Europe Faces an Economic Reality Check on Its Climate Agenda

Economic

Summary:

EU leaders are divided over a 90% emissions-cut target by 2040 as high energy costs and industrial strains threaten competitiveness, forcing a rethink of Europe’s costly green transition.

Europe is at a crossroads on climate. The road to net zero still stretches ahead, but the journey is getting tougher as countries warn their economies can’t absorb the rising costs of meeting emissions targets.

EU leaders arrive in Brussels on Thursday divided over how fast and how far to push the green transition. A key flashpoint is the European Commission’s plan to cut emissions 90% by 2040 from 1990 levels. Leaders are unlikely to agree to a specific target at the summit, instead focusing on "enabling conditions" aimed at shielding businesses and consumers from higher bills that could spark voter backlash.

“It all boils down to the impact of climate measures on the economy,” said Huan Chang, an analyst at BloombergNEF. “There’s a concern that the cost of emissions-reduction regulations could fuel inflation alongside high energy costs that have already been hurting the EU’s industrial competitiveness.”

Brussels faces an uncomfortable reality: Europe’s energy transition risks undermining its economic one. With the US and China powering ahead thanks to cheaper energy and heavy state support, European industries are losing ground. The bloc’s higher costs threaten to hollow out its industrial base — even as it leads the world in climate ambition.

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EU Emissions Pathway | How the EU is Aiming to Reach Climate Neutrality

The challenge on Thursday will be finding common ground among countries with unequal energy resources, wealth, and industrial muscle. It’s becoming clear that climate is slipping down the list of priorities as governments seek to ramp up defense spending and avoid trade conflicts.

Even if the EU sticks with its overall climate target, member states will want to make sure their national interests are protected.

“It reflects that Europe is facing so many challenges on so many fronts that some are afraid if we move too far ahead on climate, if we’re too ambitious, we won’t be able to handle it economically,” said Mette Frederiksen, Prime Minister of Denmark, which holds the EU’s rotating presidency. “It’s a shame.”

Senior EU diplomats speaking on the condition of anonymity said that conclusions drafted before the summit struck a delicate balance between ambitious countries and more skeptical nations, but cautioned that it could all unravel once leaders enter the room. The proposed wording on a revision to the EU’s emissions trading system that covers buildings and road transport is seen as particularly fragile.

Fragmented approach

At the heart of EU climate policy is the carbon market — the first major cap-and-trade program globally — which imposes limits on polluters that get tighter over time. The system’s remaining allowances are due to vanish over the next 15 years, raising concerns that industry won’t be ready.

Germany, Europe’s biggest economy, has signaled it will fight for better protection of its ailing energy-intensive industry. Chancellor Friedrich Merz is set to call for a slower pace of reductions in the Emissions Trading System in the next decade, a change that would give the industry more time to decarbonize while still meeting targets.

German firms chemical firms including BASF SE and ammonia producer SKW Stickstoffwerke Piesteritz GmbH also want additional tweaks to the carbon market to prevent a steep increase in costs. They want to continue receiving free allowances for longer.

"We need decarbonization, but decarbonization must never mean deindustrialization,” Germany’s finance minister and Merz’s coalition partner, Lars Klingbeil said on Oct. 22. “We can only achieve decarbonization with a strong industry."

France too is looking for more protections for its industry through trade measures. Paris wants the EU to tighten the bloc's carbon border levy, as well as shield European steel makers from competition from abroad before it will back the 2040 target. While Finland and Sweden are calling for a revision of rules on forestry.

Energy costs and bills

The EU is making good progress, boosting the share of renewable energy to 24.5% in 2023, a tripling from 2004 levels, according to the latest official data published in December.

Wholesale energy prices have eased from record highs in 2022 after Russia invaded Ukraine and curbed gas supplies to Europe. But costs for industry are still much higher — last year electricity prices in the EU were more than twice those in China and the US, according to calculations by lobby group BusinessEurope.

"We literally need to hang onto their coattails," said David King, Founder and Chair of the Climate Crisis Advisory Group, talking about how to stay competitive with China. “This is a matter of future proofing Europe along with the rest of the world."

Thursday’s meeting will test whether leaders can find a way to ease the cost burden of the green transition for companies and consumers while keeping climate ambition intact.

Harder From Here

The next phase of cutting emissions is going to be more difficult as deployment of new technologies, such as carbon capture and storage or hydrogen, is costly and slow.

“The lowest-hanging fruit has already been picked when it comes to reducing emissions and moving to cleaner energy sources,” said Linda Kalcher, executive director of the Strategic Perspective think tank. “European power generators have walked away from coal and are increasingly relying on renewables. That means that in the next decades, we will need to deploy more complex solutions.”

The ETS2, will be a second EU carbon market, putting a price on emissions from buildings and road transport. Many politicians fear that an additional levy at the petrol pump could turn citizens against the green transition and leaders are set to clash on the planned rollout on Thursday.

Commission President Ursula von der Leyen pledged earlier this week to adjust the cap-and-trade system to ease concerns among member states that a spike in carbon prices could spark public backlash similar to France’s Yellow Vest protests in 2018.

The proposed tweaks — including stronger price controls — may calm some governments, but others, led by Poland, Hungary and Cyprus, are demanding more drastic steps, such as delaying ETS2’s launch, currently scheduled for 2027.

The European Central Bank estimates that the scheme, if implemented as designed, could add as much as 0.4 percentage points to euro-area inflation in 2027. Goldman Sachs economist Katya Vashkinskaya projects a similar effect, forecasting a 0.2 percentage-point boost — the midpoint of the ECB’s range.

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The European Union Will Struggle to Reach Its 2030 Climate Goal | Annual total net carbon emissions in million tons

Out There Alone

Europe’s push on climate action is being called into question. President Donald Trump’s second withdrawal from the Paris Agreement and his administration’s efforts to derail climate diplomacy — including a recent move to block a shipping emissions levy at the International Maritime Organization — have shaken faith in international cooperation.

Climate experts are warning that it could spell trouble for the COP30 climate negotiations in Belem, Brazil next month and give opponents of Europe’s ambitious climate policies ammunition to lobby against fast emissions cuts at home.

“The global environment is not conducive,” said Jos Delbeke, professor at the European University Institute in Florence and former top climate official at the commission. “We’re losing the US — Trump is slowing down investment in renewables at home and delaying progress internationally. And at the same time the EU needs to find an effective strategy to stave off the competition from China in clean technologies. ‘’

What’s next

Summit discussions among EU leaders are typically reserved for the most divisive issues, with outcomes adopted unanimously — a process that demands compromises from all sides. While leaders don’t sign off on draft laws, they set the political direction for ministers to follow on climate policy.

The political statement from the summit is expected to clear the way for environment ministers to work toward a common position on the 2040 climate goal. Endorsing the 90% emissions-cut target would require qualified-majority support, a lower bar than unanimity.

Still, diplomats are split on whether a deal can be reached at the extraordinary environment council in Brussels on Nov. 4. Member states remain divided over how — and how quickly — to push the green transition across sectors such as agriculture, transport and industry.

“The goals are good ones, but we really need to assess whether we have all the tools,'' said Evika Silina, prime minister of Latvia. “We cannot afford to lose Europe's competitiveness.”

Source: Bloomberg

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