The non-paper jointly drafted by the French and British government on tiered free allocation arbitrarily determines which sector has a future in Europe and which sector has a future outside Europe.
Specifically, the proposal has three major critical points:
1. It is unjustified from both an economic and a fairness perspective
The proposal pretends to adequately ensure protection against the risk of carbon leakage. However, it reduces the share of free credits to the vast majority of industrial sectors, without providing any evidence of the impact of additional costs on their competitiveness. The proposal particularly lacks of any cost comparison between a given European and a non-European sector.
The proposal reduces the amount of free credits to certain sectors, as a supposedly fair gesture towards some others who would otherwise receive too little protection. Yet, some other sectors would unjustifiably be excluded from such a “solidarity clause”. This is far from being a fair approach.
2. It penalises competitive industries investing in low-carbon technologies
Protection against the risk of carbon leakage should provide the regulatory certainty for industries in transition towards a low-carbon economy.
However the tiered approach rewards the most carbon intensive and least profitable sectors. This is intrinsic in the formula used, which rewards high carbon intensity combined with low value added (GVA).
On the contrary, the formula punishes a sector investing in carbon emission reductions by giving a lower protection against the risk of carbon leakage as a direct consequence of these investments.
3. It hampers innovation
The ETS is expected to ultimately promote the substitution of high-carbon with low-carbon production. In this respect, solutions may come from within a given sector or as a cross-fertilisation of ideas coming from other sectors. One example is the potential coming from the bioeconomy or circular economy to provide solutions to decarbonise other sectors.
However, the proposed tiered approach provides different carbon cost exposure to different sectors, with the paradox that the most carbon intensive will bear the least carbon costs. As a consequence, the investment signal from the ETS will be totally jeopardised.
Sectors which successfully invest in decarbonising their processes are systematically at risk of being pushed outside the EU.
Alternatives to the tiered approach
Discussions on tiered free allocation are triggered by the need to avoid the application of the Cross-Sectoral Correction Factor (CSCF). The timing and magnitude of the CSCF are far from being certain, as it depends on a combination of factors (production levels, changes in the market, technological developments, innovation, development of international carbon markets, etc.).
Rather than picking one scenario and fixing the rules for the next 15 years accordingly, the EU should:
1. Define a regulatory framework that stimulates and rewards investments in low-carbon technologies, as a way to reduce the demand for free credits;
2. Support programmes to accelerate the market-readiness of breakthrough technologies for industrial installations;
3. Secure a sufficient amount of free credits to allow for low-carbon economic growth in energy intensive industries exposed to international competition;
4. Set rules to predictably assess potential shortages in the supply of free credits and, when the case, explore all possible options to preserve industrial competitiveness.