Current legislative intentions regarding emissions trading for the buildings and road transport sectors envision an introduction of a separate but adjacent to the EU ETS emissions trading system. 

         
          
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This is to avoid disturbances of the well-functioning emissions trading system for stationary installations and aviation, given the different reduction potentials in those sectors and different factors that influence the demand.

 

Legislative drafts do not exclude possible merger of the two trading systems, nevertheless reserve that it should be assessed only after a few years of the functioning of the new emissions trading, and based on information and collected market experience.

 

The inherent and distinctive feature of the design presently on the table is an upstream approach to regulated entities in the buildings and road transport sectors.

 

According to the European Commission in its Communication of 14 July 2021 ('Fit for 55': delivering the EU's 2030 Climate Target on the way to climate neutrality, COM/2021/550 final) system will be focused on upstream fuel suppliers, putting the responsibility on fuel producers to comply with the system, rather than requiring individual households or road transport users to take part directly.

 

The Commission proposes to start emissions trading - at the EU level (for example, Germany has its own carbon pricing system for transport and buildings) - in the sectors of road transport and buildings from 2026.

 

Hence, emissions will be capped, with the cap reduced over time so that total emissions fall.

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EU ETS and transport - Fit for 55: European Commission proposal of 14 July 2021


Road

• Extension of the ETS to road transport and building fuels from 2026
• Focus on upstream fuel suppliers (rather than households and car drivers)
• Revenues to be channelled to support vulnerable households and investments in cleaner mobility


Aviation

• Tighter cap on the number of allowances for intra-EU flights, starting from current levels and reduced by 4.2 % annually
• Full phase-out of free allowances by 2026
• Extra-European flights to be subject to offsetting under the international CORSIA scheme


Maritime

• Gradual extension of the ETS to maritime starting in 2023, with a 3-year phase in period
• Focus on large ships (above 5000 gross tonnage) accounting for 90 % of CO2 emissions
• Intra-EU traffic and 50 % of extra-EU voyages covered by the scheme

 

The reasons behind the proposal are that the EU ETS directly or indirectly covers only around 30% of buildings emissions from heating (this is related to the system’s coverage of district heating and electricity used for heating purposes).

 

Covering all emissions of fossil fuel combustion in this sector and integrating them in the EU emissions trading would present, in the European Commission's opinion, important benefits in terms of effectiveness of emissions reduction.

 

Key features of the future scheme are presented in the Proposal for a Directive of the European Parliament and of the Council amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union, Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and Regulation (EU) 2015/757 (COM(2021) 551 final, 2021/0211 (COD)), see the table below.

 

Act that triggers the compliance obligation Recital 45 


The act that triggers the compliance obligation under the new emissions trading should be the release for consumption of fuels which are used for combustion in the sectors of buildings and road transport, including for combustion in road transport of greenhouse gases for geological storage.


To avoid double coverage, the release for consumption of fuels which are used in other activities under Annex I to Directive 2003/87/EC should not be covered.

 
Greenhouse gas emissions permit requirements  Recital 47 


The regulated entities falling within the scope of the emissions trading in the sectors of buildings and road transport should be subject to similar greenhouse gas emissions permit requirements as the operators of stationary installations.

 

In order for the new system to start in an orderly manner, Member States should ensure that regulated entities falling within the scope of the new emissions trading have a valid permit as of the start of the system in 2025.

 

Linear reduction factor (LRF) Recital 48

 

The total quantity of allowances for the new emissions trading should follow a linear trajectory to reach the 2030 emissions reduction target, taking into account the cost-efficient contribution of buildings and road transport of 43 % emission reductions by 2030 compared to 2005.

 

The total quantity of allowances should be established for the first time in 2026, to follow a trajectory starting in 2024 from the value of the 2024 emissions limits (1 109 304 000 CO2t), calculated in accordance with Article 4(2) of Regulation (EU) 2018/842 of the European Parliament and of the Council on the basis of the reference emissions for these sectors for the period from 2016 to 2018.

 

Accordingly, the linear reduction factor should be set at 5,15 %.

 

From 2028, the total quantity of allowances should be set on the basis of the average reported emissions for the years 2024, 2025 and 2026, and should decrease by the same absolute annual reduction as set from 2024, which corresponds to a 5,43 % linear reduction factor compared to the comparable 2025 value of the above defined trajectory.

If those emissions are significantly higher than this trajectory value and if this divergence is not due to small-scale differences in emission measurement methodologies, the linear reduction factor should be adjusted to reach the required emissions reduction in 2030.

 

Allocation method  Recital 49

 

Both the buildings and road transport sectors are under relatively small or non-existent competitive pressure from outside the Union and are not exposed to a risk of carbon leakage.

Therefore, allowances for buildings and road transport should only be allocated via auctioning without there being any free allocation.

 

Rules on validity, transfer, surrender and cancellation of allowances Recital 55

 

Regulated entities should surrender allowances for the first time for their verified emissions in 2026.

 

In order to minimise the administrative burden, a number of rules applicable to the existing emissions trading system for stationary installations and aviation should be made applicable to emissions trading for buildings and road transport, with the necessary adaptations.

 

This includes, in particular, rules on transfer, surrender and cancellation of allowances, as well as the rules on the validity of allowances, penalties, competent authorities and reporting obligations of Member States.

 

Monitoring/Reporting

(MRV)

Recital 56

 

Emissions should be attributed to regulated entities on the basis of fuel quantities released for consumption and combined with an emission factor.

 

Regulated entities should be able to reliably and accurately identify and differentiate the sectors in which the fuels are released for consumption, as well as the final users of the fuels, in order to avoid undesirable effects, such as double burden.

 

To have sufficient data to establish the total number of allowances for the period from 2028 to 2030, the regulated entities holding a permit at the start of the system in 2025 should report their associated historical emissions for 2024.

 

 

 

According to the draft Annex III to the EU ETS Directive activities covered by the projected Chapter IVa of the Directive with respect to carbon dioxide (CO2) are: “release for consumption of fuels which are used for combustion in the sectors of buildings and road transport”.

 

The exclusions cover:
“(a) the release for consumption of fuels used in the activities set out in Annex I to this Directive, except if used for combustion in the activities of transport of greenhouse gases for geological storage (activity row twenty seven);
(b) the release for consumption of fuels for which the emission factor is zero”.

 

The said draft Annex III also explains that the sectors of buildings and road transport “correspond to the following sources of emissions, defined in 2006 IPCC Guidelines for National Greenhouse Gas Inventories, with the necessary modifications to those definitions as follows:

(a) Combined Heat and Power Generation (CHP) (source category code 1A1a ii) and Heat Plants (source category code 1A1a iii), insofar as they produce heat for categories under (c) and (d) of this point, either directly or through district heating networks;

(b) Road Transportation (source category code 1A3b), excluding the use of agricultural vehicles on paved roads;

(c) Commercial / Institutional (source category code 1A4a);

(d) Residential (source category code 1A4b)”.

 

 

Point of regulation

 

 

The point of regulation is a key issue in establishing the new ETS as it refers to the obligated party or the entity to whom the emissions are attributed.

 

In the current EU ETS, the point of regulation are industrial and energy installations, as well as aircraft operators, i.e. the emitters themselves.

 

Such approach is not feasible for the new ETS given the large number of small emitters in the road transport and buildings sectors (many of which are private persons).

 

As the European Commission argues, an upstream approach is more adequate, whereby not the emitters themselves but entities further up the supply chain, significantly smaller in number than the emitters, are regulated.

 

The act that triggers a compliance obligation under the new ETS would then be the putting on the market of fuels for combustion in the covered sectors.

 

As in the current EU ETS, regulated entities would need to have a permit under the new ETS for the activity that triggers a compliance obligation.

 

Regulated entities in an upstream system must be able to monitor and report accurately, per type of fuel, the fuel volumes put on the market.

 

The regulated entity must be able to distinguish energy flows for road transport and buildings from other energy flows.

 

The regulated entity therefore needs to know the end-use of the fuel, that is, whether the fuel is used in road transport and/or it is used in buildings.

 

In order to avoid double coverage, the regulated entity therefore should be able to distinguish fuels for use by installations already covered by the EU ETS from those to be used by entities not covered by the EU ETS - otherwise alternative solutions (such as compensation mechanisms) should be foreseen.

 
Moreover, as follows from Recital 46 of the draft Regulation, to properly set up the point of regulation the infrastructure of the excise duty established by the Council Directive (EU) 2020/262 of 19 December 2019 laying down the general arrangements for excise duty is going to be used - "with the necessary adaptations".

 

The said Directive already sets a robust control system for all quantities of fuels released for consumption for the purposes of paying excise duties. 

 

End-users of fuels in those sectors are not intended to be subject to the new obligations.

 

Compliance system

 

 

At this stage of legislative train the preferable option for the new ETS is to mirror analogous, existing compliance system for stationary industrial installations and aircraft operators.


The European Commission argues that such a move has numerous advantages, in particular:
- the administrative authorities could benefit from their experience in managing EU ETS,
- significant savings can be attained as regards administrative burden and capacity building matters.

 

Considerable option that might materialise in the future is also to link the existing ETS to the new created ETS. In such a case both systems’ similarities will bring further benefits.

Hence, it can be expected that the emissions trading system for road transport and buildings will reflect the existing EU ETS compliance cycle, which, in short, is based on the following main principles:
- stationary industrial installations and aircraft operators covered by the current EU ETS report their annual CO2 emissions, which have been monitored based on a the monitoring plan;
- the monitoring plan is submitted to the national competent authorities together with the operating permit;
- the approved monitoring plan must be used by the operator to monitor CO2 emissions during the year;
- operators report on their emissions once a year through the submission of a verified emissions report;
- on the basis of this report, an operator must surrender an equivalent number of emission allowances, every year by 30 April;
- any regulated entity who does not surrender sufficient allowances by 30 April of each year to cover its emissions during the preceding year is liable for the payment of an excess emissions penalty;
- the excess emissions penalty is at present 100 euros for each tonne of carbon dioxide equivalent emitted for which the operator has not surrendered allowances;
- payment of the excess emissions penalty do not release the operator from the obligation to surrender an amount of allowances equal to those excess emissions when surrendering allowances in relation to the following calendar year.

 

As regards to Registry, the new ETS would in principle be implemented and operated through the Union Registry.

 

 

Monitoring, reporting and verification (MRV)

 

 

The extension of an emissions trading system to new sectors will require the design and the establishment of a new monitoring, reporting and verification (MRV) system, which accurate, reliable and cost-effective.

 

According to the European Commission, in view of a possible future integration of the new ETS with the current EU ETS, it makes sense to design the MRV system along the same lines as the one existing for the current EU ETS.

 

As a starting point, the new MRV system would need to comply with the principles of transparency, accuracy, consistency, comparability and completeness (as also stated in the current EU MRV framework.

 

The MRV system will be important for the proper functioning and credibility of the new ETS, but also to collect adequate information for the re-assessment of the cap.

 

Under the EU ETS, the procedure of monitoring, reporting and verification consists of the following: EU ETS operators are required to have an approved monitoring plan for monitoring and reporting annual emissions (this plan is part of the permit to operate). Further, every year, operators must submit an emissions report, the data for a given year must be verified by an accredited verifier by 31 March of the following year. Based on verified emissions, operators must surrender the equivalent number of allowances by 30 April of that year, in the absence of which they face penalties (penalties will also be applied in case of errors or incompleteness in the emission reports).

 

Under an upstream ETS, the regulated entities (which are not the emitters themselves as in the current EU ETS) must also be able to monitor and report, per type of fuel, the fuel volumes put on the market.

 

They must know, in particular, to the extent necessary, the end use of the fuel to determine whether the fuel volumes put on the market are captured within the scope of the new ETS.

 

However, emissions will determined indirectly via fuel quantities put on the market, hence monitoring and reporting rules could be simpler than those applying to the current sectors.

 

In the new sectors, only sales of largely standardised fuels for combustion purposes would be monitored.

 

The new MRV system would also share some similarities with the MRV applicable to aviation both in terms of costs and obligations.

 

Assesment of impacts

 

 

An extension of emission trading to road transport and buildings is estimated to increase by more than 100% the number of regulated entities under the current EU ETS framework.

 

However, it is also expected that the complexity of the MRV rules for the new regulated entities will be lower, as only sales and distribution of largely standardized fuels for combustion purposes would be monitored.

 

This corresponds to only one activity, but it is a new kind of parameter that, as the European Commission underlines in its impact assessment document, the competent authorities need to consider when delivering their administrative tasks and activities.


The said document also mentions that just over half of respondents were in disagreement with the inclusion of emissions from buildings or road transport in the current ETS (this is in contrast, for example, with the maritime sector, where the stakeholders were generally in agreement with the proposed inclusion in the current ETS.

 

Those opposing it had concerns relating to impacts on the competitiveness of the current ETS sectors by including sectors with high abatement costs and/or different price elasticities.

 

Concerns regarding the increased administrative burden from overlapping policies were also mentioned.

 

The main problem to address will be, however, the impact of rising heating or transport prices on consumers, especially for low-income households.

 

The widespread effect will be that the ETS inclusion would increase the price of every additional kilometre driven.

Finally, considering under the new emissions trading system a new type of allowances will be issued, an entire spectrum of other questions arises, in particular regarding:

- potential parallels to existing EUAs and EUAAs,
- admission of financial institutions to the new cap-and-trade system,
- qualification of the new emission allowances as financial instruments under MiFID II,
- VAT taxation.