The new EU ETS

Climate change poses significant challenges to policymakers, and addressing it requires a concerted effort from governments, businesses, and individuals. The European Union (EU) has taken a leading role in tackling climate change, and one of its key policy tools is the EU Emission Trading System (EU ETS).

Climate change poses significant challenges to policymakers, and addressing it requires a concerted effort from governments, businesses, and individuals. The European Union (EU) has taken a leading role in tackling climate change, and one of its key policy tools is the EU Emission Trading System (EU ETS).

The EU ETS is a cap-and-trade system that sets a limit on the total amount of greenhouse gas emissions allowed and issues allowances to companies that emit greenhouse gases. The allowances can be traded on the carbon market, providing a financial incentive for companies to reduce their emissions. By putting a price on carbon emissions, the EU ETS aims to encourage businesses to invest in low-carbon technologies and reduce their emissions, thereby contributing to the fight against climate change.

In the context of the much publicized ‘Fit for 55’ climate and energy package, which includes a comprehensive set of climate and energy policy measures to achieve the EU’s goal of reducing greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels as prescribed by the European Climate Law of July 2021, a deal is reached on significant reforms to the EU ETS to make it more ambitious.

One of the most significant changes under the ‘Fit for 55’ package is the expansion of the EU ETS to include new sectors. The EU ETS currently covers emissions from power and heat generation, energy-intensive industries and aviation. The new sectors that will be brought into the EU ETS include maritime transport, road transport and buildings.

Thus, with regards to the maritime sector, the same rules on auctioning, transfer, surrender and cancellation of allowances, penalties and registries will apply to maritime transport as to the other sectors currently covered by the EU ETS. The agreement foresees in a gradual inclusion of the sector, with the obligations to surrender allowances rising from 40% of verified emissions in 2024 to 100% in 2026.

The extension to maritime transport would build on existing monitoring, reporting and verification mechanisms (MRV)[1] that exempt small ships. Most ships used for commercial purposes, cargo or passengers of 5.000 gross tonnage and above are included in the scope of the EU ETS from the start. Big offshore vessels of 5.000 gross tonnage and above will be included in the MRV from 2025 and in the EU ETS from 2027. Vessels between 400 and 5.000 gross tonnage will be included in MRV from 2025 and their inclusion in EU ETS will be reviewed in 2026. Further, also some non-CO2 emissions will be included in the MRV from 2024 and in the EU ETS from 2026.

With regards to buildings and road transport, more specifically the emissions from the building heat and road transport fuels, a separate self-standing ETS will be established (sometimes referred to as “ETS 2”), in order to ensure cost-efficient emissions reductions. It is said that a possible merger of the two ETS systems will be assessed only after a few years of the functioning of the new emission trading.

The total quality of allowances for the new ETS (ETS 2) will follow a linear trajectory to reach the 2030 emissions reduction target. The total quantity of allowances will be established for the first time in 2027[2], to follow a trajectory starting in 2024 from the value of the 2024 emissions limits, with boils down to a 5,10% linear reduction factor. From 2028, the total quality of allowances is set on the basis of the average reported emissions for the years 2024–2026, which corresponds to a 5,38% linear reduction factor. The auctioning of the allowances will start with a volume corresponding to 130% of the auction volumes for 2027, thus an additional 30%, and may be auctioned until 31 May 2028 to ensure a smooth start of the new ETS. The additional volumes shall be deducted from the auction volumes for the period from 2029 to 2031.

It is stressed that, as certain member states already have national carbon taxes that apply to the building and road transport sector, a temporary derogation of the new ETS is possible until December 2030, if the level is equivalent to or higher than the auction price for allowances in the new ETS.

In order to increase certainty for citizens that the carbon price in the initial years of the new emissions trading system does not go above 45 EUR, it was opted to include an additional price stability mechanism to release allowances from the Market Stability Reserve in case the carbon price exceeds that level.

The Commission will further assess and report by 31 July 2026 on the possibility of including the municipal waste incineration sector in the ETS with a view to including it from 2028 and assessing the need for a possibility of an opt out until 31 December 2030.

Furthermore, apart from the introduction of new sectors to ETS, the Council and Parliament agreed to increase the overall ambition of emissions reductions by 2030 in the sectors covered by the already existing ETS (under its original scope apply to heavy industry and aviation, i.e. “ETS 1”) to 62%, as opposed to the current 43%. It is agreed upon that, in 2024, the Union-wide quantity of allowances shall be decreased by 90 million allowances. In 2026, it is further decreased by 27 million allowances.[3] The linear reduction factor shall be 4,3% from 2024 to 2027 and 4,4% from 2028.

The new ETS also makes free allocation of EU ETS allowances conditional on decarbonization efforts in order to incentivize the uptake of low-carbon technologies. Installations covered by the obligation to conduct an energy audit under the current Article 8(4) of the Energy Efficiency Directive (‘EED’)[4] will be required to implement recommendations of the audit report, or to demonstrate the implementation of other measures which lead to greenhouse gas emission reductions equivalent to those recommended by the audit report. Otherwise, they would see their free allocation reduced.

In addition to this, the new EU ETS free allocation rules will better support decarbonization of energy-intensive industries by the deployment of break-through technologies. Before, innovative installations could fall out of the EU ETS because they changed their production process or because their total rated thermal input of the combustion units of an installation decreased to less than 20 MW. By unexpectedly falling out of the EU ETS, a formerly covered company could be facing a number of undesirable consequences. The new ETS remove these disincentives for innovative low-carbon technologies by specifying that installations can stay within the EU ETS even if they reduce the total capacity of their combustion units to less than 20 MW (for example through electrification).

The Council and Parliament have also reached an agreement regarding the sectors covered by the Carbon Border Adjustment Mechanism (CBAM), which includes cement, aluminum, fertilizers, electric energy production, hydrogen, iron and steel, as well as some precursors and downstream products. They have decided to gradually end free allowances for these sectors over a period of nine years, from 2026 to 2034. During this time, the CBAM will only apply to emissions that do not benefit from free allowances under the EU ETS, to comply with World Trade Organization regulations.

The phase-out of free allowances will start at a slower pace and accelerate towards the end of the period. To support decarbonization of these sectors, the Innovation Fund will be made available. Before 2026, the Commission will evaluate the CBAM’s impact on carbon leakage risks and determine whether further measures are necessary.

In conclusion, the new EU ETS as a result of the ‘fit for 55’ package is a crucial step in the fight against climate change. The package includes a range of measures to reduce emissions, promote renewable energy and create a more sustainable future. The strengthened ETS will cover more sectors, reduce free allowances, and gives substance to the CBAM, which will help prevent carbon leakage and ensure a level playing field for EU businesses. While there may be challenges ahead, the EU’s commitment to reducing greenhouse gas emissions by at least 55% by 2030 is a clear indication of its determination to tackle climate change and lead the way in building a more sustainable future.

Authors:


[1] As established by the Regulation (EU) 2015/757 of the European Parliament and of the Council of 29 April 2015 on the monitoring, reporting and verification of carbon dioxide emissions from maritime transport, and amending Directive 2009/16/EC.

[2] It should be noted, however, that the new ETS could be postponed unit 2028 to protect citizens, if energy prices are exceptionally high.

[3] In 2024, the Union-wide quantity of allowances shall be increased by 78,4 million allowances for maritime transport.

[4] Directive 2012/27/EU of the European Parliament and of the Council of 25 October 2012 on energy efficiency, amending Directives 2009/125/EC and 2010/30/EU and repealing Directives 2004/8/EC and 2006/32/EC.

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