After a sixth round of interinstitutional negotiations (‘trilogues) that began on Friday morning and ended during the night of Saturday 17 to Sunday 18 December, the European Parliament and the Council of the European Union reached a provisional political agreement on the revision of the EU’s Emissions Trading System (ETS), the cornerstone of European climate policy, shortly before 2am.
“The negotiations lasted 29 hours (...) It was really tough, but it was worth it”, said Peter Liese (EPP, German), the Parliament’s rapporteur.
A second carbon market
In particular, the agreement provides for the creation of a second ETS covering greenhouse gas emissions from building heating and road transport (ETS2 or ETS BRT).
This new carbon market, separate from the current one, will apply to distributors who supply fuel to buildings and road transport, but also to other sectors (excluding agriculture and fisheries).
At the request of the Parliament, its scope is thus extended to all fuels (regardless of their end use) compared to the European Commission’s initial proposal (see EUROPE 12762/1).
“The Council’s position would have meant that a poor family or an old lady, living in a badly insulated house or flat, would have to pay a price for CO2, but manufacturers and industry, if they are below 20 MW, would have been completely excluded, even for the heating of their offices”, Mr Liese explained.
The co-legislators agreed that ETS2 will start in 2027, one year later than in the Commission’s original text. However, the agreement introduces a temporary exemption possibility proposed by the EU Council, until the end of 2030, for Member States that have already introduced a carbon tax at national level, the level of which is equivalent to or higher than the price of emission allowances in the ETS2.
This is a very different timetable from the approach taken by the Parliament, which envisaged applying ETS2 only to commercial buildings and commercial road transport activities from 2025, with a possible extension to private activities related to these sectors (i.e. households), from 2029 (see EUROPE 12977/10).
Price cap and deferral in case of high prices
In order to contain the socio-economic impact of the ETS2, the Parliament obtained the definition of a price cap and the inclusion of a mechanism to take into account energy prices (‘emergency break’).
In concrete terms, once the system is launched, the price of allowances will be capped at €45 until 2030, so that if the price is exceeded, additional allowances will be released to reduce the price by increasing supply on the market. This mechanism will then be assessed and possibly revised after 2030.
In the event that oil or gas prices are above €106/MWh, the start of the ETS2 will be postponed to 2028.
Responding to a wish of the Parliament, the co-legislators also agreed to oblige fuel suppliers to inform the Commission of how much of their costs due to the ETS2 they pass on to end consumers. If the Commission finds misconduct, such as unfair price mark-ups, it will have to take legislative action to stop it.
Another measure to mitigate the socio-economic impact of the ETS is the creation of a Social Climate Fund to help the most vulnerable households. In this respect, the co-legislators agreed, inter alia, to increase the size of the Fund and to set it up before the launch of ETS2 (see EUROPE 13087/17).
According to the provisional agreement, the total number of allowances in ETS2 will be reduced annually by 5.1% from 2024 and by 5.38% from 2028. The Commission proposed to set this ‘linear reduction factor’ at 5.15% and 5.43% respectively.
Revision of ETS1
Regarding the existing carbon market (ETS1), negotiators agreed to make two one-off reductions in the total number of emission allowances: 90 million in 2024 (compared to around 117 million in the Commission’s proposal) and 27 million in 2026.
They also increased the linear reduction factor to 4.3% from 2024 to 2027 and to 4.4% from 2028 to 2030.
These new parameters will lead to a 62% reduction in emissions from the sectors covered by the scheme by 2030 (compared to 61% in the Commission’s proposal and 63% in the Parliament’s negotiating mandate) compared to 2005 levels, an increase of 19 percentage points compared to current legislation.
The Market Stability Reserve (MSR) - a mechanism to address the current surplus of allowances by automatically setting aside a certain number of allowances at a pre-defined annual intake rate - is strengthened by extending the current intake rate (24%) beyond 2023 and increasing the minimum quantity of allowances to be set aside from 200 to 400 million. The thresholds above/below which allowances are added to/withdrawn from the reserve are maintained at 833 and 400 million allowances respectively.
End of free CBAM allowances in 2034
The agreement on the revision of the ETS confirms the closely related agreement on the Carbon Border Adjustment Mechanism (CBAM) (see EUROPE 13083/23).
The co-legislators have thus resolved the thorny issue of free allocation of emission allowances to the sectors to be covered by CBAM by cutting the line between their positions: the full exit year for free allowances is not 2036 or 2032, but 2034.
For the phase-out path, the compromise aims to combine a soft exit with a clear signal for 2030. Free allocations of emission allowances will be reduced according to the following trajectory: 2.5% in 2026; - 5% in 2027; - 10% in 2028; 22.5% in 2029; 48.5%; - 61% in 2031; - 73.5% in 2032; - 84% in 2033; 100% in 2034.
As requested by the EPP group in the Parliament, the negotiators inserted a clause to make this trajectory conditional on the effective entry into force of the CBAM in 2026. If the CBAM is implemented later, the pace of removal will therefore be reviewed.
Protecting exporters
The Parliament did not get the export rebate it had imagined. Concerned about the competitiveness of exporters of CBAM products, MEPs wanted to maintain free allowances for them (see EUROPE 12977/12). The EU Council and the Commission maintained their opposition to such a system, as it would have been incompatible with World Trade Organization (WTO) rules.
Instead, negotiators agreed that Member States should provide more support to the exporters in question, through additional revenues from the ETS. Some €3.5 billion will be targeted to help export industries in their transition, according to Mr Liese.
In addition, the industrial sectors covered by CBAM should be the subject of specific calls for projects under the Innovation Fund, the rapporteur said.
According to the agreement, the Commission will have to carry out an analysis of the risks of carbon leakage and propose, if necessary, a legislative proposal in 2025 to adjust certain aspects of CBAM just before its launch.
Benchmarks
For sectors covered by the ETS1, but not by the CBAM, free allowances will continue to be allocated to production sites according to benchmarks - the values used to determine the amount of free allowances for each industry covered by the ETS.
However, these benchmarks will be reviewed by 2026 and will now be increased by 0.3% per year (instead of the current 0.2%), resulting in a further reduction in free allowances of 3.4 million allowances.
They will also be defined by product and not by process. This means that different modes of production, but with the same basic product, will now be measured by the same criterion.
In addition, the compromise deletes Article 10c, which allows Central and Eastern European countries to continue to grant free allowances to coal-fired power generation until the end of 2030.
It also calls on Member States to remove from the ETS allowances that will become redundant as a result of the national coal phase-out. If not, they will have to justify their choice.
On the other hand, the EU Council obtained an additional 30% of free allowances for district heating, subject to carbon neutrality plans.
A malus system
In order to encourage the sectors covered by the ETS1 to decarbonise, the co-legislators introduced a control system coupled with a malus.
Companies will have to carry out energy audits of their production processes or have an energy management system and implement decarbonisation measures based on the results. In addition, those in the bottom 20% of companies in the same sector will also have to develop decarbonisation plans.
If a company does not implement the recommendations of its energy audit (or energy management system) and/or its decarbonisation plan, its free allowances will be reduced by 20%.
Inclusion of two new sectors
The provisional agreement also provides for the extension of the ETS1 to emissions from the municipal waste incineration sector from 2028.
While this is a victory for the Parliament, the date chosen is later (the Parliament wanted 2026) and could even be pushed back.
The Commission will have to report by 31 January 2026 on the extension of the ETS to this sector, including an assessment of the need for a derogation until the end of 2030.
The ETS1 will also be gradually extended to the maritime sector from 2025 onwards (see EUROPE 13074/10 for more details).
Increase in the Innovation Fund and the Modernisation Fund
At the request of the Parliament, the EU Council finally agreed to strengthen the Innovation Fund to support the development of decarbonisation technologies.
This will increase the amount of emission allowances in the fund from 450 million to 575 million (including 20 million from the inclusion of the maritime sector). With an average price of €80 per tonne of CO2, it will therefore increase from €33.75 billion to around €40 billion.
The Modernisation Fund will be increased by auctioning an additional 2.5% of allowances, 90% of which must be directed to priority investments.
While this fund is reserved for Member States whose GDP per capita is less than 75% of the EU average, three additional countries - Greece, Portugal and Slovenia - will be eligible for funding.
The Modernisation Fund will be able to continue to finance gas-fired power generation up to €4.8 billion without conditions. Beneficiary Member States will also be able to finance gas-fired power plants up to €3.75 billion if duly justified on energy security grounds and provided that the environmental principle of ‘do no significant harm’ is respected.
The Parliament wanted to exclude any possibility of investment in fossil fuels with this fund.
Use of national revenues
According to the provisional agreement, all national revenues from the auctioning of allowances in ETS1 and ETS2 will have to be spent on climate-related measures.
Avoiding excessive price increases
In order to keep the price of allowances in the ETS1 at reasonable levels, the co-legislators agreed to strengthen the mechanism for excessive price fluctuations (Article 29a), thus responding to a request from some Member States, in particular from Poland.
If, over a period of more than six consecutive months, the average price of allowances is higher than 2.4 times the average price of allowances in the reference period of the previous two years, 75 million allowances will be released from the Market Stability Reserve. (Original version in French by Damien Genicot and Léa Marchal)