What do the reforms of the EU emissions trading system and the Social Climate Fund mean?

The EU’s Member States – under the lead of the Swedish Presidency – have taken one step closer towards the formal adoption of important climate legislation of the ‘Fit for 55’ package that will further reduce emissions and address their social impacts.

This step towards putting ‘Fit for 55’ into action was taken at an ambassadors’ meeting on 8 February.

How does the EU’s emission trading system work?

The EU’s emissions trading system (EU ETS) is one of the world’s largest and most successful carbon markets and the EU’s key tool for reducing greenhouse gas emissions through carbon pricing. Every year, entities covered by the ETS must buy and subsequently surrender allowances corresponding to their greenhouse gas emissions.

In the beginning of each trading period (the current one being 2021-2030), a cap is set to limit how many allowances are put on the market for each year; that cap then decreases with every passing year by means of the so-called linear reduction factor (LRF). This creates financial incentives for companies to reduce emissions by adopting new technologies or in other ways making their production processes cleaner and more efficient, [thereby reducing the cost of purchasing emission allowances]. Certain sectors that are particularly exposed to the risk of ‘carbon leakage’, such as cement, receive allowances to ensure production is not moved to countries with less ambitious climate policy.

Which sectors are currently covered?

The EU ETS covers approximately 10 000 installations in sectors such as electricity and heat generation, energy-intensive industry (e.g., oil refineries, steel industry, cement, glass, and paper production). The scheme also applies to commercial aviation.

How does the EU ETS contribute to the EU’s 2030-climate target and goal of climate neutrality?

The EU ETS covers around 40% of total EU emissions and has already proved to be the key tool for emissions reduction. Since its introduction in 2005, EU emissions have been cut by 41% in the sectors covered. The reform will result in further emissions reductions, bringing the EU closer to climate neutrality and contributing to the EU’s emission reduction objectives under the Paris Agreement. It will also contribute substantially towards achieving the EU’s 2030 climate target to reduce emissions by at least 55% compared to 1990’s levels.

What will change with the reform of the ETS?

Most importantly, the reform sets out a more ambitious emissions reduction goal for the sectors covered by 2030 from the current -43% to -62% (compared to 2005 levels). This is achieved by a so-called split rebasing (reduction) of the emission cap by approximately 117 million allowances as well as a revised LRF of 4.3% (2024-2027) and 4.4% (2028-2030) instead of the current 2.2%.

Further, the ETS will be extended to the maritime transport through a gradual phase-in between 2024 and 2026.

In parallel, free allowances for certain sectors will gradually be phased out in light of the phase-in of the Carbon Border Adjustment Mechanism. In order to support innovation in breakthrough technologies key for the green transition, the Innovation Fund, one of the world’s largest, will be further increased.

Another key aspect of the reform includes the introduction of a new, separate emissions trading system for buildings, road transport and certain additional sectors (such as process heating for small-scale industry). This new ETS is set to become operational in 2027, provided the so-called “emergency brake” is not triggered. It will require fuel suppliers to purchase and surrender emission allowances, similar to the main ETS. This new policy instrument will further facilitate the achievement of Member States’ national emission reduction targets while also providing an additional source of revenue to decarbonise the sectors.

What is the Social Climate Fund?

The Social Climate Fund is a new tool to financially support people and small businesses most impacted by the introduction of the new emissions trading system for buildings and road transports. Up to €65 billion will be allocated to the fund that will run over the years 2026-2032.

The fund will help tackle energy poverty and improve access to zero- and low-emission mobility and transport in the EU. It is estimated that over 34 million people in the EU live in energy poverty. The introduction of the Social Climate Fund will benefit vulnerable households, micro-enterprises, and transport users.

How will the fund work?

As part of the ‘Fit for 55’ legislative package, a new emissions trading system for buildings, road transport and fuels for additional sectors will be created. The emission trading system assigns fossil fuels for road transport and heating with a carbon price. Companies selling fuels need to buy allowances at the carbon price for the emissions caused by running their business.

Some of the revenues from the sales of these allowances are put into the Social Climate Fund and can be used by member states to help vulnerable households, micro-enterprises, and transport users. The fund may help to reach climate goals through supporting energy efficiency and the uptake of zero- and low-emission vehicles.

Through the Fund, member states are allowed to finance measures and investments for increasing the energy efficiency of buildings, building renovation, the decarbonisation of heating and cooling in buildings, and the uptake of zero- and low-emission mobility and transport. Measures providing temporary and limited direct income support can also be financed via the Social Climate Fund. Member states are going to co-finance 25% of the total cost of the fund.

Timeline of the legislative process

The EU Commission proposed a reform of the EU ETS and the implementation of the Social Climate Fund in July 2021 as part of the ‘Fit for 55’ package. The proposals were negotiated under the Slovenian and French Presidencies, and the Council reached general approaches in June 2022. Provisional agreements between the Council and the European Parliament were reached in December 2022 under the Czech Presidency.

During the first month of 2023, the Swedish Presidency has worked intensively with overseeing the final steps of the provisional political agreements with the European Parliament, translating them into consolidated legal texts. The texts were finally presented to and endorsed by the EU member states’ ambassadors on 8 February. The endorsed texts will be formally adopted by Member States later this spring, following the adoption by the European Parliament.

Putting ‘Fit for 55’ into action and speeding up the green and energy transitions are among the Swedish Presidency’s main priorities. Several important files within the ‘Fit for 55’ package remain, not least in the areas of energy and transportation.