The European Commission late Tuesday proposed measures to protect the EU Emissions Trading System from the effects of a possible pull-out by the UK due to the Brexit decision.
The move follows informal agreement between the EU Parliament and Council on October 18 on a legislative amendment that would invalidate allowances from January 1, 2018, issued by any country leaving the EU's carbon market.
That was necessary to avoid a scenario where the operators of UK-based installations receive millions of allowances that they no longer need for compliance, and sell them into the system, crashing the carbon price, before the UK leaves the market after March 29, 2019.
The UK has not yet announced any decision on whether it will continue to participate in the EU ETS post Brexit, but the country is considered to be lapsing in its obligations for 2018 unless it makes an arrangement to stay in the system.
Following the political agreement on the Brexit safeguard measure between the parliament and council, the EC on Tuesday presented the detailed regulation needed to implement it to the EU Climate Change Committee.
"The proposed measures are considered necessary because, in the absence of any future agreement between the Union and the United Kingdom, Union law will cease to apply to the UK as of March 30, 2019," the EC said in a statement.
"As of that moment, the installations and aviation operators in the UK would no longer be subject to any obligations as regards the EU ETS, in particular the obligation to surrender a number of allowances corresponding to the verified emissions during 2018 by April 30, 2019," it said.
The draft update would allow the marking and blocking of the use of carbon allowances issued by the UK as of January 1, 2018, the EC said.
"These marked allowances [using a country ID code] could no longer be surrendered in order to meet compliance obligations under the EU ETS," it said.
The measure would apply to allowances auctioned, freely allocated or exchanged for international emissions credits as of January 1, 2018.
Such allowances would no longer be valid for compliance under the EU ETS, including for compliance with calendar 2017 emissions.
The EC said the proposed measures "are without prejudice to any future agreement with the United Kingdom that may provide for specific arrangements after the date of withdrawal on March 29, 2019, to enable UK entities to effectively enforce compliance obligations arising under the EU ETS for the years 2018 and 2019."
Effectively that means the terms of the amendment would no longer apply should the UK decide to stay in the EU ETS after the Brexit date.
The proposed amendment is likely to affect the validity of at least 87 million auctioned allowances and 57 million freely allocated allowances, in addition to aviation allowances auctioned or issued to airlines -- likely less than 10 million -- based on the EC's average figures for 2015-2017.
The auctioning volume affected could be higher in 2018, as this has increased in recent years, rising to 102.5 million mt in 2017.
As a result of the Brexit decision, and in the absence of the amendment, the allowances auctioned or allocated by the UK in 2018 and 2019 could increase the surplus in the EU ETS precisely at a time when a reserve to reduce the surplus is due to become operational, undermining its performance.
The proposed amendment to the Registry Regulation would need to undergo scrutiny by the parliament and council, which normally takes around two months. That creates a tight timescale to get the proposal into law before the new year.
Potential impacts of the proposal becoming law include a devaluation in the price of UK-issued carbon allowances and increased demand for allowances issued by the remaining 27 member states, creating a divergence in price.
The regulation could also dissuade buyers from purchasing allowances in UK government auctions starting in January, prompting them to fail, and depriving the UK Treasury of up to Eur700 million (about $825 million) in auctioning revenue in 2018 alone.
In addition, the UK government may need to provide guidance to the operators of UK-based installations on how to comply with the EU ETS if no decision is made to exit the system by the end of the year.
While the amendment's main purpose is to protect the environmental integrity of the EU ETS from the effects of a hard Brexit, it also increases pressure on the UK government to make a decision on post-Brexit arrangements for participating in the EU ETS.
