Deep decarbonisation pathways for Scottish industries: research report

7 Conclusions and policy recommendations

7.1 Summary of key findings

Within the context of the updated decarbonisation targets for Scotland, which aim for economy-wide net zero emissions by 2045 at the latest, this study sought to investigate how emissions from energy-intensive industries in Scotland can be substantially reduced via the implementation of selected deep decarbonisation measures, chiefly fuel switching and CCUS.

Two deep decarbonisation pathways combining fuel switching with CCUS were investigated. A third pathway that only relied on improvements in energy efficiency was also initially considered but, given its inability to deliver significant reductions in carbon emissions, this was not analysed in depth. The results from the two deep decarbonisation pathways demonstrated that:

• It should be possible to reduce emissions from the industries in scope by over 80% compared to 2018 levels by 2045. Different ways to tackle residual emission and devise a path to net zero in industry were also reviewed, though further work is needed to evaluate their feasibility and cost.
• Combined, the industries in scope can be expected to incur additional costs of up to £1 billion per year and of just over £11 billion cumulatively, by 2045, when including capital, operational, and energy-related expenses but excluding the reduction in carbon costs.
• Substantial infrastructure as well as new energy generation and conversion assets will need to be developed before fuel switching and CCUS can be deployed on a large scale.

Industry stakeholders who were consulted for this study highlighted critical challenges that hinderinvestment in deep decarbonisation. There are three specific issues where policy may help:

• Addressing the lack of a business case. This is seen as the primary obstacle to investment. To address this issue, policy could offer a range of financial support mechanisms or enact measures that stimulate demand for low-carbon products.
• Ensuring a level playing field with international competition. Even though the inclusion of carbon cost avoidance was found to reduce the net additional cost of both deep decarbonisation pathways by over 80% (provided the price of carbon increases over time as per BEIS assumptions), this is not considered a solid basis for the business case. Indeed, increasing costs would adversely affect industrial competitiveness whether fuel switching or CCUS are deployed or not (i.e. either due to the cost of decarbonisation or due to the increasing carbon price). As a response, industries might be induced to relocate to regions were environmental regulations are looser – an issue known as carbon leakage. Policies that establish a level playing field with international competition will be required to address this.
• Mitigating the technology lock-in risk. This corresponds to the possibility that site operators may not be looking to replace their fossil fuelled appliances again until after 2045, especially if they have recently invested in fossil-fuelled appliances. This risk is exacerbated by the fact that site operators and investors have low confidence in, and/or knowledge of, new, carbon reduction technologies that have not yet been proven in their subsector, which could lead to a rate of uptake which is lower than that envisioned for the pathways here. Policy support is expected to play a role in ensuring prompt development of the required technologies and deployment of the enabling infrastructure.

The remainder of this chapter describes how government action – from the Scottish Government whenever possible, though intervention from the UK government is likely to be required in some cases – can help act to address these important challenges.

7.2 Policies to encourage investment in decarbonisation

7.2.1 Preventing carbon leakage

To mitigate the risk of carbon leakage while preserving the incentive to decarbonise that an increasing carbon price would offer, the ideal option would be to ensure that no regulatory asymmetries existed in the first place. If all industries across the world faced the same carbon price, which could be achieved by the implementation of an international agreement concerning the price of carbon, there would be no incentive to relocate. Political challenges in reaching such an agreement and the expected difficulties in its enforcement make its implementation unlikely, at least in the short term.

A more likely alternative is offered by a Border Carbon Adjustment Mechanism (BCAM), which would adjust the import and export prices of products exposed to different carbon pricing regimes. This could for instance take the form of Border TaxAdjustments (BTAs),^[170] where import fees are issued on goods manufactured in countries with a lower carbon price and carbon charges paid on exports to the same countries can be claimed back.

It should be recognised that BCAMs are complex and that their effectiveness in combating carbon leakage might depend on their detailed design features; BCAMs would also need to be compatible with World Trade Organisation (WTO) rules and Government policy on free trade arrangements. Lastly, UK-level policy action would be required to establish BCAMs given that Scottish Ministers do not have devolved competence for trade and import/export controls.

Box 8 – Carbon leakage

The term 'carbon leakage' refers to the risk that industries facing environmental regulations stronger than those borne by their international competitors may relocate to less regulated regions. If they were to do so, their carbon emissions would also relocate, or 'leak', with them.

When assessed from a global point of view, carbon leakage represents a policy failure since it does not lead to any net emissions abatement, and although it does lead to reduced territorial emissions in the country where industries are mothballed, this could come at the expense of a corresponding loss of jobs and output. Also, it is possible that global emissions might in fact increase if industries relocate to regions with looser regulations around GHG emissions.

This risk of carbon leakage is particularly acute for industries that are both energy-intensive and trade-intensive, since they have higher emissions, are exposed to greater competitive pressures from international markets and are less able to pass on additional costs, e.g. from an increased carbon price, without losing market share.

Both an internationally coordinated carbon price and suitably designed BCAMs would enable policymakers to increase the price of carbon without risking carbon leakage. In this scenario, industries would have to face the full cost associated with their greenhouse gas emissions and would therefore feel an increasing pressure to decarbonise (though the important challenges to decarbonisation discussed above would remain). However, prices for decarbonised industrial products would necessarily be higher than those of today's carbon intensive products unless ways to decarbonise industry are found which do not increase the manufacturing cost base. Price increases would negatively affect market demand for industrial products and would simultaneously incentivise innovation in disruptive, low-carbon alternative products considered too costly today, but which may become cost-competitive with more expensive decarbonised products (the difference between the two categories of low-carbon products is further explored in Box 9).

Previous research also highlighted that the narrow framing of climate change as a 'market failure' and of carbon pricing as its primary solution oversimplifies the scale of the challenge and hence hinders its resolution. If climate change is instead understood as a system problem, it becomes apparent that the transition to net zero will likely "entail profound and interdependent adjustments in socio-technical systems that cannot be reduced to a single driver, such as shifts in relative market prices".^[171] Hence, it should be expected that multiple policy measures will need to be deployed to successfully incentivise the decarbonisation of industry, and drive the path to net zero.

Box 9 – Low-carbon industry: decarbonised or alternative products?

There are two types of low-carbon products that should be differentiated for the purposes of policy making:

• Decarbonised products produced in equivalent ways to those produced today, except for the use of low-carbon fuels or for the addition of carbon capture.
• Low-carbon alternative products, which are intrinsically lower carbon than those used today. Examples include bio-based plastics, cement-less concrete, and recycled materials.

There are two key differences between the two types.

• First, while decarbonised products can be manufactured using current industrial facilities, low-carbon alternatives may require radically different processes. This has obvious implications on the different level of disruption to incumbent industries (and to their supply chains) that would arise from the uptake of one or the other type.
• Second, while decarbonised products are necessarily more expensive than current products, since both fuel switching and CCUS increase costs, low-carbon alternatives may become cheaper once produced at scale.

These differences are relevant to policy making because certain policies may incentivise the uptake of one but not the other type of product. The clearest example of this would be if subsidies were offered for the implementation of deep decarbonisation measures. These may make decarbonisation cost-neutral for industry but would do little to stimulate demand for low-carbon alternatives.

7.2.2 Financial support mechanisms

The results in Section 6.3 demonstrated that although the financial requirements for deep decarbonisation are significant and diverse in nature, the single most important policy focus should be in offsetting the increase in energy costs, which is due to hydrogen and electricity costing more than fossil fuels. Increased energy costs not only account for over 55% of the additional cost of decarbonisation in both deep decarbonisation pathways but also directly impact the marginal cost of production and hence adversely affect industrial competitiveness. A Contract for Difference (CfD) mechanism could lock the price of low-carbon energy to that of natural gas (or other fossil fuels where relevant) andensure that industries that decarbonise are not disadvantaged against competitors who use fossil fuels.

The second goal of policies aimed at supporting investment in decarbonisation should be to reduce the absolute magnitude of the capital expenditures, which represent the second largest cost factor. Grants and low-interest financing would be obvious ways for policy to intervene in this direction, though direct equity investments (where the state obtains company sharesand receive the corresponding dividends, instead of receiving an interest on the amount loaned) could also be considered. The latter approach could be especially relevant to investments in shared low-carbon energy infrastructure, which hold far larger value to society than can be accrued to any individual site operator. This might justify more direct state intervention.^[172]

For CCUS in particular, the scale of the investment and the complexity of the commercial framework is such that substantial government intervention will most likely be required to mitigate the multiple project risks and justify the business case, at least for the initial project phases. The inclusion of a "CCS Infrastructure Fund of at least £800 million" within the UK Government's 2020 budget is a promising development in this direction.^[173] A recent Element Energy report for BEIS on industrial carbon capture business models identified potential business models and policies that are applicable to wider industrial decarbonisation:^[174]

• Contract for Difference on the CO₂ price (relative to the market price of CO₂, e.g. from the UK ETS) to provide a payback on investment which reduces emissions.^[175]
• Cost plus: all properly incurred costs are reimbursed through taxpayer funding.^[176]
• Regulated asset base: public regulation allows decarbonisation costs to be recovered through product prices.
• Tradeable tax credits: a tax credit is awarded for each unit of CO₂ stored (or simply abated, which could make this mechanism relevant to fuel switching as well), and this reduces a firm's tax liability. The credit can also be traded with other firms.
• Decarbonisation certificates: certificates representing the amount of CO₂ abated (through CCUS or other technologies) which can be traded, and towards which emitters have an obligation.

It is recommended that any financial support offered be technology neutral. The findings of this study in fact highlighted that even though some decarbonisation measures are going to be central to the transition to net zero – CCUS and fuel switching for steam raising above all – different industries are likely to benefit from a different technology mix. Policy could reduce uncertainty by 'picking winners' (e.g. supporting electrification instead of hydrogen, or vice versa), but consideringthat both pathways deliver substantial decarbonisation and that there is high uncertainty around the future price of hydrogen and electricity and around the viability of the corresponding fuel-switching technologies, it would be hard to justify a choice of winners that could close off other options which may later turn out to be more effective.

7.2.3 Ensuring prompt deployment of the key technologies

The pathways outlined in this study assume that investments in fuel-switching technologies take place at the end of the current life of fossil-fuelled appliances,^[177] since this minimises the overall cost of decarbonisation. However, if the uptake of fuel switching technologies were to be delayed by slower development timelines, infrastructure unavailability, or by the lack of economic incentives, the number of sites finding themselves 'locked-in' with fossil-fuelled technologies until after 2045 could be significant. This could make it challenging to meet the economy-wide net zero target by this date. To mitigate this risk policy could:

• Support the creation of pilot projects and demonstrators useful to validate the technical and economic viability of each technology (within each subsector, if required) and help industry stakeholders acquire confidence in novel technologies.
• Finance feasibility studies for the deep decarbonisation of all subsectors (e.g. for one or a few sites within each subsector). It is recommended that a specific focus on deep decarbonisation (ideally net zero) is required, as well as extensive knowledge sharing. A key priority in this regard could be to support feasibility studies for projects which could start decarbonising immediately (predominantly in the context of process electrification).
• Ensure that the required infrastructure is developed well ahead of time, so that fuel switching and CCUS can be implemented without delay when the business case is established. To maximise the climate benefits, policy could prioritise the key deployments indicated in Section 6.2.2, since they are responsible for a large share of the overall abatement from industries in scope.
• If technology lock-in cannot be avoided for all sites, early decommissioning of fossil-fuelled appliances might need to be encouraged or mandated for cases where retrofitting is not an option.

7.2.4 Demand-side policies

By relaxing the constraint that demand for industrial products remains fixed until 2045, several additional pathways could be conceived. While the pathways investigated in this study only looked at ways to decarbonise existing industrial processes, the analysis of pathways to reduce emissions across entire supply chains (or perhaps across the whole economy) could reveal that it is in some case cheaper to replace carbon-intensive products with lower-carbon alternatives, rather to decarbonise them. There are several examples of how product substitution has already started affecting the industries considered here:

• The uptake of electric vehicles is already affecting the demand for refined fuels in developed countries.
• Increased plastic recycling could reduce demand for basic chemicals and for the petrochemical feedstock.
• Low-carbon alternatives to cement are being considered for concrete manufacturing.

And while most of these alternative products only hold negligible market shares today, an increasing carbon price might make them more cost competitive and widespread. Moreover, policy could also intervene by implementing demand-side measures that foster demand for low-carbon products (at the expense of carbon-intensive products) and thus indirectly incentivising industry to decarbonise.Relevant measures include:

• Mandating green procurement, which implies that low-carbon products would be preferred to carbon-intensive ones in procurement processes (especially within the public sector), even if they cost more.
• Implementing product standards, e.g. requiring that certain fraction of the concrete used for public infrastructure must be low carbon.
• Supporting the adoption of 'green labels' that transparently communicate a product's environmental credentials to consumers, which may trigger an increased market demand for such products.

Considering that the cost of deep decarbonisation is often more substantial on the price of intermediate products, rather than on that of final products, it is also possible that demand-side measures could represent a more cost-effective way to incentivise industrial decarbonisation. For example, a 1% increase in the cost of a soda bottle is less noticeable than a 50% increase in that of ethylene.^[178]

Further work would be required to assess the most effective ways to stimulate demand for low-carbon products in the context of Scottish industry, and whether this could indeed be more cost-effective than financially supporting investment in deep decarbonisation. In light of the stakeholder feedback summarised in Section 6.4, it is however worth noting that demand-side measures able to create significant new markets for low-carbon industrial products could help turn the decarbonisation challenge into an opportunity for clean growth, and this could be a far more compelling driver for investment in deep decarbonisation compared to cost cutting.

7.3 Supporting a Just Transition to net zero

The Scottish Government is committed to a net zero pathway that fulfils the principles of a 'Just Transition', summarised by the Just Transition Commission as:^[179]

• "plan, invest and implement a transition to environmentally and socially sustainable jobs, sectors and economies, building on Scotland's economic and workforce strengths and potential.
• create opportunities to develop resource efficient and sustainable economic approaches, which help address inequality and poverty.
• design and deliver low carbon investment and infrastructure, and make all possible efforts to create decent, fair and high value work, in a way which does not negatively affect the current workforce and overall economy."

In light of this commitment, it is useful to reflect on the different impact that alternative policy measures could have on the markets in which incumbent industrial sites operate. On the one hand, subsidies and other financial support mechanisms would help minimise disruption and help preserve Scottish industry in its current form. If, however, these mechanisms solely benefited incumbent industries (e.g. by only incentivising the decarbonisation of current industrial processes, but not other low-carbon innovations) there might be a risk that, in the long term, the Scottish industrial sector would become ill-equipped to compete internationally. On the other hand, demand-side measures that could potentially reduce the overall cost of transitioning to net zero are also likely to force more extensive structural changes upon industry.

Fortunately, there are ways to ensure that the transition to net zero is both cost effective and fair. While a detailed analysis of the best policy approach to achieve this objective is beyond the scope of this study, it is noted that there are multiple ways to "design policies in a way that ensures the benefits of climate change action are shared widely, while the costs do not unfairly burden those least able to pay, or whose livelihoods are directly or indirectly at risk as the economy shifts and change", among which:^[180]

• Public investment in research, technology development, and more generally in education can help ensure that, if innovation happens, its disruptive impact is not necessarily negative. If the local workforce can actively participate in the industries of the future, disruption of the old ones will be perceived as a smaller problem (or perhaps even as a good thing). Establishing relevant retraining programs for the workforce affected by potential site closures would be essential to ensure that everyone can find work in the new industries.
• Financial support to individuals and families that find themselves without a source of income, if industries close, could likewise help to mitigate the social cost of disruptive innovation. If the support is guaranteed and unconditional (as it would for instance be in the case of a universal basic income) this could also empower workers to realign their career towards the new demands of the net-zero economy before disruptive events happen.
• Careful consideration of the locally available skills and knowledge could provide an additional way to evaluate different pathways and select relevant policy priorities. For instance, Scotland has one of Europe's most developed wind sectors, and its extensive offshore know-how is likely to be relevant to the delivery of the substantial new renewable generation expected in both deep decarbonisation pathways. Likewise, the Scottish oil and gas sector is well-versed with hydrogen production, carbon capture, and in dealing with high pressure fluids and undersea gas storage.^[181] These are just two examples of local industries that could stand to benefit if the pathways assessed here materialise.

7.4 Recommendations for further work

This report investigated potential pathways to deeply decarbonise Scottish industry by 2045 and found that both fuel switching and CCUS are necessary to the achieve significant emissions cuts. Energy efficiency was found to offer more limited carbon savings, on average, though this should not hide the important role that efficiency improvements play in reducing future energy demand, and hence in mitigating the need (and cost) of developing new infrastructure. If these decarbonisation measures are deployed extensively, cumulative emissions from the industries considered can be reduced by over 90% compared to 2018 level. To go further, additional routes will need to be pursued; further work could assess the most cost-effective way to bridge the gap to net zero emissions.

The analysis presented in this study was underpinned by the assumption that industrial activity would remain steady through to 2045, which enabled a focused investigation of the decarbonisation potential of the selected decarbonisation options. It would be insightful investigate alternative decarbonisation pathways where the improved material efficiency from a more circular economy and the development of new markets for green industrial products affect demand for industrial products.

The scope of the analysis was also limited to sites and industries contributing 58% of all Scottish industrial emissions in 2018. It is recommended that the boundaries of the analysis be expanded to encompass the totality of Scottish industry, which is expected will require significant input from industry representatives to address current data limitations. The boundaries of the analysis can be expanded even further: future work could study potential cross-sectoral and geographical synergies of electrification- and hydrogen-centred pathways. This could reveal important reasons why, in spite of the seemingly broad equivalence between the two pathways which emerges from the present work, one or the other pathway may be preferrable in practice.

In conclusion, it is stressed that other factors will need to be considered for a complete evaluation of possible pathways for the deep decarbonisation of Scottish industries. Thus, the final recommendation is that the results from this study should be evaluated in the context of a broader, more holistic assessment of the possible decarbonisation pathways, where the technological and economic analysis offered by this study is complemented by the equally important analysis of how different pathways would affect the broader economy, society, and the environment. This approach might reveal ways in which the current workforce can benefit from disruptive innovation, rather than be adversely affected by it, and may also uncover relative merits of electrification or hydrogen fuel switching when environmental impacts other than climate change are simultaneously assessed.