Commission introduces stricter ETS Correction Factor

UPDATED: 07/02/17

DISCLAIMER: The below represents the author's interpretation of the implications of the new CSCF, and should not be taken for the official position of the Commission.

Following a ruling from the European Court of Justice (ECJ), the European Commission has revised the Cross-Sectoral Correction Factor (CSCF) values for ETS Phase III (2013-20).
 
The new values will only be applied from March 2017 when agreeing free allocation adjustments for sites that have undergone a significant capacity reduction. When applied they will reduce free allocation to an installation by an additional 4-5 percentage points compared to the old CSCF values.

If installations require no adjustment to their free allocation (because they have not experienced a significant capacity or activity level change) their allocation up to 2020 will remain as defined in existing National Implementation Measures.

If installations require an adjustment in free allocation due to a capacity extension or change in activity level they will also be unaffected by the new values.

With capacity extensions, the additional allowances come from the New Entrants’ Reserve (NER) rather than the general pool of free allowances, and the NER is not subject to the CSCF.

And with activity level changes, Article 23 of the Benchmarking Decision is clear that an adjustment is made without a recalculation that would involve the re-application of the CSCF.

I understand that the Commission is updating its Guidance Note on free allocation adjustments to make clear that activity level changes are not affected. The note currently proposes a methodology for recalculating allocation in the instance of an activity level change that uses the CSCF, but this does not have the same legal standing as the Benchmarking Decision.

In 2013, 32 installations out of 11,000 had adjustments made to their allocation as a result of a capacity reduction. Assuming a similar proportion (~0.3%) require adjustments each year from 2017, we may see 1-1.5% of installations end up on the stricter CSCF by the end of Phase III.
 
The Commission’s interpretation of the ECJ ruling is more generous to industry than analysts had predicted, only applying the higher CSCF values from 2017 (rather than retrospectively) and then only when modifications are made due to capacity reductions.
 
The new values:
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​The old values:

​Notes:

• The European Court of Justice ruled on 28th April 2016 that the Commission had underestimated the Cross-Sectoral Correction Factor (CSCF) values for Phase III due to a calculating error, and instructed the Commission to revise them.
• The CSCF is the factor by which the number of free allowances owed to installations in a given year must be multiplied so as not to exceed the amount available that year. For example, if 100 allowances were owed, but only 80 were available, a CSCF of 0.8 (or 80%) would be applied.
• Free allocation to installations (other than ‘electricity generators’) that comes from the general free share is subject to the CSCF when there is a shortfall as described above.
• The CSCF is often stated as a percentage haircut, so a correction factor of 0.8 might be referred to as a 20% CSCF. In this sense the new CSCF values are higher, i.e. they will reduce allocations by a larger amount.
• When an installation undergoes a significant capacity or activity level change, the relevant Member State must agree a new allocation for the following year with the Commission.
• From March 2017, when a new allocation is agreed with the Commission due to a capacity reduction the new CSCF values will be used.
• Adjustments to allocations made from March to accommodate capacity extensions are not affected, however, because these allowances come from the New Entrants’ Reserve (NER).
• The NER is formed from 5% of Phase III allowances (minus 300 million put into a fund called NER 300); it is separate from the general free share of allowances and not subject to the CSCF.
• The NER is first come first served, but it is over 75% full according to the latest status report and is unlikely to run out by the end of the Phase.
• When calculating allocation from the NER, the Commission applies the Linear Reduction Factor rather than the CSCF.
• Adjustments due to an activity level change (due to partial cessation or recovery) will also unaffected by the new values. While this allocation comes from the general free share (so is subject to the CSCF), adjustments are made without re-applying the CSCF, as provided for in Article 23 of the Benchmarking Decision.
• A ‘significant’ capacity reduction is essentially a reduction of at least 10% of initial capacity.
• Activity levels are deemed to change when production crosses thresholds set at 50%, 25% and 10% of historic production levels.

 
Links:
 
ECJ Ruling
 
CSCF Decision
 
FAQ
 
Benchmarking Decision

Free Allocation Guidance—To Be Updated
 
2017 NER Status Report
 
2014 Activity and Capacity Changes Report
 
Contact:
 
damien.green@perspectiveclimate.com