EU to abolish free CO2 emission allowances for companies in 2034

The Council of the EU adopted the reform of the trading scheme for CO2 emissions and passed a law on the establishment of the Social Climate Fund, which is tasked with combating energy poverty during the energy transition. CBAM, the CO2 border tax, will be fully phased in at the start of 2034, when free carbon certificates are eliminated.

After several years of negotiations, the European Parliament passed a legislative package last week for the reform of the European Union’s Emissions Trading System (EU ETS) and the introduction of a carbon dioxide border tax through the new Carbon Border Adjustment Mechanism (CBAM). Each segment was adopted with an overwhelming majority of votes.

The Council of the European Union today adopted all five said laws, formalizing the changes. The new rules increase the overall ambition of emissions reduction by 2030 in the sectors covered by the EU ETS to 62% compared to 2005 levels.

They are part of the Fit-for-55 package. It is a legislative initiative in line with the European Climate Law to cut total net greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels, on the trajectory to achieve climate neutrality in 2050.

CBAM creates CO2 emission border

Within the EU ETS reform, free allowances for companies will be phased out from 2026 until the end of 2033, in parallel to phasing in the Carbon Border Adjustment Mechanism. It is an upcoming system for the taxation of imported iron, steel, cement, aluminum, fertilizers, hydrogen and electricity according to their CO2 content. The mechanism will include indirect emissions under certain conditions.

Importers such as coal plant operators are bracing for the carbon border tax

Importers from third countries such as the Western Balkans and Turkey can avoid the CO2 border tax if their governments roll out equivalent carbon pricing schemes. The funds would need to be directed to national budgets to support decarbonization.

Energy Community contracting parties, which include the Western Balkans, have strict conditions to meet to be exempted from CBAM for electricity until 2030.

ETS 2 to provide funds for mitigating energy poverty

The new law will integrate, into the ETS, the International Civil Aviation Organization’s agreed global market-based Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). The scheme will be extended to maritime transportation as well.

ETS 2 is being created for fuel for road transportation and for buildings. A price on greenhouse gas emissions will be introduced for the sectors in 2027 (or 2028 if energy prices are exceptionally high).

The emissions trading scheme will be extended to transportation and buildings

A share of revenues from ETS 2 will be allocated to the Social Climate Fund. It will be used by member states to finance measures and investments to support vulnerable households, microenterprises and transportation users and help them cope with the price impacts on the buildings, road transportation and additional sectors.

The fund, envisaged as a tool to combat energy poverty, will be funded by revenues mainly from the new emissions trading system up to a maximum amount of EUR 65 billion, to be supplemented by national contributions with 25%. It is established temporarily over the period 2026-2032.

Cutting emissions leaves firms with cashable surplus ETS permits

The emissions trading scheme, based on the ‘polluter pays’ principle, obliges more than 10,000 power plants and factories to hold a permit for each ton of CO2 they emit. The less the greenhouse gas they emit, the less they pay. Companies have to buy them through auctions. Surplus certificates can earn them money in the ETS market.

Low emissions prices discourage companies from investing in green technology

However, some of the allowances are allocated for free, particularly in sectors at risk of having companies move production to other parts of the world with laxer emission constraints. Until recently, the CO2 certificates were very cheap, because demand for them dropped. Having a large surplus in the market in combination with low prices discourages companies from investing in green technology, thereby hampering the scheme’s efficiency in combatting climate change.

To overcome the issue, the EU created the Market Stability Reserve in 2015 to better align the supply and demand of allowances by placing 24% of all ETS allowances in a reserve, from which they can be released in case of a shortage.

European Parliament warns carbon removal is no panacea

In addition, lawmakers adopted a resolution on carbon removal. They warned the EU against relying too heavily on future CO2 removals to become climate neutral and achieve net-negative emissions after 2050.

Parliament took note of the European Commission’s proposal for a regulation on establishing an EU certification framework and its intention to put in place a framework to identify activities that clearly remove carbon from the atmosphere. It stressed that such a new monitoring, reporting and verification (MRV) framework should be used to incentivize carbon removals.

MEPs underlined that agriculture and forestry should play a significant role in the land use sector. Increasing the amount of carbon in the soil also brings multiple benefits, including improved soil quality and fertility, they noted.

The parliamentarians still acknowledged the role of carbon capture and storage (CCS) and carbon capture and use or CCU technologies. They called on the commission to establish a system to trace captured CO2, distinguishing between carbon capture on site and from the atmosphere in order to avoid double counting.

Critics claim that fossil fuel companies and some energy-intensive companies, primarily in the steel and cement sectors, are promoting CCS and carbon utilization potential as an excuse to avoid real decarbonization.