Why early action by five countries is key to ETS 2 success
The future EU carbon price for buildings and road transport will be determined by how quickly major emitters such as Germany shift to clean heating and transport. Rapidly setting up targeted support measures is crucial to cutting emissions within the next 4-5 years – and to the success of ETS 2.
The second European Union Emissions Trading System (ETS 2), covering mostly emissions from buildings and road transport, will enter into force in 2027. Five EU member states – Germany, France, Italy, Poland and Spain – account for about 70 percent of the emissions under the new carbon market.
The future carbon price will largely depend on how quickly these countries cut their emissions, with road transport playing a significant role. Expanding support now to help citizens switch to cleaner transport and heating will help reduce emissions and keep the carbon price in check – but also reduce fossil fuel dependencies.
Share of emissions by member state and sector in the ETS 2 and share of population, 2021
As the largest emitter in the ETS 2 sectors (24 percent of emissions with only 19 percent of the EU population), Germany plays a key role in accelerating emission reductions.
How will the ETS 2 work? What do we know about the expected carbon price levels? And how can governments ensure its success? An Agora study, first published in German in October 2023 and now available in English, explores these questions and outlines a path for Germany to successfully transition from a national to a European carbon pricing system.
A new carbon price to cover about a third of the EU’s emissions
The ETS 2 is designed to incentivise the switch to low-emission alternatives primarily for heating, cooling and road transport, also supporting the national (sectoral) emission reduction targets agreed under the Effort Sharing Regulation.
Fossil fuel suppliers (“regulated entities”) will buy carbon allowances auctioned by member states or on the secondary market to cover their annual emissions. The number of allowances auctioned, capped in line with EU climate targets will decrease linearly each year by more than 5 percent to achieve a 42 percent reduction in emissions by 2030 compared to 2005. Regulated entities will be able to pass on the carbon cost to final consumers – and are likely to do so.
Short-term emission reductions will be crucial to keeping ETS 2 prices in check
The more emissions are reduced by 2027 and beyond, the lower the demand for allowances and, consequently, the carbon price. However, emissions from the buildings and road transport sectors have not declined significantly in recent years. Against this backdrop, some estimates suggest prices could reach 100 to 200 euros/tCO2 by 2030.
The ETS 2 legislation includes several mechanisms to keep market prices around 56-60 euros/tCO2 (or 45 euros in 2020 prices) until 2029. One measure involves auctioning 30 percent of additional allowances – taken from 2029-2031 – in 2027 (“frontloading”). If real emissions do not decline as they should, prices could increase, especially from 2029-2030 when auction volumes drop sharply due to this very frontloading.
Exposure to the carbon price depends on several factors
As the same market price will apply across the EU, its impact as it is passed downstream will be unevenly distributed, depending on citizens’ income levels, reliance on private cars or types of home heating. In countries such as Bulgaria, Romania, and Hungary, where the median monthly net income is around 600 euros, citizens will pay disproportionately more than those in Germany, France, or Finland, where incomes exceed 2,000 euros. At the same time, regional income disparities exist also within countries.
Households that heat with firewood, district heating or electricity will be unaffected by the ETS 2, while those using coal or heating fuel are likely to face high costs. Rural residents, making up about 23 percent of the EU population and often lacking in alternatives to private cars, will be more exposed to carbon pricing than urban dwellers.
What effect does a carbon price increase of EUR 10/tCO2 have?
This will be most acute in countries with (1) a large share of emissions from road transport, such as Spain (70 percent) and Lithuania (76 percent); (2) a significant rural population (mostly Eastern European countries, the Baltics states but also France and Ireland); or (3) a higher proportion of people at risk of poverty or social exclusion in rural areas compared to urban areas (mostly Eastern and Southern EU countries). Poland faces an even greater urban-rural divide, as coal remains the most widely used fuel for space heating and is particularly concentrated in rural areas.
Anticipating and addressing these territorial differences early is critical to ensuring an inclusive and just transition – and a successful ETS 2. This requires, for example, adequate investment in public infrastructure alongside support for fuel switching.
A socially fair ETS 2: targeted measures for a just transition
Crucially, ETS 2 has the potential to generate substantial revenues for member states, thereby facilitating the transition to clean heating, cooling and transport systems. At an average price of 60 euros/tCO2, the ETS 2 could yield 45 to 80 billion euros annually from 2027-2030, potentially covering a significant portion of the 170 billion euros of additional public funding required annually by 2030 for Europe’s transition to climate neutrality. A key priority should also be to support the most vulnerable households.
In member states with existing carbon pricing, such as Germany or France, setting a national minimum price would prevent the carbon price from falling below the existing level (even after the ETS 2 is introduced), ensuring investment security for households and businesses as well as revenue stability for governments.
To be effective, the ETS 2 must be incorporated into a comprehensive policy mix that guarantees the carbon price stays in check. This requires robust measures, such as expanding public transport and low-carbon value chains in the EU, for example with a clean heat market instrument, training heating installers to switch from fossil fuels to electricity, engaging local authorities to support vulnerable households, and providing income-based financial aid for climate-friendly investments like electric vehicles.
The EU Commission’s recent proposal for a social leasing programme covering vehicles and heat pumps, as outlined in the Clean Industrial Deal, merits further exploration. Additionally, a substantial portion of carbon revenues should be redistributed to households in a targeted manner, at least until initial support measures show results.
Adequate funding is essential for these urgent measures. As part of this effort, there is compelling rationale for frontloading a portion of the ETS 2 revenues from 2030-2035 to increase immediate funding. This could unlock at least 36.2 billion euros which could be channelled through an EU-level extra-budgetary mechanism, as proposed by Agora.
The success of the ETS 2 hinges largely on the rapid implementation of mitigation strategies by the bloc’s five foremost emitters. The faster and steeper their emission reductions, the lower the carbon price in 2027 and beyond. Early action and well-targeted support will be crucial for a smooth transition and ensuring the system delivers both climate impact and social fairness.
