How to optimise EU’s energy and climate action?

Climate policy aims to reducing greenhouse gas emissions. In the European Union, these emissions are reduced by emissions trading scheme, the obligations of effort sharing sectors and the promotion of renewable energy and energy efficiency. Other relevant tools are land-use change and sinks in forests, which have their own regulations. Is the EU’s tool kit consistent and optimal in economic terms?

The EU energy and climate policy, just like any other policy, is formulated under the conflicting pressures of politics, economy and legal constraints. This column does not propose to find the ideal policy combination (after all, it would need a very thorough study); instead, it will identify and discuss economically sensible approaches.

The market, as a rule, is an efficient means of organising economic activity. The EU emissions trading scheme (ETS), covering about 45% of greenhouse gas emissions in the EU, is based on tradable emission allowances. Nevertheless, even the ETS has some barriers to optimisation. There are differences between sectors because of the restrictions in the system and especially because of the amount of free allowances (based on the carbon leakage threat). Over time, even the market stability reserve and similar systems affect optimisation.

In the effort sharing sectors, i.e., sectors not included in the ETS, the differences in targets are even more marked: each Member State has binding national emission targets, set on the basis of Member States’ relative wealth, measured by gross domestic product per capita. This “solidarity” is based on the principle that wealthier Member States bear a bigger burden. However, it is not the most cost-effective approach.

Across the EU, greenhouse gas emissions should be cut at least 40% by 2030 from the 1990 levels. The ETS sector should cut its emissions 43% from the 1990 levels and the effort-sharing sector 30% from the 2005 levels. Finland’s national target in the effort-sharing sector is at 39% one of the highest in the EU.

Partial optimisation in energy policy...

The EU’s inter-institutional negotiations regarding energy policy targets for 2030 are the most intensive trilogue phase. As the starting point in 2020, there are the EU’s ‘20-20-20’ targets: 20% cut in greenhouse gas emissions, 20% improvement in energy efficiency and 20% increase in the share of renewable energy in final energy consumption. The renewable energy target has been allocated between the Member States, Finland’s share being 38%.

In defining the targets for 2030, priority has been given wisely to the emissions target. At the EU level, there will also be targets for renewable energy (at least 27%) and for improvement in energy efficiency (at least 30%). Along the way, the European Parliament has indicated that the targets should be higher and more binding (both at least 35%) and that the renewable energy targets should be allocated between the Member States. Finland, among others, has taken a critical view on this, but why so?

The answer is to be found in the priority of the emissions reduction target and the consideration of economic realities. It is more important to reduce emissions than regulate the means available. However, the EU cannot afford to reduce its emissions at all costs. The instruments chosen should be cost-effective and preserve economic competitiveness. Member States should be able to choose the best means of reducing their emissions.

It is essential to bear in mind that while energy efficiency (in its traditional sense) and renewable energy are key means of reducing emissions, there are also others ways to cut emissions. I do not mean merely the choice of energy sources, such as nuclear energy, which falls under national competence and discretion. Other important instruments are land use and sinks (LULUCF), food production, CO2 capture and utilisation (CCU), transport solutions, the energy saving potential of digitalisation, circular economy, waste management, and so on. The list is long. The key is to change behaviours and practices, in many ways with the help of new technologies.

Case coal

The Finnish Government has decided to phase out coal in energy use by 2029, and the relevant legislation is currently being drafted at the Ministry of Economic Affairs and Employment. Some other countries, too, have announced their intention to ban coal in the 2020s or 2030s. How does the coal ban fit in with economic optimisation?

In principle, the coal ban is not optimal considering the existing capacity, and it will not automatically reduce the emissions across the EU. However, the ban on hard and brown coal draws on the power of example and the ambition to give up one of the most polluting fossil fuels. Defining the policy early on allows a controlled transition to low-carbon production capacity and can at best promote the development of new technologies, such as geothermal energy and the seasonal storage of energy. In Finland, with our high demand for heating, coal has been used mostly in cogeneration-based district heating systems in larger cities.

Economic arguments become even more important

Now, the world is far away from the path to limiting global warming to 2°C. That is why there is ever increasing pressure on the EU’s emission reduction targets and the tools for reaching the target.

Sooner or later, the increasingly tough demands on emissions reduction will highlight the need to find the most cost-effective tools. Investments in low-carbon energy technology and in lowering its costs play a key role.

The European Commission intends to issue its proposal for a long-term low-emissions strategy next November. In 2019, we will have a new European Parliament and a new Commission, making the year an important period for planning longer-term strategies. Finland’s EU Presidency in autumn 2019 falls on an interesting period.

Riku Huttunen is Director General of the Energy Department at the Ministry of Economic Affairs and Employment.