European countries are struggling to find the necessary funding for the shift to clean energy. On the EU level, the budget is even more limited, and we see increasing interest in tapping into the revenues raised by the auctioning of emission allowances (EUAs). So far, this funding has been reserved for the member states governments and two EU-level instruments that fund the green transition, but we now see other potential beneficiaries lining up for a share. It is already decided that around 200 m allowances or 1.6% of the total supply for the period 2021-2030 will be re-directed to the REPowerEU programme. Now, the European Parliament is discussing using some of the EUA auction revenues to finance the Net Zero Industry Act, an idea that was not in the original proposal from the European Commission. Some 7 billion or more EUAs are set to be auctioned throughout this decade. Assuming an average carbon price of €100/t that means €700 billion, a big source of climate funding that will be fought over by European policymakers in the years to come.
Europe is facing an urgent need to accelerate the shift to clean energy, a growing concern that American support programmes will lure Greentech investments across the Atlantic, and a persistent high price of carbon emissions – which for emitters mean costs, for governments mean revenues. Together, these factors have increased politicians’ interest in the EU emission trading system not only as a way of pricing emissions but as a source to (part)finance the green transition.
For the EU member states governments the auctioning of EUAs is an important source of revenues. Currently, at least 50% of that must be spent on climate-related measures, going forward, that share will be raised to 100%, with an exception that allows to compensate manufacturers for their “indirect carbon costs”, i.e., the higher cost of electricity.
EUA auctioning is also financing the Innovation Fund and the Modernisation Fund, two important green transition support mechanisms at the EU level. Furthermore, as of 2023, the monetisation of emission allowances is also part of the funding of the REPowerEU plan to accelerate Europe’s transition away from its dependence on Russian fossil fuels.
That member states accepted to give up some of their EUA volumes for this was a surprising move. It remains to be seen if this was a one-off or sets a precedent for others searching for a source of climate finance.
It should be remembered that the European Commission has previously eyed EUAs as a possible source of “own resources” for the EU budget, but the idea was always rejected by member states loath to let go of what they consider an important revenue stream.
To assess the importance of EUAs as a source of climate finance now and in the years to come, a good place to start is by looking at how many EUAs are scheduled to be auctioned this decade. The framework going forward, amended recently to be compatible with the overall 2030 climate target of an at least 55 per cent reduction in emissions, stipulates a steep tightening in annual issuance of EUAs, from 1,509 m in 2023 to 847 m in 2030. Overall, for the period 2021-2030, some 12.6 billion units will be issued, and the majority of these will be auctioned.
Our preliminary assessment of the various auction volumes, for a total of 7.1 billion EUAs, is shown in Figure 1. The dominant share is held by the member states, but the Modernisation Fund, the Innovation Fund, and REPowerEU are also set to monetise significant volumes. The assumptions we have made for each of the funds can be seen in Textbox 1, further down.
Assuming an average price of €100 per unit throughout this decade we can expect available finance in the order of €700 billion, nearly all of which will be earmarked for funding the green transition one way or another.
We can put that money in context by comparing it to the €640 ($700) billion Inflation Reduction Act (IRA) presented by the US administration in 2022. The two amounts are clearly in the same ballpark. A comparison is tricky, though, because none of the numbers are final. Also, the two systems use very different tools for raising and distributing funding. We discuss this more in detail toward the end of this analysis.
Before that, let’s take a deeper look into the Modernisation Fund, the Innovation Fund, and REPowerEU.
Unlike the Innovation Fund which is open to all member states, the Modernisation Fund (MF) is reserved for improving energy efficiency and the energy systems in member states with below-average GDP per capita below 60% of the EU average. Each of the ten beneficiaries is assigned a share, ranging from 43% (Poland) to 1.4% (Latvia).
As a result of the recent ETS reform, an additional pot of money will be available for members with less than 75% of the average, so a somewhat broader group.
The aim is to help modernise energy systems that are still to a large extent dependent on emission-intensive coal power plants, e.g., by deploying renewable energy, improving energy efficiency, or upgrading grids and storage solutions. The MF shall also support a so-called ‘just transition’ in carbon-dependent regions, e.g., by re-skilling workers affected by coal phase-out.
The Modernisation Fund cannot finance investments that involve coal-based generation. Gas power projects can be approved if a significant greenhouse gas (GHG) reduction is deemed to be achieved.
The EUAs destined for MF are auctioned under the aegis of the European Investment Bank as part of the Common European auction platform (see textbox below), in line with the Auctioning Regulation.
Size/sourcing: MF is funded by auctioning of EUAs. The framework for the EU ETS in the fourth trading period (2021-2030) was originally decided in 2018 when the Modernisation Fund was created as a key element under the new Article 10d. It stipulated that 2% of the total quantity of allowances between 2021 and 2030 should be earmarked for the MF.
The volume reserved for the MF was more than doubled in 2019 when five countries (Croatia, Czechia, Lithuania, Romania, and Slovakia) decided to transfer 351 m EUAs originally scheduled for free allocation to power plants (the so-called 10c derogation). Some countries also injected EUAs from a solidarity account under Article (10(2)), adding another 17 m.
Then, the FF55 revision of the ETS Directive, adopted in April 2023, stipulates that on top of the existing 2% pot (for the period 2021-2030), another 2.5% of the volume for the years 2024 and 2030 will be added. As a result of this, the annual MF monetisation will increase from 67 m units in 2023, to 100 m in 2024, before falling back to 75 p.a. in 2030, as the cap is tightening, see Figure 2.
Overall, for the period 2021-2030, we estimate that 816 m EUAs will be sold to fill up the MF. If we assume an average price of €100/t, that will generate €81.6 bn over the decade.
The creation of the Modernisation Fund was crucial for getting Poland and other central-eastern European countries on board for a tighter ETS out toward 2030. As the European Commission, the European Parliament, and the member states in the Council are scrambling for new sources for EU-level climate financing, the MF is the one possibility that has not been mentioned.
Recipients: Bulgaria, Croatia, Czechia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Slovakia are listed in the ETS Directive as member states with GDP/capital below 60% of average and thereby eligible for the original support under the MF. All ten countries are late joiners in the EU (most of them in 2004).
On 8 June 2023, the European Commission announced the disbursement of €2.4 billion for 31 projects in seven beneficiary countries, the largest hand-out to date. Some €1.1 billion was invested in Romania, another billion in Czechia, while Bulgaria received €197 million.
As for the extra volume that will be added going forward (2.5% of the volume for 2024-2030), this part of the MF will be open to applications from 13 countries, the ten listed above plus Greece, Portugal, and Slovenia.
Legal base: ETS Directive Article 10d, and the Commission Implementing Regulation 2020/1001, which provides more details on the operation of the MF. The latter is set to be updated in Q4 of 2023.
The Innovation Fund (IF) is a key source of climate-related funding in Europe and one of the world’s largest Greentech funding programmes. In addition to spurring the deployment of new net-zero solutions for energy and industry, IF aims to boost economic growth and reinforce Europe’s technological advances.
It supports technologies that are not yet commercially available but represent breakthrough solutions or are sufficiently mature to be ready for demonstration at pre-commercial. This includes for instance new, innovative forms of renewable energy generation, energy storage, carbon capture and utilisation/storage. Grants are decided based on competitive bidding.
Size/sourcing: The IF is funded by the sale of EUAs. The monetisation is spread out over the EUA auctions every Monday, Tuesday, and Thursday (see details in Text box 2). As part of the ETS reform agreed upon in December 2022 and adopted in April 2023, the overall size of the IF was increased from 450 to 530 m, and the scope was widened to include technology relevant to aviation and maritime emissions.
While the volume is set, the value will depend on how the EUA price evolves in the years to come.
Then, in a parallel move, also in 2022, European lawmakers decided to create a REPowerEU programme to veer Europe off its dependence on Russian fossil fuels. Estimated overall at €300 billion, some €20 billion will come from selling EUAs sourced from the Innovation Fund (60%), and from volumes earmarked for the member states’ auctions (40%).
Assuming an average price of €100/t, some 120 m will be redirected from IF to REPowerEU (see below). The first batch of 19 m will be sold in H2 of 2023.
So far since 2020 (a small share of the 2021-2030 IF volume was auctioned already in 2020), some 151 million EUAs have been auctioned for the IF, generating €8.5 bn. Of the 40 million units originally scheduled for the IF in 2023, 19 m have been rechannelled into REPowerEU.
From 2026 onwards, the IF is set to receive additional volumes, as the Carbon Border Adjustment Mechanism (CBAM) will become Europe’s new carbon leakage protection mechanism and trigger a gradual phase-out of free allocation. The EUAs will still be available, but only through auctions. The drop in free allowances will be felt most strongly in the years 2031-2034, but already between 2026 and 2030, some 200 m EUA could be converted from free allocation to IF. The exact size will depend on whether the cross-sectoral correction factor and other adjustment mechanisms come into play.
Recipients: Funding goes via member states’ governments and is dependent on “substantial” co-financing by the operator of the beneficiary installation.
A European Commission overview lists 73 funded projects across Europe. The selected “technology pathways” include seven hydrogen projects, and various others, such as onshore and offshore wind, photovoltaics, biofuels, batteries, CCS, and geothermal.
On 13 July 2023, the European Commission awarded €3.6 billion to 41 large-scale projects in 15 countries. They were selected among 239 applicants for the third call for large-scale projects. They represent four topics: general decarbonisation, industry electrification/hydrogen, clean tech manufacturing, and mid-size pilots. The European Commission highlights that they are particularly relevant for the REPowerEU plan and its aim to phase out imports of Russian fossil fuels.
One major beneficiary going forward will be the so-called Hydrogen Bank, which was launched in early 2023 to support the deployment of low-carbon hydrogen, an energy storage element that will be crucial to the Green Transition. This new investment vehicle will distribute €3 billion to purchase hydrogen. Some €800 m have been set aside for the first auction this year, sourced from the Innovation Fund.
The IF will also support direct air capture with carbon and storage (DACCS) and bioenergy with carbon capture and storage (BECCS).
Looking ahead: In H2 of 2023, some 19 m of the IF volume is diverted to REPowerEU. Again, assuming an average price of around €100/t, another 101 m will follow been now and August 2026, to make up the 120 m REPowerEU volume sourced from IF.
Lawmakers seem intent on replenishing the IF with 27 Mt that would otherwise be cancelled from the Market Stability Reserve, but the details are yet to be decided. More information on this is expected shortly.
Generally, by 31 December every year from 2023, the Commission shall report on the implementation of the IF. It shall list awarded projects by sector and by MS, and show how the elected projects will contribute towards climate neutrality.
Legal base: ETS Directive Article 10a(8). The Commission Delegated Regulation 2019/856 provides more details on operational objectives, forms of support, application procedure, selection criteria, and on administrative procedures such as disbursement, governance, reporting, and monitoring. This delegated act, last amended in July 2021, is now in the process of being updated. On 10 July 2023, the European Commission launched a public consultation. Stakeholders have until 7 August to provide feedback. Assuming the Commission adopts a new version in September, it could come into effect in November, after a two-month scrutiny period.
Whereas the MF and the IF are fundamental elements of the EU ETS framework, anchored in the ETS Directive, REPowerEU is Europe’s response to the energy situation that arose in the wake of Russia’s invasion of Ukraine, most notably the stoppage of piped Russian gas (Moscow’s decision to halt deliveries) and the European sanctions imposed on other types of Russian fossil fuels.
REPowerEU consists of three pillars: First, to save energy (consume less). For gas, a reduction target of 15% was set across the EU. The block achieved that target with some margin, as demand dropped by 18% between August 2022 and March 2023.
Second, to produce more renewable energy – 39% of European electricity came from renewables in 2022. As for new capacity, 41GW of new solar was added over the year and 16GW of new wind capacity.
Third, to diversify supplies of fossils, notably by increasing its piped gas imports from Norway and its LNG imports from other sources.
All three pillars will require massive investments, in upgrading/rerouting energy supply infrastructure, in domestic manufacturing of wind and solar generators, and in energy storage solutions such as batteries and hydrogen.
REPowerEU is not designed to affect the EU ETS but should rather be perceived as an instrument operating on a different level. That said, it will impact the ETS indirectly, both from the diversion/frontloading of IF auction volumes and from the way it will accelerate the transition from fossil-based to renewables-based power generation, a development that will reduce demand for EUAs.
Size/sourcing: The REPowerEU plan envisages the mobilisation of some €300 billion, mainly through the post-Covid Recovery and Resilience Facility (RRF). It will be topped up with €20 billion monetised from the sale of EUAs. Some 60% of that will come from the Innovation Fund (see above), and the remaining 40% from frontloading EUA volumes that were originally scheduled to be sold by member states’ governments in the years 2027-2030.
The exact volume to be sold will depend on how prices develop over the coming years. If we assume an average EUA price of €100/t, 200m will be the required volume.
Recipients: Projects that can improve Europe’s energy autonomy. That can for instance be infrastructure for LNG and for storing gas. Or it can be new renewable capacity, not only by deploying more solar panels and wind turbines but by producing more of them in Europe. This is where REPowerEU overlaps with the Net-Zero Industry Act (see below).
Recent/ongoing changes: The REPowerEU Regulation entered into force on 1 March 2023. It stipulates that the REPowerEU monetisation of €20 billion worth of EUAs will conclude by August 2026.
The new EEX auction calendar for 2023, updated on 21 June, shows how the monetisation will play out between July and December this year. Some 16.2 m EUAs of member states’ volumes will be sold, and another 19.1 m from the Innovation Fund. The first batches were sold on 3 July, some 543,000 EUAs combined from the two sources, raising €47.3 m (equivalent to 0.24% of the targeted amount).
To sell Innovation Fund volumes scheduled for later years will require amending the Auction Regulation, therefore this has not yet started. What the June update of the auction calendar did was to redirect 2023 volumes from IF to REPowerEU, not to frontload volume scheduled for auction in later years. Statements by a senior European Commission official at a conference in early July suggested that more details on the frontloading of IF volumes for REPowerEU will come shortly.
Legal base: Regulation 2023/435 of the European Parliament and of the Council of 27 February 2023
Any comparison between the Inflation Reduction Act on one hand, and Europe’s various initiatives on the other, is unfair at best, and misleading at worst. The two are fundamentally different, especially in terms of how the support is disbursed. The IRA funding is split mainly between tax breaks and loan guarantees, with a smaller share reserved for direct funding of power grid improvement, EV charging points, and hydrogen.
Europe’s EUA-financed cleantech funding falls into two categories. First, the MF and IF operate on a European level, to help phase out fossil power generation and support new clean energy, respectively. This financing flows across the continent, to projects selected after competitive bidding processes. Second, each member state has its own support schemes that are financed to some degree by its share of the EUA auctions, with the rest coming from national taxes or other sources of revenue. With vast differences between the member states’ priorities and capacities, it is difficult to say anything general, but what is clear is that some capitals apply a much wider definition of climate and energy-related measures than what goes for the EU level.
An approach that is possibly more fruitful, is to compare the IRA not to the wide mix of EU and member state initiatives, but to the recently presented Net Zero Industry Act (NZIA), the European Commission’s vision for how to accelerate the transition to a low emission economy while at the same time making sure that European manufacturers are not outcompeted. It is generally seen as a long-awaited response to the IRA.
That draft plan is based on several pillars, such as cutting red tape, enhancing skills, and facilitating market access. As for financing, it does not envisage the use of tax breaks – a cornerstone of the IRA, so again, a comparison is not really fair. Instead, the European Commission suggests using the European Hydrogen Bank and the Net-Zero Europe Platform to help attract private sector investments.
NZIA highlights eight key technologies in which Europe should be leading both in terms of R&D and manufacturing. The list includes renewable generation (solar, wind, and sustainable biogas), energy storage solutions (hydrogen and batteries), as well as heat pumps and carbon capture and storage. The aim is to have domestic industry delivering at least 40% of the clean energy infrastructure deployment needs by 2030. Given China’s dominant position in Greentech manufacturing, especially for solar panels, that is an ambitious target.
The NZIA file is currently being processed by the European Parliament’s industry and energy committee (ITRE). Big changes to the Commission’s proposal should not be ruled out. The rapporteur in charge (Christian Ehler of the centre-right EPP group) wants the programme to tap into the EUA auction revenues to provide proper resources for the NZIA. Most likely, that will mean re-directing money that is currently destined for member states’ governments. If so, that will surely not be a popular proposal among the member states in the Council, where Spain will now be leading the discussions on the file.
Veyt specialises in data, analysis, and insights for all significant low-carbon markets and renewable energy.
