We continue with the topic of environmental protection and climate action legislation as it pertains to the construction and real estate sectors. In the previous issue we looked at the imminent reform of the European Union’s energy performance of buildings directive, aimed at achieving a climate-neutral building stock by 2050. In the present article we discuss legal changes adopted earlier this year that extend the EU’s emissions trading scheme, known as EU ETS, to buildings and transport, creating a separate system dubbed ETS II. We begin with a brief reminder of what EU ETS is.

I.  What is EU ETS?

EU ETS is a system for trading in greenhouse gas emission permits, or “allowances”, within the EU established by Directive 2003/87/EC[1] (henceforth Directive 2003). It aims to reduce CO2 and other greenhouse gas emissions by setting a limit on the overall volume of greenhouse gases that can be emitted by power plants, energy-intensive heavy industry (e.g. production of steel, aluminum, coke, ceramic products, or pulp from timber), as well as civil aviation and maritime transport. The limit is reduced every year. To legally emit greenhouse gases into the atmosphere, companies covered by EU ETS have to receive or buy allowances that correspond to a certain amount of emissions. Each allowance gives the holder the right to emit one ton of CO2 or the equivalent amount of other powerful greenhouse gases. Each Member State is allocated its quota of allowances, which it can sell or grant to some sectors for free.[2] Since 2013, auctioning is progressively replacing free allocation as the main method for allocating allowances to all EU ETS sectors except aviation, which means businesses have to buy an increasing proportion of allowances at auctions. Companies can also trade their allowances, which creates an incentive for them to reduce emissions. The common auction platform for EU ETS allowances is the European Energy Exchange (EEX) in Leipzig.

II. ETS II – key facts

In July 2021, as part of its Fit for 55 Package of climate and energy policy proposals – which aims to reduce net greenhouse gas emissions by at least 55% by 2030 from 1990 levels (and which includes a target to achieve a zero-emission building stock by 2050) – the European Commission published a legislative proposal for a revision of ETS. The proposal included the establishment of “a separate new emissions trading system for road transport and buildings” to address the lack of emissions reductions in these sectors. In May 2023, a new Directive (EU) 2023/959 was signed and published in the Official Journal of the European Union (henceforth Directive 2023)[3] that establishes such a separate system, referred to as ETS II, from 2027 (or from 2028 if energy prices are exceptionally high, a matter we return to below).

Directive 2023 has inserted into Directive 2003 a new Chapter IVa on an emissions trading system for buildings, road transport and additional industrial sectors, and an Annex III listing activities covered by Chapter IVa, which includes emissions from both commercial/institutional buildings and residential buildings, and from road transportation.

Under Directive 2023, emissions covered by ETS II are to be reduced by 43% by 2030 compared to 2005 levels: “the total quantity of allowances for the new emissions trading system should follow a linear trajectory to reach the emission reduction target for 2030, taking into account the cost-efficient contribution of the buildings and road transport sectors of 43 % emission reductions by 2030 compared to 2005.” The system is to become operational in 2027: “The total quantity of allowances should be established for the first time in 2027, to follow a trajectory starting in 2024 from the value of the 2024 emissions limits.” The Commission is to publish the Union-wide quantity of allowances for the year 2027 by 1 January 2025.

Importantly, the allowances for buildings and road transport are to be allocated via auctioning only, i.e. without any free allocation. Significantly, too, a higher amount of allowances will be auctioned in the initial period than the EU-wide quantity established by the Commission: “In order to ensure a smooth start to the new emissions trading system and taking into account the need of the regulated entities to hedge or buy ahead allowances to mitigate their price and liquidity risk, a higher amount of allowances should be auctioned early on. In 2027, the auction volumes should therefore be 30 % higher than the total quantity of allowances for 2027. This amount would be sufficient to provide liquidity, both if emissions decrease in line with the reductions needed, and in the event that emission reductions only materialize progressively.”

ETS II covers homes, shopping malls, or private combustion-engine cars, meaning that their owners will have to buy emissions allowances. (It can be said, therefore, that ETS II introduces a kind of non-tax public levy, similar e.g. to resort fees or climate fees known from holiday destinations.) Directive 2023 admits that this will have social consequences and requires effective compensation, especially in view of the existing levels of energy and transport poverty: in a 2021 survey, about 34 million Europeans, or nearly 6.9% of the EU population, said that they could not afford to heat their home sufficiently. Therefore, a related Regulation (EU) 2023/955 of 10 May 2023 established a new Social Climate Fund that will provide financial support to Member States for measures and investments that benefit households, micro-enterprises and transport users vulnerable and particularly affected by the inclusion of emissions from buildings and road transport. With respect to the Fund’s financing, Directive 2023 says: “50 million allowances from the EU ETS . . . and 150 million allowances from emissions trading in the buildings, road transport and additional sectors, and revenue generated from the auctioning of allowances concerning the buildings, road transport and additional sectors, up to a maximum of EUR 65 000 000 000, should be used for the financing of the Social Climate Fund in the form of external assigned revenue on a temporary and exceptional basis.”

As noted, the issuance of allowances and compliance obligations under ETS II are to become applicable from 2027. However, ETS II will be postponed until 2028 if gas or oil wholesale prices are exceptionally high compared to historical trends. Specifically, it will be postponed if one or both of the following conditions are met: the average gas price on the TTF exchange in Amsterdam for the six calendar months ending 30 June 2026 was higher than the average TTF gas price in February and March 2022; and the average Brent crude oil price for the six calendar months ending 30 June 2026 was more than twice the average Brent crude oil price during the five preceding years. It seems likely, therefore, that ETS II will become operational from 2028.

Directive 2023 also contains measures in the event of an exceptional increase in the price of allowances and in the event of excessive price fluctuations, designed to increase certainty for citizens that the allowance price in the initial years of ETS II does not go above €45. Thus, if the average allowance price exceeds a price of €45 for two consecutive months, 20 million allowances will be released from the market stability reserve; and if the average allowance price for the six preceding calendar months is more than 2.4 times the average allowance price for the preceding two-year reference period, 75 million allowances will be released from the market stability reserve.

In another notable provision, Directive 2023 says that from 2027 Member States may apply emissions trading to new sectors, taking into account all relevant criteria, in particular the effects on the internal market, potential distortions of competition, or the environmental integrity of the system.

To summarize, ETS II extends the polluter pays principle from industry, civil aviation and maritime transport to homes, shopping centers and private cars. It will not come into force right away, and it will be implemented with safeguards and compensation mechanisms. Nevertheless, from a consumer perspective, it represents a revolutionary change.

By Jan Akimenkow, trainee attorney at law

Originally published in PMR Construction Insight: Poland, No. 12 (273), December 2023

[1] Cf. Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC

[2] In Poland, the official register of GHG allowances is maintained by the National Centre for Emissions Management (KOBIZE), a unit of the Ministry of Climate.

[3] Cf. Directive (EU) 2023/959 of the European Parliament and of the Council of 10 May 2023 amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union.