Three points the Energy Taxation Directive should get right 

Publish date: May 31, 2022

Our asks are developed along three axes: the complete exclusion of fossil fuels from tax exceptions, the levelling of hydrogen taxation depending on its real climate benefits, and the incentivisation of carbon capture and storage through taxation levels. 

The Energy Taxation Directive (ETD) is currently under review and is being worked on both in the Council and the Parliament. The ETD presents a crucial opportunity to include and mainstream the weight of environmental factors in defining the level of taxation of different energy carriers. The proposal of the European Commission already included provisions to foster the use of renewable electricity, as well as the end of most tax exemptions for fossil fuels for waterborne navigation, and aviation.  

However, shortcomings remain and should be addressed in the upcoming legislative phases. Our asks are developed along three axes: the complete exclusion of fossil fuels from tax exceptions, the levelling of hydrogen taxation depending on its real climate benefits, and the incentivisation of carbon capture and storage through taxation levels. 

1. Fossil fuels should not be exempt from taxes 

Fossil fuel tax exemptions remain in some sectors that already have net zero compliant alternatives.  

For example, diesel used for construction machinery does not require preferential tax treatment for fossil fuel combustion, since electric alternatives are already well beyond pilot phase. Some countries have already phased out this preferential tax treatment (such as red diesel in the UK) and going against this trend at an EU-level will hold back the ongoing progress in the decarbonisation of non-road machinery. 

Moreover, the current ETD proposal  maintains the exemption for cargo-only flights, creating detrimental perverse incentives as it strongly impacts the development of a circular economy and a broader shift towards cleaner modes of freight transport. Cheap air cargo is a prerequisite for short product life cycles. This is most noticeable in electronics, where unsustainable products are enabled by cheap fast transport. Exemptions should be warranted only for indispensable goods such as medical supplies in cases of emergencies or crises. And on the contrary, any regular operation should be heavily taxed to disincentivise the uptake of unsustainable practices. 

2. Hydrogen should be taxed depending on its effects on the climate

In the proposed ETD draft, the production and use of hydrogen is highly incentivised through preferential taxation treatment. As a potentially clean burning fuel, depending on how it was produced, hydrogen offers the possibility to decarbonise some harder-to-abate sectors. However, its production is resource-intensive and its clean supply will most likely remain limited in the upcoming decades. Moreover, if its production does not comply with very strict full life cycle emissions thresholds, it risks increasing emissions instead of abating them. It is therefore crucial to ensure that only hydrogen produced in compliance with strict emissions standards and used in a targeted way will receive tax exemptions. 

Clear definitions for hydrogen should be included in the ETD, to ensure that its production reduces emissions. For Renewable Hydrogen (so-called green hydrogen), the electricity consumed in producing hydrogen must be sourced from renewable sources that are additional. The production of hydrogen should not cannabalise existing renewable sources that provide electricity elsewhere in the system. Similarly, when accounting for Blue Hydrogen climate footprint, the entire life cycle must be assessed. This ensures that low carbon hydrogen is produced with minimal upstream methane emissions and very high CO2 capture rate. 

Moreover, where subsidies are placed has a big impact on the prioritisation of hydrogen uptake in targeted sectors that cannot be otherwise decarbonised. Targeted taxation and exemptions can therefore have significant effects on climate outcomes. Alternative fuels for aviation should not be exempt from taxation, as the fuels themselves and the mode of transport are energy-intensive. Taxation should encourage a shift towards less energy-intensive forms of travel. Similarly, providing tax exemptions to hydrogen as a storage of electricity incentivises the least efficient storage method. This goes against the energy efficiency principle as pumped storage, conventional batteries, and buildings as thermal batteries are more energy efficient.  

3. Taxation should incentivise the uptake of CCS 

The uptake of Carbon Capture and Storage (CCS) will be crucial to abate marginal emissions that are the hardest to abate, and potentially convert some processes into carbon negative ones. Thus, it should be incentivised through favourable taxation. 

The current draft of the ETD foresees tax-exemptions for power production with sustainable biomass. However, its supply will be highly constrained, thus it should be used in the best possible way. In the context of electricity production, this requires the emissions resulting from the combustion of biomass to be captured before they reach the atmosphere and geologically stored in line with the CO2 Storage Directive. Without this requirement, biomass combustion for electricity production should not be tax-exempted. 

Similarly, combined heat and power (CHP) is still envisaged to receive preferential treatment despite running on fossil fuels, given its high efficiency. Highly efficient processes, such as CHP, will probably still have a role to play in a decarbonised economy, however they are not net-zero compliant. Fully abating their emissions will ensure that, despite keeping residual fossil fuels in the system, these processes won’t contribute to further GHG emissions. Therefore, preferential taxation treatment should be granted to CHP only when a full abatement technology (such as CCS) is applied to it.