Sliced: Germany and its Novel Climate Protection Contracts
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Last week, Germany made a massive climate finance announcement that has the potential to greatly incentivize greenhouse gas (GHG) reductions in some of the hardest sectors to decarbonize.
The new German scheme is called a “climate protection contract.”
A climate protection contract, or CPC, is an agreement between the German government and German companies. In the agreement, the financial risk that is assumed by a company when it invests in low-carbon technologies to reduce GHG emissions from its operations, is mitigated by guaranteeing a fixed compensation by the government.
This hopes to not only bridge the gap between the costs of carbon-intensive and low-carbon technologies but also incentivize companies to decarbonize by providing them with financial security against a currently volatile carbon market, the European Union Emissions Trading System (EU ETS).
The core mechanism of a CPC works by offsetting the differential cost between producing goods with traditional, carbon-intensive methods and newer, cleaner technologies. For industries that are heavily reliant on fossil fuels, such as paper, steel, cement, and chemical manufacturing, the transition to green alternatives requires substantial initial investment and operational costs. By ensuring that companies can recover these costs, a CPC lowers the financial barriers to adopting more climate friendly practices, ideally accelerating the deployment of cleaner technologies across heavy GHG-emitting sectors.
The CPC scheme encourages German companies to submit bids that place a price on emitting one tonne of CO2. The system is designed so that as long as the price of CO2 in the EU, which is linked to the EU ETS, remains below the submitted bid value, these companies receive financial support from the government. However, if CO2 prices exceed the bid amount, the firms must pay back the funds.
For example, if a company in the steel industry places a bid at €100 per tonne of CO2 and the current EU carbon price is €50 per tonne, the company would receive government funding to cover the difference. However, should the carbon price rise above €100 a tonne, the company then must repay the government. This incentivizes the company to make a bid that reflects their genuine reduction costs while aiming for profitability.
German companies that emit over 10,000 tonnes of CO2 annually are eligible to compete for an initial allocation of €4 billion, distributed across 15 years. A subsequent funding phase, amounting to €19 billion, is slated for release later this autumn. Participating companies are expected to achieve a substantial reduction in emissions, targeting a 90% decrease.
The deployment of a CPC has broader implications for the global carbon market. By setting a fixed compensation rate for carbon reductions, these contracts effectively put a price on carbon that reflects the true cost of achieving emissions reductions, thereby strengthening the carbon pricing signals.
Germany is really stepping up to the plate with this move. If the country and participating companies can demonstrate success, it will show how a public-private partnership can work, and potentially offer a blueprint for other industrialized countries to replicate.
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