The European Commission has made no secret of how pleased it is the EU Emissions Trading System (ETS), the bedrock policy behind Europe’s climate action, has stood strong during the pandemic. As other markets have suffered from raging volatility, the carbon price has remained strong and the market has come to be considered one of the most stable in the world in which to invest.

On 25 March 2021, EU Energy Commissioner Kadri Simson confirmed rumours the EU executive planned to expand the system to “sectors such as buildings and road transport” in an upcoming revision of the ETS legislation this June.

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However, even within the Commission, this decision does not seem clear cut. Frans Timmermans, EU vice-president for the Green Deal, has publicly said he is against including road transport in the ETS because it would push up fuel prices for vulnerable consumers. Speaking just a few hours after Simson, he said the question was “still being analysed”.

Allowances would have to be purchased for the carbon from cars and homes under a proposal being considered by the European Commission. (Photo by ADRIAN DENNIS/AFP via Getty Images)

Several ideas are bouncing around for how the ETS could be expanded.

A study released at the end of March by Agora Energiewende suggested the new sectors could, from 2025, either be included in the main ETS or placed in a separate system, as Germany has already done for non-ETS sectors. Either option could be accompanied by adjusted national target obligations for these sectors under the Effort Sharing Regulation (ESR), which could be increased. The energy transition think tank also looked at a scenario where ESR targets are brought in line with the EU’s new 2030 55% emissions reduction target so that it isn’t necessary to enlarge the ETS to the new sectors – though countries could still choose to do it if they choose.

Many climate campaigners are dubious about using market mechanisms as key tools to fight climate change and are not thrilled with the idea of expanding the ETS. They are particularly concerned that emissions trading, which has only been used to lower emissions from power and industry, is ill-suited to road transport and buildings because they are directly consumer-facing.

“Carbon pricing has its merits, but if you make it the compliance instrument for road transport and buildings there are a lot of important shortcomings,” says Sofie Defour, climate manager at campaign group Transport & Environment (T&E). “Consumers are not rational; we are not companies. When we want to buy something, we don’t think about future price signals, we think about upfront purchasing costs.”

Lower emissions

Those arguing for the inclusion of the two sectors say the ETS has successfully helped lower emissions for power and industry. They believe transport and buildings, which account for 22.3% and 15.5% of EU greenhouse gas emissions, respectively, are failing to contribute their fair share.

While electric heat technology like heat pumps is indirectly part of the ETS because power plants have to purchase allowances, fossil fuels for heating are not, highlights Jan Cornillie from renewable energy technology consultancy 3E.

“Gas and petrol for heating stand out as having a very low carbon price,” he says. “If you want to align pricing with EU energy and climate policies, and the Paris Agreement, you need to think about how to level the playing field and give incentives for people to act on the carbon content of their heating.”

There are two ways to do that, he says. The first way would be to reform the EU energy taxation directive to increase minimum excise duties on heating fuels. The second way would be to include them in the ETS. All things being equal, reforming the taxation directive might be the best option, but this would require the unanimous support of all 27 member governments.

“It would be politically sensitive to reform taxation which immediately touches on end users, but a change in the ETS [requires only a qualified majority vote],” says Cornillie. “For process and political reasons inclusion in the ETS is the better option.”

Samuel Thomas, a senior advisor at the Regulatory Assistance Project agrees the building sector needs to rebalance heating costs. “In every country in Europe, the cost of heating your home through electricity is more than through fossil gas,” he says. “The building sector needs to take more than its fair share, and we are not driving that level of change.” In the second half of this decade, at least one in four homes will need to switch from fossil heating systems to electric, he says.

Transport worries

A similar situation exists in the rail sector, adds Thomas. In road transport, as in heating, pricing incentives are not motivating technology switches, and the sector’s exemption from the ETS is widely blamed. The rail sector has bristled at road transport’s exclusion from the ETS (rail is also exempt, while aviation is exempt for intercontinental, but not intra-EU flights).

“Emissions from transport are not decreasing, and so there is definitely a problem to address,” says Ethem Pekin from the Community of European Railway and Infrastructure Companies. “The ETS and the taxation regulation need to be reformed.” The fact emissions aren’t being priced into transport means road and aviation still enjoy pricing advantages over low-carbon rail transport. In addition, very few EU countries earmark ETS revenue – which is supposed to go to climate solutions – towards the rail sector, he says.

Patrick Graichen, executive director of Agora Energiewende, believes the ETS has been effective and “can play a central role in reducing emissions from existing cars and heating systems, supporting the business case for clean technologies and raising revenues for clean investments”.

However, the ETS’s effectiveness is up for debate, according to some commentators. Thanks to the system, between 2005 and 2019, emissions decreased 35% in the covered sectors, says the Commission. The vast majority of those reductions were in the power sector, however, while emissions from industrial installations have essentially been flat. Until a market intervention a few years ago, the system was hardly motivating any emissions reductions as it struggled with a too-low carbon price.

Expanding the ETS is “seen as a simple fix by the Commission, bringing all fossil emissions under one trajectory by 2050″, says Suzana Carp, political strategy director at Norway-based environmental organisation Bellona. “But, in reality, the ETS trajectory isn’t going to net zero in 2050, and so you would first need to fix the trajectory, and not all sectors react in the same way in an ETS-type context.” Also, even though the ETS carbon price is rising, the rate is too slow to reduce transport emissions, she says, insisting the carbon price would have to be above €200 ($237.93) a tonne (t) for this to happen.

Vulnerable consumers

One concern about bringing consumer-facing sectors into the ETS is that such price fluctuations could adversely affect vulnerable consumers.

“We acknowledge the need to send price signals to consumers,” says Monique Goyens, director-general of European consumers organisation BEUC. “However, we think the extension of ETS to road transport and buildings is not acceptable from a consumer policy perspective. It is a high-risk, low-reward measure that will harm consumers without giving them the possibility to invest in efficiency measures.”

Low-income households spend the highest proportion of their income on transport and heating, she highlights. This is also the segment of society that generally cannot afford the technology shifts that would allow them to evade new punitive pricing on fossil fuels because upfront costs are too high. Tenants, meanwhile, have no say over what heating is used in their homes.

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“If you imagine the ETS price of a CO2 allowance goes to €80–€90/t by 2030, that would lead to an increase of €0.20 a litre of gasoline,” she says. “The yellow vest movement [in France] was triggered by a €0.4–€0.5 increase. Can you imagine the public outcry?”

However, Cornillie says the ETS is designed to minimise such price movements for end users. “Electricity is already in the ETS, and people’s electricity bills aren’t changing every month because of it,” he says. “Consumer protection law sets how electricity can be charged and in most EU countries that’s still highly regulated. This is a risk the utilities are used to already and if they can do it for electricity they can do it for gas. It creates some kind of business risk for them, but it is manageable.”

Even the current carbon price of around €33/t could have a big impact in incentivising technology change in the transport and buildings sectors, says a Commission impact assessment. The idea is that if fossil fuels in these sectors were priced fairly based on their damage to the environment, people would switch to cleaner options.

National targets

The other big concern about expanding the ETS is that it could come at the expense of national ESR-driven targets. These can include efficiency standards and targets for buildings, and CO2 limits for cars. “We spend a lot of time at EU level talking about the ETS, but it only covers 38% of EU emissions, while national targets cover the bulk of emissions,” says Sofie Defour from T&E.

Defour is concerned the Commission’s plans will mean “either you have no more national targets or you make them meaningless”. She adds: “National targets have been a key driver for high-impact national policies in the transport and building sector over the past years” and assured that member states “are accountable”.

Carp shares this concern. “If you recall, when this Commission started, it said one regulation in, one out. I would be sceptical about what a separate ETS for these sectors could mean for other regulations. The Commission has said it wouldn’t scrap additional regulation, but after 2030 we could expect that direction of travel.”

In any event, creating a new ETS for these two sectors would be an enormous policy endeavour – one that could sap the energy of policymakers for other measures. “If there is a decision to extend, it will occupy a huge policy space,” says Goyens. “Policymakers will use their time and political capital to put that system in place and then defend it.”

She adds: “We have a bit of experience in how corporate lobbying takes place. If ETS is occupying that space there will be a push by corporate interests to water down the needed parallel energy efficiency measures.”

Difficult decisions

There is no need to reinvent the wheel, says Carp, suggesting solutions may be best crafted in national capitals. EU member states can already choose to extend the ETS to road transport and buildings, she says. Better EU regulations could drive national decisions, and countries that choose not to extend the ETS to these sectors can still use revenues from the system to fund decarbonisation efforts in them. The argument that only by extending the ETS will funds be freed up for emissions reductions in these sectors is a red herring, she suggests.

The Commission recently closed a consultation in which it considered all options for these sectors, including the idea of raising minimum excise duties in the energy taxation directive and of expanding the ETS. Within the next two months the EU executive will have to decide which option to propose; either one will be followed by difficult negotiations in the European Parliament and with national governments.

If a decision is taken to expand the ETS, the question of how to do it will be key. “Carbon pricing is necessary, but nowhere near sufficient to drive the change we need – it is not about whether, but about how,” says Thomas. Including buildings and transport in the ETS will only work if coupled with measures to fund renovations for buildings and infrastructure for transport, he states.

“If you introduce carbon pricing you are going to generate new revenue,” says Thomas. “We could generate many more carbon savings by using the revenue to fund investments rather than relying on the price signal to drive people to invest on their own.”