To drive low-carbon investment, policy frameworks must capture companies’ attention, provide clarity for business decisions, and enable low-carbon investment decisions.

CPI and Climate Strategies’ recent joint study indicates that the EU ETS contributes to these requirements, but it also suggests that improvements such as increasing stringency, limiting CDM use, changes in international financial reporting standards, and complementary policies are needed.

Capturing Companies’ Attention

First, the policy framework must capture the attention of the relevant decision makers in an organization.  The study finds that:

• Companies with higher expectations of the future stringency of permit allocation are more likely to invest in low-carbon innovation (based on interviews with 800 manufacturing companies).
• For low-carbon investment and innovation activities, the relevance attributed to long-term climate policy targets and to EU ETS is highly correlated, suggesting that they are mutually reinforcing (based on a survey of power generators).

Providing Clarity for Decision Making

By defining an emission trajectory beyond 2020, the EU ETS provides guidance for the assessment of low-carbon opportunities.  However, some factors complicate decision-making:

• With the Clean Development Mechanism, European installations can exceed the ETS cap by up to 1.5 billion tonnes of CO2 over the next decade, thus reducing opportunities for low-carbon investments.  In addition, the ambiguity around the availability of CDM credits creates uncertainties for investments.
• Current International Financial Reporting Standards (IFRS) do not provide a true and fair view of carbon costs and opportunities; when allowances are allocated for free, costs of emissions they cover are not reported. The study reviews options to ensure costs and exposure to carbon are reflected in financial reports.

Creating Enabling Environment for Low-Carbon Investment

The carbon price created with the EU ETS contributes to the financial viability of low-carbon projects; however, further components are often required to enable their implementation.

• On average, the surveyed companies require that energy efficiency investments pay back in less than four years, suggesting the need for additional policies that extend the investment horizon.
• Power technology companies consider technology-specific policies such as feed-in tariffs as the most important factors for both sales and R&D investments.
• For power generators, access to fuel and public perception that impact permitting process are important factors for investment decisions.

The analytical project included participants from CPI, the London School of Economics, DIW Berlin, ETH-Zürich, ISI-Fraunhofer, Universidad Carlos III de Madrid, and the University of Nürnberg.