On the 15th of July, the European Commission published its ‘Summer Package of Proposals’ - an attempt to transpose the goals set out in the 2030 Climate and Energy Policy Framework brought to light during the European Council Summit in Brussels, in October, 2014. Its most vital part is the proposal for a revision of the EU’s Emissions Trading System. Following the back-loading regulations, finalised at the end of 2013, and after the adoption of the Market Stability Reserve (MSR), it represents the last piece of the puzzle to reform the ETS, and ensure its seamless functioning after the year, 2020.
Introduced back in 2005, the scheme operates as a ‘cap-and-trade’ system, setting a limit to the maximum amount of the greenhouse gases that can be released into the atmosphere. As of 2013, it covered more than 12,000 installations, collectively responsible for approximately 45% of EU-wide emissions. Summarising the motions included in the new proposal, it advocates for:
- An increase in the number of allowances withdrawn from the Emission Trading Scheme from 1.74 % to 2% a year
- New rules for inclusion in the carbon leakage list, translating into a much shorter list.
- A more targeted benchmark system updated twice during the trading period, with a 1% flat rate of emissions decline imposed annually.
- A new funding scheme to promote innovation
- A new Modernisation Fund for low-income Member States providing compensation for the modernisation of their energy and energy-intensive industries.
Although the proposition may look as though it touches some of the right notes - addressing the risk of exodus of industrial plants out of Europe, providing funding for innovative projects and setting aside funds for the modernisation of low-income Member States, a number of included motions have met with the dissent of Central European Industry.
Carbon leakage measures
Until now, a sector or a sub-sector, could have been deemed at risk, if it fulfilled any of the following three criteria: 1) either the extent to which the sum of direct and indirect additional costs, induced by the implementation of the directive, would lead to an increase of production costs of at least 5%, and the trade intensity of the sector, with countries outside the EU, was above 10%; 2) or the sum of direct and indirect additional costs was above 30%; or 3) its non-EU trade intensity was above 30%. The standard carbon price for exposure assessment was set at 30 euros per tonne.
The new proposal, on the other hand, suggests that sectors will only be deemed in danger, if the product, from multiplying their intensity of trade with third countries by their emission intensity, divided by their gross value added, exceeds 0.2.
This move will cause a significant reduction in the length of the carbon leakage list, from 177 positions that are on it today, to as few as 50 after 2021 - a three-fold drop. Those excised will be forced to bear a 70% increase in their emission costs. Furthermore, the free allowances for the industry will be determined, first and foremost, by the best-available-technology (BAT) benchmarks. An installation will be, at most, entitled to a free allowance equivalent to the emissions assessed for the 10% best performing plants specialised in a specific product. In my view, the above does not constitute an optimal solution. Not only does it further decrease any edge it may have over competitors in other countries, it also presents an unfair disadvantage to the industrial plants located in the CE area, which are proven to be largely underdeveloped, in comparison to their Western counterparts. One has to remember that the CE states entered the EU, no earlier than 2004, and before that, they had little funding available for the modernisation of their industrial sectors. Although they have undertaken an enormous effort to bring them up-to-speed with available technology in the last 11 years, the elapsed time has simply been too short. The proposed measures would mean that even the most state-of-the-art installations of the region would be faced with additional allowance costs. One should believe that the criteria for inclusion in the carbon leakage list should stay unmodified for the next trading period and even be extended, bearing in mind the EU’s competitiveness. The amount of free allowances for sectors deemed at risk of carbon leakage, should equal the true emissions of the installations. This would allow them to fairly compete in the international market and encourage the Central European energy and energy-intensive industries to narrow the development gap more quickly.
Product benchmarks updates
52 product benchmarks and two fallback benchmarks were determined at the start of Phase 3, corresponding to each sector and sub-sector covered, based on the performance data from real-life historical industrial production in 2007-08. These do not, however, differentiate between the technology or fuel used, or the size of an installation, or its geographical location.
The revision proposal, on the contrary, advocates for more frequent updates of the benchmarks. The first update would occur at the start of Phase 4, with the second coming after five years. Indeed, the benchmarks are to be tightened for every sector by a yearly flat rate of 1%, starting from 2008 (with a +/- 0.5% leeway to take account of particular industries).
This solution seems to lack the individual approach necessary for capturing the unique characteristics of different sectors. One has to be aware that distinct technologies have various investment needs and take an uneven amount of time to complete. Imposing artificial caps will not automatically guarantee their fulfilment - the installations simply won’t be able to meet them. It seems as though the legislative body is somewhat too optimistic about the development capabilities of energy and energy-intensive industries. A more targeted approach would be more beneficial for Europe as a whole. Treating each sector as a separate case, a better assessment of their growth potential will be possible, and any risk of putting additional, undeserved, financial burdens on installations, may well be averted as a result.
Production data updates
In Phase 3 (2013-2020), allocation decisions have been made for eight years in advance. For Phase 4, the Commission proposes that allocation decisions are made every five years.
I would like to point out that the above solution lacks cohesion with the benchmarking updates proposition. If the emission benchmarks are to be revised every year, a harmonised solution would dictate that production data updates should follow. The prolonged economic crisis caused a lot of energy-intensive sectors to curb their output, and some of their capacity is currently sitting idle. Moving to an allocation methodology closely aligned with real, recent production levels, would provide the required allowances to those wishing to restart or expand production, as well as help avoid undue costs and ensure simplified and fairer rules as a consequence.
The Modernisation Fund
The proposed Modernisation Fund is a new solution, developed in order to compensate low-income Member States for undertaking steps towards modernisation of their energy and energy-intensive industries. It will be set up with 2% of all allowances available for Phase 4, which is equal to approximately 310 million units. The selection criterion for countries is based on their gross domestic product, calculated at market prices - it cannot be higher than 60% of the EU average. Ten members were found to be compliant. The projects to be supported will be chosen by a management board made up of representatives of the Beneficiary States, the European Investment Bank, the Commission and other EU countries.
It immediately comes to the attention that all the Beneficiary States were admitted to the EU no earlier than 2004, meaning they have had access to the EU funds for the shortest amount of time. Although the GDP limit for eligibility was set at 60%, the average GDP of these States is a mere 43% of the EU’s value, further proving the vast underdevelopment of the whole CE region. The idea to set-up the Modernisation Fund, in order to narrow the development gap between Central Europe and the rest of the EU is thus welcomed. However, the suggested management structure raises some concerns. The current wording of the proposal essentially empowers the EIB with the final vote on the projects. Overturning its decisions, would require approval from the decisive majority of other members of the board, and one has to remember that three of them are going to be delegates from European countries not taking advantage of this fund. Furthermore, as a result of such complexity, the smooth functioning of the fund is not assured. The large number of parties involved may result in a long-lasting and complicated selection procedure. There are also reservations that, because of the large influence that the Western States will maintain, those projects that are aligned with their interests, will be favoured, over those carrying most benefit for the low-income members. I believe that the scheme could gain from a simplified management structure, including only the aided countries. It would be in line with the EU principle of the lowest possible administrative burden, and assure a simplified and accelerated selection procedure, adopting only projects carrying the biggest added value for the Beneficiary States.
Derogations for the power generation sector in low-income Member States
The opportunity for awarding up to 40% of allowances for free by low-income Member States to their power generation sectors is to be maintained after 2021. Derogations will be available in return for an equal value of expenditures. As the investment needs of low-income Member States are estimated to be around 300 billion EUR only, up to the year 2020, these funds will surely make their financing easier and more secure.
What seems to be out of place though, is the requirement that they have to be used towards diversification of the energy portfolio. The Commission, trying to influence the choice of one source instead of the other, inadvertently disrespects the right of EU Members to freely decide on their energy mixes. It must be understood that, for ages, coal has been the main source for electricity production in CE countries, offering cheap energy and a high level of energy security. Forcing them to turn away from coal will make the use of their indigenous resources no longer possible, and result in a higher dependence on fuel imports from outside of the EU. This completely contradicts the fundamentals of the EU’s Energy Security Strategy. The most rational solution here, would be to allow the Member States to distribute the derogations, according to their own criteria. A competitive bidding process would, of course, be preserved, to assure that only the most cost-effective projects are selected. The move would also positively affect the much needed security of energy supply.
Although the proposal for revision of the ETS, has been declared by the Commission to be reaching out to the energy and energy-intensive industries, and remedying their problems, it seems to be an overstatement. Without providing much compensation, it just puts an additional burden on their shoulders. This is especially true in the case of installations located within Central Europe, that have had less time and funds to introduce the newest technologies. On top of all this, EU is now responsible for only 11% of the global GHG emissions and, after having dropped them by over 18% (data for 2012, in comparison with 1990), bringing them down any further seems to be more difficult. In the same time period, the United States enjoyed an increase of 4%, whilst China’s contribution skyrocketed 2.3 times. The evidence that Europe has already done its homework is piling up, providing numerous arguments that it is now time for other big polluters to ‘step up to the plate’ and take action.
Introducing the changes to the proposal outlined in this article, will help make it a bit more acceptable from the energy and energy-intensive industries’ point of view, shielding them better from additional, unnecessary costs, and helping them regain a competitive edge against counterparts in other regions of the world. The EU community needs to remind itself, that these sectors are among the most important creators of national wealth, and trying to put them on the road to disarray, instead of working towards their sustainable growth, will only make Europe more dependent on imports, greatly exacerbating the trade balance and draining money from the area - causing the EU to slide further into recession, leading to job reductions, and pushing more people into poverty.
Gabriel Niedziałek, Central Europe Energy Partners