The EU ETS 2, or the second EU Emissions Trading System, will bring significant changes to carbon markets in the European Union. This new phase will expand the scope of emissions regulation to include building construction, heating, and road transport.
The EU ETS 2, or the second EU Emissions Trading System, will bring significant changes to carbon markets in the European Union. This new phase will expand the scope of emissions regulation to include sectors previously not covered - building construction, heating, and road transport. With the introduction of the EU ETS 2, the EU seeks to further reduce greenhouse gas emissions and accelerate the transition to a low-carbon economy. The new system is similar to its predecessor, where emission allowances are allocated and traded among market participants to achieve emission reduction targets. But unlike the first phase, the EU ETS 2 will not provide free allowances. Additionally, the EU ETS 2 is designed to generate revenue for sustainable projects, with 50% of auction revenues allocated to a social climate fund. This fund supports lower-income households affected by potential increases in energy costs resulting from the carbon pricing mechanism.
Emissions from building construction, heating, and road transport contribute significantly to the GHG volumes released in the EU. The building sector accounts for 12.4% of European GHG emissions and road transportation represents nearly 19%. However, until now, they have not been covered by the EU ETS - this is why from 2027 or 2028, there will be a new cap-and-trade system, the EU ETS 2, to incorporate the CO2 released by those sectors.
Just like the EU ETS 1, the EU ETS 2 is a cap-and-trade system, where emission allowances are allocated and can be traded among market participants, contributing to the gradual reduction in emissions. There is a set “carbon budget” available to the economy, decreasing over time so that the bloc can reach carbon neutrality by 2050.
In the EU ETS 2 framework, the responsibility for purchasing and surrendering carbon allowances shifts from entities directly consuming fossil fuels to run their operations to the energy suppliers. For example, in household heating, it is not the household burning gas that will have to buy and surrender EUAs. Instead, the company responsible for distributing the gas to households will be legally required to comply with the EU ETS 2 rules.
Also, the new system is designed to respond to acute price fluctuations. If EU ETS 2 EUA prices exceed €45 for a specified period, regulators will inject a predetermined quantity of allowances into the economy. However, they can only do so once every running 12 months. Therefore, €45 is not a price cap but rather a signal used by regulators to increase supply. The price can very well
The start of the new EU ETS phase 2 will be no earlier than 2027, with a potential delay to 2028 if energy prices are considered to be “excessively high”. The stability mechanism described above (activated by EU ETS 2 price levels crossing a threshold), will remain effective until 2030. Then, in 2031, a new directive will determine whether to remove this price trigger.
A base forecast predicts a gradual increase in EU ETS 2 prices, reaching €222.2 per tonne of CO2 equivalent by 2030. As shared by carbon expert analysts from Vertis during a webinar, the following evolution of EU ETS 2 prices can be foreseen:
In a scenario of low emissions in the European economy, EU ETS 2 prices may stabilize at a lower level, around €111.7 per tonne of CO2 equivalent by 2030. The same report anticipated the following:
Under a scenario of high emissions, EU ETS 2 prices could surge to €259.4 per tonne of CO2 equivalent by 2030, following this trend:
Just like in the current EU ETS, revenue generated from the EU ETS 2 will be invested for sustainable projects. Those are crucial for the financing of the European transition, as discussed in our previous article. 50% of auction revenues will fund a social climate fund, with the remaining 50% distributed to member states for initiatives like Ireland's "Better Energy for Warmer Homes", Belgium's "Renopack," and France’s “MaPrimeRénov”.
The EU ETS 2 prices can lead to increased costs for consumers. This can be more visible in low-income households as they are usually more reliant on fossil fuels. A study by the WWF indicates that without social welfare redistribution mechanisms, heating and energy expenditures can significantly rise (from 32% for fuel in Hungary and Latvia to up to 91% for coal in Belgium and Poland). These changes can result in an average consumption expenditure increase of 0.4-0.8%, rising to 1.9% in countries like Poland, the Czech Republic, and Romania.
As a response, the social climate fund aims to enhance support for the lower-income households by reallocating revenues from the EU ETS 2. Projections indicate that it will accumulate a minimum of €86.7 billion from 2026 to 2032, gathering funds not only from EU ETS 2 auctions but also from the sale of 50 million allowances from the current EU ETS.
In contrast to EU ETS 1, EU ETS 2 will not include any free allowances. So, there will be no transitional period, and a high demand for purchasing EUAs (relative to the supply volumes) in the EU ETS 2 is expected from the beginning - this is expected to drive prices upward.
As discussed above, politicians need to maximize revenues from the EU ETS to finance the European sustainable transition. To achieve this, they have intentionally set supply levels to be below demand in the EU ETS 2. This creates a structural deficit (less supply of EUAs than emissions in the economy) in the market. In other words, the EU ETS 2 is "built to be short."
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