In this edition of the Weekly Compliance Digest, we cover an agreement reached on the reform of the EU emissions trading system (ETS) for the 2021-2030 phase.
EU Emissions Trading System
Revision for Phase 4 (2021-2030)
What is it?
Last month, the European Council and the European Parliament reached a provisional deal on the reform of the EU emissions trading system (ETS) for the period after 2020. The EU ETS operates in 31 countries (all EU countries plus Iceland, Liechtenstein and Norway), limits emissions from more than 11,000 heavy energy-using installations (power stations and industrial plants) and airlines operating between these countries, and covers about 45% of the EU’s greenhouse gas emissions.
As part of the EU ETS, a cap is set on the total amount of certain greenhouse gases that can be emitted by covered installations. The cap is reduced over time so that total emissions fall. Within the cap, companies receive or buy emission allowances as “permits” (1 permit = 1 ton of CO2) that they can trade with each other. After each year, a company must surrender enough permits to cover all its emissions or pay heavy fines. If a company reduces its emissions, it can keep the spare permits to cover its future needs or sell them to another company.
However, there are currently too many permits on the market and carbon prices remain low, which is why the EU decided to reform the ETS. The ETS reform aims to help the EU deliver on its target of cutting greenhouse gas emissions by at least 40% by 2030, as per the 2030 climate and energy framework and the Paris Agreement.
The EU ETS is now in its third phase, which runs from 2013 to 2020 inclusively. Phase 4 will run from 2021 to 2030.
What are the elements of the revision?
- The cap on the total volume of emissions will be reduced annually by 2.2% (linear reduction factor (LRF)).
- The number of allowances to be placed in the market stability reserve (MSR) will be temporarily doubled until the end of 2023 to speed up the reduction of the current oversupply of allowances on the carbon market.
- A new mechanism to limit the validity of allowances in the MSR above a certain level will become operational in 2023.
- The provisions of the new ETS directive will be kept under regular review, including carbon leakage rules and the LRF, and the Commission will assess the need for additional policies or measures.
In addition, the revised ETS contains provisions to protect industry against the risk of “carbon leakage” (i.e. when companies transfer production to other countries with fewer emission restrictions, which could lead to an increase in their total emissions). The sectors at the highest risk of relocating their production outside the EU will receive full free allocation. The free allocation rate for sectors less exposed to carbon leakage will amount to 30%. A gradual phase-out of that free allocation for the less exposed sectors will start after 2026. In addition, member states can continue to provide compensation for indirect carbon costs in line with state aid rules.
What is next?
The European Parliament needs to vote to confirm the deal. The legal act will then be submitted to the European Council for final adoption. The new directive will enter into force on the 20th day following its publication in the official journal.
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