The EU Emissions Trading System (ETS) is ever more relevant. Every year fewer allowances are available, the long-term price trend is upwards (despite the recent drops), and the incentive to replace CO2 intensive production techniques for less intensive ones becomes stronger every time. However, more and more countries do not seem to want to rely solely on ETS to achieve their goals for emission reductions. Partly because ETS does not apply to all sectors of the economy, and partly because they believe the incentive of ETS is not strong enough. Most recent in this list of countries is Germany, that announced as part of its Climate Action Plan for 2030 an additional CO2 emission pricing scheme for sectors not covered by ETS. Before summer the Netherlands announced a plan to introduce an additional CO2 levy. In other countries, like the UK and Sweden, additional CO2 taxes have been in place for some time already. In this blog we will try to shed some light on the various types of measures, how they interact with ETS and what effects they will have.
EU Emissions Trading System (ETS)
But first back to basics. ETS applies to all greenhouse gas emissions from electricity generation, the energy-intensive industry and civil aviation within the EU plus Iceland, Liechtenstein and Norway. This adds up to about 11 thousand heavy energy-using installations and airlines in those countries and covers around 45 percent of the EU’s greenhouse gas emissions. We often simply talk about CO2 emissions (and will do so form here on), but ETS also covers other greenhouse gasses such as N2O and PFC’s.
ETS is currently in its third phase which lasts from 2013 to 2020, during which period the yearly amount of allowances to emit CO2 within ETS is reduced by 1,74 percent. Over the total period of the third phase, 57 percent of the total amount of allowances will be auctioned, while the remaining allowances are available for free allocation. Power generators do not receive any free allowances anymore. The proportion of free allowances for the industry will gradually decrease every year from 80 percent to 30 percent in 2020. Airlines continue to receive a large part of their allowances for free.
By 2020 emissions form the sectors covered by ETS will be 21 percent lower than in 2005. During the fourth phase, which will run from 2021 to 2030, the number of allowances will be reduced by 2,2 percent per year, which will lead to the total level of emissions in 2030 being 43 percent lower than in 2005.
German Climate Action Programme 2030
Even though ETS seems to be a necessary condition for effective climate policy, it is not a sufficient condition. First of all because ETS does not cover all emitting sectors. But all emissions do matter. If we focus on 2030, the EU has an overall target for the reduction of emissions of 40 percent, which is divided in a 43 percent target for ETS and 30percent for non-ETS sectors. This general 30 percent target is specified per country, and in the case of Germany amounts to 38 percent. In its Climate Action Programme 2030, Germany has set the even more ambitious target of a 55 percent reduction overall. And so additional measures are needed.
One of the most prominent measures in the German Climate Action Programme 2030 is an additional CO2 pricing scheme. This scheme will be directed at two sectors that are not covered by ETS: the transport and the buildings sectors. Sectors that at the moment are mostly fuelled by fossil fuels, with for example heating oil still being used for the heating of buildings. The two sectors are responsible for about 33 percent of Germany’s emissions. The emissions of the building sector have fallen by 38 percent since 1990, but those from transport have actually increased by 1,8 percent. Emission reduction in these sectors will need to speed up to achieve the overall reduction target.
To speed up emission reduction Germany will introduce a CO2 pricing scheme for these two sectors. Starting in 2021, a fixed price will be paid per ton CO2 emitted. The price will start at 10 euros per ton of CO2, and then increase to 20 euros in 2022, 25 euros in 2023, 30 euros in 2024 and finally to 35 euros in 2025. Form 2026 on, a fixed number of allowances will be set and yearly decreased in line with the overall reduction target. This will come very close to the creation of a mini-ETS. Prices will be determined in the market, however there will be a price range of between 35 and 60 euros per ton of CO2. The minimum and maximum prices for 2027 will be determined in 2025.
The CO2 price will be paid by retailers of heating and engine fuels. Retailers will adjust prices to compensate for the extra costs, so that consumers will pay for the emissions that they cause. Initially this will increase the price for petrol and diesel by about 3 cents per litre, in 2026 the price increase will be between 10 and 18 cents.
Apart from the CO2 pricing scheme, the German government agreed on a number of other measures:
- Germany´s renewable surcharge on the electricity price will be reduced by 0,25 c€/kWh in 2021, and by 0,625 c€/kWh form 2023 on.
- Further earnings from the CO2 pricing scheme will be used to further reduce the surcharge on the electricity price.
- Reforms to make houses more energy efficient will become tax-deductible.
- An extra subsidy is offered for replacing oil-fired heating systems. New installation of these systems will be banned in 2026.
- The installed capacity of coal power will be reduced to 17 GW by 2030 and will be phased out by 2038.
More CO2 pricing schemes
Germany is not the only country that opts for an additional CO2 pricing scheme to reduce emissions. In fact, many countries have a complex system of taxes for energy commodities such as petrol, gas and electricity. However, some countries have taxes directly related to the amount of CO2 emitted. Among them, there are basically two approaches:
- One is to basically widen ETS by applying a CO2 price to sectors not covered by ETS, like Germany.
- The other approach is intensifying ETS by applying a minimum or additional price for CO2 emissions within the ETS-sectors.
Sweden probably has the longest running CO2 pricing scheme, in place since 1991. It takes the form of a tax on all fossil fuels in proportion to their CO2 emissions when burned. Sustainable biofuels do not cause a net increase of CO2 in the atmosphere and are therefor exempt. The tax applies to all sectors accept to the sectors covered by ETS. In Sweden ETS-participants are lucky, because the Swedish carbon tax is much more costly than ETS emission allowances. The carbon tax was introduced in 1991 at a rate of 24 €/t CO2 and has increased to 114 €/t in 2019. By increasing the tax level gradually, households and businesses have been given time to adapt, and no harm to the economy has been done.
The United Kingdom chose the ETS intensifying approach and introduced a Carbon Price Floor in 2013. This floor price applies to fossil fuels used for electricity generation, one of the ETS-sectors. The price floor sets a minimum price, and electricity generators pay two components for their CO2 emissions: the ETS emission allowance price, and the Carbon Support Price which tops up the ETS price to ensure power generators pay the set minimum amount per ton CO2. When the Carbon Price Floor was introduced, it was planned to rise every year until 30 £/t in 2020. However, the floor price has been frozen at the 2016 level of 18 £/t until 2021. Even though the Floor Price has been capped, it does seem to have been quite successful. During the first five years after the introduction of the Carbon Price Floor the UK has reduced its emissions from coal-fired power production by 50 percent. The UK now uses a significantly larger number of gas-fired power plants and has expanded its renewable power capacity. Now that the ETS price is higher than the (frozen) floor price, the floor price has lost its relevancy (for the moment).
Before summer the Netherlands announced plans to introduce a CO2 levy similar to the Carbon Floor Price in the UK. Even though the Netherlands and Germany held talks to coordinate climate policy, they both opted for different versions of additional CO2 pricing. In contrast with the UK version, the Dutch levy comprises all ETS-sectors, also the energy-intensive industry. The Dutch CO2 tax, like the British one, will set a minimum price for CO2. Companies pay the difference between the ETS and the minimum price. Companies will not have to pay the additional amount over all their emissions, only over their emissions that exceed a certain benchmark value for highly efficient production. The CO2 tax will start at 30 €/t in 2021. Assuming an ETS price of for example 25 €/t, this will mean an additional 5 €/t. The rate is foreseen to increase to 150 €/t in 2030. The price will be adjusted so as to achieve the reduction target of 14,3 Mton CO2 in 2030.
CO2 pricing schemes are regarded to be an efficient mechanism to combat climate change. Its greenhouse gasses that cause global warming. Putting a price on these emissions will let producers determine how to reduce emissions most efficiently. Best is to use a European (or even wider international) approach, to prevent carbon leaking and maintain a level playing field. But national CO2 pricing schemes (especially for domestic sectors) can also be effective and indeed needed to achieve ambitious emission reduction targets. It will be interesting to see if the new German CO2 pricing scheme can evolve into a parallel emission allowance trading scheme. If that is the case, it could possibly be the start of a wider European addition to ETS.
The effect of new national CO2 pricing schemes on ETS seems to be limited. Prices put on emissions of other sectors such as in Germany and in Sweden in principle do not affect ETS. Minimum prices for emission such as in the UK and the Netherlands make the ETS price less relevant for companies in those countries, since they will pay the minimum price anyway. It could be that because of the higher price, companies in these countries reduce their emissions more rapidly. This would lead to more emission allowances being available to companies in other countries, reducing the ETS price.
For the countries concerned there are mixed effects. The introduction of CO2 price schemes is good news with regards to climate goals. It comes at a cost for the sectors involved, but the government revenues generated can be used to reduce costs elsewhere. For example, in the German case the revenues from the CO2 pricing scheme will be used to reduce the renewable surcharge on the electricity bill. And Sweden has shown that even a CO2 price of more than 100 €/t can be sustained when it is applied wisely.