On 14 July, the EU officially proposed the extension of EU Emissions Trading System to cover the shipping sector. Amid increased discussions on the ETS, which seeks to put a price on carbon to reduce emissions, the EU answered five questions surrounding the issue.
he EU Emissions Trading System (ETS) works on the principle of ‘cap-and-trade’. It sets an absolute limit or ‘cap’ on the total amount of certain greenhouse gases that can be emitted each year by the entities covered by the system. This cap is reduced over time so that total emissions fall. IEU.Monitoring is answering the following questions:
-What reforms are you proposing to emissions trading?
On Wednesday, the European Commission presented a legislative proposal to revise the EU ETS in line with the EU’s more ambitious target of achieving net emission reductions of at least 55% by 2030, compared to 1990 levels. The sectors currently covered by the EU ETS account for around 41% of the EU’s total emissions, so their contribution is crucial to achieving the overall target.
The Commission is proposing that emissions from the current EU ETS sectors be reduced by 61% by 2030, compared to 2005 levels. This represents an increase of 18% compared to the current -43% contribution from the system to the EU’s climate target. To reach this target, the Commission proposes a steeper annual emissions reduction of 4.2% (instead of 2.2% per year under the current system), following a one-off reduction of the overall emissions cap by 117 million allowances (‘re-basing’).
The Commission also proposes to gradually remove free emissions allowances for the aviation sector, which is already covered by the EU ETS, and to move to full auctioning of allowances by 2027 to create a stronger price signal to drive emissions reduction.
The Commission also reviewed the Market Stability Reserve and proposes to strengthen it, enabling it to absorb the historical surplus of allowances more quickly and to ensure market stability, notably by maintaining the currently increased annual intake rate of allowances.
The Commission is also proposing to apply emissions trading in new sectors where sharper reductions are needed to reach the 2030 target. Under the proposal, emissions from maritime transport will be included in the existing EU ETS, while emissions from fuels used in road transport and building will be covered by a new, separate emissions trading system.
This new upstream system will regulate fuel suppliers rather than households and car drivers. It will become operational as of 2025, with a cap on emissions set from 2026, based on data collected under the Effort Sharing Regulation. During the first year, fuel suppliers will be required to hold a greenhouse gas emissions permit and to report their emissions for 2024 and 2025. The cap in the new ETS will be reduced annually to yield emissions reductions of 43% in 2030 compared to 2005. To address the social impacts arising from the fact that the fuel suppliers are likely to pass on some of their carbon costs to consumers buying road transport and heating fuels, the Commission has also presented a proposal for a Social Climate Fund.
-How will maritime transport be included in the revised EU ETS?
To ensure that the maritime transport sector contributes to the EU’s climate ambitions, the Commission is proposing to extend the scope of the EU’s Emissions Trading System to cover CO2 emissions from large ships (above 5000gt), regardless of the flag they fly. The extension will include all emissions from ships calling at an EU port for voyages within the EU (intra-EU) as well as 50% of the emissions from voyages starting or ending outside of the EU (extra-EU voyages), and emissions that occur when ships are at berth in EU ports.
Under the proposal, the EU ETS would cover around two-thirds of maritime transport emissions (90 million tonnes CO2) and result in a price signal that incentivizes improvements in energy efficiency and low-carbon solutions and reduces the price difference between alternative fuels and traditional maritime fuels. The proposal builds on the provisions in place for other EU ETS sectors as well as the existing EU Monitoring, Reporting and Verification System for shipping, which tracks CO2 emissions from ships calling at all EU ports. In the FuelEU Maritime proposal, also presented today, the Commission proposes to increase the uptake of alternative, low-carbon fuels in maritime to help drive down emissions faster.
In practice, shipping companies will have to purchase and surrender ETS emission allowances for each tonne of reported CO2 emissions. For the administration of the system, shipping companies will be attributed to an administering authority of a Member State that will ensure compliance using the same rules as for the other sectors. In addition to the EU ETS rules on penalties, ships can be denied entry to EU ports where the responsible shipping company has failed to surrender the necessary allowances for two or more consecutive years.
To ensure a smooth transition, shipping companies will only have to surrender allowances for a portion of their emissions during an initial phase-in period, reaching 100% after 3 years. A reporting and review clause is included to monitor the implementation of the rules applicable to the maritime sector and to take account of relevant developments at the level of the IMO.
-How will the revision ensure stability in the carbon market?
The EU ETS is a market-based mechanism, which means that the carbon price is determined by supply and demand of allowances. The cap on emissions ensures that the environmental objectives are reached, and tradability of allowances ensures that these reductions are achieved in a cost-efficient way.
In response to a considerable surplus of allowances on the EU’s carbon market, with corresponding effects on the price signal, the Market Stability Reserve started operating from 2019. As part of the first review of the Market Stability Reserve this year, the Commission is now proposing a small number of changes to the rules for the operation of the reserve. The Market Stability Reserve is a fully rules-based mechanism, and does not allow the Commission to intervene in the market at its discretion. Instead, it automatically places allowances in the reserve or releases them in case pre-defined thresholds are crossed. The legislative proposal contains an amendment enabling a smoother placing of allowances in the reserve the closer the surplus on the market is to the relevant threshold.
The Commission also proposes that the Market Stability Reserve operates in the new ETS for road transport and heating fuels, with specific rules. Additional measures are also proposed to mitigate a potential risk of excessive price increases in the new system through a release of allowances from the reserve under certain conditions.