1. VEMW Energy Lunch EU ETS III, present state of play Vianney Schyns Woerden, 17 June 2011 1

2. 1.Regulations: EU ETS Directive, Commission Decision & Guidance Documents 2.What were the purposes of free allocation? 3.Free allocation of allowances A.Incumbents B.New entrants, closures, partially ceased operations –Problems, major changes, product benchmarks, CHP … 4.Financial compensation (EU, NL, Germany) 5.Status ETS globally … changes EU … revision EU ETS Directive … which changes do we want? 6.Appendix: EU Climate and Competitiveness Policies towards 2050 2 Agenda

3. EU ETS Directive of 2003 –Revised, 23 April 2009 (OJ 5 June 2009), legally binding Commission Decision on Benchmarks and Allocation Rules –Comitology, adopted 27 April 2011, legally binding Guidance Documents on Benchmarks and Allocation Rules –All but one adopted 14 April 2011, not legally binding –(1) General guidance, (2) allocation methodologies, (3) data collection, (4) verification NIMs baseline data reports, (5) carbon leakage, (6) cross boundary heat flows, (7) new entrants / closure rules (not yet final), (8) waste gases, (9) sector specific guidance, PLUS guidance methodology report 3 1. The EU ETS regulations

4. Globally –Avoid carbon leakage (e.g. recital 24, statement Barroso, etc.) –Protect competitiveness as good as possible (recital 25, Tajani) EU-27 plus Norway etc. –Avoid competitive distortions in Europe: “Harmonised ETS is imperative to avoid distortions in the internal market” (recital 8) through “Community-wide and fully-harmonised implementing measures” (Art. 10a(1)) –Environmental effectiveness (recital 20 old, Art. 1, Art. 10a, etc.), away from historical grandfathering 4 2. What were the purposes of free allocation?

5. VEMW Lunch 3. Free allocation of allowances for industry in the EU ETS 2013-2020 5

6. Free allocation for direct emissions carbon leakage list 1.Sectors exposed to the risk of carbon leakage: 100% of benchmark 2.Non-exposed sectors: 80% of benchmark in 2013 down to 30% in 2020 Auctioning for electricity generation –Except for waste gases, in fact only partly free allocation –Except for “Polish” derogation (Art. 10c) Each “installation” (CITL code) is for allocation purposes (incumbents and new entrants) divided in sub-installations –One product benchmark sub-installation –One heat BM sub-installation –One fuel BM sub-installation –One process emissions sub-installation  One GHG permit may cover one or more installations (Directive, Art. 6) 6 3. Free allocation of allowances

7. Allocation = HAL x Benchmark x CLEF x CSF HAL = Historical Activity Level, 1 set of 2 years for the “installation” –Median 2005-2008 or, when higher, median 2009-2010 Benchmark –Product BMs top 10% (52), 14 with interchangeability of fuel & electricity Allocation = {(direct/(direct + indirect) of plant} x BM (direct + indirect) –Heat BM, for measurable heat: 62.3 ton CO 2 /TJ (natural gas, 90%) To consumer, if non-ETS to producer –Fuel BM, for non-measurable heat: 56.1 CO 2 /TJ (natural gas) –Process emission BM, 0.97 x median CLEF = Carbon Leakage Exposure Factor; for heat of consumer, also in case of non-ETS consumers (burden of proof to operator) CSF = Cross-sectoral correction factor, if necessary –CSF = industry cap / total preliminary allocation (CSF </= 1.00) –Industry cap declines linearly, linear factor 1.74% (of 2010) 7 3. Free allocation of allowances – incumbents (1)

8. Allocation for net heat consumption of ETS consumers, also from CHP: no distinction between source of heat (heat is heat); only no allocation for 1.Heat for electricity production 2.Heat from electric boilers 3.Heat from nitric acid 4.Heat (imported) from a non-ETS installation  Heat from product BM or (other) exothermic processes qualifies Heat export to non-ETS heat consumers, no allocation for –Same as above Incentive CHP: low ton CO 2 /MWh (  0.25-0.30) –ETS I & II: same + free allocation for electricity 8 3. Free allocation of allowances – incumbents (2)

9. Initial capacity (IC) –Average 2 highest months in 2005-2008 times 12, or experimental verif. –Must now be determined for product BM sub-installations –For fallbacks: only in case of capacity extension as incumbent (or later in case of new entrant, meaning an extension after 30 June 2011) “Significant capacity extension” or “... reduction”, definition 1.One or more physical changes 2.Extension at least 10% > initial capacity, or: 3.More than 50,000 EUAs and >/= 5% more allocation of sub-installation –Reduction: mirror, lower capacity plus “and its activity level” (!) Physical change –Excludes: more operating hrs, repaint, process software,  T-P, higher speed rotating kiln, etc. and mere replacement production line –Abatement of fallback sub-installation is no capacity reduction (needs proof to competent authority... change & production volumes) 9 3. Free allocation of allowances – incumbents (3)

10. Extension (reduction) after 1 Jan 2005, before 30 June 2011 –Capacity = average 2 highest monthly productions, in the 6 months after “start of normal operation”, multiplied with 12 –Start: First day of the 90-day period in which the extension has (aggregated) produced at least at 40% of design capacity –HALad = added capacity x average HCUF (Historical Capacity Utilisation Factor) of the sub-installation before added capacity HAL existing sub-installation = HCUF x IC HAL existing data flow in HAL of installation  HCUF: can be of different physical plants, in one sub-installation Significant capacity extension or reduction –Causality between the physical change and the capacity change No or lower production (crisis): wait; what if minor change? –Cannot be determined by experimental verification (only for IC) –Debottlenecking, series of small changes qualifies (if 10% or 50 kt & 5%) 10 3. Free allocation of allowances – incumbents (4)

11. Guidance 6: “‘Significant capacity extension’ of a heat benchmark sub-installation means either –a significant increase in the capacity of consumption of heat eligible for free allocation or –a significant increase in the capacity of heat export to non-ETS entities –or a combination of both.” Guidance 6: “‘Significant increase in the capacity of heat export to non-ETS entities' results –from one or more identifiable physical changes relating to the technical configuration and functioning of the equipment producing the heat. –This excludes mere replacements of an existing boiler. –The physical change has to take place within the boundaries of the sub- installation concerned.”  The added capacity: determined on heat consumption (nothing for new boiler)  Example: non-ETS heat consumer(s) expand 30% of total sub-installation, heat comes from spare capacity of CHP or boilers: no allocation for the extension (with a (small) physical change, allocation is possible) 11 3. Free allocation of allowances – incumbents (5)

12. Process emissions (Guidance 8): N 2 O or directly formed CO 2 12 3. Free allocation of allowances – incumbents (6)

13. Waste gases: emissions from incompletely oxidised carbon, see definition Art. 3(h) of the Commission Decision –Of product BM sub-installation: allocation to producer, is part of BM –Of non-product BM sub-installation: allocation for the emissions higher than natural gas, to consumer (note: conceptually wrong), if the waste gas is not flared but used to produce (non-)measurable heat or electricity 13 3. Free allocation of allowances – incumbents (7)

14. Waste gases use of a product BM sub-installation –Waste gases in BM, used to produce electricity outside: no allocation –Waste gases to produce (non-)measurable heat: allocation by heat benchmark to consumer, or to producer in case non-ETS consumer 14 3. Free allocation of allowances – incumbents (8)

15. Waste gases use of a non-product BM sub-installation –Waste gases used to produce electricity: no allocation –Waste gases to produce (non-)measurable heat: allocation by heat benchmark to consumer, or to producer in case non-ETS consumer 15 3. Free allocation of allowances – incumbents (9)

16. New entrants –New plants or extensions existing plants or opt-ins, all after 30 June 2011 Allocation = AL x Benchmark x CLEF x Linear Factor Activity Level “significant extensions”, eligible for allocation –Initial capacity x SCUF or RCUF –Product BMs: Standard Capacity Utilisation Factor –Fallbacks: Relevant Capacity Utilisation Factor Initial capacity –Average of the 2 highest monthly productions, in the 90-day period after “start of normal operation”, multiplied with 12 –Start: First day of the 90-day period in which the extension has (aggregated) produced at least at 40% of design capacity, (to be confirmed) in which the extension has operated each day (!) Linear Factor, 2013 as basis –Allocation = PA (preliminary allocation) – 0.0174 x PA(2013) x (k – 2013) 16 3. Free allocation of allowances – new entrants (1)

17. There is also allocation before start of normal operation –Ex-post, historical emission x CLEF x Linear Factor Initial capacity of draft Guidance 7 is disputed –Art. 18(3): added capacity existing plant is in definition CIMs Art. 3(l): Average 2 highest of 6 months after start of normal operation –Art. 17(4) for new plants: “the methodology set out in Art. 7(3) using the continuous 90-day period on the basis of which start of normal operation is determined as a reference” is in my opinion wrong reference because Methodology Art. 7(3) is 2 highest months in 48 months (2005-2008) There is no reference to 90-day period (is here not relevant) Reference should be Art. 7(4): significant change as incumbent, again average 2 highest of 6 months after start of normal operation Significant capacity reduction –Abatement of fallback sub-installation is no capacity reduction (needs proof to competent authority... physical change & production volumes) 17 3. Free allocation of allowances – new entrants (2)

18. CIMs Art. 22.1 cessation of operation (closure) –An installation is deemed to have ceased operations, where any of the following is met: a)GHG permit or environmental permit has expired b)Permit referred to in (a) have been withdrawn c)Operation of the installation is technically impossible d)Installation is not operating, but has been operating before and the operator cannot prove that operation can resume within 6 months; Member States can extend period to 18 months if operator can prove exceptional and unforeseeable circumstances that could not be avoided...; in particular “natural disasters, war, threats of war, terrorist acts, revolution, riot, sabotage or acts of vandalism” are mentioned CIMs Art. 22.2 installations kept in reserve or standby: not closed a)Operator holds GHG permit and the other relevant permits b)It is technically possible to restart without physical changes c)Regular maintenance is carried out 18 3. Free allocation of allowances – closure (1)

19. Allocation after closure of an installation –No issue of allowances in the year following closure –Member States may suspend allocation as long as it is not established that the installation will resume operations (CIMs Art. 23.4) –After re-start, the installation is a new entrant, only in exceptional cases MSs can go to interruption of 18 months Unclear: allowances after closure, to auctioning pot or to NER? 19 3. Free allocation of allowances – closure (2)

20. Partial cessation of operation, if –A sub-installation has reduced its annual activity in a calendar year by at least 50% compared to its initial activity level, and –sub-installation contributes to at least 30% of the installation’s final amount of allowances allocated free of charge, or –to more than 50,000 allowances –Unclear: allowances to auctioning pot or to NER? Partial cessation is not result of a physical change –Therefore no loss of allowances after abatement in a fallback sub- installation (proof must be delivered) Schedule of partial cessation, activity level becomes –50% until 75%: 50% lower allocation in next year –75% until 90%: 75% lower allocation in next year –90% or more: 100% lower allocation in next year (!)  Vice versa in case of higher activity level 20 3. Allocation of allowances – partial cessation (1)

21. Benchmarks for industry: The right decision –but benchmarks severe, especially since they apply from 2013 no time for adaptation Allocation rules… –… adequate for installations without production changes between 2005 – 2011 –… result partly in shortage of allowances or wrong incentives for installations with production changes 21 3. General assessment EU experience has shown: To set up a benchmark system is challenging but feasible EU system can be a model for the world  if benchmarks are phased in (time for adaptation) and  allocation is based on actual production levels safeguards right incentives, reduces complexity of allocation rules significantly etc. while maintaining carbon price signal

22. Historical Activity Level: some flexibility New Entrants Reserve: 10 % or 50.000 EUAs … Allocation to heat consumer Carbon leakage status of heat consumer considered Abatement measures will not lead to less allocation 22 3. In detail: What’s good or was improved

23. Constraints on production growth –No additional allocation in case of production growth –No additional allocation in case of capacity increase below 10% –Problematic determination of added capacity –There may be no allocation for new entrants/ capacity extensions in case New Entrants’ Reserve (NER) is used up NER allows for average of 1.2% compounded growth in period 2013-2020 –Extension of non-ETS heat consumers not sufficiently considered (sets inefficient incentives) –Capacity extensions of up- and downstream plants not considered 23 3. In detail: What’s not implemented well

24. Competitive advantage of industrial CHP reduced Wrong calculation “industry cap” may reduce free allocation (too early, unjustified CSF) –Industry cap may become too low (waste gases steel 30 Mton, CHP with separate permit (electricity generator) delivering heat to ETS heat consumers) –Electricity generator CHP heat to non-ETS heat consumer comes from auctioning pot (is OK) No hardship clause No rationalisation rule –Move of production to an existing installation (needs physical change) Lack of EU-harmonisation with regard to “installation” definition... 24 3. In detail: What’s not implemented well Financial Compensation: still the missing link in the system

25. VEMW Lunch 4. Financial compensation for the indirect EU ETS cost effect 25

26. Free allocation for direct emissions carbon leakage list 1.Sectors exposed to the risk of carbon leakage: 100% of benchmark 2.Non-exposed sectors: 80% of benchmark in 2013 down to 30% in 2020 IFIEC proposes: financial compensation for indirect emissions should also be based on carbon leakage list –Otherwise: there would be competitive distortions between installations with direct emissions and those with indirect emissions –We expect the European Commission, especially DG Competition, to prevent such competitive distortions 26 4. Financial compensation: Eligibility & Distortions

27. 27 4. Financial compensation: Eligibility & Distortions

28. Carbon leakage is loss for economy and environment –Leakage of e.g. 100 Mton CO 2 to same efficiency installations outside Europe = 100 Mton loss for the global GHG balance because EU ETS cap remains unchanged Restricted compensation contrary to Europe 2020 Strategy –Strategy: not weakening but strengthening competitiveness –Competitive industry needed for growth and jobs, for European welfare, to finance challenging climate change policies Real issues are: (1) global level playing field, (2) how to provide stability and predictability for European industry –IFIEC promoted indirect allocation of allowances 28 4. Financial compensation: General considerations

29. Electricity prices in Europe are (among) the highest globally –21% higher than in USA and 197% higher than in China (source: Commission 2020 Energy Strategy) CO 2 cost impact on power prices comes on top and depends on marginal power plant –IFIEC regrets that the carbon leakage list is based on the average emission of European power plants –The marginal effect is correct and well known in the Commission (DG COMP a.o. sector inquiry, DG Climate Action) Any reduction factor is neither justified nor effective –Neither a general reduction factor nor a CO 2 -price reduction –Environmental effectiveness is not ensured through a reduction factor but through the benchmarking approach 29 4. Financial compensation: General considerations

30. … electricity consumption benchmarks (BMs) –BMs give an incentive to lower electricity use: a) benefit of avoided cost (if worse than BM) plus b) benefit of extra revenue (if - becoming - better than BM) –Thus, a more stringent BM does not affect environmental effectiveness but affects competitiveness significantly (a + b always the same) … relevant CO 2 factor –In general: the marginal CO 2 factor –Exception for existing contracts and existing self-generation units with a CO 2 factor above the marginal: actual CO 2 factor –For new contracts and new self-generation: mechanism that maintains the ETS incentive for low-carbon technologies 30 4. IFIEC proposal: Financial compensation shall be based on...

31. VEMW Lunch 5. ETS globally... EU debate... Revision of EU ETS Directive... What do we want? 31

32. USA federal: blocked for some years ETS may start soon: –WCI California, incl. other states and Canadian Provinces –South Korea –Japan –Australia...? –Canada, after federal USA ETS pilots –China –India 32 5. ETSs status globally

33. New post 2012 Global Climate Agreement –Move from -20% to up to -30%, versus 1990 –Revision EU ETS Directive: for ETS from -21% to  -35%, versus 2005 Overhang of crisis allowances –Call for unilateral move, needs revision Directive Energy efficiency target 20% will result in only 10% with unchanged policies (MSs are still reluctant for extra actions) –Energy efficiency to go to 20% presented as new fact –Commission therefore considers “set-aside” in EU ETS, e.g. 100 Mton/year (800 Mton) not to be auctioned, needs revision Directive Roadmap 2050, then -25% in 2020 is on the path –Then -30% still for Global Climate Agreement, needs revision Directive  Ex-post... 33 5. EU debate about possible developments

34. Globally –Avoid carbon leakage (e.g. recital 24, statement Barroso, etc.) Ex-ante gives incentive, although to -50%; should move to ex-post NER limited (1.2% growth) and not refilled from auction pot if depleted, should move to refill if depleted Unstable, unpredictable financial compensation, should move to direct plus indirect allocation –Protect competitiveness as good as possible (recital 25, Tajani) Stringent top 10% immediately in 2013, should move to top 10% in or around 2020 Within EU-27 plus Norway etc. –Avoid competitive distortions in Europe: much improved –Environmental effectiveness: very much improved 34 5. Where are we and what do we want?

35. Appendix: slides Annette Loske Forum EU Climate and Competitiveness Policies towards 2050 Brussels, 9 June 2011 35

36. General strategy: EU in leading climate change policy role to 1.support global agreement by attracting followers 2.Build competitive edge as a first mover Builds on the assumption that –Transitional period with cost disadvantages will pay off in the long term (a.o. through first mover advantage, fossil fuels’ end of lifetime) Situation of energy intensive industries (EII) –Problems to survive transitional period until assumed “golden end” –Necessity for transitional measures to help EII to survive this phase –Situation of huge instability for EII in EU (will relief measures remain?) Could transitional period become eternal? –Not sustainable for EII to rely on relief measures in the long-term –Not sustainable for EU to stick to general strategy if expectations are not realised 36 Debate about possible EU developments

37. New / more jobs – but highly subsidized e.g. > 150,000 € per job in solar industry in Germany Loss of existing jobs in the production of globally demanded, innovative products Perceived benefits ( ) vs. trade-offs ( ) Economic crisis gives cheap abatement potential Economic crisis makes money an even more scarce resource Strong EU leading role helps to achieve global climate change policy agreement EU’s ever more leading role strengthens the world’s advantages and thus weakens preparedness to follow –First mover advantage in green technologies can not be caught up –Extended advantages in energy intensive industries foolish to be given up Less GHG emissions in the EU More GHG emissions globally

38. 38 Impact of - 30% EU reduction target on GDP compared to current – 20 % target EU climate change policy may weaken EU MS while in parallel huge financial support is paid to prevent state bankruptcy No further unconditional reduction targets! Study analysed two scenarios (Prognos/GWS on behalf of German Economics Ministry) –Scenario I: -30% with 50% CDM –Scenario II: -30% with 25% CDM Results: Impact on GDP –EU-27/EU-15 I: - 0,2 % II: - 0,4 % –NMS-12 I: - 0,3 % II: - 0,5 %  Spain I: - 0,2 % II: - 0,6 %  Germany I: - 0,5 % II: - 0,8 %

39. 39 EU GHG reduction targets until 2020 and beyond EU GHG reduction targets until 2020 should not be changed –Interfering with fixed ETS cap would...... create unstable and negative planning conditions for industry (contrary to Europe 2020 Strategy)... discredit the ETS system (also as a model for a global climate change policy)... not be based on any new information (e.g. 20 % efficiency target was set before) Ambitious targets beyond 2020 must be conditional

40. 40 Improving carbon efficiency of industry further Basis: Acknowledgement that... –... a lot has been done already –... EII is crucial to mitigate climate change, i.e. –Lighter materials for transport industry –Insulation materials –Input materials for renewable energy producers Crucial that –Necessary financial resources are not distracted –Time for adaptation is a must! –Global perspective is the only acceptable in a globalised world!