Revised EU Emissions Trading System to Take Effect in 2020

December 14, 2017

On November 9, 2017, the European Parliament and the European Council reached a tentative agreement on the extension of the European Union’s Emissions Trading System (ETS) for the period 2020 through 2030, or “Phase 4.”1 The ETS, which was originally established in 2003, is the world’s largest carbon market, regulating approximately 11,000 facilities from industry, the power sector, and aviation, representing about 45% of total EU greenhouse gas emissions.2 As with prior iterations of the ETS, the new requirements will have significant ramifications primarily for power producers and consumers.

The ETS reform, which implements EU commitments under the Paris climate change accord, will become final once it is approved by both the European Council and the European Parliament.3 The reform contains the following key elements:

  • Lower cap on greenhouse gas emissions for covered facilities. The ETS reform caps emissions at 43% below 2005 levels by 2030, with the cap becoming progressively tighter every year. This target is one of the implementation mechanisms to meet the EU’s “Nationally Determined Contribution” under the Paris Agreement to reduce the EU’s greenhouse gas emissions by 40% below 1990 levels by 2030. 4
  • Increased cost of carbon allowances. In the early phases of the ETS, oversupply of allowances kept prices too low to drive emissions reductions in industry. The cost of ETS allowances has remained below 10 Euros per tonne since late 2011. The EU plans to gradually transition from free allowances—intended to incentivize industry to take part in the mechanism and to account for international competition from regions with no comparable cap on emissions—to full auctioning. Even in Phase 4, however, “[a]pproximately 6.3 billion allowances, worth as much as €160 billion, are expected to be allocated for free to companies.”5 A strengthened “Market Stability Reserve” will take out allowances from the market as necessary to stabilize prices and drive emissions reductions.
  • Alternative “allowance cancellation” mechanism. Member states will have the option of voluntarily cancelling some of their auction allowances to reflect reduced national electricity-generation capacity.6 In effect, such cancellations could reduce a country’s emissions and potentially drive up the price of allowances. 
  • Assistance to disadvantaged industrial sectors. Support will be available to certain sectors to assist in their transition to a low-carbon economy. Industries facing competition from regions with no comparable carbon price are eligible to receive free emissions allowances. A consultation is currently underway to determine which industries are “at risk” and thus entitled to these allowances.7 Although the energy sector is generally not entitled to free allowances, an exception exists for energy companies in certain Eastern European countries.8 Still, some conditions are placed on the use of those free allowances, including an obligation to support “the transition to a safe and sustainable low-carbon economy” and “the long term objectives expressed in the Paris Agreement.”9
  • Creation of “Modernization Fund.” A new fund, financed through a portion of the allowances, will support approximately 3 billion Euros in investments in renewable-energy generation, energy efficiency, the modernization of energy networks, and worker “redeployment” and “re-skilling.”10 Only EU Member States with a GDP per capita below 60% of the EU average are eligible to receive funding.

In a related development, in November 2017, the EU reached an agreement with the United Kingdom over how to plan for the possibility that the UK may not remain in the ETS after Brexit. The UK is set to exit the EU before the end of the ETS’ current compliance phase (Phase 3). A compromise was reached to “safeguard” against a flood of allowances sold by UK companies that may no longer need them, driving down the price of ETS allowances.11 The UK has not yet indicated whether it plans to stay in the ETS; that option remains a possibility because the ETS is open to certain non-EU states.12

Affected industries should prepare for this newest phase of the EU ETS, given analysts’ predictions that allowance prices could increase to 20-38 Euros per tonne.13 Additional reforms to the ETS are also expected to keep pace with the Paris Agreement’s five-year global stocktakes that may result in strengthened international and national commitments. Further ETS reform also may well increase coverage of the aviation sector, and may include the maritime sector, depending on the results of ongoing negotiations at the UN International Civil Aviation Organization and the International Maritime Organization, respectively.14

1 For the full text of the proposal, see Council of the European Union, Proposal for a Directive of the European Parliament and of the Council Amending Directive 2003/87/EC to Enhance Cost-Effective Emission Reductions and Low-Carbon Investments (2015/0148(COD)), Nov. 22, 2017, available at http://www.europarl.europa.eu/RegData/commissions/envi/inag/2017/11-22/ENVI_AG(2017)615245_EN.pdf [hereinafter ETS Reform Proposal].

2 For more information on the ETS, see generally EU Emissions Trading System (EU ETS) Fact Sheet, EUROPEAN COMMISSION, CLIMATE ACTION, available at https://ec.europa.eu/clima/sites/clima/files/factsheet_ets_en.pdf.

3 The European Council endorsed the deal on November 22, 2017. See Reform of the EU Emissions Trading System—Council Endorses Deal with European Parliament, Press Release, Council of the European Union, Nov. 22, 2017.

4 Latvian Presidency of the Council of the European Union, Intended Nationally Determined Contribution of the EU and its Member States (Mar. 6, 2015), available at http://www4.unfccc.int/ndcregistry/PublishedDocuments/European%20Union%20First/LV-03-06-EU%20INDC.pdf.

5 Reform of the EU Emissions Trading Scheme, EUROPEAN COUNCIl (last reviewed Dec. 1, 2017), http://www.consilium.europa.eu/en/policies/climate-change/reform-eu-ets/.

6 ETS Reform Proposal, supra note 1, at 46 (amending art. 12).

7 Private-sector representatives, along with other members of civil society, are invited to contribute to the consultation until February 12, 2018. See Methodological Choices for Determining the List of Sectors and Subsectors Deemed Exposed to a Significant Risk of Carbon Leakage, for the Period 2021-2030, CLIMATE ACTION, EUR. COMM’N, https://ec.europa.eu/clima/consultations/methodological-choices-determining-list-sectors-and-subsectors-deemed-exposed_en (last visited Dec. 12, 2017).

8 The eligible countries are Bulgaria, Estonia, Latvia, Lithuania, Hungary, Romania, Poland, the Czech Republic, Slovakia, and Croatia.

9 ETS Reform Proposal, supra note 1, art. 10c(1).

10 Id. art. 10d(1)-(1a).

11 Dave Keating, In First Brexit Compromise, UK Gets A One-Year Reprieve For Carbon Traders, FORBES (Dec. 1, 2017), https://www.forbes.com/sites/davekeating/2017/12/01/in-first-brexit-compromise-uk-gets-a-one-year-reprieve-for-carbon-traders/#2992f46d3743.

12 The ETS operates in 31 countries—the 28 EU Member States, plus Iceland, Lichtenstein, and Norway. The EU Emissions Trading System (EU ETS), European Commission, Climate Action, https://ec.europa.eu/clima/policies/ets_en (last visited Dec. 12, 2017).

13 Ewa Krukowska, Here’s What Europe’s Carbon-Market Overhaul Means for Businesses, BLOOMBERG, Nov. 12, 2017, https://www.bloomberg.com/news/articles/2017-11-13/here-s-what-europe-s-carbon-market-overhaul-means-for-businesses; Simon Evans, Q&A: Will the Reformed EU Emissions Trading System Raise Carbon Prices?, CARBONBRIEF, Dec. 6, 2017, https://www.carbonbrief.org/qa-will-reformed-eu-emissions-trading-system-raise-carbon-prices.

14 See O’Melveny Client Alert, Agreement Reached to Cap and Regulate Greenhouse Gas Emissions from Commercial Aviation (Oct. 19, 2016), https://www.omm.com/resources/alerts-and-publications/alerts/agreement-reached-to-cap-and-regulate-greenhouse-gas-emissions-from-commercial-aviation/.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Eric Rothenberg, an O'Melveny partner licensed to practice law in New York, and Remi Moncel, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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