WG 5/6 sub-group on Benchmarking

1. WG 5/6 sub-group on Benchmarking ETG Draft Position Paper Benchmarking as an allocation methodology 14 May 2007 Jim Rushworth

2. ETG Draft Position Paper on Benchmarking as an Allocation Methodology for Phase III This paper is a common view by representatives of 15 UK Industrial Sectors (refer to appendix for list of sectors) which represent the majority of emissions in phase I of EUETS. 13 of the 15 industrial sectors support the use of benchmarking as a methodology for allocation for phase III and the remaining two sectors, namely offshore and refineries are currently evaluating benchmarking as a potential allocation methodology. 9 of these of these 13 sectors already have 100% support from member companies within these sectors for benchmarking as the preferred methodology.

3. Benchmarking – Pros and Cons • Benchmarking is the preferred allocation methodology based on the following pros which we believe outweigh the cons, both of which are listed below: • The pros are: • Reward for early action (reward remains even if the allocation period is long) • Reduction in emissions – poorer performers encouraged to meet realistic benchmark • Less competitive issues with regard to allocation as BM should be fair within the sector and EU • Free allocation means less leakage of business (emissions) out of the EU • Free allocation avoids diverting limited funds away from energy efficiency projects to purchasing of allowances

4. Benchmarking – Pros and Cons (contd) • The cons are: • Initially more complex than grandfathering or auctioning as the GF and auctioning systems are already in place • Requires some level of output to be used as a multiplier with the emission factor for energy intensive industries, however sectors with diverse products and relatively small emissions, such as food and drink, combustion input would be used • If not designed correctly can result in greater competitive distortion than grandfathering.

5. Benchmarking – Proposed bases • ETG do not believe it is possible to have a common benchmark for all industrial sectors. Benchmarks would be developed using one of two bases. • One would be based on level of production, the basis for most energy intensive industries listed in the Directive, such as aluminum, cement, ceramics, glass, lime and steel. Separate benchmarks would need to be developed for each major sector listed in the directive. • The other would be based on energy input (combustion), which would be better suited to low energy users, especially sectors with multiple products and with little or no process emissions, such as food and drink, motor manufacturing and some parts of the chemical sector. It would not be possible to find a common benchmark for these sectors based on output, however a common benchmark based on combustion may be possible for several sectors (one for ESI, one for CHP and one for “other combustion”).

6. Development and use of Benchmarking • ETG do not believe it is essential to have EU wide benchmarks for phase III. For a few sectors it may be possible to develop EU wide benchmarks and over the next few months we will be able to see the progress made in aluminum, glass and lime. It has taken steel more than 2 years to agree a EU wide benchmark. For most of the other sectors national benchmarks are being pursued due to complexities specific to UK or due to the lack of likelihood of gaining agreement for a EU wide benchmark. Several sectors are also only at very early stages in developing benchmarking concepts. • Benchmarking should be used for distributing allowances within sector. A two-stage allocation process is preferred as it allows Government to apply adjustments for growth, potential abatement and exposure to international competition specific to each sector. If benchmarking were used as a bottom up allocation methodology it would be difficult to allow for these adjustments.

7. Benchmarking – New Entrants • Different benchmarks are needed for Incumbents and for New Entrants. As with ESI for phase II it will be necessary to have different benchmarks for incumbents and new entrants due to the different processes/kilns/ • furnaces/boilers operating within a sector and possibly for the use of different types of fuels. However it may be possible to use the same methodology, but use different input variables to account for these differences. Investment in new entrants needs to be encouraged and not disincentivised as it was in phase II due to the rules adopted (namely only allocating 95% of benchmarked emissions).

8. Benchmarking – Lessons from Phases I and II • Several lessons can be learnt from phase I and phase II new entrant (NE) benchmarks. For “other combustion” in Phase I, the over simplification of operational hours undermined the effectiveness of the BM. The lessons learnt from phase II NE benchmarks were that over simplification by reducing the number of input parameters distorted the benchmark for several sectors. To encourage investment and to reduce competitive distortion it is important that the benchmark includes a small number of input parameters, which allow for differences in raw materials, fuels, types of kilns/furnaces/boilers and types of products or combustion processes, but does not significantly increasing the complexity.

9. Benchmarking – Ex-post adjustment • Ex-post adjustment has been rejected in the past by the EC and does not offer surety for Government unless it is just used to redistribute allowances within a sector cap. If this were adopted it would still lead to uncertainty for industry and Government and result in increased workload for both for the distribution exercise. Benchmarks would be based on an average of the latest production/combustion input data for a sector. It would however be possible for sectors to set up sector pools where ex-post adjustment could be carried out by sector associations external to the allocation procedure.

10. Benchmarking – Clarifications needed • Several fundamentals need to be clarified for phase III. It is important for Government/Industry to agree whether sectors could use EU sectoral BM as an alternative to EUETS, whether sector caps are needed or if ex-post adjustment could be used without caps, whether BM's would be used for bottom up determination of a NAP or only for distribution of allowances within a sector cap and to confirm the options open to sectors who do not want or do not believe they are able to develop benchmarks.