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The EU Emissions Trading Scheme (ETS) and Its Revitalization: A Brief Overview

In spite of being the world’s third-largest carbon dioxide (CO2) emitter, the European Union (EU) has set itself on a remarkable path toward ambitious climate goals. With the objective of significant emissions reduction by 2030 and achieving net-zero emissions by 2050, the EU is spearheading its sustainability efforts.

Introduced in 2005 as a crucial component of the Fit for 55 initiative, the emissions trading system (ETS) stands as a pivotal tool in realizing these targets, particularly in relation to industrial emissions.

How Does the EU Emissions Trading Scheme Operate?

The core principle of the emissions trading scheme is rooted in the concept of the polluter pays. This mechanism compels over 10,000 power plants and factories to secure a permit for each metric ton of CO2 they release into the atmosphere. This framework incentivizes emission reduction: the less a company pollutes, the lower its financial obligation. These permits are procured through auctions, with the price being influenced by the balance of demand and supply.

It’s noteworthy that some allowances have been allotted at no cost, especially in sectors susceptible to companies relocating production to regions with less stringent emission regulations.

Managing Carbon Price Dynamics

Following the 2008 financial crisis, the cost of these permits plummeted due to reduced demand while supply remained steady. However, the availability of surplus permits at low costs discourages businesses from investing in eco-friendly technologies, undermining the scheme’s effectiveness in combating climate change.

To address this predicament, the EU established the Market Stability Reserve in 2015, aimed at harmonizing the supply and demand of allowances. This reserve earmarks 24% of all ETS allowances, which can be released in the event of a scarcity. In March 2023, the Market Stability Reserve’s mandate was extended to 2030, guarding against potential CO2 price drops triggered by external shocks like the Covid-19 pandemic. Such price drops could diminish the incentive for industries to curtail greenhouse gas emissions.

Revamping the ETS in Light of the EU Green Deal

In order to align the emissions trading system with the heightened emission reduction objectives of the European Green Deal, the EU arrived at a comprehensive update in December 2022, targeting a 62% reduction in industrial emissions by 2030.

Key Reforms Encompass:

Further reduction of annual allowances leading up to 2030, ultimately achieving a 62% emissions cut by 2030—1 percentage point higher than the original Commission proposal (61%). Increased funding allocation for innovative technologies and energy system modernization through an Innovation Fund and Modernization Fund. The Social Climate Fund, designed to support households and businesses impacted by energy poverty, will receive a portion of proceeds from the new trading system. Gradual phasing out of complimentary allowances to industries by 2034, coinciding with the gradual implementation and full operation of the EU’s Carbon Border Adjustment Mechanism by the same year. This mechanism is designed to levy a carbon price on imports from countries with less stringent emission regulations, thereby discouraging production relocation.

Enlargement of the scheme to encompass maritime transport. Inclusion of emissions from municipal waste incineration facilities, effective from 2024. Introduction of a separate emissions trading system (ETS II) for buildings and road transport, commencing in 2027. In cases of exceptionally high energy prices, the launch of ETS II might be postponed to 2028, coupled with the establishment of a price stability mechanism. This mechanism would trigger the release of 20 million additional allowances if the price surpasses €45. Revitalization of the Emissions Trading System for aviation, with the aim of eliminating complimentary allowances to the aviation sector by 2026 and promoting the adoption of sustainable aviation fuels.

All proceeds generated from the Emissions Trading System are ring-fenced for initiatives directly related to climate action.

Source: https://climateactiontracker.org/countries/eu/ and https://www.europarl.europa.eu/news/en/headlines/priorities/climate-change/20170213STO62208/the-eu-emissions-trading-scheme-ets-and-its-reform-in-brief