We have strong concerns regarding the legislative texts on the revision of the Emissions Trading Scheme (ETS) and the Carbon Border Adjustment Mechanism (CBAM), presented by the European Commission, Council and Parliament.

All three bodies have proposed to extend the regime of free allocation until well into the next phase of the EU ETS, in the 2030s.

We believe that the current proposals perpetuate competitive distortions which are damaging to the EU’s competitiveness, its self-sufficiency, its resilience to inflation and its ability to adapt to a lower-carbon world.

The issues

• The allocation system of emission allowances, based on benchmarks, grants more permits to polluting production processes than to less polluting ones, thereby distorting competition.
• Plans to revise the ETS benchmarks (currently scheduled for implementation in 2026) are only a partial measure because the installations covered by the scheme produce mostly intermediary products rather than final products (e.g., “clinker”, as opposed to “houses”). It would be much more effective to incentivise overall emissions reductions on final products rather than incentivising the reduction of emissions on only part of the process. These changes will therefore fail to incentivise low-carbon activities.
• Some products, such as steel, are to be covered by the CBAM but not the upstream products (“precursors”) that are used to manufacture them, such as coking coal, sintered ore and ferro-alloys. As a result, the EU-based manufacture of precursors will keep receiving free allowances, and the embedded emissions of precursors of imported steel will not be covered by the CBAM, for obvious WTO compliance reasons.
• An amendment proposed by the Council even exempts the “hot metal” steel benchmark until 2030 from any change in annual reduction rate despite the forthcoming benchmark reform.
• While the emissions from upstream products of the more polluting blast furnace steelmaking route (coking coal and sintered ore) will likely be exempted of CBAM charges, this is not the case for a key upstream product (direct reduced iron) of the electric arc furnace (EAF) route, thus disfavouring the greener production route
• The free allocation system, which grants emission permits in proportion to production output, is designed to incentivise high levels of production activity, to the detriment of resource-saving. The Russian war in Ukraine and ensuing critical need to save resources has shown the limits of this approach.
• The 4th phase of the EU ETS planned for 2021-2030 has gaps that put recycled materials at a disadvantage compared to primary raw materials (ores, coal, etc.). The disadvantage arises because emissions from ores such as hard coal, iron ore and other non-ferrous metal ore mining are not subject to the EU ETS. The ecological burdens from ore extraction in Europe thus have no impact on the costs of steel production. Using recycled steel material does not create these same ecological burdens, however, incentives to recycle are absent from the price mechanism and the steering effect of the EU ETS.

While the proposed extension of free allocation was thought to be protective of industry generally, it only protects some industry players.

Many European companies would suffer from unfair competition if the above support measures were continued, as currently proposed. A late phase out of free allocation of allowances and a slow implementation of the CBAM would perpetuate an obstacle to otherwise profitable greener production practices. Once carbon costs are correctly accounted for, greener production practices would be more competitive against more polluting ones.

Recycling industries are labour-intensive and capital-intensive, but they are not resource-intensive. They have the potential for saving large amounts of resources, reducing the need for Russian imports and expensive fossil fuels.

Policymakers should not listen to just a handful of large stakeholders. European industrial policy should support the continent’s SMEs, especially those that are essential in securing a front seat in the development of technologies and processes which will enable faster decline in Europe’s greenhouse gas emissions and reduce dependence on Russian imports.

Our recommendations

1. Hard coal, iron ore and other non-ferrous metal ore mining sectors as well as the production of pellets and DRI pellets, should be covered by the EU ETS.
2. The free allocation of emission allowances should be phased out as soon as possible. Amendments proposed by the Parliament gradually remove free allocation for CBAM sectors by 2032 – which is already too late, and should by no means be postponed, as suggested by the Commission and Council.

3. For products covered by the CBAM, all corresponding upstream products (‘precursors’) falling under the ETS should also be covered by the CBAM For the case of steel, this includes, but is not limited to, sinter, coke, ferro-alloys and hydrogen.
4. The European Council’s Amendment exempting hot metal from the benchmarks’ reduction rate update should be rejected.

While free allocation is still in place, equivalent incentives should be set up to reward demand-reduction measures for primary steel, for example through the substitution of iron and alloying elements by steel scrap to internalize the well-documented climate benefits of using recycled materials instead of extracted ones [1].

[1] Compared to primary raw materials, the use of steel scrap in steel production processes saves 58% of CO2 and saves 72% of energy, see EuRIC (2019) Metal Recycling Factsheet; also read Sandbag’s report on the key role of circular steel in achieving climate goals. 

Photo by Christian Lue on Unsplash