Last updated: June 28th 2024

EU emissions trading system (EU ETS)

The EU emissions trading system (EU ETS) is one of the EU’s key policy tools for reducing greenhouse gas emissions in the single market. It applies to all EU countries plus Iceland, Liechtenstein and Norway and until now covered energy intensive installations (power stations & industrial plants) and airlines operating between these countries. In terms of emissions of CO2 (emissions of perfluorocarbons and nitrous oxide, among others, are also covered by the ETS), the system already covered the following sectors:

  1. power and heat generation;
  2. energy-intensive industry sectors including oil refineries, steel works and production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids and bulk organic chemicals, and from now on with the inclusion of hydrogen producers above a 5 tonne/day threshold, and 
  3. commercial aviation.

Under the Fit for 55 regulatory package, the ETS has been revised to accommodate the EU’s ambition towards decarbonisation. With the revision, the list of covered sectors is extended to the maritime sector, with a gradual phase-in for large vessels (above 5000 gross tonnage) and pending a review, later on for smaller vessels too (between 400-5000 gross tonnage). In addition, a separate ETS is set up for buildings and road transport (ETS II), which will come into effect in 2025.

The system is a cap-and-trade system, where a cap is set on the total amount of CO2 that can be emitted by installations covered by the ETS. Within the cap, companies receive for free or buy emission allowances which they can trade with one another as needed. The cap is reduced over time, following a linear reduction factor (LRF). The revised ETS means that in expanding the ETS’s previous ambition of 43% emission reduction until 2030 (compared to 2005 levels), the revised ETS will aim to achieve a 62% reduction by 2030. This also necessitated raising the LRF from 2.2% to 4.3-4.4%.

The ETS is a powerful tool to incentivise the decarbonisation of critical sectors from heavy industries through maritime transport to road mobility. It is therefore a key element in the development of a policy framework that enables the ramp-up of a clean hydrogen industry. The ETS is also the main revenue source for the Innovation Fund, which is an essential building block and key funding tool in the European clean hydrogen industry.

On top of that, the extension of the ETS to more applications and the raised ambition, the Carbon Border Adjustment Mechanism (CBAM) introduced a carbon pricing system parallel to the ETS for imported products. The scheme, initially covering a limited set of sectors (including hydrogen), will arrange for the progressive phasing out of free allowances for those sectors. (See separate section covering the CBAM).

 

What's in it for hydrogen?

The scope of the EU ETS covers many of the GHG-emitting economic activities where hydrogen can act as a clean energy carrier substitute in a cost-effective and purpose-fit manner. With the revision of the system, it is expected that the impact for hydrogen could be even bigger, since the amount of allowances will progressively be reduced, raising their price and incentivising decarbonisation efforts. Furthermore, the revised ETS now includes the coverage of all hydrogen production methods exceeding 5 tonnes per day, including electrolysis, making renewable and low-carbon hydrogen facilities eligible for free allowances.

The allocation of free allowances is based on sector specific benchmarks, which are updated regularly. The Commission, working together with an Expert Group is currently finishing the readjustment of these benchmarks and adapt technical criteria to enable clean hydrogen production facilities to get rewarded for their decarbonisation efforts. 

As mentioned above, the revised ETS Directive set up another, distinct emissions trading system (coined ‘ETS II’), running in parallel to the existing ETS (‘ETS I’). The ETS II will cover the emissions of the road transport sector, together with those of buildings. A new separate, self-standing cap-and-trade scheme is designed to avoid price spikes through emergency mechanisms.

The ETS II will place obligations on the fuel suppliers, not on the final consumers of the fuels. Surrendering of the allowances will come into effect in 2027, with monitoring, verification and reporting obligations starting in 2025. The linear reduction factor (LRF) of the ETS II is also different to that of the ETS I, settling on a higher 5.1% to 5.38% by 2028. To alleviate pressure on certain regions caused by the introduction of the ETS II scheme, a Social Climate Fund of €86,7 billion will be set up. 

The inclusion of the maritime sector under the ETS will also bring about substantial changes in the industry. Starting in 2024, shipping companies will surrender allowances for 40% of their verified emissions for large, 5000+ tonne vessels, rising to 70% in 2025 and 100% in 2026. In addition, non-CO2 emissions (methane and nitrous oxide) will also come under the ETS scope in 2026 in these sectors. The Commission will in 2026 evaluate the inclusion of smaller, 400-5000 tonne vessels under the ETS’s allowance surrendering scheme. This ambitious inclusion of the maritime sector under the ETS will give a substantial incentive to shipping companies to invest in alternative fuels, such as hydrogen or ammonia. 

Intra-EU flights have been included in the ETS since 2012. Aviation under the ETS is governed by a different type of emission allowance than that of the rest of ETS-covered sectors, using EU Aviation Allowances (EUAA). As part of the revision of the EU ETS Directive regarding aviation, there has been a consolidation of the total quantity of aviation allowances at current levels and application of an LRF; increased auctioning of allowances; application of the CORSIA system to extra-European flights and measures to ensure equal treatment of airlines.

In addition, the revised Emission Trading System puts monitoring, verification and reporting obligations on municipal waste incineration plants from 2024 onwards. After the Commission evaluates the sector by 2026, it may choose to put allowance surrendering obligations on this sector too.

 

Links to the original document and additional information:
Directive (EU) 2023/959 of the European Parliament and of the Council of 10 May 2023 amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union and Decision (EU)  015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading system