European Parliament and Council Reach Agreement on Carbon Border Adjustment Mechanism and EU Emissions Trading System

The European Parliament and Council of the European Union have reached an agreement on the text of the EU Carbon Border Adjustment Mechanism regulation and the directive providing an updated EU Emissions Trading System.

On December 13, 2022, the Council of the European Union ("the Council") and European Parliament came to a provisional agreement on the final text of a Carbon Border Adjustment Mechanism ("CBAM") regulation. On December 18, 2022, the two institutions also reached a provisional agreement on the text of a directive revising the EU's Emission Trading System ("ETS").

The texts agreed to by the Council and the Parliament have not yet been made public; rather, the two institutions have published press releases outlining their agreement.¹ This overview is based on those press releases, and, as such, the details contained herein are subject to confirmation once the text is made public. Additionally, the final text of the CBAM regulation and of the ETS directive requires formal adoption by both the Parliament and the Council and will then be published in the Official Journal of the European Union. Therefore, these agreements will not be final until early-to-mid 2023.

The agreement for a Carbon Border Adjustment Mechanism

The agreement between the Council and the European Parliament builds on the Commission's 2021 proposal² for a CBAM.

CBAM entry into force

The European Parliament and the Council have reportedly agreed on the CBAM Regulation entering into force on October 1, 2023, with a three-year transition period following during which only reporting obligations will apply. After the transition period, the CBAM will be gradually phased-in, as ETS free allowances in sectors covered by the CBAM will be gradually phased-out (see table below). Thus, the CBAM should first enter into force in 2026 and become fully operational in 2034. During the time that free allowances for sectors covered by the CBAM will be progressively phased out, the CBAM will only apply to the proportion of emissions not benefitting from free allowances under the ETS. 

Scope

The scope of the CBAM would include iron and steel, cement, fertilizers, aluminum, electricity and hydrogen, as well as "certain precursors as well as […] downstream products such as screws and bolts and similar articles of iron or steel." Before the end of the transition period, the Commission will be required to "assess whether to extend the scope to other goods at risk of carbon leakage, including organic chemicals and polymers." The goal is to include all goods covered by the EU ETS by 2030. A proposal should also be made by 2026 by the Commission to include further downstream products.

Indirect emissions

Indirect emissions would be covered "in a well-circumscribed manner." During a European Parliament press conference,³ it was stated that there would be a review of the methodology to calculate indirect emissions by the end of the transition period. 

Exemption for imports having paid an explicit carbon price

Where an explicit carbon price has been paid in the country of production, an importer would be exempted from the CBAM. It is expected that the final text will explain in more detail the mechanism of this key provision. 

The co-legislators Council and European Parliament have to formally adopt the agreement before it can enter into force. Once adopted, it will come into force 20 days after its publication in the EU Official Journal. 

ETS revision

The agreement between the Council and the European Parliament builds on the Commission's proposal⁴ for a revised ETS.

A 62 percent cut in emissions by 2030

The two institutions have reportedly agreed that emissions in sectors covered by the ETS would be cut by 62 percent by 2030, compared to 2005. This is a compromise between the Council's position, which followed the Commission proposal and called for a 61 percent reduction, and the Parliament's position, which called for a 63 percent reduction. In terms of the rate of reduction, the deal reportedly introduces one-off reductions to the overall level of allowances of 90 Mt of CO2 equivalents in 2024 and a further 27 Mt in 2026. In parallel, there will be reductions in allowances of 4.3 percent per year for the 2024-2027 period and of 4.4 percent per year for the 2028-2030 period. 

Possibility to cover municipal waste incineration

The scope of the ETS could also be expanded to the municipal waste incineration sector from 2028 onwards, subject to a decision by the Commission before the end of 2026. Should the Commission take this decision, an opt-out provision may be included. 

Phasing out of free allowances in sectors covered by the CBAM

The EU will phase out ETS free allowances in sector covered by the CBAM (i.e. iron and steel, cement, fertilizers, aluminum, electricity and hydrogen). The European Parliament and the Council have reportedly agreed to the following timeline for the phasing out of free allowances: 

The CBAM will enter into force at the same rate that free allowances in the ETS will be phased out.

The Commission would also be required to assess the risk of carbon leakage (i.e. emission offshoring) of goods produced in the EU for exportation by 2025, and present a "WTO-compliance legislative proposal" to address this risk if necessary. Additionally, 47.5 million allowances would be used to raise funds to address the risk of export-related carbon leakage.

New requirements for free allowance beneficiaries

In parallel, installations still benefitting from free allocations under the ETS would be required to comply with certain requirements, including energy audits and, "for certain installations," climate neutrality plans (although what installations would be covered by this obligation to draw climate neutrality plans is unknown at this point).

ETS II for road transport and buildings

Other than the ETS currently in place, the directive would also put in place an "ETS II" for road transport fuel and buildings, which is due to start in 2027 (although the entry into force of ETS II may be postponed to 2028" if energy prices are exceptionally high"). The European Parliament indicated that fuel for other sectors, such as manufacturing, will also be covered," although it does not provide a list of what sectors the institutions have agreed to cover. The co-legislators say they have also included an escape valve in ETS II, to the extent that if the price of an allowance rises above EUR 45, 20 million additional allowances will be released. Additionally, Member States would be able to exempt suppliers from surrendering allowances under ETS II until December 2030 where they are subject to a national level carbon tax that is equivalent or higher than the auction price for allowances under ETS II (like the Council demanded). 

_{1 See European Parliament, "Climate change: Deal on a more ambitious Emissions Trade Systems (ETS)," December 18, 2022; "Deal reached on new carbon leakage instrument to raise global climate ambition," December 13, 2022. See also Council of the European Union, "'Fit for 55': Council and Parliament reach provisional deal on EU emissions trading system and the Social Climate Fund," December 18, 2022 and "EU climate action: provisional agreement reached on Carbon Border Adjustment Mechanism (CBAM)," December 13, 2022.
2 European Commission, Proposal for a Regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism, COM(2021) 564 final, 14.7.2021. 
3 European Parliament, Press conference by Mohammed Chahim, rapporteur, and Pascal Canfin, chair of the ENVI Committee, on Carbon Border Adjustment Mechanism (CBAM), December 13, 2022. 
4 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, 14.7.2021.}

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