Central Europe Energy Partners’ Position Paper on ETS reform (Directive 2003/87/EC)

Central Europe Energy Partners’  Position Paper on ETS reform  (Directive 2003/87/EC)

1. Introduction
The Paris Agreement has shown that the EU’s proposal to decrease CO2 emissions by 40% by 2030, from 1990 levels, was the most ambitious pledge made at the Summit. This means that the other industrialised countries, such as the US, Canada and Australia, are lagging behind the EU’s ambitions, as well as the emerging powers, notably China and India. If we translate the pledges into emissions per tonne per capita, then in 2030, we can expect below 5.0 tonnes in the EU, whilst in the US nearly 12 tonnes. Why should we be so ambitious and accept a constant loss of competitiveness and not fulfill one of the basic principles of the Lisbon Treaty, which states, that the EU should implement policies ensuring advances in economic integration? As Eurostat shows, the distance between the EU-15 and EU-11 (GDP per capita), has practically not changed during the last 10 years. As figures indicate , a 1% increase of GDP per capita in the EU-15 is equal to 3.1 % in the EU-11. If the ratio is 1% to 4%, the chance to catch-up will take 40 years. This is our real European problem requiring immediate attention, as new investments are desperately needed in the EU-11.

The revision of the EU Emissions Trading Scheme (ETS) is highly important for the Central European energy-intensive industries ( steel, chemical, refining, etc) and crucial in determining how the EU aims to combine its agenda on growth, jobs and investments with climate and environmental policies.

For example, in its current form, the proposal puts at risk the viability of the steel industry in the EU, which has been recognised, even in the Commission’s own impact assessment, as one of the four to five sectors at very high risk of carbon leakage, due to its high exposure to international trade and its carbon intensity.

A level playing field is urgently needed with the global competitors and in order to safeguard a long-term operating perspective in Europe; this can at the moment only be done with a robust carbon leakage protection against direct and indirect carbon costs. In this sense, the revision of the ETS Directive should provide the legal certainty that sectors at high risk of carbon leakage, like steel ,chemical, fertilizer and refinery industries, receive truly 100% free allocation and offsetting of indirect costs in all member states, at the level of the 20% most efficient installations.

2. The EU’s success in reducing emissions
The goal to decrease CO2 emissions in the EU by 20% by 2020, was already achieved in 2013. In 2014, according to the published figure (see: COM(2015)572 final), emissions decreased by more than 23%. Our calculations show that by 2020, if we assume a conservative trajectory, it will reach a level of more than 26%. This is a splendid result, which increases the likelihood that the goal of 40% for 2030 will be achieved.

Below, you can find a graph illustrating the price of allowances (EUA) in Euros, as well as a decrease of CO2 emissions . This shows that the higher price mechanism of the EUA is not necessary in terms of achieving the EU’s goals.

Price of allowances EUA

The average annual prices of the EUA ( blue, right), source: EUROSTAT

EU GHG emissions - tonnes per capita (brown, left),  source: JRC

Implementation of new technologies and innovations, including RES development and growing energy efficiency, is the driving force behind emissions reductions in Europe. This reduction effort also clearly indicates that a high CO2 price, driven by market intervention in the EU ETS, such as backloading and MSR (Market Stability Reserve), is absolutely not necessary for the achievement of the EU’s emissions reduction targets planned for 2030 . They are also not serving the further development of industry, especially in the EU-11 countries, also referred to as “lower-income Member States”.

3. ETS linear reduction factor

The currently discussed EU ETS revision, led to the Commission’s proposal to increase the linear reduction factor for the 2021-2030 period – from 1.74% up to 2.2% p/a..

The adopted measures in the EU concerning ETS , lost their relevance through a dynamic decrease of GHG emissions. The linear reduction factor for the decade, 2020-2030, went up from 1.74% up to 2.2%, whereas, as indicated in point 2, assuming that by 2020, the decrease would reach more than 26%, leaving even less than 17% to be secured in the ETS sector. Therefore, the linear reduction factor for the ETS sector to achieve 43 % in 2030, should be established at the level of approx.1.7% from today’s perspective. There is a great probability, that if we review the situation in 2018, this factor will have to be reduced further. Anyhow, we are of the opinion that such a linear reduction factor is not actually needed at all.

4. The cross sectoral correction factor

As we always pinpoint, the situation differs in particular sectors of industry, and below, please see the steel and fertilizer industries as examples.

4.1. Steel industry

The cross sectoral correction factor should be avoided by increasing the free allocation share to at least 50%. Unused allowances from the third trading period, as well as allowances from the Market Stability Reserve, if any, should also be used to avoid it.
If best performers still face a shortage, the available free allocation should be distributed in a way that ensures that sectors at a “high risk” of carbon leakage receive 100% free allocation.

Benchmarks need to reflect the actual performance of best performers in recent years, based on real and consistent industry data, and set at the level of the 20% most efficient installations. No linear reduction should take place nor changes during the trading period, in order to grant operational certainty. The data collection and processing should also be transparent, involving industry in all steps.

Indirect carbon costs passed through in electricity prices to electro-intensive industries at risk of carbon leakage, like steel, should be fully offset through harmonised and transparent rules in all member states, preferably through free allocation based on realistic benchmarks.

4.2. Fertilizer industry

As for the fertilizer industry, it is imperative that any use of correction factors to reduce annual allowances or benchmark levels should be abandoned. In the production of fertilizers, natural gas is used to produce ammonia. Most of the CO2 emissions from chemical processes (2/3) in the fertilizer industry are associated with the use of natural gas as a raw material, and not, as for example – with heating. Further theoretical emissions reduction becomes technologically very limited or impossible, that is why 100% allocation of free allowances should be provided. Benchmarks should reflect achievable technological progress - it must be recognised that ammonia production based on natural gas will remain the main production process for years to come, until 2050 and beyond. Differentiation proposed by the European Commission is going in the right direction, but it is not enough. The correction factor of 0.2% for benchmarks should be used if the actual achievable emission reductions are much lower than 0.5%. Any general correction of free emission allowances should not be done in a uniform manner, but should vary in the way that sectors of the highest carbon leakage risk were exempted from the correction factor.

5. Compensation mechanisms (art. 10c and art. 10d)

In October of last year, the European Council adopted its conclusions on the 2030 Climate-Energy policy framework, which also included provisions of compensatory mechanisms – 1) a derogation from full auctioning for power generation, and 2) the Modernisation Fund – for Member States with a GDP per capita below 60% of the EU average.

These mechanisms are designed to decrease the economic burden of energy transition towards
a low-carbon future, particularly in new Member States, with relatively higher modernisation needs. European Council conclusions with regard to compensatory mechanisms are particularly aimed at:

  • Limiting electricity price increases in eligible Member States – the derogation mechanism is intended to modernise power generation, whilst limiting the impact of associated costs on electricity prices.
  • Financing of energy transition – the Modernisation Fund should enable eligible Member States to obtain additional funding for investments in energy infrastructure and clean technologies, which will be particularly high in those countries with a high share of fossil fuels in the energy mix. The European Council’s conclusions were clear that the selection of projects to be financed from the Modernisation Fund should be in the competence of beneficiary Member States. with the involvement of the EIB.

Meanwhile, the draft ETS Directive, published by the European Commission on the 15th of July, 2015, substantially modifies the conclusions of the European Council and the spirit of the agreement.

  • The derogation for power generation can no longer be considered a compensatory mechanism – the Commission’s proposal completely changes the current system of balancing the market value of free allocation of EUAs with undertaken investments. National Investment Plans are proposed to be substituted by an open bidding process in terms of selection of larger (above EUR 10 million) investments eligible to account for free allocation. The notion that in the post-2020 period all eligible investments would have to meet a restrictive incentive effect definition and be chosen through an open bidding process, creates a risk that free allowances will not contribute to containing electricity price increases, because their value will have to be automatically transferred to specially dedicated investment projects. Therefore, this mechanism would no longer ease the cost burden on eligible power generators, resulting from high ETS compliance costs, due to historic dependence on carbon-intensive fuels – and the resulting impact would be borne by end consumers. This is not acceptable for socio-economic reasons. Some of the eligible Member States already have very high electricity prices in terms of PPS.

For Member States eligible for a derogation, the electricity price effect is critical, and this mechanism needs to have a real impact on the minimisation of price increases associated with increased CO2 emissions reduction targets post-2020. In this scenario, proposed by the Commission, the derogation option is no longer a value added and it would make more sense to select full auctioning, with dedicated revenues going to support investments in power generation.

  • Beneficiary Member States, eligible for financing from the Modernisation Fund, may have a limited role in project selection. Current EC proposals result in larger Commission and EIB control over the Fund through a newly designed body – the Investment Board and Management Committee. The Commission, the EIB and non-beneficiary Member States have proportionally much higher control over the project selection process than envisioned in the European Council’s Conclusions. The European Council decided that the beneficiary MSs should be in control of the Fund “with the involvement of the EIB”. There is no mention of the Commission or other Member States, as the Lisbon Treaty gives Member States full sovereignty over formation of their energy policy and choice of energy mix. Therefore, beneficiary Member States know best which types of investments and technologies are most suitable for financing on their territories, in accordance with their specific national circumstances – but taking into account the importance of the contribution of these investments to realising the EU’s 2030 CO2 emissions reduction targets.

Therefore, in order to fully reflect the decision of Heads of Governments and States, it is indispensable to:

  • Re-introduce the National Investment Plan framework for larger projects for MSs preferring this solution over open bidding.
  • Move away from a strict “incentive effect” definitionthis effect should be defined as investment undertaken from 24th October, 2014 – as this was the first date (after the adoption of European Council conclusions) that investors obtained legitimate certainty that free allocation will continue after 2020.
  • Give a decisive competence over the Modernisation Fund management to beneficiary Member States – and by doing so, fulfill the decisions of the European Council, in accordance with the energy policy sovereignty principle under the Lisbon Treaty.

6. Member State’s right to determine its own energy-mix.

The EU ETS regulatory framework should be shaped in accordance with a Member State's right to determine the conditions for exploiting its energy resources, its choice between different energy sources and the general structure of its energy supply (Art. 194 TFEU). The meaning of the Member State’s energy rights cannot be undermined by the secondary legislation measures. It must be taken into account not only for the purpose of further CJEU litigation but primarily to respect the balance between the EU’s and Member State’s competences in the energy field. The EU’s legislation should be changed in this respect.

For some countries, such as Poland, one of the most effective ways to decrease GHG emissions, including CO2, is to replace the old, worn, coal power plants with 30% energy efficiency, by new ones, applying new technologies surpassing 46% of energy efficiency. Such investments produce more than 15% energy savings, and more than a 30% CO2 emissions decrease. Apart from this, supporting a ‘gas policy‘, unfortunately, can lead to a bigger dependency on the supply from outside the EU, so coal, which is an indigenous energy source, should be taken into proper consideration.

7. Market Stability Reserve (MSR)

The main reason for the introduction of MSR, was a deep concern how to achieve the EU’s 2030 goals, believing that higher EUA prices would be the main driver to reduce CO2 emissions. However, additional measures, which support the EU ETS goals, must be adopted in accordance with the TFEU and TEU provisions. The MSR decision does not refer to the right legal basis which should be Article 192 (2) (c) TFEU. It is stated in this provision: “measures significantly affecting a Member State's choice between different energy sources and the general structure of its energy supply”. should be adopted unanimously by the Council. As market analysts show, the MSR decision will drive carbon prices higher, to a point where it will significantly affect the energy mix of some Member States. The above-mentioned doubts will be challenged by the CJEU, which will deal with the Polish complaint on the legality of the MSR decision.

8. Carbon leakage

All sectors of industry eligible for the carbon leakage list should enjoy 100% of free allowances up till 2030. The measures adopted for Member States, with a GDP per capita below 60%, are absolutely not sufficient for these countries. We should remember that the ETS directive is not the only one in the EU, and there are many directives, for ex. EED,RED,FQD,IED LCPD,SOSD, etc., which either directly or indirectly, lead to a decrease in CO2, especially EED. All directives require a tremendous amount of investment to be implemented. A fitness check performed in the refinery industry, divulged that almost 25% of production costs are connected with the implementation of the directives. We may presume that, in the other sectors of industry, these costs can be even higher. There is no reason to create any extra costs for the industry, due to stringent ETS regulations, when we in the EU, fulfill all our goals, and satisfy our ambitions to be green leaders in the world. This will definitely be so up till 2030, and beyond.

It is not easy to strike a balance between the interests of energy and energy-intensive industries. We find the proposal to determine ex-ante the share of auctioned (57%) and free (43%) allowances as a fair compromise solution – it should not be a subject of further discussion.

9. Climate neutrality

Thanks to the Paris Agreement , stopping deforestation and planting new forests, were factors included into the calculations, as a means of a GHG decrease. We cannot be indifferent to the rain forest situation, as it concerns the forests in Europe as well. This is a very big issue in making the world more green. To achieve visible results, countries should spend significant resources in reversing the observed trends. We, in the EU, should take this into consideration as well, and acknowledge such efforts, by including decreases thanks to forestry, into statistics concerning the decrease overall of GHG emissions

10. Consumption-based CO2 emissions

The whole ETS system and non-ETS is built around production-based emissions, which do not reveal the actual global contribution to CO2 emissions. It is worth considering what are the consumption-based emissions in each MS, for assessing the scope of possibilities for development of the EU’s industry, contributing to global mitigation of CO2, as technologies applied in the EU, are emitting less CO2 than the overwhelming global majority.

11. Conclusions

11.1. The ETS should be reformed, as proposed above, the MSR concept should be dropped but this measure needs unanimous approval in the Council.

11.2. Each industrial sector eligible for carbon leakage, should receive free allowances up to 2030, to the extent which is necessary to deal with the negative impact of the EU ETS. The balance between auctioned EUA’s (57%) and freely allocated allowances (43%) should be respected.

11.3. The balancing of the market value of free allowances with modernisation investments should be based on National Investment Plans ,with the incentive effect defined as the investment undertaken from 24th October, 2014. Improvements of current NIP schemes should be envisaged to better address the diversification purposes, such as inclusion of RES investments in the plan.

11.4. The climate neutrality indicator (point 9) should be introduced into EU statistics, as a real GHG decrease by a Member State, starting from 2017. Same concerns consumption-based CO2 emissions.

11.5. The Modernisation Fund framework should respect the leading role of the beneficiary Member States, with the coordination provided by the European Commission and a strictly advisory role for the European Investment Bank.

11.6. More EU funds for new technologies and innovations, should go to those Member States, where GDP per capita is below 60% of the EU average – e.g. from the Innovation Fund.

11.7. Each Member State should be allowed to shape its energy-mix, and be regarded as eligible for financial support, whilst the EU’s co-legislators have to respect that right.

11.8. The next review of the EU GHG emissions should be conducted by the end of 2018, and new measures, adjusted to the situation, should be implemented.

11.9. A healthy energy-intensive sector benefits the envisaged European circular economy and EU society as a whole. The EU’s policies play an important part in fostering this, whilst fully reaching its environmental and climate goals.