ETS Directive for Emissions Trading System - Guidance

» Introduction to the EU ETS Directive

The EU ETS was established under Directive 2003/87/EC and launched in 2005 as the first and largest international emissions trading system. It creates a cap-and-trade market for greenhouse gases (GHGs), aiming to:

• Reduce emissions in a cost-effective and economically efficient manner.

• Help achieve the EU’s targets under the Paris Agreement.

• Support the European Green Deal and the goal of climate neutrality by 2050.

The Directive has undergone multiple revisions (e.g., Directive (EU) 2018/410 and Directive (EU) 2023/958) to align with increasing climate ambitions and scientific requirements.

Key historical phases:

• Phase I (2005–2007): Pilot period

• Phase II (2008–2012): Kyoto Protocol alignment

• Phase III (2013–2020): Harmonization and auctioning

• Phase IV (2021–2030): Fit for 55 alignment and enhanced stringency

» Scope and Objectives of the EU ETS

Legal Basis:

• The system applies to Annex I activities and Annex II GHGs.

• Member States must implement the Directive through national laws.

Objectives:

• Promote reduction of GHG emissions in a measurable, reportable, and verifiable (MRV) manner.

• Support innovation and transition to low-carbon technologies.

• Deliver market-based incentives for efficiency and emission reductions.

Inclusion of Activities:

• Power and heat generation

• Industrial production (e.g., cement, steel, refineries)

• Aviation (since 2012)

• Maritime transport (starting 2024)

• Expanded coverage of additional sectors from 2027 under ETS II (road transport, buildings, fuels)

» ETS Directive Definitions and Key Concepts

The Directive outlines precise legal definitions critical for enforcement and clarity. Key terms include:

• Emission Allowance: The right to emit 1 tonne of CO₂ equivalent.

• Operator: A person controlling a covered installation.

• Installation: Any stationary technical unit listed under Annex I.

• Greenhouse Gases: Gases listed in Annex II (e.g., CO₂, CH₄, N₂O, PFCs).

• MRV (Monitoring, Reporting, Verification): Framework to ensure accuracy and transparency.

Legal instruments involved:

• EU MRV Regulation

• Registry Regulation (EU No 389/2013)

• Monitoring and Reporting Guidelines (MRG)

» ETS Directive Covered Activities and GHGs

Annex I Activities include:

• Combustion of fuels in installations >20 MW

• Production of iron and steel, cement, glass, pulp, paper, chemicals

• Aviation and maritime (with detailed thresholds)

• Refineries, aluminium, and hydrogen production

• Carbon capture, storage and transport

Annex II GHGs:

• Carbon dioxide (CO₂)

• Nitrous oxide (N₂O)

• Perfluorocarbons (PFCs)

• Methane (CH₄)

• Hydrofluorocarbons (HFCs) – in specific contexts

» ETS Directive Allowances: Allocation, Auctioning, and Free Distribution

Allowances can be:

• Allocated for free based on product benchmarks and historical data (subject to carbon leakage rules).

• Auctioned via the common EU auctioning platform.

• Traded on the carbon market (spot or futures).

Key mechanisms:

• New Entrants Reserve (NER): For installations starting operations

• Free Allocation Rules: Protect carbon-intensive industries

• Auction Revenue Usage: Funding climate action, innovation, Modernisation Fund

» ETS Directive Monitoring, Reporting, and Verification (MRV)

Monitoring

Operators must submit a Monitoring Plan (MP), approved by their Competent Authority.

Key requirements:

• Use tiered methods based on accuracy levels.

• Monitor:

  • Fuel use and combustion efficiency

  • Process emissions

  • Biomass share and sustainability

Monitoring is continuous and complete over each calendar year.

Reporting

Annual emissions reports must:

• Follow the standard template.

• Be submitted by 31 March of the following year.

• Include activity data, fuel parameters, emissions factors, etc.

Verification

Reports must be independently verified by accredited verifiers, who:

• Assess the accuracy, completeness, and consistency of data.

• Issue a Verification Opinion Statement (VOS).

• Notify authorities if non-compliance or material misstatements are found.

Penalties for Non-Compliance

• €100 per excess tonne emitted (adjusted for inflation).

• Requirement to surrender missing allowances the next year.

• Possible withdrawal of the GHG permit for serious breaches.

Carbon Leakage and Benchmarks

Carbon leakage refers to the risk of industries relocating to countries with less stringent climate policies.

Protection Measures:

• Free allocation is the main tool.

• Sectors are classified as “at risk” based on:

  • Emission intensity

  • Trade exposure

  • Carbon cost sensitivity

Product Benchmarks:

• Represent the average emissions of top 10% most efficient installations.

• Benchmarks are updated every 5 years.

• Reduction factors apply (e.g., 0.2–1.6%/year depending on product).

Dynamic Allocation:

• Adjustments for changes in activity levels help prevent windfall profits or under-allocation.

Flexibility Mechanisms and Offsets

Flexibility was initially provided through the Kyoto Protocol mechanisms, now being phased out.

International Credits (Pre-2020):

• CERs (Certified Emission Reductions) from Clean Development Mechanism (CDM)

• ERUs (Emission Reduction Units) from Joint Implementation (JI)

• Use limited to 11% of compliance in Phase II and subject to restrictions

Transfers and Banking

• Banking of unused allowances between phases is allowed (esp. from Phase III to IV).

• Borrowing from future years is not permitted.

Post-2020:

• International credits are no longer allowed.

• EU ETS is domestically focused, except for potential linking with:

  • Switzerland (already linked)

  • Future third countries (pending negotiations)

Expansion of the EU ETS – Aviation, Maritime, and ETS II

Aviation

Aviation has been covered since 2012, under specific rules:

• Includes intra-European Economic Area (EEA) flights.

• Exemptions exist for:

  • Humanitarian and emergency flights

  • Military operations

  • Flights with <10,000 tonnes CO₂ annually

Directive (EU) 2023/958 revises rules:

• Phase-out of free allowances for aviation.

• Full auctioning by 2026.

• Promotion of SAFs (Sustainable Aviation Fuels) through dedicated tools.

Maritime Transport (Effective 2024)

Directive (EU) 2023/959 amends ETS to include maritime emissions, starting in 2024, via:

• Coverage of ships ≥5,000 gross tonnage, including:

  • Container ships

  • Oil tankers

  • Passenger ships

Scope:

• 100% of emissions from intra-EU voyages

• 50% of emissions from extra-EU voyages

• Includes CO₂ from 2024, methane and N₂O from 2026

Exemptions:

• Naval vessels, fishing vessels, non-commercial operations

Phased surrender obligations:

• 40% of emissions in 2024

• 70% in 2025

• 100% from 2026 onward

ETS II (From 2027)

New separate system for:

• Buildings

• Road transport

• Fuel combustion by small users

Key features:

• Fuel suppliers (not end users) are responsible.

• Auctioning of allowances only (no free allocation).

• Stabilisation mechanisms to avoid social impacts.

• Social Climate Fund established to support vulnerable households.

» Annex I Scope Interpretation: Guidance Summary

The Annex I Scope Guidance (2024 edition) by the Commission provides clarity on installations and activities covered by the ETS.

Combustion Activities

• Combustion = any oxidation of fuels generating heat, electricity, or mechanical energy.

• Threshold: >20 MW total rated thermal input.

• Includes:

  • Boilers

  • Turbines

  • Engines

  • Ovens (in specific contexts)

Biomass units are exempt if:

• Exclusively biomass-fuelled (until end 2025)

• From 2026: biomass must comply with sustainability criteria, and units must be >95% biomass.

Aggregation Rule

When determining whether the 20 MW threshold is exceeded:

• All combustion units on site must be aggregated.

• Includes:

  • Backup units

  • Parallel units

  • Units used for heating, drying, etc.

Step-by-step approach used for evaluation (updated for post-2026 scenarios).

Exclusions and Thresholds (Articles 27 and 27a)

Two types of exclusions under the Directive:

Article 27 – Small Installations

Eligibility:

• Emit <25,000 tCO₂/year

• Capacity <35 MW

Requirements:

• Must monitor and report emissions.

• Must propose equivalent reduction measures.

• Can be excluded from full EU ETS obligations.

Article 27a – Biomass-Dominant Installations

Eligibility (from 2026 onward):

• Use ≥95% biomass (by energy input)

• Must meet RED II sustainability criteria

These installations:

• Can apply for exclusion.

• Must still undergo MRV.

• May be re-included if thresholds exceeded.

Adaptation Notice under the European Emission Trading System (EU ETS)

This text has been adapted in accordance with the guidelines set forth by the European Emission Trading System (EU ETS). In our efforts to ensure transparency, accountability, and alignment, we have carefully reviewed and incorporated EU ETS principles into the content. This adaptation process reflects our commitment to high-quality, accurate, ensuring that the information presented adheres to internationally recognized standards.