Assessing the EU’s new climate and energy framework

27 November 2014

The world’s largest single market has shown its hand on cutting emissions in the medium term. This article takes a look at some of the economic and competitiveness issues raised by the proposed 2030 targets.

In October, as UN climate negotiators met in Bonn, Germany, EU heads of state and government adopted a new climate and energy framework for the 28-nation bloc to govern the period up to 2030. The framework offers important new directions for the medium term by outlining three major EU-wide targets for 2030; a 40 percent greenhouse gas emissions reduction target compared to 1990 levels; a 27 percent target for renewable energy; and a 27 percent indicative target for energy efficiency improvements. However, while the agreement on the proposed framework can be viewed as a necessary step forward for EU climate policy and the bloc’s credibility in the international climate talks, some key questions remain unanswered.

The adoption of the framework also needs to be viewed in the context of several developments in international politics and governance. First, the EU’s climate policies have been crafted with one eye on the ongoing UN climate negotiations towards a global emissions cutting deal. The framework’s announcement can be viewed as one of the opening bids by a major player in these talks  – in economic terms the bloc accounts for 24 percent of global GDP – in the run-up to the pivotal UN climate summit due to be held next year in Paris, France. Second, the EU’s policy package is drawn up against the background of mounting energy security concerns. The dramatic events that unfolded in Ukraine this year have raised questions about the continuing reliance by some member states on Russian natural gas exports. The new framework offered an opportunity to eventually reduce dependence on Russian gas by promoting renewable energy and boosting energy efficiency. At the same time, uncertainties related to gas supply led some member states to push harder for more flexibility to continue to invest in fossil fuels, including coal, liquefied natural gas, and shale gas.

Emissions reduction: High or low ambition?

The 40 percent reduction target offers plenty of ammunition for those wishing to criticise the EU’s climate change leadership aspirations. For example, from the perspective of staying below a two degrees Celsius temperature increase from pre-industrial levels, it is hard to see how the EU target can be considered ambitious. Assessing a number of different approaches to distribute the global mitigation effort, Intergovernmental Panel on Climate Change (IPCC) author Niklas Höhne suggests that the 40 percent target is at the lower end of the ambition spectrum for the bloc. Furthermore, compared to the EU’s own targets of achieving an 80-95 percent emission reduction by 2050, the 2030 goal seems to lack aspiration. It suggests that whereas the first 40 percent of emissions were to be reduced over 40 years (1990-2030), the remaining 40-55 percent would need to be cut in only half that time (2030-2050). If anything, the target postpones significant emission reductions, increasing the burden for future generations.

The target also falls short if the EU’s current climate mitigation efforts are taken into account. A few days after the framework was released, the European Environment Agency reported that the bloc has by now almost met its 2020 target of a 20 percent reduction, and that it is likely to exceed this target by a few percentage points, or perhaps even more according to some environmental groups. Yet this evidence that the EU is actually over- achieving its existing targets seems to have had little impact on the bloc’s ambition levels.

Valid though these criticisms may be they do not, however, paint the entire picture. Indeed against other benchmarks the bloc’s targets could well be deemed lofty. The EU is one of the first groups in the international arena to come forward with a medium- term emission reduction target in the run-up to the December 2015 climate talks. This is significant from a political perspective, as it puts at least some pressure on other developed states and major economies to follow suit, and submit economy-wide emission reduction targets that go beyond what has been agreed thus far. Although it is doubtful whether the EU’s announcement contributed to the mid-November deal between the US and China to reduce emissions, the step was necessary for the bloc to retain credibility in the multilateral climate talks.

The framework also offers some indications that the EU is serious about reducing emissions. The Council conclusions state that the emissions reduction target should be at least a forty percent reduction indicating that this is the minimum required. While there is no guarantee that the EU will indeed raise ambition before 2020, the wording “at least” implies that adjustments upwards are possible for the next decade, and EU leaders promised to revert to the issue after Paris.

In an interesting move, the target only covers emission reductions at home, over offsetting in carbon reduction projects abroad. Unlike previous targets, which allowed member states to achieve emission reductions abroad through international offsetting mechanisms such as the UN Clean Development Mechanism (CDM), the 2030 target suggests that member states have to adopt more ambitious policies for their own emitting sectors.

This may lead to a paradoxical situation for the international negotiations. Whereas the EU is one of the key players pushing for the expansion of carbon markets internationally – for example through the World Bank’s Partnership for Market Readiness or discussions on a new market mechanism under the UNFCCC – it is giving a signal that there will be no demand for international offsets that may emerge from such markets. According to some member states, there is a distinct possibility that any increase in the EU’s ambition level will be accompanied by allowing for international offsets, but at present the signals provided by the bloc around international carbon markets are decidedly mixed.

However, while international offsets appear to be excluded for now from the 2030 framework, some new flexibility is granted elsewhere. For instance, the land use, land-use change, and forestry sector will be included in the EU’s mitigation framework by 2020, which could reduce the pressure on other sectors to take mitigation action given that the sector already sequestered over 300 megatonnes of carbon dioxide equivalent emissions in 2011. Moreover, intra-European offsetting will be enhanced to lower the costs for the sectors not integrated into the EU’s Emissions Trading System (ETS), and some member states with relatively high targets will be allowed to reduce their ETS allowances to cover for emissions in non-ETS sectors. The latter means that countries such as Denmark will have a one-off opportunity to use ETS allowances to meet their targets in non-ETS sectors such as agriculture and transport.

Finally, taking into account the political realities of the past few years, the EU’s target can also be considered an achievement. The 28-nation bloc has faced several recent existential challenges, notably the ongoing financial and economic challenges following the recession in the late 2000s and rising levels of scepticism with the European project itself. Putting in place EU-driven policies that are likely to be perceived as costly by domestic constituencies was always going to be a hard sell. In addition the 2030 proposals by the European Commission faced significant resistance from several Eastern European member states.

In light of these challenges, it is noteworthy that the emission reduction target was agreed in the first place, and that differences between “old” and “new” member states were overcome. Yet important questions remain. Specifically, even though the Council conclusions offer basic guidance on the bloc’s medium-term emissions reduction ambition, decisions still need to be taken around how this EU-wide target will be distributed among member states.

Reforming the ETS: Kicking the can down the road?

The Council conclusions also offer some indications around the reform of the EU’s ETS, which has been both a flagship and troubled climate policy for the group. But while the Council conclusions underline its continued importance in the bloc’s emissions-cutting strategy, agreement on crucial details have been delayed until next year. For some issues – such as the European Commission’s proposed market stability reserve – no agreement was expected in October whereas for other issues – such as dealing with carbon leakage – the Council did provide basic guidance. However, for an instrument whose functioning so heavily depends on its design details, major decisions still need to be taken.

EU member states did reach agreement on a reduction of the emissions cap, meaning that emissions from the sectors included in the EU ETS will go down by 43 percent, compared to 2005. However, while boosting the stringency of the cap is generally expected to increase the scarcity of emissions allowances and hence hike up their price on the carbon market, the reality is that the EU currently has to deal with a major surplus of emissions allowances. As the environmental group Sandbag shows, at the end of 2013 this surplus amounted to 2.1 billion excess allowances, which could grow to 2.6 billion by 2020.

To tackle this burgeoning allowance supply, the Commission earlier this year proposed establishing a market stability reserve, which would serve as systematic panacea in the form of an “automatic stabiliser.” This mechanism would remove some surplus allowances from the market if an upper threshold is exceeded – 833 million in the Commission’s proposal – and would return allowances in case a lower threshold is passed – 400 million in the proposal. By doing so, the mechanism would help guard against the excessive surpluses that have plagued the EU ETS to date.

Yet while member states seem to have embraced the general idea, important battles remain to be fought, particularly around timing. Countries still need to agree on whether the reserve is launched before 2021, with Germany and the United Kingdom in favour, and several Eastern European countries opposed. The EU has also agreed on a temporary solution of “backloading” allowances – meaning that a set amount of allowances will be temporarily removed from the market – but the return of these between 2018 and 2020 would likely mean that the surplus will once again increase. Bringing the market stability reserve forward would address this risk. What is clear is that the decision on the reserve is essential for the functioning of the ETS and yet agreement on its functioning will depend on further debate between the European Parliament, the Commission, and the member states in the first months of 2015.

Another significant aspect of the framework agreed by the Council is its continued commitment to free allocation of emissions allowances for some sectors and countries and its specification of measures to address carbon leakage and competitiveness concerns. Despite an increase in the allocation of allowances through auctioning – usually the economists’ preferred distribution method – the EU suggests that free allocation will remain necessary for sectors at risk of carbon leakage, namely, energy-intensive sectors such as cement, glass, and steel. While this policy has been in place for some years now, the agreement suggests that those sectors can be compensated for the direct costs of emission allowances, which has been the case thus far, as well as the indirect costs resulting from higher electricity prices due to the EU ETS. The Council conclusions do suggest free allocation will be better aligned with changing production levels rather than being based on historical production levels. Beyond these general statements, however, new rules for dealing with carbon leakage are not spelled out in extensive detail.

What is clear is that the initial approach adopted by the EU to tackle carbon leakage through free allocation is unlikely to change in favour of alternatives that have been on the table in the past, notably border levelling or border carbon adjustments. From the viewpoint of feasibility, continuing free allocation is attractive, with border leveling having raised political and legal trade-related concerns. From the perspective of actually addressing carbon leakage concerns, border levelling may still be more effective. [Ref 1] However, the Council conclusions do not mention this option in the context of addressing carbon leakage.

Free allocation also remains on the table for the energy sectors of low-income member states – defined as “member states with a GDP per capita below 60 percent of the EU average” – although the extent of free allocation is limited to 40 percent of the auctioned allowances. This is one of several concessions to Eastern European member states in the framework. The framework also proposes the creation of a new reserve funded by sales of two percent of the allowances, which would be dedicated to low-income member states, for the purpose of modernising their energy systems or increasing energy efficiency. Critics fear that this fund, which would be managed by member states with input from the European Investment Bank (EIB), would be used for the construction of new, more efficient coal-fired power plants.

Any improvements to the EU ETS will largely depend on how these proposals and various caveats will fare through the EU’s legislative process next year. This process offers an opportunity to address some of the core challenges to the system’s effectiveness but, as the compromises reflected in the 2030 framework proposal suggest, it is questionable whether appetite exists within the bloc to seize this opportunity.

Mixed progress on renewables, energy efficiency

Much of vitriol expressed by environmental groups upon the release of the framework was aimed at the ambition levels of the renewable energy and energy efficiency targets. Compared to the bloc’s existing legal framework up to 2020 the decisions do seem rather like two steps backwards. Binding targets for renewable energy at the member state level will be abandoned, and there will no longer be an EU-wide binding target for energy efficiency, let alone targets for individual member states. Energy efficiency and renewable energy advocates have lamented the absence of stronger incentives. The European Wind Energy Association called the renewable energy target “disappointing,” while the Coalition of Energy Savings referred to a “meaningless” energy efficiency target.

Seen in a different light, however, the flexibility provided to member states might be a welcome development. Emissions trading proponents have long argued that the binding targets for renewable energy have undermined the smooth functioning of the EU ETS. After the release of the 2030 framework, the International Emissions Trading Association expressed concern that the inclusion of renewable energy and energy efficiency targets would still hamper the effectiveness of the ETS. However, as the International Centre for Trade and Sustainable Development (ICTSD)’s Sonja Hawkins argued earlier this year, if the low carbon price signal provided by the EU ETS remains unchanged, other policies may be necessary to ensure that a low-carbon transition takes place in the long run.

Lima ahead

The EU’s 2030 framework reflects uncertainties around the positions of other major players in the international climate negotiations and in relation to how to shore up competitive energy prices. The framework also makes clear the bloc’s internal struggles and the compromises necessary to move union-wide policies forward while catering to member states at different stages of economic development. Ahead of Lima the EU has provided important signals as to its climate ambition. Beyond the headline targets, however, much remains to be decided and details will need to be fleshed out. The real impact of the framework might be expected to increasingly come into focus as the legislative proposals are made and debated next year. Most importantly, the revisions to the EU ETS will determine whether the EU’s flagship policy instrument will live up to its name, and whether the EU can demonstrate that it is possible to reduce emissions in a cost-effective manner.

Harro Van Asselt, Research Fellow, Stockholm Environment Institute (SEI), Member, E15Initiative Expert Group on Measures to Address Climate Change and the Trade System

[Ref 1] VividEconomics and Ecofys (2013), Carbon leakage prospects under Phase III of the EU ETS and beyond, report prepared for the UK Department of Energy and Climate (DECC), December 2013.

 

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