The European Union (EU) Parliament approved legislation designed to reduce greenhouse gas (GHG) emissions by at least 55% by 2030 compared to 1990 levels. Under the reforms:
- Emissions trading system (ETS) sectors must cut greenhouse gas emissions (GHG) by 62% by 2030 and free allowances to companies will be progressively phased out by 2034.
- A separate new ETS II for fuel for road transport and buildings will be created that will put a price on GHG emissions by 2027.
- A Carbon Border Adjustment Mechanism (CBAM) will be phased in by 2034. Under the CBAM importers of iron, steel, cement, aluminium, fertilisers, electricity and hydrogen will have to pay any price difference between the carbon price paid in the country of production and the price of carbon allowances in the EU ETS.
- An EU Social Climate Fund (SCF) will be set up to help combat energy and transport poverty. The SCF will primarily be funded from auctioning ETS II allowances.
EU’s Emissions trading system
Established in 2005, the ETS was the world’s first international emissions trading system and operates in all EU countries plus Iceland, Liechtenstein and Norway (EEA-EFTA states).
The ETS covers around 40% of the EU’s greenhouse gas emissions and is an effective tool in helping drive emissions reductions. It limits emissions from around 10,000 installations in the energy sector and manufacturing industry, as well as aircraft operators operating between these countries.
Critically, it enables the accurate measurement, reporting and verification of carbon dioxide emissions from a range of sectors including electricity and heat generation, aviation and energy-intensive industry sectors such as oil refineries and steel works.
The ‘cap and trade’ principle is central to the ETS, with emitters having to cap and reduce emissions over time. They can also buy emissions allowances, which they can trade with other emitters.
Under the reforms, free allowances which were used in a bid to safeguard the competitiveness of the regulated industries and to avoid carbon leakage, will be phased out.
Carbon Border Adjustment Mechanism
A Carbon Border Adjustment Mechanism (CBAM) is a tariff designed to stop “carbon leakage” as economies push to decarbonise. In the EU, the CBAM discourages companies based in the EU from moving carbon-intensive production overseas where emissions reduction requirements are not as strict.
The EU will phase in the CBMA by 2034 and it will cover importers of iron, steel, cement, aluminium, fertilisers, electricity and hydrogen. Importers of these products will have to pay any price difference between the carbon price paid in the country of production and the price of carbon allowances in the EU ETS.