The EU’s Emissions Trading System (ETS) is entering its fourth phase in 2021 that will take it through to 2030 – an important year for the Union’s fight against climate change. 2030 is the year specified in Europe’s Green Deal by which emissions will need to have dropped by 55% from 1990 levels if the EU is to reach carbon neutrality by 2050. The question is, what role will the ETS play in this reduction of greenhouse gases on the continent? Current trends seem to suggest that such emissions trading systems will be crucial, in the EU and internationally, in incentivising decarbonisation and reducing global emissions levels. To understand why this is, let’s begin with what the EU ETS is and who’s involved.
Since its inception in 2005, the world’s first ETS has been the primary market for European companies to buy and sell emissions. Rather than actual gases, companies involved in the system buy and sell European Union allowances (EUA) and earn international credits through investment in emissions-saving projects around the world. At the end of each year, companies that have produced emissions must surrender enough allowances to cover their output, with each EUA corresponding to one tonne of greenhouse gas emitted. Leftover allowances can be sold to other companies or saved for future use, and those found without the adequate number of EUAs to cover their emissions are subject to strict fines.
The trading system is the EU’s primary political instrument for reducing greenhouse gases and, as such, many industries are included. All major producers of heat and electricity are required to be in the ETS and, in total, 11,000 installations and airlines are included, many in energy-intensive industries like cement, steel, oil, glass, chemicals, and fertilisers. Each year, the EU releases free allowances to companies based on previous annual totals minus reduction goals, and then holds auctions for remaining EUAs for companies to bid on, buy and sell. The system appears to have been effective, as emissions from installations covered by the ETS declined by about 35% between 2005 and 2019. By incrementally increasing the scarcity of allowances, the price gradually increases, and the end goal of the ETS will be to drive emissions prices to the point where greener energy becomes more cost effective, and hence incentivised, for businesses and industry.
Despite being in operation for over 15 years, it has taken a while for the EU ETS to get up and running effectively, but in recent years it has really taken off. Prices have been increasing, with the cost of EUAs rising from €8 a tonne in 2018 to almost €40 a tonne in February this year (see graph). This growth has even attracted traders from outside the sector and today EUAs are bought and sold by three primary groups – power and heating utilities, industrial firms and financial firms. With increasing mainstream financial appeal and other international trading systems being developed, the EU’s ETS will be a useful tool in the fight against climate change. For it to keep working effectively and producing climate-friendly returns, policymakers will need to remain vigilant and keep four main considerations in mind.
Firstly, following the loss of the Kyoto Protocol’s international credits mechanism (having been replaced by the Paris Agreement in 2016), it is important for the EU system to be linked to those internationally. In 2020, the EU and Swiss systems were linked effectively, and there are hopes that the EU ETS may soon also be linked to the Chinese system, opened in February 2021, and the UK system which is due to start trading in May 2021. However, international systems will need to be similar in order to be linked together, meaning that both nations’ systems will need to have coherent ideas about emissions caps, relevant industries and sanctions. Dissimilarity in these crucial aspects currently looks to be the greatest obstacle to the EU linking its own system with the nascent Chinese ETS. There have yet to be any talks between the UK and EU regarding a post-Brexit linkage. Finding ways to overcome these differences and create new international mechanisms will likely play an important role in the global effort to reduce greenhouse gas emissions.
Secondly, where it is not possible to create linkages, or where nations do not have their own ETSs, it will be helpful for the EU to implement levies on certain goods from outside the EU to encourage other countries to also decarbonise in line with the Paris Agreement. In February 2021, the Committee on Environment, Public Health, and Food Safety adopted a resolution on an EU carbon border adjustment mechanism, although it is important that this is implemented without being used as grounds for increased protectionism. The European Parliament will vote on this resolution this March, and the Commission is expected to present their proposal in Autumn 2021, so it will be worth keeping an eye on.
Thirdly, for the ETS to be truly effective, it will need to expand its scope, both in targets and relevant industries. In late 2020, officials implemented a more ambitious target of a 55% reduction in emissions by 2030 from 1990 levels, although currently only 45% of the continent’s yearly emissions are covered by the ETS. It seems likely that shipping will be the next to join, but it will also be key to include all international flights, as only those flying between Member States are included in the ETS. Furthermore, if the effects of Covid-19 on office and home working continue into the coming years, it would be beneficial to see companies that run home boilers also included in the system, to account for the greater use of heat and energy in private homes.
Finally, it must be remembered that the emissions trading system is a market as well as a political tool designed to incentivise the move to greener energy. As such, it will need to be monitored closely in order to reduce volatility and protect the industries that are included in the system. The ETS has been volatile in the past, with prices falling around 25% between September and November 2020, and with price surges of nearly 60% between November and February 2021. Whilst the price increase is the goal of the ETS, it is crucial that it does not rise too quickly and squeeze industries making the transition to greener energy too much or it could risk derailing the project. There are estimates that the price of EUAs could reach €80 or €90 by 2030, which should hopefully encourage widespread decarbonisation, thereby reducing global greenhouse gas emissions.
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Recommended citation:
Biggins, E. (2021) Polluting at a Premium: The EU’s emissions trading system, IDRN, 04 March. Available at: https://idrn.eu/environment-and-climate-change/polluting-at-a-premium-the-eus-emissions-trading-system [Accessed dd/mm/yyyy].