Questions on UK's carbon cap as Commission clears allocation plans

The UK's national allocation plan (NAP) for the EU emissions trading scheme was among eight to be approved by the European Commission in July. The overall emissions cap on UK industry now appears to be fixed - foxing industry's hopes of influencing the Department of Trade and Industry's ongoing work on the energy forecasts which underpin the NAP.

The EU carbon market, which is due to go live at the start of 2005, took a big step towards reality on 7 July when the Commission approved the first eight NAPs.

Plans from Denmark, Ireland, the Netherlands, Slovenia and Sweden were accepted unconditionally. Another three - from Austria, Germany and the UK - were approved subject to relatively minor "technical changes".

The approved plans will cover more than 5,000 installations and more than 40% of the total allowances which are expected to be issued across 25 Member States (see table).

In May, the Commission voiced concerns that generous allocations would fail to deliver either real emission reductions or a functioning market (ENDS Report 352, p 54 ).

However, for the first eight NAPs the Commission did not force a significant tightening of the overall caps set by Member States. The Netherlands agreed to reduce its cap by 3% shortly before the announcement, and Austria and Ireland offered only marginal reductions.

The key issues in the announcement are:

  • UK allocation plan: The UK plan was approved subject to two technical changes, which must be implemented by the end of September. The first concerns the failure to include four installations in Gibraltar.

    The second problem was that the plan contained insufficient information on the treatment of new entrants. In May, the Environment Department (DEFRA) consulted on a range of options to tackle the issue (ENDS Report 352, pp 41-44 ).

    The Commission has asked DEFRA to clarify the allocation methodology for new entrants, finalise the size of the new entrant reserve and better define the eligibility criteria.

    The UK's new entrant reserve is 56.8mtCO2 - more than twice the total reserves in the other seven Member States. Even so, the Commission concludes that it is of "a sufficiently justified size".

    The UK plans to hold annual auctions to return any surplus to the market. However, some analysts are concerned that sudden injections of allowances could destabilise the market. Friends of the (FoE) is calling on the Government to follow the Danish and German example by cancelling any surplus - effectively tightening the overall cap.

    However, the most sensitive element of the Commission's decision attracted little attention. The Commission has spelt out that UK is forbidden from increasing the number of allowances without resubmitting the plan for approval.

    The move has important implications. The NAP is built upon the DTI's energy and emission forecasts - but work on revising these is running many months behind schedule. DEFRA was forced to fall back on a DTI "working paper" to draw up the NAP - but this still needs considerable refinement, and the final projections are not expected until August (ENDS Report 353, pp 39-40 ).

    Industrial sectors are now lobbying the DTI in a bid to increase their forecast emissions, and hence their allocation. Earlier changes to the forecasts led to a 3% increase in the total allocation between the draft NAP and the final version.

    The Association of Electricity Producers is now pushing for the generators' allocation to be increased by a massive 22mtCO2 per year, or 15%. Its main concern is that the DTI may have underestimated electricity demand in 2005, but the AEP also says it has used out-of-date emission factors and double-counted in the treatment of combined heat and power and renewables.

    However, it now seems that this lobbying may come too late to alter the allocation. "Any further changes to the projections must be accommodated within the approved cap, or else a new NAP submitted," says FoE's Bryony Worthington. "But the UK would risk complete political embarrassment if it was to resubmit a more generous NAP at a later stage."

    Sources in the Commission also expressed concern at a possible move to increase the UK's allocation. They pointed out that the UK has been pressing for a tough line on other Member States' NAPs - and that Prime Minister Tony Blair has written to Commission President Romano Prodi on the matter.

  • Decisions on other allocation plans: The Commission also set out some other important principles.

    Firstly, it has blocked German and Austrian plans to allow "ex-post adjustments" - changes to an installation's allocation once the allocation decision has been taken. The Commission says this "would disrupt the market and create uncertainty for companies".

    The other key principle was that a Member State's allocation for the first 2005-7 trading period should not jeopardise the achievement of its Kyoto Protocol target for 2008-12.

    Four of the eight Member States told the Commission that they intend to buy credits from the Protocol's "flexible mechanisms" to help meet their national targets - and as a result need to set less stringent caps on their industries. Some observers have pointed out that this has state aid implications, but the Commission has not risen to the bait.

    The Netherlands has a long-established Government-funded programme to buy credits for some 100mtCO2. Austria, Denmark and Ireland told the Commission they want to buy a further 72.5mtCO2.

    The Commission accepted that three of the Member States had substantiated plans to use Kyoto credits, with budgets, contracts and administrative arrangements all in place. The Commission gave Ireland the benefit of the doubt, on the basis that it promises to have established an operational programme by the end of November.

  • Legal action against the laggards: At the same time, the Commission started legal proceedings against Greece and Italy, which have yet to submit their NAPs.

    Other stragglers such as Spain and France submitted plans just before the Commission's announcement, and appear to have avoided legal action. The Commission is hoping to reach decisions on the outstanding NAPs in September.

    So far the Commission is taking a gentler approach with the new Member States, which had a slightly later deadline to submit their NAPs.

    The Commission has also sent final written warnings to 11 of the EU15 Member States for not fully transposing the emissions trading Directive into national law by the end of 2003 deadline. The UK's difficulties again relate to implementing the scheme in Gibraltar.

  • Market reaction: Some observers felt that the Commission had lost its nerve. Environmental group WWF complained that many of the approved NAPs contain "business as usual allocations and weak targets" - and urged the Commission and Member States to avoid such "domestic wrangling" by developing clear benchmarks for allocation in future phases of the trading scheme.

    The UK Government also expressed concerns. Trade and Industry Secretary Patricia Hewitt complained of a "lack of clarity on how the Commission has reached a decision that no over-allocations have occurred. Given the impact on competitiveness as well as the market implications of any over-allocation, this falls short of the robust scrutiny that the UK has called for."

    In contrast, Rupert Edwards of Climate Change Capital described the approvals as "a pragmatic response aimed at securing a timely start for the market and satisfying the competing priorities within the Commission."

    Views on the net demand for allowances and implications for the future price of carbon were also split. The divergence is not surprising, given the very large remaining uncertainties - not least over the eventual stringency of the 17 outstanding NAPs.

    Of the eight approved NAPs, only those for Germany, the UK and Slovenia foresee a reduction in emissions compared to the baseline period. This confirms a general lack of ambition, especially in light of Member States' poor progress towards their Kyoto Protocol targets (see article ).

    On the other hand, most NAPs seem to imply a reduction from projected emissions - although few are presented in a way which permits easy comparisons. One notable exception is the German plan, which the Commission approved even though it allocates 15mtCO2 more than allowed under an existing voluntary agreement with industry.

    The UK's NAP is commonly cited as one of the more stringent. This impression stems from the fact that the UK is well-placed compared to its undemanding Kyoto target. In fact, the NAP offers only a modest departure of less than 1% from "business as usual" forecasts - assuming, of course, that these are robust.

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