Read on to find out more about the fossil subsidy 'Indirect Cost Compensation' and why we want the European Parliament to vote against it.

What is Indirect Cost Compensation? 

Indirect cost compensation is a subsidy scheme for heavy industry as part of the EU Emission Trading System.  

The EU Emission Trading System (EU ETS) is one of Europe's primary tools to reduce Greenhouse Gas emissions, by creating a price signal as an incentive for the industry to decarbonize.  Within the ETS, the industry must buy CO2 certificates for their own industrial emissions (direct costs). Electricity producers also buy CO2 rights for their emissions and include this is in the price of electricity. When large polluting factories such as chemicals or aluminium producers consume energy, they pay for these emissions as well (indirect costs).  

A major shortcoming of the EU ETS is that the EU foresees compensation for both direct and indirect costs, to avoid so called carbon leakage: CO2 intensive industries might move their businesses outside the EU to avoid purchasing ETS allowances or high energy prices.  

The EU allows the compensation of indirect costs faced by the industry under approved State Aid measures, but it is up to member states to choose whether to do so. 

What is wrong with this subsidy? 

It is a fossil subsidy! The emission trading system has been designed to reduce CO2 emissions and energy consumption. By shielding companies from price signals, there is no incentive for them to decarbonize. These are compensation schemes for the most polluting industries, like plastics and oil refineries! 

To make matters worse, the subsidy is paid from a fund that is intended for climate policy. Funds that could help decarbonize industry or pay for the energy transition of our societies is not used to compensate the energy bills of polluting industry.  

As such, the subsidy is highly unfair and unnecessary. EU citizens cannot count on similar compensation for their already much higher energy bills. Only the largest and most polluting industries are eligible. It is unnecessary as there is no compelling evidence for carbon leakage. 

How much money is involved? 

Eleven Member States have implemented a scheme under the 2012 ETS Guideline: Germany, the Netherlands, Belgium (Flanders and Wallonia), Spain, Greece, Lithuania, Slovakia, France, Finland, Luxembourg, Poland, Romania and Norway. 

Sectors that are compensated include mining and production of chemicals and fertilizers; mining of iron ores and production of aluminum, lead, zinc, tin, copper, iron and steel; production of plastics; manufacturing of leather clothes, man-made fibers, cotton fibers; and production of paper and pulp. 

Member States may use up to 25% of the revenues they earn from the auctioning of ETS allowances to compensate business sectors that are deemed to be exposed to a risk of carbon leakage as a result of indirect costs of the ETS. In the Netherlands, however, €172 million was paid out in 2021, while only 441.4 million in revenue had come in. This amounts to almost 40%.  

An impact analysis by the European Union concluded that - in case the European Commission decides to continue to grant Indirect Cost compensation as it has done in the past 9 years - Member states will spend roughly 1,5 billion euros on the subsidy each year. The subsidy is expected to ‘compensate’ roughly 60 million tons of CO2 emissions and 173 Twh of electricity. Can you imagine how much climate policy could have been funded with 1,5 billion euros each year? And what about the 60 million tons of CO2 emitted without having to pay a true carbon price? Is that fair?  

Arguments for Indirect Cost Compensation debunked 

Industrial lobby groups are well represented at the European Union. They argue that increased energy prices due to carbon costs will force them to shift their production outside the European Union. Politicians are quite susceptible to these arguments, fearing job losses and even less climate benefits. But are they true? 

Carbon leakage myth 

Research and a study commissioned by the European commission have not found any conclusive evidence for carbon leakage in Europe. Nor is it likely to happen in the future, even without free allowances or indirect cost compensation. The risk of carbon leakage is often exaggerated by industry to argue in favor of compensation. Not surprisingly, given that Europe is not the only region with carbon pricing. Of the 20 largest economies, only Australia and India do not have some form of CO2 taxation or pricing. A recent study by the European Commission on indirect cost compensation concluded that indirect cost compensation did not even have a significant effect on the competitive position of companies benefiting from the subsidy.  

Race to the bottom 

The risk that companies will relocate within the European Union is also overestimated. Energy prices within the European Union vary greatly, due to for instance differences in taxation. These differences are often much higher than the additional indirect ETS costs. The fact that governments do not lower their taxed to avoid relocation of industries might be a sign that the impact of prices on business decisions to relocate are marginal. This is probably why only 11 out of 27 member states currently grant the subsidy to their industry.  

Nevertheless, industrial lobby leads to a race to the bottom in which more and more national governments feel forced to implement indirect cost compensation, out of fear that their companies might relocate. The best way to stop this downward spiral is to abolish to this subsidy at European level. 

Overestimated prices 

Another problem with Indirect Cost Compensation is that it assumes a much larger price increase than realistically is the case. Companies do not pay spot prices for their electricity use. Moreover, the formula used by the European Union to determine the increased price of electricity is based on the most polluting from of fossil electricity. It does not matter what kind of electricity is purchased by a company; it is assumed they paid the maximum ETS price in the fossil electricity market. 

Better solutions 

 A final myth that needs to be debunked is that without the subsidy, business might fail to decarbonize. The reasoning is that CO2 intensive production receives free allowances, meaning they do not have to pay for a part of their CO2 emissions. This makes it cheaper for industry to continue using for example coal fired processes (for which they receive free allowances) rather than switching to electricity. It is a fallacy that this problem can only be solved by indirect cost compensation. That is focusing on the wrong problem; the problem are the free allowances! How about facing out free allowances for polluting processes? Or supporting sustainable energy production to reduce its price?  

What exactly is our political ask in the petition? 

We urge the members of European Parliament to exclude indirect cost compensation from the revision of the EU Emission Trading System. The latest proposal by the European Commission for the revision of the EU ETS (July 14, 2021) still contains the option for member states to grant indirect cost compensation. The proposal by rapporteur for the review of the ETS, Peter Liese, also continues to support indirect cost compensation. With this petition we therefore urge MEPs to "exclude state aid support schemes referred to in Article 10a(6) (of Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union), to compensate for indirect costs for electricity intensive industries from the revised Directive"

Why is this an urgent issue? 

As far as WISE is concerned, the European Commission should have ended Indirect Cost compensation a long time ago. But now is the time to make a difference. An important vote is coming up in the Committee on Environment, Public Health and Food Safety (ENVI) of the European Parliament. May 16, ENVI members will vote on the revision of the EU ETS, including whether to include or abolish indirect cost compensation. This is followed by a vote in the European Parliament in June 2022. However, most members of European parliament will follow the recommendations of their colleagues in the ENVI committee. Therefore, both votes present crucial moments to influence the positions of Parliamentarians.  

Currently, MEPs of the Greens, the Socialists & Democrats (S&D), Renew Europe and the Left put forward amendments to exclude Indirect Cost Compensation from the renewed ETS. These 4 parties together form a narrow majority in the European parliament (377 out of 751 seats). Therefore every vote counts!

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