European Parliament votes to phase out free allowances in emissions trading

The changes come as part of the EU’s “Fit for 55“ programme to reach its legally binding emissions reduction targets. Under the revised scheme, free allowances for the industry will be phased out from 2026 until 2034, and emissions from the maritime sector will be included in the ETS for the first time.

For the aviation sector free allowances will be phased out by 2026 and the use of sustainable aviation fuels (SAF) will be promoted. In addition, a new Emissions Trading System (ETS II) for road transport and buildings will be created.

Dr Valerian von Richthofen, energy law expert at Pinsent Masons, said: "The changes take emissions trading to a new level. With the inclusion of shipping and the revision of aviation, the reforms affect large and important sectors. As part of the ’Fit for 55’ scheme, the changes fit into the context of the ’FuelEU Maritime’ and the ’ReFuelEU Aviation’ initiatives.”

The ETS covers business sectors including energy, energy-intensive industries and aviation, among others. Undertakings that are part of these sectors must hold an EU emission allowance for each tonne of greenhouse gases emitted. Allowances are allocated free of charge for a certain amount of emissions. However, additional allowances must be purchased for emissions that exceed this amount. This is intended to provide an incentive for the undertakings concerned to reduce their greenhouse gas emissions.

The amendments to the ETS adopted yesterday by the Parliament aim to reduce greenhouse gas emissions in the ETS sectors by 62% by 2030 compared to 2005 levels – the year the ETS was introduced. Under the existing ETS, there would only be a 43% reduction. The reformed ETS will help the EU reach its climate goal of reducing greenhouse gas emissions by 55% by 2030, compared to 1990 levels, said the Parliament.

However, Dr Valerian von Richthofen also sees upcoming difficulties for energy and industry undertakings: "A lot is changing for operators of power plants and industrial plants. There will be significantly fewer allowances in the future. The market already anticipated those reforms. This is why prices have already risen. Most recently, EU allowances crossed the €100-mark for the first time. The reduction pressure on plant operators is increasing.”

The new Emissions Trading System (ETS II) covering fuel for road transport (cars) and buildings will be introduced in 2027 or 2028. The exact year of introduction depends on how energy prices develop due to the energy crisis.

The Parliament also adopted a new EU Carbon Border Adjustment Mechanism (CBAM). With the CBAM, the EU wants to impose a “CO₂ levy” on certain imported goods if they come from countries whose climate protection measures do not correspond to the climate protection level in the EU.

Florian Huber, energy law expert at Pinsent Masons, said: "We are seeing a world first here. EU lawmakers propose a CO₂ tax on imports of high-carbon goods. This also targets hydrogen – currently a very hot topic with a view to the large-volume German import plans.”

The CBAM is intended to compensate for competitive disadvantages that EU industry would otherwise face due to the rising costs of emission trading. Ultimately, the new system should also prevent carbon leakage: a term used to describe production shifting from the EU to other countries that do not have emissions trading and therefore enable cheaper production.

The CBAM is to come into force gradually from 2026 to 2034 and will initially only apply to cement, iron, steel, aluminium, fertilisers, electricity, and hydrogen imported into the EU. Indirect emissions will be covered by the CBAM under certain conditions. The CBAM will be introduced at the same speed as the free allowances in the ETS will be phased out.

Negotiators from the Commission, the Parliament and the Council of the EU had already reached a political agreement on the reform of the ETS and the introduction of the CBAM by the end of 2022. The European Commission had presented a corresponding proposal in July 2021 as part of its “Fit for 55“ package.

The new laws will have to be formally endorsed by the Council before they can be published in the Official Journal of the EU. They will enter into force 20 days after their publication.