Insight Focus
The European Commission has proposed a 90% emissions cut by 2040. It allows limited use of international carbon credits—up to 3%—to cover emissions outside the EU ETS. To address rising carbon costs, the Commission plans compensation measures to help EU exporters remain competitive.
Carbon Credit Loophole Sparks EU Climate Debate
The European Commission last week published its proposed 2040 climate target for the bloc, confirming widespread speculation that lawmakers will negotiate a 90% reduction from 1990 levels by the end of the next decade as part of its trajectory to net zero emissions by 2050.
The bloc’s current target aims to achieve a 55% reduction by 2030, and latest estimates suggest Europe will achieve a 54% cut by that date.
Source: European Commission
The 2040 plan has stirred up some controversy by proposing that Europe may be able to use a limited amount of international carbon credits to reach the 90% goal. The Commission proposal refers to this as “the possibility to use flexibilities in how the targets can be met,” but environmental groups have called this a “loophole” that “threatens to capsize EU climate action”.
“Carbon credits should not be a substitute for effective climate mitigation within the EU,” said Lambert Schneider of Germany’s Oeko-Institut. “They should only be used to go beyond ambitious domestic reduction targets and if they meet the highest quality standards and are shared fairly with partner countries.”
The Commission proposal sets a limit on the use of credits equivalent to 3% of Europe’s net 1990 emissions, and which could only be used from 2036 onwards as opposed to throughout the entire decade. Based on net 1990 emissions of 5 billion tonnes, this calculates as an approximate total of 150 million tonnes of CO2 equivalent over the five-year period from 2036 to 2040.
Critically, the Commission has said that this carbon credit quota should not be eligible for use in the EU Emissions Trading System, where the cap on emissions – represented by EU Allowances either sold or handed out free of charge – is forecast to reach zero by 2039.
Instead, the intention is to allow EU member states to use this “flexibility” to compensate for shortfalls in reductions in other areas not covered by the bloc’s carbon market, while allowing investment in carbon credit projects will also help support some of the goals of the Paris Agreement by ensuring adequate climate funding flows to developing economies.
EU Suggests Adding Carbon Removals to ETS
However, the eventual disappearance of EU Allowances from the EU ETS is expected to leave some European industrial sectors that have hard-to-abate emissions without a way to comply with EU ETS rules, which require an eligible permit to be surrendered for each tonne of greenhouse gas emitted each year.
To address this, the document suggests that the EU ETS should count “domestic permanent removals” for compliance, to allow those hard-to-abate sectors a path to compliance.
Permanent removals represent greenhouse gases that are captured from the air or from biogenic sources (plants and animals), that are stored permanently in geological formations, forests, soil or products.
Carbon removal is a relatively new activity, with costs currently running at between USD 100-600/tonne, according to research and some market activity. The European Commission is hoping that bringing it within the scope of the EU ETS will trigger additional investment in the technology to bring down prices.
EU Plans CBAM Revenues to Shield Exporters
The European Commission is also set to publish a proposal for a mechanism to help European exporters maintain competitiveness as their own costs rise due to the gradual elimination of free carbon allowance quotas under the Carbon Border Adjustment Mechanism.
CBAM is set to begin charging imports of selected materials an import levy based on the carbon emissions generated in their production. This is planned to ensure a “level playing field” between EU producers, who are to be charged the full cost of their own greenhouse gas emissions, and imports from countries that do not put a price on carbon emissions.
As the carbon cost on imports is ramped up over the period from 2026 to 2034, so the free allocation of EU Allowances to European producers will decline to zero. However, this will mean that European exporters will face higher costs that will threaten their competitiveness in other markets.
To address this the Commission intends to “make a dedicated proposal using the revenues generated by CBAM…to support production at risk of carbon leakage.”
“This would allow the affected producers to be compensated proportionally to the phasing out of the free allowances subject to deliverables on long-term decarbonisation.”
It’s not yet clear what form this compensation might take, but some analysts have suggested that it might dampen slightly industrial demand for EU Allowances in the longer term. The Commission has said it will bring forward a detailed proposal by the end of this year.
