European Parliament and Council adopt positions on ETS and CBAM proposals: next steps—final agreement & formal adoption

Alert

06 July 2022

14 min read

The EU "Fit for 55" package, if adopted, will significantly reshape environmental regulation in Europe, with impact beyond the EU's borders. In this alert, we focus on developments in two of the most impactful files, the revision of the EU Emissions Trading System ("ETS") and the proposal for an EU Carbon Border Adjustment Mechanism ("CBAM").

The European Commission (the "Commission") introduced its proposal for a revised ETS and EU CBAM on 14 July 2021, as part of the "Fit for 55" package, which is intended to enable the EU to achieve a net reduction of 55 per cent in greenhouse gas ("GHG") emissions by 2030 compared to 1990 levels. Revisions to the ETS, which requires EU producers to buy allowances for their GHG emissions, and the proposed CBAM, which would impose a carbon levy on imports, are key components of the package. The levy introduced by the CBAM is intended to reflect the cost for EU producers under the ETS, and therefore, the two files are intrinsically linked. After intense discussion, the European Parliament and the Council of the European Union ("the Council"; i.e. the governments of EU Member States) have now adopted their positions, which amend the Commission's proposals in several ways. The European Parliament is pushing for a faster and wider implementation of the ETS and the CBAM, and amendments to its position are likely necessary to achieve a compromise enabling the adoption of the ETS and CBAM proposals.

Proposal for a revised Emissions Trading System

Both the European Parliament and the Council have now adopted their positions on the Commission's proposal for a Directive amending Directive 2003/87/EC, which established a system for greenhouse gas emission allowance trading within the Union, Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and Regulation (EU) 2015/757. The amendments to the Commission text adopted by the European Parliament are available.² The full negotiating position of the Council has also been published.³ The main changes to the Commission's original proposal in light of the amendments proposed by the European Parliament and the Council are as follows:

Emission reduction level – The Commission's revised ETS proposal called for a reduction in emissions covered by the ETS of 61 per cent by 2030, compared to 2005 levels. Whilst the Council agrees, the European Parliament wants to go further and proposes that the greenhouse gas reduction target be increased to 63 per cent compared to 2005 levels.
Timing of the progressive phase out of ETS free allowances for sectors covered by the CBAM – The Commission proposed that the phase out start in 2026 and be completed in 2035. The European Parliament wants the phase out to start later, in 2027, but be completed earlier, in 2032. Further, the European Parliament wants an accelerated reduction rate. The Commission proposed a linear ten percentage point yearly free allowance reduction rate, meaning 90 per cent of the 2025 free allowance levels would remain in 2026, 80 per cent in 2027, etc.⁴In contrast, the European Parliament wants free allowances to be reduced to 93 per cent in 2027, 84 per cent in 2028, 69 per cent in 2029, 50 per cent in 2030, 25 per cent in 2031 and 0 per cent in 2032.⁵ Whilst the Council agrees with the Commission's 2026 – 2035 timeline, like the Parliament, it calls for a progressively accelerating reduction rate.⁶
ETS II for buildings and road transport – The Commission proposed that companies concerned by the proposed ETS II should have their permits in order at the beginning 2025, with allowances being auctioned for the first time in 2026 and surrendered for the first time in 2027.⁷ The European Parliament wants this to happen a year earlier, at the start of 2024, with first time allowance auctions in 2025 and surrenders in 2026.⁸Under the Council position, permits should be in order in 2025. Nevertheless, the Council wishes to postpone the auctioning of allowances until 2027⁹and their surrender until 2028.¹⁰ The European Parliament wants to entirely exclude private individuals (i.e. homeowners and car drivers) from the scope of application of ETS II until 2029,¹¹which is not contemplated by the Commission or Council. The Council does propose simplified monitoring, reporting and verification requirements for small fuel suppliers. Additionally, the Council wants to let Member States exempt suppliers from surrendering allowances until the end of 2030 if they are subject to a national-level carbon tax higher than the ETS II auction price. A further potentially important point on which the Council has provided little detail so far is that it wants to introduce an ETS II opt-in for fossil fuels.¹²
Marine shipping – The three institutions agree on the inclusion of maritime shipping within the scope of the ETS, with all emissions from routes between ports under the jurisdiction of the EU Member States covered.¹³ The Commission and the Council want the system to be gradually introduced between 2023 and 2025, with all emissions linked to intra-EU shipments covered from 2026; and 50 per cent of emissions for routes between non-EU ports and EU ports to be covered.¹⁴ The European Parliament, however, wants all emissions from intra-EU shipments to be covered from 2024, as well as all emissions for shipments between non-EU and EU ports from 2027, with a few exceptions. The Council, in addition, wants to dedicate 3.5 per cent of the ceiling of the auctioned allowances to Member States which are heavily reliant on maritime transport and wants to introduce transitional measures that would apply to small islands, winter navigation and public service-related navigation.¹⁵
"Bonus malus" incentive system – The European Parliament has introduced some new ideas of its own, specifically, a "bonus-malus system" to encourage quicker reductions in emissions, whereby not implementing recommendations made in energy audits, not certifying energy systems, not designing a decarbonisation plan for installations, or having above-average emissions could result in free allowance losses. To the contrary, companies with lower emissions would benefit from additional allowances.
Modernisation Fund – The Council supports the Commission's proposal to update the EU Modernisation Fund, under which lower income Member States receive assistance to transition to climate neutrality, but it wants to extend the list of beneficiary Member States.¹⁶ Whilst the Council does not want natural gas projects to be eligible for funding under the Fund, it does want beneficiaries to be able to continue certain natural gas projects.¹⁷
Aviation sector – The Commission proposed phasing out aviation sector free allowances by 2027 in a separate legislative proposal.¹⁸ The Council wants to set aside 20 million aviation sector free allowances to compensate for costs associated with the use of sustainable aviation fuels, and wants specific geographical circumstances to be taken into account, and some transitional derogations to the phasing out of aviation sector free allowances.¹⁹On 8 June 2022, the European Parliament adopted its position on the Commission's proposal for aviation.²⁰ The European Parliament proposes that half of free allowances for the aviation sector be phased out in 2024, with the other half phased out in 2025. The European Parliament also wants the ETS to cover all flights departing from the European Economic Area ("EEA"), including flights bound for non-EEA destinations. It considers 75 per cent of revenues derived from the auctioning of allowances should be transferred to the EU Innovation or Climate Investment Fund. It also proposes a monitoring, reporting and verification ("MRV") scheme for non-CO2 emissions from aircraft operators and envisages expanding the scope of the ETS to non-CO2 aviation emissions.

Proposal for an EU Carbon Border Adjustment Mechanism

On 14 July 2021, the European Commission introduced its proposal for an EU CBAM.²¹ The proposed CBAM is a novel trade measure which would require importers to pay a carbon levy on certain products (discussed in more detail here). Like ETS, the proposal has been subject to wide global scrutiny. The main amendments proposed by the European Parliament and Council to the Commission's proposal are:

Start date – The European Commission proposed the CBAM would apply from 1 January 2026, after a three-year transition period starting in January 2023, when only reporting obligations would be imposed on importers.²² As of January 2026, importers would need to buy "CBAM certificates" for their imported products, in amounts that correspond to the embedded emissions of their imports and mirror the ETS price. The CBAM would be gradually implemented, meaning that the amount of required certificates would be adjusted to reflect any free allowances still allocated under the ETS.²³ Both the European Parliament and Council support having a transition period, but the European Parliament and the Commission differ on the entry into force of the financial obligations of the CBAM. The European Parliament proposes gradual entry into force of the CBAM from 2027, i.e. a one-year delay compared to the Commission's proposal, and full implementation from 2032, when free allowances are completely phased out,²⁴ i.e. (as discussed above in the section on ETS) three years earlier than the Commission proposal. The Council agrees with the Commission's proposal to phase in the CBAM over the period 2026 – 2035,²⁵ but proposes a different phase-in rate, which would be slower at the start and faster towards the end of the ten-year period (which follows from the Council's announced position on the progressively accelerating reduction rate of free allowances in the ETS, as noted above).²⁶
Sectors covered – The Commission proposed that the CBAM should cover imported cement, iron and steel, aluminium, fertilizers and electricity, with a possible further extension of the scope after entry into force.²⁷ The Council endorsed the Commission's proposal,²⁸ whilst the European Parliament proposes that the scope should be extended to hydrogen and—after an assessment by the Commission—also to organic chemicals and polymers.²⁹
Indirect emissions – The European Parliament proposes that indirect emissions, defined as GHG emissions from the production processes of electricity which is consumed during the production of goods, should also be covered by the CBAM.³⁰ The amount of CBAM certificates to be bought by the importer would thus also depend on the carbon intensity of the electricity grid used by the foreign producers. This is a very significant amendment. The Commission's proposal, which is supported on this point by the Council,³¹only covers direct emissions, and proposes to assess whether indirect emissions could be included at a later stage.³²All institutions agree that it should be examined whether emissions relating to the transportation of imports can also be covered by the CBAM in the future.³³
Export rebates – The European Parliament proposed a compromise amendment that EU producers should continue to receive free allocations under the ETS for products destined for export to third countries without carbon pricing mechanisms similar to the ETS.³⁴ The Parliament's reasoning behind this is that the CBAM only compensates the phasing out of free allowances under the ETS for imports, but EU producers would be at a competitive disadvantage when exporting to other countries with less stringent climate standards. It remains to be seen whether the Commission and the Council support the Parliament's position. The European Parliament has also requested a study by the Commission to assess the impact of the ETS and the CBAM on EU exports and on the WTO-compatibility of the proposed export derogation.³⁵
Centralised administration – Both the Parliament and Council have sought to ensure greater centralisation of the CBAM, compared to the Commission's proposal, which had proposed the CBAM should be administered at the level of the Member States.³⁶The European Parliament proposes the creation of a separate "CBAM Authority" at the EU level, rather than having authorities in each Member State. The Council proposes to create a central EU registry of CBAM declarants, rather than every national authority having its own register, but still with a separate authority in each Member State.³⁷
De minimis exemption – The Council proposes a de minimis rule that shipments of less than EUR 150 should be exempted from the CBAM,³⁸in order to reduce administrative complexity: about a third of shipments to the EU would fall under this exemption, but these consignments would attribute very little to greenhouse gas emissions of total imports.³⁹ The de minimis mechanism was not included in the Commission's proposal, nor in the European Parliament's position.

What's next?

The European Parliament, Council and Commission will now enter "trilogue" negotiations, and it is likely a compromise will be found somewhere in between the different positions of the three institutions. Whilst unpredictable, the political process could still be concluded by the end of 2022.

_{1 European Commission, Proposal for a Directive of the European Parliament and of the Council amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union, Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and Regulation (EU) 2015/757, COM(2021) 551 final ("Commission revised ETS proposal"), available here.

2 European Parliament, Amendments adopted by the European Parliament on 22 June 2022 on the proposal for a directive of the European Parliament and of the Council amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union, Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and Regulation (EU) 2015/757 (COM(2021)0551 – C9-0318/2021 – 2021/0211(COD)), P9_TA(2022)0246 ("Parliament ETS position"), available here.

3 European Council, Paquet « Ajustement à l'objectif 55 » Proposition de directive du Parlement Européen et du Conseil modifiant la directive 2003/87/CE établissant un système d'échange de quotas d'émission de gaz à effet de serre dans l'Union, la décision (UE) 2015/1814 concernant la création et le fonctionnement d'une réserve de stabilité du marché pour le système d'échange de quotas d'émission de gaz à effet de serre de l'Union et le règlement (UE) 2015/757 - Oriéntation générale, 30 June 2022, 10796/22 ("Council ETS General Approach"), available here.

4 Commission revised ETS proposal, Article 10a(1a)(2).

5 Parliament ETS position, Article 10a(1a)(2).

6 Council ETS General Approach, p. 56.

7 Commission revised ETS proposal, Recitals 47 and 55.

8 Parliament ETS position, Recitals 47 and 55.

9 Council ETS General Approach, p. 28.

10 Council ETS General Approach, p. 84.

11 Parliament ETS position, Recital 44.

12 Council of the European Union, "Fit for 55 package: Council reaches general approaches relating to emissions reductions and their social impacts", 29 June 2022, available here.

13 Commission revised ETS proposal, Recital 17 and Council ETS General Approach, p. 9.

14 Parliament ETS position, Recital 17 and Council ETS General Approach, p. 10.

15 Council ETS General Approach, p. 46.

16 Council ETS General Approach, p. 54.

17 Council ETS General Approach, p. 66.

18 European Commission, Proposal for a Directive of the European Parliament and of the Council amending Directive 2003/87/EC as regards aviation's contribution to the Union's economy-wide emission reduction target and appropriately implementing a global market-based measure, COM(2021) 552 final, Article 1(2)(b), available here.

19 Council of the European Union, "Press release – Fit for 55 package: Council reaches general approaches relating to emissions reductions and their social impacts", 29 June 2022, available here.

20 European Parliament Committee on the Environment, Public Health and Food Safety, Draft report on the proposal for a directive of the European Parliament and of the Council amending Directive 2003/87/EC as regards aviation's contribution to the Union's economy-wide emission reduction target and appropriately implementing a global market-based measure (COM(2021)0552 – C9-0319/2021 – 2021/0207(COD)), 2021/0207(COD), available here.

21 Proposal for a Directive amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union, Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and Regulation (EU) 2015/757, 14.7.2021 COM(2021) 551 final ("Commission CBAM proposal"), available here.

22 Commission CBAM proposal, see Article 36 and Article 32.

23 Commission CBAM proposal, Article 31.

24 European Parliament, Amendments adopted by the European Parliament on 22 June 2022 on the proposal for a regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism (COM(2021)0564 – C9-0328/2021 – 2021/0214(COD)) ("Parliament CBAM position"), available here, Article 31(1a).

25 Council of the European Union, "Draft regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism - General approach", 15 March 2022 ("Council CBAM General Approach"), available here, Articles 31, 32, 36.

26 Council ETS General Approach, p.56.

27 Commission CBAM proposal, Annex I, Article 30.

28 Council CBAM General Approach, Annex I, Article 30.

29 Parliament CBAM position, Amendments to Annex I and Article 30. The Parliament's position also specifies that "Aluminous cement" should be covered.

30 Parliament CBAM position, Amendment to Article 3(1)(16).

31 Council CBAM General Approach, Articles 3(1)(16), 30(1).

32 Commission CBAM proposal, Articles 3(1)(16), 30(1).

33 Commission CBAM proposal, Article 30(2); Council CBAM General Approach, Article 30(2); Parliament CBAM position, Article 30(2).

34 Parliament CBAM position, Article 31(1b).

35 Ibid.

36 Parliament CBAM position, Amendments to Article 11.

37 Council CBAM General Approach, Article 14. The European Parliament also endorses to have such a registry at EU level, see Parliament CBAM position, Article 14(a).

38 Council CBAM General Approach, Article 2(2a).

39 Council of the European Union, "Press release – Council agrees on the Carbon Border Adjustment Mechanism (CBAM)", 15 March 2022, available here.}

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_{This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.}