EU Announces Agreement to Reform Europe’s Carbon Market, Cap Natural Gas Prices

European Union flags flutter outside the EU Commission headquarters in Brussels, Belgium, on June 17, 2022. Yves Herman/Reuters

The European Union announced on Dec. 18 a provisional agreement that reforms the bloc’s carbon market, successfully expanding a crucial component of the region’s broader green agenda.

After a 30-hour session, representatives of the 27 member states and the European Parliament agreed to apply the EU’s Emissions Trading System (ETS) to heating, road transportation, and maritime shipping. Officials also plan to use the agreement to accelerate requirements on companies to reduce pollution, whether they produce power or manufacture steel.

The latest reforms are a part of the EU’s broader “Fit for 55” initiative to slash emissions by a minimum of 62 percent from 1990 levels by 2030. The bloc wants to reach net-zero by 2050.

“The agreement on the EU Emissions Trading System and the Social Climate Fund is a victory for the climate and for European climate policy,” Marian Jurecka, Czech minister for the environment, said in a statement. “This will allow us to meet climate objectives within the main sectors of the economy, while making sure the most vulnerable citizens and micro-enterprises are effectively supported in the climate transition.

“We can now safely say that the EU has delivered on its promises with ambitious legislation and this puts us at the forefront of fighting climate change globally.”

The European Council and the European Parliament have yet to formally endorse and adopt the agreement.

Inside the Climate Change Package

The first key measure in the comprehensive package is creating a second Emissions Trading System (ETS) for road transport, buildings, and shipping. This feature will slap a price on emissions from these sectors by 2027, although the fee could be postponed by a year if energy prices in Europe remain elevated.

Another critical change is mandating that 10,000 factories and power plants purchase permits for emissions. Experts say this will nudge businesses to install greener technologies to reduce their carbon footprints. The plan will phase out free CO2 licenses by 2034.

EU states will be forced to measure, report, and verify emissions from municipal waste incineration installations beginning in 2024. The European Commission intends to include these installations in the ETS starting in 2028.

“Installations that will benefit from free allocations will need to comply with conditionality requirements, including in the form of energy audits and for certain installations climate neutrality plans,” the report reads. “Additional transitional free allocations can be granted under certain conditions to the district heating sector in certain member states, in order to encourage investments into decarbonising that sector.”

EU leadership will finance the shift to green technologies by tapping into and increasing allowances to climate-related funds.

The first step is raising the allowance of the Innovation Fund to 575 million euros ($610 million) from the present 450 million euros ($478 million).

The Modernization Fund also will be bolstered by auctioning 2.5 percent of allowances allocated to nations that maintain a gross domestic product per capita lower than the bloc’s average. This money will be monitored to ensure it’s assigned toward climate-related efforts.

Despite the European Union recently changing its mind and labeling natural gas as green energy, “natural gas projects will in principle not be eligible for” Modernization Fund money. However, officials noted that “a transitional measure will allow the current beneficiaries of the fund to continue time-limited financing natural gas projects under certain conditions.”

Finally, the bloc intends to establish an 86.7 billion euro ($92 billion) Social Climate Fund that will help vulnerable transit users, households, and small businesses endure the cost of emissions trading. This fund would be created from 2026 to 2032, and members may be eligible as early as Jan. 1, 2026.

“Each member state would submit to the Commission a ‘social climate plan,’ containing the measures and investments they intend to undertake to cushion the impacts of the new emission trading system on vulnerable households,” the European Council noted in the announcement. “Such measures could include increasing the energy efficiency of buildings, the renovation of buildings, the decarbonization of heating and cooling in buildings and the uptake of zero-emission and low-emission mobility and transport, and measures providing direct income support in a temporary and limited manner.”

Natural Gas Price Controls

Soon after the EU unveiled the latest green agenda development, the bloc approved a measure to institute a limit on natural gas prices to mitigate the energy crisis.

The latest policy directive, which the energy ministers describe as a market correction mechanism, will be activated on two occasions. The first is if front-month gas contracts top 180 euros ($191) per megawatt hour on the benchmark Dutch Title Transfer Facility (DTTF) for three consecutive business days. The second is if the price is 35 euros higher than a reference price for liquid natural gas on international markets during the same span.

“We have succeeded in finding an important agreement that will shield citizens from skyrocketing energy prices,” said Jozef Siklea, Czech minister of industry and trade. “We will set a realistic and effective mechanism, which includes the necessary safeguards that will steer us clear from risks to security of supply and financial markets stability. Once again, we have proved that the EU is united and will not let anybody use energy as a weapon.”

The measure is scheduled to go into effect on Feb. 15, 2023.

However, not everyone is on board with these price controls.

The European Central Bank (ECB) stated that such a measure might “jeopardize financial stability in the euro area.”

“The mechanism’s current design may increase volatility and related margin calls, challenge central counterparties’ ability to manage financial risks, and may also incentivise migration from trading venues to the non-centrally cleared over-the-counter (OTC) market,” the ECB wrote in a report (pdf). “These considerations, relevant to the stability of the financial system, should be taken into account by the Council in its deliberations on the proposed regulation.”

Germany and the Netherlands also have shared concerns about potential market disruptions.