10 Aug 2021, 09:00

Germany’s carbon pricing system for transport and buildings

The German government has decided to put a price on greenhouse gas emissions in the transport and building sectors from 2021 as a key instrument to help reach its climate targets. It starts with a fixed price, which increases every year before allowances are auctioned from 2026 onwards. This factsheet explains the details of the system, reform ideas in the 2021 election campaign, legal doubts and expected distributional effects, as well as its possible integration into a new EU emissions trading system. [Update includes EU Fit for 55 proposals]

A new carbon price in Germany has increased consumers’ bill for fuels such as petrol and diesel by several cents per litre since the beginning of 2021. The German government in 2019 adopted its fuels emissions trade law (Brennstoffemissionshandelsgesetz - BEHG), which introduced a CO₂ price on fuels used predominantly for heating and transport.

Germany, like all EU member states, participates in the European Emissions Trading System (EU ETS), which sets an overall limit on greenhouse gas emissions from power stations, energy-intensive industries (e.g. oil refineries, steelworks and producers of iron, aluminium, cement, paper and glass) and intra-European commercial aviation. The ETS is one of a growing number of carbon pricing initiatives worldwide. The latest version of the World Bank’s State and Trends of Carbon Pricing report counts 64 such instruments in operation in 2021.

Until 2021, however, greenhouse gas emissions from the transport and building heating sectors had no German or EU-wide price. The two sectors largely rely on fossil fuels, such as heating oil, natural gas, gasoline and diesel. These sectors were responsible for more than a third of Germany’s greenhouse gas emissions in 2020.

Graph shows greenhouse gas emission trends in Germany by sector 1990-2020, targets for 2030, 2040, 2045. Source: CLEW 2021.

The system

The national emissions trading system for transport and heating fuels will exist in parallel with the EU-wide ETS and cover the bulk of the greenhouse gas emissions not included in the ETS. There will be some overlaps where fuels are already covered in the ETS, but will also be priced in the new system. The law already stipulates that companies will be reimbursed, and an additional regulation is meant to avoid the need for companies to pay twice in the first place.

The new system is going to be a ‘cap and trade’ system in which the federal government sets an annual total emissions limit for transport and heating fuels in line with its annual total non-ETS targets prescribed by the European Union. The EU Effort Sharing scheme prescribes annual greenhouse gas emission budgets for all non-ETS sectors combined. However, these also include emissions that do not come from burning transport and heating fuels, such as methane emissions in agriculture. Those will not be covered by the planned German system.

Emission allowances are transferable and can be traded. They will generally be auctioned. However, during an initial phase there will be a fixed price at which they are simply sold to companies (2021-2025).

The federal government says the system’s implementation will cost companies about 31 million euros annually due to increased bureaucracy and necessary infrastructure installations.

The responsible government organ is the Federal Environment Agency (UBA).

 

What and who will be priced?

  • transport and heating fuels, such as petrol, diesel, heating oil, natural gas and coal
  • covers heating emissions in the buildings sector and of energy and industry facilities not covered by the EU ETS
  • covers transport emissions except for air transport
  • does not cover non-fuel emissions (e.g. methane in agriculture)
  • participants are not the emitters themselves, but companies that put fuels into circulation or suppliers of the fuels (upstream approach)
  • government says this currently means about 4,000 companies will participate
  • to avoid a double burden from the national system and the ETS, fuel deliveries to ETS facilities are exempt from the national price; where this leads to disproportionate administrative needs, there will be compensation

The price

  • fixed price in 2021: 25 euros per allowance (tonne of CO2 equivalent) [means around 7 cents price increase for litre of petrol, 8 ct/l of diesel]
  • 2022: 30 euros, 2023: 35 euros, 2024: 45 euros, 2025: 55 euros
  • in 2026 in auctions, with a price corridor of 55- 65 euros
  • from 2027: market price, with option for price corridors (to be decided in 2025)Flexibility
  • during fixed price/price corridor phase: should the emissions budget not suffice and targets in non-ETS sectors be missed, Germany would use the flexibility of the EU Effort Sharing scheme – this could include buying emission allocations from other member states

Revenues

  • government expects the new system to generate revenues of 40 billion euros in 2021-2024 (period of budget planning at the time)
  • part of the revenues will be used to lower the renewables surcharge for power consumers (EEG surcharge), other relief measures for citizens and industry, and for climate action support programmes

Emissions reduction

  • Based on projections, the government expects the price to save 3.1 million tonnes of CO₂ in 2025, 7.7 t in 2030 and 12.4 t in 2035

Carbon leakage risk

  • Following some delay, the government decided a carbon leakage regulation to accompany the CO2 price legislation in March 2021 and updated it in July to take into account parliament criticism. The regulation ensures compensation for the carbon price for certain companies in international competition to prevent climate-harmful industry from simply moving abroad. Compensation under the regulation is tied to climate action investments by the companies
  • A study by German Institute for Economic Research (DIW) says the new carbon price system does not contain a high risk of carbon leakage

New climate targets and the 2021 election campaign

Germans head to the polls on 26 September to elect a new parliament and thus decide who leads the next government. Following the decision to increase national climate targets, the parties fiercely debate whether the initial fixed price increase has to be more ambitious. The Green Party and the conservatives call for tightening the CO2 price path, while the Social Democrats and the Left Party warn that a quicker increase would overburden especially low-income households.

Thus, the parties also debate how to use the revenues in the next legislative period; ideas include abolishing the renewables levy and per capita payments to citizens. A reform of the national carbon pricing system is quite likely to follow the forming of a new government.

European integration

Germany’s national carbon pricing system could become the blueprint for the European Union. After deciding to increase the 2030 EU greenhouse gas reduction target, the bloc must now underpin the new ambition with measures and instruments.

The European Commission presented its package of reform proposals – the “Fit for 55” package to reach the new 55 percent greenhouse gas reduction target for 2030 – on 14 July 2021. The Commission proposed setting up separate but adjacent upstream EU-wide emissions trading for transport and buildings which would be operational from 2025, with a cap on emissions set from 2026 – very much like the German system. Member states and the European Parliament are set to enter tough negotiations on the Commission proposals and it is not yet clear whether and how such a system would be introduced at EU level. However, the German system could easily be integrated into the EU-wide instrument.

Already in its climate package decisions from 20 September 2019, the government said it will push for an EU-wide cross-sector price for CO2 emissions. It sees this as the most cost-efficient way to reach the climate goals. In a first step, it wants to implement a “moderate” floor price in the ETS, something other EU states, such as France, have called for, and the UK introduced on a national level in 2013. “In a second step, we will work in alliance with other willing member states to integrate the non-ETS sectors into the ETS,” the German government said.

Chancellor Angela Merkel floated the idea of forming a coalition of willing countries to introduce CO₂ pricing for sectors not covered by the ETS in May 2019. She said she had backing from other EU countries for the idea, adding: “[W]e need to reconsider how to find common methodologies to regulate the pricing of CO₂ in the areas not covered by emissions trade – buildings, transport and agriculture – as uniformly as possible, at least with a coalition of the willing.” The chancellor said she was not aiming for a common European solution initially because that would take too long. Merkel named the Netherlands as a possible ally, recalling that the country was currently debating CO₂ pricing.

How the system was introduced

Germany’s government coalition of Chancellor Angela Merkel’s conservative CDU/CSU alliance and the Social Democrats has for years shunned the debate about introducing a price on CO2 emissions in these sectors, often for fear of upsetting voters, businesses or industry. However, a drought in the summer of 2018 and the Fridays for Future student climate protests pushed climate action to the forefront of the political debate and increased pressure to consider carbon pricing as a central measure to mitigate global warming and bring Germany back on track to reaching its emissions targets.

In this environment and after months of talks, the coalition government presented a comprehensive climate policy package on 20 September 2019 that included the outline for a national trading system for greenhouse gas emissions from burning fuels in the transport and buildings sectors.

In the months of talks leading up to the climate package decisions, the coalition parties heatedly debated whether to introduce a tax on CO2 emissions – favoured by the SPD – or a national trading system for emissions allowances, called for by the CDU/CSU. The eventual proposal of a trading system with fixed allowance prices in the first several years is a mix of the two approaches.

In October 2019, the cabinet adopted a first draft of the National Emissions Trading System for Fuel Emissions Law. It was adopted by the Bundestag with minor changes, and the Bundesrat gave the green light on 29 November, thus clearing the last hurdle for it to take effect.

However, after other aspects of the government’s climate package became part of negotiations in the mediation committee of the Bundestag and the Bundesrat, the price was tabled yet again. The Green Party – which is part of most state government coalitions – called for an increase. In a preliminary agreement from 16 December, lawmakers decided to amend the already adopted law and increase the price. The price increase was adopted by the Bundestag in October 2020.

For an overview of the various parties' and experts’ positions on carbon pricing, as well as the developments leading up to the government’s comprehensive climate package decisions from 20 September 2019 see our article "Tracking the CO2 price debate in Germany".

Criticism of low entry-level price and distributional effects

Originally, the government had proposed (and parliament adopted) a lower price, from 10 euros in 2021 to 35 euros in 2025, which was heavily criticised by experts and institutions, such as the Mercator Research Institute on Global Commons and Climate Change (MCC). They and a large group of stakeholders ranging from business associations to environmental NGOs have criticised the low entry-level price in 2021 and the following years. This would “hardly have a steering effect,” the MCC said, adding that long-term planning and investment security was lacking as the price post-2026 would only be determined in 2025. The carbon price would thus only have a limited effect on investments and innovation.

The German Institute for Economic Research (DIW) said in an assessment of the CO2 pricing effects that it would burden poor households more than rich households in relation to net income. Despite planned relief via a decrease in the renewables levy and an increase in the commuters’ allowance, the pricing system would lead to additional revenues for the state, the DIW said. Keeping a national CO2 price "socially fair" has been one of the government’s main arguments for starting with a price of only 10 euros per tonne.

Legal doubts

Due to a compromise based on the demands of the government coalition partners, experts say the CO2 pricing system could face severe legal hurdles. As the proposal foresees the eventual creation of a trading system, but a fixed price during the early years – which Christian Lindner, head of the pro-business FDP party, calls “a CO2 tax in disguise” – a debate has erupted about the legal foundation for a price on emissions.

A legal opinion by the Institute for Applied Ecology (Öko Institut), published ahead of the final decision for the mixed system, points out that Germany’s Federal Constitutional Court previously made it clear that an upper cap for emissions is necessary for a trading system to be deemed in line with German law. The current draft states that should the cap be exceeded during the early years of the system, Germany would buy additional allocations from other EU member states.

Without “substantial” changes, the planned CO2 price carries a “concrete risk of unconstitutionality,” Thorsten Müller, chairman of the Foundation for Environmental Energy Law (Stiftung Umweltenergierecht), wrote in a message thread on Twitter after the draft law was presented in October. Müller argued that a fixed price in a trading system would not be an admissible levy, adding that the government proposal does not meet the requirements for other forms of fees, such as a CO2 tax.

Legal experts told Carbon Pulse in early 2021 that they expected lawsuits to be filed. A first lawsuit was being prepared and was set to be filed by mid-2021, reported Tagesspiegel Background in March.

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