The EU is currently working on reforms to its flagship climate policy, the Emissions Trading System (ETS) for 2021-30. Designed to incrementally cut greenhouse gas emissions from industrial plants across Europe, ETS needs urgent reform. A clear vision as to how these reforms should be designed is essential in order to reach Europe’s ambitious climate goals while supporting competition and innovation.

Carbon leakage: Myth versus reality

Carbon leakage – a term referring to the delocalisation of industry in favour of more competitive global regions – is hotly debated. Recently, researchers concluded they can find no evidence of carbon leakage. However, they studied the period before 2012 when around 96% of carbon allowances were allocated for free. It is unsurprising that there was no evidence of carbon leakage at a time when there were no direct carbon costs.

When ETS was set up, policymakers based the level of free allocation on historical production levels. The worldwide recession then hit global economies, and production slowed leading to over-allocation of carbon allowances. While some companies suffering during the declining demand may have sold part of their allowances to make ends meet, others held onto these surplus allowances and are now using them as the economy recovers and the level of allocation declines. As Europe’s industry and governments work together to tackle the worst of the recession, allowances not used during the recession can be used in catching up on lost production.

There can be no economic recovery or growth without business, and energy-intensive industries like the chemical industry are a core part of this.

Investment leakage already evident

On the other hand, while there may be little evidence of simple carbon leakage, it is clear that investment leakage is already happening. Data already shows the declining investment by the EU chemical industry in favour of other global regions.

For example, despite increasing global demand for chemicals, China now holds the top ranking in worldwide chemicals sales, a position once firmly held by Europe. It should be acknowledged that investments in production facilities are made for the long-term. Energy-intensive industries faced with the promise of a substantial long-term increase in their energy costs will think twice before making these decisions. Let’s not wait until too late to send a clear signal to industry that carbon efficient businesses can remain competitive, innovate and grow within Europe.

The tiered approach versus dynamic allocation

Current proposals for ETS reform are giving the wrong signal - even the most carbon-efficient undertakings would have to purchase an increasing proportion of their allowances at an ever higher price. Perhaps because they recognise this, some stakeholders are calling for a tiered approach, in which industrial sectors are put into different categories according to the perceived risk of carbon leakage. A proposal tabled by the UK and France would identify sectors as being at, “high risk”, “medium risk”, “low risk” and “no risk”.

Any industrial sector - even the most carbon efficient installations - in the lower tiers would be penalised with this approach, and would have to buy carbon allowances. There is no clear evidence that the assumption those costs could be passed to customers without loss of market share is valid. Therefore the tiered approach does not remove the risk of carbon leakage. Neither does it take into account the risk of investment leakage, unnecessarily making Europe look less attractive for future production than other global regions.

A better way forward: Dynamic allocation rewarding carbon efficiency

A better proposal from the Netherlands recommends amending ETS so all sectors get full allocation at benchmark standards of carbon efficiency. The European chemical industry supports this system of dynamic allocation which rewards carbon efficiency and growth – better for the climate and Europe’s economy.

We want industry to become more carbon efficient, and we want carbon efficient industry to remain in Europe. Our industry is at the heart of a strong European economy, and accounts for more than 1.2 million jobs. In terms of environmental performance, we have slashed our greenhouse gas intensity by 75% since 1990 with total emissions dropping by 58% in that period. That’s why we say the formula for a future competitive and innovative EU is clear:

• A system of free allocation based on real data on carbon efficiency and on real, rather than historical, production levels, which enables best performers to produce and grow their business in Europe without incurring a carbon penalty. This ensures ETS incentivises companies to invest in carbon efficiency, rather than investing elsewhere.
• Innovate the clean, competitive energy of the future from here in the EU. Our industry is energy intensive – energy drives the economy. If we can innovate down the cost of low-carbon energy to the point where it is competitive, market forces will take over to cut GHG emissions and tackle manmade climate change. Keeping innovative industries like the chemicals industry in Europe is a strong step towards achieving this.