Europe’s highest court has ordered a recalculation of free ETS allocations to 2020, a move expected to raise costs for heavy industry by cutting its share of Phase 3 allowances by as much as 105 million tonnes or 1.6%, while also having implications for the way the units are handed out in the future.

The European Court of Justice ruled that the European Commission’s Cross Sectoral Correction Factor (CSCF) calculations to decide free EUA allocation are invalid, supporting a November opinion by a court advisor that regulators had set too high a ceiling for distribution and thus handed out too many free units.

It gave the Commission 10 months to establish a new amount but that this would not affect annual allocations already handed out, the court said in its verdict released Thursday.

The ruling is a slap in the face of big emitters including Borealis, Dow Chemical and Esso – which brought the case against the European Commission claiming that they had been given fewer free allowances than they were entitled to.

Experts said it could result in a cut to the future free allocation for all ETS-regulated industry by up to 1.6% of its allocation of 6.6 billion EUAs for Phase 3 (2013-2020), with the allowances in question instead being put up for auction.

It could also have a slightly bullish effect on EU carbon prices as the prospect of lower free allocation may lead industrial companies to be more reluctant to sell their surplus EUAs, or for those that are forecast to be short to buy more, thereby squeezing the overall market supply.

THE RULING

The CSCF cuts the free allocation of EUAs to industry across the board by 5.73% in 2013, increasing each year to 17.56% in 2020. Its application was triggered because national plans requesting free units for industry exceeded the overall pot of available allowances.

The court ruling concerns how the Commission took into account installations that only joined the ETS from 2013.

It found that the Commission was right to not take into account the emissions of power generators while determining industry allocations, but said the executive should have requested that member states adjust their submitted data to enable it to calculate the allocation correctly.

“Consequently, depending on the information to be provided by the member states, … the maximum  annual  amount  of  allowances  could  be  higher  or lower than that thus far determined by the Commission,” the ruling said.

Analysts at Thomson Reuters Point Carbon expect the revised allocation to cut the share of EUAs given for free to industry, but they don’t expect this to happen until 2018.

“We estimate that there were 105 million EUAs for all of Phase 3 that were allocated but should not have been,” said Point Carbon’s Emil Dimantchev.

A Commission spokeswoman was not able to give a specific indication of when the revised allocation would be completed.

“The Commission will work diligently to implement the Court’s ruling, so as to reduce the uncertainty created by the ruling as to the free allocation for industry until 2020,” she said.

Point Carbon’s Dimantchev anticipated that the Commission would only be able to revise the measures in time for the 2018 allocation, but said it was unclear whether the ruling would be interpreted to reduce industry’s share by the full 105 million over 2018-2020, or merely the proportion – around 37 million – applying to the final three years of the current phase.

Because the ruling concerns the application of the CSCF, the revised numbers will affect the allocation across all ETS-regulated heavy industries, rather than any particular sector. It does not affect the power sector or airlines covered by the scheme.

THE EFFECT

Dimantchev said the ruling could also help push EUA prices up by some €0.50 over the next two years as industrial companies opt to hoard surplus units they would otherwise have sold.

“If industry reacts to the uncertainty, this could cause them to hold on to the units, which would have a bullish impact initially.  But when these volumes eventually hit the market in auctions, then this would be evened out,” he added.

EUAs are currently trading at around €6.50 but are projected to increase to around €13.50 by 2020 as the supply-curbing Market Stability Reserve is introduced in 2019.

THE FUTURE

The revision is likely to have an impact on how free allocation is determined for Phase 4 (2021-2030), rules that lawmakers are currently debating.

The European Commission has proposed maintaining the Phase 3 ratio of auctionable-to-free EUAs at 57% to 43%, but Dimantchev said the revision was likely to shift the ratio slightly to 58% to 42%

The post-2020 Commission proposal provides “as much certainty as possible for industry as regards future free allocation, such as a fixed auction share, a stable carbon leakage list and predictable benchmarks. Furthermore, these elements of the Commission proposal aim to reduce, if not avoid, the need for a correction factor to apply in Phase 4,” the Commission spokeswoman said.

Yet, the case could also spur lawmakers to carry out more radical changes to post-2020 free allocation rules than those proposed by the European Commission, in an effort to ensure the CSCF doesn’t apply.

Several lawmakers have called for a more tiered approach to free allocation that could reduce the need for the CSCF by targeting free allowances at sectors that need them most.

Ian Duncan, the lead MEP driving the post-2020 reforms through the European Parliament, urged the Commission to come up with its revised Phase 3 allocation well ahead of the 10 month court-imposed limit, claiming that it would be difficult for lawmakers to progress post-2020 reforms until this was done.

“We suddenly find ourselves in legal limbo at a time of critical importance to the Phase 4 reform,” he said in a blog post.

“Unless that timescale is significantly speeded up, it will disrupt the European Parliament’s own proposals for how the next phase of the scheme should operate, which were due to be tabled in the next few weeks.”

POLLUTER PAYS

Environmental campaigners urged policymakers to ensure the reforms did more to drive emission reductions from industry by making them pay for their CO2 output.

“The EU ETS needs to be reformed in order to make polluters pay, rather than paying polluters, as today’s ruling confirms. Policy makers must ensure that the European carbon market delivers more and faster emission reductions, and commit to phasing out free pollution permits,” said Imke Luebbeke of WWF.

Bas Eickhout, a Dutch MEP co-ordinating the position of the Greens political grouping, agreed.

“This ruling must serve as a shot across the bow of those again pushing for an over-supply of allowances to be simply given away. The court has made clear that the cap on allowances needs to be consistent with the fundamental purpose of the ETS: to reduce greenhouse gas emissions. This has to be the basis for all future decisions,” he said.

IFIEC Europe, a group of energy intensive industries including many that brought the case, called for  the Commission to be transparent in its recalculation of the CSCF and vowed to push for ETS safeguards for carbon-leakage exposed industrial sectors post-2020.

“Energy-intensive sectors remain concerned about the non-transparent procedure and stringency of the Commission Decision,” it said in a statement.

“The best performing companies in EU ETS carbon leakage sectors should not bear further carbon costs as stated in the October 2014 European Council Conclusions. To that end we support an approach based on real benchmarks, allocation based on more recent production data and last but not least an adequate reserve that ensures full allocation to benchmark levels.”

By Ben Garside – ben@carbon-pulse.com