Climate change policies will be cheaper

One of the first economic effects of the coronavirus pandemic was a sharp decline in the prices of carbon dioxide emissions allowances. This is great news for Poland, because lower prices will allow Poland’s economy to save hundreds of millions of PLN annually.
Climate change policies will be cheaper

Poland will benefit the most on the sharp reduction of the prices of CO2 emissions allowances caused by the coronavirus epidemic. Why? This question cannot be answered in a single sentence. Let’s begin with pointing out that the European Union is the only jurisdiction in the entire world with a system aimed at reducing carbon dioxide emissions that is obligatory for all member states and covers whole countries (in China or the US such measures have only been introduced in individual regions or states, and only in the form of pilot programs).

The emissions trading system

The European Union Emissions Trading System is the most important part of the EU climate policy. It covers passenger flights within the European Union and more than 11,000 industrial plants emitting the most: primarily power and heating plants (mainly coal-fired, but also gas-fired ones), as well as iron and steel works, glass works, cement plants, refineries, chemical plants, paper mills and manufacturers of ceramics (i.a. tiles, terracotta, ceramic sinks, bathtubs and toilets).

In total, they account for 45 per cent of carbon dioxide emissions in the EU. In general, it can be said that the EU ETS system covers the industries which consume the most energy — this is due to the fact that the burning of coal, gas and oil as well as their fuel products accounts for most of the CO2 emissions resulting from human activities.

As part of the EU ETS, all the companies covered by the system must obtain special documents known as CO2emissions allowances. They receive some of these allowances for free (this is known as “free allocation”), but with each passing year they have to buy more and more of them. That is, they have to pay for an increasing portion of their CO2emissions. And eventually — in accordance with the assumptions of the EU climate policy — they will be paying for each ton of carbon dioxide emitted.

The CO2 emissions allowances are traded on the market, including on the stock exchanges. They are sold by individual countries (which were granted such authority from the EU), as well as those companies which have a surplus of allowances from their free allocation.

The problem with the EU ETS system was that almost from the beginning of its functioning the price of the emissions allowances was lower than what the European Commission had expected. It was too low for companies covered by the scheme to have any real incentive to dramatically reduce their amount, and to do that at the rate desired by Brussels. This is because any investments leading to a reduction in the amount of CO2 discharged into the atmosphere are very expensive and they only make economic sense if the prices of allowances are sufficiently high.

At some point, the price of CO2 emissions allowance even started to increase, but after the 2008 crisis (whose consequences included, among other things, a decline in production and consumption in many EU member states, which resulted in the lower demand for the allowances) it once again dropped to the very low level of EUR 5-7 per ton and there was seemingly no way for it to rebound.

Limiting the supply

That’s why the EU authorities decided to introduce administrative methods to increase the price of allowances several-fold. The prices were supposed to be hiked artificially, using a “top-down” approach, by limiting the total number of emissions allowances. Brussels has decided to use two tools limiting the supply of these permits.

First, it introduced the so-called “backloading” — postponing some of the allowances to the subsequent years. Then, at the beginning of 2019, the EU launched the so-called Market Stability Reserve (MSR), which is based on a mechanism similar to intervention purchases on the grain markets.

When, according to Brussels, the price of CO2 allowances is too low, then some of the allowances are “removed” from the market and transferred to the reserve. Meanwhile, when the price is too high, the allowances are taken out of the reserve and placed on the market. This increases the supply and thus reduces the price.

Following the introduction of these mechanisms, within a few months the price of CO2 emissions allowances soared to EUR25-27. One year ago, in mid-April, the price of allowances reached the level of EUR27. In the summer of 2019, it reached EUR29, but in the autumn it began to fall due to the economic slowdown in the world, settling at EUR22 in October.

However, after that it moved up to the level of EUR25 and remained there until the second half of February. The price began to nosedive in March, along with the crash on the stock markets. Within a week it decreased to EUR15.24. Then it increased again, and entered a period of fluctuation, most likely due to market speculation, ultimately reaching the level of EUR19 in April.

Relief for the Polish economy

This indicates that EU may be heading for a repeat of the 2008 scenario, when the financial crisis led to an economic slowdown and the price of CO2 emissions allowances dropped sharply and for a long time. This is because the current economic crisis means a decrease in industrial production, including the production of energy. This results in lower emissions of carbon dioxide, and consequently, less demand for such allowances.

If the price of emissions allowances was lower by 20 per cent or more compared with 2019, this would provide huge annual savings reaching into the millions of EUR for power plants, the airlines and many other industries covered by the EU emissions trading system.

This applies in particular to Poland, whose energy sector in the most carbon-intensive (i.e. characterized by the highest CO2 emissions per unit of energy produced) in the European Union. The Polish economy has also a high share of energy-intensive, and therefore carbon-intensive sectors, and its energy efficiency is much lower than in the countries of Western Europe, where much less energy is required to produce a given unit of GDP.

This all means that the Polish economy is burdened by the costs of the EU ETS system to a much greater extent than other EU member states. This difference in costs is most clearly visible if we compare Poland with Sweden, Austria, and Denmark. These countries have a very high share of renewable energy sources (i.e. zero-emission sources) in their energy production. Countries that have a well-developed nuclear energy sector (such as France) — which is not covered by the EU ETS system due to the negligible CO2 emissions — are also in a much better position than Poland.

As a result, in Poland, when the prices of CO2 emissions allowances rose at the turn of 2018 and 2019, the prices of electricity started to increase rapidly. At the last year’s price of carbon dioxide emissions allowances, the cost of their purchase per 1 megawatt hour accounted for more than 30 per cent of the wholesale electricity prices.

In April, Grzegorz Tobiszowski, the former Deputy Minister of Energy, said that in 2019 the four largest producers of electricity in Poland — PGE, Tauron, Enea and Energa — paid nearly PLN2.9bn (EUR648m) for their CO2 emission allowances, while the Polish heating sector paid PLN2bn (EUR447m). That’s a lot, and combined with the enormous capital expenditures that that Polish energy sector had to incur (to adapt to the requirements of EU climate legislation), this created a huge upward pressure on energy prices in 2019.

With the lower prices of emissions allowances this pressure will decrease, and will provide relief not only to the energy sector but also to many manufacturing plants, which have been affected by the EU ETS in two ways. On the one hand, they have to pay for CO2 emissions (in 2019, this cost iron and steel works alone approx. EUR168m), and on the other hand, they have to buy electricity, which is more expensive because of this system.

Ideas for deeper reductions

This scenario will only materialize if the European Commission and the European Parliament do not decide to manipulate the prices of CO2 emissions allowances and artificially raise them, using the tools developed for that purpose, i.e. “backloading” and the MSR. However, there are many indications that such ideas are already starting to emerge despite the economic crisis and the difficult condition of the EU economy.

In April, Vice-President of the European Commission Frans Timmermans announced that the European Commission is working on increasing the 2030 emissions reduction target to 50-55 per cent (compared with 1990 levels).

On the next day, President of the European Commission Ursula von der Leyen said that the long-term EU budget for the years 2021-2027 should constitute a “key element of the response to the crisis caused by the pandemic”. At the same time, she pointed out that decarbonization, which is supposed to lead to a dramatic reduction in CO2 emissions, will remain one of the priorities of this budget. However, such a reduction cannot be achieved if the prices of allowances for carbon dioxide emissions remain at the level of EUR15-20. They would have to be much higher.

Carbon tax as an alternative

There is also an alternative: replacing the EU ETS system with a carbon tax, which has been advocated by many and which would be a much more efficient and fair solution. Such a tax would be levied on all goods and services whose production was associated with CO2 emissions.

This system would be better than the EU ETS, because it would also cover the goods and services imported into EU member states from outside the EU. Today producers and service providers based in the EU have to pay for CO2 emissions, as opposed to their competitors from outside the EU. This results in unequal and unfair competition, and, consequently, the shifting of production from the EU to non-EU countries.

This is clearly visible on the example of steel production. Although global steel production increased in recent years, it started to drop in the EU. Another example are the airlines which have already been acutely affected by the coronavirus pandemic.

Several years ago, the EU authorities wanted for the EU ETS CO2 emissions reduction system to cover all flights carried out within the EU territory. This would mean that the system would also apply to non-EU airlines flying to and from EU countries, e.g. the Asian carriers. This proposal was met with strong opposition, among others, from China. The European Commission ultimately conceded and decided that the EU ETS system would only apply to flights beginning and ending within the European Union. However, because of this solution the EU-based airlines, for whom the EU is the largest domestic market, are now in a less favorable position than the competing airlines.

The crisis requires new solutions

Recently, there have also been some calls, including the Polish government, for a deep reform of the EU ETS system, and even for its withdrawal. In light of the economic crisis caused by the pandemic, some have gone even further and have called for the abolishment of the European Union’s climate policy. One thing is clear. In the current conditions, this policy requires a new approach and has to be revised.

Before the outbreak of the pandemic the consumption of coal in the world was growing and new coal-fired power plants were being constructed in China and in Japan. This is because they produced and continue to produce electricity at a lower cost than renewable energy sources. China is now emitting more carbon dioxide than the EU and the United States combined. Meanwhile, the United States is emitting more CO2 than the European Union as a whole.

In this context, some have argued that even with the most ambitious climate policy possible the EU will achieve very little in its fight against global warming (while suffering economically) if the world’s biggest emitters of CO2 — namely China, the United States, India, Russia and Japan — fail to join this effort in a serious way. Unfortunately, this will now be even less likely, which puts into question the current EU climate policy.

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