A national carbon tax and a high ETS CO2 price do not go together

by: Hans van Cleef

In recent months we have seen many discussions about whether we should or should not introduce a national CO2 tax for the industry. In almost every study and petition put forward, it is emphasized that the cost can easily be supported from a macroeconomic perspective. However, for the Dutch industry and individual companies (micro-economy) these costs can be disproportionately high. A frequently heard complaint is that the existing tools of the European Commission to achieve CO2 reduction, the Emission Trading System (ETS), does not work (fast enough) due to the low price. This would justify additional national policy. But the advantage of the ETS is that it gives the industry sector more time to reduce its emissions. Most low-hanging fruit can be found in the electricity sector. Indeed, a national tax or levy could be counterproductive due to the negative impact it might have on the ETS. Allow me to explain.

The EU ETS is a system where emission allowances are partly issued free of charge, and anything in excess of that must be bought on the market. This creates a price for CO2 emissions. The electricity sector does not receive any free rights. It is therefore completely at the mercy of the whims of the ETS market. National policy in the form of subsidies for the construction of large-scale solar and wind farms has led to sharply falling costs for solar and wind energy. As a result, the market share of renewables is therefore increasing rapidly. This is accompanied by less CO2 emissions. Another form of national policy is the early closure of coal-fired power plants. This has led to a shift from coal to gas and sustainable energy, and therefore also resulted in fewer CO2 emissions.

National policies have meant that the electricity sector has not waited for CO2 prices to rise due to an increasing scarcity of emission allowances. But, to quote a well-known former Dutch football player, “every advantage has its disadvantage.” As the shifts in the power sector happened sooner than envisaged under the ETS, the price of carbon emission rights did not rise beyond the current trading range of EUR 20-26/tonne. This favours European emitters that have yet to buy emission allowances. For them, the pressure to reduce CO2 emissions is reduced. Arguably, the rapid drop in CO2 emissions in countries taking additional measures is partly offset by the low CO2 price giving other countries/companies no or less incentive to invest in emission reduction.

The vast majority of the free rights within the ETS go to the industrial (manufacturing) sector, to guarantee a fair competitive position vis-à-vis non-ETS countries. We also know that processes within industry are difficult to convert into sustainable, CO2-neutral solutions. As a result of free allowances, industry currently only has to buy permits for emissions they have not been granted allowances for, which gives the sector extra time to make its processes more sustainable. This extra time fits nicely within the path towards zero emissions, as the ETS strives for. The industry also benefits from the lower for longer costs of the ETS emission rights. This money can be invested in the transition towards a more sustainable future within the industry sector.

Can we learn from the developments in the electricity sector to see whether a national policy (tax) could be effective for the industrial sector? Just as with renewable energy subsidies, a national tax for industry interferes with the price for (European) CO2 allowances. A tax for industry leads to less production (and therefore lower CO2 emissions). It puts downward pressure on the CO2 price as a result of a decrease in the demand for emission allowances and thus less scarcity. Here too, CO2 reductions at a national level would be partly offset by higher emissions elsewhere in Europe. In other words, by introducing a national tax, you reduce the effectiveness of the European ETS. The call for a high (ETS) CO2 price and the introduction of national taxes is therefore contradictory.

In order for the ETS to function optimally, and thus to reduce CO2 emissions in Europe in the most efficient manner, as little national intervention as possible is needed. This calls for the phasing out subsidies as quickly as possible, and to refrain from introducing national taxes and/or levies. If, as the government has indicated in its coalition agreement, we want to effectively reduce CO2 emissions faster than scheduled in the current European objectives, we will have to choose – either:

1) We work much more closely with the other ETS countries to strengthen the existing regime.

2) We must abandon the ETS completely. That would mean that everyone will have to come up with solutions that would reduce their national emissions in the hope that this in total would add up to a faster CO2 reduction path than is currently being pursued in Europe.

Personally, I would choose the most efficient option: strengthen the ETS.


This column was published earlier in Dutch on Energiepodium.nl