Sandbag’s EU ETS simulator
(Fit For 55 Model)
The European Union Emissions Trading System (EU ETS) is a key policy instrument to reduce greenhouse emissions in the power, industry, and aviation sectors. This simulator has been designed to help stakeholders understand how the scheme works and what would be the impact of some parameters on its overall functioning.
On 14 July 2021, a long-expected reform proposal of Europe’s carbon market was published by the European Commission. A year after, negotiations between the European Commission (EC), the European Parliament (EP), and the Council began. On 13 December 2022, negotiators from the European Parliament and European Council reached a provisional and conditional agreement on the terms of the EU’s carbon border adjustment mechanism (CBAM). On December 18 2022, the EU reached an agreement on a broad set of policy proposals for the reform of the EU ETS. We have incorporated all relevant information from this agreement into the new version of the simulator.
We regularly update our simulator to reflect the different proposals on the table and the evolving policy landscape. In addition, we have included a new scenario focusing on the benchmarking system that affects the steel and hydrogen sectors. For more information and insights, please refer to our policy briefs published below the simulator.
Questions & Answers
How can I use this simulator?
You can select different parameters on the left menu by clicking on the buttons. The selected parameters are highlighted in blue. You can choose between two “Emissions scenarios” options, two “CBAM” options, two “Steel Free Allocation” options, two “Hydrogen Production” options, and three “EUA price” options. .
What does the simulator show?
The above graph shows the annual emissions by the industry and other sectors (power, aviation, and maritime), the cap, and the number of auctions and free allocations issued every year. The graph also shows unused allowances from previous years (Excess EUAs in circulation) as well as two pools of free allowances that can be used on top of the cap (the NER and the “rolling reserve”).
The stacked bar graph on the bottom shows an estimate of ETS revenues received by different entities.
Excess EUAs in circulation
This figure is the amount of greenhouse gas emissions permits (EUAs) left each year in the system after all installations have surrendered the permits that cover their emissions. It is therefore a surplus of EUAs which installations do not need.
This figure is similar to the Total Number of Allowances in Circulation (TNAC) published yearly by the European Commission to calculate the number of withdrawals into the Market Stability Reserve, except for an aviation-related adjustment made by the EC in the MSR’s current design, which we do not replicate in this surplus figure. Under the Fit For 55 proposal, and from 2024 onward in the simulator, the TNAC includes the net aviation demand.
NER and Rolling reserve
Allowances from the New Entrants’ Reserve are used for new entrants but also to adjust the level of free allocations given to installations whose operations have increased or decreased over the last two years by more than 15%.
As for the “rolling reserve”, it consists of any remaining allowances from the free allocation share (43% of the cap) that have not been distributed to installations, but that “shall be used to prevent or limit reduction of free allocations […] in later years”.
At the bottom right, key figures are displayed:
- EUAs available to exceed the cap: this equals the MRS’s upper threshold (inherited surplus) plus the amount of EUAs in the NER, the MSR, the rolling reserve and the reserve of 25m EUAs made available to Greece.
- EUAs used above the cap: this is the amount of EUAs effectively used above the cap.
- EUAs available after 2030: this equals the amount of excess EUAs left (always 0 if the “maximum pathway” option is selected), plus the EUAs from the MSR and any remaining EUAs left in the NER (minus 200m, diverted to the MSR) and the rolling reserve.
What are the two emissions scenarios?
The maximum emissions pathway shows an emissions scenario that would be permitted by the scheme as amended by your selected parameters. This pathway was calculated by applying a fixed growth rate to industry emissions from 2023 onwards, using up the EUA surplus by 2030.
The maximum emissions pathway is not a forecast of emissions but is intended to illustrate how the selected parameters can alter the scheme’s real constraint. It shows that, despite the stated reduction target, other structural factors of the EU ETS will have a big impact on how strictly the target must be adhered to.
The low power emissions scenario combines several “business as usual” scenarios for key sectors (aviation, steel, cement, and hydrogen), and adopted EC’s MIX scenario for the power sector. Additionally, Sandbag’s low power emissions consider a number of targets and regulations from the Fit For 55 package, but the industry emissions are assumed not to be driven by the EU ETS itself.
What are the assumptions behind each emissions scenario?
Both scenarios are based on the following assumptions:
- Domestic aviation is assumed to follow Eurocontrol’s forecasts for 2022-2028, combined with 1% annual growth in carbon efficiency until 2025.
- Emissions from the maritime sector follow the `MEXTRA50/MAR 1´ scenario from the EC’s impact assessment.
- Emissions from power generation are assumed to follow the `MIX´ scenario of the latest EC’s Impact Assessment, which focuses “on both carbon price signal extension to road transport and buildings and strong intensification of energy and transport policies”.
- The demand for hydrogen in three sectors (refining, methanol, and ammonia) are assumed to decrease in line with emission targets for cars and new farming policies, as per our Hydrogen report. Emissions from hydrogen also take into account the target of 50% of renewable hydrogen for industry laid down in the REDII directive of the FF55 package.
Assumptions for the maximum emissions pathway
- From 2027, domestic aviation follows the same trend as the industry.
- All industry emissions (except hydrogen emissions, see above) increase in line with the sector’s BAU until 2022. Afterward, a fixed growth rate applies to industry emissions from 2023 onwards, using up the EUAs in NER by 2030.
- The power sector’s emissions follow the low power trajectory until 2023, after which a fixed growth rate is applied. This ensures that the sector gradually consumes the EU Allowances (EUAs) in circulation, leading to a surplus of 0.
Assumptions for the low power scenario
- From 2027 onwards, domestic aviation follows Eurocontrol’s long-term forecasts. The sector’s annual growth in carbon efficiency is adjusted in order to reflect the targets laid down in the ReFuelEU directive: minimum share of 2% of Sustainable Aviation Fuel from 2025 and 5% from 2030.
- Emissions from the Steel sector follow the assumptions presented in our Steel report.
- From 2023 onwards, cement emissions follow the baseline scenario from New Climate Institute.
- All other industry emissions (except hydrogen – see above) increase in line with GDP growth (forecasts by IMF and OECD), adjusted by a carbon efficiency improvement.
What are the CBAM scenarios?
In July 2021, the European Commission proposed a reform package (‘Fit for 55‘), increasing the ambition of the scheme from 43% to 61% reduction in greenhouse gas emissions by 2030 and proposing changes in the distribution of ETS allowances. The proposal also included the introduction of a Carbon Border Adjustment Mechanism (CBAM), which would gradually replace the free allocation of permits to a number of sectors.
On 13 December 2022, negotiators from the European Parliament and European Council reached a provisional and conditional agreement on the terms of the EU’s carbon border adjustment mechanism (CBAM).
The “Current” scenario reflects the reached agreement on the terms of CBAM. The “faster CBAM” scenario reflects the recently reached agreement on CBAM combined with an immediate phase-out of FA for sectors covered by the CBAM.
What are the two Free Allocation Rules scenarios?
The “Sandbag” option shows a benchmark scenario that reflects a free allocation system that ensures independence from production processes. This scenario considers Sandbag’s proposal in a different system using a product-based benchmark on steel which could better incentivise the optimisation of scrap and support a circular economy.
The “Low power emissions” scenario represents the Free Allocation Regulation on Steel extracted from the concept note by the EU Commission which is in accordance with the latest reform of the EU ETS.
What are the two Hydrogen Production scenarios?
The RePowerEU scenario represents the RePowerEU targets in which the domestic production of green hydrogen will be 10 million tonnes by 2030. Meanwhile, the Sandbag scenario considers a target of 50% of renewable hydrogen for industry demand laid down in the REDII directive.
What are the model’s assumptions?
The model’s main assumptions are:
- The EU ETS’s scope includes power, industry, intra-EU aviation emissions, and maritime emissions from 2024 onwards. Shipping companies will need to buy allowances covering 100% of their emissions from 2026, after a transitional regime 2024-2025.
- The split between free allocation and auctions is based on the ETS’ regime currently in place for Phase 4. Each year, the number of free allowances is based on the previous two years’ production figures multiplied by benchmarks. During 2021-25, we assume that the emission intensity decreases yearly by a constant factor. Not having access to the carbon intensity figures held by the European Commission, we derived it from Eurostat’s industrial production index, combined with historical EU ETS industry emissions growth over 2013-19.
- In 2026-2030, emission intensity reduces more quickly thanks to the reform of the benchmarks, which for example makes green and low-carbon hydrogen eligible for free allocation. This leads to a higher use rate of free allocation. Green hydrogen in particular, the production of which is assumed to follow the target laid down in the RePowerEU and the EC’s Green Hydrogen Strategy, leads to an additional supply of free allowances.
- We also assume that there is no ‘friction’ between production and allocation variations, despite the scheme’s allocation being based on thresholds (15% up or down) rather than fully dynamic.
Which combination of parameters is the most desirable?
The above simulation shows how difficult it is to keep emissions below the stated cap using the parameters commonly discussed at EU level. For that reason, none of these parameters is really optimal. This is why Sandbag proposes that, if emissions start exceeding the cap in any one year, the ETS should block access to its many additional ‘reserves’, so that the excess emissions cannot persist for too long. This is explained in our submission to the Commission here.
The different scenarios indicate that free allocation remains the dominant protection against carbon leakage, despite the multiple obstacles it creates to industrial decarbonisation and a well-functioning carbon market. We are therefore asking to accelerate the implementation of the CBAM in sectors that do not face low-carbon competition. The extra revenues raised should be dedicated to Member States and to initiatives delivering rapid large-scale emission reductions (see our proposal in our ETS Revenues brief).
Where do the data come from?
For historical values (until 2021), we use data from the European Union Transaction Log. For 2022, we used data released preliminary by the EC in May 2023. Estimations outside industrial sectors are based on well-established scenarios provided by e.g. the European Commission, Eurocontrol or Eurostat. As we continuously adjust our model based on most up-to-date data, the data displayed on the simulator may change over time.
Does the model look at other aspects of the EU ETS?
Yes – the underlying model can also provide analysis of aspects like free allocation, revenues of the Modernisation Fund and Innovation Fund, use of flexibility mechanisms, etc. Over the coming months, we will be adding further graphs and information to our EU ETS simulator. If there’s a particular set of data you’d like to be made available or particular parameters you would like to try out, please let us know by sending an email to email@example.com.
Why is there a surplus in the EU ETS and is it necessary?
The surplus arises because the cap is so high above actual emissions levels – as the supply of allowances is greater than demand, a number of allowances remain unused. While the MSR was designed to reduce this surplus, it has not yet been able to tackle a large part of it. And indeed, the MSR will release more allowances when the surplus falls below its lower threshold.
So if even the MSR is designed to maintain a certain level of surplus in the ETS market, is a surplus necessary? Many argue that a surplus is needed to allow power utilities to hedge (reserve their allowances several years in advance). The thresholds of the MSR are indeed based on these hedging needs (albeit outdated ones from 2013). However, hedging only requires that allowances are available at the future delivery date, not the date the contract for those allowances is signed. As the surplus is not actually relevant to hedging needs, it creates an artificial demand that will be rolled over until the final years of the EU ETS/ until electricity is decarbonised. As long as this unnecessary surplus exists, it can potentially undermine the emissions reduction effect of the EU ETS cap and prevent the carbon price from reaching the levels required to incentivise decarbonisation.
What has changed since the previous version?
Following the Commission’s Fit For 55 proposal, we published an updated version of the model on July 16, 2021, which we further adjusted on July 29, 2021, and August 2, 2021. We implemented several changes: new reduction target, LRF and cap; inclusion of maritime transport; increased Modernisation and Innovation Funds; adjustments to the MSR (new rules for the cancellation of allowances, inclusion of emissions from aviation in the calculation of the TNAC); inclusion of ESR/ETS flexibilities; changes in benchmarks’ calculation rules for the period 2026-2030. We adjusted the emissions scenarios for the Power sector to make it meet the MIX scenario’s target, and Industry sector with updated BAU data and using production scenarios from our Hydrogen report. We also added a component to reflect changes in free allocation from 2026-2030 (see question on our model’s assumptions).
In September 30 2021, we added the Baseline scenario to the simulator (cf. question what are the two emissions scenarios) and made some adjustments to our forecasts based on latest data.
In February 2022, we included scenarios that reflect the different reform proposals of the ETS and CBAM (see question on the ETS/CBAM scenarios) and added extra information in the simulator on the ETS revenues.
In May 2022, we updated the simulator with 2021 emissions and a new option to show the impact of using the MSR to finance the RePowerEU plan on the supply-demand balance of the EU ETS. We also adjusted our baseline scenarios for the aviation sector and the steel sector.
In July 2022, we updated the simulator to show the different proposals on the table for the trilogues’ negotiations between the Commission, the European Parliament and the Council.
In February 2023, we updated the simulator to reflect the agreement on the ETS reform and CBAM. This includes reflecting the final figures on LRF and cap; inclusion of maritime transport; increased Modernisation and Innovation Funds; adjustments to the MSR (new rules for the cancellation of allowances, inclusion of emissions from aviation in the calculation of the TNAC); and changes in benchmarks’ calculation rules for the period 2026-2030.
In March 2023, we adjusted to our emissions forecasts based on the latest data.
In April 2023, we included a new scenario focusing on the Free Allocation system that affects the steel sector and a scenario on the production of hydrogen.
In June 2023, we updated actual 2022 emissions data and updated activity level for free allocation. Also, the baseline scenario changed to a low power emissions scenario to ensure a clearer conveyance.