EU ETS: all you need to know about the carbon market reform

The EU ETS’s reforms to the carbon market have just been adopted by the members of the European Parliament. But what exactly do they consist of?

Global Warming 🔥

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July 8, 2022

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Proposed in July 2021 by the European Commission - as part of the "Fit for 55" legislative package - the EU ETS (or European Union Emissions Trading System) reform was accepted by member parliaments this June 22, 2022. 😲

It was not expected, to say the least. However, after rejecting the first version of the amendment to the emissions trading scheme on June 8, the European Parliament finally managed to reach an agreement. This is quite a rare occasion. 😅

The reform was undeniably necessary: in its current state, the carbon market has been highly criticized for its inefficiency. So what does the reform aim to fix? What should companies subject to the carbon market expect? A roundup of the upcoming changes in this article. 👇

 

😅 The EU ETS, a controversial emissions trading scheme

What is the EU ETS (European Union Emissions Trading System)? 👀

The EU ETS is the acronym for the European Union Emissions Trading System, within the European carbon markets  (EU ETS). 

Since its creation in 2005 following the recommendations of the Kyoto Protocol, this system has made it possible to reduce the EU's emissions by an average of 4%. 

It is the world's first - and largest - carbon market. 🌍

In concrete terms, the European carbon market is made up of more than 10,000 structures, responsible for 40% of the EU's total emissions (from power generation, district heating, steel production, commercial aviation, and many others). 🥵

Within this framework, all these structures must literally pay for the carbon emissions emitted each year, in accordance with the “polluter pays” principle. 

👉 This is done through the purchase of carbon credits - also known as "rights to pollute" - which each represent one ton of CO2. ⚖️

But how exactly does this all work? 🧐 To put it simply, at the beginning of each year, the companies involved in the carbon market buy a limited number of credits, corresponding to their annual emissions target - which is incrementally reduced every year. 

If the company surpasses its target, it can sell its credits. If not, it must instead buy credits on the carbon market to offset its additional emissions.

🎯 This device is obviously intended to encourage companies to reduce their emissions, and to accelerate the fight against global warming. But, there is a "but"...

Why did the carbon market need to be reformed? 🤔

The carbon market has long been criticized for its inefficiency. And rightly so.

Why? Due to the free allowances allocated to heavy industry. Given that this type of allowance covers 94% of the sector's emissions, it prevents relocation and, by extension, carbon leakage to countries with less stringent legislation. This is a strategy adopted by companies in order to freely pollute outside their home country. 😏

However, this "gift" is reflected in the price of carbon credits. The price begins to fall and therefore has no incentive effect on companies. 

Don’t forget that the goal is to encourage companies to reduce their greenhouse gas emissions, to keep their "rights to pollute" and thus to resell them at the end of the year in order to pocket a profit.

But what’s to incentivise companies to make efforts to reduce their emissions and thus keep their emission allowances, if in the end it's a matter of selling them back at a derisory price? 👀 Financially, this does not hold.

From 2005 to 2014, many companies wouldn’t even bother trying to reduce their emissions, as there were more financially strategic ways to work around this system. 

Faced with this observation, short and long term measures have been proposed. The European Commission is suggesting:

  • the end of free quotas;
  • the expansion of the carbon market;
  • the creation, as of 2026, of a second carbon market dedicated to road transport and building heating. 

 

Furthermore, considering the urgency of global warming, the EU's regulations have gotten more ambitious. It is now necessary to reduce greenhouse gas emissions (GHG) by 55% by 2030 (compared to 1990), in order to reach climate neutrality by 2050. 

An ambitious goal... But it’s very much so attainable if we’re all on board. 

 

🙌 The reform of the EU ETS and the MEPs' vote on 22 June 2022

What does the EU ETS reform contain? 📝

The members of the European Parliament agreed by 439 votes to 157 (with 32 abstentions):

  • Expanding the carbon market to the maritime sector, office buildings and heavy goods vehicles - citizens remain excluded from the carbon market until 2029;
  • Phasing out the free allowances. The reduction will take place from 2027 onwards - instead of 2025, in accordance with the European Commission's wishes - before their definitive disappearance in 2032. 

This abolition will be carried out at the same time as the introduction of a carbon tax at the EU's borders on polluting products (steel, aluminium and electricity in particular).

👀 Did you know: on June 8, the EPP (European People's Party) wanted to maintain free quotas in the EU until 2034, in order to postpone the introduction of the border tax. This was formally rejected by the representatives of the Green party and Democratic Socialist party. 

What's the deal with the carbon tax at the European Union's borders? 🔎

In July 2021, the European Commission published its so-called "climate package" - known as "Fit for 55" - which contained several proposals, including the strengthening of the border carbon adjustment mechanism (BCA).

Closely linked to the reform of the carbon market, the carbon tax at the EU's borders should gradually come into force, along with the disappearance of free allowances. 

This strict control at the borders seeks to cut down on the notorious "carbon leakage" by imposing a charge on products imported into the EU - proportional to the amount of emissions generated by their production. 

 

Why is a carbon tax at the EU's borders so important  for the EU ETS reform? 🕵️‍♀️

As we've seen, the decision to increase the EU's environmental ambitions hasn't made everyone happy...

Some companies simply decide to relocate their polluting activities to countries where environmental policies are less restrictive. 

The problem is: the emissions produced in these less restrictive countries have exactly the same consequences on the environment. 😅

In light of this situation, the carbon tax at the borders is intended to be applied to certain imported products (iron, steel, cement, fertilizer, aluminum and electricity), coming from third countries. 

In fact, there is no point in abolishing free allowances if it is still possible to pollute elsewhere without being financially penalized for it.

👉 Keep in mind: in addition, this system will allow France and its neighbors a more competitive advantage, since the price of CO2 will be the same for imported products that pollute, and locally produced polluting products. 

Have we explored all avenues? 🔮

In addition to these initial decisions, the MEPs also agreed on a 63% reduction in emissions from sectors subject to the carbon market by 2030 (compared to 2005). 

This decision most notably supports the phasing out of coal - which requires a significant amount of carbon credits. The decision will also stimulate the development of renewable energy. ✅

Finally, the plans establish the creation of a Social Climate Fund (SCF) Intended for people affected by the rising costs of the energy transition, this aid will allow them, among other things:

  • undertake in energy efficient home renovations ;
  • Support their access to public transportation;
  • switch to renewable energy.

📅 What’s to come? 

The EU ETS agreement must still be negotiated by MEPs and ministers from the 27 member states on June 28.

After that, it can officially be enacted. 

👉 Before this can happen, the measure will need to be agreed upon by 55% of the countries (i.e. 16 of the 27) or, the agreement of a single country representing at least 65% of the EU's population.

What can we expect next? 

In 2023, each of the proposals in the "Fit For 55" climate package will have to be voted on and agreed on in the final text. As such, they will all have to pass through the European Parliament and the Council of the EU.

By 2030, Europe's GHG emissions must be reduced by 55%.

In 2050, Europe will hopefully become carbon neutral!

 

🐸 Who are we?

If you too wish to take up the cause of the climate, carry out your company's carbon assessment now and start reducing your own emissions. Our experts are waiting for your call 👋

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Arnaud Delubac

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