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Optional derogation: transitional free allowances for power generators

Temporary free allocation

Investments in national plans (July 2012)

Are all investments in the national plan mandatory? Is there an obligation for Member States to carry them out?

Member States have included more investments in the National Plan than would be necessary to make up for the value of the free allocation. This way, Member States or more precisely investors/recipients of free allowances in the Member States concerned have a certain level of flexibility in terms of which investment to undertake.

Such flexibility is considered useful from the Member States' point of view, as nobody can guarantee that all investment envisaged by an operator can indeed be undertaken. There may be reasons which prevent an investment from happening. In such a case and in order to be able to use the value of the free allowances, investors/recipients of free allowances in the Member States concerned should be able to undertake another investment. Otherwise, they cannot use the free allowances to fund investments.

It is therefore important to understand that the list of investments as such is indicative, i.e. investors/recipients of free allowances in the Member States concerned are not obliged to undertake all investments on the list. However, once the free allowances are allocated, there is an obligation to undertake investments the value of which is at least equal to the value of the free allowances. In this respect, which investment from the list approved by the Commission is irrelevant in this respect.

Rules and guidance on allocation of free allowances to the power sector (March 2012)

What is the issue?

When the revised directive[1]governing the EU Emission Trading System (EU ETS) was adopted in 2009, it was decided to introduce a harmonised EU-wide approach to the allocation of greenhouse gas emission allowances to installations covered by the system.

In particular it was agreed that, from the start of the third phase of the ETS (2013-2020), allowances should no longer be granted for free to power plants, who would instead have to buy all their allowances through auctions (or on the secondary market).

However, to help modernise their electricity sector 10 new Member States were given the option[2]of exempting themselves from the 'full auctioning' rule and continuing to allocate a limited number of emission allowances to power plants for free until 2019.

The Commission's Decision sets out the rules governing the allocation of free emission allowances to power installations in the 10 Member States. The Decision has been discussed with Member States in the EU Climate Change Committee, which in November 2010 gave a favourable opinion.

Why is the derogation allowed?

This option was introduced as part of the overall compromise leading to the agreement on the so-called 'climate and energy package' reached by the Council and European Parliament in December 2008. The legislation was formally adopted in April 2009.

The main motivation for the Member States which asked for this provision appears to have been a desire to prevent too sharp increases in electricity prices for households. Another factor was to help the power sector in these countries cope more easily with the costs of making the transition to less carbon-intensive electricity generation.

Which Member States are eligible to deviate from full auctioning in their power sector?

Ten Member States are eligible since they meet one or more of the relevant criteria laid down in the revised EU ETS Directive. They are Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland and Romania.

The eligibility criteria are as follows:

  • in 2007, the Member State had no connection to the electricity grid operated by the Union for the Coordination of Transmission of Electricity (UCTE) which existed then; or
  • in 2007, the Member State had only one direct or indirect connection to the electricity grid operated by UCTE with a capacity of less than 400 MW; or
  • in 2006, more than 30% of the electricity generation in the Member State concerned was produced from a single fossil fuel and the GDP per capita (at market prices) did not exceed 50% of the EU average.

Are eligible Member States required to derogate from full auctioning for their power sector?

No, the derogation from full auctioning for the power sector is optional. Eligible Member States need to decide whether they want to make use of this option or not.

If an eligible Member State wants to make use of the derogation, what must it do and by when?

The Member State needs to decide for how many years and to what extent they want to make use of the derogation, as the Directive defines only maximum values in this regard. It must submit an application to the European Commission by 30 September 2011.

Member States applying for the derogation need to take into account that the number of free allowances to be given to the power sector reduces the number of allowances they can sell at auction, thus lowering their national auctioning revenues.

From when, and for how long, will the option of free allocation for the power sector be applied?

The maximum period for which the derogation can be authorised is from 1 January 2013 to 31 December 2019. Eligible Member States can decide to apply for a shorter period.

Full auctioning in the power sector will be applied from 2020 onwards.

How many emission allowances may be allocated for free under the derogation?

The number of free emission allowances that may be handed out to power plants is limited. The revised ETS Directive stipulates that even when the derogation is granted, the level of free allocation in 2013 must not exceed 70% of the allowances needed to cover emissions for the supply of electricity to domestic consumers[3]. In each year following 2013, this percentage has to decrease – the rules are set out in the Communication - and, in 2020, has to be 0%.

Eligible Member States can decide to distribute fewer free emission allowances than the maximum amount permitted.

Which installations are covered by this provision?

Free allowances can be given only to power plants that were operational, or for which the investment process was physically initiated, by 31 December 2008.

The use of the derogation is not allowed for newer power plants, in order to avoid undue distortion of competition on the European power market.

Are cogeneration plants eligible to receive free emission allowances under this provision?

Cogeneration or Combined Heat and Power (CHP) plants are eligible to receive free emission allowances only for the electricity they produce, not for the heat.

What conditions must Member States fulfil when using the option to derogate from full auctioning for their power sector? (Updated July 2012)

The use of transitional free allocation for the power sector is conditional on investments being made to modernise electricity generation. If the option is applied, the Member State has to ensure that investments are undertaken in retrofitting and upgrading the infrastructure, in clean technologies and in diversifying the energy mix and sources of supply. The overall amount of these investments must match or exceed the market value of the allowances allocated for free. Any Member State submitting an application to the Commission for free allocation for their power sector also has to submit a national plan with the list of investments foreseen.

Member States also have an obligation to ensure the proper execution of investments identified in the national plan. To this end, they have to put in place the necessary legal provisions, including penalties and corrective measures in case companies do not undertake the necessary investments.

What is the role of the European Commission in the assessment and implementation of the derogation?

In the Communication, the Commission provides guidance with a view to ensuring the proper implementation of the derogation from full auctioning in the 10 Member States eligible to benefit from it. The Communication also sets out a transparent framework which the Commission will use to assess any applications to use the derogation, which must be submitted by the end of September 2011. The Commission can reject the application as a whole or in part if it deems that it does not conform with the rules set out in the Directive and/or the Decision adopted today.

The assessment by the Commission will particularly concern

  • the eligibility of the Member State concerned to apply for the derogation;
  • the list of installations eligible to receive free emission allowances and the number of allowances to be allocated to each;
  • the national plan listing the investments to be undertaken;
  • the monitoring and enforcement provisions a Member State has to put in place with respect to the investments;
  • information showing that no undue distortions of competition will be created.

Once a derogation is granted, the Commission has to check annual reports on investments which Member States are obliged to submit. If these reports do not provide sufficient evidence that the investments have been carried out in accordance with the national plan, the Commission may consider this an illegal application of the EU ETS Directive and launch an infringement procedure.

Non-compliance with obligations arising from use of the derogation may furthermore breach state aid rules, in which case the Commission may open a formal investigation procedure.

How are free emission allowances to be allocated to individual power stations in the Member States concerned?

The absolute number of allowances to be allocated per installation will be calculated by the Member States' competent authorities on the basis of the allocation methodologies laid down in the Decision.

Is there a limit on the number of free emission allowances that can be allocated to individual power installations in eligible Member States?

The number of free emission allowances to be allocated to each eligible installation in a Member State is determined by the allocation methodology applied. There are two allocation methodologies, one using ex-ante efficiency benchmarks and the other based on the annual average verified emissions of the power plants concerned in 2005-2007.

The total number of free emission allowances allocated must not exceed the maximum number determined in the Directive (see Question 'How many emission allowances may be allocated for free under the derogation?'). To ensure this limit is respected, Member States may have to apply a correction factor.

Which ex-ante efficiency benchmarks can be used to determine the free allocation in the power sector?

Member States can choose between an EU-wide ex-ante efficiency benchmark or an ex-ante-efficiency benchmark that has to be established in accordance with the methodology set out in Annex I of the Decision. The latter takes into account the fuel mix of a specific Member State for electricity production and thus better reflects a Member State's specific features of electricity production than the EU-wide benchmark, which is based on the relevant fuel mix of the EU.

However, all benchmarks take into account the most efficient ways to generate electricity from a specific fuel.

How are free emission allowances allocated based on verified emissions in 2005-2007?

Under this option, the annual average of verified emissions in the period 2005-2007 forms the starting point. In a second step, this average is compared to each installation's annual average of verified emissions in the period 2008-2010. The allowances are then allocated with a view to rewarding those installations that have improved their greenhouse gas emissions performance compared to the period 2005-2007.

This methodology ensures that the highest emitting installations are not granted more free allowances than those that have improved their greenhouse gas performance in recent years. This methodology therefore does not amount to a simple 'grandfathering' approach based solely on historical emissions.

Can different allocation methodologies be used in the same Member State?

Yes. Member State may use the same allocation methodology for installations where verified emissions for the period 2005-2007 exist, but may use a different one for installations where this is not the case (e.g. installations which started operations later than 2005 or where the investment process was physically initiated by 31 December 2008).

Is the timing of free allocation under Article 10 c linked to free allocation under the NIMs? (added November 2013)

The implementation of the derogation under article 10c of the EU ETS Directive, allowing for transitional free allocation for power generators, takes place separately from the implementation of free allocation for industry and heat production. The allocation to power operators under article 10c, therefore, does not need to happen in parallel to the allocation of free allowances under the national implementing measures.