While the EU Emissions Trading Scheme (EU ETS) has been in place since 2005, the expectation that carbon prices will rise in the future creates potential for it to become a new source of substantial funds. The World Wildlife Fund (WWF) Maximiser project estimates that by 2030, the EU ETS could deliver revenues of €200 bn to MS.[1]
Pricing carbon aims to stimulate action in both production and consumption of energy. At present, an overarching challenge remains. Price signals aim to promote ‘demand response’ by increasing the price consumers pay for carbon-intensive energy. Where access to low-carbon energy is limited, such schemes may simply drive up costs — with the impact being highest for low-income households.
In the power sector – so far, the most important sector covered by the EU ETS – the second, more systemic incentive of carbon pricing is to drive change in the dispatch order of power generation, such that the extra cost to fossil-fuel plants makes their bids higher and lower-priced, cleaner power generation will be selected earlier in the supply mix. Depending on the carbon price and the types of power plants in a given power market, this impact on dispatch – the so-called ‘merit order effect’ – can have either moderate or negligible impacts on emissions. Unless lower-emitting resources are actually available to be run more often and carbon prices are high enough to prompt their use, the impact on dispatch is often rather low.
A more direct route to emission reductions is needed, especially in the buildings sector. Dramatically boosting energy efficiency is the most direct route to lowering demand, but comes with heavy up-front costs and long-term payback — difficult conditions for both households and businesses.
Across the EU, natural gas supplies just over 45% of heating appliances in buildings while oil accounts for 20% of the market share. In Poland, 3.5 mln homes still rely on coal. Photo: Phil Augustavo
The introduction of new carbon taxes and carbon prices is challenging and struggles to gain public support in many areas, as the cost of the schemes are passed on to consumers through the cost of energy. With the carbon price in the EU ETS currently low – at around €20 – the reality is that across European power systems, carbon reduction can carry a cost for consumers as high as €248 per tonne avoided.[2] It is well known that power markets magnify the consumer cost of carbon prices, because increased fossil prices drive up the clearing price in the wholesale market for all power in the mix.
Box 1 • What makes emissions abatement costly in power markets?
The current structure of electricity markets – and particularly how supply is chosen to balance with demand – has a huge impact on the cost of reducing CO2.
In single price electricity wholesale markets, generators bid in to supply a portion of anticipated demand. The lowest cost generator is selected first, then the system operator moves up the price scale as needed to deliver against total projected demand for that period. The last generator selected is the most expensive and, in today’s markets, is usually fossil-fuel based. Known as the ‘clearing generator’, this supplier sets the price for all generation in the mix at a given time.
At present, it is the CO2 emissions of the clearing generator that determine the relevant carbon price; however, that carbon price gets added to the clearing price for all generation. As a result, consumers end up paying the carbon price on all megawatt hours (MWh) in the mix, not just the supply generated by carbon-intensive suppliers.
At €20/t, however, carbon prices are not effective on either of the intended aims. The degree to which consumers reduce use in response to the price signal is very low and only limited shifts have been noted in dispatch order.
Given that passing the costs associated with CO2 emissions on to both producers and consumers is a core element of carbon pricing, it effectively raises the value of units of carbon-intensive energy that don’t need to be produced or consumed. In this regard, using carbon revenues to support investment in energy efficiency renovations is a straightforward way to buffer the costs. In fact, a recent study by the Regulatory Assistance Project (RAP), based on evidence from Europe and abroad, shows that directing carbon revenues to energy efficiency saves 7-9 times more carbon than price mechanisms alone, while also delivering other benefits (Figure 1).[3] Data from the European Commission show that the greatest need for energy efficiency renovations is - by far - in the residential sector (Figure 2).
Figure 1 • Cumulative carbon emissions reduction with 3% rise in rates only versus 3% rise + directing funds to energy efficiency. Source: Regulatory Assistance Project (2015)
Figure 2 • To reach the EGD goals of 32% renewables and 32.5% improvement in energy efficiency, the EU must get serious about renovating people’s homes.
Additionally, investment in improving the energy performance of buildings can offset current regressive forms of revenue generation – i.e. taxes on energy bills – that have higher impacts on low-income households. Taxes calculated as a percentage of income and expenditures clearly place a much heavier burden on such households.
At least three MS have programmes that link carbon pricing to energy efficiency. Germany dedicates KfW loans to such projects while in France, the Association national de l’habitat (ANAH) targets renovations of low-income households.
One stand-out example, which could be replicated within the roll-out of the European Green Deal, comes from the Czech Republic, where a 2012 law requires that at least 50% of carbon revenues be devoted to measures that reduce greenhouse gas (GHG) emissions. The Czech scheme directs half of the recycled revenues toward the New Green Savings Scheme, a building renovation programme recognised to be among the most cost-effective energy saving schemes across all sectors in the country.
Over the period 2014-18, this programme distributed €350 m for the energy renovation of over 32 000 dwellings. These subsidies, offered to households to undertake renovations, achieved a leverage factor of about 1:3, with each euro invested by the State attracting a further three euros of private (householder) investment. If this 1:3 return were to be sustained and 100% of national revenues were to be recycled into the scheme, by 2030 in the Czech Republic alone, EU ETS revenues of €4-7 bn could deliver €12-21 bn of investment in renovation.
An evaluation of the broader benefits of these investments found that for each €1 m of State investment, a return to public budgets of €0.97-1.21 m accrued through income tax paid by companies and their employees, lower costs to social and health insurance, and reduced payout of unemployment benefits. In parallel, the expenditure induced GDP growth of between €2.13 and 3.39 m.
Ultimately, the evaluation shows that all of these benefits to public budgets and the economy were achieved while reducing CO2 emissions far beyond what could have been done by using the same money to abate CO2 in power markets.
If similar programmes were rolled out across the EU as part of the Renovation Wave, the impacts would be exponential.
For the full set of articles co-produced by EnAct and Renovate Europe, follow the links below:
Part 1 of 5 / Building renovations and the EU Green Deal
Part 2 of 5 / Proof of how building renovations can help meet the EU Green Deal
Part 3 of 5 / Tapping into the Just Transition Mechanism
Part 4 of 5 / Leveraging carbon revenues for EU buildings renovation
Part 5 of 5 / Financing residential deep energy renovation
