All sectors will contribute to the European emission reduction target of 55%. Jose Maria García Barrendero and Bernadett Papp, July 2021

On 14 July, the European Commission adopted a package of proposals to bring the EU’s climate, energy, land use, transport and tax policies in line with the target of reducing net greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels.

The European Green Deal, presented by the Commission on 11 December 2019, sets the target of making Europe the first emission-neutral continent by 2050. The European Climate Law, which will come into force this month, enshrines in binding legislation this commitment and the intermediate target of reducing net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels.

Achieving these emission reductions over the next decade is crucial for Europe to meet its 2050 target and make the European Green Deal a reality.

The proposals of the so-called Fit for 55 legislative package will allow the necessary acceleration of greenhouse gas emission reductions in the next decade. They combine the introduction of emissions trading into new sectors and a tightening of conditions for the sectors that are already present in it; as well as increased use of renewable energy, greater energy efficiency, an intensive deployment of low-emission transport methods and the infrastructure and fuels to support them, an alignment of fiscal policies with the objectives of the European Green Deal, measures to prevent carbon leakage, and tools to preserve and grow our natural carbon sinks.

Most of the reform proposals concern the European Emissions Trading System (EU ETS), as a cornerstone of the process of decarbonisation of the European economy. The current rules of the system are defined to meet the EU-wide 40% emissions reduction target by 2030 that the European Union committed to by signing and ratifying the Paris Climate Agreement in 2015. However, different impact assessments and feasibility studies demonstrated that this emission reduction target results in a greater than acceptable increase in average temperatures and that a higher target could be achieved. For this reason, the EU adopted in December 2020 an emission reduction target of at least 55% by 2030. Since different sectors of the economy also have different capacities to decarbonize their processes, the companies covered by the ETS scheme will have to reduce their emissions by 61% according to the different proposals.

The emission limit allowed by the emissions trading system will decrease further as the linear reduction factor (currently at 2.2%) increases to 4.2% from the year following the entry into force of the amendments. The number of allowances available in the system will be further reduced by a single reduction (recalculation of the total emission limit) by a number estimated by the Commission at 117 million allowances.

The rules for the free allocation of allowances to those installations entitled to receive them will also be stricter. The product benchmarks that are the basis of the free allocation calculations will be revised and may be reduced by a maximum rate of 2.5% from 2026 instead of the current 1.6% if the Commission considers further emission reductions based on available technologies to be feasible.

In addition, free allocations for sectors affected by the Carbon Border Adjustment Mechanism (CBAM) will be phased out over ten years from 2026. Aviation companies should also prepare for the reduction of their free allocation. (Starting in 2021, aviation companies can use the same type of emission allowance for compliance as energy companies and industries.)

All of the above will result in lower availability of allowances in auctions and on the secondary market and, most likely, also in higher prices in the US.

Since December 2020, the benchmark carbon contract gained 78.48% when it reached an all-time high of €58.4 on July 5. Analysts agree that the price of European carbon allowances could rise further once the EU ETS reforms are implemented. Market consensus shows that the price of the 1tn allowance (EUA) could reach almost €100 by the end of the decade, placing a significant burden on electricity producers who do not receive any free allocation, and who therefore have to buy all their rights on the market or invest in renewable technologies. Utilities can cover these costs by transferring them to their consumers, which then translates into higher electricity prices.

All the proposals (including those concerning the use of renewable energy or energy efficiency) now need the approval of the different political groups in the European Parliament and that of the Member States in the Council. The negotiations could last several months, as there is a risk that citizens who are already in energy poverty will pay most of the decarbonisation costs. The final form of the new rules may be different from the Commission’s proposal, but if the EU is to achieve the 55% emission reduction target, all economic actors will have to contribute to the long-awaited target.

Jose Maria García Barrendero – Country Manager – Vertis Environmental Finance
Bernadett Papp- Senior Market Analyst – Vertis Environmental Finance

Company Member of the Private Company and Climate Foundation