COVID-19 And Long-Term Decarbonization For Industry: An Opportunity To Mitigate Future Costs

By: Jan-Martin Rhiemeier and Boris Lagadinov

Industrial production and electricity demand in Europe have dropped dramatically as a result of the coronavirus outbreak. This has also led to a drop in emissions. While the effects cannot be quantified precisely yet, recent estimates from market analysts suggest that emissions could easily fall by up to 25% in 2020. The EU emissions trading system (ETS) was operating with over 1.6 billion metric tons of allowances in circulation; the additional excess supply, assuming a quick recovery, does not significantly change that. What could significantly affect the balance between supply and demand is how long the downturn lasts and the trajectory of any recovery.

The impact on prices is even more difficult to predict since short-term considerations, such as price movements in energy markets, affect them in addition to the fundamental market balance. After an initial drop in March, EUA prices have rebounded (albeit still below levels prior to the crisis) largely due to the existence of the market stability reserve (MSR), which was designed to mitigate excess surplus in the system. Whether the MSR can tackle demand shocks of higher magnitude is yet to be tested.

Companies Must Prioritize Long-Term Efforts

For many industrial operators, reduced emissions would mean lower compliance obligations. At the same time, many companies are currently operating in crisis mode, which can put decarbonization efforts in the background on the short term. This can be particularly dangerous as companies do not lose free allocations in 2020. These liquid assets are immediately available as additional funding and should be used for financing long-term decarbonization efforts as opposed to filling short-term cash needs.  

Companies can now use the additional funds as an opportunity to undertake decarbonization options that they may have previously lacked sufficient investment budget for. Examples range from simple energy efficiency measures like improving insulation on heat transfer pipelines to the retirement and replacement of specific energy intensive assets. Apart from the EU ETS, several EU member states have introduced or are planning to introduce additional measures based on taxes for emissions not covered by the ETS. While in general no direct overlap of the policies is expected in terms of cover-age for the industrial sector, there are indirect impacts on company costs linked to electricity prices or transportation costs.

An alternative option is to do nothing and use any excess allowances as a buffer for the future, when EUA prices are expected to reach much higher levels, especially with the possible increase in EU 2030 targets following the European Green Deal. Such an approach assumes that there are no avail-able emission reductions for companies to implement at prices below expected EUA prices. Another option is to use these assets to cover short-term cash needs; however, a similar argument on future price expectations is valid in addition to increased risk of just moving liabilities into the future.

Take Steps to Reduce Emissions Today

Any freed-up capital should always be ringfenced for internal emission reduction projects. If not immediately invested, it can also be placed into an internal carbon fund. The additional funds, depending on size, could be included in existing investment assessments, reducing financing costs or could help the launch of new initiatives in post-COVID-19 times.

All companies exposed to carbon pricing should take advantage of the current situation to mitigate future risks by taking steps to actually reducing emissions now.