The European Union's Emissions Trading System (ETS) sets the price of CO₂ emissions based on the "polluter pays" principle. Discussions are currently underway in Brussels regarding the need to adapt this system to high energy costs and Europe's now legendary climate goals.

What are these goals?

One of the most important directions is maintaining the competitiveness of European industry, which has suffered severely in recent years, losing ground to China and the US. To protect European factories from bankruptcy in the global competitive struggle, it has been proposed in the European Parliament to change the rate of emissions cap reduction. Initially, it is proposed to reduce the volume of quotas more slowly after 2031 – by 3.4% per year, rather than the 3.7% proposed by the European Commission, allowing industries to "recover" and implementing a steeper reduction only in the second half of the decade.

Member states rightly object

The parallel system – ETS II – which will directly affect wholesale and retail fuel and heating suppliers, is being gradually expanded. This means that the carbon price will also be applied to road transport and residential heating. A proposal is being pushed to allocate up to 75% of ETS revenue directly to the green transformation of industry. It is planned to establish a special Industrial Decarbonisation Bank that could support low-carbon projects worth up to 100 billion euros. Furthermore, 30% of revenues are planned to be directed to the overall European budget for the 2028-2034 period. Several countries that always defend their interests in Europe, such as Poland and other Visegrád Group countries, are actively warning and openly threatening Brussels bureaucrats that they will block measures that make energy excessively expensive for citizens and businesses. Our neighbours – Estonia and other smaller economies – emphasise that when redistributing funds, geographical balance and the needs of smaller countries must be taken into account, not just large industrial centres. It is to be hoped that Latvia will also be able to shed its traditional timidity and actively stand up for our country's interests in Brussels. Both the European Parliament and member states are currently "fine-tuning" their negotiating positions. An official agreement and common ground are expected during a ministerial meeting this December. We shall see what and how Latvian representatives can achieve.

Latvian characteristics due to which the impact will be particularly pronounced

The introduction of the ETS II system, which will fully start operating in 2027, will affect Latvia much more directly and tangibly than the current system. While the old system (ETS I) only applied to large factories and aviation, the goal of ETS II is to reduce fossil fuel consumption in the building and road transport sectors. The system is based on the condition that suppliers of fuel and heating resources – excise warehouses, traders – will have to buy CO₂ emission quotas for every volume of fossil resource released into the market. These costs will inevitably be passed on to end consumers.

Fuel again…

In Latvia, the transport sector generates 37% of the country's total economic emissions – it should be emphasised that the EU average is only around 14%. The reason is simple: ~98% of Latvian cars still run on petrol and diesel, and the average age of our vehicle fleet is around 15 years.

If the carbon emission quota price reaches the European planned stability cap of 45 euros per tonne of CO₂, fuel prices at Latvian filling stations will rise by approximately 10-12 cents per litre. By 2030, taking into account national restrictions as well, the additional rise in fuel prices could reach just under 19 euro cents per litre, which will have a devastating impact on the prices of virtually all goods and services.

A "gift" to the public

The European Union's new ETS II will directly affect residents and businesses that use fossil resources for heating. Households and small heat producers using natural gas or diesel fuel for heating will have to reckon with an increase in tariffs. For example, if the quota price is 50 EUR/t, the cost of natural gas in heat production theoretically increases by about 10 EUR per megawatt-hour.

Since wood biomass is considered CO₂-neutral in the context of the ETS, fortunately, this tax will not be applied to these resources. However, because the whole of Europe, especially Germany and Poland, will try to switch to biomass to avoid ETS II taxes, the demand for Latvian wood will increase. Due to the high export demand, this could cause a huge price spike for wood chips and pellets on the local market.

Bleak times for the Latvian forest industry?

The Latvian forest industry, which is traditionally considered the backbone of our country's export and economic security, faces the most pronounced and direct risks with the introduction of Europe's new ETS II system. Although the industry creates environmentally friendly, renewable and carbon-sequestering products, its "physical operation" is highly dependent on fossil resources and transport, on which ETS II will impose a significant financial burden. Evaluating the situation, the blow to the industry can manifest in four main stages, significantly affecting Latvia's international competitiveness.

The first stage of timber extraction – logging – is entirely reliant on heavy specialised machinery – harvesters and forwarders working in extreme conditions – deep forests, swampy areas with difficult access; these machines require high power to operate. It appears that in the coming decade, there will be no realistic and economically justified alternatives for the electrification of this machinery or a transition to other alternative energy sources. Since logging machinery consumes large amounts of fuel, the price rise caused by ETS II, which at the maximum cap could reach up to 20-25 cents per litre, will directly increase the cost price of every cubic metre of prepared roundwood right in the forest.

The specific nature of the Latvian wood industry involves long logistics chains – roundwood from the forest must be taken to sawmills and processing plants, and the finished products – sawn timber, pellets, plywood – must then be transported to major ports – Riga, Liepāja, Ventspils – for export. Transport is carried out by heavy timber trucks and lorries. Calculations by European transport associations show that the introduction of ETS II in the road transport sector will create approximately 6,000 euros in new additional costs per year for a single truck with an annual mileage of 100,000 km.

As Latvian road infrastructure in the regions is often poorly maintained and long periods of bad weather hinder access to cutting areas, transport time and fuel consumption increase. This will make logistics costs a critical burden that companies will not be able to absorb so easily or solve.

Loss of competitiveness for wood processors and tension in the local market

Our wood processors export most of their production and are dependent on global price fluctuations and trade conditions. A dangerous "scissor effect" is emerging here, as the cost price will rise, but it will not be possible to dictate the selling price. While internal costs for Latvian manufacturers – fuel, logistics, rising wages – will rise sharply due to ETS II, it will be impossible to set the global market price for finished products, as this is dictated by demand in the construction sector and competition. Latvian companies will have to compete with producers from regions and countries that do not have such ecological taxes and systems, for example, the USA and Canada, or other countries outside the European Union. As a result, Latvian products – especially cheaper base products, such as sawn timber and boards – may become too expensive and lose market share.

To compensate for the huge increase in costs in the transport and logging stages and to maintain profitability, processing companies and sawmills may be forced to reduce the prices at which they purchase roundwood from Latvian forest owners.

This, in turn, may make traditional forestry less attractive to private forest owners, reducing logging volumes and making the availability of raw materials completely unpredictable. In our forest industry, which is based on long investment cycles, such instability and unpredictability are an even greater risk than short-term price fluctuations.

How can the industry survive?

It seems the only real option will be to move towards higher value-added products, such as timber structures and wooden house construction, rather than producing raw boards or pellets. The share of transport costs in the final price will then be relatively smaller. State support must be demanded, and it must be ensured that part of the money collected by the state into the Social Climate Fund or through ETS II operators is directed specifically to increasing the efficiency of forest machinery and improving logistics roads.

Although ETS II will certainly bring a rise in prices, the goal of the system is to return the collected money to the member states' economies. Latvia will have access to Social Climate Fund financing – approximately 462 million euros. To be frank, this is a relatively meagre and small "plaster", but the state will be able to use this money to compensate for the blow to industries and help the residents...

A rather miserable consolation, but again and again – must we "hope for the best" and trust Brussels, or actively cooperate with the Visegrád countries – together defending our interests loudly and confidently?

Sources: European Union information websites and databases