View from Brussels: Santa comes early for Europe’s industries

The EU’s headline climate goals of more than halving emissions by 2030 and neutralising them by 2050 only work if the bloc’s carbon market is firing on all cylinders.

By charging emitters for every tonne of carbon emitted, the market creates an incentive for polluters to invest in green technology. If buying pollution permits is a bigger expense for a steel producer than purchasing next-generation blast furnaces, the decision is an easy one.

After many years of ineffective pricing, where the cost of pollution permits was a negligible cost that big companies simply put up with, the market has come into its own lately. The price has rocketed up towards €100, which cannot be ignored.

That is why officials call it the flagship policy of the Green Deal and have called for more firepower in recent years to reinforce its decarbonisation potential. 

They got their wish last year, when the EU’s executive branch announced a big update to the emissions trading system (ETS) and embarked on tweaking the rules that underpin the world’s biggest and most effective carbon market.

Much of the review was focused on reducing the number of permits released onto the market every year. The ETS suffered in early years because there was a glut of allowances, which kept the price low. 

Negotiators have tried to strike a balance between removing too many permits, which would spike the price too much, and a sustainable annual decrease which preserves and gradually increases the incentive to decarbonise.

If the agreement brokered this weekend holds, the market will reduce the emissions of sectors covered by the ETS by 62 per cent by 2030 and save emissions equal to twice Germany’s annual output. 

Climate groups insist that the ETS deal deploys too many accounting tricks and is not in keeping with the EU’s commitments under the Paris Agreement. But for a massively political and complex bit of rulemaking, it is ostensibly not a bad result.

Dive into the details though and you can see what a decent deal this is for Europe’s industries, which is unsurprising given national concerns about offshoring and inflation triggered by Russia’s invasion of Ukraine.

Ever since it was set up, the carbon market has provided a chunk of free allowances to industries, in a bid to ease the financial burden of going green and preserve Europe’s competitiveness against countries that do not have carbon pricing.

But those free allowances are incompatible with the EU’s plan to set up a carbon border tax, which would charge a tariff on certain imports that are produced using polluting technology, for example, steel.

Gifting a European steelmaker free pollution permits and charging foreign producers for using the same manufacturing processes is against international trade principles and is a guaranteed recipe for souring commercial ties.

So free allowances have to be phased out. The carbon border tax is coming in 2026 but industries will keep getting some gratis permits all the way up to 2034. More than half of the current amount will still be doled out after 2030.

That means billions of euros in industrial subsidies. Considering that industries like steelmaking, cement production and other large-scale operations think in decades rather than years, it is arguably a soft approach to laggard polluters.

Revenues generated by the sale of emission permits are currently split up between the EU’s member countries and it has always been up to their discretion to decide how to spend those billions of profits.

Now, every euro made by the ETS will have to be invested in climate and just-transition policies, in what officials are calling a “virtuous climate circle”. What counts as ‘green’ will be left up to governments but it is still a huge source of funding for clean tech.

Other funds fuelled by the ETS include the innovation fund and modernisation fund. The former will dole out cash from a €40 billion warchest, while poorer countries will get payments from the latter to bring their industries and energy systems up to code.

Shipping will also be charged to pollute for the very first time and will get dedicated funding to invest into green vessels and fuels. Waste incineration might be added to the market by 2028 pending a further review in a couple of years.

It all adds up to an agreement that is kind on industries in the short run but which sets the long-term destination very clearly. More announcements about zero-carbon cement, clean aluminium and green steel will only become more frequent as a result.