EU carbon market reform: Between dark clouds and silver linings
The final deal to reform the EU Emissions Trading System (EU ETS) will bring down emissions, but not fast enough, and helps poor and vulnerable citizens during the transition but not as much as the freebies it lavishes upon fat cat industries.
An online workshop organised by ZERO unpacked the final reform package for the Emissions Trading System agreed by the EU institutions at the end of 2022. It shed light on the main outcomes (good and bad) and what lies ahead for governments, people and industries.
Klaus Röhrig from CAN Europe started off by tackling the main takeaways from the tough negotiations, which included critical discussions on overall targets, the inclusion of other sectors, revised rules for free allocations, and the functioning of the Innovation and Modernisation Funds.
On the overall ambition, the co-legislators missed their chance “to actually go beyond what the Commission had put on the table, but also what is needed in light of the climate crisis,” Röhrig explained.
Although it is definitely a step forward from the current status quo, with the ETS’s cap on emissions hitting zero in 2039, the final deal only increases the 2030 target to a 62% cut in emissions, Röhrig pointed out, which is no more ambitious than the 61% proposed by the Commission. This means that the EU ETS does not go beyond the EU’s under-ambitious goal of reducing net emissions by at least 55% in 2030.
When it comes to resilience, the results are also not as good as civil society had demanded. This is because the Market Stability Reserve (MSR) thresholds remain static and the excessive price mechanism allows for the release of 75 million allowances from the MSR if the carbon price multiplies by 2.4. However, there is a review coming up in 2026, so there is still a chance to strengthen the MSR then.
The end of free allowances is also in sight, but, disappointingly, Röhrig explained, the bulk of this effort has been postponed until after 2030. These freebies were the biggest political battle, with little to show for it, considering that the phase out of free allowances only to sectors covered by the Carbon Border Adjustment Mechanism (CBAM) will take place in 2034, which still allows for around 5 billion pollution permits to be gifted to highly polluting industries during the entirety of the trading period.
The ETS funds have also been subject to changes, though not all of them are good. The Modernisation Fund has been topped up with 2.5% of allowances, which will be used to provide financing to a second tier of member states (Greece, Portugal, and Slovenia). However, there’s still room for fossil gas investments under certain criteria. The Innovation Fund has shrunk slightly due to the diversion of resources to the RePowerEU plan.
The welcomed novelties in the system
Chiara Corradi from Transport&Environment gave a broad and insightful overview of the discussions and outcomes around the new ETS for buildings and road transport, known as ETS2 or ETS BRT, which was one of the most contentious topics during the reform negotiations.
Corradi explains that emissions in road transport and buildings rose by 7% and 2%, respectively, between 2014 and 2019. The ETS2 was introduced as a backstop solution if member states failed to deliver the necessary emissions cuts. In this way, the ETS2 can contribute to around 45% of the additional emissions cuts needed by 2030.
The ETS2 will apply from 2027 to fossil fuel consumption for both private and commercial uses, with an extension also to heating used in industrial processes. This made it necessary for policymakers to put in place some safeguards to shield citizens, such as a price cap of €45 and an emergency brake that allows for a postponed entry into force until 2028 if energy prices in the first six months of 2026 are too high. Corradi added that even though it is good to have a price cap, it should increase over time, for example, by €10 per year, to account for inflation and ensure that the necessary emission cuts are delivered.
EU countries can opt out until 2030 in cases where they have an existing national carbon tax that is higher than the ETS2 carbon price. Where the ETS2 is in effect, businesses must report to the Commission the average share of the carbon price passed on to consumers, which can be at most 100% of the carbon cost, ensuring that companies cannot reap windfall profits. However, Corradi believes stronger provisions are necessary to require companies to absorb part of the costs and avoid citizens paying the full carbon price.
Overall, ETS2 is putting a price on pollution in additional sectors, incentivising a shift in demand for cleaner solutions without losing sight of the social dimension of climate policies. This will be achieved through the establishment of the Social Climate Fund (SCF), which is the first ever EU fund to address social issues raised by climate policies, Corradi highlighted.
The SCF will redistribute the ETS2 revenues from higher to lower income countries and households who consume and pollute less but are more affected by the ETS2, particularly households in energy or transport poverty. The resources will derive from 150 million ETS2 allowances, 50 million ETS1 allowances, and ETS2 revenues up to a maximum of €65 million. Despite this relative progress, the resources dedicated to the SCF could have been greater, especially when considering the amount of free allowances given out to industry for free. “There’s still an imbalance between a fixed SCF versus free allowances,” Corradi said.
To access the SCF, member states must prepare social climate plans and contribute 25% of the estimated value of the plan. It is essential that each country carefully identifies the most impacted households because resources must go to those who need them the most. Corradi also stressed that households would bear the costs of the transition in any case, even without an ETS2. However, the silver lining of the ETS2 is that it raises necessary revenues. The SCF will also not cover all the investment needs, but it will ensure that the support is targeted and is complementary to the national resources and doesn’t substitute them.
Both speakers agreed that the overall results should have been more ambitious, especially in light of the urgency of the climate crisis and the EU’s historical responsibility. Nevertheless, some positive points stand out, such as the need to earmark 100% of ETS revenues to climate action, which is “a big step forward”, according to Röhrig. It is very important, Corradi stressed, that all EU countries ensure that “resources are streamlined to address climate and social issues, avoiding a fragmented approach to a long-term issue across the EU”.