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ESG Matters: Extending and strengthening the Emissions Trading System (EU ETS)

Update
05.02.2024
In this month’s ESG Matters, we take a special look at the EU Emissions Trading System, which is undergoing a major overhaul in the coming years. Our spotlight keeps you up to date with January’s key developments in ESG governance, disclosure and litigation.

Highlight:

  • EU ETS and shipping, aviation, road transport and real estate

    In May 2021, the EU adopted a binding greenhouse gas emission reduction target of 55% by 2030, compared to 1990 levels. One of the EU's main instruments to achieve this target is the European Emissions Trading System (EU ETS). The EU ETS is a 'cap-and-trade-system': EU emissions are capped by issuing a limited number of allowances to emit for sectors covered by the system and allowances can be traded. The EU ETS has been in place since 2005 and is undergoing a major overhaul per 2024.

    The main changes are the following. From 2024, the maritime sector is covered by the EU ETS and from 2026, the aviation sector will no longer receive free emission allowances. Other EU ETS sectors also face the phasing out of free allowances. At the same time, the European industry will be protected by the introduction of the Carbon Border Adjustment Mechanism (CBAM), which requires importers of CBAM goods – such as steel, electricity and hydrogen – to pay a carbon price. In addition, the Social Climate Fund will start in 2026. From 2027, a new EU ETS will cover the emissions from fuel combustion in buildings, road transport and other sectors.

    Shipping sector
    Maritime transport is subject to the EU ETS from 1 January 2024, and will be required to comply with emission monitoring and reporting obligations and to surrender emission allowances for a part of their emissions. The obligation to cover emissions of large ships will be phased in gradually: 40% of emissions will have to be covered by emission allowances in 2024, 70% in 2025, and all emissions from 2026 onwards. In practice, we see that shipping companies are in the process of opening Maritime Operator Holding Accounts in the EU ETS Registry and are preparing for the new reporting requirements.

    Aviation sector
    The aviation sector is also facing stricter rules. The free allocation of emission allowances will be phased out over the next few years. From 2026, the sector will no longer receive free allowances and all allowances will be auctioned. Under the European ReFuelEU regulation, aviation fuel suppliers will also have to blend increasing amounts of sustainable aviation fuels (SAF): a minimum of 2% by 2025, 6% by 2030 and 70% by 2050. To ensure the production and long-term availability of SAF, the sector will increasingly need to enter into agreements with other market players and sectors in the coming years.

    Further strengthening of EU ETS
    In addition, all existing EU ETS sectors will face an accelerated reduction in the total number of emission allowances to be issued under the EU ETS (the cap). The percentage by which this number is reduced will be increased from 2.2% to 4.3% from 2024 and to 4.4% from 2028. There will also be one-time cap reductions, of 90 million allowances in 2024 and 27 million in 2027. Free allocation of emission allowances will also be phased out from 2026, resulting in no free allocation in any sector from 2034.

    Carbon Border Adjustment Mechanism
    The phasing out of free allowances is expected to have a negative impact on the competitive position of European companies. The Carbon Border Adjustment Mechanism aims to protect the level playing field for European companies covered by the EU ETS. From October 2023, importers of CBAM goods such as iron, steel, cement, electricity and hydrogen have to report the amount of greenhouse gases emitted during the production of these goods (outside the EU). From 2026, importers will actually have to pay a price for these emissions. They will have to buy CBAM certificates through a central IT platform that is being developed by the European Commission. The price of a CBAM certificate will be based on the average auction price of allowances under the EU ETS. This will align the carbon price adjustment for CBAM imports with the ETS price as much as possible.

    EU ETS 2: fuel in the built environment, road transport and other sectors
    A new emissions trading system, called EU ETS 2, will cover fuel use in the built environment, transport and other sectors not covered by the EU ETS. The obligation to monitor emissions and pay the CO2 price will apply to fuel suppliers (upstream) rather than end users (downstream). As the EU ETS 2 will take full effect from 2028, fuel suppliers need to take preparatory steps now. Fuel suppliers must have an emissions permit before 1 January 2025 and have to apply for a permit from the Dutch Emissions Authority (NEa) in the second half of 2024. Fuel suppliers should start preparing the permit application and the associated monitoring plan in the coming months.

    Social Climate Fund
    In addition, a social climate fund will be set up to help vulnerable households, small businesses and transport users most affected by energy and transport poverty. Measures that could be financed by the fund include reducing energy taxes and charges, promoting the renovation of buildings, or developing a second-hand market for electric vehicles. The fund will be launched in 2026, one year before EU ETS 2 enters into force. It will be co-financed by the auctioning of allowances from the EU ETS 2.

    What does it mean for you?

    • Shipping. The shipping sector is subject to the EU ETS from 1 January 2024. Market participants are currently in the process of opening Maritime Operator Holding Accounts in the EU ETS Registry and will have to comply with all monitoring and reporting requirements for the first time in the coming year.
    • Aviation. The aviation sector will face the phasing out of free emission allowances in the coming years and will therefore experience higher costs for buying emission allowances. The future blending obligation is a reason to think about the production and procurement of sustainable aviation fuel.
    • CBAM. Importers of CBAM goods such as iron, steel, cement, electricity and hydrogen have been subject to specific reporting requirements since October 2023 and will have to buy CBAM certificates from 2026 to place the goods on the European market.
    • Built environment and road transport: EU ETS 2. Fuel suppliers to these sectors must have an emissions permit by 1 January 2025 and will have to submit their permit application to the NEa in the second half of 2024. Fuel suppliers should therefore start preparing their permit application and the corresponding monitoring plan in the coming months.

    Spotlight on ESG developments:

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