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European Green Deal: EU working with global partners to develop international carbon markets

What the EU’s 2050 net zero target could mean for the ETS and global carbon prices

The EU confirmed yesterday that it is working with global partners to develop international carbon markets in what it called “key tool to create economic incentives for climate action”. 

The news came alongside a slew of climate-related policy aspirations under new Commission President Ursula von der Leyen’s European Green Deal banner, which has designs on getting the block to carbon neutrality by 2050.

Beefing up the ETS in the context of a lack of global ambition could harm the competitiveness of EU industry, and scupper any progress made towards upholding the Paris Agreement goals

The EU Emissions Trading System (ETS) was the cornerstone of the Commission’s greenhouse gas reduction strategy back in 2005 – and with a newly ramped up gameplan, the world’s biggest carbon market will again be a tool in meeting its targets.

But the nod towards the importance of international carbon prices – inconspicuously included on page 20 of the document – is a reminder that beefing up the EU mechanism in the context of a lack of global ambition could harm the competitiveness of EU industry, and scupper any progress made towards upholding the Paris Agreement goals. 

Earlier this week, a “meaningful” price on carbon was one of a series of demands from a group of global institutional investors. There are still some uncertainties as to how exactly the ETS could be strengthened. 

It’s not yet confirmed, for example, how much of the new 2030 emissions reductions target (which currently stands at 43% compared to 2005 levels, but will be hiked to 50-55% compared with 1990 levels) the EU ETS will be responsible for delivering, and how much will be left to other measures. But the cap will need to be revised in line with the 2030 target to ensure a smooth emissions reduction trajectory. 

The EU said the role of the Innovation and Modernisation Funds, which are funded by proceeds from ETS auctions, will also be reviewed, with the aim being to strengthen their effectiveness in supporting climate-related innovation.

The Innovation Fund, for example, will help support breakthrough technologies in key industrial sectors by 2030, according to the document. It also said the Commission would consider using additional revenues from allowances towards strengthening the financing of the Just Transition.

The Commission also said it would propose extending the ETS to incorporate the maritime sector and assess the possibility of including road transport emissions in the ETS. Both moves will likely throw up technical and political complications that will take a lot of thrashing out. 

Measuring emissions for road transport will be much more difficult than the sectors currently covered by the ETS, which tend to consist of large-scale installations that are relatively easy to measure in a top-down manner, such as oil refineries, power and heat generation, and aluminium production.

Road transport is already regulated by the Effort Sharing Decision (ESD) and by emissions standards for vehicles, so there would have to be a discussion about how to reconcile existing legislation with the ETS, for example looking at whether the regulatory framework could be brought into the ETS. 

The Commission has said it will propose a carbon border adjustment mechanism for selected sectors to protect industry, “should differences in levels of ambition worldwide persist as the EU increases its climate ambition”

Bringing the maritime sector in looks to be politically complex, with some close to the matter fearing it could give rise to the kind of global rows sparked by aviation’s entry into the ETS. 

The Commission initially applied the ETS to all airlines departing from or arriving at an EU airport, but had to backtrack after outcry and the threat of trade war from international carriers. It has since limited application to airlines operating flights between EU airports only, known as “stop-the-clock”. 

The Commission also said it would launch work on the possibility of including emissions from buildings in European emissions trading, as part of broader efforts “to ensure that the relative prices of different energy sources provide the right signals for energy efficiency”.

Aviation under the ETS, too, looks likely to be reviewed under the new Commission, which said it would propose reducing the free allowances allocated to airlines in coordination with the International Civil Aviation Organisation. 

The aviation sector is a case in point as to why the go-to measure taken against carbon leakage so far – compensating domestic producers with free allocation provisions rather than imposing prices on imports – arguably needs a rethink. More than 80% of allowances in the aviation sector are granted for free to airlines, and a severe overallocation of allowances until recently has given airlines effectively unlimited access to cheap auctioned permits.

In response to such issues, the communication says that by 2021 the Commission will propose a carbon border adjustment mechanism for selected sectors to protect industry, “should differences in levels of ambition worldwide persist as the EU increases its climate ambition”. 

This, according to the document, would “ensure that the price of imports reflect more accurately their carbon content”.

This appears to be a change in tack to the approach taken so far. But border tax adjustments are not a new suggestion – the idea has been around since at least as early as 2007 – and have to date proved technically and politically difficult to implement.

For example, while the Commission’s communication says the measure will be designed to comply with World Trade Organization rules and other international obligations of the EU, some close to the matter are not so optimistic and maintain that there’s no obvious way of such tariffs co-existing with WTO rules.