Decarbonizing the Industrial Sector: The Potential for Ambitious EU Member States to Use Flexible Performance Standards to Strengthen Carbon Price Signals

The policy brief has discussed the potential to use flexible performance standards by individual ambitious EU member states to strengthen the EU ETS carbon price signal, with a specific focus on the industrial sector. We conclude that flexible performance standards have potential as complementary policies to strengthen carbon pricing and drive innovation. Flexible performance standards combine a carbon price with a production incentive that tempers changes in final product prices, which addresses a key concern of industry regarding carbon pricing. However, to be able to reap the full efficiency gains from flexible performance standards, countries such as Sweden, with few industrial producers, should explore the possibility of creating a trading market between either the industrial and transportation sectors within the country or a market with other jurisdictions in the EU. If trading is not possible in the short run, a flexible performance standard policy can be implemented without it and possibly evolve into a tradable performance standard scheme over time. It should be noted that creating an intensity standard without trade would, in practice, involve both taxes and subsidies, and Sweden would therefore need to consider EU state aid rules that place restrictions on subsidies that member states can provide to constituent firms. However, a flexible performance standard is consistent with the principles of competition and innovation that motivate state aid rules.