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Category: Legal Alert

 

The long-awaited Guidance Document n°7 issued in September specifies which technical modifications constitute ‘physical change’ in the EU ETS installation and which do not. The additional or reduced allocation of emission allowances valid in the third trading period obviously is at stake.

 

 

The long-awaited Guidance Document n°7 on the harmonized free allocation methodology for the EU-ETS post 2012 Guidance on New Entrants and Closures (Final version) has been  issued on 14 September 2011. Those interested in the issue should refer to the webpage http://ec.europa.eu/clima/documentation/ets/benchmarking_en.htm for the full text of this important document.

 

It is evident that the significance of the document concerned will extend throughout the entire third trading period i.e. till 2020. Furthermore, given the fact, the statutory definition of ‘new entrant’ covers the period since 30 June 2011, the Guidance Document n°7 should be the subject of particular, urgent consideration of every EU ETS installation’s operator. It is likely it would be necessary to return to the detailed analysis contained in the Guidance Document n°7 not once but in this place let’s start with elaborations thereof on the definition and practical examples of a ‘physical change’ made to the installation and its correlations with the extent of free allocation of carbon credits valid in the third trading period.

 

As the Guidance Document explains, in the context of the definition of significant capacity extensions/reductions, such physical changes must be understood as modifications of production processes and the equipment required, and the different subparts of the definition should be interpreted as:

 

Article 3 points (i) and (j) of the  Commission’s Decision determining transitional Union-wide rules for the harmonised free allocation of emission allowances pursuant to Article 10a of Directive 2003/87/EC of 27 April 2011:


'significant capacity extension' means a significant increase in a sub-installation's initial installed capacity whereby all of the following occur:

(i) one or more identifiable physical changes relating to its technical configuration and functioning other than the mere replacement of an existing production line take place, and

(ii) the sub-installation can be operated at a capacity that is at least 10% higher compared to the initial installed capacity of the sub-installation before the change, or

(iii) the sub-installation to which the physical changes relate has a significantly higher activity level resulting in an additional allocation of emission allowances of more than 50000 allowances per year representing at least 5% of the preliminary annual number of emission allowances allocated free of charge for this sub-installation before the change.


(j) 'significant capacity reduction' means one or more identifiable physical changes leading to a significant decrease in a sub-installation's initial installed capacity and its activity level of the magnitude considered to constitute a significant capacity extension

 

1. The necessary condition is the physical nature of the change related to the technical configuration and functioning. This excludes all types of merely organizational or operational changes (e.g. longer daily operation hours, higher speed of rotating kiln, application of new process control software, change in major process parameters such as pressure, temperature).

 

2. The impact of the physical change on the technical configuration and functioning constitutes the sufficient condition. Any physical change without such impact (e.g. a repaint coating of the outer face of a kiln) does not match the definition as there needs to be a clear causality link between the physical change(s) and the change in capacity. In other words, only physical changes allowing for changes in throughputs could lead to a significant change of capacity.

 

3. Furthermore, the mere replacement of an existing production line cannot be considered in the context of the definition of significant capacity extensions. This includes the replacement of parts of a production line without impacts on the technical configuration and functioning (e.g. replacement of a pre-heater with the same performance). But, in case of higher maximum throughput of the production line after the replacement, this change could in principle constitute a physical change leading a significant capacity extension (provided the

quantitative criteria are met).

 


 

Debottlenecking could also lead to a significant capacity extension if:

- The debottlenecking process involves one or more physical changes: changes to the programming of machinery or planning of production alone can never lead to significant capacity changes.

- The physical change(s) lead to an increase in activity level of the relevant subinstallation.

- The activity level of the relevant sub-installation is sufficiently increased to meet one of the two thresholds above.

 

Heat benchmark sub-installations can have a significant extension in capacity if - after one or more physical changes at the heat producing facilities, the increased  export of heat to non-ETS heat consumers allows the heat benchmark sub-installation concerned to match one of the two above mentioned quantitative criteria or - after one or more physical changes at the heat consuming facilities (within the installation), the increased consumption of heat allows the heat benchmark sub-installation concerned to match one of the two above mentioned quantitative criteria.

 

Guidance Document n°7 gives also three illustrative examples for above-mentioned principles.

 

Example of a new sub-installation that is a significant change in capacity

 

An installation produces a benchmarked product and has no sub-installations outside the product benchmark sub-installation. In 2016, the installation makes a physical change allowing it to provide excess heat to a nearby swimming pool. Heat delivery to the swimming pool constitutes heat export to a non-ETS entity which should be covered by a heat benchmark sub-installation. This new sub-installation is the result of a physical change and should therefore be regarded as a significant capacity extension and receive allocation accordingly.

 

Example of a change that is not a significant change in capacity

 

A bricks producer initially has no sub-installations outside the bricks product benchmark subinstallation. In 2014, the installation starts to produce pavers without making any physical changes to the installation. Pavers are not covered by the product definition for the bricks benchmark. The production of pavers is therefore not covered by the bricks product benchmark sub-installation.

 

Since no significant change was involved, the start of paver production is not regarded as a significant change in capacity and receives no allocation. If the start of paver production leads to a decrease in activity level of the bricks product sub-installation in the production of bricks, it could lead to partial cessation (see section 6)

 

Example of a change that is not a significant change in capacity since it is not the result of a physical change

 

ETS installation A contains a heat benchmark sub-installation that covers its own heat consumption. In addition, it provides heat to ETS installation B. Both installations A and B are not deemed to be exposed to a significant risk of carbon leakage. Installation B will go out of scope of the ETS. Installation A will not receive allowances for this change. Although the activity level of its heat benchmark sub-installation would increase this is not the result of a physical change.

 

It is noteworthy that the Guidance Document n°7 contains numerous referrals to the section 6.4 of the Guidance Document n°2 and as a result these documents need to be read jointly.

 

In my opinion the practical examples presented in the Guidelines: first - with pavers and bricks and second – about the installation B that goes out of scope of the ETS are, however, not clear enough. Evidently too many nuances exist as regards the issue and it is difficult to set up the unambiguous line distinguishing the two fields, in which first leads to free allocation and the second does not. Isn’t really starting the production of pavers instead of the bricks the physical change in the meaning of the Benchmark Decision? If the Guidelines are right asserting that such a change does not qualify for a free allocation, it seems that such a interpretation leads to effects which are not just from the point of view of common logic.

 

The practical example considered is concluded with the contention that the start of paver production is not regarded as a significant change in capacity and receives no allocation. Furthermore, if the start of paver production leads to a decrease in activity level of the bricks product sub-installation in the production of bricks, it could lead to partial cessation.

The entrepreneur conscious of the said provisions would be very careful in taking the decision on changing the product from bricks to pavers, since it risks loosing free emission allowances and in effect potential economic loss.

Such a regulatory approach from the wider economic perspective evidently prefers the preservation of the manners of production that have been applied so far and discriminate against the flexibility in reacting to the changing market conditions. Being mindful of the significance of such a flexibility for the overall success in business, it is doubtful whether the above-described regulatory approach serves the best interests of the economy as a whole.