A summary of key dates relating to the implementation of the ETS Phase IV deal, and further ETS reform.

This graph shows under what circumstances a CSCF will be triggered in Phase IV. A data point above the curve represents an activity level and benchmark scenario that would trigger a CSCF; a data point below the curve represents an activity level and benchmark scenario that would not trigger a CSCF. 

Explanation

• By 'Phase III Historical Activity Level' we mean the sum of all average annual activity levels originally used to calculate Phase III entitlements, based on data from 2005-08 or 2009-10 (installations were free to choose their baseline period).
• By 'Phase IV Historical Activity Level' we mean the sum of all average annual activity levels used to calculate entitlements in Phase IV, which will likely be based on data from 2014-23 (split into two periods).
• By 'Phase III Weighted Average Benchmark' we mean the average of all the benchmark values used in Phase III, weighted to reflect the amount of activity on each.
• By 'Phase IV Weighted Average Benchmark' we mean the average of all the benchmark values used in Phase IV, weighted to reflect the amount of activity on each (and taking account of both halves of the phase).
• It is assumed that if HAL and WAB were the same in Phase IV as in Phase III, installations would be entitled to 9 billion allowances during Phase IV. This is based on adjusting the Phase III entitlement to reflect the longer duration of Phase IV, as well as the shorter carbon leakage list and continued reduction of the CLEF for certain installations. (No adjustment has been made for the UK potentially leaving the ETS.)
• It is assumed that the maximum number of allowances available for free allocation in Phase IV is 43.9% of the cap (6,806,087,813). (No adjustment has been made for the UK potentially leaving the ETS.)
• Under these assumptions, to avoid a correction factor, the product of the index value for the Phase IV HAL and Phase IV WAB has to be less than ~7560 (i.e. 10,000 x 6,806,087,813/9,000,000,000).

Benchmark reduction rates

If we assume no change in the proportion of activity associated with each benchmark, Phase IV WAB values would correspond as follows to the annual benchmark reduction rates used by the European Commission to revise benchmarks:

Of course, the weighted average benchmark reduction percentage is unlikely to be uniform across all benchmarks (or equivalent to the simple average) and it may be influenced by a change in the proportion of activity associated with each benchmark. 

Observations

If we assume production will be about 10% lower in the Phase IV baseline period (i.e. Phase IV HAL = 90), we would expect to avoid a CSCF if the weighted average benchmark reduction exceeded 1%. As we deviate from this scenario with a higher level of activity or lower benchmark reduction, we would expect to trigger a CSCF of increasing severity.

​Two such scenarios are shown below: one assuming 5% lower production in the Phase IV baseline period, coupled with a 1% weighted average benchmark reduction; and the other assuming 10% lower production in the Phase IV baseline period, coupled with a 0.5% weighted average benchmark reduction.

It is assumed in the graph that there is no change in the proportion of activity associated with the benchmarks, and that the number of free allowances available in a given year is 40.9% of the relevant annual cap, plus whatever remains of the CSCF buffer pool of allowances, which is 3% of the total cap (where the total cap is defined as above, assuming a 2.2% LRF throughout and inclusion of the UK).

The trajectory of the CSCFs reflects the fact that the 3% buffer is concealing a growing shortfall between entitlements and the annual cap. In the year the buffer runs out, this large shortfall is partially revealed. In the following year, the shortfall is fully revealed (including an additional year of the LRF). And from this point on the CSCF tracks the LRF. 

Uncertainties

It is unclear where activity levels and benchmarks will come out at this stage. The Commission will gather data ahead of each half of the phase, so we will have a much better sense of the CSCF outlook in 2020, but the ultimate values will only be known around 2025.

It is assumed in the modelling that the LRF is 2.2% throughout Phase IV, but this could be upgraded, which would increase the risk of a CSCF.

Depending on how the Commission interprets the provisions in the ETS Directive, it is also possible that a CSCF might follow a different trajectory to the ones graphed above.

For further information please contact damien.green@perspectiveclimate.com