European Parliament rubberstamps key carbon market reforms

• Revised ETS raises 2030 carbon reduction target to 62%
• EU CBAM to be phased in from 2026, will impact global trade
• Carbon market overhaul could provide support to EU carbon prices

The European Parliament formally approved reform of the EU’s Emissions Trading System and the introduction of a carbon border tax, both of which will revamp the bloc’s carbon market, and impact global trade.

Some 413 European lawmakers voted for the ETS reform on April 18 while 167 voted against, with 57 abstentions.

Meanwhile, the EU’s Carbon Border Adjustment Mechanism received 487 votes in favor and 81 opposing the carbon tax, with 75 abstentions.

European carbon prices saw modest gains immediately after the Parliament gave the green light to the policies.

EU Allowances for December 2023 rose by around Eur1/mtCO2e ($1/mtCO2e) in morning trading and were trading at Eur94.00/mtCO2e at 1134 GMT, according to ICE. That was up from the previous day’s price of Eur93.04/mtCO2e, as assessed by Platts, part of S&P Global Commodity Insights.

The votes came four months after negotiators agreed to reform the EU’s ETS, increasing carbon cutting ambitions to 2030, detailing the removal of free allowances and confirming the inclusion of maritime shipping and a new ETS II for buildings and transport.

Under the amended ETS, free allowances will be phased out from 2026, just as the CBAM will be phased in.

ETS revisions

Carbon-pricing schemes, such as the EU’s ETS, are considered an effective and economic way to reduce greenhouse gas emissions.

The cap and trade system places a limit on the amount of emissions covered by different sectors, and it includes around 45% of the bloc’s total greenhouse gas emissions. Companies can buy and sell carbon permits known as EU Allowances, which can be traded for each ton of CO2 they emit.

The 10,000 installations covered under the ETS, will need to reduce their carbon emissions by 62% on 2005 levels by 2030, one percentage point more than proposed by the European Commission and a 44% hike on the current target.

The reforms also include a separate ‘EU ETS II’ for road transport and buildings, which will be in place by 2027 — a year later than proposed by the EC.

Analysts at S&P Global expected EUAs to be supported after the passing of the reform, part of EU’s Fit for 55 policy.

“The sum of 2021-2030 EU ETS free allocations are set to fall by around 10%, led by a reduction of nearly 50% from sectors covered by the new CBAM by 2030,” the analysts said in a recent note.

A one-off reduction in EUAs of 90 million mtCO2e in 2024 and 27 million mtCO2e in 2026 would help the EU deliver on the target, in combination with an annual reduction in EUAs of 4.3% from 2024-27 and 4.4% from 2028-30, the same as previously agreed by the EU Council and European Parliament.

Consequences of CBAM

A key feature of the new ETS is the introduction of CBAM, which will oblige companies that import into the EU to pay a tax or tariff to account for the difference between the carbon price paid in the country of production and the price of carbon allowances in the EU Emissions Trading System.

The goods covered by CBAM are iron, steel, cement, aluminum, fertilizers, electricity, hydrogen as well as indirect emissions under certain conditions. This mechanism will be phased in from 2026 until 2034 at the same speed as free allowances in the EU ETS are phased out.

Many in the industry believe the mechanism will push exporter countries to adopt domestic carbon prices, while some might challenge the measure at the WTO on protectionist grounds.

“We may also see a re-orientation and shuffling of global trade — where the lowest emitting countries and producers shift a greater share of their exports to meet EU demand,” analysts at S&P Global said. “Challenges to the legitimacy of CBAM as an environmental tool (and not a trade protectionist tool) through the WTO are possible but unlikely to be successful.”

The EU says the measure will help put a fair price on carbon emitted during production of imported products while pushing European industry to decarbonize without being undercut by other geographies.

The texts of the reforms will be formally endorsed by the European Council, and they will then be published in the EU Official Journal and enter into force 20 days later.

Author Eklavya Gupte, eklavya.gupte@spglobal.com