M&R Regulation applies a constant allowance price of 20 € as an input for important business estimations and assessments. Another regulatory document, the European Commission’s Guidance on the optional application of Article 10c of Directive 2003/87/EC (2011/C 99/03) adopted the relevant price levels between 14.5 € (years 2010 - 2014) and 20 € (2015 – 2020).
What are the effects of the above assumptions considering the background of current market prices for carbon?
Current extraordinary low market prices for carbon permits have already gained their supporters as well as evenly committed adversaries. Regardless, however, of the present political battle between regulatory-set versus market conceptions for shaping carbon prices (the nearest battlefield scheduled for 19 February 2013 is the European Parliament's environment committee (ENVI) vote on backloading) it would be interesting to observe how the whole situation influences on certain EU ETS mechanisms where certain levels for an allowance price have been incorporated in advance.
Among these instances in the Commission Regulation (EU) No 601/2012 of 21 June 2012 on the monitoring and reporting of greenhouse gas emissions pursuant to Directive 2003/87/EC of the European Parliament and of the Council (OJ L 181, 12.7.2012, p. 30), which entered into force on 1 August 2012 and applies from 1 January 2013 (M&R Regulation).
Dossier and documentation on the M&R Regulation is available under the link
The great merit of the new M&R Regulation is the possibility for the operator to get permission from the competent authority to derogate from a specific monitoring requirements (such as in particular the required tier level), if fully applying the requirement would lead to “unreasonable costs”.
Point 4.6 of the Guidance document No. 1 - General guidance for installations of 22 November 2012 clarifies that when assessing whether costs for a specific measure are reasonable, the costs are to be compared with the benefit it would give and costs are considered unreasonable where the costs exceed the benefit. The detailed description of the cost-benefit analysis is a new element in the M&R Regulation.
And there we come to the point. Under the M&R Regulation the benefit is considered to be proportionate to an amount of allowances in the order of magnitude of the reduced uncertainty, however, the M&R Regulation requires a constant allowance price of 20 € to be applied for all the estimations of the allowance value. Generally the purpose of this is to make estimations independent from daily price fluctuations.
Acknowledging the value of the above argument it is, however, logical that the value of hypothetical benefits under the M&R Regulation rules is overestimated comparing with the market price for allowances. This, in turn, forces economic operators and installations to apply metering technologies, the costs thereof are not fully supported by business analyses based on actual market data.
Such an outcome appears to be in contrast with cost effectiveness which is the underlying assumption embedded in the foundations of the M&R Regulation. It also results in measurable economic loss on the part of economic operators (for practical example see: Tiers - data quality levels under the EU ETS M&R Regulation - overstated).
When it comes to details Guidance document No. 1 underlines that it is up to the operator to provide a reasonable estimation of the costs involved. Only costs which are additional to those applicable for the alternative scenario should be taken into account. The M&R Regulation also requires that the equipment costs are to be assessed using a depreciation period appropriate for the economic lifetime of the equipment. Thus, the annual costs during the lifetime rather than the total equipment costs are to be used in the assessment.
On the part of determining the assumed benefit, the allowance price is to be multiplied by an “improvement factor”, which is the improvement of uncertainty multiplied by the average annual emissions caused by the respective source stream over the three most recent years. The improvement of uncertainty is the difference between the uncertainty currently achieved.
Where no direct improvement of the accuracy of emissions data is achieved by an improvement, the improvement factor is always 1%. Article 18(3) lists some of such improvements, e.g. switching from default values to analyses, increasing the number of samples analysed, improving the data flow and control system, etc.
However, accumulated improvement costs below 2 000 € per year are always considered reasonable, without assessing the benefit. For installations with low emissions this threshold is only 500 €.
In order to make these theoretical remarks more illustrative it would be useful to refer to a practical example given by the above-mentioned Guidance document No. 1:
An old measuring instrument is found to not function properly any more, and is to be exchanged for a new one. The old instrument has allowed reaching an uncertainty of 3% corresponding to tier 2 (±5%) for activity data. Because the operator would have to apply a higher tier anyway, he considers whether a better instrument would incur unreasonable costs. Instrument A costs 40 000 € and leads to an uncertainty of 2.8% (still tier 2), instrument B costs 70 000 €, but allows an uncertainty of 2.1% (tier 3, ±2.5%). Due to the rough environment in the installation, a depreciation period of 5 years is considered appropriate.
The costs to be taken into account for the assessment of unreasonable costs are 30 000 € (i.e. the difference between the two meters) divided by 5 years, i.e. 6 000 €. No cost for the working time should be considered, as the same workload is assumed to be necessary independent from the type of the meter to be installed. Also same maintenance costs can be assumed as approximation.
For the replacement of meters, the benefit of “improvement” for instrument A is zero, as it is a mere replacement maintaining the current tier. It cannot be unreasonable, as the installation cannot be operated without at least this instrument.
In case of instrument B, tier 3 (threshold uncertainty = 2.5 %) can be reached.
Thus, the uncertainty improvement is: 2.8% – 2.5% = 0.3%.
The average annual emissions are AEm = 120 000 t CO2/year. Therefore, the assumed benefit is 0.003 ·120 000 ·20 € =7 200 €. This is higher than the assumed costs.
Guidance document No. 1 concluded that it is therefore not unreasonable to require instrument B installed. It is clear that the whole conception, estimations and final conclusion is actual only assuming 20 € as the allowance price (which is not the case under the current market conditions).
Another area where artificial, regulatory-set emission allowances price is established for calculation purposes is the European Commission’s Guidance on the optional application of Article 10c of Directive 2003/87/EC (OJ C 99, 31.3.2011, p. 26).
Article 10c of Directive 2003/87/EC allows Member States whose electricity systems meet certain criteria to provide for transitional allocation of emission allowances free of charge to installations for electricity production. The criteria relate to the need to modernise the energy system, and Member States deciding to use this option must in parallel undertake action aimed at securing investments in the energy system, such as upgrades of infrastructure, clean technologies etc., of an amount corresponding to the value of the corresponding emission allocations allocated for free.
Annex VI to the above-mentioned Guidance laid down model-based projections of carbon prices in the third trading period which contain price levels between 14.5 € (years 2010 - 2014) and 20 € (2015 – 2020).
The unexpected effect of the discrepancy between these ill-designed projections with the current market prices is that it may occur that it will not at present be advantageous for the electricity generator to spend for instance 25 € on investments in order to gain free emission allowance worth 5 € only.
Nevertheless, for investment projects being at the threshold of financial viability, free hand-outs of emission allowances may be an influential driver for ultimate investment decision.