A price on carbon for building emissions: the EU ETS2 regulation

A price on carbon for building emissions: the EU ETS2 regulation

One commonly proposed solution to mitigate CO2 emissions is to put a price on carbon emissions. These prices could be implemented either through a tax on every unit of carbon emitted or in the form of a cap-and-trade scheme.

In this article, Linde Kattenberg, a PhD Candidate in Finance at the School of Business and Economics, Maastricht University, discusses a revision of the cap-and-trade system that is in place in the EU: the EU ETS2.

A glance at cap-and-trade

Cap-and-trade schemes exist all around the world in different forms and cover different sectors of the market. In such a scheme, the governmental authority caps the total amount of CO2 that is allowed to be emitted for a certain group/region. Then, a fixed amount of permits is issued either through an auction or given away for free. Afterward, the permits can also be traded. That means that those emitters who are willing to pay a high price for emissions will keep emitting and buy permits from other firms. The firms that sell can cut emissions at lower prices and are thus willing to sell their permits to the higher emitters. Every firm will emit up until the point where it is cheaper to reduce emissions than to buy a permit.

However, those firms that might keep emitting at first, can be inclined to also cut emissions at a later stage. That is the case because the permit issuing authority can reduce the total amount of permits. Due to this decreased supply of permits, the price of a permit might increase, which boosts the incentive to reduce emissions.This type of system is generally seen as one that creates incentives to efficiently reduce CO2 emissions in the overall market.

Proposed EU regulation for the built environment: the EU ETS2

Such a system is currently present in the European Union (EU) and is named the Emissions Trading System (ETS). The EU ETS currently covers firms in the energy, manufacturing, and aircraft sectors. However, from 2027 onwards the EU ETS will extend its scope and will start including, among others, the emissions from energy usage in the built environment. This new system will be named the EU ETS2 and is aimed at bringing emissions from the covered sectors down by 42% by 2030 compared to 2005.

The implementation of the EU ETS2 means that building occupiers need to buy rights for all emissions from energy usage in a building. There will be a gradual transition towards this system, where 2025 will be the first year where organizations that might fall under the EU ETS2 system need to monitor and report their emissions. When a firm’s emissions exceed the amount that is allowed by their permits, they need to pay a fine for every ton of CO2 that exceeds their limit. The challenge is to limit the burden on households and firms and to ensure a smooth transition into the new system. Therefore a measure that has been taken is that until 2029, when the price of one permit will exceed 45 Euros, additional permits will be issued to lower the price.

Indirect impact is also an impact

Although building owners are not the direct target of the regulation, they will still be affected by their tenants’ behavior. This is the case because the cap-and-trade system will apply to emissions from energy usage in the building, which is consumed by the tenants. This means that even though the administrative burden will not be on building owners, they will certainly feel an indirect impact through a change in tenant demand. This announced regulation could lead to a further push in demand from tenants towards more energy-efficient buildings.

The burden for building tenants can be substantial. Although the price of carbon is capped until 2029, future prices can increase, such as those already announced in Canada. E.g. a report by JLL and EPRA states that investor QuadReal calculated the impact of the Canadian carbon tax of 170 CAD per ton of CO2 that will be implemented in 2030 on their total portfolio of 45 million square feet. They estimate that more than 8 million square feet of their portfolio will see a tax burden of more than 1 CAD per square foot, and 1.5 million square feet will see an impact larger than 2 CAD.

Uncertainty in regulation and market

There are still unknowns regarding this regulation, such as the final price of the penalty. Additionally, we lack information on the total scope of the sectors that will fall under the ETS and their current emission levels, which are essential for assessing the stringency of the policy. Potentially, after the price cap is removed in 2030, there will be higher uncertainty regarding the final market price of a permit. Next to that, the start of the implementation is yet to be certain. In July 2026, the EU will announce whether the implementation will be done as planned, or whether the start date will be postponed to 2028. This depends on whether the prices of oil and gas are disproportionate compared to historical levels.

However, increased uncertainty can already be reflected in the market. For instance, it can mean that tenants demand shorter lease periods such that they can more easily relocate to respond to the final ETS2 system. Another related regulation is the Carbon Border Adjustment Mechanism (CBAM) implemented last year, aimed at putting a fair price on products that have carbon-intensive production processes, such as iron, steel, and electricity-generating technologies. This measure is taken to mitigate so-called ‘carbon leakages’, where carbon-intensive goods are taxed at similar prices as under the EU ETS system when imported. The scope of the CBAM will eventually cover around 50% of all sectors under the EU ETS2. This means that building owners that would like to retrofit buildings due to increased ‘green’ demand from potential tenants, might pay more for the materials they need for such retrofits if they are imported from outside of the EU.

Harness for uncertainty

There are still unknowns regarding this regulation, such as the final price of the penalty. Additionally, we lack information on the total scope of the sectors that will fall under the ETS and their current emission levels, which are essential for assessing the stringency of the policy. Potentially, after the price cap is removed in 2030, there will be higher uncertainty regarding the final market price of a permit. Next to that, the start of the implementation is yet to be certain. In July 2026, the EU will announce whether the implementation will be done as planned, or whether the start date will be postponed to 2028. This depends on whether the prices of oil and gas are disproportionate compared to historical levels. However, increased uncertainty can already be reflected in the market. For instance, it can mean that tenants demand shorter lease periods such that they can more easily relocate to respond to the final ETS2 system.

Call upon other investors to collaborate to achieve real-world impact

GREEN is a not-for-profit collaborative engagement initiative for institutional investors, focusing on reducing climate risk in the real estate industry. GREEN members acknowledge the importance of collaboration to initiate change and maximize impact. We, therefore, call upon other institutional investors to join GREEN and work together towards a Paris-aligned real estate sector. Check the investor statement for more information.