Who will pay, and how much, for reducing transport emissions?

Ir.lv Justs Dimants 19.01.2024

In setting new targets, the EU uses both the “whip and carrot” principle: it provides funding for investments but also imposes penalties for failing to meet the goals. We are used to receiving EU funds, but we will also have to get used to the possibility of paying fines for emissions that are not reduced sufficiently. However, EU regulation on emissions is complex, and misunderstandings or misplaced accusations should be avoided.

First, the responsibility for purchasing CO₂ quotas is placed on companies in the fuel sector. Expenses will increase for those traders who mainly sell fossil fuels, as they will spend more money buying emission quotas. Competition among fuel traders will grow, which means that we, as consumers, will have more choice.

Second, we may end up in a situation where state budget funds will have to be spent on purchasing quotas from countries that have reduced emissions more effectively. Each EU member state has specific targets it must achieve.

Third, several EU member states foresee fines in the literal sense of the word, to be applied to market participants if decarbonization targets are not met. Penalties are not an end in themselves, but they also serve the function of motivating market players to make broader use of renewable energy sources (RES) and reduce fossil fuels. For example, in Slovakia there are currently three types of penalty mechanisms. For insufficient reduction of GHG emissions, the fine is €370 per ton of CO₂. For failing to meet the renewable resource target – €0.05 per megajoule. For non-compliance with the mandatory blending requirement – €2 per liter.

In some other EU countries, fines reach as high as €600 per ton of CO₂ – for comparison, CO₂ quotas can currently be purchased at a price roughly ten times lower. Thus, the function of the fine should be to motivate traders to choose sustainable solutions to offer their clients.

Despite the clear mandate of the Renewable Energy Directive, under which an increasing share of renewables should be used in transport in Latvia, the new Latvian draft law provides an opportunity to ignore these requirements.

In other words, an option has been proposed for fuel suppliers to continue selling imported fossil fuels if they make payments into the State Treasury – essentially, they can “buy themselves out.” At present, the proposed “buyout” fee is too low to motivate fuel suppliers to choose renewable resources and thereby reduce emissions.

In Latvia, there needs to be a discussion about ways to improve the situation, possibly also about the content and amounts of penalties, since both low and high fines can have either a positive or negative impact on economic development and its associated risks.

The possibility of “buying out” the share of renewable energy that is objectively unavailable on the market is understandable, but such a system should not undermine the core objective – reducing transport emissions. Therefore, the practice in other EU countries of introducing differentiated penalties is justified, i.e., depending on whether renewable energy products are available on the market or not. Fines for failing to use products that are available on the market should be higher, and this is the logic behind the regulations in other EU countries.

Last year, Estonia faced a similar situation – even a €10 million fine did not prevent one of the fuel market participants from avoiding the blending of biofuel into the fuel sold, as paying the fine turned out to be financially more advantageous.

Local Bioeconomy Helps Transport Decarbonization

In 2023, on behalf of the Swedish government, an extensive review of the bioeconomy was conducted. It emphasized the significant role of the bioeconomy in Swedish society, employment, and self-sufficiency in food and energy. Sweden imports large volumes of fuel, including renewable fuels. Thus, Swedes recognize the risk – the country could be affected by a prolonged energy blockade or a global shortage of raw materials. The review concluded that one way to reduce energy vulnerability is to increase the production of domestic renewable fuels and resources.

In Latvia, we are in a much less favorable situation, since almost all of the transport energy consumed in the country is imported, with the exception of a small share from biofuels and domestically produced electricity. However, in the previous year, their share accounted for only 2% of total consumption. Some hope lies in the fact that on May 22, 2023, representatives of parliamentary factions signed the “Memorandum on Latvia’s Energy Strategy 2023–2050”, expressing their commitment to supporting the use of local resources.

Existing renewable fuel producers in Latvia are capable of making a greater contribution to the country’s energy security. For example, in 2021, Latvia produced approximately 40% more biodiesel than the country’s total consumption, and in 2022, the production volume was nine times higher than consumption. The local biofuel production capacity is sufficient to provide biodiesel blending in diesel fuel throughout the year, but currently, this requirement is mandated only for the non-winter period. In Lithuania, Poland, and other countries, the requirement for biodiesel blending applies year-round.

The use of biomethane in transport also has potential, for instance in freight and public transport sectors, but investments are needed in technologies that would enable such biomethane utilization. Players in this sector also require stable legislative conditions, specifically clear emission reduction obligations for fuel suppliers. Support instruments promoting electricity consumption in transport would facilitate the wider adoption of electric vehicles. Meanwhile, the use of hydrogen in the transport sector is currently challenging due to limited infrastructure; progress could be made by defining national-level development directions, similar to the hydrogen development strategies established in other countries. We also need to develop such a document. All of these are local resources, and their utilization should be a priority.

Social Climate Fund – to cushion price increases

Continuing to rely on fossil fuels and ignoring renewable energy resources is becoming increasingly difficult. In 2027, the so-called second Emissions Trading System (ETS2) is expected to start operating.

This ETS2 system will cover CO2 emissions from fuel consumption in households, commercial and public sectors, as well as CO2 emissions from fuel and energy use in road transport. ETS2 requires fuel suppliers, starting in 2027, to purchase emission allowances for each ton of CO2 produced by the products they sell. In other words, the more renewable fuel is sold, the fewer allowances need to be purchased, and the associated costs are included in the fuel price by the suppliers.

The European Union is aware of the risk of price increases and has taken initial steps to mitigate it – in spring 2023, a decision was made to establish a Social Climate Fund, which will also be available to Latvia. The purpose of this fund is to support vulnerable households, micro-enterprises, and transport users.

Who ultimately pays for the right to pollute the atmosphere?

Consumers of fossil fuels will have to pay when buying fuel from suppliers who purchase emission allowances and include these costs in the fuel price. However, some market participants may be recognized as vulnerable and receive EU support.

There is a risk that the costs could be covered by the state budget. In that case, an additional burden would fall on all taxpayers, thereby reducing the budget’s capacity to fund other necessary needs.

By actively working on transport decarbonization, there is a possibility in the near future to prevent or at least reduce unnecessary future expenditures from the state budget on purchasing emission allowances.

Author: Dr.oec., economist at the Sustainability Cluster Latvia