The EU ETS for Road Transport and Buildings - a step on the pathway to zero emissions.

The scope

In December 2022, during internal EU negotiations between European institutions on the ETS reform necessary to implement the Fit for 55 package, the EU Council, the European Parliament, and the Commission reached an initial agreement on, among other issues, the setting up of a new emissions trading scheme, separate from the current EU ETS (ETS1) and covering GHG emissions from fuels used in the road transport, buildings and in other sectors. The new emissions trading system has been referred to as either the BRT ETS (the proposed abbreviation coming from ?Buildings and Road Transport”, BRT) or the ETS2, to distinguish it from the EU ETS for industrial installations, the ETS1. It seems that the term ETS2 will gain currency as more appropriate and easier to remember. It will cover all public and private buildings (housing, services, retail and industrial buildings below the ETS1 threshold) that use fossil fuels for heating and hot water as well as emissions resulting from road transport. On top of that, emissions from combusting fuels in sectors other than that of road transport, for example, emissions from heavy machinery used in construction will also be included. The Commission proposed to include almost all vehicles with combustion engines. During negotiations it was agreed that agricultural machinery, fishing boats and train engines will be exempt in the first phase of the ETS2, leaving effectively agriculture, fishing and rail transport outside of the scheme. ETS2 is going to function separately from ETS1. However, the linking of both systems in the future has not been ruled out.

ETS2 Participants and its effective date of entry into force

In the ETS1, the entities participating in the scheme and subject to monitoring, reporting, and verifying emissions are the operators of the installations that are the source of the emissions. However, the entities participating in ETS2 will not be the end users of cars, road machinery, construction machinery, or users of boilers and central heating furnaces, stoves, and ovens. These will be fuel suppliers. In the process of shaping the ETS2 system, various ways of imposing charges resulting from emissions (downstream/midstream/upstream approach) were considered. Ultimately, the average European will feel the entry into force of ETS2 through changes in the prices of fossil fuels that he will use after 2027, and changes in the prices of goods and services, which will be affected by the launch of this system from January 1, 2027. It will thus pay not only for the emissions generated in the ETS1 but now additionally in connection with the introduction of ETS2. The compromise reached in the course of the Trialogue[1] postpones the entry into force of the new system by 1 year (now it will enter into force from 2027) compared to the original EC proposal but is 2 years earlier than the EP deadline for launching ETS2 (from 2028. It was also agreed that in the event of exceptionally high energy prices in the Member States, the launch of the new system would be delayed for an additional year, i.e. until 2028. ETS2 participants will start monitoring and reporting the level of fuels placed on the market as early as 2024. For small fuel suppliers, these requirements will be simplified. In the first year of ETS2's operation, an additional 30% of the planned volume of emission allowances will be auctioned, which is to help stabilize the prices of allowances. If, on the other hand, the price of allowances exceeds EUR 45 within a certain period of time, additional allowances will be released, increasing supply on the market.[2] An intervention mechanism in the form of the Social Climate Fund was also adopted.

Linking ETS2 to other emission abatement measures in the sectors covered by the trading scheme

The Commission proposal includes calculations showing that by 2030 ETS2 will reduce emissions in the sectors covered by this system by 45% compared to 2005. At the same time, this is the objective to be achieved through the implementation of this system. Interestingly, EU Member States will have the option to temporarily exclude fuel suppliers from ETS2. As part of the Trialogue agreement, temporary exemptions from the surrender of allowances in the period up to December 2030 were allowed to fuel suppliers, if at the national level, they are subject to a carbon tax the level of which is equal to or exceeds the auction price of allowances in the new ETS. However, a carbon tax is a less flexible instrument than emissions trading, so in practice, this would probably mean a permanently higher markup on fuel prices. On the other hand, a carbon tax would mean greater predictability and stabilization of fuel prices. It is therefore possible that some Member States will opt for this solution.

Why is the EU implementing ETS2?

ETS2 should be seen in the context of the objective that the EU has set itself in its Communication on the European Green Deal and had it validated in climate law. This goal is to achieve zero emissions by 2050 and afterward, the EU will pursue negative emissions, i.e. capturing CO2 from the atmosphere. According to calculations provided by the European Commission, buildings are responsible for 40% of energy consumption and 36% of greenhouse gas emissions in the EU as a whole.[3] Without the decarbonisation of buildings, the zero-emission goal will not be achieved. Road transport, which currently accounts for 1/5 of EU emissions[4], must also become zero-emission in this context, and the sooner this happens, the greater the likelihood of the EU reaching the zero-emissions objective within the assumed deadline. Without decisive action at the EU level, which assumes the implementation of ETS2, and the strengthening of decarbonisation at the national level in these sectors, emissions from transport in the EU will increase until 2025, and planned reduction measures by 2030 will reduce emissions from this sector to only 9% above those in 1990.[5]

Moreover, according to the EEA, the actions currently planned by Member States, consisting mainly of promoting electric vehicles and incentivising (in some Member States) the use of other modes of transport, will reduce EU transport emissions in 2030 to 6% below 1990 levels. Therefore, these actions are completely insufficient to achieve the decarbonisation announced by the EU.

Promoting electric vehicles as a silver bullet to achieve zero-emission transport?

Electric vehicles are primarily considered to be zero-emission[6], although, taking into account the lifecycle emissions of such vehicles, as well as the share of RES in the production of electricity that these vehicles are powered by in individual Member States, defining them as zero-emission vehicles is a great simplification. However, due to the ongoing transformation of the electricity generation sector, it is the electrification of transport that will be strongly promoted in the coming years. Electric vehicles are recognised in the EU as the future of European mobility. Support for the uptake of electric vehicles goes hand in hand with measures to reduce emissions from vehicles with internal combustion engines. In June 2022, the EP backed the Commission's proposal to achieve zero-emission new cars and vans by 2035.  The next step towards adopting this target was the provisional agreement on the revision of CO2 emission standards for new cars and vans by the Council of the EU and the EP in October 2022, which supported the objective of achieving zero emissions of new cars by 2035.[7] Contrary to media reports, this does not mean a total ban on the production of new cars with internal combustion engines. The agreement also opens the door to maintaining the production of vehicles with internal combustion engines, provided that CO2-neutral fuels are implemented. Therefore, it should not be ruled out that the production of vehicles with internal combustion engines in Europe will continue after 2035, provided that zero-emission fuels for such cars come into use. It is also necessary to take into account the insufficient level of development of infrastructure allowing for the replacement of combustion cars with electric ones and the huge consumption of electricity that the transition to electric cars will entail and the related problems with the stabilization of the electricity network. In some countries, measures to reduce excessive energy consumption due to charging electric cars are to be implemented from 2024.

An intermediate step towards achieving zero-emission new cars will be to reduce the average emissions of new passenger cars by 55% by 2030 and of new vans by 50% compared to the average emissions of these vehicle categories in 2021. Companies producing fewer than 10,000 passenger cars a year will have an additional year to comply with the regulations. Small manufacturers, producing between 1,000 and 10,000 new passenger cars or 1,000 to 22,000 new vans per year, can apply for derogations until the end of 2035. Companies producing up to 1,000 new vehicles per year, such as luxury brands such as Ferrari and Lamborghini, will be completely exempt from meeting the requirements for reducing emissions from the internal combustion engine and zero-emission vehicles. Decarbonisation of transport requires not only a rapid reduction in the use of fossil fuels (oil and its derivatives, as well as LPG and CNG) and their final elimination but also actions to reduce emissions from electric cars throughout their life cycle. First of all, this means the need to decarbonize electricity production. Electric cars driving in countries such as France, where only 9% of electricity is produced from burning fossil fuels, have the lowest carbon footprint. A life-cycle emissions analysis commissioned by Reuters in 2021 found that a mid-size electric passenger car generates as much as 47 grams of CO2 per mile and more than 8.1 tonnes of CO2 before the vehicle reaches its first owner, during the process of extracting raw materials and producing the vehicle itself, while the production of a comparable car with an internal combustion engine generates only 32 grams of CO2 per mile and just over 5.5 tons of CO2 before being purchased by the first owner.[8] The same analysis also showed that in the worst-case scenario of using electricity produced entirely from burning coal, a vehicle with an electric motor will emit 4.1 tonnes of CO2 per year, and a comparable car with an internal combustion engine and the same mileage will emit about 4.6 tonnes of CO2 per year. The lifetime of both types of vehicles, which for an electric car is about 8-12 years, and a comparison of the costs of disposing of an electric car and its counterpart with an internal combustion engine should also be taken into account.

During the negotiations on the revision of CO2 emission standards for cars and vans, the EP proposed the adoption of a methodology for assessing and reporting life-cycle CO2 emissions data for cars and vans sold on the EU market. The EC will present this methodology by 2025, together with the relevant legislative proposals. By the end of 2025, the EC is also expected to present a report assessing progress towards zero-emission mobility, which will be updated every 2 years. It should be stressed that life-cycle greenhouse gas emissions will become increasingly important in assessing not only vehicles but also other sources of emissions.

The ban on the sale of new cars with internal combustion engines will not apply to the secondary market. Emissions from second-hand cars at the EU level, which will still be marketed and used after 2035, remain a problem for legislators and policymakers. These are the emissions that the ETS2 and other measures taken by Member States are intended to reduce in order to achieve their individual reduction targets. In this context, it is worth noting the planned review of progress towards achieving zero-emission vehicles, which the EC is to carry out by the end of 2025 and repeat every 2 years. The EC report will include an assessment of the impact of the measures on consumers and employment, an assessment of progress in energy efficiency, and information on the affordability of zero- and low-emission vehicles, as well as impacts on the second-hand market. The review of the information necessary for the preparation of the EC report will not only make it possible to assess the progress in achieving the assumptions of the regulation but will also allow for a possible change (increase in ambition) of the objectives. The deadline set is not accidental. In 2025, the EU and other Parties to the Paris Agreement will present new, updated Nationally Determined Contributions (NDCs), which by definition must be at least as ambitious as previous contributions under a number of successive COP/CMA[9] decisions taken after the entry into force of the Paris Agreement and should be increasingly ambitious. A significant increase in the ambition of the parties to the agreement is necessary to contribute to reducing the gap between the declared results of the parties' actions and the aggregate level of emission reductions necessary to achieve the objectives of the agreement. The adoption of an EU target of at least 55% emission reduction by 2030, legally sanctioned in European climate law, allows for another possible increase in the EU reduction target from the -57% by 2030 recently declared in Sharm el-Sheikh to an even higher level.

Decarbonisation of buildings

The strategy adopted to achieve the decarbonisation of buildings across the EU is similar to the strategy adopted to decarbonise transport. The inclusion of buildings in ETS2 is intended to accelerate the decision of the owners and tenants to move away from the use of boilers and central heating furnaces powered by coal, oil, and gas. Heat pumps are promoted as an alternative to fossil fuels, especially gas, which until recently seemed to be a transitional fuel. They need electricity to operate, providing yet another argument supporting the modernisation of the electricity grid and the development of microgrids and off-grid operation. On the other hand, an additional and key requirement for the decarbonisation of buildings is to achieve a significant reduction in energy demand in this sector. This is to be achieved through the implementation of the Renovation Wave Strategy and its Action Plan, announced by the EC in 2020. At the same time, the revision of the Energy Performance of Buildings Directive (EPBD) will accelerate the transition from requiring only near-zero emission buildings (NZEBs) from 2030 to only Zero Emission Buildings (ZEBs) that can only be used for heating and supplying RES sources. By 2027, 15% of the most emission-intensive non-residential buildings in each Member State must be upgraded to change their energy class from G to at least F, and by 2030 this condition must be met by 15% of the most energy-intensive residential buildings in each Member State. Renovations are to be carried out first in public, industrial and commercial buildings, and then in the homes of the poorest part of society. All new public buildings must meet the zero-emission standard from 2027. Buildings must meet certain criteria to be considered zero-emission: consume little energy while meeting the highest standards of energy efficiency, use only renewable energy where possible and do not emit CO2 from fossil fuels at source (on-site), consume little energy while meeting the highest standards of energy efficiency, use only renewable energy where possible and do not emit CO2 from fossil fuels at source (on-site), and their energy performance certificates must contain information on the global warming potential based on emissions over their life cycle.

The EU Member States will be required to develop national building renovation plans as part of their national energy and climate plans. These activities will be carried out by the Member States to achieve the country-specific reduction levels under the amended Regulation on the Effort-Sharing Regulation (ESR). In contrast to the upcoming mandate to produce only zero-emission vehicles, the mandate to implement zero-emission of all new buildings from 2030 and the possibility of banning the use of fossil fuels at the level of individual Member States have not yet gained comparable media coverage.

Additional efforts of Member States towards zero emissions

Despite the introduction of ETS2, the sector comprising buildings, road transport, waste and small enterprises (hitherto outside the ETS due to emissions below the threshold for inclusion) and agriculture, which is not (yet) included in ETS2 will continue to be covered by the Effort Sharing Regulation (ESR), which until now covered sectors outside of the current ETS (ETS1) which regulates emissions from large industrial installations and, in part, aviation and, soon, also partially and on a similar basis to that applicable to air transport, emissions from the maritime transport sector. Therefore, the introduction of ETS2 does not mean lowering the ambition of the ESR  targets.[10] On the contrary, they will increase from the previously planned 29% for 2030 to 40% compared to 2005.[11]

Thus, emissions from a sector that includes buildings (residential, commercial and other) and road transport and other sectors hitherto regulated by the Member States under the ESR, will be managed both at the EU level, through the ETS2, and by individual countries, which will have to resort to additional emission reduction instruments in the ESR sectors - whether in the form of orders and bans or through new taxes. We must not forget about the ambitions of individual European cities, which have their aspirations to conduct climate policy and, therefore, they adopt their proper measures (in the form of, for example, a ban on entering the centre of certain categories of vehicles, creating pedestrian zones, promoting public transport, subsidising low-emission heat sources or photovoltaics, or support for the transition to low-emission energy sources in heating buildings or thermal modernization).

The Social Climate Fund as a source of support addressing the effects of an ambitious EU climate policy

The inevitable social impact of rising fossil fuel prices in the context of the implementation of all these measures is to be mitigated by the Social Climate Fund (SCF) established to provide financial support to households in difficulty, and support micro-enterprises and transport users in coping with the price impact of ETS2. The Fund will run from 2026 to 2032 and, as part of the EU budget, will be funded by dedicated external revenues and the ETS2 auctioning revenues. This financial structure will allow the fund to benefit from a range of guarantees linked to the European budget without reopening the EU's Multiannual Financial Framework. EU Member States will co-finance actions they undertake from their budgets at the level of at least 25%. In 2026, i.e. before the launch of ETS2, the fund will be endowed with EUR 86.7 billion from the auctioning of emission allowances in the EU ETS. Poland should receive a share in these resources equal to 17% of the value of the fund. Access to the fund's resources will be conditional on individual Member States submitting to the European Commission "social climate plans". All countries that meet this condition will be eligible to benefit from the SCF. Each plan will include a description of the measures and investments that would be taken to mitigate the impact of ETS2 on vulnerable households. Temporary direct income support for people at risk of energy poverty may not exceed 37.5% of the estimated total cost of implementing the plans. National social climate plans may include actions at the national level, such as increasing the energy efficiency of buildings, renovating buildings or decarbonising heating and cooling in buildings. These activities are to be addressed to both individuals and SMEs.

[1] Negotiations between the European Council and the EP, with the participation of the European Commission.

[2] With the price of one allowance above EUR 45, 20 million additional allowances will be auctioned.

[3] Energy performance of buildings directive (europa.eu)   

[4] EEA: Greenhouse gas emissions from transport in Europe (europa.eu)  

[5] EEA: Greenhouse gas emissions from transport in Europe (europa.eu)  

[6] Vehicles using hydrogen are also considered zero-emission. In the case of hydrogen, the issue of emissions generated during its production is also important.

[7] This is a proposal to amend Regulation (EU) 2019/63112 2022 | A European Green Deal | Revision of CO2 emission performance standards for cars and vans, as part of the European Green Deal (europa.eu)  

[8] P. Lienert, ?Analysis: When do electric vehicles become cleaner than gasoline cars?”, Reuters Business News, June 29, 2021 (Analysis: When do electric vehicles become cleaner than gasoline cars? | Reuters; access: 5.01.2023  

[9] COP is the Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC) and the CMA is the Conference-Meeting of the Parties to the Paris Agreement. Both of these conferences take place in parallel and are known to the public as the COP.

[10] I.e. before the adoption of the new reduction targets for 2030 resulting from the ambition of the European Green Deal to be achieved zero emissions by 2050, which are to be implemented through the Fit for 55 legislative package.

[11] The previous reduction target in the ESR sectors, which the EU aimed to achieve by 2030, was a 29% reduction compared to the 2005 emission level.