Barriers to Industrial Decarbonisation May 2018Sandbag 2 CONTENTS cutive summary Introduction What are the main pathways for reducing CO 2emissions from industrial sectors What barriers and opportunities are there to decarbonising industrial sectors What can be done to improve the competitiveness of low carbon products and processes in view of existing ETS benchmarks Does the EU ETS product benchmarking design support the development and uptake of low carbon products and processes What factors should EU policymakers take into account in developing policies to reduce industrial CO 2emissions In what ways is the ETS framework helping industries to reduce CO 2emissions What are the longer term challenges for industry What opportunities to reduce emissions are not being supported by the ETS at present What additional EU policy improvements could help companies significantly reduce CO 2emissions Conclusions Table 1 Respondents to Sandbags call for evidence 3 6 8 10 12131416 16 17 1820 73 Stakeholder views on Barriers to Industrial Decarbonisation Industries operating within the EU’s Emissions Trading System ETS account for some 42 of the blocs total CO₂ emissions. Reducing these sources of greehouse gas - es is critical to meeting the EU’s overall emissions targets and limiting global temperature rise in line with the Par- is Agreement. In practice, cutting emissions has proven to be particularly challenging for a host of reasons. This paper explores both the barriers faced in decarbonising industries and solutions put forward by stakeholders - in their own words. In previous reports, Sandbag has analysed emissions profiles of industrial sectors operating within the ETS, tracked their perance in reducing emissions, and scrutinised the policies designed to deliver CO₂ reduc - tions. While undertaking these projects we regularly hear accounts of the challenges faced in realising low carbon production from stakeholders in different sectors. It has become apparent that issues raised to us often manifest themselves in ways that are particular to certain indus- tries but share common underlying elements or origins. To gain insight into those challenges, Sandbag issued an open call for evidence in November 2017 where we sought feedback from stakeholders about their experi- ences of EU industrial emissions policy. In view of the recently concluded ETS res and the Commission’s ongoing efforts to implement policy for Phase IV of the ETS, our enquiries were focussed particularly on these areas. This report summarises responses to our call for evidence which brought to light numerous complexities and issues around decarbonising industrial sectors and their implications. These are detailed in the sections that follow. Carbon pricing CO₂ abatement Many potential levers for reducing GHG emissions were highlighted by respondents. It is apparent, however, that in the current carbon pricing regime, there is an unwill- ingness to invest in CO₂ abatement solutions that sig - nificantly increase production costs in the short to me- dium-term, unless those investments can be recouped through reduced compliance costs, cost pass-through, EU funds and grants, or other measures. The lack of alignment between ETS sectoral emissions trajectories and the EU’s overall emissions targets, and a further discrepancy between those targets and the EU’s ambitions under the Paris Agreement, also sends mixed signals to the market. While a less ambitious short term target might seem less onerous to business at present, the implication is that most of the work to cut emissions will be delayed until after 2030. This, according to respond- ents, is not conducive to attracting continued investment in industrial production in Europe. CUTIVE SUMMARY Sandbag 4 Many respondents alluded to the importance of strength- ening the price signal of the EU ETS while providing clear rules and long-term investment certainty for indus- tries. Several felt the ETS carbon price is not sufficiently high or stable to support the cost of developing break- through decarbonisation technologies. At the same time, concerns were raised over how industry will sustain itself in the face of future ETS carbon price rises which will lead to increased financial pressure on industrial sectors in the short term. Meanwhile those same industries will necessarily undergo a period of technological transition requiring high levels of investment. Historically, this is- sue has been addressed through Free Allocation which was accepted as a temporary derogation from the pol- luter pays principle of Article 191 of the Treaty of the Functioning of the European Union. Free Allocation was intended to provide a cushion during the initial years of the ETS that would allow innovation while shielding in- dustry from full exposure to the carbon price. However, carbon prices have not risen to the levels envisaged when Free Allocation was introduced and this has contributed to a weak investment climate for CO₂ abatement solu - tions in industrial sectors. Respondents from industrial sectors also called for har- monised compensation for indirect carbon costs in the price of electricity as well as increased coordination of EU and Member State funds to support low carbon tech- nology pilot and demonstration projects, and greater access to low carbon energy infrastructure. There is an expectation among many stakeholders that national gov- ernments bear responsibility for putting in place shared infrastructure, such as hydrogen distribution networks, low carbon electricity and CO₂ transport and storage infrastructure that is necessary for low carbon manu- facturing. It is not clear whether Member State govern- ments share this expectation although several do at pres- ent compensate industries for indirect carbon costs, for example in electricity consumption. ETS product benchmarks The role of product benchmarks in driving emissions re- ductions was a particular focus of this call for evidence. Several respondents felt that investments to reduce carbon intensity could be justified at installation level. However, by virtue of free allocation being based on a benchmark calculation of top perers, they believe certain operators will be less willing reduce emissions at a single plant so as not to lower the associated product benchmark value which might increase their ETS com- pliance costs for other less efficient assets. Over a third of all respondents felt that the ETS encourages a cautious approach to cutting emissions at present - one that is geared towards distributed incremental improvements rather than supporting breakthrough CO₂ abatement technologies. Further assessment is needed to determine the extent to which this view is borne out. There was also concern among respondents that even CO₂ reduction solutions which incur low or negative costs are not being implemented to their full potential. For example, there is a historic precedent of product substitution, particularly in the steel and cement sec- tors, whereby low carbon materials are commonly used to partially or completely replace more carbon-intensive materials. However, in some cases low carbon substi- tutes have been excluded from applicable ETS product benchmarks and producers of those materials therefore don’t benefit from receiving equivalent levels of free al- location. One such example put forward by respondents relates to iron ore pellets - a lower-carbon substitute for sinter in steelmaking - which, based on the existing ev- idence, falls into the product definition of sinter that is used in the EU Benchmark Decision but has to the pres- ent date been treated under a different benchmark. This approach to applying benchmarks actively discourages substitution and, in some cases, has created competitive distortions that favour more polluting technologies over innovative products and processes. There is a compelling case for improving product benchmark definitions to in- clude viable processes and product substitutes regardless of production technology - as mandated in Article 10a of the ETS Directive. Moreover, using a more selective 5 Stakeholder views on Barriers to Industrial Decarbonisation approach to applying fallback benchmarks would help address competitive distortions while avoiding a situa- tion where more polluting processes are incentivised or substitutable products are treated under separate prod- uct benchmarks. Respondents from industrial sectors overwhelmingly supported the updating of existing ETS product bench- marks which are based on data from 2007-2008 with more recently available data. A particular cause for concern with existing benchmarks is the perceived dis- crepancy between the benchmark values and achieva- ble perance of industrial installations. A number of respondents consider that some current benchmarks reflect theoretical calculations rather than current best perance. New ination collection would provide a basis upon which to revise such benchmarks using ac- tual data from installations within the EU ETS. Product benchmarks for the first half of Phase IV will be based on the observed improvement between the 2007- 2008 values and values calculated with newly collected 2016-2017 data. It was pointed out that sectors which have achieved greater emissions reductions during that period will most likely be required to cut at a faster rate in the future than those whose emission levels have changed little. This appears to put producers who have taken early action to reduce emissions at a disadvantage. Another view commonly shared by respondents is that ETS benchmarks and free allocation focus on emissions at specific points in a supply chain and do not fully ac- count for product lifecycle emissions or cross-border material flows. This has contributed to the sense of an uneven playing field between competing businesses both within the European Single Market and international- ly. A commonly shared sentiment is that the burden of environmental compliance is not distributed equitably throughout the value chain or applied consistently for same product sold in the EU but produced in different jurisdictions. A broad range of measures were suggest- ed for improving this situation including green public procurement, expanding the scope of benchmarks to include upstream emissions, crediting useful manufac- turing by-products under the ETS, integration of carbon pricing and trade policy, and carbon consumption taxes. Going beyond the ETS Around a quarter of respondents felt the role of national bodies in driving green public procurement should be expanded. The public sector’s position as major consum- er of basic materials creates opportunities to specify low carbon materials as part of a procurement strategy for taxpayer-funded projects. Material costs typically repre- sent a fraction of overall project budgets and additional costs arising from green procurement are therefore likely to deliver value for money. Given the scale of public sec- tor works, it follows that the potential impact of green procurement on CO₂ emissions can be significant over relatively short timescales. As noted by some respond- ents, this is contingent on public authorities being af- forded the tools, expertise and financial flexibility to en- act green procurement criteria. Finally, the importance of keeping technical norms rele- vant and up to date was emphasised by a number of re- spondents. Norms are intended to maintain product per- ance and safety while also supporting innovation. However, outdated or prescriptive norms lead to techno- logical lock-in and delay products’ entry to the market. Oversight of norms falls outside the remit of policymak- ers. However, norms must be compliant with EU legisla- tion and are therefore not immune to legislative changes. As preparations are made for the start of Phase IV of the ETS, several key elements remain to be finalised, includ- ing the carbon leakage list and product benchmark val- ues. Both decisions will influence how industrial sectors are incentivised to cut emissions. It is therefore impor- tant that experiences from the current phase of the ETS in decisions on implementation in the next phase so that barriers to decarbonisation can be overcome.Sandbag 6 The EU has set targets to reduce domestic GHG emis- sions by at least 40 in 2030 and 80 by 2050 rela- tive to 1990 levels. It has established a broad climate policy framework encompassing a range of instruments for cutting greenhouse gas GHG emissions across all major sectors of the economy. Its cap-and-trade carbon market, the Emissions Trading Scheme ETS, which was launched in 2005, is a core component in this frame- work. It is currently the largest market of its kind, cov- ering 1.8 gigatonnes of CO₂ emissions from more than 14,000 power, industrial and aviation permit holders in 2017, and it has inspired the creation of similar schemes in other parts of the world. Since 2005, European power sector emissions have fall- en significantly but progress has been slower in cutting emissions from industrial sectors which represent 42 of the Bloc’s total emissions. This is due in large part to EU-wide policies targetting reductions in power sector emissions and exposure of the power sector to carbon pricing regimes. Conversely, industrial sectors are large- ly shielded from carbon costs and, even where exposed- to carbon pricing, the costs of compliance are, in many 1 Sandbag. 2017. Out of touch ETS re puts Member States in the spotlight https//sandbag.org.uk/2017/11/09/touch-ets-re-puts-member-states-spotlight/ 2 Climate Action Tracker Countries. http//climateactiontracker.org/countries/eu.html accessed on 28th February 2018 cases, well below the cost of emissions abatement. The recently concluded package of ETS res for the post 2020 period together with the introduction of a market stability reserve are unlikely to completely rein in the chronic surplus of allowances that has built up since 2008. Sandbags analysis suggests the allowance surplus will persist through 2030 with an inevitably impact on prices. 1 Under the 2015 Paris Agreement, the EU commited to further reduce emissions by 2050 in line with limiting warming to well below 2C. This is yet to be reflected in the EUs policy targets while other key players in the international community have targeted rapid CO₂ cuts by reducing coal burning and promoting investment in clean energy and more efficient manufacturing. Ac- cording to Climate Action Tracker - an organisation that assesses NDCs - India and Morocco are among the re- gions which rank higher in terms of climate action than Europe. 2If the EU is to maintain its mantle of climate leadership, additional actions will need to be taken in all sectors of the economy to cut emissions before 2030 and to address the gap between Europe’s carbon budget and its commi