Ep. 2: Sam Van den plas of Carbon Market Watch discusses the European Emission Trading System’s successes, failures, and challenges.

SEASON 01, EPISODE 2

[INTRODUCTION]

[0:00:07] ANNOUNCER: This is Financial Climate. Can innovations in finance help the world decarbonize? How can trillions of dollars of assets be redirected to catalyze a net zero economy? We explore these questions through conversations with innovators, experts and investors from around the world. Here's your host, Alex Roth.

[OVERVIEW]

[00:00:34] AR: For a long time, it was widely accepted that to solve the climate problem, governments would need to put a price on carbon pollution through a carbon tax, or a program of tradable emission credits. But in the US, at least at the federal level, those policies have been a nonstarter for more than a decade. And in recent years, a number of smart people working on the climate problem have argued that the idea of carbon pricing is impractical and ineffective. Some believe that in the real world, carbon pricing should be ignored or bypassed in favor of other policies like subsidies for renewable energy. But despite the skepticism, carbon pricing programs have kept expanding and proliferating.

Today, about 68 countries or jurisdictions globally have a price on carbon emissions, even with a lot of very real shortcomings of these programs. Nearly 23% of global emissions today face some kind of price on carbon. Internationally, one of the most advanced emission trading programs is in the European Union. It's been around in some form since 2005, making it one of the world's oldest. Yes, it still has many flaws. But in a lot of respect, it's also seen clear improvements over the years, and it's a huge market.

The EU produces about 1/6 of global GDP. The EU emission trading system raises the equivalent of tens of billions of dollars in revenues yearly, and a significant share of that is set aside for climate related investments. So, I was excited to sit down with someone who knows the EU system backwards and forwards. I wanted to learn about how the EU system has evolved, and where it has succeeded and failed. I also wanted to understand how the system might change in the near future, and what the rest of the world can learn from it.

Sam Van den plas is based in Brussels. He's the policy director for a European NGO called Carbon Market Watch. Here's our conversation.

[INTERVIEW]

[00:02:32] AR: Sam Van den plas, welcome to Financial Climate.

[00:02:36] SVDP: Nice to be here, and thanks for having me.

[00:02:39] AR: For those who are unfamiliar with it, just briefly, what is Carbon Market Watch? And what does it do?

[00:02:45] SVDP: Carbon Market Watch, we are an international NGO based in Brussels, and we work specifically on carbon pricing policies in Europe, but also globally under UNFCCC. So, the International Climate Agreements, the Paris Agreement and implementation of that, but also carbon pricing for shipping and aviation is in our work area. So basically, everything we do is working for fair and effective carbon pricing.

[00:03:11] AR: Great. So, I know the EU Emissions Trading System is very complex. But for people who aren't familiar with it, can you just describe at its most basic level, what it is and how it works?

[00:03:23] SVDP: Well, the system, European Emissions Trading System, carbon market was designed and first implemented in 2005. So, it's been operational for more than a decade and a half now. It covers a bit less than half, about 40% of the total greenhouse gas pollution in the European Union, and then a couple of neighboring countries which are linked to the system like Norway, Switzerland, Iceland, and others.

Basically, it covers around 11,000, what they call installations, which are basically the factories in the power sector, power plants, coal fired power plants, gas fired power plants, but also manufacturing industries like steel, cement, chemical industries are covered by the system. So, all in all, the largest point sources of greenhouse gas pollution are covered by this market, which basically, it sets a limit on the total amount of available emissions. This is defined by the European climate targets, and then it allows the companies underneath the installations to trade amongst themselves in order to meet that cap, to meet their own emission reductions. For every a ton of CO2 emitted, a company at the end of the year has to surrender one emission allowance.

[00:04:45] AR: Well, you mentioned that it started in 2005. How has it changed over time and what's driven that change?

[00:04:52] SVDP: There have been many legislative review processes. I think we're counting more than 10 already right now. Several iterations. A lot of those were driven by enhanced climate targets agreed by the European Union. Every time a new climate goal was defined first under the Kyoto Protocol later, European 2020 climate targets, 2030 climate targets afterwards, which we are now, by the way, in the process of upgrading those, every time the emission reductions delivered by the European Emissions Trading System had to be calibrated accordingly. So, that's one of the major drivers of progress, I would say.

Other design features were also as a consequence of basically improved governance. In the early years, a lot of the implementation of the Emissions Trading System at national level was delegated to the European member states, who could basically draw up their own plans and their own allocation plans for their industries, for their power sector, and other manufacturing industries, which I should say it was a pretty disastrous exercise in the beginning. The carbon price in 2006, 2007 crashed completely to the level of zero, at the moment that market realize that governments have been so generous in handing out emission allowances and we often refer to them as pollution permits to industries that basically led to a market which was completely oversupplied then it crashed the carbon price.

From that experience, lawmakers learned now the system is more centralized to European Commission which has legislative oversight, and now basically, harmonized rules are in place to allocate emission allowances. Another feature last but not least, was also the evolution where emission allowances are increasingly auctioned rather than handed out for free to mainly the power sector. This is slowly also happening for the manufacturing industries.

[00:07:03] AR: One major area of criticism of the EU Emission Trading System has been its treatment of heavy industry. How does the system deal with heavy industry and what are the concerns?

[00:07:14] SVDP: Yes, indeed. This is still a major problem from our viewpoint, because the industries we're talking about are energy intensive industries, they're often also trade exposed industries, as they compete on global markets. Largest polluters there are in Europe, the steel sector, cement sector, also chemical sector. Those industries, unfortunately, if you look at their emission reductions in the past 10 years, not much has happened. The greenhouse gas pollution from those sectors has been stagnant, and the ETS and its design features is no stranger to that.

Why am I saying that? Because those sectors, by and large, are exempted from the carbon price signal. They do receive more than 95% of all the emission allowances they need for free, which basically is undermining the carbon price signal towards those industries. It mutes the incentive to invest in cleaner technologies in the power sector we're auctioning off emission allowances is the default. We have seen rapid development of renewable energy technologies, strong decline in coal and lignite being used in the power sector. And the ETS has clearly been a lot more effective there. For those heavy manufacturing industries, there's still a large problem with the handouts of free pollution permits. They're basically a subsidy to pollute for free, because it's important to keep in mind that as the emission allowances are auctioned, this means revenues which go to the European member states, revenues which can and they should be invested into further climate action.

So, you could use the ETS as a source for helping deployment of clean technologies, including in those sectors, like steel, cement and chemicals. But for the moment, this is not happening, unfortunately and we still see continued handout of the free emission allowances.

[00:09:18] AR: Yeah, so that's an interesting point about the free emission allowances, and I want to ask you a bit more about that, because the economists would say that from their perspective, that it shouldn't matter how those emissions are allocated. Of course, there's an issue as you're talking about very important issue around revenue and important issue around fairness that's appropriate that a polluter pays. But in terms of incentivizing the industry to reduce its emissions, most economists would say, “Well, as long as there's a marginal cost, that's appropriate, it doesn't matter.” So, if you're an industry for example, let's say the cost of emission was 200 euros, if you got all your emissions for free, emission credits you need for free, but the market cost is 200 euros, then you still have the incentive to reduce your emissions. Because if you reduce it by one ton, you get 200 euros and that provides an incentive just as much as the other way around. Just as if you didn't have the credit, you had to pay the 200 euros. It’s still is a 200-euro differential between whether you pollute that incremental ton or you don't. So, how do you see that in terms of this issue around the giving away of permits as disincentivizing the industry?

[00:10:27] SVDP: Yeah, thanks. Those are really good points, because it does relate to economic theory and also looking at what takes place in practice, and there has been a lot of academic literature looking at this and basically handing out the emission allowance for free. It does have an effect of muting the carbon price signal, as I said earlier, but also, it lowers what economists would describe as an optimal market participation.

To make a long story short, having auctioning as a direct price signal towards those companies would ensure full market participation. But we also see a few other perverse effects and at current market watch, we have documented those extensively.

[00:11:13] AR: On that issue, you said about market participation. You mean that in other words, that an industry where historically they didn't have to participate in a market because there maybe there was no market. Then if they're getting all their emissions for free, they just don't pay attention, they just ignore the market and go about their business. Is that what you mean?

[00:11:29] SVDP: Yes, exactly. For some companies, and especially when smaller companies that has been the strategy not really have a strategy. Also, keep in mind that historically, for the vast majority of these sectors, they received more free emission allowances than they needed to cover their annual greenhouse gas emissions. So, we had around five to seven years ago, major cement producers, steel producers in Europe, actually declaring millions of profits as a consequence of selling the surplus emission allowances they had received for free. Another thing companies did was at the time, also international carbon offsets were allowed into the European system. That's not possible today anymore. Those were available very cheaply, sometimes maybe 20 or 30-euro cents per ton, whereas the carbon price at the time was around 8 or 10 euros per ton, the European carbon price.

I mean, companies were basically selling the European allowances, buying the international allowances and then making a profit on the spread. Even if an emission allowance is handed out for free, it still carries in economic opportunity costs. So, the value of the allowance was translated into the product prices. I mean, depending on the sector you look at to a larger or to a smaller extent, we estimate that in total, the energy intensive industries, steel cement and chemicals which were perceiving the free emission allowances generated about 50 billion euros of windfall profits in the decade between 2008 and 2019. So, that's significant for a system which was designed to make polluters pay, actually, the polluters were paid.

[00:13:23] AR: That's an enormous amount. So, still on this issue around you're talking about the more effective in the power sector and less effective in these industrial sectors, I've heard some critics of cap and trade programs generally suggest that these programs are most effective in areas with established technologies, and maybe the power sector might be one of those relatively speaking as compared with something like cement or steel, where new technologies are needed to produce a low carbon alternative. And that that mechanism of a cap and trade or emissions trading program, I use those interchangeably. But emission trading program is just not the best policy instrument for that, because the amount of investment that's needed to develop those new technologies is just much larger than a carbon price could ever realistically provide even at a very high price. Do you think that's an appropriate view? Or you have a different opinion on that?

[00:14:23] SVDP: According to economic theory, what a carbon market or a carbon price, it will deliver the carbon abatement options along the cost curve. So, whatever is the cheapest to do first, the market will deliver that. And indeed, that tends to work in sectors where there is relatively mature technology available first, because those would come at a relatively low cost. But I would say it's never a silver bullet, because looking specifically at the power sector, there tends to be also untapped potential, which is even available at what economists call negative abatement costs, meaning that the payback time of those emission reductions is extremely short. You can basically make a profit on those investments. And even those are not always happening.

When it comes to energy savings, often there are what again, you can almost call non-market barriers in place. Investments in energy savings, for example, they require upfront capital to make those investments. Now, if you don't have the money available, whatever the carbon price is going to be, those investments will not materialize. On the other side of the cost curve, if you look at more innovative, whether it's renewable energy technologies, but it could also be breakthrough technologies in energy intensive sectors. The starting point should be to ask the question, what do we need in the longer run to tackle the climate crisis? And if the current price today is not enough to make sure we deploy those technologies at scale, in the longer term, that calls for additional policies and measures. Look at the standards for a specific technology, renewable energy targets to make sure these solutions can be deployed at scale.

So often, carbon price should price or carbon market should not be seen as a silver bullet, but rather, one element in the policy mix, you need to deliver those emission reductions. And it can do some of the heavy lifting. It can set the baseline for further action. But still, you need to be targeted in the policies and measures to see what you need. A big advantage of good carbon pricing, carbon markets, as well as that by putting the price on the carbon, you generate the revenues. And again, those can be smartly invested into those solutions.

[00:16:58] AR: Yeah, so that makes a lot of sense that it's one policy tool among many and not the only one. And related to that, can you talk a little bit about the EU Green Deal? And what that includes, and what other policies work together with the EU emission trading system?

[00:17:14] SVDP: Yeah, sure. So, the European Green Deal was announced three years ago already as part of the European plans to basically implement a project of climate neutrality by 2050. This had also an impact on the near-term climate targets. Back in 2016, 2017, the EU signed up to 40% emission reduction target of total greenhouse gases by 2030. The Green Deal lead to an improvement of that target, an increase of the target to minus 55%, below 1990 levels, that is by 2030. This has implications on a lot of the underlying policies and targets the EU has in place. So, the Emissions Trading System is one of them. There are also binding climate targets towards speech member states in the EU. So, 27 national targets. There are binding targets for deployment of renewable energy sources, energy saving targets, also other mandates like CO2 standards for cars and vans.

So, it's a whole suite of measures, which should function hand in hand to deliver that overall goal. A lot of legislation, which was announced on the back of the EU Green Deal is generally referred to as a fit for 55 packages. So basically, a wide set of climate and energy policies, making the EU fit for delivering a 55% emission reduction target by 2030.

[00:18:58] AR: I see. So, is it right then, that what you're describing is that a lot of the implementation of that goes country by country that the targets are set at the EU level and the implementation is in individual countries?

[00:19:11] SVDP: Yes, indeed. So, there is oversight at the European level. There's also joint agreement. Keep in mind, this is never imposed from Brussels on the member states. The way European decision-making works that there's usually a proposal, legislative proposals come from the – you would call it in the USA, the executive branch, which is the European Commission in this case. And then those proposals are discussed with the involvement of all the member states and all the elected representatives in the European Parliament. Those get to amend the proposals, vote on them. Those processes typically take several years in the case of the European Emissions Trading System. They are still discussing the proposal which was made in the summer of last year. So that takes time, but that's part of the democratic process. 

Indeed, after the legislation is decreed, there's a combination. The member states are usually responsible for the implementation. They are also responsible for implementing national policies and measures which can help deliver those goals. For example, the buildings and the transport sector, also major contributors to greenhouse gas emissions. A lot of the measures needed in those sectors are delegated to the member states. For example, when it comes to infrastructure, railways, cycling parts, et cetera. This is not decided in Brussels, but this is decided by the national authorities. Building standards have a European component, but for example, the support for renovation programs at national level, those will be implemented.

[00:20:53] AR: So, another criticism of the EU approach is how aviation is handled. Can you talk a bit about that?

[00:20:58] SVDP: Aviation as an international transport sector is a bit of a special case. It was not included in the original design of the European emissions trading system. But proposed to be included in 2012. This was when EU regulators already saw there was very little, if not no progress, taking place at the International UN level where the International Civil Aviation Organization based in Montreal is basically in charge of regulating the sector. There was no carbon pricing proposals in sight at the international level and the EU went ahead decided to include all incoming and outgoing flights in its Emissions Trading System.

The key development and what happened after the EU announced these plans was a very large international pushback, mainly inspired by the aviation industry, which did not see reasons for having what they called, at the time, a unilateral carbon price by the EU slapped on them, and basically caused a lot of pushback, which did lead to the EU scaling back its emissions trading system to only cover domestic flights. So, intra-European flights are currently covered by the EU ETS. The International Civil Aviation Organization has agreed in the meantime, carbon offsetting and reduction scheme. We have looked at this in detail and the issue there is that only a very small proportion of the greenhouse gas emissions from the aviation sector internationally are covered. And as far as they are covered, the quality of the offsets which can be used, carbon offsets are questionable, highly questionable, I should say.

Therefore, in conclusion, the US still has a lot of good rights to make sure the aviation sector is properly covered by the ETS. Actually, we believe that it should snap back to its original shape or all the flights, incoming and departing are covered by the European system. Also, for the aviation sector, the practice of handing out free emission allowances should end here. Also, the intention is to move to more and more auctioning preferably as soon as possible.

[00:23:18] AR: I see. And going back to the proceeds raised by the Emissions Trading System, can you talk a bit more about approximately how much revenue is raised over time and how that's being used?

[00:23:32] SVDP: So, the emission allowances currently, the market value is between 70 and 80 euros per ton. Collectively, the member states auction about 800 or 900 million allowances every year. So, I don't have the calculator in front of me. But there are annually tens of billions of euros which are generated as an income under the European Emissions Trading System. And this has increased significantly in recent years as the carbon price went up from rather low levels, we saw between 2008 and 2020, the carbon price was hovering between 5 and 10 euros per ton. Again, currently it's closer to eight euros per ton. It was up earlier this year, close to 100 euros per ton. So, that's significantly increased also, the revenue stream to member states.

It doesn't only go to the member states. There are a couple of centralized European funds, which are resorts through the auctioning revenues. There is an Innovation fund, which deals with a couple of those technologies we discussed earlier. So more costly, innovative, clean breakthrough technologies in the power sector but also in manufacturing industries are currently supported by an innovation fund which is resourced through the auctioning revenues. Also, that's foreseen to significantly scale up in the coming years.

There's also a modernization fund, which basically assists the diversification of the power sector in lower income member states. There's some inbuilt solidarity in the European emissions trading system where in this case, it's not for all member states, but especially those who have high reliance on coal and lignite and the power sector, and that's often current Central and Eastern European countries, which are entitled to those funds. But the bulk of the revenues go to the member states. Currently, unfortunately, there are rather loose provisions. They should use half of the revenues on a wide range of climate and energy related purposes. So, the practices diverge widely between member states. Some of them indeed have good ways of spending the revenues.

France, for example, there's a large-scale program which insulates houses in France, focusing also on lower income households, helps them to reduce their energy bills by investing in energy savings, and the money comes from putting a price on pollution. So, that's a very interesting example. But then there are also other member states who just allocate the revenues to the general budget without delivering on those added climate benefits. We hope with the current legislative review, which is ongoing, that member states of the European Parliament can agree on full earmarking of all those revenues and dedicate those to investments in further emission reductions in clean technologies. We believe this should also can really show to European citizens, it makes sense to put a price on the carbon pollution and help invest in solutions.

[00:26:57] AR: I see. Going back to the innovation fund that you mentioned, that's very interesting that you're saying a portion of the proceeds from the emission trading system goes to fund cutting edge innovative technologies, and that you expect that to increase in time. But how is that innovation fund set up? Does it operate as grants? Does it operate more as an investment fund that takes an ownership interest in the companies and innovations that are eventually created? Can you talk a little bit more about that?

[00:27:24] SVDP: So, the innovation fund will receive around 500 million oxygen emission allowances in the coming decade. Well, up to 2030. So again, the carbon price of around eight euros per ton, this is a pretty significant amount of revenues. The funding goes to mainly grants. There are different calls divided by size. So, there are small scale projects, but also large-scale projects. And companies, private entities have to submit proposals to the fund, which are then selected on the basis of the costs, but also the emission reductions achieved by the projects. 

So, it's funding those breakthrough technologies in those sectors where, I think, fair enough, a lot of these industries do have a lot of capital costs for investing in new technologies. You don't construct a new steel blast furnace or a chemical cracker every year. Now, on the contrary, once built, those assets will remain there for several decades. So here, we believe also is justified, that there is some government support for assisting those industries. I'd hope in return, we also see the emission reductions from those sectors. Unfortunately, that's not the case yet, but we should be getting there.

[00:28:51] AR: How do you think about the relative success or failure of the European Emissions Trading System overall up to this time?

[00:29:00] SVDP: It's a nuanced picture, I would say. And I think when you take a step back and you look at environmental or climate legislation, there are a lot of good components in the European Emissions Trading System. Keep in mind, there's a very elaborate system for monitoring for reporting, for verifying the emissions from these 11,000 installations and companies and what they emit has to be clearly monitored and reported and externally verified. Data is publicly available as well. So, you can look up for each plant what it has emitted in the past year, but even the past 15 years, how many allowances it has received? How many allowances it has surrendered? So, this is all available. Also, if a company or an airline refuses to comply, there are fines available. In that case, the company would need to pay 100 euro extra as a fine and still has to surrender the emission allowance the next year.

Basically, this does guarantee the defined environmental outcome and also the defined climate targets under the EU ETS. But that brings us also to one of the major shortcomings is that those emission reductions achieved by the EU ETS are still inadequate. They are inadequate of what needs to be done to tackle the climate crisis, and they're also inadequate in light of Europe's responsibility to do more. Keep in mind, historically, European Union is a very large polluter as the United States. It's also a very wealthy region as the United States. And therefore, it can and should do more in contributing to limiting global warming to 1.5 degrees, as enshrined in the Paris Agreement. So, there is need to do more. And also, the inadequate emission reductions achieved by the EU ETS are no stranger to that.

The second major shortcoming are those free pollution subsidies we discussed earlier. And the fact that still, today, the vast majority of all the emission allowances required by the steel cement and the chemical sector are still handed out for free. And this is not nothing. The monetary value of all those free emission allowances are around 400 to 500 billion euros, up to 2030. Again, these are public resources, which can and should be invested in a much smarter way. I believe there, we clearly see the fingerprints of large polluting industries on the legislation, unfortunately, I hope one day those fingerprints will be wiped off.

[00:31:50] AR: Well, that's very interesting, and related to that issue around the influence of industry. Another one of the criticisms of cap and trade programs, lately, is the idea that it doesn't make sense from a political perspective, in the sense that a cap and trade or emission trading program tends to impose a lot of costs on different industries, and creates a lot of political enemies without developing strong political constituencies. So, for example, compared to some form of industrial policy, like, for example, subsidies to the solar industry. If you give subsidies to the solar industry, then you immediately create some friends in the solar industry, and maybe some friends among constituents who benefit from inexpensive solar power, that over time will fight to retain those policies.

Whereas, well, a cap and trade program looks like a perfect program from a theoretical or economic perspective, that in the political or more realistic complex world perspective, that it doesn't work as well. I'm curious, if that's something you've seen, as well, in Europe. I asked that in part, because when we look around the world at all these different areas that have implemented these kinds of programs, Europe is really one of the most successful that we've seen, certainly compared to the United States and a lot of other places that have either very low carbon prices or none.

[00:33:14] SVDP: I don't know if that translates well to English. But in Dutch, my mother tongue, there's a saying you can't make an omelet without breaking the eggs. This is to say, the challenge remains for all us industries to get rid of fossil fuel production and consumption sooner rather than later. And what you need in order to do that is not just the support and the subsidies and the rebates and tax breaks and what have you, but you also need to create an incentive to steer away from those polluting fossil fuel resources in the first place.

So, a smart mix of having the sticks and the carrots available to industrial sectors is what is required. I believe whether the incentive comes from a carbon price or a mandate or other technology standards requirements, it's never going to be easy, and there are always going to be vested economic interests, which have a strong interest to stay at the business as usual way of doing things. But the policymakers should act in the longer-term society wide interest. This is where some of the problems, so you cannot blame these industries for acting in their own economic interests and also asking for rules which make them prosper and their shareholders prosper. But policymakers should keep an eye on the longer-term call.

This is where, sometimes of course also, in these carbon pricing discussions, yes, there is a vested community of stakeholders and as an NGO, we often find ourselves for example, when we are in these meeting rooms discussing this with policymakers surrounded by well, 50 or 100 industry representatives, and there's one NGO person in the room, but it's up to the policymakers to make sure that the what they decide is calibrated. And unfortunately, this is not always the case. But you're absolutely right. When it comes to industrial policymaking, there is more work to be done. I wouldn't say that the EU is the smartest example. If you look at, for example, recent announcements by major chemical companies in the EU leaving the European Union with their investments going elsewhere, and it's unfortunate, that I mean, a decade and a half of handing them out, the free emission allowances and the free pollution subsidies, did not manage to retain these industries here. So, the pollution is up in the atmosphere for free, and the jobs are lost, unfortunately.

This is a sad example of how we're still not capable of creating a forward-looking path for those industries. Because I mean, having these investments in your economy is of course critical. I mean, even as NGOs, we're very mindful of, I mean, the jobs that that create, the wealth that that creates. It’s ultimately, families who have their income dependent, including those industries.

[00:36:24] AR: I guess it goes back to what you were saying earlier about having a mix of different strategies where cap and trade is one aspect and not the only one. The other thing that occurs to me, in thinking about these criticisms of the cap and trade program, a lot of them make sense. But it's also have to think about how the other policies have fared, because it's hard to think of any single one policy that really has done a great job of solving this problem over the last 45 years that we've been working on it, right?

[00:36:49] SVDP: Exactly. It's a hard job. I mean, greenhouse gas emissions have so many different sources in our society, in our industries, and it would be not smart to think that you can solve this by just one single set of policies or instruments.

[00:37:08] AR: From an outside perspective, it seems encouraging that the overall direction of the EU program has been seemingly to become stronger and more effective over time. And along those lines, I'm interested to know, one of the subjects that's been in the news quite a bit lately is the idea of the Carbon Border Adjustment Mechanism. It'd be great if you could talk a little bit about, first of all, what that is for folks who are unfamiliar with it, and then what is the status or the prospect for something like that to be implemented?

[00:37:37] SVDP: Yeah, that's a great point, because the carbon border adjustment mechanism, I think, is also one of the key aspects which will define if the EU ETS is indeed strengthened over time or not. It can give an important international signal as well. But I'll explain a bit what this is about, and it goes back to the free emission allowances we were discussing earlier, and the way the EU currently deals with the internationally trade exposed sectors.

Those sectors and it's again, steel, cement, chemicals, have been very successful in promoting the narrative that any carbon price on them in the European Union is an added cost, which they don't have elsewhere on the globe. And therefore, as they are trading their goods internationally, putting that price on them only in the EU would make them delocalized and take their production elsewhere. And this has been framed as what they call carbon leakage. So basically, the emissions take place elsewhere, and industry would leave the European Union. 

This narrative has been so successful and it has led to those continued handouts of free emission allowances. So basically, they need to protect industries against international competitors. The problem is that the scale at which this happens is so large that it basically protects everybody and the kitchen sink. All those industries are covered by free emission allowances and more than 95% of their carbon pollution is covered by a free emission allowance, whereas not everybody faces an equal carbon leakage risk, if you would say so.

[00:39:27] AR: Because some industries are more difficult to move overseas, you mean, or have less incentive to move those industries overseas?

[00:39:33] SVDP: Yes, there are a lot of factors there. And one specific point is that the investment or production decisions of such industries are taken on the basis of a whole host of considerations. You need access to raw materials, you need demand for your product, you need a skilled workforce. You will be looking at social policies, what type of pensions do you need to pay your workers? What type of safety measures do you need to put in place? Other environmental legislation may play a role. How much does it cost to transport your product? And I could go on and on and on just to say that whatever the carbon price component of those business decisions is, it's extremely small and extensive academic literature has looked at this because it's been hotly debated in the EU, whether this carbon leakage is taking place under the EU ETS or not. The findings are, it's not detectable at all.

So, it may be a convenient narrative from the industry perspective, because you do receive free pollution permits if people agree to that narrative. But it's not something which in reality, is such a threat, or is taking place at such a scale. So, there needs to be an alternative and one alternative would be to auction all the emission allowances, and you could still design some compensation or some protection based on the revenues of the emission allowances, if that's needed. That's not the route which was chosen under the announcements of the European Green Deal. But the route which was chosen as an alternative is the carbon border adjustment mechanism, which basically would put requirements on importers of those goods into the EU, to declare their carbon emissions associated with the goods they import, and to also have an obligation to pay for the carbon emissions associated to the products and the price to pay would be comparable as what the European producers pay under the European emissions trading system.

Thereby, you would level the playing field between European production under the EU ETS and the imports subject to a carbon border adjustment mechanism, which if designed effectively it could lead to a reduction of the free emission allowances under the European emissions trading system. So, that's what's currently being hotly debated in the EU design and the establishment of the carbon border adjustment mechanism. This is still not implemented. It's a legislative proposal, which is under discussion, and it goes hand in hand with the review of the European emissions trading system, and hopefully the full phase out of the free emission allowances. This is a very hard discussion. And until now, we were very concerned that the industries are, again, being very successful in arguing to keep these free emission allowances for as long as possible, while at the same time, maybe implementing a carbon border adjustment mechanism, but which in reality, would not do very much because you still have the free emission allowances present under the EU ETS.

[00:42:54] AR: So, sounds like from your perspective, the most important outcome of these discussions will be to eliminate the free emission allocations?

[00:43:02] SVDP: Yes, absolutely. This is, I believe, a hidden scandal at the heart of Europe's climate energy policymaking. The sheer scale of these free pollution subsidies are basically unacceptable in times of a climate crisis. Nobody, would argue that it's wise to allow continued free pollution as you do need to reduce your carbon pollution as soon as possible. On the back of that, there are proposals now on the table to extend the European Emissions Trading System to cover also emissions from buildings and from transport. Basically, meaning when I heat my home, I would pay a certain carbon price. Or when I would drive my car, I don't own one. But if I would have one, I would also pay for the carbon emissions associated to that. And this may be all fine and well, and this could be also justified if you say, well, let's make sure that lower income households are not negatively impacted, and they can still pay their bills at the end of the month. But these kinds of proposals are also being put on the table while industry can still pollute for free, households are expected to pick up the tab. So, here's a serious equity consideration, which I wish policymakers in the EU would keep more prominently on top of their mind, because you cannot expect the citizens to start to pay us as large polluters are off the hook.

[00:44:31] AR: Sure, of course. And so, what do you see broadly as lessons for nations or regions elsewhere in the world, addressing their climate policy when they look at the European Emission Trading System?

[00:44:45] SVDP: Well, there are all of the board and design features, but I would start by having the adequate climate targets in place in the first place is the absolute priority. You can look at your instruments only after you're sure what the direction of travel is, and making sure that the emission reductions achieved economy wide inside your country, your region. That's what matters most for the atmosphere, whether emissions trading or carbon pricing is more appropriate that will depend ultimately on the national circumstances. But in any case, having a carbon price signal available, it will make your life overall easier in terms of getting where you want to be. Because all things equal, it makes it more expensive to pollute, even if you want to, and I think rightly so, there should be some support for clean technologies. But it will make the need for that support a bit smaller as you have a carbon price already as, I would say, a floor for further action.

[00:45:49] AR: So that seems like a very important point, especially from the US where we're relying only on those kinds of primarily, I'd say, in individual states, there may be carbon prices. But in general, most cases where we are relying on those kinds of subsidies and assistance, and what you're saying is that if you have a price on carbon, you really get a lot more mileage out of that public money, because there's a stronger incentive, just based on that program, that there's a price on carbon and that creates an incentive for the private industry to change to decarbonize.

[00:46:22] SVDP: Yeah, exactly. There needs to be a stick as well next to the carrot created by the incentives. So, you need to make sure that also highly polluting industries have a predictable signal and a predictable timeline for them to phase out their installations.

[00:46:41] AR: As we're getting nearer to the end of our time here, do you have any thoughts on how you expect the European Emissions Trading System to evolve over the next 5 or 10 years?

[00:46:51] SVDP: Well, it's been very interesting looking at the developments of the past few years, because we did come out of a more than a decade of very low carbon prices and ineffective market which was heavily oversupplied. Corrections have been made, especially to temporarily evacuate surplus emission allowances from the market, cancel them, and retire them permanently afterwards, agreeing on higher climate targets that says all ensured that there is support for the stronger carbon price signal right now. And I definitely hope that the days of paying only 5 or 10 euros per ton of CO2, that those days are permanently over. And I hope that the increase of the price signal will be there, will continue to be there, steadily but surely.

In addition to that, what I mentioned many times over, but it is an important hope of us and we will hold policymakers accountable as a civil society organization to ensure that the polluter pays principle is more thoroughly applied, and that it is ultimately rolled out to all the sectors in combination with requiring those industries to have proper climate plans in place to make sure that they have a place and a future in a zero carbon economy. There's still a lot of work to do there. But I think the option of failing will also not be acceptable. There is a big responsibility, and those coming years will be crucial to ensure that European Emissions Trading System is fit for purpose.

[00:48:33] AR: Absolutely, yes. I think it's a critical time period for everywhere in the world in terms of their policies. Well, this has been a tremendously interesting and enlightening conversation. I've learned so much about the European Emissions Trading System and so much else. Sam Van den plas, thank you so much for talking with us.

[00:48:52] SVDP: Thank you very much for having me. It's been a pleasure.

[END OF INTERVIEW]

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