The EU Emissions Trading Scheme so far: a licence to pollute?

Sandbag, a climate policy think tank, published its report on the European cement sector entitled ‘Cement - The Final Carbon Fatcat’ last week on 16 March 2016. Amongst its findings the report accused the European Union (EU) Emissions Trading Scheme (ETS) of pushing up emissions created by the cement industry. Unsurprisingly, Cembureau, the European Cement Association, took exception to some of the content of the report and issued a rebuttal. Notably, it said that ‘allegations that the ETS has incentivised overproduction are based on thin air.’

Here we present a section of the executive summary of Sandbag’s report that describes the current situation with the EU ETS and how Sandbag argue this has distorted the European cement industry.

The depressed carbon price under the EU ETS has done little to effect a reduction in emissions from the European cement sector. A surplus of more than 2bn EU allowances (EUAs) has built up in the European carbon market since 2008 with no expectations for the situation to change significantly over the medium term. Industry sources cite that the costs of upgrades to best available technology are tantamount to greenfield investments. The current low carbon price alone is not enough to render such investments economic, especially in the context of a depressed cement market. This applies even more so in the case of capturing and storing/using direct emissions (CCUS) which at this stage seems to be an expensive technology merely in the development stages across Europe.

Figure 1: Expected development of allowance surpluses for major industrial sectors until the end of Phase 3. Source: EUTL (Sandbag calculations).

The rules governing free allocation of allowances have failed to incentivise abatement in the cement sector. In particular, the sector’s inclusion on the list of sectors exposed to the risk of carbon leakage, as well as insensitivity to production changes, will cause its over-allocation to balloon. As we reveal in Figure 1, if activity levels continue at 2014 levels, by 2020 this surplus will be larger than 2.5 years’ worth of emissions. This is more than would be the case for almost any of the other major industrial sectors, practically all of whom expect to lose all or most of their earlier surpluses by the end of this decade.

The chronic oversupply of EUAs to the cement sector is partly due to the fact that cement firms are able to optimise their production of different products across different facilities to maximise their free allocation. Free allocation to cement installations is based on benchmarks relating only to the manufacture of clinker, an intermediate product. Many firms have been able to retain maximum free allocation, corresponding to peak production, by keeping a range of their facilities operating at just above 50% of their historic activity levels – the level required to retain 100% free allocation.

Figure 2: EU net clinker trade. Source: UN COMTRADE (Sandbag calculations).

This free allocation loophole has resulted in both windfall profits and a de facto production subsidy for highly carbon-intensive clinker. This clinker is then either blended in higher than necessary shares into cement or, as we show in Figure 2, actually exported, as EU cement subsidised by free allowances has a competitive advantage compared to manufacturers outside the ETS. This creates a net import of emissions to the EU – the complete reverse of the carbon leakage threat that many industry groups have emphasised. As we show in Figure 3, this stimulation of clinker exports to countries outside the EU has been the single most damaging factor to the decarbonisation of this sector, pushing 2013 emissions nearly 15Mt higher than they could have been.

Figure 3: Different factors’ contribution to cutting the cement sector’s emissions EU-wide during 2005 - 2013. Source: Cement Sustainability Initiative ‘Getting the Numbers Right’ database (Sandbag calculations).

As well as causing a surge in emissions, the insufficiently responsive free allocation rules leave cement companies strongly over-allocated. Table 2 shows the surpluses we estimate that the five cement majors have accumulated (or monetised) since the beginning of Phase 2.

Table 2: Largest cement companies’ surpluses and emissions (millions of EUAs, euros and tonnes). Source: EUTL (Sandbag calculations).

These five companies from the cement sector have collectively received nearly Euro1bn worth of spare EU allowances (EUAs) for free between 2008 and 2014. As the number of free allowances available to all industry is fixed, over-allocation to cement companies reduces the allowances available to other sectors that might really need protection.

The ETS therefore provides few incentives for these firms to invest in decarbonisation technologies. Given widespread expectations for an over-supplied carbon market well in to the 2020s and, consequently, a low carbon price, the opportunity cost of holding onto allowances is negligible when compared to the high cost of investment in abatement technologies.

Thanks to Alex Luta and Wilf Lytton at Sandbag for letting Global Cement publish this extract of their report. The full version of ‘Cement - The Final Carbon Fatcat: How Europe’s cement sector benefits and the climate suffers from emissions trading flaws’ is available to download from Sanbag’s website.