Nordic Economic Policy Review 2023

Introduction: EU climate policy and Fit for 55

Harry Flam and John Hassler

In 2021, the EU decided to set more ambitious targets for the abatement of greenhouse gas emissions, including a 55% reduction in carbon emissions by 2030, compared to 1990 levels, and achieving climate neutrality – emitting and absorbing equal amounts of greenhouse gases – by 2050. To ensure that the new goals could be met, the EU Commission proposed a package of measures under the heading Fit for 55 to accelerate the abatement process. By the end of 2022, most of the proposed measures had been provisionally agreed in a trialogue between the European Parliament, the Council of the European Union and the European Commission. Final agreements are expected in 2023.

This issue of Nordic Economic Policy Review explores the implications of Fit for 55 for the Nordic countries. All of them have introduced more ambitious targets for abatement than the EU. However, the level of divergence has shrunk considerably, and EU requirements for greater uptake of carbon in forests and through land-use change are not necessarily satisfied under current national targets.

The new, more ambitious EU-wide climate policy gives rise to several questions: Are national targets and measures consistent with Fit for 55? If not, how should national policies be made consistent with EU policy? EU directives set targets for national climate policy, but member states are free to choose the means of achieving them. Are national measures to meet targets set by EU directives efficient? If not, how can they be made so? What are the costs and benefits of national climate policy aiming for more stringent targets than those under Fit for 55? We have put these questions to experts on the economics of climate policy in Denmark, Finland, Norway and Sweden. Before turning to their responses, it is useful to review the main elements of the Fit for 55 proposal package.

Structure of EU climate policy

EU climate policy covers greenhouse gas emissions from all sectors of the economy, including land use and forestry. The policy consists of three parts:

For a more detailed account, see Vis et al. (2016).

The EU Emission Trading System (EU ETS), which covers the energy sector, large industrial installations (about 15,000 of them) and aviation within the EU. EU ETS is a cap-and-trade system; every year a specified number of emissions allowances are allocated to the market, 43% without cost and 57% through auctioning. Each allowance affords the owner the right to emit one ton of greenhouse gases (measured as carbon equivalents). Allowances can be saved and traded. The system provides a ceiling on the total amount of emissions from the sectors covered. The amount is currently reduced by 2.2% of the average yearly number of emissions allowances allocated between 2008 to 2012. This corresponds to a yearly reduction of 43 million allowances per annum. In 2019, emissions of greenhouse gases from participants in the system amounted to 1,385 million tons. This was 38.5% of total emissions of 3,602 million tons in the EU (37.3% if international aviation is included in the calculation). In terms of CO₂, the coverage of EU ETS is close to 50% since most other greenhouse gases (methane and nitric oxide) are emitted from agriculture and waste management, which are not part of the EU ETS.
The efforts sharing regulation (EU ESR), which covers the other sectors not included in the EU ETS: small industrial installations, agriculture, the operation of commercial and residential buildings, maritime and road transport, and waste management. A greenhouse gas reduction target is set for the EU as a whole and then for each member state (‘efforts sharing’). The regulation implies a linear reduction of emissions for every year between 2021 and 2030. By 2030, emissions are required to be 40% lower than the 2005 level in Sweden and 39% lower in Denmark and Finland. Iceland and Norway have agreed to enforce the same reduction. The regulation allows a number of flexibility mechanisms to ensure cost-effectiveness. In particular, emissions allocations can be traded between member countries as well as Norway and Iceland. Within the EU ESR sector, buildings and road transport accounted for 37.8 and 20.1% of emissions under ESR in 2019. Agriculture accounts for a very small share of carbon emissions but a large share of other greenhouse gases, i.e., methane and nitric oxide. Measured by the carbon equivalent, agriculture was responsible for 10.6% of total emissions in the EU. Of these emissions, only 2.5% were in the form of CO₂.
Regulation of emissions from Land Use, Land-Use Change, and Forestry (LULUCF). Land use and forestry are both carbon emitters and absorbers. The land use and forestry sector in the EU, as a whole, absorbs more carbon than it releases into the atmosphere, meaning that it is a net carbon sink. The net uptake was 249.1 million tons of CO₂e (carbon dioxide equivalents) in 2019. The net uptake varies considerably across countries. Among the Nordic countries, Sweden has a large net uptake, around 40 million tons per year (41.6 MtCO₂e in 2021, which was almost as large as the total emissions of 47,9 MtCO₂e), while Denmark is a net emitter. The current EU regulation requires that the net uptake is positive in each country.

In addition, prior to Fit for 55, there were other goals, regulations and directives in specific areas. The average emission intensity of cars and vans measured in CO₂/km is capped for each manufacturer. Currently, the cap is 95 grams CO₂/km for cars and 147 grams for vans. Directives also existed to encourage the expansion of renewable energy, the increased energy efficiency of buildings and the taxation of energy products and electricity.

EU ETS

Fit for 55 includes a comprehensive set of changes to emissions trading that should result in an overall emission reduction of 55% by 2030 compared to 1990.

For a more detailed account, see European Council and Council of the European Union. (n.d.).

Within the EU ETS, the number of emission allowances allocated to the market each year will fall faster. The yearly reduction will increase from 43 to 84 million tons between 2024 and 2027, and to 86 million thereafter. If this reduction continues, no allowances will be allocated after 2040.

In addition, emissions from maritime transport will be included in the ETS, and the free allocation of emission allowances to intra-EU aviation and industries that are major carbon emitters will be gradually phased out as the carbon border adjustment mechanism (see below) is phased in. The EU participates in CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation), a global scheme for offsetting carbon emissions from international aviation. EU operators will offset emissions from their operations outside the union.

Carbon border adjustment mechanism (CBAM)

The new carbon border adjustment mechanism seeks to prevent emission reductions in the EU being offset by increased emissions outside the Union either by the relocation of production from EU to non-EU countries or by increased imports of carbon-intensive products (‘carbon leakage’). Exporters to the EU will have to buy CBAM certificates at a price equal to the price of ETS allowances in the same product category to ensure a level playing field between the EU and their non-EU competitors. Initially, CBAM applies to producers of iron and steel, aluminium, fertilisers, cement, hydrogen and electricity and includes some up- and downstream activities.

The creation of CBAM will facilitate the phasing out of the current free allowances system to major carbon emitters to prevent carbon leakage. Free allowances will be gradually phased out as the CBAM certificates are phased in.

Non-ETS sectors

Fit for 55 sets more ambitious national targets for the sectors covered by the ESR – agriculture, the operation of buildings, small industrial installations, road transport and waste management. For 2030, the required reductions will be 50% relative to 2005 emissions for Denmark, Finland and Sweden.

A new, separate emissions trading system for road transport, the operation of buildings and the use of other fuels will also come into operation in 2026. The number of allowances allocated every year will fall linearly. If the agreed reduction factor is maintained, no new emission allowances will be allocated after 2044. In total, the new and the old system cover almost all carbon emissions (however, they only account for a small share of other greenhouse gas emissions such as methane and nitric oxide).

In addition to more ambitious national targets for road transport and its inclusion in a new emission trading system. Fit for 55 also sets more ambitious targets when it comes to carbon emissions from new cars and vans. From 2035 onwards, all new cars and vans must be emission-free in the EU.

Land Use, Land-Use Change and Forestry (LULCF)

As part of Fit for 55, there is a provisional agreement to increase the net absorption from LULUCF from 249.1 to 310 MtCO₂ by 2030. Member states will be assigned national targets depending on the extent of their landmass and forests. These targets vary greatly across countries. For Sweden and Finland, the targets for 2030 are an uptake of 47.3 and 17.8 MtCO₂e, respectively, while Denmark is allowed to have a net release of 5.3 MtCO₂e.

Fit for 55 and EU emissions

The Fit for 55 package puts a strict cap on almost all future EU carbon emissions. If the proposed rate at which the number of allowances allocated within EU ETS is maintained, no new allowances will be awarded after 2039. Until then, 16 billion new allowances, each corresponding to one ton of emissions, will enter the market. Similarly, in the new emission trading system for buildings and transport, approximately 11 billion emission allowances will be sold. Since the systems cover almost all carbon emissions, these will be capped at 27 billion tons. This corresponds to 60 tons per current EU citizen. To put this number in perspective, the Intergovernmental Panel on Climate Change (IPCC) carbon budget to ensure global warming stays below 1.5 degrees is 420 billion tons, corresponding to 52 tons per global citizen. The carbon budget for 2-degree warming is 1,150 billion tons, corresponding to 144 tons per citizen. Although emissions in the EU will be somewhat higher than 60 tons per citizen, since the new emission trading system will not be in place until 2026, it is clear that the Fit for 55 package represents an ambitious step forward.

National vs EU climate policies

The Nordic countries' emission abatement targets are more ambitious than those currently set by the EU. Denmark’s target for 2030 is 70% compared to 1990, Finland’s target is climate neutrality by 2035 and net negative by 2040 (forests account for more than 75% of Finland’s landmass), Norway's target is 55% by 2030, and Sweden's target for the non-ETS sector is 63% by 2030 relative to 1990 – and overall climate neutrality by 2045. With Fit for 55, the gap is closing considerably and, in some areas disappearing altogether. The deal includes some regulatory policies that differ from national tools. The Nordic countries also have sector targets that can appear redundant or at odds with EU policies. Here are some examples of how Nordic climate policies can or may be affected by Fit for 55.

The common view (shared by Rolf Golombek and Michael Hoel, see below) is that a more ambitious abatement in the ETS sector in one country allows room for higher emissions in another EU state since the number of allowances remains unchanged and therefore leaves the total emissions unaffected. In other words, a more ambitious national target gives rise to carbon leakage to the rest of the EU, even if this is not necessarily inconsistent with overall EU policy. Contrary to the more common view, Frederik Silbye and Peter Birch Sørensen argue in their paper that Denmark’s more ambitious national policy for the ETS sector actually affects the EU cap on emissions and makes it more restrictive.

Matti Liski and Iivo Vehviläinen take the more ambitious Finnish climate policies in three sectors as a given and demonstrate how these could be made consistent with EU policies and remain cost-effective. In the road transport sector, they show that a national emission trading system can exist in parallel with an EU-wide system, making reaching more ambitious national targets possible while simultaneously achieving cost efficiency. In the building and construction sector, they argue that a more ambitious national target can be reached by creating an emissions trading system for the actual construction element, which is not covered by the new emissions trading system for the heating of buildings.

Norway has a substantial set of climate policies, including general as well as sector- and even city-specific measures (Oslo). Rolf Golombek and Michael Hoel argue that Norway does not need targets and policies for some sectors already covered by the EU ETS because of the reason mentioned above: The total amount of emissions in the EU is fixed, so these policies become ineffectual in reducing emissions under the cap. In the non-ETS sector, they argue that the Norwegian tax exemption for electric cars will become redundant when the EU creates an emissions trading system for the road transport sector and mandates that cars and vans must be emission-free by 2035.

David von Below, Björn Carlén, Svante Mandel and Vincent Otto use a detailed general equilibrium model of the Swedish economy to analyse the costs of self-imposed Swedish climate policies. These include a stricter emission target for the ESR sector, a special target for emissions from the transportation sector and restrictions on purchasing ESR allocations from other countries under the flexibility mechanism. The latter is particularly expensive and implies a cost in the order of 1% of national income. If ESR allocations are not used, different combinations of increased carbon taxes and forced biofuel blending in petrol and gas are analysed. To reach the national targets, Swedish carbon taxes need to be increased to between €700 and €1,700 per ton of CO₂, corresponding to approximately 7 to 17 times the current price.

References

Vis, P., Slingenberg, Y., & Lefevere, J. (2017). EU climate policy explained, (P.Vis, editor, J.Delbeke, editor) Routledge. European Commission, Directorate-General for Climate Action. Retrieved from https://data.europa.eu/doi/10.2834/656859

European Council and Council of the European Union. (n.d.).Fit for 55, , Retrieved from https://www.consilium.europa.eu/en/policies/green-deal/fit-for-55-the-eu-plan-for-a-green-transition/