The production of basic industrial materials such as steel, cement, aluminum and major chemicals causes, for the time being, roughly a fifth of EU greenhouse gas emissions.
Even though companies are innovating extensively and there are various pilot projects for low-carbon production pathways in place, there are for the time being rarely commercial-scale investments in breakthrough technologies.
This has a clear reason: economics. These low-carbon production processes typically come at a substantially higher cost than established processes and, at the same time, markets are rarely willing to pay a price premium to cover these higher costs.
Consequently, such low-carbon production processes for basic industrial materials typically face the problem, that they represent no viable, bankable business cases. Logically, major investments do not materialize in such a context. Instead, even most innovative processes which are crucially required for the comprehensive and swift transformation of our energy and industrial sector in line with climate targets face the risk to remain in the unpopular yet frequently observed trial stage; the so-called “valley of death”.
In theory, there is a policy instrument in place to solve this problem. However, the carbon price provided by the EU ETS is far too low to turn important breakthrough technologies (in the industrial sector and beyond) economically viable.
Starting from the current price of carbon allowances at a level of around 25 €/tonCO2, Sartor and Bataille (2019) put together in their paper the required carbon prices to achieve for very low-carbon cement, primary steel and primary aluminum the breakeven production costs as compared to the traditional production in place (see figure below).
Thanks to the high level of research activity in the sector and the overall shift in energy and industrial policy, the situation is dynamic and such cost comparisons might be considered outdated right after being developed. However, the overall assessment mentioned above remains to be valid and – without smart solutions – will not change quickly.
In this context, so called ‘carbon contracts for difference (CCfD)’ could be an effective and economically efficient tool to kick-start investments into low-carbon production processes. By doing so, they can complement other instruments in place and, most importantly, may immediately unfold their impact without having to wait until the political pledges for a comprehensive carbon tax, a carbon border adjustment or whatsoever materialize sooner or later.
But how do these CCfD work? Without going into too much detail, the major aspects of this instrument are outlined in the following:
- In analogy to the use of feed-in premiums or tariffs to attract investments in renewable energy supply (RES), a CCfD may be granted to an investor into industrial low-carbon production processes (e.g. a steel company willing to transform its steel making process or a chemical company willing to transform its production process in line with climate targets)
- Again similar to RES, this could happen through a competitive tendering process
- The tender may only be open for commercial-scale projects that have demonstrated their impact and functional capacity through successful pilot projects, etc.
- Winning projects would enter into a CCfD with an official body for a period that is sufficiently long to provide investment security (to be based on industrial investment cycles)
- The major function of the CCfD is to the guarantee such investors into industrial low-carbon production processes throughout the entire CCfD contract period a fixed carbon price that allows to cover both CAPEX and OPEX of the breakthrough industrial process implemented
- After each year, the average EU ETS price and the actual (and verified) production of the relevant low-carbon industrial material are considered
- If the EU ETS price was lower than the carbon price guaranteed with the CCfD, the investor would receive for each ton of CO2 avoided through the low-carbon production the difference between the guaranteed carbon price and the actual EU ETS price
- If the EU ETS price was higher than the carbon price carbon guaranteed with the CCfD, the investor would receive no payment or may even by required to share its profit with the CCfD counterparty (subject to the design of the CCfD; similar concepts to be found in RES support schemes)
It is important to note, that the compensation as illustrated above is granted only for actual low carbon production and related CO2 being actually avoided. Consequently, all project delivery and production risks remain with the investor. On the other hand, the investor obtains – with regards to the carbon price – the predictability and security required to undertake large scale investments into low-carbon production processes. This is key to get the necessary transformation started!
Reference and recommended follow-up reading:
Sartor, O; Bataille, C. (2019). Decarbonising basic materials in Europe: How Carbon Contracts-for-Difference could help bring breakthrough technologies to market. https://www.iddri.org/sites/default/files/PDF/Publications/Catalogue%20Iddri/Etude/201910-ST0619-CCfDs_0.pdf
Note: This is based on personal views. Although prepared with care, errors and omissions excepted.
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