Researcher: Lowering electricity taxes is cheapest way of meeting EU climate goals

In its first annual report, the independent advisory council on climate highlighted France's insufficient efforts in reducing greenhouse gas emissions in relation to international commitments and called on France to radically change its climate policy.

This article is part of our special report Funding a just energy transition in Europe.

The energy transition will hit the poor hardest unless it’s balanced by a shift in taxation, says Christian Egenhofer. The EU needs to acknowledge this and get started by lowering taxes on electricity to achieve the EU’s carbon reduction goals at least cost, he argues.

Christian Egenhofer is Senior Research Fellow and Head of the Energy and Climate programme at the Centre for European Policy Studies, a think-tank based in Brussels. He spoke to EURACTIV’s energy and environment editor, Frédéric Simon.

INTERVIEW HIGHLIGHTS:

  • The energy transition will imply cost increases, which may be covered with new taxes
  • But any tax increase on polluting energy has to be offset by decreases elsewhere to cushion the social impact
  • The European Commission has so far shied away from this debate about the distributional effects of the energy transition
  • The Juncker Commission made a first step by acknowledging that energy poverty must be dealt with at EU level
  • But member states now face tough choices and will need EU support, including financial, as well as “special policies”
  • The proposed €5bn Just Energy Transition Fund is “peanuts” but it sends a very strong political signal
  • When funds are limited, they should be directed at “no-regret” solutions like electricity grids and renewables, not gas infrastructure.

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All the main political parties at the last European elections voiced their support for a “just transition” to clean, affordable, carbon-free energy by 2050. How can they now put these good words into practice?

The European elections sent a clear statement that climate change and the energy transition is an important issue that EU citizens care about.

Although the Greens did not get many more seats in Parliament, they did extremely well in terms of the popular vote, with 20 million votes. And that, of course makes an impact, even if the Liberals got many more seats, with only 12 million votes.

In addition, it’s become quite clear that there is a big political willingness to move ahead among the member states and the European Parliament. And you cannot postpone the energy transition any longer, I think people have understood that.

So now the question is how to do it. And one of the big issues which has completely been ignored, because it’s politically very sensitive, is the distributional impact of climate change policies.

By and large, you can say all climate change policies are regressive – they will hit the poorest people hardest, because the poor spend a disproportionate part of their budget on energy, mobility, and so on.

That was typically what the “Yellow Vest” protests in France were about. The protests started because of an increase in fuel prices caused by a rise in the French carbon tax on petroleum products…

Let’s not overdo the Yellow Vest protests. They were also caused by how the Macron government mishandled the carbon tax, in a way that was not enough revenue neutral.

In Belgium, the increase of diesel taxes was compensated by a reduction in social security contributions, which made it visibly revenue neutral. And I think the Belgian way here is the way forward.

Just increasing taxes and then assuming people will accept it because it’s good for the climate – that doesn’t work.

‘Yellow vests’ spark EU debate about just transition to clean energy

Protests against high fuel prices in France have propelled climate policy to the forefront of the political debate, just days before Poland hosts the UN’s annual conference on climate change, with a focus on the “just transition” to low-carbon energy.

Can the energy transition ever be tax neutral or budget neutral? Will it necessarily imply tax increases in your view?

The energy transition will imply cost increases, and those may be covered with taxes or other revenues. But it has to be offset by decreases somewhere else because the transition has big distributional impacts, which have been largely ignored until now.

For example, electric vehicles and rooftop solar panels will first be bought by the more well-off, not by the poor people. And this applies to other low-carbon products and services – they will first be picked up at massive scale by well-off people or by industries that can pass on the costs to their customers.

In short, you’re saying the energy transition can be boiled down to a tax shift?

The tax shift will definitely form a major part of the energy transition. And it should start with the electricity sector. All studies suggest that electrification – up to 60-70% of the economy – is the cheapest solution to achieve Europe’s carbon reduction objectives. Yet at the same time, we put very high taxes and levies on the electricity sector, which brings up power prices.

The only way you can deal with this is to reduce taxation on electricity and raise taxes on high carbon fuels and products. The European Commission proposed this last year but EU member states have so far refused. And this will probably be the biggest political issue for the new Commission. Member state will have to face that question. They cannot put more tax burden on the electricity sector.

Taxation is not an EU competence, so unanimity will be required.

That’s another very interesting point which the new Commission and the new Parliament will have to address. We should probably abandon the idea that all this should be done at the European level. The energy transition ultimately, is very much a national, local thing. And you see the transition happening at very different speeds across the member states.

So this taxation issue will have to be solved at the national level, and I believe more and more member states now accept this. Now, it’s also clear that these transitions need a national consensus. And those will be very, very different from one country to the other. In Poland for instance, it’s inconceivable that coal will not continue to play a role. In France, it’s nuclear and in Germany, renewables will play the biggest part.

So there are clearly different national policies. But they all face the same challenges and distributional issues, which have to be addressed. Now the question is what the EU can you do in all this.

Clean energy transition ‘is a social policy issue’, Poles insist

The social policy dimension was largely overlooked when the European Union decided energy and climate change objectives for 2030, Poles have warned, calling on policymakers to endorse a “just transition fund” to support the country’s coal phase-out.

So, what do you think the EU can or should do?

The last European Commission – and Parliament – have shied away from this debate about the distributional effects of the energy transition.

I think what the new Commission will need to do is to have a serious discussion with all the members states – separately or in regions – on how they intend to address this issue, perhaps based on the national energy and climate action plans (NECPs).

A number of them will need help by the EU – financial or otherwise. That also means some member states will probably need special policies. Now, as soon as you speak about special frameworks in the EU context, you don’t make many friends, especially at the European Commission, which wants to avoid distortions of competition in the single market.

But the energy transition is so fundamental that there has to be what the British call ‘horses for courses’ – or special approaches for some countries.

How does that translate in practice? Does that mean relaxing state aid rules? Or tweaking competition rules? Or maybe allowing special treatment for so-called “capacity mechanisms” in support of coal or gas generation capacity in some countries?

That may be part of it. But first of all, I think it takes good faith from the member states in coming up with strategies that actually work. Not first ask for relaxation of EU rules and then have a strategy. It needs to be the opposite. First, I would say we need National Energy and Climate plans that are credible.

Are you suggesting the National Energy and Climate Plans are not credible?

In Brussels, we are always quite negative about member states or the EU – that’s our job.

But to produce a National Energy and Climate plan, if you have never done so in the past, is not very easy. First, a lot of national administrations are not equipped to do this kind of work from a technical point of view. In some EU countries, it’s the first time that energy people speak with the environmental administration, with industrial policy people or those dealing with local issues.

That will be a long process. I think nobody expects that we will get perfect National Energy and Climate plans from day one, except perhaps for a few member states. This might take five years or even more, after the 2019-2024 Commission mandate expires.

The UK, Sweden, Finland and others now have an ambitious plan and have already prepared the ground. But for others, it won’t come overnight. And I think the first step is to acknowledge that the distributional impacts will be very large in some countries.

And then you have to find solutions. Bulgaria, for example has the cheapest electricity retail prices in the EU. Yet the government of Boyko Borissov fell in 2013 because of rising electricity prices. In Bulgaria, you would need to quadruple electricity prices in order to encourage the industry to invest again and make a profit.

The Juncker Commission has already made a first step. After years of hesitation, they finally acknowledged that energy poverty may be something that should be dealt with at European level.

But if you’re talking about quadrupling the price of electricity, I cannot see any government touching that. How do you want to win an election saying you’ll implement climate policies that will quadruple the cost of electricity? No political system is able to do that – this is a hard fact which cannot be ignored. So let’s sit down and try to find solutions.

‘Yellow vests’ killed EU bid to phase out regulated electricity prices

A European Commission proposal to phase-out regulated prices of electricity looked set to win approval from EU member states until the ‘yellow vest’ movement swept across France and nipped it in the bud.

If they cannot raise electricity prices, how then can member states fund the transition? The European Commission has proposed dedicating a minimum of 25% of the EU’s next long-term budget to climate-related funding, up from 20% in the previous period. This means an increase from €206 billion to €320 billion for the 2021-2027 period. How significant is this in your view?

It should not be exaggerated, but I think it makes a big political impact to increase funding by more than €100 billion. It shows to the population that you’re actually getting serious about climate action.

But the more important part in my view is the spending rules set by Brussels – the Financial Regulation, which governs how EU Structural Funds are disbursed. These rules can change the course of action at national level because if governments receive more money by doing something on climate change, a lot more projects will see the light.

Take the Modernisation Fund, which is attached to the EU Emissions Trading System. We’re talking about €6-9 billion over the period 2021-2030. And a lot of companies are already making proposals. Suddenly, you have a frenzy of activity on climate-friendly projects in the energy sector in countries like Romania and Bulgaria, which you did not have before.

So EU funding makes a big difference. And if the Structural Funds actually have more rules and guidance on climate, then the national projects will be much more aligned with climate objectives. And that really has a major impact, it’s not so much the money, which is of course is very important politically.

But in terms of actual impact on the ground, it’s the Financial Regulation that sets the direction and catalyses change in the region. And that applies to the Modernisation Fund as well.

In short, you’re saying EU funds are an effective carrot to bring about change in the EU countries?

It’s a carrot and it’s a catalyst. It’s the steering wheel with which the EU can relatively elegantly and uncontroversially steer change. And this goes under the radar screen. But at the national level, this is what makes things happen.

But are the amounts enough? We’re talking about €320 billion until 2027 but the European Commission said about €1 trillion will be necessary for the energy transition by 2030. So, there is a gap there, obviously.

With EU funding, it’s always an administrative struggle: everybody wants more money, and the finance ministers don’t want to give more. And that’s part of the EU folklore.

And if there is another €100 billion, it is clear that the majority of this funding will have to come from the member states. But I cannot see that Sweden or Germany will need a lot of money from the EU. Whereas countries coming out austerity, or lower-GDP countries – they will need a lot of money.

Now, when it comes to EU regional funds, shortcomings are often not related to lack of money but to lack of administrative capacity to absorb it. So for different reasons, I would not focus too much on the actual amount.

An increase in EU funds for the energy transition in itself sends a very big political signal. Which is why I think the Just Energy Transition fund is a very important tool. We’re talking about just €4-5 billion, which is peanuts. But politically, this is a very big signal that money will be available, even though some of it might be wasted because of transaction costs.

The Commission is not very keen, because you have to create new rules, which creates administrative work. But politically, it is very important and the Parliament has made this very clear.

At the end of the day, it’s peanuts. But politically it’s important and all the Prime Ministers can go back home and claim they got another €5 billion. And whether it’s lost in administration doesn’t really matter, it’s the political message that’s important. It’s a signal that something is happening.

The Juncker Commission has understood that, for example when they launched the European Battery Alliance for electric vehicle value chains. Juncker also said we cannot talk about the energy transition if we don’t have an interconnector between Spain and France. Now, that interconnector as such is not so important, but it is important politically and the Commission has put a lot of money into it. Same goes with the Baltic interconnection plan.

This is why the Just Energy Transition fund is important – you need some high-level political initiatives. Whether they always make economic sense can be debated of course.

Energy poverty hinders EU push to end regulated electricity prices

The European Commission has renewed its push to phase out regulated electricity prices, arguing they distort the market and slow down the transition to clean energy. But faced with reluctance from EU countries, it has now tabled a compromise based on a common EU definition of energy poverty.

You say Structural Funds matter. But in the EU budget, this money is reserved for countries whose GDP is below 60% of the EU average, meaning a country like Poland could be left out. And others like Germany won’t benefit for sure, even though they’re going through an important energy transition as well. So do you think these rules still make sense? Politically, maybe these countries deserve something too, no?

Like you said, we’re talking about huge amounts, trillions of euros. And that cannot be covered by the European Union. If you have limited funds, like the EU does, then they should be concentrated on those that are really in need.

Now, there may be special cases like Poland. But again, the Polish have a new energy strategy. And they certainly look at what the EU can do for them.

But I cannot conceive that relatively rich countries, like Germany, need this political signal that the European Union is doing something for them in the energy transition, when the German government has been claiming for 10-15 years that they are the leaders.

The same goes for Sweden or Finland. These countries may have vulnerable regions in the north which may be eligible for EU funding. But if the EU engages funding in these countries, then there will be less for those who are really in need.

For them, it’s the sustainable finance agenda which matters most, probably.

Yes, most of the funding will have to come from private investment in capital markets. And for this, you need the necessary regulatory framework.

And that brings in the politics again, and the distributional impacts. And all the member states will have to address this, including the better-off regions in Germany.

A lot of industrial regions will suffer from the distributional impacts of climate change. And many other regions will suffer from climate-related impacts such as floods, heatwaves and droughts. Just look to the Mediterranean, they will need assistance on that front, so money will have to be sent over there.

By the way, EU countries and the European Commission will also need to look into the financial liabilities of climate change adaptation that will accumulate in the coming decades. We did a study in 2010 looking at the fiscal implications of climate change adaptation. And what we found is that EU member states don’t accumulate reserves for the climate adaptation that will be coming in 2030 or 2040.

That’s another area where I think the next Commission could do something and nudge member states to set some money aside. Everybody is focused on pension liabilities but all of a sudden, EU countries will be facing another huge bill, for which they are currently unprepared.

When the climate bill suddenly hits, they will call on the EU to address it. And those member states which have accumulated reserves will ask why they should pay for those who haven’t done their homework. Especially in the Mediterranean and in some Northern parts of Europe, they will be facing significant climate impacts.

Climate change will affect EU monetary policy ‘one way or the other’, ECB says

Whether humankind fails or succeeds in keeping the rise in global temperatures within manageable levels, central banks will sooner or later be called upon to act, said Benoît Cœuré, a member of the European Central Bank’s (ECB) Executive Board.

New rules for structural funds are currently being debated at EU level. Under the current state of play, both the EU Council and the Parliament want to prohibit structural funds going to gas or nuclear projects, meaning only electrification and renewable energy projects will be eligible. Can renewables alone deliver in a country like Poland, which is 80% dependent on coal for its electricity?

Of course, they cannot switch everything to renewables. But let me start with the gas question. Unless there is a serious carbon price in Europe, the energy transition will be very difficult because you give all the wrong signals.

Poland and the other EU countries understand that if you want to move out of coal, a price signal will have to be given, otherwise you are constantly fighting against windmills. And again, the Emissions Trading Scheme (ETS) has distributional impacts, it’s very clear. And you have to face it: industrial sectors that emit carbon will have to pay while others won’t. That will have different impacts on the member states depending on their energy mix – this is just unavoidable.

Now, when you look at Poland, they accept the necessity for the transition. They have been boosting, their renewable energy sector. And in their new energy strategy, which was designed at the end of last year, they look at the full suite of measures.

Because if you want to have this transition, you need everything, including natural gas. They started off with optimal use of their own energy resources, including biomass, wind and solar. They are investing a lot also in offshore wind from the Baltic Sea, which is meant to deliver a lot of their electricity, but they have also have big potential in onshore wind.

The second biggest part for Poland is the development of the electricity grid. And that tells you where they’re heading, it’s very much consistent with their planned development of offshore wind. It’s also consistent with their industrial strategy of electrification to deal with the high level of air pollution in cities like Warsaw.

Now, there is also a role for traditional fossil fuels during the transition, mainly to diversify oil and gas supply networks. That’s the third priority. Nuclear energy is also one of these ideas that Poland are trying to promote. And then, heating and cooling, co-generation as well as energy efficiency, which cuts across the board.

In a way, the Polish strategy is no different from the German, Swedish, or UK strategy, although the priorities are different.

But everywhere there is a strengthening of the electricity grid. And nobody contests that we are moving to an electrification rate of 60, perhaps 70% in 2050. So that’s a win-win, or a no-regret option. And building as much offshore wind is probably also a no-regret option.

Climate cash cow: Where EU countries can get their funding

Europe’s green ambitions will largely hinge on being able to finance a transition away from polluting energy sources. But where will the money actually come from?

Is it right for the EU to support electricity networks and renewables but not gas, which helps decarbonisation in the short-term?  It’s a tricky question for policymakers of course, because the EU will be criticised either way, for different reasons…

I don’t think it’s that difficult. All projections point to a short-term increase in gas demand, which should remain stable at the very least until 2030. But after that, all projections point to a decline in consumption.

And overall, there is enough gas infrastructure, especially if you look at LNG terminals, which are currently being built.  In fact, we probably have excess import infrastructure for gas. Europe’s internal gas grid is very well developed. Just look at the map, we have gas infrastructure almost everywhere in Europe.

Of course there are some issues in Central and South East Europe but overall, we have made a lot of progress on gas, driven by security of supply and market integration objectives. And gas infrastructure projects are supported by the Projects of Common Interest and the Connecting Europe Facility. And this process will continue until 2025, maybe a bit longer, which means remaining gas connectivity problems are being dealt with.

Now beyond that, why would Europe put public money into an infrastructure, which after 2030 will be phased out? Some studies claim there will be a lot of renewable gas but it’s still unclear how much. So why would the EU or the member states invest public money in an infrastructure that might not be needed after 2030? Especially when you consider that building new infrastructure takes 5-6 years on average, if you start building them now, we will get it in 2025, or 2030, at which point the demand will start going down.

So I think there is a case for being extra careful with public money going into gas infrastructure. If there is a business case, the money might be brought up by private investors. Or the member states themselves can find ways of doing it.

You also need to keep in mind that gas takes up a lot of volume compared to its calorific value. That means gas infrastructure is fairly expensive relative to the amount of energy that you get. If you have a lot of existing infrastructure, gas will be cheap because the infrastructure is already financed. So you might in effect encourage more gas.

Now, from the perspective of a national government, you would probably think hard about what kind of energy infrastructure to support. Do you want to support electrification? Or do you want to support an energy source that will decline after 2030? I think most of the member states have made up their mind. They’re putting their money into electrification, some carbon capture and storage, some nuclear, electric vehicles, storage, etc.

That’s a choice that all the member states face. And I’m fairly confident that, at the end of the day, they will all come to fairly similar decisions.

In a way you’re saying the EU is right to double down on renewables and electrification, and trying to skip the gas transition phase as much as possible.

Let’s put it like this: Why support infrastructure investment that will materialise in 2025 when you’re about 5-10 years maximum from the gas peak? Is that a good way of spending money? member states may come to different decisions, but I would say reinforcing the electricity grid, building offshore and onshore wind, solar, and even nuclear if it’s acceptable from an economic perspective, certainly are no-regret options.

To get to an electrification rate of 60%, you need about 4% growth in electricity generation. So whatever you put there, you can be reasonably sure it will still be useful in 2050. Whatever you put in gas, you have to ask yourself whether it will still be valuable in 2050. It’s up to the member states to make up their minds.

Five benchmarks for a just transition to low-carbon energy

The new long-term climate strategy for the EU can be a tool for a prosperous zero-carbon society if it addresses Just Transition, write Lisa Fischer and Rebekka Popp.

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