Austria

Belgium

Bulgaria

Croatia

Cyprus

Czech Republic

Czechia

Denmark

Estonia

Finland

France

Germany

Greece

Hungary

Ireland

Italy

Latvia

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Luxembourg

Malta

Netherlands

Poland

Portugal

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United Kingdom

Elena Benaim

Isabelle-Chan

Lindsey Walter

Solutions to Shield EU Industry from Elevated Gas Prices

josh-freed

The Answer to the UK’s Energy and Cost of Living Crises Clean Energy Industrial Strategy

HG Designing a Carbon Border Adjustment Mechanism

HG-AnswerstoUKCrises

Memo

Isabelle Chan

Non-Resident Fellow

Co-founder of Carbon-Free Europe

Josh Freed

Former Policy Analyst

<div class="Highlight">
<div class="content">
<h2>Key Takeaways</h2>
<ul>
<li>The CBAM is a fundamental mechanism needed to replace the unsustainable scheme of free allowances under the ETS. However, is not a breakthrough tool alone to decarbonize industrial sectors and reach carbon neutrality.</li>
<li>Because the path for decarbonization for industrial subsectors such as cement and aluminium, will not begin to rapidly scale down before 2035, a slower implementation of CBAM up to 2030-2032 will not prevent industry’s ability to reach net-zero by 2050.</li>
<li>The CBAM should be implemented in two phases. The first will ensure the implementation of an enforceable mechanism without exacerbating the current burdens carried by industries. In the second phase, the CBAM should expand, allowing for a greater impact from an environmental perspective.</li>
</ul>
</div>
</div>
<h2>Introduction to the CBAM</h2>
<p>Reaching climate neutrality by 2050 requires targeted solutions for different sectors of the economy. For industry, the European Union (EU) is proposing as a cornerstone solution a Carbon Border Adjustment Mechanism (CBAM). If properly designed and implemented, a CBAM would ensure emissions reductions for major industrial subsectors while maintaining the competitiveness of EU industries. In this memo, we outline the status of current negotiations on CBAM in the EU and Carbon-Free Europe’s recommendations to design and implement a CBAM that enables climate commitments but also takes into consideration the current energy crisis.</p>
<p>In 2019 the European Commission unveiled an ambitious European Green Deal, to set up the roadmap for the EU to become the first carbon-neutral economy by 2050. In July 2021, the Commission published an adherent major legislative package to deliver the Green Deal, the Fit For 55. As part of this legislative package, EU institutions are currently discussing the design and implementation of a CBAM.</p>
<p>A CBAM is a long-term solution that aims at limiting carbon leakage by levelling the playing field between domestic and foreign production, through the implementation of a border carbon tax that reflects the domestic carbon price. The CBAM is envisioned by EU institutions as a tool that will support the decarbonization of domestic industries that so far have been granted free allowances under the Emission Trading System (ETS). Sectors at risk of carbon leakage, emission-intensive, trade-exposed (EITE) goods, were afforded special treatment and received up to 100% of free allowances under the ETS. This scheme of allocation clashes with the overall climate objectives of the EU, and it is therefore of pivotal importance that the unsustainable free allocation regime is replaced by an effective CBAM.</p>
<p>Although a CBAM is easy to explain in principle, it is an extremely complicated multidimensional measure and, depending on its design, could raise challenges on legal, technical and geopolitical grounds. Different design elements of the CBAM could introduce challenges from a  World Trade Organization (WTO) perspective, whereas others could introduce administrative burdens or create trade frictions. These challenges often interact with one another, creating trade-offs. When analysing different options for design and implementation, it is fundamental to take into consideration the risks at play and the possible trade-offs that they might introduce.</p>
<h2>Status of Negotiations</h2>
<p>The CBAM proposal is subject to the ordinary legislative procedure which requires both the European Parliament and the Council of the EU to approve the final text. The Parliament and Council have adopted their positions on the Commission’s proposal and are now discussing in the trialogue phase where they will need to reach compromises for the final text, which will then be adopted in national laws. While the respective positions are similar on several elements, they differ substantially on key issues that will be at the heart of the trialogue discussion.</p>
<p><img src="//images.ctfassets.net/228txxvb8tt7/1wsde9uTaCvBIkyXwBIwtt/8e8ee449d93e5504b15f8e90807dc100/CFE_CBAM_Table_110222.jpg" width="1372" height="1276"></p>
<h2><strong>Impact of the Current Energy Crisis</strong></h2>
<p>The CBAM discussion falls in a dramatic economic and geopolitical moment. The unfolding of the war in Ukraine, in addition to creating a humanitarian crisis, has also driven up energy prices across the world. Today, Europe is in the midst of an unprecedented energy security and affordability crisis. The emergency has called for several Extraordinary Energy Council meetings. Energy ministers have reached agreements on some elements to address the current crisis and further measures will be taken in the weeks to come to cope with the high energy prices in order to provide some relief to consumers and industries that are carrying the burden of unsustainable costs across the EU.</p>
<p>If we look at specific cases for intensive industries, in the last year, production across the EU has decreased significantly. For the aluminum sector, there has been a 50% reduction in production<sup>1</sup>with energy costs that are 10 times higher<sup>2</sup> and the fertilizer industry is expected to see a 70% reduction by the end of 2022 with 10 fertilizer plants that have already closed by July of 2022<sup>3</sup>.</p>
<p>Today, Europe is faced with a triple challenge: a climate crisis, an energy security crisis, and an affordability crisis. Addressing these different and interconnected challenges entails considering implementing policies that could support one challenge while hindering another. For this reason, it is fundamental to look at two different scales of implementation: the short-term and the long-term.  Policymakers are required to find solutions for the energy security and affordability crisis while ensuring the ultimate goal of reaching carbon neutrality by 2050.</p>
<h2><strong>CFE’s Position on 4 key Design Elements</strong></h2>
<h3><strong>Sectoral Scope</strong></h3>
<p>The Commission and the Council share the same position of covering a first set of five EITE sectors: cement, iron and steel, aluminium, electricity, and fertilizers. They both also propose an assessment in 2026 for potential expansion of the scope into other sectors. The Parliament is proposing to expand the scope from the beginning to hydrogen, polymers, and organic chemicals as well as downstream sectors by 2030,with the possibility of expanding the scope to all ETS sectors. Although from an environmental perspective, the broader the scope the better, it is important to underline the rationale of the CBAM, which is to tackle carbon leakage. Following this principle, only sectors at risk of carbon leakage should be covered<sup>4</sup>.</p>
<p>Another important consideration is that countries outside of the EU will be impacted by the CBAM proportionate to their exports to the EU. By expanding the scope of the sectors, there is a higher chance of impacting trading partners, and therefore creating geopolitical frictions. This is fundamental when looking at how the additional sectors will negatively impact the economies of developing countries as well as close EU trade partners such as the US.</p>
<p>Take US exports to the EU, for example. Under the more comprehensive list of the Parliament, an estimate of $21 billion would be impacted in reference to the 2021 trade flows, against $1.4 billion if only the 5 core sectors were to be covered<sup>5</sup>.</p>
<p>A first phase of implementation with a smaller subset of industries, with the potential to expand in later stages, would allow the EU to tackle a core group of sectors in the short-term, create a mechanism that is more easily enforceable because of the reduced complexity and limit the negative impact on third countries in the initial phase. This scale would ultimately provide time to expand the CBAM to other sectors once the EU has more knowledge and experience with implementation.</p>
<h3><strong>Emissions Scope</strong></h3>
<p>Similarly, the Commission is proposing to only cover direct emissions (“emissions from the production process of goods over which the producer has direct control”)<sup>6</sup>, whereas the Parliament is proposing the inclusion of also indirect emissions from electricity (“direct and indirect emissions released during the production of goods and the electricity consumed during the production processes of goods”)<sup>7</sup>.</p>
<p>A first argument in favor of including indirect emissions is that they often represent a large share of industrial emissions. For example, 84% of emissions in the aluminium sector are indirect and only 18% are direct<sup>8</sup>. From a climate perspective, the inclusion of indirect emissions is important.</p>
<p>The CBAM needs to mirror the ETS. Since the EU ETS covers emissions from combustion processes to generate electricity, heat and steam, producers that buy inputs from outside their industrial facility, will be faced with charges related to the (ETS) carbon cost that is passed to them through the imports of electricity steam or heat needed to generate their products. This could be used as an argument for the inclusion of indirect emissions as it would not create an unbalance between the CBAM coverage and the ETS, although it is unsure if this would represent an infringement of WTO law.</p>
<p>However, the inclusion of indirect emissions could actually create a disadvantage for EU producers due to the electricity market price at the margin. Indeed, EU producers that have a very clean energy mix may end up paying for a high indirect energy cost because the price is given by the marginal plant i.e., the most expensive plant that is required to serve demand<sup>9</sup>.</p>
<p>One important thing to be noted is that in the current system, in order to protect industries against these costs of embedded indirect emissions member states can decide to provide for an indirect cost compensation mechanism. The two mechanisms could not coexist, and the CBAM that would cover for indirect emissions would have to then be accompanied with a strategy to replace the existing cost compensation measure.</p>
<p>Finally, from an administrative and technical perspective, including indirect emissions represents bigger complexity.</p>
<p>Eventually, the expansion of the scope to indirect emissions is desirable, however, there are also many issues related to it. For this reason, in the first phase of implementation, the best option is to exclude indirect emissions This would allow for more analysis to be carried out and to find ways to effectively replace the existing indirect cost compensation mechanism while giving time to the EU’s grid to decarbonize.</p>
<h3><strong>Phase in of CBAM</strong></h3>
<p>Perhaps the most sensitive question around CBAM design is the timeline and schedule for phasing out free allowances under the ETS while phasing in the CBAM. With industries facing uniquely astronomical energy prices, additional costs could have severe impacts on the ability ofindustrial facilities to continue production. The options on the table vary significantly, with the Commission envisioning a gradual implementation over the period of 10 years, the Council envisioning a slower implementation until 2030 and a faster implementation up until 2035 within a 10 year period, and the Parliament envisioning a full phase out by 2032 with a more rapid phase out scale from 2030.</p>
<div class="entry-image entry-image-offset"><img src="//images.ctfassets.net/228txxvb8tt7/1y0AAaNKRcx8lfPoO0vh6L/8a36807972c46618067a658de10d0ec4/CFE_CBAM_Charts_Figure_1.png" alt="Image Alt Text" width="2255" height="1308"></div>
<p>Decarbonization pathways for the industrial sector suggest that most progress this decade will depend on electrification while simultaneously investing in the innovation and deployment of next- generation technologies than can tackle parts of industry that cannot be electrified. In the 2030s and 2040s, industrial emissions will be reduced with innovative clean energy (<strong>S</strong><strong>ee Figure 1</strong>).Given the trajectory for industrial emission reductions (<strong>See Figure 2</strong>), full implementation of the CBAM by 2032 versus 2035 will unlikely impact the EU’s ability to decarbonize the industrial sector by 2050. The phasing out of free allowances is a fundamental step in order to incentivize a sustainable transformation, however, a more rapid timeline is unnecessary to ensure net-zero by 2050. A faster timeline could also exacerbate the current burdens on industries.</p>
<div class="entry-image entry-image-offset"><img src="//images.ctfassets.net/228txxvb8tt7/78gDF3ZZE4DEfHkWWNATai/e031e958b0de079d8034dfc9b368e10d/CFE_CBAM_Charts_Figure_2.png" alt="Image Alt Text" width="1625" height="1257"></div>
<p>As mentioned above, new clean energy technologies will play an important role in decarbonizing industries. So a CBAM policy should also be accompanied by policies to support the innovation and deployment of a diversity of clean energy technologies. Because heavy industries operate in long investment cycles (20-30 years), the next years are fundamental to kick-start the large-scale deployment of breakthrough technologies that will then represent a major push along the phase out of free allowances to decarbonize the industrial sector.</p>
<h3><strong>Export Adjustment</strong></h3>
<p>Neither the Commission nor the Council envision the implementation of some type of export mechanism. On the other hand, the Parliament is proposing a system in which companies continue to receive free allowances for the products that they export to ensure competitiveness in foreign markets that have no carbon pricing mechanisms. The rationale behind export mechanisms is that without it, there would be a risk of carbon leakage. This would result in the loss of competitiveness of EU industries in global markets that would be replaced by more intensive products from jurisdictions with no stringent climate policies.</p>
<p>Export mechanisms have been triggering a lot of discussion around WTO compatibility in reference to the rules on prohibited subsidies outlined in the Agreement on Subsidies and Countervailing Measures (ASCM). Specifically, it could be argued that this mechanism is providing an unfair advantage to EU products in the global market. Because of the complexity of determining whether the CBAM represents a prohibited subsidy is important to assess the compatibility with trade rules prior to the implementation, as suggested by the proposal of the EU Parliament.</p>
<p>There are good arguments for both positions. However, in tandem with the phase in of the CBAM and the subsequent phase out of the free allowances, there is the opportunity to link the two policy designs so that, only when free allowances are substantially phasing out and therefore the risk of carbon leakage becomes more relevant, then an export mechanism could be implemented to protect the competitiveness of domestic industries.</p>
<h2>Conclusion</h2>
<p>Today the CBAM discussion falls in a very different economic and geopolitical environment compared to the Green Deal’s announcement in 2019. Europe is faced with an unprecedented energy security and affordability crisis, that has forced already many industries to shut down or reduce production. Although the ultimate goal is and will remain the decarbonization of the industrial sector by 2050, in the short-term it is fundamental to implement policies that do not exacerbate the current crisis.</p>
<p>The CBAM should be viewed in this framework as a necessary tool to replace the unsustainable free allowances scheme under the ETS, and as a long-term solution that however, is not a breakthrough tool alone. Only if paired with policies that support the innovation and deployment of clean energy technologies, the EU will be able to  achieve the decarbonization of the industrial sectors and reach carbon neutrality by 2050.</p>
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Designing a Carbon Border Adjustment Mechanism: Reducing Industrial Emissions While Facing an Energy Crisis 

<h2>Introduction</h2>
<p>After a summer of crippling energy prices and energy company bankruptcies, the United Kingdom is entering a fall and winter of more privation and a mounting cost-of-living crisis. Global supply chains are extremely strained by the Covid pandemic and Russia’s illegal invasion of Ukraine. Gas and oil imports are unreliable. Authoritarian leaders like Putin and Xi are looking to exploit instability, further deepening the challenges experienced in the West. Today, the UK is poorer, less stable, and less secure because of these dynamics.</p>
<p>The goal of net-zero emissions did not cause or contribute to these crises, but it is a key solution. To accomplish this, the UK should consider borrowing a page from the United States and implement a true clean energy industrial strategy. In many ways, the UK is already well-positioned to be ahead of the US on this. For example, the UK has the Business, Energy, and Industrial Strategy Department. It also has set and met ambitious clean energy goals and has the potential to produce an enormous amount of clean electricity, heat, and hydrogen with offshore wind and nuclear power. With the right national policies, this shift could also spur a reindustrial revolution. That’s because the emerging <a href="https://www.thirdway.org/executive-summary/when-america-leads-competing-for-the-future-of-clean-energy-executive-summary">global clean energy market is expected to be worth well over £2 trillion annually</a>. A clean energy industrial strategy could provide the UK with affordable, secure energy, reduce its vulnerability to spikes in international oil or gas prices, and become a net-energy exporter.</p>
<h2>Why Industrial Strategy?</h2>
<p>The United States just enacted $500 billion clean energy industrial strategy investments within historic legislation (the Inflation Reduction Act, CHIPS Act, and Infrastructure Law) that will cut emissions by one gigaton in a decade. It did so by making a bet that only government policy could move the economy and private sector to embrace clean energy at scale; and the only way to do this required restoring US manufacturing, addressing the supply chain crisis, and making energy both carbon-free and cheap. Atlantic columnist Robinson Meyer summarized the strategy best by describing it as, “For America to decarbonize, it must reindustrialize.”</p>
<h2>Economic Opportunity</h2>
<p>Industrial strategy is useful because the world is moving to clean energy. The <a href="https://www.iea.org/news/record-clean-energy-spending-is-set-to-help-global-energy-investment-grow-by-8-in-2022" target="_blank" rel="noopener">International Energy Agency estimates</a> that there will be more than £1.2 trillion in clean energy investments in 2022, with investment growing by 12% since 2020, up from 2% in 2015. The UK could win a large share of this expanding market. <a href="https://www.gov.uk/government/news/cop26-uk-government-launches-call-to-action-for-exporters-to-go-green" target="_blank" rel="noopener">According to the UK Export Finance</a>, clean trade could deliver up to £170 billion of export sales in goods and services for the UK by 2030. That doesn’t include opportunities in many of the rapidly emerging clean technology sectors. New <a href="https://www.thirdway.org/executive-summary/when-america-leads-competing-for-the-future-of-clean-energy-executive-summary" target="_blank" rel="noopener">Third Way Analysis</a> of clean energy market potential led by the Boston Consulting Group (BCG) estimates that by 2050, segments from key industries that support six clean technologies it initially studied will have a market of <strong>£2 trillion a year.<sup>1</sup></strong></p>
<p>Even without looking beyond its borders, the UK must build a tremendous amount of new clean electricity to meet growing demand, replace aging gas boilers, and abate rising costs. Cutting-edge modelling conducted by <a href="http://www.carbonfreeeurope.org/" target="_blank" rel="noopener">Carbon-Free Europe</a> finds that the UK could do this in a way that generates enough electricity to match growing electricity demand with domestic clean energy and become a net-exporter. By our model’s estimates, UK electricity demand will increase by approximately 240% compared to current demand. This will result in the UK seeing the second largest reduction in consumer gas demand in Europe and the third largest drop in consumer oil demand. It will also require an extensive build out of nuclear power and a 3.5x increase in the pace of renewables deployment.</p>
<p>While the climate goals are important broadly, the economic benefits for the UK are most striking. If the UK sets this as a national target, backed by a strategy where the government partnered with the private sector to make investments and incentivize clean energy, it would spur significant reindustrialisation and set the UK up to become:</p>
<ul>
<li>An essential exporter of electricity and hydrogen to mainland Europe.</li>
<li>The second largest constructor of new transmission, strengthening ties with France, Norway, Denmark, Belgium, and the Netherlands and exporting large amounts of energy to serve German loads via Denmark and the Netherlands. </li>
<li>The leading builder of nuclear power and offshore wind in Europe (more than any EU country) – and a top energy producer and exporter of low-carbon hydrogen.</li>
<li>A leading nation in carbon management, storing the fourth largest amount of captured carbon and helping reduce emissions from heavy industries like cement production.</li>
<li>The sixth largest producer of biofuels to replace fossil fuels, primarily in aviation and chemical manufacturing.</li>
</ul>
<h2>Components of a UK Clean Energy Industrial Strategy</h2>
<p>A UK clean energy industrial strategy would deploy national government policy to incent and remove regulatory obstacles for the private sector to act rapidly to decarbonise and create clean energy, build it domestically, and create jobs. This is the only way to get the scale of investment and clean energy infrastructure that is needed and reduce energy costs to earn broad public support and reach net-zero emissions. Specific outcomes could include:</p>
<ul>
<li>Scaling up investment in clean energy infrastructure to ensure the UK becomes a net energy exporter based on low-carbon energy by 2040</li>
<li>Training a transitioning energy workforce to fill the <a href="https://www.theguardian.com/business/2020/jan/28/uk-must-create-120000-green-energy-jobs-by-2030-to-meet-targets-national-grid">120,000</a> clean energy jobs Britain will need by 2030</li>
<li>Investing in an array of clean energy technologies to meet demand in the residential heat, transport, electricity, and industrial sectors and for export to Europe</li>
<li>Planning for reduced energy supplies from the continent and petrol-dictatorships</li>
<li>Increasing efficiency standards to save money for British households and businesses</li>
<li>Partnering with the US and other allies to create democratic-lead clean energy driven alternative to the Belt and Road pushed by Xi or Russia’s petro-blackmail</li>
</ul>
<h2>The National Vision</h2>
<p>While there is clearly a range of legislative and policy changes that can be made to achieve these aims, immediate priorities could include:</p>
<ul class="boldList">
<li>
<strong>Create a comprehensive roadmap: </strong>The government should conduct a clean energy competitiveness study to identify the best opportunities for the country to invent, manufacture, produce, and export clean fuels, power, and products, and which domestic or international companies are in the best position to lead in the UK. It should also include which parts of the value chains in electricity generation and storage, industrial efficiency and manufacturing, carbon removal and management, transportation, and building operations it  has the highest competitive advantage.</li>
<li>
<strong>Make smart investments in the UK supply chain: </strong>Based on the comprehensive roadmap, the government should significantly expand its Supply Chain Plans. This would go beyond renewables to cover every technology in the industrial clean energy economy, like advanced nuclear and carbon management. It would identify which specific parts of the clean energy supply chain are of strategic or economic interest and should be domestic. It would also provide targeted investments and other access to inexpensive capital to companies that will build out these parts of the supply chain.</li>
</ul>
<h3>Give British households a break</h3>
<ul class="boldList">
<li>
<strong>Insulate the UK:</strong> The Government should provide a mixture of grant funding and incentives to ensure a rapid increase in domestic insulation standards. This will cost £8 billion annually up to 2050 but will produce rapid benefits in terms of reduced (imported) fossil fuel use. At 2016 prices, this would save around £6 billion per year. Given the current elevated prices, savings may reach £18 billion a year.</li>
<li>
<strong>Make home heating cheap and clean:</strong> In conjunction with making British homes more energy efficient thanks to better insulation, the government should stimulate domestic market demand and production of heat pumps and subsidise their installation for residential use. This would save households up to £1,410 annually in lower heating bills and cost less than £2.5 billion over thirty years, with the goal of ensuring that by 2030 home heat pumps are less expensive than gas-fired boilers to install and operate.</li>
</ul>
<h3>Go all in on domestic clean energy</h3>
<ul class="boldList">
<li>
<strong>Scale domestic electricity generation: </strong>The enormity of the energy challenge should not be underestimated. <a href="http://www.carbonfreeeurope.org/">Carbon-Free Europe’s modelling</a> shows that, by 2050, the UK’s electricity capacity will need to be more than three times the current level. This challenge is even greater given that all of the UK’s current wind capacity and all but one of the nuclear plants will need to be re-provided by 2050. The current gas and coal plants will also need to be replaced with low carbon generation.</li>
<li>
<strong>Use every clean technology to generate electricity and heat: </strong>The government should adopt a technology-neutral UK Green taxonomy that allows investment funds to finance all low-carbon developments under it, including renewables, nuclear, and carbon capture. <a href="http://www.carbonfreeeurope.org/">Carbon-Free Europe’s modelling</a> shows that this would require £770 billion in total public and private investment in key technologies over the next thirty years. This includes electricity generation and storage, clean fuels, direct air capture, and heat pumps.</li>
<li>
<strong>Develop advanced nuclear: </strong>The UK should accelerate the development and deployment of advanced nuclear for electricity and industrial heat. Public-private partnerships should be made with leading developers to deploy first-of-a-kind reactors, rapidly expand commercialisation, and to support deployment with UK-based fuel fabrication. This will increase energy reliability and replace existing reactors and natural gas assets that will be retired in the 2030s. It would also create greater flexibility in the electricity grid, lower network costs, and add new heat usages, for example, for hydrogen production. Across all forms of nuclear technology, £352 billion of investment will be required up to 2050.</li>
</ul>
<h2>Conclusion</h2>
<p>The United Kingdom led the world into the industrial revolution in the 19<sup>th</sup> century, and can lead the world in the affordable, clean energy revolution of the 21<sup>st</sup> century. But the UK needs to act now. Too many people are suffering from high energy prices, which threaten to cripple the economy and stall the immense progress made toward decarbonisation. Investing £770 billion now and over the next three decades, while simultaneously partnering more closely with the United States will finally allow the UK to build the kind of cheap, reliable, clean energy infrastructure every modern nation must have to survive, thrive, and remain independent.</p>
<p>The UK must take the path of inventing, producing, and exporting the clean energy that will power the 21<sup>st</sup> century. By working together, the government and industry can create jobs, revive industry, and reduce Britain’s vulnerability to horrific energy price spikes—while simultaneously setting the pace for meeting ambitious emissions reduction goals.<a href="#_ednref1" name="_edn1"></a></p>

The Answer to the UK’s Energy and Cost of Living Crises? Clean Energy Industrial Strategy

<h2>Introduction</h2>
<p>In the wake of Russia’s invasion of Ukraine and the subsequent global energy crisis, the restricted natural gas supply from Russia has caused energy prices in Europe to dramatically increase. High natural gas prices impact all sectors of the economy, but Europe’s industrial sector is particularly sensitive because industrial products typically compete in global markets—meaning producers can’t always pass high energy costs on to consumers. Some energy-intensive industries have already announced plant shutdowns in Europe and sustained high gas prices threaten more closures in the near future.<sup>1</sup> European Union (EU) policymakers seeking to shield industrial producers from rising gas prices have a range of options—some aligned with the EU’s broader climate and energy goals, and some in opposition to those goals. In this memo, we outline the EU industrial sector’s challenge with high natural gas prices as well as strategies to reduce costs and natural gas demand for industrial consumers.</p>
<p>To recall, EU institutions are already working on a range of policy tools to mitigate the effects of Russia’s invasion of Ukraine on the EU energy landscape and on high energy prices. In May, the European Commission presented the REPowerEU plan, which provides a roadmap to end the EU’s dependence on Russian fossil fuels through energy savings, diversification of energy supplies, and accelerated roll-out of renewable energy to replace fossil fuels among others in industry. Additionally, in July, the Commission proposed a Council Regulation envisaging an immediate voluntary gas demand reduction of 15% this winter in all EU Member States, which was adopted by the Council in August. Possible measures listed in the Regulation include reducing gas consumed in the electricity sector and measures to encourage fuel switch in industry. Most recently, the European Commission confirmed that it is working on an emergency intervention and a structural reform of the EU electricity market that would address the high gas prices at EU level, with a possible gas price cap as one of the options supported by selected EU Member States. There will be an extraordinary Energy Council meeting on the 9<sup>th</sup> of September to discuss solutions to the soaring energy prices.</p>
<h2>The Industrial Sector’s Exposure to Natural Gas Prices</h2>
<p>The natural gas cost faced by industrial consumers in the EU is made up of several components. The largest component is the cost of energy and supply, for example the price of the fuel itself. The chart below shows the average annual natural gas fuel price faced by EU industrial consumers from 2019-2021.<sup>2</sup> For comparison, the chart also shows the average monthly spot price of natural gas imports to the EU.<sup>3</sup> Because much of industrial gas demand is typically served with long-term contracts, industrial consumers are not immediately exposed to fluctuations in spot market prices. Nonetheless, as the spot price increases, industrial consumers will eventually face these higher prices and should anticipate a drastic increase in the price of gas during the rest of 2022.</p>
<p><img src="//images.ctfassets.net/228txxvb8tt7/1vZeWYHmwTh3v9b5qnBIju/5f9c6442d1c3dd6374d8044b2de02a56/SolutionsCharts.jpg" alt="" width="2750" height="1292"></p>
<h2>Which Industries are Large Natural Gas Users?</h2>
<p>Different industries have varying levels of energy intensity and dependence on natural gas. The figure below shows the total natural gas consumption by industry in the EU + UK in 2019.<sup>4</sup> (We use 2019 as a benchmark year because it is the most recent pre-pandemic year, and the last year for which EUROSTAT has compiled detailed energy balances).</p>
<p><img src="//images.ctfassets.net/228txxvb8tt7/1huaFH9r4IyJQxlogVt60X/84a28ad39c8c06a4efc0aa51c0c4e992/SolutionsCharts2.jpg" alt="" width="2750" height="1750"></p>
<h2>Strategies to Reduce Costs and Natural Gas Consumption</h2>
<ul>
<li>Direct Subsidies</li>
<li>Alternative Gas Supply</li>
<li>Fuel Switching</li>
<li>Energy Efficiency</li>
<li>Electrification</li>
</ul>
<h3>1. Protecting Industry with Direct Subsidies</h3>
<p>Subsidies are one available approach for governments seeking to preserve the competitiveness of domestic industry. They can take the form of tax cuts, energy price caps, or rebates. Below, we estimate the total amount of subsidization that would be needed to fully bridge the gap between the 2019 average gas supply price and the average future gas supply price paid by an industrial user. Without knowing exactly how natural gas prices will increase for industrial consumers, we used today’s spot prices as an indicator. Figure 3 below shows the total annual subsidy required at a range of natural gas prices if natural gas demand remains constant at 2019 levels.  </p>
<p><img src="//images.ctfassets.net/228txxvb8tt7/4jbpWbKc9gvntel8qElPJa/081aa322bddefa83d100cdf1fe59f0a4/SolutionsCharts3.jpg" alt="" width="2750" height="1500"></p>
<p>These values represent annual subsidies that would be required every year that natural gas prices remain elevated, making them costly to maintain. While subsidies might be effective at protecting Europe’s industrial competitiveness, they’re at odds with other EU policy priorities: subsidies encourage continued natural gas use in opposition with the EU’s climate commitments, and they may perpetuate dependence on Russian energy imports. They also do not protect Europe’s industrial sector if gas rationing is required this winter as recommended by the Council of the EU’s regulation that calls for a voluntary reduction of natural gas demand by 15% this winter.</p>
<h2>Alternatives to Subsidies</h2>
<p>Rather than or complementary to subsidizing natural gas consumption, European governments could support their industrial sectors by financing other energy investments that avoid natural gas use and reduce industrial energy costs.</p>
<h3>2. Alternative Gas Supply</h3>
<p>The EU has already responded to reduced natural gas imports from Russia by increasing LNG imports and even planning new LNG terminals. Policymakers could complement that approach by encouraging the development of renewable and synthetic natural gas (RNG and SNG). Both types of natural gas have the potential to compete with imported fossil gas at today’s spot prices, while also contributing to greenhouse gas emissions reductions.</p>
<p>The most significant limitation to RNG and SNG is rapidly expanding supply, which would require capital investment in production facilities—investment that could be supported by government incentives. Since some amount of renewable and synthetic fuel is likely to be a component of any long-term climate solution, public investment in fuel production could deliver important technological advances or price reductions with widespread benefits in the long-term. The following figure shows that various sources of RNG and SNG are competitive with fossil gas in the 20-40 Euro/GJ range.</p>
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<h3>3. Fuel Switching</h3>
<p>Many industrial energy uses that consume natural gas can also be configured to run on other fuels (for example coal, biomass, or petroleum products). This is especially true for boilers, which use fuel to produce heat, and are often designed to operate on multiple fuel types to insulate against fuel price volatility. Policymakers could support investment in adapting or replacing existing industrial equipment to use fuels other than natural gas. Switching to biomass, which is produced, processed, and used in a sustainable and efficient way, is consistent with climate goals and may be cost-effective when compared to current gas prices, though biomass supply will be limited in the near-term. Any fuel switching to coal, while a solution for reducing gas demand and addressing higher energy prices, would delay emissions reductions commitment.</p>
<h3>4. Energy Efficiency</h3>
<p>Energy efficiency presents another opportunity to reduce industrial consumption of natural gas and corresponding costs. Given the increase in natural gas prices in Europe, incremental energy efficiency measures which were uneconomic at lower gas prices are now cost-effective. Industrial gas users may lack motivation to make energy efficiency investments, even if cost-effective, due to limited capital availability, or misalignment with standard planning and investment cycles. Energy efficiency investments also do not guarantee competitiveness—cost-effective energy efficiency will reduce industrial production costs, but not necessarily enough to achieve competitiveness. However, given that industrial energy efficiency is critical to achieving the EU’s climate targets, this period of high natural gas prices presents an opportunity to advance efficiency deployment, in line with the ongoing revision of the Energy Efficiency Directive, that will deliver long-term climate benefits.</p>
<h3>5. Electrification</h3>
<p>Electrification is a final alternative to natural gas consumption. Like energy efficiency, it’s a key piece of the EU’s long-term climate strategy—a large share of industrial energy demand will ultimately need to be converted to electricity to meet emissions targets. Investments in industrial electrification today will provide important pilot opportunities for technologies that will be needed at scale in the coming decades.</p>
<p>The challenge to electrification in the near-term is that high natural gas prices are also straining Europe’s electricity sector—if new electric load is met by increased operation of coal or gas power plants, it’s unlikely to deliver economic benefits or align with the EU’s climate objectives. Industrial gas users may be unwilling to allocate capital to electrification when electricity prices are volatile, making electrification another appropriate area for government support.</p>
<h2>Advancing the EU’s Energy Priorities</h2>
<p>Policymakers considering strategies to insulate European industry from natural gas price shocks should think beyond direct subsidies for natural gas consumption, which are likely to be costly and don’t align with the EU’s climate commitments<strong>. Alternate (non-fossil) supplies of natural gas, fuel switching, energy efficiency, and electrification are all strategies that could be pursued in tandem to lower industrial energy costs while advancing industrial decarbonization.</strong> <strong>Each of these approaches is likely required at scale to meet 2050 emissions targets, and public investment today has the potential to lower cost and technology barriers to facilitate future decarbonization.</strong> These considerations should be reflected in the urgent EU policy responses to the energy crisis in the near term, but also over the medium term, including in the finalization of negotiations of the Fit for 55 package. Overall, there are many strategic actions the EU can take to free up natural gas supply in the near-term while supply is constrained, better protect its residents from volatile natural gas prices, and limit dependence on Russian energy imports in the long-term.</p>

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Designing a Carbon Border Adjustment Mechanism: Reducing Industrial Emissions While Facing an Energy Crisis

The Answer to the UK’s Energy and Cost of Living Crises? Clean Energy Industrial Strategy

Solutions to Shield EU Industry from Elevated Gas Prices