Berlin confirms intention to cancel EUAs rendered superfluous after closure of coal power plants

On 3 May, the European Commission shared a notification it received in late 2023 from the German government about Berlin’s intention to voluntarily cancel emission allowances (EUAs) associated with the closure of two coal power generators in 2022 as part of Germany’s coal phase-out policy.

Voluntary cancellation of EUAs is meant as a possible way to avoid a situation of EUA surplus that would otherwise occur when demand drops as a result of certain member states having domestic policies that affect emitters already covered under the EU ETS (whose cap is decided on an EU level). Several countries, most notably Germany and Poland, have decided to phase out or reduce the share of coal in their power mix. So far, only Germany has said it will cancel a corresponding volume of EUAs to avoid flooding the market with unused EUAs.  The cancellation will cut the number of EUAs the German government will auction and thereby also reduce its future revenues.

If no action is taken, the disappearance of one of the key groups of EUA buyers will free up allowances for emitters in other sectors or states. This type of demand shock could easily weigh on carbon prices.

Germany’s notification to the Commission follows the procedure for the cancellation of allowances laid down in Article 25 of Commission Delegated Regulation (EU) 2023/2830 (‘Auctioning Regulation’).

The present notification relates to a Neurath A (294 MW) and Frechen (120 MW), one power station and one briquette production facility in Frechen, both operated by RWE until their closure on 1 April 2022 and 31 December 2022, respectively. It states that up to 12.25 million tonnes worth of EUAs can be cancelled in the years 2025-2030.

Germany on course for zero coal in 2038

In July 2020, Germany decided to phase out coal power by 2038 to reach its domestic climate targets. Then, EUAs were trading at less than EUR 30/t and there was genuine concern that the price signal alone might be insufficient to push coal out of the fuel mix. This was also well ahead of the 2022 gas price crisis which forced Germany to temporarily increase its coal-based generation.

The phase-out plan spells out how much capacity will be closed yearly in the period 2020 to 2038, with a detailed breakdown by region (Rhineland, Lusatia, and Central Germany) and by type of coal (hard and lignite).

From a coal power capacity of 44 GW in 2019 (hard and lignite combined), Germany reduced to 30 GW in late 2022. The plan is to be at 26 GW by the end of this year, and 17 GW in 2030.

The timeline was adjusted in December 2022, to end power generation from brown coal in North-Rhine-Westphalia in 2030 instead of 2038 as originally envisaged. The regulatory update also clarifies that due to the difficult supply situation (the then very high gas prices), the two generators Neurath D and Neurath E were prolonged from 2022 to 2024. More information here.

In addition to a detailed timeline for each power station, the phase-out plan also stipulates some EUR 4.25 billion in compensation to coal plant operators, plus EUR 40 billion in economic support for the regions most affected.  

Unclear what effect Berlin assumes the MSR will have

The notification to the European Commission lays out the calculation method Germany will use to estimate the number of allowances subject to cancellation. This is done in four steps: 1) Identification of closed installations, 2) Model calibration, 3) Electricity market modelling and 4) Taking account of the MSR effect and deducting the cancellation volume.

In the first steps, an electricity market model calibrated with fuel and carbon prices, electricity consumption, generation capacities, transfer capacities etc., is used to do two runs.

First, one scenario where the plant subject to decommissioning is in the power stack, then another where it is not. The delta between emissions for the two runs for the various years will be the basis for the cancellation. Hence, the difference will depend on the available power stack and which generation types are filling the gap of the decommissioned plant. If the power generation is mainly replaced by coal, the gap between the two runs will be less than if it leads to more gas burn.

In the fourth and last step, the operation of the Market Stability Reserve is taken into account. If TNAC is above 833 Mt, the Market Stability Reserve is active and withholding allowances from the auctions. In this case, there will be no cancellation for the respective year. However, if TNAC is below 833 Mt the volume for the reduction effort calculated in the previous steps will be cancelled from Germany’s auction volume.

The notice does not display any particular assumptions taken on the MSR operation. We assume Berlin has taken a conservative view, if any, as they communicate the maximum amount that will be cancelled. In Veyt’s base case we see the MSR being active until 2028, meaning the TNAC published in 2027 will still be above 833 Mt. 2028 will be the first year where with a TNAC below 833 Mt and hence the first year where Germany will cancel allowances from their auction volumes due to coal phase-out policies.

We believe the closures of Neurath A and Frechen will lead to cancellations well below the 12.25 million tonnes maximum stated in the announcement. Hence, we expect the cancellation notification to have a limited market impact.

More details can be found in the document submitted to the European Commission in December 2023 (available in German and English) here.