In a Nutshell

In February 2024, the European Commission presented a Communication entitled “Securing our future: Europe’s 2040 climate target and path to climate neutrality by 2050, building a sustainable, just and prosperous society”, recommending a net reduction of 90% greenhouse gas (GHG) emissions by 2040 compared to 1990 levels.

As part of the European Green Deal, the EU has set out legally binding climate objectives to (1) cut domestic GHG emissions by at least 55% by 2030 and to (2) reach climate neutrality by 2050. The European Climate Law provides the legal framework to support these objectives and requires the European Commission to propose an intermediary 2040 climate target for the EU in the first half of 2024, accompanied by an indicative EU GHG budget for the period 2030-2050.

In its 2040 target communication, the Commission breaks down the 90% emission reduction target into twin targets, suggesting that by 2040, the EU should have less than 850 MtCO2 remaining emissions (so-called “residual emissions”) with a maximum of 400 MtCO2 removed through industrial and land-based solutions. However, it does not go as far as proposing a percentage target for removed carbon at this stage, nor does it clearly specify how much different types of removals should contribute to the overarching amount of removals. The Communication also considers the role of carbon capture and storage (CCS) and carbon capture and utilisation (CCU) in decarbonising the economy towards 2040.

Whilst the Communication does not impose any legally binding obligations on the EU, it will serve as the basis for a forthcoming Commission proposal to amend the European Climate Law as part of the post-2030 climate policy agenda. The Communication outlines eight building blocks necessary to achieve the 2040 target, which represent the recommended focus areas for the next Commission’s legislative mandate.

The 2040 climate target is closely linked to the Industrial Carbon Management Strategy, which elaborates on the Communication’s vision for how so-called ‘industrial carbon removal’ (iCDR, defined as BECCS, DACCS and biogenic carbon), CCS and CCU can help deliver climate neutrality in the EU by 2050, and net negative emissions thereafter.

What's on the Horizon?

The publication of the Communication is the first step towards coming to an agreement on the climate targets for 2040, which will result in the adoption of an amended European Climate Law with a new binding 2040 target and an accompanying package of proposals for sectoral policies from the European Commission.

  • Following the publication of the Communication, the Commission’s services (at Directorate General level) will kick off the work on the legislative proposal to revise the European Climate Law and enshrine the 2040 target, with DG CLIMA leading this file. The proposal is expected to be adopted by the Commission in the first quarter of 2025.
  • Member states in the Council will have a first exchange of views during the Environment Council on 25 March 2024, followed by a policy debate on 17 June 2024.
  • The European Parliament will form a lead committee responsible for the file and appoint a rapporteur, with the Committee on Environment, Public Health and Food Safety (ENVI) likely to be named in charge.
  • Following the June 2024 elections, the new European Parliament and the Council will both propose amendments to the Commission’s proposal and negotiate the final text.
  • Once approved, the 2040 target will serve as the basis for the EU’s updated Nationally Determined Contributions (NDC) under the Paris Agreement. The NDC will need to be submitted ahead of COP30, in November 2025. Therefore, the EU will strive to find an agreement by that date, although the revised Climate Law will likely be finalised in early 2026.
  • The adoption of the revised European Climate Law serves as the foundation for a new package of legislative proposals, aimed at realising the EU’s 2040 climate target.

Deep Dive

Understanding the targets

The proposed target does not yet have any binding effect on the EU or its member states. It serves to initiate a political debate that will inform the revision of the European Climate Law during the next legislative term. The preparatory process is expected to be challenging, as the 2040 target will need to strike a balance between climate ambition and pragmatism, given a changing political landscape with less focus on climate policy combined with a growing focus on industrial competitiveness and cost of living.

In the Communication and the accompanying Impact Assessment, the Commission considered three scenarios varying in ambition, taking the input from the public consultation and the advice of the European Scientific Advisory Board on Climate Change (ESABCC) into consideration:

  • Scenario 1: GHG reduction up to 80%
  • Scenario 2: GHG reduction between 85-90%
  • Scenario 3: GHG reduction between 90-95%.

The recommended -90% target, thus, falls between scenarios 2 and 3 and sets a floor for remaining emissions (850 MtCO2e) and a ceiling for removals (400 MtCO2) by 2040. The ESABCC recommendation was to adopt a target in keeping with scenario 3 of 90-95% emission reductions by 2040. The Communication’s focus on carbon management aligns more with Scenario 3, which requires early deployment of CDR, CCS and CCU technologies. The maximum target of 400 MtCO2 to be removed through industrial and land-based solutions effectively limits the extent to which the EU can rely on carbon removals to reach the 2040 target. Depending on its final level and design, the target could also potentially affect the ability of different CDR methods to scale and effectively contribute to reaching climate neutrality and net negative emissions thereafter.

Apart from those estimations, no other quantified CDR-related projections were included in the Communication. The Commission Impact Assessment does provide projections for removals under all three scenarios. Scenario 3, the most ambitious of all three, projects 391 MtCO2 to be removed from the atmosphere by 2040, amounting to -75 and -317 MtCO2 of industrial and land removals respectively. This falls short of the 400 MtCO2 to be removed according to the Commission Communication. The fact that the total amount of removals is not broken down into separate sub targets for industrial and land removals is incompatible with the like-for-like principle, according to which fossil emissions can only be compensated by permanent CDR.

Delivering on the 2040 targets: the role of carbon removal

  1. Asserting that the path towards climate neutrality ought to be complemented with a sustainable and competitive economy able to withstand geopolitical risks, the Commission outlines eight building blocks of the future policy agenda. These building blocks could incorporate CDR in various ways.
    1. A resilient and decarbonised energy system aims at phasing out fossil fuels and building clean supply chains and will require a broad portfolio of zero-/low-carbon technologies Here, iCDR can help balance residual emissions from hard-to-abate sectors like heavy industry and transport, as well as compensate for the last tons of fossil emissions in the power sector, enabling the transition to net-zero.
    2. An industrial revolution with competitiveness seeks to make Europe an attractive destination for investments, which could mean increased capital flows and efforts to de-risk investments in early-stage CDR projects.
    3. Infrastructure to deliver, transport and store CO2 will be essential for industrial decarbonisation and will also help scale up certain industrial carbon removal technologies like Direct Air Carbon Capture and Storage (DACCS) and Bioenergy with Carbon Capture and Storage (BECCS). Such a scale up of CO2 infrastructure will require significant investments accompanied by a non-discriminatory regulatory framework that is favourable to iCDR.
    4. Enhanced emissions reduction in agriculture could promote sustainable agricultural practices and carbon farming activities.
    5. Climate policy as investment policy is expected to create a stronger business case for zero- and low-carbon technologies and direct public investments towards sectors where high investment risks jeopardise commercial viability, which could help scale up and decrease the costs of DACCS/BECCS.
    6. Fairness, solidarity and social policies could ease the burden and costs of the clean transition with a growing CDR sector offering job opportunities for those previously employed by fossil fuels companies, whilst carbon farming practices provide an additional income stream for forest and land managers.

    EU climate diplomacy and partnerships should help the EU continue pushing for global climate ambition, promote successful EU policies and accelerate the work being done under Article 6 of the Paris Agreement.

  2. Risk management and resilience will see the EU develop a comprehensive climate adaptation strategy. In this context, land-based CDR can provide additional benefits for biodiversity and ecosystem restoration.

Room for improvement: integrating CDR in the 2040 climate framework

The publication of the 2040 Communication is a positive development for CDR in the EU, as it recognises the role of CDR in delivering climate neutrality and calls for their early deployment. In order for CDR to truly be a part of the solution to climate change, several improvements should be made.

  • The 90% net GHG emissions target for 2040 should be split into quantified “twin” targets for gross emissions reduction and CDR, both expressed as minimum contributions. This will provide clarity regarding each component’s contribution while safeguarding against over-reliance on removals.
  • The 2040 removal targets should be further split into sub targets for permanent and land-based removals, thereby ensuring clarity and visibility and providing the necessary investment incentives. Importantly, it will also recognise the difference between their contributions in line with the like-for-like principle and reduce the risks of mitigation deterrence.
  • The European Climate Law should adopt the notion of “permanent” rather than “industrial” removals in line with the Carbon Removal Certification Framework. Currently, the 2040 communication and the Impact Assessment differentiate between land removals and “iCDR”, defined as DACCS, BECCS and biogenic carbon. Such distinction fails to consider other promising methods, such as enhanced rock weathering. Only developing a future-proof diverse portfolio of CDR methods can ensure the EU meets its climate targets.

To address these points, the European Commission should produce a strategy solely dedicated to CDR.

 

Read more about Carbon Gap’s position on CDR under the 2040 climate framework here.

Timeline

29 July 2021
6 February 2024
Q1 2025
November 2025
29 July 2021

Enforcement of the European Climate Law

6 February 2024

Publication of the 2040 Communication

Q1 2025

Commission proposal to revise the European Climate Law

November 2025

Deadline to submit updated NDCs

Official Document

Year

2024

Unofficial Title

2040 targets

In a Nutshell

The Common Agricultural Policy (CAP) aims to support farmers and ensure Europe’s food security. It sets out the EU legal framework and funds the support member states can provide to agriculture, forestry, and rural development. It has a double objective of ensuring Europe’s food security and incentivising environmentally friendly agriculture. 

The CAP has greatly evolved since its creation in 1962. In its latest iteration, the CAP 2023-2027 pursues 10 overreaching objectives aimed at ensuring agricultural productivity and farmers’ income while encouraging environmentally friendly practices.  

The total budget of the CAP 2023-2027 amounts to EUR 386.6 billion. The budget is divided into two funds, which are often referred to as the two pillars of the CAP:  

Each country implements the CAP 2023-2027 at their national level through a CAP Strategic Plan. These plans operationalise the numerous targeted interventions each country undertakes while contributing to the ambitions set by the European Green Deal 

Direct payments to support farmers are granted on the condition that they implement “good agricultural and environmental conditions” (GAEC). Around 90% of the total European utilised agricultural area (UAA) is covered by this conditionality. Furthermore, 25% of direct payments are optional and require farmers to implement eco-schemes (specific to each country) rewarding environmentally friendly farming. 

Carbon dioxide removal (CDR) and the CAP interact closely in several important ways. Practices that improve carbon sequestration in soils and ecosystems have many overlaps with soil health and agriculture and thus the CAP. The CAP provides an array of measures aiming to incentivise agroforestry practices, as well as the maintenance and restoration of land ecosystems. Finally, enhanced weathering and biochar are two novel CDR methods that also intersect with farming and may thus interact with the CAP in the future. 

There is, however, a dual dynamic within the CAP. On the one hand, some measures within the CAP still indirectly promote intensive farming practices depleting soil carbon stocks. On the other hand, more and more measures are targeted towards improving soil carbon stocks. The significant leeway provided to member states in their implementation of national measures means that the contribution of CAP to carbon removals varies across the EU.

What's on the Horizon?

As a response to the farmers’ protests across the EU, the Commission proposed a targeted review of the good agricultural and environmental conditions (GAEC) of the CAP. This review would reduce administrative burdens for farmers and but also waters down some of the CAP’s environmental criteria. The EU Parliament plenary adopted the targeted review on 24 April. The Council now needs to formally adopt it before it enters into force.

The CAP 2023-2027 and the national CAP Strategic Plans entered into force on 1 January 2023. In 2024, countries will have to report to the EU Commission on their performances. In 2025, the national CAP Strategic Plans will be reviewed by the EU Commission.  

A new obligation to protect wetlands and peatlands will be included in the CAP by 2025 at the latest; wetlands and peatlands are part of the conventional CDR methods.  

The Commission will propose an improved methodology to ensure that the contribution of the CAP to climate action is correctly measured and accounted for by 2026 at the latest. 

Deep Dive

National Strategic Plans and support mechanisms  

Within the CAP 2023-2027, CAP National strategic plans operationalise the CAP’s policy objectives at the national level.  

The CAP amounts to 20% of the total EU budget and plays an enormous role in the EU’s intervention in the land sector. It provides different support mechanisms:  

  • income support through direct payments, among others, to incentivise environmentally friendly practices; 
  • market measures to deal with difficult market situations; 
  • rural development measures (national and regional programmes to address specific needs and challenges). 

Each member state has relative freedom to distribute funding across these three types of support mechanisms and can freely allocate up to 25% of its budget between income support and rural development. The CAP Strategic Plans outline this allocation and describe which measures will be supported within each member state. The CAP 2023-2027 puts higher emphasis on tracking outcomes by setting an annual performance report and a biannual review process for national plans, assessing progress towards their goals and the 10 CAP overarching objectives. 

Direct payments use the biggest share of the CAP funding and are conditional to Good Agricultural and Environmental Practices (GAEC), which include measures on maintaining a minimum soil cover, limiting erosion and maintaining soil organic matter, and requiring farmers to save at least 3% of their arable farmland for non-productive areas/features with the possibility to get support to extend it to 7% of the arable land. The new CAP introduces a requirement prohibiting drainage, burning or extraction of peat from peatlands. This prohibition could have a favourable impact on peatlands, allowing them to serve as carbon sinks rather than as sources of carbon emissions.  

While a large share of utilised agricultural area (UAA) is set to be farmed under GAECs, only a limited share is set to be under commitments to reduce emissions or to maintain or enhance carbon storage, which includes permanent grassland, permanent crops with a permanent green cover, agricultural land in wetland and peatland. Moreover, this share varies dramatically between countries, from 0% to 85%. The metrics used in the strategic plans are also not the same; some mention the peak coverage year (note: peak year also varies between countries) while others use the average over the 2023-2027 period. It is quite concerning to see that several states currently have no measures to increase soil carbon storage. Experts have also raised the question of whether the measures proposed are enough to reach the objectives set in the strategic plans. 

Eco-schemes 

Additional subsidies in the form of eco-schemes can be made available to states as a reward for more environmentally friendly practices. Eco-schemes support various types of voluntary actions that go beyond the CAP’s obligation of conditionality. These include practices related to agro-forestry and carbon farming among others. The Commission has published an extensive list of examples. However, it includes only a handful of practices linked to CDR. Member states are not exploiting this opportunity to the fullest, as only a minority of them plan to use eco-schemes in relation to CDR. Some environmental NGOs raised concerns questioning the eco-schemes’ true environmental benefits. 

Carbon farming and related debates 

The recent communication by the EU Commission on “Sustainable Carbon Cycles” has highlighted that the CAP should be one of the primary mechanisms to promote carbon farming at the European level, together with LIFE and Horizon Europe’s “Soil Deal for Europe”. The Commission encouraged states to include measures to incentivise carbon farming in their strategic plans. The current efforts on the Carbon Removal Certification Framework (CRC-F), among others, aim to clarify what good carbon farming practices mean. 

There are, however, several issues related to carbon farming that need to be discussed and tackled with high priority.  

Firstly, carbon farming is a very loaded term. The EU defines it vaguely as “a green business model to reward farmers for adopting practices leading to carbon sequestration”. Therefore, carbon farming as an economic concept and the underlying practices it encompasses should be separated in order to differentiate the business model from the underlying practices.  

Secondly, there is a strong opportunity in the CRCF to make clear that the durability of carbon sequestration in soil is lower than for other CDR methods. Any market-facing claims need to be strictly regulated to ensure that fossil emissions are not compensated for through such practices.  

Thirdly, soil carbon sequestration comes along with many co-benefits besides carbon removal. These include improved soil quality, positive biodiversity impacts and better water retention. These practices should thus be incentivised. However, key questions remain, such as who should pay, and be paid, to implement these practices and what the basis for payment should be. 

Finally, the measuring, reporting and verification (MRV) of soil carbon fluxes is still very much a work in progress. There is currently a trade-off between the accuracy of results and the costs/scalability of methodologies. The EU has yet to determine how best to deploy MRV and at which geographical scale and granularity. The purpose of MRV deployment should be better defined. Furthermore, the commodification of sequestered soil carbon requires more strenuous MRV. 

Timeline

1962
1984
1992
2003
2014-2020
2021
2021-2022
2 December 2021
January 2023
December 2023
2024
15 March 2024
15 April 2024
24 April 2024
2025
2026
2027
1962

Launched in 1962. 

1984

First big reform of the CAP to bring production closer to what the market needs. 

1992

Shift from market support to producer support through direct payments to farmers. Farmers are incentivised to endorse more environmentally friendly practices. 

2003

The CAP introduces income support tied to environmental, food safety and animal health and welfare requirements

2014-2020

The CAP is once again reformed to increase the competitiveness of the sector, promote sustainable farming and support rural areas. 

2021

The EU Parliament, the Council and the Commission agree on the need to reform the CAP again and shift implementation responsibilities.

2021-2022

A transitional agreement is put in place while the reform is negotiated. 

2 December 2021

Adoption of the CAP 2023-2027.  

January 2023

The CAP 2023-2027 and the CAP strategic plans enter into force. 

December 2023

The EU Commission will submit a report to assess the joint CAP strategic plans in reaching Green Deal targets.

2024

Each country will present an annual performance report. 

15 March 2024

The EU Commission proposed a targeted review of the CAP

15 April 2024

Adoption of the targeted review by the AGRI Committee (Committee responsible)

24 April 2024

EU Parliament plenary adopted the targeted review

2025

The Commission will conduct its first performance review of the CAP strategic plans. 

2026

The Commission will conduct an interim evaluation of the CAP 2023-2027.

2027

The Commission will conduct a second performance review of the CAP strategic plans.

Status

Unofficial Title

CAP

Year

1962

Official Document

Last Updated

24/07/2023

In a Nutshell

Article 6.4 of the Paris Agreement establishes the Article 6.4 mechanism, a market-based instrument that countries can voluntarily use to trade credits from emission reduction and removal projects. Under the mechanism, reducing emission levels in one country can be used by another country to fulfill its climate target, Nationally Determined Contribution (NDC).

Often seen as a tool to help countries achieve their climate targets cost-effectively, its real goal is to bring about higher ambition – enabling countries to do more than they could without using it. It’s built to incentivise and facilitate the participation of authorised public and private entities by crediting their emission reduction and removal activities. The projects need to deliver an overall mitigation in global emissions.

It’s a centralised UN crediting mechanism governed by Article 6.4 Supervisory Body. Being a successor of the Clean Development Mechanism (CDM) under the Kyoto Protocol, it will operate under the Paris Agreement, where all countries have climate targets. This means that the host countries need to know that they can still meet their climate targets when selling credits via the Article 6.4 mechanism, and double counting of the same emission reductions or removals must be avoided through the double-entry bookkeeping for emissions accounting (“corresponding adjustments”).

Among its other work in setting up the instrument, the Supervisory Body is preparing the foundation for how the Article 6.4 mechanism will apply to removals. There is a growing ecosystem of novel removal methods, and many of these are poised to be used by countries in their climate targets. Given the lack of broadly accepted international accounting rules for a range of removal methods, the decisions taken under Article 6.4, and the methodologies approved under it, are bound to have an outsized impact on carbon markets globally.

What's on the Horizon?

  • The Article 6.4 Supervisory Body has prepared recommendations on methodologies and removals. These recommendations have been sent for approval and were reviewed at the Conference of the Parties serving as the meeting of the Parties to the Paris Agreement (CMA5 – during COP28). If the recommendations are approved, Article 6.4 will become operational in principle. More recommendations from the SB will be needed to make Article 6.4 fully operational.
  • The Subsidiary Body for Scientific and Technological Advice (SBSTA) is preparing recommendations on including emission avoidance and conservation enhancement activities in the scope of Article 6.4 mechanism, authorisation of credits, and connection between registries for adoption at CMA5 (during COP28).

 Getting the Article 6.4 mechanism up and running will take a few years. 

Deep Dive

How will it work? 

The Article 6.4 Supervisory Body is responsible for establishing guidance and procedures, approving methodologies, registering projects, issuing credits, and more.

Methodologies may be developed by project participants, host countries, stakeholders, or the Supervisory Body.

The credits are called the Article 6.4 Emission Reductions (A6.4ERs). These are used for both emission reductions and carbon removal. The host country will have to authorise A6.4ERs and account for these by applying corresponding adjustments unless the A6.4 ERs contribute to the national target in the host country (mitigation contribution A6.4ERs). 

Removal activities get a maximum of 15-year crediting periods, renewable twice. The mechanism credits emission reductions and removals by public and private sector actors.

2% of Article 6.4 credits are subject to cancellation (“Overall Mitigation in Global Emissions” clause), 5% of credits are dedicated to the Adaptation Fund (“Share of Proceeds for Adaptation”) and other fees for registration, inclusion, issuance, renewal, and post-registration apply as well (“Share of Proceeds for Administrative Expenses”).  

Many other details are yet to be ironed out, listed in the “Open elements” section below. 

How will removals be covered? 

Whilst the mechanism covers emission reductions and removals, it will likely focus on emission reductions in the coming decade, with interest in removals growing as climate targets get closer to net zero and beyond. 

The Supervisory Body has been tasked with preparing a general framework for including the full spectrum of carbon removal methods under Article 6.4, called “recommendations”, to be approved at CMA5 during COP28.  

For the first time, novel carbon removal methods will be tackled under the Paris Agreement, and the recommendations will set a precedent by establishing broad removals-specific rules under the UN crediting mechanism. 

Open elements 

Two separate ongoing work streams are ironing out the details of the mechanism – (1) the Supervisory Body and (2) the Subsidiary Body for Scientific and Technological Advice (SBSTA) where international climate negotiations under the Paris Agreement are ongoing on the technical elements. 

The Supervisory Body has a busy work program for 2023 and has been tasked to prepare several deliverables for adoption for CMA5 (during COP28). This includes recommendations on methodologies (baseline, monitoring methodologies, methodology development process, review), recommendations on activities involving removals (monitoring, reporting, accounting for removals and crediting periods, addressing reversals, avoidance of leakage), transitioning the Clean Development Mechanism into the Article 6.4 mechanism, developing accreditation standard, and designing project activity cycle.

SBSTA is negotiating recommendations on including emission avoidance1 and conservation enhancement activities in the scope of Article 6.4 mechanism, authorisation of credits by host countries, and work on the registry. These discussions are very technical, have continued throughout the Bonn Climate Conference in June 2023, and will be submitted for adoption at CMA5 during COP28.

1 Emission avoidance in this context mainly refers narrowly to reducing emissions from deforestation and forest degradation (REDD+ projects), not to be confused with how the term “emission avoidance” is used in the voluntary carbon markets where some stakeholders use it as a blanket term for emission reductions and avoidance. 

How can stakeholders engage with the Article 6.4 process?   

Documents for stakeholder input will be published at least a week before each Supervisory Body meeting. Any organisation can provide written input before meetings, but only UNFCCC-accredited observer organisations can attend the Supervisory Body meetings. Everyone can follow the live stream and watch recordings of past sessions.

 

Meeting number  Meeting dates  Deadline for registering as an observer  Deadline for submitting public comments on the meeting agenda 
SB 006  10-13 July 2023  19 June  3 July 
SB 007  11-14 September 2023  21 August  4 September 
SB 008  10 October to 2 November 2023  9 October  23 October 

In June 2023, the UNFCCC launched a dedicated Article 6.4 newsletter covering the latest news, calls for inputs and other announcements from the Supervisory Body. 

The negotiations under SBSTA take place in 2-week sessions twice a year during the Bonn Climate Conference and COP. 

 

Timeline

12 December 2015
4 November 2016
November 2021
November 2022
19 November 2022 - 15 March 2023
7-10 March 2023
16 March - 11 April 2023
18-25 May 2023
31 May - 3 June 2023
5-15 June 2023
5-19 June 2023
23 June 2023
10-13 July 2023
11-14 September 2023
Until 19 September 2023
30 October - 2 November 2023
Before SBSTA29/COP28
18 November 2023
30 November - 12 December 2023
12 December 2015

The Paris Agreement is adopted

4 November 2016

The Paris Agreement enters into force 

November 2021

CMA3/COP26 Glasgow – Adoption of the rules, modalities and procedures for Article 6.4 mechanism 

November 2022

Adoption of guidance on Article 6.4, elaborating on key processes and principles, providing SBSTA to work on remaining elements, and mandating the Supervisory Body to operationalise the mechanism 

19 November 2022 - 15 March 2023

Request for submissions by Parties and admitted observer organisations to submit their views on activities involving removals via the submission portal

23 June 2023

Article 6.4 Supervisory Body stakeholder webinar

Until 19 September 2023

Public consultation on the three SBSTA working areas on Article 6.4 (inclusion of emission avoidance and conservation enhancement, registries, authorisation of credits) 

Before SBSTA29/COP28

Technical expert dialogue on the three SBSTA working areas on Article 6.4 (inclusion of emission avoidance and conservation enhancement, registries, authorisation of credits) 

18 November 2023

The SB has approved the long-awaited recommendations on activities involving carbon dioxide removal and Article 6.4 mechanism methodologies.

30 November - 12 December 2023

CMA5/COP28 in Dubai.The Article 6.4 Supervisory Body’s recommendations on removals and methodologies have been sent for approval to CMA5. 

Unofficial Title

Article 6.4

Year

2015

Last Updated

23/06/2023

In a Nutshell

The EU Emissions Trading System (EU ETS) is a market-based approach for setting a price for carbon dioxide (CO2) emissions. It works on a ‘cap and trade’ basis whereby a ‘cap’ or limit is set on the total greenhouse gas (GHG) emissions allowed from specific sectors of the economy each year, with the aim of achieving emissions reductions over time. This cap is converted into tradable emission allowances, which are then allocated to market participants through free allocation or auctions. One allowance gives the holder the right to emit one tonne of CO2 (or its equivalent) during a specified period. Companies covered by the EU ETS must monitor and report their emissions each year and purchase or trade allowances as needed to cover their annual emissions.

Participants who are likely to emit more than their allocation have a choice between taking measures to reduce their emissions or buying additional allowances; either from the secondary market, for example companies who hold allowances they do not need, or from member state-held auctions. When participants reduce their emissions, they can either sell their allowances or keep them for the future.

The ETS is the EU’s main tool for addressing emissions reductions, covering the following sector, representing about 40% of the EU’s total CO2 emissions: power, heat generation, energy intensive industrial sectors, aviation, and, since the latest revision, the maritime sector. It is now in its fourth trading phase (2021-2030). In December 2022, the European Parliament and Council reached a political agreement on the reform of the ETS. The overall target of the revised ETS was increased to a 62% reduction in carbon emissions from the sectors covered by the scheme by 2030, up from 42.8% since its introduction in 2005.

Carbon removal is not included under the EU ETS, but the Commission is set to report, by 2026, on how negative emissions could be accounted for and covered by emissions trading.

The Innovation Fund, a key source of EU support for nascent carbon removal projects amongst other clean technologies, is funded by the auctioning of ETS allowances. At 75 euro/tCO2, the ETS is set to provide around EUR 38 billion from 2020 to 2030 to the Fund.

What's on the Horizon?

The provisional political agreement reached between the European Parliament and Council in late 2022 needs to be formally adopted before the Regulation can enter into force:

  • 18/04/2023: Formal adoption by the European Parliament
  • 25/04/2023: Formal adoption by the Council of the European Union
  • 16/05/2023: Publication in the Official Journal of the European Union
  • 05/06/2023: Entry into force

By 31 July 2026, the European Commission is required to submit a report to the Parliament and the Council on the possibility of integrating negative emissions technologies (NETs) into the EU ETS. This should explore how emissions removed from the atmosphere through methods such as direct air capture can be safely and permanently stored, and how these negative emissions can be accounted for and covered by emissions trading without compromising necessary progress in reducing emissions.

By 31 July 2026, the Commission will have to assess and report on the possibility of including the municipal waste incineration sector in the ETS with a view to including it from 2028.

Deep Dive

Update to the ETS

The ETS was revised as part of the Commission’s ‘Fit for 55’ package, which aims to introduce new or improve existing legislative tools for achieving the EU’s target of reducing net GHG emissions by at least 55% below 1990 levels by 2030. The proposed changes to the ETS include:

  • Increased ambition to reduce emissions by 62% in the sectors covered by the ETS by 2030  and reduction of the cap by 4.3% per year in 2024-2027, and by 4.4% in 2028-2030.
  • End of free allowances for sectors covered by the Carbon Adjustment Mechanism (CBAM) in 2026-2034.
  • Phase-out of free emissions allowances for aviation (25% in 2024, 50% in 2025 and 100% from 2026).
  • Inclusion of maritime shipping in the ETS.
  • Creation of a separate ETS for the building and road transport sectors, applying to the distributors that supply fuels for combustion. A new Social Climate Fund will direct part of the revenue from the auctioning to support vulnerable households and micro-enterprises.
  • Increase in the Modernisation Fund and Innovation Fund.
  • Strengthening the market stability reserve (MSR), the mechanism to help prevent excessive carbon price fluctuations.

Support for CDR through the Innovation Fund

Although the EU ETS is designed to incentivise emissions reductions as opposed to carbon removals, money raised through auctions of emission allowances under the ETS are reinvested into the EU’s Innovation Fund, which provides a source of funding support for technology-based CDR methods among other low-carbon technologies.

For more information on the link between CDR and the Innovation Fund, see here.

Should carbon removal be integrated into the EU ETS?

The inclusion of carbon removal (with permanent storage of captured carbon) in the EU ETS is subject to a nascent and growing debate in the EU policy ecosystem, in anticipation of the announced Commission report. Integrating negative emissions into the ETS would allow participants to offset a portion of their emissions by purchasing carbon removal credits. This, in turn, could create a potential long-term market for CDR.

Including removals in the EU ETS could have a number of benefits. As the ETS allowance cap is steadily reduced over time, integrating negative emissions would create additional market liquidity and decarbonisation options for hard-to-abate sectors. It would therefore help to satisfy demand for removal credits or allowances from hard-to-decarbonise sectors like aviation and would allow for carbon removal credits to be easily integrated into existing market infrastructure and trading platforms.

Carbon removal project developers and investors would gain greater confidence that there will be sustainable long-term demand for carbon removal credits. It would also allow removal projects to benefit from the carbon price. However, the price differential between the cost of CDR and the EU ETS carbon price will be a key consideration. The EU ETS would only incentivise CDR solutions within a certain range of the ETS price. This could be sufficient for some approaches such as BECCS (cost at scale  USD 15 – 400/tCO2) and waste-to-energy with CCS, but additional incentives would be needed for direct air capture given its higher price point (cost at scale USD 100 – 300/tCO2) – although this is expected to change as technologies improve and costs of different methods decrease. Complementary incentive mechanisms such as Carbon Contracts for Difference (CCfDs) could bridge the gap between the actual cost of certain CDR methods and the EU ETS carbon price to drive the investment needed. The Commission is considering CCfDs as part of the overall agreement on the revision of the ETS Directive.

However, it is imperative that the potential inclusion of carbon removal credits in the EU ETS does not undermine the incentive for emitters covered by the ETS to decarbonise, or the urgency with which they should do so. One option to address this risk would be to limit access or quantities of removals to specific sectors that are harder to decarbonise and more likely to have residual emissions.

Another important consideration is the impact that any inclusion of CDR in the EU ETS would have on the integrity of the market. Developing robust monitoring, reporting and verification (MRV) standards would safeguard the integrity of the ETS. The introduction of these standards is underway under the EU’s CRCF legislation.

An alternative approach might be establishing a separate, regulated negative emissions market. This separate market could later be linked with the EU ETS after the differential between CDR and ETS prices has been reduced and CDR technologies have a demonstrated track record at scale.

The EU ETS & other markets

The EU ETS was the world’s first international emissions trading system when it was set up in 2005. It has since inspired the development of emissions trading in other countries and regions, including most recently the UK and China. The potential role of the UK ETS as a market for CDR was signalled in July 2023, when the UK Government stated its intention to include Greenhouse Gas Removals (GGRs) in the UK ETS, subject to further consultation, a robust MRV regime being in place and the management of wider impacts. In 2017, the EU and Switzerland signed an agreement to link their emissions trading systems. The agreement entered into force on 1 January 2020, and the link became operational in September 2020.

Timeline

27 October 2004
ETS Phase 1 (2005-2007)
ETS Phase 2 (2008-2012)
ETS Phase 3 (2013-2020)
ETS Phase 4 (2021-2030)
14 July 2021
18 December 2022
2026
27 October 2004

Entry into force of Directive 2004/101/EC establishing a scheme for GHG emission allowance trading

ETS Phase 1 (2005-2007)

The cap is set based on estimates. The majority of allowances are given for free, and ETS covers CO2 emissions from power generators and energy-intensive industries.

ETS Phase 2 (2008-2012)

The cap is lowered around 6.5% in comparison to 2005, based on actual emissions. Around 90% of the allocations are given for free, and auctions are held. N₂O emissions are included by certain countries. The aviation sector is included in 2012.

ETS Phase 3 (2013-2020)

National caps are traded with a EU-wide cap. Default auctioning method replaces the free allocation system, and the scope is expanded to include more sectors and gases.

ETS Phase 4 (2021-2030)

Current trading phase

14 July 2021

Proposal for a revision of the EU ETS released as a part of the Fit for 55 package

18 December 2022

Provisional agreement between co-legislators on the revision of the EU ETS

2026

Commission’s report on the inclusion of negative emissions in the ETS expected

Further reading

Status

Unofficial Title

EU ETS

Year

2022

Official Document

Last Updated

24/04/2023