European Commission publishes proposal to expand EU emission trading system

Today the European Commission published its proposal to expand the EU emission trading system (EU ETS). The overall aim of this proposal is to strengthen the EU ETS and to bring it in line with the EU’s overall climate ambitions for 2030: a net reduction of CO2 emissions of at least 55 per cent compared to 1990 levels. The proposal to amend the EU ETS is a central part of the Commission’s ‘Fit for 55’ package, which includes several proposed legislative changes across the board to further this goal.

Key changes proposed

The proposed key changes to the existing EU ETS are:

• The scope of the EU ETS is extended to cover three new sectors: maritime transport, buildings, and road transport. As early as 2023 (ie within the current trading period) operators of ships within the EU and those with incoming voyages to an EU port will have to gradually begin to cover their CO2 emissions with emission allowances and, as of 2026, 100 per cent. The inclusion of the maritime transport sector is in some way comparable to the application of the EU ETS to aircraft operators. In line with the phasing in of other industries into the EU ETS, we would expect this process to be accompanied by an allocation of free emission allowances to ship operators.
  
• Emissions from buildings and road transport activities will not immediately be included in the existing EU ETS. Rather, the European Commission envisages a separate fuel emissions trading system to come into force as of 2026. Different from the existing EU ETS, this new system will be based on an upstream approach: the obligation to surrender and hence to buy allowances will not be triggered by the emission of CO2 but rather by bringing or keeping carbonaceous fuels into circulation. Consequently, the EU ETS obtains a new pillar that has some similarities to the German fuel emission trading system that went live at the beginning of 2021. 
• The linear reduction factor, ie the percentage by which the overall quantity of emission allowances across all industries is reduced annually, will be increased to 4.2 per cent, including a one-off reduction to apply as of 2021. This is likely to put further price pressure on freely trade emission allowances (with prices having already risen continually over the last years).
• Member states will be required to use all revenues from auctioning emission allowances for climate-related purposes, including support for renovation projects of low-income households.
• The allocation of free emission allowances will become subject to more stringent benchmarking and – partially – dependent on decarbonisation efforts. This initially only applies to those companies required to conduct an energy audit under the EED.
• The carbon border adjustment measure (CBAM) is introduced as an alternative measure to mitigate carbon leakage risks. In the long term, we expect that CBAM will be accompanied by a limitation and eventually abolishment of the allocation of free allowances. 
• Carbon contracts for difference (CCD) are strengthened to guarantee investors in innovative climate-friendly technologies a fixed price, thus rewarding CO2 emission reductions above the respective market price of an emission allowance.
• No emission allowances will have to be surrendered for CO2 emissions that end up permanently chemically bound in a product (ie are not released in the atmosphere) by way of carbon capture and utilisation technology.
• The use of innovative low-carbon technologies is strengthened by removing certain disadvantages under the current EU ETS, which discourages their use in favour of technologies just below the current benchmark level.
• In addition, several changes will be introduced to the current Market Stability Reserve (MSR) ie to ensure it takes net demand from aviation into account and to create a separate MSR for emissions from road transport and buildings.

What’s next

The European Commission's proposal is currently just that – a proposal. It remains to be seen in which form the draft legislation, aimed at amending Directive 2003/87/EC and Decision (EU) 2015/1814, will eventually come into force. However, with some of the changes scheduled to take effect already in 2023, this could happen rather quickly.

Businesses already subject to the EU ETS should assess the commercial impact of the proposed changes. In particular the steeper linear reduction factor is likely to put further price pressure on emission allowances. But they should also assess whether there may be new business opportunities in the instruments that are now being promoted, such as the CCD and the carbon capture and utilisation technology.

Businesses dealing with maritime transport, road transport and real estate should begin to assess the impact of their activities soon being subject to emissions trading requirements.