June 21. 2024. 6:17

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CO2 removals: The case for establishing a European Carbon Central Bank

As part of the EU’s carbon market, the control of CO2 removal certificates could be managed by a Carbon Central Bank to ensure security for all players, write Wilfried Rickels, Roland Rothenstein, and Felix Schenuit.

In its Fitfor55 climate policy overhaul, the EU sets not only the path to reducing net greenhouse gas emissions by 55% until 2030 but already prepares the next steps to net-zero and net-negative CO2 emissions.

This becomes in particular evident by looking at the new reduction path for the EU Emissions Trading System (ETS), covering in particular the energy and industrial sector.

In this system, the annual volume of new emission certificates (allowances) declines linearly and, in the course of the reforms now adopted, the last allowance is expected to be issued as early as 2039, rather than between 2057 and 2060 as previously envisaged.

To reach this target, emissions in the energy and industrial sectors must fall quickly, CO2 capture and storage (CCS) supply chains must be built, and atmospheric CO2 removal (CDR) must be gradually integrated into the EU ETS.

The latter must exceed remaining or gross emissions after 2039 so that net-negative emissions are then achieved.

While incentives for CCS with geological or permanently chemically storage are already in place since companies are not required to surrender allowances for stored CO2, this is not the case for CDR. CDR reverses the process of emitting CO2.

In the logic of the EU ETS, this would mean that certificates equivalent to allowances, the currency of the EU ETS, are created (or be reactivated from the pool of already surrendered allowances).

However, the creation of allowances (or carbon removal certificates) requires sufficient physical underlying, i.e. physical CO2 removal, such that the net emissions do not increase by this kind of currency creation.

We argue that this kind of CO2 currency control could be managed by a Carbon Central Bank. In more detail, we propose that physical CO2 removal should already be purchased well before 2039, converted into CO2 removal certificates and booked in a corresponding reserve, so that they can then possibly be auctioned.

In this way, CO2 prices on the path to net zero become controllable.

The role of a Carbon Central Bank

A Carbon Central Bank would mean more security for all players. Even if it is specified how many emissions may still be emitted in the EU ETS, it is unclear how CO2 prices will develop.

While the transformation of the energy sector appears feasible, there are still numerous questions and innovation gaps for the industrial, aviation, and the soon-to-be included shipping sector.

Additional pressure is being exerted by the early reduction in the free allocation of emission allowances in the course of the introduction of the CO2 border adjustment. This provides for a CO2 price to be paid for imports into the EU in the future.

This is intended to compensate for the competitive disadvantage of European industry in supplying the European market and, in return, to abolish the free allocation already by 2034 and thus before the end of the allowance issue.

Against this background, there is concern that excessive CO2 price jumps and volatility on the way to net-zero emissions will jeopardise political acceptance and support for the EU ETS.

In the past, there have already been repeated calls from individual countries in the EU to limit CO2 prices in the EU ETS by issuing additional certificates.

Combination of price and volume control

The economic literature is comparatively unanimous that in a situation of high uncertainty about abatement costs, quantity and price control should be combined.

Although the EU ETS already includes a provision to counter excessive price spikes by releasing additional allowances from the market stability reserve, this mechanism can only work as long as allowances are available.

Accordingly, it makes sense to be able to use CO2 removal certificates to counter-balance emissions even before 2039.

Unlike conventional allowances, the auctioning of CO2 removal certificates does not change net emissions. If fewer certificates have to be released from the market stability reserve as a result, net emissions will actually fall.

CO2 removal technologies do not yet exist on an industrial scale. On the contrary, technologies such as Direct Air Capture with Carbon Storage (DACCS) still require significant learning and economies of scale if they are to make their contribution to climate policy.

An upfront procurement program could stipulate the necessary learning-by-doing effects. Note that this is very different to a subsidised, unconditional integration where for example the difference in the prevailing allowance price is compensated.

We propose to develop the CO2 removal sector in parallel with abatement in the EU ETS and to integrate it only gradually so that incentives exist for technology development in both removal and abatement.

Creation of a CO2 Removal Allowance Reserve

In doing so, our proposal to manage removals through a Carbon Central Bank takes advantage of the fact that CO2 emissions are a stock variable.

The purchase of CO2 removals and the auctioning of the associated allowances can—and must—diverge in time because credible intervention to support the price of CO2 requires that a sufficiently large reserve be built up in advance.

Such a purchase program could be financed by the additional proceeds from the reduced free allocation of allowances in the course of the introduction of the CO2 border adjustment.

These proceeds should flow into the EU Innovation Fund and also be earmarked to promote technologies in the area of carbon removal. Technology-specific auctions would then allow the different, technological maturity of CO2 removal methods to be taken into account within the purchase.

Such a purchase program would be based on the amount of CO2 removal. Only after purchase would conversion to CO2 removal allowances occur. This would address potential certification and permanence issues for different removal methods.

Even if DACCS and bioenergy with carbon capture and storage (BECCS) are the main technologies being discussed for long-term integration into the EU ETS, it makes sense to promote other capture methods as well.

The purchase program, or the institution entrusted with it, would thus also function as a kind of clearing house that, analogous to the current allowances in the EU ETS, generates homogeneous CO2 removal certificates which is necessary for a liquid market.

The question of how to integrate CDR into the ETS will receive more and more attention in the context of the 2040 target debate.

A Carbon Central Bank offers the chance to shape the integration gradually and responsibly—this new institution could be the key facilitator for the transition of the ETS towards a net-zero-compatible policy instrument.