Free emissions permits may stifle EU industry – studies

Polluting industries are earning windfall profits which may ultimately undermine them says UK report

(Pic: Elliot Brown/Flickr)

Many steel makers have passed on carbon costs to customers (Pic: Elliot Brown/Flickr)

By Gerard Wynn

The European Union’s emissions trading scheme may be over-compensating heavy industry, allowing windfall profits which may stifle competitiveness in the long-run.

The European Union has the world’s largest cap and trade scheme, the EU emissions trading scheme (EU ETS), and the most comprehensive carbon emissions targets across industry.

The impact of the scheme on industrial competitiveness is a big concern, and a major handicap to increasing its ambition.

Carbon leakage refers to the risk that tough climate policies in one country lead to the relocation of polluting industry to another, less restrictive country, simply displacing rather than cutting global carbon emissions.

Particularly vulnerable sectors include those with high emissions and which have to compete internationally, including in regions without carbon controls.

Under the EU ETS, such sectors get free emissions permits, called EU allowances (EUAs), and in some cases additional financial compensation.

But they may have been over-compensated, and the design of such schemes may actually reduce their competitiveness in the long run.


There is no question that some sectors would suffer as a result of the EU ETS without some form of compensation.

Analysis of the exact carbon cost is complicated, given it has to disentangle other impacts on competitiveness, such as changes in productivity.

A study published this week for Britain’s Department of Energy and Climate Change showed how companies in all the sectors studied managed to claw back at least some of their carbon costs, by passing these on to selling prices.

“Most sectors succeed in passing on the bulk of the costs,” it said, referring to a hypothetical carbon cost of 15 euros per tonne of emitted CO2.

Such sectors included those which presently get their entire quota of EUAs for free under the EU ETS, such as iron, lime, fertiliser manufacture and cement.

The study concluded that the way the EU calculated vulnerable sectors was simplistic, failing to take account of how easy it was to cut emissions, and whether imports were from countries with carbon controls.

“The cost-effectiveness of free allowance allocations could be improved by making revisions to the eligibility criteria which the European Commission uses,” it said, without spelling out whether some sectors or companies were over-compensated.

Other studies have similarly found that energy-intensive sectors, such as iron and steel, can pass on some carbon costs to customers, despite getting their EUAs for free, earning a windfall profit.

“There is ample evidence that the energy intensive industry has passed through the prices of their freely obtained allowances in … the EU ETS. This has generated windfall profits in these sectors,” found a report published in 2010 by the Netherlands-based consultancy CE Delft.

Additionally, the same sectors have not only received free EUAs, but too many, allowing them to sell the surplus.

A report published by the green group Sandbag calculated the EUA surpluses held by the biggest companies in 2011. The top ten carbon emitting iron and steel companies held surpluses worth 2.9 billion euros, and the top ten emitting cement companies held surpluses worth 1.5 billion euros, it found.

“These findings run strongly counter to recent claims by industry groups that more ambitious EU emission reduction targets would be a burden and would excessively damage the competitiveness of European Industry,” it said.


The way that compensation is presently arranged may actually reduce EU industrial competitiveness, by removing incentives to innovate to cut carbon emissions and improve efficiency.

“The combination of the free allocation and low carbon price for most of the period under Phase I and II (from 2005-2012) provided an insufficient economic incentive to further leverage emission reduction options in this sector,” said a report into the impacts of the EU ETS on the cement sector, published in February.

“No operational carbon leakage has taken place so far and free allocation may be credited for that. There is also currently no evidence that investments in Europe have been cancelled and moved abroad because of the EU ETS. However, free allowance allocation provisions also create severe distortions.”

Another study, also published in February 2014, found that the EU cement sector was now less energy efficient than the sector in China and India

“Comparatively, the European cement industry still uses older and less efficient plants because there is no demand growth. This creates a risk that equipment suppliers for cement plants might move with the investment to other regions of the world.”

“Climate policy could increase the incentives for additional investments and innovations in the European cement sector.”

Under the EU ETS, companies have to meet energy efficiency benchmarks to get their full free EUA allocation.

But that allocation is also based on maintaining historical production levels, discouraging companies from innovating by shutting old capacity and replacing this with smaller, leaner operations.

Global action

The best solution would be for all countries to implement carbon controls, and so allay competitiveness worries.

That is a big goal of UN climate talks, meant to agree next year a global climate deal for implementation from 2020.

Germany illustrated a typical position, regarding the problem of competition.

The country this week said that the EU could offer bigger cuts in carbon emissions if other nations also stepped up, in a note to the group of EU leaders, called the European Council.

“The European Council should make it clear that in the context of an international climate agreement the EU is prepared to raise its level of ambition on climate action above a domestic target of at least 40% (cut in carbon emissions by 2030, compared with 1990 levels).”

So far, the signs are that countries will take small steps to cut emissions, but more timid than action that scientists say would avoid more dangerous climate change including heat waves, floods and sea level rise.

For nations determined to push through more ambitious action, that would forces them to protect their domestic industry.

Perhaps the most efficient alternative to free emissions permits or cash compensation would be to implement carbon border tariffs, which forced importers to buy a carbon emissions permit for every tonne of CO2 emitted in the manufacture of their products.

However, the failure of the EU to force non-EU airlines to do just that for international flights leaving from or arriving in Europe illustrated the political problem.

China, India, Russia and the United States condemned the plan, forcing the European Commission to back off and limit emissions limits to flights within the EU.

Read more on: Climate finance | EU |