The European Commission’s proposal to include new sectors in the EU Emissions Trading Scheme (ETS) is not expected to significantly reduce emissions but could risk the stability of the EU’s carbon market and the decarbonisation of the power sector, argue Outi Haanperä and Verena Graichen.
Outi Haanperä is a leading specialist at Sitra, the Finnish Innovation Fund. Verena Graichen is a senior researcher at the Öko-Institut.
The European Commission seeks to increase the EU 2030 emission reduction target from 40% to at least 50% from 1990 levels, with a possibility to extend this to 55%. The communication on the European Green Deal also suggests extending the EU Emission Trading System (EU ETS) to cover international maritime transport and possibly land transport and building specific heating, too.
The expansion of the EU ETS is not a clear-cut decision, however. Is the Commission proposal fit for purpose? Do the possible benefits outweigh the risks associated with the extension?
Let us first take a look at international maritime transport. Emission reduction efforts in this sector have been limited in the past and the sector is not exposed to carbon pricing.
Therefore, including it into the EU ETS could stimulate emission reductions. While the extension could be an improvement for the maritime sector, alone it is not sufficient to reform the EU ETS, as our recent study suggests.
If the expansion goes ahead, two important questions need to be addressed. First, whether the sector will be fully incorporated into the ETS or only linked to it, following the example of aviation.
Second, whether the sector will be included in the EU’s 2030 emission target under the Paris Agreement (the so-called Nationally Determined Contribution, NDC) or treated separately.
What about land transport? The available evidence suggests that emission reductions in the transport sector are more expensive than, for example, in the power sector. The current price level of the emission allowance (approximately €25 per tonne of CO2) is not expected to stimulate emission reductions in the transport sector.
Importantly, petrol and diesel are already taxed in the Member States and topping the price of petrol with the current price of emission allowances would have a negligible impact, only a few cents per litre.
Therefore, the sector would mainly end up covering its emissions by purchasing allowances from the market instead of driving emission reductions through the ETS.
The current surplus of emission allowances amounts to approximately 1.7 billion allowances, roughly equivalent to the annual emissions under the EU ETS. One might argue that the inclusion of the transport sector could therefore reduce the surplus.
However, there is already a mechanism to address the surplus of emission allowances, the Market Stability Reserve (MSR).
The situation for building-specific heating and cooling is similar. The heating sector is characterised by low price elasticity of demand, meaning that an increase in the price of heating fuel has a limited impact on demand.
In addition, many barriers hinder the adoption of emission reduction measures even if they would bring cost-savings in the long term. For example, flat owners in apartment blocks might not have an incentive to individually invest in technologies that enhance energy efficiency of the whole building even if that would be in their collective interest.
To conclude, the decision to bring in land transport or heating and cooling to the EU ETS is likely not enough to trigger notable emissions reductions. Therefore, other measures would need to be implemented alongside the emission trading system.
This finding is also recognised by the European Commission, as the EU ETS is suggested on top of the existing measures, and not as an alternative.
The important question is whether the extension is then the best use of political capital? If other measures are needed in any case, would it make sense to prioritise these?
For example, measures such as a production quota for zero-emission vehicles as well as strengthening the CO2 emission standards for vehicles and expanding it to cover buses and other heavy vehicles are likely needed in the transport sector.
In the heating sector, the focus should be on more ambitious energy efficiency standards and improved support schemes for the energy renovation of old buildings.
In our opinion, the greatest risk of bringing in new sectors in the ETS is to get the cap wrong again. There has been a long learning process with the current format to understand the right level for the cap. If new sectors are brought in, a debate about additional allowances will begin.
The issue of additional allowances is vital and bringing in too many allowances will risk the stability of the system.
We simply cannot risk the decarbonisation of the European power sector in exchange for lesser and more uncertain emission reductions. Instead, we should rather look to tightening the cap and strengthening the MSR in order to align the EU ETS with a more ambitious climate policy.