The revision of the EU Emissions Trading System

The key elements of the proposal are: 

1) alignment of the Emissions Trading System (ETS) cap with the 2040 climate target by reducing the linear reduction factor (LRF) to 3.7% for 2031–2035 and 1.7% for 2036–2040, allowing continued issuance of allowances into the 2040s

2) the introduction of a mechanism under which up to 260 million allowances may be set aside for the Commission by which the Commission may fund its purchase of up to 260 Mt of high-quality, high-integrity international credits, contributing to ETS-sector ambition from 2036 to 2040, while complementing domestic action and resulting in a domestic reduction target of -85% compared to 1990 

3) integration of 250 Mt of domestic permanent carbon removals (BioCCS and DACCS) into the ETS through a Commission purchasing programme, whereby the cap of allowances will be increased by 250 million allowances for auctioning between 2031 and 2040 (with an additional 10 million allowances if the revenues of the aforementioned 250 million auctioned allowances would prove insufficient)

4) reform of the Market Stability Reserve, including a reduction of the intake rate from 24% to 12% and the introduction of dynamic, annually declining parameters 

5) extension of benchmark-based free allocation beyond 2030, with continued support conditional from 2031 on operators establishing verified “Invest in EU Decarbonisation Plans” and investing the equivalent of 100% of their free allocation value in decarbonisation in the EU 

6) a slower phase-out of free allocation for sectors covered by the Carbon Border Adjustment Mechanism (CBAM),² now extended to 2038, but subject to conditions such as adhering to a decarbonisation plan 

7) establishment of the Industrial Decarbonisation Bank (IDB) with an estimated EUR100 billion in funding, whose first phase is the ETS Investment Booster, providing approximately EUR30bn in support through 400 million allowances for 2028–2030, followed from 2031 by a second phase deploying a further 400 million allowances through competitive bidding 

8) extension of the EU ETS geographic scope for aviation from 2029 to flights departing from the EEA and landing at aerodromes in third countries no further than 5,000 km from Frankfurt, as the largest aerodrome in the geographical centre of the Union, with a CORSIA deduction mechanism 

9) extension of the maritime ETS to certain categories of smaller ships (below 5,000 GT but not below 400 GT) and establishment of a Sustainable Maritime Alternative Propulsion (SMAP) mechanism

10) inclusion of municipal waste incineration from 2031 with a phased surrender obligation reaching 100% in 2034.

Importantly, the Commission limited its proposals to ETS1 and does not intend to amend ETS2. As described in the proposal, ETS2 is excluded from the scope of this proposal as it will become fully operational in 2028, its application is due for review by 2029, and any assessment of the feasibility of integrating the sectors under ETS2 into the EU ETS is due by 2031.

The ETS review is being negotiated against a backdrop of heightened concern over industrial competitiveness, energy prices and the cost of decarbonisation. The Irish presidency of the Council of the European Union (“Council”) has indicated that it plans to rapidly move forward, with a view to reach a Council negotiating position in time for a meeting of environment ministers in mid-December, stressing that certainty on the ETS is vital for European competitiveness.³  

Market participants should expect continued political pressure on core parameters, including free allocation, CBAM timing, price-stability tools and sectoral scope.

Footnotes

1. Press release available here. 

2. Established by Regulation (EU) 2023/956 of the European Parliament and of the Council of 10 May 2023 establishing a carbon border adjustment mechanism.  

3. Ireland kicks off talks on ETS with hope of deal by year end.