Launched back in 2005, the EU Emissions Trading Scheme (EU ETS) is the EU’s key carbon pricing instrument and the world’s earliest international emissions trading system. Currently, it operates in 27 EU member States and in Iceland, Liechtenstein, and Norway, and covers more than 10,000 installations in the power sector, the manufacturing industry, and airlines operating in the European Economic Area (EEA).

The EU ETS is a “cap and trade” system, which sets an annual limit on the total greenhouse gas (GHG) emissions (cap) of covered entities. The cap is gradually reduced annually to achieve emissions reduction. Market players purchase or receive an initial amount of allowances. Deficit of allowances ensures that there is a market price for them. Depending on GHG abatement cost and company strategy, each entity decides whether to cut emissions or buy allowances from other installations. This market-based approach ensures that emissions are cut in a cost-effective manner.

The European Commission estimates that the EU ETS delivered almost 43% of the GHG emissions reduction achieved by power generation and energy-intensive industries over the past 16 years. However, the Commission also acknowledges the mechanism needs to be updated. Without amendment, the sectors covered by the EU ETS will likely achieve emissions reduction of -51% in 2030 compared to 2005. This is an insufficient contribution to the EU-wide target of at least -55 % compared to 1990 and a primary reason for the planned revision of the EU ETS.

On 14 July 2021, the European Commission released proposed amendments to the EU ETS as part of the ‘Fit for 55’ package – policies designed to deliver a cumulative emissions reduction of at least 55% by 2030 compared to 1990 levels. The proposed directive highlights the EU ETS as “a core instrument to help the EU achieve the increased 2030 target and a successful and just transition towards the 2050 climate neutrality.”

Tightening emissions cap

Key proposed amendments involve tightening the emissions cap and increasing the carbon price. In particular, a more ambitious emissions reduction target is planned for the sectors covered: – 61% by 2030, compared to 2005 levels. This is an 18% increase on the current contribution of emissions trading to the EU’s climate efforts. To achieve this target, the linear reduction factor – a percentage of annual reduction of total allowances – would be increased from 2.2% to 4.2% following the EU ETS Directive amendments’ entry into force. The reduction factor is combined with a one-off adjustment of the cap by 117 million allowances so that the adjustment has the same effect as if it had been applicable since 2021. Further, free allocation of allowances for aviation will be gradually phased out by 2026 so that this sector also contributes its fair share. 

Broadening the scope of EU ETS to maritime transport

Recognizing the success of the EU ETS at putting the price on carbon emissions from power plants and industrial installations, EU climate chief Frans Timmermans said “it is a huge incentivising instrument and it is clear that we need to expand it.” This is another proposed major change in the EU ETS’s design.

The EU ETS currently encompasses power generation, manufacturing, and aviation – emissions sources responsible for around 41% of the EU’s GHG emissions. However, sectors with significant emissions such as maritime and road transport as well as buildings are currently outside of the EU ETS. In its proposal, the European Commission stresses that all economic sectors will need to contribute to the EU’s climate efforts.

GHG emissions from maritime transport have increased since 1990 and are expected to grow further under the business-as-usual (BAU) scenario. To shift this trend, the European Commission is proposing to extend the EU ETS to maritime transport, particularly for large ships (above 5,000 gross tonnage) from 2023. The extension would apply to emissions from intra-EU voyages, to 50% of the emissions from extra-EU voyages, and to emissions from ships while at berth in EU ports. These provisions would result in additional coverage of 90 million tonnes of carbon dioxide (CO2) – around two-thirds of maritime transport emissions within the EU – and send a price signal to incentivize the application of energy-efficient and low-carbon solutions in the maritime sector. To ensure a smooth transition, the provisions mean shipping companies would be initially required to surrender a portion of their verified emissions, which would then be gradually increased to 100% in 2026.

Establishing a new emissions trading scheme for road transport and buildings

The building sector is responsible for 36% of the EU’s energy-related GHG emissions and has a large cost-effective emissions reduction potential. At the same time, the transport sector accounts for 20% of the EU’s emissions, which have increased by 25% since 1990.

To stimulate emissions reduction in the road transport and buildings sector, the Commission proposes a separate but adjacent emissions trading system, which should deliver emissions reduction in these sectors of -43% in 2030 compared to 2005.

The Commission also proposes an upstream approach to regulated entities. The new system would target fuel suppliers for heating and the road transport sector rather than households and car drivers. The rollout of the system would start in 2025. During the first year, regulated entities would be required to report on their emissions for 2024 and 2025, while the allocation of allowances and compliance obligations would be introduced from 2026. A merger with the main ETS could be considered at a later stage after the separate system has worked on its own for several years.

The politics of the transition may not be as smooth as the rollout design though. The carbon price introduced for heating and transport fuels would be inevitably passed on to end-users, so the new system might result in a considerable increase in heating and transportation costs for households, which is a major reason for discontent among Members of the European Parliament (MEPs). Pascal Canfin, a French MEP chairing the European Parliament Committee on the Environment, called a new ETS “political suicide,” referring to risks of social unrest similar to the 2018 Yellow Vests movement in France.

To address these concerns, the Commission proposed the establishment of the Social Climate Fund to provide support for vulnerable households, micro-enterprises, and transport users, which may face challenges as a result of the new ETS.

The Commission elaborates further proposed amendments to the EU ETS on a dedicated webpage.

The proposal for a directive is open for feedback until 18 October 2021. The European Commission will summarize all received comments and present this summary to the European Parliament and Council, which will then need to negotiate and reach an agreement on the final text before amendments are approved and implemented. It remains to be seen which of the proposed amendments will end up written into law.

By Yuliia Oharenko, Associate, IISD Energy Program