Update on the EU ETS for buildings and road transport

A controversial proposal  becomes less controversial?

The Commission’s idea to create a separate system (known as ETS II) sparked a wave of contradictions, controversy and heated debates. The inclusion of private households and road transport was the main point of discord. This proposal was viewed by many as a huge risk, especially in the context of skyrocketing energy prices. However, on 17 May the European Parliament’s rapporteur on the file, Peter Liese (European Peoples Party, DE) exclaimed “Eureka! We have reached an agreement on the ETS.” Indeed, after several months of intense political negotiations, the Parliament reached a compromise in its Committee on the Environment, Public Health and Food Safety (ENVI) and decided that a separate new ETS for fuel distribution for commercial road transport and buildings will be established on 1 January 2025. In contrast to the Commission’s initial proposal, the Parliament decided that the new ETS is to be enacted one year earlier, in 2025, and that private buildings and private transport are not be included before 2029. This means that lawmakers have eliminated the political risk and for now the system would only apply to commercial housing and transport. The inclusion of private ones will depend on the Commission’s assessment process scheduled to take place in 2026, in order to determine whether energy and transport poverty has sufficiently decreased to justify extending ETS to private consumers by 2029.

The Commission is not fully satisfied with this outcome, as it has warned that such a compromise would “majorly weaken” the mechanism. However, rapporteur Liese said that “This compromise is good for the climate, jobs and people in Europe... I am particularly happy that the important ETS II and the connected Social Climate Fund are out of ‘intensive care’ and even ‘out of hospital’. Although I would have wished for a broader approach, I am happy that ETS II is alive and kicking.”

What about financing?

Together with the ETS II, the Commission put forward its proposal to create a new EU funding streamcalled the Social Climate Fund (SCF). Initially, the Commission envisaged €72.2 billion of funding to the Member States, for the period 2025–2032, to be paid for mainly by ETS credits in the buildings and road transport sectors in order to counter the possible negative social impacts. However, the political negotiations in the European Parliament once again showed a different picture. The position adopted at the committee level highlights the following adjustments:

• Budget

In terms of financing, the budget for the implementation of the Fund has been split into two financial envelopes. The first one is foreseen for the period 2025–2027 and shall be at least €11 billion in current prices. In addition, the Fund will be complemented by the revenues from the 150 million allowances auctioned according to ETS provisions. Assuming a carbon price of 35 euros per ton, there would be additional availability of 5.25 billion euros. This means that the final amount for the first financial envelope of the SCF would be €16.39 billion for the first period, i.e.2025–2027. The financial envelope for the second period (2028–2032) will be established after the Commission’s revision of ETS II, which will determine the inclusion of private consumers.

• Planning

Member States will be required to submit “social climate plans”, after consulting with local and regional authorities, economic and social partners as well as civil society, in order to elaborate a coherent set of measures to address energy and mobility poverty.

• Measures

Temporary direct income support would be funded (such as a reduction in energy taxes and fees) to tackle the increase in road transport and heating fuel prices. Moreover, the fund would cover investmentsin buildings renovation, renewable energy, and a shift from private to public transport, car-pooling, car-sharing, and cycling. In this sense, measures may include fiscal incentives, vouchers, subsidies or zero-interest loans.

The Parliament also introduced a number of additional provisions, which include:

• a definition of “mobility poverty”, referring to households that have high transport costs or limited access to affordable public or alternative modes of transport required to meet essential socio-economic needs;

• a definition of “energy poverty”, referring to poverty affecting households in the lowest income deciles, including lower middle-income households that have a significant share of energy expenditure to disposable income, and including, as a result of low-quality housing, arrears on utility bills due to financial difficulties, or limited access to essential and affordable energy services that underpin a decent standard of living and health, including adequate warmth, cooling, lighting, and energy to power appliances; and

• link to the rule of law, in order to benefit from EU funds.

Stakeholders react: insufficient funding and limited impact on decarbonisation

Several stakeholders have voiced their position on the compromise. For example, Carbon Market Watch argues that despite some breakthroughs and improvements on the original Commission draft, such as limiting the ability of companies to shift the cost of pollution permits on to consumers and ensuring that all ETS II revenues will be used to finance the Social Climate Fund, the reformed EU ETS will still not slash emissions deeply enough or fast enough to keep global heating within the 1.5°C limit. On the downside, the system only applies to commercial vehicles and buildings until 2029, which means that for the remainder of the decade, three-quarters of emissions from vehicles and buildings will be exempted. This will slow down progress in decarbonising these sectors. While it is important to protect vulnerable people from experiencing increased energy poverty, there is no reason not to have included wealthier households and used the revenue to help poorer households to switch to renewables, according to the Carbon Market Watch. WWF also reacted to the compromise. In its view, carbon pricing can play a role to reach the necessary emission reductions in transport and buildings, but it is critical for this to be embedded in a range of policies, including a transformative Social Climate Fund, public investments, and high regulatory ambition. “It is important to protect vulnerable citizens from an unfair burden, particularly in the midst of this energy crisis. But the deal struck today leaves a gap in the investment support that households can expect to receive, and therefore a gap in emission reductions of buildings and transport. This needs to be filled with other measures, including massive public investments in heat pumps, district heating and deep renovations,” said Jonathan Packroff, Climate and Energy Policy Assistant at the WWF European Policy Office. 

The European Trade Union Confederation (ETUC) highlights that the Commission should significantly increase the size of the Social Climate Fund while abandoning the idea of creating a second ETS on road transport and buildings. On the contrary, the European Public Service Union (EPSU) welcomed the suspension of the application of the ETS II to private households by 2029. They also agree on the approach of making a further extension of the system contingent on the impact assessment that will determine the inclusion of private households. However, they highlight their disappointment in the drastic cut to the Social Climate Fund down to €16 billion, from the original €72 billion envisaged. According to EPSU, this is wholly inadequate for the challenge ahead. At the same time, the International Road Transport Union (IRU) describes the Parliament’s compromise as unfit for purpose. According to them, including 35 million commercial vehicles in the scope of ETS II while excluding 300 million private vehicles will deprive it of any real impact. Without the majority of road users included, from a financial perspective, the setting-up and administration of the ETS II will be an inefficient and costly exercise for the EU, which will result in limited proceeds collected for the funding of the EU climate goals.

Next steps

The European Parliament will have its final vote at the plenary session on 6–9 June 2022 after which the Parliament will be ready to start negotiations with the Member States in the Council. The final decision on ETS II, its design and budget will depend on the outcome of the negotiations with EU governments.