CER: The EU emissions trading system after the energy price spike
04 April 2022
The economic recovery from the pandemic has led to an energy crunch, and war in Ukraine has contributed to increasing energy prices and complicated the politics of carbon pricing. This policy brief discusses how to make a higher and more comprehensive EU carbon price both effective and politically feasible.
- Before Putin’s invasion of Ukraine,
the EU had planned to expand its emissions trading system (EU ETS) and
strengthen the carbon price it generates.
- The EU’s existing ETS establishes a carbon price for
heavy industry, electricity generation and intra-EU flights. However, to
maintain the competitiveness of European industry, many emissions
permits are handed out for free, which has so far dimmed the incentives
for industries to cut CO2. Carbon emissions from road
transport and building heating, so far excluded from the ETS, are priced
unevenly across the EU, with energy and carbon taxes varying across
countries.
- The EU’s Fit for 55 climate policy package aims to
change this, strengthening the role of carbon pricing in the transition
towards carbon neutrality by 2050.
- As part of this package, the
European Commission has proposed a lower cap on emissions, to bring the
ETS in line with tougher climate targets, and tighter conditions under
which industrial plants can claim free permits. Free permits will be
gradually phased out, while a carbon border adjustment mechanism (CBAM)
will be introduced to level the playing field between the carbon price
faced by EU and foreign producers. The Commission has also proposed that
all ETS revenues that member-states receive should go towards climate
investment.
- These reforms go in the right direction, but should be stricter and implemented more rapidly:
- A
gradually increasing price floor, below which the price of emissions
permits cannot fall, would provide investors with certainty of the
direction of carbon prices.
- The current proposal envisions the
full phase-out of free allowances in 2036, ten years after the CBAM’s
full implementation. Scrapping free allowances for heavy industry by
2030 would force producers to innovate more quickly and would not make
European industry less competitive.
- Member-states should devote
ETS revenues to climate investment as planned – but more of that should
go towards low-carbon innovation.
- The European Commission
wants to introduce a new ETS (ETS2) covering emissions from road
transport and buildings, where decarbonisation is lagging. This would
impose a larger burden on poorer households and smaller businesses who
cannot easily afford to insulate their home or upgrade to more energy
efficient production processes. The EU wants to use part of the ETS2
revenues to help such vulnerable energy users and has proposed a Social
Climate Fund (SCF) to do so, but it could do more:
- All revenues from the ETS2 should be devoted to the SCF.
- The Fund should start as soon as possible: it would provide a good EU-wide response to recent energy price spikes.
- The
EU should clearly communicate that all revenues from ETS2 will be
devoted to supporting citizens and businesses in the green energy
transition. Without clarity on this link, popular support for carbon
pricing may falter.
- A ‘price corridor’ for ETS2 carbon prices
could help avoid excessive carbon price fluctuations. Households and
small businesses are not equipped to deal with large fluctuations in
their energy and fuel expenses.
- The EU should align all policies
concerning road transport and buildings with climate targets: reform of
the energy taxation directive is needed to remove energy subsidies
(such as those for aviation) and to ensure that high energy taxes do not
put electricity, which will become greener over time, at a cost
disadvantage relative to fossil fuels.
In the EU, not all CO2
emissions are considered equal: heavy industry and electricity
producers face an EU-wide carbon price under the EU Emissions Trading
System EU (ETS), but road transport and the heating of buildings do not.
All EU member-states tax fuel, but tax rates vary. And some
member-states have their own national carbon taxes in addition to the
ETS. This is about to change. In July 2021, the European Commission
presented the ‘Fit for 55’ climate and energy package, a set of policies
to cut carbon emissions by 55 per cent by 2030 relative to 1990 levels.
The package proposes reforms to tighten the EU ETS cap on emissions
from heavy industry and electricity generation, and to create a new
scheme to put a price on carbon emissions from road transport and
buildings.
Since 2005, the ETS has capped carbon emissions from
over 10,500 installations in the European power sector and in
energy-intensive industrial sectors such as oil refining, iron and
steel, and cement. The cap covers about 36 per cent of total European
emissions and is gradually tightened every year to reduce them.1
The cap is enforced via permits to emit, which are traded on carbon
markets, leading to a price for carbon emissions. The problem is that,
while the energy sector has cut its emissions by 15 per cent since 2005,
the carbon price from the ETS has, so far, not driven down carbon
emissions from heavy industry in a comparable way.
But prices on the European carbon market reached an all-time high of €100 per tonne of CO2
in early February 2022, as Europe’s climate targets – and its policies –
have become more ambitious. That is a welcome change from the first 15
years of the EU ETS, when heavy industry found that emitting carbon was
so cheap that reducing emissions was not worth the hassle. A carbon
price with bite is a necessary tool to reach the EU’s climate goals. But
a high price poses a challenge for Europe’s heavy industry, which
competes globally with producers who are not (yet) subject to comparable
carbon pricing.
The proposed ETS reform lowers the cap on
emissions to bring the ETS in line with tougher climate targets. It also
tightens the conditions under which industrial plants can claim free
permits, paving the way for their gradual phase-out. This will be paired
with the phase-in of a carbon border adjustment mechanism, which will
charge importers of some heavy industry outputs to the EU a fee based on
the EU carbon price, effectively levelling the playing field between
domestic and foreign producers.
The other main policy change
related to carbon pricing included in the Fit for 55 package is the
proposal to introduce a new system to cap and trade carbon emissions
from two major laggard sectors, road transport and buildings, which
account for about 25 per cent and 15 per cent of EU-wide greenhouse gas
emissions respectively.2
Manufacturing
and energy industries, currently covered by the EU ETS, have cut
greenhouse gas emissions since 1990 by about 40 per cent, while
decarbonisation in the commercial and residential building sector has
not been as fast, with emissions reductions below 30 per cent. However,
emissions from road transport have increased by almost 30 per cent (see
Chart 1). The new ETS aims to reverse this trend in transport emissions
and accelerate decarbonisation in buildings, cutting combined emissions
from these sectors by 45 per cent by 2030 relative to 2005 levels.
CER
© CER
