More Certificates Hardly Solve European Competition Problems

Last week, the European Commission presented its reform proposals for an overhaul of the European Emissions Trading System (ETS). It reduces the pace at which industrial producers are required to cut emissions and provides billions of financial support for industrial decarbonisation. Ultimately, this means that the EU’s major instrument for climate action is weakened. Sebastian Rausch, professor at the University of Heidelberg and head of the ZEW Research Unit “Environmental and Climate Economics”, comments: 

“The Commission tries to strike a difficult balance: On the one hand, it reduces future scarcity of allowances on the market; on the other hand, the Commission intends to accelerate investment in electrification and decarbonisation. The second approach is right; the first one is risky. More certificates will hardly solve Europe’s structural competition problems, but they risk weakening investment incentives and the credibility of the carbon price. 

Coupling free allowances to verifiable investments in climate action is a step in the right direction. The export gap caused by the CBAM provides an economic argument in favour of a temporary continuation of free allocation: Coupling it to additional, verifiable transformation investments improves the performance of the instrument. However, a competitive investment subsidy would ensure a more targeted approach.

A flatter cap trajectory may be needed as 2039 approaches to accommodate hard-to-abate residual emissions beyond that date. But flattening the cap as early as 2031 goes beyond what is required for this purpose: it increases the cumulative supply of certificates and thereby reduces scarcity in the ETS well before the end point is reached. If the EU climate targets are maintained, this means that additional ETS emissions must be compensated by greater reductions in other sectors, additional CO2 sinks or international credits. This shift would only be cost effective if these sectors have cheaper and equivalent carbon reduction options.”ZEW Economist Professor Sebastian Rausch on Reform Proposals for European Emissions Trading System (ETS).