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Highlights


Coal funding ruled out from Modernization Fund

Reserve to remove surplus by 24%/year from 2019-2023

Excess reserve volume to be canceled after 2023

Negotiators from the EU Parliament, European Commission and European Council on Thursday struck a provisional deal to overhaul the EU Emissions Trading System post-2020, after almost three years of legislative work.

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The deal includes most of the key measures already on the table in the formal negotiating mandates.

It also managed to overcome a major stumbling block by ruling out coal and other emissions-intensive power generation fuels from receiving funding through the proposed EU ETS Modernization Fund.

The deal reached early Thursday set out rules for the EU ETS in the fourth trading phase, running 2021-2030.



The key elements agreed are:

- Market Stability Reserve: will remove 24% of cumulative surplus of carbon allowances each year from 2019-2023.

- Cancellation: all carbon allowances in the MSR in excess of the previous year's auctioning volume will be canceled after 2023.

- Linear Reduction Factor: the CO2 cap will decline by 2.2% per year from 2021-2030, from 1.74%/year in the 2013-2020 period.

- Modernization Fund: coal ruled out from receiving funding, except for Bulgaria and Romania.

- Shift in free allocation share: 3% conditional shift from auctioning to free allocation in case a correction factor is applied.

- Plant closures: member states allowed to voluntarily cancel allowances linked to plant closures.


COAL FUNDING RULED OUT


The issue of coal funding had prompted a stalemate at the last negotiating session on October 12 and threatened to block progress in Wednesday night's session in Brussels, which lasted into the early hours of Thursday.

Some of the more coal-dependent central and eastern European EU member states wanted coal-fired power plants to qualify for carbon market funding, but the parliament and a group of northern and western EU states wanted to rule out emissions-intensive fuels from receiving additional subsidies.

"EU ETS preliminary agreement reached with [Estonian Presidency of the EU Council] after a long night of negotiations," the Parliament's chief lawmaker for the post-2020 carbon market reforms, Julie Girling, said.

The European Commission said the revision "will put the EU on track to achieve a significant part of its commitment under the Paris Agreement to reduce greenhouse gas emissions by at least 40% by 2030."

Non-governmental group Carbon Market Watch said negotiators agreed to exclude funding for solid fossil fuels under the Modernization Fund, with the exception of the two poorest countries, Bulgaria and Romania, and only for plants used for district heating.

The planned Modernization Fund consists of 310 million carbon allowances to be auctioned to fund power generation upgrades in the lowest-income EU member states.


STRENGTHENED MARKET STABILITY RESERVE


The deal also includes the previous agreement between the council and parliament to double the strength of the Market Stability Reserve, which will remove 24% of the cumulative surplus of carbon allowances each year for five years starting January 2019.

The EU ETS negotiations have been fraught because Europe has been trying to strike a balance between the need for ambitious and cost-effective emissions reductions while protecting trade-exposed industry from undue distortions arising from carbon costs.

To protect the competitiveness of the EU's industry, negotiators also agreed a 3% conditional shift in allowances from the auction share to the free allocation share, according to the International Emissions Trading Association.

Power generators' industry group Eurelectric welcomed the provisional agreement.

"Investors across Europe have received the much needed legal clarity that will enable them to take better informed decisions on low-carbon investments," Eurelectric's secretary general Kristian Ruby said in a statement.

"Eurelectric is particularly pleased to see that the measure to double the MSR intake rate is now a concrete part of the agreement. Furthermore, the measure to cancel those ETS allowances which are above the previous year's auctioning volume, already from 2023, is an important signal of the EU's commitment to address the toxic oversupply of allowances," the group said.

The deal means the main political hurdles in the proposed post-2020 EU ETS reforms have been overcome.

EU Allowance futures contracts for December 2017 delivery on the ICE Futures Europe exchange were quoted at Eur7.82/mt ($9.10/mt) at 1215 GMT, up 10 euro cent/mt from Wednesday's close.

The initial muted price response may reflect a remaining degree of uncertainty over the post-2020 reform deal.

The next step is for EU ambassadors to approve the deal at the committee of permanent representatives to the EU Council, known as COREPER.

Approval by COREPER was expected, but not a foregone conclusion, because the provisional deal reached Thursday includes measures that were not part of the Council's formal negotiating mandate -- specifically on the issue of funding for fossil fuel-fired power plants.

COREPER is set to meet Friday when EU ambassadors will be debriefed on the outcome of Wednesday's meeting, and another meeting will be needed before agreement can be made, an EU source said Thursday.

"They will be asked to endorse the provisional text in one of the forthcoming COREPER meetings [after November 10]," the source said.

Once passed by COREPER, the deal would need approval by the EU Parliament's environment committee and at a full plenary vote. The agreement would then need formal rubberstamping by the EU Council before becoming law.

All those approvals can be expected after the political agreement reached on Thursday.

The European Commission first started consultation on post-2020 EU ETS reforms in December 2014 before unveiling a legislative proposal in July 2015.

Since then, the proposal has gone through scrutiny and subsequent amendments and revision by the EU parliament's committees before approved negotiating mandates were developed for negotiation between the parliament and council.

Europe's informal agreement to overhaul its cap-and-trade system comes as almost 200 countries gather in Bonn, Germany, to discuss globally coordinated action on climate change at the United Nations 23rd Conference of Parties to the UN Framework Convention on Climate Change (COP23).

--Frank Watson, frank.watson@spglobal.com
--Edited by Dan Lalor, daniel.lalor@spglobal.com

(Update adds further detail throughout)