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June 23, 2022
2022-5600

European Parliament adopts carbon legislation package, final negotiations with EU Member State representatives expected soon

Executive summary

On 22 June 2022, the European Parliament (EP) adopted the package of carbon legislation, with a significant majority of votes. The package includes the revision of the European Union (EU) Emission Trading System (EU ETS), the new Carbon Border Adjustment Mechanism (CBAM) and the Social Climate Fund.

In the EU legislative process, the next step will be negotiation of the EP with the EU Council, i.e., the EU Member State representatives. Media reports indicate that the French Presidency will likely drive the process quickly.

The adoption of the carbon package comes after a rejection of the previous draft version of the carbon legislative package on 8 June 2022 in the EP (see EY Global Tax Alert, European Parliament rejects carbon legislation package, including more ambitious rules for EU Emission Trading System and new EU Carbon Border Adjustment Mechanism, dated 13 June 2022). This prompt new agreement reflects a strong commitment to implement the European Green Deal measures. The vote also points toward the balancing act of ambitious climate goals and the need for time for the EU industry to transform.

Detailed discussion

Emissions Trading System reform

The EU ETS is a cornerstone of the EU’s policy to combat climate change. Notably, the 2030 greenhouse gas (GHG) emissions reduction target should be increased from 61% to 63% (compared to 2005 levels).

With the EU ETS reform, the EP is looking to incentivize key EU industry players to further reduce emissions and at a faster pace, and invest in low-carbon emitting technologies. The EU ETS will be reformed, including the following changes:

  • Free allowances phase-out from 2027: The free allowances of certificates granted in accordance with the EU ETS will be phased out from 2027 and will end by (beginning of) 2032. The reduction will follow the progressive curve pattern, i.e., free allowances will be reduced to 93% in 2027, 84% in 2028, 69% in 2029, 50% in 2030, 25% in 2031 and 0% in 2032.

  • Bonus-malus system: A bonus-malus system is to be introduced from 2025, i.e., the most efficient installations in a sector will be rewarded with additional free allowances. Manufacturers who do not implement recommendations set out in energy audits, do not certify their energy systems or do not establish a decarbonization plan for their installations, could lose some or all of their EU ETS free allowances.

  • Inclusion of maritime transport: The EU ETS will be extended to maritime transport. The EP asks to cover 100% of emissions from intra-European routes as of 2024 as well as 50% of emissions from extra-European routes from and to the EU from 2024 until the end of 2026. As of 2027, emissions from all routes should be covered 100% with possible derogations for trips from/to non-EU countries where, subject to conditions, coverage could be reduced to 50%. The definition of covered GHG emissions will also include methane nitrous oxides. It is planned that 75% of income generated from auctioning maritime allowances will be allocated to an Ocean Fund, which will support the transition to an energy-efficient and climate-resilient EU maritime sector.

  • Municipal waste incineration: As of 2026, municipal waste incineration will be included in the EU ETS.

  • Buildings and road transport: Extension of the Emission Trading System (ETS II) to fuels used for heating of buildings and road transport by 1 January 2024. Fuels used for private transport and residential buildings will be excluded until 2029 to reduce the rise of energy costs for citizens, with the condition of a prior comprehensive assessment and a new legislative proposal to be agreed upon by the EU Council and EP. The EP also intends to install a price cap of €50. If the average price of certificates under ETS II goes beyond this cap before 2030, it is planned that 10 million allowances should be released from the EU Market Stability Reserve. The income made from 150 million ETS II certificates will be made available for the Social Climate Fund, which is aimed to support low income families.

  • Use of revenues: Revenues of the EU ETS will be used exclusively for climate action in the EU and Member States.

Carbon Border Adjustment Mechanism (CBAM)

The CBAM is designed to reduce the risk of carbon leakage (i.e., the relocation of emission intensive business to non-EU countries without or with less carbon pricing) and help to meet global carbon ambition goals. It is also hoped the policy measure will encourage other jurisdictions to adapt their climate policies to standards similar to the EU.

The EP envisages the following amendments to the previously released drafts of legislation:

  • Scope extension: Original proposals for a CBAM regulation included a large coverage of goods in the categories of iron and steel, refineries, cement, organic basic chemicals and fertilizers. The latest amendments will extend the originally proposed scope to also include organic chemicals, plastic polymers, hydrogen and ammonia. The implementation of organic chemicals and polymers is intended to be subject to further assessment about technical specificities.

  • Indirect emissions from electricity: CBAM calculations will include indirect emissions derived from the electricity used by manufacturers.

  • Transition period for reporting in 2023: The transition period in which reporting is required by importers will start in 2023, spanning until end of 2026.

  • Implementation from 2027: The full implementation of CBAM is designated for 1 January 2027 with a phase-in until 2032. Accordingly, CBAM applicable to imported goods would be reduced mirroring the phase-out of free allocations under EU ETS to EU industries to provide for World Trade Organization (WTO)-compatibility.

  • Export adjustment mechanism: It is considered to implement an export adjustment mechanism. The mechanism entails free allocations under EU ETS for EU manufacturers for emissions in context of manufacture of product covered by CBAM, which are intended for export to non-EU countries without carbon pricing mechanisms similar to the EU ETS. By 31 December 2025, the European Commission will present a report with a detailed assessment of the effects of the EU ETS and CBAM on the EU industry sectors manufacture of products covered by CBAM and exported outside the EU, on the development of global emissions and on the WTO-compatibility of the export facilities.

  • Centralized EU CBAM authority: A centralized EU CBAM authority will be established, instead of having 27 competent authorities.

  • Use of revenues: Revenues generated by CBAM certificates purchased by importers will be allocated to the EU budget. However, at least the equivalent in financial value to the revenues generated by the sale of CBAM certificates will be provided to support least developed countries' efforts in decarbonizing their manufacturing sectors.

Social Climate Fund

The Social Climate Fund will support low income families with increasing price levels for energy. The fund would support the financial resources of EU Member States by:

  • Temporary direct income support measures (such as a reduction in energy taxes and fees) to address the increase in road transport and heating fuel prices.

  • Long-lasting structural investments in renewable energy, buildings renovation, a shift from private to public transport, car-sharing and car-pooling as well as promotion of active modes of transport, such as cycling.

  • The support mechanism may include fiscal incentives, vouchers, subsidies as well as zero-interest loans.

Implications

The EU carbon package aims to transform the EU economy to zero-emissions by 2050, and notably some EU Member States have greater national goals. The goals of the EU energy and emission policies are clear, reflecting the urgent need to reduce emissions and meet overall climate goals.

The upcoming negotiations of the EP with the EU Council may result in some change in details, however, overall there is now a greater level of clarity and certainty about the EU’s future climate and emission policy. With the ultimate goal of reducing and eventually eliminating GHG emissions, transformation is essential. Transformation achieved by innovation and advancement of infrastructure and technology applied across the value chain and supply chain will take time, potentially years from planning to implementation. Many factors should be considered, including fiscal and non-fiscal incentives available to support the transition.

With many details now known, businesses should consider impact assessments, strategy planning and kick-off preparatory measures. Initial measures such as the CBAM reporting period for covered imported goods is intended to start in 2023.

The impact is not limited to the EU, rather it will impact across global sourcing and distribution footprints of businesses. The EU’s new emission policy can also be expected to motivate other jurisdictions around the world to implement similar measures. The impact is also not limited to new data and reporting requirements. There potentially will be additional costs for businesses in terms of emissions occurring during product manufacture, which can heavily impact on product competitiveness, sourcing, supply chain and investment strategy, and corporate value, among others.

Businesses should proactively address the changes and prepare to align their business model accordingly.

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For additional information with respect to this Alert, please contact the following:

Carbon Border Adjustment Mechanism

Emission Trading System

EMEIA Sustainability Tax Services

 
 

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