Article | 30/08/12 | Pierre Descheemaeker
In the wake of the Rio +20 summit, environment and climate challenges are, now more than in the past, an essential issue for economic players.
In order to implement the Kyoto Protocol, adopted in 1997 and which came into force in 2005, the European Union created a greenhouse gas (GHG) emission allowance trading scheme (ETS). The purpose was to reduce said emissions by 5% by 2012 compared to emission levels recorded in 1990.
Directive No. 2003/87/CE of October 13, 2003 set down the basis of this market mechanism, which was reinforced by Directive No. 2009/29/CE of April 23, 2009.
French Government Order No. 2012-827 of June 28, 2012 (the Government Order, or ‘ordonnance’ in French) aims at transposing into French law the provisions of the 2009 Directive. This marks France’s admission to the third stage of the European Union ETS.
Following a brief summary of NAP (National Allocation Plan for Greenhouse Gas Emission Allowances) I and II, we discuss the main changes resulting, for NAP III from the Government Order of June 28, 2012.
From NAP I to II: a difficult expansion that proved quite successful
Up until now, every EU member State was required to draw up its NAP in consideration of its own commitments under the Kyoto Protocol. The first NAP (NAP I, 2005-2007) was criticized by reason of the member States’ large allowance to GHG producers, thereby pushing the price of a ton of Carbon down. Given the impossibility to use NAP I Allowances within the scope of NAP II, the excess of NAP I Allowances pushed their market price down, which price ultimately collapsed. (See chart below).
After this test stage, NAP II (2008-2012) corresponds to the Kyoto Protocol’s commitment period. France decreased allocated Allowances by 5.9%, as compared to NAP I. At the end of 2008, recession caused the price of carbon allowances to fall drastically, but the possibility to carry allowances over from stage II to stage III enabled the market to find a relative balance. Major industrial sectors and financial players now consider that GHG emissions have a price in the European Union and that carbon allowances will remain expensive, even if with material variations. This constitutes a significant progress, but will it be enough to remove the climate risk by supporting a low-carbon economy? Nothing could be less certain.
On a European Union scale, the strengthening of constraints for the 2013-2020 period is conveyed by the imposition of a –1.74% yearly reduction factor to the cap as from 2013. This should result in a 21% drop of GHG emissions in 2020, as compared with 2005.
For reference purposes, approximately 11,000 plants located within the European Union are covered by the ETS, including ca. 1,000 in France. With the inclusion of aircraft operators since January 1st, 2012, approximately 50% of the activities that are responsible for GHG emissions are covered. A hypothetical carbon tax to be levied at the level of the European Union, might be applied to the remaining 50%. For the time being, however, road and maritime transport are not subject to the ETS.
NAP III (2013-2020) or the coming to age of the ETS
For the 2013-2020 period, an in-depth re-examination of the rules was carried out by Directive No. 2009/29/CE, transposed into French law by the Government Order. In particular:
Payment for allowances, unless an exception applies
Unlike the two previous stages where allowances were free for the most part, in this third stage they must gradually be paid for. As of January 1st, 2013, 20% of the allowances will be put up for auction. That percentage will increase every year to reach 70% in 2020. The plan is to abolish all free allowances by 2027. The schedule and practical terms and conditions of the auction were defined by a European Commission Regulation of November 12, 20101, amended in November 2011.
There are two exceptions to this principle. First, sectors considered as being exposed to “carbon leaks” (i.e., with activities which are at risk of delocalizing GHG emitting operations) will continue to receive free allowances. Every five years, the Commission draws up a list of sectors concerned by such risk2. Second, as from January 1st, 2013, electricity producers (receiving about half of the allowances delivered in the EU), GHG capture, transport and storage sites will no longer receive free allowances.
A slightly modified scope
The Government Order broadens the scope of the French ETS. First, new plants: besides certain environmentally sensitive plants3, power plants rated at more than 20MW necessary for the running of a nuclear plant (i.e. diesel generators) are now concerned. However, among small plants whose submission to ETS is optional, the Government Order excludes hospitals, as long as they accept equivalent constraints (without enjoying any grant of allowances).
At the same time, the ETS is extended to other GHGs, such as perfluorocarbons (PFCs, extensively used in aluminum production) and Nitrous Oxide (N2O), it being specified that each State is authorized to add other GHGs with the prior approval of the EU Commission4.
The EU Commission is regaining control of the ETS
Free allowances are now allocated on an EU-wide basis with an EU cap on allowances. Said harmonization is accompanied by the suppression of the national registry (Seringas in France) for the benefit of a EU registry. The French Caisse des Dépôts et Consignations (the major State financial institution) continues however to manage this registry for French operators: those operators must appear on a list which is prepared and maintained by the French Ministry in charge of environmental matters.
Disruption of allocation terms and conditions
Quantitatively speaking, free allowances are no longer allocated by reference to past grants but by reference to various objective benchmarks (products involved, heat, fuel and processes) and by sub-plants that may be grouped together within a given plant5. On that basis, the application requesting the allocation of free allowances had to be filed by the operators before July 1st, 2011.
These new terms and conditions should eventually favor the more efficient plants.
A carbon market that is more open but better supervised
The legal status of the allowance raised an issue. The Government Order qualifies the allowance as chattel property (‘meuble’) as long as it is registered with the European registry.
CO2 allowances are admitted to trading on regulated financial markets6, and are increasingly considered as financial instruments, like shares or bonds. The European CO2 allowance trading market today weighs approximately €80 billion and involves 6 billion allowances.
Note, in that respect, that the EU country citizenship (for individuals) or registration (for corporate entities) condition for the opening of an allowance trading account is no longer applicable7. This market is opening up, but controls will be increased simultaneously. In order to be admitted to participate in auctions, banks and investment institutions will need to secure a prior authorization from the French Autorité de Contrôle Prudentiel (or ACP, a French financial supervisory authority in charge of banks and insurance companies)8 ; similarly, entities trading financial instruments for their own account, or providing certain investment services will need, when established in France, a prior authorization delivered by the French Autorité des marchés financiers (or AMF, the French authority in charge of the supervision of financial markets).
AMF just opened a public consultation regarding the conditions to be set for the grant and withdrawal of said authorization9.
More importantly, this summer the EU Commission made a bold proposal aimed at sustaining the carbon price by temporarily withdrawing a significant volume of allowances. The idea would be to “set aside” up to 1,2 billion allowances from 2013 on, and replace it on the carbon market in 2016. This proposal, which of course raised much concern, should be discussed next October.
Through these successive stages and changes, the ETS appears to be a full-scale experiment that implements a complex process, involving political, legal, economic, financial and environmental components. Stage III’s chances of success are of course still unknown but the context, marked by an ecological urgency and the increasing development of green economy and sustainability concerns, inspires a certain optimism. However, in order for the ETS to prove its effectiveness, it is important that the other major economic blocks, in particular the United States and BRICS countries, acknowledge the interest of market rules to drive economy toward sustainability.