What is wrong with the EU’s Emissions Trading System?

The EU’s Emissions Trading System is one of the most important European instruments in our concerted effort to reduce CO2 emissions. It is a market instrument that covers more than 11,000 factories, power stations and other installations in all EU-member states. However, the system does not work so well.

Major problems of the EU Emission Trading System

The carbon market suffers from an oversupply, resulting in carbon prices which are way too low to pose an incentive for businesses to start producing more climate-friendly. Since the introduction of the ETS, the EU has structurally given out more carbon permits than the industry needed. This was exacerbated by the economic crisis, resulting in a surplus of over 2.1 billion CO2 emission permits. 

A major additional flaw is the supply of free allocation to EU industries (to protect them from foreign competition). By providing the majority of permits for free, there was hardly an incentive to decarbonize for these industries. To make matters worse, not only did companies receive allowances for free, they were getting more allowances than they needed, which meant they could sell those allowances for profit. 

In 2019 a new mechanism came into effect. The so-called Market Stability Reserve aims to correct the oversupply of permits by placing a percentage of the permits in circulation into a reserve. This way, the EU tries to stabilize the ETS, and this has already resulted in rising CO2 prices. Unfortunately, the MSR needs to be improved, as currently these CO2 emission permits can be allowed back on the market in times of increasing scarcity. 

In July 2021, the European Commission launched the Fit for 55 package, in which they propose to revise the ETS. This proposal contains a number of improvements to the current situation, like a higher lineair reduction factor (decreasing the amount of permits in circulation). However, the ETS proposal is not ambitious enough to limit global warming to 1.5°C per the Paris Agreement.

What should be improved in the Fit For 55 ETS revision

First, the target of -55 % GHG emissions compared to 1990 is not ambitious enough to achieve the Paris Agreement Target of 1.5°C. The various elements of ETS should be implemented better and faster to ensure a faster transition. This means a more ambitious one-off reduction of the cap, a faster introduction of CBAM and corresponding facing out free allowances, full inclusion of the shipping and aviation sector by 2023, and a stronger and dynamic MSR.

Secondly, the ETS should contribute to a just transition with real climate benefits. Now that 100% of ETS revenues should be spent on climate action, better criteria are need to ensure all funds are spend on climate purposes, rather than fossil fuels, unsustainable biomass, nuclear energy and ETS indirect cost compensation through state aid schemes.

Third, the ETS revision should better address the distributional and social effects of the energy transition. For instance, a new ETS for buildings and road transport will disproportionately affect households with lower incomes and from lower income countries. In addition, we are concerned about the social implications of a CBAM on Low- and Lower Middle-Income countries.

Finally, the revision of the ETS does (properly) include major polluting sectors, such as Municipal Solid Waste incineration and the use of Biomass for energy production. 



Emission trading