The need to reduce greenhouse gas emissions has led to a number of environmental policies which may increasingly drive demand for biofuels in the heavy industrial and transport sectors. This could happen in several important ways, which we will explore further in this article.
Important shifts are taking place in the EU Emissions Trading System (ETS), which regulates CO₂ emissions in the power sector, energy-intensive industry, aviation and shipping; the EU’s Carbon Border Adjustment Mechanism (CBAM) which will place a charge on the carbon content of certain products imported into the EU; and the voluntary carbon markets, which will help create demand for nature-based carbon removal projects.
These three policy arenas can all affect demand for cleaner fuels such as biomass and biofuels, which could gradually displace unsustainable sources such as fossil fuel-derived products, and this may increasingly affect heavy industry and transport.
Biomass zero-rated under EU ETS
In Europe, the EU ETS has regulated CO₂ emissions since 2005 from sectors including electricity and heat generation, production of metals, chemicals, cement, refining and several other carbon-intensive industries. The scope of the EU ETS was expanded in 2012 to include emissions from the international aviation sector, and again in 2024 to include emissions from international shipping.
Biomass producers are set to see increased demand for their products due to the decarbonisation of Europe’s economy. If sourced sustainably, and in line with the requirements under the EU’s Renewable Energy Directive (RED II), emissions from biomass combustion are ‘zero-rated’ under the EU ETS. This means companies burning sustainably-sourced biomass to generate power or heat do not need to surrender carbon allowances to cover their CO₂ emissions. For example, some electricity generators have already retro-fitted coal-fired power facilities to allow for biomass co-firing, reducing their carbon costs under the EU ETS.
This means the EU ETS can increase demand for a range of bio-energy products in Europe, for example, standardised combustible biomass such as wood pellets and wood chips, biofuels for shipping, and gaseous biomass produced from anaerobic digestion, to be processed into biomethane.
However, while the EU ETS has been successful at driving emissions reductions in electricity and heat generation, progress has been slower in other emissions-intensive sectors. That’s about to change in a significant way, for at least four reasons:
- Free carbon allowances under the EU ETS will soon be phased out progressively
- The EU CBAM will place a cost on the carbon content of certain imported goods
- Emissions from new sectors such as transport will soon be regulated in the EU (under ETS 2)
- Tightening supply of EU carbon allowances means carbon prices are set to rise further
Heavy industry to face full carbon costs
Until now, EU policymakers needed to shield carbon-intensive industries from the competitive disadvantages arising from the need to pay a price for carbon when producers in other regions face no such cost. To protect against this threat, most of the heavy industrial sectors were given free carbon allowances under the EU ETS, meaning they were partially shielded from the full cost of CO₂ emissions.
This is all set to change soon with the introduction of the EU’s CBAM, which is designed to replace free allocation of carbon allowances under the EU ETS. Once the CBAM enters the full implementation phase in 2026, it will place a charge on the carbon content of certain goods imported into the EU. This will effectively expand the EU ETS outwards for the first time, so that carbon pricing will affect the production of carbon-intensive goods made outside the EU’s borders.
The CBAM aims to:
- Level the playing field in terms of carbon prices inside and outside of the EU
- Protect EU-based industries from competitive disadvantage linked to carbon costs
- Encourage other countries to adopt their own carbon pricing systems to make their industries exempt from the EU CBAM
As the CBAM is introduced using a phased-in approach, the free allocation of carbon allowances to EU-based heavy industrial companies will be phased out simultaneously. This means that within a few years, these industries will face the full cost of their CO₂ emissions. Heavy industrial companies will therefore face a choice between decarbonising their operations or paying the full price of carbon for EU-based production, or the CBAM price for imported materials.
This is likely to drive demand for lower-carbon technologies, for example electrification of some industrial processes such as steel-making, or the use of lower carbon fuels such as biomass and hydrogen for other industrial processes.
Biofuels demand set to increase in transport sector
Further expansion of carbon pricing in Europe is planned too, and this will begin to affect the transport sector as well as heavy industry, potentially driving demand for biofuels in new sectors.
Emissions from the road transport sector have not been regulated by the EU ETS, but they will come under a new carbon market known as EU ETS 2. This separate carbon market, which is set to start in 2027, will cover emissions from transport and buildings. It will apply to the upstream emissions in these sectors, which means fuel suppliers will be responsible for reporting their emissions and surrendering carbon allowances. This is set to increase demand for liquid biofuels such as bioethanol, as well as increased electrification of transport and potential use of hydrogen, ammonia, LNG, synthetic non-fossil fuels, Sustainable Aviation Fuels (SAF) and other lower-carbon fuels.
Voluntary carbon markets
Companies in industries that are not regulated by legally-binding carbon markets can make use of the voluntary carbon markets to address their greenhouse gas emissions. They can do this by investing in projects which reduce or remove greenhouse gases outside their operations. This can also help to create demand for low-carbon technologies and processes. It can also drive demand for ‘carbon removals’ such as nature-based carbon sequestration using forests, soils and other land-use approaches that remove CO₂ from the atmosphere.
The COP29 UN climate talks in Baku in November 2024 also produced progress on the Paris Agreement’s Article 6, which sets out the rules for international emissions trading and a centralised UN market for project-based carbon credits involving the public and private sector. This is also likely to create new demand for projects that involve land-use and other nature-based activities.
However, it is the legally binding carbon markets that will have the biggest impact in terms of driving the significant shifts toward low-carbon fuels such as biomass and biofuels in the heavy industrial and transport sectors in Europe.
Energy transition accelerating
In summary, legally binding carbon markets in Europe are already increasing demand for biofuels by changing the relative economics of burning fossil fuels versus lower-carbon alternatives. This will become more significant as free carbon allowances under the EU ETS are phased out, and the EU’s CBAM is phased in. In addition, the ever-tightening supply of allowances under the EU ETS is likely to trigger higher carbon prices in future. With the expansion of the EU ETS to include aviation and shipping and the new EU ETS 2 for road transport sectors, this will accelerate the energy and low-carbon transition in Europe, creating stronger incentives for heavy industrial and transport companies to increase their use of cleaner and more sustainable fuels such as biomass and biofuels.
