„Decarbonization of manufacturing companies " (EU ETS) analyses the challenges and opportunities related to the decarbonisation of manufacturing companies in the EU. Decarbonisation of European manufacturing companies is key to achieving of the EU climate neutrality objective. In 2022, emissions from the manufacturing sector accounted for 21 % of total EU emissions. This sector, together with electricity, gas, steam and air conditioning supply, was one of the largest greenhouse gas producers in Europe. Although industrial emissions have decreased, progress is insufficient and the pace of emission reductions needs to be increased to reach the 2030 and 2050 targets. The European Scientific Advisory Board on Climate Change has highlighted that the average annual emission decline from 2005-2022 (-17 Mt CO2e per year) needs to accelerate to -24 Mt CO2e per year in 2023-2030 and -19 Mt CO2e per year in 2031-2050. However, decarbonisation must not jeopardise economic competitiveness, as the manufacturing sector makes a significant contribution to the European economy. Policies must be designed with their social impacts in mind, considering that higher relative costs of decarbonised production may lead to reduced output and increased import dependence. Mario Draghi warns in his European Competitiveness Report of a possible acceleration of deindustrialisation without targeted policies.

Emissions and production trends of manufacturing companies in the EU ETS: Emissions from the manufacturing sector are covered by the EU ETS, which is a key pillar of Europe's decarbonisation strategy. The coverage of emissions in these sectors exceeds 75 %. In 2023, there was a 7.5 % decrease in emissions from the manufacturing sector in the EU ETS compared to 2022, which the Commission attributes to a combination of reduced production and increased efficiency. European industrial production fell by 1.2 % in 2023 compared to 2022, which can be explained by the higher relative energy costs of European firms compared to their global competitors. Although to a limited extent, emissions costs also put pressure on European competitiveness. The increase in carbon prices over the last 5 years has led to increased production costs, but these amounted to only 2 % for European steel producers in 2019 and around 10 % for cement producers in 2021. Companies at risk of carbon leakage have been given free allowances to limit the negative impacts of increased carbon costs and to support the competitiveness of European producers. With the “Fit for 55” reforms, increased pressure is expected from the EU ETS, with future carbon prices in the EU projected to reach up to €250/tCO2 by 2030. Analyzing the evolution of emissions and production levels is key to assessing progress in decarbonisation. The aim is to achieve a reduction in emissions intensity, which means decoupling emissions levels from production levels. Since 2005, the emission intensity estimates for steel, cement and chemicals in the EU have been relatively stable or even slightly increasing, but since 2020 there has been an accelerated reduction in industrial emission intensity, with significant differences between sectors. In 2023, the pulp and paper sector reduced its emission intensity the most, while the chemical industry increased it.

EU ETS as a driver of industrial innovation: The EU ETS is intended to incentivise companies to invest in low-carbon or carbon-neutral technologies. Manufacturing companies in the EU ETS interviewed by the EIB consider carbon pricing to be an important factor for investment in green technologies and processes. However, persistent investment gaps and low uptake of clean production practices show that the current policy framework has not been effective enough. Academic literature finds limited impact of the EU ETS on low-carbon technological change between 2005 and 2013. The scheme appears to have had a greater impact on stimulating low-carbon innovation than on its uptake during this period. Over-allocation of free allowances has also had a negative impact. More recent data after 2013 suggest that the scheme has incentivised investment. However, the EU ETS alone is unlikely to unlock the necessary investment in the development and deployment of low-carbon technologies. Therefore, a combination of policy instruments, including carbon pricing, technology mandates and targeted research subsidies, is needed. There are significant differences between companies in their willingness or ability to invest in decarbonisation. Different EU sectors have different decarbonisation pathways. For example, for the iron and steel industry, the main pathway is the transition to electric arc furnaces, while for the cement industry, the most promising pathway is carbon capture and storage (CCS). To incentivise decarbonisation, a sector-specific or value chain approach is important, rather than just specific technologies. The design of free allowances in the EU ETS should be reviewed to effectively reward decarbonisation. For example, for the cement sector, a transition from a clinker-based benchmark to a product-based benchmark could support decarbonisation in a technology-neutral way.

Uncertainty as an obstacle to low-carbon investments: Companies often cite uncertainty about future energy and carbon costs, as well as regulation and taxation, as the main obstacles to decarbonisation. The EIB survey confirms this, with over 90 % companies surveyed saying that uncertainty is holding them back from investing in low-carbon technologies. However, European industrial companies have one of the clearest and most structured regulatory environments compared to their international competitors. This includes a commitment to climate neutrality by 2050 and measures to prevent carbon leakage. It is therefore questionable whether uncertainty is a real barrier or just a perceived barrier. Environmental innovation requires long-term commitment from companies, and stability of policies and regulations is key. The EU ETS is an example of a policy instrument that has reflected the EU’s climate ambitions for two decades. Regulators have sought to address policy uncertainty by setting long-term emission reduction targets. Predictability of carbon price developments is also key. The introduction of the Market Stability Reserve (MSR) in 2019 was intended to stabilise the carbon price and reduce the risk of extreme price fluctuations. The introduction of a floor price or price band, as well as carbon contracts for difference (CCfDs), which would provide companies with financial certainty for low-carbon investments, has also been discussed. However, uncertainties remain, in particular regarding the EU’s post-2040 strategy and the role of carbon capture and storage (CDR). The future of addressing carbon leakage after 2026, when the Carbon Border Compensation Mechanism (CBAM) comes into operation, is also unclear. There is a need for clarity as soon as possible on the evolution of the EU’s carbon pricing framework after 2030. Companies’ investment decisions are also influenced by the overall economic situation and other incentives from EU and Member State policies. Overall, policy consistency and alignment are key.

A call to action for industrial companies lagging behind in decarbonization: Some companies still do not have a decarbonisation strategy in place. These companies represent ‘vulnerable spots’ and will be most affected by tightening climate policies. One explanation could be that these companies do not consider decarbonisation as a strategic priority and rely on protection from their Member States. Another explanation could be the lack of resources for decarbonisation, which often concerns small and medium-sized enterprises (SMEs) in energy-intensive sectors. Some economic activities in certain locations may disappear as a result of the transition to low-carbon production, which will have an impact on regions, particularly in Central and Eastern Europe. A common European approach to managing this structural change is therefore needed, which could build on existing initiatives such as the Just Transition Mechanism and the Net Zero Emissions Industrial Act. The upcoming Clean Industry Deal will be a key opportunity to put in place the necessary measures.

Manufacturing companies need to decarbonise for the EU to achieve its climate neutrality. However, current trends show that European industry is not on track to meet its emissions reduction targets. A sector-specific approach and a rethink of the design of free allowances in the EU ETS are important to incentivise decarbonisation. Carbon contracts for difference can offer relief and risk reduction in the short term. However, clarity is still needed on the EU’s carbon pricing framework after 2030. Decarbonisation must not jeopardise economic competitiveness and policies must take social impacts into account. The emergence of a competitive and decarbonised industrialised EU may lead to the closure of some manufacturing companies, which requires increased strategic coordination at EU level to mitigate the negative consequences in the affected regions. Spring

Glossary of key terms

• Decarbonization: The process of reducing emissions of carbon dioxide and other greenhouse gases with the aim of achieving carbon neutrality.
• EU ETS (European Union Emissions Trading System): An emissions trading system in the European Union that sets a limit on the total amount of greenhouse gases that covered entities can emit.
• Carbon intensity: The rate of greenhouse gas emissions per unit of economic activity (e.g. production, GDP). Reducing carbon intensity means decoupling emissions from growth.
• Carbon Leakage: A situation where businesses move their production to countries with less stringent environmental regulations to avoid the costs associated with carbon policy.
• Low-carbon technologies: Technologies that produce significantly fewer greenhouse gases compared to traditional technologies, or none at all.
• Carbon Contracts for Difference (CCfDs): Financial instruments that provide companies with certainty about the future price of carbon, thereby reducing the risk of investments in low-carbon technologies.
• Fit for 55: The European Commission's 2021 package of legislative proposals aims to reduce EU greenhouse gas emissions by at least 55 % by 2030 compared to 1990 levels.
• CBAM (Carbon Border Adjustment Mechanism): A carbon offset mechanism at the EU border, which will apply carbon tariffs on imports of selected carbon-intensive products.
• Pockets of vulnerability: A designation for companies or sectors that are particularly vulnerable to the negative impacts of stricter climate policies due to a slower pace of decarbonization.
• Just Transition Mechanism: The EU's Just Transition Mechanism, which provides financial support to regions and communities most affected by the transition to a climate-neutral economy.
• Net Zero Industry Act: The Net Zero Industry Act aims to strengthen the competitiveness of European industry in clean technologies.
• Emission intensity: The amount of greenhouse gas emissions per unit of output or gross value added.