The package aims to deliver on the targets agreed in the European Climate Law and fundamentally transform the EU’s economy and society for a greener future.
By Paul A. Davies, Nicola Higgs, David Little, Elisabetta Righini, JP Sweny, and Michael D. Green
On 14 July 2021, the European Commission (the Commission) unveiled a long-awaited package of proposals that seeks to align the EU’s climate, energy, land use, transport, and taxation policies with the European Green Deal’s emissions reduction target of at least 55% by 2030, compared to 1990 levels. The European Climate Law, which enters into force this month, will enshrine this target into binding legislation.
This blog post outlines the key elements of the package, which aims to fulfil the Commission’s ambition for Europe to be the world’s first climate-neutral continent by 2050. The proposals are interconnected and aim to ensure responsibility is shared evenly across sectors, with measures providing additional financial support where necessary.
Source: European Commission Architecture Factsheet
Tightening the existing EU ETS
The EU Emissions Trading System (EU ETS) sets a cap on the total amount of certain greenhouse gases that can be emitted each year by the entities covered by the system. The Commission is proposing that emissions from the current EU ETS sectors be reduced by 61% by 2030, compared to 2005 levels (an increase from the current 43% reduction target).
To achieve this goal, the Commission wants to impose a steeper annual emissions reduction of 4.2%, following a one-off reduction of the overall emissions cap by 117 million allowances. The Commission also proposes to gradually remove free emissions allowances in the second part of the decade, and allocate such free allowances (for as long as they exist) in a more targeted way. For example, among other criteria, free allocation would be made conditional on decarbonisation efforts. In addition, the Commission aims to move to full auctioning of allowances by 2027 to create a stronger price signal to drive emissions reduction.
Furthermore, the Commission wants to extend the system to new sectors. For example, maritime transport would be included in the existing EU ETS (large ships above 5000 gross tonnage that stop at any EU port, regardless of the flag they fly), while emissions from fuels used in road transport and building would be covered by a new, separate emissions trading system that would become operational from 2025. This new ETS for fuels used in road transport and building would regulate fuel suppliers, rather than households or car drivers, and would target emissions reductions of 43% in 2030, compared to 2005. The Commission foresees that fuel suppliers are likely to pass on some of their carbon costs to consumers, and has presented a proposal for a Social Climate Fund to address this concern (see below).
In parallel, the proposals would implement the Carbon Offsetting and Reduction Scheme for International Aviation (the CORSIA), which would apply to EU-based airline emissions from flights to and from countries outside the European Economic Area. When emissions from these flights reach levels above 2019 levels, they would be required to be offset with appropriate carbon credits.
In its proposals, the Commission includes a number of measures to promote carbon capture, utilisation, and storage (CCUS) and address certain concerns that have been expressed by market participants regarding the treatment of CCUS under the current rules. All means of transport for captured CO2 are envisaged to get equal treatment under the EU ETS system, and obligations to surrender the allowance would not arise for emissions of CO2 that end up permanently chemically bound in a product. The proposals also seek to address certain issues related to double counting. For example, implementing acts will be introduced in due course to specify how to account for storage of emissions from a mix of zero-rated and non-zero-rated sources, and how to account for emissions from renewable fuels of non-biological origin and recycled carbon fuels.
Measures to prevent carbon leakage
The proposals introduce a Carbon Border Adjustment Mechanism (CBAM), which would increase levies on imports of emission-intensive products. The Commission anticipates that the CBAM would reduce the risk of carbon leakage and encourage EU partners to increase their climate targets by creating a level playing field.
Initially, the CBAM would cover only imported goods of certain sectors that in the EU are among those determined to be at high risk of carbon leakage: cement, certain fertilisers, iron, steel, and aluminium. A reporting system would apply as from 2023, and importers would start paying a financial adjustment in 2026.
The CBAM would require importers of covered goods into the EU to register with national authorities and purchase and surrender a number of certificates that reflect the goods’ embedded emissions. The price of the certificates would reflect the weekly average auction price of the ETS allowances. The Commission clarified that once a non-EU producer could show that it already paid a price for the carbon used in the production of the imported goods in a third country, the corresponding cost could be fully deducted for the EU importer.
The CBAM is among the more controversial measures unveiled by the Commission. Questions are being raised around its compatibility with WTO rules and it remains to be seen the reaction it will elicit from EU’s international partners, although recent G20 comments did endorse carbon pricing.
Increased use of renewable energy
The Commission’s proposed amendment to the Renewable Energy Directive (REDII) would implement a more ambitious target to produce 40% of energy from renewable sources by 2030, with all Member States required to contribute. To achieve this goal, the Commission has proposed specific targets for renewable energy use in transport, heating and cooling, buildings, and industry. In transport, for instance, the proposal specifically promotes renewable fuels that achieve the highest greenhouse gas emission savings, setting out a 13% target for the reduction of the emission intensity, including for international aviation and maritime transport fuels. It also increases the ambition level for advanced biofuels to 2.2% of the transport sector’s energy consumption and introduces a 2.6% target for hydrogen and hydrogen-based synthetic fuels in the sector.
To ensure consistency with other climate and environmental goals, the Commission has strengthened sustainability criteria for the use of bioenergy, asking Member States to design schemes in a way that respects the cascading principle of uses for woody biomass — prioritising use, re-use, and recycling of wood materials before burning them for energy.
Greater energy efficiency
The Commission’s proposal for an Energy Efficiency Directive contains binding targets to increase energy savings at the EU level and achieve an overall reduction of 36% by 2030. The Directive would guide how the levels of contributions are established in each Member State, and is expected to almost double the annual energy saving obligation currently in place. Under the Directive, the public sector would be required to renovate 3% of its buildings each year, which would likely result in new job creation and bring down energy use and costs to the taxpayer.
A faster rollout of low-emission transport, and the infrastructure and fuels to support it
The Commission’s proposals would establish stronger CO2 emissions standards for cars and vans by requiring average emissions of new cars to lower by 55% from 2030 and 100% from 2035, compared to 2021 levels. As such, all new cars registered as of 2035 would be required to produce zero emissions.
To ensure the availability of a reliable charging and fuelling network, the revised Alternative Fuels Infrastructure Regulation would require Member States to install charging and fuelling points at regular intervals on major highways.
But it’s not just road transport that the Commission is focusing on — the revised Alternative Fuels Infrastructure Regulation would require that aircraft and ships have access to clean electricity in major ports and airports. The ReFuelEU Aviation Initiative would oblige fuel suppliers to blend increasing levels of sustainable aviation fuels in jet fuel taken on-board at EU airports (excluding crop-based biofuels, hydrogen, and electricity) and airlines would have an obligation to uplift a minimum volume of fuel at the EU airport of departure regardless of their nationality, thus making tankering not acceptable. Meanwhile, the FuelEU Maritime Initiative would encourage increased use of sustainable maritime fuels and zero-emission technologies by setting a maximum limit on the greenhouse gas content of energy used by ships.
Alignment of taxation policies with the European Green Deal objectives
The revision of the Energy Taxation Directive focuses on two main areas of reform: (1) introducing a new structure of tax rates based on the energy content and environmental performance of the fuels and electricity, and (2) including more products in its scope and removing some of the current exemptions and reductions (e.g., kerosene and heavy oil in the maritime industry).
All minimum rates would be expressed in unified metrics to facilitate easy comparison between fuels with different polluting levels and between various emerging uses of electricity.
Tools to preserve and grow natural carbon sinks
The Commission stated its view that restoring nature and biodiversity offers a quick and cheap solution to absorb and store carbon. Therefore, the Commission wants to introduce measures to preserve Europe’s forests, soils, wetlands, and peatlands.
The Regulation on Land Use, Forestry and Agriculture sets an overall EU target for carbon removals by natural sinks, equivalent to 310 million tons of CO2 emissions by 2030. By 2035, the EU hopes to reach climate neutrality in the land use, forestry, and agriculture sectors, including agricultural non-CO2 emissions, such as those from fertiliser use and livestock.
Further, the proposed EU Forest Strategy aims to improve the quality, quantity, and resilience of EU forests. It sets out a plan to plant 3 billion trees across Europe by 2030 and contains measures to support forest-based bio-economy.
Socially fair transition
The Commission recognises that, in order to be successful, this wide-ranging green transition must be implemented in a fair and socially balanced way. Among the key proposals to support this is the Effort Sharing Regulation (the ESR), which assigns strengthened emissions reduction targets to each Member State for buildings, road and domestic maritime transport, agriculture, waste, and small industries. These targets are based on respective countries’ GDP per capita, with adjustments made to take cost efficiency into account. To meet the EU’s overall emission reductions target by 2030, the Commission is now proposing to reduce emissions under the ESR by at least 40%, compared to 2005 levels.
Moreover, a new Social Climate Fund (the Fund) would provide dedicated funding to Member States to help citizens finance investments in energy efficiency, new heating and cooling systems, and cleaner mobility. The Fund would be financed by the EU budget, using an amount equivalent to 25% of the expected revenues of emissions trading for building and road transport fuels. It would provide €72.2 billion of funding to Member States, for the period 2025-2032, based on a targeted amendment to the multiannual financial framework. The Fund would mobilise €144.4 billion for a socially fair transition when the matching funding contribution from Member States is taken into account.
The Commission also proposes to increase the size of the Innovation and Modernisation Funds (both paid for by the portion of EU ETS auction revenues), which respectively support innovations towards climate neutrality across the EU and power sector modernisation in lower-income Member States.
To what extent the Commission will be able to convince the Member States that the effort of cutting emissions is being shared fairly remains to be seen. So far, the debates have revealed some scepticism and divisions between the countries, with concerns being raised that European households, rather than polluters, will bear the burden of a more expensive system and that compensation funds being an overly complex system, will not deliver to those most at need.
The Commission’s package of proposals aims to put the EU on a path to become a global leader in the fight against climate change. The EU remains committed to working with the G7, the G20, and other international partners, and the Commission stated that it will set out proposals for a global green transition agenda ahead of the COP26 conference taking place this November. As highlighted by the Commissioner for Economy, Paolo Gentiloni: “Our efforts to tackle climate change need to be politically ambitious, globally coordinated and socially fair.”
The package sits alongside the EU’s budget for the next seven years, which will provide support to the green transition. Thirty percent of programmes under the €2 trillion 2021-2027 Multiannual Financial Framework and NextGenerationEU are dedicated to supporting climate action; 37% of the €723.8 billion (in current prices) Recovery and Resilience Facility, which will finance Member States’ national recovery programmes under NextGenerationEU, is also allocated to climate action. It is also accompanied by an in-depth revision of the State aid compatibility rules in the sector. A draft Communication on State aid for climate, environmental protection and energy (CEEAG) was published in June for public consultation to replace the 2014 Guidelines on State aid for Energy and Environmental Protection (EEAG). The draft CEEAG reflects the new climate, environmental, and energy priorities of the Green Deal and sets out the conditions for the Commission’s approval of all subsidies granted by Member States with these aims as of 2022.
The package of proposals will now be transmitted to the EU co-legislators, the European Parliament and the Council (i.e., Member States). To become EU law, they will have to be adopted by both after having been analysed and discussed by each institution. In the course of the legislative process, the texts of the proposals will undergo potentially significant changes in the form of amendments adopted by both the EU Parliament and the EU Council. Normally the legislative process lasts between 12 and 18 months so that some of the new rules could be applicable across the EU already by Q1 2023.
Latham & Watkins will follow the progress of what is anticipated to be tough negotiations between the Member States and European politicians (including among the Commission itself). Whether the proposals will be subject to change in the parties’ efforts to balance fairness, emissions reductions, and competitiveness remains to be seen.
This post was written with the assistance of Aleksandra Dulska in the London office of Latham & Watkins.
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