The European Commission announced the release of its highly-anticipated EU Emissions Trading System (ETS) review, proposing a series of changes to its main decarbonization policy, including measures to provide relief to industry by slowing the pace of emissions reduction mandated under the carbon pricing system and extending the allocation of allowances for several years, while also introducing measures to drive significantly more capital from the ETS system into industrial decarbonization.
The Commission’s initiatives would also significantly impact the carbon removal industry, with a proposal to integrate permanent domestic carbon removals into the ETS, through a mechanism allowing the Commission to purchase certified removals and increase the ETS cap by an equivalent amount of emissions allowances.
The Emissions Trading System is the EU’s internal cap and trade carbon pricing mechanism. Established in 2005, the ETS puts a price on carbon emissions for key GHG intensive sectors, including electricity and heat generation, oil refineries, steel, cement, paper, chemicals, and commercial aviation, among others. Since its launch in 2005, the ETS has generated more than €270 billion in revenues, and has been credited by the Commission as a key driver in reducing emissions in the covered sectors by 50%.
As Europe has faced rising energy prices, driven by geopolitical factors such as the Russia-Ukraine and Iran wars, several member states have called on the Commission to review the ETS to help reduce pressure on industry. Earlier this year, EU Commission President Ursula von der Leyen pledged to launch a review of the ETS, acknowledging a “need to modernise it and make it more flexible,” while defending the system as an effective tool to drive reduced dependence on imported fossil fuels, accelerate the shift to cleaner energy sources and fund investments in decarbonization-focused technologies.
The review includes several measures to provide relief to industry, including an adjustment to the Linear Reduction Factor, which dictates the annual percentage by which the emissions cap under the ETS is reduced each year, from its current 4.3% and planned 4.4% from 2028 to 2030, to a new trajectory of 3.7% from 2031 to 2035 and 1.7% from 2036, which the Commission said would align with the EU’s 2040 climate target of a 90% reduction compared to 1990, and the pathway to climate neutrality by 2050.
Under the ETS, industrial companies are required to pay for their greenhouse gas emissions by surrendering carbon allowances. To help companies remain competitive while encouraging emissions reductions, the EU provides a portion of these allowances for free, based on emissions “benchmarks” that reflect the performance of the most efficient facilities in each sector. Companies that emit less than their allocation can sell excess allowances, while those exceeding their allocation must buy additional permits, creating a financial incentive to cut emissions.
Notably, the Commission highlighted that proposed change to the LRF would extend the issuance of allowances into the 2040s. Additionally, the proposal also would extend the free allocation for companies beyond 2030, with the Commission proposing slowing the phase out of free allocation for sectors covered by the Carbon Border Adjustment Mechanism (CBAM) until 2038.
Additionally, the proposal includes the integration of 250 million tonnes of high-quality permanent domestic carbon removals in ETS to create more breathing space for the hardest-to-abate sectors by enabling more allowances to be made available, which the Commission said would also help kickstart the market for removals.
Alongside the reliefs, the Commission also introduced several measures designed to drive investment in industrial decarbonization through the ETS, including a new requirement for Member States to spend 50% of their national ETS revenues on investments to decarbonize ETS sectors, the establishment of an “Industrial Decarbonisation Bank (IDB)” to make up to €100 billion available to support investments in industrial decarbonization technologies and the production of clean technologies, the launch of ETS Investment Booster to kick-start the IDB by rewarding companies that invest early in decarbonization with an estimated €30 billion as phase I of the bank. Additionally, the planned extension of free allocation would be more closely linked to requirements to investments in industrial decarbonization, with the Commission stating that “free allocation will become conditional upon operators developing Invest in EU Decarbonisation Plans and investing an amount equivalent to 100% of the value of their free allocation into decarbonisation in the EU.”
In addition to the above changes, the Commission’s review also includes changes specific to the aviation and maritime transport sectors, including extending the ETS aviation scope to departing international flights to destinations within 5000 km and to all incoming and departing flights by business jets, and for the maritime sector to certain categories of smaller vessels, while also dedicating direct support for the uptake of EU-produced sustainable aviation and maritime fuels, clean technologies and hydrogen. Additionally, the proposal extends the ETS to the waste incineration sector.
The Commission’s proposals will now be submitted to the European Parliament and the Council, kicking off the process for each legislative body to develop their respective positions and negotiate a final legislative text before it can be formally adopted.
Wopke Hoekstra, Commissioner for Climate, Net Zero and Clean Growth, said:
“The EU ETS has proven that carbon pricing works. It has cut emissions, strengthened Europe’s energy security and mobilised investment across our economy. Today’s proposal on the ETS review brings together three key goals: climate action, competitiveness, and independence. It advances climate action, by also transforming the ETS into a genuine engine for innovation and investment.”
Click here to access the European Commission’s EU ETS review.
