European environment ministers approve carbon market reform

European environment ministers have agreed on the reform of the European carbon market and the gradual abolition of free allowances. They validate the creation of a carbon border tax and a social fund for the climate.

It was around two o’clock in the morning on Wednesday 29 June in Luxembourg when European environment ministers reached agreement on the five texts of the “Fit-for-55” climate package, which aims to reduce greenhouse gas emissions in the European Union by 55% by 2030. After the European Parliament, on June 22, ministers voted to reform the European carbon market (known as ETS, for Emissions Trading System).

The States have agreed on the gradual abolition, between 2026 and 2035, of free emission quotas, granted to manufacturers in the ETS sectors covered by the carbon border adjustment mechanism (CBAM or MACF).

Abolition of free emission quotas and carbon tax at borders

Indeed, the gradual end of the allocation of allowances free of charge will be accompanied by the establishment of the MACF. As proposed by the European Commission and confirmed by the Council of the EU, the carbon border tax would apply from 1 January 2023, with a transition period until the end of 2025, when importers of goods should only report the carbon emissions of imported products. From 2026, they would be required to buy carbon certificates from national authorities, the price of which would be indexed to that of CO2 in the European market. During the period 2023 to 2025, the MACF would therefore operate solely as a reporting obligation and would be phased in from 2026, over a period of ten years, until 2035.

However, the environment ministers are proposing a more gradual rate of elimination of free allowances than that recommended by the Commission (from 2025 to 2035) and less rapid than that proposed by MEPs (from 2027 to 2032). “The Council agreed to a slower reduction at the beginning and an accelerated rate of reduction at the end of this ten-year period [between 2026 and 2035]. Support for the decarbonization of these sectors will be possible, via the Innovation Fund. The Council also asked the Commission to monitor the impact of the MACF, including with regard to export carbon leakage, and to assess whether additional measures are necessary. in a press release.

The ministers endorsed the sectors concerned by the carbon border tax proposed by the Commission: iron and steel, cement, fertilisers, aluminum and electricity production. Parliament wants to extend the scope of the tax so that it also applies to organic chemicals, plastics, hydrogen and ammonia.

ETS applied to intra-European air flights

In addition, the free quotas allocated to airlines would be phased out by 2027, the ministers added (against 2025 proposed by MEPs). States would also like to apply the Carbon Offsetting and Reduction Scheme for International Aviation (Corsia) established by the International Civil Aviation Organization (ICAO) to commercial flights. Thus, the ETS would apply to intra-European flights (including the UK and Switzerland), while the Corsia would apply to EU operators for extra-European flights to and from the third countries participating in Corsia. The ministers also want to “reserve 20 million of the free allowances being phased out to offset the additional costs associated with the use of sustainable aviation fuels (SAF)”. Parliament came out in favor of the ETS being applied to all flights departing from an airport located in the European Economic Area (EEA).

New ETS for building and transport

Ministers also approved the creation of a new emissions trading system (ETS-II) for buildings and the distribution of fuel for road transport. They decided that “the start of the obligations to auction and return allowances will be delayed by one year compared to the Commission’s proposal: auctioning of allowances from 2027 and their return from of 2028”. In addition, the building and road transport sectors will be covered both by the new ETS and by the regulation relating to the sharing of the climate effort between the Member States.

For their part, MEPs support the implementation of the new ETS in 2024, in particular targeting tertiary buildings first. And according to them, residential buildings and private transport should not be included in the new system until 2029.

The ministers also reached an agreement to include maritime transport emissions in the scope of the ETS, but with “transitional” measures for serving small islands, winter navigation and journeys under public service obligation. They approve the Commission’s proposal on the gradual introduction of obligations imposed on shipping companies to surrender quotas. And they want to “redistribute 3.5% of the cap on auctioned allowances to Member States heavily dependent on maritime transport”. Parliament, for its part, wants to extend the ETS to maritime transport from 2024.

In addition, the Council maintains the general ambition of reducing emissions in the sectors included in the ETS by 61% by 2030 compared to 2005, as proposed by the Commission (against 63% voted by MEPs).

Social Climate Fund

The Council of the EU also agreed on the creation of a Social Fund for the climate, endowed with 59 billion euros. Each Member State would submit to the Commission a “social plan for the climate”, containing measures and investments to deal with the impact “on vulnerable groups” of carbon pricing for the buildings and road transport sectors, says the Council. The fund would help Member States to “finance the measures and investments defined in their plans, to increase the energy efficiency of buildings, the renovation of buildings, the decarbonisation of heating and cooling in buildings and the adoption of zero- and low-emission mobility and transport, including measures providing direct income support, on a temporary and limited basis”.

The fund would be set up during the period 2027 to 2032, coinciding with the entry into force of the ETS for the building and road transport sectors, with retroactive eligibility of expenditure to January 1, 2026, underlines the Council.

For their part, the MEPs are proposing to top up this fund via the income from the auctioning of 150 million allowances within the framework of the ETS as well as 25% of the expected income linked to the inclusion of road transport and buildings in the ETS. They also provide for a higher envelope for the fund estimated at 72 billion by 2032.

The European Parliament is therefore more ambitious than the Member States on these texts, and the negotiations promise to be difficult to reach an agreement.

Regulation on the sharing of the effort to reduce emissions

The Council of the EU has agreed on an EU-wide greenhouse gas (GHG) emissions reduction target increased to 40% compared to 2005 for sectors not covered by the ETS, namely national shipping, agriculture, waste and small industries. Environment ministers also kept the national emission reduction targets for 2030 set for each member state, as proposed by the Commission in its July 2021 draft regulation on effort sharing. France, for example, must aim for a 47.5% reduction in its GHG emissions.

Furthermore, the Council plans to increase the level of annual emission quotas that can be transferred between Member States to 10% for the years 2021 to 2025 and to 20% for the years 2026 to 2030. nine Member States could use a limited amount of ETS allowances to offset their emissions in the sectors falling under effort sharing from 2021 to 2030.