Effective CO2 cost balance needed for the commodity industry
The European basic industry must invest to remain competitive, yet it faces a significant dilemma. Traditional production technologies pose long-term risks to climate targets, while climate-neutral alternatives remain costly and economically unviable in the short term. The European Emissions Trading Scheme (EU ETS) aims to improve the financial feasibility of sustainable technologies, but international competition presents a challenge. Free allowances in emissions trading help maintain competitiveness but reduce incentives for climate-neutral production. The EU’s border adjustment mechanism (CBAM) was introduced to address CO2 cost disparities, yet its implementation has not sufficiently compensated for international price differences. Until CO2 pricing becomes comparable worldwide, a pragmatic transition solution is needed.
The European basic materials industry, particularly in sectors such as steel, cement, and chemicals, faces a challenging task. It must transition to climate-friendly practices while competing in a global marketplace. Energy-intensive production processes generate significant CO2 emissions, and the EU’s CO2 pricing through the ETS is intended to make climate-neutral production more viable. However, outside the EU, CO2 costs are significantly lower or nonexistent. This discrepancy could lead to production relocation and carbon leakage, where companies move operations to regions with lower emissions costs. To prevent this, raw material manufacturers in the EU have historically received free emissions certificates, but this also diminishes the motivation to invest in sustainable production and material efficiency.
The introduction of the CBAM aims to correct this imbalance by replacing free allowances with a mechanism that adjusts for CO2 cost differences between the EU and third countries. However, the CBAM does not fully account for export-related CO2 costs or the complexity of value chains. As a result, high CO2 price discrepancies continue to impact competitiveness. Discussions around extending free allowances have emerged, but such a move could hinder incentives for sustainable production. Further complicating matters, the current U.S. administration under Donald Trump has shown no intention of implementing a comparable CO2 pricing system in the near future.
A practical transitional strategy is needed to maintain EU industry competitiveness while CO2 pricing mechanisms mature globally. Three key instruments can be combined to achieve this:
EU Emissions Trading: Companies continue receiving free allowances but must implement climate neutrality transformation plans. This incentivizes efficiency improvements in existing production.
Climate Protection Contracts: These contracts provide financial rewards for CO2 reductions, encouraging investments in sustainable production technologies.
Clean Economy Contribution: A standardized levy on domestic and imported raw materials promotes material efficiency and funds climate protection initiatives.
The CO2 compensation framework operates through three mechanisms: free allowances for conventional manufacturers, financial incentives for climate-neutral producers, and a clean economy contribution applied to both domestic and imported raw materials. This levy can be refunded on exports in accordance with world trade regulations, ensuring compliance and minimizing competitive distortions.
The CBAM has only partially addressed CO2 cost disparities. While it encourages global partners to adopt CO2 pricing, it does not fully mitigate competitive disadvantages. Firstly, export-related CO2 costs remain uncompensated due to trade law constraints, exposing a significant portion of European manufacturing to carbon leakage risks. Secondly, processing industries are not adequately protected under CBAM, forcing European manufacturers to bear higher material costs than non-EU competitors. Thirdly, loopholes such as resource shuffling—where climate-friendly production is directed toward EU exports while more polluting processes are redirected elsewhere—allow companies to sidestep the border adjustment mechanism.
A Clean Economy Contribution offers a viable alternative to these challenges. By applying a fixed levy on all raw materials, regardless of origin, and allowing refunds for exports, it reduces administrative complexity and trade distortions. This contribution is based on the previous year’s average EU ETS CO2 price and adjusted using sector-specific benchmarks. It also generates substantial revenue—potentially €50 billion annually at a CO2 price of €75 per ton—which can be reinvested into industrial decarbonization and circular economy initiatives.
By integrating the Clean Economy Contribution with the existing EU ETS framework, the industry would benefit from stronger incentives for material efficiency, increased funding for climate protection, and greater alignment with global trade rules. The transition to climate-neutral production remains financially challenging due to the high cost of new technologies. To address this, Germany, the Netherlands, and France are implementing Carbon Contracts for Difference (CCfD), which provide regulatory security for investors in sustainable production.
For this strategy to be effective across Europe, sufficient funding for climate protection contracts is needed. A Clean Economy Contribution at the EU level would provide this financial support while maintaining fair competition. A study commissioned by the European Commission’s Directorate-General for Taxation and Customs Union (TAXUD) found that a Clean Economy Contribution effectively reduces greenhouse gas emissions, minimizes carbon leakage risks, and provides strong financial backing for industrial transformation. Despite this, the EU has prioritized CBAM to incentivize international partners to implement CO2 pricing.
While the CBAM is being phased in, its financial impact will not be fully realized until 2034. In the meantime, introducing a Clean Economy Contribution would help maintain industrial competitiveness and drive climate-friendly investments. Implementing this contribution would ensure that CO2 pricing supports industrial modernization even before global CO2 prices converge. Moderate price increases would result, but these would be progressive and have a minimal impact on lower-income households. For instance, at a CO2 price of €75 per ton, the cost increase for wealthier households would be approximately 0.5%, with lower-income groups experiencing even less impact.
To safeguard the competitiveness of the European basic materials industry, a balanced approach is necessary. The EU must continue emissions trading while ensuring that raw material manufacturers and processing companies do not bear disproportionately high CO2 costs. Global CO2 pricing progress, supported by CBAM, remains the long-term solution. However, until international CO2 pricing reaches parity, a transitional framework is essential. By combining emissions trading, climate protection contracts, and a Clean Economy Contribution, the EU can effectively balance environmental goals with economic competitiveness.
The new German federal government should advocate for the introduction of a Clean Economy Contribution at the EU level. Implementing this measure within the next two years would optimize the effectiveness of the EU ETS. Additionally, national governments should expedite climate protection contract tenders and set quotas for climate-neutral raw material production. By taking these steps, the EU can drive sustainable investments, reduce carbon dependency, and maintain its leadership in industrial innovation.
Source: DIW Berlin
