CAN YOU PROVIDE MORE INFORMATION ON THE EUROPEAN UNION’S EMISSIONS TRADING SYSTEM AND ITS IMPACT ON RENEWABLE ENERGY DEPLOYMENT?

The European Union Emissions Trading System (EU ETS) is a cap-and-trade system implemented in 2005 that aims to combat climate change by reducing greenhouse gas emissions from heavy energy-using industries in the EU, including power plants. Under the EU ETS, there is a declining cap on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. Within this cap, companies receive or buy emission allowances which each allow emissions of 1 tonne of carbon dioxide equivalents. Companies can buy and sell allowances as needed in annual emissions trading auctions and on the secondary market. This creates a price signal encouraging greenhouse gas reductions where they can be made most cost-effectively.

The EU ETS has played an important role in driving the deployment of renewable energy sources across Europe. The carbon price signal created by the trading of emission allowances under the EU ETS incentivizes power generators to switch away from fossil fuel-based generation towards lower-carbon alternatives such as renewable energy sources. Several studies have found that the carbon price resulting from the EU ETS has increased the deployment of renewable energy capacity in the power sector across the EU. For example, a study by the European Environment Agency found that about 45% of new renewable capacity installed between 2008-2015 could be attributed to the impact of carbon pricing under the EU ETS. This effect is due to renewable energy sources such as wind and solar having very low marginal generation costs once invested, giving them a competitive advantage over fossil fuel generation as carbon prices rise.

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The increased deployment of renewable energies under the EU ETS also displaces fossil fuel generation, contributing to emission reductions in the capped sectors. A study published in Nature Climate Change found that cumulative emission reductions due to renewable energy deployment driven by the EU ETS amounted to around 20 million tonnes of CO2 between 2008-2015. This displacement effect amplifies the overall impact of the emissions trading system on emission reductions beyond a simple cap-and-trade mechanism. The incentive for renewable energy provided by the carbon price is largely dependent on the stability and predictability of the price signal. Periods of low and volatile carbon prices, such as those seen in Phase 2 and Phase 3 of the EU ETS to date, undermine this effect to some extent.

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The EU ETS also indirectly supports renewable energy deployment through specific provisions within the design of the system. For example, the EU ETS electricity sector benchmark used for free allocation distribution considers a renewable energy benchmark. This favors renewable generators who face no carbon costs and thus need fewer free allowances. Also, the directive establishing the EU ETS allows Member States to use revenues from EU ETS allowance auctions to support national renewable energy and energy efficiency measures. Many countries have implemented such ‘carbon pricing measures’ like UK carbon price support and Sweden’s carbon tax, with revenues dedicated to green energy goals. Estimates suggest up to 30% of renewable support spending across EU nations between 2008-2015 was financed through carbon pricing revenues. So in several ways, the design and operation of the EU ETS provides dedicated support for scaling up renewable electricity.

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The emissions trading mechanism of the EU ETS has played a significant role in driving renewable energy deployment across the European Union over the past decade. By placing a price on carbon emissions, the EU ETS incentivizes the replacement of fossil fuels with lower-carbon alternatives like various renewable energy sources. Empirical analysis has shown over 40% of new renewable capacity installed since Phase 2 can be attributed to this effect. The displacement of fossil fuel use by renewables supported by the ETS also amplifies its emission reduction impact. While a stable and high enough carbon price is critical, features within the EU ETS that support renewable energy further increase its positive impact on deployment of clean energy alternatives across Europe’s power sector.

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