Carbon Contracts for Difference (CCfDs) as an instrument of choice
Bridging the funding gap for EU Energy Intensive Industries (EIIs)
“[CCfDs]…would help companies to decarbonise while simultaneously launching industry investments and technological innovation.”-1Robert Habeck, Germany’s Minister for Economic Affairs and Climate Action
At a glance
Accelerate the transition to net-zero while enhancing competitiveness
President Ursula von der Leyen’s political guidelines for the new European Commission (2024−2029) and the Mission letters to the new EU Commissioners aim to prioritize steps to accelerate the transition towards a low-carbon, circular, competitive and resilient EU industrial base.2 The prioritization of the transition of the industrial sector emphasizes the need to continue reducing carbon emissions while enhancing global competitiveness, particularly by capitalizing on the potential of clean energy technologies and services markets.
To achieve these objectives, the EU’s Energy-Intensive Industries (EIIs), which include key sectors such as chemicals, basic metals, non-metallic minerals (ceramics, glass, and cement), plastics, and pulp and paper, will play a pivotal role. This presents a significant opportunity for EIIs, which over the past few decades have experienced a decline in competitiveness, driven by a combination of high energy prices (exacerbated by the 2022 energy crisis), high feedstock prices, increased carbon emissions costs, funding shortfalls, policy unpredictability and regulatory complexity. As a result, the sector has experienced substantial losses in output potential, a downturn in domestic production and increased reliance on imports, leading to early signs of deindustrialization in certain areas.
While tackling these issues will require a reduction in energy costs, the deployment of infrastructure and reforms, funding shortfalls for EIIs in net-zero projects can be addressed through Carbon Contracts for Difference (CCfDs). This paper argues that CCfDs could be a key instrument for mobilizing capital by de-risking private investment for EIIs in net-zerot zero projects.
Funding challenges for the transition
Funding is critical in order for the transition to be effective. The EU’s Communication on a 2040 Climate Target estimates that almost EUR 500 billion in annual private investment will be necessary for the low-carbon transition in the EIIs from 2025 to 2040.3 However, to date, the high costs and relatively unproven nature of net-zero technologies have deterred investment amidst declining competitiveness. Despite the availability of multiple public funding sources at both the EU level and at the Member State level, in our experience, funding for the transition in EIIs in the EU has inadequately addressed market entry, remained fragmented and complex to navigate, and been primarily capital expenditure (CAPEX) focused.
In July 2024, von der Leyen announced a Clean Industrial Deal to support industrial decarbonization and enhance competitiveness. This policy package, supported by the Industrial Decarbonization Accelerator Act and a new European Competitiveness Fund, will focus on assisting EU industries in their decarbonization efforts while increasing global competitiveness. The package will include key initiatives to unlock investment, create lead markets for the development, production and diffusion of clean energy technologies in industry, and accelerate related planning, tendering and permitting processes.
CCfDs can help unlock funding and re-disk investments for net- zero projects
CCfDs are a market-based funding mechanism designed to support both capital CAPEX and operating (OPEX) expenditure for companies pursuing net-zero technologies. CCfDs are a subset of Contracts for Difference (CFDs) which specifically focus on the price of carbon. CCfDs are typically awarded through competitive auctions, and provide financial assistance for the difference in costs between traditional fossil fuel technologies and innovative net-zero alternatives, contingent upon carbon price fluctuations. CCfDs therefore serve as both a market-based hedging instrument and an investment subsidy solution. The funding instrument enhances the bankability of capital-intensive projects, improves long-term investment security and efficiently allocates public resources through competitive bidding. CCfDs can create lead markets for net-zero technologies, thereby effectively driving demand for net-zero technologies and products. The EU has explored in the past the potential implementation of CCfDs, although no EU-wide CCfD schemes exist.
EIIs need to consider how CCfDs could be deployed in practice, how CCfDs would change the economics of investment opportunities that they are considering, and what they could do to contribute to the effective implementation of CCfDs in the EU
Deploying CCfDs at the EU-level
The paper provides an overview of how CCfDs are currently deployed in Germany and the Netherlands. It goes on to explore the opportunities and risks associated with the implementation of CCfDs in the EU more widely, through three distinct approaches: at the EU level, at the national level and in an hybrid approach similar to the Auctions-as-a-Service mechanism under the European Hydrogen Bank or the Important Projects of Common European Interest (IPCEI) scheme; and across four categories: economic efficiency and internal market integrity, governance, political and economic influence, and administrative factors.
While each approach presents advantages and disadvantages, our analysis concludes that establishing a CCfD scheme at the EU level as a central element of a comprehensive industrial transformation policy is the most attractive option to support both industrial decarbonisation and increased competitiveness. A hybrid approach funded by Member States could however serve as a fallback option.
As EIIs review potential investments in new technologies to meet their 2030 and post-2030 emission targets, they should consider whether and to what extent CCfDs could change the economics of the investment opportunities. Understanding the mechanics of the instruments and how they might be deployed in the EU is critical to this analysis. EIIs can contribute to the design and successful implementation of CCfDs in the EU.
The paper recommends practical actions that EIIs can take to contribute to the effective implementation of CCfDs in the EU. In particular, EIIs can engage proactively with policymakers, to explain the benefits of CCfDs to their businesses, and to contribute to CCfD programme design. For example, EIIs could support policymakers in defining the objectives and scope of the CCfD, develop guidelines, ensure flexibility mechanisms are integrated and launch pilot projects to test the CCfD mechanism on a smaller scale before full implementation.