Energy-intensive firms continue to suffer from low profit margins even as energy prices have fallen from their peak. The ECB Blog discusses implications for the green transition in the EU (By Gert Bijnens, Cédric Duprez and John Hutchinson).
The euro area's economy has been significantly affected by the recent surge in energy costs, with energy-intensive companies bearing the brunt of this shock. The ECB research reveals a contrasting picture: while less energy-dependent firms have managed to restore their profit margins after the shock, energy-intensive firms have not. These firms, crucial to the EU’s industrial competitiveness, experienced significant drops in input costs due to falling energy prices in 2023, but failed to see a rebound in their profit margins.
Successes and challenges of European carbon taxes
The energy-intensive firms must prepare for an additional cost increase caused by an expected rise in carbon price exposure. This issue is tied to the ETS (Emissions Trading System), the main policy instrument that regulates EU industry’s carbon emissions. By imposing a financial burden on carbon emissions from industrial installations and aviation, this system is expected to incentivise investments in low-carbon production techniques and pressure heavily polluting firms to either adapt or exit the market (source: THE ECB BLOG, Obstacles to the greening of energy-intensive industries, 17 September 2024).
The EU ETS has demonstrated its effectiveness in driving down greenhouse gas emissions. The scheme achieved its 2020 emission reduction target in 2014, six years early. More recently, emissions covered by the EU ETS fell by a substantial 16% in 2023 compared to the previous year. This significant drop means that more than three-quarters of the targeted reduction by 2030 (relative to 2005 levels) has already been realised. These results underscore the EU ETS's role as a cornerstone of the EU's climate policy.
Relative evolution of emissions from different sources regulated by the EU ETS (2013 = 100)
Source: EU Transaction Log accessed via EUETS.INFO, version May 2024.
So what’s the problem?
The reduced emissions were to a large extent realised by producing less rather than by greening the production processes. This conflicts with the ETS's goal of balancing emission reductions with continued economic growth. Moreover, the phase-out of free emissions allowances accelerates from 2026 and the gap between actual emissions and free emissions widens, leaving firms to a more severe carbon price exposure and an increase in costs. vast investment in carbon efficiency of the industrial sector will hence be needed if emission reduction targets are to be met without a continued drop in industrial output. Otherwise, European firms risk becoming “brown zombies” – entities unable to compete in an increasingly green economy.
Broader Implications
The continued squeeze on the profit margins of energy-intensive industry makes it harder for these firms to internally finance the investments they want to make. Falling margins may therefore impede crucial investment in carbon abatement technologies, potentially leading to higher future carbon costs and eroding industry’s edge in the transition towards low-carbon production. More generally, high energy costs pose a broader threat to economic growth. This situation not only jeopardises green investments but also undermines the overall economic stability necessary for a sustainable transition to low-carbon production.
The findings can be of relevance for other euro area countries with significant energy-intensive industries, particularly Germany, Italy and the Netherlands. These economies likely experienced similar effects, given their comparable industrial structures and exposure to energy price fluctuations. These technologically advanced industries are important for Europe's shift to carbon neutrality and maintaining its industrial competitiveness. The retention of these energy-intensive sectors in light of the climate transition demands coordinated efforts and substantial investments, combining firms making the necessary adjustments and external policy support measures. In this regard, the proposed Industrial Decarbonisation Accelerator Act in the next European Commission is very promising.
