Phase III of the EU Emissions Trading System (EU ETS)

1. Phase III of the EU Emissions Trading System (EU ETS) Michelle Kennard Policy Advisor – EU ETS team Wednesday 26 May 2010

2. Contents • Revised EU ETS Directive • Carbon leakage provisions • Free allocation rules including new entrant and closures • National Implementation Measures – the process

3. Revised EU ETS Directive The revised Directive includes: • Centralised, EU-wide cap which will decline annually by 1.74% delivering an overall reduction of 21% below 2005 verified emissions by 2020.  • Adjustment of the EU ETS cap up to the 30% GHG reduction target when the EU ratifies a future international climate agreement. • A significant increase in auctioning levels – at least 50% of allowances will be auctioned from 2013; compared to around 3% in Phase II. • 100% auctioning to the power sector in the UK and across most of the EU from 2013.

4. Revised EU ETS Directive (2) • Sectors at significant risk of carbon leakage will receive 100% of their benchmark or other allocation methodology for free. • 12% of the total allowances to be auctioned will be re-distributed to Member States with lower GDP in the interests of solidarity. • Non-legally binding commitment from EU member states to spend at least half of the revenues from auctioning to tackle climate change both in the EU and in developing countries. • Access to international project credits from outside the EU will be limited to 50% of the reductions required in the EU ETS. • Potential for opting out small emitters and hospitals. • Inclusion of aviation in the EU ETS from 2012.

5. Main elements of Phase III Implementing Measures There are 11 implementing measures contained in the revised Directive

6. Carbon Leakage provisions • The European Commission’s proposed list of sectors at risk of carbon leakage was agreed by Member States and the European Parliament in December 2009. • Sectors were assessed on the basis of two quantitative criteria (EU ETS related cost increase as a proportion of GVA and non-EU trade intensity) and three qualitative criteria (abatement potential, market structure, profit margins). • Sectors which exceeded the quantitative thresholds in the Directive were deemed to be at risk. The thresholds are: • combined threshold of >5% cost increase and > 10% non-EU trade intensity • single cost increase threshold of > 30% • single non-EU trade intensity threshold of >30% • 164 sectors were deemed to be at risk in the European Commission’s assessment.

7. Carbon Leakage provisions (2) • Extraction of crude oil and petroleum had a cost increase of 0.8% and a non-EU trade intensity of 60.2%. They were therefore included in the list as the sector met the single 30% trade intensity threshold. • Revised Directive commits the European Commission to review sectors at risk of carbon leakage by 30 June 2010. We expect the review is likely to focus on measures and will not lead to a change in the list of sectors at risk. • Next substantive review of sectors will be in 2014, although Article 28 of the revised Directive allows for a further review following the conclusion of the international climate negotiations. • Timing of this review will be dependent on the progress of those negotiations. There is also the possibility of adding sectors to the list on an ad hoc, annual basis

8. Free allocation rules The revised EU ETS Directive agreed in December 2008 sets out the principles by which free EU allowances will be distributed to installations on a harmonised EU-wide basis. These principles are that: • the allocation should be ex-ante i.e. based on historic data and not adjusted ex-post; • the allocation should give incentives to reduce emissions and take into account efficient techniques such as high efficiency Combined Heat and Power (CHP); • the allocation should be calculated for final products rather than inputs to maximise emissions reductions and; • the starting point shall be the average performance of the 10% most efficient installations in a sector or sub-sector in the EU in 2007-2008. The final EU-wide allocation rules are due to be agreed by 31 December 2010.

9. Free allocation rules Allocation methodologies Allocations will be determined through a hierarchy approach: DECC undertook a study to determine if a product benchmark was feasible for the upstream oil and gas sector: http://www.decc.gov.uk/en/content/cms/what_we_do/change_energy/tackling_clima/emissions/eu_ets/publications/publications.aspx#phase3 As product benchmarks are not feasible the fallback allocation methodologies will apply. In upstream oil and gas this is most likely to be the heat benchmark and fuel benchmark.

10. Free allocation rules Data collection The UK has undertaken a data collection exercise to determine individual installation’s allocations to include in the UK’s National Implementation Measures (NIMs). Production and other relevant data was due to be submitted to the Environment Agency by 30 April 2010. The verifiers opinion of this data must be submitted to the Environment Agency by 30 June 2010. The Environment Agency have produced guidance documents for operators on: • Inclusion criteria for Phase III (2013 - 2020) – Guidance Note 3 • Baseline data verification for Phase III – Guidance Note 4 Both are available from the Environment Agency’s website: http://www.environment-agency.gov.uk/business/topics/pollution/32244.aspx#Phase_III

11. Free allocation rules New entrants and closures EU-wide new entrant and closures rules will be included in the allocation rules. The UK’s overarching objectives with the new entrant and closure rules are: • Create the right environmental incentives • Equity between existing installations and new entrants • Minimise intra-EU distortions • Administrative simplicity

12. Free allocation rules New entrants • 5% of EU cap set aside for new entrants in an EU-wide reserve (Article 10a (7)) • New entrants are defined as: • new builds which obtain a GHG permit for the first time after 30 June 2011. • “significant extensions” after 30 June 2010 • European Commission shall adopt harmonised rules for “significant extension” to ensure harmonised implementation across Member States. The revised Directive sets basis for this definition (Recital 16): • “significant extension” should, wherever appropriate, be defined as an extension by at least 10% of the installation’s existing installed capacity or a substantial increase in the emissions of the installation linked to the increase in the installed capacity. • No free allocation shall be made in respect of any electricity produced by new entrants Article10a (7). • Allowances which remain in the new entrants’ reserve in 2020 should be auctioned Article10a (7).

13. Free allocation rules Closures • Provisions for installations that permanently and temporarily cease operations Article 10a (19): • “No free allocation shall be given to an installation that has ceased its operations, unless the operator demonstrates to the competent authority that this installation will resume production within a specified and reasonable time.” • Provisions for installations which partially cease operations and significant reductions of capacity Article 10a (20): • “The Commission shall...include measures for defining installations that have partially ceased to operate or significantly reduced their capacity, and measures for adapting, as appropriate, the level of free allocations given to them accordingly.” • Allowances from closed installations (both permanent and partial) shall be auctioned Art 10(1).

14. Free allocation rules Timetable for adoption of the harmonised rules Ongoing: TWGs/ECCP/EC bilaterals

15. National Implementation MeasuresProvisional UK timetable CCC vote on free allocation rules

16. Any questions? Contact Michelle Kennard michelle.kennard@decc.gsi.gov.uk 0300 068 5268 Sarah Resouly sarah.resouly@decc.gsi.gov.uk 0300 068 5272 CCC vote on free allocation rules