The industrial transformation towards climate neutrality in Germany is still in its infancy. However, it is clear that industry will have to undergo a wholesale transition in the next 15 years to meet climate goals. Carbon pricing is a key tool to reduce industrial emissions, and with the recent reform of the EU carbon market rules, prices have risen significantly. Nevertheless, they are still mostly lower than the cost of preventing emissions with the production of green steel, low-carbon cement, or green chemical products. So-called carbon contracts for difference (CCfD) help to close this cost gap until carbon prices have risen to the necessary level. CCfDs are therefore the perfect complement to European emissions trading in order to allow the transformation of the manufacturing industry to begin as early as the mid-2020s.
What are carbon contracts for difference?
With Carbon Contracts for Difference the government agrees to pay companies that invest in low-carbon technologies for industry the difference between their production costs and those of conventional alternatives (including carbon prices). In practice, this usually means that companies can invest in low-carbon technologies without being put at a competitive disadvantage compared to rivals who produce at lower costs. However, the contracts work both ways: in years when the cost of conventional production is higher than the price agreed in the CCfD tender (due to high carbon prices), companies pay the difference to the state.
Agora Industry introduces new policy concept
Agora’s first study on climate neutrality in industry back in 2019 identifies CCfDs as a key policy instrument for rapidly initiating the industrial transformation. Through 2020 and 2021 Agora further refined the idea, determining the transformation costs in the main sectors and estimating the financing required. The new German government introduced the concept in its “coalition agreement” late 2021. Following Russia’s full-scale attack on Ukraine and the resulting sharp rise in energy prices, doubts arose about the feasibility and financing of CCfDs. In response, Agora updated the financing calculations and made the case for how CCfDs can also contribute to reducing gas demand – much of which had until then been met by Russian imports. In the summer of 2023, the German government published funding guidelines for carbon contracts for difference.
CCfD policy win in Germany paves the way for global impact
In Europe, state support to companies needs to comply with EU-wide competition rules. In February 2024, the European Commission gave Germany the green light to issue the first tender for CCfDs worth 4 billion euros. The aim is to ensure that the heavy industry sectors formerly known as hard-to-abate, which are responsible for around one fifth of Germany’s annual greenhouse gas emissions, begin to convert their production towards climate neutrality as early as the mid-2020s. Effective implementation of the policy could help avoid millions of tonnes of emissions.
The Commission’s approval sends a strong signal across Europe that this type of support is justified and in line with competition policy. The idea of climate protection contracts is now also being examined in other countries, such as Spain and the Netherlands. Beyond Europe, Agora Industry has so far organized workshops on the concept of CCfDs with South Korean policymakers. The team will continue to work to further the implementation of this essential policy to kick-start industrial transformation globally.
