What is the problem / the issue?

Preventing climate change is one of the main challenges of the 21^st century. One means to reduce the Greenhouse Gas (GHG) emissions causing climate change is to give them a price: when a human individual or an organisation causes the emission of climate-deteriorating Greenhouse Gases, s/he must pay the price. This price for GHG emissions is a means to:

• shift consumption towards less climate-damaging patterns

• justify economically investment in lower-emissions technologies or infrastructure.

One very important source of GHG emissions is the energy incorporated into some industrial materials (steel, plastics, glass, cement, basic chemicals…).

The external competitiveness of industries producing these materials (also known as "energy-intensive industries") strongly depends on energy prices. If the energy price in the EU is high, due to a price given to GHG emissions, then these industries established in the EU lose their market to foreign competitors: their production is replaced by imports. As a result, a high price for GHG in Europe could have the result of merely shifting GHG emissions from the EU to the outside, with no climate benefit, and massive job losses in the EU. This phenomenon is known as "carbon leakage".

The Emissions Trading System (ETS) is the flagship policy of the European Union to reduce its GHG emissions (see also the factsheet in the working space). It addresses 11,000 large and concentrated sources of GHG emissions (power plants, energy-intensive industrial sites) in a "cap and trade" system. However, this policy has completely failed to deliver its promise: the price of GHG emissions has hovered between 3 and 9 EUR / tonne CO₂e over the 2013 – 2016 period (whereas the target price to influence behaviours and investment ranges around 20 to 30 EUR / tonne CO₂e), and has been so volatile that it discouraged any investment. "tonne CO₂e" stands for "tonne of carbon dioxide equivalent" and is the measure of GHG emissions. (See the historical chart: change the "time frame" to "monthly" and adjust the calendar dates you want to see). Specifically, the prices of GHG emissions have collapsed at the end of each "period" of the ETS (in 2007 and in 2012).

The failure persisted over the last decade, despite many attempts to fix the system (the EU is currently reflecting about a 4^th design of the ETS), which have added layers of complexity and of loopholes (free allowances, "back-loading" of allowances, stabilisation fund, NER300 innovation fund).

In addition, "carbon leakage" has taken place over the last 20 years. Despite the cheerful claims that the EU has reduced its GHG emissions, the GHG contained in the goods consumed by the EU has remained constant since 1990 (see spreadsheet document in the workspace). This means that the GHG emissions caused by Europeans have simply been shifted outside – mainly to Chinese manufacturing, which is precisely what "carbon leakage" is about.

Our interpretation of why the ETS failed is that the price level was subject to contradictory pressures between the two phenomena outlined above:

• climate change prevention requires high prices

• preservation of the external competitiveness of energy-intensive industries requires low prices.

Because the ETS did not manage to solve this contradiction, it has never been able to achieve its goals: set reasonable and predictable price for GHG emissions, at levels sufficient to elicit investment in energy-intensive industries and to change consumption patterns.

Why is the problem / the issue important?

The ETS is the main policy in the EU attempting to reduce GHG emissions. The sectors covered represent more than 45% of the total emissions of the EU. The system is the largest GHG emissions trading system in the world, and is a benchmark for others existing regionally or nationally in China, Japan, South Korea, Switzerland, Canada and the United States. A failure there would jeopardise many of the current efforts to tackle climate change.

For energy-intensive industries, the price of GHG emissions is a determinant element of their international competitiveness. Their products are very commoditised, so that competition bears essentially on price. Typically, the price of energy (of which the price of GHG emissions is a component) amounts to 25% of the total price of the product. The prevention of carbon leakage for energy-intensive industries is considered so important that it is the purpose of a specific set of adjustments to the ETS.

What are the existing Public Policies on the issue?

Since 2013, the EU attempts to reconcile its climate policy goals with the prevention of carbon leakage by targeting specific policies to those sectors considered as being at risk. An official list of sectors considered at risk of carbon leakage was established and is revised every 5 years. As of 2017, this list contains 170 sectors and sub-sectors. Installations in these sectors receive special treatment to support their competitiveness. Installations meeting or beating an energy-efficiency benchmark (defined in cooperation with industry) in principle receive all allowances they need for free. Those installations that do not meet the energy-efficiency benchmark need to purchase their allowances on the market.

The Public Policy = what should the public body do?

We propose that Border Adjustment Measures be set up to compensate the effects of the ETS on energy-intensive industries. This means that the GHG emissions allowances should be considered as an internal tax on consumption, whereby products containing a large amount of GHG emissions pay more than those which contain less. According to World Trade Organisation (WTO) law, internal tax on consumption, such as the Value Added Tax (VAT) existing in the EU for more than 50 years, are allowed to preserve the external competitiveness of their producers by:

• having importers to pay the internal tax on consumption

• re-funding it to exporters.

These are called Border Adjustment Measures. The only condition set by the WTO is that these Border Adjustment Measures should not penalise the importers, nor should they give an advantage to exporters (by re-funding them more than the tax they paid).

We propose that:

• the importer should pay for the GHG emissions contained in the materials of the product that it sells, i.e. it should purchase ETS allowances according to this GHG content

• the exporter is refunded on the basis of a VAT-like accountancy system of ETS allowances.

For importers, this means that they pay e.g. for the GHG emissions contained in the steel of a car, but not for the GHG emissions caused by the machining of this steel. Information on the GHG content of materials is publicly available, e.g. here. In general, the GHG emissions contained in a material are ca. 10 times larger than those in the processing, so that the approximation is good. Using this system, importers are given a light advantage, and cannot claim to be discriminated against. Additionally, customs officers can easily check the adequacy of the number of ETS allowances purchased by the importer, by analysing the material content of the product – which is daily business for them.

To enable exporters to have the price of their GHG emissions being re-funded when their product leaves the European Union, we propose that the existing accountancy systems of VAT be duplicated for the GHG emissions allowances. On each invoice, a line would be added, containing the amount of GHG emissions for which payment is required from the customer. Thereby, manufacturers along the supply chain (and specifically the energy-intensive industries at the start of this supply chain) would fully forward the additional cost of GHG emissions, due to the ETS, to their customers, until the final consumer (which would then bear the full cost, and thus have a strong incentive to shift his/her consumption pattern towards products containing less GHG emissions). If a company along this supply chain exports its goods outside of the EU, it would have all the accounting evidence available to justify its request for re-fund from the tax authorities (or its selling of GHG emission allowances on the market) – just as it has been doing for the last 60+ years for VAT.

This proposal is very much in line with the recently adopted Opinion of the European Economic & Social Committee: "The sectoral industrial perspective of reconciling climate and energy policies"

Why is the Public Policy in line with the "raison d'être" of the CosmoPolitical Cooperative?

This Proposal specifically targets the environmental sustainability pillar of the Society of Agreement, while taking due consideration for the social justice pillar.

This Proposal would lead to an increase in the price of GHG emission allowances, which may lead to higher energy prices – which could be an issue for poorer people living in homes with low energy performance (this issue is referred to as "energy poverty"). Tackling this issue of "energy poverty" would be the purpose of another Public Policy Proposal.

Why will the Public Policy work?

This Public Policy will work because it addresses one of the fundamental design flaws of the existing ETS: the fact that it did not consider carbon leakage, i.e. the consequences on the external competitiveness of some key industries – the energy-intensive industries – of setting a high price of energy.

The solution provided is conceptually simple, it relies on proven concepts that have been working for decades. There will of course be difficulties to solve in the detail, but they have nothing to do with the complexities and ultimate inefficiency of the current tinker-grade policy-making, where patches are added on top of one another.

What are the other positive effects of the Public Policy? What other opportunities does it open?

One interesting additional positive effect of the proposed Public Policy is that the invoice to the final customer will include the cost of the GHG emissions embedded in the product. This information has the potential of having the customer fully feeling the price signal that the overall ETS intends to send him/her. It has the potential to speed the shifts in consumption behaviours towards those products and services with less embedded GHG emissions.

What are the negative effects of the Public Policy?

Border Adjustment Measures on GHG emission allowances will require a transformation of the existing accounting systems of companies across the EU, in order to include the price of GHG emissions allowances in the invoicing and in the balance sheets. This is a significant work. However, accounting systems are currently based on Information Technology and software. Therefore, the change would need to be performed by the software editors, and would automatically spread to their customers, with very limited added complexity. In addition, accounting software, like any software, is the purpose of periodic updates which includes adaptation to changes in legislation or new features. Provided enough lead time is given, the inclusion of GHG emissions allowances in the accounting system would be smoothly included in the normal plan of periodic software updates.

Border Adjustment Measures on GHG emission allowances may be the purpose of debates with the European Union's trading partners within the World Trade Organisation (WTO), e.g. China, the United States of America. However, since:

• importers are not discriminated against (they would rather be given a slight advantage),

• the data to compute the GHG emissions embedded in materials is publicly available,

• the evidence regarding the mass of each material in a given imported item is easy to measure and indisputable,

• the principles of Border Adjustment Measures for internal consumption taxes have been accepted since the 1970s

an acceptable agreement should be reached.

Energy-intensive industries may be unhappy to see that this policy results in having the price of their products increase on the EU internal market, thereby driving consumption patterns to move away from their products (which is the ultimate goal of the whole EU climate change policy). The whole debate on external competitiveness is a real issue. It has also helped them delaying any change in their own business. One way to address this issue is to support the uptake of recycled materials – a part of the Circular Economy concept. Recycled materials typically embody 10 times less GHG emissions than primary materials (obtained from raw materials extracted from mines).

What are the risks and uncertainties attached to the Public Proposal?

The main risks regarding the implementation of Border Adjustment Measures on GHG emission allowances relate to the political resistance of those stakeholders being negatively impacted by the Public Policy – and which are listed above.

How are the benefits, costs and risks of the Public Policy Proposal shared between groups in society?

The sectors, companies and workers which would be most impacted by this measure are those manufacturing goods with a high GHG emissions content (such as cement, virgin steel or aluminium, ceramics, glass, virgin plastics).

When compared to the current situation (early 2020), where the price of GHG emissions allowances is low, they are negatively impacted, because this Public Policy enables higher prices for GHG emissions allowances, and thus deteriorates their competitive position against alternatives with lower GHG emissions (wood, recycled steel, aluminium or plastics). This is however an accepted, and desired consequence, namely to shift consumption and production away from products with a high GHG emissions content, towards thos with a lesser content in GHG emissions.

Compared to a situation where the price of GHG emissions allowances has risen, but where no border adjustment measure is taken, their situation has massively improved, because they are not placed at a competitive disadvantage against extra-EU producers.

Quantitatively, what consequences will the Public Policy have?

The number of GHG emissions allowances is ca. 2 billion tonnes CO₂e per year (2013 figures) – see here. If all these allowances were actually auctioned, at the target price of 30 EUR / tonne CO₂e, instead of being mainly given away for free (which is the current situation), this would generate an additional income for crisis-stricken public budgets of 60 bio. EUR / year.

With Border Adjustment Measures on GHG emission allowances, a high internal price within the EU would have no effect on the external competitiveness of energy-intensive industries, and on the related jobs.

Why did you make these choices?

If a given policy increases the price of an essential industry input like energy within a given market, it is the duty of the public authorities to protect local companies against the unfair competition from external competitors not subject to the same policy.

An alternative could have been to hope that a unified price for GHG emissions exist across the whole world, so that all companies be placed on an equal footing. The COP 21 negotiations in Paris 2015 could have had this effect. Despite the success of this conference, it has fallen short from this level of international cooperation. The recent political developments in the United States of America (election of Donald Trump as president) make the prospects of such world-wide cooperation unlikely in the short term. This is why an approach at EU level only, where political decision is possible, is preferred.