While the International Energy Agency (IEA) advocates an aggressive implementation of carbon pricing mechanisms across the globe, it focuses less on affordability and social implications than the European Commission’s ‘Fit for 55’ climate roadmap, writes Ivan Pavlovic.
Ivan Pavlovic is senior energy specialist with Natixis CIB Research, where he covers green and sustainable finance.
Since the European Commission (EC) agreed on more ambitious greenhouse gas (GHG) emissions targets last December, the “Fit for 55” package has been eagerly awaited by many as the next step in the battle against climate change.
The package, presented on 14 July, provides a detailed analysis of the European Union’s carbon output, and identifies the region’s more challenging sectors and corresponding plans to decarbonise. Buildings, industry and mobility are identified as the key problem areas in terms of the EU’s CO2 emissions, together comprising almost 50% of the total.
The proposals – which could enter into force as soon as 2023 – lay out four distinct areas of action: carbon pricing, sectoral targets and rules and support measures. A proposed strengthening of carbon pricing within the EU includes extending the Emissions Trading Scheme (ETS) to include maritime transport, buildings and road transport, and the introduction of a new Carbon Border Adjustment Mechanism (CBAM) for selected sectors, subject to the pre-existing ETS. For the time being, the CBAM would only apply to “direct” (scope 1) CO2 emissions, and it will later be decided whether it should extend to cover “indirect” (scope 2) emissions that come further down the value chain. For industries with mostly “indirect” emissions, such as aluminium production, the proposals will therefore likely have a limited immediate impact.
The EC also suggests increasing EU-wide targets in renewable energies, low carbon fuels, energy efficiency, and use of land and forest for carbon capture and sequestration, as well as outlining new policy frameworks to spur on decarbonisation, especially in the production and use of low-carbon fuels in the building and mobility sectors.
Perhaps mindful of the recent “yellow vest” crisis in France – a by-product of the French government’s decision to implement climate-related policy changes without proper consideration of the associated social impacts – the “Fit for 55” package comes with some proposed safety nets; namely in the form of proposed creation of a Social Climate Fund (SCF). This fund is specifically aimed at tackling the risk of increased energy or mobility poverty arising from the extension of the ETS to include buildings and road transport.
Interestingly, the EC’s unveiling of its decarbonisation toolkit for the EU comes just weeks after the International Energy Agency (IEA) released a widely-discussed energy scenario underpinning the achievement of a 1.5-degree scenario by the world economy – the Net Zero Emissions scenario (NZE). As such, the NZE scenario offers a valuable benchmark against which to assess the various disruptions and policy options that the EC’s “Fit for 55” package comprises.
Obvious similarities in the overall decarbonisation pathways underly both approaches; for instance, removing the use of fossil fuels as much as possible in buildings, industry and mobility.
But when comparing the two, some interesting divergences appear. Indeed, the EC’s approach focuses heavily on the development of renewable energy to support decarbonisation and, while it highlights the pivotal role of carbon pricing in incentivising technological and behavioural disruptions, also places emphasis on offsetting the negative social impacts that the transition may bring.
The NZE, on the other hand, advocates a thorough implementation of carbon pricing mechanisms across the globe, with particularly aggressive pricing modelled in developed economies, but focuses less on affordability and social implications.
Such difference can easily be accounted for: IEA’s NZE has a global perspective and therefore looks into developed as well as developing regions. For the latter, due to lack of infrastructure, access to energy still takes precedence over all other affordability considerations.
Beyond this, comparison between the two strategies highlights some specificities in the EC’s approach.
Firstly, the “Fit for 55” focuses heavily on decarbonisation within the transport and mobility sectors, instead of industry – the proposals for the latter revolving around strengthening of the ETS, which would likely not impact many of the sub-sectors until at least 2026.
Notably too, the EC takes a comparatively restrictive approach to low-carbon fuels supporting decarbonisation. For instance, while the IEA views nuclear power as a necessary low-carbon energy component, the EC does not address its potential – perhaps attributable to the fact that the EU still lacks consensus around the role of nuclear in the energy transition.
Lastly, the EC’s stance on the potential role of carbon capture, utilisation and storage (CCUS) in industrial activities, remains unclear. There is an implied preference towards nature-based solutions, such as tree planting, rather than tech-based solutions, but the EC’s plans to strenghten the ETS in hard-to-abate industrial activities (chemicals, cement and steel production) also implicitly incentivise CCUS, leaving the overall stance ambiguous.
Despite the suggested Social Climate Fund, the acceptability of certain measures within society may still prove challenging. This is perhaps most notable in the proposed ban on sale of new internal combustion engines in light-duty mobility by 2035, and the expected increase in fuel costs, especially in the aviation industry as a result of the restrictive approach towards low-carbon hydrogen – an integral component in synthetic kerosene used in sustainable aviation fuels (SAFs), and a cheaper alternative to its green counterpart.
In terms of the practical efficiency and workability of many of the elements within the “Fit for 55”, only time will tell. Key pending issues that require clarification include the emissions benchmarks used for allocation, up until 2035, of free allowances to activities benefitting from the carbon leakage mechanism, and also the inclusion of “indirect” emissions in the scope of the CBAM.
With the plans now to be submitted to the European Council and the European Parliament for approval, intensive debate will likely ensue. Our hope is just that the “Fit for 55”’s underlying climate ambition is not weakened as a result.