Update on REPowerEU: Plenary vote, EU ETS sale, and the trilogues ahead

Summary

Today and tomorrow the Parliament will debate and then vote on REPowerEU. EU ETS market participants will be closely watching the amendments on funding drawn from EUA sales, however the vote is expected to confirm the plan opined by the ENVI committee. The trilogue negotiations, expected to begin late November/early December, will hinge on the source of EUAs to be monetized to fund the plan. Regardless of which option or compromise is ultimately adopted, prices are expected to be depressed by oversupply early in phase 4 and buoyed later in the decade by MSR intake.

Context

On 9 November at 15:00 CET, the European Parliament will take up debate on the REPowerEU plan. On 10 November beginning at 11:00 CET, the plenary vote will take place confirming or rejecting amendments to the Commission's proposal. This will be followed by the press conference with REPowerEU rapporteurs beginning at 12:00 CET. The proposed measures seek to accelerate the bloc's shift away from Russian fossil fuels through energy saving, emphasis on renewables, and energy supply diversification. The majority of the funding (225 billion EUR) for the proposed package will flow from unused COVID relief loans. More relevant to carbon market participants is a smaller funding pool (20 billion EUR) that will be monetized through the sale of EUAs.

This monetization of allowances has seen considerable debate since the announcement of the Commission’s proposal in May 2022. The 20 billion EUR scope is unopposed and likely to remain unchanged, but the source of allowances and the timeline for monetization are contested.

The initial proposal from the Commission would raise the 20 billion EUR from the sale of allowances sequestered in the Market Stability Reserve (MSR) over a four-year period. The Council favors the frontloading of allowances from the Innovation Fund and member state auctions in a 75/25 split (€15bn/€5bn) to be monetized over four years.

The EP’s ENVI committee has backed a plan that will bring forward auction volumes from later in the decade, shifting the revenue from member state budgets to REPowerEU. The sale of these allowances will occur between 2023 and 2026, a three-year period.

The result of the vote on Thursday will formally establish the EP’s position and set the stage for trilogue negotiations. We will be watching the plenary closely, but ENVI’s proposed changes are expected to stand. The trilogue negotiations are expected late November/early December with the objective of finalization before 2023.

The trilogue negotiations ahead – weighing the options

Member state auctions

Member state auctions face opposition in the Council because of the hit that national budgets would take. First, the added supply from 2023 to 2025 or 2026 would lower EUA prices in the short term. These dampened prices translate into lower revenue flowing to member state budgets from auction.

Second, these allowances would be brought forward from later in the decade where prices are expected to be much higher. Assuming an EUA price of 75 EUR (based on current levels), the number of allowances required to be sold to reach 20 billion EUR is 270 million. Assuming an average price between 110 and 130 EUR for the years 2027-2030, these 270 million would cost member state budgets between 29.3 and 34.6 billion EUR (these numbers are based on a rough average of price forecasts from the 2022 Carbon Forward Analyst Showdown).

Innovation Fund

The use of Innovation Fund allowances is strongly opposed by the Parliament. The primary opposition to its use is the misalignment between the needs being addressed by the Innovation Fund and by REPowerEU. REPowerEU is aimed at shifting the bloc quickly away from Russian fossil fuels through energy efficiency, clean energy, and diversified supply – largely short- to medium-term measures. The Innovation Fund seeks to fund not yet profitable or risky technologies needed to decarbonize industry. Both seem to have similar goals but eating into Innovation Fund allowances would harm EU industry’s ability to deliver late decade (and beyond) abatement that would not otherwise be possible without breakthrough technology.

Market Stability Reserve

The sale of allowances from the Market Stability Reserve has been controversial since entering the policy arena in May. A key argument against tapping the MSR is that it interferes with the integrity of the market. The MSR is set up as a rules-based mechanism, injecting/removing allowances when total supply is under/over a specified benchmark. As a politically created market, policy risk is always high but by using the MSR as a ‘piggy bank,’ the door is opened for further market interventions. For market actors, this increases policy risk and decreases predictability in an already volatile market. For environmental advocates, this undermines the price signal needed to drive abatement.

Trilogue negotiations

In principle, the MSR option is off the table; in practice it might not be. Neither the Council nor the EP have included any fraction of the REPowerEU funding to come from the mechanism. Instead, the balance of sourcing allowances may be found somewhere between the two institutional positions. So far, the Council has been willing to include member state auctions in its plan – but only up to 25%. On the other hand, the EP has not been willing to agree to any movement on the Innovation Fund. If either the EP or the Council position remains immovable, a middle ground will need to be found. Both lawmaking institutions oppose using MSR funding but if a compromise cannot be reached, discussion on the sale of MSR allowances might find purchase.

Market impact from supply injection and MSR intake

We can expect each of these plans to dampen prices short-term through the periods in which the additional supply is injected. The EP’s amended plan will have a more pronounced short-term impact through the three-year timeline rather than the Council and Commission’s four-year plan.

What remains unclear is how quickly prices will rebound after the REPowerEU sale. Both of the frontloading proposals are ‘cap neutral’ with more allowances coming to the market early decade and less being auctioned between 2027 and 2030. However, the additional supply brought to the market early in the decade will mean an increase in the volume removed from circulation by the MSR; roughly 200 – 250 million allowances more than would be soaked up without a REPowerEU sale. The sequestered early-phase 4 EUAs will lead to a tighter market and higher price later in phase 4.

Additional measures in the Fit for 55 package can be expected to impact the degree to which late-decade prices are impacted. The EP has proposed changes to the MSR’s intake thresholds in line with the cap that would further increase the total number of allowances removed from the market, resulting in additional tightening of the market compared to the status quo. Whether sharp price spikes occur as an outcome will depend on the extent to which renewable generation meets ambitious Commission goals and takes pressure from the market.

Key takeaways

• Debate begins 9 November at 15:00 CET, voting begins 10 November at 11:00 CET
• The plenary vote will not deviate significantly from ENVI’s recommendations; the real policy unknown is where a compromise can be found between EP and Council positions in trilogues
• Each of the plans will be bearish in the short term and bullish later in the decade compared to the status quo