Which role can carbon contracts for differences play in decarbonizing the European industry? A perspective from EU border regions

Abstract

The commitment to stringent long-term deep decarbonisation targets on national and European level has put the industrial sector, responsible for approximately a quarter of EU emissions, in the spotlight for drastically reducing their emission intensity. Especially the production of basic materials, such as steel, nonferrous metals, cement, and chemicals is highly emission intensive, while relying heavily on highly optimized and standardized production processes. Alternative low-emission production technologies are under development, but high initial investment costs, operational risks, uncertain costs for alternative green fuels and the lack of confidence in prospectively high EU ETS emission prices jeopardize their timely industrial scale implementation. As such, national governments, EU policy makers and other stakeholders are currently exploring options to support the business case for low emission technologies in the industrial sector. One of these options is to use contracts to share investment projects’ risks between private investors and public parties. Contracts for Differences (CfDs), have been used successfully in various types of infrastructure projects such as renewable and nuclear power plants. In a similar vein (although with some relevant differences), Carbon Contracts for Difference (CCfD) could help to hedge some of the risks associated with the adoption of novel low-emission technologies. Industrial agents and public institutions agree on a fixed reference strike price for emission allowances over a given period. This means that supported projects receive additional non-market payments for each emission allowance they sell below the strike price. New technologies, which would only be competitive at elevated future CO2 prices that are significantly higher than today’s market prices, could become economically attractive, today. By means of CCfDs public institutions assume not only the project risks related to future emission prices, but, among others, also improve the financial credibility of the project. This work encompasses the analysis of economic and societal benefits of CCfD, highlights different aspects to be considered for its implementation and explores possible links to other national and European policies to support the industrial transformation towards a low emission economy, such as green public procurement. Findings are contrasted with insights gained from interviews conducted with Hungarian and Spanish industry partners, financial institutions, and government stakeholders with the objective to evaluate the possible role of CCfDs as a building block for the industrial policy mix. The analysis presented in this work highlights both benefits and limitations of CCfDs in fostering industrial scale investments in low emission production processes. As such, we conclude that CCfDs cannot be the sole policy instrument to ensure a viable business case for low emission technologies. CCfDs must be accompanied by other policies, which help to create markets for products with a low emission footprint and thereby pave the way for effectively reducing industrial emissions in line with deep decarbonization targets.