Commission finalises phase III EU ETS benchmark criteria

Controversial benchmarking criteria assigning free emission allowances to industries at risk of carbon leakage have been passed subject to acceptance by MEPs and the European Council. But some measures have been watered down.

Proposed criteria for free EU emission allowances by member states to energy-intensive industries deemed at risk from foreign competition were agreed by the European Commission’s Climate Change Committee on 16 December 2010.1 These allowances are for phase III of the EU emissions trading scheme (EU ETS), which begins in 2013.

Assuming the rules are uncontested, key elements of phase III are now all but in place. An overall emissions cap, auctioning platforms for the sale of allowances, and changes to EU allowance registries were agreed in mid-2010 (ENDS Report 426, pp 53-54).

The decision came despite continuing objections from the ferrous metal sector over the lack of free allowances for industrial waste gases in power generation (ENDS Report 428, p 53), and was arrived at days before the deadline set in the revised EU ETS Directive.

It is still subject to a three-month consultation in the European Council and parliament, and lobbying, mainly by the ferrous metal sector is continuing. Poland led opposition to the proposals, stressing that benchmarking performance against gas consumption would leave it at a disadvantage due to its dependence on higher carbon intensity coal.

But high-level objections are now thought to be less likely because any change at this stage would lead to the whole document being rejected. This could jeopardise the timetable for phase III implementation.

Under the revised 2008 EU ETS Directive (ENDS Report 403, pp 38-41), industrial sectors covered by the EU ETS will initially receive up to 80% of their greenhouse gas allowance for free in 2013. By 2020 this will decline to 30% as reliance on auctioning of allowances increases. The power sector will be subject to 100% auctioning throughout the period.

But the bloc recognises that certain energy-intensive industries, such as steel and chemicals, facing strong international competition could relocate outside the EU rather than reduce emissions, leading to carbon leakage.

The EU’s preferred means of mitigating this risk is to issue up to 100% of allowances free to these sectors rather than impose border taxes on imports. But it wants this to be based on benchmarking, against the lowest emitting operators, to ensure there is incentive to cut emissions.

The European Commission’s proposals are largely in line with expectations following technical briefings in September 2010.

They establish benchmarks for 53 industry product groups covering 75% of industrial emissions under the EU ETS, based on extensive consultation with the sectors concerned.

These benchmarks are now fixed until 2020, but could be tightened in the event of a global climate deal and a move from the existing 20% EU-wide emissions reduction target for 2020 (relative to 1990) to a tougher, 30% target. 

Only the top 10% most carbon-efficient firms in a sector or subsector are likely to receive the full amount of free allowances to cover their emissions, based on performance in 2007 and 2008.

Where there is insufficient data to establish benchmarks based on product groups, the proposals include three alternative, generic fall-back options.

Heat use benchmarks are expected to account for most of the remaining industrial EU ETS emissions, about 20%. The benchmark here for 100% free allocation is the efficient production of heat using low-carbon natural gas production. Where heat cannot be measured easily, allocation will be based on fuel use, with emissions from efficient natural gas heat production again the benchmark.     

Most process emissions of greenhouse gases are included within product benchmarks, but a small proportion of these combustion or chemical-related emissions, put at 1% by the commission, fall outside these categories.

This happens when too few plants exist for development of a product benchmark to be worthwhile, such as silicon carbide production, or where a new activity is absorbed into the EU ETS, such as downstream hot rolled steel in Italy.

They are based on historical emissions data for plants, but annual free allowance allocations are to be pegged at 3% below this level throughout phase III to ensure they are not less demanding than product benchmarks.

In practice, it is unlikely that even the most efficient plants under any benchmark will get 100% free allowances. Allocations eventually decided by member states will be subject to a downward cross-sectoral correction factor by the commission, to ensure fairness in distribution of allowances between sectors and consistency with the overall EU ETS cap. They will also be affected by the 1.74% annual reduction in the overall EU ETS cap through phase III.

Transitional allowances

The free allowances for vulnerable sectors subject to carbon leakage are intended to be transitional.

One of the biggest changes, and a lost opportunity, came from dropping a key provision that would have rewarded more efficient cement producers that reduce reliance on energy-intensive clinker, by mixing with substitutes during production.

The proposal, understood to be favoured by some producers, was challenged by the industry association Cembureau as likely to increase costs for most firms. 

Another long-standing dispute with the steel industry over how to reward efficient use of waste gas in steel production remained unsettled, with earlier proposals adopted largely unchanged for this product benchmark.

The commission refuses to grant allowances to fully cover emissions from electricity generation from waste gases, as this would be inconsistent with the principle of 100% auctioning for power generation in phase III.

But it recognises that using waste gas for generation is preferable to venting it. The final decision means that allowances will now only cover emissions over and above those that would arise from efficient natural gas generation. The commission believes this will still preserve incentives to burn waste gas.

But Axel Eggert, director of public affairs at iron and steel production trade association Eurofer told ENDS the decision violates the principle that the best performers should not have any additional costs as a result of the directive. He said even the best performers will have to upgrade, buy more allowances or cut production, even though they already face electricity costs 200% higher than those in China.

An unachievable benchmark

Mr Eggert claims that even the best performers in the industry will be 7% short of allowances as a result of the waste gas decision, even before the correction factor and gradual shrinking of the EU ETS cap are allowed for.

As a result, he describes the benchmark as “technically unachievable”. Eurofer is still in discussion with the commission on the point. It may now look to recoup costs through concessions aimed at cutting energy costs, though this is a complex process and may fall foul of state aid regulations.

Assuming the allocation rules are uncontested, the rules will be applied by member states when they publish their allowance allocation plans.

These will be contained in National Implementation Measures (NIMs), which unlike previous national allocation plans in phases I and II, must conform closely to central guidance by the commission. NIMs must be published by 30 September 2011.

Not all aspects of phase III are settled. The inclusion of aviation emissions, criteria for acceptable international offsets, and considerable technical details remain to be resolved, not least on auctioning platforms.

The overall cap may still need refinement as the final data trickle in from new sectors covered and tardy member states, and as legal challenges to phase II allocations needed to help determine the phase III cap are settled.

But the greatest uncertainty is over whether the bloc goes for a 30% economy-wide target, which would lead to a tighter EU ETS cap, and tighter thresholds for free allocation.

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