Eurofer Analysis On Communication On Moving Beyond 20 Percent - June 2010

Unilateral increase by the EU of its climate change reduction objective and the competitive situation of sectors exposed to leakage risk

Eurofer welcomes the fact that the Communication reconfirms the conditions set by the European Council in December 2008 for expanding the Community's unilateral commitments above minus 20% by clearly stating that other developed countries must commit to comparable reductions and economically more advanced developing countries must contribute according to their capabilities ad responsibilities. The Communication states that, today, these conditions are clearly not met. This is in line with the constant position held by Eurofer which has opposed a unilateral move by the EU

With respect to the competitive situation of sectors exposed to leakage risk in the wake of the Copenhagen negotiations, the Communication adopts the generally accepted analysis that the Copenhagen Accord in itself is not sufficiently strong and comprehensive enough to alter the conclusion that free allocationand access to international creditsremain justified.

Analysis of the - 20% target

The main conclusions of the authors of the Communication is that compliance with the 20% target is now cheaper than assumed in 2007. This result rests on three elements all linked to the crisis of 2009:

• Due to the assumed reduced GDP growth and fall of GDP in 2009, no absolute emissions reductions in the ETS need to take place between 2013 and 2020. In this context it is assumed that the crisis will result in the availability of a “buffer” of unused allowances from the period 2008 to 2012.
• However, the renewables and non-ETS targets targets will not be met and would need an additional incentive of 36 Billion Euros.
• Lastly it is assumed that lower GDP means less emissions and therefore less demand for allowances, which in turn reduces prices for allowances to 14.5 Euro per ton of CO2 in 2013. These are expected to rise to 25 Euro per ton of CO2 in 2020.

Eurofer has some strong reservations on the basis of these findings and would appreciate if the Commission could take the following comments into account:

• Use of econometric models: the European Commission bases its findings mainly on the output from economic models. The same models are applied to discussions on air quality policies and in this context their database is an issue of intense debate. Eurofer submits that it is essential to rely on data from industry that should serve as input to the policy debate. The use of an application of models should be subject to an intense consultation with stakeholders. Also the role and effects on company profits of the now entirely unpredictable raw material prices, which underwent a sudden surge of 90% in the last months (with indications for a pending another 30% increase) cannot be captured by these models.
• In addition, some more technical aspects of the modelling need more explanation. For example the notion that auctioning of allowances does not constitute a cost for the economy due to the fact that the revenues will be recycled (page 37 of the Part II of the Staff Documents). This “zero sum approach” may be challenged as the consequences for the value chain starting with electricity intensive industries may not be included. Also the reference to a cost of 12 Billion related to “higher energy efficiency measures" is not fully explained (page 37 of Part II of the Staff Documents).
• Abatement cost: From the view of manufacturing industry the notion that the crisis has made emissions abatement cheaper is somewhat surprising. The Communication explains this avoided cost by the lower GDP but neglects that this loss in GDP is a cost in itself. Even though the Commission does acknowledge that the downturn has left industry with much less capacity for investments, it does not fully explore the interaction between growth and financing capacities of industry, a debate which Eurofer deems essential for the EU’s competitveness.

Concerning steel production the information available to Eurofer indicates that currently a fragile recovery can be observed, which is largely driven by stock replenishments and less by consumer demand. Significant macro political and macro economical uncertainties do not allow any prognosis beyond end of 2010. However expectations of markets that this technical rebound will lead to a recovery is reflected in current CO2 prices. In spite of the crisis, these CO2 prices have already doubled since the height of the crisis from 8 Euro to 15 Euro per ton of CO2 (otherwise the allowance prices would already now be close to zero).

Discussion of a “green technology revolution”

The Communication also provides an overview of the main levers available to reduce emissions. From the outset, Eurofer observes that the concept ofa “path of abatement” is misleading. As the benchmarking exercise shows for manufacturing industry there is a technological bottom for CO2 efficiencies which can only be overcome by radical breakthrough innovations. Therefore any “early investments and efforts” will not bring manufacturing industry on something like a “path”. Such efforts can only pave the way for possible breakthroughs which, if actually found, would lead to a change resembling rather more to a sudden phase change than to a smooth transition. Eurofer hopes that this element will be part of the reflection.

In the table below Eurofer has sumarised economic activities, which according to the Communication provide levers for emission abatement, and the corresponding political framework to maximise the respective contributions to emission abatements.

Eurofer fully shares the focus on the four levers identified but expresses concern that the importance of CO2 price signals for the “green technological revolution” is overstated in the following areas:

• large scale infrastructure: it is not clearly expressed that only coordinated long term investment (e.g. smart grids, DC grids) and development by Member States can secure the creation of such large scale change, which will never be achieved through only a CO2 price signal (independently of its strength).
• renewable energy technologies: although not clearly expressed as such the Communication conveys the message that lack of a CO2 price signal has led to the decline of market shares of EU renewable technology providers, as exemplified by the PV producers and that CO2 price signals in the Community will be sufficient to reverse this trend. Eurofer reminds of the visible trends in global economic development where the application of mass production techniques to services and invention combined with a continuing low cost base and huge scale consumer markets are the main drivers of the near future global economy. In such an economy the CO2 price has a very limited role and especially will not be able to restore market leadership in single technologies as PV production. Against this background Eurofer holds the view that the Community will be competitive only in high price products which are based on not easily transferable aspects as sophisticated value chain integration and process know how. This combines material producing industries with technology providers and does not rely only on the latter;
• with respect to consumer products, the Communication rightfully does not emphasise the CO2 price signal with respect to consumer products but refers to the role of product standards instead of assigning a predominant role to the C02 price signal. Eurofer fully supports this view. Eurofer strongly advocates the use of life cycle thinking when defining such standards whereby the recyclability of steel and its contribution to a more sustainable society should be properly addressed.

Analysis of the 30% target

With respect to the ETS sectors the Communication states that the greatest potential for emissions reductions comes from the electricity sector and that tightening the ETS cap in the electricity generating sector only is sufficient. This is further underpinned by the modelling assumption explained on page 52 of Part II of the Staff Documents which assumes full coverage by free allowances for the manufacturing sector.

On the one hand Eurofer interprets this as a very positive clarification concerning the nature of manufacturing industry operations. Thereby the Commission implicitly confirmsand supports the long time request of the business community to take into accountthat manufacturing processes cannot deliberately reduce CO2 per reference product but are bound to laws of nature and technical development and the restrictions imposed by these.

However, explicit clarification is missing how an increased target will not lead to the application of the “correction factor” on manufacturing industry.

There is another aspect of concern, which relates the impact of higher electricity prices on manufacturing industry. The Emissions Trading Directive has the defect that it does not address this aspect of leakage on the same level as leakage risk caused by direct emissions. This aspect will become even more pronounced, if indeed it would be intended to achieve an increase in the target above 20% by reducing the “sub-cap” of the electricity generators.

The section on “Options Inside the ETS” of the Communication stresses the idea of increasing the allowance price which would allow strengthening the incentive effect of the carbon market. To Eurofer this approach is most likely in conflict with Article 1 of the ETS Directive which stipulates that Emissions Trading shall serve to promote reductions of emissions in a cost-effective manner. In addition, it does not take into account the comment made above in respect of the abatement path, i.e. that for some industries only a breakthrough technology can result in significant CO2 reductions. In those situations, a higher CO2 price will not have an incentive effect but will result on an increased risk of carbon leakage and an impact on competitiveness of the industry in Europe.

Leakage risk assessment

The results of the modelling performed with respect to leakage risk produce surprising low figures on assumed production losses under all combinations of the lower and upper ranges of the pledges made by countries under the Copenhagen Accord (especially the EU pledges of between 20% and 30%). In the case of both 20% or 30% as an EU pledge the expected production losses are around 1% (with some exceptions going up to 3.5%).

On page 52 of Part II of the Staff Documents as well as on page 11 of the Communication it is explained that the models assume free allocation of allowances to manufacturing industries. However, it is not expressed to which extent these allowances cover the best performer needs. Only by assuming full coverage for at least the best performers, the low production loses can be understood. However the actual approach taken by the authors of the Communication needs clarification. The possible interconnection of low production losses and free allowances however underlines the general position of Eurofer that free allocations are both needed as the first and most effective measure to combat leakage.

The fact that reductions of free allowances below best performer values would indeed have a significantly higher impact can be derived from possible effects on profits. For example a study on the steel industry1Indicators of the Risk of Carbon Leakage, NERA Consulting, December 2008 found exemplaric impacts on GVA between 30% and 40% and short term profit margin reduction between 100 % and 400% in case of loss of free allocation. It is obvious that such impacts will not be without significant consequences for production.

Eurofer emphasises that border measures shall not be considered as a primary means to act against leakage risk. Border measures can not substitute either measures for free allowances or a comprehensive international agreement which provides equal treatment for globally traded goods. Eurofer however reaffirms its position that border measures should be kept on the table as a complementary negotiating tool and further work should be done on how a cross-border mechanism can be designed in line with the EU’s obligations under WTO.