Benjamin Lee looks at the effects of higher EU ETS prices on the cement industry.
The cement industry in Europe is facing a future of higher carbon prices under the auspices of the EU Emissions Trading Scheme (ETS). The industry will have to adapt to this new world. Long gone are the days when EU Allowances (EUAs) cost just a few €/t. EUA prices averaged €11/t in the 2010s when the market was oversupplied with emissions allowances. A multi-year effort by the EU to tackle oversupply has resulted in prices rising significantly in the 2020s, breaching the €100/t mark in 2023. Prices have pulled back in 2024, but Energy Aspects expects this dip to only be temporary before the march upwards resumes.
A rapidly declining cap
A key driver of higher EUA prices over the next two decades will be the rapid fall in EUA supply. The cap in the EU ETS, which dictates how many EUAs will be made available, is set to fall from 1571Mt in 2021 to around 800Mt in 2030. Cutting emissions covered under the EU ETS by around 50% over those nine years to correspond with the decline in the cap is no small feat - one that Energy Aspects does not think will be achieved.
The EU is in the process of setting its emissions reduction target for 2040 and seems to be leaning towards a 90% cut compared to 1990 levels. This would be a bloc-wide target, but the EU ETS sectors could have a slightly more ambitious target than 90% than the non–EU ETS sectors. This raises the prospect of the ETS cap potentially falling to zero sometime between 2039 and 2042, meaning sectors covered by the EU ETS, including cement, will need to be completely decarbonised and net-zero by
that time.
Removal of free allocations
Industrial companies will become increasingly exposed to carbon prices as free allocation of EUAs to companies is set to fall and ultimately be phased out. Industrial installations in the EU ETS have historically received many of the allowances needed for free - to try to protect against ‘carbon leakage,’ in essence European industries shutting their plants and relocating outside of the EU in response to climate legislation. Revised EU ETS rules mean free allocation is set to reduce further for the 2026 to 2030 period, versus the previous 2021 to 2025 allocation period, given that more stringent revised benchmarks will be used to set free allocation.
In addition, the phase-in of the EU’s Carbon Border Adjustment Mechanism (CBAM) will lead to a corresponding phase-out of free allocations, with the cement industry being one of the sectors initially covered by the CBAM. The phase-out will be gradual at first, starting at 2.5% in 2026, but will rise annually to reach almost 50% by 2030 and then 100% by 2034.
The CBAM and free allocation are both mechanisms that aim to protect against carbon leakage, but they go about it in different ways. Free allocation reduces EU industry’s exposure to carbon prices because it is cushioned from some of the impact by not having to purchase some allowances. In contrast, CBAM charges importers of products into the EU an equivalent carbon price to EUAs to protect domestic industry against imports. But EU industry will eventually have to buy all the EUAs it needs to cover emissions (unless an organisation has an inventory of EUAs it can draw from) and will therefore be fully exposed to carbon prices.
To decarbonise or to buy EUAs?
Industry in Europe will face a choice of surrendering EUAs to meet its EU ETS compliance obligation, decarbonising to reduce its EU ETS exposure or shuttering production. The continent’s cement industry has various options for decarbonisation - switching to alternative fuels, improving energy efficiency, reducing the percentage of clinker in cement and utilising carbon capture and storage (CCS). All these factors will play a role in decarbonising the industry. CCS is particularly important as 60-70% of cement emissions are process emissions from calcination. Alternatives beyond CCS for decarbonising these process emissions are limited.
For industry to invest in decarbonisation measures, the EU ETS will need to send a price signal that it will be more cost effective to invest in these measures than to simply purchase an EUA. Energy Aspects sees the EU ETS supply–demand balance getting sufficiently tight later this decade, meaning EUA prices will have to rise to signal that further emissions abatement technologies, including CCS, will be needed. It is through this dynamic that Energy Aspects thinks EUA prices will need to rise to over €100/t later in the 2020s to send this price signal. Subsidies will also help. The EU’s Innovation Fund has provided €1.9bn in funding to CCS projects in the cement and lime industry to date.
Increasingly manage carbon price exposure
Cement companies will likely be under pressure in the future to increasingly manage their carbon price exposure for those emissions that are not abated, given falling free allocation and rising EUA prices.
Energy Aspects is of the opinion that cement companies will increasingly hedge their EUA exposure as a result. Hedging by buying EUAs to hold not just for compliance for year +0 but also for rolling year +1 (or beyond) would help minimise a company’s risk to fluctuating carbon prices. This practice is already common in the power sector, where utilities purchase EUAs to cover their expected emissions from power generation for two or three years ahead. If industrials start hedging more, this will only place a further call on the market’s inventory of EUAs, further tightening the market.
A volatile market
The long-term outlook for EU carbon prices is up, but this market can be volatile in the short and medium term. EUAs have traded between roughly €50 - 100/t over the past year or so. Several factors have played into the wide price range. EUA prices crashed due to emissions from stationary installations falling hugely in 2023, by 16% year-on-year. Declines in emissions occurred across both the power and industrial sectors. Low power load and the build-out of renewable generation capacity helped cut power-sector emissions, while a weak economy in Europe and still-historically high energy prices weighed on industrial production and emissions.
On the supply side, the EU started selling EUAs in 2023 to raise money for its REPowerEU programme to fund shifting away from reliance on Russian natural gas. These sales added to downward price pressure on EUAs.
Investors in the EUA market also shorted the market when fundamentals turned bearish, exacerbating the downward move in prices.
Energy Aspects forecasts another substantial drop in power emissions in 2024, if not quite on the same scale as in 2023. Many of the drivers remain the same - low power load and higher low-carbon generation. However, the fourth quarter of 2024 could bring some support for thermal power generation if wind and hydroelectric generation fall year-on-year due to weather effects. Energy Aspects does not expect the large fall in industrial emissions to be repeated in 2024 as there should not be a severe year-on-year decline in industrial activity as in 2023.
Concluding remarks
The EUA market is likely to remain volatile in the future, but the long-term pathway for prices is up in Energy Aspects’ view. Cement companies will need to plan and adapt to this world of greater exposure to carbon prices.
