The Use of Renewables and the EU Emissions Trading System

In 2023, the EU achieved an 8% net reduction in greenhouse gas (GHG) emissions compared to the previous year[1]. This represents the most significant annual drop in decades, excluding 2020 when emissions fell sharply due to Covid-19 restrictions. Overall, the bloc’s emissions are now 37% below 1990 levels, while its GDP has grown by 68% over the same period. This represents a significant and important decoupling of economic growth from emissions[2].

The reduction in 2023 was linked to the acceleration of the energy transition and driven in large part by the energy sector, which saw a reduction in GHG of 18% compared with the previous year, achieved primarily by an increase in solar and wind capacity, and to a lesser extent a reduction in electricity production from coal and gas[3]. Against a backdrop of the record-breaking temperatures seen over the same period, this shines a light of hope. Indeed, preliminary data for 2023 indicate that for the first time, renewable energy sources became the dominant source of electricity generation in the EU by a significant margin, accounting for 44.7% of the total, compared to 32.5% from fossil fuels and 22.8% from nuclear power[4].

In the context of the EU, it would make sense for renewable energy to be attributed as the technology that has made the most significant impact on climate mitigation. By driving a substantial shift in the electricity mix and reducing reliance on fossil fuels, renewables have become a cornerstone of the EU’s efforts to achieve its climate targets and transition to a low-carbon economy.

However, while renewables address the “how” of decarbonisation, the “why” has been driven by the economic and regulatory pressures that must be in place to incentivise a shift from the comfort of the status quo. For this, the EU Emission Trading Scheme (EU ETS) has been instrumental in driving systemic changes and providing the economic incentives necessary for the transition, including spurring the adoption of renewables.

The EU ETS is Europe’s emission trading scheme covering most high-emission sectors, including heavy industry power generation and aviation, covering 36% of the EU’s total GHG emissions. The scheme limits the emission allowance on industries and their constituent entities. By trading between those entities, the EU ETS ensures emissions are reduced where they are most cost-effective, allowing companies with a lower abatement cost to reduce their emissions and trade the surplus with those with a higher abatement cost. In doing so, EU ETS indirectly supports adopting renewable energy by increasing competition between businesses and generating the economic incentive to invest in lower-emission fuels and technologies while providing the legal and market framework that ensures accountability and long-term climate targets.

According to projections, EU ETS emissions are expected to decrease by 41% to 48% by 2030 and by 55% to 62% by 2040, compared to 2005 levels, but fall short of the new target of a reduction of at least a 55% emission by 2030, compared with 1990 levels. Achieving these reductions will depend on additional measures implemented by certain Member States. In July 2021, the European Commission introduced a policy package aimed at the new 2030 target, paving the way for carbon neutrality by 2050. A central element of this package was a proposed revision of the EU ETS. The revision set a more ambitious target: a 61% reduction in emissions by 2030, compared to 2005, incorporating aviation and newly integrated shipping emissions. The package also revised the Effort Sharing Regulation (ESR), introducing a 40% reduction target for 2030 relative to 2005 levels[5]. In addition to the sectors already covered by the EU ETS, the ESR covers emissions from other key sectors, including buildings, domestic transport, waste, small industry, and agriculture. The revised target significantly increased from the previous target of 29%.

The EU ETS has, however, not been without criticism; during the initial phase, the EU ETS faced criticism over the allocation of allowance, with too many given away for free, leading to windfall profits for some companies without significant reductions in emissions. Secondly, while the trading system’s scope is significant, high-emission sectors such as agriculture and the buildings sector represent additional challenges and are not fully covered. One such challenge concerns the additional burden of rapid decarbonisation or costs associated with buying emissions allowances that can put these industries at a disadvantage compared to their counterparts in less stringent emission regimes. Similarly, companies may face closure or shift production outside of the EU ETS if the burden is too high. This undermines the EU’s emission reduction efforts and impacts the competitiveness of businesses within the EU. The EU recently introduced the Carbon Border Adjustment Mechanism (CBAM) to counteract these issues. Adopted by the European Commission on August 17th, 2023. This mechanism complements the EU ETS by addressing carbon leakage and reinforcing the EU’s climate objectives. Once the transition phase is completed on January 1st, 2026, importers of carbon-intensive goods, such as iron, steel, cement, aluminium, fertilisers, and electricity, will need to purchase CBAM certificates to adjust for the costs they would have incurred if the goods were produced under the EU’s carbon pricing policies, thereby levelling the playing field[6].

While the EU ETS may not align with a common understanding of technology as a mechanical device or process, it represents the application of scientific knowledge, tools and processes ingeniously combined to address a practical problem and therefore fits the definition of a technology in a broader conventional sense. In its absence, alternative carbon pricing mechanisms would likely have emerged. However, as the world’s largest market for carbon emissions, the EU ETS stands as a cornerstone of EU climate policy. It has been instrumental in addressing the challenge of collective inaction, providing the regulatory framework, market incentives, and economic pressures needed to drive significant emissions reductions in the EU’s most carbon-intensive sectors across its 27 member states. With ongoing plans to expand its coverage and support consumers through mechanisms like the Social Climate Fund, the EU ETS is well-positioned to continue its pivotal role in achieving the EU’s climate ambitions.

This Post was submitted by Climate Scorecard EU Country Manager George Scott.

[1] https://climate.ec.europa.eu/document/download/7bd19c68-b179-4f3f-af75-4e309ec0646f_en?filename=CAPR-report2024-web.pdf

[2] ibid

[3] ibid

[4] ibid

[5] https://www.eea.europa.eu/publications/the-eu-emissions-trading-system-2#:~:text=According%20to%20their%20projections%2C%20ETS,Market%20Stability%20Reserve%20(MSR).

[6] https://www.frontier-economics.com/uk/en/news-and-insights/articles/article-i20084-eu-emissions-has-the-ets-been-a-success/

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