The European chemical industry has warned that doubts about proposed changes to the European Union’s carbon emissions trading system (ETS) could hold back investment in petrochemicals and bulk polymer plants as well as other energy intensive installations into the next decade.

The warning comes after downstream polymer users have fiercely protested about raw material shortages as a result of a high number of force majeure declarations triggered by abrupt shut-downs mainly of ageing bulk polymer plants in need of upgrading.

The European Plastic Converters Association (EuPC) announced this summer the creation of an Alliance for Polymers for Europe to assist downstream companies hit by polymer shortages and to press for the easing of duties on polymer imports.

“Uncertainties about the way the ETS will operate beyond 2020 will impact investment decisions,” said Jean-Pierre Clamadieu, president of the European Chemical Industry Council (CEFIC) at a press conference at the association’s general assembly in Brussels in early October.

“Any investment decision has to take into account the payback period which will extend into the 2020s,” he explained. “Proposed changes to the ETS have created a situation in which companies are less inclined to make investments. Lack of clarity in the proposals has become an obstacle to the making of investment decisions.”

In the European chemical industry as a whole total investment had remained static or even declined in real terms in recent years. In 2013 it amounted to $19 billion against $18 billion in 2003, according to Clamadieu, who is also Solvay’s chief executive.

By contrast investment in chemicals in China had soared from $7 billion in 2003 to $67 billion in 2013 while chemicals investment in the US had gone up from $6 billion to $24 billion in the same period, he said.

The squeeze on investment in petrochemicals and bulk polymers as well as energy intensive sectors like chlor-alkali has stemmed from high energy costs in Europe and climate change measures by both national governments and the EU.

Combating Global Warming

The ETS, which was introduced in 2005 and comprises the pricing and trading of emission allowances for each tonne of CO₂, is one of the EU’s main legal instruments for combating global warming.

In the current phase 3 of the system in 2013-2020, over 40% of emission allowances are distributed for free to industrial installations, including chemical plants. The primary aims of the free allocations is to preserve the international competiveness of European energy intensive industries like petrochemicals and to prevent ‘carbon leakage’ — the relocation of carbon-based production to areas outside Europe with fewer restrictions on carbon emissions.

Under the current allocation of allowances, a benchmark of relatively low carbon intensity is used to determine how many free allowances are allocated. In petrochemicals and bulk polymers the benchmark covers around 5-10% of plants.

The European Commission’s proposals, published in the summer, will apply to phase 4 of the ETS from 2020-2030 and will help the EU meet its target of a 40% reduction in greenhouse gas emissions by the end of the next decade. Among the sectors covered by the ETS there will have to be a cut of 43% by 2030 compared with emission levels in 2005.

The Commission wants the availability of free allowances to be decreased by tightening the benchmark values by 1% a year. Allocations will also be reset in 2025 to reflect changes in output levels of individual plants.

The share of allowances which will be auctioned will remain at 57% during phase 4, according to the Commission. But the proportion will be lower among Eastern European member states.

A block of unallocated allowances, expected by analysts to number around 550-700 million, will remain in a Market Stability Reserve (MSR) to balance supply and demand in the trading of allowances.

An excess of allowances due to the post-2008 recession and slow growth in Europe drove the ETS price to as low as €3 per tonne in 2013. It has since been rising slowly so that in July it exceeded €8 per tonne. But with the manipulation of the MSR its price could be raised to much higher levels.

Investing In Carbon Efficiency

Money from the auctioning of allowances will be channeled into a modernization fund to help lower-income member states to invest in plant improvements to reduce greenhouse gas emissions. Cash from auctions will also be put into an innovation fund to support development throughout Europe of new low-carbon technologies, such as renewables and carbon capture and storage.

CEFIC supports the purpose behind the Commission’s proposals – to meet the EU’s target for carbon emissions reduction cost-effectively by encouraging investment in carbon efficiency and to keep carbon-efficient production and jobs in Europe.

However it points out that some of the key proposals are inconsistent with principles laid down last year by the European Council, representing EU member states. These included an undertaking that the best performers or those operating at the benchmark level should not be subject to additional carbon costs, particularly the need to purchase allowances in order to expand output.

In addition the Commission has contradicted its own objective of having benchmarks which “reflect technological progress” and having allowances allocations which are in “alignment with production data”, according to CEFIC. Instead CEFIC accuses the Commission of putting forward arbitrary thresholds and incompatible means of implementing them.

“First it has introduced the arbitrary figure of a 1% annual decrease in benchmark levels which will be applied automatically without any links to technological progress or best available technologies (BAT),” explained Chris Scott-Wilson, CEFIC’s director of advocacy and public policy, in an interview at the general assembly.

“This lack of a relationship between benchmark levels and what is technologically achievable is asking companies to do the impossible,” he added.

Furthermore the gradual shrinkage in the numbers of free allowances will compel the best performing producers to purchase emission allowances in order to increase their output. On the other hand producers wanting to cut output will be able to offset lower revenue by selling their excess allowances.

“The system being proposed by the Commission is fundamentally flawed,” said Scott-Wilson. “Reductions in production would be subsidized through the ETS while increases in output would be discouraged by the need to buy allowances.”

As an alternative to the Commission’s plan CEFIC is backing a system, called ‘dynamic allocation’ which has been put forward by the Dutch government. It would ensure that allowances are allocated fairly on the basis of actual output.

Under the Commission’s reforms the amount of allocated allowances would be recalibrated after five years to match output, as long as it had grown or decreased above a threshold of 50%.

“With a system of dynamic allocation carbon-efficient growth in production would be entitled to a commensurate increase in free allocations while reduced output would mean a reduced allocation of allowances,” said Scott-Wilson. “The adjustment in allowances would be made a year after the increase or decrease in output and would not be limited to a 50% threshold.”

The implementation of dynamic allocation requires the creation of an additional reserve of allowances. This will provide free allowances to those best performers increasing production while it would take back allowances from producers which have been cutting output.

CEFIC also wants benchmarks to be reviewed and updated by reference to proven technological advances so that producers are encouraged to reduce emissions by using innovations to upgrade their plants.

Establishing a Low-carbon Economy

The long-term vision behind the EU’s initiatives is that innovations will ultimately make possible the transition to a low-carbon economy sometime beyond 2030.

“As a result of the level of the carbon prices fossil-derived electricity will be the most expensive source of energy,” explained Scott-Wilson. “The key to the future will be greater resource efficiency which will be achieved through initiatives like the circular economy. But the only way we can get where we want to be is through innovation.”

The Commission’s proposals for phase 4 of ETS will have to be approved – and inevitably modified—by the European Parliament and the European Council. This process could take at least 1-2 years before the Parliament and Council can agree on what will become an EU directive on cost-effective emission reductions and low-carbon investments.

Even after the approval of the directive there will still be uncertainties, including the likelihood of a hefty rise in the ETS carbon price. “In 2020-2025 the Commission seems to be envisaging a fairly rapid increase in the price,” said Scott-Wilson. “Companies are asking themselves how they can decide on investments without knowing what the carbon price will be.”

Plastic converters and other downstream customers of energy-intensive chemical businesses can be hardly optimistic about a wave of investment in bulk chemical facilities much before 2025.

Instead they are likely to be seeking security of raw materials through imports. Some of these will probably be coming from areas there are few or no restrictions on carbon emissions. This is equivalent to carbon leakage which, ironically, is exactly what the ETS is trying to avoid.