(The author is a Reuters market analyst. The views expressed are his own.)
By Gerard Wynn
LONDON, April 16 (Reuters) - The European carbon market will bounce back from the rejection by the European Parliament on Tuesday of a proposal to skim off surplus allowances which have smothered the market as a result of the financial crisis.
The market works by issuing factories and power plants a fixed quota of EU allowances (EUAs). A surplus of these has cut demand and seen carbon prices fall by more than 90 percent compared with all-time highs.
The European Parliament rejected a so-called back-loading proposal which would have delayed the sale of some 900 million EUAs from 2013-2015, or about half of annual carbon emissions under the scheme.
The Parliament's 315-334 rejection is probably the death of that proposal, but not the market.
The European Commission's back-loading proposal was step one in a long process to permanently remove the surplus EUAs.
It threatened to destabilise the market for two to three years as the market tried to follow each twist and turn in that approval process involving the Commission, Parliament and EU member states, with no guarantee of success.
Reform proposals will now shift away from the short-term when it could be argued the EU has bigger political priorities than hiking carbon and power prices, to right its flagging economy.
It is time that the Commission combined proposals for an ambitious 2030 EU-wide carbon emissions cap with reform of the carbon market for a coherent climate policy which looks beyond the present economic crisis.
The Commission responded to the Parliament's rejection by saying that it continued to support the back-loading proposal, preferring more clarity on the position of the Council of 27 EU member states before letting it die.
"The Commission remains convinced that back-loading would help restore confidence in the EU ETS in the short term until we decide on more structural measures," said Climate Commissioner Connie Hedegaard.
"We will now reflect on the next steps to ensure that Europe has strong EU ETS (emissions trading scheme). In doing so the Council's position on the proposal will be an important factor and I take note of the Irish Presidency's reaction today to urgently pursue and conclude discussions among Member States."
Little or no further reputation damage will be inflicted upon the market from a further period of hiatus while the Commission clarifies the Council position.
However the proposal is now badly damaged below the water-line and will probably die.
This probably also fatally wounds the next stage of deeper, so-called "structural measures", where the Commission published options in November.
These were supposed to be step two, after the EU had approved temporarily withholding some EUAs.
The Commission's preferred option was probably to cancel permanently some of those EUAs, but it listed five other options, all applied to the present trading cycle from 2013-2020.
Those other five options were to: tighten the existing EU-wide carbon cap in 2020; make steeper annual cuts in EUAs under the scheme; bring more economic sectors into the scheme; limit access to international offsets; or introduce a carbon price floor.
The Parliament on Tuesday rejected a lighter version of all these, merely to withhold EUAs temporarily.
More ambitious structural measures also appear off the table for now.
Chart 1: link.reuters.com/cuk66t
Chart 2: link.reuters.com/duk66t
But there is an option which will see prices rise again before the end of the present trading cycle.
It is remarkable that the Commission has not yet linked reform of the carbon market to its parallel efforts to agree a new EU-wide carbon emissions target in 2030.
It made no mention of the year 2030 in its review of EU ETS structural measures, published in November, "Report from the Commission to the European Parliament and the Council: The state of the European carbon market in 2012".
And it kicked off a consultation on an EU-wide 2030 carbon cap in March, "A 2030 framework for climate and energy policies", with no link to reform of emissions trading.
The two make a good fit.
An informal Commission proposal for a 40 percent EU-wide cut in greenhouse gas emissions by 2030 - compared with 1990 levels - is a good place to start in longer term emissions trading reform.
If the cut were applied entirely to the ETS - leaving the non-ETS sector including transport, small businesses and households unscathed - then the cumulative EUA surplus would be wiped out by 2026 and price tension restored long before then. (Chart 1)
That would be a similar impact to cancelling 1.5 billion EUAs today, a far more ambitious move than that rejected by Parliament. (Chart 2)
(Reporting by Gerard Wynn)