Call to European leaders: do not bury the ETS2

The European Parliament is currently working on the ‘Fit for 55’ package proposed by the Commission to reduce CO2 emissions by 40% in the current decade (that is -55% between 1990 and 2030), with the further objective of climate neutrality in 2050.

This package, the core element of the European Green Deal, is a consistent set of legislations that would achieve the EU’s climate goal in a rather fair and efficient way.

Simplifying a bit (see here for details on the Green Deal), the EU emissions are separated into two categories. The first category comprises large industrial installations (power plants, steel mills, cement factories, etc.): the 40% of EU emissions they represent are subject to an emissions trading scheme (ETS).

Their emissions are verified, and the cap on allowances (or emission permits) put into circulation each year ensures that industrial emissions do not exceed the planned values.

The second category contains all other CO2 emissions, which are currently not subject to an enforceable cap. The Commission aims to cap most of these other emissions through a second market of emission permits.

This second ETS, or ETS2, is the centrepiece of the Green Deal. It would cover 41% of EU emissions: those from road transport and buildings. Starting in 2026, permits would be auctioned to fossil fuels companies each year in line with the objective of emission reductions.

Companies would pass on the cost to consumers, who would thus be incentivised to reduce their fossil fuel consumption.

Auctioning revenues from the ETS2 shall entirely be used to protect vulnerable households, even though the EU would not decide by itself how the money is spent. Indeed, 75% of the revenues would directly accrue to the State where emissions occur, while the remaining 25% would flow into a Social Climate Fund, which will allocate it to the States.

The allocation key of the Social Climate Fund would be determined to approach a fairness principle: the same right to pollute for each European. In a nutshell, the Commission’s proposal is an efficient, fair, and binding way to achieve the emission reductions sought.

The Environment Committee of the European Parliament amended the reform of both ETSs (see the amendments, the detailed account by the deputy Michael Bloss or this longer version of our column where we comment on more amendments as well as the Effort Sharing Regulation).

It plans to reinforce the stringency of the existing ETS, extending it to new sectors (aviation, maritime, and waste) while increasing the amount of emission reductions. At the same time, the ENVI committee emptied the ETS2 from its substance through different amendments.

As a first step, the ETS2 would only apply to commercial usage (heavy-duty vehicles and commercial buildings), and would only be extended to private usage following a positive assessment by the Commission and a new legislative procedure.

Besides, the price of emission permits would be capped at 50€/tCO2 (i.e. +0.12€/L of gasoline) until at least 2030, and the deadline for surrendering them would be postponed as long as fuel prices are high (higher than in March 2022).

These amendments greatly undermine the goal of the ETS2, which is to ensure emission reductions in line with the target for transport and buildings. Indeed, the bulk of these sectors (households’ emissions) may never be covered, and even if they are, the provisions against high carbon or fuel prices may prevent the price mechanism to operate.

Let us recall that carbon pricing works precisely because it makes fuel prices rise, as this is what incentivises people and firms to change their equipment and decarbonise their consumption.

Cambridge econometrics (2021) and the Polish Economic Institute (2021) estimate the price needed to meet the climate targets at no less than 150€/tCO2 in 2030 while in official guidelines used by the French administration (Quinet, 2019), it is estimated at 54€/tCO2 in 2018; 250€ in 2030; 500€ in 2040, and 750€ in 2050.

Needless to say, with a price capped at 50€/tCO2, and given that many States do not have national carbon prices (and that taxes on heating fuels are sometimes quite low), we might fail to achieve the emission reductions needed.

Why did the ENVI committee adopt these amendments? We understand that, amidst record-high fuel prices, legislators are reluctant to pass measures that would raise fuel prices even more. But keep in mind that the ETS2 would only start in a few years.

Also, States can, should, and will take complementary measures to help people and firms decarbonise their consumption (public investments in public transport and railroads, subsidies for the thermal renovation of buildings, stricter standards on the CO2 emissions of new cars…).

By reducing emissions through other means, these measures reduce the need to incentivise people through the carbon price, i.e. they reduce the carbon price. If these measures are sufficient to reach the emission target, the carbon price will simply be zero.

The ETS2 is here to provide a guarantee that emission reductions will be met, by pricing emissions in case the complementary measures are not enough.

To sum up, we urge the Members of the European Parliament (MEP) and the Council to stick to the Commission’s vision for the ETS2 and reject any amendment that threatens the planned trajectory of emission reductions.

Our objections would be alleviated if the Parliament proposed alternative measures to guarantee emission reductions equivalent to the ETS2. But we are afraid it will not be the case.

We do share the concerns of MEPs that households should be given enough time and resources to adapt. To that goal, the ENVI committee already included a provision to fund low-carbon alternatives for transport and heating early on, so that people can change their habits and equipment in anticipation of the future carbon price.

In addition to funding low-carbon alternatives, the MEPs could also require that the auctioning revenues be redistributed as cash transfers to households.

This would ensure that low-income households gain financially from the reform (this well-known effect comes from the fact that low-income households consume less fossil fuels than average; cf. Figure 13 in Gore, 2022 for simulation of redistributing all ETS2 revenues as cash transfers) — low-income households would then gain even further when the carbon price rises. 

The ETS2 would provide the best guarantee to meet the EU’s climate target while equitably sharing the efforts between Member States. The extension of the ETS2 to households’ transport and heating fuels should not be left to the whims of a future legislative procedure.

Households’ emissions should be covered from the start, as the ETS2 is designed for applying the carbon price to refineries and importers, not consumers (yet the latter would be needed if households and commercial consumers need to be distinguished).

Finally, the provisions to avoid high prices should be lifted, and if the price ceiling is retained, it should be high enough (say, 300€/tCO2 in 2035) and increasing in time. Indeed, we all want to cap emissions, not the energy transition. 

Signatories (in alphabetical order):

1. Lucas Bretschger, professor of economics at ETH Zürich

1. Éric Chaney, economic advisor at Institut Montaigne

1. Maxime Chambonnet, activist at Oxfam

1. Mireille Chiroleu-Assouline, professor of economics at the Paris School of Economics and University Paris 1 Panthéon-Sorbonne

1. Thomas Douenne, assistant professor of economics at the University of Amsterdam

1. Adrien Fabre, post-doctoral researcher at ETH Zürich

1. Christian Flachsland, professor of economics at the Hertie School

1. Jean-Michel Glachant, energy economist, president of the Internaitonal Association of Energy Economists

1. Christian Gollier, professor of economics at Collège de France and Toulouse School of Economics

1. Théo Konc, post-doctoral researcher at TU Berlin and PIK Postdam

1. Linus Mattauch, assistant professor of economics at TU Berlin

1. Luisa Neubauer, activist at Fridays for Future

1. Christian de Perthuis, professor of economics at the Université Paris-Dauphine

1. Agustín Pérez-Barahona, professor of economics at CY Cergy Paris Université and École Polytechnique

1. Grischa Perino, professor of economics at Universität Hamburg

1. Antoine Pietri, activist at Lobby Climatique Citoyen – CCL France

1. Armon Rezai, professor of economics at Wirtschaftsuniversität Wien

1. Francesco Ricci, professor of economics at Université de Montpellier

1. Sidonie Ruban, president of Lobby Climatique Citoyen – CCL France (President)

1. Katheline Schubert, professor of economics at the Paris School of Economics and Université Paris 1 Panthéon-Sorbonne, member of the French Council of Economic Advisors

1. Ingmar Schumacher, professor of economics at IPAG Business School

1. Julia Steinberger, professor of ecological economics at Université de Lausanne

1. Thomas Sterner, professor of economics at University of Gothenburg

1. Rick Van der Ploeg, professor of economics at University of Oxford

1. Gernot Wagner, professor of economics at Columbia Business School

1. Cees Withagen, professor of economics at Vrije Universiteit Amsterdam

Future Thought Leaders is a democratic space presenting the thoughts and opinions of rising Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem. This article has also been published on ​Euractiv and Le Monde.