EUobserver opinion: EU must scrap carbon compensation scheme

At one point, one of the characters in the Star Wars saga says: “What if the Republic has become the very evil we have been fighting to destroy?”

We in the EU are now asking ourselves: Could it be that the EU Emissions Trading System (ETS), a mechanism created for the purpose of reducing greenhouse gas emissions, is in fact incentivising the polluters? As the ETS is currently under revision, the question is highly relevant and the window is wide open for repairing the system's flaws.

While the idea of an emissions trading system was innovative and clever, the ETS has not been allowed to spread its wings and show its full potential. The market is flooded with emission allocations, which has led to a too low cost for polluting. Moreover, the industry is making a considerable windfall profit from selling unused emission allowances.

These problems are well known. However, one important aspect relating to the ETS has largely escaped public scrutiny: the existence of national schemes for compensation for indirect carbon costs.

National policies

The idea is the following: some electricity-intensive industries - such as steel, cement and aluminium - hypothetically incur additional costs when they buy electricity from coal or gas-powered plants with high tariffs, due to carbon prices they have to pay. Therefore, some nations or entities - including the UK, Belgium’s region of Flanders, Germany, Greece, Spain and the Netherlands - have decided to provide financial aid to those industries.

These national policies received the blessing of the European Commission. In fact, in its recent ETS revision proposal, the commission changed the wording in a way that member states now "should" (not "may", as before) provide compensation for indirect carbon costs.

This is a terrible idea. In effect, it turns the entire purpose of the ETS upside down. The compensation paid by several member states actually rewards industry for buying electricity from carbon-intensive power generators.

Let us not forget that the industry has a choice of electricity provider. Buying carbon-free electricity is now possible from a technical standpoint, it could be just as affordable and it is in line with European climate objectives.

The member states' compensation schemes eliminate the incentives for industry to choose carbon-free electricity. In Germany, for instance, buying electricity from a clean generator indicates no compensation. The scheme is effectively a lifeline for carbon-fired power plants.

The formulas for calculating state aid are also problematic for indirect costs. Or, at least, their implementation is poor.

Allowances

Let us take the example of the Flanders region, which according to one study subsidises up to four times more than the actual cost of the industry.

One of the components of the formula determining the state aid is the amount of CO2 emitted for each megawatt hour (MWh). The average of Flanders is 0.23 tonnes of CO2.

However, the Flemish government uses the broader regional factor of 0.76, which is the maximum factor for the entire Central Western Europe.

Another component is the average price of emission allowances (EUAs). Instead of using the actual price the industry pays for their allowances, the Flemish government uses the so-called forwarded price. In 2014, the forwarded price was €7.93, but the actual price was €4.47.

According to Bond Better Environment Vlaanderen, a federation of more than 140 environmental organisations in Flanders, the industry of the entity received some €60 million from the government as a result - four times more than the actual additional cost that the industry had to bear due to the ETS.

Today the electricity market prices will continue getting lower than the subsidies because there are more renewable energy sources on the market and more interconnection of different areas.

Furthermore, the indirect cost compensation distorts the level playing field and fair competition between industries of member states.

The level of aid programmes varies considerably across member states. While Spain budgeted the modest sum of €5 million for the 2013-2015 period, Germany earmarked €756 million for indirect cost compensation for the same period. Many EU nations do not have such schemes at all, but are now being forced to consider introducing them.

This "compensation race" is expensive, unnecessary and counterproductive. If we really want to help our electricity-intensive industry, the more effective way is to ensure affordable electricity prices across the union though more interconnectivity, in order to create a common electricity market and more renewables.

Distorting the market

So far, our policies vis-a-vis the ETS have been driven by exaggerated fears of so-called carbon leakage - the perceived risk that the ETS could price business out of Europe and into less regulated markets. Hence the national compensation schemes and the abundance of allowances.

However, the a study of energy intensive sectors requested by the commission showed that there was no evidence for carbon leakage. The industry has largely been able to pass on those ETS-related costs to product prices without losing significant market share. It is therefore safe to assume that the industry has been clearly overcompensated in order to avoid the perceived risk of carbon leakage.

The ETS is currently under revision. It is an opportune moment to address its flaws and to make it work in the way it was intended.

The ETS has to be more ambitious in order for us to achieve our climate goals; we have to be less generous with the emission allowances in order to save future generations. We also have to work for greater market integration and promotion of innovation which will drive down the cost of sustainable energy sources for industry.

We definitely ought to scrap the ETS “compensation” schemes. They distort the market and reward polluters. We are better off without them.

It is not just the future of our continent that is at stake here. Our emissions trading system serves as a model for the rest of the world. So let us do this right.


 Peter Eriksson i is a Green MEP. He is a member of the industry, research and energy committee of the European Parliament and shadow rapporteur for the revision of the ETS system.