The future of the EU emissions trading scheme

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The 1st of January 2021 marks the start of a new phase of the EU ETS and a new set of emission reduction and energy targets to see the EU through to 2030. This may seem like a relatively long time away, but the decisions that will shape the climate change framework and the future look of the EU ETS are being made and discussed right now. Heads of government will meet at the October European Council meeting to, hopefully, make a decision on an emissions reduction target for the EU for 2030 and the possibility of a renewables and energy efficiency targets to accompany it. Proposals are already on the table and discussion are already well underway on the thorny issue of how to reduce the surplus of allowances in the EU ETS, so much so that many regard the introduction of a Market Stability Reserve (MSR) as essentially a fait accompli. DECC have recently published a paper on their vision for a post 2020 EU ETS and the EU Commission has just finishing gathering views on the carbon leakage provisions for industry in phase IV of the scheme. The final decisions on these issues will have a major impact on many in manufacturing sector, not least though a major increase in regulatory and energy costs. 

EEF has today released a paper setting out what reform it believes is required to ensure that industrial competitiveness is adequately protected in the coming decade and that industry is able to effectively decarbonise and contribute to the low carbon economy. At the heart of the reform EEF is calling for is a need for policy makers to have a greater understanding of the difficulties carbon and energy intensive industries face in drastically reducing their emissions and to take this account in future policy decisions. Using the example from the report, the EU steel industry is one of the most efficient in the world; according to data from the International Energy Agency, the steel sector of OECD EU countries is the second most efficient in world with an estimate 1.6 GJ/tonne of steel saving potential remaining if best available technologies were implemented across the board, this is second only to Japan (with 1GJ/tonne potential remaining) and well ahead of India and China whose sectors have 5.4 and 6.7GJ/tonne of energy saving potential remaining. The point here is a simple one, yes there are relatively small incremental change remaining within the sector and these will achieved up to 2020 but beyond this we are looking at step change technology in the form of industrial carbon capture and storage (CCS) and the R&D, investment and implementation of this isn’t simply going to happen through the EU ETS alone.

As our report details, in the UK, the bulk of industrial CCS operations would require a carbon price in the region of £80 to £100 before they would become commercially viable, however this assumes that the technology is proven and commercially available, the UK has the infrastructure available for transportation and storage of carbon and that we have a global carbon price; these are big assumptions and ones we are still some distance from achieving. In the absence of a global carbon price, a carbon price of £100/tonne would unilaterally add some £135 to the cost of producing a tonne of steel in the EU and given that contracts can be lost on figures as small as £5/tonne it doesn’t take too much imagination to understand what the impact of this would be on the EU industry. To counteract this Government must provide the correct level of protection to ensure that carbon intensive industry can continue to produce in the EU and remain competitive with other regions around the world. So we reach somewhat of an impasse, in order to make CCS a commercially viable option Government needs to expose industry to carbon prices in the region £100 a tonne but if it did the outcome would simply be the closure of plants and the offshoring of production; Government is therefore faced with a difficult decision – either provide additional support to carbon intensive industries, much in the same way has been provided to the power sector, or accept that until a global carbon price is in place it can only expect a modest amount of further emission reduction.

This brings us to the second major area of reform require, that of the carbon leakage provisions provided to industry beyond 2020. The current system of free allocation of allowances requires a major overhaul for phase IV to avoid placing major costs on industry and seriously damaging its international competitiveness. Importantly, this is not to ignore the current issue over a low carbon price and a two billion tonne surplus of allowances in the system, but to recognise that once reforms have been made and industry faces a carbon price of €30 to €40 a tonne it will have a major impact on competiveness and the cost of production. Eurofer, the European Steel Association, has calculated that  if no reform is made to the current system of free allocation of allowance the EU ETS could cost the European Steel industry between 40 and 60 billion euros up to 2030, this would have a catastrophic effect. To avoid this we are calling for three principle reforms;

  • A move to a system of free allocation based on actual production rather than historic production, this would ensure that installations had additional allowances during times of increased production but also that allocations were reduced when production went down. This would allow the supply of allowances to reflect economic cycles and, importantly, is an essentially element of tackling the continued oversupply of allowances.
  • An end to the application of the cross sectoral correction factor (CSCF) which is wholly at odds with the notion of protection industrial competiveness and supporting growth. The CSCF will reduce allocation by around 7% this increasing to 17% in 2020 and by some estimates by 40% in 2030. A 40% reduction in allowances by 2030 would mean that even the most efficient plants in the EU, producing at the same level as their historical baseline, would face 40% of the costs of the scheme; any production over and above the baseline would become increasingly expensive.  
  • The Commission should move to use the current surplus of allowances to create an allocation reserve for carbon leakage sectors that would allow the flexibility to allocate on the basis of actual production and end the application of the CSCF.
  • Finally, a review of the current product benchmarks to ensure that those set are actually achievable by the top 10% of installations in the EU. For example, the current benchmark for hot metal at 1.328 tonnes CO2e/tonne deliberately excludes CO2 related to the waste gases utilised in electricity generation; this has the effect of reducing the benchmark by some 10% and ensuring that it is not practically achievable by any current steel plant.

It is essential that Government makes reform to the EU ETS as a package of measures considering the impact of any reform on industry before forging ahead. In practical terms this means that any moves to reduce the surplus and drive up the carbon price through a Market Stability Reserve should only be made at the same time as these vital reforms to free allocation.  

Beyond these structural changes to the current system, EEF believes there is a need for a more fundamental debate about the EU ETS and the wider climate change landscape in which it sits. How does the EU ETS interact with other policies like renewables and energy efficiency targets? Is our current method of support low carbon electricity generation through both a carbon price and support mechanisms the most efficient and the most cost effective? What do policy makers actually want the EU ETS to achieve, is it simply emissions reductions or a high carbon price and provision of support for pre-determined technologies? These and many other questions are ones that need to be discussed if we are to move towards a more coherent and more effective emissions reduction framework in the 2020s.  

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This person has now left EEF. Please contact us on 0808 168 1874 or email us at enquiries@eef.org.uk if you have any questions.

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