The EU Emission Trading Scheme put to the test of State aid Joëlle de Sépibus

Outline The EU ETS –The Directive 2003/87/EC ( ) The compatibility of the grant of free emission allowances with the rules on State aid of the European Union –Art EC Treaty The possibility of legal challenges of allocation rules based on the European State aid rules

The EU ETS The world’s largest 'cap and trade' system –System creating a financial incentive to reduce emissions by assigning a cost to pollution –Establishment of a “cap” that limits emissions from a designated group of polluters –Allowed emissions are allocated as individual allowances ( 1 EUA = the right to emit one ton of CO2) that correspond to the right to emit that amount –Companies are free to buy and sell allowances in order to reduce emissions in the most cost-effective manner

The EU ETS 27 Member States (+ Norway, Iceland and Liechtenstein since 2009) More than 10,000 installations in the energy and industrial sectors –electricity generators, heat & steam production, mineral oil refineries, ferrous metals: production, & processing, cement, lime glass, bricks and ceramics, pulp & paper sector Covers about half of the EU's emissions of CO 2 and 40% of its total greenhouse gas emissions

The EU ETS Key features of the Directive 2003/87/EC –Two trading periods : / –Establishment of national allocation plans (NAPs) by Member States for each period Determination of the cap and the number of allowances each covered installation receives Great discretion of Member States regarding the cap and the distribution of allowances, however –at least 95 % (1st trading period ) resp. 90% of EUAs (2 nd trading period) must be distributed for free –Review of NAPs by the European Commission, which may reject them or parts of them

The EU ETS The implementation of the Directive 2003/87 –Most Member States chose to allocate all allowances for free –Grant of allowances mainly based on historical emissions or expected needs –Special rules for closures, early action, new entrants, etc.

‘Windfall’ profits Important ‘windfall’ profits due to EU ETS –Installations passed through the cost of allowances to costumers even though they had been granted them for free –Greatest pass-through in the power industry due to reduced global competition –Fossil power stations the main beneficiaries

The EU ETS The review of the NAPs by the European Commission: –1st phase ( ): Control that overall allocations did not exceed expected needs of installations –Difficulties due to the absence of reliable information on emission data –2 nd phase ( ) Drastic cuts of caps of new Member States Rejection of discriminatory allocation methods

Questions Does the grant of gratuitous allowances amount to state aid in the sense of Art. 87 EC Treaty ? Can affected competitors challenge the decision of the European Commission in the light of Article 87 EC Treaty ?

EC State aid rules Art EC Treaty –Principle: State aid (Art. 87 par. 1 ) is illegal unless it is approved by the European Commission (Article 87 par. 2 and 3 EC Treaty) –Procedure: Member States must notify State aid and await the approval of the European Commission before implementing it –Sanction in case of non-compliance Obligation of Member States to request repayment of illegally granted state aid

State aid (Art. 87 par. 1 EC Treaty) Key elements: –Financing by Member State through state resources –Selective economic benefit –Distortion of competition and effects on trade between Member States

Financing by Member States through State resources Case law: –Unilateral and autonomous decision of Member States –Direct transfer or waiver of state revenue The gratuitous allocation of allowances –Autonomous decision up to 5% resp.10% of the allowances –Waiver of revenue ? Usually no state revenue from the taxation of CO 2 emissions Benefits come from the sale of allowances on the market and not from the state

Selective economic benefit Case law : –economic advantage which the recipient undertaking would not have obtained under normal market conditions –favour certain undertakings or the production of certain goods The gratuitous allocation of allowances –Legitimate counterpart for the costs incurred in reducing the emissions ?

Distortion of competition and effects on trade Case law: –If financial aid strengthens the position of an undertaking compared with other undertakings competing in intra-Community trade, The free allocation of allowances –Position of fossil fuel power stations clearly strengthened

The derogations from the prohibition to grant State aid The European Commission may approve State aid based on Art. 87 par. 2 and 3 EC Treaty –Great discretion of the European Commission Has to weigh the benefical effects of the aid against its adverse effects on trading conditions and on the maintenance of undistorted competition

Review of the NAPs in the light of Article 87 EC Treaty European Commission : –The notification of the NAPs does not amount to a formal notification of state aid –Only provisional evaluation of state aid –No approval of state aid, but Information of Member States that the Commission will consider potential state aid as justified as long as caps are lower than ‘expected needs’ and that there is no case of individual over-allocation Threat to open state aid investigation if discriminatory allocation modes are not changed by Member States

Legal challenge by affected competitors Possibility of legal action by affected competitors based on State aid rules: –Request the Commission to open a state aid investigation –Lodge an action of annulment against the Commission’s decision on the NAPs with the Court of First Instance –Request to block temporarily state aid in front of a national Court

Request to open a state aid investigation Case EnBW Württemberg AG v Commission (2007) (T-387/04) –Request to open a state aid investigation regarding a German allocation rule favouring fossil fuel power stations –Refusal of the European Commission to open a state aid investigation by a ‘service letter’ Consequence: –Affected competitors cannot lodge an action of annulment against the decision of the European Commission

Action of annulment of the Commission’s approval of the NAPs The case EnBW Württemberg AG v Commission (2007) (T-387/04) –The Court of First Instance denied the interest of the complainant in the annulment of the Commission’s decision Consequence: –Affected competitors cannot challenge an allocation rule of a NAP, which has not been rejected by the European Commission

Request to block temporarily the aid in front of a national Court It is unlikely that a national Court suspends an allocation rule which has not been rejected by the Commission in its decision on the NAP

Conclusions The free allocation of allowances has led to significant distortions of competition, in particular through the generation of significant windfall ‘profits’ The question whether the grant of free allowances amounts to state aid under Article 87 EC has not been clarified by the European Courts The legal challenge of allocation rules by affected competitors is fraught with difficulties

Conclusions Consequences: –The European Commission remains the strategic ‘master’ of the state aid ‘instrument’ This allows it to avoid that legal action puts at risk the functioning of the EU ETS Allows it to use the state aid ‘instrument’ as a ‘stick’ against Member States