The European Commission has adopted a package of measures intended to put the EU firmly on the road to climate neutrality by 2050 with the intermediate step of a minimum 55% reduction in net greenhouse gas emissions by 2030. An overhaul of the EU emissions trading system (ETS) and of the Energy Taxation Directive (ETD), and the introduction of a carbon border adjustment (CBAM) form part of the package.
ETS overhaul
The Commission’s proposal for the overhaul of the ETS includes proposals to tighten its rules and broaden its application, and establish a parallel regime.
A directive is proposed which would bring maritime transport within the scope of the ETS and accelerate the reduction of the number of emissions allowances that can be issued each year by changing the linear reduction factor from 2.2% to 4.2%. A separate proposed directive would lead to the gradual reduction of free emissions allowances available to the airline industry (which is also set to lose under the ETD overhaul).
The Commission’s Q&A on the ETS overhaul also envisages the establishment of a separate emissions trading system for road transport and heating fuels which would apply from 2026 at the fuel supplier level. Its introduction would be accompanied by the establishment of a social climate fund which would use resources equal to approximately 25% of the 2026-32 auction revenues from the new system to help member states fund measures to mitigate the social impact of its introduction.
ETD overhaul
Having entered into force more than 15 years ago, the ETD has been in dire need of a makeover. A September 2019 report by the European Commission noted that the ETD does not reflect the current mix of energy products and criticised that it does not link the minimum tax rates to energy content and CO2 emissions.
This will change with the proposed recast of the ETD. Minimum tax rates would be based on the real energy content and environmental performance of each product, with most polluting fuels taxed at the highest level. The tax base would also be expanded – including through the removal of existing exemptions. An eye-catching change in this respect is that fuels for the aviation and maritime industries would lose existing exemptions.
The Commission’s Q&A on the ETD overhaul acknowledges the risk that the burden of higher minimum levels of energy taxation may be felt disproportionately by consumers and poorer households. The mitigation of this risk does, however, appear to be left mostly to the member states. Whilst the social climate fund (discussed above) and certain other EU initiatives are mentioned, the Q&A notes that the distributional impact of the ETD overhaul would largely depend on each member state’s tax system (i.e. something normally outside the Commission’s control, unless state aid is involved) and encourages member states to consider using energy tax revenues to support vulnerable households.
CBAM introduction
During the European Parliament’s green taxation hearing on 12 July 2021, Alice Pirlot, research fellow at the University of Oxford, had stressed that clarity on the overarching aim of the CBAM would be crucial to its design. If the priority goal was to protect the environment, it could be difficult to justify its application in respect of imports from countries that do not have a carbon pricing system, but otherwise do everything they can to fulfil the aims of the Paris Agreement. The preamble of the proposed CBAM regulation, however, makes clear that the overarching aim is to prevent carbon leakage, and this could very much justify the application of the CBAM in such circumstances – and this seems to be what is envisaged.
The CBAM has been designed as a system of certificates to complement the ETS rather than, for instance, an import tax. Importers will be required to purchase certificates at a price to be set by the Commission on a weekly basis to mirror average ETS prices (which are established on a daily basis) in respect of relevant goods (being, at least initially, only iron and steel, cement, fertiliser, aluminium and electricity generation as per Annex I to the proposed CBAM regulation) imported into the EU customs territory from third countries.
Imports from countries that participate in the ETS or have an emissions trading system linked to it are exempt from CBAM. Unfortunately, following Brexit, the UK established its own emissions trading system which is not currently linked to the ETS and, consequently, the UK is not listed among the exempt third countries in Annex II, Section A of the proposed CBAM regulation. Its article 9 should, however, help to ensure that there is no double charge in respect of UK products under the UK ETS and CBAM. It envisages that a claim could be made for the carbon price paid in a third country to be taken into account to reduce the required number of CBAM certificates, but this would clearly mean an additional administrative burden as compared to a full exemption.
Tanja Velling, Slaughter and May
The European Commission has adopted a package of measures intended to put the EU firmly on the road to climate neutrality by 2050 with the intermediate step of a minimum 55% reduction in net greenhouse gas emissions by 2030. An overhaul of the EU emissions trading system (ETS) and of the Energy Taxation Directive (ETD), and the introduction of a carbon border adjustment (CBAM) form part of the package.
ETS overhaul
The Commission’s proposal for the overhaul of the ETS includes proposals to tighten its rules and broaden its application, and establish a parallel regime.
A directive is proposed which would bring maritime transport within the scope of the ETS and accelerate the reduction of the number of emissions allowances that can be issued each year by changing the linear reduction factor from 2.2% to 4.2%. A separate proposed directive would lead to the gradual reduction of free emissions allowances available to the airline industry (which is also set to lose under the ETD overhaul).
The Commission’s Q&A on the ETS overhaul also envisages the establishment of a separate emissions trading system for road transport and heating fuels which would apply from 2026 at the fuel supplier level. Its introduction would be accompanied by the establishment of a social climate fund which would use resources equal to approximately 25% of the 2026-32 auction revenues from the new system to help member states fund measures to mitigate the social impact of its introduction.
ETD overhaul
Having entered into force more than 15 years ago, the ETD has been in dire need of a makeover. A September 2019 report by the European Commission noted that the ETD does not reflect the current mix of energy products and criticised that it does not link the minimum tax rates to energy content and CO2 emissions.
This will change with the proposed recast of the ETD. Minimum tax rates would be based on the real energy content and environmental performance of each product, with most polluting fuels taxed at the highest level. The tax base would also be expanded – including through the removal of existing exemptions. An eye-catching change in this respect is that fuels for the aviation and maritime industries would lose existing exemptions.
The Commission’s Q&A on the ETD overhaul acknowledges the risk that the burden of higher minimum levels of energy taxation may be felt disproportionately by consumers and poorer households. The mitigation of this risk does, however, appear to be left mostly to the member states. Whilst the social climate fund (discussed above) and certain other EU initiatives are mentioned, the Q&A notes that the distributional impact of the ETD overhaul would largely depend on each member state’s tax system (i.e. something normally outside the Commission’s control, unless state aid is involved) and encourages member states to consider using energy tax revenues to support vulnerable households.
CBAM introduction
During the European Parliament’s green taxation hearing on 12 July 2021, Alice Pirlot, research fellow at the University of Oxford, had stressed that clarity on the overarching aim of the CBAM would be crucial to its design. If the priority goal was to protect the environment, it could be difficult to justify its application in respect of imports from countries that do not have a carbon pricing system, but otherwise do everything they can to fulfil the aims of the Paris Agreement. The preamble of the proposed CBAM regulation, however, makes clear that the overarching aim is to prevent carbon leakage, and this could very much justify the application of the CBAM in such circumstances – and this seems to be what is envisaged.
The CBAM has been designed as a system of certificates to complement the ETS rather than, for instance, an import tax. Importers will be required to purchase certificates at a price to be set by the Commission on a weekly basis to mirror average ETS prices (which are established on a daily basis) in respect of relevant goods (being, at least initially, only iron and steel, cement, fertiliser, aluminium and electricity generation as per Annex I to the proposed CBAM regulation) imported into the EU customs territory from third countries.
Imports from countries that participate in the ETS or have an emissions trading system linked to it are exempt from CBAM. Unfortunately, following Brexit, the UK established its own emissions trading system which is not currently linked to the ETS and, consequently, the UK is not listed among the exempt third countries in Annex II, Section A of the proposed CBAM regulation. Its article 9 should, however, help to ensure that there is no double charge in respect of UK products under the UK ETS and CBAM. It envisages that a claim could be made for the carbon price paid in a third country to be taken into account to reduce the required number of CBAM certificates, but this would clearly mean an additional administrative burden as compared to a full exemption.
Tanja Velling, Slaughter and May
