Navigating the opportunities and pitfalls of the EU carbon market for road transport and buildings

The latest ETS Talk webinar focused on the challenges associated with the implementation of the Emissions Trading System for road transport and buildings (ETS2) in the EU policy mix.

The online workshop, which was organised by Life ETX partner ZERO, focused on the implementation challenges of ETS2, also provided valuable insight into the example of Germany, comparing the ETS2 with the German system of carbon trading for the non-ETS sectors.

Jakob Graichen of the Öko Institute explained that  the climate policy architecture of the European Union consists of elements of different nature. On the one hand, we have the Emissions Trading System (ETS), which is an EU-wide direct implementation mechanism that goes beyond 2030. On the other hand, there is the Effort Sharing Regulation (ESR) and the Land Use, Land-Use Change and Forestry (LULUCF) Regulation with country specific target systems for 2030.

In this sense, the “EU ETS was much easier to regulate and to reduce emissions with single measures”. However, the ETS2 is important as emissions under ESR – which comprise road transport, buildings, non-ETS industries and agriculture sectors – have not decreased enough to reach the EU’s climate targets. The ETS2 will address all these sectors except agriculture.

This means that the ETS2 can play an important role in the policy mix, but Graichen mentioned that the emission reductions triggered by ETS2 significantly differ from those in the original ETS. This is because there is a limited role for “clean dispatch” (i.e. the prioritisation of cleaner, low-carbon energy sources) but a significant one for the decommissioning of high-carbon assets. Moreover, this can also result in substantial system effects, such as the impact of including buildings and road transport on demand in these sectors and whether it is met by clean energy or dirty fossil fuels.

“ETS2 should not be the only driver to cut emissions in road transport and heating, we always need to have other measures and help those most affected,” Graichen emphasised, concluding that “we need more commitment and stronger policies to bring emissions down” and ETS2 is a way forward “but it’s not going to solve all our problems”.

German lessons

Anne Gläser, from Germanwatch, elaborated on the German emissions trading system for heat and road transport diving into some lessons learned from its implementation that could benefit the roll out ETS2.

The German ETS was launched in January 2021 and encompasses road transport, buildings and process heat in small industries. It is an upstream system, which means distributing companies are charged the carbon price. Gläser highlighted that  one of the most important features of the German system is that it has yearly rising fixed prices until 2025, instead of having a fixed cap with prices subject to supply and demand.   

However, due to the high energy prices of 2022, the German Government decided to postpone the planned carbon price increase in October 2022. In view of counteracting the steering effect of the existing carbon price, the Governement also implemented a number of relief measures such as fuel discount and energy price lump sum. Gläser considers that the steering effect was not substantial enough to apply these measures, which were heavily criticised.

Starting off with a low carbon price fostered social acceptance with no public outcry and little media coverage, Gläser added. Furthermore, the fixed prices fostered predictability and also social acceptability because it prevented the escalation of prices, therefore providing security in investments  However, with fixed prices and no hard cap, the policy mix is crucial, Gläser observed. This involves a combination of carbon pricing, regulatory law and support schemes in order to reach the desired level of environmental targets, she suggested. 

“What we see in Germany is that we have low carbon prices but the complementary measures are still weak, for example in the transport and building sector, so we are missing the climate targets,” Gläser noted. There is also the problem that high prices might entail the risk of political intervention, such as what happened with the postponement of the increase of the carbon price, because there is political pressure to keep prices low.

When it comes to the use of funds, all revenues go to a dedicated climate fund to finance support programmes for building renovation and electric cars. This measure is controversial as there is the question of whether revenues should be used to benefit directly those who pay or whether it should go to supporting the vulnerable and general decarbonisations, Gläser mentioned. Some people argue that revenues should be returned to individuals as a “climate dividend” and others that it should be used to provide financial assistance to those who may be adversely affected by higher carbon prices.

There is also a discussion on climate dividend around lump sum payments to individuals or adjusting payments according to income, to benefit lower income individuals that should receive more assistance: “These issues around revenue use can cause social acceptability problems around higher carbon prices,” she pointed out.