Transforming industry to be climate-friendly: Emissions trading requires reliable accompanying measures
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This week, the European Commission will publish its reform proposal for the European Union’s Emissions Trading System (EU ETS). While this reform is necessary, it must form part of a comprehensive package of measures to ensure the successful transformation of industry and its shift towards climate-friendly production, particularly in light of the new global economic and geopolitical conditions. This is demonstrated by a new study by Oeko-Institut and the German Economic Institute, which was conducted with financial support from the Climate Neutrality Foundation.
Emissions trading remains the cornerstone of European climate protection. However, it is not enough on its own to enable companies to invest in climate-neutral processes and operate them profitably. What is crucial is a reliable framework that gives companies planning certainty while at the same time accelerating the transition.
Putting industry in the spotlight
Since 2005, the EU ETS 1 has made a decisive contribution to reducing greenhouse gas emissions in the energy sector and industry. In Germany, emissions covered by the EU ETS 1 fell by around 49 per cent, and across Europe by 51 per cent. While a large proportion of the reductions to date have come from the energy sector, the focus is now shifting more strongly towards industry.
However, energy-intensive sectors such as steel, cement and chemicals are facing high investment costs, uncertain sales markets and increasing international competitive pressure. At the same time, the free allocation of emission allowances that has so far provided relief to energy-intensive companies in the face of international competition are gradually being phased out.
“The current reform must take the situation facing industry into account. The geo-economic conditions for almost all industrial sectors have deteriorated: the wars in Ukraine and Iran are driving up the cost of fossil fuels, while Chinese overcapacity and trade policy distortions are increasing competitive pressure,” said Matthes. “That is why the reform of the Emissions Trading System must be accompanied by further measures.”
What measures could help the industry?
In order to transform industry into a climate-neutral sector, targeted measures are necessary for the electrification, hydrogen production and carbon capture and storage. These measures help to offset higher operating costs and ensure the expansion of infrastructure. Furthermore, for energy-intensive industries, the demand side can be addressed on a sector-specific basis through public and private markets. According to the study, many climate-friendly industrial processes are technically feasible but not yet economically viable. The authors therefore recommend limiting operating cost risks, accelerating infrastructure decisions and providing targeted support for investment; they also put forward specific proposals and describe the necessary packages of measures.
Emissions trading as a cornerstone
For the upcoming reform of the EU ETS 1, the study recommends considering all elements collectively and makes specific proposals across the entire scope of the regulatory framework. The emissions cap, Market Stability Reserve and free allocation should be further developed in such a way as to provide planning certainty, stabilise price signals and enable investment in climate-friendly processes.
From the mid-2030s onwards, the cap should be aligned with the EU climate targets for 2040 and 2050. The Market Stability Reserve should be further developed into a mechanism for covering unavoidable industrial emissions and for channelling sink allowances.
Revenue from the EU ETS 1 should be earmarked for the transformation of industry and the energy system. According to the study, free allocation should be maintained for a period of no more than five years where significant competition and carbon leakage risks persist, or where the EU’s absolutely essential Carbon Border Adjustment Mechanism (CBAM) has not yet demonstrated its effectiveness with sufficient robustness.
Climate policy needs to be embedded in trade and industrial policy
The dominant drivers behind the current crisis in the basic materials industries are of a geo-economic nature: industrial subsidies, tariff policies and increasing protectionism, which, through the diversion of exports, has not only direct but also indirect effects on Europe. Climate policy instruments cannot offset this pressure – ultimately, targeted supporting measures of trade and industrial policy are also necessary.
This study was conducted by Oeko-Institut e.V., in collaboration with the German Economic Institute, and was funded by the Climate Neutrality Foundation.
