Last year, the European Commission published its proposal to expand the EU emissions trading scheme (“EU ETS”). The expansion of the EU ETS forms a central part of the Commission’s “Fit for 55” package, which seeks to revise EU climate, energy and transport-related legislation to align it with the wider 2030 and 2050 climate ambitions agreed by the Council and European Parliament. The package also introduces a number of new climate initiatives to help meet these goals. The proposal underwent a consultation period from July to November 2021, during which the Commission received feedback on the expansion. Since then, the proposal has been in the hands of the Council, which has deliberated the contents and suggested amendments numerous times. Recently, the EU Parliament’s Rapporteur, MEP Peter Liese, published his draft report on the proposed ETS expansion. This report is the first step in the long process to approval by the European Parliament. Further amendments to the proposal are currently being considered, with a vote on the final amendments expected to take place around June 2022.

So, how exactly is the proposal seeking to amend the EU ETS? The overall aim of the proposal is to ensure that emissions trading in the EU is aligned with the goal of reducing GHG emissions in the EU by 55% by 2030. To make this more achievable, the Commission’s proposal consists of a number of key elements.

Firstly, the Commission proposes that emissions from EU ETS sectors are to be reduced by 61% by 2030, compared to 2005 levels. To achieve this target, a steeper annual emissions reduction of 4.2% – rather than the 2.2% annual reduction under the current system – is required, along with a one-off reduction of the overall emissions cap by 117 million allowances. The Commission also proposes to strengthen the Market Stability Reserve (“MSR”), which addresses the surplus of allowances that has built up in the EU ETS, to enable a smoother and quicker intake of allowances to the reserve.

Secondly, the Commission has separately put forward a proposal for a Carbon Border Adjustment Mechanism (“CBAM”) which aims to reduce the risk of carbon leakage for a specific number of energy intensive industries (iron and steel, cement, fertiliser, aluminium and electricity generation), by putting a price on the carbon content of imports. We have been closely following the passage of the CBAM proposal, as most recently covered in our colleagues’ blogpost on 7 January 2022. To ensure a smooth transition from one system to the other, the free allocation of allowances will be gradually phased out as the CBAM is phased in for these industries. The aim is to reach no free allocations by the tenth year of the operation of the CBAM.

In relation to the aviation sector specifically, the Commission is proposing to cap the total number of aviation allowances in the ETS at current levels, and to then reduce allowances annually under the ETS linear reduction factor. The number of free allowances allocated to aircraft operators will also gradually reduce to reach full auctioning by 2027. The Commission is looking to expand the reach of the CORSIA (the Carbon Offsetting and Reduction Scheme for International Aviation) to cover all international flights. CO2 emissions from aviation have been included in the ETS since 2012, but only for flights between airports located in the EEA. The revised EU ETS seeks to apply CORSIA to EU-based airline emissions from flights to and from countries outside the EEA. When emissions from flights outside the EEA reach levels above 2019, they will have to be offset with corresponding carbon credits.

Another key element of the Commission’s proposal is the expansion of the ETS to cover maritime activities. The extension will cover CO2 emissions from all ships above 5000 gross tonnage, and will apply to: (i) all emissions from voyages within the EU, (ii) 50% of emissions from voyages starting or ending outside the EU, and (iii) all emissions that occur when ships are at berth in EU ports. The same rules as for the other sectors would apply to maritime emissions. The requirement to surrender allowances under the maritime ETS will be phased in gradually over the period 2023 to 2025, with 100% implementation from 2026. If the ETS administering authority finds that a shipping company has not complied with ETS requirements for two or more consecutive years, its ships could be denied entry to EU ports. From 2024 onwards, the Commission will publish and regularly update a list of shipping companies covered by the ETS and their respective administering authority.

Finally, the Commission is proposing to create a parallel ETS for road transport and buildings from 2025, with fuel suppliers (rather than households or car drivers) required to surrender allowances from 2026. Emissions from road transport and building sectors will be capped, with the cap reduced over time so that total GHG emissions for these sectors are reduced by 43% by 2030, compared to 2005 levels. The intention is to incentivise fuel suppliers to decarbonise their products, and to encourage consumers to switch to low carbon solutions. To address the likely risk that fuel suppliers will transfer some of their carbon costs to consumers, the Commission has proposed to create a Social Climate Fund.

The recently published EU Parliament’s Rapporteur report suggests a number of amendments to the Commission’s proposal. Notably, it suggests to advance the dates for including all maritime emissions into the existing EU ETS to 2025, along with suggested changes to the definitions, scope, phase-in periods and thresholds of the expansion. The report also suggests that the start-date of the new ETS for buildings and road transport is brought forward by 1 year, and that the proposed ETS should cover other fuels released for consumption, such as those used for process heating in smaller installations.

It will be interesting to see how the Commission, Council and Parliament negotiate the proposal and subsequent amendments in the coming months.

The European Commission’s proposal is available here.