Comment: David Veredas and Wim Van Hyfte say adding those two sectors would bring 80% of Europe’s greenhouse gases under its emissions trading scheme, but quick implementation will be key
With COP26 just a few weeks away, world governments are taking a closer look at policies that can be implemented to tackle climate change, and reverse its damages.
The EU, already a world-leader in this area, wants to cut its greenhouse gas emissions even further through its EU’s Fit for 55 package, which includes an extension of the Emission Trading System (ETS) to cover heating of buildings and fossil fuel for transport and by further reducing free allowances in its existing ETS, which covers emissions in the power sector, heavy industry and, from this year, the aviation sector. (See Policy Watch: European Commission heads into open water with climate plan)
An ETS works on the principle of “cap-and-trade”. It sets an absolute limit, or cap, on the total amount of certain greenhouse gases that can be emitted each year by the entities covered by the system. This cap is reduced over time so that total emissions fall.
If the new ETS feeds through to the end consumer, there is a real risk of a pan-European version of the gilets jaune
Such systems are not new, and have proven to be cost-efficient instruments to reduce emissions if appropriately implemented. And an ETS in heating and transport is not new, either. Germany, New Zealand, California, Quebec already have ETS that includes buildings and transport, while China has a pilot. Of course, every ETS has its own idiosyncrasies, but the point is that the EU proposal is in line with the global trend of emissions trading schemes expanding, both in terms of the sectors that are covered and geographically.
With about 41% of CO2 emissions coming from road transport and buildings, an ETS for transport and buildings is certainly needed. Adding these sectors implies that about 80% of the EU’s greenhouse gases will fall into a cost-efficient cap-and-trade system.
However, the implementation will be challenging. The Commission, Parliament, and Council will need to reach an understanding before the COP26 in November; there is not much time left. If the trialogue is successful, the EU will arrive at Glasgow with the homework done, ready to take the lead by example, and convince the main trading partners that the CBAM and the new ETS (as well as the reform of the old ETS) go hand in hand.
After COP26, the trialogue needs to continue and pass the required legislation. This may take two years, however, as France may not have an appetite to support legislation before spring 2022, as it may fuel Marie Le Pen’s chances in the presidential election in spring 2022. To be realistic, actual implementation will be no earlier than 2023, leaving seven years for accomplishing such an ambitious package.
Second, allowances to pollute in transport and buildings will be capped and traded in a new ETS, parallel to the current EU ETS’, like Germany’s. Many design questions remain unknown. For instance, prices in the German ETS are too low (starting at €25 in 2021 and increasing to €55 in 2025). Extension of the ETS is imperative for a successful transition, and its credibility and effectiveness lies in the price. Too low prices won’t induce the economic and behavioural changes needed, but too high prices may have disruptive economic and social impacts. It is a delicate balancing act to allow companies to transition and, at the same time, stay on track to achieve the net-zero objective by 2050.
Third, we will not reach a carbon-neutral society with the ETS alone. Climate warming is not only a market failure to price externalities, it is also a system problem that requires structural changes in socio-economic policies and regulation. The Fit for 55 package addresses these concerns with a comprehensive reform of numerous directives and regulations.
However, while most of these policy tools focus on the upstream, behavioural change is also needed in the downstream, i.e. consumers need to change habits. If the new ETS feeds through to the end consumer, there is a real risk of a pan-European version of the gilets jaune. The success of the Social Climate Fund will depend on its ability to mitigate the Fit for 55 package’s unintended distributional impact on lower-income people, the most vulnerable part of the EU.
The European Commission is in the right direction, and it must be implemented as quickly and firmly as possible
Fourth, the European Commission has a major asset and liability-management problem. On the one hand the ETS generates billions of euros every year (currently about €16bn, and only a fraction goes to the Commission).
On the other hand, the Commission will need to honour its debt to investors and generate revenue to pay back €390bn of grants given to member states (as part of Next Generation EU). Since the new ETS on buildings and transport will increase the revenue that will be partly used for the social action, it remains to be seen where the revenue for paying back €390bn will come from.
To sum up, the proposal of the European Commission is in the right direction, and it must be implemented as quickly and firmly as possible with the right design, price, and complemented with social policies.
David Veredas is professor and director of the Center for Sustainable Finance at Vlerick Business School, and Wim Van Hyfte is global head of responsible investments and research at Candriam Investors Group.
European Green Deal Fit for 55 EU ETS GHG emissions climate change Gilets jaune COP26 Social Climate Fund Candriam Vlerick Business School