ETS reform: EU tightens screw on ‘carbon leakage’ handouts for polluting industries

Cooling towers at the Drax power station in North Yorkshire. [Les Haines/Flickr]

Energy intensive industries will continue to receive free carbon emissions allowances, as compensation for the EU’s stricter climate rules, under planned reforms to the EU’s Emissions Trading System (ETS), but fewer will be granted.

The European Commission plans to reduce the number of free allowances and the number of industries that qualify for them, it said today (15 July). It is also speeding up the annual rate at which it reduces allowances, compared to the current ETS trading period.

But the plans include safeguards for the international competitiveness of EU energy intensive industries, the executive said.

About 50 sectors, including all the major industrial ones, will continue to receive free allowances from 2021, the next ETS trading period, because of the risk of carbon leakage.

Carbon leakage is when businesses transfer production to countries with weaker restraints on greenhouse gas emissions because of lower costs.

Industries that are likely to still qualify for the free allowances are expected to include sectors such as steel, aluminium, chemicals, paper, fertilisers, lime and glass.

The ETS is the world’s biggest scheme for trading emissions allowances. Regulated businesses measure and report their carbon emissions, handing in one allowance for each tonne they release. Permits can be traded on the markets as an incentive for companies to reduce emissions.

Pollution credits were grossly over allocated by several countries during the 2005 initial implementation phase of the ETS, forcing down carbon prices and undermining the scheme’s credibility, which prompted the EU to toughen up the system. Carbon prices have since remained stubbornly low, at about €7.4 a tonne.

2030 target

Energy and Climate Commissioner Miguel Arias Cañete hailed the reforms as the first decisive step to enshrining the bloc’s commitment to reducing greenhouse gas emissions by at least 40% by 2030 in EU law.

The reforms announced today (15 July) in Brussels, must be backed by the European Parliament and Council of Ministers before they become law.

>> Read: EU leaders adopt ‘flexible’ energy and climate targets for 2030

Today’s reforms cut down on the number of allowances, divided into permits for auction by governments and free allowances to industry, available to the market from 2021-2030.

They also increase the rate of annual reduction of allowances from the current 1.74% a year to 2.2%. That should deliver a drop in emissions of 43% compared to 2005 by 2030, the Commission said.

It would cut 556 million tonnes of carbon emissions in ETS-regulated sectors over the decade, the same as the UK’s annual emissions, the executive said.

15.5 billion permits

The Commission expects a total 15.5 billion allowances worth €387.5 billion to be made available during the 2021-2030 trading period. It is working with a figure of €25 euros per permit.

57% of them will be auctioned by member states, the same as in the previous Emissions Trading System trading period of 2013-2020. They are estimated to be worth €225 billion.

6.3 billion allowances (43%) will go to industry in free allocations, worth an estimated €160 billion. Those will be divided out, with the most efficient companies being prioritised. So the best performing companies will still get the benefit of free allowances.

Less efficient business will have to buy permits, incentivising them to improve their efficiency and cut emissions.

177 sectors currently qualify for free permits. About 100 will drop off the list for 2021-2030. They are likely to be those that qualified because of their trade intensity rather than their emissions intensity.

The list will stay the same for ten years, rather than the five years of the previous trading period. This will make it more stable and give greater investor certainty.

The benchmark to decide how to reward the better performing companies will also be based on new data, rather than the pre-crisis data of the current period. This will take into account technological progress and lower emissions during recession.

The new system will take into account production increases and decreases more effectively, and adjust the amount of free allowances accordingly. A number will be set aside for new and growing installations.

Member states

EURACTIV understands the 57% share of allowances for member states was also a stipulation of national governments for their support to the 40% target, agreed to by EU leaders in October.

The Commission is putting pressure on nations to use the revenue to compensate electricity-intensive industries, such as aluminium, which have carbon costs passed to them in the price of electricity. Any that do must ensure that they don’t break EU competition law.

But the executive also encourages nations to put revenues from their auctions toward climate finance, helping non-EU countries adapt to climate change, or social policy to ease the transition to a low carbon economy.

While there is no system of hard enforcement, member states will be compelled to report on how the revenues are spent. At least 50% of the money “should” go to climate related policies, according to the Commission.

Currently, member states spend 80% of the cash on climate policies on average, EURACTIV was told.

Energy package

The ETS reforms are part of the Commission’s energy summer package. They include a new Modernisation and Innovation Fund.

>> Read: Poorer EU nations get carbon money for backing emission target

The package also includes a revamp of energy efficiency labelling policy for products.  The label will be rescaled to make it clearer. EURACTIV exclusively revealed those plans on 1 July.

>> Read: A+ energy labels will be ditched

The Commission also launched a consultation into how best to redesign energy markets to help consumers and increase shares of renewable energies.

“After more than a decade, the EU’s main climate instrument still lacks the teeth to make the polluter pay and drive emission reductions. Today’s proposal serves the interests of Europe’s largest polluters at the expense of the climate and taxpayers’ money” said Femke de Jong, EU climate policy advisor at Carbon Market Watch.

“Handing out pollution permits worth hundreds of billions of euros for free on the assumption that other countries will not take similar action is not only damaging the process for a strong climate treaty in Paris, it also ignores that revenues from auctioning these permits could fill public budgets to invest in Europe’s climate-friendly economy,” de Jong added.

Markus J. Beyrer, BusinessEurope director general said, "The Commission’s proposal is failing to safeguard the competitiveness of European industries. It does not match with the objective of keeping a strong and competitive industrial base in Europe. By unnecessarily reducing the volume of free CO2 emission allowances so drastically, it raises the risk of investment leakage, exposing our industries to unfair competition from countries without comparable climate efforts.

"We nonetheless acknowledge the efforts to increase the threshold for the innovation fund which will support innovative low-carbon technologies and processes from industry."

ALDE MEP Gerben-Jan Gerbrandy said, "I much welcome this timely launch of the EU's carbon market reform. In the coming weeks I will assess the Commissions's proposal. My attention will focus on boosting low-carbon innovation and a targeted approach to protect the competitiveness of the European industry. We must also ensure that the free allocation of carbon allowances to power plants in Central and Eastern Europe won't distort the Energy Union and the emerging European electricity sector."

Geneviève Pons, director of the WWF European Policy Office, said, “This proposal fails to show how the EU ETS will ensure that Europe’s largest polluters pay a meaningful price for their carbon pollution. The European Commission is setting Europe’s carbon market up for another decade of failure. Reducing the effectiveness of European climate policy in order to appease vested economic interests is unacceptable.

The idea to finance CO2 reductions and clean technologies through a meaningful price on carbon is the right one. This should be strengthened through more earmarking of ETS auctioning revenues and can send an encouraging signal ahead of the international climate negotiations in Paris later this year. The other European institutions have to act responsibly and intervene to rescue the EU ETS from redundancy and to deliver a carbon market with society wide benefits.”

"The proposal does not take into account that the EU Council explicitly decided that the EU should reduce its greenhouse gas emissions by ‘at least’ 40% ” said Wendel Trio, director of CAN Europe. “Fixing the ETS would mean setting a more ambitious target and cancelling the 2.5 to 4.5 billion surplus allowances that will have accumulated by 2020. This would ensure that the EU’s climate targets are met by actual emission reductions rather than with left over surplus.”

Lies Craeynest, Oxfam’s EU policy advisor, said, “The European Commission has wasted an opportunity to make its flagship climate tool fit for purpose by offering compensation to heavy polluters instead of making pollution pricing work for low carbon development and climate change adaptation in poor countries. 

“By failing to make the sale of pollution permits pay for clean development and climate adaptation abroad, the European Commission has lost an opportunity to restore its international climate leadership, and leaves the people most impacted by climate change without additional support. Employment in the European steel industry has dropped by over 20% compared to levels in the sector before the economic crisis and EU steel demand is still 25% below pre-crisis levels. If not adjusted and improved, the Commission’s new ETS proposal will deliver another major blow to our sector,” said Axel Eggert, director general of the European Steel Association (EUROFER).

Kristian Ruby, chief policy officer at the European Wind Energy Association said, "We need an ETS that will allow those member states that rely heavily on fossil fuels to transition their economies toward more sustainable, decarbonised and cost-effective forms of energy such as onshore wind. And in the long run, the instrument must be realigned with Europe’s political ambition on climate change. 
"The removal of surplus permits and the phase-out of free allocation are the first steps to achieving this, but Europe has room to go much further. The ETS needs a root and branch overhaul. The ambition of the reforms laid out in this summer package will not be enough to guarantee a fuel switch and drive investments in renewables."

Gerd Götz, director-general, European Aluminium, said, "Today’s proposal falls short in terms of restoring our global competitiveness. It ignores unanimous calls from all 28 member states and the European Parliament for harmonised EU compensation for indirect ETS costs. Our sector is the most exposed to carbon leakage as a result of these costs, which are six to seven times higher than the direct costs and cannot be passed on.”

Guy Thiran, the European Association of Metals' director general, said, “Today’s proposals ignore the European Council’s request that best performers should be protected from any undue indirect carbon costs, with the system to remain largely unchanged. Regrettably, although several alternatives were offered for EU-level compensation of indirect costs, administrative simplicity has prevailed over the competitiveness of Europe’s electro-intensive industries.”

“What is missing are policies for the job changes that will inevitably occur” said Józef Niemiec, ETUC deputy secretary general. “Europe needs a ‘Just Transition strategy’ to help workers make the energy transformation, and make winners out of industries and regions that risk losing out.”

“The additional support for low-carbon industrial innovation is certainly welcome” said Niemiec, “although it is unlikely to be enough investment to put the EU on track to meet its 2050 targets and build a low-carbon manufacturing industry and all the jobs that could create.”

Jan Ahrens, director market analysis at  ICIS Tschach said, "Linking free allowances more closely with actual production, reforming carbon-leakage provisions, and the setting up of innovation funds are all positive changes. We might even see carbon prices boosted slightly over the next few years as companies look to stockpile some allowances." 

Sandrine Dixson Decleve, director of The Prince of Wales' Corporate Leaders' Group, said, “While we welcome elements of this new package of reforms with open arms, we remain cautious about its overall strength and potential impact. We are disappointed that the proposal has failed to address the huge oversupply of ETS pollution permits available to the carbon market, nor the inadequate rules to define risk of ‘carbon leakage’.

“We have always advocated bold, swift action to ensure the right signals are sent to the market and the carbon price increases significantly. It’s the level of the carbon price that will be the make or break of the ETS over the next ten years - we’re yet to be convinced that today’s proposal will go far enough to secure the much needed high prices.”

Javier Goñi del Cacho, president of Fertilizers Europe said, “The fertilizer industry takes great pride in being responsible for feeding half the Global population. The recent ETS proposal by the European Commission does not take account of the competitiveness of the European fertilizer industry. As a result the proposal threatens food security in Europe.”

The EU's Emissions Trading System is the world’s biggest scheme for trading emissions allowances. Regulated businesses measure and report their carbon emissions, handing in one allowance for each tonne they release. Companies can trade allowances as an incentive for them to reduce their emissions. Countries can also sell permits to the market.

The European Commission has proposed a series of reforms to the ETS. 

Pollution credits were grossly over allocated by several countries during the 2005 initial implementation phase of the ETS, forcing down carbon prices and undermining the scheme's credibility, which prompted the EU to toughen up the system. Carbon prices have since remained stubbornly low at about €7.4 a tonne.

The European Union has agreed a 2030 framework for climate and energy policy based on the following commitments:

  • to reduce the bloc's greenhouse gas emissions by 40% compared to 1990 levels, a binding objective which has to be broken down to individual member states based on their GDP per capita and may not be met by carbon offsets;
  • The use of carbon offsets to meet further emissions reduction commitments made in international climate talks;
  • A 27% renewable energy target that is binding at an aggregate European level but voluntary for individual member states;
  • An indicative target to increase energy efficiency by at least 27%;
  • Non-binding shale gas recommendations which could be made binding after a review in 2015;
  • A market reserve facility for the Emissions Trading System, with the power to withhold or release up to 100 million allowances;
  • and to implement the fuel quality directive by 2020, imposing a 6% reduction in greenhouse gas emissions from combustible fuels in the EU. 
  • November/December: UN Climate Change Conference in Paris

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