The European Union is set to relax emissions-reduction rules for thousands of companies, recalibrating the world's most rigorous carbon market under pressure from industry and governments concerned about the region's sinking competitiveness.
Before a summit of EU leaders next week on strengthening the bloc's economy, talks are heating up on reforming the Emissions Trading System, a key tool to curb greenhouse gases. Less than three years after tightening the market in a green push, governments are ready to slow the pace of pollution cuts and consider measures that would alleviate industry costs, according to EU policymakers and diplomats with knowledge of the issue.
The details of the planned overhaul, which will impact supply and demand in the market, are due to be unveiled by the European Commission in the third quarter of this year and are expected to trigger intense negotiations among governments. Slovakia's Prime Minister Robert Fico has already called for a suspension of the ETS and his Czech counterpart Andrej Babis wants steps to curb price swings. Carbon futures fell as much as 4.6% on Thursday, to the lowest since Nov. 10.
“The EU narrative has shifted — from aspirational targets to implementation and execution, from idealism to pragmatism,” said Ingo Ramming, head of carbon markets at Banco Bilbao Vizcaya Argentaria SA in Madrid.
With the EU reassessing its long-standing partnership with the US, trying to stave off increasing competition from China and seeking to boost defense spending following the Russian invasion of Ukraine, the ambitious green transition has slipped down the political agenda. The broad consensus on climate action that prevailed five years ago has fractured, giving way to trade protectionism and policies that prioritize lowering energy costs.
While in December EU negotiators agreed a new interim goal to slash emissions by 90% by 2040 from 1990 levels, they also signaled that 10,000 installations in the ETS should have more time to decarbonize. That will avoid the caps dropping to zero in 2039 under the current design of the cap-and-trade system, one of the key guidelines for the forthcoming market reform.
‘Irresponsible' Attacks
“All the attacks on the ETS to destroy it or put it on hold are completely irresponsible,” Peter Liese, a German member of the EPP — the biggest political group in the EU Parliament — said in an interview. “But changes are needed and we can ease the pressure for companies without risking our climate targets.”
The commission declined to comment on the details of the overhaul.
The rising political sensitivity to carbon prices has been highlighted in the December talks on the 2040 climate goal, when the EU agreed to postpone the start of a new carbon market for road transport and heating fuels. The focus is now turning to preventing a spike in prices in the existing cap-and-trade program, where analysts see benchmark carbon contracts rising to as high as 400 euros ($472) per ton by 2040 compared with the current level of around 82 euros.
For Jos Delbeke, a former senior climate official at the commission and one of the architects of the ETS, the market should be part of a well-designed industrial policy that avoids “prohibitive” emissions prices.
“As market liquidity will shrink in line with the declining cap, the risk of price spikes may increase,” Delbeke, currently professor at the European University Institute in Florence, said in an interview.
His recommendations for the reform include managing the supply of allowances to moderate prices, with an option of creating an implicit price corridor, at least for analytical purposes. That would also involve fine-tuning a special tool that automatically adjusts the supply of permits in the market and recalibrating the pace of annual emission cuts.
System Overhaul
How fast emission caps will shrink in the coming years is determined by the Linear Reduction Factor, a key indicator that almost doubled to 4.3% from 2024 as part of the European Green Deal and is due to rise further to 4.4% starting in 2028. While some policymakers do not rule out lowering the factor before 2030, the legislative process of overhauling the system will take at least two years, limiting the choice of short-term measures to prevent price increases.
To remedy that, Delbeke said the EU could use about 370 million free allowances parked in a special buffer to hand them out to companies as support of low-carbon investments.
While most allowances in the market are sold at auctions, companies at risk or relocating their production to countries with laxer climate policies still get some permits for free. Their allocation is based on a system of emissions efficiency benchmarks, which rewards the cleanest producers. The commission, which is next due to publish revised benchmarks in April, is already under pressure from the chemical industry to freeze the indicators.
The issue of how many free permits emitters will get in the coming years is one of the biggest sticking points in the debate. It's also linked to the introduction of a carbon border tax, which will involve the EU gradually walking away from free allowances in the sectors covered. In the deal on the 2040 climate law in December, policy makers have already signaled they want the phaseout pathway to be slower.
European climate and energy policies are set to be among the issues discussed by the EU leaders at their informal gathering in Belgium on Feb. 12. During a meeting of ambassadors in the run-up to the summit, countries including Czech Republic, Hungary, Slovakia, Bulgaria, Romania and Poland signaled concerns that carbon prices undermine EU competitiveness, according to people with knowledge of the matter.
“If we don't change anything before 2030, some industries covered by the ETS may not see the day,” Krzysztof Bolesta, Poland's deputy climate minister, told Bloomberg News.
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