Following two days of lengthy, late-night negotiations, lawmakers have agreed to a provisional agreement on the entirety of the EU ETS revision. The sweeping legislation tackles a laundry list of policy dimensions designed to strengthen and expand the European carbon market and reinforce commitment to reaching ambitious abatement goals.
Overview of provisional agreement
Ambition
Ambition for the ETS is split into three elements: reduction target, rebasing of the cap, and the linear reduction factor. The provisional agreement found compromise between Parliament’s more ambitious goals and the common Commission and Council positions. The overall abatement target for ETS covered sectors was raised to 62% from 43% as compared to 2005 levels. To achieve this, the cap will be rebased by 90 million EUAs in 2024 and 27 million EUAs in 2026. The linear reduction factor will be increased to 4.3% in 2024 and again to 4.4% in 2028.
Market stability reserve
Structural changes to the MSR were largely expected. Rather than reverting back to 12% in 2024, the intake rate will remain at 24% moving forward. Thresholds will remain the same at 833 million and 400 million EUAs in circulation, however a buffer will be implemented between 833 million and 1096 million EUAs. If TNAC falls between these levels, the intake rate will be decreased. This moves supply closer to the 833 threshold in order to avoid drastic cuts to supply. Additionally, reserve volumes over 400 million EUAs will be cancelled.
Article 29a
The price control mechanism detailed in Article 29a will be updated in this agreement. The trigger for release of allowances has been lowered to 2.4x the 2-year average price over a 6-month period. Rather than undergoing review by the Commission as was the previous rule, an automatic 75 million EUAs will be released from the MSR over a 6-month period. Read more on this agreement here.
CBAM
The carbon border adjustment mechanism will begin to enter into force from 2026. Coverage of sectors includes cement, iron & steel, fertilizers, aluminum, electricity, hydrogen, and some downstream products. Both direct and indirect emissions will also be included in consideration of imported products’ embedded emissions. Indirect emission inclusion will likely raise questions on compatibility with WTO rules.
One of the more contentious elements was the timeline for phasing out free allocation in favor of CBAM. The timeline was finalized over the weekend:
For more on CBAMs, see our analysis here.
Waste
Waste incineration will be included in the EU ETS beginning in 2028. This will be preceded by an MRV period beginning in 2024 and a Commission assessment of sectoral inclusion in 2026. Derogations to coverage may be allowed up to 2030.
Maritime
Shipping will be included in the EU ETS from 2024, increasing the cap by roughly 90 million tons. Coverage includes ships over 5000 gross tons, all intra-EU voyages, and 50% of the emissions from shipping between EEA ports and those in third countries. Maritime emissions will gradually be phased in between 2024 and 2026. In 2024, 40% of emissions will be required to surrender of EUAs. In 2025 and 2026 this compliance obligation will increase to 70% and 100% respectively.
See our analysis here.
Aviation
Full aviation coverage will roll out in parallel to the maritime sector with free allocation to operators decreasing by 25% in 2024, 50% in 2025, and 100% by 2026. Decarbonisation in the sector will be supported by 20 million EUAs earmarked for sustainable aviation fuels (SAF) and 5 million EUAs (in the Innovation Fund) set to support electrification of the sector. CORSIA will be reviewed by the European Commission to assess adequacy in abatement goals, after which extra-EEA flights may be included under the ETS. In 2026, the Commission will also issue a report on the inclusion of non-CO2 emissions from aviation. By 2028, these are expected to be included under the scheme.
Use of revenues
The Innovation Fund will be bolstered under the provisional agreement, increasing from 450 million to 575 million allowances.
The Modernisation Fund will also see support increased by 2.5%. Recipients for the fund are set to expand to member states with GDP per capita below 75% of the EU average.
The agreement establishes a Social Climate Fund (SCF), designed to protect vulnerable populations from the impacts of the newly established ETS II for road transport and buildings.
Finally, member states will now be required to use 100% of the revenues generated from sales of EUAs towards climate related activities.
ETS II
The ETS II will establish a carbon market covering road transport and buildings. This was one of the stickiest points during the trilogue negotiations, as the impact will fall directly on private citizens. The start date for the new scheme will be 2027 with the possibility for postponement to 2028 in the event that energy prices rise excessively. Covered activities will receive some protection through a price control mechanism that will release 20 million allowances to the market if prices rise above EUR 45/t. The system will be parallel but separate to the original ETS.
Below, find a timeline for the impending implementation of the latest rule changes.
Market Impact:
The market has already begun to react to the news of the EU ETS revision, reversing a bearish trend. While most of the changes to the keystone climate legislation were expected and likely priced into the market, the energy crisis introduced uncertainty as to whether the projected climate ambition could be maintained from a practical and a political perspective. The provisional agreement, expected to pass final voting in the Council and Parliament, allayed that policy uncertainty. Raising ETS abatement targets, increasing the LRF, and rebasing all will serve to tighten the market balance. Free allocation phase-out (albeit slower than originally envisaged) will further expose industry to a carbon price and will likely shift hedging behavior. The expansion to and phase out of free allocation in maritime, aviation, and waste expands the market, drawing in more compliance actors and increasing demand for EUAs. The additional support for decarbonization of industry, shipping, and aviation may counter the bullish impact of increased ambition in the longer term.
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