Constructive carbon trading: Shaping the design of the EU ETS for buildings

An online workshop organised by ZERO explored the intricacies of the proposed EU Emissions Trading System (ETS) for buildings and road transport. This so-called ETS2 has sparked both interest and concern, and the main question remains: can it effectively reduce emissions while delivering a socially fair climate transition?

Thomas Nowak, Secretary-General of the European Heat Pump Association, presented the case that by 2050 heat pumps will be the main way of heating (and cooling) buildings. Nevertheless, even though the market for heat pumps has been steadily growing with a peak rise in 2021 (25% growth), the pace of change is not fast enough compared with the use of less sustainable options like gas boilers.

So is there a need for a level playing field?

Nowak argues in favour, noting that heat pumps are already covered by the ETS1 and need to become more attractive in the market: “Fossil heating is not cheap, it is simply generously paid for by society, while the individual is benefiting from ‘perceived’ cheap heating.”

This problem relates closely to the tax levels on electricity, which are much higher than on fossil gas, so the price signals that end users receive are unbalanced. “If you really want people who are able to invest and to switch from fossil fuels to electrically powered heat pumps, we need to address those price signals,” explained Samuel Thomas, a senior advisor for the Regulatory Assistance Project (RAP).

In this sense, Thomas Nowak advocates that the new ETS2 and the Energy Taxation Directive need to be considered together.

BURDENS VS. REDISTRIBUTION

Another common concern associated with the extension of the ETS to buildings is the potentially negative social impact it can have on already energy poor households. Sorcha Edwards, secretary general of Housing Europe, warned that, depending on how the ETS for buildings is actually implemented, it can “turn out to be a tax on energy systems where people actually have no agency to change their existing polluting boiler, yet you have a tax that makes it more expensive”.

Both pointed out that consumer behaviour tends to be quite inelastic to heating cost changes, so there is a risk that, faced with rising energy prices, the energy poor groups would end up rationing their energy use, thus exacerbating the risk of energy poverty.

So, can the Social Climate Fund (SCF) properly address these concerns?

While Thomas believes the mechanism can work since “the richer countries would pay quite a tremendous amount of money (…) to help the other countries to move in the right direction”, Sorcha stresses that the SCF “is not targeted enough to actually correct the potential negative social impact of the ETS2”.

Nevertheless, all speakers agreed on the need to ensure that the revenues coming in from the building sector are channelled to investments in energy efficiency, building renovation and social redistribution. Thomas mentioned earmarking revenue from the ETS1 as well, since that system already covers some of the emissions coming from the building sector.

WHAT IS THE WAY FORWARD?

While Thomas suggests that “carbon pricing is the only viable instrument to reach emission reduction targets and create a revenue stream to finance it”, Sorcha highlights that “this ETS is not the only tool in the box”, mentioning the Renovation Wave and the need to increase public funding. Nevertheless, implementing an ETS for buildings would force action at the EU level and contribute to the redistribution of funding from rich to poor countries, says Samuel.

All speakers seemed to agree that although the ETS2 presents a lot of potential, it would not be sufficient on its own. A mix of policy and financial instruments is necessary to achieve emissions reductions and tackle the potentially negative social impacts. This means having strong regulatory targets in place, coupled with a carefully designed ETS for buildings and supporting policies (SCF) “to get the industry moving and to financially support those who are unable to bear the costs of this transition”, as Thomas mentioned. We also need to avoid that the ETS2 results merely in a tax on those least able to afford it, Sorcha insisted.

Sam Van den plaas, policy director at Carbon Market Watch, closed the session by reminding the audience of the missed financing opportunity created by the planned giveaway of over 5 billion free allowances to energy-intensive industries between 2021 and 2030. Assuming a carbon price of €60€ per tonne, this could amount to a monetary value of around €300 billion, so it is not fair to expect “citizens to pick up some price for their carbon pollution while steel, cement and chemicals can continue business as usual”.