The propositions of the European Commission tabled on 25 July 2012 for fixing the seemingly ailing EU ETS price-setting mechanisms reveal the hidden truth (somewhat unpleasant for the creators of the EU ETS original legal documentation), namely the fundamental flaws consisting, among others, in ex-ante method of cap-setting, insensitive to any subsequent macro-economic changes, the current deep financial and economic crisis including. How the EU ETS carbon price could be capable to stimulate investment in hi-tech green know-how, while the overall allowances cap is unresponsive to fluctuations in real economy?
The fundamental contradiction appears to be intrinsic to EU ETS scheme methodology – either the system is market-based with the free interplay of the supply and demand for the benefit of the environment or the higher-ranking purpose of the whole thing justifying market intervention is to stimulate structural industrial change. The absence of the clear determination as regards priorities causes the current efforts appear schizophrenic.
Whilst the Commission asserts that its proposal is not a market intervention, these contentions are not convincing in light of the assessment of the overall documentation tabled.
From the legal point of view the documentation presented does not seem excessively elaborate given the range of methodological novelty applied and due to this fact it seems the whole concept to be prone to legal challenges with future outcomes of such potential judicial disputes not easy to predict.
The lack of consequence and legal certainty is clearly visible in the regulatory approach with respect to the Auctioning Regulation.
Whilst the Commission published the Auctioning Regulation on 12 November 2010, it was amended in July 2011 already. Amendment related to early auctions to accommodate hedging demand and allowed for the auctioning of 120 million allowances before 2013, with corresponding reductions in the 2013 and 2014 volumes by 60 million allowances each.
The current legislative initiative is intended to run in the opposite direction and consists in back-loading of a certain amount of allowances (the volumes to be determined yet).
Among most salient objectives of the ETS Directive was to provide much greater regulatory foresight and stability with regard to crucial regulatory parameters. These intentions have been voiced notably in the introduction of a linear factor that provides a default cap even beyond 2020 (which will apply pending any change to the ETS Directive).
It should be recalled that the ETS Directive requires the Commission to adopt a regulation on timing, administration and other aspects of auctioning to ensure that it is conducted in an open, transparent, harmonised and non-discriminatory manner. Notably, the transparent and non-discriminatory character of such chaotic moves can be legally debatable given often contradictory interests of various businesses and industry branches.
Four separate issues seem key from legal perspective:
1) whether changing the directive in the form of a decision is legally effective,
2) how the provision regarding the backloading of allowances influences on the remaining parts of the ETS Directive,
3) what are the rules under which the European Commission will acquire knowledge that the carbon market does not function properly (in particular, what are the sources of data),
4) how many times the auction calendar and auction volumes could potentially change.
Setting aside the above criticism it is noteworthy that the Draft Commission Staff Working Document ‘Information provided on the functioning of the EU Emissions Trading System, the volumes of greenhouse gas emission allowances auctioned and freely allocated and the impact on the surplus of allowances in the period up to 2020’ (hereinafter referred to as ‘Staff Working Document of 25 July 2012”) makes, however, several useful summaries and assessments.
EU ETS cap-setting as of 2013
With respect to cap-setting the said document recalls that in phase 3 the cap is established directly in European legislation and no longer the result of a bottom-up process of national decision-making. Allowances will be distributed for free according to EU-wide harmonised rules, meaning that the same rules will apply to installations of a certain type across the internal market. Free allocation rules will largely be based on ex-ante performance benchmarks so as to ensure that they strengthen the incentives for reductions in greenhouse gas emissions and reward the efficient installations. The amount of free allocation will be phased out over time. In 2013 only 80% of the quantity determined according to the ex-ante performance benchmarks will be allocated for free, gradually reducing to only 30% by 2020 with a view to reaching no free allocation in 2027. Sectors deemed exposed to a significant risk of carbon leakage will continue to receive up to 2020 100% allowances for free based on ex-ante performance benchmarks. An EU wide new entrants reserve is foreseen equivalent to 5% of the total amount of allowances for phase 3. 300 million allowances in this reserve will be made available to stimulate the construction and operation of large-scale demonstration carbon capture and storage (CCS) projects as well as innovative renewable energy technologies.
The annual volumes to be auctioned mirror the difference between the total amount of allowances under the cap (which declines in a linear manner) and the amount of allowances handed out for free in that year (in line with the benchmarks), i.e. cap minus free allocation for each year.
The EU ETS cap is the absolute quantity of allowances over a multi-year trading period. For the first and second trading period, the Member States determined the total quantity of allowances in their National Allocation Plans (NAPs). As from the third trading period, there will be a single EU-wide cap.
The ETS Directive requires the Commission to publish the absolute EU-wide quantity of allowances for 2013 based on the total quantities of allowances issued or to be issued by the Member States in accordance with the Commission Decisions on the national allocation plans for the period 2008-2012. It also requires the Commission to publish the adjusted quantities in respect of installations that were opted into the system during the period 2008-2012, and those carrying activities which were only included from 2013 onwards. The Commission adopted a first Decision in July 2010 and the second in October 2010 with respect to the quantity of allowances to be issued for 2013. Further technical adjustments to this are possible, for instance to take into account the unknown amount of additional issuance of phase 2 allowances from the national new entrants reserves.
Exclusion of small installations subject to equivalent measures
As regards exclusion of small installations subject to equivalent measures Staff Working Document of 25 July 2012 indicates that in total seven Member States, i.e. France, Germany, Italy, the Netherlands, Slovenia, Spain and the UK, have notified such measures and that Member States concerned have notified only a limited number of eligible installations for exclusion. The said document mentions that the assessment of these notifications is ongoing.
Let’s recall that the above notifications are made under Article 27 of the ETS Directive which contains an option for Member States to exclude from the EU ETS, under certain conditions, installations falling within the scope of the EU ETS but emitting less than 25,000 tonnes of CO2 equivalent, and hospitals.
Changes to combat VAT fraud
Interesting comparative information contained in the Staff Working Document of 25 July 2012 as regards so-called carousel fraud in the context of allowance trading, is that most (unfortunately not all) Member States have already chosen to apply reverse-charge mechanism and notified the Commission thereof. The Commission’s document does not enumerate Member States not applying reverse-charge mechanism in that regard. The aim of this mechanism is to reverse VAT liability for the allowances and make it payable by the buyer.
Use of international credits
The Commission’s Staff Working Document of 25 July 2012 indicates that the determination of the details for the exchange process of JI and CDM credits held by companies with compliance obligations under the EU ETS into Phase 3 allowances will be defined in the upcoming amendment of the Registries Regulation (planned for 2012 as a part of actions to finalise the preparation of Phase 3).
Additionally, the exact limit on the use of international credits pursuant to Article 11a(8) of the ETS Directive will be established by a separate Commission Regulation.
The two important remarks can also be found in the above Commission’s Staff document as regards international units, first on the use of certain project types (that no further restrictions are envisaged at present but the possibility still remains to do so in the future), and second on the access to credits in the absence of an international agreement through bilateral agreements (that at present no concrete plans exist for this).