UK Emissions Trading Group EU ETS issues requiring attention in Phase 4 in relation to carbon leakage 1. Auction vs Free allocation split 57% Auctioning leaving the remainder (39%) for benchmark free allocation (once 4% has been subtracted for innovation and growth) Points raised by the Subgroup How was the 57/43% split calculated? Is it correct? (CSCF opinion is being challenged in ECJ). Will the ratio be appropriate through the phase? Does the fixed auction share give certainty to the auction market? What is the impact of lack of flexibility to free allocation sectors? What opportunities exist for supplementing the free allocation amount if it is shown that the best performers will not have sufficient allocation? Can a mechanism be added so that the best performers do not face undue costs in-line with the October 2014 Council Conclusions Those sectors expecting free allocation do not believe that 43% (minus the innovation and growth allowances) will be sufficient to meet demand and maintain international competitiveness, particularly given the post-recession growth that is expected and hence seek a more relevant share. Free allocation meant to guard against carbon leakage risks should not be used to capitalise the innovation fund. Increased flexibility in the free allocation amount by use of a reserve (such as the Market Stability Reserve, unallocated allowances, New Entrant Reserve and/or another). Modifying how the innovation and growth is funded with more equitable sourcing from auctioned allowances as well as free allocation. Potentially adjusting the 57:43 split throughout the phase depending on whether power generation or manufacturing decarbonises fastest. 2. Benchmark ratchet Commission Proposal: Default flat rate of 1% - for sectors with verified annual improvement rate 0.5%-1.5% annually (±0.5% for others) Questions raised by the Subgroup Are technological advances taking place at a speed that justifies a second benchmark ratchet mid-phase? The default ratchet is unscientific and a guesstimate of improvement 1
The historic CO 2 reduction is not a predictor for future abatement potential. The influence of the benchmark update should be looked at with the updated activity level to give the overall free allocation demand picture. The ratchet does not take account of the 2014 Council conclusions that the best performers should not face undue costs. Some sectors are in favour of a scientific review of abatement potential, whereas others are accepting of the simplistic ratchet proposed by the Commission. The solution might be a hybrid whereby some sector benchmarks undergo a full review of abatement potential (where they have special circumstances e.g. high proportion of process emissions and others take a standard factor reduction). A complementary solution to the Commission s default ratchet approach could be to provide free allocation informed by sector activity data (already required in the Commission s proposal and by benchmarks, updated once via a recalculation to redefine benchmark top 10% once per phase). This can be collected at the same time as the last three years data collected. If allocation is calculated more accurately, the risk use of the cross cutting factor (CCF) is less likely. With the over-allocation/ under-emission minimised via targeted activity based allocation, the risk is that the proposed ex-ante approach (1% BM ratchet, tiering, 5-year phases) is reduced but doesn t remove the possibility of unallocated allowances being placed in the NER instead of being allocated to EU ETS installations. In both cases the Benchmark adjustment must be looked at in context of the other adjustments. In this regard the sequencing is important, first the activity level must be decided, then the benchmark adjusted based on evidence only then is an estimation possible for the carbon leakage list and necessity for the cross cutting factor.recalculated benchmarks should be retained over the whole phase, not updated midway through so best performers can benefit from their investments. It would also give all participants the certainty of their allocations because the midphase recalculation infers a new calculation of the adjustment factor leaving participants uncertain what their allocation will be in 2026-2030. Such limited visibility is not conducive for investment in large industrial plants. Furthermore, more frequent revision is not appropriate since major breakthrough technologies are not expected to be widely deployed before the end of the phase. 3. Revised production baseline Two data collection cycles are proposed, i.e. production figures (HALs) will be updated twice during Phase 4 for allocation purposes: average of 2013-2017 activity data will be used for the first 5-year period average of 2018-2022 activity data will be used for the second 5-year period Points raised by the Subgroup Annual data are currently required to determine partial cessation as well as for emissions and allocation. Installation level production activity, transfers of heat and gases, electricity production and emissions at sub-installation level over the five calendar years 2
preceding its submission is also required in the Commission s proposal. If this data was supplied annually (rather than captured annually and stored for 5 years) it could inform tailored allocation reduction or increase in line with installation activity, and avoid the hurried end-of- year declaration of partial cessation to competent authorities. It also allows allocation alignment harmonisation between new entrants and incumbents once relevant post commissioning baseline is established (see section 5) Annual EU ETS data collection should be mandated, harmonised and systematic. This allows the allocation process to be more efficient by use of activity-based allocation. The data collection system could be readily devised to limit additional burdens for operators and competent authorities alike, such that the benefits of having a more accurate allocation system outweigh any additional administrative burden. The proposal appears to be too rigid and will only minimise rather than eliminate the problems experienced by Phase III where the HAL and the actual activity were greatly different for many installations. Administration of an annually calculated HAL (Y-x) is within the possibility for the scheme Many industries are in favour of a more dynamic production reference e.g. ex-ante n-1 or n-2 4. Indirect ETS costs The Commission encourages ( should ) rather than requires Member States to use auction revenue for compensation purposes. The proposed text does not address the necessity to replace the existing State Aid Guidelines on indirect ETS costs when they expire at the end of Phase 3 Questions raised by the Subgroup Is there scope for one carbon leakage direct and indirect list? After all carbon leakage exposure is a combination of direct+indirect added costs. Is the should recommendation for Member States to use auction revenue for indirect CO 2 compensation strong enough? i.e. How many Member States will actually take the opportunity? The package is largely silent on updating the State Aid list for indirect ETS costs and so there uncertainty for electro-intensive installations regarding post-2020 compensation eligibility. This will become an increasingly important aspect as CO 2 prices increase. To give sectors early sight of their expected position on this issue the combined direct+indirect carbon leakage test could be used as eligibility for indirect CO 2 compensation and free allocation. 3
Indirect ETS costs for electricity should be based on installation electricity consumed. The current State Aid Guidelines only recognise imported electricity. Own generation of electricity also receives no free allocation and is also is not counted towards calculation of indirect exposure. 5. New entrants, expansion, rationalisation and partial cessation EUAs will be provided for increases of production without adding capacity Questions raised by the Subgroup Will the growth clause be sufficient for a company rationalising e.g. two plants into one? i.e. is it really encouraging the closure of old plant in favour of new. Phase 3 NER access has been administratively complex, slow and needs revision. Investor certainty (ex-ante allocation) vs Accuracy (ex-post allocation) The new entrant definition appears to be unchanged (30 June 2011 not OK to use until 31 December 2030?), The new entrant definition includes new phase 3 sectors and gases & significant extensions (change date & delete new sectors & significant extensions?) Multiple sub-installations are treated differently in an NER allocation application Is it sensible to use 30 June 2015 as cut off for incumbent installations? This date gives commissioning time before start of Phase 4 recent three base data years (2016-18?) Partial cessation rules could be avoided with a more dynamic production reference (n- 1, n-2 or similar). New Entrant allocation should as closely as possible match that of incumbents hence attractiveness of activity based approach. Scrap the arbitrary 90 day/40% normal operations threshold which is not a good reflection of rest of phase activity plus its allocation methodology based on arbitrarily determined SCUF/RCUF values. Use current ex post new entrant allocation system until an historic activity baseline is sufficiently established following commissioning. This could be fixed at say four years from first emissions- four years being based on up to 12 months between GHG permit issue and first emissions, a year of activity then use of n-2 data (effectively a two year time delay between actual activity and activity level used for allocation). This time duration is selected for ease of application - installations with long or interrupted commissioning periods would have allocation increased in line with their activity levels albeit with a n-1 or n-2 delay. 4
6. Data issues The allows for new data collections but does not appear to have improved the compatibility between emissions and economic data. The use of NACE 4 digit sector definition is proposed for the carbon leakage assessment Questions raised by the Subgroup Is there an opportunity to move to NACE and PRODCOM use to match emissions data? Is NACE GVA data accurate? ETS activity descriptions don t fit well with NACE code/prodcom Eurostat data. Risk of lack of /poor data: Some sectors sub defined lower than 4 digit and others higher i.e. there needs to be flexibility to ensure there is compatibility between economic (GVA), emissions (CO2), industry classification (NACE/PRODCOM), EU ETS Annex I (activity descriptions) and benchmarked entities (product, intermediate products, activities, processes, fuel/heat). NACE code at 4 digit level of aggregation does not represent all sectors well (NACE 2, NACE 6, PRODCOM 8 defined sectors are also justified) Poor data means that there is little room for error between 0.2 factor and above 0.18 CL factor threshold for qualitative approach There are examples of installation NACE sector miscoding issues or differences between sector descriptions and benchmarked activities. Transparency of allocation: Publish allocation at sub benchmark level to separate out heat from industry sector benchmarks? Leakage assessments must not be limited to evaluations at NACE (4-digit) code level and must continue to be made at an appropriate level of disaggregation (2, 4, 6 or 8-digit). See ETG data issues paper: Use of installation NACE coding for annual emissions and allocation data 7. Carbon Leakage status determination Sectors with >0.2 CL factor 100% benchmarked free allocation Sectors with <0.2 CL factor 30% benchmarked free allocation Sectors with 0.18 to 0.2 CL factor subject can elect for a qualitative assessment. Points raised by the Subgroup - It is vital that vulnerable manufacturing industries are provided with free allocation that allows them to be internationally competitive. - Tiering leads to incomplete protection increased leakage risk and increased costs for sectors / subsectors NOT in top tier - Some materials are subject to substitutability - e.g. potential distortion of competition between ETS sectors in different tiers competing in the same market (e.g. construction products). - Treatment of best performers different between tiers very difficult to improve past 5
top 10%, but the best installations not in the top tier would get a much reduced allocation, resulting in a penalty for early action. - Is the Commission s EUROSTAT data good enough for multiple tiers? Issues of correct NACE sector coding, and transparency of data. - Although assessed at EU level, when assessed at Member State level, the quantitative carbon leakage indicator varies considerably, with higher scores occurring in countries more exposed to imports via road and sea transportation. - Leakage is a complex issue that is characterised and influenced by a number of factors including: Competitive pressure due to differential energy, climate and environmental costs in and outside the EU Cumulative effects of EU regulation increasing the risk of carbon and/or investment leakage (Many sector have been subject to the full cost of indirect emissions via electricity prices in particular). Investment leakage is an issue for sectors in that other regions are proving more attractive to invest. This is not well documented in the literature that often looks at historic information in a simplistic causality relationship between the ETS and carbon leakage, rather than considering forward looking elements. DECC s assertion on Page 6 of The UK s position on Phase IV of EU ETS that Numerous studies have shown no robust evidence of carbon leakage from the EU ETS in the current Phase so far is challenged by the limited literature base from which to draw, their publication early in the development of the scheme and the expected large difference between the historic / current EUA price and what is expected in Phase IV. As a specific example the EU has lost 20% of mineral oil refineries. While some is due to demand reduction, some missing production has partially been made up from increased imports. A similar situation exists for clay construction products (bricks and roof tiles). Carbon leakage increases the vulnerability of sectors to relocation - particularly when there are economic cycle downturns. EU installations may then become the default region for closure as EU ETS and other cumulative costs cannot be controlled in many cases. The UK, with the higher energy costs, ease of imports, and ease of employment redundancy, is more exposed than many other Member States. Sectors are impacted differently; depending on where tier boundaries are drawn, the level of mitigation in each tier and into which tier each sector is categorised into. Although the Commission has proposed a two tier system the Recent UK et al nonpaper mentions a 4 tier system e.g. high-, medium-, low-, or no-risk. Thresholds to be set on the basis of emissions and trade intensity criteria Tiering is arbitrary and is a trade-off between other aspects of the system (e.g. the total quantity of free allocation to industrial participants and benchmarking) to meet the linear trajectory The option of a qualitative assessment must be maintained is it allows for an in-depth review of carbon leakage risks in a sector. There is a cliff edge for sectors achieving <0.18 CL factor so there needs to be a qualitative assessment route to account for poor data and other issues that might 6
affect a sector s position. The solutions are different for different sectors but the principles agreed in the earlier sub-group paper should be followed. See Appendix I below Allow a qualitative assessment for sectors with CL <0.18. 8. Small Emitters opt-out facility and exclusion To retain Article 27 text. Exclusion of small installations subject to equivalent measures Points raised by the Subgroup Excluding more small emitters is desirable to reduce the administrative burden on Member States, the Commission, Competent Authorities and small emitters - in many cases compliance costs are disproportionate to emissions Exclusion of small emitters reduces administration of EU ETS without significant loss of emissions But currently, some very low emitters are still captured (e.g. <5000tCO2/year). We know who the small emitters are as their emissions are reported, verified and transparent. Decisions on their exclusion can be safely made on the basis of verified data. Some Options for amending Article 27: 1. Introduce an absolute exclusion based on tco2 for very small emitters in Annex A (i.e. no need for equivalent measures). 5ktCO2 was proposed as the absolute exclusion threshold because Art.27 already allows for simplified MRV for <5ktCO2. Excluding installations emitting <5ktCO2 would remove 0.26% of the ETS emissions in 2014. 2. Raising the current small emitters scheme thresholds (thermal and CO2) which allow opt-out into Member State equivalent measures. Raising the CO2 threshold to 50ktCO2 would remove around 5.6% of the 2014 ETS emissions. 3. Removing the 35MWth threshold (or making it necessary to meet the CO2 threshold in addition to the thermal threshold to be captured by EU ETS). Points were raised that there is no relationship between thermal capacity and emissions. An example of asphalt manufacture was provided where sites >35MWth have emissions of 3-4ktCO2. 2014 ETS installations Tonnes CO2 % All 1,616,467,451 100% 0 to under 5k 4,134,851 0.256% 0 to under 25k 44,985,717 2.783% 0 to under 50k 90,505,036 5.599% 50k and above 1,525,962,415 94.401% - Interaction with Annex I combustion plant and sector specific activities. There is a need to ensure that modifications to Article 27 don t create distortions for sector activities especially where a 20MWth threshold is used in Annex I. - Interaction with rules on small sources. Any de minimis exclusion of small emitters 7
would need to be consistent with the treatment of small combustion sources i.e. there may be a need to also introduce a de minimis - Is the optional exclusion possibility for Member States to opt installations into equivalent national measures strong enough? i.e. how many Member States will actually take the opportunity? - Further simplifications of monitoring, reporting and verification requirements are possible within national opt-out schemes and these should be progressed. There seems to be broad acceptance that there are a number of small emitters where the compliance and administration costs outweigh any marginal emissions saving benefit in the EU ETS. As such there seems to be considerable benefit to introducing an absolute exclusion for very small emitters and to raising the Article 27 CO2 threshold so that a larger number of small emitters have the opportunity to opt-out into less complex, equivalent measures. As there is no direct link between thermal capacity and emissions it seems sensible that the thermal capacity threshold is removed providing any consequential interaction on Annex I sector specific activities can be managed. These suggestions are in accordance with the Commission s objective of EU ETS simplification. 8
Appendix I UK Emissions Trading Group Abstract of EU ETS issues requiring attention in Phase 4 in relation to carbon leakage as agreed by UK ETG members at the EU Working group meeting 7 July 2015 following earlier subgroup carbon leakage meetings. Focusing the carbon leakage list must be compatible with the EU s manufacturing growth ambitions. Sufficient leakage protection must remain in place until global carbon cost equalisation Leakage protection (free allocation+indirect state aid) should not be diminished by a weak or insufficient international agreement Minimising the impact or removal of the CSCF/uniform correction factor should be the priority because it would take allocation below benchmarks in some sectors. This necessitates the need for an allocation reserve to preserve allocation levels to top performing installations. To avoid CSCF issues tiered allocation could be explored but might not be needed if other issues are addressed. Short-term losses to the Treasury from providing leakage protection need to be balanced against the potential longer term costs of losing carbon leakage industries The impact of tiering should be phased/smoothed no cliff edges All of the leakage threat (up to the benchmark) should be minimised by free allocation. It should be the benchmark that drives technological change not a punitive allocation method Without extensive analysis on justifying tiering threshold levels, the use of multiple tiers encourages political reverse calculation to include / exclude sectors in order to meet the cap, potentially undermining important issues such as security of supply. 9