Will EU ETS2 deliver a rapid switch from gas in heating?

The EU ETS2, which comes into effect in 2028, could make it more costly for European households to use gas for heating. But some fear the system will not incentivise a switch to electric heat pumps but instead penalise low-income households in the form of higher utility bills.

The EU Emissions Trading System 2 (EU ETS2) will impose a carbon price on emissions from fuels used for road transport and domestic heating, which could drive up costs for those relying on gas to heat their homes and on petrol to fuel their cars. 

The EU ETS2 was originally expected to take effect in 2027, but, wary of the rising costs of living, the EU recently postponed the launch of the system until the beginning of 2028. 

Buildings account for around 50% of the EU’s gas consumption, according to the European Commission, and the thinking is that the ETS2 will incentivise a switch from gas to cleaner technologies such as heat pumps in order for households to avoid the added carbon cost. But some fear the system could backfire, as low-income households often lack the upfront funds to invest in new technologies.

To this end, the European Investment Bank (EIB) announced in early February that it will make 3 billion euros available to support low and middle income households through a so-called ETS2 frontloading facility. This is much lower than the 6 billion euros previously proposed, but funding may be scaled up in the future.

The frontloading mechanism is to ensure the transition in ETS2 sectors is “both socially fair and economically efficient,” according to a statement released by the European Commission. The funding will mainly drive investments in cleaner heating and cooling and reduce energy demand in homes and buildings in the EU, according to plans. 

Under the frontloading mechanism, EU Member States can access early financing ahead of the start of ETS2 auction revenues expected in 2027.

“The ETS2 Frontloading Facility accelerates investments normally funded by future ETS2 revenues by enabling them to occur earlier,” an EIB spokesperson told Gas Outlook .

“Repayment is expected to be covered by ETS2 auction revenues once the system starts, while the facility gives Member States flexibility over how repayments are managed over the long term, in line with their overall public finances.”

Transition, but at what price?

There are still many questions as to how the EU ETS2 will pan out in practice and what the price for carbon allowances under the scheme will be. Analysts at Bloomberg New Energy Finance (BNEF) said in September last year that under its current structure, the ETS2 could see carbon prices reach 122 euro/tonne in 2030 and an average of 99 euro/tCO2 between 2027 and 2030. However, BNEF also presented scenarios with lower prices.

The EU ETS2 is a ‘cap and trade’ system under which fuel suppliers, rather than end-consumers, such as households or car users, will be required to monitor and report their emissions. These fuel suppliers, or ‘regulated entities,’ will purchase allowances at auctions to cover their emissions.

But the costs of purchasing CO2 allowances will, one way or another, be passed on to end-users which could lead to higher gas prices for households.

“For buildings and end consumers, ETS2 will definitely have a strong impact. That may also be one reason why the EU is still discussing it and has postponed it for the time being,“ Dr. Jana Bosse, a Senior Expert at the Deutsche Energie-Agentur (dena) – the German Energy Agency – told Gas Outlook on the sidelines of the E-World conference in Essen in February.

“I think that pretty soon, if the EU ETS2 is coming, then gas prices will rise. People will switch from gas to heat pumps or other alternatives more quickly, at least those who can afford to. Those who stay on the gas grid are expected to pay higher gas fees. Prices will rise due to the rising CO2 prices and because grid tariffs will be distributed among less people,” said Bosse.

Millions of households affected

The scope of ETS2 is significant. While the EU ETS1 has about 11,000 participants representing power plants and heavy industry, plus around 4,000 airline operators, the ETS2 will cover hundreds of millions of households and car users. Moreover, unlike EU ETS1, there will be no free allocation of CO2 allowances under ETS2.

Dr. Ingmar Rövekamp, Senior Business Developer for Environmental Markets at the European Energy Exchange (EEX), said during a panel discussion at the E-world conference that liquidity on the ETS2 futures market – which started on the exchange in July last year –  has so far been limited as political uncertainties have prevented market participants from taking positions. But once auctions begin, possibly in early 2027, the ETS2 will be a market that is characterised by a large number of obligated entities, he said.

“Personally, I am excited about the new upcoming ETS2 market. It is going to be a second, major European carbon market. A physical market size comparable to EU ETS1 but with one important difference – there will be no free allocation,” said Rövekamp.

Meanwhile, Jürgen Abend, Head of Taxes and Customs at en2x – a fuels and energy association representing suppliers – told the discussion panel in Essen that there are great uncertainties linked to the future carbon prices under ETS2.

“There is uncertainty for the regulated entities, because they cannot foresee what will come. If the price is too low, there is no incentive for investors, if the price is too high, it will be bad for consumers. So this dilemma must be resolved.”

Abend added: “The ETS2 must become a reliable instrument for long-term investments in low-carbon technologies. The risk of political intervention, in the event of rising certificate prices, must be minimised or avoided so that investors can have sufficient confidence in the system.”

(Writing by Andreas Walstad; editing by Sophie Davies)