European Union: EU/CEE: Carbon Trading Post-2012 – A Battle For Transitional Free Allocation Of Emission Allowances

The EU Climate Change Package provides for a substantial change to the current European Trading Scheme. The principle of allocating emission allowances for free is replaced by auctioning. The power sector and certain industries will therefore face substantial carbon costs in future. The CEE power plant sector may, however, benefit from transitional free allocation of allowances. Unfortunately, this benefit is accompanied by legal uncertainties bringing headaches to the operators.


The EU Climate Change Package provides for a revision and strengthening of the Emissions Trading System (ETS). A single EU-wide cap on emission allowances will apply from 2013 and will be cut annually, reducing the number of allowances available to businesses to 21% below the 2005 level in 2020. Further, the free allocation of allowances will be progressively replaced by auctioning. In July 2011 the EU member states agreed to the EC proposal to auction 120 million emission allowances for phase 3 of the ETS in 2012, the year before phase 3 starts. These so-called "early auctions" are required in view of the widespread commercial practice in the electricity sector of selling power on a forward basis and purchasing the required inputs (including emission allowances) when they sell their output.

Apropos the electricity sector, power plant operators are the most concerned of the new ETS. Unlike industrial plant operators, they do not benefit from the phasing out of free allocation; from the start of the third trading period in 2013, no more allowances are allocated for free in the electricity sector. However, member states may derogate from this rule if certain conditions are met (eg, high carbon dependency of the national energy sector, weak network connection). The criteria relate to the need to modernise the energy system, and member states deciding to use this option must in parallel undertake action aimed at securing investments in the energy system, such as upgrades of infrastructure, clean technologies, etc. of an amount corresponding to the value of the corresponding emission allocations allocated for free.

Particularly, the CEE power sector is addressed by this derogation clause (eg, Bulgaria, Czech Republic, Hungary and Romania).

The CEE power sector: Legal uncertainties about free allocation

As stated above, particularly the CEE power sector meets the conditions set by the ETS Directive for derogating from the auctioning rule. The CEE electricity sector may therefore benefit from a transitional free allocation of allowances. But this benefit comes with many legal uncertainties and brings headaches to the power sector.

Firstly, it is not clear which plant operators qualify for free allocation. The ETS Directive stipulates that installations in operation by 31 December 2008 and installations for which the investment process was physically initiated by the same date may receive allowances for free. But what is meant by "physical" initiation of the "investment process"? The EC Guidelines consider this to mean when construction works have physically started on site and were visible before 31 December 2008, or when a contract for the construction of a power plant was signed before 31 December 2008. So far, so good, but there are still open questions. To what extend does preparatory work for construction qualify for in-vestment in terms of the ETS Directive? Does the construction (preparatory) work have to be covered by a permit? What happens if, under national law, no permit is required – how are preparatory works assessed? What happens when the plant is substantially amended (expanded) after the cut-off date provided in the ETS Directive? Poland, for instance, has been attacked by environmental NGOs for having bent EU and national law by issuing "faked" permits for unbuilt coal fired power plants that had not even been planned at the time of the cut-off date.

Secondly, plant operators may only benefit from free allocation if they are included in the list of installations covered by the application for derogation to be filed by the member state. This list had to be drafted and filed with the EC by 30 September 2011. However, the EC may reject the application, or any aspect thereof, within six months of receiving the application. Plant operators thus face the uncertainty of (not) being considered in the final list of installation receiving allowances for free.

Thirdly, the transitional free allocation is linked to the enforcement of a national plan that provides for investments in retrofitting and upgrading of the infrastructure and clean technologies. As such investments are always linked to legal and political risks, it cannot be ruled out that the investment plan will only be partially fulfilled. In this case the question is whether and to what extent non-compliance with the requirements of the national investment plan may impact the business operation concerned (eg, suspension of free allocation).

The EC is of the opinion that a recipient of allowances allocated for free must use the value of the free allowances by investing appropriately. Consequently, where companies receive allowances for free without undertaking such an investment, or where they receive more allowances than necessary to undertake the investments as set out in the national investment plan, operators will have to provide the value of the excess allowances to the entity undertaking the investment. Importantly, the EC explicitly claims unlawful state aid in the event of "over allocation"; there fore, legal procedure might be initiated against the member state concerned. A potential consequence of such procedure is the suspension of free allocation.


The CEE power sector may benefit greatly from transitional free allocation of allowances. But the transition of the ETS Directive into the CEE national laws might be different from member state to member state, and recent developments show that even the Directive itself creates real legal uncertainties. Power plant operators are therefore advised to keep an eye on the EC's carbon law related activities. Particularly, operators should consider the risk of total or partial suspension of free allocation.

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