Briefing
EU Legislation in Progress
May 2018
Post-2020 reform of the EU Emissions
Trading System
SUMMARY
In July 2015, the European Commission proposed a reform of the EU Emissions
Trading System ETS for the 2021-2030 period, following the guidance set by the
October 2014 European Council meeting. The proposed directive introduces a new
limit on greenhouse gas GHG emissions in the ETS sector to achieve the EU climate
targets for 2030, new rules for addressing carbon leakage, and provisions for funding
innovation and modernisation in the energy sector. It encourages Member States to
compensate for indirect carbon costs. In combination with the Market Stability
Reserve agreed in May 2015, the proposed reform sets out the EU ETS rules for the
period until 2030, giving greater certainty to both industry and investors. In the European Parliament, the ENVI Committee took the lead on the proposal, while
it shared competence with the ITRE Committee on some aspects. The European
Parliament and the Council adopted their respective positions in February 2017, and
interinstitutional trilogue negotiations were concluded in November 2017. After its
adoption by Council and Parliament, the Directive entered into force on 8 April 2018.
Proposal for a Directive of the European Parliament and of the Council amending
Directive 200387EC to enhance cost-effective emission reductions and low-carbon
investments
Committee responsible
Rapporteur
Procedure completed. Environment, Public Health and
Food Safety ENVI
Julie Girling ECR, UK
Directive EU 2018410
OJ L 76, 19.3.2018, pp. 327
COM2015 337
of 15 July 2015
procedure ref. 20150148COD
Ordinary
legislative
procedure
This briefing updates an earlier edition, of November 2017 PE 614.601. EPRS European Parliamentary Research Service
Author Gregor Erbach
Members Research Service
PE 621.902
EN
EPRS
Post-2020 reform of the EU Emissions Trading System
Introduction
In July 2015, the Commission presented a proposal for reforming the EU Emissions
Trading System for the fourth phase 2021-2030, in line with the 2030 climate and energy
targets endorsed by the European Council. The proposal lowers the amount of
greenhouse gases that may be emitted each year, introduces new rules for protecting
industries from carbon leakage, and establishes two funds for modernisation and
innovation. The proposal follows recent modifications to the functioning of the EU ETS the decision
to postpone the auctioning of allowances backloading, and the introduction of a Market
Stability Reserve that aims to better align demand for and supply of emission allowances. The proposed reform will provide certainty to industry and to investors by setting the
rules for the EU ETS in the period up to 2030. Context
The EU ETS is a key element of EU climate policy. In line with the internationally agreed
objective of keeping global warming below 2 degrees Celsius, the EU has set targets for
reducing its greenhouse gas GHG emissions and decarbonising the economy. The long-
term objective for 2050, agreed by the European Council in 2009, is an 80-95 reduction
in GHG emissions compared to 1990. In the medium term, the EU aims to reduce GHG
emissions by 20 by 2020, and by 40 by 2030. The EU participates in international efforts to reduce GHG emissions under the
UN Framework Convention on Climate Change UNFCCC. The Kyoto Protocol commits
developed nations to GHG emissions reductions, up to 2020. In December 2015, the
Parties to the UNFCCC adopted the Paris Agreement, a new legally binding climate
agreement that applies to all countries and entered into force in November 2016. The
EUs emissions reduction target for 2030 is part of the EUs Nationally Determined
Contribution to the Paris Agreement. Without international cooperation, regional efforts to combat climate change may lose
effectiveness, because emission-intensive production may be relocated from regions
with strong climate policies to regions with less ambitious policies, a phenomenon known
as carbon leakage.
If investments are relocated, one speaks of investment leakage. Existing situation
The European Emissions Trading System ETS was established by the ETS Directive
200387EC, amended by Directive 200929EC setting out rules for the third phase
2013-20.1 It is a cap and trade scheme, in which there is a fixed annual number the
cap of emission allowances, which can be traded among GHG emitters. It covers
emissions of CO2, nitrous oxide N2O and perfluorocarbons PFCs, and applies to more
than 11 000 power stations and industrial plants in the 28 EU Member States as well as
Iceland, Liechtenstein and Norway, thereby accounting for around 45 of GHG emissions
in these 31 countries. Since 2012, it also applies to the aviation sector. One EU allowance EUA gives its owner the right to emit one tonne of CO2 or equivalent. In the 2013-2020 period, 57 of the available allowances are sold in regular auctions,
and 43 are allocated to industry for free.2 By 30 April of every year, each installation
must report its emissions for the preceding year and surrender the corresponding
number of EUAs or equivalent international emissions credits. Any unused allowances
remain valid and can be used in subsequent years. Members Research Service
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The system encourages companies to invest in emissions-reducing technology if the cost
of reducing emissions is lower than the market price of emission allowances. If companies
find that the cost of reducing emissions is higher than the carbon price, they can buy
allowances to cover their emissions. Rational economic actors will thus find the lowest-
cost ways to reduce overall emissions. An EU-wide cap limits total GHG emissions for industrial installations which are subject
to the ETS. In order to achieve, by 2020, a 20 emissions reduction compared to
1990 levels, the cap is lowered by 1.74 percentage points per year, as laid down in the
ETS Directive 200929EC. A separate non-declining cap applies to the aviation sector
until 2020 5 below the average annual emissions in the years 2004-2006. Carbon leakage
The European Commission establishes a list of industries that are at risk of carbon leakage the
relocation of production to countries with less ambitious climate policies. The most efficient
installations can receive up to 100 of the required allowances for free. Criteria for inclusion in
the carbon leakage list are emissions intensity and trade intensity, assuming a price of 30 per
allowance. A new list is established every five years. The second carbon leakage list, for the period
2015-2019, was adopted in October 2014. A 2013 study for the European Commission found no evidence of past carbon leakage under the
conditions of free allocation to industries on the carbon leakage list, and a low carbon price. Research by CDC climat found no carbon leakage in the primary aluminium industry, and
concluded that energy prices play a much larger role than the cost of emissions. Free allocation of allowances
In contrast to the power sector, manufacturing industries receive free allowances. In
order to incentivise emissions reductions, the allocation depends on benchmarks set out
in Commission Decision 2011278EU on the basis of the average emissions intensity of the
10 most efficient installations. Sectors at risk of carbon leakage can get up to 100 of
their required allowances3 through free allocation. Other industries receive only part of
the required allowances for free 80 of their sectors benchmark in 2013, declining to
30 in 2020. If not enough allowances are available for free allocation, the free
allocation for all installations is reduced by a cross-sectoral correction factor.4 As a
result, no installation receives 100 of the allowances for free, even if it is on the carbon-
leakage list, and would have to buy allowances if it does not have reserves.
Recent developments
In response to an over-supply of allowances, the auctioning timetable for the 2013-2020
ETS phase was adapted to allow for the delayed auctioning backloading of some
900 million allowances that would have been auctioned in 2014-2016. In May 2015,
Parliament and Council agreed on introducing a Market Stability Reserve MSR for the ETS,
starting in 2019. The MSR aims to better align supply and demand of allowances by placing
surplus allowances in a reserve, from which they can be released in case of shortage.
The
900 million backloaded allowances will be placed directly in the MSR. Complementary policies
Emissions from sectors not covered by the ETS, such as road transport, waste, agriculture
and buildings, are subject to the Effort Sharing Decision 4062009EC that sets national
emission targets for the non-ETS sector5 The Renewable Energy Directive 200928EC
seeks to ensure that by 2020 renewable energy such as biomass, wind, hydroelectric and
solar power make up at least 20 of the EUs total energy consumption. The Energy
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Efficiency Directive 201227EU sets legally binding rules for end-users and energy
suppliers, and requires Member States to establish indicative national energy efficiency
targets for 2020.
The Commission put forward legislative proposals intended to update
the current legislative framework as part of the clean energy for all Europeans package
presented on 30 November 2016. Effectiveness with the ETS
A European Commission study and academic research indicate that the EU ETS has
contributed to small but real emissions reductions and had limited but positive impact on
investment decisions and innovation, although it appears that some industries have
generated windfall profits by passing on the cost of free allowances to consumers. By the end of the second phase, the ETS had accumulated a surplus of more than 2 billion
allowances. The main reason for this surplus was falling demand during the economic
crisis, combined with an inflexible supply of allowances.6 Due to this oversupply, the EUA
price fell to levels that do not incentivise low-carbon investments or the switching from
coal to less polluting gas for electricity generation. Analysts expect the surplus to persist
until the mid-2020s. The European Court of Auditors found weaknesses in the management of the ETS by the
European Commission and Member States, and issued recommendations for improving
market regulation and oversight. The Commissions carbon market report 2015 of November 2015 concludes that the EU
ETS has created a functioning market infrastructure and a liquid market, with a robust
system architecture. It is confident that the EU ETS will regain importance in the coming
years, due to backloading and the introduction of the MSR. The CEPS Carbon Market Forums 2016 state of the EU ETS report assesses the EU ETS on
four criteria, and finds that it functions reasonably well as a market and delivers on
emission reduction targets, but does not drive medium-to-long-term change and suffers
from an erosion of trust. The changes the proposal would bring
The Commission proposal concerns phase 4 of the ETS 2021-2030. It consists of three
main elements
1. more ambitious linear reduction factor for GHG emissions,
2. new rules for free allocation and carbon leakage,
3. provisions for funding innovation and modernisation. New linear reduction factor for GHG emissions
The proposed directive would raise the linear reduction factor of the ETS cap from 1.74
per year to 2.2 per year from 2021, in order to achieve a 43 reduction in GHG
emissions in the ETS sector by 2030, compared to 2005 levels. The increased reduction
factor should lead to additional emission cuts of 556 million tonnes CO2e during the next
decade. Together with emission reductions of 30 in the non-ETS sector, this should
enable the EU to achieve its target of reducing emissions by 40 by 2030, compared to
1990 levels. In phase 4, 57 of the emission allowances would be auctioned, the same proportion as
in phase 3. The proposal leaves it up to Member States how to spend the auction
revenues, but says at least half of the revenues should be used for climate action,
decarbonisation and compensation of indirect emission costs. Members Research Service
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Member States would continue to have the option to exempt small installations from the
ETS if they make an equivalent contribution to cut emissions. Free allocation and benchmarks
As in phase 3, industry would receive free allowances. Installations on the carbon-leakage
list would receive up to 100 of the required allowances for free, others would get up to
30 . Free allocation would be decided for a period of five years, compared to eight years
at present. The free allocation for an installation would be increased in case of increased
production. Currently, this is only possible when production capacity is added. Free allocation would be decided on the basis of benchmarks, based on the 10 most
efficient installations. The benchmarks would be updated twice during phase 4 for the
periods 2021-2025 and 2026-2030, in order to take account of technological advances. The benchmarks would be tightened by 1 per year by default, in order to account for
expected emission reductions through technological progress. For industries with lower
potential for reducing emissions, the benchmarks would be reduced by only 0.5 per
year, and for industries with more potential by 1.5 . According to the Commission, these
changes reduce the chance that a correction factor would need to be applied. The Commission proposes to move 250 million unallocated allowances from the MSR to
a new entrants reserve that can provide free allocation for new market entrants and
growing companies. Provisions for carbon leakage
The new criteria for establishing the carbon-leakage list would be a combination of
emissions intensity and trade intensity. As a result, around 50 industrial sectors would be
on the carbon-leakage list, down from 177 at present.7 Analysts estimate that sectors on
the carbon leakage list would still account for over 90 of EU industrial emissions, down
from 97 currently. Compensation for indirect costs
Indirect costs for electricity consumers arise when the cost for electricity producers
emissions is passed on to consumers through electricity prices. Member States are
encouraged to compensate such indirect costs for sectors exposed to carbon leakage,
subject to state aid rules.
However, there would be no obligation and no harmonisation,
and thus the legal situation would remain unchanged. Innovation Fund
Similar to the existing NER 3008 fund, the new Innovation Fund would provide financial
support for projects in the areas of renewable energy sources and carbon capture and
storage. In addition, industrial demonstration projects for low-carbon innovation can be
supported. Up to 60 of project costs can be funded. The fund would be financed by the
sale of 400 million allowances, which could raise up to 10 billion, according to the
Commission. In addition, 50 million unallocated allowances from phase 3 would be taken
from the MSR, in order to enable the fund to start before 2021. Support for modernisation of energy systems
The proposal introduces the Modernisation Fund, a new fund for modernisation of
energy systems in lower-income Member States.9 It would be financed by the auction of
some 310 million allowances. In addition, the proposal would prolong the possibility for lower-income Member States
to give free allowances to their electricity producers for modernisation of the energy
sector. Modernisation projects above 10 million would be selected at national level
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through a competitive bidding process, and lower-value projects on the basis of objective
and transparent criteria. Parliamentary analysis
An initial appraisal of the Commissions impact assessment prepared by the Ex-Ante
Impact Assessment Unit DG EPRS notes that the impact assessment offers a balanced
presentation of the different options, but little original analysis. An implementation appraisal of the EU ETS performed by the Policy Performance
Appraisal Unit DG EPRS concludes that the EU is on track to meet its target of 20
reduction in greenhouse gas emissions by 2020, due to a number of factors including the
ETS, whose effectiveness has been affected by a surplus of allowances and weaknesses
in implementation. A study on energy efficiency and the ETS DG IPOL, 2013 concluded
that there are only limited interactions between the ETS and the Energy Efficiency
Directive, which concerns mostly non-ETS sectors. Legislative process
In Parliament, the Committee on Environment, Public Health and Food Safety ENVI has
exclusive competence for the proposal as a whole, expect for the provisions on carbon
leakage and the innovation and modernisation funds, where competence is shared with
the Committee on Industry, Research and Energy ITRE. The ENVI Committee held a
hearing on 18 February 2016 to discuss the ETS reform with experts, industry
stakeholders and NGOs. The ITRE Committee adopted its opinion on 13 October 2016,
and the ENVI Committee rapporteur Ian Duncan, ECR, UK since replaced by Julie Girling,
ECR, UK adopted its report on 15 December 2016. On 15 February 2017, the European Parliament adopted its first-reading position in a
plenary vote. It would maintain the linear reduction factor at 2.2 , as in the
Commissions proposal, but keep it under review, with a view to increasing it to 2.4 by
2024 at the earliest. Decision EU 20151814 would be amended to double the intake
rate of surplus allowances in the MSR from 12 to 24 during the first four years,
starting in 2019. In addition, 800 million allowances from the MSR should be cancelled on
1 January 2021. In cases of closures of power plants, Member States would be able to
retire a corresponding volume of allowances. In order to avoid the application of the
cross-sectoral correction factor, up to 5 of the allowances could be allocated to industry
for free instead of being auctioned. The rules for excluding small installations from the
ETS are extended to cover installations operated by small and medium-sized enterprises
SMEs emitting less than 50 000 tonnes CO2e. All revenue from the auctioning of
allowances would have to be used for climate action, decarbonisation and compensation
of indirect emission costs. Companies that are at risk of carbon leakage as a result of
indirect emission costs passed through electricity prices would be compensated with
revenues from auctioning 3 of the allowances. The resources of the Innovation Fund
would be increased to 600 million emission allowances. A Just Transition Fund would be
established to assist workers affected by the transition towards a low-carbon economy,
through measures like training, support for job-seeking and business creation.
It would
be funded from 2 of the auction revenues. The rules concerning which countries may
use the Modernisation Fund are amended to include countries whose 2014 per capita
GDP is below 60 of the EU average.10 To ensure EU climate policy is aligned with the
Paris Agreement on climate change, the resolution requires the Commission to assess the
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adequacy of the ETS to meeting the goals of the Paris Agreement after the 2018
facilitative dialogue, and after each of the five-yearly global stocktakes. The resolution also contains provisions for emission allowances for aviation and maritime
transport. In the absence of a comparable system agreed by the International Maritime
Organization, maritime emissions from ships within, arriving at or departing from EU
ports should fall under the EU ETS from 2023. A maritime climate fund financed from
one fifth of the auction revenues from maritime shipping would be created to offset
maritime transport CO2 emissions, improve energy efficiency and encourage investment
in technologies for reducing CO2 emissions from the sector. Aviation emissions should be
tackled by gradually decreasing the allocation of allowances to the aviation sector,
starting in 2021 with 10 fewer allowances than the 2014-2016 average. More aviation
allowances would be auctioned, and auctioning revenue would be spent on climate
action in the EU and third countries. The global market-based measure agreed by the
International Civil Aviation Organization would be taken into account. In the Council, Environment Ministers held a policy debate on the proposal on
20 June 2016. On 19 December 2016, the Environment Council discussed the EU ETS
reform on the basis of a progress report from the Councils General Secretariat. On 28 February 2017, the Environment Council adopted a general approach on the ETS
reform. It would maintain the higher intake rate for the MSR until the end of 2023, one
year longer than proposed by Parliament. Starting in 2024, if the total number of
allowances in the MSR exceeds total auction volume of the previous year, the difference
would be cancelled. In order to avoid the use of the cross-sectoral correction factor, up to
2 of the allowances could be allocated to industry for free instead of being auctioned. Interinstitutional trilogue negotiations between the Parliament, the Council and the
Commission started in April and were concluded on 8 November 2017. The main
elements of the trilogue agreement are
the linear reduction factor will be 2.2 from 2021, as proposed by the Commission
each year from 2019 to 2023, 24 of the cumulative surplus of allowances will go to
the Market Stability Reserve from 2023 the allowances held in the reserve above the
total number auctioned during the previous year will be cancelled
conditional lowering of the auction share by 3 of the total quantity if needed, to
avoid applying the cross-sectoral correction factor this is between the 5 proposed
by Parliament and 2 proposed by Council
Member States may voluntarily cancel allowances to offset national climate and
energy policies that lead to a reduction of their electricity generation capacity
the modernisation fund will not be used to finance coal-fired generation as
demanded by Parliament, with the exception of plants used for district heating in
the two poorest Member States Bulgaria and Romania, provided that they offset by
using an equivalent amount of free allocation for the modernisation of the energy
sector for investments not involving solid fossil fuels. The agreed text was endorsed by Coreper on 22 November, and was voted in the ENVI
committee on 28 November. The Parliament approved the text in plenary session on
6 February 2018, followed by formal approval by EU Member States in the Council on
27 February 2018. The final act was signed on 14 March and published in the Official
Journal on 19 March 2018.
The Directive entered into force on 8 April 2018. Member
States have to transpose it by 9 October 2019.11
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References
Enhancing cost-effective emission reductions and low carbon investments, European Parliament,
Legislative Observatory OEIL. Initial Appraisal of a European Commission Impact Assessment EU Emissions Trading System EU-
ETS cost-effective emission reductions and low-carbon investments, Samuele Dossi, EPRS,
September 2015. Implementation Appraisal Climate Action. Greenhouse Gas Emissions and the EU Emissions
Trading System, Gertrud Malmersjo and Jessica Porcelli, EPRS, September 2015. Study on the impacts on low carbon actions and investments of the installations falling under the
EU Emissions Trading System EU ETS, European Commission, February 2015. Endnotes
1 After an introductory phase 2005-07, the second phase 2008-12 of the ETS was characterised by the allocation of
allowances to industry by Member States, and the possibility to make use of international carbon credits. In the third
phase 2013-20, more of the allowances are auctioned, the ETS covers more emissions, and a central registry and
common auction platform is introduced to increase transparency and prevent fraud. Moreover, the use of
international credits has been restricted. 2 Allowances for electricity producers are subject to auctioning with the exception of free allocation for the
modernisation of the power sector in some Member States, whereas industry receives a proportion of the required
allowances for free. 3 The free allocation is based on historical production data. The amount of free allocation depends on the benchmark
less efficient installations receive only as many allowances as the 10 most efficient installations would need for the
same amount of production. 4 A cross-sectoral correction factor was first used in 2013, reducing free allocation by 6 . The factor will rise to 18
by 2020.
5 In July 2016, the Commission presented a legislative proposal for an Effort Sharing Regulation for the 20212030
period, for which a trilogue agreement was reached in December 2017. 6 Other factors contributing to the surplus were national allocations of free allowances, cheap international emissions
reductions credits and emissions-reducing effects of complementary policies.