Last week, the European Commission published a list of 44 industries, representing 90% of total industry emissions, that will continue to receive their pollution permits for free under Europe’s carbon market rules after 2020. Over-generous hand-out of free pollution permits doesn’t incentivise emission cuts, and policymakers will need to find other ways to put industry on a pathway that reduces emissions in line with the Paris Agreement.
While other sectors need to pay for their pollution, heavy industry in Europe gets their emission permits for free under the ‘carbon leakage’ rules. Carbon leakage refers to the hypothetical situation where industry moves production to countries with laxer environmental laws.
So far, however, there has been no evidence of carbon leakage. It is also unlikely to happen in the future, following the adoption of the Paris climate agreement and the worldwide move towards carbon pricing. Industries have even been able to make over €25 billion in windfall profits as a result of the over-generous hand-out of emission permits.
Under the revision of the EU Emissions Trading System (EU ETS), free pollution permits will continue to be given out to the industry in the next decade. The European Commission deems 44 industrial sectors to be at risk of ‘carbon leakage’. A secondary application process could allow an additional 28 (sub-)sectors to get free pollution permits in the 2021-2030 period. These include mining of lignite, an activity that leads to a considerable amount of both air pollution and greenhouse gas emissions.
The new proposed ‘carbon leakage’ list is considerably smaller than the current list that counts 177 industries and represents 97% of industrial emissions. In reality, however, all the biggest industrial emitters, such as steel, cement, chemicals, and refineries, will still receive free pollution permits after 2020. Therefore, even with fewer industries on the new list, 90-95% of industrial emissions will continue to go largely unpriced.
Experience with free pollution permits shows that it provides little to no incentive for reducing emissions. In 2017, for example, industrial emissions rose by 2% and emissions are not projected to go down in the coming years. This is clearly incompatible with the Paris climate goals which require that industrial emissions go down to zero by 2050 at the latest.
The European Commission is expected to publish a new long-term climate strategy for Europe by the end of the year. It must use this opportunity to set out the path towards a thriving, zero-carbon industry in Europe, including additional measures beyond the EU ETS to incentivise the uptake of climate-friendly innovations to put industry on a Paris-compatible pathway. A coordinated effort to phase-out free pollution permits in carbon markets will moreover help to ensure that the costs of the carbon-free transition are fairly distributed across the society.