The eighth edition of the State of the EU ETS Report has just been published. This annual report is a joint effort between the European Roundtable on Climate and Sustainable Transition (ERCST), BloombergNEF, the Wegener Center for climate and global change at the University of Graz and EcoAct. It aims to provide an independent contribution to the policy debate on the role and effectiveness of the EU carbon market.
The report comes at a key moment for the EU ETS, as the main elements of its reform have just been adopted by European institutions. In particular, the mechanism’s emission reduction target has been raised (-62% by 2030 compared to 2005) and will now cover shipping emissions from the maritime sector. A separate new ETS will be created to cover emissions from fuels used in commercial buildings and road transport, and a Carbon Border Adjustment Mechanism (CBAM) will be introduced on several pilot products.
EcoAct experts, Anouk Faure and Chimdi Obienu who helped write the 2023 State of the EU ETS Report, review the key messages of the 2023 report to keep you updated on changes in the EU Carbon Market.
- Emissions reductions during the first three phases of the EU ETS (2005-2020) were mainly due to the decarbonisation of the power sector. The latest reforms for phase 4 (2021-2030) and beyond will bring increased funding for decarbonising ETS sectors.
- Free allowances for industrial installations will end by 2034: to avoid carbon leakage, the Carbon Border Adjustment Mechanism (CBAM) will be introduced.
- The scope of the EU ETS will be extended to the maritime sector from 2024, and a separate new ETS (“EU ETS2”) will be created in 2027 to cover emissions from fuels used in commercial buildings, road transport and additional sectors.
- With the phasing out of free allowances, the EU ETS will become a major source of revenue to support the Innovation Fund, a tool for promoting low-carbon technologies, and the Social Climate Fund to support vulnerable households, micro-enterprises and transport users that may be affected by the price impacts of the ETS.
- Although not yet on the negotiating table, stakeholders agree that reopening the EU ETS to international carbon credits, including those from carbon sequestration projects, is important for achieving the EU target of net-zero in 2050.
- 2022 was marked by the war in Ukraine and the energy crisis. The availability and price of natural gas were impacted, leading to a return to coal for energy generation, the price of which skyrocketed.
- As a result, the EU ETS emissions only decreased by 1.2% compared to 2021, a total of 1,320 million tonnes of CO2 equivalent (tCO2e) in 2022. A rise in emissions due to the increased use of coal (+3.9%) was offset by a fall in industrial emissions (-5%) due to the slowdown in production.
- However, for the first time, wind and solar generation overtook gas in the EU’s electricity mix, helping to mitigate emissions.
- The GHG emission reduction target has been increased from -43% to -62% by 2030 compared to 2005. If emissions continue along their current trajectory, they could hit the EU ETS cap in a few years’ time. Major mitigation efforts will therefore be required to ensure that emissions fall as quickly as the cap.
- Between 2012 and 2021, the increased share of renewables accounted for around 80% of the emission reductions in the EU power sector, with the remainder mainly due to the substitution of coal for gas. The decline in nuclear power has contributed to slowing down the decarbonisation of the sector.
- However, this trend was reversed between 2020 and 2021: emissions from the power sector increased due to the post-Covid economic recovery and a more carbon-intensive electricity mix than in previous years.
- Within the industry, the carbon intensity of installations has improved significantly since 2020, particularly in the glass, cement, paper, and steel sectors.
- Industrial installations have historically received a large share of their ETS allowances for free as protection against carbon leakage. However, this began to change during Phase 3 (2013–2020), when there has been a greater need for industrial installations to purchase allowances.
- In particular, the pharmaceutical, equipment and petrochemical sectors experienced a rapid increase in their allowance shortfall.
- The use of EU ETS revenues is key to limiting the economic and social impacts. In 2021, €2.4 billion was paid to electricity-intensive companies as compensation for carbon costs passed on in electricity prices.
- Around 30% of auction revenue is redistributed to the companies covered by the EU ETS. In 2021, the rest was used to finance the greening of mobility, energy efficiency, and tax relief measures for households. Poland and Germany accounted for 45% of auction revenues.
How the market works:
- In 2022, the total volume traded fell by 26% from the record level of 2021 to 7 billion allowances traded. This is due to the war in Ukraine which has redirected capital to energy assets.
- The number of participants in the auctions also decreased, with an average of 19 participants per auction. The number of non-regulated players increased only slightly. The buy-sell decisions of these players are broadly in line with carbon price movements.
- Volatility increased sharply in 2022 to an all-time high of 53%, indicating a turbulent market due to geopolitical events. The carbon price has risen from around €50/tCO2e in 2021 to over €80tCO2e in 2022.
- Analysts’ projections agree on an upward trend in the price of carbon by 2030, with prices possibly exceeding €130/tCO2
Competitiveness and carbon leakage:
- Free allowances and compensation for indirect costs are the historical tools for limiting carbon leakage. Following the successful conclusion of the negotiations, the CBAM will gradually take over by taxing certain products imported into the EU, based on their level of embedded emissions.
- Today, most manufacturing installations are considered at risk of carbon leakage. The removal of free allowances for these installations would therefore have a significant economic impact. At a carbon price of €120/tCO2e in 2030, the ETS compliance cost could amount to €8.5 billion in 2030 for the manufacturing sector in 2030, four times higher than in 2022.
- However, if installations meet the new target (-62% emissions compared to 2005 by 2030), industrial emissions could remain roughly equivalent to the free allowances distributed between 2025 and 2028. Industry representatives agree that this would require significant investment in industrial decarbonisation.
- While industry will be more constrained by the scheme in the coming years, electricity generation remains the largest emitter within the EU ETS. The total cost of the scheme to businesses and households therefore depends, above all, on the power sector’s ability to maintain an ambitious decarbonisation pathway.
Carbon border adjustment mechanism:
- The transitional phase of the CBAM will begin in October 2023, starting its implementation in 2026. The next few months will be devoted to its operational implementation.
- Compared to the current situation with free allowances, recent studies suggest that the EU’s trade balance could worsen in the short term, as the expected decrease in imports would not compensate for the loss of exports, due to higher production costs in the EU.
- Therefore, certain parameters will have to be examined in the first years of the CBAM’s existence, such as:
- Extension to other sectors and Scope 2 emissions to reflect the coverage of the EU ETS
- Extension to downstream products to avoid carbon leakage;
- Treatment of exporters
- However, the market perception survey shows that stakeholders are rather in favour of the CBAM to address the risk of carbon leakage. It would also be a way to engage non-European suppliers in climate action.
- Furthermore, Europe will have to compete with other climate policy models, such as those of the US or China, which rely on large subsidies for emission reductions far more than on carbon taxation.
Read the full EU ETS Report here.