Emissions trading for road transport and buildings
- Category: European Union Carbon Market Glossary
The legislative set-up regarding emissions trading for the buildings and road transport sectors introduces a separate but adjacent to the EU ETS emissions trading system.
16 May 2023
Directive (EU) 2023/959 of the European Parliament and of the Council of 10 May 2023 amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union and Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading system published in the EU Official Journal
A new, separate emissions trading system for the buildings, road transport and additional sectors (mainly small industry) has been established, in order to ensure cost-efficient emissions reductions in these sectors, which have thus far proven difficult to decarbonise. The new system will apply to distributors that supply fuels to the buildings, road transport and additional sectors from 2027. A safeguard has been put in place whereby if the price of oil and gas are exceptionally high in the run up to the start of the new system, this will be postponed until 2028.
18 December 2022
The co-legislators agreed that the system will start in 2027. The emissions reduction trajectory and the linear reduction factor was set at 5.10 from 2024 and 5.38 from 2028. The Council and Parliament agreed to auction an additional 30% of the auction volume for the first year of the launch of the system, so that it runs smoothly (“frontloading”).
The agreement extends the scope of the system to fuels used in certain industrial sectors. As a consequence, it has been agreed to increase the size the Social Climate Fund correspondingly.
The co-legislators agreed on a temporary possibility for member states to exempt suppliers from surrendering allowances until December 2030, if they are subject to a carbon tax at national level, the level of which is equivalent to or higher than the auction price for allowances in the new emission trading system.
There will be a simplified monitoring reporting and verification requirements for small fuel suppliers.
In case the energy prices will be exceptionally high, the start of the new ETS will be delayed until 2028.
Once the system has started if the price of allowances exceeds 45 EUR over a certain period of time, additional allowances will be released increasing the supply on the market.
14 July 2021
Commission Communication 'Fit for 55': delivering the EU's 2030 Climate Target on the way to climate neutrality, COM/2021/550 final
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), Recitals 43 - 51, 55 - 59, Article 1(21) adding Chapter IVa
Questions and Answers - Sustainable transport, infrastructure and fuels
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.
Directive (EU) 2023/959
Emissions trading in the buildings, road transport and additional sectors will start in 2025.
During the first years, the regulated entities will be required to hold a greenhouse gas emissions permit and to report their emissions for the years 2024 to 2026. Regulated entities must have a valid permit as of the start of the system in 2025.
The issuance of allowances and compliance obligations for those entities will be applicable as from 2027.
Regulated entities are required to surrender allowances for their verified emissions corresponding to the quantities of fuels they have released for consumption (combined with an emission factor).
The deadline for transposing the provisions relating to the emissions trading system for the buildings, road transport and additional sectors is 30 June 2024, as the rules on monitoring, reporting, verification and permitting for those sectors apply from 1 January 2025.
As an exception, Member States must transpose the obligation to report on historical emissions for those sectors by 31 December 2023, as that obligation relates to the emissions in the year 2024.
The inherent and distinctive feature of the design tabled in 2021 was an upstream approach to regulated entities in the buildings and road transport sectors.
According to the European Commission 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) the system was intended to 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 proposed 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.
EU ETS and transport - Fit for 55: European Commission proposal of 14 July 2021
• Extension of the ETS to road transport and building fuels from 2026
• Tighter cap on the number of allowances for intra-EU flights, starting from current levels and reduced by 4.2 % annually
• Gradual extension of the ETS to maritime starting in 2023, with a 3-year phase in period
The reasons behind the proposal were 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 scheme were 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
|Greenhouse gas emissions permit requirements
|Recital 47, 56
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 and should report their associated historical emissions for 2024.
|Linear reduction factor (LRF)
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.
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
Regulated entities should surrender allowances for the first time for their verified emissions (corresponding to the quantities of fuels they have released for consumption) in 2026.
/Note that the said year 2026 has been substituted by the year 2027 by the Directive (EU) 2023/959 - see recital 86 of the said Directive/
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.
Emissions will 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.
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.
Hence, finally the Directive (EU) 2023/959 of the European Parliament and of the Council of 10 May 2023 amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union and Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading system added the following definition of regulated entity in Article 3 of the EU ETS Directive:
"(ae) “regulated entity” for the purposes of Chapter IVa means any natural or legal person, except for any final consumer of the fuels, that engages in the activity referred to in Annex III and that falls within one of the following categories:
(i) where the fuel passes through a tax warehouse as defined in Article 3, point (11), of Council Directive (EU) 2020/262 (*6), the authorised warehousekeeper as defined in Article 3, point (1), of that Directive, liable to pay the excise duty which has become chargeable pursuant to Article 7 of that Directive;
(ii) if point (i) of this point is not applicable, any other person liable to pay the excise duty which has become chargeable pursuant to Article 7 of Directive (EU) 2020/262 or Article 21(5), first subparagraph, of Council Directive 2003/96/EC (*7) in respect of the fuels covered by Chapter IVa of this Directive;
(iii) if points (i) and (ii) of this point are not applicable, any other person that has to be registered by the relevant competent authorities of the Member State for the purpose of being liable to pay the excise duty, including any person exempt from paying the excise duty, as referred to in Article 21(5), fourth subparagraph, of Directive 2003/96/EC;
(iv) if points (i), (ii) and (iii) are not applicable, or if several persons are jointly and severally liable for payment of the same excise duty, any other person designated by a Member State".
End-users of fuels in those sectors are not intended to be subject to the new obligations.
The preferable option for the new ETS was 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 the Registry, the new ETS would in principle be implemented and operated through the EU ETS 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.
The European Commission impact assessment documents for the Fit for 55 legislative package are not definitive as regards the aforementioned dilemmas, however, some accents are already present. They allow for drawing some conclusions based on strong balance of probabilities. Hence, assuming the new trading system becomes reality, as planned, the following features of the emissions trading system for road transport and buildings can be expected:
- as per the very nature of a cap-and-trade system, emission allowances will be tradable;
- trading will not be limited to the regulated entities (i.e., those that have compliance obligations under the new system) but opened up also to other persons, both as regards primary trading at auctions and secondary trading), in particular financial intermediaries;
- new emission allowances will be classified as financial instruments under financial market legislation, in particular MiFID II Directive.
All the above assumptions follow from the main logical imperative that the possibility of a future linking of the new system with the existing EU ETS makes sense to design both constructive features along the same lines as for the existing ETS. Opening-up of the new trading system (including primary trading at auctions and secondary trading) also to financial institutions is necessary in order to ensure a proper price discovery process and sufficient liquidity in the market.
Also, entities with compliance obligations under the new system need possibilities to hedge against price fluctuations, and will therefore need access to financial products that allow such hedging. Classification of emission allowances as financial instrument under financial market legislation is, in turn, necessary to ensure a safe and efficient trading environment and robust oversight regime for the new type of allowances.
To conclude, it is highly probable that the new emissions trading system will be set up under the umbrella of Directive 2003/87/EC, which will involve one more important consequence: the application of the VAT reverse charge mechanism to transfers of the new type of allowance.
Outcome of the legislative process
On 16 May 2023 the Directive (EU) 2023/959 of the European Parliament and of the Council of 10 May 2023 amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union and Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading system has been published in the EU Official Journal.
New rules introduced in Directive 2023/959, besides the extension of the scope of the existing EU ETS (ETS 1) to maritime transport, include the introduction of a new and separate emissions trading system for buildings, road transport and additional sectors (ETS 2).
With the new Chapter IVa of Directive 2003/87/EC, a new ETS 2 is established as an upstream separate system from ETS 1. Allowances for buildings, road transport and industrial facilities under the ETS 2 will only be allocated via auctioning.
Due to the need of the regulated entities to hedge or buy ahead allowances to mitigate their price and liquidity risk, a higher amount of allowances will be auctioned early on. In 2027, the auction volumes will therefore be 30 % higher than the total quantity of allowances for 2027 (Recitals 81 and 82 of Directive (EU) 2023/959).