EU revises emissions trading system

What is the EU ETS?

The EU ETS is one of the EU’s main climate policy instruments. It places a price on emissions from companies in sectors including the energy sector, heavy industry, aviation and shipping. These sectors must surrender one emission allowance for every tonne of CO₂ emitted. These allowances are partly auctioned and partly allocated free of charge to prevent so-called ‘carbon leakage’. Carbon leakage is the risk that production will move to countries outside the EU where climate regulations are less stringent.

The total number of available emission allowances (also known as ‘the cap’) decreases each year, making CO₂ emissions increasingly expensive and investment in clean technology more attractive. Since 2005, the sectors covered by the system have reduced their emissions by more than 50 per cent, while the economy has continued to grow.  

The main proposed changes

The proposal contains a series of specific adjustments. The most relevant are:

• Reducing the number of allowances available
  The system is being aligned with the emission reduction target of –90% by 2040, with a more gradual phase-out pathway so that allowances may continue to be issued into the 2040s. This amends the trajectory from 2031 onwards. Whereas the original directive envisaged a steeper annual decrease in ‘the cap’, the proposal provides for a slower decrease.
  
• Free allowances will be conditional
  From 2031 onwards, companies will only receive free allowances if they submit a sustainability plan that is approved. Once that plan has been approved, 80 per cent of the allowances will be allocated. The remaining 20 per cent will only be released once it has been demonstrated that the planned investments have actually been carried out and have led to lower emissions. If these investments are not made, this 20 per cent will lapse. The 80% previously granted will basically not be reclaimed. This will only happen when a company relocates its activities outside the EU (see also the point below on the obligation to repay).
  
• Obligation to repay in the event of relocation
  If a company relocates its activities outside the EU, the free allowances received must be repaid.
  
• Delayed phase-out for CBAM sectors
  The phase-out of free allowances for sectors covered by CBAM will be delayed, with full phase-out not taking place until the end of 2037.
  
• Inclusion of household waste incineration
  The incineration of non-hazardous household waste will gradually be covered by the EU ETS system (25% in 2031, rising to 100% in 2034).
  
• Extension in respect of aviation and shipping
  Certain flights outside Europe will be covered by the system, with a deduction mechanism to prevent double pricing. The shipping sector will be subject to stricter anti-circumvention measures and an extension to smaller vessels will be implemented.
  
• Integration of CO₂ capture
  Permanent removal and storage of CO₂ (such as BioCCS and direct capture) will be included in the system.
  
• Reform of the market stability reserve
  The reserve, which mitigates price fluctuations, will be given dynamic parameters to ensure it continues to function in a shrinking market.
  
• Stricter requirements on the use of revenues
  Member States must spend at least 50 per cent of their EU ETS revenues on sustainability measures, with a ban on investments that prolong dependence on fossil fuels.
  

More detailed information on the proposal

A key theme of the proposal is to have a larger share of the revenue be channelled back to the sectors paying the carbon price. Only a small proportion of the revenue (around 5 per cent) currently goes directly towards improving the industry sector’s sustainability, while its component sectors are precisely the ones responsible for almost half of the emissions covered by the system. The proposal aims to strike a better balance in this respect.

The main new instrument is the Industrial Decarbonisation Bank (IDB), which supports the upscaling of clean technology in heavy industry. The bank operates in two phases. First, an ‘Investment Booster’ (2028–2030) with 400 million emission allowances, designed to quickly kick start the investments. Next, a second phase starts from 2031, involving long-term contracts that provide companies with certainty about the CO₂ price. The aim is to make available a total of 100 billion euros for industrial sustainability.

In addition, two existing subsidies will be continued and expanded. The Innovation Fund will continue to stimulate early-stage, high-risk technologies. The Modernisation Fund supports Member States with smaller budgets in modernising their energy systems and is now also being made available for electrification, CO₂ storage and industrial sustainability.  

What does this mean for your organisation?

The common thread running through this proposal is a shift in the foundations of the EU ETS. While the previous focus was mainly on pricing emissions, the EU ETS is now shifting its focus to investments in the industrial sector’s sustainability. The following points are relevant for companies that are covered by the EU ETS, or will be soon:

• Prepare for the conditional free allocation
  Identify which sustainability investments are required and how you can demonstrate them, as 20 per cent of your free allowances depends on this.
• Take account of the repayment obligation
  The obligation to repay free emission allowances when relocating activities outside the EU creates new implications when relocating production facilities.
• Examine the new funding opportunities
  The IDB and the expanded subsidy opportunities may provide significant support. Early positioning will increase your chances.
• Waste processors and new sectors: start on time
  The phased introduction from 2031 onwards calls for thorough preparation and adjustments to accounting records.

This proposal is not yet final and is subject to approval by the European Parliament and the Council of the European Union. Many details will only be finalised later, in supplementary regulations.