The Trading of Greenhouse Gas Emissions is Expanding

The environmental narrative has been a primary focus among leaders in the West, including those in the European Union. There is a significant effort by EU leaders to encourage the introduction of directives and various rules to motivate both companies and individuals towards sustainable actions and to do something good for the planet that we have severely damaged on a global level. Thus, the EU has established the European Emissions Trading System (ETS) as the foundation of its climate change policy. It has been in existence since 2005 and is the oldest system currently in operation, and as explained by the Executive Director of ATD Solutions, Antonija Zorić, it is the backbone of the EU’s policy to combat climate change and reduce greenhouse gas emissions in a cost-effective manner.

Polluter Pays

The system currently covers about 11,000 sources of greenhouse gas emissions in the energy and industrial sectors as well as domestic air transport, which account for about 40 percent of the total greenhouse gas emissions in the Union.

– The impetus for establishing the ETS was the application of the environmental principle ‘polluter pays’ and the obligations that signatory states undertook under the Kyoto Protocol, and today the global Paris Agreement. The goal of the Paris Agreement is to limit the increase in the average global temperature to a maximum of 1.5 °C by 2100 compared to the pre-industrial period – explains Zorić.

The ETS is, she says, one of the mechanisms to encourage sectors that emit the most greenhouse gases to reduce and completely cease emissions by transitioning to clean technologies, using energy from renewable sources, and enhancing existing carbon sinks in a cost-effective manner.

– The assumption of the system is an effective procedure for monitoring, reporting, and verification (MRV) of CO₂ emissions along with related processes, which is referred to as the ETS compliance cycle. Each year, entities that emit CO₂ into the environment must have an approved monitoring plan for tracking and reporting annual emissions, which is also part of the regular operating permit, and is accompanied by verification of the emissions report that ensures the reliability, accuracy, and credibility of the greenhouse gas emissions reports from the facility. The data must be verified by an authorized verifier – explained the Head of Sustainable Business at Cemex Croatia, Merica Pletikosić.

The Carrot and Stick Principle

The system operates on the principle of trading emission units (cap and trade), adds Pletikosić, as the EU sets a limit or cap on the amount of emissions that may be released into the environment. This total amount of emissions is sold or allocated to companies in the form of emission allowances (EUA), which represent the permitted amount of emitted emissions. Companies are required to adhere to their allowances, thereby encouraging emission regulation and investment in decarbonization, and those that do not have enough emission allowances to cover verified emissions must purchase allowances from those who have a surplus.

– The goal of trading is that the buyer of allowances essentially pays a penalty for emitting more harmful gases into the environment than is permitted, while the seller of allowances is rewarded for having reduced emissions of those gases. In theory, it is more expensive for the polluter to buy additional allowances than to invest in technologies to reduce emissions – explained Pletikosić.

The EU ETS entered its fourth trading phase on January 1, 2021, which will last until 2030, notes Zorić, and its last revision for the fourth phase was completed in 2018. However, based on the goals of the European Green Deal, the European Commission proposed reforms in 2021 to align the system with the updated climate target for 2030, namely a reduction of net greenhouse gas emissions by at least 55 percent compared to 2005 (‘Fit to 55%’). In December 2022, the European Parliament and the EU Council reached a provisional agreement on the reform of the EU ETS as part of the negotiation process for the goals of the European Green Deal.

This agreement also foresees the creation of an additional system (EU ETS II) for trading emissions for buildings, road transport, and fuel in certain industries starting in 2027 – modeled after the German fuel emissions trading.

– It is expected to become operational at the earliest by 2027. Not all details have been worked out yet, but it is anticipated that its introduction will bring the EU closer to its climate goals for 2030 and that it will provide a common basis for pricing emissions in other sectors in the EU. This scheme is expected to cover as much as 75 percent of total emissions compared to the current 40 percent – explained Pletikosić.

Namely, Zorić states that the obligors of EU ETS II, which will initially be separate from the existing EU ETS, are not emitters in the construction and transport sectors, but suppliers of fossil fuels consumed in those sectors. EU ETS II is expected to merge with the existing EU ETS in later years based on the experiences gained after several years of operation. She adds that the European Commission believes that the new requirements imposed on the construction and road transport sectors will have a positive social impact as they will encourage the creation of new jobs, new facilities for the development, production, and distribution of new technologies, as well as the acquisition of new skills and knowledge for employees and new educational programs in the education system.

– By promoting measures to increase energy efficiency in households in vulnerable and low-income households, they can help avoid rising costs. The establishment of a social climate fund for member states aimed at the social aspects of including construction and road transport in the ETS is also anticipated, particularly for low-income households, micro-enterprises, and transport users – adds Zorić.

What is the Price

The current price of emission units is 90 euros, but Zorić emphasizes that it will continue to rise to encourage operators to accelerate the decarbonization of their business strategies and models.

– This means that an operator who is not entitled to free allocation, if, for example, they emit one million tons annually, must pay 90 million euros for emission units – explains Zorić, but also adds that any increase in the price of emission units means an increase in the variable operational costs of EU ETS obligors, which then affect the final price of services, goods, and works.

Therefore, we can expect price increases leading up to the transition to a low-carbon economy, which will be influenced by changes in the EU ETS, among other factors.

– The decarbonization process is not simple. It requires changes in business strategies and models, new knowledge and skills, changes in technologies, increased energy efficiency, and a transition to renewable energy sources, which is not always simple or quick, and above all, it is not cheap. As in everything else, operators who manage to adapt in time will be able to operate successfully – emphasizes Zorić.

Pletikosić explains that the expansion of trading in emission certificates will impact further reductions in greenhouse gas emissions, which could have a range of favorable effects: economic (reduced consumption of fuel, raw materials, transport), social (improved health of people due to less exposure to pollutants), administrative (reduction of administrative barriers), and ecological (cleaner environment). An increase in the investment fund for decarbonization projects is also expected, which will yield additional positive effects.

When it comes to entrepreneurs and their awareness of the topic, Pletikosić believes that large companies already involved in the EU ETS system are following regulations and have been improving their processes and technologies for years. However, those that have not participated in it so far may face challenges and should start preparing.

Zorić adds that the adoption of the EU taxonomy Regulation in 2020 and implementing regulations that outline the technical criteria for assessing sustainable activities is an additional incentive for reporting obligors to decarbonize their strategies and business models.

– Awareness can always be better, but operators are also informed about changes in the EU ETS through professional and sectoral associations. In general, we must be aware that we have been EU members for ten years and that various ways of informing offered by the European Commission and EU associations are available to us – concludes Zorić.