The Expansion of the European Carbon Emissions Trading Market to the Building and Transportation Sectors

This article was originally published in our newsletter "Mobility" Analysis, June 23, 2021.
To receive future articles by email as soon as they are published, Subscribe now.

Michel Colombier is a co-founder and scientific director of IDDRI (Institute for Sustainable Development and International Relations). He is also an associate professor at Sciences Po Paris. He is a member of the High Council for Climate, alongside Jean-Marc Jancovici and Alain Grandjean, partners at Carbone 4, among others.

Background:

At the special climate summit hosted by the United States in late April, European Commission President Ursula von der Leyen confirmed a plan that has been under discussion since the current Commission took office in 2019: the expansion of the European Union Emissions Trading System (EU-ETS)^[1] the construction and transportation sectors^[2]. This carbon market is currently limited to the energy sector and a list of heavy industries. So why expand it? How would it work? What are the associated risks and opportunities? What options are available for such an expansion? Michel Colombier, scientific director of IDDRI, kindly answered Carbone 4’s questions to shed light on the issue.

Q - Why wasn't transportation included in the ETS until now? Why the change?

A – There are several reasons why the transportation sector has been excluded until now. First, historical reasons, The European carbon market was modeled after the U.S. experience with SO2 emissions which promoted the idea that such a mechanism was effective in regulating industrial companies—and, by extension, the energy-production sectors, but not the transportation (or construction) sectors. It was also practical, The nature of the transportation market makes this exercise difficult : It combines personal and commercial transportation, a wide variety of modes of transportation, and accounts for emissions that are, for the most part, widespread (tens of millions of vehicles rather than a few thousand industrial facilities).

Q - Why this change?

A – The Commission is listening to a certaineconomic theory discourse, which calls for expanding the market to improve its liquidity and ensure it functions more efficiently: “the wider the better.” Next, there is the Commission’s desire to raise the EU-ETS carbon price to increase pressure on manufacturers. Expanding the carbon market to the transportation sector would create scarcity in the carbon market and thus drive up prices. This is all the more true given that the operational cost required to effectively change behavior in the transportation sector is estimated to be over €100 per metric ton—a figure roughly twice as high as the current price of carbon on the EU-ETS. Finally, such an approach—with a single, harmonized mechanism for all European countries—could seem easier to sell politically to member states than the current “effort sharing” approach in which Brussels sets emission reduction targets that vary from country to country.

Q - How would the mechanism currently under discussion work in relation to the existing ETS market? Who would pay for the allowances?

A – First of all, it’s important to remember that this expansion of the carbon market to include transportation and the building sector is still only a proposal. The exact details have not yet been finalized, and several options are on the table. There are two such approaches in terms of scope of application: an “upstream” approach and a “downstream” approach.

In the “upstream” approach,It is the fuel suppliers who pay for and trade the quotas based on the volume of fuel sold. The resulting additional cost would be passed on to the price at the pump. For consumers, this would have the same economic effect as a fuel tax.

In the "downstream" approach, it is the consumers themselves, who pay for and trade the allowances. This approach seems a priori unfeasible for individuals because it is designed solely for companies of a certain size, such as those in the logistics sector. However, it would have the merit of positioning the market at the level of economic actors who have the means to take action on the ground (fleet renewal, reduction of distances traveled, etc.).

Q – How does this relate to the current carbon market?

Once again, there are various options available, each with different consequences depending on the choices made ^[3].

First option: Transportation is included directly in the current EU-ETS, with the expected result of raising prices for all eligible individuals.

Second option: a separate, completely independent carbon market is created for transportation (or transportation and the building sector), which allows the two markets to be managed separately in order to achieve the most efficient carbon prices in each market; a priori around 100€ per metric ton for transportation and less for industrial use.

Third option: a hybrid of the two models with limited trading rules, such as floor or ceiling prices, which could potentially regulate both markets together.

Q - Why implement such a mechanism rather than simply continuing to enforce current regulations—such as emissions standards for new vehicles—by extending them, for example, to heavy-duty vehicles?

The purpose of such a mechanism is indeed to raise the price of carbon-based transportation to bring it closer to its true cost (taking all its externalities into account), and thereby make it easier for low-carbon alternatives to emerge—something that current standards do not necessarily achieve, or at least not quickly enough. Carbon standards and carbon pricing are not mutually exclusive tools, but rather the various options available to the government. The implementation of a carbon price should not be used as an excuse by states and public authorities to abandon sectoral policies.

Q - What are the risks associated with such a mechanism?

A – The expansion of the carbon market to the EU-ETS automatically results in to raise fuel prices by the same amount for all affected parties. In a way, this would make it possible to indirectly implement a harmonized tax system at the European level, which is not possible with traditional tax instruments.

If the scheme were expanded to include household transportation, it would amount to taxing a poor household and a wealthy household—or a Luxembourgish household and a Romanian household—in the same way. The risk of “Europe-bashing” is therefore very high, especially since such a measure could—and rightly so—be perceived as technocratic and highly undemocratic. An EU-ETS limited solely to commercial transportation may be a solution to reduce this risk.

Another way to cushion this social shock would be tomake good use of the revenue that the auctioning of allowances will generate for the EU or the member states ^[4]. The question then lies in the details of how this prize pool will be distributed to reconcile objectives that are sometimes contradictory : protecting the most vulnerable, assisting those stranded in their vehicles (in the short term, electric vehicles are not yet affordable for everyone), ensuring public acceptance of the system—all while keeping in mind the primary goal, which remains to increase the cost of carbon-based transportation to encourage behavioral change. In short, this is a highly complex economic and political undertaking.

Get in-depth analysis of the latest news from the mobility sector by subscribing to the newsletter.