What exactly does the EU ETS Review include, and what other legislative changes are to come for the European carbon market this year?
The review of the European carbon market is now moving fast: the EU Parliament and Council reached an agreement on new measures late last year, paving the way for full adoption by April 2023. So what exactly does the EU ETS Review include, and what other legislative changes are to come for the European carbon market this year?
EU ETS Review
On December 18, 2022, the European Parliament and Council concluded so-called “trilogue negotiations” around Europe’s ‘Fit for 55’ Package, which includes a revision of the Union’s decarbonization goals and its mandatory offsetting scheme, the EU Emissions Trading System (EU ETS).
The EU ETS is based on a system of cap-and-trade of emission allowances for energy-intensive industries and the power generation sector. Covering about 40% of the EU’s total CO2 emissions, It is the EU’s main decarbonization tool – and it is an efficient one: since its introduction in 2005, the EU’s emissions have decreased by 41%.
- EU ETS: What is it and why is it changing?
- EU ETS reform: What’s to come for the mandatory carbon market?
Now, the EU Parliament and Council have agreed on the review of the system, including the following changes:
EU ETS ambition changes
- The sectors covered by the scheme will now have to reduce their emissions by 62% by 2030 (from a 2005 baseline). This is a significant increase from the 43% reduction ambition adopted in 2021.
- Emissions allowances issued by the EU will be reduced by an annual rate of 4.3 % per year from 2024 to 2027 and 4.4% per year from 2028 to 2030. In the July 2021 Phase 4 Revision, the EU had set an annual reduction rate of only 2.2% from 2021 onward, so this is also a marked increase in ambition.
- In terms of aligning reduction targets to actual emissions (a process called ‘rebasing’), the negotiators agreed to rebasing the emissions ceiling by 90 million allowances in 2024 and by 27 million allowances in 2026.
- To absorb potential price shocks from these changes, the Market Stability Reserve (MSR) will be strengthened by prolonging beyond 2023 the increased annual intake rate of allowances (24%) and setting a threshold of 400 million allowances.
At a webinar by the International Emissions Trading Association to explain the changes, Marcus Ferdinand, Head of Analysis at Greenfact, noted that despite being in line with market expectations, these adjustments constitute “a massive ambition upscaling”.
EU ETS sector changes
- In terms of sectors, the revised scheme will phase in emissions from the maritime industry between 2024 and 2026, which will lead to an increase of around 79 million allowances in the cap, with a reduction rate of 3.9% per year.
- It could also potentially include waste incineration from 2028. This option is currently being assessed, with the Council to produce its final report by July 31, 2026.
Carbon Border Adjustment Mechanism
On top of changes to the EU ETS, negotiators agreed on final rules for the implementation of the Carbon Border Adjustment Mechanism (CBAM), considered the world’s first carbon tariff. The mechanism will impose a carbon tax mirroring the price of allowances on the EU ETS to products arriving in the EU. It will initially apply to imports including iron and steel, cement, aluminum, fertilizers and electricity, as well as hydrogen – sectors considered vulnerable to carbon leakage (moving production to countries with looser carbon rules to remain competitive).
Following the trilogue negotiation, the Council and Parliament agreed to end free allowances for these sectors, over a nine-year period between 2026 and 2034, during which time the CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS.
CBAM is expected to be fully in place in 2026, and will lead to increasing compliance costs for CBAM sectors, particularly towards the end of the decade and they begin to face penalties for not complying with carbon leakage measures.
EU carbon market price impact
This strengthening of the EU carbon market legislation is expected to result in a significant increase in the price of EU allowances, from €80-85 currently to around €100 by 2030. This is the highest carbon price in the world.
