Unlocking transition to climate-friendly material sector in Europe with Carbon Contracts for Difference and Climate Contribution - CFM TRACTION ...
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CFM TRACTION — BRIEFING NOTE Unlocking transition to climate-friendly material sector in Europe with Carbon Contracts for Difference and Climate Contribution
Report for Project CFM TRACTION (Climate Friendly MaTeRials - mArket
Authors CreaTIon through pOlicy iNnovation
This policy brief presents an overview of the key takeaways from the CFM
OLGA CHIAPPINELLI
TRACTION project, which focused on refining the concepts and exploring
DIW Berlin
socio-economic impacts of two policy instruments supporting industrial
decarbonisation: Project-based Carbon Contracts for Difference (CCfDs)
ALEKSANDER and the Climate Contribution in Germany and Poland. For a more detailed
ŚNIEGOCKI review of the results, please see the CFM TRACTION synthesis report
WiseEuropa Contracts for Difference and Climate Contribution: a comparison between
Germany and Poland.
JÖRN C. RICHSTEIN
DIW Berlin
About CFM TRACTION
MATS KRÖGER Working with stakeholders in Poland and Germany, the Climate Friendly
DIW Berlin Materials – Market Creation through Policy Innovation (CFM TRACTION)
project has co-created new insights into the policy toolkit to support
systemic transformation of the EU basic materials sector to net zero by
FREDERIK LETTOW
2050.
DIW Berlin
KARSTEN NEUHOFF
Acknowledgements
DIW Berlin
The project team would like to thank the participants of the national co-
JAN STEDE production workshops, whose insights were integral to the knowledge
DIW Berlin creation process.
The project was made possible by the funding from EIT Climate-KIC. We
KRZYSZTOF also thank the European Climate Foundation (ECF) as co-funders to the
BRZEZIŃSKI project.
WiseEuropa
PROJECT MANAGEMENT:
Julie-Anne Hogbin (Climate Strategies – lead)
Zoe Rasbash (Climate Strategies)
Karolina Marszał (WiseEuropa)
Report design and cover by Wilf Lytton (wilflytton@gmail.com)Contents Carbon Contracts for Difference 1 Climate Contribution 3 Insights for European Climate Policy 6 References 8
Carbon
Contracts for
Difference
Carbon Contracts for Difference (CCfDs) are a project-based financial instrument through
which the government would guarantee companies developing an innovative low-carbon
projects a fixed carbon price level for emissions reductions below a benchmark baseline
over a specified period. When the realised carbon price is below the agreed upon CCfD
reference price level, the government pays the company a premium on the carbon price
for emissions reductions. On the other hand, when the carbon price exceeds the CCfD
reference price level the company pays the difference back to the government.
The results of the analysis conducted within the project highlight two important
advantages of CCfDs. First, CCfDs lead to investment in clean technology at lower
expected carbon prices than for commonly discussed minimum CO2 price levels,
facilitating industrial transformation at a lower cost for the economy and consumers
(Figure 1). The reason is that the CCfD removes the risk associated with carbon price
uncertainty, thereby reducing the level of price needed for investment profitability.
FIGURE 1
Comparison of CCfD and CO2 minimum price –
German steel sector example
200
CCfD CO2 minimum price, 30 EUR/ton 185
180
160
Necessary expected CO 2 price
139
140
120 110
[EUR/ton]
100
77
80
60
40
20
0
Medium cost scenario High cost scenario
Source: Richstein et al. (2021)
1Second, the contracts can also significantly reduce the scale of government funding
required for industrial transformation, as well as lead to positive cash flows for the
government over time, when carbon prices rise.
Depending on carbon price development and technology costs, the Net Present Value
(NPV) can become neutral or even positive for governments. The introduction of CCfDs
would substantially decrease the required scale of funding in both countries (Figure 2).
Even in the case of low future carbon prices, the payment is estimated to be EUR 13 bn in
Germany and EUR 10 bn in Poland. In the scenario with higher carbon prices, the German
government would gain an estimated revenue of EUR 17 bn, while net costs for the Polish
government decrease to EUR 0.35 bn. Therefore, thanks to the hedging nature of CCfDs, a
combination of CO2 price and CCfDs can substantially reduce the costs of supporting the
transition of basic materials by the governments.
FIGURE 2
Net present value (r = 0.8%) of government funding by CO2 price
scenario for the medium cost scenario to decarbonise 30% of the
production of selected materials in Germany and Poland by 2035.
Germany Poland
40 18
16
30
14
20 12
Billion EUR
Billion EUR
Low CO2 price 10 Low CO2 price
10
Medium CO2 price
8
Medium CO2 price
0 6
4
-10
2
High CO2 price
High CO2 price
-20 0
NO CO2 WITH CO2 NO CO2 WITH CO2
PRICE PRICE PRICE PRICE
Source: Richstein et al. (2021) for Germany, WiseEuropa based on Richstein et al. (2021) for Poland.
CO2 prices in 2045: low – 58 EUR/t, medium – 80 EUR/t, high – 166 EUR/t.
2Climate
Contribution
The climate contribution is a weight-based charge on basic materials like steel, cement,
aluminium or plastic at the level of EU ETS benchmarks for the specific materials. These
benchmarks will continue to be used for granting free allowance allocation and power
price compensation to basic material producers as carbon leakage protection. The
climate contribution is also levied on imported materials – including as part of products
– but is not charged where the materials or products comprising these materials are
exported.
The liability is passed along the value chain and paid upon final consumption or at the
point where a given intermediate producer decides to pay the contribution, because the
products are not exported to third countries which would allow for waving the liability.
The climate contribution applies to the products regardless of whether they are produced
within the EU ETS system or outside of it.
There are several significant advantages of complementing free allocation within the EU
ETS with a climate contribution:
– Consistent carbon price is ensured, benefiting all mitigation options (clean
production processes, efficient material choice and recycling) both on supply and
demand side, and ensuring that the value of free allowances currently granted for
free to the industry is captured and can be used to fund climate action and post-
COVID recovery.
– Credible carbon leakage protection: climate contribution addresses the main
concerns associated with maintaining free allocation:
– It reinstates a consistent carbon price signal weakened by the free allocation,
addressing climate protection concerns.
– It captures the full value of the allowances granted for free, addressing revenue
concerns.
– It provides revenue to either purchase allowances under EU ETS to be granted
for free to clean production processes or to directly fund their incremental costs,
addressing the concerns related to perceived lack of compatibility between
declining EU ETS cap and free allocation.
3– Legal and administrative feasibility: The climate contribution can be built on the
legal and administrative experience from excise charges, and as such be levied on
imports and not on exports, while being fully aligned with WTO principles.
The results of the analysis show that climate contribution can generate around EUR 17-
21 bn of revenues in Europe annually (see Figure 3 for the distribution across industries)
that can be used for funding climate action, including covering CCfDs costs.
FIGURE 3
Revenues generated by the climate contribution mechanism at the
EU level (EUR bn, CO2 price = 30 EUR/t)
25
Climate contribution - domestic production
20
Climate contribution - imports
Exports (excluded from climate contribution)
15
10
5
0
-5
-10
Steel Aluminium Plastics Cement Pulp & paper Total
Source: Pauliuk et al. (2021)
In both Germany and Poland, the projected impact of carbon pricing on consumption
is not only small (less than 0.5% of household expenditure) but also progressive, as
the structure of consumption is more material-intensive for higher-income households
(Figure 4).
The actual effect may be even lower, as this estimate does not reflect response in
terms of enhanced material efficiency or substitution. The analysis suggests that the
relative impact of consistent carbon pricing in basic materials on final expenditures will
be somewhat stronger in Poland than in Germany which could reflect lower prices for
products due to lower retail mark-ups related to branding or labour costs.
4FIGURE 4
Climate contribution impact on consumption expenditures per
income quantile in Poland and Germany (CO2 price = 30 EUR/t)
0.6%
0.5%
Increase in consumption expenditures
0.4%
0.3%
0.2%
0.1%
0.9%
1 2 3 4 5
Income quintile (1 = 20% of the lowest income households, 5 = 20% of the highest income households)
DE - only basic materials PL - only basic materials DE - all materials PL- all materials
Source: WiseEuropa based on estimates for Germany from Pauliuk et al. (2021).
For Poland, these estimates are corrected by the differences in price level and consumption expenditure
composition between Germany and Poland.
5Insights for
European
climate policy
Unlocking full investment potential of innovative low-carbon solutions for production and
use of materials requires clarity, favourable market conditions and regulatory framework
as elements necessary to secure predictability in the transition from the current state to
the fully decarbonised sector. This is important both from a climate and an industrial policy
perspective as it would resolve the current investment limbo. Currently, investments in
conventional projects are deemed non-viable, given the prospect of mid- and long-term
decarbonisation targets, while, in absence of regulatory clarity, investments in innovative
low-carbon technologies and business models are too risky. To ensure a robust framework
for achieving climate targets, the EU policy should provide incentives to decarbonise:
– across materials – to avoid artificial and inefficient resource substitution
between different materials, and to ensure that Europe develops a broad set of
decarbonisation options for all material markets,
– across mitigation options – to enable the most efficient and effective combination
of supply- and demand-side measures, in particular utilising the potential of Circular
Economy to deliver emission cuts, improve the resilience of supply chains and
decrease the total scale of adjustments required on the supply side,
– across European countries and regions – to make sure that the climate policy does
not lead to new divisions between North and South, West and East, and to enable
just transition in carbon-intensive local economies.
While the assessment of CCfDs and climate contribution indicates that they can provide
crucial incentives to decarbonise the European material sector and overcome the
investment limbo, their timely and equitable implementation across Europe requires
enabling framework for countries and regions which are catching up in terms of industrial
transition.
6Therefore, they should be considered as a part of the broader policy framework, including
dedicated innovation funding, green public procurement and gradual introduction of
product standards. Further options to ensure inclusive transition across Europe include:
– providing access to low-cost financing options, e.g. through European Investment
Bank or Recovery and Resilience Facility,
– ensuring balanced geographical coverage of the crucial infrastructure enabling
decarbonisation (electricity, low-carbon gas networks, etc.),
– ensuring that regulatory framework (e.g. state aid rules) provide flexibility regarding
technology choices, allowing countries to fully utilise their potential to deliver
decarbonised materials,
– supporting joint research and innovation initiatives in the area of industrial
decarbonisation and circular economy,
– providing long-term policy roadmap for the EU to achieve climate-neutral materials
sector.
7References
Brzeziński, K. and A. Śniegocki (2020), Pauliuk, S., Hardadi, G., Neuhoff, K., and
Climate Contribution and its role in J. Stede (2021), Quantifying the effects
European industrial decarbonisation, of consistent carbon pricing on basic
Climate Friendly Materials Platform Policy materials. DIW Politikberatung kompakt
Brief, Climate Strategies. (forthcoming).
Linares, P. and T. Gerres (2020), Carbon Richstein, J., Kroeger, M., Lettow, F., and
Contracts for Differences: their role in K. Neuhoff (2021), "A cost-assessment
European industrial decarbonisation, analysis of CCfDs for Germany", Technical
Climate Friendly Materials Platform Policy report, forthcoming.
Brief, Climate Strategies.
Neuhoff, K., Chiappinelli, O., Gerres, T.,
Haussner, M., Ismer, R., May, N., Pirlot, A.,
and J. Richstein (2019), “Building blocks
for a climate-neutral European industrial
sector: Policies to create markets for
climate-friendly materials to boost EU
global competitiveness and jobs”. Climate
Strategies Report.
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