European Commission unveils the broad lines of the EU ETS reform

The reform of the European emissions trading system proposed by the European Commission has four components:

• Revising the trajectory for cutting allowances in circulation: the Commission proposes to revise the path for reducing the total number of allowances in circulation – set by the linear reduction factor (LRF) – after 2030. The LRF would fall from 4.4% in 2028 to 3.7% over the 2031-2035 period, then drop to 1.7% from 2036 onwards. On this basis, the number of allowances in circulation would reach zero between 2046 and 2048.
• Reforming the market stability reserve: the Commission proposes to adjust the rules for feeding the reserve so as to leave more allowances in circulation. Under the current rules, 24% of allowances are placed in the reserve – and thus withdrawn from the market – when the number of allowances in circulation exceeds 1,096 million. The text would halve the intake rate, bringing it down to 12%, and raise the threshold to 947 million. Conversely, 100 million allowances would be returned to the market if the number in circulation falls below 300 million (against 400 million today).
• Allocating free allowances: for sectors covered by the carbon border adjustment mechanism (CBAM), the Commission proposes to reintroduce 15% of free allowances. Free allowances would not be fully phased out until 2038, instead of 2034 under the rules currently in force. Over the 2021-2025 period, free allowances covered around 85% of the emissions of energy-intensive industries. The Commission estimates this figure will average 78% over the 2026-2030 period. Each year, 80% of the allowances granted free of charge to companies will be conditional on their first publishing decarbonisation plans.
• Financing decarbonisation: the Commission wants to turn the ETS into a tool for financing decarbonisation by channelling the revenue from states' allowance sales towards decarbonisation investments.