Understanding the ETS Phase IV cap

[Revised on 17/11/20 to align the total cap with the Commission Decision on the Union-wide quantity of allowances to be issued under the EU Emissions Trading System for 2021]

Based on our analysis of the provisionally agreed Phase IV ETS text, the Phase IV cap breaks down as follows:

Assumptions and notes:

• Percentages relate to the total fixed installation cap, which is 13,781 million as of 17/11/20
• This cap will be tightened to deliver a more ambitious 2030 climate target, with a proposal expected in 2021
• Dotted arrow flows are not reflected in the percentages
• The number of allowances available for compliance also includes the market surplus, which is not considered here
• Auction volumes (and NER allowances) can enter the Market Stability Reserve (MSR), which is not represented here
• Article 10c transitional free allocation is made from Member States’ auctionable allowances
• Unused Article 10c allowances from Phase III may be added to 2021 auction volumes or the Modernisation Fund, which is not represented here

Auction Share Key Points

• The auction share will comprise 57% of the total cap, but this can fall to as low as 54% if allowances need to be transferred to the free share to avoid a CSCF
• 2% of the total cap will be taken out of the auction share for the Modernisation Fund; this increases to 2.5%, if allowances are not required for avoidance of the CSCF
• 75 million allowances from the auction share will go into the Innovation Fund; this will increase to 125 million if allowances are not required for the avoidance of the CSCF
• 10% of the allowances available for Member State auctioning will be used for solidarity purposes
• Member States may voluntarily cancel auctionable allowances in the event of the closure of electricity generation in their territory
• Member States may transfer solidarity and Article 10c allowances to the Modernisation Fund
• The amount auctioned in practice will determine the level of cancellation from the MSR and is affected by the following factors:
  • The percentage of the auction share transferred to the free share to avoid a CSCF
  • The amount of allowances that the MSR withdraws (which is administered through adjusting down auction volumes)
  • The amount of Article 10c free allocation, which reduces the number of allowances auctioned
  • The amount of voluntary cancellation of auction volumes by Member States
  • The auctioning of non-auction share allowances (e.g. free allowances and Phase III unallocated allowances for the Innovation Fund), which increases the number of allowances auctioned
• The timing of these factors will also have a bearing on the timing of cancellations from the MSR

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Free Share Key Points

• The free share will comprise 43% of the total cap, but this can rise to 46% if required to mitigate the CSCF
• 325 million allowances from the free share will go into the Innovation Fund
• The free share can be supplemented with allowances from the Phase IV NER to allow for allocation to new entrants and growing installations; the Phase IV NER is stocked with unallocated allowances from Phase III 
• The actual amount given out for free in Phase IV will be affected by bottom-up eligibility calculations, the application of the CSCF (and in some cases the LRF) as a haircut, as well as the extent to which certain Member States use the Article 10c derogation

Funds Key Points

• The Innovation Fund is stocked as follows:
  • 325 million allowances from the free share
  • 75-125 million allowances from the auction share (depending on whether CSCF flexbility is required)
  • 50 million unallocated Phase III allowances not allocated due to cessations, partial cessations, and the Phase III NER being underused, which enter the MSR under Article 1(3) of the MSR Decision in 2020
  • It is also supplemented with revenues from its predecessor NER300
• The New Entrants' Reserve (NER) is stocked as follows:
  • Phase III allowances not allocated to installations not on the carbon leakage list (referred to as 'CLEF' allowances in the diagram above), which the EC's 2015 Impact Assessment estimated will number 145 million (Greece, however, has first claim on up to 25 million of these)
  • 200 million Phase III allowances not allocated due to cessations, partial cessations, and the Phase III NER being underused, which enter the MSR under Article 1(3) of the MSR Decision in 2020
  • Allowances will leave and enter the NER depending on growth/contraction in the industries receiving free allocation
  • Up to 200 million allowances will be transferred from the NER to the MSR at the end of Phase IV if NER allowances remain unused
• The Modernisation Fund is stocked as follows:
  • 2-2.5% of the total cap, taken from the auction share
  • Member States may top this up with solidarity and Article 10c allowances

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