Q&A: Climate obligations under the EU effort sharing scheme

Greenhouse gas emission limits for EU countries have been set and pursued in two different schemes, the so-called Emissions Trading System (ETS) sectors and non-ETS sectors, otherwise known as effort sharing sectors.

ETS sectors: Emissions from electricity and heat generation, energy-intensive industries, civil aviation within the EU and a few additional countries in Europe, and parts of maritime transport are capped under the European Emissions Trading System (EU ETS). These amount to around 40 percent of the EU’s total greenhouse gas emissions. The ETS is a cap-and-trade mechanism that has established a marketplace for CO2 allowances. In this EU-wide carbon market, emitters such as industrial producers are directly responsible for the CO2 that their activities release into the atmosphere.

Non-ETS sectors: Greenhouse gas emissions from domestic transport (excluding aviation), buildings, agriculture (excluding land use, land-use change and forestry – LULUCF), small industrial producers and waste disposal are limited by an EU-wide target under the EU Effort Sharing Regulation. These account for almost 60 percent of the EU's total domestic emissions. In this system, national governments must ensure that emissions decrease through a range of instruments and policies.

This division of sectors is set to change. Following a reform in 2023, a new scheme called ETS 2 will take full effect by 2027 to then also include emissions from transport and buildings in the trading system. Both sectors will thus be covered by each scheme in parallel until at least 2030.

Under the amended Effort Sharing Regulation, EU-wide emissions are to be reduced by 40 percent by 2030, compared to 2005 levels - and member states “share” in the “effort” to reach the joint target. Each state is assigned an individual emissions reduction target based on their respective capacity. Wealthier countries, such as Germany, Denmark (-50%), or the Netherlands (-48%), must cut more. Countries with lower GDP per capita are assigned lower targets, which include Croatia (-16.7%) or Bulgaria (-10%).

The regulation also defines annual emission limits for each country for the years from 2021 to 2030. Every year, member states receive a set number of Annual Emissions Allocations (AEAs), with each allocation equal to one tonne of CO₂. This amount decreases annually.

Each country must fulfil its emission reduction targets itself and stay below its total Annual Emission Allocations. Countries have a certain amount of flexibility within the system to make it easier to achieve these targets. They are allowed to bank, borrow, buy and sell emission allocations. According to the EU, this is to ensure a “cost-effective and fair” achievement of emissions targets.

• Banking (flexibility over time): If a country’s emissions are lower than the annual budget in a given year, it can bank unused allocations to use them in the future.
• Borrowing: If emissions are higher than the annual budget, member states can borrow a limited number of allocations from the following year.
• Buying and selling: Countries can buy allocations from other member states, who are allowed to sell them if they have emitted less than their budget allows.
• Use of ETS allowances: Certain member states are permitted to achieve national targets by covering a limited share of emissions with EU ETS allowances. For this purpose, they can cancel these allowances instead of auctioning them.
• Land use sector extra credits: All member states are permitted to credit emissions reductions from land use, land-use change and forestry (LULUCF) against their effort sharing targets (provided that these sectors have absorbed more carbon from the atmosphere than they emit). This benefits countries with large agriculture and forestry sectors but also acknowledges the fact that reducing emissions from these areas is more difficult than in others.

The ETS 2 will introduce a market-based CO2 price for emissions from transport and buildings, similar to the CO2 pricing mechanism already established in other ETS sectors. The ETS 2 will complement the effort sharing system, as the carbon price creates a financial incentive for companies and households to invest in energy efficiency, building renovations, and low-carbon mobility.  This will reduce emissions and supports member states in meeting the effort sharing obligations, says the European Commission.

Until now, countries which emitted more than they were permitted to have been able to buy allocations from those that overperformed. Notably, there is no fixed system in place to determine how the buying and selling of CO2 allocations between countries is conducted. The EU says that the transparency of such transfers should be ensured, and they “ought to be carried out in a manner that is mutually convenient, including by means of auctioning, by the use of market intermediaries acting on an agency basis, or by way of bilateral arrangements”.

For the period until 2020, Germany, for instance, bought more than 11 million allocations from Hungary, Bulgaria and the Czech Republic for one euro each.

However, by the end of the 2020s, emissions across the EU are projected to be higher than available allocations – meaning there simply will not be enough overperforming countries to supply the laggards. Even if enough allocations were available across the bloc, they are set to become expensive and could potentially cost countries like Germany billions of euros - money that instead could be invested into domestic climate action.

The purchase of allocations does not happen every year. Instead, bills are settled following two five-year periods (2021-25, and 2026-30). As final emissions data is only available with a two-year delay, countries will only know the exact amount they must buy – or the amount they can sell – by around 2027 and 2032, respectively. However, countries could choose to secure purchases based on preliminary data.

It is unclear how the EU and member states would handle a situation where allocation prices skyrocket, or where there are not enough of them available any more.

If a member state fails to comply with its annual emission reduction targets despite using the flexibilities listed above, the Commission can require it to come up with a “corrective action plan.” These include additional reduction efforts and a strict timetable for implementing them.

In two compliance checks, scheduled for 2027 and 2032, member states falling behind on their emission reduction obligations will be subjected to punitive measures: Excess emissions multiplied by a factor of 1.08 will be added to the country’s emissions in the following year, therefore reducing the states’ overall emission allowances for that year.

As a measure of last resort, the EU Commission could initiate infringement proceedings if member states fail to follow the rules. The Commission and the country concerned would then jointly try to ensure compliance with EU rules. If no agreement is reached and the country fails to take sufficient corrective measures, the Commission can refer the matter to the European Court of Justice (ECJ). The ECJ decides whether there has been a breach of contract and can impose sanctions, including fines.

Germany must reduce overall emissions in the effort sharing sectors by 50 percent by 2030 compared to 2005 levels, in contrast to its national targets that are measured against 1990 emissions levels. The volume of annual allocations for the years 2021 until 2025 is laid down in a Commission decision. The annual emissions allocations for the years 2026-2030 will be determined in 2025, following a comprehensive review of emissions data.