Revenue from the EU’s Emissions Trading System (EU ETS) continues to be spent on subsidising heavy industry pollution rather than on climate action and ending energy poverty.
In 2027, ETS2 will be introduced, extending the European Union’s Emissions Trading System (EU ETS) coverage to fuel usage from buildings, homes and transport. The creation of ETS2 has inflamed the debate on who must pay more for their carbon pollution as heavy industry continues to be granted free allowances for most of their share. A recent report by Carbon Market Watch found that ArcelorMittal led the pack, receiving an eye-watering €3.7 billion in free allowances in 2022 alone.
There appears to be no shortage of funding to subsidise industrial pollution, as over 5 billion allowances, with an estimated value of €400 billion, are to be granted between 2021 and 2030. In contrast, the Social Climate Fund, created alongside ETS2 to combat a potential growth in energy poverty is capped at €86.7 billion (the equivalent of 200 million allowances). This clear misdirection of public money is incompatible with the vast expenditure needed to fund our transition to a net-zero economy. It’s time for industry to pay for their emissions and for EU ETS revenue to be spent where it is needed most: decarbonising our society, leaving no one behind and ensuring a liveable planet for all.
The polluter gets paid
The ‘polluter pays’ principle is central to EU climate policy and implies that polluters should pay for the pollution they cause. This is the logic behind the creation of the ETS1, the emissions trading system for industrial polluters, created in 2005. ETS1 requires all pollution from power generators, heavy industry and aviation to be covered by the holding of an equivalent emissions allowance. Since its inception, the scheme was rife with an oversupply of allowances effectively giving industry free pollution permits. Despite the existence of a cap that decreases total allowances annually, in 2022 alone, a staggering €47.6 billion in ETS revenues for EU member states was foregone in the form of these freebies.
The allocation of free allowances persists due to alleged carbon leakage, the poorly evidenced idea that industry will flee the bloc if made to pay for their emissions in full. The introduction of the Carbon Border Adjustment Mechanism (CBAM) attempts to put an end to the ‘risk’ of carbon leakage by effectively imposing a carbon tax on imports into the EU and fully phasing out free allowances by 2034. However, CBAM’s timeline is nowhere near ambitious enough and, until then, industry will continue to receive handouts using public money for their emissions.
Citizens pick up the tab
The introduction of the ETS2 will mean that the polluter pays principle is extended to all EU citizens who will be required to pay for their carbon pollution caused by their homes and vehicles from 2027 onwards. The upstream function of the regulation means that fuel suppliers must purchase allowances for the volume of fuel they sell and this cost will then be passed on to the customer. The ETS2 price will be levied equally across the continent regardless of individual or member state income.
The EU created the Social Climate Fund: direct income support and green investments to offset the negative impact of ETS2 on the living standards of vulnerable groups, starting in 2026, one year before the ETS2 is introduced. It will be funded by 50 million allowances from ETS1 and 150 million allowances from ETS2.
To access the fund, member states will have to submit National Social Climate Plans outlining how they will spend their share of the resource to ensure that fuel and energy poverty does not increase, while assisting lower income groups to reduce their fossil fuel dependency in the long term.
Disappointingly, the size and ambition of the Social Climate Fund has shrunk since the Commission initially proposed that member states stump up half of the co-financing for SCF projects, rather than the current 25%. As the total funding of the SCF is not fully linked to the ETS2 price but rather capped at €86.7 billion, the relative size of the fund compared to ETS2 revenue decreases as ETS2 prices rise. While a soft price ceiling within the ETS2 exists at €45 a tonne, ETS2 prices may exceed this. The SCF should increase in proportion to ETS2 price increases to ensure support is available for economically vulnerable groups to transition from fossil fuels.
The contradiction of free allowances
Given the scale and magnitude of the challenges ahead, all revenue must now be dedicated to climate action (as required by the reformed EU ETS). Ensuring access to renewable energy for all will require a massive mobilisation of resources. The EU itself recognises that investment in clean technology will need to hit €396 billion per year until 2030 and then reach highs of €575 billion per year until 2050 to achieve its net zero commitment. The issuing of free allowances squanders much-needed public funds which could be reinvested in scaling up the necessary technologies to hasten the net-zero transition, through the Innovation Fund, Modernisation Fund, and member states’ direct funding.
The Emissions Aristocracy, our recent report, highlights how industrial emitters continue to avoid paying for their pollution, even profiting from ETS1. The situation is especially gratuitous for heavy industries which are deemed by the Commission to be “at risk of carbon leakage”: they consistently received more free allowances than their verified emissions up until 2016; and even in 2020, 2021 and 2022, free allocations covered respectively 104.5%, 89.5% and 94.7% of these industrial emissions.
Industrial installations which receive the majority (or entirety) of their emissions allowances at no cost do not bear the financial responsibility for their greenhouse gas pollution. Instead, these complimentary gifts have had the opposite effect, enabling emitting industries to sidestep the expected emission reduction measures and mutating these allowances into very profitable assets: heavy industries gained €50 billion in EU carbon market windfall profits from allowances they received for free between 2008 and 2019 alone.
The EU must take its commitment to the polluter pays principle seriously and enforce full auctioning of allowances within ETS1 just as it expects Europeans to pay for their pollution under ETS2.
Unlocking ETS revenue potential
Today, we are confronted with the urgent need to invest in climate action that also benefits society. The expansion of the EU ETS is an opportunity for the EU to uphold its stated values of fairness and equity through the polluter pays principle. The maximum potential of ETS revenue must be unlocked to reduce our dependence on fossil fuels and put an end to energy and transport poverty in the long term.
ETS1 free allocation needs to be phased out fully – all free allowances should be eliminated as soon as possible, with a faster implementation of CBAM to cover all heavy industries. The end of free industrial allowances can generate much needed resources to expand the SCF. Support for lower income groups must increase relative to the carbon price under ETS2 to ensure that all members of society can access the means to lower their emissions. Now is the time to rebalance the status quo so that polluters pay their fair share rather than citizens and the planet picking up the tab.