Posted: 29 April 2022
EU ETS: Where do we stand?
The EU ETS system has undergone many revisions since its introduction and has been divided into phases or trading periods, each distinguished by specific dynamics; both in terms of the number of allowances in circulation as consequently the price of the allowances themselves. A new system shock occurred in 2020 with a significant drop in emissions and allowance prices due to the pandemic-related production shutdown and the UK's final exit from the ETS as a result of Brexit, officially effective from January 1, 2021.
The departure of the UK, the second largest emitter in Europe and one of the largest purchasers of allowances, was handled with a one-year transition period to ensure the market’s adjustment to the lack of demand from the UK. In 2020, precisely, the sharp decline in verified emissions combined with a significant increase in supply due to the UK auctioning its allowances for both 2019 and 2020, meant that supply again exceeded demand. The situation stabilized in 2021, with emissions again rising and the price of permits reaching a record high at the end of the year.
From a more structural point of view, in particular after the 2015 Paris Treaty which replaced the Kyoto Protocol and marked the "new" phase of international climate policy; the ETS, for which an entire article of the treaty was reserved, has rightfully become the pivotal environmental policy for achieving the European Union's climate goals. When, at COP 26 in Glasgow last November, Article 6 of the Paris Agreement was officially adopted, the way was definitely opened to greater international climate cooperation through market-based mechanisms.
The ETS, which since 2021 has entered the fourth trading phase which will last until 2030, must also maintain alignment with the evolution of the European climate policy. As part of the Green Deal, the major reform project with the goal of achieving the Union's climate neutrality by 2050, in July 2021 the Commission announced the interim target of a net reduction of at least 55% in greenhouse gas emissions by 2030, the so-called "Fit for 55" package.
As part of this scheme the European Commission has proposed to further strengthen the Market Stability Reserve during the fourth phase of the ETS, doubling the rate at which allowances are taken from the market from 2,1% to 4,2%. This allows for a faster reduction of the historical surplus and even allows for a shortage of allowances in the market. In April, EU lawmakers voted overwhelmingly to support this Commission proposal. Another important development is also the agreement reached by the Council in mid-March on the Carbon Border Adjustment Mechanism (CBAM) regulation, which is the other key element of the EU's "Fit for 55" package.
The main objective of this environmental measure is to prevent efforts to reduce emissions in Europe from being offset by an increase in emissions outside the territory of the Union, a situation defined as "carbon leakage". This would happen due to the relocation of production to countries where environmental policies are less ambitious or due to increased imports of carbon-intensive products. In 2021, therefore, came the proposal to introduce a mechanism of "border adjustment" of carbon emissions on selected imports through the gradual replacement of free allocation of allowances, a tool currently used to mitigate the risk of "carbon leakage". This has been envisaged in sectors such as cement, aluminium, fertilizer, power generation, iron and steel, and is intended to encourage countries to work together to establish carbon pricing policies.
Also on the Commission's table is the future entry of the maritime sector into the ETS, to cover emissions from large ships. The Commission has presented a document with the stages of this expansion, the main opportunities, the challenges as well as the need for further action in the framework of the International Maritime Organization. In contrast, there remains much scepticism and division over the extension of the ETS to the construction and transportation sectors.