The "Fit for 55" package is the main tool to achieve the objective of cutting emissions by at least 55% by 2030 and becoming climate neutral by 2050. These targets are set by the European Climate Law, which is part of the European Green Deal strategy.
The "Fit for 55" package contains comprehensive changes to the EU Emissions Trading System (EU ETS), a proposal for a Carbon Border Adjustment Mechanism (CBAM), Effort Sharing Regulation (ESR) setting emissions reduction targets, or an amendment to the Renewable Energy Sources directives, energy efficiency and energy taxation.
Summary of the most important proposals for amendments to the ETS Directive:
Increasing the Linear Reduction Factor (LRF)
The Linear Reduction Factor determines the rate of emission reductions under the EU Emissions Trading System, by reducing the total number of emission allowances each year. The latest amendment to the ETS Directive in 2018 changed its value from 1.74% to 2.2%.
The ETS Directive proposal raises the value of the LRF to 4.2%. This will lead to an even faster reduction of emission allowances. This change is combined with a one-time cap adjustment so that the new linear reduction factor will have the same effect as if it had been in force from 2021.
According to the Commission's predictions, this mechanism will result in an overall reduction in emissions from EU ETS sectors of 61% by 2030 (compared to 2005).
Use of auctioning revenues
Under the ETS Directive proposal, Member States should spend all of their auctioning revenues (excluding revenues allocated to indirect cost compensation) on climate and energy projects. Until now, this obligation only applied to half of the funds. Member States were allowed to freely spend the remaining revenue. According to the proposal, ETS auctioning revenues could further contribute to mitigating social impacts on vulnerable households, micro-enterprises and transport users.
Market Stability Reserve (MSR)
The proposed directive would include aviation allowances (EUAAs) in the calculation of the total quantity of allowances in circulation. As the proposed Directive does not provide separate allowances for the maritime sector, they will be included in the total pool of allowances in circulation (however it is necessary to take into account the MRV mechanism).
The increased MSR intake rate of 24% remains unchanged. However, the Commission proposes that if the number of allowances available in circulation is between 833 million and 1096 million, a number of allowances corresponding to the difference between the number of emission allowances available in circulation and the threshold of 833 million will be transferred to the reserve.
Measures to address carbon leakage
The Carbon Border Adjustment Mechanism (CBAM) will be the second key element of the "Fit for 55" package. It aims to prevent the risk of carbon leakage and increase global efforts to reduce emissions.
The ETS Directive provides two mechanisms to address the risk of carbon leakage, i.e. shifting production to countries with lower climate ambitions and associated environmental costs. The fundamental element of this system is the free allocation of emission allowances to industrial installations. It is supposed to allow these sectors to maintain their competitive position in the global market. The second mechanism is indirect costs compensation, i.e. partial reimbursement of costs incurred by industries due to shifting the costs of emission allowances to electricity prices.
The ETS Directive proposal indicates that CBAM should be an alternative to the free allocation of allowances. Sectors and subsectors included in this measure cannot receive free emission allowances. The proposal establishes a transition period to allow manufacturers, importers and traders to adapt to the new system, with a gradual reduction in free allocation as CBAM is introduced. During the transition period, a factor to free allocation (CBAM factor) will be applied. This percentage should be equal to 100 % during the transitional period between the entry into force of CBAM Regulation and 2025, 90 % in 2026 and should be reduced by 10 percentage points each year to reach 0 % and thereby eliminate free allocation by the tenth year. The proposal also established rules for calculating the value of free allowances that will not be allocated to installations, thereby increasing the allowances to be auctioned.
Compensation of benchmarked sectors with fuel and electricity fungibility
According to the ETS Directive proposal, Member States should implement a compensation mechanism for indirect costs under the condition that such measures do not cover indirect costs related to emissions covered by benchmarks. The only benchmarks that take indirect emissions into account are those for which fuel and electricity exchangeability has been determined.
Free allocation of allowances - product benchmark limits and linear reduction
According to the proposal, the Commission will revise the current boundaries of the product benchmarks. This change is intended to ensure that the definitions of activities in the relevant sectors are technologically neutral (removing references to fossil fuels or specific production processes). Moreover, the directive assumes that in certain cases the activities covered by the EU ETS will also depend on the production capacity, instead of the current criterion of the thermal capacity of combustion sources. Additionally, the maximum annual reduction rate for benchmarks is to be changed to 2.5% per annum (so far 1.6%).
As in the system for indirect costs compensation, the allocation of free allowances will depend on the fulfillment of conditions concerning the implementation of energy audit recommendations. Beneficiaries obliged to conduct an audit (currently this obligation refers to large enterprises) must implement the recommendations included in the audit report if the period of return from the related investments does not exceed 3 years and the costs of their investments are proportional. Otherwise, the free allocation of allowances will be reduced by 25% unless the beneficiary proves the implementation of other measures which lead to a reduction of greenhouse gas emissions equivalent to those recommended in the audit report.
Carbon contracts for difference (CCfD)
The scope of the Innovation Fund has been expanded. It is designed to allow projects to be supported through competitive bidding such as carbon contracts for difference. In addition, the Innovation Fund is increased by 50 million allowances from the allowances available for free allocation and auctioning. The idea of carbon contracts for difference is to guarantee investors implementing innovative low-carbon technologies permanent support above current levels of emission allowance prices.
Maritime transport, buildings and road transport
The ETS Directive proposal extends the scope of the ETS to include maritime transport in respect to all emissions from intra- EU voyages, half of the emissions from voyages only starting or ending outside the EU and emissions from ships at berth in EU ports. The obligation to redeem allowances in the maritime transport sector will be phased between 2023 and 2025. The sector will be fully included in the ETS from 2026 onwards.
For the building and road transport sectors, the ETS proposal is to establish a separate system from 2025. Due to the wide dispersion of emission sources in these sectors, technical feasibility and administrative efficiency, the regulation will not apply directly to emitters but further up the supply chain. The system is intended to authorize the use of fuels used for combustion in the building and road transport sectors (including heat generation and cogeneration for the residential and commercial sectors).
Authors:
Katarzyna Kłaczyńska-Lewis
Tomasz Ziomek
