The impact of implementing a climate deposit on carbon-intensive materials in Europe

The production of basic materials like steel, cement and aluminium accounts for around 25% of global greenhouse gas emissions. These emissions result both from energy use and directly from the industrial processes that are applied in production. The potential for energy efficiency in these sectors is limited and such efficiency improvements would not reduce process emissions. Hence additional mitigation options need to be unlocked:

  • Break-through technologies, for example based on renewable hydrogen or electricity, or carbon capture and sequestration (CCS), could allow for production of carbon-neutral materials, if incremental production costs are covered.
  • Material efficiency and substitution reduces the need for primary material production and can thus reduce costs and address resource constraints – but such gains will only be realised with incentives for material users, e.g. from carbon prices passed on to material costs.

It is also important to note that the sectors that produce basic materials are often subject to high levels of international competition and therefore potential carbon leakage.

Current policies for basic materials are mainly focused on the producers of the materials. As materials can be traded internationally, carbon costs are only partially, and to an uncertain degree, passed through to intermediate and final users. This effect dampens incentives for efficient material use and climate friendly substitutes. It also makes it difficult for investors in new technologies to see how incremental production costs could be recovered.

This points to the need to expand policy instruments for basic materials beyond producers, as we explore in our paper. Policy must incentivise and support the users of carbon-intensive materials to improve rates of material efficiency, reuse, recycling, substitution with other materials, and to prolong the lifetime of manufactured products. Circular economy policies often aim to achieve these same goals.

So far there has been relatively limited analysis of how such policies might impact on CO2 or GHG emissions. More generally, the linkages between material consumption and climate policy remain relatively unexplored. However, in a new paper in Climate Policy, my co-authors (Karsten Neuhoff and Xinru Lin) and I explore one such example.

The paper assesses the effects of levying a charge (climate deposit) on the consumption of steel, cement and aluminium in the EU. The value of the charge is set per tonne of material and proportional to the carbon intensity of the production of the respective material with best available conventional production technologies. In the model the charge increases in line with a projected carbon price gradually to €80/tCO2 by 2050. The charge is applied to each unit of material consumed, regardless of its production method. Crucially, imported and domestically-produced materials are charged identically.

In our analysis we used the E3ME macro-econometric model (see www.e3me.com) and ran scenarios with three different price responses. The figure shows results for the two scenarios where the price response is greater than zero (i.e. higher prices leads to lower consumption). It suggests that material charges could reduce total EU energy CO2 emissions by 6% by 2050, compared to baseline. However, this is not the whole story. There is also a potential large reduction in process emissions (40%). Total EU CO2 emissions (excluding land use) could be reduced by about 10% by 2050.

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Figure: Energy CO2 emissions compared to the baseline (%), EU28

Furthermore, because the charge is applied to both domestically-produced and imported materials, there is no carbon leakage, i.e. these emission reductions are not offset by increases elsewhere. The modelling suggests there could be a small increase in EU GDP (mainly from reduced energy imports) if the revenues from the material charge are used to offset other taxes, although employment in the industrial sectors may fall slightly.

Our analysis should only be seen as a starting point but highlights the potential of climate deposits on material consumption. Much more detail is needed about how material consumption may be reduced and how the efficiency of carbon pricing could be enhanced with complementary policy. For example, public authorities could play a role in providing information and skills, or facilitating better coordination across the multiple actors involved in construction projects. But as rapid emission reductions are now needed to meet the targets of the Paris agreement, this is an area that needs to be explored with some urgency.

Read the paper here.

Hector Pollitt is a Director and the Head of Modelling at Cambridge Econometrics

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