leading international economic consulting firm. With 23 offices and more than 500 analysts globally, Compass Lexecon offers transparent analysis of complex issues to law firms, businesses and government customers. Compass Lexecon was named Competition Economics Firm 2020 by WWL. The firm has been winning this award since it was formed in 2015.

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