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'Fit for 55': Council and Parliament reach provisional deal on EU emissions trading system and the Social Climate Fund

The Council and the European Parliament reached a provisional political agreement on important legislative proposals of the ‘Fit for 55’ package that will further reduce emissions and address their social impacts. The deal is provisional pending formal adoption in both institutions.

Marian Jurečka Czech minister for environment yesterday said:

The agreement on the EU Emissions Trading System and the Social Climate Fund is a victory for the climate and for European climate policy. This will allow us to meet climate objectives within the main sectors of the economy, while making sure the most vulnerable citizens and micro-enterprises are effectively supported in the climate transition. We can now safely say that the EU has delivered on its promises with ambitious legislation and this puts us at the forefront of fighting climate change globally.

EU emissions trading system

The EU Emissions Trading System (EU ETS) is a carbon market based on a system of cap-and-trade of emission allowances for energy-intensive industries and the power generation sector. It is the EU's main tool in addressing emissions reductions, covering about 40% of the EU's total CO2 emissions. Since its introduction in 2005, the EU's emissions have decreased by 41%. The agreement reached yesterday makes the system more ambitious in order to cut down even further emissions.

ETS installations

The Council and Parliament agreed to increase the overall ambition of emissions reductions by 2030 in the sectors covered by the EU ETS to 62%.

The co-legislators agreed to a rebasing of the overall emissions ceiling over two years of 90 and 27 million allowances respectively and increase the annual reduction rate of the cap by 4,3 % per year from 2024 to 2027 and 4,4 from 2028 to 2030 (“linear reduction factor').

The market stability reserve (MSR) will be strengthened by prolonging beyond 2023 the increased annual intake rate of allowances (24%) and setting a threshold of 400 million allowances.

The Council and Parliament agreed to reinforce the mechanism on excessive price fluctuations, including by providing for an automatic release of allowances from the MSR to the market.

Installations that will benefit from free allocations will need to comply with conditionality requirements, including in the form of energy audits and for certain installations climate neutrality plans. Additional transitional free allocations can be granted under certain conditions to the district heating sector in certain member states, in order to encourage investments into decarbonising that sector. The co-legislators agreed to delete the derogation for installations for electricity generation and move the remaining allowances into Modernisation Fund to support modernisation, diversification and sustainable transformation of the energy sector.

The Commission will assess and report by 31 December 2026 on the possibility of including the municipal waste incineration sector in the ETS with a view to including it from 2028 and assessing the need for a possibility of an opt out until 2031.

Sectors vulnerable to carbon leakage

As regards sectors covered by the Carbon Border Adjustment Mechanism (CBAM) - cement, aluminium, fertilisers, electric energy production, hydrogen, iron and steel, as well as some precursors and a limited number of downstream products - the Council and Parliament agreed to end free allowances for these sectors, over a nine-year period between 2026 and 2034. During this time the CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS, in order to fully respect the World Trade Organisation's rules.

The free allowances will be phased-out at a slower rate at the beginning and an accelerated rate at the end of this period. Support for the decarbonisation of these sectors will be possible through the Innovation Fund. In addition, a part of free allocations produced as a consequence of the application of conditionality will be transferred to member states for auctioning to address any residual risk of carbon leakage. Before 2026 the Commission will review the impact of the CBAM, including on carbon leakage risks, and see whether additional measures are needed.

EU ETS maritime

The Council and Parliament agreed to include maritime shipping emissions within the scope of the EU ETS. They agreed on a gradual introduction of obligations for shipping companies to surrender allowances: 40% for verified emissions from 2024, 70% for 2025 and 100% for 2026.

Most large vessels will be included in the scope of the EU ETS from the start. Big offshore vessels of over 5000 gross tonnage and above will be included in the 'MRV regulation' on the monitoring, reporting and verification of CO2 emissions from maritime transport regulation from 2025 and in the EU ETS from 2027. General cargo vessels and off-shore vessels between 400-5 000 gross tonnage will be included in the MRV regulation from 2025 and their inclusion in EU ETS will be reviewed in 2026.

In addition, the agreement takes into account geographical specificities and proposes transitional measures for small islands, ice class ships and journeys relating to outermost regions and public service obligations and strengthens measures to combat the risk of evasion in the maritime sector.

Certain member states with a relatively high number of shipping companies will in addition receive 3,5% of the ceiling of the auctioned allowances to be distributed among them.

The co-legislators agreed to include non-CO2 emissions (methane and N2O) in the MRV regulation from 2024 and in the EU ETS from 2026.

Modernisation Fund and Innovation Fund

As regards the Modernisation Fund, its volume will be increased through the auctioning of an additional 2.5% of the cap for which 90% must be used to support priority investments. Three additional member states will be eligible to receive funding (Greece, Portugal and Slovenia).

Although natural gas projects will in principle not be eligible for funding, a transitional measure will allow the current beneficiaries of the fund to continue time limited financing natural gas projects under certain conditions.

The Council and the Parliament also strengthened the Innovation Fund. In comparison to the current size of the fund, an extra 20 million allowances coming from the extension of the scope of EU ETS maritime to additional large vessels and inclusion of methane and nitroxides was added. There will be dedicated calls to decarbonise the maritime sector under the Innovation Fund.

EU ETS for buildings and road transport and fuels for additional sectors

The Council and Parliament agreed to create a new, separate emissions trading system for the buildings and road transport sector and fuels for additional sectors, in order to ensure cost-efficient emissions reductions in these sectors that have been difficult to decarbonise so far. The new system will apply to distributors that supply fuels to the buildings, road transport and certain other sectors. Part of the revenues from the auctioning will be used to support vulnerable households and micro-enterprises through a dedicated Social Climate Fund.

The co-legislators agreed that the system will start in 2027. The emissions reduction trajectory and the linear reduction factor was set at 5.10 from 2024 and 5.38 from 2028. The Council and Parliament agreed to auction an additional 30% of the auction volume for the first year of the launch of the system, so that it runs smoothly (“frontloading”).

The agreement extends the scope of the system to fuels used in certain industrial sectors. As a consequence, it has been agreed to increase the size the Social Climate Fund correspondingly.

The co-legislators agreed on a temporary possibility for member states to exempt suppliers from surrendering allowances until December 2030, if they are subject to a carbon tax at national level, the level of which is equivalent to or higher than the auction price for allowances in the new emission trading system.

There will be a simplified monitoring reporting and verification requirements for small fuel suppliers.

In case the energy prices will be exceptionally high, the start of the new ETS will be delayed until 2028.

Once the system has started if the price of allowances exceeds 45 EUR over a certain period of time, additional allowances will be released increasing the supply on the market.

Social Climate Fund

The Council and Parliament agreed to establish a Social Climate Fund to support vulnerable households, micro-enterprises and transport users cope with the price impacts of an emissions trading system for the buildings and road transport and fuels for additional sectors.

The Council and Parliament agreed that the fund would be part of the EU budget and fed by external assigned revenues up to a maximum amount of 65 billion euro. This budgetary architecture allows the fund to benefit from a series of guarantees linked to the European budget, without reopening the EU’s multiannual financial framework.

The fund would be established over the period 2026-2032, with eligibility of expenditures from 1 January 2026 based on auctioning of 50 million allowances in 2026 to allow for support at the start of the fund ('frontloading') while the new emission trading system would provide for financing of the Fund as of 2027.

The fund will be used by member states to finance measures and investments to address the impact of carbon pricing on vulnerable citizens and micro-enterprises.

Each member state would submit to the Commission a ‘social climate plan’, containing the measures and investments they intend to undertake to cushion the impacts of the new emission trading system on vulnerable households. Such measures could include increasing the energy efficiency of buildings, the renovation of buildings, the decarbonisation of heating and cooling in buildings and the uptake of zero-emission and low-emission mobility and transport, and measures providing direct income support in a temporary and limited manner.

The Council and Parliament decided to apply a ceiling of 37.5% of the estimated total costs of social climate plans to the possibility for member states to offer temporary direct income support.

The Council and Parliament agreed that the fund would benefit all member states and kept the allocation method proposed by the Commission, while increasing the minimum share from the fund per Member State.

Member states will be contributing nationally from their own budgets to the measures undertaken (co-financing 25%). With regard to the fund's management method the Council and Parliament agreed on direct performance management combined with elements of shared management. Member states will have the possibility of receiving technical assistance up to 2,5% for the implementation of the plan’s measures and 15% of the resources could be used within Cohesion policy programmes.

Background and next steps

Presented by the European Commission on 14 July 2021, the 'Fit for 55' package will enable the European Union to reduce its net greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels and to achieve climate neutrality in 2050.

The Council adopted its general approach on the environment-related proposals of the 'Fit for 55' package on 29 June 2022.

The political agreement reached yesterday is provisional pending formal endorsement. The Parliament and then the Council will adopt the pieces of legislation, after which they will be published in the EU's Official Journal and enter into force.

This is dedicated to the memory of Mauro Petriccione.

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Original article link: https://www.consilium.europa.eu/en/press/press-releases/2022/12/18/fit-for-55-council-and-parliament-reach-provisional-deal-on-eu-emissions-trading-system-and-the-social-climate-fund/

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