Proposal is sent back to the drawing board, with policy experts arguing “no deal is better than a bad deal”.
The EU Parliament’s failure to back EU carbon market reforms has increased the prospect of a watered-down scheme that weakens the European Commission’s Fit for 55 (Ff55) strategy, according to policy experts.
Last week, MEPs voted against a proposal to increase the ambition of the EU Emissions Trading System (ETS) to a 63% reduction in CO2 emissions from covered industries by 2030 (compared to 2005 levels), removing 70 million carbon credits from the market in 2024 and 50 million in 2026. The proposal also included an outline for ETS2, which will extend carbon pricing from road transport and buildings.
It was brought down both by MEPs who said ETS-covered companies were being pushed too hard given energy security concerns, and those who said it failed to align with a 1.5°C pathway.
With 340 votes against and 265 in favour, the proposal – drafted by Peter Liese, an MEP from the centre-right European People’s Party (EPP) – was sent back to the drawing board.
Anders Nordeng, Senior Analyst of Carbon Research at research and data provider Refinitiv, told ESG Investor that, in trying to reach a compromise, “[Liese] seems to have upset everyone”.
“He could easily have brokered a solid majority, but that would have meant accepting an earlier end to free allowances,” Nordeng added.
First introduced in 2005, the ETS works by setting a cap on the amount of CO2 emissions that can be released by EU-listed companies in certain carbon-intensive sectors through a limited number of credits – their ‘free allowance’. Any additional allowances must be purchased.
If the number of free allowances decreases over time, companies will have to pay more to cover their emissions, which incentivises them to instead transition to low-carbon alternatives. Further, the scheme provides investors with information on the cost of CO2 emissions from investee firms in their equity portfolios.
“The ETS is the most effective and efficient regime towards achieving the Ff55’s emission reduction objective, because it controls total emissions volumes and leads to carbon reduction where it is cheapest to reduce emissions,” said Bernhard Bartels, Executive Director of ESG Analysis at data provider Scope Group.
The Ff55 strategy aims to reduce European emissions by 55% by 2030 compared to 1990 levels by amending regulations such as the Land Use, Forestry and Agriculture regulation, Renewable Energy Directive and Energy Efficiency Directive.
“The ETS is a very valuable concept and instrument. We just have to make it bite,” Bartels said.
Due to the outcome of the ETS vote, further votes to introduce the Carbon Border Adjustment Mechanism (CBAM) regulation and the Social Climate Fund have been postponed until the ETS reform debate is settled.
A parliamentary committee will present its amended ETS proposal for another plenary vote by 23 June, ahead of the European Council finalising its own position by the end of the month. If there are no major delays, trilogue discussions will take place later this year to adopt the reform.
Wrong direction
Climate activist NGOs including the World Wide Fund for Nature (WWF) were disappointed with the outcome, emphasising the ETS’ role in realising the Commission’s 55% emissions reduction by 2030 target.
“But no deal is better than a bad deal,” said Camille Maury, Policy Officer at the WWF European Policy Office.
“The reform proposal wasn’t going in the right direction on some of the key amendments – the ETS’ degree of ambition and the phasing out of free allocations.”
The European Parliament’s Committee on Environment, Public Health and Food Safety (ENVI) originally proposed a 68% emissions reduction target compared to 2005 levels by 2030 – higher than the 63% voted on in Parliament and 61% proposed under Ff55.
WWF has called on the committee to now strengthen the proposal ahead of the next vote, increasing the emissions reduction target to 70%.
In terms of free allowances, ENVI again proved to be more ambitious than the Commission, initially proposing phase-out by 2030 instead of 2035.
Last week’s compromise proposal, with its staggered removals, would have resulted in more emissions in the short-term, noted Samar Pratt, President of Advisory Solutions at Exiger, a provider of risk management SaaS solutions to corporations, government agencies and banks.
“It therefore crossed a red line for left-wing MEPs,” she said.
WWF says MEPs should adopt ENVI’s recommended introduction of “strong conditionalities”, such as stipulating that companies must demonstrate plans to achieve climate neutrality and energy efficiency in order to obtain any free allowances.
New compromise
Recent price volatility on the EU ETS likely influenced some MEPs’ decision to call for a slower phasing out of free carbon credits, experts told ESG Investor.
The EU ETS carbon price spiked by 137% over a 12-month period, according to a recent report by investment bank Jefferies. In February, EU diplomats debated measures to attempt to curb ETS prices, which reached €98 per tonne of CO2 earlier that month.
“[MEPs] are being lobbied daily by national industries telling them that an early end to free allowances will mean an end of industry,” Refinitiv’s Nordeng said. “My best guess is that we could see a new compromise proposal for ending free allowances by 2033.”
The ENVI Committee’s rejected proposal also outlined plans to extend the ETS to include maritime transport, covering 100% of emissions from intra-European routes as of 2024 and 50% of emissions from extra-European routes to and from the EU as of 2024 until the end of 2026.
However, new documentation suggests the inclusion of maritime transport may be delayed until 2027.
Knock-on impacts
Until the ETS reform passes through Parliament, discussions around the introduction of CBAM and ETS2 will be put on hold, delaying the extension of carbon pricing.
CBAM was first proposed as part of the Ff55 last year, and aims to ensure importers of certain carbon-intensive goods into the EU are required to pay for their pollution, by purchasing carbon credits priced according to the EU ETS market. This will prevent ’carbon leakage’, where companies offset their emissions by importing carbon-intensive products that have been manufactured in non-EU countries not subject to emissions-related costs.
The Commission proposed that CBAM should be phased in over a seven-year period, starting from 2023, and cover aluminium, iron, steel, electricity, cement and fertilisers. It estimated that CBAM will generate at least €1 billion a year in revenue between 2026-30.
In March, the EU Council reached an agreement on CBAM, opting to centralise its governance structure, but leaving open details about alignment with the EU ETS.
“CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS, thus ensuring that importers are treated in an even-handed way compared to EU producers,” the Commission noted in the CBAM Q&A document.
This means that CBAM will apply to an increasing proportion of emissions as the ETS phases out free allowances.
“Effective policy will be ensured through a combination of both the ETS and the introduction of CBAM – they therefore need to be considered at the same time,” said Bartels.
Social aspect
As well as raising the ambition of the existing ETS, the Commission proposed introducing a separate system – ETS2 – that would cover an additional 41% of the EU’s emissions produced by road transport and buildings.
ETS2 will require covered companies to increasingly purchase carbon credits for their emissions from 2026.
“Ultimately, when the ETS is extended to cover these industries, households will have to pay for each unit of CO2 that relates to their activity. It remains to be decided how exactly this will be put into practice – there’s a social aspect to consider as lawmakers need to protect the socially vulnerable against rising energy bills,” said Bartels.
Any revenues produced from these permit sales will be channelled into the proposed Social Climate Fund, which would then allocate capital back to member states to contribute to their efforts to address challenges for low-income families.
However, the ENVI Committee revised the ETS2 proposal so that it would initially only apply to commercial vehicles and buildings from 2029. The committee noted that it should only be extended to private usage through a new legislative procedure proposed by the Commission. Further, the committee said the price of emission permits would be capped at €50 per tonne of CO2 until at least 2030, which experts have argued undermines the overall goal of ETS2.
