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EU reforms Emissions Trading System: What you need to know

December 29, 2022

The European Union has negotiated its "biggest climate law" ever. With emitters forced to pay more, billions of euros are expected to go toward a climate social fund. DW takes a closer look.

The lignite-fired Niederaussem power plant operated by German energy giant RWE near Niederaussem, western Germany
The Eu reformed its Emissions Trading System (ETS) which caps how much companies in certain sectors can emit Image: Ina Fassbender/AFP/Getty Images

The European Union wants to become the world’s first climate neutral continent by 2050. And to achieve this goal, it aims to emit 55% less CO2 by 2030 compared with 1990 levels.

At the core of the plan is a carbon market known as the Emissions Trading System (ETS). It sets caps on how much companies can emit and allows them to trade these emission rights. 

Now the EU Parliament has struck a deal to reform this system after lengthy negotiations with government representatives. 

Peter Liese, an MEP with the conservative European People’s Party, led the talks and called the agreement "the biggest climate law ever negotiated in the EU."

The ETS includes oil refineries, coal and steel power plants as well as cement, glass, paper and parts of chemical industries. These sectors make up 40% of total emissions in the EU, and about 10,000 of their companies have had to pay for their emissions since 2005.

The new plan involves removing permits for around 90 million metric tons of CO2 from the system in 2024. Each year after that, the cap on CO2 permits will fall by 4.3% every year. Starting in 2028, they will fall by 4.4%.

The cost of emitting will go up, too. This year alone the price of carbon climbed to more than 85€ ($90) per ton in the EU, or roughly double its price two years ago.  

In the future, the price will go up to 100€ per ton for industries that fall under the ETS , according to the French MEP Pascal Canfin, chairman of the European Parliament’s environment committee. Emissions in ETS sectors are expected to drop over 60% by 2030 as a result. Previously, they were only expected to go down by 42%. 

"The targets have been raised fairly significantly compared to where we were. This is one of the major pieces," said Thorfinn Stairnforth of the Institute for European Environmental Policy (IEEP), a Brussels-based think tank. 

This decision follows closely after the EU's adoption of the Carbon Adjustment Mechanism (CBAM)in mid-December. CBAM aims to prevent CO2 emissions from spilling over to countries outside the EU. After a test phase, a tariff will be levied on carbon-intensive imported goods such as steel, cement and aluminum. 

Cleaning up steel production

Reducing free allowances for carbon-intensive industries

Another important development is the move away from so-called "free allowances" in the ETS system. 

Up until now, a number of industries were given carbon permits so that international companies that didn’t have high carbon prices wouldn’t outcompete them. Almost half of permits were handed out for free, including to heavy industry whose activities are particularly harmful to the climate. That means that no carbon price was paid for almost 90% of industrial emissions covered by the ETS. 

Under the new plan, this will change drastically. By 2030 free permits will be slashed by half, and by 2034 they will be eliminated completely.

Last year, emissions trading generated around 32€ billion across the EU. Now all revenues from the ETS are to be used for climate-relevant measures — that didn’t always happen in the past.

"In Germany, that is already the case for the most part. But Poland spent 50% for completely different causes. Italy even spent 70%," said German MEP Peter Liese. "This will end now. Emissions trading will become a tool for environmental protection."

"The ETS is actually a tool to give a Polluter Pays Principle signal and that will help," said Sofie Defour, freight director at the Brussels-based think tank Transport and Environment. "But mainly it's a tool that will generate revenues that will be reinvested into the sector to help companies decarbonize."

Pay to Pollute: Emissions trading explained

More pressure on ships, little on flights

From 2024, the shipping industry will also have to gradually pay for its emissions for the first time. The higher costs for ship operators are intended to provide an incentive to switch quickly to more sustainable alternatives. But according to Defour, this will have little impact on consumer prices for goods imported by sea.

"What we found is that about 3 cents would be added to the price of your television and about 8 cents to your pair of Nikes," she said. "Because there's so much stuff that you can put on on one ship, it doesn’t make much of a price difference for one item."

Large parts of air traffic will continue to be exempt from carbon prices. The think tank Transport and Environment estimates that the European aviation industry will only have to pay for 22% of its emissions by 2030.

However, gas, petrol and diesel used for transport or heating are set to become significantly more expensive from 2027. And in a new market for carbon emissions (ETS2), emissions from buildings and the transport sector will also have to be paid for.  

The aim is a maximum carbon price of 35€ in ETS2. It’s difficult to predict what this means for consumer prices. 

Currently it is assumed that diesel and gasoline will become between 11 and 12 Euro cents more expensive per liter at the pump. In Germany alone, this would put 2.3 million households at above-average risk of high heating costs. 

A sensitive issue as electricity and gas prices have soaredas a result of the energy crisis. If energy prices remain this high in the long term, the introduction of ETS2 will be postponed by one year to 2028.

Climate justice despite higher energy costs?

Many people, particularly in eastern European countries, continue to rely heavily on fossil fuels. Because their incomes are comparatively lower, rising CO2 prices are expected to hit them even harder than people with a higher average income in Germany or France, for example. 

That’s why an EU-wide 86€-billion social climate fund is in the works. This money will subsidize national social climate plans to make up for the negative effects of higher gas and petrol prices. For example, they could finance climate-friendly renovations, heat insulation for houses, the expansion of public transport and social measures for low-income groups. 

Michael Bloss, a Green Party MEP in the European Parliament, agreed with the new carbon price. But he would have liked to see a more generous social fund. 

"Citizens in the EU have to be prepared for higher CO2 prices. This social climate fund is not enough to make up for the toll this will take," he said. "Climate protection in the EU is leaning away from social justice."

Experts say it is crucial that revenue from the new EU climate package be invested in climate-relevant measures. 

That's because a high carbon price alone won’t achieve climate targets, according to Defour. She says the 27 EU member states must now hone their national climate plans and press ahead with them. 

"The ETS is  just a tool that helps you," she said.