Last month, EU negotiators agreed on reforms to bring the Emissions Trading System (ETS) in line with the bloc’s new 2030 emissions target of 55% below 2005 levels. The changes are expected to be officially adopted by this summer and will have wide-ranging implications for businesses and policymakers in the EU and beyond.
- A faster falling emissions cap will put pressure on allowance prices.
- The free allocation of allowances will end entirely by 2034.
- Most shipping companies will be included under the ETS from 2024.
- A new system for buildings and road transport fuels will be implemented from 2026.
- A Carbon Border Adjustment Mechanism will put a price on the embedded emissions of certain energy-intensive goods imported into the EU from 2026.
Enhanced Climate Ambition of the EU Fit for 55
The central feature of this deal on the EU ‘Fit for 55’ package is the goal to reduce emissions in sectors covered by the ETS by 62%, compared to the previous 43% target. Consequently, the amount of annual emission allowances issued (the ‘cap’ in ‘cap & trade’) will be lowered at a faster rate. This change is expected to contribute to a tighter market for allowances. As firms seek to pass compliance costs through to consumers, sectors dependent on purchases of energy-intensive goods and services, such as logistics and manufacturing, should pay close attention to evolving prices.
The shipping sector will be regulated under the ETS for the first time. Participation will begin in 2024, from when companies will be required to pay for emissions of CO2, NO2 and methane produced by the voyages of most large vessels. Firms will be required to purchase allowances for all emissions from intra-EU journeys, as well as 50% of emissions from trips that begin or end outside the EU. This represents a significant advancement in climate policy. In contrast, cross-border flights (to or from outside the EU/EEA) remain uncovered by the ETS cap.
From 2027, a separate mechanism – ETS II – will operate for distributors of fuel used in buildings (commercial and residential) and road transportation. This will create a distinct system for more control over allowance prices, which could drive up already-high energy bills for vulnerable households and businesses. The EU plans to establish controls to stop allowance prices rising above 45€ , and may delay the start of ETS II until 2028.
Another important update is the end of free allocations. At present, the aviation and industrial sectors receive most of their allowances for free to prevent the costs from driving firms and buyers away from the EU and towards markets with looser climate regulations (in a process known as ‘carbon leakage’). All such support will be phased out for the aviation sector by 2026 and industry by 2034, meaning many firms will start paying for their emissions for the first time since the ETS was established in 2005.
Carbon Border Adjustment Mechanism (CBAM)
Companies exporting to the EU should also be aware of regulatory developments designed to promote decarbonisation. From 2026, a pioneering Carbon Border Adjustment Mechanism (CBAM) will replace free allocations as the means of preventing carbon leakage. CBAM will put a price on the emissions associated with the production of EU imports of iron and steel, cement, aluminium, fertilisers, electricity, and hydrogen. Imported goods produced in countries with high carbon prices will be granted some leeway. As such, the mechanism aims to protect EU industry while encouraging the establishment of more ambitious carbon prices around the globe. Reporting requirements are set to commence in October 2023.
What next for the UK ETS?
Given the deep trade ties and possible future linkage of the EU and UK emissions trading systems, EU reforms are highly likely to influence UK climate policy. The government has already promised to launch a consultation on creating its own CBAM-style policy, while the inclusion of shipping in the UK ETS has been under consideration for several years.
Next steps for the EU Fit for 55
The European Parliament and European Council still need to formally approve the agreements before the new rules can come into force. After 18 months of debate surrounding the Commission’s original ‘Fit for 55’ proposal, the final stages are expected to pass smoothly, and the new law adopted in early-mid 2023.
How EcoAct can help
The EcoAct Carbon Pricing Tool allows companies to analyse financial exposure to carbon price mechanisms. Based on up-to-date research and scenarios built by our climate experts, the tool models future carbon pricing costs based on the scale and location of a company’s energy-intensive activities. Implementing the Carbon Pricing Tool can show investors and regulators alike that an organisation is taking a proactive and robust approach to assessing their climate transition risks.
EcoAct is an active member of the International Emissions Trading Association (IETA), and will again be contributing the annual ‘State of the EU ETS Report’, which serves as a guide for policymakers and other stakeholders on the functioning of the system.
- Climate change: Deal on a more ambitious Emissions Trading System (ETS), European Parliament (2022)
- ‘Fit for 55’: Council and Parliament reach provisional deal on EU emissions trading system and the Social Climate Fund, European Council (2022)
- Deal reached on new carbon leakage instrument to raise global climate ambition, European Parliament (2022)
- EU climate action: provisional agreement reached on Carbon Border Adjustment Mechanism (CBAM), European Council (2022)
- Emissions Trading System: Partial deal reached with Council to include shipping, European Parliament (2022)