European Emissions Trading Scheme
1. Overview of the European Union Emissions Trading Scheme (EU-ETS)
The European Union's Emissions Trading System (EU ETS) is a cornerstone of the EU's policy to combat climate change and a key tool for cost-effectively reducing greenhouse gas emissions from the power, industrial, and aviation sectors. Based on the "cap-and-trade" principle, it sets a cap on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. The EU ETS covers approximately 45% of the EU's greenhouse gas emissions and targets energy-intensive industries, power generation, and commercial aviation. As part of the EU's upgraded climate ambitions under the "Fit for 55" package, which targets at least a 55% reduction in emissions by 2030 compared to 1990 levels, the ETS sectors are now expected to reduce emissions by 62% compared to 2005 levels. Free allowances in the aviation sector will be phased out starting in 2026, and maritime transport will be included in the ETS for the first time, with obligations for shipping companies to surrender allowances gradually increasing from 2024. The integration of the ETS into the wider European Green Deal framework is also facilitated by the creation of new green own resources based on the EU ETS and the Carbon Border Adjustment Mechanism (CBAM) to support the transition to a carbon-neutral economy.
The EU ETS plays a pivotal role in meeting the EU's climate targets, as it incentivizes covered sectors to invest in cleaner, more efficient technologies. The revenues generated from auctioning ETS allowances, which have amounted to approximately $120 billion, are used to finance climate and energy-related investments, including the Innovation and Modernization Funds focused on supporting the carbon-neutral transition. Furthermore, the EU's climate mainstreaming approach ensures that a significant portion of the budget is allocated to climate-related measures, with an increased target of 30% for climate spending in the 2021-2027 Multiannual Financial Framework. However, the EU faces challenges in decarbonizing non-ETS sectors under the Effort Sharing Regulation (ESR), indicating that member states may struggle to meet their 2030 targets without utilizing provisions to tap abatement from the ETS or land use sectors 2019.- EU adopts 2030 climate targets on carbon emissions
- Working documents 2023
- Understanding Carbon Markets: Prospects for India and Stakeholder Perspectives
2. Impacts and Developments of EU ETS
The European Union's Emissions Trading System (EU ETS) has been a cornerstone in the EU's carbon pricing regime since 2005 and is now embarking on its fourth phase with an escalated emissions reduction target and the inclusion of new sectors. Historically, the EU ETS has mitigated the risk of carbon leakage—where companies could potentially move productions to countries with laxer emission rules—by providing free emissions allowances to firms, benchmarked at the sectoral 90th percentile of emissions intensity. However, with the heightened climate ambitions necessitating substantial investments in new technology, the effectiveness of free allocations is under review as they may not incentivize the required advancements. To address these issues and ensure that emissions reductions targets are met without harming the competitiveness of European industries, the EU is considering the implementation of a Carbon Border Adjustment Mechanism (CBAM). This mechanism will aim to equalize the cost of carbon between domestic goods and imports to prevent carbon leakage and encourage other countries to ramp up their climate efforts. The CBAM is expected to be aligned with World Trade Organization rules and other international obligations of the EU, with a proposal slated for presentation by June 2021
The CBAM represents a pioneering effort to incorporate the carbon content of imports into their price, thereby leveling the playing field for EU industries subject to the EU ETS, and deterring the outsourcing of emissions. Initially applicable to sectors like steel, aluminum, cement, fertilizers, and electricity, this mechanism is anticipated to expand over time. Additionally, it will link the carbon price on imports to the EU's emissions-allowance market, which has seen its price per ton of CO_2 increase significantly, reflecting the urgency and intensity of the EU's climate objectives. The implications of such a mechanism are far-reaching, including potential impacts on international trade relations and a nudge for countries to establish their own carbon regulations. In addressing concerns like trade retaliation and economic implications, the EU is signaling its commitment to a climate-forward trade policy that not only combats climate change but also propels global action- Enabling Climate Ambition: Border carbon adjustment in Canada and abroad
- IISD Trade and Sustainability Review, Volume 1, Issue 3, July 2021
3. National Implementations and Reforms within the EU ETS
In Spain, the European Emissions Trading System (ETS), overseen by Law 1/2005 and various Royal Decrees, has engaged about 900 industrial and power generating installations, as well as over 30 active aircraft operators. Notably, around 280 installations benefit from exclusion schemes under Articles 27 and 27 for an alternative to full ETS participation. To counteract the impact of carbon pricing on electricity, a mechanism for the compensation of indirect costs, established by Royal Decree 1055/2014 and updated by Royal Decree 309/2022, has been deployed. To this end, approximately EUR 244 million was allocated in the latest aid call to cover 94% of eligible indirect costs for 2021. Looking ahead, the General State Budget anticipates new calls for compensating costs incurred in 2022. The revenue from allowance auctions, with an annual average of around EUR 2.850 billion, is legislated for climate change and energy transition objectives under Law 7/2021, specifying that EUR 450 billion will support renewable energy-related electricity system costs, up to 30% may address social impact measures, and up to 25% can offset indirect cost effects. These allocations are detailed annually in the General State Budget, reflecting Spain's commitment to transitioning to a low-carbon economy and adhering to the evolving EU ETS regulations under the Fit for 55 package