COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a Directive of the European Parliament and of the Council amending Directive 2003/87/EC to enhance cost-effective emission reductions and low-carbon investments
Date: 2015-07-15
Institutions: Directorate-General for Climate Action, European Commission
Subjects: EU Emissions Trading Scheme, EU investment, UN Framework Convention on Climate Change, energy efficiency, greenhouse gas, innovation, modernisation of industry, reduction of gas emissions, tradeable emission permit

EN 

   EN 

   EUROPEAN COMMISSION  Brussels, 15.7.2015  SWD(2015) 135 final   COMMISSION STAFF WORKING DOCUMENT  IMPACT ASSESSMENT  Accompanying the document Proposal for a Directive of the European Parliament and of the Council amending Directive 2003/87/EC to enhance cost-effective emission reductions and low-carbon investments {COM(2015) 337 final} {SWD(2015) 136 final}  
 
 
TABLE OF CONTENTS 

6. 

6.1. 
6.2. 

5.1. 
5.2. 
5.3. 

1.  PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES ....................................................... 10 
Identification ....................................................................................................................................... 10 
1.1. 
Organisation and timing ................................................................................................................... 10 
1.2. 
1.3. 
Consultation and expertise .................................................................................................................. 10 
1.3.1.  Expertise used ..................................................................................................................................... 10 
1.3.2.  Consultation ........................................................................................................................................ 11 
Subsidiarity ......................................................................................................................................... 13 
1.4. 
Scrutiny by the Commission Impact Assessment Board ..................................................................... 14 
1.5. 
2.  POLICY CONTEXT ....................................................................................................................................... 14 
3.  GENERAL EVALUATION AND LESSONS LEARNT .......................................................................................... 16 
4.  GENERAL PROBLEM DEFINITION ................................................................................................................ 19 
5.  OBJECTIVES ................................................................................................................................................ 20 
General policy objectives .................................................................................................................... 20 
Specific policy objective ..................................................................................................................... 21 
Consistency with other policies and objectives ................................................................................... 21 
IMPLEMENTATION OF THE EU'S GHG EMISSION REDUCTION TARGET .................................................... 22 
Linear reduction factor ........................................................................................................................ 22 
Auction share ...................................................................................................................................... 23 
7.  FREE ALLOCATION AND ADDRESSING THE RISK OF CARBON LEAKAGE .................................................... 27 
7.1. 
Problem definition ............................................................................................................................... 28 
7.1.1.  Underlying drivers of the problem ...................................................................................................... 29 
Operational policy objectives ........................................................................................................... 32 
7.2. 
Policy options for free allocation and other carbon leakage measures ................................................ 33 
7.3. 
7.3.1.  Benchmark values ............................................................................................................................... 33 
7.3.2.  Production level and adjustments ........................................................................................................ 34 
7.3.3.  Reserve for new entrants ..................................................................................................................... 35 
7.3.4.  Carbon leakage groups ........................................................................................................................ 36 
7.3.5.  Cross-sectoral correction factor .......................................................................................................... 37 
7.3.6.  Compensation for indirect carbon costs .............................................................................................. 37 
Option packages .................................................................................................................................. 38 
7.4. 
7.5. 
Analysis of impacts ............................................................................................................................. 41 
7.5.1.  Direct and indirect effects ................................................................................................................... 41 
7.5.2.  Environmental impacts ........................................................................................................................ 41 
7.5.3.  Economic impacts ............................................................................................................................... 42 
7.5.3.1.  Quantified impacts on competitiveness .......................................................................................... 42 
7.5.3.2.  Administrative burden .................................................................................................................... 46 
7.5.4.  Social impacts ..................................................................................................................................... 46 
Employment .................................................................................................................................... 46 
7.5.4.1. 
7.5.4.2. 
Energy prices for households .......................................................................................................... 47 
7.5.5.  Comparing the options ........................................................................................................................ 47 
7.5.5.1.  Quantified environmental and social impacts ................................................................................. 47 
7.5.5.2.  Reflect technological progress in industry sectors .......................................................................... 48 
7.5.5.3. 
Fully preserve incentives for industry to innovate .......................................................................... 48 
7.5.5.4.  Most efficient installations do not face undue carbon costs leading to carbon leakage .................. 49 
7.5.5.5.  Better alignment with production levels ......................................................................................... 50 
7.5.5.6.  Avoid windfall profits ..................................................................................................................... 50 
7.5.5.7.  No increased administrative complexity ......................................................................................... 51 
7.5.6.  Concluding remarks ............................................................................................................................ 51 
8.  LOW-CARBON FUNDING MECHANISMS ....................................................................................................... 53 
8.1. 
Innovation fund ................................................................................................................................... 54 
8.1.1.  Problem definition ............................................................................................................................... 54 
8.1.1.1.  Underlying drivers of the problem .................................................................................................. 55 
8.1.2.  Operational policy objectives .............................................................................................................. 56 
8.1.3.  Policy options ...................................................................................................................................... 57 
8.1.3.1. 
Screening of projects ...................................................................................................................... 57 
8.1.3.2.  Conditionality of Awards ................................................................................................................ 58 

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Type of instrument .......................................................................................................................... 58 
8.1.3.3. 
8.1.3.4.  Maximum rate of funding ............................................................................................................... 59 
8.1.3.5. 
Parameters not varied in the options ............................................................................................... 60 
8.1.4.  Option packages .................................................................................................................................. 61 
8.1.5.  Analysis of impacts ............................................................................................................................. 62 
8.1.5.1.  General impacts .............................................................................................................................. 62 
Economic impacts ........................................................................................................................... 64 
8.1.5.2. 
Environmental impacts ................................................................................................................... 68 
8.1.5.3. 
8.1.5.4. 
Social impacts ................................................................................................................................. 68 
8.1.6.  Comparing the options ........................................................................................................................ 68 
8.2.  Modernisation Fund ............................................................................................................................ 70 
8.2.1.  Problem definition ............................................................................................................................... 70 
8.2.1.1.  Context ............................................................................................................................................ 70 
8.2.1.2.  Underlying drivers of the problem .................................................................................................. 71 
8.2.1.3. 
Lessons learnt ................................................................................................................................. 71 
8.2.2.  Policy Objectives ................................................................................................................................ 72 
8.2.3.  Development and screening of policy options .................................................................................... 72 
8.2.3.1. 
Policy options ................................................................................................................................. 72 
8.2.3.2.  Option packages .............................................................................................................................. 73 
8.2.4.  Analysis of Impacts ............................................................................................................................. 75 
8.2.4.1. 
Effectiveness ................................................................................................................................... 76 
8.2.4.2.  Coherence ....................................................................................................................................... 78 
8.2.4.3.  Market Distortion ............................................................................................................................ 79 
8.2.4.4.  Administrative Burden .................................................................................................................... 80 
8.2.5.  Comparing the Options ....................................................................................................................... 81 
8.3. 
Free allocation to promote investments for modernising the energy sector ........................................ 81 
8.3.1.  Policy objective and problem definition ............................................................................................. 81 
8.3.2.  Conclusions on lessons learnt and policy context ............................................................................... 82 
8.3.3.  Operational policy objectives .............................................................................................................. 83 
8.3.4.  Development and screening of policy options .................................................................................... 83 
8.3.4.1.  Aspects not varied between the options .......................................................................................... 84 
8.3.5.  Retained option packages .................................................................................................................... 85 
8.3.6.  Assessment of options ......................................................................................................................... 87 
8.3.6.1.  General impacts - Effectiveness...................................................................................................... 87 
8.3.6.2.  General impacts - Complexity and administrative burden / flexibility to adjust to MS 
circumstances ................................................................................................................................................... 88 
8.3.6.3.  General impacts - Transparency ..................................................................................................... 89 
8.3.6.4.  General impacts - Potential distortion of EU energy market / complementarity with existing EU 
instruments ....................................................................................................................................................... 89 
8.3.6.5. 
revenues of investments .................................................................................................................................... 90 
Environmental impacts - Potential decarbonisation ........................................................................ 91 
8.3.6.6. 
8.3.6.7. 
Social impacts ................................................................................................................................. 92 
8.3.7.  Comparing the options ........................................................................................................................ 92 
Inter-linkages between the low carbon funding mechanisms .............................................................. 93 
8.4. 
9.  MONITORING AND EVALUATION ................................................................................................................. 94 
ANNEXES .............................................................................................................................................................. 96 
1.  GLOSSARY ................................................................................................................................................... 96 
SUMMARY OF RELEVANT FINDINGS OF THE 2030 IMPACT ASSESSMENT ................................................. 100 
2. 
3. 
SUMMARY OF STAKEHOLDER CONSULTATIONS ....................................................................................... 102 
3.1.  GENERAL CONSULTATION ON THE ETS REVISION .................................................................................. 102 
I. 
Free allocation and addressing the risk of carbon leakage .............................................................. 103 
Industry stakeholders ...................................................................................................................................... 103 
Public authorities ............................................................................................................................................ 103 
Civil society .................................................................................................................................................... 104 
II. 
Innovation Fund .................................................................................................................................. 104 
Industry stakeholders ...................................................................................................................................... 104 
Public authorities ............................................................................................................................................ 105 
Civil society .................................................................................................................................................... 105 
III.  Modernisation Fund ........................................................................................................................ 105 

Timing and distribution of investments and volume and timing of allowances on market / auction 

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Industry stakeholders ...................................................................................................................................... 105 
Public authorities ............................................................................................................................................ 106 
Civil society .................................................................................................................................................... 107 
IV. 
Free allocation to promote investments for modernising the energy sector............................... 107 
Industry stakeholders ...................................................................................................................................... 107 
Public authorities ............................................................................................................................................ 108 
Civil society .................................................................................................................................................... 109 
V.  SMEs/regulatory fees/other ................................................................................................................ 109 
Industry stakeholders ...................................................................................................................................... 109 
Public authorities ............................................................................................................................................ 110 
Civil society .................................................................................................................................................... 110 
VI. 
General evaluation .......................................................................................................................... 110 
Industry stakeholders ...................................................................................................................................... 110 
Public authorities ............................................................................................................................................ 111 
Civil society .................................................................................................................................................... 111 
3.2.  Consultation on carbon leakage provisions and innovation support .................................................. 111 
I. 
Business and trade representations of business interests ................................................................. 112 
II.  Government and regulatory authorities ............................................................................................ 116 
Academic and research organisations, NGOs, citizens, trade unions (civil society) .................. 118 
III. 
4. 
SUMMARY OF EVALUATION ...................................................................................................................... 121 
4.1.  NER 300 - lessons learnt .......................................................................................................................... 121 
4.1.1. 
Introduction ....................................................................................................................................... 121 
NER 300 principles ........................................................................................................................... 121 
4.1.2. 
4.1.2.1.  Definition .......................................................................................................................................... 121 
Legal basis ........................................................................................................................................ 121 
4.1.2.2. 
Selection of projects .......................................................................................................................... 122 
4.1.2.3. 
State-of-play ...................................................................................................................................... 123 
4.1.3. 
4.1.3.1.  Results of calls for proposals ............................................................................................................ 123 
4.1.4. 
Lessons learnt so far .......................................................................................................................... 125 
4.1.4.1.  Geographical coverage ..................................................................................................................... 125 
4.1.4.2. 
Technological coverage .................................................................................................................... 125 
Support to innovation ........................................................................................................................ 125 
4.1.4.3. 
4.1.4.4.  Cost-effectiveness in the use of NER 300 funds ................................................................................. 126 
4.1.4.5.  Administrative simplification ............................................................................................................ 126 
4.1.4.6.  Monetisation of allowances for grants .............................................................................................. 126 
4.1.4.7.  No ring-fencing ................................................................................................................................. 127 
4.1.4.8.  Number and timing of calls ............................................................................................................... 127 
Length of preparatory phase ............................................................................................................. 128 
4.1.4.9. 
Impact of projects ......................................................................................................................... 128 
4.1.4.10. 
NER 300 and other financing instruments .................................................................................... 128 
4.1.4.11. 
4.1.5. 
Main challenges encountered ............................................................................................................ 129 
4.1.5.1.  Financial barriers ............................................................................................................................. 129 
4.1.5.2.  Management structure ...................................................................................................................... 130 
4.1.6. 
Conclusions ....................................................................................................................................... 131 
4.2.  Free allocation to the power sector ......................................................................................................... 132 
4.3.  Exclusion of small emitters – lessons learnt ........................................................................................... 135 
4.4.  Guaranteeing a robust and secure EU ETS (registry fees) – lessons learnt ........................................ 137 
5.  DETAILED DESCRIPTION AND SCREENING OF OPTIONS FOR FREE ALLOCATION  TO INDUSTRY ............. 139 
Benchmarks ....................................................................................................................................... 139 
5.1. 
5.1.1.  Lessons learnt from the current system in phase 3 (2013-2020) ....................................................... 139 
5.1.2.  Policy options for updating benchmark values for 2021-30 .............................................................. 140 
5.1.3.  Screening ........................................................................................................................................... 141 
Carbon leakage groups and criteria ................................................................................................... 143 
5.2. 
5.2.1.  Lessons learnt from the current system in phase 3 (2013-20) ........................................................... 143 
5.2.2.  Policy options .................................................................................................................................... 146 
5.2.3.  Screening ........................................................................................................................................... 150 
5.3. 
Production level and adjustments ...................................................................................................... 151 
5.3.1.  Lessons learnt from the current system in phase 3 (2013-20) ........................................................... 151 
5.3.2.  Policy options .................................................................................................................................... 153 
5.3.3.  Screening ........................................................................................................................................... 154 

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Reserve for new entrants ................................................................................................................... 155 
5.4. 
5.4.1.  Lessons learnt from the current system in phase 3 (2013-20) ........................................................... 155 
5.4.2.  Policy options .................................................................................................................................... 155 
5.4.3.  Screening ........................................................................................................................................... 156 
5.5. 
Compensation for indirect carbon costs ............................................................................................ 157 
5.5.1.  Lessons learnt from the current system in phase 3 (2013-20) ........................................................... 157 
5.5.2.  Policy options .................................................................................................................................... 159 
5.5.3.  Screening ........................................................................................................................................... 159 
6.  FURTHER IMPROVEMENTS TO THE CURRENT SET OF RULES ................................................................... 161 
Validity of emission allowances ....................................................................................................... 161 
6.1. 
6.1.1.  Problem definition ............................................................................................................................. 161 
6.1.2.  Operational policy objective ............................................................................................................. 162 
6.1.3.  Policy options .................................................................................................................................... 162 
6.1.4.  Analysis of impacts ........................................................................................................................... 162 
6.1.5.  Comparing the options ...................................................................................................................... 162 
6.2. 
Optional exclusion of small emitters ................................................................................................. 163 
6.2.1.  Problem definition and general objective .......................................................................................... 163 
6.2.2.  Operational policy objective ............................................................................................................. 164 
6.2.3.  Policy options .................................................................................................................................... 164 
6.2.3.1.  Assessment of the options ............................................................................................................. 164 
6.2.3.2.  Comparing the options .................................................................................................................. 165 
6.3. 
Guaranteeing a robust and secure EU ETS (registry fees) ................................................................ 166 
6.3.1.  Problem definition and general objective .......................................................................................... 166 
6.3.2.  Operational policy objectives ............................................................................................................ 167 
6.3.3.  Policy options .................................................................................................................................... 167 
6.3.3.1. 
Screening of the options ............................................................................................................... 168 
6.3.3.2.  Analysis of impacts ....................................................................................................................... 168 
IMPACTS OF DIFFERENT OPTION PACKAGES FOR FREE ALLOCATION ON INDIVIDUAL SECTORS ........... 170 
Effect of carbon leakage groups on sectors ....................................................................................... 171 
Cross sectoral correction factor ......................................................................................................... 174 
Estimated level of free allocation for biggest sectors in phase 4 ....................................................... 174 
Estimated compliance cost per sector, taking into account cost pass through................................... 179 
Sensitivity analysis ............................................................................................................................ 183 

7.1. 
7.2. 
7.3. 
7.4. 
7.5. 

7. 

8. 
IMPACTS OF DIFFERENT OPTION PACKAGES FOR FREE ALLOCATION: ADMINISTRATIVE BURDEN AND 
SOCIAL IMPACTS ................................................................................................................................................ 186 
Analysis of administrative burden ..................................................................................................... 186 
8.1. 
8.2. 
Analysis of social impacts ................................................................................................................. 188 
8.2.1.  Employment ...................................................................................................................................... 188 
8.2.2.  Energy prices for households ............................................................................................................ 191 
9.  LITERATURE REVIEW ON COST-PASS THROUGH RATES ........................................................................... 193 
Theoretical studies on cost pass-through ........................................................................................... 194 
Ex-ante empirical studies on the EU ETS ......................................................................................... 195 
Ex-post empirical studies for the EU ETS ........................................................................................ 197 
Conclusions ....................................................................................................................................... 201 

9.1. 
9.2. 
9.3. 
9.4. 

10.  DESCRIPTION OF FINANCIAL BARRIERS FOR ENERGY SECTOR: POWER GENERATION, ENERGY 
EFFICIENCY AND NETWORKS ............................................................................................................................. 206 
11.  IMPACTS OF CREATING THE MODERNISATION FUND COMPARED TO THE BASELINE ............................ 208 
12.  MORE COMPREHENSIVE OVERVIEW OF IMPACTS FOR DIFFERENT OPTIONS FOR CREATING THE 
MODERNISATION FUND ..................................................................................................................................... 213 
13.  TIMING AND APPROACH TO THE MONETISATION OF ALLOWANCES FOR THE INNOVATION FUND AND 
MODERNISATION FUND ..................................................................................................................................... 215 
14.  SENSITIVITY ANALYSIS FOR POSSIBLE FUNDING RATES FOR THE INNOVATION FUND ........................... 222 
15.  OPTIONS FOR UNALLOCATED ALLOWANCES ............................................................................................ 225 
Policy options ................................................................................................................................................. 225 
Comparison between the options .................................................................................................................... 226 

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List of tables 

Table 1: Option packages for addressing the risk of carbon leakage .................................................................... 40 
Table 2: Estimated number of sectors and distribution of free allowances under 'Baseline', 'limited changes' and 
'targeted 'options ................................................................................................................................................... 44 
Table 3: Overview of assessment of policy option packages compared to 'Baseline B' ....................................... 52 
Table 4: Option packages for Innovation Fund .................................................................................................... 61 
Table 5: Comparison of options for the innovation fund ...................................................................................... 69 
Table 6: Retained options for examining for the Modernisation Fund ................................................................. 74 
Table 7: Impact of policy options for the Modernisation Fund ............................................................................ 81 
Table 8: Option packages for the free allocation to the power sector ................................................................... 86 
Table 9: Comparison of options for the free allocation to the power sector ......................................................... 92 
Table 10 Stakeholder consultation responses ..................................................................................................... 111 
Table 11: Projects submitted and awarded ......................................................................................................... 124 
Table 12: Distribution of awarded NER 300 funding ......................................................................................... 124 
Table 13: Screening of options for updating benchmark values ......................................................................... 143 
Table 14: Overview of minimum cost pass-through values found in existing literature .................................... 146 
Table 15: Screening of options for carbon leakage groups and criteria .............................................................. 151 
Table 16: Screening of options for production level and adjustments ................................................................ 155 
Table 17: Screening of options for reserve for new entrants .............................................................................. 156 
Table 18: Screening of options for compensation for indirect cost .................................................................... 160 
Table 19: Comparison of options ....................................................................................................................... 163 
Table 20: Comparison of the options in relation to relevant problems and objectives ....................................... 166 
Table 21: Comparing the options in relation to relevant problems and objectives ............................................. 169 
Table 22: Estimated number of sectors, share of gross free allocation and GVA in the different groups .......... 173 
Table 23: Estimated carbon leakage status at sectoral level based on past data ................................................. 173 
Table 24 Overview table on estimated compliance cost per sector, taking into account cost pass-through rates
 ............................................................................................................................................................................ 183 
Table 25 Sensitivity analysis of compliance costs compared to sector turnover at different carbon prices ....... 184 
Table 26: Estimated administrative costs for additional NIMs exercises: .......................................................... 186 
Table 27: Estimated additional annual administrative costs for production level adjustments .......................... 187 
Table 28: Estimated administrative costs for harmonised rules for indirect cost compensation (additional costs 
compared to national compensation currently applied in 6 MSs as baseline)..................................................... 188 
Table 29: Estimated employment impacts of policy option packages compared to baseline B from the pass 
through of additional costs (annual average for 2021 – 2030, underlying assumptions in italics) ..................... 190 
Table 30: High estimate of employment impacts of policy option packages compared to baseline B from 
additional costs absorbed (annual average for 2021 – 2030, underlying assumptions in italics) ....................... 190 
Table 31: Analysis of impacts of policy option packages on the district heating sector 2021-30 ...................... 191 
Estimate of cost pass-through rates from ex-post econometric studies ......................................... 199 
Table 32 
Overview of the range of average cost pass-through in selected sectors from literature .............. 202 
Table 33 
Table 34: Comparison under baseline and creation of the Modernisation Fund for allocation of 2% of total 
allowances, 2021-2030 ....................................................................................................................................... 209 
Table 35: Modernisation Fund allocation shares per beneficiary Member States, 2021-2030 ........................... 209 
Table 36: Monetised health benefits in 2030 as a percentage of GDP ............................................................... 211 
Table 37: Reduced air pollution control costs by 2030 as a percentage of GDP ................................................ 211 
Table 38: EU28 jobs associated with investments in the power sector and energy efficiency, 2011-2030 ........ 212 
Table 39: Overview of impacts for different options for creating the Modernisation Fund ............................... 213 
Table 40: Sensitivity of amount to raise by RES, CCS or industry project sponsor to funding rates and project 
size ...................................................................................................................................................................... 224 
Table 41: Sensitivity of 15% to price of carbon ................................................................................................. 224 
Table 42: Comparison of options for further action with unallocated allowances ............................................. 226 

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List of figures 

Figure 1 Respondents from industry ..................................................................................................................... 12 
Figure 2: Structure of the total quantity of allowances in phase 3 ........................................................................ 25 
Figure 3: Sectors on and off the carbon leakage list. ............................................................................................ 36 
Figure 4: Estimated combined effect of carbon leakage groups and the correction factor under different option 
packages ............................................................................................................................................................... 45 
Figure 5: Annual allowances from fund by type .................................................................................................. 88 
Figure 6: Combined free allocation trajectories .................................................................................................... 91 
Figure 7: Stakeholder consultation responses ..................................................................................................... 102 
Figure 8: Industry stakeholders – shares of each sector replying ....................................................................... 102 
Figure 9: Distribution of installations in terms of amount of emissions ............................................................. 135 
Figure 10: Annual Emissions from small installations (installations with annual emissions < 25 kt) and from opt-
out installations ................................................................................................................................................... 136 
Figure 11: Ranking of sectors in terms of emissions in EU ETS ........................................................................ 170 
Figure 12: Indicative carbon leakage groups in the 'Limited changes' option package based on 2009-2011 data
 ............................................................................................................................................................................ 172 
Figure 13: Indicative carbon leakage groups in the 'Targeted' option package based on 2009-2011 data .......... 172 
Figure 14: Estimated combined effect of carbon leakage groups and the correction factor under different option 
packages ............................................................................................................................................................. 175 
Figure 15: Employment in selected energy-intensive industries ........................................................................ 189 
Figure 16 
Cost pass-through rates derived by Vivid Economics (2014) in sectors investigated in reduced and 
full detail (2020, € 15/tCO2) ............................................................................................................................... 197 

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EXECUTIVE SUMMARY SHEET 

Executive Summary Sheet 

Impact  assessment  on  Proposal  for  a  Directive  of  the  European  Parliament  and  of  the  Council  amending 
Directive 2003/87/EC  

A. Need for action 

Why? What is the problem being addressed? 
The  EU's  long-term  goal,  also  agreed  in  the  context  of  the  UNFCCC,  is  to  limit  global  average  temperature 
increase  to  below  2°C  compared  to pre-industrial  levels.  The  general  problem  analysis  concerning  EU  climate 
policy targets for 2030 and the ETS has been done in the impact assessment on the 2030 climate and energy 
framework. The European Council agreed on the 2030 framework in October 2014, including a binding domestic 
reduction  of  greenhouse  gas  GHG)  emissions  of  at  least  40%  in  2030  as  compared  to  1990,  and  a 
corresponding  emission  reduction  target  for  the  sectors  in  the  EU  Emissions  Trading  System  (ETS)  of  43% 
compared to 2005. The European Council also gave strategic guidance on the continuation of free allocation to 
industry  and  the  establishment  of  low-carbon  funding  mechanisms  to  ensure  EU's  low-carbon  transition.  The 
problem to be addressed is how to adapt the respective ETS Directive provisions  to make them suitable post-
2020, including also further improvements to the system based on lessons learnt in phase 3 since 2013.  

What is this initiative expected to achieve?  

The specific policy objective is to align the EU ETS architecture with the 2030  emission reduction commitment 
and  refine and improve the EU ETS post-2020  framework  in the light of the  lessons  learnt in a context where 
fully comparable climate policy measures may not yet be undertaken by all other major economies; reinforced 
research, development and innovation efforts should take place in order to maintain Europe's industrial base and 
competence, and support the 2030 climate and energy framework as well as the long-term goal of low-carbon 
economy;  reinforced  investment  efforts  should  take  place  in  order  to  modernise  the  energy  system  and 
experience  gathered  during  the  first  years  of  phase  3  since  2013  suggests  that  there  is  potential  to  reinforce 
efficiency.  

What is the value added of action at the EU level?  
The EU ETS Directive exists and will continue  being in force post 2020. It is an EU policy instrument. Climate 
change  is  a  trans-boundary  problem.  Therefore,  coordination  of  climate  action  at  European  level  and,  where 
possible,  at  global  level  is  necessary  and  EU  action  is  justified  on  grounds  of  subsidiarity.  Many  of  the  policy 
elements have an important internal market dimension and many of the required investments and infrastructures 
have an important European dimension. Therefore, the objectives can be better achieved by an EU framework 
for action. Delegating the legislative powers to Member States would lead to partitioning, an uneven playing field 
and decreased efficiency. 

B. Solutions 

What  legislative  and  non-legislative  policy  options  have  been  considered?  Is  there  a  preferred 
choice or not? Why?  
The impact assessment was carried out for a number of aspects on which the European Council gave strategic 
guidance  allowing  some  discretion  -  addressing  the  risk  of  carbon  leakage,  establishment  of  a  Modernisation 
and an Innovation Fund, optional free allocation to modernise the electricity sector in some Member States, and 
aspects  building  on  the  lessons  learnt  since  2013  (validity  of  emission  allowances;  guaranteeing  a  robust  and 
secure Registry; and optional exclusion of small emitters). The options in these areas are screened preliminarily 
in  view  of  achieving  the  operational  objectives.  There  are  numerous  possible  combinations  of  options  on 
different  elements  that  could  be  evaluated.  Therefore,  based  on  the  screening,  combinations  of  options  are 
selected  to  form  coherent  packages,  representing  different  ends  of  a  spectrum  and  differentiating  across  the 
different elements to evaluate their specific impacts, while also focusing on the realistic options. For addressing 
the  risk  of  carbon  leakage,  options  are  considered  concerning  benchmarks,  production  levels,  new  entrant 
reserve, carbon leakage groups and indirect cost compensation. For the Innovation Fund, options are developed 
for the way that projects are screened and selected, and the way in which financial support is provided. For the 
Modernisation Fund, potential options are considered on its governance. For the optional free allocation to the 
energy  sector,  options  are  developed  for  improving  its  modalities  and  enhance  transparency  compared  to  the 
current practice.          

Who supports which option?  
Different  stakeholders  have  different  views,  sometimes  within  the  same  sector,  making  it difficult  to categorise 

8 

 
 
homogenous groups of stakeholders supporting particular options. On addressing the risk of carbon leakage, a 
number of industry stakeholders are in favour of limited changes to the current system, while other stakeholders, 
including  Member  States  and  civil  society,  believe  that  more  targeting  or  further  harmonisation  is  needed.  For 
the  Innovation  Fund,  energy  and  industry  stakeholders  generally  welcome  continued  support  for  low-carbon 
innovation  and  the  expansion  of  scope  to  include  industry,  with  diverging  views  on  how  the  risk  sharing 
approach could be tailored for industry or CCS to improve the effectiveness compared to the current NER 300 
mechanism,  for  example  by  providing  support  at  an  earlier  stage  in  the  project  life  cycle  or  a  higher  rate  of 
support.  On  the  Modernisation  Fund  some  stakeholders  support  a  key  role  in  managing  it  for  the  beneficiary 
Member States, while others ask for a stronger role for all Member States, the Commission and the European 
Investment  Bank.  On  the  optional  free  allocation  to  the  energy  sector,  market  participants  generally  support 
streamlined, common and simplified rules, and harmonised reporting guidelines.  

C. Impacts of the preferred option 

What are the benefits of the preferred option (if any, otherwise main ones)?  
The general benefit of measures to address the risk of carbon leakage is addressing competitiveness issues and 
the potential risk of carbon leakage, as long as comparable climate policies are not undertaken by other major 
economies.  The  overall  benefit  of  establishing  the  Innovation  Fund  is  a  stepped-up  effort  to  rapidly  introduce 
new low-carbon technologies to the market enabling the EU to reach its  long-term decarbonisation goals. The 
general  benefit  of  establishing  the  Modernisation  Fund  and  optional  free  allocation  to  the  energy  sector  is 
contributing to the modernization of the energy systems in low-income Member States. 

What are the costs of the preferred option (if any, otherwise main ones)?  
Costs  must  be  seen  in  the  overall  context  of  the  EU  climate  objectives  of  limiting  global  average  temperature 
increase to not more than 2°C above pre-industrial level. Measures to address the risk of carbon leakage directly 
affect  the  costs  for  industrial  installations covered  by  the  ETS  or  EU  Member  States'  budgets.  Options  for  the 
Innovation  and  Modernisation  Fund  affect  primarily  administrative  costs  and  for  the  Modernisation  Fund  may 
lead to market distortion. Together with a possible impact on the carbon market, these types of costs are also 
relevant for the options for the optional free allocation to the energy sector. 

How will businesses, SMEs and micro-enterprises be affected?  

Businesses  covered  by  the  EU  ETS  are  directly  affected.  The  overall  impact  is  independent  of  the  assessed 
policy choices as the contribution the EU ETS has to make to the overall EU 2030 reduction target has already 
been set. Sectoral impacts in major industrial sectors covered by the EU ETS vary to some degree depending on 
policy choices. However, choices that lower the costs and impacts on some industrial sectors necessarily result 
in  higher  costs  and  impacts  for  other  industrial  sectors.  The  proposal  also  affects  producers  of  renewable 
energy, and manufacturers of equipment for low carbon technologies. Innovative technologies will generate new 
business  opportunities.  The  revision  of  the  ETS  also  constitutes  an  important  part  of  the  work  on  the 
achievement of a resilient Energy Union with a forward looking climate change policy at its core, which has as 
one  of  its  goal  giving  EU consumers  –  including  businesses  –  secure, sustainable, competitive  and  affordable 
energy.  The  majority  of  installations  under  the  EU  ETS  are  in  the  energy  intensive  industries  with  market 
structures  characterised  by  large  enterprises.  Small  emitters  (not  necessarily  owned  by  SMEs  or  micro 
entreprises)  should  benefit  from  the  option  envisaging  continuation  of  the  possibility  for  Member  States  to 
exclude them from the ETS if they are subject to equivalent measures.   

Will there be significant impacts on national budgets and administrations?  
National  budgets  and  administrations  are  primarily  affected  due  to  the  link  to  auctioning  revenues.  If  Member 
States were to be required to share the EU-level costs of the Union registry, this would also have an impact on 
their national budgets, but not a significant one. 

Will there be other significant impacts?  
 No other significant impacts are expected. 

D. Follow up 

When will the policy be reviewed?  
Not  specifically  foreseen,  but  Articles  10(5)  and  29  of  the  ETS  Directive  require  the  Commission  to  establish 
regular reports on the carbon market and to verify whether the carbon market is functioning properly. 

9 

 
 
1. 

PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES  

1.1. 

Identification  

Lead Directorate-General (DG): Climate Action 

Other  services  involved:  Secretariat-General;  Legal  Service;  DG  Budget;  DG  Competition; 
DG  Economic  and  Financial  Affairs;  DG  Employment;  DG  Energy;  DG  Environment;  DG 
Internal  Market,  Industry,  Entrepreneurship  and  SMEs;  DG  Mobility  and  Transport;  DG 
Regional and Urban Policy; DG Taxation and Customs Union; DG Trade and DG Research, 
Science and Innovation. 

Work Programme 2015 reference: Included under initiative no. 5 Strategic framework for the 
Energy Union  

Agenda Planning reference: 2015/CLIMA/001 

1.2. 

Organisation and timing 

The analysis of the policy framework for climate and energy in the period from 2020 to 2030 
(hereafter 'the 2030 framework')1 has played a central role in identifying the key elements for 
the revision of the European Union Emission Trading System (EU ETS) for the period after 
2020. The current impact assessment is a follow-up exercise from the impact assessment for 
the  2030  framework2  and  focuses  on  certain  ETS-specific  methodological  elements  not 
already assessed.  

The work for this impact assessment (IA) started in December 2014 with the launch of a 12-
week online consultation on the revision of the EU ETS3.The work also builds on the results 
of  the  consultation  on  the  2030  framework4  and  a  separate  consultation  on  the  post-2020 
carbon leakage provisions5.      

DG  Climate  Action  invited  the  above-mentioned  Commission  services  to  be  part  of  an 
Impact  Assessment  Steering  Group.  Three  meetings  took  place  (on  18  December  2014,  26 
February  2015  and  16  April  2015)  where  comments  were  exchanged  and  taken  into  due 
account.  The  final  draft  impact  assessment  was  submitted  to  the  group  on  13  April  2015. 
Another  meeting  of  the  Steering  Group  took  place  to  discuss  the  revised  draft  on  23  June 
2015. 

An evaluation of the existing ETS Directive  is part  of the  impact  assessment work and has 
fed into the assessment of the policy options.6  

1.3. 

Consultation and expertise 

1.3.1.  Expertise used 

This  impact  assessment  builds  on  the  impact  assessment  for  the  2030  framework  and 
analyses ETS-relevant aspects not covered in it.   

1  Communication  on  A  policy  framework  for  climate  and  energy  in  the  period  from  2020  to  2030, 
COM(2014)15 final 
2 Commission Staff Working Document accompanying the Communication on A policy framework for climate 
and energy in the period from 2020 to 2030, SWD(2014) 15 final 
3 http://ec.europa.eu/clima/consultations/articles/0024_en.htm  See summary in Annex 3 
4 http://ec.europa.eu/energy/en/consultations/consultation-climate-and-energy-policies-until-2030  
5  Recordings  of  the  meetings  and  the  presentation  can  be  found  on  the  DG  Climate  Action  website: 
http://ec.europa.eu/clima/policies/ets/cap/leakage/documentation_en.htm  
6 See in particular sections on lessons learnt and Annex 4 

10 

 
                                                           
In terms of external expertise, the Commission drew upon a study on evaluation of the ETS, 
commissioned  in  2014  and  carried  out  by  a  consortium  led  by  ICF  International7. 
Furthermore, in  2014, a study8 was commissioned  to  assess the issue of costs being passed 
through  from  industrial  sectors  to  their  downstream  customers  and  to  determine  the  factors 
influencing  such  ability  to  pass  through  costs  quantifying  it  for  major  energy  intensive 
industry sectors. Another study9 was commissioned to evaluate the experience gathered with 
the harmonised benchmark-based allocation process, and in particular to evaluate whether the 
benchmarks have achieved the intended objectives. In 2013, a study10 was commissioned to 
assess the evidence for carbon leakage in the period 2005-2012 for ten major energy intensive 
industry sectors. The findings of these studies are discussed in chapter 7. 

In  terms  of  data,  in  2011-2013,  Member  States  submitted  to  the  Commission  verified, 
detailed,  confidential  and  commercially  sensitive  data  on  preliminary  free  allocation  to 
industrial  installations.11  After  checking  their  compliance  with  the  harmonised  allocation 
rules,12  these  data  were  used  for  the  analysis  of  the  amount  of  free  allocation  to  industrial 
installations. 

1.3.2.  Consultation 

Relevant  stakeholders  (Member  States,  industry  representatives,  NGOs,  research  and 
academic  institutions,  trade  unions  and  wider  public)  were  involved  throughout  the  entire 
process.  Complementing  the  consultation  for  the  2030  framework,  an  extensive  follow-up 
stakeholder consultation was carried out on various technical aspects of the post-2020 carbon 
leakage provisions, as well as on innovation support. It included three stakeholder meetings 
(June, July and September 2014)13 and a written consultation (May–July 2014)14.  

An  online  consultation  (December  2014-March  2015)  also on  other  aspects  (free  allocation 
for  the  power  sector,  Innovation  and  Modernisation  Funds,  small  and  medium  sized 
enterprises  (SMEs),  regulatory  fees  and  general  evaluation  of  the  EU  ETS)  followed.  The 
Commission did its best to accept also late submissions, and the consultation attracted a total 
of over 529 contributions from a broad spectrum of stakeholders.15 The main findings of the 
public consultation are found in Box 1 and the summary report in Annex 3. 

Moreover,  there  have  been  bilateral  meetings  with  many  stakeholders,  allowing  them  to 
express their specific views on the future of the system, as well as their dedicated efforts on 
certain aspects. A questionnaire on benchmarks for industry stakeholders  was distributed in 
March 2015 and a conference on the Modernisation Fund was organised. 

7 ICF International, Umweltbundesamt, SQ Consult, Ecologic Institut, Vivid Economics and ZEW – on-going 
work 
8 'Study on different pass-through factors to assess the impact of the EU ETS carbon cost' – on-going work  
9 'Assessment of the first years of the functioning of the new allocation system based on benchmarks' – on-going 
work 
10 Carbon Leakage and Competitiveness Assessment, Ecorys, 2014 
(http://ec.europa.eu/clima/policies/ets/cap/leakage/docs/cl_evidence_factsheets_en.pdf ) 
11  The  National  Implementation  Measures  (NIMs)  to  the  Commission  pursuant  to  Commission  Decision 
2011/278/EU 
12 Commission Decision 2011/278/EU 
13  Recordings  of  the  meetings  and  the  presentation  is  published  on  DG  Climate  Action  website: 
http://ec.europa.eu/clima/policies/ets/cap/leakage/documentation_en.htm 
14  A  summary  of  the  findings  and  the  individual  submissions  is  published  on  DG  Climate  Action  website 
http://ec.europa.eu/clima/consultations/articles/0023_en.htm 
15 Published on DG Climate Action website http://ec.europa.eu/clima/consultations/articles/0024_en.htm  

11 

 
                                                           
 
All of the above consultations have been published on the DG Climate Action website. The 
Commission minimum standards on stakeholder consultation have all been met.  

The views of the stakeholders were taken into account to  the extent  possible  in this impact 
assessment, given their number, the sensitivity and complexity of the issues and the diverging 
opinions expressed by different stakeholder groups. The respective sections indicate how the 
opinions have been reflected in the proposed options. 

Box 1: Main findings of the general consultation on ETS revision  

Over 500 responses were received both through the website and by email, including general position 
papers  on  the  ETS  revision.  Some  responses  were  coordinated  at  the  level  of  industrial  sector  (e.g. 
over  100  identical  submissions  from  ceramics  companies  and  associations),  and  also  in  the  case  of 
several NGOs. The majority of submissions - 86% of which 14% from the power sector - were from a 
wide  variety  of 
industry  stakeholders  (companies,  SMEs,  national  associations,  European 
associations). The graph below shows the various industry stakeholders: 

Figure 1 Respondents from industry 

The public consultation showed that the EU ETS is considered to correspond well to the EU climate 
policy  objectives  and  is  perceived  as  an  adequate  tool  to  achieve  these  objectives.  There  is  overall 
support for the system as a central instrument to reduce greenhouse gas emissions in the EU and as a 
market-based  system.  The  majority  of  stakeholders  support  continuation  of  the  existing  principles, 
though  with  improvements  in  certain  aspects  according  to  their  different  concerns  -  e.g.  industry 
would  like  enhanced  protection  against  the  risk  of  carbon  leakage,  whereas  NGOs  would  like 
increased ambition of EU ETS and more investments in low-carbon technologies.  

Stakeholders took the opportunity provided by the consultation to present their broader positions on 
climate  and  energy  policy  and  highlighted  their  specific  concerns.  For  instance,  the  steel  sector 
stakeholders underline the issue of waste gas transfers, the ceramics sector highlights the issue of high 
labour  costs  leading  to  high  gross  value  added  which  make  the  sector  appear  to  have  lower  carbon 
costs, the non-ferrous metals sector refer to the importance of electricity costs in their total costs and 
argue  for  a  better  system  for  indirect  cost  compensation.  Member  States  express  concerns  about 
administrative  complexity,  while  civil  society  advocates  for  using  auctioning  revenues  for  climate-
related measures. Given the variety of views not just among, but also within stakeholder categories, 
this  box,  the  summary  in  Annex  3,  and  the  analysis  of  policy  options  tries  to  focus  on  the  views 
receiving widest support.  

Free allocation and addressing the risk of carbon leakage  

There  is  overall  support  for  free  allocation  as  the  measure  to  address  direct  carbon  costs.  Industry 
stakeholders from different sectors (steel, ceramics, glass, chemicals) supported the idea that the best 
performers should be fully compensated by free allocation and therefore no correction factor should 
apply.  Continuing  with  the  existing  principles  and  basing  benchmarks  on  the  most  efficient  EU 

12 

 
 
installations  gathered  quite  some  support,  but  some  respondents  (notably  NGOs)  argue  for 
benchmarks  based  on  worldwide  performance  in  the  sectors.  Public  authorities  highlight  the 
importance of maintaining the incentive to innovate and of rewarding the best performers.  

The energy intensive industry stakeholders support 'dynamic allocation' or allocation based on more 
recent production volumes. However, some energy sector stakeholders stress that defining the amount 
of  free  allowances  available  for  industry  should  not  create  uncertainty  on  the  available  auction 
volumes, and therefore the amounts of allowances to be auctioned by Member States should be fixed 
ex-ante. They also argue that given the final EU objective to conclude an international agreement, the 
system of free allocation should continue to be considered as a transitional instrument only to address 
the risk of carbon leakage.  

Regarding  cost  pass-through  (passing  the  cost  of  allowances  in  product  prices),  many  stakeholders 
claim it is difficult to quantify since products are traded on global markets and prices are determined 
internationally,  influenced  by  a  multitude  of  factors.  Civil  society  stakeholders  concur  with  the 
empirical  evidence  and  are  of  the  view  that  all  industrial  sectors  are  able  to  pass  through  to  their 
customers at least some of the carbon costs. Some public authorities believe there should be no free 
allocation for the costs passed through by companies. Many stakeholders express the view the issue of 
cost pass through should be addressed.  

Innovation Fund: Stakeholders support continuing with the application of the general set of rules for 
the  NER300  programme  and  increasing  the  amount  of  allowances  dedicated  to  the  new  Innovation 
Fund,  while  they  also  highlight  the  need  for  some  improvements.  Industry  stakeholders  typically 
support  the rules being adapted to ensure they match  industry needs, including those of SMEs. The 
energy  sector  stakeholders  argue  that  the  current  NER  300  programme  contains  several  lessons  on 
pitfalls  in  energy  innovation  demonstration  policy,  such  as  insufficient  coordination  and  Member 
State  commitment.  Some  academics  raise  concerns  about  a  lack  of  available  information  on  the 
decision  process  and  especially  on  lessons  learnt  from  the  current  NER  300  programme.  Similarly, 
NGOs ask for increased transparency particularly on the selection phase.      

Modernisation Fund: Regarding the investments, some energy-intensive industry stakeholders argue 
that as a principle, private and public projects should be on an equal footing, and that industrial actors 
should  also  be  eligible.  The  energy  sectors  highlight  inefficiency  and  high  administrative  cost  of 
complex funding systems, and hence the importance for investors of having simple structures. Some 
beneficiary  Member  States  expressed  preference  that  the  main  responsibility  to  ensure  an  effective 
and  transparent  management  of  the  Fund  should  be  at  the  Member  State  level.  In  contrast,  other 
Member States support an important and strong role for the European Investment Bank (EIB) to play 
in managing the use of the Fund within the constraints of available EIB resources.     

Optional free allocation to the energy sector: In principle, stakeholders tend to support agreeing on 
common,  general  EU  level  criteria  for  the  selection  of  projects.  Should  free  allocation  to  the 
electricity  sector  be  introduced,  it  should  at  least  ensure  that  the  support  does  not  subsidise 
investments in inefficient power generation.  

General evaluation: Many energy intensive industry stakeholders support the EU ETS as a resilient 
and flexible solution to achieve EU emissions reductions in a cost-effective manner. However, strong 
concerns are raised about the absence of an international agreement and the EU ETS not being linked 
to any similar emission trading system. Stakeholders from the energy sector and public authorities see 
the objectives of the EU ETS as being in line with EU’s climate policy objectives for 2020 and 2030. 

Subsidiarity 

1.4. 
The EU ETS Directive16 exists and will continue being in force post 2020. It is an EU policy 
instrument.  A  revision  of  the  EU  ETS  can  only  be  implemented  through  proposals  by  the 
Commission to amend the EU ETS Directive.   

16 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:02003L0087-20140430&from=EN  

13 

 
                                                           
Climate  change  is  a  trans-boundary  problem.  Therefore,  coordination  of  climate  action  at 
European level and, where possible, at global level is necessary, and EU action is justified on 
grounds  of  subsidiarity.  Articles  191  to  193  of  the  TFEU  confirm  and  further  specify  EU 
competencies in the area of climate change.  

Many of the policy elements have an important internal market dimension, in particular the 
options  related  to  the  indirect  cost  compensation  for  industry  (see  section  7.3.6),  the 
Modernisation Fund (see section 8.2) and the free allocation to power (see section 8.3), and 
many of the required investments and infrastructures have an important European dimension, 
especially in the low-carbon funding mechanisms and the free allocation  to industry.  

The  Modernisation  Fund  aims  to  modernise  the  energy  systems  and  improve  energy 
efficiency in the beneficiary Member States, but the fund also has important implications on 
the internal energy market as the investments supported would  be made  in the context  of a 
liberalised European energy market.  

Therefore, the objectives can be better achieved by an EU framework for action. Delegating 
the legislative powers to Member States would lead to partitioning,  an uneven playing field 
and decreased efficiency.  

1.5. 

Scrutiny by the Commission Impact Assessment Board 

The Impact Assessment Board of the  European Commission assessed a draft version of the 
present  impact  assessment  and  issued  its  opinion  on  22  May  2015.  The  impact  assessment 
was improved and resubmitted to the Board, which issued its final opinion on 17 June 2015. 
The Impact Assessment Board made several recommendations and, in the light of the latter, 
the final impact assessment report contains a clearer presentation and explanation of options 
and  their  impacts,  including  more  assessment  of  impacts  on  particular  sectors  as  added  in 
section 7.5.3 and Annex 7. The report also explains better the rationale behind the choices of 
values  for  thresholds  and  criteria  in  sections  7.3  and  8.1.3.  The  coherence  between  various 
funding  mechanisms  is  also  addressed,  as  well  as  their  options  and  impacts.  Various 
methodological questions are clarified (use of carbon leakage criteria and relation to cost pass 
-through, modelling of employment effects and energy prices for households). Annex 15 was 
added to address the issue of using the unallocated allowances inter alia for carbon leakage 
and innovation as agreed in the context of the market stability reserve proposal.17 A particular 
effort has been made throughout the text to simplify the language and improve readability for 
non-expert audience, including boxes briefly explaining ETS and carbon leakage. 

2. 

POLICY CONTEXT 

Building on the Commission Communication on the 2030 framework and the accompanying 
impact assessment, in October 2014 the European Council18 and with the endorsement of the 
European  Parliament19  agreed  on  the  2030  framework,  which  includes  a  binding  domestic 
reduction of greenhouse gas (GHG) emissions of at least 40% in 2030 as compared to 1990.20 
To meet this target, the European Council also specifically agreed that the emissions in the 
EU ETS should be reduced by 43% compared to 2005. As a result of the measures needed to 

17 
http://www.europarl.europa.eu/meetdocs/2014_2019/documents/envi/dv/ets_msr_annex_/ets_msr_annex_en.pdf  
18 http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/145397.pdf  
19 European Parliament resolution on a 2030 framework for climate and energy policies (2013/2135(INI))  
20 The European Council also agreed on a binding EU target of at least 27% for the share of renewable energy 
consumed in 2030 and an indicative target at the EU level of at least 27% for improving energy efficiency. 

14 

 
                                                           
meet this emission reduction target for the 2030 framework and the Market Stability Reserve 
which  is  expected  to  become  operational  in  2019  as  provisionally  agreed  by  the  co-
legislators21, the EU ETS will deliver a meaningful carbon price and stimulate cost-efficient 
emission  reductions.  A  reformed  EU  ETS  will  play  an  important  role  in  giving  the  right 
investment signals to businesses and Member States to ensure emission reductions happen at 
the least cost.  

Box 2: EU ETS in brief  

The EU ETS is the EU cornerstone policy to combat climate change. It is the first - and still by far 
the biggest - international system for trading GHG emission allowances covering more than 11,000 
power  stations  and  industrial  plants  in  31  countries  (28  EU  Member  States  and  3  EEA/EFTA 
states), as well as airlines. It covers around 45% of the EU's emissions. 

It is a 'cap and trade' system: a 'cap', or limit, is set on the total amount of greenhouse gas that can 
be emitted by the factories, power plants and other installations in the system. The cap is reduced 
annually over time so that total emissions fall: in 2020, emissions from sectors covered by the EU 
ETS will be 21% lower than in 2005, and by 2030 43% lower. 

Within  the  cap,  companies  receive  or  buy  emission  allowances  which  they  can  trade  with  one 
another as needed. After each year a company must surrender enough allowances to cover all its 
emissions, otherwise fines are imposed. If a company reduces its emissions, it can keep the spare 
allowances  to  cover  its  future  needs  or  else  sell  them  to  another  company  that  is  short  of 
allowances. The flexibility that trading brings ensures that emissions are cut where it costs least to 
do so. Participation in the EU ETS is mandatory for companies operating in the sectors covered.  

By putting a price on carbon and thereby giving a financial value to each tonne of emissions saved, 
the  EU  ETS  has  placed  climate  change  on  the  agenda  of  company  boards  and  their  financial 
departments  across  Europe.  A  sufficiently  high  carbon  price  also  promotes  investment  in  clean, 
low-carbon technologies.  

Launched in 2005, the EU ETS is now in its third phase (2013 – 2020), significantly improved and 
based on EU-wide harmonised rules. For more details see Section 3. 

Allowances  are  either  auctioned  or  allocated  for  free  to  address  international  competitiveness 
concerns of industrial sectors that are deemed to be exposed to carbon leakage. The power sector is 
not eligible for free allocation, except under special conditions in few Member states (See section 
8.3).  

According  to  market  analysis  (Bloomberg  New  Energy  Finance),  the  EU  carbon  market  for 
emission allowances in 2014 had a volume of 8 330 Mt, amounting to a value of €47.4 billion. For 
more information and explanations see:   
http://ec.europa.eu/clima/publications/docs/factsheet_ets_en.pdf   

Mainly  as  a  result  of  the  severe  economic  recession  the  EU  ETS  has  faced  the  challenge  of  a 
growing surplus of allowances for some years. In the short term this surplus risks undermining the 
orderly functioning of the carbon market; in the longer term it could affect the ability of the EU 
ETS to meet more demanding emission reduction targets cost-effectively. As an intermediate first 
step, he co-legislators agreed to postpone (or 'back-load') the auctioning of 900 million allowances, 
followed  by  an  agreement  to  establish  a  market  stability  reserve  -  a  sustainable  solution  to  the 
surplus in the longer term. The latter proposal is informally agreed by co-legislators (at the time of 
writing) and is expected to start in 2019. 

For more information see http://ec.europa.eu/clima/policies/ets/index_en.htm 

http://www.europarl.europa.eu/news/en/news-room/content/20150526IPR59608/html/CO2-market-fix-

21 
Environment-Committee-MEPs-back-deal-with-Council. Compromise text 
http://www.europarl.europa.eu/meetdocs/2014_2019/documents/envi/dv/ets_msr_annex_/ets_msr_annex_en.pdf
and Commission proposal COM(2014) 20 final   

15 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                           
 
The  European  Council  also  gave  strategic  guidance  on  several  issues  regarding  the 
implementation  of  the  emission  reduction  target,  namely  free  allocation  of  allowances  to 
industry,  the  establishment  of  a  Modernisation  Fund  and  an  Innovation  Fund,  as  well  as 
optional  free  allocation  of  allowances  to  modernise  electricity  generation  in  some  Member 
States.  Similarly,  the  European  Parliament  highlighted  the  necessity  of  a  revised  and  well-
functioning  ETS,  including  the  continuation  of  provisions  on  the  need  to  address  the 
international  competitiveness  of  industrial  sectors  deemed  to  be  at  risk  of  carbon  leakage. 
This  guidance  is  being  translated  into  a  legislative  proposal  to  revise  the  EU  ETS  for  the 
period  post-2020  and  this  impact  assessment  focusses  on  choices  to  be  taken  to  establish 
these rules.  

The  free  allocation  of  allowances  to  industry  is  a  key  element  in  addressing  industry 
competitiveness concerns and how to determine the rules for this allocation constitutes a key 
part  of  this  impact  assessment,  addressed  mainly  in  chapter  7.  The  low-carbon  funding 
mechanisms are analysed in chapter 8. 

This impact assessment and the legislative proposal for revision of the ETS Directive do not 
cover detailed methodological options to establish the technical measures to implement these 
revised rules. Respective legislative proposals and accompanying analysis will follow in due 
course.  

The  revision  of  the  EU  ETS  makes  an  important  contribution  to  the  efforts  to  establish  a 
resilient Energy Union22 with a forward looking climate change policy at its core. The goal of 
the Energy Union is to give EU consumers – households and businesses – secure, sustainable, 
competitive and affordable energy.   

The EU climate policy will continue contributing to a major shift away from expenditure on 
fuels towards innovative equipment with high added value that will stimulate investments for 
innovative  products  and  services,  create  jobs  and  growth  and  improve  the  Union's  trade 
balance23. As already shown, together with the 2020 targets for renewable energy and energy 
savings, the GHG emission  reduction target and the ETS have  played a key role in driving 
progress  to  low-carbon  economy  and  sustaining  the  employment  of  more  than  4.2  million 
people in various eco-industries24, with continuous growth during the crisis. 

3. 

GENERAL EVALUATION AND LESSONS LEARNT  

The  main  aim  of  the  EU  ETS  is  to  incentivise  cost-effective  emission  reductions  in  the 
sectors in its scope. As the emission reductions and thus the positive environmental outcome 
in  the  EU  ETS  is  guaranteed  by  its  absolute  limit  on  emissions,  i.e.  the  cap25,  the  EU  is 
currently well on track to meet its 2020 targets for GHG emissions reduction not only for the 
sectors in the EU ETS, but for the EU as a whole. As decided in the 2008 climate and energy 
package, thanks to the emission reductions incentivised by the European carbon market and 
the measures taken in sectors out of the EU ETS, as well as the policies on renewables and 
energy efficiency, in 2020 the GHG emissions from the sectors in the EU ETS will be at least 
21% lower than in 2005. Thus, the ETS in particular, and EU climate and energy policies in 
general, seem to be working well. 

22 COM(2015) 80 final 
23  Communication  on  A  policy  framework  for  climate  and  energy  in  the  period  from  2020  to  2030, 
COM(2014)15 final 
24 Eurostat data on the environmental good and services sector quoted in A policy framework for climate and 
energy in the period from 2020 to 2030 (COM(2014) 15 final) 
25 For explanation of terms, see the Boxes and Annex 1 Glossary. 

16 

 
                                                           
The regulatory framework of the EU ETS was largely unchanged during the first eight years 
of  its  operation  (2005-2012).  Based  on  the  lessons  learnt  in  these  years,  in  phase  3  (2013-
2020), a significant number of architectural and regulatory changes took effect, improving the 
functioning of the system.  
The following fundamental changes have been applied: 
  an  EU-wide  cap  on  allowances  was  introduced,  as  opposed  to  individual  Member  State 
caps. This EU-wide cap decreases by 1.74% annually, up to and beyond 2020, providing 
much greater regulatory predictability and stability; 

  auctioning  became  the  default  system  of  allocation  of  emission  allowances  in  phase  3, 
ceasing  the  previous  practice  of  granting  free  allocation  for  electricity  production. 
Revenues  from  these  auctions  are  distributed  to  Member  States  (for  more  details  see 
section  6.2).  At  least  50%  of  these  revenues  are  to  be  used  for  climate  action.  As  a 
transitional derogation, some Member States can still grant some of their auction volume 
as free allowances to their power sector (for more details see section 8.3); 

  harmonised  rules  for  transitional  free  allocation  to  industrial  sectors  were  introduced, 
ensuring  that  all  companies  in  the  EU  in  one  sector  receive  free  allowances  based  on 
harmonised rules to address the risk of carbon leakage. The amount of free allocation  for 
the  installations  is  calculated  based  on  emission  performance  benchmarks  established 
prior to phase 3, production data and a carbon leakage factor measuring the exposure of 
the  industrial  sectors  to  international  competition  and  carbon  leakage  risk  (for  more 
details see chapter 7); 

  stricter rules on the type and quantity of international credits that are allowed for use in 
phase  3.  These  aspects  are  not  analysed  in  the  current  impact  assessment,  as  they  have 
been covered by the impact assessment by the 2030 framework; 
replacement of national registries by a single Union registry; 

 
  Emission allowances were classified as a financial instrument with the latest revision of 

the financial markets legislation in 2014, to be enforced in 201726.  

The revised EU ETS Directive can be considered as fairly  recent legislation. However, it is 
already  clear  that  the  present  institutional  framework  with  auctioning  and  EU-wide 
harmonised  free  allocation  rules  constitutes  a  significant  improvement  and  simplification 
compared to the previous trading periods that still had  National Allocation Plans. Allowing 
for  auctioning  to  fully  function  as  the  main  driving  principle  of  the  ETS  -  as  compared  to 
having  rules  for  free  allocation  to  industry  and  to  power  sector  in  certain  Member  States  - 
would bring further simplification to the system.  

Research  concludes  that  in  periods  when  the  carbon  price  is  likely  to  increase,  other 
beneficial  impacts  of  the  EU  ETS  are  visible  through  a  broad  range  of  mechanisms  –
incentives  for  cost-cutting  and  attention,  experimentation,  learning  and  investment  in  low-
carbon solutions outside business-as-usual for companies27. Studies show that due to the EU 
ETS a large proportion of firms pursued some measures to reduce GHG emissions and that 
CO2 has now become part of the investment appraisal in construction of power stations28. 

26 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial 
instruments and Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014 
on market abuse (market abuse regulation) 
27 Jon Birger Skjærseth and Per Ove Eikeland (eds), Corporate Responses to EU Emissions Trading, 2013 
28 E.g. literature review of studies in: Tim Laing et al, Assessing the effectiveness of the EU Emissions Trading 
System, 2013 

17 

 
                                                           
However, at the start of phase 3 in 2013, the EU ETS was characterised by a large imbalance 
between  supply  and  demand  of  allowances,  resulting  in  a  surplus  of  around  2  billion 
allowances expected to grow over the coming years to  more than 2.6 billion allowances by 
2020, and a correspondingly weak carbon price signal.  

As  a  short  term  measure  to  mitigate  the  effects  of  the  surplus  on  the  carbon  market  it  was 
decided to postpone (“back-load”) the auctioning of 900 million allowances in the early years 
of  phase  329.  This  was  followed  by  a  proposal  for  a  long-term  measure  of  establishing  a 
Market  Stability  Reserve  to  make  the  auction  supply  of  emission  allowances  more  flexible 
and increase shock resilience. The reserve's architecture also captures changes in the demand 
of allowances due to renewables and improved energy efficiency and, if need be, adjusts the 
auction supply accordingly. Hence, the Market Stability Reserve will, once fully functional, 
also  strengthen  the  coherence  between  the  EU  ETS  and  energy  efficiency  and  renewables 
policies,  which  also  lead  to  lowering  of  emissions.  The  operation  of  the  Market  Stability 
Reserve is open-ended and does not affect the total quantity of emission allowances (the cap). 
Therefore, the introduction of the Market Stability Reserve improves the functioning of the 
EU ETS, but does not change its nature as a market-based policy instrument.  

According to many energy-intensive industry stakeholders, the EU ETS corresponded well to 
the  EU  climate  objectives,  namely  to  cost-effectively  reduce  GHG  emissions,  in  its  initial 
architecture. However, they argue that with back-loading and the Market Stability Reserve30, 
the  EU  ETS  sectors  will  be  facing  a  stricter  GHG-target  compared  to  EU  climate  policy 
objectives31.  In  contrast,  other  business  stakeholders,  including  from  renewables  sector32, 
believe  that  the  EU  ETS  is  currently  giving  neither  a  long-term  price  signal  that  impacts 
investment decisions nor a short-term signal for operating decisions. Hence, they advocate in 
favour of structural measures, such as earlier implementation of the Market Stability Reserve 
and additional measures to address the surplus in order to 'fix' the EU ETS in the short and 
mid-term.    

Some  stakeholders  responded  that  the  EU  ETS  does  not  correspond  to  the  EU's  climate 
policy  objectives,  because  no  country  in  the  world  has  accepted  the  EU  ETS  concept33. 
However,  it  should  be  stressed  that  there  are  actually  17  emission  trading  systems  in 
operation across four continents, accounting for 40% of global GDP34.   
The  study  to  evaluate  the  existing  ETS  Directive  is  ongoing35.  It  analyses  the  EU  ETS  in 
terms  of  relevance,  effectiveness,  efficiency,  EU-added  value  and  coherence  with  other 
Union policies.  
The preliminary findings36 indicate that despite criticism on some of its details, the EU ETS 
as a policy tool combining environmental regulation with a market instrument is working in 
practice  and  delivering  on  its  targets.  It  is  highly  relevant  for  meeting  the  EU's  climate 
targets, as it represents a cost-effective way for emission reductions. Emissions in the covered 
sectors have decreased steadily, and even though not all emission reductions can be attributed 

29 Decision No 1359/2013 EU 
30  Proposal  for  a  Decision  of  the  European  Parliament  and  of  the  Council  concerning  the  establishment  and 
operation  of  a  market  stability  reserve  for  the  Union  greenhouse  gas  emission  trading  scheme  and  amending 
Directive 2003/87/EC – COM(2014) 20 
31 E.g. CEPI response to the consultation   
32 E.g. EWEA response to the consultation 
33 Central Europe Energy Partners response to the consultation 
34 International Carbon Action Partnership, Status Report 2015: https://icapcarbonaction.com/status-report-2015  
35 See section 1.3.1 
36 At the time of writing, the final evaluation report has not yet been received. 

18 

 
                                                           
to  the  ETS  alone,  evidence  has  been  found  that  the  system  does  contribute  effectively  to 
emission reductions.  
At the same time, the study observes that the EU ETS has found its way to the board rooms 
of  companies  and  thus  facilitates  the  internalisation  of  CO2  costs.  The  ETS  contributes  to 
investments decisions, even though with the current low carbon price, the CO2 costs are often 
included  in  the  general  envelope  of  energy  costs.  Smaller  improvements  in  terms  of  GHG 
efficiency  have  become  regular  practice,  but  larger  investments  in  GHG  efficiency  still 
remain the exception.  
Moreover, the EU ETS has a clear EU value added since different systems or other climate 
policies  at  Member  State  level  would  lead  to  a  fragmented  and  costly  situation  for  the 
regulated entities, as well as different ambition levels and carbon prices throughout the EU, 
leading  also  to  unfeasibility  and  administrative  complexity.  The  EU  ETS  with  an  EU-wide 
carbon  price  and  its  harmonised  infrastructure  takes  advantages  of  the  synergies  that  EU 
action can provide.  
In  terms  of  coherence  with  EU  policies,  the  study  observes  that  renewables  and  energy 
efficiency  policies  both  overlap  with  the  EU  ETS  and  may  affect  the  cost  of  achieving  the 
ETS' target, but both policies fully support the environmental effectiveness of the EU ETS as 
they do not affect the cap. In terms of coherence with international climate policy, the study 
also finds that the EU ETS performs well. It is widely used as a model for emissions trading 
systems around the world, benefitting from the EU's learning effects. 
Specific evaluation and lessons learnt on the different aspects of the EU ETS are presented in 
the corresponding chapters.  

A comprehensive evaluation summary report on individual aspects can be found in Annex 4. 

4. 

GENERAL PROBLEM DEFINITION 

The general problem analysis concerning EU climate policy targets for 2030 and the ETS has 
been done in the impact assessment on the 2030 climate and energy framework.  

In  brief,  despite  the  fact  that  the  EU  is  on  track  to  meet  its  short-term  emission  reduction 
target of -20% by 2020, to ensure the long-term goal of a low-carbon economy and emission 
reductions of 80 to 95% by 2050, an intermediate step needs to be made with the binding EU 
target of at least 40% domestic reduction by 2030 compared to 1990. This target should be 
delivered  collectively  by  the  EU  in  the  most  cost-effective  manner  possible,  with  the 
reductions in the ETS sectors amounting to 43% and 30% in the non-ETS sectors compared 
to 2005. Concerning the implementation of the emission reduction target, setting the cap at 
the  emission  level  leading  to  a  reduction  of  43%  would  require  a  change  in  the  linear 
reduction  factor37  from  2021  onwards.  The  European  Council  conclusions  already  foresee 
certain methodological elements for the implementation of the EU's GHG emission reduction 
target, for which no options were hence developed. These include the change in the annual 
linear  reduction  factor  reducing  the  EU  ETS  cap  from  2021  onwards  and  the  share  of 
allowances to be auctioned. These elements are outlined in chapter 6.  

Free  allocation  and  carbon 
low-carbon  funding  mechanisms  and  further 
improvements to the current system need to be analysed and specific problem definitions and 
options are developed in the respective sections. 

leakage, 

37 The ETS cap for stationary installations declines linearly, by an annual amount equal to 1.74% of the average 
annual allocation during phase 2 (2008-2012), referred to as the linear reduction factor. See section 6.1. 

19 

 
                                                           
Free allocation and carbon leakage  

While current policies to prevent carbon leakage such as the allocation of free allowances in 
the  ETS  have  been  successful38,  these  do  not  automatically  apply  beyond  2020.  In  its 
strategic guidance the European Council has been clear that free allocation should not expire. 
Existing  measures  should  continue  after  2020  to  prevent  the  risk  of  carbon  leakage  due  to 
climate  policy,  as  long  as  no  comparable  efforts  are  undertaken  in  other  major  economies, 
with  the  objective  of  providing  appropriate  levels  of  support  for  sectors  at  risk  of  losing 
international  competitiveness.  The  problem  to  be  addressed  is  how  to  adapt  the  respective 
ETS Directive provisions to make them suitable post-2020. 

Low-carbon funding mechanisms: Modernisation Fund and Innovation Fund 

The impact assessment of the 2030 climate and energy framework indicated that significant 
investments  will  be  needed  in  the  EU  in  the  period  through  2030  related  to  energy  system 
modernisation and to reach the objectives of the 2030 climate and energy framework. In this 
context, the European Council has also given clear guidance that Member States with a GDP 
per  capita  below  60%  of  the  EU  average  may  opt  to  continue  giving  free  allowances  to 
modernise their energy sector up to 2030 (see section 8.3). In addition, a new reserve of 2% 
of the total quantity of allowances should be set aside to address particularly high additional 
investment  needs  in  these  Member  States  (so-called  Modernisation  Fund).  The  specific 
problems  to  be  addressed  with  the  setting  up  of  the  Modernisation  Fund  are  analysed  in 
section 8.2 

The European Union will have to step up its efforts in research and innovation to support the 
post-2020  climate  and  energy  framework.  The  European  Council  conclusions  provide  clear 
guidance that the existing NER 300 facility should be renewed, including for carbon capture 
and  storage  (CCS)  and  renewables,  with  the  scope  extended  to  low-carbon  innovation  in 
industrial  sectors  and  the  initial  endowment  increased  to  400  million  allowances  (so-called 
Innovation Fund). The specific problems to be addressed with the setting up of the Innovation 
Fund are analysed in section 8.1 

While  the  current  architecture  of  the  EU  ETS  is  relatively  recent,  based  on  experience 
gathered, certain additional technical changes to the current set of rules in the ETS Directive 
should also be considered for the period post-2020. Since these changes are of more technical 
nature, options for these are developed in Annex 5.  

This  impact  assessment  explicitly  does  not  address  issues  related  to  aviation  emissions  as 
covered  under  the  ETS. As  indicated  in  Regulation  (EU)  No  421/2014,  following  the  2016 
ICAO Assembly, the Commission shall report to the European Parliament and to the Council 
on actions to implement an international agreement on a global market-based measure from 
2020,  that  will  reduce  greenhouse  gas  emissions  from  aviation  in  a  non-discriminatory 
manner.  

5. 

OBJECTIVES  

5.1. 

General policy objectives 

The  general  objective  of  climate  action  policy,  and  of  EU  ETS  as  its  key  instrument,  is  to 
contribute to achieving the EU climate goal of limiting global average temperature increase 
to  not  more  than  2  degrees  Celsius  above  pre-industrial  level.  EU  action  against  climate 
change  was  translated  into  a  GHG  emission  reduction  target  of  20%  compared  to  1990  as 

38 See section 1.3, and 7.1, as well as Annex 3 

20 

 
                                                           
adopted  in  the  2020  Climate  and  Energy  Package.  For  the  period  2021-2030,  the  GHG 
emission  reduction  target  of  at  least  40%  domestic  reductions  compared  to  1990  by  2030, 
ensures the EU is on the path of low-carbon transition to emission reductions of 80-95% by 
2050. 

5.2. 

Specific policy objective  

The specific policy objective is to align the EU ETS architecture with the 2030 emission 
reduction target and refine and improve the EU ETS post-2020 framework. This needs 
to be achieved in the light of the lessons learnt in a context where: 

  Fully  comparable  climate  policy  measures  may  not  yet  be  undertaken  by  all  other 

major economies; 

  Reinforced research, development and innovation efforts should take place in order to 
maintain Europe's industrial base and competence, and support the 2030 climate and 
energy framework as well as the long-term goal of a low-carbon economy; 

  Reinforced  investment  efforts  should  take  place  in  order  to  modernise  the  energy 

system, and support the 2030 climate and energy framework;  

  Experience gathered during the first years of phase 3 (from 2013) suggests that there 

is still potential to reinforce efficiency of the system. 

These specific objectives for the revision of the ETS Directive are further  developed in the 
operational  objectives  of  each  of  the  chapters  and  sections.  The  operational  objectives  are 
tailored to the specifics of each cluster of issues, but also contribute to the achievement of the 
specific and general policy objectives of the ETS revision. 

5.3. 

Consistency with other policies and objectives 

As outlined in the 2030 impact assessment, the policy aim of the 2030 framework was to set 
climate  and  energy  targets  up  to  2030,  which  are  consistent  and  mutually  reinforcing.39  A 
well-functioning EU ETS is a key instrument to achieve the GHG emission reduction target 
and cornerstone of Europe's climate policy, consistent also with emission reduction efforts in 
non-ETS sectors. In line with the Energy Union strategy40, by putting a price on carbon at EU 
level the EU ETS reinforces the functioning of the internal energy market and stimulates the 
uptake of renewables and other low-carbon and energy-efficient technologies. Through low 
carbon funding mechanisms, it financially supports power sector, industry and Member states 
in the low-carbon transition.  

In  general,  consistency  of  a  revised  EU  ETS  with  any  related  policies  is  addressed  in  this 
impact  assessment  when  discussing  specific  issues,  such  as  for  instance  a  forward-looking 
approach to CCS for the power and industrial sectors and the Innovation Fund.  

There is a need to continue driving progress towards a low-carbon economy, as this ensures 
competitive  and  affordable  energy  for  all  consumers,  creates  new  opportunities  for  growth 
and jobs and provides greater security of energy supplies and reduced import dependence for 
the European Union as a whole. This ETS revision initiative is coherent with these objectives 
in the field of climate and energy policy.  

In  terms  of  international  competitiveness,  previous  Commission  analyses  of  energy  prices 
and costs have shown that there has been little impact on the EU's relative competitiveness 

39 Consistency between targets is in particular assessed in the 2030 impact assessment. 
40 COM(2015) 80 final 

21 

 
                                                           
which  could  be  directly  attributed  to  the  ETS  carbon  price  in  the  context  of  energy  prices, 
although  in  the  future  the  carbon  price  is  assumed  to  be  reflected  in  electricity  retail  prices41. 
However,  as  long  as  there  are  no  comparable  efforts  undertaken  in  other  major  economies, 
policy  measures  (including  a  system  of  free  allocation  of  allowances)  are  appropriate  after 
2020 to address the competitiveness of Europe's energy-intensive industries.  

6. 

IMPLEMENTATION OF THE EU'S GHG EMISSION REDUCTION TARGET  

6.1. 

Linear reduction factor 

The outcome of the ETS in terms of emissions is determined by its cap on the total number of 
allowances.  According  to  the  ETS  Directive  and  the  present  target  of  -21%  by  2020 
compared  to  2005,  the  ETS  cap  for  stationary  installations  declines  linearly,  by  an  annual 
amount equal to 1.74% of the average annual allocation during phase 2 (2008-2012), referred 
to as the linear reduction factor. Setting a cap at the 2030 emission level of -43% compared to 
2005 requires a change in the linear reduction factor from 2021 onwards. This change is also 
needed in line with the EU's longer-term GHG emission reductions objectives. According to 
the analysis in the impact assessment  accompanying the 2030 framework42, a revised linear 
reduction factor of 2.2% from 2021 onwards is required to ensure coherence with a 2030 cap 
equal  to  43%  emission  reductions.  The  change  from  1.74%  to  2.2%  reduces  the  supply  of 
allowances by around 556 million in the period 2021-2030.  

The European Parliament has called for legislation to be proposed at the earliest appropriate 
date with a view to adjusting the 1.74% annual linear reduction requirement so as to meet the 
requirements  of  the  2050  emission  reduction  target  of  80  to  95%  emission  reductions.  The 
European  Council  also  explicitly  endorsed  the  linear  reduction  factor  of  2.2%.  As  the 
Commission  proposal  for  the  ETS  revision  has  to  achieve  the  objective  of  emission 
reductions  in  the  ETS  sectors  of  43%,  meeting  the  specific  requirements  of  the  European 
Council  conclusions,  no  diverging  policy  options  for  the  linear  reduction  factor  post-2020 
could be developed. 

The  impact  assessment  for  the  2030  framework  provides  a  comprehensive  analysis  of  the 
impacts of emission reductions in the ETS of 43% by 2030 compared to 2005, and hence of 
the required linear reduction factor of 2.2%43.   

Although the Market Stability Reserve was not explicitly included in the modelling work for 
the impact assessment for the 2030 framework, its effects can be considered as reflected: in 
the analysis the emission reductions required to reach the 40% GHG target in 2030 and the 
80%  in  2050  and  the  respective  carbon  prices  were  determined  so  as  to  achieve  these 
emission  reductions  cost-efficiently  and  assuming  rational  behaviour44.  In  reality,  however, 
businesses seem to base their abatement decisions on a shorter outlook for their industry than 
the 2030 reduction target would imply.45 This is likely to mean that the current large supply-
demand imbalance in the ETS reduces the incentives for low-carbon investment and thereby 

41 COM(2014) 21; SWD(2014) 19; SWD(2014) 20 
42 SWD(2014) 15 finals 
43  The  relevant  scenario  that  achieves  this  is  the  scenario  with  40%  GHG  reductions  and  moderate  energy 
efficiency and renewables policies up to 2030. 
44  The PRIMES  model  simulates  emission  reductions in  ETS  sectors  as a  response  to current  and future ETS 
prices. Furthermore the model assumes perfect foresight of the ETS carbon price progression in the period 2020-
50, allowing as such sufficient investor confidence in the carbon market to make long term optimal investment 
decisions. 
45 Luca Taschini and Corina Comendant, Report on cost-containment mechanisms and market oversight, 2012: 
http://entracte-project.eu/uploads/media/ENTRACTE_Report_EU-ETS_Reform_and_Expansion.pdf   

22 

 
                                                           
negatively affects the cost-efficiency of the system and of the achievement of EU emission 
reduction  goals.  Hence,  by  simulating  the  achievement  of  the  40%  target,  the  economic 
model  actually  acts  as  capturing  in  a  simplified  way  the  expected  impact  of  the  Market 
Stability Reserve of addressing the surplus, increasing the confidence of market participants, 
and  in  turn  delivering  a  meaningful  price  on  carbon  emissions  and  ensuring  the  emissions 
evolve in line with the cap by stimulating cost-efficient emission reductions.  

Concerning changes in the underlying assumptions in the work for the impact assessment for 
the 2030 framework, notably the recently lower oil prices, it can be concluded that this price 
drop  is  not  expected  to  lead  to  any  major  changes  in  the  modelling  results,  even  if  it  is 
sustained. It has had no major impact on the carbon price because of the reduced supply due 
to  back-loading  and  the  increasing  expectation  of  the  Market  Stability  Reserve  being 
established.  According  to  the  International  Energy  Agency,  the  recent  developments  have 
made non-OPEC production more responsive to price swings than previously, which would 
likely set the stage for a relatively swift recovery46. In addition, as relatively little oil is used 
as a fuel by installations in the ETS, the direct impact of changes in the oil price to the carbon 
price between 2021 and 2030 are expected to be limited, and a separate sensitivity analysis 
would not affect the outcomes for this impact assessment. 

6.2. 

Auction share 

In phase 2 (2008-2012), the overall cap that limits the amount of emissions and thereby sets 
the  ambition  level  of  the  ETS  was  equal  to  the  sum  of  national  caps  determined  by  the 
Member States  in  their National  Allocation  Plans (NAPs).  These national  plans determined 
different  allocations  at  sector  and  installation  level  among  the  Member  States.  Allocating 
allowances on the basis of historical emissions (grandfathering) was the general rule and the 
auctioning  of  allowances  the  exception,  leading  to  non-optimal  investment  and  undesired 
distributional effects. As part of the EU's climate and energy package for 2020, it was thus 
agreed that as of 2013 a single EU-wide cap would be set and that auctioning would become 
the rule with transitional declining free allocation of allowances. 
For phase 3, the EU-wide total cap47 amounted to 2.084 billion allowances in 2013 and this 
annually decreases by the linear reduction factor of 1.74%. 

The total cap is divided into a part that is made available to installations for free and a part 
that is auctioned. While the rule is that everything that is not allocated for free is auctioned 
and the volume of auctioned allowances increases over time, the maximum amount for free 
allocation  is  currently  a  fixed  share  of  the  total  cap48.  Setting  a  maximum  to  the  free 
allocation constitutes a backstop to ensure long-term environmental integrity of the system, 
effectively  implementing  the  polluter-pays-principle,  while  recognising  the  need  for 
maintaining  the  international  competitiveness  of  industrial  sectors  exposed  to  the  risk  of 
carbon leakage. 

In  2013,  the  maximum  amount  available  for  free  allocation  was  around  809  million 
allowances.49  The  determination  of  the  maximum  amount  for  free  allocation  has  been  a 

46 IEA, Medium-Term Oil Market Report 2015: 
http://www.iea.org/newsroomandevents/pressreleases/2015/february/a-business-as-unusual-outlook-for-oil-in-
the-medium-term.html  
47 Commission Decision 2013/448/EU 
48 See Article 10a(5) of Directive 2003/87/EC 
49 Commission Decision 2013/448/EU 

23 

 
 
                                                           
 
lengthy  process  (involving  the  Commission,  Member  States'  authorities  and  companies 
included in the ETS), in particular due to the amount and nature of the  necessary data. The 
wider public generally perceived the procedures as complex and insufficiently transparent.  

Over the period 2013 to 2020, free allocation is provided on the basis of EU-wide harmonised 
rules  and  product  benchmarks.  Because  the  aggregate  amount  of  gross  free  allocation50 
calculated by Member States  on the basis of these rules exceeded the maximum amount of 
free allocation available to industry, the allocation for all installations over the period up to 
2020  is  reduced  by  the  same  proportion  through  the  application  of  the  cross-sectoral 
correction factor (Article 10a(5) of the ETS Directive) (for more details, see section 7.1). 

As  an  exception  to  the  general  rule  that  electricity  generators  should  not  receive  any  free 
allocation, additional allocation is provided in case these installations produce heat. Since this 
allocation  benefits  the  power  generation  sector,  this  free  allocation  is  not  part  of  the 
maximum amount for free allocation to industry, but of the quantity of allowances auctioned 
by Member States which is reduced accordingly. 

Additional free allocation is made available from the new entrants' reserve (NER) for newly 
built plants or in case installations extend their capacity by more than 10%. The new entrants' 
reserve is  constituted  from  5%  of  the  total  cap,  amounting  to  a  total  of  around  780  million 
allowances for  the  period  2013  to 2020.  300 million  of  the  allowances  in  the  new  entrants' 
reserve  have,  however,  been  earmarked  and  used  to  support  carbon  capture  and  storage 
(CCS) or innovative renewable energy projects under the NER300 facility. 

Since, according to the ETS Directive, everything that is not allocated for free is auctioned, 
some  allowances  are  foreseen  to  be  added  to  the  auction  volume  at  the  end  of  phase  3  in 
2020. This concerns in particular, allowances that remain unused in the new entrants' reserve 
and allowances that are not handed out to installations because they stop operations (closures) 
or reduce their production (partial cessations) will be auctioned at the end of the period. In 
the context of the legislative discussions on the Market Stability Reserve, the co-legislators 
decided that these allowances (so called "unallocated allowances") should be transferred into 
the  Market  Stability  Reserve  in  2020  to  avoid  that  auctioning  them  would  create  another 
supply  peak  adversely  affecting  the  market  balance  in  2020.  The  ETS  revision  should  also 
analyse  whether  these  unallocated  allowances  can  be  used  inter  alia  for  innovation  and  to 
address the risk of carbon leakage. This analysis is provided in Annex15. 

Certain Member States have the option to provide free allocation to the power sector in return 
for investments modernising power generation. This option constitutes a derogation from the 
general principle that no free allowances are available to installations generating electricity. 
However, considering the investment needs in the power sector in certain Member States, the 
ETS Directive foresees this derogation. While this amount is qualified as free allocation, the 
allowances  given  to  the  power  companies  are  provided  from  the  Member  States'  auction 
volumes if, and to the extent, Member States make use of this option. If not used to the full 
extent,  the  allowances  are  auctioned  on  behalf  of  the  Member  State  concerned.  For  more 
details, see section 8.3. 

50 'Gross' free allocation is the amount of free allocation determined by applying the benchmark values to the 
production data, before the application of any further factors, such as carbon leakage factor and the correction 
factor. 

24 

 
                                                           
Figure 2: Structure of the total quantity of allowances in phase 3 

Figure 2 illustrates the auction share over phase 3 (2013-2020). It translates the starting point 
of  the  ETS  Directive,  according  to  which,  in  principle,  all allowances  should  be  auctioned, 
but  free  allocation  is  granted  transitionally.  Over  phase  3,  39%  of  the  total  quantity  of 
allowances  available  will  be  allocated  for  free  to  industry  and  electricity-generating 
installations for the heat they produce. This share of free allocation will be further increased 
due  to  allocations  to  new  entrants  until  2020.  Today,  it  is  not  yet  known  how  much  of  the 
NER  will  be  used  in  the  coming  years.  However,  up  until  January  2015,  247  installations 
have received allocation from the NER, which will amount to 69.6 million allowances to be 
allocated from the NER by 2020, representing 14% of the total of 480.2 million allowances. 
Based on these trends, it is thus expected that no more than 2% of the cap may additionally 
be allocated for free from the NER. In total, the free allocation over phase 3 is thus expected 
to be around 41% of the total amount. 

To the same extent  that the allocations from the NER are not  yet known today, it will also 
only  be  known  at  the  end  of  the  phase  how  many  installations  that  currently  receive  an 
allocation will stop operation or reduce their capacity  or production. Where installations no 
longer receive free allowances, the legal default is that these allowances will be auctioned on 
behalf of the Member States. In 2013 and 2014, the allocations to around 1100 installations 
were  revised  downwards  by  85.7  million  allowances.  In  general,  the  uptake  from  the  NER 
and  the  return  from  closures  and  reductions  are  expected  to  be  within  the  same  order  of 
magnitude51, so that another 2% of total allowances are expected to remain within the auction 
share. 

Another  some  2%  of  the  total  cap  is  used  to  fund  the  NER300  programme  for  CCS  and 
innovative renewables projects.  

As explained above, free allowances provided to the power sector in return for investments 
modernising power generation are deducted from or added to the auction share of the relevant 

51 Returns because of partial cessations  and closures and additional allocations from the new entrants' reserve 
depend  on  the  economic  development  over  the  coming  years.  In  case  of  more  returns  of  allowances  due  to 
closures, partial cessations and capacity reductions than requests for new entrants' allocations, the auction share 
would increase; in the opposite case, i.e. lower new entrants' allocations than reductions, it would lower. As a 
working assumption, it is considered that they balance out over phase 3. 

25 

 
 
                                                           
Member State and, as such, remain part of the auctioned volumes even though they are given 
for free to the energy sector52.  

Taking into account these different elements, the average auction share over phase 3 amounts 
to 57%.  

For  phase  4,  these  elements  should  not  fundamentally  change.  As  was  the  case  for  the 
NER300  programme,  400  million  allowances  should  be  made  available  for  innovation 
support. Free allocation provided to the power sector in return for investments modernising 
power generation should continue and allowances used for this purpose would remain part of 
the auction volumes which individual Member States can decide to allocate for free in return 
for  investments.  In  line  with  the  starting  point  in  the  ETS  Directive,  that  in  principle  all 
allowances  should  be  auctioned,  the  allowances  that  according  to  the  European  Council 
should  be  auctioned  for  a  new  fund  for  the  modernisation  of  the  energy  systems  in  certain 
low-income Member States are part of the auction share in phase 453. 

The  "backloading",  i.e.  postponing  auction  volumes  into  the  latter  part  of  phase  3,  and  the 
functioning of the Market Stability Reserve to address the structural surplus of allowances in 
the EU carbon market both relate to the amount of allowances auctioned by Member States. 
For example, in case of the Market Stability Reserve, auction volumes will be reduced when 
allowances are transferred into the reserve and increased at the time allowances are released 
from the reserve. Both these mechanisms have a neutral effect on the overall auction share.54  

The European Council agreed that the share of allowances to be auctioned under the EU ETS 
post-2020  should  not  be  reduced55.  This  principle  of  not  reducing  the  auction  share  was  an 
important  and  integral  part  of  the  agreement  to  which  Member  States  attach  particular 
importance.  Any  change  to  the  auction  share  would  have  distributional  implications  and 
adversely affect the balance of the European Council agreement56, and have implications on 
the low-carbon funding mechanisms, in particular the free allocation  to power, and on the re-
distribution for solidarity purposes of allowances to be auctioned.   

so 

(see 

status 

far  been  below 

the  annual  maximum 

52 A theoretical total of around 680 million allowances may be allocated for free by the 8 Member States that 
have  chosen  to  make  use  of  the  option  in  the  period  2013-2020.  For  most  of  those  Member  States,  actual 
allocations  have,  however, 
tables  at: 
http://ec.europa.eu/clima/policies/ets/cap/auctioning/documentation_en.htm ). 
53  To  note  that  the  European  Council  conclusions  provide  that  the  "allowances  from  the  reserve  will  be 
auctioned according to the same principles and modalities as for other allowances". See EUCO 169/14European 
Council (23 and 24 October 2014) ‒ Conclusions, point 2.7. 
54 The proposal to establish a Market Stability Reserve has been politically agreed by the co-legislators. See at 
http://www.europarl.europa.eu/meetdocs/2014_2019/documents/envi/dv/ets_msr_annex_/ets_msr_annex_en.pdf
.  The  Market  Stability  Reserve  will  operate  as  of  2019  and  allowances  in  the  reserve  will  count  towards  the 
auction  share.  At  the  end  of  each  trading  period,  allowances  in  the  reserve  will  not  be  cancelled,  but  carried 
forward to the next trading period. This way, they remain available for release. Appropriate accounting ensures 
that in case of release, the distribution between Member States takes place according to the key in place during 
the  trading  period  when  the  allowances  where  placed  in  the  reserve  instead  of  being  auctioned.  Accordingly, 
allowances  in the  reserve  are  counted  towards  the  auction  share of  their  trading  period "of origin".  The  same 
principle applies to allowances held by operators on their respective accounts. 
55  For  more  information  on  the  impact  of  auctioning  or  free  allocation  in  respect  of  a  40%  GHG  emission 
reduction target by 2030, see 2030 framework Impact Assessment SWD(2014) 15 final 
56 For example, 10% of the EU ETS allowances to be auctioned by the Member States will be redistributed to 
the  benefit  the  low-income  Member  States  and  only  if  the  overall  auction  share  is  known  the  Member  States 
concerned have clarity on how much this would be. The same applies to Member States that make use of the 
transitional free allocation for the modernisation of the power sector (see section 8.3), which may hand out for 
free after 2020 up to 40% of the allowances allocated for auctioning to them and need to know what the auction 
share will be to determine this maximum.  

26 

 
                                                           
The  system  post-2020  builds  on  phase  3.  The  shares  of  auctioned  allowances  between 
Member States  are already set in the Directive and, to  meet the specific requirement of the 
European Council conclusions, it is appropriate to express the auction share as a percentage 
figure  in  the  legislation.  The  environmental  integrity  of  the  system  guaranteed  by  the  cap 
would remain entirely preserved, while providing a percentage figure for the auction share in 
the legislation would have considerable positive impacts on  transparency, predictability and 
the  functioning  of  the  carbon  market.  It  would  enhance  planning  certainty  of  investment 
decisions and transparency for market participants inside and outside the system, as well as 
for  the  wider  public.  It  would  render  the  system  simpler,  more  transparent,  more  easily 
understandable and thus positively impact the confidence in the EU ETS.  

7. 

FREE ALLOCATION AND ADDRESSING THE RISK OF CARBON LEAKAGE  

The main policy tool to address the risk of carbon leakage is the provision of free allowances 
to  industry.  Free  allowances  lower  the  effective  carbon  cost  for  industry  as  otherwise 
allowances  would  have  to  be  purchased  on  the  carbon  market.  The  total  amount  of 
allowances  available  to  be  handed  out  for  free  to  industry  for  the  period  under  assessment 
(2021  to  2030)  is  in  the  order  of  6.3  billion  allowances.  The  value  of  these  allowances 
depends on the market price at the time and could be in the order of €160 billion.  

If not handed out for free to industry, these allowances could be auctioned by Member States 
and provide them with revenues. Free allowances are thus a public resource. This section of 
the impact assessment covers different options on how to distribute this public resource in a 
way that gives optimal impact in terms of effectively addressing the potential risk of carbon 
leakage.  

Box 3: Carbon leakage 

The EU ETS is in principle a quite simple instrument. The quantity of allowances is determined by 
policymakers, and any installation under the system has to cover the  tonnes of CO2 it has emitted 
with allowances bought on the market. Incentives to reduce emissions and improve technology are 
driven by the fact that each tonne of CO2 to be covered by one allowance has a price (carbon price).  
Since  buying  allowances  represents  a  cost  (carbon  cost),  there  have  been  concerns  about  the 
competitiveness  impacts  on  the  industry  covered  by  the  ETS,  as  long  as  competitors  in  other 
countries are not covered by a similar system or a carbon tax. There have also been environmental 
concerns  linked  to  this:  if  European  companies  move  production  to  outside  of  the  EU,  this  could 
lead  to  increased  emissions  globally  (in  particular  if  the  installations  outside  of  the  EU  are  more 
carbon intensive, which is often the case). This problem is the so called carbon leakage. 
If  most  major  economies  in  the  world  had  set  a  price  on  carbon  and  if  these  carbon  prices  were 
similar across the world, carbon costs would not be a problem for competitiveness since the impact 
would be the same for all companies. 
Steady  progress  is  being  made  towards  having  an  international  carbon  price  which  is  one  of  the 
long-term  goals  of  international  climate  negotiations.  Until  this  happens,  the  EU  ETS  foresees 
certain  measures  to  reduce  the  risk  of  carbon  leakage.  The  measures  consist  of  providing  free 
allowances  to  industry,  thereby  reducing  the  cost  of  buying  allowances  (e.g.  if  an  installation 
receives  free  allowances  covering  90%  of  its  emissions,  it  has  to  buy  the  remaining  10%). 
Nevertheless, it was deemed  important that companies should  still have an  economic incentive to 
reduce their emissions and this was ensured when designing the free allocation system.  
To  efficiently  create  such  a  system,  the  right  balance  should  be  found  between  addressing  the 
problem  of  carbon  leakage  and  avoiding  compensating  beyond  the  actual  needs  for  allowances 
(over-compensating).  
The  risk  of  carbon  leakage  differs  across  sectors  as  carbon  costs  are  more  or  less  important  in 
relation to total costs in a given sector. The sectors which are deemed to be exposed to a significant 
risk  of  carbon  leakage  and  which  therefore  receive  more  free  allowances  are  included  in  the  so-
called  "carbon  leakage  list"  which  the  Commission  is  mandated  to  draw  up  every  five  years.  At 
27 
present, the sectors on the list represent more than 97% of industrial emissions under the ETS. 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
7.1. 

Problem definition 

Free allocation of allowances to industry is designed to address the potential risk of carbon 
leakage (increase in greenhouse gas emissions in third countries where industry is not subject 
to  comparable  carbon  constraints)  until  an  international  agreement  is  concluded  or 
comparable climate policy measures are undertaken by other major economies. This gives the 
justification  to  deviate  from  the  general  principles  of  EU  environmental  policy,  i.e.  the 
"polluter  pays  principle"  and  "internalisation  of  external  cost"  principle,  meaning  that  the 
costs  of  measures  to  deal  with  pollution  should  be  borne  by  the  polluter  and  that  all  costs 
associated  with  the  protection  of  the  environment  should  be  included  in  the  companies' 
production costs57. 

Since carbon leakage could lead to an increase in worldwide emissions, thereby undermining 
the  EU  climate  policy  objective,  free  allocation  was  chosen  as  a  transitional  measure  to 
address this risk. 

In the first two phases of the ETS (2005-2007 and 2008-2012), free allocation was based on 
historic emissions and decided nationally. Basing the allocation on historic emissions implied 
that installations that emitted relatively more received more free allowances, compared to the 
more efficient ones.  

The revision of the ETS Directive ensured that in the third phase (2013-2020), the approach 
for allocation of allowances was harmonised58  across the EU to ensure a level-playing field 
across the internal market and to address concerns about potential market distortion.  

From  2013,  the  amount  of  free  allowances  that  each  installation  receives  is  determined 
mainly  by  performance  benchmarks  instead  of  historic  emissions.  Generally  speaking, 
benchmarks  represent  a  value  in  CO2  emissions  per  tonne  of  product,  reflecting  the 
greenhouse gas emission performance of the best installations in the EU producing a specific 
product. Allocation to each industrial installation is calculated by multiplying the benchmark 
for the product it makes with its production data (for more details see Box 4). 

For  allocation  purposes,  each  industrial  sector  is  classified  according  to  its  exposure  to  the 
risk  of  carbon  leakage  that  is  assessed  combining  two  parameters:  trade  intensity  (imports 
and exports) and carbon intensity (CO2 emissions per tonne of product). Those sectors with a 
high combination of these two parameters are in general deemed as more impacted by the EU 
ETS, and therefore get a higher share of free allowances. They are put on the carbon leakage 
list and as  such receive 100%  of the amount  of  free allocation  determined  according to the 
benchmark-based  methodology.  The  percentage  of  free  allocation  for  sectors  not  on  the 
carbon leakage list decreases in a linear manner from 80% in 2013 to 30% in 2020.  

In  line  with  the  EU's  climate  policy  to  reduce  GHG  emissions,  the  ETS  cap  (maximum 
amount  of  allowances  available)  decreases  gradually  over  time.  The  total  amount  of 
allowances  available  for  industry  is  a  share  of  the  total  cap  and  therefore  decreases 
correspondingly. For more details see chapter 6. 

According  to  the  current  legal  provisions,  higher  free  allocation  for  sectors  deemed  to  be 
exposed  to  the  risk  of  carbon  leakage  ends59  in  2020.  Thereafter  free  allocation  for  all 

57  Commission  Staff  Working  Document  accompanying  document  to  the  Proposal  for  a  Directive  of  the 
European Parliament and of the Council amending Directive 2003/87/EC so as to improve and extend the EU 
greenhouse gas emission allowance trading system, Impact Assessment, SEC(2008)52 
58  Commission  Decision  2011/278/EU  of  27  April  2011  sets  out  the  rules  for  free  allocation,  including  the 
benchmarks. 
59 See Article 10a(12) of the ETS Directive  

28 

 
                                                           
industrial  sectors  would  correspond  to  30%  of  the  amount  determined  based  on  the 
benchmarks. 

A further element in reducing costs for industries affected by the ETS is that installations in 
certain sectors can be compensated by Member States for higher electricity prices due to the 
ETS. These so called "indirect costs" are due to the power sector passing through the costs of 
the  allowances  (needed  to  cover  their  emissions)  to  their  customers.  This  compensation  is 
provided through state aid schemes determined at national level under the relevant State Aid 
Guidelines60.  

The ETS is a flexible tool as it allows companies to choose the most cost-effective options to 
contribute  to  the  overall  emission  reduction  target,  either  by  purchasing  allowances  on  the 
market, or investing in less-carbon intensive technologies. 

A crucial input to the work on revising the EU ETS came from the European Council, which, 
in its Conclusions of October 201461 gave strategic guidance on the 2030 climate and energy 
framework in general, but also on the design of the ETS post-2020. As long as no comparable 
efforts  are  undertaken  by  other  international  partners,  the  European  Council  underlined  the 
need  to  continue  free  allocation  to  industry  after  2020.  This  is  meant  to  ensure  appropriate 
level of support for sectors at risk of losing international competitiveness due to the carbon 
costs when operating in the EU. It can be noted that industry stakeholders also hold the view 
that free allocation is an adequate instrument.62  

The European Council also stated that the  most efficient installations in sectors should face 
no undue carbon costs, that there should be no windfall profits due to free allocation, and that 
existing measures to compensate for indirect emissions should remain also in phase 4.  

Considering that the amount of free allowances is limited and will continue to decline in line 
with  the  necessary  emission  reductions,  the  future  system  to  address  the  risk  of  carbon 
leakage  needs  to  be  better  targeted.  The  total  amount  of  allowances  available  for  free 
allocation  in  phase  3  (2013-2020)  is  some  6.6  billion  allowances,  amounting  to  some  €  50 
billion (based on current carbon price), and the total amount available for free allocation in 
phase 4 (2021-30) is some 6.3 billion allowances, amounting to as much as €160 billion. 

The future system also needs to ensure that incentives for industry to innovate will be fully 
preserved  and  windfall  profits  (i.e.  situation  when  industry  receive  allowances  to  cover 
carbon costs, even though they are able to pass on these costs to their consumers)  avoided, 
without reducing the share of allowances to be auctioned.  

The problem to be addressed in this section concerns the future rules for free allocation 
to  industry,  and  notably  based  on  the  principles  defined  by  the  European  Council  to 
establish how to optimally allocate the roughly 6.3 billion free allowances available. 

7.1.1.  Underlying drivers of the problem 

The starting point for the analysis is the existing system.  

Some  general  observations  can  be  made.  The  harmonised  rules  applicable  as  of  phase  3 
represent  an  improvement  compared  to  the  previous  situation.  The  harmonised  approach  is 

60  Guidelines  on  certain  State  aid  measures  in  the  context  of  the  greenhouse  gas  emission  allowance  trading 
scheme post-2012 (2012/C 158/04) 
61 EUCO 169/14 European Council (23 and 24 October 2014) ‒ Conclusions. 
62 See Annex 3 

29 

 
 
                                                           
functioning well (an OECD study finds that the EU ETS has stimulated substantial emissions 
abatement of up to 28% compared to business-as-usual, while, at the same time, not causing 
disadvantages  for  the  competitive  position  of  the  EU  ETS  firms63)  and  the  risk  of  carbon 
leakage  seems  to  be  properly  addressed,  while  emission  reduction  incentives  are  also 
preserved64.  A  study  concluded  in  201365  that  no  conclusive  evidence  of  carbon  leakage 
occurrence can be found.  

However,  when  determining  the  amount  of  free  allowances  to  be  handed  out  each  year  for 
phase 3 (2013-2020) the amount calculated based on the agreed rules  exceeded the amount 
available.  Already  in  2013,  the  demand  for  allowances  ("gross  free  allocation",  i.e.  the 
amount  of  free  allocation  determined  by  multiplying  the  benchmark  and  production  before 
the application of the carbon leakage and the possible correction factor) exceeded the amount 
available by about 6%. This triggered, as foreseen in the ETS Directive, the application of a 
uniform  cross-sectoral  correction  factor66.  Since  the  amount  of  allowances  available 
decreases  each  year,  and  since  allocation  for  phase  3  was  determined  for  the  entire  period 
2013-20,  the  cross-sectoral  correction  factor  increases  each  year  to  2020,  when  it  will  be 
18%. 

While  the  cross-sectoral  correction  factor  is  effective  in  ensuring  that  free  allocation  stays 
within the overall allocation limit and the amount of allowances available for auctioning and 
delivering  fiscal  revenue  to  Member  States  remains  predictable,  it  does  not  differentiate 
among  sectors:  i.e.  does  not  account  for  differences  in  terms  of  ability  to  decarbonise  over 
time, exposure to the risk of carbon leakage, the pass through of costs in product prices, etc. 
Given  the  shrinking  amount  of  allowances  it  is  self-evident  that  unchanged  carbon  leakage 
rules would result in an increasing correction factor beyond 2020 reaching potentially a level 
of 35 % in 2030.  

It should be noted that the cross-sectoral correction factor does not determine which sectors 
receive a certain level of free allocation: its purpose is only to ensure that the overall limit is 
respected and Member States auctioning revenues guaranteed.  
The  correction  factor  is  subject  to  strong  criticism  by  industry  stakeholders67,  which 
constitute  the  majority  of  the  stakeholders  replying  to  the  consultation,  mainly  because  it 
applies  equally  to  all  sectors  and  therefore  the  system  does  not  guarantee  that  the  most 
efficient  installations  in  each  sector  do  not  face  undue  carbon  costs.  It  has  also  has  been 
criticised for having been determined too shortly before the start of phase 3.  

Since  many  industry  stakeholders  considered  that  the  cross-sectoral  correction  factor 
represents  high  unpredictability  in  the  system,  one  element  of  this  impact  assessment  is  to 
analyse different ways that the current allocation system can be improved to ensure a fair and 

63 Arlinghaus, J. (2015), “Impacts of Carbon Prices on Indicators of Competitiveness: A Review of Empirical 
Findings”, OECD Environment Working Papers, No. 87, OECD Publishing, Paris. 
64  See  Annex  3.2.  Summary  of  the  Stakeholder  Consultation  on  carbon  leakage  provisions  and  innovation 
support:  over  90%  of  respondents  confirmed  that  free  allocation  preserves  the  incentive  to  innovate. 
Furthermore, it is noteworthy that the EU is on track to meet its Kyoto and EU2020 GHG emission reduction 
targets (COM(2014) 689).   
65 See inter alia Ecorys' Carbon Leakage Evidence Project: Factsheets for selected sectors, September 2013. 
66 Commission Decision 2013/448/EU. 
67 In both public consultations (Consultation on the ETS revision and Consultation on carbon leakage provisions 
and  innovation  support)  industry  stakeholders  from  many  sectors  called  for  a  removal  of  the  cross-sectoral 
correction  factor  considering  its  gradually  increasing  impact  (along  with  decrease  of  the  amount  of  free 
allocation). 

30 

 
                                                           
efficient allocation of allowances, while avoiding or minimising the likelihood that  a cross-
sectoral correction factor would apply in phase 4.  

Box 4: The basics of the free allocation system  

For each installation in the EU ETS the amount of free allocation is calculated based on a formula 
where its production quantity (in tonnes of product) is multiplied with the benchmark value for that 
particular product (measured in emissions per tonne of product). A producer of lime thus multiplies 
its  production  of  lime,  e.g.  10000  tonnes  with  the  benchmark  for  lime  (0.954  tonnes  of  CO2  per 
tonne  lime).  This  provides  an  amount,  in  this  example,  9540  allowances  for  the  installation.  The 
installation is in principle eligible to receive this amount each year until from 2013 to 2020. 

The legislators have also decided that 100% of this amount should be provided only to sectors that 
were deemed to be at a significant risk of carbon leakage and are on the carbon leakage list (See Box 
3: Carbon leakage). Sectors not on this list get a gradual reduction of the amount of free allocation. 

After checking whether the sector in which the installation operates is on the carbon leakage list or 
not,  the  allocation  per  installation  is  adjusted  if  needed,  and  Member  States  report  requested 
allocation  amounts  to  the  Commission.  The  Commission  adds  up  the  requested  allocations  for  all 
installations  in  the  EU.  If  this  amount  exceeds  the  amount  pre-determined  as  available  for  free 
allocation, a reduction  is made for all – i.e. the allocation calculated per installation is reduced by 
the same percentage for all installations. This is the cross-sectoral correction factor which had to be 
applied as from 2013. It has reduced allocation by ca 6% in 2013 and will reach 18% in 2020 as it 
increases each year as the amount of allowances available to be handed out for free decreases each 
year. 

In brief, the formula to determine the amount of free allocation is: 
𝐴𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 = 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 ∗ 𝑏𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘 𝑣𝑎𝑙𝑢𝑒 ∗ 𝑐𝑎𝑟𝑏𝑜𝑛 𝑙𝑒𝑎𝑘𝑎𝑔𝑒 𝑓𝑎𝑐𝑡𝑜𝑟 ∗ 𝑐𝑜𝑟𝑟𝑒𝑐𝑡𝑖𝑜𝑛 𝑓𝑎𝑐𝑡𝑜𝑟 

For  the  analysis,  it  is  necessary  to  look  at  the  different  elements  that  determine  free 
allocation. These are:  

 

 

the updating of the benchmark values; 

the classification of sectors, based on market situation including the possibility to pass 
through carbon costs into product prices; 

 

the production data used. 

On these three elements in the allocation system, the following can be noted: 

1) The starting point for determining the benchmark values in phase 3, in accordance with the 
ETS Directive, was the average emission performance of the 10% most efficient installations 
in  a  sector  in  the  years  2007-08.  Since  the  benchmark  values  were  set  based  on  data  from 
2007-08, any technological progress since then is not taken into account. The ambition level 
of  the  benchmark  values  therefore  erodes  over  time  and  in  2030  benchmarks  would  reflect 
the state of technology of more than two decades ago. 
2) Currently based on criteria defined in the ETS Directive68, almost all industrial sectors, i.e. 
those responsible for more than 97% of industrial emissions under the ETS are on the 'carbon 
leakage list'. The system is thus not targeted.  

3)  The  third  element  in  the  allocation  formula  is  the  production  data  used  to  multiply  the 
benchmark  values.  According  to  the  current  implementing  rules,  operators  were  allowed  to 
choose  between  two  historic  production  baseline  periods  (either  2005  –  2008  or  2009  – 

68 See Article 10a(15-17) of the ETS Directive 

31 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                           
2010). This led to a significantly higher demand for free allocation than if the same baseline 
period  had  been  used  for  all.  Furthermore,  in  general  these  years  had  particularly  high 
production  levels  for  most  installations,  but  due  to  the  economic  crisis  and  slow  recovery, 
actual  production  levels  in  2013  and  2014  were  significantly  lower  in  certain  sectors 
compared  to  the  baseline  production.  This  latter  fact,  however,  is  not  always  reflected  in 
lower amounts of free allocation, resulting in a situation where some installations with  low 
production levels receive allocation that exceeds the amount needed to cover their emissions. 

All the above features must thus be assessed in order to improve the existing system with a 
view  to  ensuring  the  optimal  allocation  of  allowances  and  targeting  the  measures  against 
carbon leakage to those sectors most exposed. A more general goal is to ensure predictability 
for companies covered by the system (which is a key request from a considerable number of 
industry stakeholders). 

4) A further element important to consider is how new and/or growing installations i.e. "new 
entrants" will be treated in the system post-2020. The current system provides specific rules 
and a specific amount of allowances is set aside (new entrants' reserve) for this purpose.  

5) Due to requests from the electricity intensive sectors, which argue that the current system 
of  addressing  indirect  carbon  costs  passed  through  in  electricity  prices  via  state  aid  causes 
distortions  in  the  internal  market,  the  issue  of  compensation  for  these  costs  will  also  be 
analysed.  

Since  the  correction  factor  is  a  less  efficient  way  of  directing  free  allowances  to  those 
sectors  most  exposed  to  the  risk  of  carbon  leakage,  an  objective  of  this  impact 
assessment is to analyse how a more focused system, resulting in a reduced likelihood of 
triggering a significant correction factor post-2020, should be designed.  

7.2. 

Operational policy objectives 

As mentioned above, the overall objective of the free allocation system is to address the risk 
of  carbon  leakage  by  providing  appropriate  levels  of  support  to  sectors  at  risk  of  losing 
international competitiveness, as long as no comparable efforts are undertaken in other major 
economies.  In  line  with  the  European  Council  Conclusions  of  October  201469,  this  general 
objective is operationalized in the following operational objectives: 

  Reflect technological progress in industry sectors; 

  Fully preserve incentives for industry to innovate;  

  Most efficient installations do not face undue carbon costs leading to carbon leakage; 

  Better alignment with production levels; 

  Avoid windfall profits; 

  No increased administrative complexity. 

The  options  for  each  element  to  be  assessed  will  be  screened  preliminarily  for  the 
effectiveness,  efficiency  and  feasibility  in  achieving  the  operational  objectives.  Not 
increasing administrative complexity reflects the efficiency and feasibility criteria, while all 
the  other  operational  objectives  relate  to  the  effectiveness.  Some  operational  objectives  are 
particularly relevant for some aspects of the free allocation rules, but not for others, so when 

69 EUCO 169/14 European Council (23 and 24 October 2014) ‒ Conclusions. 

32 

 
 
                                                           
screening  and  comparing  options, preference will  be  given  to  the  most  relevant  operational 
objective(s).  

The  degree  of  fulfilling  an  objective  is  indicated  with  pluses  and  minuses.  Their  meanings 
are:  "--"  much  worse  than  baseline,  "-"  worse  than  baseline,  0  equal  to  baseline,  "+"  better 
than baseline, "++" much better than baseline.  

As  mentioned  above,  the  likelihood  of  triggering  a  correction  factor  post-2020  will  be 
analysed for the option packages as a whole to assess the cumulative impacts of the elements 
composing them. 

It should be underlined that the development and assessment of options for the future system 
of  free  allocation  and  measures  addressing  the  risk  of  carbon  leakage  are  based  on  the 
assumption  that  no  comparable  climate  policy  measures  are  undertaken  by  other  major 
economies.  

However, there are a number of countries and regions that have or are intending to develop 
different  emission  trading  systems  (e.g.  China,  South  Korea,  California,  Switzerland,  some 
regions  in  Canada).  Their  approaches,  design  features  and  levels  of  ambition  are 
heterogeneous,  making  it  difficult  to  quantify  the  impacts.  The  policy  options  therefore 
assume that third countries fulfil Copenhagen/Cancun pledges, but there is no assumption on 
any further significant climate action in third countries.  

Should an international climate agreement be concluded, it will be necessary to first analyse 
the concrete measures taken as a consequence and to determine their implications for the EU 
climate  policy  in  general,  and  impact  on  the  competitiveness  of  EU  industry  in  particular, 
before any revision of the existing/proposed rules.  

7.3. 

Policy options for free allocation and other carbon leakage measures  

As  explained  above,  the  carbon  leakage  and  free  allocation  system  contains  a  number  of 
elements.  The  level  of  free  allocation  per  installation  is  the  mathematical  product  of  a 
benchmark  value,  a  production  level  value,  a  carbon  leakage  factor  and,  if  needed,  a 
correction  factor  (see  Box  4).  The  guiding  principles  adopted  by  the  European  Council 
address  these  elements  and  also  compensation  for  indirect  costs.  Depending  on  the  policy 
choices  made,  there  will  be  differences  in  terms  of  the  degree  of  realising  individual 
operational  objectives.  The  choices  may  also  have  different  distributional  effects  between 
industrial sectors. 

This  section  summarises  the  underlying  rationale  and  range  of  policy  options  which  have 
been used to design option packages. A more detailed discussion of the options can be found 
in Annex 5. 

7.3.1.  Benchmark values 

The  first  element  in  the  allocation  formula  is  the  benchmark  value.  It  determines  tonnes  of 
carbon emissions per tonne of product and is independent of the mode of production in terms 
of technology, fuel, the size of an installation, or its geographical location.  

The  currently  used  benchmark  values  were  determined  based  on  performance  data  of  the 
most carbon efficient installations throughout the EU in each sector based on real-life historic 
industrial production in the years 2007 and 2008. 

33 

 
 
 
The  European  Council  has  requested  a  regular  review  of  the  benchmark  values  in  order  to 
reflect  technological  progress.  The  benchmark  values  should  thus  be  lowered  in  phase  4, 
leading ceteris paribus to reduced allocation. However, this reduced allocation reflects lower 
emissions thanks to the ongoing technological progress and does therefore not as such make 
the allocation system less generous.  

There are various options how and how frequently to update the benchmark values. The full 
range of these options is presented in Annex 5.1, and out of the screened options two are used 
in the option packages. 

The  baseline  option  is  to  update  all  benchmark  values  based  on  new  data  reported  by 
operators of ETS installations on mandatory basis and to keep the benchmarks constant over 
phase 4 (2021-2030). This baseline option is also used in the "Baseline Bbis" and "Limited 
changes" option packages. 

One alternative option is the single flat-rate update (option 1 from Annex 5.1), updating all 
benchmark values by the same percentage once before the start of phase 4 and keeping them 
constant in the whole phase 4. This option is used in the "Simple" option package. 

The other option is the full data collection update (option 4 from the Annex 5.1), updating all 
benchmark values based on new full data collection, and revising them every five years, i.e. 
twice during phase 4. This option is used in the "Targeted" option package. 

In summary, the analysis shows that single flat rate is administratively simple, but may not 
sufficiently  capture  technological  differences  across  sectors.  However,  using  multiple  flat 
rates  (e.g.  high,  medium,  low)  can  address  this  downside.  On  the  other  hand,  full  data 
collection  update 
is  administratively  highly  complex,  creates  prolonged  regulatory 
uncertainty  for  companies  and  compromises  the  incentives  to  innovate,  as  realised  profits 
from lowering emissions are taken away from fast movers. For further details see Annex 5.1. 

7.3.2.  Production level and adjustments 

The  second  element  in  the  allocation  formula  is  the  production  level.  The  determination  of 
the  production  value  is  important  for  the  functioning  of  the  system.  Linked  to  this  are  the 
rules on how allocation can change over the phase, e.g. if production increases or decreases  

Currently historic production data from 2005-2010 were used to determine allocation for the 
8-year period 2013-2020. Each installation had thus certainty in 2012 how many allowances 
it would receive year by year until 2020. 

From  the  point  of  view  of  an  installation,  the  system  is  quite  stable  and  predictable.  The 
installation  keeps  its  allocation  unchanged  until  the  production  level  is  50%  below  the 
historic level. If the installation invests in new capacity it can apply for additional allowances 
from the new entrants' reserve. 

Many  industrial  stakeholders  have  commented  on  the  current  situation  and  proposed  that 
allocation  should  be  adjusted  not  only  for  capacity  increases,  but  also  for  production 
increases. 

These rules can have a considerable impact on the total amount of allowances to be handed 
out  per  year  in  different  economic  circumstances,  i.e.  during  an  economic  slowdown  or 
upturn.  The  rules  therefore  also  have  an  impact  on  the  likelihood  for  the  need  for  the 
correction  factor.  Moreover,  the  rules  have  a  large  bearing  on  the  degree  of  administrative 
complexity and costs.  

34 

 
 
There are various options to tackle production level and adjustments. The full range of these 
options is presented in Annex 5.3, and out of the screened options two are used in the option 
packages. 

The  baseline  option  is  to  have  the  production  levels  determined  once  and  keep  the  current 
rules  for  production  changes.  This  baseline  option  is  also  used  in  the  "Baseline  Bbis" 
package. 

Out of the screened options (see Annex 5.3), the ones used in the option packages are: 

  One alternative (option 1) has the historical production levels defined once and based 
on five years (2013-17) for the entire 10-year period. Significant production increases 
and  decreases  are  addressed  through  symmetrical  annual  adjustments70,  i.e.  same 
thresholds for increased and decreased production. This option is used in the "Simple" 
option package.  

  Another  alternative  (option  2)  has  the  production  levels  defined  for  two  five-year 
periods  (2013-17,  respectively  2018-22)71.  Significant  production  increases  and 
decreases are addressed through symmetrical annual adjustments i.e. same thresholds 
for increased and decreased production. This option is used in the "Limited changes" 
and "Targeted" option packages. 

In  both  options,  the  increased  allocation  for  increased  production  comes  from  the  new 
entrants' reserve.  

These options provide for a closer alignment to production levels building on lessons learnt 
from the current system and responding to requests from the European Council to this effect. 
A careful balance needs to be struck to avoid creating red tape and undermining incentives 
for further emissions reductions. For further details see Annex 5.3. 

7.3.3.  Reserve for new entrants 

A  topic  related  to  the  previous  aspect  on  production  level  and  adjustments  is  the  so-called 
new entrants' reserve. This is a reserve that in the current phase of the ETS is used to provide 
allowances to installations that are new or increase their capacity. As a result of the European 
Council's  strategic  guidance  to  continue  free  allocation,  such  a  reserve  is  also  needed  for 
phase 4.  

It is important to ensure that the size of the new entrants' reserve is sufficient to accommodate 
new  demands  during  phase  4,  but  new  installations  are  typically  more  carbon-efficient  and 
therefore  facilitate  the  gradual  transition  to  a  low-carbon  economy.The  analysis  therefore 
assesses  different  options  –  guided  by  building  on  current  practice  while  making  the  rules 
more flexible – for how to create this reserve and ensure that it will not be depleted. 

The  baseline  option  is  to  have  a  new  entrants'  reserve  with  a  fixed  amount  of  allowances 
(about 374 million allowances in phase 4). This baseline option is also used in the "Baseline 
Bbis". 

Out of the screened options (see Annex 5.4), the one used in the option packages is the option 
(Option 1) with new entrants reserve set up with phase 4 or unallocated phase 3 allowances 

70 The exact threshold for significant changes is to be determined in implementing legislation. For the purposes 
of this IA it is assumed that the threshold is 15% difference compared to the baseline production level. 
71 Data collection for production levels to be undertaken jointly with data collection for updating benchmarks, in 
order to minimise administrative burden. 

35 

 
 
                                                           
and replenished throughout 2021-2030 with unused phase 4 allowances (see Annex 14). This 
option is used for the "Simple", "Limited changes" and the "Targeted" packages. 

7.3.4.  Carbon leakage groups 

The third element in the allocation formula is the carbon leakage factor. The ETS Directive 
currently categorises industrial sectors in two categories depending on the level of exposure 
to the risk of carbon leakage.  

Installations in sectors and subsectors which are deemed to be exposed to a significant risk of 
carbon leakage are inscribed in the so-called 'carbon leakage list' (see Box 3) and are given 
free  allocation  at  100%  of  the  quantity  determined  based  on  the  benchmark  values  and 
production levels, i.e. the carbon leakage factor in the allocation formula is 1. 

Installations in other industrial sectors not covered by the carbon leakage list receive a lower 
(annually decreasing from 80% to 30%) level of free allocation, i.e. the carbon leakage factor 
in the allocation formula is 0.8 in 2013 and shrinks to 0.3 in 2020. 

In  practice,  there  is  very  limited  differentiation  among  industrial  sectors  since  sectors 
accounting for more than 97 % of industrial ETS emissions are on the carbon leakage list (see 
Figure 3). Hence, practically all industrial sectors receive the same treatment irrespective of 
the degree of exposure to carbon leakage risks, including the ability to pass on costs. 

Figure 3: Sectors on and off the carbon leakage list The chart indicates the share of sectors from 
industrial emissions 

A more targeted approach to allocation whereby differences in terms of exposure to carbon 
leakage risk translate into differentiated allocation levels could have made it possible to limit 
or even avoid the need to apply a cross-sectoral correction factor in phase 3. It is therefore 
pertinent to explore the possibility of enhanced differentiation between industrial sectors. 

The  baseline  option  considers  two  carbon  leakage  groups  based  on  the  current  trade  and 
emission intensity criteria. It is used in the "Baseline B" package. 

Out of the screened options (see Annex 5.3), the ones used in the option packages are: 

  A slight variation to the baseline option (option 2) with somewhat modified criteria is 

used in the "Baseline Bbis" package. 

36 

 
 
 
  An  alternative  is  an  approach  with  no  groups  and  a  uniform  carbon  leakage  factor 
(option 1), i.e. no differentiation among sectors and activities. This option is used for 
the "Simple" option package. 

  Other  alternative  options  (options  3  and  4)  with  four  groups  ('Very  high',  'High', 
'Medium'  and  'Low'  level  of  carbon  leakage  risk)  are  also  based  on  the  criteria  of 
emission  intensity  and  trade  intensity.  These  options  are  used  for  the  "Limited 
changes" and "Targeted" option packages72. 

The options vary according to the differentiation they bring among sectors – from none (all 
sectors in one group), to two groups (exposed / not exposed) and four groups (more detailed 
differentiation of the level of risk exposure).  

The 'Baseline approaches' and Option 1 fail to sufficiently differentiate between the different 
levels of carbon leakage and lead to a high correction factor that cuts free allowances for all. 
The alternative approaches should lead to a more targeted distribution of allowances across 
sectors and provide a better outcome for the most exposed sectors.  

See Annex 5.2 for further details. 

7.3.5.  Cross-sectoral correction factor 

A  fourth,  potential,  element  in  the  allocation  formula  is  the  cross-sectoral  correction  factor 
which  is  a  stopgap  to  ensure  that  the  available  budget  for  free  allocation  is  not  over-
subscribed.  No  options  are  developed  for  this  factor  as  the  likelihood  of  this  factor  being 
necessary  and  its  magnitude  depends  on  the  policy  design  of  the  first  three  factors.  The 
avoidance of having to apply this factor is  an important consideration in assessing different 
options and option packages. 

7.3.6.  Compensation for indirect carbon costs 

Indirect  carbon  costs  occur  in  many  sectors  across  the  economy  and  are  a  natural 
consequence of pricing carbon emissions. In the political debate, the term is used to describe 
the  costs  of  carbon  emissions  related  to  producing  electricity,  which  are  passed  through  to 
industrial  consumers  of  electricity.  As  electricity  producers  covered  by  the  ETS  do  not 
receive  free  allowances  to  cover  their  emissions  (and  therefore  have  to  buy  needed 
allowances  on  the  market)  and  given  the  situation  of  the  electricity  market  (i.e.  almost  no 
imports  from  outside  the  EU  and  still  a  high  proportion  of  fossil  fuel  used),  electricity 
producers typically pass through these carbon costs in their prices to industrial customers and 
households alike.  

As a safeguard against potential carbon leakage, the ETS Directive gives Member States the 
possibility to compensate certain electro-intensive industries for these costs, subject to state 
aid control73.  

Some  industries  with  high  electricity  intensity  have  criticised  the  fact  that  compensation  of 
indirect costs is at the discretion of individual Member States74. They notably  highlight  the 

72 For the purposes of the analysis, it is assumed that free allocation is 100%, 80%, 60% and 30% of the amount 
calculated based on the benchmarks and production activity – sectors are divided in three groups: the 'Very 
high', 'High', 'Medium' and 'Low' group, respectively. As far as the thresholds between carbon leakage groups 
are concerned, different approaches are assumed under the 'Limited changes' and the 'Targeted' options 
packeages. For further details, see Annex 5. (section 5.2.2) 
73 The current measures are assessed under the Commission's 2012 Guidelines on state aid measures related to 
the ETS: http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri= CELEX:52012XC0605(01)&from=EN  

37 

 
                                                           
risk of distortion of competition due to a lack of harmonisation. As a consequence, electricity 
intensive  industry  stakeholders  have  asked  that  compensation  of  indirect  costs  is  done 
through an EU-wide harmonised system.75 

The impact assessment therefore analyses different options of providing such compensation, 
whereby  different  aspects  have  to  be  taken  into  account  such  as  whether  compensation  is 
optional or mandatory and how it is resourced, which could be national state budgets, auction 
revenues or free allowances.  

Based on the screening, the following two options are used in the option packages: 

  The baseline option is to continue with the optional compensation by Member States 
with  the  key  features  for  compensation  determined  at  EU  level,  but  the  decision  to 
grant compensation is discretional and depends on the respective Member State and is 
subject to State aid control. This option is used in the option packages "Baseline B", 
"Baseline Bbis", "Simple" and "Limited changes".  

  The other option is a mandatory Union-wide compensation scheme, financed by using 
national auctioning revenues. The compensation would be triggered when the carbon 
price exceeds a certain value, and when this situation occurs,  a minimum amount of 
compensation is to be given by all Member States. The system would be financed by 
each Member State using its national auctioning revenues. Compensation would, like 
in baseline, be limited to certain sectors and limited to a share of the estimated carbon 
costs. This option is used in the "Targeted" option package. 

See Annex 5.5 for further details. The options for indirect cost compensations differ in terms 
of  the  nature  of  compensation:  optional  or  mandatory  for  Member  States  to  provide  it.The 
analysis  indicates  that  more  harmonised  arrangements  for  indirect  cost  compensation  has 
benefits  but  care  is  needed  to  avoid  red  tape  and  lock-in  in  emission  intensive  production 
methods. 

7.4. 

Option packages 

The options for all relevant elements presented above are combined into "Option packages" 
in  order  to  facilitate  the  assessment  of  impacts.  The  option  packages  contain  the  elements 
needed  to  determine  the  amount  of  free  allocation  (see  Box  4:  The  basics  of  the  free 
allocation system)  and  some  other  relevant  aspects,  such  as  indirect  cost  compensation  and 
new entrants' reserve. 

As  already  mentioned,  some  important  provisions  that  are  currently  in  place  will  expire  in 
2020 (e.g. increased free allocation for sectors deemed to be exposed to a significant risk of 
carbon leakage). As such, the "legal baseline" option (i.e. the provisions of the ETS Directive 
with no change whatsoever) - 'Baseline A' does not correspond to the key requirements of the 
European Council, therefore this option is not further pursued.   

74  These  views  have  been  also  reiterated  during  the  stakeholder  consultations.  A  part  of  energy  intensive 
industry  asked  for  the  development  of  an  EU-wide  instrument  to  replace  the  national  state  aid  mechanisms. 
However,  a  significant  number  of  industry  stakeholders  have  also  highlighted  the  fragmentation  of  the  EU 
power market, noting that the impact of the ETS is marginal compared to the large variation of electricity prices 
across Member States. These industries have underlined the need for strengthened EU market, and competitive 
energy prices, as being of greater importance.  
75  In  this  context  'harmonised'  means  a  system  under  which  indirect  costs  are  compensated  at  the  same  level 
across the countries concerned. 

38 

 
 
                                                                                                                                                                                     
The more relevant baseline ('Baseline B') assumes the current rules are prolonged to the next 
ETS  phase  (i.e.  amendments  to  the  ETS  Directive  required).  The  option  packages  will 
therefore be assessed against the Baseline B in order to allow for easier comparisons between 
policy options. 

Furthermore, an additional 'Baseline Bbis' package is developed. It is similar to the 'Baseline 
B', but with modified carbon leakage criteria, so the sectors with low emissions are excluded 
from the carbon leakage list. This will shorten the carbon leakage list by  some 100 sectors, 
but will otherwise not have a more distinctive impact, as these sectors only emit about 2% of 
the industrial emissions in the ETS. 

Based  on  the  initial  screening  performed  in  previous  sections,  and  aiming  to  ensure  a 
manageable  level  of  complexity,  three  option  packages  are  proposed  in  addition  to  the 
Baselines. These option packages are developed based on the following guiding principles: 

  The  "Simple"  package  is  structured  around  the  concept  of  minimum  level  of 
administrative burden and complexity. It should be noted that some of the operational 
objectives nevertheless require administrative efforts (e.g. some data collection is still 
needed, but this should be less extensive). 

  The "Targeted" package is based on policy options aiming to ensure that the sectors 
most exposed to the risk of carbon leakage do not face undue costs, while, at the same 
time, avoiding windfall profits. This would be achieved by providing an optimal level 
of free allocation (i.e. regularly updated benchmarks, 2 allocation decisions to reflect 
more recent production data, 4 carbon leakage groups) and mandatory compensation 
for indirect costs to installations.  

  The 'Simple' and 'Targeted' packages represent different ways to address the trade-offs 
between the guiding principles defined by the European Council, as most of the policy 
options  used  for  'Targeted'  package  require  intensive  data  collection,  thereby  going 
contrary to the minimum administrative burden principle. 

  The third package, 'Limited changes', uses a more conservative approach in trying to 
achieve  the  operational  objectives,  while  building  upon  the  current  rules.  This 
package therefore entails only moderate changes compared to 'Baseline B', instead of 
more ambitious exercise presented in 'Simple' and 'Targeted' packages. The 'Limited 
changes' mainly concerns the number of allocation decisions (two instead of one per 
phase) and the number of carbon leakage groups (4 instead of 2). 

The table below summarises the main features of the option packages. 

39 

 
 Table 1: Option packages for addressing the risk of carbon leakage 

Policy option package 

Benchmark update 

Carbon Leakage groups  and criteria / 
Cost pass-through rates 

Production levels and reserve for new 
entrants 

Indirect cost 
compensation 

Baseline B: 
Current rules continued  

Once before 2021 based on real data 

2 groups: 
 
 
Same criteria and thresholds as in Phase 3 

100% - CL-exposed; 
30% - non CL-exposed 

Baseline B bis: 
Current rules continued 
with adjustment of carbon 
leakage criteria 

Simple 

Once before 2021 based on real data   2 groups: 

Reducing all benchmark values by a 
same uniform percentage to reflect 
technological development  

100% - CL-exposed; 
30% - non CL-exposed 

 
 
Somewhat modified criteria and thresholds as 
in Phase 3  

No groups, '100% of costs not passed 
through' reflected by default value (e.g. 90% 
for all, i.e. default level of costs not passed 
through) 
No criteria needed  

Limited changes 

Once before 2021 based on real data   4 groups according to cost pass through 

capability with fixed allocation rates 
Emission intensity and trade criteria  

Targeted 

Two updates (before 2021 and mid-
term) based on real data  

4 groups according to cost pass through 
capability with fixed allocation rates 
Emission intensity and trade criteria  

1 NIMs exercise for 10 years; Same rules for 
capacity changes and (partial) cessations 
New entrant reserve: 5% minus NER300 (i.e. 
ca.3.1% of the cap available for new entrants, 
amounting to some 480 million allowances) 

1 NIMs exercise for 10 years; Same rules for 
capacity changes and (partial) cessations  
New entrant reserve: 5% minus Innovation Fund 
(i.e. ca.2.4% of the cap available for new entrants, 
amounting to some 375 million allowances)  

1 NIMs exercise for 10 years. Annual adjustments 
for significant production level changes (both 
directions: up and down)  
New entrant reserve set up from unallocated 
allowances from phase 3, and replenished by 
allowances from cessations76  

2 separate NIMs exercises for 5 years each. 
Annual adjustments for significant production 
level changes (both directions)  
New entrant reserve set up from unallocated 
allowances from phase 3, and replenished by 
allowances from cessations  

2 separate NIMs exercises for 5 years each. 
Annual adjustments for significant production 
level changes (both directions)  
New entrant reserve set up from unallocated 
allowances from phase 3, and replenished by 
allowances from cessations  

National compensation (subject 
to state aid rules) 

National compensation (subject 
to state aid rules) 

National compensation (subject 
to state aid rules) 

National compensation (subject 
to state aid rules) 

Mandatory financial support by 
Member States from auction 
revenues 

76 For further details please see Annex 14. 

40 

 
 
                                                           
7.5. 

Analysis of impacts 

In  this  section,  the  impacts  of  the  option  packages  presented  in  section  7.4  are  compared  to 
'Baseline B'77 and assessed in terms of achieving operational objectives. 

7.5.1.  Direct and indirect effects 

Free allocation addressing the risk of carbon leakage has a direct impact on industrial installations 
covered by the ETS and on the budgets of the Member States. The amount of free allowances to 
companies  has  an  effect  on  their  cash-flows  and  profit  margins  (as  it  decreases  total  carbon 
costs). It could be argued that free allocation also indirectly affects a company's clients and final 
consumers,  depending  on  the  ability  of  each  actor  in  the  supply  chain  to  pass  the  carbon  costs 
downstream. Due to multiple variables and uncertainties, it is not possible to quantitatively assess 
these indirect effects. 

The  analysis  will  therefore  focus  on  the  analysis  of  the  economic  impacts  (competitiveness 
considerations  for  industry),  environmental  impacts,  social  impacts  and  assessment  of 
administrative complexity. 

7.5.2.  Environmental impacts 

The  environmental  outcome  of  the  ETS  is  determined  by  its  overall  cap  and  the  EU  climate 
ambition. The European Council has decided to reduce GHG emissions in sectors covered by the 
ETS by 43% until 2030. Consequently, the environmental outcome of the ETS is determined by 
the EU ambition in general terms and by the overall cap in particular. This means that a limit is 
set  on  emissions  allowed,  corresponding  to  allowances,  to  ensure  the  reduction  foreseen  is 
achieved.  

When it comes to the international context, EU policies may impact on third country policies on 
climate  and  other  connected  areas.  In  view  of  the  upcoming  international  negotiations  and 
meetings (Conference of the Parties to the UNFCCC set to take place at the end of 2015 in Paris) 
the EU has come forward with an Intended Nationally Determined Contribution (INDC) 78 in the 
form of a binding, economic-wide emission reduction target.  

The  target  includes  the  sectors  benefitting  from  free  allocation.  However,  the  specific  rules  for 
the  distribution  of  free  allowances  will  not  impact  the  policy  choices  of  third  countries.  The 
general setup of the EU ETS and the benchmarking system in particular, has served as an input 
for the design of  other emissions trading systems worldwide, but the positive impact cannot be 
quantified or considered in comparing option packages. 

Another aspect to consider is the impact of the ETS on air quality. In addition to carbon dioxide 
emissions, many installations covered by the EU ETS also generate a significant amount of other 
air pollutants (e.g. NOX, SOX and particulate matter). The reduction of carbon dioxide emissions 
imposed  by  the  ETS  and  the  cap  will  lead  to  a  reduction  of  the  other  air  pollutants,  but  the 
specific choices for the distribution of free allocation will not make a difference in this sense: the 
reduction will happen regardless with the corresponding positive effect on air quality. The overall 

77  'Baseline  A'  reflects  the  current  text  of  the  ETS  Directive,  and  is  the  ‘legal’  baseline.  'Baseline  B'  takes  into 
account the current ETS Directive and assumes that current rules will continue beyond 2020, in line with the spirit of 
the Directive. As such, this is a ‘pragmatic’ baseline. This is the primary baseline for the impact assessment.  
78 Commission Communication "The Paris Protocol – A blueprint for tackling global climate change beyond 2020" 
COM(2015) 81 

41 

 
 
 
                                                           
environmental  goal  remains  unchanged  irrespective  of  the  exact  methodology  to  allocate 
allowances for free.  

In terms of environmental impacts, the risk of carbon leakage has also been considered since it 
implies  a  potential  increase  in  global  emissions.  Nevertheless,  this  is  a  risk  that  has  been 
considered  at  every  step  of  this  analysis  and  all  policy  packages  proposed  include  safeguard 
measures against it, making significant carbon leakage unlikely. As such, the potential impact of 
the  packages  at  global  level  is  considered  to  be  minimal  and  beyond  the  scope  of  this  impact 
assessment. 

7.5.3.  Economic impacts 

The  analysis  carried  out  in  the  context  of  the  2030  climate  and  energy  framework  included 
detailed modelling of economic impacts, including sectoral impacts79, which concluded that free 
allocation of allowances would be an effective means of reducing the risk of carbon leakage and 
preserving  the  output  of  the  concerned  industries.  It  also  notes  that  understanding  of  different 
levels of cost pass-through is needed in order to elaborate carbon leakage measures that provide 
adequate  safeguards,  but  avoid  over-compensation  of  industry  for  costs  recovered  through  the 
market. 

The order of magnitude of the economic impacts of free allocation modalities is estimated to be 
about 6.3 billion allowances, which could amount to some €160 billion80. These public resources 
need  to  be  allocated  in  an  optimal  way,  while  ensuring  that  the  polluter  pays  principle  is  not 
undermined.  In  the  stakeholder  consultation,  NGOs  emphasized  that  these  public  resources 
should be provided only when strictly necessary. 

7.5.3.1.  Quantified impacts on competitiveness 

This section investigates the impact of free allocation options on the compliance costs at sector 
level and the  possibilities to  pass on these  compliance costs to  consumers81. It should be noted 
this analysis does not cover all aspects of competitiveness. In particular, a qualitative assessment 
on incentives for innovation – which will determine carbon costs in the long-term – will follow in 
section 8.1 below.  

The  purpose  of  the  free  allocation  and  carbon  leakage  rules  is  to  address  the  costs  which 
installations  included  in  the  ETS  may  be  facing  due  to  the  ETS,  potentially  putting  them  at 
disadvantage vis-à-vis international competitors that do not face comparable climate policy costs. 
If  installations  in  third  countries  would  face  similar  costs,  for  instance  as  a  result  of  the 
conclusion  of  an  international  binding  agreement  on  climate  change  or  the  implementation  of 
climate policies at national level, the carbon leakage risk would disappear. It should be noted that 
other countries may also use  policy measures like free allocation. However, the more countries 

79 See Impact Assessment for the 2030 Climate and Energy Framework (e.g. Section 5.1.4.). 
80 Calculated with the allowance prices estimated in the "EU Energy, Transport and GHG emissions Trends to 2050 
– Reference scenario 2013 (http://ec.europa.eu/clima/policies/2030/docs/eu_trends_2050_en.pdf ) 
81  OECD  study  found  that  substantial  cost  pass-through  of  EU  ETS  allowance  price  is  found  in  the  empirical 
literature, both in electricity and manufacturing sectors. Especially in electricity markets, cost pass-through rates to 
wholesale  prices  are  found  to  lie  between  60%  and  larger  than  100%.  In  manufacturing,  the  extent  of  cost  pass-
through is varied. Pass-through rates found in the literature vary between 0% pass-through for UK glass production 
to  20%  in  ceramics,  and  more  than  100%  in  iron,  steel,  chemicals  and  refineries.  This  implies  that  in  all  markets 
investigated, producers do not bear the full carbon costs and that in most markets investigated, producers can pass on 
a large share of the carbon cost to product prices and do thus not bear more than a minor share of carbon costs. For 
details, please refer to Arlinghaus, J. (2015), “Impacts of Carbon Prices on Indicators of Competitiveness: A Review 
of Empirical Findings”, OECD Environment Working Papers, No. 87, OECD Publishing, Paris. 

42 

 
 
 
                                                           
taking action against climate change, the less there is a need for individual countries to provide 
free allocation. 

(a) Impact on compliance costs  

The compliance costs depend on the carbon price, the level of free allocation, and the amount of 
emissions released during production. 

The carbon price is not directly impacted by modalities for distribution of free allocation, as the 
total amount of allowances available (the cap) has been fixed in advance (see section 6.1 on the 
linear  reduction  factor)  and  is  not  affected  by  the  modalities  of  allocation  (auctioning  or  free 
allocation).  The  carbon  price  is  rather  influenced  by  other  factors,  such  as  the  surplus  of 
allowances in the system, the level of industrial production, the level of emissions, etc.  

Therefore,  the  total  carbon  costs  at  macro  level  are  determined  by  the  40  %  overall  GHG 
reduction target, and the specific 43% reduction target for the ETS. The effects of these targets 
have  been  analysed  in  the  impact  assessment  for  the  2030  climate  and  energy  framework. 
Furthermore, it is important to recall that the European Council conclusions have also determined 
the total amount of available allowances for free. The difference between the option packages is 
therefore how this finite amount is distributed among industrial sectors. The higher the amount of 
free allocation, the lower the compliance costs for a sector. 

The  impacts  of  free  allocation  and  carbon  leakage  options  on  the  competitive  position  of  ETS 
sectors  have  been  analysed  and  compared  to  the  outcome  under  'Baseline  B'82.  Other  factors 
affecting competitiveness, but not related to the EU ETS (e.g. global change of demand and trade 
patterns, labour costs, access to finance and capacity to invest etc.) are not analysed since they are 
independent from the ETS. 

Following the call of the European Council conclusions "to provide appropriate levels of support 
for  sectors  at  risk  of  losing  international  competitiveness",  the  carbon  leakage  rules  should 
achieve a targeted allocation of free allowances across sectors such to avoid undue costs for the 
most efficient installations.   

The 'Baseline B' package – based on the current ETS rules – fails to respond to this call because 
a mere continuation of the current approach – based on two carbon leakage groups – would lead 
to an average correction factor of some 10% to 20% over the next decade83. This means that free 
allocations  across  all  sectors  would  be  reduced  by  this  percentage  irrespective  of  their  carbon 
leakage risk.  

As shown in Table 2, 'Baseline Bbis' would reduce by two thirds the number of sectors eligible 
for increased level of free allocation as a result of being on the carbon leakage list, but still lead to 
similar  levels  of  free  allocation  as  'Baseline  B'.  The  free  allocation  would  only  be  reduced  by 
about  2%  since  most  of  the  sectors  removed  from  the  list  emit  very  little.  Consequently,  this 
would entail some redistribution from the sectors removed from the carbon leakage list to those 
on the list but not significantly reduce the correction factor. The "Simple" package is not included 
in Table 2 since all sectors would be in one and the same group.  

82 Please see the more detailed analysis results in Annex 7 Impacts of different option packages for free allocation on 
individual sectors. 
83 For the purposes of the analysis it is assumed that (i) benchmarks values would be reduced by 1% per annum on 
average if recalculated based on new performance data, and (ii) that production will moderately increase compared to 
2014  level  (last  available  data  at  the  time  of  the  analysis),  but  on  average  will  not  reach  the  production  levels 
experienced in the baseline period for phase 3 (median annual production during 2005-08 or 2009-10, depending on 
which value is higher per sub-installation).  

43 

 
 
 
                                                           
Table 2: Estimated number of sectors and distribution of free allowances under 'Baseline', 'limited 
changes' and 'targeted 'options 

Baseline B 

Baseline Bbis 

Limited changes 

Targeted 

# sectors 

Very High 

150 

Distribution of 
free 
allowances 
across groups 
95% 

# sectors 

Distribution 
of free 
allowances 
across groups 

54 

93% 

High 

Medium 

Low 

86 

5% 

182 

7% 

# sectors 

Distribution of 
free allowances 
across groups 

# sectors 

Distribution of 
free allowances 
across groups 

4 

12 

42 

178 

33% 

32% 

32% 

3% 

5 

9 

21 

201 

33% 

49% 

11% 

8% 

The  'Simple'  option  package84  offers  a  similar  level  of  free  allocation  as  'Baseline  B'  and 
'Baseline Bbis'  for the  industrial  sectors  that are currently  on the carbon leakage list.  There are 
some  limited  differences  among  sectors  in  terms  of  level  of  free  allocation  level  compared  to 
'Baseline B', because updating the benchmark value by using a flat rate can have different effects 
for  different  sectors.  This  happens  because  of  varying  rates  of  emission  intensity  reductions 
linked to technological improvements and investment cycles. 

At  the  same  time,  the  'Simple'  option  package  would  lead  to  significantly  higher  levels  of  free 
allocation than 'Baseline B' for those sectors that are currently not on the carbon leakage list, as 
they would move from the group with 30% free allocation to 90% free allocation. 

Even though the coverage is reduced from 100% to 90% for most sectors, a correction factor of 
5% to 10% would kick in and lead to an effective coverage of around 80% (comparable to levels 
under 'Baseline B'). 

The 'Limited changes' and the 'Targeted' options packages offer a more refined classification 
of  sectors  into  four  carbon  leakage  groups  based  on  the  same  criteria  –  emission  and  carbon 
intensity  –  as  in  the  'Baseline'  packages.  Depending  on  the  carbon  leakage  group  (Very  high, 
High,  Medium  or  Low),  the  amount  of  free  allowances  can  increase  or  decrease  compared  to 
'Baseline  B'.  The  more  refined  classification  into  four  groups  is  estimated  to  minimise,  if  not 
avoid the correction factor. 

Sectors  in  the  'Very  high'  group  (100%  free  allocation)  will  receive  more  free  allowances 
compared to the 'Baseline B' packages if the correction factor disappears.  

For sectors in the 'High' carbon leakage group, the total amount of free allocation under these two 
option  packages  would  be  quite  similar  to  allocation  under  'Baseline  B'.  This  would  happen 
because the difference in carbon leakage  factors85 (80% instead of 100% under 'Baseline B')  is 
estimated  to  be  in  the  same  order  of  magnitude  as  the  average  cross-sectoral  correction  factor 
estimated for 'Baseline B' over phase 4. So instead of a correction factor of about 20%, there will 
be a reduction of allocation of 20% due to the lower allocation rate (assuming the same level of 
benchmark updates under both options). 

For sectors, which are in the group with 100% free allocation under the 'Baseline B' package but 
would now change to the 'Medium' and 'Low' groups, the level of free allocation would be lower 
('Medium' group) or significantly lower ('Low' group) compared to 'Baseline B'.  

84 For the purposes of the analysis, a 1% per annum flat-rate benchmark update and a 90% uniform carbon leakage 
factor has been assumed for the 'Simple' package 
85 The carbon leakage factors define what percentage of the 'gross' free allocation sectors in the given carbon leakage 
group receive 

44 

 
 
 
 
 
 
 
 
 
 
 
 
                                                           
The  figure  below  summarises  how  the  various  carbon  leakage  groups  impact  the  level  of  free 
allocation  for  the  15  largest  sectors.  All  sectors  are  under  current  rules  ('Baseline  B')  on  the 
carbon leakage list and entitled to 100% free allocation. However, due to the correction factor of 
around 15-20% on average, they will effectively receive only around 80-85% of free allocation 
(to respect the overall constraint on the total amount of available allowances for free).  

Figure  4:  Estimated  combined  effect  of  carbon  leakage  groups  and  the  correction  factor  under 
different option packages86 

(b) Compliance costs and possibilities for cost pass through  

The compliance costs borne by sectors are ultimately dependent on their ability to pass through 
carbon  costs  to  their  customers.  The  ETS  Directive  already  recognises  this  fact  suggesting  that 
the  level  of  carbon  leakage  risk  possibly  faced  by  sectors  depends  on  the  extent  to  which  it  is 
possible for these sectors to pass through their costs without losing market share.  

Although there is a general understanding that carbon-intensive sectors are able to pass through at 
least  a  part  of  the  carbon  costs,  it  remains  to  date  difficult  to  quantify  the  exact  rate  of  costs 
passed through per sectors or products. 

It is  generally recognised that some  industrial sectors may face increasing competitive pressure 
on the international markets, potentially making it more challenging for them to sustain existing 

86 See Annex 7. As data from the (currently: future) baseline period for any actual future carbon leakage assessment 
are  not  yet  available  at  the  time  this  estimation  is  prepared,  the  graphs  should  be  interpreted  purely  as  a  rough 
indicator of the possible outcome of the option packages. The final outcome of the actual assessment, i.e. to which 
group  each  sector  will  belong,  can  be  similar  to  the  situation  illustrated  by  the  graphs  below  in  case  the  main 
indicator values (emission intensity and trade intensity) in the future will be similar to  the ones based on 2009-11 
data. 

45 

 
 
 
 
                                                           
pass-through rates. At the same time, it is reasonable to assume that climate policies will become 
more  significant  in  other  countries  over  time,  which  could  lead  to  increased,  or  at  least  stable, 
cost pass-through rates.  

As the number of total allowances will further decrease over the next decade, it is possible that 
industries will face increased compliance costs after 2020 but this will ultimately depend on the 
ability  to  increase  carbon  efficiency  in  production,  and  the  ability  to  pass  on  carbon  costs,  e.g. 
through more specialised products. Considering that a share of carbon costs is likely to be passed 
through,  it  can  effectively  limit  carbon  cost  increases  for  industrial  sectors.  In  some  cases, 
additional carbon costs may be more than fully offset by increases in product prices. See Annex 7 
for  more  detailed  results  for  some  of  the  biggest  sectors  in  terms  of  emissions  (steel,  cement, 
refineries, chemicals, fertilisers, glass, paper and aluminium).  

7.5.3.2.  Administrative burden 

Avoiding an increase of the administrative complexity is an operational objective relevant for all 
elements  of  the  option  packages.  For  the  purposes  of  this  impact  assessment,  the  level  of 
administrative complexity was quantified using the EU Standard Cost Model, complemented with 
qualitative  expert  judgment.  In  particular,  the  costs  were  estimated  separately  for  the  data 
collection  needed  for  NIMs  exercises87,  benchmark  update,  annual  adjustments  for  production 
level  changes  compared  to  baseline  (capacity  changes  and  cessations);  and  compensation  for 
indirect carbon costs. 

The underlying methodology and detailed calculations are presented in Annex  8.1. In short, the 
option  packages  'Limited  changes'  and  'Targeted'  lead  to  higher  costs  compared  to  'Baseline  B' 
(€82  million  and  €110  million,  respectively),  reflecting  a  higher  level  of  administrative 
complexity  (due  to  additional  data  collection  exercise).  To  note  in  this  context,  one  full  data 
collection  is  estimated  to  cost  about  €80  million.  The  annual  adjustment  for  significant 
production changes is  not  expected to  trigger substantial additional administrative costs as they 
replace activities currently required for 'Baseline B' (capacity changes and partial cessations). For 
that  reason,  the  administrative  costs  of  the  ''Simple"  package'  and  'Baseline  B'  package  are  not 
expected  to  differ  significantly.  The  'Targeted'  package  shows  the  highest  administrative 
complexity due to the mandatory financial support for indirect cost compensation. 

7.5.4.  Social impacts 

7.5.4.1.  Employment 

The  analysis  of  social  impacts  has  been  undertaken  and  is  presented  in  detail  in  Annex  8.2.  It 
concluded that the estimated impacts across different option packages are limited in nature. In a 
more  targeted  allocation,  the  costs  for  the  sectors  that  receive  lower  allocation  will  be  higher, 
which a priori could lead to more employment losses for those sectors. But as explained above, 
since the reason for the lower allocation to some sectors would be the ability to pass on costs, this 
should limit the employment effects. 

87  In  2011-2013,  Member  States  submitted  their  National  Implementation  Measures  (NIMs)  containing  verified, 
detailed and commercially sensitive data on preliminary free allocation to industrial installations in the EU Member 
States, which was subsequently checked by the Commission for compliance with the harmonised allocation rules and 
are used for the analysis of the amount of free allocation to industrial installations. 

46 

 
 
 
                                                           
Total  employment  impact  has  been  estimated  by  considering  whether  the  additional  costs  are 
absorbed  by  the  manufacturing  sectors,  or  are  being  passed  through  in  higher  prices  to  the 
customers, resulting in decreasing sales (i.e. not absorbed by the sector).  

For  the  option  packages  'Simple',  'Limited  changes'  and  'Targeted',  small  positive  impacts  on 
employment compared to 'Baseline B' are expected in the order of magnitude of up to 5000 jobs, 
representing an increase of 0.1%. 

An  additional  aspect  on  employment  is  the  likelihood  that  an  ambitious  climate  policy  will 
generate  a  demand  for  low  carbon  technologies,  and  renewable  energy.  If  industrial  sectors 
covered by the ETS do not receive more free allocation than necessary to cover their real costs 
(that  cannot  be  passed  on),  this  should  incentivize  higher  demand  for  such  technology  and 
services, leading to positive employment impacts. These effects have not ben quantified. 

The  employment  impact  of  'Baseline  A'  is  slightly  negative  reflecting  the  additional  cost  for 
companies.  

In  the  lower  estimate  case,  where  all  absorbed  costs  are  reflected  in  changed  profits,  the  total 
employment  impact  will  reflect  the  consequences  of  the  costs  passed  through.  In  this  case,  the 
employment impacts are even more negligible. 

7.5.4.2.  Energy prices for households 

The impacts on the energy prices for households that are supplied by district heating covered by 
the ETS were also assessed (Annex 8.2). 

Overall,  the  estimated  impacts  of  the  'Simple'  option  package  compared  to  'Baseline  B'  are 
reductions in heat prices of € 0.77/GJ (almost 3% of baseline price). For 'Limited changes' there 
will be no significant change, while for the 'Targeted' a small increase of 0.8% is projected, due 
to a reduction of the heat benchmark.  

The  'Simple'  option  package  results  in  the  highest  reduction  due  to  the  significantly  more 
generous carbon leakage factor compared to 'Baseline B' which outweighs the effect of a reduced 
benchmark value. The limited cost reduction for 'Limited changes' results from the fact that no 
cross-sectoral correction factor is expected to be used for these options. 

7.5.5.  Comparing the options  

In the following assessment step, in addition to the quantified impacts, the operational objectives 
as described in section 7.2 are used to compare the option packages. 

7.5.5.1.  Quantified environmental and social impacts 

No  significant  differences  have  been  identified  between  policy  option  packages  in  terms  of 
environmental impacts because the required GHG emission reduction of 43% in 2030 (compared 
to 2005)s and air pollution are determined through the increased linear reduction factor of 2.2% 
(see section 6.1).  

In terms of social impacts employment level and prices for district heating have been considered. 
Regarding impacts on the level of employment, no significant differences between policy option 
packages  and  'Baseline B' have  been  identified.  With the exception  of  the  'Simple'  package, no 
significant  impacts  on  prices  for  district  heating  have  been  identified.  The  'Simple'  package  is 

47 

 
 
 
 
 
expected to lead to lower  prices in the order of magnitude of 3%  of the baseline price. For the 
'Targeted' package, a limited price increase of 0.8% is estimated. 

In conclusion, for social impacts, overall, the differences between the options packages are rather 
small.  The  'Simple'  package  could  be  considered  as  slightly  better  than  'Baseline  B'  due  to  the 
positive  impact  on  district  heating  prices  for  households.  'Baseline  Bbis'  and  the  'Targeted' 
packages  could  be regarded as  less beneficial  due to  slightly higher district  heating prices. The 
'Limited changes' package shows no significant difference compared to 'Baseline B'. 

7.5.5.2.  Reflect technological progress in industry sectors 

Regular updates based on data collection ('Baseline', 'Limited changes' and 'Targeted' packages) 
will most closely align the benchmark values to technological progress. 

Updates based on a single flat rate ('Simple' package) will yield a benchmark value that is more 
demanding for sectors with below-average technological capabilities than for sectors with above-
average technological capabilities. A more nuanced approach, for instance with an update based 
on multiple flat rates (e.g. low, medium, high) and/or complemented with data collection, could 
bring a closer alignment to achieved technological progress in different sectors. 

The 'Targeted' package ensures technological progress is reflected in the benchmark values more 
closely than other packages due to regular recalculation of all benchmarks based on collection of 
sector-specific data.  

The  'Simple'  package  reflects  technological  progress  by  applying  a  flat-rate  percentage  to  all 
benchmark  values.  At  the  same  time,  this  simple  approach  based  on  a  single  flat-rate  cannot 
account  for  differences  between  sectors  in  terms  of  their  historic  ability  to  reduce  GHG 
emissions.  

The option packages 'Limited changes', 'Baseline B' and 'Baseline Bbis' update benchmarks once 
prior  to  2021  based  on  newly  collected  data.  This  allows  for  a  reflection  of  technical  progress 
made  by  then.  However,  technical  developments  after  this  update  cannot  be  considered. 
Therefore, these packages can be ranked between 'Targeted' as the best package, and 'Simple'. 

7.5.5.3.  Fully preserve incentives for industry to innovate  

A  too  close  alignment  of  free  allocation  to  the  characteristics  of  an  industry  (technological 
progress, production or emission levels) may reduce the incentives to innovate.  

More  frequent  benchmark  updates  based  on  full  data  collection  (like  in  the  'Targeted'  package) 
may lower innovation incentives as companies would fear that they could not earn the full return 
on  their  innovation  efforts.  To  the  contrary,  a  benchmark  update  that  is  based  on  a  single  or 
multiple flat rate(s) does not  as rapidly and fully reduce allocation of the best performing sectors 
but leaves them a fair share of these gains. At the same time, it keeps the pressure on sectors with 
slow innovation rates to improve further.  

Similarly, a mandatory compensation of indirect carbon costs in full, as desired by some industry 
stakeholders,  may  come  at  the  cost  that  companies  have  less  incentives  to  search  for  contracts 
with providers of renewable energy on the market or for Member States to support investments 
into renewable energy with a view to bring down the carbon intensity of electricity (and thereby 
the carbon costs).  

48 

 
 
 
 
7.5.5.4.  Most efficient installations do not face undue carbon costs leading to carbon leakage 

A key request from the European Council conclusions is to better target free allocation towards 
those installations that are best performers and are most exposed to carbon leakage risks. 

The  benchmark  values  have  to  be  updated  in  line  with  technological  progress  (but  without 
compromising innovation incentives).  

The amount of free allocation has to be brought in line with the degree of carbon leakage risk to 
which  the  sectors  are  exposed.  The  'Baseline'  packages  fail  to  achieve  a  targeted  allocation 
because  the  correction  factor  –  that  may  increase  to  around  30-35%  in  2030  –  decreases  free 
allocation across sectors irrespective of their carbon leakage risks. The option packages 'Limited 
changes' and 'Targeted' show how to better address the differences in carbon leakage risk across 
sectors by classifying sectors into 4 carbon leakage groups and possibly avoiding the correction 
factor. 

To ensure that the most efficient installations do not face undue carbon costs leading to carbon 
leakage, it is important that those installations that can operate at a carbon-efficiency level close 
to the applicable benchmarks receive a level of free allocation that covers their carbon costs that 
are not passed through to consumers.  

The  benchmarking  approach  in  general  leads  to  a  low  risk  of  undue  carbon  costs  for  the  most 
efficient installations as those de facto set the benchmark values. However, the 'Simple' package 
is  not  sector-specific  (reducing  values  of  2007-08  benchmarks  by  a  flat-rate  percentage)  and 
some sectors might not be able to reduce their emissions to the same extent as others. Examples 
are  activities  with  a  significant  share  of  CO2  process  emissions.  This  specific  situation  could 
however  be  addressed  by  using  multiple  flat  rates,  and/or  complementing  with  additional  data 
collection.  Therefore,  the  "Limited  changes",  "Targeted"  and  "Baseline  B"  packages  with  their 
sector-specific benchmark updates score better in ensuring that the most efficient installations can 
operate at benchmark levels. 

The  option  packages  'Limited  changes'  and  the  'Targeted'  offer  refined  classification  of  sectors 
into four carbon leakage groups and are expected to avoid the application of the correction factor. 
The 'Baseline' packages and the 'simple' package do not achieve a free allocation that matches the 
carbon  costs  of  the  most  efficient  installations  because  the  correction  factor  kicks  in:  the 
estimated average correction factor (over the period 2021 – 2030) for package 'Simple' is around 
5-10% and 10-20% for 'Baseline B' and 'Baseline Bbis'. In 2030, the correction factor may even 
reach 35%. 

It is noteworthy that 'Baseline Bbis' excludes a high number of sectors with low trade or carbon 
intensity  from  100%  free  allocation,  However,  this  is  not  enough  to  significantly  reduce  the 
correction factor because those excluded sectors would anyway be eligible only for a low number 
of free allowances (due to their low carbon intensity). 

As part  of the 'Targeted' package,  mandatory  financial  support to  compensate for indirect costs 
(passed  through  carbon  costs  of  electricity  production)  would  minimise  the  risk  that  the  most 
efficient installations of electro-intensive sectors could face undue carbon costs.  

To  conclude,  'Targeted'  package  offers  a  range  of  elements  to  ensure  the  most  efficient 
installations  do  not  face  undue  carbon  costs.  The  package  'Limited  changes'  addresses  indirect 
costs to a lesser extent, but has a clearly higher capability to avoid undue costs for most efficient 
installations  than  'Baseline  B'  (since  in  "Limited  Changes"  a  cross-sectoral  correction  is  not 
expected  to  be  applied).  'Baseline  Bbis'  leads  to  similar  results  as  'Baseline  B'.  The  'Simple' 

49 

 
 
package fails to provide a better targeted allocation as all sectors receive the same percentage of 
free allocation and the correction factor is also triggered.  

7.5.5.5.  Better alignment with production levels 

Based  on  the  lessons  learnt  from  the  current  EU  ETS  phase,  the  rules  for  the  adjustments  to 
changes in production levels and for the New Entrants Reserve can be improved (as in 'Simple', 
'Limited  changes',  and  'Targeted'  option  packages).  These  changes  can  further  contribute  to 
reduce the correction factor and provide more free allowances for fast-growing companies. 

'Baseline  B'  allows  adjustments  for  production  level  decreases  (partial  cessation  rules)  and 
significant capacity increases. However, no additional free allowances are granted for production 
increases. Furthermore, the rules for the New Entrants' Reserve stay unchanged. 

The  'Limited  changes'  and  'Targeted'  packages  ensure  a  very  high  level  of  alignment  with 
production levels as they use two baseline periods, thus avoiding that allocation at the end of the 
period  is  based  on  production  data  more  than  a  decade  old.  Furthermore,  they  allow  annual 
adjustments  for  changing  production  levels  in  both  directions  (increases  and  decreases).  This 
means additional allocation can be provided for significantly increased production even without a 
capacity increase. 

For the 'Simple' package, the alignment with production levels is better than for 'Baseline B' due 
to the annual adjustments for changing production levels in both directions. However, only one 
data collection process for 10 years is part of this package.  

More  flexible  rules  for  the  New  Entrants  Reserve  (with  the  'Simple',  'Limited  changes'  and 
'Targeted' packages) will provide more allowances for fast-growing installations. Furthermore, if 
the New Entrants Reserve is funded by unallocated allowances from phase 3 (and not from the 
available  free  allowances  in  phase  4),  a  higher  amount  of  free  allowances  will  be  available  for 
distribution  to  industries.  This  will  help  to  reduce  the  correction  factor  and  lead  to  a  more 
targeted allocation of free allowances. It could however impair to some extent the functioning of 
the Market Stability Reserve. 

7.5.5.6.  Avoid windfall profits 

A better targeted allocation system, considering cost pass-through (as with the 'Limited changes' 
and 'Targeted' packages), will also reduce the likelihood for windfall profits. 

Windfall  profits  are  avoided  if  the  allocation  system  provides  compensation  only  for  costs  that 
are actually assumed  by the operators, i.e.  costs which  cannot be  passed on into product prices 
without a significant loss of market share. A well-targeted allocation system aims to achieve this 
objective.  

The 'Limited changes' and 'Targeted' packages are highly targeted with their four carbon leakage 
groups  and  benchmark  values  reflecting  updated  performance  data,  and  thus  represent  a  lower 
level of risk of windfall profits than 'Baseline B'.  

On  the  contrary,  the  'Simple'  package  (with  no  carbon  leakage  groups)  has  a  higher  risk  of 
windfall profits in certain sectors than in 'Baseline B' (two groups).  

Furthermore,  the  high  level  of  alignment  with  production  levels  of  the  'Limited  changes'  and 
'Targeted' packages leads to a lower risk of windfall profits from overestimated production levels 

50 

 
 
 
 
for those two packages. The  'Simple' package allows such adjustments to  a lesser extent, but is 
still somewhat better in that respect than the 'Baseline B' packages. 

7.5.5.7.  No increased administrative complexity 

A fully targeted allocation system comes at the cost of higher administrative complexity. 

Administrative complexity puts a burden both on private companies, as well as public authorities.  

The  'Limited  changes'  and  'Targeted'  packages  show  the  highest  degree  of  administrative 
complexity:  the  frequent  and  detailed  adjustments  of  all  elements  (benchmark  values,  carbon 
leakage  groups,  production  levels)  may  lead  to  lengthy  administrative  processes  and  therefore 
reduce predictability for industry. In particular, a regular  update of the benchmark values based 
on  full  data  collection  (from  all  installations  in  the  EU)  will  involve  a  high  workload  for  all 
involved  parties  because  each  benchmark  value  has  to  be  re-calculated  precisely  taking  into 
account lessons learnt from the first data collection exercise. To the contrary, an approach based 
on flat rates can build on the existing benchmarks. 

With regard to the alignment to production data, the administrative costs of the 'Simple' package 
and 'Baseline B' are not expected to differ significantly as both packages are based on one  data 
collection exercise. The annual adjustment for significant production level changes (as introduced 
in  the  'Simple'  package)  is  expected  to  decrease  administrative  complexity  because  these  new 
rules would simplify the current procedures for capacity changes and partial cessations.  

With  regard  to  carbon  leakage  rules,  a  higher  number  of  groups  could  require  some  more  data 
from  certain  installations  (e.g.  installations  exporting  or  using  heat  for  several  activities)  and 
therefore  slightly  increase  administrative  costs.  Finally,  the  'Targeted'  package  foresees  that  all 
Member  States  shall  provide  compensation  for  indirect  costs.  As  currently  the  vast  majority  of 
Member States does not provide compensation, this requirement will increase the administrative 
burden for those national authorities which would otherwise not provide compensation, as well as 
beneficiary companies in those Member States.  

7.5.6.  Concluding remarks 

The  2030  Climate  and  Energy  Framework  –  as  endorsed  by  the  European  Council  in  October 
2014 – sets important limits on the allocation of free allowances to industry:  

  There will only be a limited amount of allowances available for free allocation to industry 

as from 2021 (see section 6.2 on the auction share);  

  This  limited  amount  of  free  allowances  will  decrease  further  in  line  with  the  linear 

reduction factor (see section 6.1.).  

Furthermore,  the  European  leaders  have  given  clear  guidance  that  the  allocation  of  this  limited 
amount of free allowances should be done in such a way not to constrain the competitiveness of 
European industries (as long as other major economic regions have not adopted similar climate 
policies).  The  operational  objectives  (as  listed  in  the  table  below)  are  therefore  based  on  the 
guidance  by  the  European  leaders,  and  the  first  four  operational  objectives  refer  to 
competitiveness in its different dimensions.  

The foregoing assessment has shown that it is possible to better target the available allowances 
towards those sectors that are most exposed to carbon leakage risks ("Targeted" option package):  

51 

 
 
 
 
  Regular updates of benchmarks to better reflect technological progress; 

  More refined classification of sectors according to their carbon leakage risks; 

  Closer alignment of free allocation to recent production levels. 

However,  such  a  policy  has  its  costs  in  terms  of  reduced  innovation  incentives  and  increased 
administrative  complexity.  In  particular,  repeated  benchmark  updates  based  on  full  data 
collection may lower innovation incentives as companies would fear that they could not retain the 
full  return  on  their  innovation  efforts.  Furthermore,  each  additional  collection  of  benchmarking 
and production data increases administrative costs for private companies and public authorities. 

Similarly, a more harmonised compensation of indirect carbon costs – out of the EU ETS auction 
revenues  for  Member  States  –  has  the  benefit  to  offer  a  better  protection  for  electro-intensive 
industries.  But  this  comes  at  the  cost  that  auction  revenues  cannot  be  used  to  support  e.g. 
renewable electricity generation that may in the long term be the better investment to reduce the 
carbon  costs.  Furthermore,  higher  compensation  may  reduce  the  incentives  for  companies  to 
search for contracts with providers of renewable energy on the market. 

Table 3: Overview of assessment of policy option packages compared to 'Baseline B' 

Operational objectives 

Baseline B 

Baseline B 
bis 

Simple 

Limited 
changes 

Targeted 

Technological progress 
reflected 

Incentives to innovate fully 
preserved 

No undue costs for most 
efficient installations 

Better alignment with 
production levels 

Avoid windfall profits 

No increased 
administrative complexity 

0 

0 

0 

0 

0 

0 

0 

0 

0 

0 

0 

0 

- 

+ 

- 

+ 

- 

++ 

0 

0 

++ 

++ 

+ 

- 

++ 

- 

++ 

++ 

++ 

-- 

Given the trade-offs emerging from the analysis and the range of guiding principles for the future 
carbon leakage and free allocation rules agreed by the European Council, policy makers will have 
choices between the following alternatives:  

  The  'Baseline  B'  and  'Baseline  Bbis'  packages  provide  predictability  to  industry  as  the 
current rules are continued. However, industry will be subject to a uniform cross-sectoral 
correction factor that may increase up to 35% in 2030 and reduce  free allocation across 
sectors  irrespective  of  their  carbon  leakage  risk.  Even  though  'Baseline  Bbis'  excludes 
sectors with low trade or carbon intensity from 100% free allocation group, this will not 
significantly  reduce  the  correction  factor  because  those  excluded  sectors  would  anyway 
be eligible only for a low number of free allowances (due to their low carbon emissions). 

  The 'Simple' package groups together the options with low administrative complexity:  

o  The  benchmarks  are  updated  based  on  a  flat-rate  –  which  reflects  the  average 
technological progress over the last decade – instead of going through a laborious 

52 

 
 
 
and complex data collection exercise to re-establish new benchmark values for all 
sectors.  This  keeps  administrative  costs  low  and  provides  good  incentives  for 
innovation as above-average performers can keep a larger share of their profits. A 
further  benefit  is  the  closer  alignment  of  free  allocation  to  production  data  that 
comes at limited additional administrative cost. 

o  However,  on  the  down-side,  this  simple  benchmark  and  a  single  carbon-leakage 
group with 90% free allocation do not  sufficiently take account of differences in 
technological  capabilities  or  in  carbon  leakage  risks  across  sectors.  The  'Simple' 
package  scores  therefore  poorly  on  avoidance  of  undue  costs  and  reflection  of 
technological progress. 

o  An interesting improvement to better reflect technological differences could be to 
use  three  flat  rates  (low,  medium,  high)  instead  of  one  to  address  outliers.  Even 
though  some  data  collection  would  become  necessary,  the  administrative 
complexity  would  still  be  considerably  lower  than  with  a  full-fledged  re-
benchmarking of all individual rates. 

  The  option  packages  'Limited  changes'  and  'Targeted'  show  how  to  better  address  the 
differences in carbon leakage risks across sectors. Instead of two carbon leakage groups 
('Low risk' with 30% free allocation and 'Very high' risk with 100% free allocation), the 
sectors are classified into four groups according to their risk exposure. In addition to the 
two  existing  groups,  a  'High  risk'  group  with  80%  free  allocation  and  a  'Medium  risk' 
group with 60% free allocation are created. This more refined classification methodology 
provides  a  better  targeted  distribution  of  allowances  across  sectors  and  avoids  that  the 
most  exposed  sectors  face  undue  carbon  costs  but  also  that  less  exposed  sectors  enjoy 
windfall profits. 

Together  with  regular  benchmark  updates  based  on  data  collection  (two  collection 
exercises in 'Targeted package") and a more harmonised indirect cost compensation (only 
with  'Targeted'  package),  these  packages  show  also  the  highest  degree  of  administrative 
complexity.  Furthermore,  the  frequent  and  detailed  adjustments  of  all  elements 
(benchmark values, carbon leakage group, production level) may reduce predictability and 
therefore investment and innovation incentives.  

Given the advantages and disadvantages of the different packages, it could also be considered to 
choose  certain  measures  of  the  'Simple'  package  that  perform  well  with  regard  to  economic 
incentives and administrative simplicity – e.g. benchmark values based on (multiple) flat rate(s) 
and closer alignment to production data – and combine them with the carbon leakage rules (from 
the  'Limited  changes'  and  'Targeted'  packages)  to  better  target  free  allowances  towards  those 
sectors  that  are  most  exposed  to  carbon  leakage  rules.  However,  the  policy  choice  ultimately 
depends on what emphasis decision-makers put on the different objectives. 

8. 

LOW-CARBON FUNDING MECHANISMS 

The impact assessment of the 2030 climate and energy framework indicated that in the period to 
2030  significant  investments  will  be  needed  in  the  EU  for  energy  system  modernisation  and 
reaching the 2030 climate and energy framework objectives. According to the impact assessment, 
the  investments  for  meeting  the  2030  objectives  would  be  higher  compared  to  GDP  for  lower 
income  Member  States,  reflecting  the  relatively  higher  carbon  intensity  and  lower  energy 
efficiency  of  their  economies  and  more  limited  financial  resources.   Lower  income  Member 
States may face general and financial barriers (less liquid local financial markets, high risk profile 
and  limited  creditworthiness  of  several  key  actors)  to  mobilise  the  required  investments  which 

53 

 
 
may  prevent  full  financing  by  the  market  and  limit  the  potential  to  finance  the  needed 
investments  without  public  support.  Realising  the  emission  reductions  in  the  lower  income 
Member States could thus contribute to cost-effective reductions from a European perspective. It 
could also contribute towards the priorities of the European Energy Union with a forward-looking 
climate policy: more sustainable, secure, competitive and affordable energy for both citizens and 
businesses. 

In this context, the European Council has agreed that a reserve of 2% of the EU ETS allowances 
will be set aside between 2021 and 203088, and the proceeds from selling the allowances in this 
reserve  will  be  used  to  create  a  Modernisation  Fund  supporting  the  lower  income  EU  Member 
States (with GDP per capita below 60% of the EU average) in improving energy efficiency and 
modernising  their  energy  systems,  while  ensuring  simplified  arrangements  for  small  scale 
projects. Furthermore, the existing option for lower income Member States to allocate allowances 
for  free  to  their  power  sectors  is  to  be  continued  up  to  a  maximum  of  40%  of  the  allowances 
belonging  to  a  given  Member  State  before  redistribution.  Such  investments  will  need  to  be 
aligned with European climate and energy policies and (where relevant) support will be subject to 
State aid control. In contrast to the Innovation Fund, where allowances belonging to all Member 
States  are  used  and  projects  from  across  the  EU  are  eligible  for  support,  for  the  Modernisation 
Fund,  while  allowances  from  all  Member  States  are  used,  only  projects  in  the  beneficiary 
Member  States  would  be  eligible.   The  share  of  each  of  the  beneficiary  Member  States  for  the 
Modernisation Fund follows directly from the European Council conclusions of October 2014. 

In  addition,  the  ETS  Directive  supports  low-carbon  innovation  through  renewables  and  carbon 
capture  and  storage  through  the  existing  NER  300  mechanism.  The  €2.1  billion  of  NER  300 
funding  awarded  so  far  will  leverage  approximately  €2.7  billion  of  private  investments  and 
mobilise  €700  million  from  other  public  sources  (see  Annex  4.1).  Recognising  the  continuing 
importance  of  technological  development,  in  its  conclusions  on  the  2030  framework  the 
European Council agreed to broaden the support by including industrial innovation. To achieve 
this,  it  was  agreed  to  set  up  an  Innovation  Fund  also  including  industry  and  with  an  initial 
endowment increased to 400 million allowances.89  

This chapter builds on existing experience and analyses options for the implementation of these 
low-carbon funding mechanisms in the ETS Directive. 

8.1. 

Innovation fund  

8.1.1.  Problem definition 
To  reach  its  long-term  decarbonisation  goals90  the  EU  needs  to  step  up  its  efforts  to  rapidly 
introduce new low-carbon technologies to the market. An innovation-driven transition to a low-
carbon economy contributes to the EU climate objectives and offers opportunities for growth and 
jobs. This has been recognized in the EU’s framework strategy for a resilient Energy Union with 
a forward looking  climate change policy91, which highlighted as  key priorities  for research and 
development  renewable  energies  and  CCS  for  the  power  sector  and  industry.  To  reach  the  EU 
objectives, further support is needed for innovative low-carbon technologies and processes in the 
demonstration phase, which is a crucial step towards commercialisation and deployment.  

88 This translates into around 310 million allowances, which could result in as much as € 8 billion  
89 The 400 million allowances could mobilise as much as € 10 billion. 
90 In line with the EU Roadmap for moving to a competitive low-carbon economy. COM(2011) 112 final 
91 http://ec.europa.eu/priorities/energy-union/docs/energyunion_en.pdf  

54 

 
 
  
                                                           
At the end of 2014, the Special Task Force (Member States, Commission, EIB) on Investment92 
report  indicated  that  while  the  EU  remains  a  world  leader  in  a  number  of  medium-  and  high-
technology sectors (including  clean energy technologies), the EU position is  increasingly being 
challenged  by  our  global  competitors,  such  as  USA  and  China.  As  indicated  in  the  report,  an 
increasing number of Member States have started to cut back direct public R&D spending in their 
fiscal consolidation efforts. Complementary action at EU level is  an effective way to maximise 
the  development  of  highly  innovative,  low-carbon  demonstration  projects  through  EU-wide 
competition.  Therefore,  the  Commission  has  identified  the  expansion  of  renewable  energy  and 
resource efficiency as well R&D as priority areas of the European Fund for Strategic Investment 
(EFSI) that will generate €315 billion of additional investment in the EU in the next three years. 
These efforts could be complemented by using revenues generated through the sale of EU ETS 
allowances to promote cost-effective emission reductions in line with the ETS. 

This impact assessment analyses how to design the Innovation Fund to enable highly innovative, 
low-carbon  first-of-a-kind  (FOAK)  projects  in  the  European  energy  and  industry  sectors  to 
support innovative low-carbon technologies and processes, especially in the demonstration phase. 

8.1.1.1.  Underlying drivers of the problem 

Together  with  the  price  of  EU  ETS  allowances,  the  need  for  companies  to  remain  competitive 
and to create new products incentivises the development of innovative low-carbon technologies. 
Irrespective  of  the  level  of  the  carbon  price,  the  ETS  by  itself  may  be  insufficient  to  drive 
investment  in  R&D  and  trigger  pre-commercial  demonstration  phase  of  new  low-carbon 
technologies,  in  particular  where  other  factors  such  as  the  high  inherent  level  of  technological 
risk,  are  present.  The  prevailing  low  carbon  price  has  further  underlined  the  need  for  public 
support for highly innovative technologies to achieve the necessary emission reductions. Still, the 
long-term development of the carbon price will be a key driver for the projects to be effectively 
supported by the Innovation Fund.  

Innovative  technologies,  notably  those  involving  FOAK  projects,  face  considerable  risks  and 
often require public financial support to make the transition from R&D to commercialisation and 
to overcome the "valley of death", i.e. the transition between R&D and market uptake, when new 
products have to be produced and tested at commercial scale for the first time. The risk profile of 
demonstration  investments  in  low-carbon  innovations  is  often  too  high  to  attract  conventional 
commercial  finance  and  there  is  a  considerable  technological  risk  in  the  construction  and 
implementation  of  new  technologies  for  industrial  users.  Once  the  technologies  are  proven  and 
performance  is  validated,  the  market  can  provide  private  finance  to  scale  them  up  and  to 
commercialise them. 

Most EU energy-intensive industries and low-carbon energy sectors have developed sectoral low-
carbon  roadmaps  for  2050,  identifying  promising  future  technologies  to  decrease  CO2 
emissions93.  However,  in  an  uncertain  environment  many  companies  might  be  reluctant  to 
commit to innovation cycles, which put notable strain on their human and financial resources, and 
are  a  liability  on  their  balance  sheets.  This  uncertainty,  in  particular  during  the  construction 
phase, forms a financial barrier for both small companies, who often suffer from a lack of access 

http://ec.europa.eu/priorities/jobs-growth-investment/plan/docs/special-task-force-report-on-investment-in-the-

92 
eu_en.pdf  
93 The European Strategic Energy Technology Plan (SET-Plan) supports this process through the European Industrial 
Initiatives (EIIs) which bring together industry, the research community, the Member States and the Commission in 
risk-sharing,  public-private  partnerships  aimed  at  the  rapid  development  of  key  energy  technologies  at  European 
level. 

55 

 
 
 
                                                           
to  capital,  and  large  ones,  who  may  lack  sufficient  financial  incentives  in  the  decision-making 
process to justify innovative and therefore risky investments. A stable carbon price signal is one 
of the elements that can improve the investment climate for low-carbon investments.  

The  need  to  provide  additional  incentives  to  trigger  private  investments  in  new  low-carbon 
technologies  has  been  confirmed  by  Commission  analysis  which  highlighted  the  importance  of 
speeding up investments in breakthrough technologies and addressing access to finance as a key 
challenge94.  There  is  a  need  to  channel  public  funds  to  support  investments  that  contribute  to 
achieving the EU policy objectives related both to climate and economic growth. Existing support 
has not always provided the financing required for deployment of all new technologies due to the 
high level of risk and large size of the projects. 

Financial  support  for  innovation  could  be  provided  through  traditional  grants  and/or  through 
financial instruments. The Commission95 has highlighted that financial instruments as a form of 
policy  intervention  can  have  several  benefits,  including  increased  effectiveness  and  multiplier 
effects for limited public resources.  

The Innovation Fund could help to bridge this financing gap by providing grants and/or financial 
instruments  specifically  targeted  at  the  risk  profile  of  low-carbon  demonstration  projects  for 
renewable energy sources (RES), CCS and industry.  

For  these  reasons,  this  analysis  focuses  on  how  to  address  the  financial  barriers  preventing 
investments  in  low-carbon  innovation,  with  the  existing  approach  of  the  NER  300  as  starting 
point. For detailed analysis of lessons learnt on NER300 see Annex 4. Section 8.2.1.3 indicates 
which lessons can be drawn from other existing EU instruments. 

8.1.2.  Operational policy objectives 

Based  on  the  underlying  problem  drivers  and  the  lessons  learnt  from  the  existing  NER  300 
mechanism, the operational objectives for the design of the Innovation Fund are the following: 

  Achieve breakthrough innovation in the energy and industry sectors in Europe, while targeting 

support to ensure best use of limited funds; 

  Address  financial  barriers  that  the  project  developer  needs  to  overcome  when  starting  the 

project and provide incentives to commercial-scale low-carbon FOAK projects; 

  Avoid  distortion  of  competition  and  minimise  the  impact  on  the  general  functioning  of  the 

European carbon market; 

  Set up an efficient, simple management structure. 

The  operational  objectives  will  be  used  to  derive  criteria  for  comparing  policy  options  and 
assessing their impacts. 

94 COM(2014) 14 final - For a European Industrial Renaissance 
95 COM(2011) 662 final: A framework for the next generation of innovative financial instruments  - the EU equity 
and debt platforms 

56 

 
 
 
 
                                                           
8.1.3.  Policy options 

A  key  challenge  in  developing  the  policy  options  is  to  appropriately  cover  the  different 
breakthrough technologies and proposals within the RES, CCS and industry sectors to ensure the 
selection  of  sufficiently  innovative  proposals.  The  Innovation  Fund  also  has  to  ensure  that 
appropriate types and levels of support can be offered. The question of addressing risk – both in 
terms of the funding rate and of reducing the operational risk – needs to be tackled. To this end, 
potential  options  are  considered  both  for  the  screening  and  selection  of  projects  and  for  how 
financial support is given. 

8.1.3.1.  Screening of projects 

As under the NER 300, to be eligible projects should fall under one of the pre-defined innovative 
technology  categories.  The  proposals  should  then  be  assessed  to  ensure  they  are  sufficiently 
innovative.  Eligible  projects  should  then  be  ranked  based  on  the  cost-effectiveness  of  their 
performance.   

Industry  projects  might  merit  a  different  approach,  since  putting  projects  with  different 
characteristics and needs in direct competition might not deliver a good technological spread of 
proposals. Ranking industry projects only on the basis of their performance would likely reward 
only  the  large  ones,  which  may  benefit  from  economies  of  scale  and,  thus,  have  better  overall 
cost  performance.  The  selection  would  then  risk  primarily  reflecting  the  differences  between 
sectors and in physical boundaries, rather than level of innovation.  

Certain  sectoral  low-carbon  roadmaps  for  2050  developed  by  industry  have  identified  possible 
future  technologies  with  a  high  level  of  detail,  for  instance  in  the  forest  and  fibre  sector96. 
However,  more  work  is  still  needed  to  identify  innovative  low-carbon  breakthroughs  in  many 
other industrial sectors.  

In industrial sectors, capturing the relative merits of proposals in terms of innovation based on a 
directly comparable criterion could be done through a qualitative assessment, but this approach 
would make a direct comparison more difficult than a quantitative criterion such as cost-per-unit 
performance.  Special  attention  must  be  paid  to  maintaining  an  objective  way  of  comparing 
diverse industry projects, to  ensure that funding will deliver  innovation breakthroughs  with EU 
value  added.  For  these  reasons,  comparing  improvements  to  a  pre-defined  benchmark97  or  the 
replicability potential of a technology98could be considered as eligibility criteria when making the 
support scheme operational.  

Alternatively,  innovation  could  be  used  as  a  ranking  criterion.  Industry  projects'  innovative 
potential  could  for  example  be  rated  from  1  to  499  by  comparing  projects'  technologies  to  the 
state-of-the-art and measuring their availability amongst multiple vendors, degree of development 
and potential for scale-up. Where the innovative quality is judged to be equal and the funds are 

96In  the  forest  and  fibre  sectors,  the  identified  technologies  potentially  offer  significant  leaps  of  more  than  a  20% 
improvement that could be demonstrated within a few years. 
97  This  would  be  the  indicator  of  progress  compared  to  products'  benchmarks,  e.g.  a  20%  reduction  compared  to 
current product benchmarks for ETS free allocations. 
98 Replicability is important to streamline technologies across the board in a specific sector. It could be measured in 
terms  of  EU  installations  that  could  implement  the  same  solution.  This  can  be  ensured  for  example  via  licencing 
agreements, continuous development in excellence centres or multi-year consortia agreements, aiming to achieve a 
certain number of industry installations. 
99 1. Little or no innovation 2. Some innovation demonstrated, but mainly incremental 3. Highly innovative project 
for some component or aspect of technology 4. Highly innovative project that is likely to represent a game changing 
step in technology 

57 

 
 
                                                           
insufficient  to  fund  all  proposals  within  the  same  rating,  the  cost-effectiveness  of  performance 
could be used as a second criterion. 

It should be noted that innovation should be used either as an eligibility criterion or as a ranking 
one, to avoid confusion in the selection process.  

8.1.3.2.  Conditionality of Awards  

NER  300  awards  are  linked  to  projects  achieving  operational  performance.  In  order  to  cover 
some  of  the  risks,  the  project  can  receive  a  certain  degree  of  upfront  funding  upon  a  Member 
State's guarantee, followed by 100% of funding when demonstrating at least 75% of the targeted 
performance. 

An alternative approach in order to widen the risk coverage in the Innovation Fund would be to 
award part of the funding on the basis of achieving milestones in the construction phase. A fixed 
percentage  (e.g.  30%)  of  the  additional  costs  of  innovation  could  be  granted  conditional  on 
finalising steps in design, permitting and construction. This is the approach followed by the US 
ARPA-E  programme100,  advancing  high-potential,  high-impact  energy  technologies.  ARPA-E 
selectees may request a Budget Plan Payment (BPP), to obtain reimbursements on a prospective 
basis  in  order  to  purchase  the  necessary  equipment  or  services  required  to  achieve  specific 
milestones.  

Linking funding to the achievement of specific milestones has proved beneficial also in the EU 
based on one of the lessons from the 2009 European Energy Programme for Recovery (EEPR). 
Under  this  programme,  grants  were  awarded  to  highly  strategic  projects  in  gas  and  electricity 
infrastructure, offshore wind and carbon capture and storage101. This could apply to both energy 
and industry projects, since there is no material difference in the construction process. 

As  an  example,  the  hypothetical  steps  in  the  construction  of  an  innovative  offshore  wind  farm 
could be considered to identify some steps which could be considered milestones: reaching final 
investment  decision  (FID),  construction  of  all  foundations,  construction  of  all  turbines  or 
installation of all turbines and the start of the delivery of power to the grid. All milestones should 
be relevant in terms of justifying the partial granting of investment support. 

8.1.3.3.  Type of instrument 

The  NER  300  mechanism  provides  cash  grants.  Such  support  is  attractive  both  for  financial 
institutions, for which innovative projects are often not bankable, and for project sponsors, which 
find  in  grants  an  effective  way  of  improving  their  financial  standing  (see  also  section  8.1.5.2). 
The NER 300 programme has linked such grants to operational performance to deliver funding to 
highly innovative FOAK projects characterised by long planning and construction times, a high 
risk profile and hard-to-predict budgets. 

An alternative could be to switch to a financial instrument. Financial instruments are designed to 
address  market  failures  or  sub-optimal  investment  situations  which  have  proven  to  be 
economically viable  but do not  give rise to sufficient funding from  market sources due to their 
particular risk structure. As an illustration, financial instruments can include guarantees on first 
loss that could allow banks to provide loans to riskier projects than they would otherwise support. 
An alternative could be to invest public equity, in which case projects would be selected through 

100  Bill  Text  Versions  111th  Congress  (2009-2010)  H.R.5116  -  America  Creating  Opportunities  to  Meaningfully 
Promote  Excellence  in  Technology,  Education,  and  Science  Reauthorization  Act  of  2010  (Enrolled  Bill  [Final  as 
Passed Both House and Senate]) 
101 Report from the Commission to the European Parliament and the Council on the implementation of The European 
Energy Programme for Recovery, COM(2013) 791 

58 

 
 
                                                           
a  permanent  financing  facility  on  an  open-call  basis.  Due  to  the  high  risk  involved  in  FOAK 
demonstration, the Innovation Fund should target projects with higher risk levels when compared 
to the investments supported through existing financial instruments. 

8.1.3.4.  Maximum rate of funding 

NER 300 covers up to 50% of the projects' additional costs of the innovation (for example, the 
CCS part of a power plant or additional costs for a RES plant compared to a fossil fuel reference 
plant). RES projects on average requested NER 300 funding equivalent to 39% of their additional 
costs.  Due  to  'funding  cap'102,  no  more  than  €300  million  could  be  awarded  to  the  only  CCS 
project, which covers 34% of its additional costs.   
In the consultation on carbon leakage provisions and innovation support103, more than half of the 
industry respondents indicated that in their view, there is a particular need to strengthen the EU's 
innovation  support  for  the  implementation  of  large-scale  pilot  projects.  In  the  general 
consultation  on  the  ETS  revision,  different  industrial  sectors,  Member  States  and  civil  society 
members  (including  trade  associations  and  NGOs)  have  highlighted  the  importance  of 
appropriate risk sharing in the innovation process, for example through an increase in the current 
co-financing rate. At the same time, for industry innovation, the projects are not as large as for 
CCS. They are thus not likely to be limited by the 'funding cap' of 15% share of the total amount 
available. However, a low limit on the funding rate per project could have a negative impact on 
the financial viability of highly innovative and therefore risky industrial projects.   

Access to finance is a major barrier for implementation of innovative projects and in certain cases 
the  current  50%  co-financing  requirement  has  been  too  high  for  project  promoters  to  secure 
implementation and may also have resulted in some projects not participating.   

For  these  reasons  and  to  reduce  the  significant  financial  barriers  (e.g.  lacking  or  not  ensured 
national funding, additional operating support, feed-in-tariffs or similar national support schemes, 
equity,  long-term  debt  financing  or  revenues104)  as  well  as  the  level  of  technological  risk,  the 
maximum funding rate in the Innovation Fund could be increased to up to 75%.  

For CCS, 10 out of 11 submitted proposals were not confirmed, mainly due to a lack of sufficient 
additional  funding  and  as  such,  increasing  the  rate  will  improve  their  financial  viability.  As 
regards  other  technologies,  existing  experience  suggests  that  for  most  subcategories  of  RES 
projects,  the  actual  requested  funding  for  such  projects  from  the  NER  300  will  on  average  be 
lower than the  maximum allowed.  At the same time, many awarded RES projects have  not yet 
achieved  a  Final  Investment  Decision,  which  could  be  a  reason  to  also  consider  allowing  an 
increased maximum rate for RES projects, if further experience confirms this is needed.  

As  the  lessons  learnt  from  the  NER  300  are  limited  to  a  few  years  of  implementation  and  the 
NER 300 has  a  more limited  scope  than the  Innovation  Fund,  the exact impact of using higher 
rates is challenging to evaluate. Specific needs should, therefore, be assessed separately for RES, 
CCS  and  industry  through  more  extensive  market  testing  in  the  context  of  the  implementing 
legislation.  Comparing  options  which  include  the  current  maximum  funding  rate  of  50%  to  an 
increased maximum rate 75% gives a first indication of the potential range of effects. To provide 
additional  information  on  what  these  thresholds  mean  for  project  promoters,  a  short  sensitivity 
analysis in (Annex 14) shows the level of possible funding for a range of RES, CCS and industry 
projects, across a range of funding rates. 

102 €300 million is equivalent to 15% of the total available resources following the monetisation of allowances. 
103 See Annex 3.2 
104 See also Annex 4.1 

59 

 
 
                                                           
If  support  was  provided  through  financial  instruments  rather  than  grants,  this  would  imply  a 
different  approach.  While  the  detailed  parameters  for  such  support  would  need  to  be  further 
elaborated, financial instruments could for example take the form of equity participation or of a 
guarantee on the first loss covering a certain percentage of the additional cost of the innovation. 
With  such  an  approach,  there  would  be  no  directly  comparable  level  of  funding,  but  rather  a 
maximum  coverage  of  risk  related  to  the  investment  with  the  aim  to  increase  the  financial 
viability of the project.     

The State aid guidelines for Energy and Environment, which apply until 2020, note that centrally 
managed funding, including also NER 300 funding105 does not constitute State Aid. When such 
funding  is  combined  with  state  aid,  only  the  latter  is  considered  for  determining  notification 
thresholds  and  maximum  intensities.  The  existing  maximum  aid  intensities  vary  between 
technologies and other factors, such as size of the targeted recipients or innovative nature of the 
project.  For  the  Innovation  Fund,  the  maximum  funding  rates  and  further  design  of  the 
operational modalities would need to be consistent with future State Aid rules. Moreover, the use 
of different financial instruments (for instance equity vs. guarantees) may have different effects 
and  the  further  design  of  the  operational  modalities  for  such  instruments  should  be  consistent 
with future State Aid rules.  

8.1.3.5.  Parameters not varied in the options 

There  are  a  number  of  design  features,  which  have  proven  appropriate  under  the  NER  300 
programme  and  it  is  proposed  not  to  vary  these  in  the  options,  except  for  an  adjustment  to  the 
higher  volume  (400  instead  of  300  million  allowances)  and  longer  duration  (10  instead  of  5 
years) of the Innovation Fund: 

The  NER  300  management  structure,  consisting  of  cooperation  between  the  European 
Commission, Member States and the EIB, was effective for developing and selecting projects, for 
monetising  allowances  and  for  managing  revenues.  While  the  simplification  of  the  interaction 
between the three bodies and a reduction of administrative burden for project sponsors should be 
considered, this will mainly be subject to a future implementing measure and will be assessed in 
this context. 

The  'funding  cap'  (limit  of  maximum  15%  allowances  per  project)  is  proposed  to  be 
maintained106.  A  higher  limit  would  increase  the  potential  for  large  projects  to  participate,  but 
would result in a lower total number of projects funded. 

The limit of 3 projects per Member State introduced in the NER 300 Decision was appropriate to 
ensure  adequate  geographical  coverage  under  the  programme  (see  Annex  4.1).  It  could  be 
maintained or adjusted to 4 projects per Member State, dependent on other design features such 
as  the  maximum  funding  rate  and  the  resulting  total  number  of  projects.  This  element  will  be 
subject to a future implementing measure and will be assessed in this context. 

Two calls for proposals within 5 years were adequate under the NER 300 programme, to ensure 
stability  in  funding  and  monetisation  of  allowances.  This  could  be  maintained  or  adjusted  to  4 
calls, depending on the appropriate timing of monetising 400 million allowances, as described in 
Annex 4.1  

105 Recital (81), Guidelines on State aid for environmental protection and energy 2014-2020  (2014/C 200/01) 
106 The resulting amount will be higher, due to the increase from 300 million to 400 million allowances. For example, 
if  the  average  value  of  the  monetised  allowances  were  between  €10  -  25,  the  resulting  total  resources  would  be 
between € 4 and 10 billion. 15% of this total would then be € 0,6-1,5 billion. 

60 

 
 
                                                           
The  current  knowledge-sharing  provisions  could  be  streamlined 
to  ensure  smoother 
implementation.  An  element  of  knowledge  sharing  should  be  kept  as  there  is  a  clear  public 
interest  in  replicability  of  the  projects.  Industrial  sectors that  have  an  intra-sectoral  cooperation 
already  incorporated,  i.e.  that  have  elaborated  their  low-carbon  roadmaps,  could  have  better 
possibilities  of  developing  breakthrough  technologies  than  individual  companies  acting  alone. 
Previous  examples,  such  as  e.g  the  ULCOS107  process  of  the  steel  sector,  illustrate  that  such 
cooperative  approach  is  possible  and  accepted  by  industry.  In  case  several  companies  of  a 
particular  sector  join  resources,  the  benefits  of  knowledge-sharing  –  and  of  their  possible 
licensing  -  could  be  included  as  one  of  the  design  features,  taking  into  account  respect  of 
competition  rules.  These  knowledge-sharing  provisions  are  set  in  implementing  legislation  and 
will be assessed in this context. 

Indicative  shares  for  CCS  and  RES  projects  with  a  smooth  spill  over  possibility  between  the 
groups were crucial under the NER 300 programme to ensure the allocation of all available funds. 
A similar indicative share could be set for industry projects.  

8.1.4.  Option packages 

Four option packages are taken into consideration, by combining the options for the elements set 
out  in  chapter  8.1.3.  The  legal  baseline  scenario  would  imply  no  changes  to  the  ETS  Directive 
and hence no continuation of support to innovation. The alternative baseline scenario represents a 
continuation  of  the  current  practice  by  extending  the  current  NER  300  rules  to  industry, 
increasing its endowment to 400 million allowances, and its duration to 10 years.  

Option 1 envisages tailored rules and selection criteria applying for industry, and the current rules 
for  RES  and  CCS.  The  risk  approach  would  be  changed  for  all  categories  (industry,  RES  and 
CCS)  by  higher  co-funding  rates  and  early  disbursement  of  part  of  the  funds  following  the 
achievement of construction  milestones.  The essence of this option is to provide alternatives to 
share investors' risks and create a more conducive climate for innovative investments.  

Option  2 foresees  the  creation of a  permanent financing facility selecting projects  continuously 
on a first-come-first-served basis considering the innovation merits of the proposal. This option 
assumes financial instruments instead of grants. 

Table 4: Option packages for Innovation Fund 

Screening of projects  

Eligibility  

Ranking 

Conditionality of 
awards 

Not applicable   Not applicable 

Not applicable  

Innovation 

Performance 
(CPUP) 

Achieving 
operational 
performance 

Type of 
instrument / 
risk 
approach  
Not 
applicable  

Grant  
(2-4 rounds / 
calls for 

Maximum rate of 
funding  
(for all categories) 

Not applicable  

Up to 50% of 
additional costs 

Baseline 
(Directive 
unchanged) 
Alternative 
baseline 

107    ULCOS  (Ultra-Low  Carbon  dioxide  (CO2)  Steelmaking)  is  a  consortium  of  48  European  companies  and 
organisations from 15 European countries that launched a cooperative R&D initiative to enable substantial reductions 
in  CO2  emissions from  steel  production. The  consortium  consists of all  major EU  steel  companies,  of  energy  and 
engineering partners, research institutes and universities and has been supported by the European commission. The 
consortium  brings  together  the  shared  knowledge  so  that  for  a  particular  technology  developed,  patents  may  be 
owned by different companies and licencing rights for new plants may have been agreed with other partners 

61 

 
 
 
                                                           
 
 
Current rules 
continued 

Option 1 

Amended 
approach for 
all sectors 
with tailoring 
for industry 

Option 2 

Permanent 
financing 
facility 

For industry: 
Innovation 
(e.g. certain 
percentage 
improvement of 
benchmark, 
where 
applicable) 

AND 

Replicability  
(e.g. applicable 
in installations 
representing a 
minimum share 
of ETS 
emissions) 

Current rules 
for RES and 
CCS 
Innovation  

proposals) 

Up to 75% of 
additional costs 

Grant 
(2-4 rounds / 
calls for 
proposals ) 

Performance 
(CPUP) 
potentially 
complemented 
with  

"innovation 
criterion" for 
industry 

(funds awarded 
based on realising 
75% of 
performance) 
Achieving 
milestones in 
construction 
phase 
(e.g. 30% of 
additional costs, 
awarded for 
finalising steps in 
design, 
construction) 

AND  

Operational 
performance 
(e.g. 45% of 
additional costs, 
upon realising 
75% of 
performance) 

Selection based 
on due diligence - 
projects are 
approved on 1st 
come 1st served 
basis if eligible 

Not award but 
financial 
instrument 
(e.g. guarantee on 
first loss covered, 
loan or equity) 

Financial 
instrument 
with 
continuous 
open window 

Not applicable, 
depends on design 
of financial 
instrument 

8.1.5.  Analysis of impacts  

8.1.5.1.  General impacts 

Complexity and administrative burden 

In  the  alternative  baseline  and  Option  1  the  innovation  support  would  be  awarded  via  calls  for 
proposals, primarily carried out under the responsibility of the European Commission. Building 
on the NER 300 experience, well-organised and managed calls would not increase the complexity 
or administrative burden compared to current practice. However, specific rules for the inclusion 
of industrial projects might increase the complexity of the selection  assessment, since elements 
such  as  replicability  and  ranking  based  on  innovation  and  cost-effectiveness  of  performance 
would need to be considered. 

In  Option  2,  the  permanent  financing  facility  would  allocate  support  to  projects  selected  on  a 
first-come-first-served  basis.  This  continuous  selection  would  provide  applicants  with  more 
flexibility as their proposals would not be tied to the timing of calls for proposals.  In terms of 
project evaluation, for a comparable number of projects to be reviewed under Options 1 and 2, no 
substantial  differences  are  expected  in  the  overall  administrative  burden.  Structuring  financial 
instruments  to  address  the  specific  needs  of  different  technologies  would  require  considerable 
know-how  to  assess  and  allocate  the  risks  properly  and  this  could  increase  complexity.  At  the 

62 

 
 
 
 
 
 
 
 
 
 
 
 
 
same time, under Option 2 this role would need to be assumed by financial institutions such as 
the EIB that already has extensive experience in structuring complex deals. An expanded role for 
such a financial institution may be reflected in an increase of the fees charged for the activities 
carried  out  when  compared  to  the  baseline  scenarios.  The  transparency  of  the  level  of  support 
should also be ensured. The experience in setting up and operationalising the new European Fund 
for Strategic Investments under the EU Investment Plan would also be relevant to ensure a simple 
and transparent governance structure.  

When compared to the alternative baseline, the complexity and administrative burden of Option 1 
and Option 2 would be higher, due to the additional factors to be taken into account during the 
selection process. 

Complementarity to other EU instruments 

A range of instruments has been developed at EU level to support the development of innovation 
activities, and research and development more broadly108, and these are expected to support total 
R&D investments of approximately €48 billion through 2020109. Additionally, at the end of 2014 
the  Commission  unveiled  the  new  European  Fund  for  Strategic  Investments  under  the  EU 
Investment  Plan110.  It  is  expected  to  make  an  important  contribution  in  the  short  term  to  the 
climate and energy investments, highlighting the importance of infrastructure, energy efficiency 
and renewables111.  

While it cannot be anticipated what EU level instruments will exist in 2021, the complementarity 
of  the  Innovation  Fund  to  existing  policy  instruments  would  come  from  its  specific  focus  on 
support  for  low-carbon  innovation  at  the  pre-commercial  demonstration  phase.  Managing  the 
Innovation  Fund  at  EU  level  ensures  that  it  complements  and  reinforces  other  existing 
instruments. 

Providing  support  in  the  form  of  a  performance-based  grant  (as  in  the  alternative  baseline  or 
option 1) or through a financial instrument which explicitly targets projects with a higher level of 
risk  when  compared  to  other  existing  EU-wide  instruments,  such  as  the  existing  InnovFin112  
programme (as in option 2) can be complementary to other EU instruments.  

When compared to the alternative baseline, the complementarity of both Option 1 and Option 2 is 
similarly  positive,  and  explained  primarily  by  the  focus  of  the  support on  low  carbon  first  of a 
kind demonstration projects and the expansion of scope to industrial projects. 

108 For example as part of InnovFin under Horizon 2020. 
109 http://europa.eu/rapid/press-release_IP-14-670_en.htm  
110 http://ec.europa.eu/priorities/jobs-growth-investment/plan/index_en.htm 
111 It should be noted that the NER 300 and the Innovation Fund differ from the new European  Fund for Strategic 
Investments.  EFSI  will  work  through  financial  instruments  only,  lending  to  existing  projects  ready  to  start  within 
three years and will have a wider scope covering variety of sectors such as the digital economy and education. 
112  In  particular,  the  Commission,  in  cooperation  with  the  EIB,  has  developed  a  pilot  scheme  under  InnovFin, 
InnovFin  Energy  Demo  Projects  (EDP),  that  aims  to  support  technologies  in  the  pre-commercial  stage  of 
development in the energy sector. It will provide loans to first-of-a-kind demonstration projects at industrial scale in 
the  fields  of  renewable  energy  and  hydrogen  and  fuel  cells,  or  extend  guarantees  to  financial  intermediaries  who 
make  such  loans.  It  will  address  projects  with  a  higher  risk  profile  than  the  current  InnovFin  suite  of  products.  If 
successful and further developed, possible synergies between this scheme and the Innovation Fund could be explored 
in 
Fund. 
(http://www.eib.org/infocentre/press/releases/all/2015/2015-134-eib-group-and-ec-expand-support-for-innovative-
companies-across-europe.htm) 

implementing 

Innovation 

legislation 

context 

the 

the 

for 

of 

63 

 
 
 
                                                           
8.1.5.2.  Economic impacts  

Several economic impacts are considered in this section. Firstly, the overall ability of the fund to 
attract and support a  large number of innovative projects is considered to  be the result of three 
impacts: the ability to attract innovative projects, the fund's effectiveness in addressing barriers to 
allow  these  projects  to  be  realised  and  finally  the  expected  leverage,  indicating  the  volume  of 
additional investment mobilised as a result of the support offered. Two other economic impacts at 
a  higher  level  are  also  considered,  the  effects  on  competitiveness  and  the  EU  added  value 
realised. 

Effectiveness in addressing barriers for low-carbon innovation 

The  NER  300  lessons  learnt  (see  Annex  4.1)  showed  that  the  current  NER  300  rules,  i.e.  the 
alternative  baseline  option,  were  effective  in  encouraging  the  development  of  projects  for  RES 
innovation. However, the deadlines for reaching the final  investment decision  within two years 
and  starting  operations  within  four  years  proved  to  be  too  ambitious  due  to  factors  such  as  the 
long  preparation,  construction  and  permitting  timelines  of  FOAK  projects.  In  addition,  this 
approach  does  not  seem  to  adequately  address  the  risks  for  pre-commercial  demonstration 
projects in energy intensive industries and CCS projects. This is supported both by the NER 300 
experience of only 1 CCS project awarded and by the majority of stakeholders113.  

Various stakeholders indicated that the current NER 300 rules would not be sufficient to trigger 
innovation for the energy intensive industry, since project sponsors would have to bear the high 
financial  and  technical  risks  of  capital  intensive  investments.  Since  the  return  on  such 
investments can be reaped only in the longer term, in the short run such projects do not seem to 
be  ranked  as  a  first  priority  in  companies'  internal  decision-making  processes.  As  a  result, 
innovation  might  not  occur  at  the  speed  needed  to  meet  the  EU's  long-term  decarbonisation 
objectives.  It  is  likely  that  such  investments  would  rather  be  realised  in  those  Member  States 
where higher levels of national public support are offered, while in others the emission reduction 
and innovation potential could remain underdeveloped.  

In  that  regard,  Option  1  could  substantially  lower  the  project  sponsors'  needs  for  co-financing, 
given  the  higher  funding  rate  and  the  early  disbursement  of  part  of  the  funds  following  the 
achievement of milestones. The funding provided through a grant would lower the costs borne by 
project  sponsors,  improving  the  financial  viability  of  the  project.  At  the  same  time,  linking  the 
grant  to  the  achievement  of  milestones  would  be  more  attractive  when  compared  to  the 
alternative baseline. Under the alternative baseline, the funding is tied to operational performance 
at  a  later  stage  and  discounts  will  be  applied  by  the  company  to  reflect  uncertainty  about  the 
current value of funds that will be received in future.  

Option 2 which envisages the creation of a financial instrument (e.g. guarantees, loans or equity 
investments,  and  risk-sharing  instruments)114,  can  also  address  barriers  faced  by  project 
promoters.  If providing public equity, the projects could be supported from the initial stages of 
development. Such public equity investment could lower the need for project promoters to raise 
debt  and  private  equity.  As  an  alternative,  if  the  financial  instrument  is  implemented  as  a 
guarantee  that  would  cover  for  a  percentage  of  the  losses  in  case  of  a  loan  default,  this  would 
allow financial institutions such as the EIB, national promotional banks and/or commercial banks 
to lend to riskier projects than they would have  done otherwise. This also addresses projects in 
the earlier stage of development compared to the alternative baseline, i.e. continued current rules. 

113 See Annex 3 
114 As an illustration, the funds could be used to invest in equity alongside project promoters. This would lower the 
costs for private investors, while also lowering their expected revenues from the project. 

64 

 
 
                                                           
In  certain  cases,  financial  instruments  might  not  address  the  large  financing  gap  in  the 
demonstration  of  FOAK  projects  (e.g.  CCS  projects).  Financial  instruments  can  stimulate  a 
significantly  higher  level  of  private  investments,  but  this  will  likely  be  in  technologies  that  are 
closer to commercial scale deployment.  

In  conclusion,  while  both  Option  1  and  2  have  potential  to  address  barriers  for  low-carbon 
innovation when compared to the alternative baseline, Option 1 is expected to be more effective 
due to the combination of a more targeted risk sharing approach and the possibility of a higher 
rate of funding. 

Potential to attract innovative projects 

The lessons learnt from the existing NER 300 mechanism (Annex 4.1) show that the current rules 
and  selection  mechanism  have  resulted  in  a  portfolio  of  projects  for  renewables  that  were 
identified  in  many  cases  as  highly  innovative  or  even  game  changing  (80%)  in  the  existing 
framework. At the same time, while multiple proposals  were initially submitted, only  one CCS 
project has been confirmed.  

The  alternative  baseline  option  would  imply  applying  a  one-size-fits-all  approach,  using  the 
existing rules for RES, CCS and industry. As discussed in Section 8.1.5.2, there is a risk of not 
attracting a similar number of innovative project proposals in the CCS and industry sectors. As a 
result, in particular CCS projects could still face similar risks as the existing NER 300 projects, 
such as uncertain national funding, lack of private equity or long-term debt financing. 

Option  1  has  a  higher  potential  to  attract  innovative  projects  with  its  risk  sharing  elements. 
Raising the maximum funding rate (up to 75%) has the potential to encourage more innovative 
project  proposals  to  be  submitted  for  the  Innovation  Fund.  In  addition,  directly  targeting 
innovation  for  industry  proposals  as  the  basis  for  the  ranking  of  projects  during  the  selection 
process  (compared  to  the  current  practice  of  innovation  as  eligibility  criterion)  is  expected  to 
make the system more attractive for innovative projects with a lower technological maturity. As 
discussed  above,  increasing  the  maximum  funding  rate  would  also  facilitate  addressing  the 
financial barriers of such innovative projects, if they are selected. 

Option  2  involves  providing  support  to  projects  through  financial  instruments,  such  as  loans, 
guarantees  or  equity  which  would  target  projects  with  a  higher  risk  level  compared  to  existing 
instruments  (e.g.  the  current  InnovFin  programme,  with  the  exception  of  the  recently  launched 
InnovFin Energy Demo Projects (EDP) pilot facility which does cover such higher risk levels). 
This  could  enable  a  pipeline  of  more  innovative  projects  with  a  higher  risk  profile  to  access 
financing when compared to existing EU and EIB financial instruments, for example by covering 
the  first  loss  which  would  be  incurred  or  through  co-investing  equity  (See  Section  8.1.5.2).  A 
decision on supporting a project would be carried out by an entrusted financial entity such as the 
EIB that would evaluate the projects based on economic, financial, technical and environmental 
criteria. There is a risk that such an approach would be more beneficial to closer to market pre-
commercial  technologies  that  have  higher  short-term  revenue  generating  potential,  overlooking 
technologies  that  take  longer  to  develop  but  are  more  interesting  in  the  long  term.  Therefore 
under Option 2 financial instruments might not be sufficient to fully address the financial barriers 
faced by breakthrough innovation projects without additional public interventions, such as grants. 
In conclusion, while financial instruments could be targeted at earlier stages in project life cycle 
when compared to the performance based grant in the alternative baseline, there is a risk that such 
an approach would be likely to attract technologies closer to commercialisation. Whether Option 
2  could  attract  more  high  risk  innovative  projects  when  compared  to  the  alternative  baseline 
would therefore depend on how the instrument is operationalised. 

65 

 
 
In conclusion, option 1 has the highest potential to attract innovative projects when compared to 
the alternative baseline, while option 2 would be expected to lead to comparable outcomes. 

Leverage 

A  similar  leverage  as  for  the  NER  300  funding  (see  Annex  4.1)  is  expected  for  the  alternative 
baseline. The leverage of Option 1 would likely be lower due to the higher co-financing rate and 
hence  the  lower  need  for  private  investments.  Additionally  under  Option  1  part  of  the  funds 
would be reimbursed prior to proof of performance. While funding partial success or failure can 
still  deliver  benefits  in  the  form  of  knowledge  sharing,  from  a  financial  perspective  this  would 
imply  the  loss  of  some  funds  compared  to  disbursement  based  on  proving  operational 
performance. 

On  the  other  hand,  significantly  higher  overall  leverage  could  be  reached  under  Option  2. 
Preliminary evidence shows that the EU contribution to financial instruments mobilises a global 
investment exceeding the EU contribution by 4 to 10 times on average115. Since the Innovation 
Fund addresses inherently riskier innovation projects, the leverage realised would likely be in the 
lower  range  but  still  significantly  higher  than  for  traditional  grants  under  Options  1  and  the 
alternative baseline. While project failures may lead to overall higher losses than with grants or 
debt  instruments,  financial  instruments  proceeds  might  reflow  into  the  fund  and  be  used  to 
finance additional projects. 

When compared to the alternative baseline, Option 1 would result in a lower leverage due to the 
higher funding rate, while Option 2 would be expected to result in an increase of the leverage as 
financial instruments can mobilise more additional funding. 

Competitiveness 

Low-carbon  innovation  in  the  energy  and  industry  sectors  would  improve  the  overall  EU 
competitiveness by supporting low-carbon technologies in which the EU has global technological 
leadership. Better and more efficient technologies will benefit the entire supply value chain and 
ultimately consumers. Furthermore, such innovative technologies can create a substantial number 
of  new  jobs  and  generate  new  business  opportunities.  There  is  also  evidence  that  low-carbon 
technologies  bring  larger  overall  economic  benefits,  as  they  generate  more  knowledge  in  the 
economy,  which  in  turn  can  be  used  by  other  innovators  to  further  develop  new  technologies, 
leading to a virtuous cycle of innovation.116  

Additionally, knowledge-sharing requirements under the Innovation Fund would contribute to the 
dissemination of the results across EU borders, technology exchange and associated catching-up 
effects.  It  could  also  help  to  reduce  the  innovation  gap  between  and  within  sectors  and/or 
Member States. 

The  Innovation  Fund  could  improve  the  prospects  for  EU  companies  to  increase  exports  in 
rapidly  growing  low-carbon  markets,  thus  enhancing  EU  competitiveness.  The  extent  to  which 
the  different  options  would  improve  EU  competitiveness  would  depend  on  how  effectively  the 
fund  incentivises  innovation  in  new  low-carbon  technologies  and  processes.  The  alternative 
baseline and Option 1 would strengthen the global competitive position of EU businesses selling 
low-carbon  technologies.  The  inclusion  of  replicability  as  an  eligibility  criterion  for  industry 
projects  in  the  assessment  would  also  ensure  a  measure  of  the  overall  potential  for  improved 

115 Report from the Commission to the European Parliament and the Council on financial instruments supported by 
the general budget according to Art.140.8 of the Financial Regulation as at 31 December 2013, COM(2014) 686. 
116 The impacts of environmental regulations on competitiveness,  Grantham Research Institute on Climate Change 
and the Environment, UK, 2014 

66 

 
 
                                                           
competitiveness  through  a  significant  contribution  to  overall  industrial  emissions  across  the 
energy  intensive  industry  sector  in  the  EU.  This  could  help  to  ensure  higher  benefits  for 
competitiveness. 

Option 2 is expected to result in higher leverage and may be more attractive to investments which 
are close to commercialisation. This could lead to quicker realisation of the projects and a more 
rapid diffusion of the technologies supporting competitiveness, but there is a risk that to enable 
breakthrough innovative FOAK demonstration projects additional support might be needed in the 
form of grants.  

Consequently, Options 1 and 2 both have the potential to improve competitiveness compared to 
the alternative baseline. 

EU added value and geographical distribution 

The Innovation fund would target support towards projects with EU-wide significance. Through 
EU-wide  coordination,  it  would  be  possible  to  reach  the  requisite  scale  for  highly  capital 
intensive  demonstration  projects  in  RES,  CCS  and  industry  across  Member  States  in  particular 
compared  to  a  scenario  where  only  national  schemes  exist.  The  EU  focus  could  provide 
additional benefits in terms of the development of technological standards at EU-level. Under the 
alternative  baseline  and  options  1  and  2  such  benefits  would  also  be  extended  to  the  energy-
intensive industry sectors.  

The  Innovation  Fund  is  to  cover  projects  in  industry,  CCS  and  RES.  Investment  projects  in  all 
Member  States,  including  small-scale  projects.  The  experience  with  the  NER  300  projects, 
selected  and  ranked  through  two  calls  for  proposals  by  EU-wide  competition,  showed  the  EU 
value added of the programme in terms of maximising innovation and decarbonisation benefits. 
The geographical and technological spread of innovative projects (see Annex 4.1), combined with 
the  knowledge-sharing  requirement  for  project  sponsors,  is  likely  to  result  in  an  effective 
knowledge  spill-over  throughout  Europe.  As  indicated  in  Annex  4.1,  the  rules  relating  to  the 
maximum number of projects per Member State did not guarantee that projects were funded in all 
Member  States,  but  acted  as  a  relatively  light  safeguard  against  a  high  number  of  project 
proposals being approved in only one Member State. The alternative baseline for the Innovation 
Fund would lead to a comparable outcome in terms of geographical distribution and contribution 
of EU value added. On the other hand, for both options 1 and 2, the expansion of scope to include 
industry  is  an  opportunity  to  develop  a  promising  project  pipeline  in  lower  income  Member 
States  which  have  high  potential  for  economic  growth.  This  could  contribute  to  a  wider 
geographical distribution. 

Since  Option  1  also  includes  replicability  as  one  of  the  eligibility  criteria  for  industry  projects, 
this  could  help  ensuring  an  even  higher  EU  value  added,  since  projects'  technology  could  be 
deployed  /  licensed  at  a  larger  scale  to  other  similar  installations.  Additionally,  under  the 
alternative baseline, project promoters should have received a guarantee from Member States to 
receive up-front financing. In Option 2, financial instruments would need to include a provision 
for maximum geographical concentration ratio to ensure geographical balance. In fact, through a 
large portfolio of projects with different risk profile, an optimal level of portfolio risk could be 
achieved.  As  a  result,  both  Option  1  and  Option  2  can  be  considered  to  represent  a  higher 
potential EU added value than the alternative baseline. 

67 

 
 
 
8.1.5.3.  Environmental impacts 

The Innovation Fund addresses investments in low-carbon innovation for CCS, RES and energy 
intensive industries. All three scenarios would facilitate the commercialization of new low-carbon 
technologies that would facilitate achieving the long-term decarbonisation objectives in the EU. 
The  environmental  benefits  of  low-carbon  technologies  will  increase  over  time  as  the 
technologies are replicated and deployed on a larger scale. 

In the longer term, more direct environmental benefits such as increased use of renewable energy 
resources, improved energy efficiency, improved local air quality and related health benefits are 
expected.  

It should be noted that projects supported under the three options could have a different impact 
regarding  verified  avoidance  of  CO2  emissions.  Under  the  alternative  baseline,  funding  would 
continue to be disbursed strictly upon proof of avoided CO2 emissions. Options 1 and 2 would be 
less directly linked to such reductions, as the support could be paid before the project enters into 
operation.      

With  regard  to  environmental  impacts,  Option  1  and  2  are  thus  considered  to  have  a  similar 
impact when compared to the alternative baseline. 

8.1.5.4.  Social impacts 

Although  it  is  not  possible  to  quantify  the  impacts  on  employment  in  the  individual  Member 
State, a positive impact on employment such as the creation of new high value-added jobs across 
the entire supply chain, could be expected in proportion to the level of investments triggered by 
the Innovation Fund. 

As indicated in the impact assessment accompanying the Communication from the Commission 
"Horizon  2020  -  The  Framework  Programme  for  Research  and  Innovation"117,  a  wealth  of 
evidence demonstrates the crucial role that research and innovation play for the creation of more 
and better jobs, for productivity growth and competitiveness, and for structural economic growth. 
To  boost  future  productivity  and  growth,  it  is  critically  important  to  generate  breakthrough 
technologies and translate them into innovations that are taken up by the wider economy.  

8.1.6.  Comparing the options  

In the previous section, seven different impacts, in particular economic impacts, were analysed as 
presented  in  the  table  below.  These  impacts  contribute  to  the  operational  policy  objectives  that 
were  identified  (section  8.1.2)  as  follows.  A  positive  score  on  the  impacts  "potential  to  attract 
innovative  projects",  "EU  added  value  and  geographical  distribution",  "competitiveness"  and 
"leverage" would contribute to the objective of achieving breakthrough innovation in the energy 
and industry sectors in Europe, while targeting support to ensure best use of limited funds.  

The  impact  "Effectiveness  in  addressing  barriers  for  low-carbon  innovation"  relates  directly  to 
the  objective  to  address  financial  barriers  that  the  project  developer  needs  to  overcome  when 
starting the project and provide incentives to commercial-scale low-carbon FOAK projects.  

Thirdly,  a  positive  score  on  the  impact  "minimise  complexity  and  administrative  burden" 
contributes to the objective to set up an efficient, simple management structure. Finally, while the 

117Commission Staff Working Paper – Impact Assessment accompanying the Communication from the Commission 
"Horizon 2020 - The Framework Programme for Research and Innovation", SEC(2011) 1427 

68 

 
 
 
 
                                                           
objective of minimising the impact of the mechanism on the general functioning of the European 
carbon  market  is  not  directly  reflected  in  the  comparison  of  the  options,  there  is  a  further 
discussion  of  potential  impacts  in  relation  to  the  timing  and  monetisation  (Annex  13). 

Table 5: Comparison of options for the innovation fund 

Baseline 

(directive 
unchanged / no 
support for 
innovation) 

Not applicable 

Not applicable 

Not applicable 

Not applicable 

Not applicable 
Not applicable 
Not applicable 

Alternative 
baseline 

(Current rules 
continued) 

0 

0 

0 

0 

0 
0 
0 

Option 1 

Option 2 

(Amended 
approach for all 
sectors with 
tailoring for 
industry) 
- 

+ 

++ 

++ 

- 
++ 
+ 

(Permanent 
financing facility) 

- 

+ 

+ 

0 

+ 
++ 
+ 

Minimise complexity and 
administrative burden 
Complementarity with other EU 
instruments 
Effectiveness in addressing 
barriers for low-carbon 
innovation 
Potential to attract innovative 
projects 
Leverage 
Competitiveness 
EU added value and 
geographical distribution 

When  screening  and  comparing  the  options,  two  pluses  indicate  a  major  improvement  when 
compared  to  the  alternative  baseline,  one  plus  indicates  an  improvement,  zero  indicates  no 
change and one minus indicates deterioration.   

The analysis of the options shows that the options  involve several trade-offs with regard to the 
resulting  impacts.  While  all  seven  criteria  presented  above  are  relevant  to  comparison  of  the 
options,  relative  to  the  other  criteria  the  ‘Effectiveness  in  addressing  barriers  for  low-carbon 
innovation’ and ‘Potential to attract innovative projects’ are key factors contributing towards the 
fund objectives. 

Option  1  would  be  very  effective  in  addressing  specific  barriers  for  low-carbon  innovation  by 
substantially  lowering  the  financial  barriers  for  project  sponsors.  It  would  provide  cash  grants 
(opposed  to  a  financial  instrument  such  as  equity  or  a  guarantee  in  Option  2)  combined  with  a 
higher funding rate (up to 75%, as opposed to 50% in the alternative baseline) and the option for 
early  disbursement  of  part  of  the  funds  following  the  achievement  of  construction  milestones 
(opposed to the disbursement of funds only on the basis of achieving operational performance as 
in the alternative baseline).   

While it would be expected to result in a lower leverage and a lower number of projects being 
supported  than  either  the  alternative  baseline  or  Option  2,  Option  1  represents  the  highest 
potential  to  address  the  specific  barriers  to  support  the  commercialization  of  breakthrough 

69 

 
 
 
 
 
 
 
 
 
 
 
 
 
innovation  for  CCS,  RES  and  energy  intensive  industry.  This  package  would  likely  attract  the 
highest number of applications of innovative FOAK projects in the energy and industry  sectors 
and ensure effective project implementation. 

Option  1  could  also  deliver  significant  EU  value  added  by  taking  into  account  replicability  of 
industry  projects,  while  still  rules  providing  safeguards  to  allow  a  wide  variety  in  the 
geographical and technological spread of projects within the EU and achieving a critical mass of 
funding which would not be attainable by Member States alone.  

Similar outcomes could also be realised by the first-come-first-served selection process provided 
by  Option  2,  but  this  option  would  offer  smaller  scope  for  a  comparison  between  numerous 
project proposals and may need to be combined with additional public support in order to enable 
more far reaching innovative projects to be realised. Both Option 1 and Option 2 are expected to 
provide significant benefits with regard to competitiveness and to be complementary to existing 
EU instruments.  

An  Innovation  Fund  implemented  through  Option  1  (provision  of  grants),  could  be  closely 
coordinated with  other  EU-level  and  national  level  support  schemes.  To  increase  the  impact  of 
the  Innovation  Fund  under  Option  1,  an  increased  level  of  coordination  between  grants  and 
financial  instruments  could  be  beneficial  to  address  market  failures.  Duplication  should  be 
avoided,  but  a  combination  of  such  instruments  could  cater  to  a  wider  set  of  technologies  and 
projects as grants and financial instruments normally do not fully cover the same underlying risks 
and could be regarded as complementary. How to ensure the coordination between the Innovation 
Fund  and  relevant  existing  financial  instruments  should  be  assessed  in  the  context  of  the 
implementing legislation for the Innovation Fund. 

More  detailed  assessment  of  the  relevant  modalities  should  take  place  in  the  context  of  the 
preparation of a future implementing legislation for the Innovation Fund. 

8.2.  Modernisation Fund 

8.2.1.  Problem definition 

8.2.1.1.  Context 

The European Council in October 2014 agreed that a reserve of 2% of the  EU ETS allowances 
will be set  aside between  2021 and 2030118, and the proceeds from this reserve will be  used to 
create a Modernisation Fund to support the EU Member States with lower income (with GDP per 
capita  below  60%  of  the  EU  average)  in  improving  energy  efficiency  and  modernising  their 
energy  systems,  while  ensuring  simplified  arrangements  for  small  scale  projects.  There  are  10 
beneficiary  Member  States:  Bulgaria,  the  Czech  Republic,  Estonia,  Croatia,  Latvia,  Lithuania, 
Hungary,  Poland,  Romania,  and  Slovakia119.  The  creation  of  the  Modernisation  Fund  implies  a 
net transfer of 223 million allowances, translating into potentially as much as € 5.5 billion, to the 
beneficiary Member States from the remaining EU Member States (See Table 34 in Annex 11).  

118 This translates into around 310 million allowances, which could result in as much as € 8 billion  
119 Eurostat, 2013 GDP per capita at market prices. 

70 

 
 
 
 
                                                           
8.2.1.2.  Underlying drivers of the problem 
At the end of 2014, the Special Task Force (Member States, Commission, EIB) on Investment120 
as  one of its tasks  analysed  the market barriers for investments to  various sectors in  the EU. It 
concluded  that  across  sectors  macroeconomic  uncertainty,  insufficient  structural  reforms, 
incomplete  single  market  as  well  as  regulatory  constraints  negatively  affect  the  investment 
climate.  Administrative  burden  has  also  been  identified  as  a  major  bottleneck.  The  report 
highlighted  that  for  the  energy  sector  the  barriers  to  investment,  and  hence  potential  solutions, 
differ  between  grids,  production  projects,  energy  efficiency  and  distributed  renewable  energy 
projects. See Annex 10 for details on the financial barriers for investment in the energy sector. 

The  Modernisation  Fund  could  play  a  role  in  addressing  specific  financial  barriers.  While  the 
European Council already agreed on the establishment of the fund and its purpose to modernise 
the  energy  sector  and  improve  energy  efficiency,  it  did  not  define  the  governance  structure, 
including  the  details  of  the  respective  roles  of  the  beneficiary  Member  States,  EIB  and  other 
institutions.  

Since the governance structure matters for the effectiveness of funding mechanisms, this impact 
assessment focuses on the design of the fund to make best use of the expertise and knowledge of 
the various institutions involved. As the Modernisation Fund is a new funding mechanism created 
with allowances which belong to the Member States and as such are not part of the EU budget, 
this Impact Assessment aims to determine, as a first step, to what extent the different institutions 
would be involved in setting the eligibility and selection criteria for the projects to be supported 
by the fund.  Thus at this stage no options are developed on the eligibility criteria and the specific 
type of support used (grants, financial instruments or a mix of the two). The further details on the 
modalities  of  the  fund,  including  eligibility  criteria  and  specific  type  of  support  used  (grant, 
financial instrument or a mix of the two) would need to be clarified and analysed in a subsequent 
implementing legislation following further assessment and/or decided by the board of the fund, 
depending on the  option chosen for the governance structure.  

8.2.1.3.  Lessons learnt 

The  Modernisation  Fund  is  a  new  policy  mechanism,  so  it  should  draw  on  the  experience  of 
existing  initiatives  related  to  the  ETS  such  as  the  optional  free  allocation  to  the  power  sector 
under  Article  10c  of  the  ETS  Directive  (see  section  8.3.2  and  Annex  4.2)  and  the  funding  of 
innovative investments through the NER300 initiative (see Annex 4.1). More general lessons on 
governance  of  investment  platforms  can  be  drawn  from  the  Commission,  EIB  and  Member 
States’ experience in implementing financial instruments, and from the work related to setting up 
of the European Fund for Strategic Investments under the EU Investment Plan.121 

One element that has been highlighted by private stakeholders in the recent discussions of the EU 
Investment Plan is the importance of robust project quality criteria and an independent selection 
of  projects122.  Additionally,  Member  States  have  expressed  political  commitment123  to  have 
financial  instruments  play  a  more  important  role  in  the  multiannual  financial  framework  for 
2014-2020,  preliminary  data  suggest  that  the  uptake  can  be  higher124.  The  experience  gained 

http://ec.europa.eu/priorities/jobs-growth-investment/plan/docs/special-task-force-report-on-investment-in-the-

120 
eu_en.pdf  
121 http://ec.europa.eu/priorities/jobs-growth-investment/plan/index_en.htm  
122 http://ec.europa.eu/priorities/jobs-growth-investment/plan/docs/proposal_regulation_efsi_en.pdf  
123 EUCO 9622/15' (http://data.consilium.europa.eu/doc/document/ST-9622-2015-INIT/en/pdf)' 
124 http://ec.europa.eu/regional_policy/sources/docoffic/official/reports/cohesion6/6cr_en.pdf  

71 

 
 
                                                           
during the 2007-2013 implementation period with financial instruments125 developed by the EU 
and EIB shows that the effectiveness and efficiency of financial instruments can be enhanced by 
implementing fewer financial instruments with larger volumes to ensure critical mass126.  

As discussed in Section 8.3, the free allocation to the power sector in the lower income Member 
States  indicates  the  need  for  a  simple,  transparent  and  clear  approach  to  make  effective  use  of 
available  resources.  Finally,  the  NER300  programme  (see  Section  8.1  and  Annex  4.1), 
demonstrates  the  EIB’s expertise  to  cooperate  with  the  Commission  and  Member  States  in  due 
diligence to select projects and act as an agent to monetise allowances. An important element to 
ensure that the Modernisation Fund can start financing projects in 2021 is to time the auctioning 
of  allowances  in  such  a  way  as  to  provide  certainty  of  available  funds,  while  also  avoiding  a 
negative impact on the carbon market.  

8.2.2.  Policy Objectives 

As  discussed  above,  the  impact  assessment  focuses  on  the  governance  structure  of  the 
Modernisation  Fund.  The  fund  should  support  transition  to  low  carbon  economy  in  beneficiary 
Member States and contribute to ensuring EU-value added and support the completion of the EU 
internal energy market, while ensuring that the specific market barriers and national priorities in 
the  beneficiary  Member  States  are  addressed.  In  this  respect,  the  impact  assessment  will  also 
assess the potential role the Commission could play. This reflects also the views of stakeholders: 
on the one hand, many stakeholders127 highlighted the importance of reflecting national priorities, 
while on the other hand, many indicated the importance of minimising distortion to the internal 
market and contributing to the EU long-term climate objectives128.  
An  additional  concern  raised  by  many  stakeholders129  is  that  the  governance  structure  and 
decision-making  process  should  minimise  administrative  burden,  be  feasible  for  operational 
implementation,  and  be  coherent  in  order  to  catalyse  additional  investments.    In  particular,  the 
process should be simplified for small-scale projects.  

8.2.3.  Development and screening of policy options  

8.2.3.1.  Policy options  

The main options assessed relate to the governance structure of the Modernisation Fund and in 
particular the different roles that Member States, the European Commission and the EIB can play 
to  advance  its  objectives.  The  approach  taken  involves  varying  their  role  of  these  actors  in 
aspects,  such  as  who  determines  the  investment  guidelines  (including  criteria  for  project 
eligibility  and  selection)  monitors  performance,  and  selects  projects  and  programmes.  While 

125 Financial instruments may take the form of equity or quasi-equity investments, loans or guarantees, or other risk-
sharing instruments, examples include credit enhancement mechanisms (e.g. Project Bond Initiative), risk sharing for 
financial intermediaries (e.g. PF4EE) and the setting-up of funds, including senior and junior loans, guarantees and 
equity participation (e.g. Marguerite). 
126 COM(2014) 686 final 
127 For example, several energy sector stakeholders from beneficiary Member States indicated the need for Member 
States  to  be  able  to  set  priorities  for  the  use  of  resources,  in  line  with  subsidiarity,  while  the  other  stakeholders 
highlighted  the  need  for  investments  in  a  modernized  power  sector  in  lower  income  Member  States  in  order  to 
achieve Europe-wide decarbonisation. See annex 3 with summary of stakeholder consultation results. 
128 See Annex 3 with summary of stakeholder consultation results. 
129 For example, several energy sector stakeholders indicated the need for simple structures for investors. See annex 3 
with summary of stakeholder consultation results 

72 

 
 
 
 
                                                           
various combinations are possible, the key consideration is that the governance structure needs to 
reflect the specific strengths and expertise of the different institutions involved.  

Eligibility, selection criteria, investment guidelines and monitoring  

A  main  factor  that  can  be  varied  is  the  composition  of  the  Steering  Board,  which  will  further 
define the rules and guidelines insofar as this has not been done in the implementing legislation 
of the Modernisation Fund. Membership of the Steering Board could either be primarily reserved 
for the beneficiary Member States, or for a balanced representation of all 28 Member States and 
the Commission.  

  Variation 1: the 10 beneficiary Member States have control over defining the eligibility 
criteria,  selection  criteria  and  investment  guidelines  of  the  fund  and  monitoring  its 
performance. The Commission provides general guidance. 

  Variation 2: the 28 Member States together with the Commission are involved in defining 
eligibility,  selection  criteria  and  investment  guidelines  and  monitoring  the  operations  of 
the fund. 

  Variation  3:  The  Commission  defines  the  eligibility,  selection  criteria  and  investment 
guidelines and monitors performance. Within this framework beneficiary Member States 
pre-approve the project pipeline in line with these criteria, but do not directly define the 
priorities of the fund.  

Project selection 

With regards to project selection, the role of the EIB and other institutions is examined. There are 
two general options of how the EIB can be involved in the selection of projects and programmes:  
  Variation  1:  the  EIB  is  involved  in  due  diligence  and  takes  an  advisory  role130.  The 
Commission  and  beneficiary  Member  States  are  responsible  for  project  selection  and 
approval,  following  advice  by  the  EIB.  The  Steering  Board  would  need  to  justify 
investment decisions that deviate from the EIB advice. 

  Variation  2:  the  EIB  is  delegated  to  take  the  role  of  a  fund  manager  on  behalf  of  the 
beneficiary Member States and the Commission, and therefore takes investment decisions 
in line with investment guidelines. The Steering Board would need to justify a refusal to 
support investment decisions taken by the EIB.  

The EIB could also act as an agent to monetise the EU ETS allowances. Finally the EIB may be 
one of the institutions that implements the financial instruments selected under the Modernisation 
Fund, together with national and regional promotional banks.  

8.2.3.2.  Option packages  

Three different combinations for the governance structure are examined to evaluate the specific 
impacts  and  reflect  the  differences  in  stakeholder  views  on  the  relative  roles  of  the  beneficiary 
Member States, other Member States, the Commission and the EIB131: 

  Baseline - a legal baseline would imply that 2% of the ETS allowances would be allocated 
to  all  28  Member  States  rather  than  being  used  for  modernising  energy  systems  and 

130 This implies involvement of national and regional promotional banks in the day-to-day management of the fund 
with respect to financial instruments. 
131 See Annex 3 on stakeholder consultation to the revision of the EU ETS directive. 

73 

 
 
 
                                                           
improving  energy  efficiency  in  the  beneficiary  Member  States132.  The  lower  income 
Member States would then receive only some 87 million allowances, less than a third of 
the 310 million in the Modernisation Fund. 

  Option 1 - large discretion and responsibility for the 10 beneficiary Member States as the 
only  representatives  on  the  Steering  board,  setting  eligibility  criteria  and  investment 
guidelines.  The  EIB  would  have  a  limited  advisory  role,  including  performing  due 
diligence,  while  the  Commission  could  administer  calls  for  proposals  for  grants.  The 
implementation could be either through grants and/or financial instruments. 

  Option 2 - a wider representation on the Steering board of all 28 Member States and the 
Commission as well as a greater role in implementation for the EIB. The implementation 
would  be  through  grants  and/or  financial  instruments,  for  which  the  EIB  could  have  an 
enhanced role as fund manager, but remaining accountable to the Steering Board to which 
it  would  report.  The  Commission  could  administer  calls  for  proposals  for  grants,  for 
which the EIB performs due diligence. 

  Option 3 - the beneficiary Member States would identify a pipeline of projects to which 
funds  should  be  allocated,  but  projects  would  conform  to  eligibility  criteria  and  general 
principles  for  project  selection  analysed  and  set  in  the  fund’s  implementing  legislation. 
The  Commission  would  administer  any  calls  for  proposals,  for  which  the  EIB  would 
perform  due  diligence.  For  the  purposes  of  the  analysis,  the  implementation  would  be 
through a grant rather than financial instruments133.  

An option in which each beneficiary Member State implements the funds individually at national 
level is not analysed further, since this would have a limited added value compared to instruments 
that the beneficiary Member states already have at their disposal134. Such an option also has the 
potential to have a higher administrative burden, a higher distortive effect on the common energy 
market and to be less suited to promote investments with beneficial cross-border effects.   

The options are summarised below: 

Table 6: Retained options for examining for the Modernisation Fund 

Eligibility and Selection Criteria  

Investment Guidelines 
& Monitoring done by 

Day-to-Day Management done by 

Baseline  No Modernisation Fund 

No Modernisation Fund  No Modernisation Fund 

132 The current ETS Directive provides that Member States should spend at least 50% of the auctioning revenues for 
climate and energy related purposes but has no provisions for the creation of a Modernisation Fund, 
133 It should be noted that financial instruments could also be used under Option 3. However, to reflect the Council 
conclusions that beneficiary Member States should have a role in the Modernisation Fund, and to ensure sufficient 
differences between the options, for the purposes of the analysis, the implementation assumed is through grants with 
beneficiary Member States involvement in approving a project pipeline. 
134 For example, the optional free allocation to the power sector and the European Structural and Investment Funds. 

74 

 
 
 
                                                           
Option 
1 

Implementing legislation: general 
principles; Steering board of 
beneficiary MS decides further 
details 

Steering board of 
Beneficiary MS 

Financial instruments: beneficiary MS 
approval; EIB advisory role 
Grants: COM organizes call for 
proposals; EIB performs due diligence 

Option 
2 

Steering board of COM and 28 MS   Steering board of COM 

and 28 MS with input 
from EIB 

Financial instruments: EIB acts as fund 
manager 
Grants: COM organizes call for 
proposals; EIB performs due diligence 

Option 
3 

Implementing legislation: detailed 
principles 

COM 

Grants: beneficiary MS approve project 
pipeline; COM organizes call for 
proposals; EIB performs due diligence 

8.2.4.  Analysis of Impacts 

The environmental, social and economic implications of the creation of the Modernisation Fund 
are driven by the European Council strategic guidance that determined the number of allowances 
available  for  the  fund,  the  criteria  based  on  which  Member  States  are  determined  as  eligible 
beneficiaries, as well as the method for allocation among Member States and the type of project 
supported135. Annex 11 assesses the impacts of having a Modernisation Fund against the baseline 
scenario  of  not  having  a  Modernisation  fund  at  all.  In  summary,  the  effects  of  creating  the 
Modernisation Fund when compared to the baseline are: 

  Economic  impacts:  Compared  to  the  baseline  scenario,  the  Modernisation  Fund  would 
help trigger important investments in the beneficiary Member States that could contribute 
towards  the  key  aspects  of  creating  a  strong  European  Energy  Union  with  a  forward 
looking  climate  policy.  It  is  expected  to  contribute  not  only  towards  cost-effectively 
reaching the 2030 climate and energy objectives, but also towards diversifying the energy 
mix, improving security of supply and lowering import dependency. 

  Environmental impacts: The creation of the Modernisation Fund has environmental and 
health  benefits  for  the  beneficiary  Member  States  compared  to  the  baseline  scenario. 
Through facilitating investments in energy efficiency and modernising the power sector, 
the  fund  would  contribute  to  lowering  greenhouse  gas  emissions  in  the  beneficiary 
Member States  under  both  the ETS  and the non-ETS sectors.  Additionally, by lowering 
fossil  fuel  consumption,  local  air  quality  may  improve  leading  to  health  benefits  in  the 
beneficiary  Member  States  and  contributing  to  lower  costs  related  to  controlling 
emissions of air pollution.  

  Social impacts: Since the Modernisation Fund would contribute to realizing investments 
to  facilitate  the  energy  sector  modernisation  and  improving  energy  efficiency  in  the 

135 The distribution of funds will be based on the combination of a 50% share based on verified emissions and 50% 
share based on GDP  

75 

 
 
 
                                                           
beneficiary  Member  States,  when  compared  to  the  baseline,  it  is  expected  to  have  a 
positive impact on employment for the beneficiary Member States, for example, through 
the  creation  of  jobs  through  small  scale  projects.  The  final  impact  will  depend  on  the 
amount of realized investments and in which specific sectors these are implemented. 

After  being  compared  to  the  baseline  option  of  not  creating  a  Modernisation  Fund,  the  three 
options  identified  and  presented  in  Section  8.2.3  will  be  compared  with  one  another  in  their 
ability  to  achieve  the  operational  objectives  as  outlined  in  Section  8.2.2.  the  following  criteria 
will be used in order to assess the relevant differences in achieving the specific policy objectives, 
categorized as follows: 

  Effectiveness:  a  governance  structure  should  be  able  to  catalyse  additional  investments, 
address specific barriers that limit investments in the modernisation of the energy sector 
and  in  increased  energy  efficiency  in  lower  income  Member  States,  including  for  small 
scale projects. Since a different set of instruments might be needed to address the market 
barriers  in  the  different  sectors,  the  implications  of  the  options  on  the  possibility  to  use 
grants, financial instruments or a mix of both would be considered.  

  Coherence: a coherent governance structure should appropriately align the interests of the 
institutions involved, while achieving transparency in the use of the funds. The coherence 
evaluates the extent to which the options present a governance structure that would give 
confidence to private investors. In this context, the transparency of the fund is evaluated 
against  the  possibility  for  the  European  citizens  and  the  private  sector  to  be  informed 
about the setting up and operations of the Modernisation Fund. 

  Market distortion: Evaluate to what extent there is a risk of distorting the internal energy 

market.  

  Administrative burden: Minimize the complexity and the administrative burden of setting 
the 

includes  consideration  of 

up  and  operating  the  Modernisation  Fund.  This 
administrative burden for project promoters.   

8.2.4.1.  Effectiveness 

The  three  options  are  expected  to  be  more  effective  in  modernizing  the  energy  systems  and 
improving  energy  efficiency  in  the  lower  income  Member  States  compared  to  the  baseline 
scenario as they channel specific funds towards these objectives.  

Depending  on  the  barriers  faced,  the  different  types  of  projects  in  the  lower  income  Member 
States may require public intervention in the form of grants, financial instruments, or a mix of the 
two (see Annex 10 for discussion on the barriers in different sectors, including networks, energy 
efficiency,  and  power  generation).  The  specific  type  of  support  provided  through  the 
Modernisation Fund would depend on the project eligibility that would be determined at a later 
stage,  depending  on  the  chosen  governance  option.  Based  on  this,  a  suitable  form  of  public 
intervention would need to be determined based on the specific market needs. It may be needed 
to  contribute  part  of  the  funding  towards  providing  technical  assistance  facilities  to  speed  up 
project preparation, and improve the quality of projects.  

76 

 
 
 
 
Grants  are  typically  used  to  support  non-revenue  generating  projects  that  at  the  same  time 
advance  the  EU  policy  objectives136.  Grants  require  a  certain  rate  of  co-financing  by  project 
promoters,  so  assuming  a  co-financing  rate  of  50%,  grants  would  lead  to  2  fold  leverage  on 
investment.  However,  this  rate  could  vary  so  that  the  minimum  needed  support  is  provided. 
Financial instruments, on the other hand, can realise higher leverage and scale-effects and enable 
cost-effective  use  of  public  resources.  Evidence  from  the  use  of  financial  instruments 
implemented  by  the  Commission  and  the  EIB  in  the  energy  sector  shows  that  financial 
instruments, depending on how they are structured, can leverage public money in the range of 6 
to 15137 times. It is possible to also blend financing options. 

The  options  on  governance  have  some  implications  for  the  design  of  any  future  grants  and/or 
financial  instruments.  Options  1  and  2  allow  flexibility  to  balance  between  addressing  sub-
optimal  investment  situations  that  need  grant  support,  and  maximizing  leverage  by  using  the 
funds through financial instruments. On the other hand, under Option 3, the proceeds  would be 
disbursed  through  grants  so  focus  will  likely  be  given  to  specific  sub-sectors  where  providing 
grant support would not distort the internal energy market.  

Under  Option  1  the  use  of  financial  instruments  would  potentially  be  more  limited  than  under 
Option  2.  As  discussed  in  Section  8.2.1.3,  the  experience  with  the  European  Structural  and 
Investment Funds indicates that the use of financial instruments in Member States may be limited 
due to bottlenecks in administrative capacity and in some cases market maturity. Therefore, under 
Option  1,  the  beneficiary  Member  States  might  opt  for  more  traditional  means  of  supporting 
investments  such  as  grants.  Under  Option  2,  the  EIB  can  use  its  extensive  experience  with 
financial  instruments  and  the  expertise  to  ensure  the  effectiveness  and  competitiveness  of  such 
instruments. Therefore,  once  project eligibility is determined  under this option it is  more likely 
that the use of grants would be limited only to situations where financial instruments cannot help 
adequately. 

Regarding the possible use of financial instruments, under Option 1, it is more likely that national 
and regional promotional banks would be more involved in structuring the financial instruments, 
which,  in  turn,  could  lead  to  a  more  fragmented  approach  resulting  in  different  structures  and 
financial terms offered in the different Member States for similar projects. This may result in a 
suboptimal  level  of  risk  sharing  and  diversification.  On  the  other  hand,  it  would  allow 
promotional  banks  in  the  beneficiary  Member  States  to  strictly  tailor  these  instruments  to  the 
specificity of the domestic market, in particular to support small scale projects.  

On  the  other  hand,  in  Option  2  the  management  role  of  the  EIB  could  allow  applying  a 
harmonised  approach  across  the  beneficiary  Member  States.  Standardised  financial  instruments 
have  the  advantage  to  offer  consistent  financial  terms  to  project  promoters  and  intermediary 
financial institutions. They could also contribute to a  more optimal level of risk-sharing, which 
can  be  achieved  with  a  larger  portfolio  of  projects  with  different  risk  profile  across  the 
beneficiary  Member  States.  The  EIB  could  play  a  pivotal  role  in  providing  more  assurances  to 
project  promoters  and  ensuring  that  evaluation  and  selection  are  performed  ensuring  value  for 
money. Regarding small scale projects, under Option 2 it will be necessary to work with financial 

136 For example, the EU budget has already contributed grant support to investments in energy efficiency (through 
the  European  Structural  and  Investment  Funds,  for  instance)  where  financial  instruments  may  not  be  sufficient  to 
overcome  the  financial  and  technical  barriers.  The  EU  budget  has  also  provided  grant  support  for  cross-border 
projects  (through  the  Connecting  Europe  Facility)  that  face  additional  difficulties  in  terms  of  coordination, 
justification, permitting and social acceptance. 
137 Report from the Commission to the European Parliament and the Council on financial instruments supported by 
the general budget according to Art.140.8 of the Financial Regulation as at 31 December 2013, COM/2014/0686 

77 

 
 
                                                           
intermediaries138.  It  allows  to  aggregate  together  similar  projects  of  smaller  size  across  the 
beneficiary  Member  States  to  build  a  critical  mass,  diversify  the  risks  and  make  such  projects 
more attractive to private investors.  Specific targeted calls for proposals could be organised for 
small  scale  projects  (e.g.  less  than  €5  million)  under  Option  3,  as  well  as  for  awarding  grants 
under Options 1 and 2. 

Option  1  gives  the  highest  discretion  to  the  beneficiary  Member  States  to  address  national 
priorities but there is a risk that projects with higher EU-wide value added, such as cross-border 
projects  might  not  be  sufficiently  included.  This  is  addressed  or  at  least  mitigated  through  a 
stronger role for the Commission and all EU 28 Member States in Option 2. Certainty that EU-
wide value added will be achieved is maximised under Option 3, under which the Commission 
will  have  high  discretion,  ensuring  alignment  with  EU  objectives.  Under  this  option  the  pre-
approval of a project pipeline by beneficiary Member States would give them flexibility to align 
the fund to their national priorities. 

Under the three options, the EIB would be involved in the technical and financial due diligence of 
the  projects  supported  by  grant  schemes.  This  would  ensure  that  the  grants  are  provided  to 
maximise  the  environmental  and  economic  impact  and  in  the  minimum  needed  amount.  The 
organisation of calls for proposals by the Commission would avoid the issue of fragmentation and 
also create better visibility for the Modernisation Fund, which could improve the quality of the 
submitted projects.   

8.2.4.2.  Coherence 

Since the three options provide different balance of the roles between the institutions, there are 
varying impacts on coherence of the governance structure.  

Under  Option  1,  since  the  rules  of  the  fund  are  agreed  only  among  the  beneficiary  Member 
States,  these  might  introduce  fragmented  approaches  based  on  national  preferences,  not 
necessarily aligned with internal rules of the EIB139 or with EU objectives, and thus not ensuring 
EU value added. This might limit the  scope of the EIB role with regard to implementation  and 
increase the uncertainty for investors about how projects will be assessed. 

Under  Option  2,  with  a  wider  representation  of  Member  States  and  institutions  at  the  Steering 
Board, it is more likely that the guidelines for selection of projects will be consistent with internal 
guidelines  of  the  Commission  and  the  EIB,  and  with  EU  objectives.  This  would  make  it  more 
likely to enhance the EIB role, which would provide certainty for private investors. Under such 
circumstances  it  is  more  likely  that  the  EIB  may  decide  to  be  involved  in  risk-sharing  or  co-
financing of projects, which could decrease the cost of capital for project promoters who can take 
advantage of the EIB's favourable financial terms.  

On complementarity with existing instruments, Option 1 may facilitate coordination with existing 
national  schemes  and  the  use  of  the  European  Structural  and  Investment  Funds,  which  are 
distributed at national level, but it will be more challenging to ensure complementarity with EU-
level instruments. On the other hand, in Option 3, the Commission will have higher discretion in 
setting priorities and selecting projects, ensuring alignment with EU objectives. The involvement 
of  the  beneficiary  Member  States  through  pre-approval  of  projects  that  can  apply  for  funding 

138 For example, the EIB and the Commission are already using this approach with the Private Finance for Energy 
Efficiency financial instrument. It provides guarantees managed by the EIB to commercial banks in Member States 
to support small scale energy efficiency projects. 
139  The  EIB  has  internal  energy  lending  criteria,  set  at  EU  level  with  the  agreement  of  all  28  Member  States 
(http://www.eib.org/infocentre/publications/all/eib-energy-lending-criteria.htm). 

78 

 
 
 
                                                           
would ensure that the selected projects are in line with the national investment plans. As a more 
balanced  distribution  of  the  roles,  Option  2  would  ensure  that  consideration  is  given  to 
consistency  with  existing  initiatives  both  at  beneficiary  Member  State  and  at  EU  level,  while 
maximising the respective strengths of the Member States, Commission and the EIB. 

In terms of transparency, under Options 1 and 2, the operational details of the fund will be set by 
a Steering Board, rather than during the process of defining implementing legislation. This may 
reduce the transparency in how investment criteria are set. However, stronger involvement of the 
Commission,  which  is  accountable  to  the  European  Parliament,  would  likely  improve 
transparency  vis-à-vis  European  citizens  in  designing  the  rules  of  the  fund  and  monitoring  the 
operations, notably for Option 2. In that vein, Option 3 provides the highest level of transparency 
as  the  majority  of  the  operational  rules  would  be  analysed  and  included  in  the  implementing 
legislation.  The  Commission  would  ensure  an  EU  level  competitive  process,  including 
appropriate reporting on the use of funds and the timely review of the Modernisation Fund.  

8.2.4.3.  Market Distortion 

Since the energy sector is commercially driven and revenue bearing, public intervention should 
use  the  least  distortive  tools  to  address  potential  market  failures  or  sub-optimal  levels  of 
investment.  Any  support  provided  should  maintain  a  level  playing  field  in  the  internal  energy 
market,  so  as  to  ensure  open  access  for  possible  use  of  infrastructure.  Support  should  avoid 
overcompensation and wasteful duplication of investments.  

Under Option 1, beneficiary Member States are strongly involved in the investment decisions. As 
discussed, this might result in more fragmented approach with different criteria and terms applied 
in each beneficiary Member State and a risk that minimising the distortions of the internal market 
are  considered  to  a  lesser  extent.  The  support  may  be  cumulative  to  aid  granted  under  other 
options of funding. 

Option 2 would differ from Option 1 through a wider representation in the governance structure, 
but  the  way  in  which  support  is  granted  could  still  lead  to  distortions.  Therefore,  this  support 
would  again  have  to  be  subject  to  State  aid  control.  The  EIB  and  the  Commission  would  act 
under  mandate  from  the  EU28  Member  States  to  ensure  consistent  selection  and  treatment  of 
financing  for  equivalent  projects  across  the  beneficiary  Member  States.  This  would  make 
distortion of the internal market less likely.  

Option  3  would  imply  the  most  extensive  rules  and  procedures  to  avoid  the  risk  of  market 
distortion, by analysing and setting detailed eligibility and selection criteria in advance, including 
requiring  the  use  of  competitive  bidding  processes  where  possible.  The  involvement  of  the 
Commission  would  ensure  that  the  fund  addresses  concerns of  market  distortion  and  takes into 
account the EU-value added, for example through contributing to creating an Energy Union and 
completing an internal energy market. 

Across  all  options,  support  granted  by  Member  States  would  need  to  be  subject  to  State  aid 
control  (where  relevant).  However,  small-scale  projects  may  fall  in  categories  which  exempt 
them from ex-ante notification under state aid rules or benefit from low support levels. Under the 
current rules, small-scale projects could qualify for an exemption from state aid notification under 
the de minimis regulation140 if less than EUR 200,000 of aid is given over 3 years. While the fund 
would be operational only as of 2021, some projects could qualify for an exemption from ex-ante 

140 http://ec.europa.eu/competition/state_aid/legislation/de_minimis_regulation_en.pdf  

79 

 
 
 
                                                           
notification under a possible future general block exemption regulation141, if certain conditions on 
amount, intensity and recipients are met, as the Commission evaluated that the provision of such 
aid does not unduly distort competition in the single market. .  

8.2.4.4.  Administrative Burden 

Under all options, project promoters need to provide information to facilitate an assessment of the 
necessity and proportionality of support and to assist the selection process.  As such, all options 
involve  some  administrative  burden  for  project  promoters,  Member  States  the  EIB  and  the 
Commission. 

On  administrative  burden  for  the  institutions  involved  in  managing  the  Modernisation  Fund, 
Option  3  is  the  least  burdensome  for  Member  States  since  it  involves  the  setup  of  a  single 
mechanism – a competitive call for proposals across all beneficiary Member States. Option 1 and 
2  may  involve  higher  administrative  burden  due  to  the  setting-up  of  additional  financial 
instruments.  This  burden  would  fall  on  the  financial  institutions  that  would  be  entrusted  to 
implement  these  instruments,  unless  the  Steering  Board  decides  to  implement  the  fund  through 
already  existing  instruments.  Under  Option  1,  a  decentralized  solution  to  financial  instruments 
may  increase  the  management  complexity  and costs  and  might  be less efficient  in  ensuring  the 
due diligence process is conducted in a uniform manner. Compared to Option 1, Option 2 could 
limit the administrative burden through the implementation of standardised financial instruments.  

Administrative  simplification  for  project  promoters  is  important  for  facilitating  investment,  in 
particular  for  small  scale  projects.  Two  aspects  are  noteworthy  in  that  regard:  1)  the  extent  to 
which  there  is  clarity  for  project  promoters  and  investors  on  project  selection  and  investment 
criteria, and 2) the administrative burden faced by project promoters in applying for funding. 

Option 3 provides the highest clarity on the criteria for project selection as they would be defined 
in the implementing legislation and be applicable to all beneficiary Member States. Compared to 
this, Option 1, results in a fragmented national approach with different criteria per Member State. 
This could result in confusion for project promoters, in particular for international investors, and 
become  an  obstacle  to  effective  implementation.  Option  2  would  simplify  the  procedures  for 
international  investors  through  the  introduction  of  standard  financial  instruments  across  the 
beneficiary  Member  States.  It  would  improve  visibility  through  the  'one-stop  shop'  approach, 
providing  the  same  procedures  and  terms  for  project  promoters  and  investors  across  the  10 
beneficiary Member States. It will be particularly important to ensure simplified procedures for 
financing of small-scale projects to facilitate the specific challenges these projects face. Under all 
Options,  calls  for  proposals  could  target  small-scale  projects  applying  for  grant  schemes. 
Compared  to  Option  2,  under  Option  1  there  would  be  closer  proximity  between  local  project 
promoters  (that  tend  to  support  smaller  ticket  projects)  and  the  managing  financial  institutions 
and this would facilitate the support for small-scale projects. On the other hand, Option 2 could 
address small  scale projects through local financial intermediaries. This would  mean simplified 
rules for project promoters, but it would create additional burden for setting up such intermediary 
arrangements  with  the  financial  institutions.  Specific  technical  barriers  could  be  addressed  by 
dedicated technical assistance facilities. 

141 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R0651&from=EN  

80 

 
 
 
 
                                                           
8.2.5.  Comparing the Options  

As the Modernisation Fund is a new funding mechanism that will be operational as of 2021, the 
detailed operational modalities would ultimately need to reflect the types of projects eligible and 
the  specific  barriers  that  need  to  be  addressed  to  realize  these  investments.  The  governance 
structure  of  the  fund  is  therefore  a  crucial  first  step  towards  further  choices  regarding  eligible 
projects and the modalities for financing. Compared to the baseline scenario, the creation of the 
Modernisation Fund is expected to have important positive benefits for the beneficiary Member 
States through contributing towards the key dimensions of a strong Energy Union with forward-
oriented climate change policy and towards cost-effectively reaching the 2030 climate and energy 
objectives.  It  is  expected  to  trigger  investments  that  create  employment  opportunities,  lower 
greenhouse gas emissions and improve air quality in the beneficiary Member States.  

The table below lists the evaluation of impacts of the three different options. 

Table 7: Impact of policy options for the Modernisation Fund 

Increase coherence  Minimise risk of market 

Increase 
effectiveness 
No Modernisation 
Fund 
+ 

No Modernisation 
Fund 
0 

++ 

0 

+ 

+ 

distortion 
No Modernisation Fund 

- 

+ 

++ 

Minimise administrative 
burden 
No Modernisation Fund 

- 

+ 

+ 

Baseline 

Option 1 

Option 2 

Option 3 

When  screening  and  comparing  the  options,  two  pluses  indicate  a  major  improvement  when 
compared  to  the  alternative  baseline,  one  plus  indicates  an  improvement,  zero  indicates  no 
change and one minus indicates deterioration.   

The  three  examined  options  illustrate  some  key  trade-offs  to  be  considered  in  the  overall 
governance  of  the  fund.  While  all  four  criteria  (effectiveness,  coherence,  market  distortion  and 
administrative burden) are instrumental in the comparison of the options, ‘effectiveness’ is key in 
ensuring  the  governance  structure  contributes  towards  the  objectives  to  modernise  the  energy 
sector and improve energy efficiency served by the Modernisation Fund 

While Option 3 provides for a clear and simple governance structure, it may have a more limited 
impact on mobilising private investments  if implemented by grants  and would therefore have a 
more limited effect on the modernisation of the energy systems.  

Option  1  has  clear  advantages  in  addressing  national  priorities  and  specificities,  but  it  may  not 
fully reflect European priorities. Furthermore the risk of distortions to the internal energy market 
is  higher  and  fragmentation  may  be  too  burdensome  for  larger  investors  resulting  in  lower 
effectiveness compared with Option 2. Option 2 presents a balanced approach that would allow to 
maximize  private  investments,  while  taking  in  account  both  national  and  European  priorities. 
However, appropriate structure of intermediation would be needed to finance small scale projects.  

8.3. 

Free allocation to promote investments for modernising the energy sector 

8.3.1.  Policy objective and problem definition 

For  the  electricity  generation  sector,  the  rule  is  that  operators  no  longer  receive  any  free 
allowances but  have  to  buy them.  However, eight  of the  Member States which  have  joined the 

81 

 
 
 
 
 
 
 
 
EU  since  2004  -  Bulgaria,  Cyprus,  Czech  Republic,  Estonia,  Hungary,  Lithuania,  Poland  and 
Romania  -  have  made  use  of  a  derogation  under  Article  10c  of  the  EU  ETS  Directive  which 
allows  them  to  give  a  decreasing  number  of  free  allowances  to  existing  power  plants  for  a 
transitional period until 2019. Latvia and Malta were also eligible to use this derogation but chose 
not to.  

In  the  context  of  the  2030  climate  and  energy  framework  European  leaders  have  decided  in 
October 2014 that  this option should also be available for lower income Member States  with a 
GDP of less  than 60%  of the EU average in  2013 during the next decade  up to a maximum of 
40%  of  their  allowances  before  redistribution  is  taken  into  account.142  If  all  eligible  Member 
States make full use of this option, the maximum amount given for free could be more than twice 
as much as the number of allowances used for the Modernisation Fund.  

The  policy objective  of  the  optional  free  allocation  to  the  power  sector  is  similar  to  that  of  the 
Modernisation Fund - to enable lower income Member States to modernise their energy sector. 
As indicated in Annex 10, besides the scale of the relevant investment challenges in the energy 
sector  in  these  Member  States  between  2021  and  2030,  common  barriers  to  realising  the 
investments  also  occur,  such  as  underdeveloped  financial  markets,  split  incentives  for  realising 
improvements  to  energy  efficiency  and  a  higher  perceived  level  of  risk,  which  can  form 
challenges  to  mobilising  the  necessary  investments  in  the  energy  sector,  as  also  noted  for  the 
Modernisation Fund 

Free allocation to the power sector differs from the Modernisation Fund because the allowances 
which  can  be  given  for  free  are  deducted  from  the  auction  volume  of  the  Member  State 
concerned, while the Modernisation Fund has a collective funding basis and thus re-distributional 
characteristics.  Consequently,  free  allocation  is  optional,  and  during  the  current  trading  period 
(2013-2020) several Member States have chosen not to make use of it or only to make limited use 
of  this  possibility.  The  free  allowances  can  only  be  given  subject  to  carrying  out  investments 
aimed  at  modernising  the  energy  sector  in  the Member  State.  The investments  must  be  at  least 
equal in value to the free allocation.  

To  assess  the  potential  options  for  continuation  of  this  policy,  the  lessons  learnt  from 
implementation of the existing arrangements to  make use of free allocation to the power sector 
are first considered.   

As  with  the  Modernisation  Fund,  optional  free  allocation  to  the  power  sector  aims  to  support 
investments  to  improve  energy  efficiency  and  to  modernise  the  energy  systems  in  10  lower 
income Member States. Underlying problem drivers include the general barriers to investment to 
investments  described  in  section  8.2.1.2  and  the  financial  barriers  specific  to  the  energy  sector 
listed in Annex 10. 

8.3.2.  Conclusions on lessons learnt and policy context 

An extensive discussion of the lessons learnt from the current implementation of free allocation 
to  power  can  be  found  in  Annex  4.2.  The  initial  results  from  the  experience  of  the  first  year 
(2013) of implementation of this provision indicate that while many of the investments included 
by  the  beneficiary  Member  States  in  their  national  investment  plans  on  free  allocation  to  the 
power  sector  are  taking  place,  the  modalities  for  the  implementation  of  the  provision  differ 

142 Assuming a range for the average annual total quantity of 1 to 25 million allowances this could be as much as €25 
million - €625 million 

82 

 
 
 
                                                           
significantly. These differences between Member States, combined with differing availability of 
public data, make a direct comparison difficult and result in limited transparency. 

There is scope for streamlining and creating a simpler, clearer and more transparent approach for 
the  Member  States  that  will  choose  to  use  the  derogation  after  2020.  Care  should  be  taken  to 
avoid  distortion  of  the  energy  market,  for  example  by  more  clearly  establishing  the  need  for 
investments and their effect.  

The European Council has indicated that the continuation of free allocation should be based on 
improved modalities to ensure the funds are used to promote real investments in modernising the 
energy  sector,  while  avoiding  distortions  of  the  energy  market.  In  this  context,  and  taking  into 
account  the  lessons  learnt,  this  impact  assessment  focuses  on  the  options  for  improvement  of 
these modalities compared to current practice. 

8.3.3.  Operational policy objectives 

The operational policy objectives for free allocation to the power sector relate to the key areas for 
improvement identified in relation to the existing mechanism.  

The main operational objectives are:  

 

to  improve transparency  and ensure that  the  funds are used to  promote real investments 
modernising the energy sector;  

  Simplicity - lowering the complexity and reduce the administrative burden related to the 

implementation;  

  Avoid  distortions  of  the  internal  energy  market  and  minimise  the  impact  of  the 

mechanism on the general functioning of the European carbon market.  

In  this  context,  "real"  is  considered  to  refer  to  additional  investments  compared  to  what  would 
have been invested in the absence of the free allocation. 

8.3.4.  Development and screening of policy options 

The  main  options  assessed  relate  directly  to  the  timing  and  selection  of  investments  and  to 
transparency requirements. These elements are key issues for which the implementation currently 
varies among Member States and which can affect either the volume of allowances coming to the 
market (timing of investments and auctioning of unused allowances), or the achievement of the 
operational  objectives,  such  as  transparency  and  simplicity  (selection  of  investments  and 
transparency requirements). 

With  regard  to  the  selection  of  investments,  the  current  practice  based  on  national  plans 
designed by Member States based on common principles143 could be replaced by the selection of 
investments  at  the  national  level  through  an  open  competition  based  on  targeted  performance, 
which  could  be  e.g.  organised  through  a  tender  or  competitive  bidding  with  the  investment 
representing the best value for money being selected / prioritised.  

A  change  which  could  be  considered  to  reflect  the  longer  period  covered  (2021-2030)  and 
potentially changing investment priorities would be an optional revision or update of the national 

143  For  example,  principle  5  in  the  guidance  document  on  the  optional  application  of  Article  10c  (2011/C  99/03) 
states that "Investments identified in the national plan should contribute to diversification, and reduction in carbon 
intensity, of the electricity mix and the sources of energy supply for electricity production. 

83 

 
 
 
 
                                                           
investment plan, for example midway through the trading period. This could allow changes to the 
design of proposed investments to be evaluated. At the same time, ensuring equal treatment for 
revised and initial investments could necessitate an approval process for such an update similar to 
the  one  carried  out  for  the  initial  national  plan.  This  would  result  in  a  significantly  higher 
administrative  burden  for  operators,  Member  States  and  the  Commission,  and  would  pose 
comparability concerns, while de facto limiting the possible scope of the review.  

A  competitive  bidding  process  would  need  to  take  place  before  the  trading  period,  in  order  to 
determine  the  investments  eligible  for  free  allocation.  The  bidding  process  could  be  a  tender 
based on pre-determined criteria and cost-per-unit of performance, to provide an objective way of 
assessing  which  investments  would  offer  value  for  money.144  A  further  change  that  could  be 
considered is applying this process for large investments, while allowing smaller investments to 
be approved without the competitive bidding process subject to State aid regulations145.   

With regard to transparency, instead of reporting at Member State level, the Commission could, 
for  instance,  be  mandated  to  centrally  publish  the  relevant  information  in  a  timely  manner.  In 
addition,  the  selection  of  investments  through  an  open  competition  would  likely  also  enhance 
transparency. 

With regard to timing, a flat or consistent share of free allocation (equal amount per year) could 
be considered instead of the current approach which was in line with the transitional nature of the 
free allocation to power provisions in phase 3 and requires the highest level of investment at the 
start of the period and a decline to zero at the end of the trading/derogation period. From 2021 to 
2030,  a  similar  distribution  could  be  maintained  or  a  choice  could  be  made  for  a  flatter 
distribution of allocation and corresponding investments over the derogation period. For example, 
the share could be a consistent percentage of the auctioning volume of the Member State for each 
year, or the amount over the period could simply be divided over the years with a high start and a 
linear decline to zero to the end of the period. Changing the timing would potentially affect both 
the distribution of investments over the period and the supply of allowances to the market.  

One other issue identified in the lessons learnt are the variations of provisions for the auctioning 
of  unused  allowances  provisions  across  beneficiary  Member  States.  Harmonised  rules  on 
auctioning after a specified time or during the same year if the allowances are not given for free 
could  be  envisaged.  This  would  reduce  the  variation  between  Member  States  and  set  a  clear 
timetable for auctioning of unused allowances, enhancing predictability for the carbon market. 

8.3.4.1.  Aspects not varied between the options 

In the current legislation two aspects are regulated differently: i) the use of either benchmarks or 
verified emissions as the basis for determining potential free allocation to individual installations 
and ii) the use of a reference price determined in advance or based on observed market prices in 
the year concerned to calculate the market value of free allowances. As described in the lessons 
learnt, these choices result in differentiation between Member States, increase the complexity of 
the implementation and make it considerably more difficult for outside parties to understand what 
the basis for the free allocation to individual installations is.   

144 For example, investments in renewable energy could be compared based on the cost per unit of renewable energy 
produced,  investments  in  modernising  existing  power  plants  could  be  compared  based  on  the  cost  per  unit  of 
reduction in emissions intensity achieved or the reduction in energy use could be compared based on the cost per unit 
of reduction in primary energy use. 
145 Under the currently existing regulations, small projects can qualify for an exemption from state aid rules under the 
de minimis regulation (if less than €200,000 of aid over 3 years is provided) or under the general block exemption 
regulation  (if certain conditions on amount, intensity and recipients are met).  

84 

 
 
                                                           
To ensure a more consistent and transparent approach, an easy and effective simplification would 
be to use only one approach rather than allowing several alternatives which differ mainly in the 
methodology used, rather than the underlying principles. To determine the maximum allocation 
for  an  individual  operator,  the  existing  benchmark  methodology  could  be  applied  to  all 
installations.  To  determine  the  reference  price  for  free  allowances,  the  approach  applied  by 
several  Member  States  to  use  the  average  market  price  in  primary  auctions  for  the  calendar 
year146 could be generalised. These methods more closely reflect market conditions and could be 
easily applied. To ensure consistent implementation, only one approach would be allowed in each 
case.   

The  existing  approach  now  taken  by  almost  all  Member  States  to  base  the  request  for  free 
allocation  by  operators  on  proof  that  the  investments  have  been  carried  out  is  foreseen  to  be 
continued  for  all  assessed  options.  Several  Member  States,  such  as  the  Czech  Republic  and 
Estonia, emphasised the importance of this practice for the monitoring of the investments.147 

8.3.5.  Retained option packages 

Four  coherent  combinations  of  options  are  analysed  below,  representing  an  increasing  level  of 
change compared to the continuation of the current practice, in particular reducing the variation 
in  certain  aspects  currently  implemented  differently  in  individual  Member  States  and  moving 
towards a competition as the basis for the selection of investments by Member States.  

Baseline  A:  a  strict  legal  baseline would  imply  no  continuation  of  free  allocation  to  the  power 
sector after 2020. The allowances in question would then be auctioned and the revenues would be 
at the disposal of the individual Member States. The same result would be achieved if Member 
States choose not to make use of the derogation for free allocation to the power sector.  

Alternative  baseline  B:  this  scenario  most  closely  represents  a  continuation  of  the  current 
practice of the implementation of free allocation to the power sector. 

Option 1: Streamlined: this option envisages more consistent rules and procedures compared to 
current  practice.  The  allowances  are  either  given  for  free  for  a  specific  calendar  year,  or 
otherwise  auctioned  in  the  following  calendar  year,  excluding  delays  for  investments.  The 
relevant information reported to justify the free allocation would no longer be reported separately 
by  the  individual  Member  States,  but  directly  and  centrally  by  the  Commission,  enhancing 
transparency.  

The  determination  of  the  maximum  allocation  per  installation  and  the  reference  price  are  also 
replaced by one method, thus making a more standardised version of current practice, reducing 
differences in methodologies now varied between Member States while leaving in place most of 
the principles for free allocation to the power sector. 

For this option, it is assumed that the timing  of  the free allocation remains as it is now, with a 
high  start  and  a  declining  trajectory.  The  option  for  a  revision  of  the  national  plan  could  be 
included in such an approach. 

Option 2: Open selection: this option involves further changes to the provisions for the selection 
of  investments  as  compared  to  the  current  practice.  Changing  the  selection  can  affect  the 
effectiveness in promoting investments and the transparency of the basis for this selection. The 
change compared to Option 1 is that for large investments any potential risk of market distortion 

146 If this is more than 20% lower compared to the value set in advance based on the guidance document 
147 See Annex 3 on summary of stakeholder consultation 

85 

 
 
 
                                                           
would  be  reduced  by  requiring  an  open  competition  based  on  best  value  for  money  and  an 
objective  to  which  the  investments  should  contribute  set  by  Member  States.  The  competitive 
selection process to compare the investments will be based on value for money, rather than listing 
the investments in a national plan as for the current free allocation. Smaller investments could be 
approved without the selection process provided they comply with relevant State aid rules148. The 
possibility  to  delay  the  auctioning  of  unused  allowances  for  1  or  2  years  is  maintained.  It  is 
assumed  that  the  timing  of  the  free  allocation  remains  as  it  is  now,  with  a  high  start  and  a 
declining trajectory.   

Option  3:  Annual  basis  and  open  selection:  this  option  would  imply  the  greatest  level  of 
standardisation, by applying the permitted percentage of free allocation on an annual basis. This 
"use it or lose it" approach has the benefit of being  fully predictable for the market in terms of 
timing of the supply be it as free allocation or via auctions. As in option 2, the selection of the 
investments  is  changed  to  an  open  competition  based  on  best  value  for  money.  This  option 
provides the additional possibility to 'opt-in'/'add' the free allocation to power allowances to the 
Member  State's  share  of  resources  for  the  Modernisation  Fund.  Doing  so  would  allow  for 
implementation  through  the  single  governance  structure  of  the  Modernisation  Fund  rather  than 
through two parallel administrative procedures. Although in principle this 'opt-in' is possible for 
each option, it is indicated specifically here because this option represents the greatest number of 
changes compared to current practice. 

Table 8: Option packages for the free allocation to the power sector 

Baseline  
(Directive 
unchanged – 
10c 
discontinued) 
Alternative 
baseline 

(current rules 
continued) 

Option 1 

As base case 
(+ streamlined) 

Option 2 

As base case 
(+open 
selection) 

Timing of 
investments 

Selection of  
investments 

Not applicable 

Not applicable 

Auctioning of 
unused 
allowances 
No free 
allowances 

Reporting 

Not applicable 

High allocation in 
2021 and 
declining 
trajectory to 0 in 
2030 

High allocation in 
2021 and 
declining 
trajectory to 0 in 
2030 
High allocation in 
2021 and 
declining 
trajectory to 0 in 
2030 

National plan with 
investments selected by 
Member States 

1 or 2 years 
after planned 
allocation if not 
used 

Application and 
annual reports 
published by 
Member States 

National plan with 
investments selected by 
Member States 

Same year if 
not used 

Application and 
annual reports 
published by 
Commission 

Open competition for large 
scale investments based on 
value for money at  
Member State level, small 
projects under state aid 
rules 

1 or 2 years 
after planned 
allocation if not 
used 

Application and 
annual reports 
published by 
Commission 

148 Under the currently existing regulations, small projects can qualify for an exemption from state aid rules under the 
de  minimis  regulation    (if  less  than  EUR  200,000  of  aid  over  3  years  is  provided)  or  under  the  general  block 
exemption regulation  (if certain conditions on amount, intensity and recipients are met). 

86 

 
 
 
 
 
 
                                                           
Option 3 

(Annual basis 
and 
open selection) 

Start in 2021 and 
equal amount per 
year  or share of 
auctioning 

Open competition for all 
investments based on value 
for money at  Member 
State level 

Same year if 
not used 

Application and 
annual reports 
published by 
Commission 

(with possibility to add 
allowances to the MS share 
for the Modernisation 
Fund) 

8.3.6.  Assessment of options 

The assessment of the impacts focuses on the economic, environmental and social impacts of the 
relevant policy options, specific impacts relating to the operational objectives are outlined in the 
section  on  general  impacts.  In  each  case,  Option  1,  2  and  3  are  compared  with  the  alternative 
baseline, which represents a continuation of current rules for Article 10c. 

8.3.6.1.  General impacts - Effectiveness 

A  strict  legal  baseline  would  imply  that  the  current  provisions  for  free  allocation  to  the  power 
sector  expire  after  2020.  This  would  exclude  the  possibility  for  Member  States  to  give  free 
allowances to their power sector in return for investments in modernising the energy sector and 
could slow the modernisation of the energy sector. On the other hand, the Member States would 
receive  higher  revenues  from  the  auctioning  of  the  allowances  which  would  otherwise  be 
allocated  for  free.  50% of these  revenues should then be spent on climate action  in accordance 
with the existing provisions of the ETS Directive. Such revenues could be spent on modernisation 
of the energy sector.149 

The level of investment is not quantified for the options under consideration. However, in general 
it could be expected that the options with a higher amount of allocation in the early years of the 
trading period lead to a proportionally higher level of investment for these years. The provisions 
for delays could affect the investment in two ways. If a longer delay is allowed, this may allow 
for  investments  which  would  otherwise  not  be  eligible  to  be  counted  for  free  allocation,  thus 
increasing  the  potential  investment  that  can  be  triggered.  However,  the  use  of  such  delay 
provisions  can  also  make  it  easier  for  investments  to  take  place  later  than  planned.  This  could 
affect the distribution over time with  more investments  taking place  later in  the trading  period, 
and such delays may also be associated with cost increases. 

The  scenarios  involving  an  open  selection  of  projects  would  be  more  effective  at  encouraging 
private investment, given that the winning projects in such a competitive selection would be those 
scoring best in terms of the value for money. On the other hand, scenarios based on national plans 
may lead to a diverging outcome, depending on the priorities and energy policy objectives of the 
individual Member States, and thus lead to a fragmentation of the common market. 

A final consideration relates to the possibility to add allowances to the Member States share in 
the Modernisation Fund. Because this fund will involve the EIB, this option may allow Member 
States  to  avoid  the  administrative  burden  and  complexity  of  having  to  implement  two 
programmes with overlapping objectives. The governance structure for the Modernisation Fund 
will also provide a mechanism for the selection and guidelines for support for investments aimed 
at modernising their energy sector.  

149 50% of these revenues would be expected to be spent on climate action in accordance with the existing provisions 
of the ETS Directive. Where applicable, such spending should comply with State aid rules. 

87 

 
 
 
  
 
                                                           
For  Member  States  with  the  lowest  absolute  number  of  allowances  under  the  derogation,  i.e. 
small Member States, the ability to combine both resources may also be a valuable way to ensure 
a  critical  mass  making  the  use  of  public  resources  more  effective.  For  instance,  it  could  allow 
Member States  to support larger  projects, assuming  that otherwise  combining funding from the 
Modernisation Fund and free allocation to the power sector is not possible. For more than half of 
the  beneficiary  Member  States,  the  combined  resources  from  the  Modernisation  Fund  and  the 
optional free allocation to the power sector would amount to less than 5 million allowances per 
year. Although the amounts depend on the timing of the allocation and the applied market value, 
there  is  a  clear  indication  that  combining  the  Modernisation  Fund  and  free  allocation  to  power 
could contribute to less fragmentation and more effective use of public resources. 

In conclusion, when compared to the alternative baseline, option 2 and 3 are considered to have a 
positive  impact  due  to  the  competitive  selection,  while  option  1  would  be  expected  to  lead  to 
similar outcomes. 

Figure 5: Annual allowances from fund by type 

8.3.6.2.  General  impacts  -  Complexity  and  administrative  burden  /  flexibility  to  adjust  to  MS 

circumstances  

A delay of one or two years is allowed in realising the investments will require monitoring and 
verification  by  the  Member  State  and  the  assessment  of  the  associated  annual  reports  by 
Commission to track these investments and the allocation linked to them over a period of two or 
three  years.  This  significantly  increases  the  complexity  and  administrative  burden  as  the 
reference price used to estimate the market value of the allowances can also differ from year to 
year leading to uncertainty on the number of allowances that will be allocated in any individual 
year.  On  the  other  hand,  if  allowances  are  either  issued  or  auctioned  in  a  single  year,  the 
monitoring and reporting would be simpler, but it could mean that investments which take place 
one or two years later than planned become ineligible for free allocation, providing less certainty 
to investors. 

Drawing up an individual national plan with a full framework of specific rules per Member State 
places a significant administrative burden on the Member States. By contrast, if the selection of 
investments  is  based  on  an  open  competition  and  general  principles  ensuring  limited  market 
distortions, the process could be relatively straightforward. However, depending on the number 
of  different  types  of  projects  for  which  a  competitive  bidding  process  would  be  organised,  it 

88 

 
 
 
 
 
could also pose an administrative burden. For option 2, the possibility for smaller investments to 
be  approved  without  competitive  bidding,  subject  to  compliance  with  State  aid  rules  could 
facilitate a simpler approval process leading to a lower complexity. 

An  optional  revision  or  update  of  the  national  plan  as  part  of  Option  1  would  be  expected  to 
significantly increase the administrative burden.  

In conclusion, when compare to the alternative baseline, option 1 is expected to have a positive 
impact  due  to  the  streamlined  modalities,  while  option  2  and  3  would  be  expected  to  lead  to  a 
higher  administrative  burden  when  compared  to  the  alternative  baseline  as  a  result  of  the 
requirement to organise a competitive selection process. 

8.3.6.3.  General impacts - Transparency 

Transparency  is  related  to  both  the  accessibility  of  information  and  the  level  of  detail  of  the 
information in the public domain on the preparation and implementation of the free allocation to 
the  power  sector.  As  indicated  in  the  lessons  learnt,  transparency  is  affected  by  the  general 
process  for  the  selection  of  investments,  the  implementation  of  free  allocation,  and  also  by  the 
wide  variation  in  reporting  and  the  difficulty  in  some  cases  of  accessing  the  available 
information.  

First,  those  options  involving  a  centralised  publication  by  the  Commission  would  increase  the 
transparency compared to the current practice. The clarity of the information and transparency of 
the process would benefit from a single consistent reporting format .  

Second,  having  the  harmonised  rules  for  auctioning  of  unused  allowances  would  improve  the 
clarity and predictability of market supply of allowances, while a direct link to the actual year in 
question (a "use it or lose it" approach) would be best. If it is known that all unused allowances 
are  auctioned  either  one  or  two  years  later,  then  it  is  much  easier  to  assess  the  range  of  the 
potential quantity of allowances that could be issued under the derogation or auctioned if unused. 
If  all  unused  allowances  are  auctioned  in  the  following  year,  the  volume  can  immediately  and 
automatically  be  identified  once  the  allocation  for  a  year  is  known.  The  greatest  uncertainty 
would arise from continuing the current variation, which makes it difficult for market analysts to 
interpret how many allowances will be allocated or auctioned at which stage. 

Third,  the  options  differ  in  the  selection  of  investments.  If  done  by  Member  States  through  an 
open competition based on clear pre-defined criteria with a clear measure of value for money, it 
is likely to contribute to a more transparent process as compared to distinct national investment 
plans.  

When  compared  to  the  alternative  baseline,  options  1,  2  and  3  are  all  expected  to  lead  to  an 
improvement. For option 2 and 3, the positive impact is expected to be greater, as reporting of the 
relevant  is  centralised  and  the  open  selection  process  for  investments  is  expected  to  also 
contribute to greater transparency regarding the selection of investments when compared to the 
alternative baseline. 

8.3.6.4.  General  impacts  -  Potential  distortion  of  EU  energy  market  /  complementarity  with 

existing EU instruments 

Giving  allowances  for free from 2021 to  companies  operating  on the energy market in  specific 
Member States in return for realising investments modernising the energy sector has the potential 
to  distort  competition  on  the  energy  market.  It  can  also  lead  to  a  fragmentation  of  the  internal 
market, especially along national borders. Assuming a range for the average annual total quantity 
of 1 to 25 million allowances and a price per allowance of €25, the allocation could represent an 

89 

 
 
 
annual market value between €25 million and €625 million. In particular, if the free allocation is 
distributed selectively to power producers in a Member State, but not to potential competitors in 
the same market or in neighbouring Member States where no free allocation is given to the power 
sector, this can lead to an undue advantage and thus a market distortion.  

The  potential  distortion  of  the  energy  market  also  depends  on  the  progress  towards  market 
liberalisation  and  on  the  types  of  investments  receiving  free  allocation.  If  the  investments  are 
only  in  activities  in  markets  with  clear  market  failures  (e.g.  renewable  energy  or  energy 
efficiency),  or  to  activities  related  to  infrastructure  investments  in  regulated  markets  (such  as 
energy  grids),  the  risk  of  distortion of  competition  is  considerably lower  than  if  investments  in 
conventional  power  generation  also  receive  free  allocation.  Investments  in  conventional  power 
generation  risk  to  fragment  the  internal  market  or  to  prevent  alternative  solutions  from  being 
developed (e.g. demand response). 

This is also the case where the rules specify that investments related to power generation must be 
strictly  limited  to  the  modernisation  of  installations.  For  example,  this  is  currently  regulated 
through requirements to de-commission an equivalent capacity if an investment would otherwise 
lead to a net increase in the level of generating capacity. 

Another  potentially  significant  factor  relates  to  the  basis  for  selection  between  comparable 
investments.  If  the  selection  is  based  on  a  competitive  open  procedure  (i.e.  a  tender  or  bidding 
process  based  on  value  for  money  that  is  open  to  all  the  operators)  and  an  objective  basis 
ensuring  selection  of  the  investments  based  on  best  value  for  money,  as  is  the  case  for  large 
investments  in  Option  2  or  for  all  investments  in  Option  3,  an  undue  distortion  of  the  market 
would be less likely. The options based on such selection mechanism are thus assumed to involve 
a lower risk of market distortion than those based on national plans.    

In  conclusion,  although  the  actual  outcome  will  depend  on  the  type  of  investments  selected, 
Option  1  is  expected  to  lead  to  similar  outcomes  as  the  alternative  baseline.  By  contrast,  the 
competitive  selection  process  for  investments  in  Option  2  and  3  is  expected  to  have  a  positive 
impact in reducing the risk of potential distortion of the energy market. 

8.3.6.5.  Timing and distribution of investments and volume and timing of allowances on market / 

auction revenues of investments 

The  volume  and  timing  of  market  supply  of  allowances  depends  on  the  trajectory  for  free 
allocation, which varies for the options considered. Specifically, the impact is determined by the 
counterfactual  scenario  of  what  would  happen  if  the  Member  State  chose  to  auction  all  the 
allowances, instead of allocating them for free.  

If the free allocation trajectory is assumed to decline in a linear manner from a high start, as is the 
case in the current free allocation, a relatively higher amount of allowances will be issued in the 
initial  years  of  the  period  ("front-loading")  compared  to  what  would  otherwise  have  been 
auctioned,  while  a  lower  amount  is  issued  in  the  later  years  of  the  period.  The  degree  of  any 
front-loading  also  has  implications  for  the  transfer  of  allowances  into  the  Market  Stability 
Reserve. In case individual Member States decide to front-load a substantial amount, the surplus 
would  be  higher  and  relatively  more  allowances  would  be  transferred  to  the  reserve150.  If  by 
contrast the share of freely allocated allowances is kept constant relative to the annual auctions, 
the impact is much lower. Similarly, if an equal amount of allowances is allocated for free each 

150  Under  the  MSR  proposal  (COM/2014/20),  each  year  12%  of  the  total  number  of  allowances  in  circulation  are 
transferred in the MSR provided this total number is higher than 833 million allowances. 

90 

 
 
 
                                                           
year, the impact on the market in terms of additional supply is relatively low. This is shown in a 
stylised  example  illustrated  below.  Thus,  the  options  with  a  constant  share  or  flat  amount  of 
allowances per year will have a more limited impact on the carbon market. 

Figure 6: Combined free allocation trajectories 

This aspect, however, interacts with another factor further determining the impact on the carbon 
market: the rules governing the auctioning of unused allowances. If an investment is allowed to 
be delayed for one or more years, then this creates uncertainty about when these allowances will 
enter  the  market,  either  through  free  allocation  or  auctioning.  The  quantity  of  allowances  for 
which this uncertainty applies is highest during the early years of the trading period, in particular 
if a linear trajectory with a high start is assumed in combination with a longer delay. If unused 
allowances are auctioned in the same year, there is no underlying uncertainty because regardless 
of the way they are put in circulation, the quantity of allowances reaching the market is known. 

As  described  in  the  lessons  learnt  (see  Annex  4.2),  in  the  first  year  of  implementation  for  free 
allocation under Article 10c, roughly 18 million allowances remained unused (around 12% of the 
maximum  amount  that  could  be  allocated  for  free).  This  quantity  is  likely  to  increase  during 
future  years,  as  unused  allowances  accumulate.  The  timing  and  scale  of  volumes  of  unused 
allowances  being  auctioned  by  the  Member  States  will  determine  their  impact  on  the  carbon 
market. 

8.3.6.6.  Environmental impacts - Potential decarbonisation 

At the EU level, the reduction in greenhouse gas emissions within the sectors covered by the EU 
ETS  is  guaranteed  by  the  declining  cap.  As  a  result,  the  different  options  described  here  are 
assumed to have no impact on emissions at the EU level, although if additional investments take 
place  as  a  result  of  the  free  allocation  to  the  power  sector  these  could  ensure  that  a  relatively 
larger share of the expected reduction takes place in the Member States concerned. A higher level 
of reductions in greenhouse gas emissions can also deliver a corresponding improvement in other 
pollutants which negatively affect air quality.   

Direct environmental benefits may occur at Member State level, in particular through improved 
local air quality and the related health benefits. Certain investments relating to energy efficiency 
such as renewing heat networks may also lead to a larger reduction of carbon emissions in sectors 
outside the EU ETS. 

Option 1, 2 and 3 are thus considered to have a similar environmental impact when compared to 
the alternative baseline. 

91 

 
 
 
 
8.3.6.7.  Social impacts 

It  is  not  possible  to  quantify  the  impacts  on  employment  in  the  individual  Member  States, 
although  a  positive  impact  on  employment  may  be  expected  in  proportion  to  the  level  of 
increased investment, if this is realised as a result of the free allocation to the power sector. At the 
same  time,  if  such  investments  lead  to  the  replacement  of  existing  assets  in  the  power  sector, 
there may be a net shift in employment rather than an expansion. 

On the other hand, if Member States  choose not  to  provide free  allocation to  the power sector, 
they will have more revenues from the auctioned allowances to be used for climate action, in line 
with  the  existing  provisions  of  the  Directive  that  at  least  50%  of  revenues  should  be  used  for 
these  purposes,  including  all  revenues  from  allowances  redistributed  to  lower  income  Member 
States151. 

Options 1, 2 and 3 are considered to have similar social impact outcomes when compared to the 
alternative baseline. 

8.3.7.  Comparing the options 

The outcomes of the impacts for the different options are displayed below. 

Table 9: Comparison of options for the free allocation to the power sector 

Effectiveness 

Minimise 
administrative 
burden 

Increase 
transparency 

Minimise risk 
of market 
distortion 

Baseline (Directive 
unchanged – 10c 
discontinued) 
Alternative baseline 
(current rules 
continued) 
Option 1 
As base case 
(+ streamlined) 
Option 2 
As base case 
(+open selection) 
Option 3 
(annual basis and 
open selection) 

No support for 
modernisation 
- 

0 

No change 

+ 

+ 

Not applicable 
+ 

Not applicable 
+ 

No risk 
++ 

0 

+ 

0 

0 

0 

+ 

+ + 

+ + 

0 

+ 

+ 

+ 

Minimise 
impact on 
carbon 
market 
No impact 
++ 

0 

+ 

No change 

+ 

When  screening  and  comparing  the  options,  two  pluses  indicate  a  major  improvement  when 
compared  to  the  alternative  baseline,  one  plus  indicates  an  improvement,  zero  indicates  no 
change and one minus indicates deterioration.   

In  terms  of  comparison  of  the  options,  the  strict  legal  baseline  would  imply  discontinuation  of 
free  allocation  to  the  power  sector.  If  this  is  the  case,  the  policy  objective  of  supporting 
investment in the eligible low-income Member States may not be met.  

The alternative baseline by contrast implies the continuation of current practice, expecting to lead 
to a continued high administrative burden for Member States and perceived lack of transparency. 
It  also  offers  little  scope  for  improvement  with  regard  to  the  potential  risk  of  distortion  of  the 
energy markets. As a result, this option would not allow the objectives to be met. 

151 Article 10(3) 

92 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                           
As the table shows, the streamlined approach  (option 1)  would provide some  improvements on 
most of the criteria considered: it would help improve transparency and reduce the administrative 
burden because of simpler implementation with fewer exceptions. If an option to revise or update 
the  national  plan  was  included,  this  would  significantly  increase  the  administrative  burden. 
Transparency would benefit from centralised reporting. This option 1 would not involve radical 
changes  to  the  selection  of  investments  and  provision  of  free  allocation,  and  therefore  the 
effectiveness is assumed not to improve compared to the current practice.  

Changing the trajectory of free allocation and including specific procedures for the selection of 
investments  based  on  a  competitive  process  may  lead  to  a  higher  administrative  burden,  in 
particular  for  option  3  where  this  is  applied  to  all  investments.  However,  at  the  same  time  this 
also offers a greater potential to improve transparency  by using a clear and consistent basis for 
the selection of investments. A competitive selection based on value for money could also lead to 
a higher effectiveness in realising investments in modernising the energy sector.  

A possibility to provide additional benefits would be to allow those Member States that choose to 
do  so  to  use  the  governance  structure  of  the  Modernisation  Fund  to  efficiently  select  and  fund 
projects aimed at modernisation of their energy sector. This would avoid unnecessary duplication 
of  administrative  structures,  reduce  overhead  and  give  the  potential  to  make  use  of  the  EIB 
expertise  in  project  selection.  This  option  would  also  provide  a  single  and  therefore  simpler 
structure for potential investors. 

In  conclusion,  no  single  option  clearly  scores  best  on  all  the  criteria  considered  in  this  impact 
assessment.  The  final  choice  depends  on  whether  limited  changes  implied  by  Option  1  are 
considered  sufficient  in  light  of  the  main  operational  objectives  of  improved  transparency  to 
ensure that the funds are used to promote real investments modernising the energy sector, while 
lowering the complexity and the administrative burden related to the implementation. Options 2 
and  3  offer  the  potential  for  further  reaching  improvements,  but  may  result  in  an  increased 
administrative burden unless the governance structure of the Modernisation Fund is used. 

8.4. 

Inter-linkages between the low carbon funding mechanisms 

Three  main  inter-linkages  can  be  identified  between  the  low-carbon  funding  mechanisms 
described in this chapter. 

Both  the  Innovation  Fund  and  the  Modernisation  Fund  will  involve  the  monetisation  of 
allowances in order to provide funds for investment. Annex  13 provides a further discussion of 
the  relevant  choices  and  impacts  related  to  the  timing  of  the  monetisation,  showing  that  the 
auctioning  of  a  steady  amount  of  the  allowances  between  2021  and  2030  would  allow  for  a 
minimal  price  risk  and  market  impact  when  compared  to  front-loading  the  allowances.  At  the 
same  time,  ensuring  that  both  the  Innovation  Fund  and  the  Modernisation  Fund  become 
operational from 2021  would require the timely  monetisation of the corresponding share of the 
total  number  of  allowances.  A  balanced  approach  is  therefore  needed  to  time  the  auctioning  of 
allowances  in  such  a  way  as  to  provide  certainty  of  available  funds,  while  also  avoiding  a 
negative impact on the carbon market. 

Both the Modernisation Fund and the optional free allocation to the power sector aim to support 
investments  to  improve  energy  efficiency  and  to  modernise  the  energy  systems  in  10  lower 
income Member States. While under the Modernisation Fund, specific investments may receive 
financing, the optional free allocation would directly provide free allowances from the auctioning 
share  of  the  Member  State  concerned  to  operators  in  return  for  investments  being  carried  out. 
Specific  barriers  for  such  investments  are  described  in  Annex  10.  In  order  to  prevent  the  same 

93 

 
 
 
investment receiving aid from two different sources, which would reduce the efficiency of the use 
of  scarce  public  resources,  it  is  proposed  to  include  a  provision  on  the  potential  accumulation 
between  free  allocation  to  the  power  sector  and  the  Modernisation  Fund.  Several  stakeholders 
indicated support for such rules as part of the consultation. 

Transposition  of  and  compliance  with  the  measures  relating  to  the  implementation  of  the 
Modernisation Fund and the optional free allocation to power will particularly affect the 10 lower 
income  beneficiary  Member  States.  Adding  the  free  allocation  to  allowances  used  for  free 
allocation to power sector to the Member States' share in the Modernisation Fun would allow a 
single  approach  to  be  used  for  modernisation  of  the  energy  sector,  avoiding  the  administrative 
burden  and  complexity  of  implementing  two  programmes  with  overlapping  objectives,  while 
taking  advantage  of  the  governance  structure  offered  by  the  Modernisation  Fund.  For  Member 
States with the lowest absolute number of allowances under the free allocation to power provision 
in particular, the ability to combine both resources may be a valuable way to ensure critical mass 
that can make the use of public resources more effective.   

9. 

MONITORING AND EVALUATION 

The  Commission  will  continue  to  monitor  and  evaluate  the  functioning  of  the  EU  ETS  in  its 
annual Carbon Market Report, as foreseen under Article 10(5) of the ETS Directive. This covers 
also the impacts of the revision of the EU ETS.  

Furthermore,  evaluation  of  progress  on  the  application  of  the  ETS  Directive is  regulated in  the 
current Article 21, which requires Member States to submit to the Commission an annual report 
paying  particular  attention  to  issues  including  the  allocation  of  allowances,  operation  of  the 
Registry,  application  of  monitoring  and  reporting,  verification  and  accreditation  and  issues 
relating to compliance.  

The envisaged  Energy Union integrated governance and monitoring process is also expected to 
make sure that energy-related actions at European, as well as regional, national and local level, 
including the EU ETS, contribute to the Energy Union's objectives. 

Additionally,  the  Commission  regularly  carries  out  studies  on  various  pertinent  aspects  of  EU 
climate policy. Such examples in the past years are the studies on evidence for the occurrence of 
carbon leakage, the study on effectiveness of benchmarks and the study on evaluation of ETS (for 
more details see section 1.3.1). This approach will also continue throughout phase 4.  

Several  market  analysts  regularly  closely  follow  various  aspects  of  the  carbon  market  and  its 
functioning  and  the  Commission  will  continue  to  monitor  this  work.  Also,  through  regular 
contacts  with  stakeholders  the  Commission  is  alert  to  their  views  and  concerns  about  the 
functioning of the EU ETS. There is also a dedicated forum for discussion of ETS related matters 
with Member States in the form of regular technical working groups.  

There  is  also  the  EU  ETS  Compliance  forum,  which  provides  all  28  Member  State  Competent 
Authorities with a platform for sharing information, learning and experience, leading to effective 
implementation of EU ETS. The forum executes targeted events, such as the Compliance Forum 
Conference,  aimed  at  sharing  experiences  and  facilitating  dialogue  amongst  Member  State 
Competent Authorities.152  

Furthermore, the  EU ETS Accreditation and Verification Forum brings  together representatives 
of  Member  State  Competent  Authorities,  National  Accreditation  Bodies,  National  Certification 
Bodies (where relevant) and Verifiers to share experiences and suggestions concerning effective 

152 For more information, see http://ec.europa.eu/clima/events/articles/0100_en.htm  

94 

 
 
                                                           
and  efficient  implementation  of  the  EU  ETS  Accreditation  and  Verification  Regulation, 
Commission Regulation (EU) No. 600/2012.153 

153 For more information, see http://ec.europa.eu/clima/events/articles/0099_en.htm  

95 

 
 
                                                           
ANNEXES 

1. 

GLOSSARY 

Auctioning: The default method of allocating allowances within the EU emissions trading system 
(ETS). Regulated entities  have to buy an increasing  proportion of allowances through auctions. 
Auctioning is the most transparent allocation method and puts into practice the principle that the 
polluter should pay. 

Auction share: the part of the total amount of allowances determined by the cap that is allocated 
through auctioning. 

Backloading:  the  postponement  of  the  auctioning  of  900  million  allowances  from  the  years 
2013-2015 until 2019-2020 due to the surplus of allowances in the ETS. 

Benchmark:  a  value  used  to  calculate  free  allocation  per  installation.  A  benchmark  does  not 
represent  an  emission  limit  or  even  an  emission  reduction  target.  The  benchmarks  have  been 
developed per product, to the extent feasible and do not differentiate according to the technology 
or fuel used, nor the size of an installation or its geographical location. 

Cap: the overall volume of greenhouse gases that can be emitted by the power plants, factories 
and other fixed installations covered by the EU emissions trading system is limited by a 'cap' on 
the number of emission allowances.  

Carbon Capture and Storage: family of technologies and techniques that enable the capture of 
CO₂  from  fuel  combustion  or  industrial  processes,  the  transport  of  CO₂  via  ships  or  pipelines, 
and its storage underground, in depleted oil and gas fields and deep saline formations. 

Carbon  leakage:  term  used  to  describe  the  situation  that  may  occur  if,  for  reasons  of  costs 
related to climate policies, businesses transferred production to other countries which have laxer 
constraints on greenhouse gas emissions. This could lead to an increase in their total emissions. 
The risk of carbon leakage may be higher in certain energy-intensive industries 

Carbon  leakage  list:  official  list  featuring  sectors  and  sub-sectors  which  are  deemed  to  be 
exposed  to  a  significant  risk  of  carbon  leakage.  These  sectors  receive  a  higher  share  of  free 
allocation than other sectors. The list is established for five years, on the basis of clearly defined 
criteria and after extensive consultation with stakeholders. The first carbon leakage list applied to 
the free allocation of allowances in 2013-2014. The second for the period from 2015-2019. 

Cost pass-through: describes what happens when a business changes the price of the products it 
sells to recuperate at least part of the costs incurred to ensure compliance with the EU ETS. 

Cross-sectoral correction factor (CSCF): a backstop provision in the ETS Directive which caps 
the  total  amount  of  allowances  that  can  be  handed  out  for  free  to  industry  sectors  in  phase  3 
(2013-2020). Because the aggregate amount of preliminary free allocation calculated by Member 
States  in  the  NIMs  exceeds  the  maximum  amount  of  allocation  available  to  industry,  the 
allocation  for  all  installations  is  reduced  by  the  same  proportion  through  the  application  of  the 
cross-sectoral  correction  factor.  According  to  Commission  Decision  2013/448/EU,  the  factor  is 
5.7% (94.3% of preliminary allocation) in 2013 going to 17.6% (82.4% of preliminary allocation) 
in 2020. 

96 

 
 
EU Allowances: EU Allowances are emission credits used in the EU Emissions Trading System. 
Each allowances equals one tonne of CO2 emitted. 

EU  emissions  trading  system  (EU  ETS):  the  cornerstone  of  the  European  Union's  policy  to 
tackle  climate  change  and  its  key  tool  for  reducing  industrial  greenhouse  gas  emissions  cost-
effectively. The first - and still by far the largest - international system for trading greenhouse gas 
emission allowances, it covers ca. 12,000 installations in 31 countries, as well as airlines. 

First-of-a-kind (FOAK) technology: the first item or generation of a new technology and which 
can cost significantly more than later items or generations using that technology. 

Free  allocation:  To  address  industry  competitiveness  issues  or  specific  needs  related  to  the 
transition  to  a  low  carbon  economy,  allowances  can  be  allocated  for  free  to  industrial  sectors 
falling  under  the  scope  of  the  EU  ETS.  The  amount  of  free  allowances  for  an  installation  is 
calculated  according  to  the  harmonised  allocation  rules  outlined  in  the  Benchmarking  Decision 
(Commission Decision 2011/278/EU) and is in principle calculated by multiplying a benchmark 
value with the historic production data of the installation. If an installation also produces products 
not covered by a product benchmark, additional allowances will be provided based on heat or fuel 
used  for  those  products  or  for  process  emissions  (so-called  fall  back  approaches).  Besides, 
production  from  sectors  and  sub-sectors  deemed  to  be  exposed  to  a  significant  risk  of  carbon 
leakage will receive a higher share of free allowances. 

Greenhouse gas (GHG): A greenhouse gas is any gaseous compound in the atmosphere that is 
capable of absorbing infrared radiation, thereby trapping and holding heat in the atmosphere. By 
increasing the heat in the atmosphere, greenhouse gases are responsible for the greenhouse effect, 
which  ultimately  leads  to  climate  change.  Greenhouse  gases  regulated  under  the  EU  ETS  are 
listed in Annex II of Directive 2003/87/EC. 

Gross  free  allocation:  The  amount  of  free  allocation  determined  by  applying  the  benchmark 
values to the production data, before the application of any further relevant factors, such as, for 
example, the carbon leakage factor. 

Indirect carbon costs: costs incurred not because of own direct GHG emissions, but because of 
higher electricity prices due to the impact of the carbon price from the EU ETS passed-through in 
electricity prices. 

Installation:  according  to  the  ETS  Directive  (Directive  2003/87/EC),  an  installation  is  a 
stationary technical unit where one or more activities under the scope of the ETS and any other 
directly associated activities which have a technical connection with the activities carried out on 
that site and which could have an effect on emissions and pollution. 

Internalisation  of  external  costs:  economic  activities  give  rise  to  greenhouse  gas  emissions 
contributing to climate change. In contrast to the benefits, the costs of these effects are generally 
not  borne  by  those  causing  the  emissions.  The  internalisation  of  external  costs  means  making 
such emissions part of the decision-making process of those carrying out relevant activities. 

Intended  Nationally  Determined  Contributions  (INDCs):  Under  the  framework  of  the 
UNFCCC, countries committed to create a new international climate agreement by the conclusion 
of  the  U.N.  Framework  Convention  on  Climate  Change  (UNFCCC)  Conference  of  the  Parties 
(COP21)  in  Paris  in  December  2015.  In  preparation,  they  have  agreed  to  publicly  outline  what 
post-2020 climate actions they intend to take under a new international agreement. 

97 

 
 
Monitoring, reporting and verification: Monitoring, reporting and verification (MRV) of CO2 
emissions from maritime, aviation transport and stationary installations. Operators are required to 
establish an annual emissions report, with the data being verified by an accredited verifier. Once 
verified, operators must surrender the equivalent number of allowances by 30 April of each year. 
This  annual  procedure  of  monitoring,  reporting  and  verification  is  known  as  the  'compliance 
cycle' of the EU ETS. 

Market Stability Reserve: Legislative proposal from the Commission tabled in January 2014 to 
establish a market stability reserve in order to tackle the current imbalance between supply and 
demand in the EU ETS and to make the system more resilient to future demand shocks. 

Nomenclature  statistique  des  activités  économiques  dans  la  Communauté  européenne 
(NACE):  the  statistical  classification  of  economic  activities  in  the  European  Community, 
abbreviated as NACE, is the nomenclature of economic activities in the European Union (EU); 
the term NACE is  derived from the French title. Various NACE  versions have  been  developed 
since  1970.  NACE  is  a  four-digit  classification  providing  the  framework  for  collecting  and 
presenting  a  large  range  of  statistical  data  according  to  economic  activity  in  the  fields  of 
economic  statistics  (e.g.  production,  employment  and  national  accounts)  and  in  other  statistical 
domains developed within the European statistical system (ESS). 

National  Allocation  Plan  (NAP):  in  the  first  (2005-2007)  and  second  (2008-2012)  trading 
periods, Member States had to decide how many allowances to allocate in total and to each EU 
ETS installation on their territory. This was done through National Allocation Plans (NAP). 

New Entrants  Reserve:  a reserve of allowances equal to 5%  of the cap  that  allows to  provide 
free  allocation  to  new  installations  ('greenfields')  and  to  installations  that  significantly  increase 
their capacity. 

New Entrants Reserve 300 (NER300): a financing instrument managed jointly by the European 
Commission, European Investment Bank and Member States, so-called because Article 10(a) 8 of 
the Directive contains the provision to set aside 300 million allowances (rights to emit one tonne 
of  carbon  dioxide)  in  the  New  Entrants’  Reserve  for  subsidising  installations  of  innovative 
renewable energy technology and carbon capture and storage (CCS). The allowances will be sold 
on the carbon market and the money raised will be made available to projects as they operate. 

National  implementation  measures  (NIMs):  according  to  Article  15  of  the  Benchmarking 
Decision (Commission Decision 2011/278/EU), Member States have to notify to the Commission 
the list of installations covered by the EU ETS in their territory and the preliminary amount  of 
free allowances to be allocated to these installations for the period 2013 to 2020 calculated on the 
basis of the Union-wide harmonised rules for free allocation. 

One  product  –  one  benchmark  principle:  principle  applied  for  the  determination  of  the 
benchmarks for free allocation. It means that the benchmark methodology does not differentiate 
according to the technology or fuel used to produce a given product, nor the size of an installation 
or its geographical location. 

Partial  cessation:  reduction  of  an  installation's  level  of  free  allocation  that  applies  when  the 
production/activity level of an installation was less than 50% of its historic level. 

Phases 1, 2 and 3 of the ETS: The first trading period or phase 1 lasted from the launching of 
the  ETS  in  2005  until  the  end  of  2007.  The  second  trading  period  began  in  2008  and  ended in 

98 

 
 
2012. In phase 1 and phase 2, the amount of allowances to be allocated for free to industry was 
decided on national level. The main differences between phases 1 and 2 and the current phase 3 
(2013-2020)  is  that  auctioning  has  become  the  principle  method  for  allocation  and  a  greater 
harmonisation at the EU level. There is no free allocation for electricity production (with some 
exceptions  for  electricity  modernisation  in  the  new  Member  States)  and  the  transitional  free 
allocation to industry is based on EU harmonised rules outlined in the Benchmarking Decision. 

PRODCOM:  statistics  on  the  production  of  manufactured  goods.  The  term  comes  from  the 
French  "PRODuction  COMmunautaire".  The  PRODCOM  headings  are  coded  using  an  eight-
digit numerical code, the first four digits of which are identical to the respective NACE code. 

Product  benchmarks:  a  product  benchmark  is  based  on  a  value  reflecting  the  average 
greenhouse  gas  emission  performance  of  the  10%  best  performing  installations  in  the  EU 
producing that product and used to calculate free allocation. 

Small  emitters:  installations where emissions  of CO2 are less than 25,000 tonnes per year and 
that have a rated thermal input less than 35 MW; in phase 3 Member States had the possibility to 
exclude such installations from the EU ETS under certain conditions. 

Union  registry:  online  database  that  holds  accounts  for  stationary  installations  as  well  as 
accounts for aircraft operators, which have been included in the EU ETS since January 2012. The 
registry records the NIMs, accounts of companies or physical persons holding those allowances, 
transfers  of  allowances  ("transactions")  performed  by  the  account  holders,  annual  verified  CO2 
emissions  from  installations  and  the annual reconciliation  of  allowances  and  verified  emissions 
("surrender"). 

Windfall profits: unexpected profits that come to an economic actor and which by nature are not 
directly foreseen.  Under an  ETS, such  profits  can  occur if companies  pass-through the costs of 
allowances which they have obtained for free. 

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2. 

SUMMARY OF RELEVANT FINDINGS OF THE 2030 IMPACT ASSESSMENT 

Lessons  learnt  and  problem  definition:  The  EU  is  on  track  to  meet  its  -20%  GHG  target  for 
2020.  Present  policies  are  not  sufficient  to  reach  the  EU's  long  term  climate  objective  in  the 
context of necessary reductions by developed countries as a group to reduce GHG emissions by 
80-95% in 2050 compared to 1990. 

Environmental  impacts:  Reduction  in  fossil  fuel  use  results  in  significant  air  pollution 
reductions.  

Impacts in the energy system (including economic impacts): For the domestic -40% reduction 
in GHG emissions, the additional costs of adapting the energy system compared to the reference 
scenario would be contained to 0.15-0.54% of GDP in 2030, with the lowest cost projected in the 
scenario  most  coherent  with  the  agreed  outcome,  i.e.  combining  a  40%  GHG  target  with 
moderate energy efficiency and renewables measures.  

Macro-economic  and  social  impacts  (GDP,  employment,  affordability  of  energy):  This 
assessment assumed that third countries do not take measures beyond the pledges they had made 
at the time of the 2030 IA in the context of the UNFCCC. One modelling tool, GEM E3, projects 
negative impact of 40% GHG reductions on GDP driven by the GHG target and carbon pricing, 
ranging  from  -0.10  to  -0.45%154  in  2030  compared  to  the  reference  scenario.    Both  E3MG  and 
E3ME  modelling  tools  project  positive  contributions  of  up  to  0.55%  in  the  scenario  including 
energy  efficiency  policies,  taking  into  account  the  positive  impact  of  energy  efficiency 
investments on GDP155. 

In terms of employment, the underlying structural changes are expected to have a relatively small 
positive or negative impact on the overall employment level depending on the methodology used 
for  the  assessment,  but  significant  shifts  in  employment  among  or  within  sectors  are  expected. 
Such impacts will require that adequate labour market policies are implemented. 

Fossil  fuel  prices  are  projected  to  increase  irrespectively  of  the  EU's  approach  to  2030  targets, 
and electricity prices are projected to increase significantly under the Reference Scenario.  

Competitiveness of energy-intensive sectors and carbon leakage: The results indicate that the 
carbon  price  differential  between  the  EU  and  other  main  world  regions  increases  if  the  EU 
commits  to  -40%  GHG  emission  reductions  if  others  are  not  increasing  their  efforts  too. 
Compared to the reference scenario, overall production losses for industrial sectors with a GHG 
reduction of -40% can be limited.  

The  impact  of  new  GHG  reduction  targets  on  the  production  of  industrial  sectors  with  high 
energy needs, exposed to international competition, has been assessed as well. For the observed 
energy-intensive  industrial  sectors,  the  analysis  indicates  that  impacts  are  alleviated  to  some 
extent if free allocation is continued, while other ETS features, like benchmarks and production 
levels, are periodically reviewed. Furthermore, strong climate actions undertaken in other regions 
are expected to strongly improve the competitive position of EU industries. 

Differential impacts across Member States: The analysis indicates that assuming cost-effective 
approaches for GHG targets, RES targets and EE policies, efforts in lower income Member States 
are  relatively  larger  than  for  higher  income  countries,  with  relatively  higher  increases  in 

154  Depends  on  if  and  how  carbon  pricing  is  used,  with  best  result  with  auctioning  in  all  ETS  sectors  and  CO2 
taxation in the non-ETS, while using the revenues to lower labour costs. 
155 Highest result takes into account the impact of energy efficiency investments.  

100 

 
 
 
                                                           
investments  and  system  costs  compared  to  GDP,  but  also  relatively  higher  benefits  in  terms  of 
fuel savings and air quality. Several distributional mechanisms are conceivable to allow for more 
equitable outcomes, such as the differentiation of targets, the distribution of auctioning revenues 
and the use of smart financial instruments, structural funds etc. 

101 

 
 
3. 

SUMMARY OF STAKEHOLDER CONSULTATIONS  

3.1. 

General consultation on the ETS revision 

The stakeholder consultation gathered over 500 replies from different stakeholders.  

Figure 7: Stakeholder consultation responses 

The  submissions  will  be  summarised  by  section,  and  within  each  section,  by  profile  of 
respondents.  Respondents  were  classified  into  three  groups:  industry  stakeholders  (including 
companies,  trade  associations representing  businesses,  SMEs  and  SME  business organisations), 
public  authorities  and  civil  society  (NGOs,  academic  and  research  institutions,  citizens,  trade 
unions  and  other  stakeholders).  This  division  was  done  based  on  the  fact  that  each  group  has 
different stakes and will be similarly affected by the future system. 

The prevailing majority of replies came from industry stakeholders (of which approximately 14% 
representing  the  power  sector)  meaning  approximately  86%  of  the  respondents  are  directly 
concerned by the elements of the future system  that adress the potential risk of carbon leakage, 
notably the options to adress free allocation. Industry stakeholders are also the stakeholders most 
concerned, although in a more indirect way, by the Innovation and Modernisation Funds.  

Figure 8: Industry stakeholders – shares of each sector replying 

Submissions from public authorities (of which 17 Member States) are analysed separately since 
the  future  system  has  important  implications  also  for  them  in  terms  of  implementation 
(complexity and administrative burden aspects) and budget (auctioning revenues, funds).  

102 

 
 
 
 
Replies  from  academic  and  research  institutions,  NGOs,  citizens,  trade  unions  and  other 
stakeholders are analysed in a third section under the common heading of 'civil society'. 

I. 

Free allocation and addressing the risk of carbon leakage 

The first section of the questionnaire focused on specific aspects of the future system (benchmark 
revision, allocation principles and cost-pass through ability). While the submissions represented 
different interests and positions, some views will be briefly highlighted below as they had wide 
support either in terms of number of replies or in terms of number of stakeholder categories.   

Industry stakeholders  

Concerning the allocation principles, a considerable number of industry stakeholders from across 
sectors (notably, steel, ceramics, glass, chemicals) support the view that best performers should 
get  full  free  allocation  (100%  of  benchmark  level).  This  is,  in  turn,  linked  to  support  for  a 
dynamic  allocation  system  or  at  least  one  based  on  more  recent  production  data  and  a  call  to 
eliminate  reduction  factors  applying  to  the  calculation  of  free  allocation  (the  cross-sectoral 
correction factor and the linear reduction factor).  

When  it  comes  to  benchmarks,  industry  stakeholders  mostly  do  not  challenge  the  10%  best 
approach,  but  many  express  concerns  about  the  benchmark  values  and  highlight  the  need  to 
ensure  they  are  technically  and  economically  achievable;  some  make  reference  to  the  limits  of 
currently available technologies. The issue of benchmark revision frequency is commonly linked 
with  the  predictability  needed  for  long-term  planning  and  investment  decisions  and  many 
stakeholders  expressed  a  preference  for  one  update  per  trading  period.  Some  industry 
stakeholders are of the opinion that benchmark revision should be done through data collection.  

Many industry stakeholders underline the different approaches by Member States on the state aid 
schemes for indirect cost compensation and call for a more harmonised approach. Linked to this, 
some  industry  stakeholders  expressed  concerns  that  climate  policies  may  affect  energy  prices, 
while  others  underline  that  other  factors  have  a  strong  impact  on  energy  prices  (including  the 
fragmented internal market) and call for an integrated, well-functioning internal energy market.  

As regards the issue of cost-pass through (passing on the cost of allowances in product prices), 
many stakeholders claim it is difficult especially since the products are traded on global markets 
(and  thus  internationally  priced),  while  others  underline  that  determining  concrete  cost-pass 
through rates may be challenging as many factors are at play.  

Other issues brought up by industry stakeholders include concerns about competitiveness linked 
with  the  call  to  ensure  coherence  between  climate  and  industrial  growth  policies.  They  also 
highlight the need to ensure a level playing field both within the EU and vis-à-vis competitors in 
third countries. 

Public authorities 

Public  authorities  generally  support  the  benchmark-based  system  (including  the  10%  best 
approach) and the need to regularly update the benchmark values. They highlight the importance 
of the incentive to innovate and of rewarding the best performers. There are mixed views on the 
frequency of the update (e.g. every trading period or every 5 years). 

There is some support for using more recent production data to determine free allocation. In case 
cost pass-through is possible, some public authorities think there should be no free allocation for 
the costs passed through, to avoid windfall profits, and a few ask for the cost pass-through rate to 
be clearly determined.  

103 

 
 
 
Some public authorities call for a more focused carbon leakage list, whereas others would like a 
more differentiated approach that would include different carbon leakage exposure groups. While 
there is some agreement that indirect costs are an issue that has to be addressed, public authorities 
support different options: maintaining the national compensation system, increased harmonisation 
of such a system, or establishing an EU-wide compensation system.  

Civil society 

Benchmarks  should  be  based,  according  to  some  civil  society  stakeholders,  on  worldwide  best 
technologies  available.  The  revision  should  be  frequent  (at  least  every  5  years)  and  should  be 
accompanied, according to some, by a pre-determined annual improvement factor.  

Most  civil  society  stakeholders  would  like  to  see  a  phasing  out  of  free  allocation  and  thus  a 
transition  to  a  full  auctioning  system  as  foreseen  in  the  ETS  Directive.  They  argue  this  would 
ensure  higher  auctioning  revenues  which  could  be  used  to  promote  climate  policies  and  would 
prevent  over-allocation  (windfall  profits).  Many  civil  society  stakeholders  underline  that  cost 
pass-through  is  possible  for  all  companies  to  some  extent  and  that  the  cross-sectoral  correction 
factor should remain a key element of the system as long as free allocation continues. 

Regarding the risk of carbon leakage, some call for a more differentiated approach with several 
exposure level groups. Others are of the opinion that the qualitative assessment should also allow 
removing sectors from the carbon leakage list if necessary. 

II. 

Innovation Fund 

The second section of the questionnaire focused on the Innovation Fund: whether the modalities 
applied  in  the  current  NER300  system  require  changes  and  whether  low-carbon  innovation  in 
industrial sectors will have to be treated differently than support for CCS and renewable energy 
technologies.  

Industry stakeholders  

Many industry stakeholders are favourable to a fund for innovation support and in general to the 
necessity of promoting research and development. A considerable number of them are in favour 
of  changes  to  the  current  NER300  system,  in  particular  to  ensure  simplification  and  flexibility 
especially as regards procedures at Member State level, deadlines and data requirements. A few 
called for continuity of support to bridge the gap years between the end of NER300 and the start 
of the Innovation Fund. 

When  it  comes  to  modalities:  many  industry  stakeholders  underline  the  need  to  ensure 
appropriate  risk  sharing,  for  example  by  linking  the  funding  to  earlier  stages  in  the  project  life 
cycle (either upfront, or in line with milestones) and not linked only to the performance as in the 
current  system;  the  approach/assessment  of  projects  should  be  technology-neutral;  some 
underline  the  need  to  allow  for  small-scale  projects.  Some  stakeholders  believe  the  limit  to 
funding  should  be  removed  and  there  is  wide  agreement  on  the  fact  that  the  fund  should  help 
mitigate the risks for applicants.  

Concerning the focus of the new fund, reducing the costs of renewable energy technologies, CCS, 
CCU  and  innovation  were  mentioned.  Many  replies  highlighted  the  need  for  breakthrough 
technologies  and  therefore  asked  that  more  funding  be  given  to  sectors  with  unavoidable 
emissions or where further emission reductions are not feasible with available technologies.  

The  fact  that  the  amount  of  funding  available  depends  on  the  price  of  allowances  raises  some 
concerns  about  predictability,  according  to  some  stakeholders.  In  this  context,  a  significant 
number of replies called for Member States' auctioning revenues to be used to support innovation 

104 

 
 
 
and to help the transition to a low carbon economy. In this sense, another concern expressed by a 
few  industry  stakeholders  was  that  protection  against  the  risk  of  carbon  leakage  should  take 
precedence over support for innovation when it comes to the use of the available allowances.   

Views  are  mixed  when  it  comes  to  CCS:  some  think  more  projects/funding  is  needed,  while 
others are of the opinion that there are still issues related to public acceptance and high costs.  

Public authorities 

Public authorities presented different views on a number of aspects of the future Innovation Fund: 
it  should  serve  to  fund  innovative  projects  for  which  no  alternative  technology  exists;  there 
should  be  some  simplification  in  the  process;  some  referred  to  the  need  for  an  adequate 
geographical balance and technological diversity. The need to take into account the specificities 
of different technologies was underlined and some called for a technology neutral approach along 
with the development of specific criteria.  

In  order  for  CCS  to  become  reality,  some  respondents  argue  that  more  support  is  needed, 
however the opinion is not shared by all.   

While some would like to see pre-defined amounts per category of projects, others highlight the 
need for flexibility.  

Some replies called for linking the support to earlier phases in the project life cycle (as opposed 
to  linking  it  to  operational  performance  as  is  currently  the  case)  and  underlined  that 
mitigating/sharing the risk is very important.  

Civil society 

Many civil society stakeholders ask for increased transparency in the selection phase. Some feel 
that the current system is too prescriptive and should be simplified. Moreover, reference is made 
to the need to more strongly link projects (including improved support for CCS) with the ultimate 
goal  of  decarbonisation  and  the  climate  policy  objectives.  While  some  support  a  technology 
neutral  approach,  others  refer  specifically  to  the  importance  of  ensuring  support  to  energy 
efficiency improvement and renewable energy. 

Concerning the design of the system some call for the 50% funding limit to be removed and for 
support  to  be  linked  to  phases  in  the  project  life  cycle;  a  few  point  out  that  projects  should  be 
selected  only  if  the  technologies  proposed  are  truly  innovative;  some  stress  the  importance  of 
CO2 reduction as a selection criterion.  

A few civil society stakeholders underlined the need to provide support before 2021 as well.  

III.  Modernisation Fund 

The third section is focused on the Modernisation Fund: 2% of total EU ETS allowances to be 
dedicated  for  the  particularly  high  investment  needs  of  Member  States  with  GDP  per  capita156 
below 60% of the EU average. The questions were related to views on the governance of the fund 
(responsibilities  of  Member  States,  EIB  and  other  institutions),  types  of  eligible  projects  and 
possible criteria, accumulation rules (coherence with other funding mechanisms) and assessment.  

Industry stakeholders  

Regarding the governance structure for the fund, industry stakeholders (including energy sector 
respondents)  advocate  for  a  split  of  responsibilities  between  EU  level,  EIB  and  Member  State 

156 2013 GDP per capita at market prices. 

105 

 
 
 
                                                           
level  but  have  different  views  on  how  to  divide  them  (e.g.  at  which  level  criteria  should  be 
specified,  whether  the  approval  of  projects  should  be  a  direct  responsibility  of  Member  States, 
and whether the involvement of the EIB should be limited to an advisory role in project selection 
or  more  extensive).  Some  industry  stakeholders  highlight  the  need  to  minimize  administrative 
burden  and  create  a  simple  structure  with  clear  investment  criteria  and  independent  project 
evaluation. 

Industry  stakeholders  propose  a  wide  range  of  projects  with  different  priorities  (e.g.  energy 
efficiency as well as grid infrastructure, cost efficient abatement options) and some argue that the 
projects should contribute to the modernisation of the energy systems in the concerned Member 
States. Some are of the view that funding should be technology neutral and should prioritise cost 
efficiency  and  that  projects  should  not  be  allowed  if  already  accessing  EU  funding  (concerns 
related to the risk of potential distortion of the energy market), while a few think the focus should 
be on research and development and demonstration projects.  

In relation to criteria for the selection of projects, most industry stakeholders express support for 
cost-efficiency or cost per unit as possible options. Some propose to have requirements that are 
aligned  with  the  EIB's  energy  lending  criteria,  including  efficiency  and  emissions  performance 
standards  that  are  compatible  with  the  EU’s  2030  climate  and  energy  targets.  Industry 
stakeholders  mostly  agree  that  the  level  of  funding  should  be  linked  to  concrete  performance 
criteria, while a few express concerns that such an approach cannot be applied to all projects. 

As  regards  the  coherence  with  other  funding,  some  industry  stakeholders  argue  that  double 
funding of investments should be avoided. They argue that market incentives should be the main 
driver  for  investments  even  if  public  support  is  granted  and  that  a  mix  of  instruments  can  be 
considered for specific projects as long as they fulfil the relevant eligibility criteria.  

On  the  assessment  of  projects,  industry  stakeholders  highlight  that  it  should  be  coherent  with 
national climate programmes and national targets. Others think the project assessments should be 
monitored in the context of the 2030 governance process.  

Public authorities 

Public authorities believe there should be a split of responsibilities. They argue for flexibility in 
deciding  eligible  projects  and  that  Member  States  should  help  design  the  criteria.  There  are 
diverging views on what the focus for the Modernisation Fund should be, according to a few of 
them,  on  final  energy  consumption,  cost  efficient  energy  efficiency  and  renewable  energy. 
Several  beneficiary  Member  States  emphasise  the  need  to  be  able  to  target  the  investments  in 
relation  to  their  specific  national  priorities,  and  underline  the  importance  of  simplifying  the 
procedures  for  small  scale  projects.  Member  States  that  are  not  beneficiaries  express  generally 
support for a stronger involvement of the EIB. They ask for the involvement of all 28 Member 
States in the design of the fund, highlighting that the fund need to be transparent and to minimize 
administrative burden. 

Most public authorities are in favour of establishing concrete criteria for the selection of projects: 
some mentioned cost per unit, amount of emissions reduced per unit produced and energy saved. 
Concerning performance criteria, public authorities in general believe they should be established 
only if they impose low levels of administrative burden, are selected transparently and allow for 
adequate flexibility of differences between Member States. 

Views  are  mixed  concerning  the  coherence  with  other  funds  as  some  public  authorities  think 
overlap should be avoided, while others think there are benefits to combining different funding 
sources. 

106 

 
 
Some  public  authorities  note  the  governance  processes  should  be  aligned  when  it  comes  to  the 
assessment  of  projects'  reflecting  in  the  forthcoming  governance  process  (e.g.  national  climate 
programmes, plans for renewable energy and energy efficiency).  

Civil society 

A significant number of the civil society respondents are in favour of a governance structure that 
places the EU (Commission sharing responsibility with the EIB and Member States) in the fund 
management position. 

Regarding  the  types  of  eligible  projects,  many  civil  society  stakeholders  underline  the  need  to 
fund exclusively projects in energy efficiency and renewable energy, while a few argue for the 
exclusion of unabated coal and biomass co-firing. 

Many civil society stakeholders are of the opinion that criteria for project selection should take 
into account the amount  of carbon emissions reduced. Criteria should prioritise energy savings, 
the  displacement  of  fossil  fuel  use  by  renewable  energy,  and  the  reduction  of  costs  for  energy 
saving and renewable energy technologies.  Criteria should be transparent and developed through 
a  separate,  dedicated  open  consultation  with  stakeholders  and  the  selection  process  should  also 
follow an open and objective process, according to civil society stakeholders. Some advocate for 
criteria  ensuring  cooperation  between  Member  States  and  regional  integration  occurs  and  that 
medium and small-scale projects are funded. 

Civil society stakeholders indicate that while combining various sources of funding may help to 
enable projects, there should be rules preventing duplication of existing aid structures to ensure 
an efficient process. 

When it comes to the assessment of projects in the forthcoming governance process, civil society 
stakeholders  argue  for  a  transparent,  binding  process,  including  the  eligibility  criteria  and  rules 
allowing  timely  and  accurate  monitoring  of  the  progress  in  projects’  implementation.  Some 
stakeholders  suggest  that  the  projects  should  be  compatible  with  the  energy  efficiency  and 
renewable  energy  objectives  of  the  Member  States.  In  this  context,  civil  society  stakeholders 
argue that the Member States concerned should be required to adopt ambitious and binding low-
carbon strategies for 2050 and that their investment plans should be scrutinised by the EIB.  

Civil  society  stakeholders  argue  that  performance  criteria  should  be  in  place  to  determine  the 
maximum level of funding and that they should be established transparently.  

IV. 

Free allocation to promote investments for modernising the energy sector 

Industry stakeholders  

Energy-intensive  industries  responded  that  modernisation  of  the  energy  sector  should  be 
primarily taking place through private investments attracted by the internal energy market, while 
public funding should only provide additional and temporary support. Energy-intensive industries 
and  energy  sector  representatives  broadly  agree  that  provisions  concerning  project  selection 
criteria  for  modernisation  of  the  energy  sector  are  to  be  strengthened  and  uniform  across  the 
relevant  Member  States  to  avoid  the  risk  of  distortion.  They  also  argue  the  criteria  should  be 
publicly  available,  without  undue  advantages  for  state-owned  companies.  Many  noted  that 
selection criteria should be technology-neutral. Energy sector responses from stakeholders active 
in  Member  States  making  use  of  the  current  free  allocation  under  Article  10c  of  the  Directive 
note  that  the  current  compliance  measures  under  national  investment  plans  already  provide  a 
solid  basis  for  continuation  of  activities.  Only  a  few  respondents  believe  that  project  selection 
criteria  should  be  determined  on  the  national  level,  while  a  few  others  believe  that  individual 

107 

 
 
 
project selection should be transferred to the individual operators, while only framework rules are 
designed at a national or EU level.  

In  terms  of  coherence  with  other  funding,  most  industrial  stakeholders  believe  that  no  free 
allocation  should  be  given  to  the  energy  sector,  and  that  accumulation  should  not  be  allowed. 
However, others noted that accumulation rules are required to avoid overcompensation, while a 
minority feels that it could be justified in special cases.  

Many industrial stakeholders argue that free allocation of allowances to power sector should be 
transitional  and  decrease  over  time.  Some  industry  associations  note  that  the  free  allowances 
should be evenly distributed over the 2021-2030 period, to ensure market liquidity and stability. 
However, other respondents point out the complexity and specifics of the investment cycle in the 
energy sector, arguing that power operators should receive the allowances in the beginning of the 
trading phase. Around two thirds of industrial stakeholders support the idea of having priorities 
guiding  the  Member  States  for  areas  to  be  supported,  with  priority  areas  of  interconnectors, 
energy  efficiency  and  renewable  energy  investments.  Some  respondents  responded  against 
common guiding principles for the Member States in the selection of priority areas, arguing that 
diversification of the energy mix is done on the national level, but noting that general eligibility 
criteria could be defined at the EU level.  

There  was  a  low  response  rate  regarding  the  improved  transparency  for  selection  and 
implementation of investments within the context of free allocation for energy modernisation, but 
mainly  noting  that  publication  of  the  relevant  documentation  relating  to  all  stages,  from  the 
application  and  the  national  plan  to  the  implementation  and  greater  openness  to  stakeholders 
would  be  welcome.  About  half  of  energy-industry  industries  that  have  responded  believe  that 
when  the  investment  is  not  carried  out  within  the  agreed  timeframe,  the  allowances  should  be 
added to auctioning volumes. Others argue that Member States should be allowed sufficient time 
for  investments  and  freely  decide  on  allocation  of  allowances.  Some  also  propose  these 
allowances are added to the free allocation pot for the industry. Energy sector respondents agree 
that a specific timeframe could be set (e.g. 2-4 years), but without a clear opinion on how unused 
allowances should be used. 

Public authorities 

The responses of several public authorities on project selection support the idea of common, EU-
level  criteria.  They  underline  that  value-for-money  and  low-carbon  investments  should  be 
embedded in the selection criteria. Consistency with the 2030 climate and energy targets should 
also  be  ensured.  Some  beneficiary  Member  States  support  common  criteria,  while  others  from 
beneficiary  Member  States  emphasise  specific  ideas  for  investments  that  could  be  supported  to 
modernise  their  national  energy  sector.  The  majority  of  public  authorities  believe  that 
accumulation rules should be applied to the energy sector. Most also argue that free allocation to 
energy sector should be subject to state aid provisions.  

Varying opinions were expressed regarding the level of funding and the distribution over time of 
the free allowances for the power sector. Some feel that Member States should have the option to 
distribute the free allowances over the trading period in order to give security of investments to 
companies,  while  others  believe  that  market  impact  should  be  an  important  consideration.  The 
majority  of  public  authorities  also  support  the  EU-wide  priorities  for  selection,  suggesting 
prioritization to energy efficiency, energy storage, smart grids and renewable energy investments 
and interconnectors. However, there were a few responses against priorities guiding the Member 
States in the selection of areas, arguing that they should have the right to choose their own energy 
mix.  

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Some beneficiary Member States express support for greater harmonisation of the administration 
process  among  all  Member  States  applying  the  derogation,  while  emphasising  that  the  main 
responsibility  for  project  selection  and  allocation  of  allowances  should  remain  on  the  Member 
States. 

If  the  investment  is  not  carried  out  within  the  agreed  timeframe,  most  public  authorities  who 
responded  agree  that  allowances  should  be  added  to  auctioning  volumes  after  a  certain  time 
period.  While  several  Member  States  support  a  year-by-year  allocation,  to  minimise  impact  on 
the  carbon  market,  some  beneficiary  Member  States  indicate  that  they  would  prefer  a  greater 
flexibility in the timing of investments and allocation when compared to the current rules. Some 
Member States also mention the current practice, adopted by most beneficiary Member States, of 
allocating only upon proof of investment. 

Civil society 

Many civil society stakeholders expressed criticism of the current situation, as investments in the 
modernisation  of  the  existing  fossil  fuel  generation  capacity  have  been  supported  to  a  greater 
extent than those related to diversification of electricity generation. They call for stronger degree 
of  EU  institutional  oversight.  They  also  support  common  project  selection  criteria,  and  often 
propose examples of investments which should be ineligible for financing (e.g. coal power plants 
or CCS).   

Regarding  the  accumulation  rules  of  free  allocation  to  energy  sector  with  other  sources  of 
funding, civil society stakeholders support the accumulation rules, provided that projects clearly 
contribute  to  EU's  climate  targets,  are  in  line  with  eligibility  criteria,  state  aid  rules  and  other 
legislation. 

Civil society stakeholders in general agree that free allowances should be used in a specific time-
period (e.g. on an annual basis), in order to manage the surplus of allowances. A few note that 
Member  States  should  be  free  to  use  the  allowances  as  needed,  but  to  ensure  that  excessive 
liquidity  on  the  market  is  avoided.  However,  civil  society  stakeholders  overall  argue  that  the 
allowances handed out for free should decline in time, in a linear manner.  The areas most often 
mentioned  as  priorities  for  support  up  to  2030  by  civil  society  stakeholders  are  –  in  order  of 
magnitude  –  smart  grids,  energy  efficiency,  renewable  energy,  energy  storage  and 
interconnectors.  

Regarding  improved  transparency  for  modernization  of  projects,  civil  society  stakeholders 
believe  that  all  information  regarding  the  implementation  of  the  free  allowances  should  be 
publicly available and published on a dedicated Member States' website. They also propose that 
all  modernisation  investments  should  be  accompanied  by  environmental  assessments.  Civil 
society  stakeholders  have  divided  opinions  on  how  unused  allowances  from  investments  not 
taking  place  should  be  used.  Some  believe  they  should  be  added  to  auctioning  volumes,  others 
that they could be returned for free allocation, while there are also opinions that they should be 
placed in the Market Stability Reserve or cancelled.  

V. 

SMEs/regulatory fees/other 

Industry stakeholders  

Industrial respondents believe that the EU ETS administrative requirements can be simplified, in 
particular the rules for the new entrants and installation closures. In general, a more harmonised 
approach is proposed for small installations, both for the application of simplified rules, as well 
as  the  opt-out  or  exclusion  from  the  EU  ETS.  A  majority  of  industry  stakeholders  advocate  to 
retain  the  possibility  to  exclude  small  installations  from  the  EU  ETS  post-2020.  While  some 
would  prefer  harmonisation  at  EU  level,  others  believe  that  the  option  of  exclusion  should  be 

109 

 
 
retained  by  Member  States.  Only  a  few  respondents  would  not  be  in  favour  of  opt-outs.  Even 
though there was a small response rate regarding the Union registry questions, a few respondents 
note that registry fees should be reduced. Most of the responses also favour aligning the registry 
fees at EU level, or at least more harmonisation is preferred. 

Regarding the use of auctioning revenues, most industrial producers are in favour of earmarking 
auction  revenues  as  much  as  possible,  to  be  allocated  to  the  development  of  low-carbon 
technologies,  justifying  it  with  carbon  leakage  concerns.  Respondents  from  the  power  sector 
believe that the current provisions regarding the use of revenues are adequate.  

Public authorities 

Public  authorities  see  further  potential  for  reducing  the  administrative  burden  for  small 
installations,  for  example,  further  simplifications  of  requirements  for  monitoring,  reporting  and 
verification. The majority of public authorities are in favour of continuing the option to exclude 
small  installations  from  the  EU  ETS.  Most  of  them  request  further  harmonisation  of  exclusion 
criteria and other measures.  

There  was  a  high  response  rate  of  public  authorities  regarding  the  Registry  questions.  They 
highlight  the  importance  of  high  level  security,  and  they  would  find  a  more  user-friendly 
interface also beneficial. There was no prevailing opinion about registry fees. Most respondents 
are in favour of retaining different registry fees across Member States, while only a few believe 
that some harmonisation (e.g. minimum and maximum) may be justified.  

A few  public  authorities believe that Member States should have  the discretion over the use of 
auction revenues and that earmarking should be avoided.  

Civil society 

Civil society stakeholders in general had a very low response rate to this section, except on the 
use of auction revenues. They believe that the current system of revenues allocation for climate-
related purposes is not optimal. They propose more investments to be channelled to international 
climate  change  mitigation  and  adaptation  efforts.  A  few  suggest  a  special  fund  to  be  set  up  to 
direct auction revenues for this purpose.  

VI.  General evaluation 

Industry stakeholders  

The vast majority of energy-intensive industries state that ETS is fully aligned with EU's climate 
policy.  However,  they  note  that  ETS  alone  cannot  deliver  the  EU's  climate  objectives,  and 
underline  the  need  for  contributions  of  non–ETS  sectors  to  reach  these  goals.  The  ETS  is 
considered  as  the  most  cost-effective  mechanism  for  reducing  emissions,  and  some  responses 
note  that  other  policy  alternatives  are  inferior  to  the  cap-and-trade  system.  Many  say  that 
emissions  trading  on  the  global  scale  would  be  an  ideal  approach  to  reach  global  climate 
objectives, but in the current situation, they underline that carbon leakage protection is essential 
to protect the competitiveness of industry in Europe. The need for stability and predictability is 
underlined as well. Some industrial stakeholders also advocate against any market interventions 
in  the  functioning  of  the  ETS,  and  voice  their  concerns  regarding  the  "artificial"  increases  of 
carbon prices in the long run, which would severely impact the abatement costs.   

In terms of efficiency, most of the industrial stakeholders' opinion is that the costs of the system 
do not  exceed its  benefits.  However, a  smaller group  of respondents do note the administrative 
costs  of  the  ETS.  Others  flag  the  carbon  costs  induced  by  ETS  to  power  producers  and 
subsequently passed through to power consumers as relatively high and differing across Member 

110 

 
 
States.  Industry  stakeholders  in  general  noted  the  benefits  of  a  harmonised  EU  approach  to 
climate policies, as well as establishment of a single carbon price.  

The stakeholders from the energy sector in general consider that a market-based EU ETS is the 
best  approach  to  incentivize  a  wide  range  of  CO2  abatement  options.  They  also  note  it  should 
remain technology-neutral.  However, they consider it unlikely that ETS alone would be able to 
meet  the  EU's  long-term  climate  policy  objectives,  as  the  large  surplus  of  accumulated 
allowances does not provide the necessary incentives for low-carbon investments. They strongly 
advocate for an early adoption of the Market Stability Reserve, and some suggest extending the 
ETS to other sectors (e.g. cooling or transport).   

Some energy stakeholders state that the EU ETS provides the basis for a level playing field and 
the completion of the internal energy market, by providing a single EU carbon price.  

Public authorities 

The  public  authorities  also  provided  positive  opinions  regarding  the  EU  ETS,  stating  it 
corresponds to the general GHG emission reduction targets, and as a flexible market instrument it 
provides the required incentives for technological development. Public authorities also noted that 
the EU ETS is an important element in EU climate policy, but not sufficient to meet the climate 
targets on its own. Linking with other carbon markets was also supported. Public authorities also 
assess the EU ETS as cost-effective, although the administrative burden for national authorities 
was mentioned (particularly during the establishment of the system).  

In  terms  of  coherence  with  other  relevant  EU  legislation,  a  few  respondents  argued  that  the 
energy  legislation  (renewable  and  energy  efficiency)  may  overlap  with  the  EU  ETS,  and  may 
consequently weaken its effectiveness.  

Civil society 

The  large  majority  of  civil  society  stakeholders  responded  that  EU  ETS  is  in  line  with  core 
principles of EU's climate policy, but believe it was not able to deliver on its objectives yet. They 
underline  that  the  investments  into  low-carbon  technologies  have  been  slow,  and  call  for 
immediate  reform  of  the  system  to  urgently  address  the  surplus  of  allowances  and  windfall 
profits.  Nevertheless,  they  note  the  importance  of  an  EU-wide  system  that  internalises  the 
negative  externalities  of  carbon  dioxide  emissions.  Civil  society  stakeholders  have  also  noted 
than other sectors, such as shipping and aviation, should be to a greater extent incorporated in the 
EU ETS.  

3.2. 

Consultation on carbon leakage provisions and innovation support   

The stakeholder consultation gathered over 400 responses and the summary is published online.157 
The  submissions  were  analysed  by  clustering  them  into  three  groups:  business  and  trade 
associations representing business interest, public authorities and civil society. This division was 
done  based  on  the  fact  that  each  group  has  different  stakes  and  will  be  affected  by  the  future 
system. 

Table 10 Stakeholder consultation responses 

Profile 
Business 

Number  % of total 
224 

52% 

157 See DG CLIMA website 
http://ec.europa.eu/clima/consultations/docs/0023/stakeholder_consultation_carbon_leakage_en.p
df 

111 

 
 
                                                           
 
Trade association representing business  158 
16 
Government/regulatory authority 
4 
Academic/ research institution 
9 
NGO 
14 
Citizen 
2 
Other (trade union) 
382 
Total business related 

Total non-business 

45 

37% 
4% 
1% 
2% 
3% 
1% 
89% 

11% 

I.  Business and trade representations of business interests 

Contributions  to  the  public  consultation  came  from  individual  companies,  and  European  and 
national  sector  associations  from  a  wide  range  of  sectors  (steel,  cement,  chemicals,  refineries, 
paper and pulp, power, lime, nonferrous metals, metals, glass, ceramics etc). Approximately 8% 
of replies were from the power sector and the rest from mainly energy intensive industry sectors. 

a.  General: competitiveness, carbon leakage and present free allocation rules 

Industry stakeholders treated the first two questions of this section (i.e. a question on the potential 
for industry to further reduce emissions and a second on the role of EU ETS in helping industry 
become  more  efficient)  as  an  opportunity  to  make  general  comments  on  many  aspects  of  the 
system. Therefore the following three paragraphs reflect their broader views.  

Some  47%  of  industry stakeholders  believe  there  is  still  potential  for  reducing  emissions  while 
42% do not share this view (11% showed no preference for either opinion). Regarding the role of 
the EU ETS in helping industry become more efficient and thus contributing to competitiveness, 
industry stakeholders underlined a number of concerns related to this point: improvements (both 
in  terms  of  energy  efficiency  and  in  terms  of  reducing  emissions)  have  already  been  achieved; 
process  emissions  are  unavoidable  and  existing  technologies  have  limits  –  breakthrough 
technologies are needed (but they require investments and thus a stable, predictable, innovation-
supportive  framework).  Industry  stakeholders  further  stressed  the  relatively  high  energy  prices, 
inability to pass on costs and issues resulting  from the fact  that  competitors  are not exposed to 
same  constraints,  linked  with  the  call  for  an  international  agreement  to  ensure  a  level  playing 
field. 

Other issues mentioned in relation to the system as a whole include the problematic acceptance 
and  development  of  CCS;  the  low  carbon  price;  switching  to  renewable  sources  of  energy 
depends  on  availability  of  supply,  efficiency,  the  impact  on  the  quality  of  the  products;  ETS 
design does not give additional allocation for increases in production other than those linked to 
capacity  extensions;  non-ETS  sectors  should  contribute  more  to  overall  reduction  targets; 
problematic  access  and/or  prices  of  raw  materials;  the  EU  reduction  target  of  40%;  need  for 
coherence  between  EU  policies.  Several  views  bring  emphasis  to  the  fact  that  there  are 
differences between sectors: different reduction potentials, specific issues and objectives.  

The answers also stress the fact that innovation and technological development are essential for 
Europe's  industry  to  remain  globally  competitive,  especially  given  the  potential  international 
market  for  resource  efficient  products.  Some  industry  stakeholders  (glass  sector  and  refineries) 
state  that  EU  ETS  and  carbon  prices  are  less  significant  relative  to  other  costs  (e.g.  energy  or 
fuel) that have a bigger impact on company decision-making. 

Given  the issues  underlined,  industry  stakeholders  almost  all  (98%)  support  measures  meant  to 
protect  EU  industry  and  strongly  believe  (88%)  free  allocation  to  be  an  adequate  instrument  in 
this sense. Some concerns were expressed concerning the cross sectoral correction factor (CSCF) 

112 

 
 
that is considered as more significant than the rate of improvements in carbon  efficiency. Most 
stakeholders from the glass sector argue that a more frequent update of the benchmarks could be 
the  counterpart  for  abolishing  the  cap  on  free  allocation  to  industry.  Other  concerns  expressed 
refer to the production data used as basis for allocation, with many views advocating for the use 
of actual or more recent production data. It is important, in the view of industry stakeholders, to 
ensure that the best performers receive adequate allocation. 

Almost  all  (93%)  industry  stakeholders  believe  free  allocation  keeps  the  incentive  to  innovate, 
but  underline  their  concerns  regarding  the  fact  that  best  performers  may  not  get  100%  free 
allocation. Some industry stakeholders (mostly refining sector) say that the biggest incentive to 
improve their performance is not carbon costs but rather energy costs.  

Some  52%  of  industry  stakeholders  are  of  the  opinion  that  the  administrative  burden  for 
companies involved in ensuring free allocation through the implementation of the benchmarking 
provisions  are  proportionate  to  the  objectives.  Those  who  consider  the  burden  disproportionate 
expressed concerns regarding the burden for smaller firms, the additional burden from having to 
apply several policies at the same time, and the need to simplify rules wherever possible while 
ensuring that the system is accurate and fair. It was also underlined that specificities of national 
implementation also lead to considerable administrative burden.  

b.  Options for post-2020 – Strategic Choices  

Concerning  the  future  share  of  allowances  that  should  be  dedicated  to  carbon  leakage  and 
competitiveness,  considerable support (73% of industry stakeholders) was expressed for having 
no limit to free allocation for industry. A concern was the view that the current system with the 
application of an ever-steeper CSCF reduction is incompatible with industry stakeholders' strong 
support for the idea that the best performers should be fully compensated through free allocation 
and that growth in production beyond capacity expansion should be accommodated.  

There are mixed views on the continuation of the NER300: 26% are against such future support 
(almost all ceramics and a few from other sectors such as chemicals and non-ferrous metals) as 
there are some concerns regarding CCS (seen as problematic in terms of cost, reliability, public 
acceptance  and  applicability  to  all  sectors).  By  contrast,  there  is  wide  support  (81%)  for  an 
instrument  of  funding  manufacturing  industrial  low  carbon  innovation  as  many  industry 
stakeholders  emphasise  the  need  for  investments,  notably  in  innovation  and  deployment. 
According to some industry stakeholders, such support would have to be more technology neutral 
and more flexibly managed than the current NER300.  

Industry  stakeholders  accentuated  some  issues  regarding  the  funding  of  such  an  instrument,  as 
follows: the amount of funding depends on the price of allowances and is therefore not reliable; 
other instruments already support innovation (e.g. Horizon 2020) and they should be enhanced; 
the  importance  of  ensuring  Member  States  use  at  least  50%  of  the  auctioning  revenues  for 
decarbonisation measures; there might be a need for a mix of public and private funding sources 
to ensure that low carbon innovation has the necessary support to happen; some underlined that 
these funds could be used to ensure cheaper loans for industry. 

On the question of whether industry should have additional safeguards beyond free allocation and 
EU-level  innovation  support,  most  (89%)  industry  stakeholders  answered  in  the  positive. 
Suggestions point in particular towards possible adjustments/improvements of the current system 
rather than radical changes (e.g. improved coherence between EU policies, ensuring protection in 
the absence of an international agreement, removing the CSCF, indirect cost compensation, need 
for long-term stable regulatory framework, ensuring allocation is closer to real production etc.).  

113 

 
 
c.  Options for post-2020 - Allocation modalities 

On  the  more  technical  aspects  of  the  allocation  modalities  there  was  considerable  support  for 
maintaining  some  of  the  existing  features:  56%  of  industry  stakeholders  are  in  favour  of 
maintaining  the  current  two  categories  for  sectors  in  terms  of  exposure  to  the  risk  of  carbon 
leakage  (i.e.  deemed  exposed  or  not)  in  order  to  ensure  predictability,  to  avoid  additional 
uncertainty and complexity. Those who believe more differentiation is needed (15%) argue that 
the  degree  of  exposure  is  different  and  the  rules  should  reflect  that.  Those  who  believe  all 
installations should be treated as exposed (21%) highlight the fact that there is a global economy 
and that there are interconnections, including in terms of value chains (downstream and upstream 
links).  

Similarly, 39% of industry stakeholders are in favour of maintaining the current carbon leakage 
criteria  for  the  sake  of  predictability,  simplicity  and  consistency.  There  are  many  different 
opinions  in  the  case  of  those  who  argue  for  additional  criteria:  taking  into  account  cumulative 
costs (indirect costs, RES-related, environmental taxes etc.), fuel mix (as well as accessibility and 
relative costs thereof), the impact of value chain effects, export and import competition and the 
possibility  of  using  Gross  Operating  Surplus  instead  of  Gross  Value  Added  (GVA)  in  the 
calculations because of the labour costs included in the latter, which they argue penalises labour-
intensive sectors. Some industry stakeholders also claim that they have an overall positive carbon 
footprint  (in terms  of their  life-cycle  assessment:  saving  more energy and GHG emissions  than 
used in the manufacturing phase) and that this should be taken into account.   

On the subject of thresholds for the carbon leakage criteria there is considerable support (57%) 
for  maintaining  the  existing  ones.  Some  industry  stakeholders  are  concerned  that  stricter 
thresholds would lead to some sectors being removed from the carbon leakage list.  

There is wide support (87%) for having a qualitative assessment to complement the quantitative 
assessment:  industry  stakeholders  argue  that  some  products  are  unlike  the  others  in  the  same 
sector, that statistical data does not always accurately reflect the reality of the exposure of some 
sectors  and  that  it  is  important  when  determining  exposure  to  consider  certain  factors  such  as 
ability  to  pass  on  costs,  value  chain  analysis,  different  levels  of  aggregation/disaggregation  of 
data analysed and the positive contribution of some sectors to EU economy. There are some (7%) 
who  believe  the  assessment  should  be  based  on  simple  metrics  linked  to  clearly  defined 
thresholds.  

Regarding  the  validity  of  the  carbon  leakage  list,  there  is  considerable  (68%)  support  among 
industry stakeholders to align it to the duration of the next trading phase based on the argument 
that it would ensure consistency and predictability for industry, taking into account the long-term 
investment  planning.  The  other  respondents  have  mixed  views  and  expressed  preferences  for 
different timeframes (e.g. 10 years of a validity expiring only at the conclusion of an international 
agreement to ensure a level playing field). 

Over  a  third  (37%)  of  industry  stakeholders  want  "the  10%  best  approach"  for  determining 
benchmarks  to  remain  with  a  view  to  ensuring  stability  and  predictability.  53%  of  the  views 
advocate  for  a  less  stringent  approach,  by  underlining  a  number  of  concerns:  requests  that  the 
installations that comply with the benchmarks should be ensured no carbon costs, request for less 
strict,  or  so  called  "technically  achievable"  benchmarks  (in  this  context  it  can  be  noted  that 
benchmarks  were  set  based  on  10%  best  existing  installations  in  2007/08);  that  when  applied 
together with the CSCF the allocation is too strict, and that progress happens at different pace in 
different sectors.  

There are mixed views (44% in favour and 50% not in favour) on the updating of benchmarks in 
line with technological state of the art. Those in favour view this as a necessary exercise in order 

114 

 
 
to reflect GHG improvements over time and they emphasise that the update should be in line with 
technological developments and uptake of new technologies. On the other hand, the latter point is 
a reason for concern by most of those against the updating: state of the art could be difficult to 
determine,  may  be  possible  to  implement  only  in  new  plants,  might  not  be  achievable  or 
financially  viable,  may  punish  early  movers.  Stakeholders  from  the  glass  sector  underline  that 
periodically updated benchmarks could remove the need for the CSCF. 

There is wide support (75%) for using more recent data to determine allocation to industry: many 
stakeholders would like to see ex-post allocation with an allocation supply reserve, i.e. a reserve 
that is filled up by those that produce less, and is used to provide allocation to those that produce 
more.  The  main  argument  in  favour  of  this  or  using  more  recent  years  (e.g.  previous  year, 
previous  two  or  three,  or  a  rolling  average  thereof)  is  that  such  an  approach  reflects  economic 
reality  and  as  such  would  ensure  flexibility  and  allow  for  production  increases.  Industry 
stakeholders  also  acknowledge  the  problematic  aspects  such  an  approach  would  entail,  namely 
considerable  administrative  burden,  ensuring  the  quality  of  data  (i.e.  production  reported)  and 
confidentiality of commercially sensitive information.  

On  the  topic  of  possible  deviations  from  the  general  harmonised  allocation  rules  in  case  of 
particular  hardship  or  too  favourable  a  situation,  most  industry  stakeholders  (75%)  are  against 
such  a  possibility  since  they  consider  this  would  lead  to  distortions  of  competition.  Some, 
however, argue that exceptional cases should be assessed individually.  

Industry stakeholders prefer (87%) indirect cost compensation taking place at EU level (either in 
the  form  of  financial  compensation  -  51%  or  free  allowances  -  36%)  in  order  to  ensure  equal 
competition  and  predictability.  Those  who  advocate  maintaining  the  current  system  argue  that 
guidelines  are  already  in  place  ensuring  transparency  and  certainty  and  that  there  are  different 
energy prices (which give certain signals to the market) and different fuel mixes across the EU. 

d.  Options for post-2020 - Innovation support 

As  shown  above,  while  industry  stakeholders  are  widely  in  favour  of  low  carbon  innovation 
support,  there are  some  mixed views on the subject of funding sources.  Many  (63%)  believe it 
should  come  from  auctioning  revenues,  while  others  underline  that  both  public  and  private 
sources for funding must be considered and mobilised.  

Concerning  the  stage  of  the  process  at  which  innovation  support  is  considered  most  important, 
most  industry  stakeholders  believe  this  to  be  the  stage  of  implementing  a  large-scale  pilot  as 
shown below by the graph: 

115 

 
 
e.  Other issues 

Some 63% of industry stakeholders brought up a number of other issues they wished to underline 
including: importance of research and supporting legislation; the need for a clear price signal and 
for a clear industrial policy; taking  into account the whole value chain; looking into the risk of 
investment  leakage;  need  for  an  international  agreement;  call  to  ensure  distortions  are  avoided 
when designing policies; ensuring consistency between policies. It is noteworthy that there was 
also an explicit call to make not only a statistical analysis of the questionnaire that served as basis 
for this analysis but also a qualitative one. 

II.  Government and regulatory authorities 

Responses  were  received  from  the  following  governments  and  regulatory  national  or  regional 
authorities:  Czech  Republic,  Denmark,  Estonia,  Finland,  Hungary,  Malta,  Poland,  United 
Kingdom,  Bavaria,  Thüringer  State,  Canary  Islands,  City  of  Vienna,  Flemish  Region,  Walloon 
Region, and a local authority from Spain. 

a.  General: competitiveness, carbon leakage and present free allocation rules 

Most  authorities  believe  there  is  still  potential  for  industry  to  reduce  emissions  but  underline  a 
number of issues that must be addressed including the need to tackle the carbon price issue, the 
need to consider international negotiations and developments, the potential of using biomass, the 
need  for  an  ambitious  innovation  strategy  to  support  the  development  of  new  breakthrough 
technologies.  Estonia  emphasised  the  decoupling  that  has  taken  place  there:  a  50%  decrease  in 
GHG  emissions  compared  to  1990  levels  happened  alongside  a  5  times  increase  in  GDP. 
Reduction  potential  is  different  depending  on  industry  (Poland).  It  is  also  important  to  limit 
administrative burden (Denmark).  

116 

 
 
 
 
There is an overall positive view on the role of the ETS: the system needs some improvement, 
and  it  should  be  stressed  that  energy  efficiency  represents  a  benefit  for  companies.  The  UK 
stresses  that  the  system  is  flexible  in  that  it  allows  businesses  to  decide  whether  and  when  to 
invest in carbon abatement or to buy allowances.   

All agree on the need to protect industry against potential competitiveness disadvantages relative 
to  third countries with less ambitious climate policies.  Measures  are needed  to  provide focused 
and targeted protection to those sectors most exposed to the risk in the absence of an international 
agreement.  

Regarding  the  adequacy  of  free  allocation  as  a  policy  instrument,  the  general  perception  is  a 
favourable  one  –  it  is  seen  as  a  good  instrument  for  protecting  industry  in  the  absence  of 
comparable measures by other major economies. A number of elements of the system as a whole 
need  to  be  addressed:  ensuring  that  protection  is  well-targeted  (UK,  Denmark),  taking  into 
account  the  ability  of  some  sectors  to  pass  on  the  carbon  costs  to  their  customers  (Walloon 
Region).  

The impact of free allocation on the incentive to innovate is considered positive by many since 
benchmarks  provide  an  incentive  to  installations.  The  concern  is  that  it  may  shield  operators 
partially from the price signal (Walloon Region).  

Most see the administrative burden linked to the implementation of the benchmarking provisions 
proportionate  to  the  objectives.  Simplification  should  happen  wherever  possible  (UK,  Canary 
Islands) to ensure the system runs appropriately. 

b.  Options for post-2020 – Strategic Choices  

National  and  regional  authorities  had  mixed  views  on  the  share  of  allowances  that  should  be 
dedicated  to  carbon  leakage  and  competitiveness.  This  should  depend  largely  on  international 
developments in terms of climate policies (Czech Republic). Poland underlined the importance of 
ensuring protection considering international competition and differences in energy prices. This 
protection however cannot be guaranteed as the free allocation available is declining unless it is 
targeted to those most at risk (UK).  

Low  carbon  innovation  support  is  seen  as  very  important  by  most  authorities,  with  a  broader 
scope  to  include  industry  beyond  CCS  preferred  by  several.  There  were  mixed  views  on  the 
sources of such funding.  

Regarding the need for additional safeguards against the risk of carbon leakage, some expressed 
concern  at  the  differences  in  energy  prices,  while  others  stressed  the  importance  of  an 
international agreement to ensure a level playing field. 

c.  Options for post-2020 - Allocation modalities 

There  were  mixed  views  on  the  number  of  carbon  leakage  groups  (carbon  leakage  and  non-
carbon leakage as opposed to several groups differentiated based on level of exposure) with some 
preferring  either  the  continuation  of  the  current  system  (Czech  Republic,  Finland,  Thüringer, 
Vienna)  while  others  expressing  a  preference  for  the  development  of  more  categories  (Poland, 
Hungary, Walloon Region, Bavaria, Canary Islands). The aspects to consider include: assessing 
the risk based among others on geographical location and the possibility of having risk defined as 
low, medium or high. A differentiated system might ensure protection to those most at risk but 
would require careful consideration (UK).  

Regarding the criteria for determining the carbon leakage status of sectors, many indicated that 
they were against the rule that allow sectors to be on the carbon leakage list by complying with 
only one of the two criteria (carbon costs in GVA and trade intensity). Criteria should take into 

117 

 
 
account a realistic carbon price, the emission abatement potential, the ability to pass on costs to 
customers, trade patterns (possibly linked to geographic location) and also availability of data, as 
well  as  (according  to  Denmark)  the  fact  that  risk  varies  across  EU  depending  on  extent 
installations compete with companies in third countries.  

There were mixed views on maintaining the qualitative assessment: some expressed a preference 
for having criteria based on simple metrics (Hungary, Bavaria, Vienna, Canary Islands), whereas 
others are of the opinion that some factors may be difficult to assess/take into account otherwise. 
As  for  the  validity  of  the  carbon  leakage  list,  quite  a  few  expressed  support  for  a  correlation 
between  the  validity  of  the  list  and the  duration  of  the  ETS  phase  (predictability, transparency, 
long-term  investment  planning)  with  the  possibility  to  revise  the  assessment  in  case  of 
comparable international climate policies or a considerably lower/higher carbon price.  

On  the  issue  of  benchmark  revision,  some  are  in  favour  of  maintaining  the  current  "10%  best 
approach" as it rewards the most efficient and provides incentive for the others. At the same time, 
most agree  that benchmarks  should be revised in line  with technological advances  (with mixed 
views on frequency of updating). 

When  it  comes  to  updating  the  production  data  used  for  allocation,  some  would  opt  for  2016-
2018  as  the  updated  reference  period.  The  Walloon  Region  cautions  on  extra  administrative 
efforts  and extra verification costs that an ex-post  approach  would engender. The UK indicates 
that more recent data would be good but only balanced with the need for manageability.  

Some among the authorities are in favour of deviations from the general harmonised allocation 
rules, in case of hardship or too favourable a situation. At the same time, the UK expressed its 
concern  about  such  deviations,  stressing  that  a  uniform  system  ensures  certainty  and  that  there 
was a risk of distortions and added complexity. 

Concerning  the  compensation  for  indirect  costs,  maintaining  the  present  approach  based  on 
Community  state  aid  guidelines  has  support  from  some,  while  others  express  concerns  on 
possible distortions in the market. On the latter, the UK stressed that  compensation done at EU 
level would be problematic and would create considerable complexity as there are differences in 
electricity markets between Member States.  

d.  Options for post-2020 - Innovation support 

There  were  mixed  views  on  the  stage  that  would  most  benefit  from  support  in  the  innovation 
process,  as  well  as  on  where  the  funding  should  come  from  (auctioning  revenues  or  free 
allowances). Support should depend on the risk of the project (Poland). Some stressed the need to 
support large scale deployment, bringing technologies to the market.  

III.  Academic and research organisations, NGOs, citizens, trade unions (civil society) 

a.  General: competitiveness, carbon leakage and present free allocation rules 

Academic and research organisations, NGOs, citizens, trade unions are generally positive (75%) 
about industry's ability to further reduce emissions. In order for this to happen there is a need for 
support  from  policies  which  should  among  other  things  protect  against  carbon  leakage.  Studies 
have  been  quoted  in  support  of the  view that  industry  can  further improve (through changes in 
technologies  and  practices)  and  it  was  stressed  they  would  benefit  from  being  more  energy 
efficient and innovative.  

The ETS is  perceived as an important instrument that  nevertheless  requires  improvement:  need 
for  a  strong  price  signal,  addressing  the  issue  of  surplus  of  allowances,  taking  into  account  the 

118 

 
 
 
ability to pass on costs. It was further stressed that ambitious goals require strong incentives. In 
the  absence  of  an  international  agreement  and/or  comparable  climate  policies/efforts,  82%  of 
civil society respondents are in favour of measures to protect EU industry. Such measures should 
focus on innovation support and should be linked to the international developments (i.e. more and 
more countries/regions are implementing climate policies). Free allocation is seen as problematic 
(61%) and there are concerns about its impact on the incentive to innovate. The main reason for 
this  is  the  surplus  of  allowances  that  the  system  led  to,  which  in  turn  negatively  affected  the 
carbon price. The incentive is therefore not strong enough and the system needs to be improved. 

There  were  no  strong  opinions  on  the  proportionality  of  administrative  burden  for  companies, 
though  some  respondents  expressed  concern  for  the  possible  issues  that  small  companies  deal 
with.  

b.  Options for post-2020 – Strategic Choices  

Some  29%  of  civil  society  respondents  expressed  their  preference  for  no  more  free  allocation 
after  2020,  while  25%  believe  the  share  of  allowances  dedicated  to  carbon  leakage  and 
competitiveness  should  be  lower  than  in  2013-2020.  Measures  after  2020  should  focus  on 
to  clean 
innovation  support, 
products/technologies  –  all  this  will  provide  a  comparative  advantage  to  EU  industry  (one 
stakeholder  noted  that  EU  ETS  provides  the  opportunity  to  mainstream  both  the  climate  and 
industrial policy). 

investments,  bringing 

rewarding  efficiency 

focus 

the 

When it comes to the future financial support for innovation similar to NER300, most (79%) are 
in favour of it. Some respondents (20%) expressed concerns about the feasibility and acceptance 
of CCS. There seems to be however wide support for low carbon innovation funding that is not 
restricted to one technology. 50% of civil society respondents are of the opinion that the support 
should come in the form of a specific instrument with auctioning revenues as the funding source.  

There seems to be wide support (68%) for having additional measures in place to protect against 
carbon  leakage.  Measures  should  be  linked  with  an  assessment  of  whether  carbon  leakage  has 
occurred and should mainly relate to improvements of the system to ensure it prevents such risk, 
that it provides incentive to be climate efficient, that it supports innovation. One view put forward 
the possibility of developing carbon leakage measures jointly with international partners even in 
the  absence  of  a  global  agreement,  while  another  underlined  the  need  to  provide  incentives  to 
switch to lower carbon products. 

c.  Options for post-2020 - Allocation modalities 

There  were  mixed  views  on  the  number  of  carbon  leakage  groups  (carbon  leakage  and  non-
carbon leakage as opposed to several groups differentiated based on level of exposure), criteria 
underlying  the  groups  and  associated  thresholds.  38%  of  civil  society  respondents  expressed  a 
preference  for  maintaining  the  two  groups,  while  24%  are  of  the  opinion  that  more  categories 
should be developed. On the issue of criteria for determining the carbon leakage status, 28% of 
civil  society  stakeholders  would  like  the  current  ones  to  be  maintained,  whereas  34%  think 
additional  criteria  could  be  developed.  Those  who  advocate  for  maintaining  the  current  system 
call for certainty and less administrative burden. If more carbon leakage categories are developed 
(i.e. high, medium, low exposure status), one proposal is for a risk factor to be determined that 
could then be used to establish the right to access innovation support funding.  

Some views ask for the elimination of the stand-alone criteria and the associated 30% threshold, 
with others quoting research to underline trade exposure is not a good predictor of carbon leakage 
vulnerability.  Several  civil  society  stakeholders  underlined  that  what  should  be  considered  in 
determining carbon leakage status is ability to pass on costs, the potential to increase efficiency 

119 

 
 
and room for products substitution, as well as trade patterns (e.g. excluding third countries with 
comparable climate policies from the assessment).  

Views expressed are also mixed when it comes to the need for a qualitative component as part of 
the assessment of carbon leakage status. Several NGOs indicated it could be applied in addition 
to  the  quantitative  assessment  to  ensure  that  only  those  most  in  need  are  on  the  list.  The 
assessment  should  therefore  take  into  account  the  ability  to  pass  on  costs,  profit  margins, 
abatement potential. About a third of civil society respondents believe the assessment should be 
based  on  simple  metrics.  No  clear  view  emerged  on  the  validity  of  the  carbon  leakage  list 
however  a  few  respondents  stressed  that  it  could  be  correlated  with  the  duration  of  the  trading 
period and that it could be reviewed based on international developments.   

When  it  comes  to  the  updating  of  benchmarks,  some  NGOs  call  for  a  revision  based  on 
worldwide  best  performance  and  almost  all  civil  society  stakeholders  (82%)  agree  that  updates 
should reflect technological advances.  

Concerns  were  expressed  about  the  production  data  on  which  allocation  is  based.  While  some 
believe more recent data would perhaps allow for a better picture, NGOs stress that a 'dynamic' 
ex-post allocation system poses numerous problems including administrative complexity and the 
challenge of obtaining timely and accurate confidential information from firms.  

61%  of  civil  society  respondents  believe  there  should  be  no  deviations  from  the  general 
harmonised  rules  in  order  to  avoid  distortions.  Views  are  mixed  on  the  matter  of  indirect  cost: 
10% advocate for maintaining the present approach of state aid, 41% asked for compensation at 
EU  level,  while  38%  think  no  compensation  is  necessary.  NGOs  stress  that  there  is  no  single 
European energy market to have compensation harmonised across the EU. 

d.  Options for post-2020 - Innovation support 

There  were  mixed  views  on  the  stage  that  would  most  benefit  from  support  in  the  innovation 
process,  as  well  as  on  where  the  funding  should  come  from  (auctioning  revenues  or  free 
allowances). Some highlighted that such support should remain complementary to private support 
as improvements of any kind would represent benefits for the operator.  

e.  Other issues 

Some  civil  society  respondents  (chiefly  NGOs)  underlined  a  number  of  other  issues  including: 
the  need  to  reward  best  low-carbon  performers,  the  need  to  address  allowances  surplus,  the 
possibility of linking free allocation to efficiency and innovation requirements. Some expressed 
concern related to 'dynamic' allocation: in addition to confidentiality issues, complexity and the 
administrative  burden  required,  the  approach  would  negatively  impact  the  incentive  to  reduce 
emissions.  

120 

 
 
4. 

SUMMARY OF EVALUATION 

4.1. 

NER 300 - lessons learnt 

4.1.1. 

Introduction 

This document summarises the lessons learnt from implementation of the NER 300 programme 
as part of the Impact Assessment on the reform of Directive 2003/87/EC158 (ETS Directive). 

As the vast majority of NER 300 projects are not in operation yet and half of them were awarded 
only in July 2014, it is too early for a full evaluation of the  implementation of the programme. 
Such an evaluation will be carried out at a later stage. 

4.1.2.  NER 300 principles 

4.1.2.1.  Definition 

NER  300  is  one  of  the  world's  largest  funding  programmes  for  innovative  low-carbon  energy 
demonstration  projects.  It  promotes  the  demonstration  of  environmentally  safe  carbon  capture 
and storage (CCS) and innovative renewable energy (RES) technologies on a commercial scale 
within  the  EU.  As  such,  it  supports  first-of-a-kind  plants  deploying  innovative  RES  and  CCS 
solutions, hence it would not fund traditional wind turbines but it can fund floating offshore wind 
turbines.  

4.1.2.2.  Legal basis 

The NER 300 programme was established by Article 10a(8) of the ETS Directive. This provision 
indicates  that  300  million  allowances  in  the  New  Entrants  Reserve  were  to  be  made  available 
until 31 December 2015 for co-financing up to 12 commercial CCS demonstration and innovative 
RES projects in the EU. 
Commission  Decision  2010/670/EU159  (NER  300  Decision)  outlines  the  rules  of  the  funding 
scheme. The design of the competitive selection and disbursement process of the programme is 
laid down in the Decision as the Public Procurement Directives160 (addressed to Member States) 
and the Financial Regulation161 do not apply (allowances do not form part of the Union budget). 

NER 300 projects were awarded through two calls for proposals. The first round of awards was 
funded  by  the  sale  of  200  million  allowances  and  was  adopted  on  18  December  2012162.  The 

158 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme 
for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, OJ 
L 275, 25.10.2003, p. 32 
159  Commission  Decision  2010/670/EU  laying  down  criteria  and  measures  for  the  financing  of  commercial 
demonstration  projects  that  aim  at  the  environmentally  safe  capture  and  geological  storage  of  CO2  as  well  as 
demonstration projects of innovative renewable energy technologies under the scheme for greenhouse gas emission 
allowance trading within the Community established by Directive 2003/87/EC of the European Parliament and of the 
Council, OJ L 290, 6.11.2010, p. 39 
160 The so-called Public Procurement Directives refer to the Directives 2004/17/EC and 2004/18/EC of the European 
Parliament and of the Council. 
161  Commission  Delegated  Regulation  (EU)  No  1268/2012  of  29  October  2012  on  the  rules  of  application  of 
Regulation  (EU,  Euratom)  No  966/2012  of  the  European  Parliament  and  of  the  Council  on  the  financial  rules 
applicable to the general budget of the Union, OJ L 362, 31.12.2012, p. 1 
162 Commission Implementing Decision of 18.12.2012, Award Decision under the first call for proposals of the NER 
300 funding programme, C(2012) 9432, amended by C(2014) 383 

121 

 
 
                                                           
second  round  of  awards,  funded  by  the  sale  of  the  remaining  100  million  allowances,  was 
adopted on 8 July 2014163. 

The  European  Investment  Bank  (EIB)  has  been  engaged  in  certain  implementation  tasks  of  the 
NER  300  programme164.  The  NER  300  Decision  sets  out  a  number  of  tasks  relating  to  project 
selection, monetisation of allowances as well as management of revenues that the EIB performed 
on request of, on behalf of and for the account of the Commission. 

4.1.2.3.  Selection of projects 

Project sponsors were required to submit their proposals to the Member State in which the project 
were to take place. Following a pre-selection at national level, the Member States submitted the 
proposals to the EIB. 

Eligibility check 

The eligibility check was carried out by the Member States and verified by the Commission. To 
be  eligible,  projects  had  to  fall  into  one  of  the  innovative  technology  categories  set  out  in  the 
NER  300  Decision,  be  located  in  the  EU,  meet  specific  capacity  thresholds  and  demonstrate 
reasonable expectations to become operational. 

Furthermore,  projects  had  to  demonstrate  to  be  innovative  in  comparison  to  state-of-the-art 
technologies,  including  evidence  of  being  sufficiently  mature  for  demonstration  at  pre-
commercial scale and having a high replicability potential. 

Due diligence and ranking 

Member States submitted eligible projects to the EIB for a financial and technical due diligence, 
and the Commission checked and validated the result.  

The  EIB's  due  diligence  covered  technical  scope,  costs,  financing,  implementation,  operation, 
environmental impact and procurement procedures. The NER 300 funding can cover up to 50% 
of the additional costs of the so-called relevant costs, which are: 

  For CCS projects, investment costs borne by the project due to the application of CCS net 
of the net present value of the best estimate of operating benefits and costs arising due to 
the application of CCS during the first 10 years of operation; 

  For RES projects, extra investment costs borne by the project as a result of the application 
of  an  innovative  renewable  energy  technology  net  of  the  net  present  value  of  the  best 
estimate  of  operating  costs  and  benefits  arising  during  the  first  5  years  compared  to  a 
conventional  production  with  the  same  capacity  in  terms  of  effective  production  of 
energy. 

Upon  completion  of  due  diligence,  the  projects  were  ranked  by  their  cost-per-unit  performance 
(CPUP),  which  is  the  total  request  for  public  funding  plus  the  best  estimate  of  the  net  present 
value of additional benefits, divided by the performance, i.e. the amount of CO2 stored for CCS 
projects, and the amount of energy produced for RES projects. 

163 Commission Implementing Decision of 8.7.2014, Award Decision under the second call for proposals of the NER 
300 funding programme, C(2014) 4493 
164  Cooperation  Agreement  on  the  implementation  of  Commission  Decision  C(2010)  7499  between  the  European 
Commission and the European Investment Bank, OJ C 358, 31.12.2010, p. 1 

122 

 
 
                                                           
Confirmation and award 

The  Commission  then  asked  Member  States  to  confirm  their  support  to  the  projects  that  had 
passed the selection assessment, as well as the value and structure of the total public funding. As 
set out in the NER 300 Decision, each Member State could confirm up to three projects taking 
place in its territory,  with  the exception of cross-border ones,  which  did not  count towards this 
cap.  Furthermore,  no  project  could  receive  more  than  15%  of  the  total  available  NER  300 
funding. 

Once the list of projects to be awarded had been finalised, the Commission consulted the Climate 
Change Committee and adopted the award decisions. 

Projects that passed the selection assessment but could not be awarded were placed in a reserve 
list. The reserve list was to be used should funds become available in case of project failure or 
withdrawal. The  reserve  list  of the  first  call  for proposals  had  to  be  closed  when launching the 
second call, whereas the one  of the second call will  be  closed on 31 December 2015  when the 
capacity to award projects in the NER 300 programme expires. 

4.1.3.  State-of-play  

4.1.3.1.  Results of calls for proposals 

The  NER  300  funding  resulting  from  the  sales  of  300  million  EU  ETS  allowances  totals  €2.1 
billion.  Altogether  38  innovative  RES  projects  and  one  CCS  project  in  20  EU  Member  States 
were  selected  through  two  calls  for  proposals.  The  awarded  RES  projects  are  estimated  to 
increase  the  annual  EU  renewable  energy  production  by  some  18  TWh  and  the  emissions 
captured by the CCS project will total on average 1.8 million tons of CO2 per year. 

In the first call for proposals 79 project proposals (13 CCS and 66 RES) from 21 Member States 
were submitted with the total amount of requested funding totalling €11.8 billion, of which €6.6 
billion  for  CCS  projects  and  €5.2  billion  for  RES  ones.  Of  these  projects,  6  were  withdrawn 
during the selection process, 14 were rejected (having failed the eligibility check and/or the due 
diligence) and 36 were either not confirmed by Member States or could not be supported due to 
insufficient funds. As a result, 23 projects were awarded €1.5 billion.  

Of the projects awarded under the first call only three projects have been withdrawn. One of them 
has been successfully resubmitted under the second call. The other two have been replaced by the 
concerned Member State by more promising projects in the second call. 

In  the  second  call  for  proposals,  32  project  proposals  (1  CCS  and  31  RES)  from  12  Member 
States were submitted, out of which 19 were awarded. The total funding request was €1.6 billion, 
of which €1.3 billion for RES projects and the remaining €300 million for the CCS one. Of the 
remaining projects, 9 were rejected during the evaluation and 4 were not confirmed as exceeding 
the limit of three projects per Member State under the two rounds of call for proposals. 

All available funds resulting from the monetisation of 300 million allowances are now allocated 
to awarded projects, with the exception of a minor surplus of €2.6 million. Table 11 presents the 
list of projects submitted and awarded under both calls for proposals. 

123 

 
 
Table 11: Projects submitted and awarded 

Type of project 

CCS categories 
CCS pre-combustion 
CCS post-combustion 
CCS oxyfuel 

CCS in industry sector 

RES categories 

Advanced bioenergy 
Concentrated solar power 
Photovoltaics 
Geothermal 
Wind 
Ocean 
Hydropower 
Smart grids 

First call 
submitted/awarded 

Second call 
submitted/awarded 

13/0 
3/0 
6/0 
2/0 

2/0 

66/20 

24/7 
9/3 
4/0 
3/1 
15/6 
8/2 
0/0 
3/1 

1/1 
0/0 
0/0 
1/1 

0/0 

31/18 

10/6 
3/2 
3/1 
4/2 
3/2 
5/3 
0/0 
3/2 

The  awarded  NER  300  funding  in  million  euro  and  number  of  projects  per  Member  State  is 
distributed as presented in Table 12.  

Table 12: Distribution of awarded NER 300 funding 

CCS 

Bioenergy  CSP 

Geothermal  Ocean 

PV 

Smart 
grids 

8.2 (1) 

11.1 (1) 

Wind 

Total 

11.3 (1) 

11.3 (1) 

8.2 (1) 

117.9 (3) 

182.6 (2) 

204.9 (3) 

39.3 (1) 

31,9 (2) 

86.6 (2) 

67.4 (2) 

96.6 (3) 

88.5 (1) 

34.3 (1) 

293.2 (4)165 

14.7 (1) 

39.3 (1) 

23.3 (1) 

153.4 (3) 

3.9 (1) 

199.0 (1) 

30.9 (1) 

106,8 (2) 

86,6 (2) 

22.3 (1) 

39.3 (1) 

31,9 (2) 

29.2 (1) 

88.5 (1) 

170.0 (1) 

16.8 (1) 

14.7 (1) 

39.3 (1) 

72.1 (1) 

23.3 (1) 

3.9 (1) 

199.0 (1) 

30.9 (1) 

262.5 (2) 

28.4 (1) 

40.0 (1) 

85.0 (1) 

9.1 (1) 

8.0 (1) 

30.0 (1) 

47.2 (3) 

15.0 (1) 

277.5 (3) 

165 The geothermal project is cross-border with Germany. Cross-border projects do not count towards the 3 projects 
per Member State cap. 

124 

AT 

BE 

CY 

DE 

DK 

EE 

EL 

ES 

FI 

FR 

HR 

HU 

IE 

IT 

LV 

NL 

PL 

PT 

SE 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                           
UK 

Tot 

Average 
funding 

300.0 (1) 

37.4 (2) 

337.4 (3) 

300.0 (1) 

905.8 (13) 

233.4 (5) 

70.9 (3) 

142.0 (5) 

8.0 (1) 

104.2 (3) 

340.5 (8) 

2,104.9 (39) 

300.0 

69.68 

46.68 

23.63 

28.4 

8.0 

34.73 

42.56 

53.97 

4.1.4.  Lessons learnt so far 

4.1.4.1.  Geographical coverage  

24  Member  States  submitted  proposals  under  the  two  calls  for  proposals  and  20  of  them  were 
awarded at least one project (see table in section 4.1.3.1). 

Applications  and  awards  were  evenly  spread  across  the  Member  States  and  reflect  their 
competitive  advantages  due  to  their  geography,  natural  resource  endowment,  and/or  policy 
priorities.  The  limit  of  maximum  three  projects  per  Member  State,  which  was  reached  by  7 
Member  States,  enabled  the  coverage  of  20  Member  States  and  hence  a  wide  geographical 
coverage. However, it also influenced the confirmation of projects, as Member States tended to 
favour those with the higher budgets. 

4.1.4.2.  Technological coverage 

The  selected  projects  cover  a  spectrum  of  RES  technologies,  spanning  all  but  one  technology 
category, hydropower (see table in section 4.1.3.1). For CCS, applications were received for all 
technological  categories;  the  final  low  coverage  is  due  to  difficulties  the  projects  faced  in 
securing all the necessary financing. 

The  technological  categories  of  the  programme  represent  highly  innovative  RES  and  CCS 
technologies.  They  were  defined  on  the  basis  of  the  Strategic  Energy  Technology  Plan  (SET-
Plan)166,  which  identified  a  number  of  technologies  to  be  supported  by  a  European  Industrial 
Initiative, relevant low-carbon roadmaps and technology platforms, as well as a wide stakeholder 
consultation. 

The technology categories and subcategories approach was applied in the NER 300 to eliminate 
undue competition between technologies. This applies particularly to the RES group. One could, 
however, explore if some flexibility with regard to those categories could be applied in a follow-
up scheme and whether those flexibilities could benefit the final outcome. For instance, one could 
consider  lowering  certain  thresholds  or  allowing  for  technology  updates  in  the  course  of  the 
programme. For the CCS category, one could explore if lower capacity thresholds could result in 
more projects being submitted and implemented.  

4.1.4.3.   Support to innovation 

The  NER  300  eligibility  criteria  regarding  innovativeness  of  projects  aim  at  allocating  limited 
funds to highly innovative projects. 

Eligible  technologies  had  to  be  innovative  in  relation  to  the  state-of-the-art  of  the  particular 
technology  category,  not  yet  commercially  available  but  mature  for  demonstration  at  pre-
commercial  scale,  require  public  support  for  demonstration  due  to  their  risks,  ready  to  be 
demonstrated at a scale which is easily conducive to further scaling up and have a cost-effective 
CO2 reduction potential. 

166 Investing in the Development of Low Carbon Technologies (SET-Plan), COM(2009) 519 

125 

 
 
 
 
 
 
 
 
                                                           
The vast majority of RES and CCS submissions by Member States met the NER 300 innovation 
requirements. Although projects are selected on the basis of cost-effectiveness as reflected by the 
CPUP  indicator,  it  is  estimated  that  almost  80%  of  the  NER  300  awards  went  to  highly 
innovative or even potentially game changing projects. This is the result of a qualitative analysis 
within  the  eligibility  check  based  on  difference  of  the  project's  technology  from  existing 
solutions, availability of the project's technology amongst other vendors, availability of previous 
tests  for  the  chosen  technology,  potential  for  scale-up  and  replicability  and  availability  of 
resources to be used by the project. 

4.1.4.4.  Cost-effectiveness in the use of NER 300 funds 

The €2.1 billion of NER 300 funding has mobilised €700 million from other public sources and 
leveraged  €2.7  billion  from  private  operators  to  cover  investment  costs.  Awarded  projects  will 
also accrue over €3.1 billion in additional benefits (net present value) over the first five years of 
operation. These additional benefits are mainly  support schemes such as feed-in tariffs but also 
avoided costs or existing tax incentive measures.  

The funding cap of maximum 15% of total allowances per project seems to have a negative effect 
on  the  number  of  confirmed  CCS  projects.  It  appears  that  CCS  projects  would  have  benefitted 
from the possibility of a higher share of NER 300 funding. Due to the cap however, no more than 
€300 million could be awarded to the selected CCS project, which effectively covers only 34% of 
the  relevant  cost.  The  remaining  project  costs  need  to  be  provided  by  other  sources,  mainly 
additional public funding.  

On the other hand, the RES projects were not affected by the 15% limit. In fact, on average, the 
awarded RES projects applied for 39% of their relevant costs to be covered by the programme, 
less than the possible maximum of 50%. The NER 300 funding for RES projects ranges from €7 
to €203 million.  

In a follow-up scheme, one could, therefore, further analyse the level of the co-funding rate and 
its prospective impact on the number of successful projects.  

4.1.4.5.  Administrative simplification 

The  application  and  submission  forms  were  simplified  before  the  second  call  for  proposals 
following requests from stakeholders for reduction of administrative burdens. Implementation of 
awarded projects could be facilitated by streamlining of the knowledge sharing requirements.  

Knowledge-sharing is a pre-requisite of the programme and considered essential to ensure value 
for funding and to encourage the spread of innovative technologies. The critical issue concerning 
it was defining what information should be shared, how and with whom, as onerous requirements 
may  discourage  participation  from  project  developers  cautious  about  IPR  risks.  However,  a 
broader NER 300 goal is to support the wide-scale deployment of clean energy technologies and 
this necessitates that the advances made by project developers are shared more broadly. 

On the basis of the experience to date, the knowledge sharing exercise could be simplified and 
implemented  more  efficiently  via  conferences  and  social  media,  which  would  encourage 
exchange of information between projects and with the wider public, rather than through detailed 
reports submitted to the Commission. 

4.1.4.6.  Monetisation of allowances for grants 

NER 300 provides funding to innovative, first-of-a-kind projects, characterised by long planning 
and  construction  times,  as  well  as  a  higher  risk  profile  with  regard  to  budget  planning  and 

126 

 
 
financing. With this in mind, the NER 300 programme was set up to co-finance projects through 
cash  grants,  which  are  considered  the  most  suitable  instrument  for  such  non-commercial 
endeavours where equity, loans or guarantees might not be very effective. 

The allowances were  centrally monetised before  award  decisions to  avoid  a  prospective risk of 
the  carbon  price  on  the  project  sponsor  or  a  Member  State  which,  in  turn,  could  jeopardise 
projects. 

The EIB was in charge of monetising allowances by April 2014. In terms of sales of allowances, 
they  were  executed  gradually  to  minimize  the  market  impact.  This  was  achieved  by  spreading 
volumes  to  follow  liquidity,  both  intra-day,  daily  and  monthly.  The  average  sale  price  of  the 
monetisation was €7.19 per allowance, which is in line with the average market price167.  

Funds resulting from monetisation, awaiting their turn for disbursement, have been reinvested by 
the EIB, following Asset Management Guidelines. Over €23 million of interests were generated 
in the first year of this asset management exercise in 2014.  

The entire exercise covering central monetisation of allowances and management of revenues has 
been seamless and efficient; the approach has proven to be non-distortive of the carbon market.  

4.1.4.7.  No ring-fencing 

No ring-fencing was applied in the NER 300 programme. In other words, there was no  ex-ante 
split  of  the  amount  of  funding  attributed  to  CCS  and  RES  categories.  If  this  would  have  been 
done, a considerable portion of the resources would probably not have been used (for example by 
allocating  50%  of  the  allowances  to  CCS,  €750  million  of  the  €2.1  billion  available  could  not 
have  been awarded).  Instead, the chosen  approach to  set targets for the share  between  the RES 
and  CCS  group  (up  to  8  CCS  projects  and  1  RES  project  per  renewable  category),  with  the 
possibility  for  a  smooth  spill  over  between  both  groups,  allowed  for  avoiding  a  significant 
amount funds remaining unspent. 

4.1.4.8.  Number and timing of calls 

Two  calls  for  proposals  were  launched  in  2011  and  2013  respectively,  so  as  to  have  a  purely 
competitive  process  first  and  a  modified  competitive  process  at  a  later  stage  to  allow  for 
adjustment  of  any  technological  and  geographical  imbalances.  Projects  targeting  non-awarded 
categories  were  given  the  priority  under  the  second  call,  and  a  cap  was  introduced  (up  to  3 
projects per Member State). These goals would not have been achievable with one call only or 
with an open call system based on the first-come-first-serve principle.  

A  2-year  interval  of  calls  received  widespread  support  at  national  and  project  sponsor  level 
because it created a certain continuity and stability in NER 300 funding. 

A lower number of applications were received under the second call compared to the first one (32 
versus 79). This could have been influenced by the fact that it was launched 4 months after the 
first award decision, which might not have provided project sponsors with enough time to prepare 
for a new call.  

The first call's cycle lasted 25 months and this may seem as too long, but one has to bear in mind 
that the first call was also a learning curve for all involved parties. Considerable improvements, 

167 EIB summary report on the monetisation of 300 million allowances:  
http://ec.europa.eu/clima/policies/lowcarbon/ner300/docs/summary_report_ner300_monetisation_en.pdf  

127 

 
 
                                                           
due to the streamlining of the process, were made during the second call and that lead to a much 
shorter cycle of 15 months. 

4.1.4.9.  Length of preparatory phase 

Of  the  20  projects  awarded  under  the  first  call  in  December  2012,  two  have  started  so  far  to 
produce  energy,  whereas  four  more  reached  a  positive  Final  Investment  Decision  (FID).  19 
projects were awarded in the second call in July 2014 and are progressing.  

With regard to the implementation of the NER 300 projects, the necessary preparation phase for 
first-of-a-kind,  commercial-scale  power  plants  has  probably  been  underestimated.  The  projects 
need time to obtain all necessary permits, secure the participation of all investors, obtain state aid 
clearance  where  applicable  and  finally  complete  the  construction  phase  before  they  enter  into 
operation.  Furthermore,  the  financial  crisis  has  jeopardized  financial  viability  of  some  projects 
and  made  it  more  difficult  to  secure  project  financing.  Therefore,  a  number  of  Member  States 
requested extension of the deadlines for the FID and entry into operation by two years. Following 
that, an amendment to the NER 300 Decision was adopted on 5 February 2015. 

The  adopted  extension  of  deadlines  means  that  disbursements  of  NER  300  funds  will  be 
concentrated  between  2017  and  2024,  when  the  majority  of  projects  is  expected  to  become 
operational. The length of the preparatory phase should be adequately taken into account in any 
follow-up scheme, as experience indicates that four years from the award decision are necessary 
to reach the FID and six years to get into operation.  

4.1.4.10.  Impact of projects 

NER 300 provides funding and prepares the ground for market uptake of 38 first-of-a-kind RES 
power  and  heat  generation  plants  and  1  CCS  installation.  The  environmental  impact  of  these 
projects  in  terms  of  renewable  energy  production  and  CO2  avoidance  will  make  substantial 
contributions towards reduction of CO2 in the period beyond 2020.  

4.1.4.11.  NER 300 and other financing instruments 

NER 300 targets a very specific moment in the life of an innovative power generation project: the 
development  of  the  first  commercial-scale  plant,  marking  the  initial  market  uptake  of  a  new 
technology.  As  such,  it  supports  first-of-a-kind  projects  in  any  Member  State  and  provides 
funding to endeavours in the so-called "valley of death", i.e. the gap between the end of R&D and 
the  beginning  of  full  commercialisation.  For  this  reason,  stakeholders  and  Member  States  have 
expressed  interest  in  continuing  such  a  scheme,  as  it  is  the  only  EU  instrument  supporting 
companies  in  this  very  moment  of  a  project's  lifetime  through  grants  (the  recently  launched 
InnovFin  Energy  Demo  Projects  (EDP)  pilot  facility  provides  such  support  via  loans  and  loans 
guarantees). 

NER  300  is  fundamentally  different  from  R&D  programmes,  such  as  the  EU’s  Seventh 
Framework  Programme  for  Research  (FP7)  and  Horizon  2020,  or  the  other  ETS  funding 
mechanism described in Article 10c thereof, the transitional free allocation of allowances for the 
modernisation  of  electricity  generation  in  Member  States  with  a  GDP  per  capita  not  exceeding 
60% of the EU average. 

NER  300  is  also  different  from  financial  tools  such  as  the  InnovFin  SME  Guarantee  Facility, 
launched by the Commission and the EIB under Horizon 2020 with the aim of covering losses of 
financial intermediaries on loans, leases and guarantees provided to SMEs. 

128 

 
 
Finally,  NER  300  is  different  from  the  European  Economic  Programme  for  Recovery  (EEPR) 
which provided €1 billion for six CCS demonstration projects for investments in all stages of an 
integrated  CCS  project  and  related  front-end  engineering  design  (FEED)  studies,  permits  and 
environmental impact studies, with a maximum contribution of €180 million per project.  These 
two funding schemes (NER 300 and EEPR) could have been used to complement each other but 
the CCS project funded under NER 300 decided not to  apply for financing from the EEPR. By 
end 2014, 4 of the 6 CCS projects financed under EEPR were terminated.  

In  a  follow-up  scheme  more  attention  should  be  paid  to  the  need  of  coherent  use  of  available 
funding schemes that can only be beneficial to the final outcome.  

4.1.5.  Main challenges encountered  

The  main  challenge  encountered  so  far  has  been  to  ensure  the  complementary  financing  of  the 
projects beyond the NER 300 contribution. Because of their high risk and of the current economic 
crisis they tend to face a number of financial barriers with the potential to compromise or slow 
down their implementation. 

4.1.5.1.  Financial barriers 

During due diligence, the EIB identified for almost all awarded renewable projects a number of 
financial  risks,  such  as  lack  of  national  co-funding,  feed-in-tariffs  or  similar  national  support 
schemes,  equity,  long-term  debt  financing  or  revenues.  Lack  of  national  funding  was  the  main 
reason  why  Member  States  did  not  confirm  the  10  CCS  projects  that  passed  the  selection 
assessment  in  the  first  call.  Insufficiently  developed  financing  plans  could  become  the  main 
reason  why  awarded  projects  might  not  reach  their  final  investment  decision,  although  no 
awarded project is currently in this situation.  

NER  300  funds  cover  50%  of  the  costs  of  the  innovation  and  are  in  principle  disbursed  once 
projects  go  into  operation  and  on  the  basis  of  their  performance.  Upfront  funding  is  possible. 
Maximum 60% of the awarded NER 300 funding can be provided as upfront funding although a 
Member  State  concerned  needs  to  provide  an  appropriate  guarantee.  In  the  current  NER  300 
programme the Commission awarded upfront funding to six projects to the total of €210 million. 

It should be noted that although not all projects that required upfront funding were granted it this 
has not jeopardised their implementation. (Six projects awarded under the second NER 300 call 
applied for upfront funding but only three received it.) 

If  a  Member  State  does  not  provide  a  guarantee  for  upfront  funding,  the  credit  risk  cannot  be 
supported by the NER 300 programme (for instance by setting aside a portion of allowances to 
cover  project  default),  because  the  ETS  Directive  stipulates  that  award  of  support  must  be 
conditional on verified avoidance of CO2. Although the NER 300 funds cannot be used, for the 
same reason, to guarantee loans in a risk sharing facility, projects can additionally apply for loan 
finance  from  the  Risk-Sharing  Finance  Facility  (RSFF)  managed  by  the  EIB.  The  Commission 
steers  NER  300  projects  into  this  direction;  however,  no  project  has  made  use  of  RSFF  up  to 
now. 

There  is  evidence  that,  for  CCS  in  particular,  cost  estimates  are  very  uncertain  until  detailed 
engineering design work is done, which makes proper budgeting difficult. When setting up NER 
300,  the  Commission  considered  imposing  a  requirement  for  a  FEED  (Front  End  Engineering 
Design) for all submitted projects, but in cost and timing terms this was considered unrealistic. 
The  cost  of  a  FEED  study  is  significant  and  requiring  projects  to  fund  this  may  be  substantial 

129 

 
 
disincentive. An option for a follow-up programme would be to foresee refunding of portion of 
FEED studies required for the application process.  

Financial risks for NER 300 projects are significant. In the current set-up, project sponsors would 
have  benefited  from  being  better  informed  of  the  possibility  of  receiving  upfront  funding,  also 
destined for the construction phase, and combining NER 300 support with other EU and national 
funding sources (in line with state aid guidelines) and financial instruments, such as, for instance, 
the  RSFF.  This  could  help  projects  in  mitigating  those  risks.  Further  options  that  may  help 
overcome  financial  barriers  could  also  be  explored  when  designing  a  prospective  follow-up 
programme. 

4.1.5.2.  Management structure 

The NER 300 programme is managed by the Commission and the Member States, while the EIB 
performs its tasks on request of, on behalf of and for the account of the Commission. 

The  Commission  has  the  overall  responsibility  for  the  implementation  of  the  NER  300 
programme.  Its  role  before  the  award  decisions  includes  developing  the  necessary  legal  basis, 
publishing  calls  for  proposals,  verifying  Member  States'  eligibility  checks  and  EIB's  due 
diligence  assessments,  supervising  the  monetisation  of  allowances  and  adopting  award  and 
rejection  decisions.  After  the  adoption  of  awards,  the  Commission  continues  to  maintain  the 
overall  responsibility  for  the  implementation  of  the  programme.  Furthermore,  it  confirms 
compliance with the knowledge sharing requirements, approves disbursements and, if necessary, 
amends award decisions following significant changes to selected projects. 

The  work  load  for  the  Commission  in  implementing  the  programme  after  award  decisions  has 
proven to be significant. In order to facilitate the management of a larger number of projects in 
the future, tasks related to implementation could be outsourced, with the Commission retaining 
the overall control, supervision and coordination of the programme, including the development of 
its priorities and  adoption of awards to ensure the geographical and technological spread in the 
EU. 

Member  States  were  responsible  for  receiving  proposals  from  project  sponsors  and  defining 
reference  plants,  conducting  the  first  eligibility  check,  submitting  proposals  deemed  eligible, 
defining the level of national co-funding and confirming projects to be supported. Following the 
adoption of award decisions, Member States establish the contracts with project sponsors, submit 
annual reports on the implementation of projects to the Commission, notify the Commission of 
any proposed changes to awarded projects, submit payment requests and disburse revenues. Even 
though the selection of NER 300 projects takes place at the EU level, the involvement of Member 
States proved essential to perform a pre-selection at the national level, to prepare the support at 
the national level and to ensure the proper management and disbursement of the NER 300 funds. 

The  EIB  was  in  charge  of  monetising  allowances  and  carrying  out  a  due  diligence  assessment 
before  the  adoption  of  NER  300  award  decisions.  After  the  award  decisions,  the  EIB  manages 
revenues  and  disburses  to  Member  States  following  their  request  and  the  approval  of  the 
Commission.  The  involvement  of  the  EIB  proved  to  be  essential  for  a  smooth  monetisation  of 
allowances  without  disturbing  the  carbon  market,  professional  asset  management  and  project 
selection.  The  EIB  generated  €23  million  of  accrued  interests  in  2014  alone  through  asset 
management,  indicating  that  this  exercise  has  the  potential  to  cover  the cost  of  its  involvement 
several times over. 

In summary, some simplification in the project management structure and streamlining in the role 
of the players can be envisaged in the future, such as, for instance, shorter due diligence by EIB, 

130 

 
 
less  notification  requirements  for  Member  States,  and  less  involvement  of  the  Commission  in 
project management and disbursements. 

4.1.6.  Conclusions  

The awarded NER 300 funding totalling €2.1 billion will leverage approximately €2.7 billion of 
private investments and mobilise €700 million from other public sources. The average sales price 
of 300 million allowances was €7.19 per allowance. The monetisation did not disturb the carbon 
market  and  the  funds  are  fully  allocated  through  two  calls  for  proposals  to  38  innovative  RES 
projects and one CCS project in 20 EU Member States.  

There is a balanced geographical and technological coverage. In particular for RES, the NER 300 
programme was effective in making awards to a spectrum of RES technologies, spanning all but 
one  technology  category.  For  CCS,  applications  were  received  for  all  technological  categories 
and  all  proposals  passed  the  capacity  threshold.  One  may  explore  increasing  the  flexibility  in 
technology  categories  to  allow  for  future  updates  and  streamlining  of  the  application  process 
bearing in mind, however, that technologies at different stages of development should not be put 
in competition with each other.  

Targets  were  set  for  the  share  between  RES  and  CCS  projects  (up  to  8  CCS  projects,  1  RES 
project  per  renewable  category)  in  awards.  However,  the  possibility  for  a  smooth  spill  over 
between the RES and CCS group was crucial to avoid a significant amount of funds remaining 
unspent. 

Almost  80%  of  awarded  projects  were  deemed  highly  innovative  or  even  potentially  game 
changing.  

The 2-year interval of calls created continuity and stability in NER 300 funding.  

Many  awarded  projects  face  significant  financial  risks.  The  possibility  of  upfront  funding  and 
combining NER 300 support with other EU and national sources as well as financial instruments 
such  as  the  Risk-Sharing  Finance  Facility  could  help  projects  to  mitigate  those  risks.  For  CCS 
projects, the lower than expected revenues from the sale of NER 300 allowances  seem to  have 
compromised the programme's ability to fund the portfolio of CCS technologies and at the same 
time set a low cap for funding due to the 15% rule. This together has undermined a business case 
for CCS projects which in the end were not confirmed by Member States. 

The roles of the various institutions, i.e. the Commission, the EIB and the Member States could 
be simplified in project management in the future. 

It can be concluded that the existing NER 300 programme allocated limited funds efficiently to 
highly  innovative  RES  and  CCS  projects.  The  smooth  cooperation  between  Commission, 
Member States and EIB was crucial for the adoption of the awards. As the vast majority of NER 
300 projects are not in operation yet and half of them were awarded only in  July 2014, it is too 
early for a full evaluation of the implementation of the programme.  Once such an evaluation is 
effectuated,  one  may  explore  streamlining  and  simplification  of  processes  in  any  follow-up 
scheme. 

The  scope  of  a  prospective  follow-up  programme  should  be  extended  to  cover  low-carbon 
innovations in industry. Also, financial barriers should be considered and reflected accordingly, 
in particular for CCS. Finally, interaction and division of labour between the involved institutions 
could be simplified. 

131 

 
 
4.2. 

Free allocation to the power sector 

In  contrast  to  the  Modernisation  Fund,  free  allocation  to  the  power  sector  has  already  been 
applied  in  Member  States  that  opted  to  use  it  since  2013168.  Each  Member  State  applying  free 
allocation to the power sector between 2013 and 2019 first prepared an application identifying the 
eligible  installations,  setting  out  the  rules  for  the  operators  involved  and  a  detailed  National 
Investment Plan listing eligible investments aimed at modernising the energy sector along with an 
intended date of realisation169. This application and the National Investment Plan were based on 
principles  set  out  in  a  Commission  guidance  document170.  The  Commission  assessed  these 
applications, asked for additional information where necessary and adopted decisions approving 
them in 2012, followed by a separate state aid assessment of the national plan.  

The ETS Directive requires annual reporting on the realisation of the investments. Member States 
are required to make these reports public. Implementation of the free allocation is underway, and 
the  first  year  of  reporting  by  Member  States  and  allocations  is  complete.  Based  on  the  current 
experience, the following interim lessons learnt can be drawn and are relevant to the continuation 
of the free allocation after 2020. 

The  transparency  of  the  free  allocation  process  is  related  both  to  the  accessibility  of  the 
information  and  the  level  of  detail  of  the  information  that  is  in  the  public  domain  about  the 
preparation  and  implementation  of  free  allocation  to  the  power  sector.  The  existing  Directive 
requires  Member  States  that  make  use  of  the  derogation  to  publish  annual  reports  on  the 
implementation  of  investments  from  their  national  plans.  The  applications  should  also  be 
published. Experience shows that the existing reports that have been published vary in content. 
For  example,  some  Member  States  restrict  the  information  provided  on  investment  costs  with 
reference  to  business  confidentiality.  Further,  the  format  of  the  information  provided  varies  by 
Member  State  from  a  limited  overview  of  the  numbers  to  a  more  comprehensive  qualitative 
report,  including  explanatory  information  on  the  reasons  for  project  delays  and/or  for  the 
difference  between  original  estimates  and  final  reported  costs  that  occurs  in  some  cases.  The 
underlying independent audit reports required for each operator have been published only by one 
Member State (the Czech Republic). 

Another  aspect  which  influences  the  perceived  transparency  is  the  openness  of  the  process  by 
which investments are selected. Several factors lower the transparency for outside parties, such as 
other electricity companies within the Member State or in neighbouring countries. Firstly, the fact 
that most Member States have included specific provisions for this process makes it difficult to 
compare them. In addition, the late implementation of the changes to the national legislation and 
the inaccessibility in some cases of the final versions of the national applications make assessing 
the way in which investments were selected more difficult. 

While  certain  principles  for  the  free  allocation  are  established  at  the  level  of  the  Directive  and 
through the guidance document, the modalities for the existing free allocation to the power sector 
differ  significantly  depending  on  provisions  decided  by  the  individual  Member  States.  For 
example, rules relating to the selection of investments for the national plan, provisions related to 
the timing of the investments, rules related to the timing of the auctioning of unused allowances 
and the methodology used to determine the market value of allowances are all decided at national 

168 Article 10c of the ETS Directive created the legal basis for optional free allocation to the power sector between 
2013 and 2019. 
169 For example, principle 5 in relation to the requirements for the national plan states that "Investments identified in 
the national plan should contribute to diversification, and reduction in carbon intensity, of the electricity mix and the 
sources of energy supply for electricity production." 
170 Guidance document on the optional application of Article 10c of Directive 2003/87/EC: (2011/C 99/03) 

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level and differ between the Member States. This fragmented approach reduces the transparency 
of the mechanism for outside parties and significantly increases the administrative complexity for 
Member States, who have the primary responsibility for monitoring and reporting, because they 
have to track the progress of the national investment plans over multiple years and to enforce the 
specific framework of rules. 

The  development  and  approval  of  the  national  applications  was  a  time  consuming  process  for 
Member  States  and  the  Commission.  Since  the  applications  were  based  on  individual  national 
investment plans per Member State, they required a two-step assessment to evaluate whether the 
application itself was in line with the provisions of the Directive and to assess the associated state 
aid  aspects.  Annual  monitoring  and  reporting  of  the  hundreds  of  investments  often  involved 
accounting for cumulative costs over several years.  

The provisions in the Directive explicitly limit the use of free allocation to existing installations 
based  on  a  cut-off  date,  with  a  view  to  focussing  it  on  the  modernisation  of  the  energy  sector 
rather than expanding the generation capacity in a Member State with a view to avoid distortions 
of  competition  in  the  power  market.  Based  on  the  provisions  in  the  Directive,  installations  for 
which Member States could demonstrate that these were "physically initiated" by this date were 
also eligible for inclusion in the application. Evaluating the evidence for this was a complex issue 
during the assessment process for the Member State applications.  

Significant investment costs – for almost 400 investments with a total cost of almost € 6 billion – 
were  reported  for  the  first  year  for  which  full  data  are  available  for  the  8  Member  States 
concerned  (2013).  This  represents  the  total  expenditure  that  has  been  reported  in  relation  to 
investments  from  the  national  investment  plan  for  the  period  up  until  the  end  of  2013.  The 
investment must be at least equal to the market value of allowances requested to be allocated for 
free for 2013. Of course, the actual investment costs can be higher than the market value of the 
free allocation. But they may not be lower, in order to meet the conditionality which is required 
by the ETS Directive in order to apply the derogation. In the first year, Member States allocated a 
total of roughly 133 million allowances for free.  

The  types  of  investments  which  have  been  realized  under  the  programme  vary  significantly 
between  Member  States,  but  the  largest  share  (about  90%  in  2013)  of  the  investments  were 
defined  as  upgrading  and  retrofitting  infrastructure  (including  networks),  while  the  rest  of  the 
investments  were  related  to  investments  in  clean  technologies  or  diversification  of  the  energy 
mix.  While  the  combined  national  plans  list  more  than  1100  investments  for  the  full  period, 
including several very large scale investments in the order of magnitude of tens or hundreds of 
millions  of  euros,  the  large  bulk  of  investments  are  much  smaller  in  size.  The  average  size  of 
investments  is  around  €  38  million  while  the  median  size  is  lower  (€  2  million).  The  national 
plans  were  subject  to  a  state  aid  assessment,  and  there  are  rules  preventing  companies  from 
justifying  free  allocation  based  on  costs  that  are  higher  than  those  listed  for  the  investments  as 
specified  in  the  national  plans.  At  the  same  time,  once  the  implementation  is  underway,  it  is 
difficult to assess based on the annual reports to which extent these investments may have also 
taken place without the possibility of free allocation.  

There are a number of aspects which have been regulated differently depending on the provisions 
set by individual Member States.  

All  national  plans  foresee  a  decline  in  free  allocation  to  0  by  2020.  However,  some  Member 
States have included more potential investments in their national plans, to allow more flexibility 
if  not  all  projects  are  realised,  while  others  have  only  specific  investments  which  directly 
correspond to the market value of the free allowances for each operator. Provisions that allow for 
the delay of investments are included in most Member State applications and these in some cases 

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create  a  long  potential  time  lag  between  the  initially  planned  year  of  investment,  the 
corresponding  free  allocation  and  the  eventual  auctioning  of  unused  allowances,  the  extent  of 
which  can  also  differ  between  Member  States.  Furthermore,  the  distribution  of  the  planned 
investments  (as  indicated  in  the  national  plans)  over  the  derogation  period  differs  between  the 
Member States, and investment costs can be counted in subsequent years, if the value is higher 
than  the  maximum  free  allocation  given  in  that  year.  These  aspects  when  combined  make  it 
difficult to predict the number and the timing of auctioning of unused allowances.  

With regard to the first year of implementation, roughly 18 million allowances remained unused 
(around 12% of the maximum amount that could be allocated for free). This quantity is likely to 
increase during future years, as unused allowances accumulate. The total quantity of allowances 
that can potentially be issued is deducted in advance from the auctioning rights of each Member 
State concerned, while the year in which they are allocated for free or auctioned depends on when 
and the extent to which the corresponding investments take place. This could be after a delay of a 
number  of  years,  depending  on  the  rules  set  by  the  Member  States  in  their  application  and 
implementing rules. The Directive requires that allowances which are definitely not allocated for 
free are auctioned at the latest in 2020. 

Another aspect which has been implemented differently across beneficiary Member States relates 
to the determination of the maximum number of free allowances per eligible installation. Within 
the total amount defined based on the provisions in the Directive, the potential allocation to each 
installation could be set either based on their historic emissions related to electricity production in 
the  years  2005-2007  or  based  on  an  ex-ante  efficiency  benchmark  based  on  a  common 
methodology171.  Benchmarks  were  applied  in  6  Member  States  for  one  or  more  of  the 
installations.  In  many  cases  this  was  done  in  parallel  with  an  approach  for  other  installations 
based on verified emissions. Further differentiation was applied by some Member States through 
assumptions on the relevant load factors which were used in combination with the benchmark to 
determine the allocation. Finally, in two cases the Member States made use of a benchmark based 
on  a  national  fuel  mix.  This  varied  approach  reduced  the  consistency  of  the  basis  for  potential 
free allocation to eligible installations between and within Member States. The two Member State 
specific benchmarks (reflecting the national rather than the Union wide fuel mix) both resulted in 
a benchmark that was around a third higher than the Union average of 0,6408 tonnes of CO2 per 
megawatt hour electricity produced.   

A final aspect which has been implemented differently by Member States, concerns the reference 
price that is used to calculate the market value of free allocation. In order to calculate the number 
of free allowances which can be justified based on the costs related to a specific investment, the 
market  value  of  the  allowances  needs  to  be  determined  using  a  reference  price.  Most  Member 
States  have  based  this  reference  price  on  the  values  set  out  in  the  guidance  document,  which 
result in a price of € 14.5 per allowance in 2014 and 2015 and € 20 per allowance thereafter. A 
number  of  Member  States  have  however  included  provisions  in  their  application  and 
implementing  legislation  allowing  for  the  possibility  to  determine  the  reference  price  based  on 
observed  market  prices,  if  these  diverge  by  more  than  a  set  percentage  (e.g.  20%)  from  the 
reference  price.  This  has  resulted  in  a  divergence  in  the  reference  price  used;  with  prices 
depending  on  the  method  used  of  almost  50%  lower  for  the  first  year.  These  diverging 
approaches  result  in  corresponding  differences  in  the  implementation  between  the  Member 
States, as was for example highlighted by Poland in its consultation response. 

171  C(2011)  1983  Commission  Decision  on  the  methodology  to  transitionally  allocate  free  emission  allowances  to 
installations in respect of electricity production under Article 10c(3) of Directive 2003/87/EC 

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4.3. 

Exclusion of small emitters – lessons learnt 

Currently,  there are  more than 12,000 installations included  in  the EU ETS. These installations 
represent a large range of emitters, from power plants to industrial installations in various sectors. 
Annual emissions from these installations vary from less than 5,000 tCO2 to more than 5,000,000 
tCO2. The largest 5% of installations in the EU ETS represent 71% of total emissions, while the 
20% smallest only account for less than 1% of emissions. 

Figure 9: Distribution of installations in terms of amount of emissions  

Source: Umweltbundesamt based on EUTL verified emissions 2013 

Taking  into  account  this  distribution,  the  possibility  to  exclude  small  emitters  was  allowed  in 
2005-7  and  is  also  being  applied  since  2013.  Member  States  applied  to  the  Commission  by 
September 2011 in case they wanted to make use of the option to exclude small emitters from the 
EU ETS. The decision allowing the opt-out was taken by the Commission. 

The main condition for the exclusion was that installations excluded are subject to measures that 
will achieve an equivalent contribution to emission reductions. The Directive requires emissions 
from excluded installations to be annually monitored and reported to check whether the relevant 
emission threshold is not exceeded and the installation can remain excluded. 

The  starting point for the analysis  on excluding small  emitters is the thresholds  on the basis of 
which installations are deemed to be covered by the EU ETS. These thresholds are determined in 
Annex  1  of  the  Directive,  with  the  main  threshold  being  a  rated  thermal  input  of  20MW 
combined with a number of more activity-related criteria and thresholds. These thresholds were 
subject of considerable discussion and analysis ahead of the previous ETS revision in 2008 and 
are not put in question by stakeholders. 

The threshold for allowing the exclusion of installations from the EU ETS (a rated thermal input 
below 35 MW and reported emissions of less than 25,000 tCO2 per year) were also intensively 
discussed  in  2008  and  there  is  no  reason  to  believe  that  a  significant  change  has  taken  place 
compared to the situation when these thresholds were introduced. Therefore, these thresholds will 
also not be further analysed. 

In  terms  of  environmental  effectiveness,  the  current  combination  of  an  emission  threshold  of 
25.000 tCO2 and a capacity threshold would have cut down the overall emission coverage of the 

135 

 
 
 
 
EU ETS by  2.7%  if  all  Member States had applied. Considering the limited use  of this  option, 
currently  the  overall  emission  coverage  has  been  reduced  by  0.3%,  corresponding  to  2.7  Mt 
CO2e. Since 2013, no installations have been brought back in the system because they exceeded 
the relevant threshold. 

In this context, it is also important to note that small emitters as defined in the Directive may not 
necessarily be small installations owned by operators of small and medium-size enterprises (i.e. 
enterprises with less than 250 employees), notably if the activity is not very energy-intensive. 

Figure 10 provides an overview of the annual emissions from small installations compared to opt-
out installations. 

Figure 10: Annual Emissions from small installations (installations with annual emissions < 25 kt) 
and from opt-out installations  

Source: EUTL, Article 21 reports 

As is also shown by this graph, the option to exclude small emitters from the ETS was used only 
to  a  limited  extent  by  Member  States.  The  reasons  were  probably  that  developing  appropriate 
alternative measures presented drawbacks in terms of administrative complexity and costs for the 
Member States compared to applying the ETS. Since the start of the EU ETS, most operators of 
covered  installations,  including  those  with  low  emissions,  have  become  used  to  the  annual 
compliance  cycle  of  monitoring,  reporting  and  verification  of  emissions  and  surrendering  of 
allowances. Operators have developed an understanding of the EU ETS and best-practices, they 
established internal procedures and hold accounts in the Union registry so that they might have 
been reluctant to request changing from the EU ETS to a different national system involving new 
administrative procedures and requirements. In particular, since the Directive requires monitoring 
and  reporting  of  emissions  and  an  equivalent  contribution  to  emission  reductions,  and  as  ETS 
monitoring  and  reporting  is  in  any  case  lighter  for  small  emitters  through  the  implementing 
legislation, this might have caused operators not seeing any additional benefits in the  exclusion 
and therefore  Member States not  making  use  of this option. In  addition, excluding installations 
from the EU ETS increases the stringency of a Member State's effort sharing target, which may 
also have played a role when considering the use of this option. 

The measures presented to the Commission by the Member States varied to a certain extent. In 
line with the overall objective of the EU ETS, a measure was considered equivalent if it achieved 

136 

 
 
 
a  contribution  to  emission  reductions  equivalent  to  those  achieved  by  the  EU  ETS  without 
causing  any  distortions  of  competition.  In  terms  of  costs  per  ton  of  CO2  most  Member  States 
opting  for  this  required  operators  to  pay  a  specific  levy  based  on  an  'annual  emission  target' 
(equivalent to the amount of allowances the installations would have received for free under the 
EU ETS) multiplied with the average carbon price over a certain period. 

While such systems were accepted, other proposed measures were rejected by the Commission. 
For  instance,  a  measure  that  required  the  operator  to  improve  an  emission  value  expressed  in 
relative  terms,  i.e.  emissions  per  marketable  unit  of  product  was  not  considered  equivalent.  In 
terms of environmental integrity, such a measure provides no guarantee that absolute emissions 
from  the  installation  actually  decrease  since  a  decline  of  the  specific  emission  value  may  only 
mean that the production of the installation grows faster than its emissions. 

4.4. 

Guaranteeing a robust and secure EU ETS (registry fees) – lessons learnt 

With the move from national registries to the Union registry, many roles and responsibilities were 
shifted  from  Member  States  to  the  Commission.  For  example,  changes  to  the  IT  infrastructure 
and software are implemented at the EU-level only and not separately in each Member States. At 
the  same  time,  maintaining  an  appropriate  level  of  security  for  the  system  has  become  crucial 
over  the  past  years  and  notably  after  several  successful  fraudulent  attacks  on  Member  States' 
registries in 2010 and 2011. A security failure in the system which tracks the ownership of the 
allowances  can  potentially  have  far-reaching  legal  and  financial  consequences.  The  Union 
registry  has  successfully  improved  the  overall  security  of  the  EU  ETS  by  enforcing  common 
security standards, but improving security is a constant task. Investments in security ought to be 
expanding at a rate commensurate with the growth of the European carbon market. Since the start 
of the EU ETS in 2005, the volume of allowances traded has been increasing from 95Mt in 2005 
to  8336  Mt  in  2014172.  Furthermore,  the  Commission  manages  for  the  Member  States  a 
communication link between the EUTL and the International Transaction Log (ITL) managed by 
the  UNFCCC  for  the  purposes  of  the  Kyoto  protocol.  The  Commission  thus  represents  all 
Member States in relation with the UNFCCC at a technical level and is required to maintain and 
add certain features to the Union registry that would otherwise not be needed.  

Finally, with the shift to the Union registry, the Commission also expanded the support services 
to  the  Member  States.  A  central  helpdesk  was  set  up  to  provide  full-day  assistance  (12-hour 
service) to national authorities, with even longer hours during more critical periods (e.g. close to 
the  surrender  deadline  for  operators  on  30  April).  A  reporting  service  has  been  established  to 
regularly  provide  data  extracts  to  Member  States.  Through  a  Change  Management  Board, 
Member States may request the Commission to make changes to the Union registry. 

Despite this shift of tasks to the EU-level, the Union registry is solely financed by the EU budget. 
While  the  Commission  does  not  charge  any  fees  to  the  account  holders  in  the  Union  registry, 
national  authorities  may  charge  fees  to  the  account  holders  administered  by  them.  These  fees 
charged  to  account  holders  at  the  national  level  vary  significantly  across  Member  States.  The 
reason is mainly that differences in terms of operational efficiencies and effort put into different 
registry activities exist. Also, the sources of funding of  registry activities differ across Member 
States. While registry activities in some Member States are funded from additional sources, such 
as revenues from the EU ETS auctions, others solely rely on registry fees. 

172 Compiled by Bloomberg New Energy Finance: trading figures taken from Bloomberg, ICE, EXC, Bluenext, EEX, 
CCX, Nordpool, other sources include UNFCCC and Bloomberg New Energy Finance own estimates. 

137 

 
 
                                                           
Since 2012, costs of the Union registry have been increasing and are expected to increase in the 
coming years before stabilising at a certain point. Some of the costs, however, are recurring costs, 
in  particular  costs  with  regard  to  maintaining  a  high  level  of  security  for  the  system  and  its 
infrastructure. For example, to further secure the IT environment, the Commission has planned to 
equip all Member States' authorities with specific hardware (security token) and incurs the initial 
costs  of  acquiring  the  tokens,  but  will  also  incur  future  costs  related  to  replacing  them  where 
necessary. 

There have so far not been difficulties to secure the financial envelope for the Union registry in 
the  EU  budget.  Nevertheless,  over  the  past  years,  pressure  on  the  Commission  to  cut  back  in 
particular administrative costs, including IT costs, has been increasing. 

138 

 
 
 
5. 

DETAILED  DESCRIPTION  AND  SCREENING  OF  OPTIONS  FOR  FREE  ALLOCATION    TO 
INDUSTRY 

For  all  the  elements  of  the  free  allocation  system  (benchmarks,  production  levels,  new  entrant 
reserve, carbon leakage groups) and for the indirect cost compensation issue, lessons learnt and 
options are presented below. 

5.1. 

Benchmarks 

5.1.1.  Lessons learnt from the current system in phase 3 (2013-2020) 

The  benchmark  determines  tonnes  of  CO2  per  tonne  of  product,  no  matter  how  the  product  is 
produced  in  terms  of  technology,  fuel  used,  the  size  of  an  installation,  or  its  geographical 
location.  

Article  10a(1)  of  the  ETS  Directive  stipulates  that  benchmarks  should  be  developed  for  each 
sector  and  subsector,  to  the  extent  feasible.  The  result  was  52  product  benchmarks173  and  two 
fall-back174 benchmarks. Each benchmark consists of a clear definition, and a value. Benchmark 
values  were  determined  based  on  performance  data,  i.e  from  real-life  historical  industrial 
production in 2007-08175.  

Benchmarks  are  not  a  regulatory  standard,  but  serve  as  a  tool  to  calculate  free  allocation  to 
installations.  Nevertheless,  as  expressed  by  stakeholders,  benchmarks  should  be  seen  as  an 
indication of what is technologically feasible at a given time and of the level of performance it is 
possible to strive for.  

The  benchmarking  approach  as  specified  by  the  Directive  has  proven  feasible  to  use  for 
allocation. It is a clear, fair and transparent way of calculating the free allocation in a manner that 
rewards  the  most  carbon  efficient  installations  and  thus  provides  the  necessary  incentives  to 
reduce emissions, as intended by the ETS.  

There  is  broad  agreement  that  the  benchmarking  system  has  worked  well,  and  there  are  no 
plausible alternatives achieving the same results in terms of environmental integrity, innovation 
incentives  and  addressing  the  risk  of  carbon  leakage176.  The  majority  of  stakeholders  from  all 
categories  (industry,  public  authorities,  civil  society)  generally  support  the  current  approach  to 

173 Most of the 52 product benchmarks are based on products (and not inputs) to maximise the incentive for GHG 
efficient production. Exceptions from this output-based approach have been applied to traded intermediate products 
(e.g.  in  the  steel,  paper  and  chemical  industry)  to  ensure  a  level-playing  field  for  integrated  and  disintegrated 
production facilities and different permitting practises in Member States. 
174  Allocation based on so-called fall-back approaches for processes not covered by a product benchmark: based on 
the  heat  benchmark,  the  fuel  benchmark  or  process  emissions.  In  Phase  3,  about  two  thirds  of  the  available 
allowances  are  allocated  for  free  based  on  product  benchmarks,  and  one  third  is  allocated  based  on  fall-back 
approaches. 
175 The verified data used for setting the benchmarks was voluntarily submitted by the concerned industry sectors. 
This  voluntary  data  collection  with  a  high  level  of  participation  was  carried  out  in  2009-2010  out  prior  to  the 
determination of the free allocation to individual installations. Member States had to submit national implementation 
measures to determine the allocation for each installations in their territory by 30 September 2011. 
176 The EU opted for the use of free allowances as measures to reduce the risk of carbon leakage. While there were 
some  initiatives  to  implement  a  border  tax  mechanism  to  tackle  the  risk  of  carbon  leakage,  it  is  considered  as  a 
significantly  less  appropriate  tool.    Such  border  measures  would  be  in  potential  conflict  with  World  Trade 
Organization's  rules,  and  UNFCCC  principle  of  Common  but  Differentiated  Responsibility  (CDR).  The  risk  of 
retaliation and trade conflicts with third countries should also be considered. In that context, EU's focus remains on 
implementation of current free allocation rules, as well as strengthened carbon leakage measures in Phase 4.  

139 

 
 
                                                           
setting  benchmark  values  i.e.  the  average  10%  best  as  starting  point.177,  i.e.  adhering  to  the 
current principles. Therefore, and also to ensure regulatory predictability, the European Council 
endorsed  the  continuation  of  the  benchmark-based  approach  and  this  issue  is  not  subject  to 
further  assessment178.  It  is  also  assumed  that  the  definitions  of  the  existing  benchmarks  will 
remain unchanged, as this has not appeared as a concern for stakeholders. 

The European Council requested, however, the regular update of the benchmark values in order 
to  reflect  technological  progress.  The  benchmark  values  should  be  lower,  leading  to  reduced 
allocation in line with lower emissions thanks to the ongoing technological development (which 
is  to  be  reflected  in  the  updated  benchmark  values).    The  question  is  how  to  update  the 
benchmark values within existing system to ensure that the values remain up to date and continue 
to provide allocation efficiently and preserve incentives to innovate are avoided.  

Concerns about the stringency of the benchmark values lead several stakeholders (from different 
sectors  e.g.  glass,  ceramics,  chemicals,  steel)  to  call  for  benchmarks  that  are  technically  and 
economically achievable and viable.   

The  benchmark  values  for  phase  3  required  collecting  the  necessary  data  from  industry 
associations.  It  is  considered,  based  on  recent  experience,  that  the  data  necessary  for  setting 
future  allocations  can  be  complemented  with  some  limited  additional  data  requests  needed  to 
update  the  benchmark  values,  and  this  can  lead  to  less  administrative  burden  for  industry, 
Member  States  and  the  Commission  compared  to  collecting  data  two  times  –  once  for 
determining the benchmarks, and once for determining the amount of free allocation. This "two 
in  one"  approach  would  also  ensure  consistency  of  benchmark  value  determination  and  the 
allocation process.  

5.1.2.  Policy options for updating benchmark values for 2021-30 

As outlined above, the benchmark values need to be updated to reflect the recent technological 
progress. Otherwise, by 2030 they would be based on data more than two decades old. Updating 
benchmark  values  is  important  for  retaining  the  economic  incentives  for  further  emission 
reductions,  thereby  supporting  the  transition  to  more  carbon-  and  fuel-efficient  production,  and 
also  for a more targeted allocation where  the need  to apply a cross-sectoral correction factor is 
avoided or minimised. This was underlined by some industry stakeholders: e.g. the glass sector 
argued  that  periodically  updated  benchmarks  could  remove  the  need  for  the  cross-sectoral 
correction  factor,  while  the  steel  sector  acknowledged  it  is  justified  to  update  the  benchmark 
values as new technologies come to the market all the time179.  

There  are  some  concerns  from  industry  about  the  update  of  benchmark  values.  For  example, 
paper  and  pulp  stakeholders  argue  that  an  update  might  penalise  early  movers  (i.e.  better 
performance  by  the  sector  means  less  allocation  due  to  a  lower  benchmark  value);  the  cement 
sector  is  of  the  opinion  that  the  focus  of  the  revision  should  be  on  sectors  with  the  widest  gap 
between best and worst performers; the lime sector believes that an update should be undertaken 
only  when  sufficient  evidence  exists  of  technological  progress  (and  as  such  that  it  should  be 
preceded by an expert assessment). 

177    See  Annex  3  –  Summary  of  Stakeholder  Consultations.  Regarding  the  details  however  the  views  are  mixed: 
industry  stakeholders  underline  concerns  about  the  limits  of  existing  technologies,  public  authorities  are  of  the 
opinion  that  it  is  important  that  the  system  rewards  the  best,  while  civil  society  stakeholders  would  like  to  see 
benchmarks based on worldwide best technologies. 
178 The 2008 ETS Directive impact assessment assessed this aspect in more detail  
179 See Annex 3 – Summary of stakeholder consultations 

140 

 
 
 
                                                           
A  particular  case  concerns  the  updating  of  the  fall-back  benchmark  for  heat.  On  the  one  hand, 
there  is  technological  development  in  producing  heat  more  carbon  efficiently  which  could 
warrant an update of that benchmark. On the other hand, one needs to take into account that if an 
installation becomes more energy efficient, the amount of heat it uses (this, and not the tonnes of 
concrete  product,  is  relevant  to  determine  allocation  based  on  the  heat  benchmark)  will  also 
decrease, even if the quantity of products it produces is unchanged. A right balance therefore has 
to  be  found  for  the  updating  of  the  heat  benchmark.  Similar  issues  also  apply  for  the  fuel  fall-
back  benchmark.  However,  these  details  are  outside  the  scope  of  this  impact  assessment  since 
they are subject to implementing legislation. 

Keeping in mind the above analysis, the considered options for the update of benchmark values 
are the following: 

'Baseline A': Using existing benchmark values, i.e. no update.  

'Baseline B': Continuation of the current system - update of all benchmark values based on 
new data once before 2021, based on actual data reported by operators of ETS installations on a 
mandatory basis. Benchmarks are kept constant thereafter (2021-30). 

Option 1. Update of all benchmark values by the same percentage once: all benchmarks are 
updated  once  before  2021  by  using  a  flat-rate  that  reflects  the  average  relative  decrease  in 
emission intensity since 2007-08 as a result of technological development. Benchmarks are kept 
constant thereafter (2021-30). A variation of this option is the use of more than one flat-rate with 
a low, medium and high flat-rate. 

Option 2. Update of all benchmark values by the same percentage regularly: all benchmarks 
are updated regularly based on a flat-rate that reflects the average relative decrease in emission 
intensity since the last update. Benchmarks are updated twice: before 2021 and before 2026 (i.e. 
mid-tern  review).  Benchmarks  are  kept  constant  for  five  year  periods  (2021-2025  and  2026-
2030).  

Option 3. Updating all benchmark values based on new data, and then regularly updating 
them by a standard percentage: benchmarks are updated once before 2021 based on actual data 
reported  by  operators  on  a  mandatory  basis.  Benchmark  values  decrease  thereafter  by  a  pre-
defined rate.  

Option 4. Updating all benchmark values based on new data, every five years: benchmarks 
are  updated  based  on  actual  data  reported  by  operators  on  a  mandatory  basis.  Benchmarks  are 
updated twice: once before 2021 and once before 2026 (i.e. mid-term review). Benchmarks are 
kept constant for five year periods (2021-25 and 2026-30).  

The options above address the two main issues for the benchmark update – its basis (i.e. flat rate 
or data collection) and its frequency (once or twice in phase 4). 

5.1.3.  Screening 

For  the  screening  of  the  different  options,  the  objective  of  "better  alignment  with  production 
levels"  is  not  relevant  so  this  is  not  included  in  the  screening  below.  Similarly,  using  a 
benchmark-based approach ensures that "incentives for industry to innovate are fully preserved" 
so this is not analysed further. 

The Baseline A option is not in line with the European Council conclusions and is not analysed 
further. 

Options Baseline B and 4 are the ones with a data collection update; options 1 and 2 are the ones 
with a flat rate update; and option 3 is mixed.  

141 

 
 
Baseline B and Option 4 both imply a new data collection to update the current benchmarks, so 
that they reflect the technological situation in 2015/16, i.e. some 5 years before the start of phase 
4.In Option 4, there is also another update during the period. Thus, baseline B and option 4 differ 
in the frequency of benchmark update, not in its method.  

Benchmarks  based  on  newer  data  would  not  be  possible,  since  the  process  of  collection, 
verification and calculation of values takes approximately two years and the benchmarks should 
be  available  well  in  advance  of  the  trading  period  (e.g.  before  2019).  The  current  benchmarks 
were  determined  based  on  a  data  collection  organised  by  industry.  To  reduce  administrative 
burden,  this  data  collection  should  take  place  simultaneously  with  the  data  collection  of 
production data for the allocation. 

Options 1 and 2 use a flat rate approach for benchmark update and differ in its frequency (once 
for Option 1 and twice for Option 2). The main advantage of these options is their simplicity as 
no data collection is required. Furthermore, once the improvement rate is decided, these options 
provide an advanced degree of certainty to industry regarding the future benchmark values  that 
would answer the repeated calls for predictability from industry stakeholders.  

Based on latest emissions and production data, it is estimated that the improvement rate should be 
in  the  range  of  some  1.5-2.0%  annually  in  order  to  properly  reflect  technological  development 
since  2007-08.  Historical  carbon  efficiency  improvement  rates  of  various  sectors  can  be  found 
inter  alia  in  the  2050  sector  roadmaps.  For  most  sectors  in  the  1990  –  2010  horizon  annual 
improvement rates have been around 2% within a range of 0.5 – 3.6%180.  

For technological reasons, improving carbon efficiency will be easier for some sectors and more 
difficult for others. Furthermore in some sectors some of the most cost effective measures may 
have  already  been  implemented,  even  though  technological  development  also  provides  for  new 
cost  effective  measures.  Thus,  using  a  flat  rate  can  be  complemented  with  specific  rules  for 
outliers, i.e. sectors with considerably faster or slower carbon efficiency improvement rate. Such 
a nuanced approach can ensure that even the slowest performers contribute to some degree, but 
also  that  best  performers  maintain  the  realised  profits  from  lowering  their  emissions,  albeit 
somehow reducing the future incentives to improve.  

Several  sectors  have  expressed  support  for  a  data  collection  update  of  benchmark  values, 
underlining the need to base it on accurate real data (e.g. ceramics, refineries, non-ferrous metals) 
and  use  a  robust,  transparent  approach  (e.g.  cement)  comparable  among  sectors  (e.g.  ceramics, 
steel).  

For a flat-rate approach, some verification with the help of a data collection may be warranted to 
improve  accuracy.  Furthermore,  to  the  extent  that  past  and/or  future  technological  progress 
differs substantially in some sectors, a single flat-rate approaches could lead to unduly different 
levels of ambitions of  some updated benchmark values (a few stakeholders argue against using 
proxies or estimations to determine the updated values e.g. lime sector advocates that a "one size 
fits all" approach should be avoided).  

These weaknesses could be mitigated by using multiple flat rates (e.g. low, medium, high).  The 
medium flat rate is used as default and the two others are applied in case that the data collected to 
determine the activity levels of installations provide evidence that the medium flat rate is too high 
or too low. 

180  Improvements  for  refineries,  cement  and  steel  have  been  in  the  order  of  1%  per  year;  the  chemical  industry 
improved  by  3.6%  per  year  and  fertiliser  production  by  11%  per  year  since  2004  mainly  due  to  the  abatement  of 
N2O emissions. 

142 

 
 
                                                           
The regular update in option 2 better reflects the continuous technological progress, while the risk 
of  undue  carbon  costs  for  the  most  efficient  installations  might  be  slightly  higher,  and  the 
administrative  complexity  is  somewhat  increased  due  to  the  regular  changes  of  benchmark 
values. Therefore, option 1, as the least complex and entailing least administrative burden, 
is used in one of the option packages. 

Options 3 and 4 score highly on most criteria as real performance of sectors is well reflected. The 
main  difference  between  the  two  options  is  the  further  updating  either  by  applying  a  flat-rate 
(option  3)  or  based  on  an  additional  full  data  collection  (option  4).  The  latter  increases  the 
administrative complexity and reduces certainty to some extent, but better reflects the changes in 
real performance. Since the data collection for the benchmark values would be done at the same 
time  as  the  other  needed  data  collections,  the  future  benchmark  values  would  only  be  known 
together  with  the  other  parameters  of  the  allocation  formula  (production  levels  and  possible 
correction factors) which might somewhat reduce predictability for industry. Given that option 4 
shows  high  results  in  three  of  the  four  screening  criteria,  it  is  part  of  one  of  the  option 
packages. 

Table 13: Screening of options for updating benchmark values 

Technical progress 
reflected 

No undue costs for 
most efficient 
installations 

No increased 
administrative 
complexity 

Avoid windfall 
profits 

0 
- 
0 
+ 
++ 

'Baseline B' 
Option 1. 
Option 2. 
Option 3. 
Option 4. 
*Note on scoring: The symbols used are indicators of the comparison between a proposed option 
and the Baseline B. Their meanings are: "--" much worse than baseline, "-" worse than baseline, 0 
equal to baseline, "+" better than baseline, "++" much better than baseline. 

0 
+ 
0 / + 
- / 0 
- 

0 
- 
- 
0 / + 
+ 

0 
-/0 
-- 
0 
+ 

In summary, for the option packages, option 1 is used for the simple packages, and option 4 
for the more targeted packages. 

5.2. 

Carbon leakage groups and criteria 

5.2.1.  Lessons learnt from the current system in phase 3 (2013-20) 

The ETS Directive links the level of carbon leakage risk to the extent to which it is possible for 
sectors  to  pass  their  carbon  costs  into  their  product  prices181.  This  is  therefore  an  important 
element in deciding the share of emissions that can be covered by free allocation. If costs that can 
be passed on to consumers are compensated, this may lead to windfall profits for the industrial 
sectors receiving the free allocation.  

Based on the ETS Directive, there are currently three categories of sectors depending on the level 
of exposure to the risk of carbon leakage. Each category has different levels of free allocation:  
  Electricity  production  is  not  deemed  to  be  exposed  to  the  risk  of  carbon  leakage,  and 
electricity producers are typically assumed to be able to fully pass through their carbon costs 

181 See Article 10a(14) of the ETS Directive 

143 

 
 
 
 
 
 
 
                                                           
 
in  increased  electricity  prices  to  their  consumers.  Therefore,  electricity  production  is  not 
eligible for free allocation in phase 3. 

  Industrial  sectors  and  subsectors  which  are  deemed  to  be  exposed  to  a  significant  risk  of 
carbon leakage are identified in the 'carbon leakage list' and are given free allocation at 100% 
of the quantity determined based on the benchmarks182, i.e. are assumed not to be able to pass 
through any carbon costs. 

  Other  industrial  sectors  receive  a  lower  (annually  decreasing  from  80%  in  2013  to  30%  in 
2020) level of free allocation183, i.e. are assumed to be able to pass through some carbon costs. 

The extent to which it is possible for sectors to pass through carbon costs without losing market 
shares should be assessed in accordance with the ETS Directive in order to determine exposure to 
the  risk  of  carbon  leakage.  It  is  difficult  to  accurately  measure  this  risk  in  detail,  so  this 
requirement  is  operationalised  in  phase  3  by  using  quantifiable  criteria.  These  criteria  were 
deemed to provide an approximation of the ability to pass  through carbon costs, and in general 
the  exposure  to  the  risk  of  carbon  leakage.  It  was  deemed  important  to  use  officially  available 
data for the application of the criteria. This led in the current ETS Directive to the provision that a 
sector or sub-sector is deemed to be exposed to a significant risk of carbon leakage in case:  
  the sum of direct and indirect additional costs resulting from the ETS is at least 30% of gross 

value added (GVA); or 

  the intensity of trade with third countries is above 30%; or  
  the  trade  intensity  with  third  countries  is  above  10%  and  the  costs  resulting  from  the  ETS 

amount to at least 5% of GVA184. 

Both  trade  data  and  gross  value  added  can  be  found  in  official  statistics,  and  emissions  data  is 
available via the EU ETS registry database. 

The  quantitative  assessment  based  on  the  abovementioned  criteria  may  be  supplemented  by  a 
qualitative  assessment,  which  is  based  on  the  abatement  potential,  market  characteristics  and 
profit margins of sectors where relevant data are available185. Stakeholder views are mixed on the 
possible  continuation  of  the  qualitative  assessment186:  some  industry  stakeholders  argue  that 
quantitative criteria cannot always take into account all specific situations, while others believe 
simple metrics would be more adequate in determining carbon leakage status. Civil society on the 
other hand advocates for using the qualitative assessment also to remove sectors from the carbon 
leakage list since at present, sectors can be added if appropriate convincing evidence is provided, 
but cannot be removed from the list.  

The experience  with  both  the quantitative and qualitative assessments  so far has  been  that  they 
increase the administrative burden as the Commission has to check that sufficient evidence exists 
to justify this and companies invest resources in preparing an application; and also the qualitative 
arguments can be interpreted in different ways which make them a difficult basis for regulatory 
decisions.   

Based on the criteria explained above, the Commission is required to draw up the list of sectors 
and  sub-sectors  deemed  to  be  exposed  to  a  significant  risk  of  carbon  leakage  ('carbon  leakage 

182 See Article 10a(12) of the ETS Directive 
183 Installations in sectors or subsectors not on the carbon leakage list but eligible for free allocation received 80% of 
the quantity determined based on the benchmarks and the applicable correction factor in 2013. The free allocation 
decreases every year and in 2020 reaches 30% of the quantity determined. See Article 10a(11) 
184 See Article 10a(15-16) of the ETS Directive 
185 See Article 10a(17) of the ETS Directive 
186 See Annex 3 – Summary of stakeholder consultations 

144 

 
 
                                                           
list') every five years. The first carbon leakage list187 was adopted by the Commission at the end 
of  2009  and  was  applicable  for  free  allocation  of  allowances  in  2013-14.  The  second  carbon 
leakage list188 was adopted in 2014 and applies for 2015-19. 

The lists have been determined by analysing all 258 manufacturing industry sectors. The outcome 
of the analysis is that a large majority of assessed  sectors are on the carbon leakage list, and in 
particular  almost  all  sectors  with  any  significant  carbon  emissions  (see Figure  11). In  total,  the 
current list includes activities collectively responsible for more than 97% of industrial emissions 
covered  by  the  ETS.  While  being  on  the  carbon  leakage  list  is  described  in  the  recitals  of  the 
Directive as an exception, it has de facto become the norm.  

Many companies operating installations receiving free allocation are able to pass through at least 
part of their carbon costs and this was acknowledged already in 2008189. Although precise data is 
difficult  to  collect,  it  is  quite  clear  from  the  growing  body  of  empirical  studies  that  there  is  a 
difference  between  sectors  in  this  respect.  However  there  is  very  limited  differentiation  among 
industrial sectors in terms of free allocation, i.e. almost all industrial activities receive the same 
treatment irrespective of a degree of exposure to carbon leakage risks and in the related ability to 
pass on costs.  

A more targeted approach whereby differences in the degree of exposure to carbon leakage risk 
translate into differentiated allocation levels adapted to the real need of sectors could have made 
it  possible  to  limit  or  even  avoid  the  need  to  apply  a  cross-sectoral  correction  factor.  It  is 
therefore pertinent to explore the possibility of a real differentiation among sectors currently on 
the carbon leakage list with free allocation levels accordingly adjusted. 

The  ability  to  pass  through  carbon  costs  into  product  prices  for  final  customers  without  losing 
market  share  has  been  assessed  in  preparation  for  the  ETS  revision.  Based  on  an  extensive 
literature review of theoretical and empirical studies (see Annex  9),  it can  be observed  that the 
cost pass-through rates are not homogenous among different products. While it may be difficult 
to  quantify  these  cost  pass-through  rates,  it  can  be  concluded,  based  on  literature  and 
stakeholders' views190 that most of the carbon-intensive sectors have been able to pass through at 
least part of their carbon costs.  

The  following  table  gives  an  overview  of  the  average  estimated  cost-pass-through  in  some 
industrial sectors based on the literature review. While there is not a one to one correlation to the 
criteria  currently  used  in  the  ETS  to  estimate  the  risk  of  carbon  leakage  and  ability  to  pass 
through costs, the literature nevertheless shows that cost pass through appears to be a reality. This 
important topic merits further analysis. 

187 See Commission Decision 2010/2/EU. The list was amended (i.e. additional sectors and sub-sectors were added) 
three times: by Decisions 2011/745/EU, 2012/498/EU and 2014/9/EU. 
188 See 2014/746/EU: Commission Decision of 27 October 2014 determining, pursuant to Directive 2003/87/EC of 
the European Parliament and of the Council, a list of sectors and subsectors which are deemed to be exposed to a 
significant risk of carbon leakage, for the period 2015 to 2019 See Commission Decision 2014/746/EU 
189 Commission Staff Working Document, accompanying document to the Proposal for a Directive of the European 
Parliament and of the Council, amending Directive 2003/87/EC so as to improve and extend the EU greenhouse gas 
emission allowance trading system: Impact Assessment (SEC(2008) 52). 
190 During the stakeholder consultations, energy-intensive industrial sectors have mainly emphasized the difficulties 
in providing the evidence for cost pass-through. Electricity sector noted that companies able to pass on carbon costs 
should be excluded from free allocation. Similarly, a number of public authorities/Member States propose that the 
free allocation for such sectors are reduced or removed. NGOs claim that all sectors have the ability to pass through 
costs to a certain extent, and argue for an ex-post deduction of free allowances. 

145 

 
 
                                                           
Table 14: Overview of minimum cost pass-through values found in existing literature191 

Iron and steel 

Cement 

Glass 

Refineries 

Petrochemicals 

Fertilizers 

Minimum 

60% 

35% 

20% 

40% 

25% 

0% 

To conclude, sectors that are able to pass through a significant part of carbon costs are at a lower 
risk of carbon leakage, ceteris paribus. In the case of sectors that can pass through costs only to a 
limited  extent,  and  therefore  bear  most  of  the  carbon  costs,  it  can  be  assumed  that  they  face  a 
higher risk of carbon leakage.  

5.2.2.  Policy options  

The policy options for phase 4 build on existing principles for assessing the level of exposure to 
the  risk  of  carbon  leakage,  i.e.  carbon  cost  intensity  in  relative  terms  and  trade  intensity  with 
other countries.  

However,  the  existing  use  of  carbon  cost  intensity  used  for  the  current  carbon  leakage 
assessments is proposed to be replaced, in all options except Baseline A and Baseline B, with a 
reference  to  carbon  emissions  intensity.  The  notions  are  very  similar,  but  using  emissions 
intensity would help avoid a recurrent debate on which carbon price to use in the assessments to 
determine the carbon leakage list(s). 

This change implies that for the two thresholds used in the current carbon leakage assessments, 
the  carbon  cost  threshold  of  5%  is  translated  into  a  carbon  intensity  of  2  kg  CO2  per  €  GVA. 
Similarly, the 30% CO2 cost threshold is equivalent to a CO2 intensity threshold of 12 kg CO2 
per € GVA.  

The options developed are as follows: 

'Baseline A': Uniform carbon leakage factor of 30% is used for all installations.  
In this option there is no need for differentiating through carbon leakage groups192.  

'Baseline B': Two groups based on cost intensity and trade intensity criteria. 

The  binary  approach  is  maintained  (i.e.  sectors  are  either  on  the  carbon  leakage  list  or  not). 
Criteria  and  thresholds  currently  in  the  Directive  (illustrated  by  the  chart  below),  including  the 
qualitative criteria, remain. 

191  For  further  details  and  exact  references  please  see  Annex  9.  There  are  broadly  speaking  two  approaches  to 
empirical  analysis  of  cost  pass-through:  ex-ante  and  ex-post.  The  former  refers  to  the  use  of  economic  models  to 
simulate impact of hypothetical carbon pricing. The latter refers to the use of econometrics and other tools to assess 
historical cost pass-through. In case of estimations at 100% or more, this is marked as full. 
192 The ETS Directive only foresees an increased level of free allocation for sectors and sub-sectors on the carbon 
leakage list until 2020.  

146 

 
 
 
                                                           
Option 1. No groups, uniform carbon leakage factor.  

In this option there is no differentiation among sectors and activities. A uniform carbon leakage 
factor is used for all installations based on an estimated average  cost pass-through rate. For the 
purpose of this impact assessment, a low generic factor of cost pass through of 10% is assumed, 
implying free allocation at 90%. There is no chart for this option since there are no thresholds. 

Option 2. Two groups based on emissions intensity and trade intensity criteria.  

In this option the binary approach of the current system is maintained (sectors are either on the 
carbon  leakage  list  or  not).  The  option  builds  on  the  thresholds  currently  applied  for  the 
assessment of exposure to carbon leakage but are slightly different for two reasons.  

One reason is to have a full symmetry between cost and trade intensities. The other reason is to 
remove  sectors  with  very  low  carbon  intensity  from  the  carbon  leakage  list,  since  it  can  be 
considered that they are not much economically impacted by the ETS. 

As  explained  above,  the  carbon  cost  criteria  used  in  the  current  system  is  replaced  by  carbon 
emission intensity. 

As  illustrated  by  the  chart,  the  option  builds  on  the  current  thresholds  applied  for  the 
determination of the carbon leakage list. In this option a sector is added to the carbon leakage list 
in case the following criteria are complied with:  

  emission intensity is above 12 kg CO2 / EUR GVA (same as 30% cost intensity) (irrespective 

of trade intensity), or 

  emission intensity is above 4 kg CO2 / EUR GVA (same as 10% cost intensity) and trade 

intensity of at least 5%, or 

  emission intensity is above 2 kg CO2 / EUR GVA (same as 5% cost intensity) and trade 

intensity of at least 10%; or 

 

trade intensity above 30% and (a new threshold to remove low emitting sectors) emission 
intensity is above 0.3 kg CO2 / EUR GVA. 

147 

 
 
 
 
Option 3. Four groups based on emission intensity and trade intensity criteria:  

In this option, there are four carbon leakage groups corresponding to 'Very high', 'High', 'Medium' 
and 'Low' level of carbon leakage risk, as illustrated by the chart below.  

As  explained  above,  the  carbon  cost  criteria  used  in  the  current  system  is  replaced  by  carbon 
emission intensity. 

For  information  purposes,  the  current  thresholds  as  determined  by  the  ETS  Directive  are 
indicated  by  a  dotted  red  line.  The  option  thus  builds  on  existing  thresholds,  but  compared  to 
those, puts a number of low emitting sectors in the lowest group, and provides a more targeted 
approach, with the highest allocation share to the most exposed sectors.   

The  threshold  between  the  'High'  and  'Medium'  groups  is  in  essence  equivalent  to  the  current 
phase 3 threshold for the determination of the carbon leakage list (the 5% carbon cost intensity 
threshold is translated into emission intensity of 2 kg CO2 / EUR GVA).  

148 

 
 
 
 
 
The  new group  called  'Very  high' is intended  to  make  further differentiation among the sectors 
deemed to be exposed to carbon leakage risk, with the aim of ensuring that sectors in this group 
get  the  highest  protection193.  The  threshold  value  to  distinguish  between  these  two  groups  was 
determined in order to capture only the most exposed sectors in this group. The more sectors are 
classified as 'Very High', the higher the likelihood of the need for a correction factor.  

Finally, a low threshold is proposed to identify those sectors for which carbon costs represent a 
marginal share in their GVA, and therefore are deemed not much economically affected by the 
ETS. The threshold of 0.2 kg CO2 / EUR GVA is equivalent to a CO2 cost intensity of 0.5% in 
the  current  ETS  Directive,  and  was  selected  since  it  is  considered  that  below  this  carbon  cost 
level the economic impact of the ETS is minimal, and thus the risk of carbon leakage very low.  

Free allocation is proposed to be 100%, 80%, 60% and 30% of the benchmark in the 'Very high', 
'High',  'Medium'  and  'Low'  groups,  respectively.  While  100%  and  30%  are  values  from  the 
current  Directive,  the  values  of  60%  and  80%  for  the  new  groups  are  determined  as  an 
approximation of the ability to pass on the carbon costs. 

Option 4. Four groups based on a combined indicator resulting from the multiplication of 
the emission intensity and trade intensity rates:  

This  option  also  includes  four  groups;  'Very  high',  'High',  'Medium'  and  'Low'  level  of  carbon 
leakage risk. As explained above, the carbon cost criteria used in the current system is replaced 
by carbon emission intensity. 

In order to avoid the "step effects" and create a fairer system it is proposed in this option to make 
a  system  based  on  curves.  The  result  of  the  multiplication  of  the  two  indicators,  the  trade  and 
emission intensity curves are illustrated in the chart below.  

Regarding  the  thresholds  to  define  the  borderline  between  the  groups,  following  consideration 
could be made: 

193 A more targeted approach will reduce the risk of the application of the cross sectoral correction factor, and the 
distinction into more groups will thus be favourable to the sectors that would be in the "Very high" group. 

149 

 
 
 
 
                                                           
  The  border  between  the  'low'  and  'medium'  groups  is  defined  by  an  'anchor  point' 
(highlighted  by  red  circle  in  the  graph)  of  the  combined  emission  –  trade  intensity 
criterion used in phase 3 (2 kg CO2/ GVA and 10% trade intensity) and is therefore close 
to the 'yes – no' border of phase 3 (red dashed line). The corresponding threshold for the 
multiplied emission and trade intensity is 0.2. 

  The border between the 'medium' and 'high' groups is designed to be as close as possible 
to the two corner points of the phase 3 'yes – no' border (highlighted by blue triangle in 
the graph). This ensures that all sectors fulfilling all three phase 3 criteria (costs, trade and 
combination) are at least in the 'high' group'. The resulting threshold value is 1.0. 

  The threshold of 2.5 is proposed to define the 'very high' carbon leakage group to cover 
about  a  third  of  industrial  emissions,  in  line  with  the  need  of  a  targeted  carbon  leakage 
system.  

Free allocation is proposed to be 100%, 80%, 60% and 30% of the benchmark in the 'Very high', 
'High',  'Medium'  and  'Low'  groups,  respectively.  While  100%  and  30%  are  values  from  the 
current  Directive,  the  values  of  60%  and  80%  for  the  new  groups  are  determined  as  an 
approximation of the ability to pass on the carbon costs.  

Option 5. Carbon leakage factors based on precise cost pass-through rates. In this option, a 
detailed  methodology  to  assess  cost  pass-through  rates  will  be  developed  for  the  20  largest 
sectors,  and  a  default  pass-through  rate  applied  to  all  others.  This  approach  results  in  several 
carbon leakage groups. 

The  Baseline  A  option  does  not  reflect  the  European  Council,  and  is  therefore  not  further 
assessed. 

5.2.3.  Screening 

Reflecting  technological  progress  in  sectors,  and  better  reflection  of  production  levels  are  not 
relevant  for  the  options  assessed.  Therefore  the  following  objectives  will  be  assessed:  "Most 
efficient  installations  not  facing  undue  costs",  "Avoid  windfall  profits",  and  "Not  increasing 
administrative complexity". 

The objectives of ensuring that  most efficient installations face no undue costs and of avoiding 
windfall  profits  are  interlinked.  Both  of  these  two  objectives  can  be  achieved  via  well-targeted 
free allocation of allowances, and will below be assessed in terms of effectiveness. Such system 
would  also  minimise  the  need  to  apply  (or  lower  the  magnitude  of)  a  cross-sectoral  correction 
factor.  

In this respect, 'Baseline B' reflects the current system: almost all industrial emissions originate 
from  sectors  that  are  on  the  carbon  leakage  list  with  the  maximum  allocation  rate,  making  the 
differentiation among industrial sectors very limited. Option 1 and option 2 deliver a comparable 
result in this respect as Baseline B. Option 2 differs from 'Baseline B' as it implies removing from 
the  carbon  leakage  list  those  sectors  that  have  very  low  carbon  costs.  Concretely,  this  would 
result  in  removing  some  two  thirds  of  the  156  sectors  currently  on  the  carbon  leakage  list. 
However, as the 'gross' free allocation to these sectors represents only ca 2% of all emission of 
industry, the overall impact on making the free allocation more targeted is very small. 

The options leading to a  higher level of differentiation  based  on the  level of the risk of carbon 
leakage  (options  3  to  5)  are  expected  to  deliver  better  results  than  Baseline  B  in  terms  of  
effectiveness. Notably, by creating  two additional carbon leakage groups, with allocation better 
adapted to the estimated risk of carbon leakage and related ability to pass on carbon costs, they 

150 

 
 
 
reduce the risk of the application of the correction factor, and thereby improve the allocation to 
the sectors most exposed, while reducing the risk of windfall profits for the sectors that have the 
largest possibility to pass on costs.  

Option  5  reflects  the  individual  characteristics  of  the  largest  ETS  sectors  and  thereby  assures  a 
targeted system based on established ability of sectors to pass on costs. It would therefore score 
very well, compared to baseline B, in ensuring that the best installations do not bear undue costs, 
and  avoid  windfall  profits.  However,  given  data  limitations  it  remains  difficult  at  this  stage  to 
quantify the exact rate of costs passed through per sectors or products, and it is uncertain whether 
such limitations could be overcome before the start of phase 4 (i.e. 2021).  

In terms of administrative simplicity, option 1 scores better than Baseline B. It does not require 
the  assessment  of  carbon  intensity  and  trade  intensity  for  all  sectors  as  it  assumes  no  carbon 
leakage  lists  or  groups.  This  leads  also  to  less  data  being  needed  and  less  administrative 
complexity when calculating the allocation to individual installations. 

Options  2,  3  and  4  all  require  the  same  data  collection  as  Baseline  B  to  determine  in  which 
carbon leakage group a sector would belong to. Therefore that part of administrative costs would 
be  identical.  Option  5  would  require  a  different  and  more  complex  type  of  data  collection  and 
therefore has a higher administrative cost compared to Baseline B. 

Options  2,  3,  4  and  5  all  have  an  increased  number  of  carbon  leakage  groups  compared  to 
Baseline B, and this may lead to a somewhat higher administrative complexity of the allocation 
system.  However,  since  each  installation  will  get  an  allocation,  and  only  the  share  of  the  base 
amount differs, the difference in administrative complexity is limited.  

While  option  5  can  be  regarded  as  the  most  appropriate  from  a  theoretical  point  of  view,  its 
practical feasibility remains doubtful and its complexity considerable and thus, at this stage, it is 
not considered in subsequent analysis. 

The screening of the options can be summarised in the table below. 

Table 15: Screening of options for carbon leakage groups and criteria  
Avoid windfall profits 
Most efficient 
installations not facing 
undue costs 
0 
0 
0 
+ 
+ 
++ 

'Baseline B' 
Option 1. 
Option 2. 
Option 3. 
Option 4. 
Option 5. 
*Note on scoring: The symbols used are indicators of the comparison between a proposed option 
and the baseline B. Their meanings are: "--" much worse than baseline B, "-" worse than baseline 
B, 0 equal to Baseline B, "+" better than baseline B, "++" much better than baseline B. 

Not increasing 
administrative 
complexity 
0 
++ 
0 
- 
- 
-- 

0 
0 
0 
+ 
+ 
++ 

In  summary,  the  Baseline  is  used  for  Baseline  B  package,  option  one  for  the  Simple 
package, and option 4 for the Targeted and Limited changes package. 

Production level and adjustments 

5.3. 

5.3.1.  Lessons learnt from the current system in phase 3 (2013-20) 

a) Production levels used for allocation 

The  second  main  element  to  determine  free  allocation  to  installations  in  a  benchmark-based 
system is the production level of each installation.  

151 

 
 
 
 
 
In the current  system production levels are determined in advance, for the entire 8-year period. 
The  production  data  to  be  used  was  defined194  as  median  annual  historical  production  of  a 
particular  product  at  the  installation  level,  during  the  4-year  baseline  period  (2005-08)  or, 
alternatively,  a  2-year  baseline  period  (2009-10),  depending  on  which  value  is  higher.  The 
justification  for  having  more  than  one  baseline  period  was  that  the  crisis  had  a  significant 
negative impact on production in many installations. 

Several  drawbacks  need  to  be  considered.  In  case  an  installation  reduced  production  after  the 
selected  baseline  period,  allocation  could  remain  at  an  unduly  high  level  –  until  specific  rules 
concerning reduction would be triggered (by pre-determined thresholds). Moreover, installations 
that increase production without increasing capacity do not get additional allocation.  

These  two  aspects  (an  8-year  fixed  allocation  and  the  use  of  two  historical  baselines)  led  to  a 
substantially higher cross-sectoral correction factor than would have been the case otherwise. The 
choice  of  two  historical  baselines  increased  the  overall  correction  factor  by  some  5-6%.  It  is 
further estimated that if the phase 3 allocation were based on two separate decisions for 4-years 
each (instead of one for 8 years), the correction factor would be lower by some 7% towards the 
latter years in phase 3. 

b) Changes in production  

The  current  system  addresses  significant  changes  of  output  of  installations  compared  to  their 
baseline in three ways. First, installations that increase production and corresponding emissions 
can  acquire  allowances  from  the  market.  Secondly,  installations  can  apply  for  free  allowances 
from the so-called "new entrants' reserve" if there is a production increase linked to a significant 
capacity  increase195.  Thirdly,  there  are  rules  to  reduce  free  allocation  to  installations  that  either 
produce  considerably  less  than  in  the  baseline  period  (so-called  partial  cessations),  or 
significantly reduce their capacity196. These rules are based on pre-defined thresholds.197   
Some  industry  stakeholders  call  for  ex-post  allocation198  (which  they  sometimes  refer  to  as 
"dynamic")  where  allocation  would  be  determined  ex-post  based  on  annual  production  data 
instead of historical production.  

Those in favour of ex-post allocation argue this would improve the flexibility of free allocation, 
would facilitate long-term planning and would more closely reflect production levels.  

Compared  to  the  current  system,  an  ex-post  allocation  would  be  beneficial  to  installations  that 
increase production, and less beneficial for installations producing less, which may be deemed a 
positive feature. A system of  ex-post allocation with annual re-calculation of allowances would 
nevertheless present a number of problems.  

First,  ex-post  allocation  could  significantly  undermine  the  emission  reduction  incentives  for 
installations whose allocation is based on the fall-back benchmarks. Concretely, this means that if 
an installation reduced its heat consumption it would be entitled to lower allocation. Incentives to 
substitute  carbon-intensive  semi-products  with  less  carbon-intensive  ones  would  also  be 
compromised,  since  such  substitution  would  also  lead  to  lower  allocation.  If  the  incentive  for 

194 Historical activity levels were defined by the Commission Decision 2011/278/EU.   
195  Installations  get  an  extra  allocation  after  a  significant  capacity  extension  from  the  reserve  set  aside  for  new 
entrants based on Article 10a(7) of the ETS Directive. 
196 See Article 10a(20) of the ETS Directive.  
197 See Commission Decision 2011/278/EU on free allocation rules for the ETS, as well as Guidance Document n°7 
on the harmonised free allocation methodology for the EU-ETS post 2012: Guidance on New Entrants and Closures.  
198  For example, see Ecofys report Dynamic allocation for the EU Emissions Trading System, May 2014 

152 

 
 
                                                           
cost-effective  emission  reductions  is  compromised,  the  attainment  of  EU  emission  reduction 
targets becomes more costly, resulting in higher carbon price for all participants in the system. 

Additionally, a fully 'dynamic' allocation system (i.e. a system where the adjustments are made 
annually in accordance with production data) would lead to a considerable administrative burden 
on  installations,  Member  States  and  the  Commission,  since  this  would  imply  an  annual 
recalculation of allocation for some 11,000 installations. Experience shows that the full cycle of 
data  collection,  verification,  calculation  and  final  assessment  cannot  be  completed  within  less 
than  two  years199.  An  annual  system  would  therefore  have  two  or  three  parallel  processes  of 
recalculating allocation resulting in significant administrative complexity. Moreover, the business 
confidentiality of data would also be an important constraint, as calculating production figures of 
individual installations could be easily done based on their allocation200. 

Last but not least, an ex-post system would also lead to uncertainty, as the need for a correction 
factor would have to be determined each year, and thus operators would not know in advance the 
amount  of  free  allocation  for  their  installations.  The  incentive  effect  for  installations  to  reduce 
their emissions could be seriously undermined. 

A  full  ex-post  dynamic  free  allocation  system  therefore  does  not  seem  realistic  and  able  to 
address the concerns expressed by industry stakeholders. An ex-ante system with more frequent 
production  data  adjustments  than  the  current  8-year  phase,  as  included  in  some  options  below, 
would be better suited to address the need for stability, predictability and flexibility. A number of 
industry stakeholders also support this latter approach, highlighting the benefits of predictability 
as conducive to new investments. Moreover, both public authorities and civil society stakeholders 
hold the view that more recent data to be used for allocation is necessary in the future system201.  

5.3.2.  Policy options 

The  considered  options  for  production  data  updating  are  the  following.  They  are  designed  to 
address  different  ways  of  how  to  do  this  updating,  with  various  impacts  on  more  precise 
allocation versus administrative complexity: 
'Baseline A': Baseline production levels202 defined once, adjustments based only on capacity 
reductions, closures and (partial) cessation rules (but no allocation to new capacity increases, 
given that no  reserve  for  new entrants  or  capacity increases is  foreseen  in  the Directive  for the 
post-2020 period). 

'Baseline  B':  Baseline  production  levels  defined  once,  with  existing  rules  for  production 
changes. Under this option, the historical production levels would be based on 5 years (2013-17) 
for  the  entire  10-year  period.  The  current  rules  for  capacity  changes  and  partial  cessations 
continue to apply. 

Option 1. Baseline production levels defined once, with annual adjustments for  significant 
production changes. The baseline historical production levels would be based on 5 years (2013-
17)  for  the  entire  10-year  period.  Significant  production  increases  and  decreases  are  addressed 

199 It may take longer as allocation can only be finalised once the last Member State has submitted its fully verified 
data. 
200 In the case of installations applying product benchmarks. 
201 See Annex 3 – Summary of the Stakeholder Consultations. 
202 Data collection for production levels described in all options could be undertaken jointly with data collection for 
updating benchmarks, in order to minimise administrative burden.   

153 

 
 
 
                                                           
through  symmetrical  annual  adjustments  203,  i.e.  same  thresholds  for  increased  and  decreased 
production. Allocation for increased production comes from the new entrants' reserve. 

Option 2. Baseline production levels defined twice with annual adjustments for significant 
production changes. The baseline historical production levels would be defined for two 5-year 
periods.  The  basis  would  be  5  years  (2013-17,  respectively  2018-22)204.  Significant  production 
increases  and  decreases  are  addressed  through  symmetrical  annual  adjustments  i.e.  same 
thresholds  for  increased  and  decreased  production.  As  in  option  1  increased  allocation  for 
increased production comes from the new entrants' reserve.  

Given that Baseline A does not correspond to European Council conclusions (no support for new 
installations), this option is not further assessed. 

5.3.3.  Screening  

For the screening of the different options, the operational objectives of "reflecting technological 
progress  in  sectors"  and  "fully  preserving  the  incentives  to  innovate"  are  not  relevant  for  the 
production  levels  and  adjustments  debate.  The  incentive  criterion  is  disregarded  because  all 
options are based on an ex-ante allocation system. Any ex-post allocation system would seriously 
undermine incentives to innovate. 

'Baseline  B'  allows  for  free  allocation  to  change  for  both  for  increases  and  decreases  of 
production. Production increases have to be linked to capacity increases. The continuation of this 
system assumes the maintaining of the 'capacity' notion205 and the accompanying implementing 
rules, and therefore leads to higher administrative complexity than other options. 

Options 1 and 2 foresee annual adjustments in both directions, i.e. both options foresee additional 
allocation  for  significantly  increased  production  even  without  a  capacity  increase.  Also  new 
installations  would  get  allocation  based  on  real  production  data,  until  they  have  sufficient 
historical production data. Consequently, there is no need to calculate the capacity of installations 
under these options, which leads to decreased administrative complexity compared to Baseline B.  

Option  2  in  addition  ensures  better  alignment  of  production  levels  by  using  two  consecutive 
baseline periods, thus avoiding that allocation at the end of the period is based on production data 
more than a decade old. For the same reason, this option scores somewhat better than option 3 in 
avoiding windfall profits. However, data collection would have to take place twice in the phase 
requiring somehow higher administrative burden. 

In addition to Baseline B, options 1 and 2 are further considered when creating different option 
packages.   

203 The exact threshold for significant changes is to be determined in implementing legislation. For the purposes of 
this IA it is assumed the threshold id 15% difference compared to the baseline production level. 
204  Data  collection  for  production  levels  to  be  undertaken  jointly  with  data  collection  for  updating  benchmarks,  in 
order to minimise administrative burden. 
205 Installations that increase their capacity are provided additional allocation. Although the rules on this are clear and 
specific, they nevertheless pose some difficulties in their implementation and as such an allocation system  that does 
not use this notion of 'capacity' would allow for improved administrative simplicity. 

154 

 
 
 
                                                           
Table 16: Screening of options for production level and adjustments 

Better alignment with 
production levels 

No increased 
administrative 
complexity 

Avoid windfall profits 

'Baseline B' 
Option 1. 
Option 2. 
*Note on scoring: The symbols used are indicators of the comparison between a proposed option 
and the baseline. Their meanings are: "--" much worse than baseline, "-" worse than baseline, 0 
equal to baseline, "+" better than baseline, "++" much better than baseline. 

0 
+ 
++ 

0 
+ 
++ 

0 
0 
- 

In  summary,  option  1  is  used  for  the  simple  packages,  and  option  2  for  the  more  targeted 
packages. 

5.4. 

Reserve for new entrants 

5.4.1.  Lessons learnt from the current system in phase 3 (2013-20) 

Over the period from 2013-20, five percent of the allowances in the ETS have been set aside at 
the  EU  level  as  a  reserve  for  new  entrants  in  order  to  promote  growth  and  allow  for  new 
investments. This translates into some 480 million allowances, as the legislators have earmarked 
300 million allowances for the NER300 programme. The definition of ‘new entrants’ in the ETS 
Directive: it encompasses new installations and those having capacity extensions. All such new 
entrants are eligible under the same allocation rules defined in implementing legislation.  

Based on the rate of consumption in 2013 and 2014, the size of the reserve is expected to be more 
than sufficient to meet the demand for allowances throughout phase 3: actually it is expected that 
a significant amount of these allowances will not be used, resulting in the so-called "unallocated 
allowances"206 .  

Providing a reserve for 2021-30 acts as an incentive for new investments. Considering the longer 
phase 4 (10 years, as compared to 8 years), it is also worth exploring whether the system could be 
rendered more flexible, i.e. not limited by a fixed amount of allowances to ensure that there will 
be enough allowances available. 

5.4.2.  Policy options 

The considered options for new entrants' reserve updating are the following: 

'Baseline A': No reserve for new entrants. This is the legal baseline. 

'Baseline  B':  New  entrants  reserve  with  fixed  amount  of  allowances.  This  option  continues 
the current rules for 2021-30, i.e. 5% of the total allowances are set aside for this purpose, which 
is unchanged and thus does not cover increases in production207. In phase 4 this would amount to 

206 See Annex 15 
207 5% of total amount available, minus 300 million allowances which are available to help stimulate the construction 
and  operation  of  environmentally  safe  CCS  projects,  as  well  as  demonstration  projects  of  innovative  renewable 
energy  technologies,  i.e.  NER300  (see  Article  10a(7-8)  of  the  ETS  Directive).  As  outlined  in  the  October  2014 
European Council Conclusions, the existing NER300 facility will be renewed in the post-2020 period, and extended 
in scope and scale.) 

155 

 
 
 
 
 
 
 
 
 
                                                           
 
some  374  million  allowances  (after  deducting  400  million  allowances  to  source  the  Innovation 
Fund, i.e. the successor of the NER300 programme). 

Option 1. New entrants reserve with fixed amount of (phase 4) allowances and replenished 
with unused phase 4 allowances. The reserve is  established  with  a fixed amount  (374  million 
allowances), as in Baseline B, and is replenished with allowances resulting from production level 
decreases and installation closures in phase 4. 

An alteration of this option is Option 1 developed in Annex 14, where the fixed amount to set up 
a New Entrants Reserve would be sourced from unallocated (phase 3) allowances in the Market 
Stability Reserve. 

5.4.3.  Screening  

The  operational  objectives  of  "reflecting  technological  progress  in  sectors",  "preserving 
incentives  to  innovate",  and  "avoidance  of  windfall  profits"  are  not  relevant  for  the  analysis 
below. 

As Baseline A is not in line with European Council conclusions, it will not be further assessed. 

Baseline  B  proposes  to  set  aside  a  fixed  amount  of  allowances  for  new  entrants.  Phase  3 
experience shows that has in principle worked. However, significant amount of allowances from 
the  reserve  are  expected  to  remain  unallocated  due  to  inter  alia  slower  than  expected  growth 
(lower  consumption  of  allowances  in  the  reserve  and  flow  back  of  allowances  from  closed  / 
partially  closed  installations), and  thus  some reflection  on the optimal amount  of allowances in 
the  new  entrance  reserve  is  merited.  Nevertheless,  considering  that  phase  4  will  be  longer  (10 
years),  setting  aside  the  same  amount  of  allowances  (expressed  as  a  percentage  of  the  total 
amount  of  allowances)  might  not  be  sufficient  and  therefore  could  lead  to  uncertainty  for  new 
investments and undue costs for new entrants by the end of the period.  

The  reason  a  longer  trading  period  has  a  big  impact  is  that  allocation  for  each  new  entrant  is 
calculated  for  the  entire  trading  period  (e.g.  if  an  installation  enters  the  EU  ETS  in  2021,  its 
allocation  will  be  calculated  for  each  year  between  2021  and  2030).  Basically,  the  longer  the 
period, the higher the demand for new entrant allowances, as it cumulatively increases over time. 

Given  the  above  considerations,  'Baseline  B'  scores  overall  well  in  achieving  the  objectives.  It 
does imply some administrative burden, but it is assessed based on the experience of phase 3, it 
should be considered as medium.   

Option 1 foresees adding leftover allowances resulting from closures and partial cessations to the 
new  entrants  reserve,  instead  of  auctioning  them  at  the  end  of  phase  4  as  in  Baseline  B  (as 
initially decided for phase 3). This mitigates the risk of a depleted reserve before the end of phase 
4,  and  therefore  reduces  the  possibility  that  the  most  efficient  installations  face  undue  costs. 
Given  its  advantages,  option  1  scores  highest  and  is  used  for  three  option  packages.  Using  the 
unallocated  allowances  from  phase  3  (for  more  details,  see  Annex  15)  would  lead  to  the  same 
screening results and would in addition reduce the need / size of a correction factor in phase 4. 

Table 17: Screening of options for reserve for new entrants  

'Baseline B' 
Option 1 

Most efficient installation not 
facing undue costs 
0 
+ 

Better alignment with 
production levels 
0 
+ 

No increased administrative 
complexity 
0 
0 

156 

 
 
 
 
 
*Note on scoring: The symbols used are indicators of the comparison between a proposed option 
and the baseline. Their meanings are: "--" much worse than baseline, "-" worse than baseline, 0 
equal to baseline, "+" better than baseline, "++" much better than baseline. 

In summary, option 1 is used for all the packages. 

5.5. 

Compensation for indirect carbon costs 

5.5.1.  Lessons learnt from the current system in phase 3 (2013-20) 

Indirect carbon costs is the term used to describe the costs of CO2 emissions related to producing 
electricity  which  are  passed  through  to  industrial  consumers  of  electricity.  As  electricity 
producers in the ETS do not receive free allowances to cover their emissions (and therefore have 
to buy allowances on the market) and given the situation of the electricity market (i.e. almost no 
imports and still a high proportion of fossil fuel used), full cost pass-through is widely considered 
as possible.  

The  ETS  Directive  gives  Member  States  the  possibility  to  compensate  certain  electro-intensive 
industries for these indirect carbon costs  subject to State aid control208. The aim is to  minimise 
the  risk  of  carbon  leakage  due  to  indirect  costs.  The  State  aid  guidelines  ensure  that  the  aid  is 
proportionate  and  that  the  incentives  for  electricity  efficiency  and  the  transition  from  ‘grey’  to 
‘green’  electricity  are  maintained,  as  the  formula  used  includes,  inter  alia,  production  levels, 
electricity consumption levels and specific regional CO2 emission factors. 

As  it  stands  in  2015,  some  countries  (the  Netherlands,  Germany,  Greece,  UK,  Spain,  Belgium 
(Flanders) and Norway) have opted to compensate for indirect costs, although not always to the 
full  amount  allowed.  The  low  number  of  countries  providing  this  aid  is  probably  linked  to 
relatively low carbon price which on the one hand reduce the need for the support, and, on the 
other, reduce the income to the Member States from auctioning allowances.  

Some  industries  with  high  electricity  intensity  have  criticised  the  fact  that  compensation  of 
indirect costs is optional for  Member States209. They claim this does not efficiently address the 
risk of carbon leakage, and highlight the risk of distortion of competition linked with the lack of 
harmonisation across the countries covered by the EU ETS. As a consequence, electro-intensive 
industries, i.e. industries using a lot of electricity, have asked that compensation of indirect costs 
is done through an EU-wide and harmonised system.210  

In  this  context,  some  industry  stakeholders  argue  that the indirect  cost  compensation  should  be 
done  by  using  auctioning  revenues  or  providing  additional  allowances  to  electro-intensive 
industries  cover  the  additional  costs.  This  has  e.g.  been  proposed  by  the  non-ferrous  metals 
association Eurometaux. 

208 The current measures are assessed under the Commission's 2012 Guidelines on state aid measures related to the 
ETS.  
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52012XC0605(01)&from=EN  
209 These views have been also reiterated during the stakeholder consultations. A part of energy intensive industry 
asked  for  the  development  of  an  EU-wide  instrument  to  replace  the  national  state  aid  mechanisms.  However,  a 
significant number of industrial sectors have also highlighted the fragmentation of the EU energy market, noting that 
the impact of the ETS is marginal compared to the large variation of electricity prices across Member States. These 
industries  have  underlined  the  need  for  strengthened  EU  market,  and  competitive  energy  prices,  as  of  greater 
importance.  
210 By 'harmonised system' in the analysis is understood a system under which all Member States compensate indirect 
costs to the same level. 

157 

 
 
 
 
 
                                                           
 
A  recent  study211  concluded  that  indirect  costs  did  not  have  a  significant  effect  on  the  risk  of 
carbon leakage in most industries, while it acknowledged that producers using a large amount of 
electricity may have faced some cost increase due to indirect carbon costs. 

This was also concluded in the two cumulative cost assessments on the aluminium and the steel 
sectors212  prepared  for  the  Commission  services  in  2013.  For  some  electro-intensive  primary 
aluminium plants, which did not have long-term contracts for purchasing electricity, the indirect 
costs reached levels in the order of 8% of production costs. Also for some electricity-based steel 
plants the costs  were significant. Given that it was the first time such a study was done, it was 
difficult to determine unambiguously all the factors that could impact the costs. It should also be 
noted that these studies were carried for a period when the carbon price was considerably higher 
than today, and when State aid was not allowed.  Furthermore, some of these indirect costs may 
have been passed through to consumers. 213 

A  difficulty  with  providing  the  same  level  of  compensation  to  all  eligible  industries  is  that  the 
actual retail power prices paid by industry are not fully known. Major consumers typically have 
negotiated preferential prices through long-term contractual arrangements and these do not (fully) 
reflect  the  carbon  costs  of  electricity  production.  It  is  equally  noteworthy  that  Member  States 
have  a  very  wide  variety  of  carbon  intensities  of  electricity  production,  national  markets  are 
integrated to variable degrees and a number of Member States provide significant taxes and levies 
exemptions for industry.  

To avoid the risk of overcompensation, a harmonised EU-wide system compensating all eligible 
industries to the same level would require a detailed control and verification for each individual 
company resulting in a significant administrative burden.  

A system providing compensation for indirect costs has a high risk of providing windfall profits 
if  the  allowances  are  distributed  based  on  harmonised  parameters  across  Member  States,  for 
instance  in  low-carbon  electricity  markets.  As  an  alternative,  rules  can  address  national  and 
regional  differences  and  mitigate  the  risk  of  windfall  profit  at  the  expense  of  additional 
administrative complexity.  

In  exploring  the  options  for  full  harmonisation,  one  approach  could  be  to  no  longer  allow 
Member States to have compensation schemes in place as this would lead to equal treatment of 
all installations across the EU (the level of compensation would be 0 for all). This would however 
entail risks of undue costs for the most efficient installations, notably in case of a higher carbon 
price than currently. This is  not in line with the European Council conclusions and therefore  is 
not considered in subsequent analysis.  
In  sum,  and  as  analysed  in  the  2008  ETS  impact  assessment214,  the  compensation  for  indirect 
costs  is  a  complex  issue  including  many  considerations  and  needs  to  be  approached  with  care 
since it might convert free allocation into production subsidies for the indirect costs concerned.  

211 Ecorys: Carbon Leakage Evidence Project - Factsheets for selected sectors, September 2013. 
212 Centre for European Policy Studies and Economisti Associati: Assessment of cumulative cost impact for the steel 
industry, 2013.  Centre for European Policy Studies and Economisti Associati: Assessment of cumulative cost impact 
for the aluminium industry, 2013.   
213 The extent to which indirect costs are passed by the manufacturing industry into product prices depends on the 
general  cost pass  through  ability of each  sector. When  a sector  is able  to pass  through  the  costs related  to  the  EU 
ETS, it does not differentiate between direct and indirect costs. In this sense, full compensation for indirect costs (as 
well as for direct) can lead to overcompensation as some of the costs may have been passed through to consumers.  
See http://ec.europa.eu/competition/sectors/energy/impact_assessment_main%20report_en.pdf  
214 Commission Staff Working Document, accompanying document to the Proposal for a Directive of the European 
Parliament and of the Council, amending Directive 2003/87/EC so as to improve and extend the EU greenhouse gas 
emission allowance trading system:, Impact Assessment (SEC(2008) 52).,  

158 

 
 
                                                           
5.5.2.  Policy options 

The  considered  options  for  indirect  cost  compensations  differ  in  respect  to  two  aspects:  (1) 
whether  compensation  is  optional  or  mandatory;  (2)  the  source  of  financing,  which  could  be 
national state budgets, auctioning revenues or free allowances: 

Baseline:  Continued  optional  compensation  by  Member  States.  In  this  option  the  current 
system of optional compensation for indirect costs at national level continues. The key features 
for  compensation  are  determined  at  the  EU  level,  but  the  decision  to  grant  compensation  is 
discretional and depends on the respective Member State and is subject to State aid control.  

Option  1.  Mandatory  Union-wide  compensation  scheme,  financed  by  using  national 
auctioning  revenues.  The  compensation  would  be  triggered  when  the  carbon  price  exceeds  a 
certain value, and when this situation occurs, a minimum amount of compensation is to be given 
by  all  Member  States.  The  system  would  be  financed  by  each  Member  State  using  its  national 
auctioning  revenues.  Compensation  would,  like  in  baseline,  be  limited  to  certain  sectors  and 
limited to a share of the estimated carbon costs.  

Option  2.  Mandatory  Union-wide  compensation  scheme  financed  through  free  allocation. 
Compensation is given at EU level to installations in sectors deemed at risk of carbon leakage due 
to  their  indirect  carbon  costs,  and  is  financed  through  free  allocation  of  ETS  allowances. 
Compensation is provided based on similar criteria as in the Baseline. 

Option  3.  Mandatory  Union-wide  compensation  scheme,  financed  through  free  allocation 
plus  optional  compensation  at  national  level  (subject  to  State  aid  control).  The  mandatory 
compensation is given at EU level to installations in sectors deemed at risk of carbon leakage due 
to their indirect carbon costs, and is financed through free allowances. Member States can top up 
the compensation from national resource subject to Commission approval. 

5.5.3.  Screening 

Under  the  Baseline  option,  Member  States  may  decide  not  to  compensate  for  indirect  carbon 
costs for any number of reasons, e.g. considering there is no risk of carbon leakage due to indirect 
costs  or  because  of  other  national  priorities215.  This  option  like  all  proposed  options,  presumes 
that  only  some  of  the  carbon  costs  are  allowed  to  be  compensated,  like  in  the  State  aid  rules 
currently in force. This ensures that the incentives to innovate are preserved as the maximum aid 
intensity  ensures  only  partial  recovery  of  costs216.  All  options  therefore  score  equally  on  this 
point. 

For  the  Baseline,  the  current  level  of  administrative  complexity  remains  unchanged.  However, 
this option could distort intra-EU trade as company decisions regarding location of their activities 
could be driven by different level of State aid in different Member States instead of underlying 
market fundamentals. 

The compensation not covering the full costs in the Baseline option in principle avoids the risk of 
creating  windfall  profits.  However,  since  industry  might  be  able  to  pass  through  some  of  the 
carbon costs, the options that lead to a higher amount of compensation also increase the risk of 

215 The Commissions' approval of State aid schemes is required. 
216  Otherwise,  poorly  targeted  aid  would  transfer  the  emission  reduction  costs  from  the  installations  to  the  other 
sectors of the economy, and consequently limit these incentives. 

159 

 
 
 
 
                                                           
windfall profits compared to the baseline. This is the reason why option 1 and 2 score somewhat 
worse than the Baseline, and option 3 much worse than the Baseline. 

In  Option  1,  all  Member  States  provide  harmonised  compensation  for  indirect  costs  using 
national auctioning revenues. At the same time, all companies could be put on equal footing since 
compensation  would  no  longer  depend  on  the  Member  States'  decision.  This  option  requires 
capacity  for  design  and  implementation  of  compensation  schemes  in  each  Member  State,  and 
consequently increases the administrative burden for the Commission and national authorities. As 
all  Member  States  would  need  to  grant  some  compensation,  aggregate  public  spending  would 
increase217.  At  the  same  time,  limiting  market  distortions  have  a  positive  impact.  It  should  be 
noted  that  effort  would  not  be  equal  across  Member  States  as  those  with  a  high  share  of 
electricity-intensive  industry  relative  to  GDP  may  experience  relatively  more  strain  on  public 
resources.  

Options 2 and 3 could also increase the pressure on the total amount of allowances available for 
free allocation (used for direct emissions) thus requiring more stringent rules for free allocation 
and possibly increasing exposure to the risk of carbon leakage for many industrial installations218. 
This problem would not occur if the system would be financed from allowances intended to be 
auctioned by the Member States. 

To  conclude,  a  harmonised  system  (any  of  the  option  1,  option  2  and  option  3)  can  reduce 
distortions in competition between Member States, though with increased administrative burden. 
While  financing  compensation  through  free  allowances  could  limit  the  impact  on  national 
auctioning revenues (State budget), it would also reduce the amount available for compensation 
of direct ETS costs. Due to the abovementioned shortcomings of options 2 and 3, along with their 
relatively  low  overall  scoring,  only  the  Baseline  and  Option  1  are  included  in  the  policy 
packages. 

Table 18: Screening of options for compensation for indirect cost  

Avoid windfall 
profits 

Fully preserve 
innovation 
incentives 
0 
0 
0 
0 

Most efficient 
installations not 
facing undue costs  
0 
Baseline 
+ 
Option 1 
+ 
Option 2 
++ 
Option 3 
*Note on scoring: The symbols used are indicators of the comparison between a proposed option 
and the Baseline. Their meanings are: "--" much worse than baseline, "-" worse than baseline, 0 
equal to baseline, "+" better than baseline, "++" much better than baseline. 

Not increasing 
administrative 
complexity 
0 
- 
- 
-- 

0 
- 
- 
-- 

In  summary,  the  Baseline  is  used  for  the  simple  packages,  and  option  1  for  the  targeted 
package. 

217  Auctioning  revenues  as  a  potential  source  of  funding  may  also  be  used  for  a  variety  of  objectives,  including 
compensation for indirect costs (currently optional). For example, Member States may use revenues from auctioning 
of allowances, between 2013 and 2016, to support the construction of highly efficient power plants, including new 
power plants that are carbon capture and storage (CCS)-ready. In general, at least 50 % of auctioning revenues or the 
equivalent  in  financial  value  of  these  revenues  need  to  be  used  by  Member  States  for  climate  and  energy  related 
purposes. 
218  In  the  hypothetical  case  of  a  fully  harmonised  system,  industry  itself  has  estimated  a  need  of  2.3  billion 
allowances in 2021-30, or 36% of all allowances available for free allocation in this period. This would lead to a very 
high cross-sectoral correction factor for direct emissions. 

160 

 
 
 
 
 
 
 
 
                                                           
 
6. 

FURTHER IMPROVEMENTS TO THE CURRENT SET OF RULES 

While the current architecture of the EU ETS is relatively recent, based on experience gathered, 
certain limited changes to the current set of rules in the ETS Directive should also be considered 
for the period post-2020. Since these changes may be seen as politically less sensitive, they are 
not referred to in the European Council conclusions. Nevertheless, they concern core aspects of 
the  ETS,  such  as  the  validity  of  allowances,  the  Union  registry  or  its  scope.  They  offer  the 
opportunity to enhance the smooth operation of the European carbon market driving cost-efficient 
emission reductions for all participants, including the smallest. 

6.1. 

Validity of emission allowances 

6.1.1.  Problem definition 

The ETS Directive defines the allowance as a right to emit one tonne of CO2eq during a specified 
trading  period.  The  allowances  can  be  surrendered  in  any  year  within  the  period  they  are  valid 
for. For instance, the allowances issued from 2013 onwards are valid for emissions during eight-
year period beginning in 2013. Four months after the beginning of each period, allowances from 
the  previous  period  which  are  no  longer  valid  for  the  current  period,  and  have  not  been 
surrendered or deleted are replaced by allowances for the current period. This process is referred 
to as "banking" of allowances. 

Taking the example of the transition from the second (2008-2012) into third trading period (2013-
2020), this meant that technically the ETS Directive did not allow the use of allowances from the 
second period for compliance in the third one. However, it did ensure the banking of allowances 
held in user accounts from the second period to the third one, which took place in 2013.  

In  practice, the banking of allowances was carried out in  17350 registry account  in accordance 
with the Registries Regulation219. The process required important changes in the operations of the 
Union  Registry  and  a  planned  downtime  of  the  Union  Registry  for  four  consecutive  working 
days, implying a suspension of the spot market during this period. Furthermore, despite the ETS 
Directive being clear, the sole process of replacement of one type of allowances (phase 2) with 
another type (phase 3) allowances could have contributed to perceived uncertainty at the market. 
If  this  solution  remains  for  the  future,  the  market  uncertainty  could  be  even  higher  taking  into 
account the calculation of the allowances in the Market Stability Reserve. 

Making these technical arrangements more effective can be achieved primarily at the level of the 
implementing rules, i.e. the Registries Regulation. Nonetheless some changes may be needed at 
the level of the ETS Directive, in particular to allow any allowance to remain valid for any period 
after it was issued. The Commission has no intention of considering any changes related to the 
general ability of the allowances to be used in different trading periods. This is central to price 
formation and a long-term price signal to drive investment in less-carbon intensive capital stock 
and innovation. However, certain (negative) impacts of the technical implementation of banking 
may be alleviated in the future.  

219  COMMISSION  REGULATION  (EU)  No  389/2013  of  2  May  2013  establishing  a  Union  Registry  pursuant  to 
Directive  2003/87/EC  of  the  European  Parliament  and  of  the  Council,  Decisions  No  280/2004/EC  and  No 
406/2009/EC  of  the  European  Parliament  and  of  the  Council  and  repealing  Commission  Regulations  (EU)  No 
920/2010 and No 1193/2011, OJ L 122, 03.05.2013, p. 1. 

161 

 
 
 
                                                           
6.1.2.  Operational policy objective 

The  operational  objective  is  to  remove  any  temporary  uncertainty  concerning  the  use  of 
allowances  in  subsequent  phases  associated  with  the  need  to  carry  out  the  replacement  in  the 
Union Registry. 

6.1.3.  Policy options 

Baseline: Replacement of allowances at the end of each trading period.  

Option  1:  Continued  use  of  phase  x  allowances  beyond  that  phase  x.  This  would  imply  same 
treatment of allowances notwithstanding of when they were issued.  

6.1.4.  Analysis of impacts 

Banking of allowances (baseline option) took a number of weeks of technical preparatory work 
and  more  than  €10,000  cost  under  the  contract  signed  by  the  Commission  for  the  purpose  of 
implementing the Registry related provisions of the  ETS Directive. Although to an extent what 
was  developed  for  the  end  of  phase  2  might  be  reused  for  the  subsequent  transitions  into  new 
phases, it is again expected to entail some preparatory work and temporary closure of the Union 
Registry.  The  banking  process  also  meant  significant  uncertainty  for  market  participants  and 
exchanges offering allowance contracts. 

The  current  Registry  infrastructure  is  designed  based  on  trading  periods.  If  continued  use  of 
phase  x  allowances  (option  1)  would  be  implemented,  it  will  require  new  one-off  technical 
preparatory work with respective associated costs for the technical adjustment. This is estimated 
to be an effort comparable to that related to the preparatory work for banking of allowances at the 
end of phase 2. While  it is challenging to assess the  precise cost, for the new adjustment, it is 
clear  that  it  would  be  indeed  a  one-off  solution  and  would  avoid  additional  cost  for  the 
subsequent  phases.  Concerning  temporary  the  suspension  of  the  Registry,  downtime  would  no 
longer  be  needed,  as  the  relevant  changes  could  already  be  integrated  in  one  of  the  envisaged 
regular  upgrades  of  the  Registry  well  before  the  end  of  phase  3.  Continued  use  of  allowances 
would  simplify  the  operations  for  market  participants,  exchanges  and  authorities.  Most 
importantly,  this  could  in  turn  avoid  possible  perceived  regulatory  risk  at  the  end  of  trading 
periods.   

Other than that, no major  economic, social  or  environmental impacts  can be  expected from  the 
choice of baseline or alternative option 1.  

6.1.5.  Comparing the options  

With respect to the objective of avoiding any perceived risk due the need to replace allowances, 
the continued use of allowances (option 1) would effectively address the issue of the validity of 
allowances once and for all. Achieving the objectives efficiently, at lowest administrative burden 
and  Registry  temporary  closure  time,  is  also  best  ensured  by  continued  use  of  allowances. 
Overall, this option is expected to bring simplification to the system and will be more consistent 
with the general principle of continuous application of the main elements of the EU ETS, beyond 
the  period(s),  including  the  linear  reduction  factor.  It  would  give  a  fully  coherent  signal  to  the 
market that allowances once issued are a valid instrument for the EU ETS. In terms of coherence 
with other EU policies, neither of the options is likely to have any negative impacts. 

162 

 
 
 
 
 
Table 19: Comparison of options 

Effectiveness 

Simplicity  One-off cost  Ongoing 

Baseline: 
Replacement 
of allowances 

Option 1: 
Continued use 
of allowances 

0 

+ 

- 

+ 

+ 
(possible 
partial reuse 
of what was 
developed for 
phase 2) 
- 
(cost of new 
changes) 

Coherence 

0 

Registry 
suspensio
n 
- 
(still 
required) 

cost 

- 
(new 
cost 
every 
phase) 

+ 
(no cost) 

+ 
(not 
needed) 

+ 
(continuation 
of EU ETS 
beyond 
phases) 

6.2. 

Optional exclusion of small emitters 

6.2.1.  Problem definition and general objective 

Currently,  there are  more than 12,000 installations included in  the EU ETS. These installations 
represent a large range of emitters, from power plants to industrial installations in various sectors. 
Annual emissions from these installations vary from less than 5,000 tCO2 to more than 5,000,000 
tCO2. Today, the largest 5% of installations in the EU ETS emit 71% of total emissions, while the 
20% smallest only account for less than 1% of emissions. Smaller installations in the system thus 
have generally higher transaction costs220, i.e. higher costs arising from monitoring, reporting and 
verification  of  emissions  as  well  as  Registry  costs.  An  overview  of  the  number  of  installations 
and their share in total emissions can be found in Annex 4.3. 

To increase the cost-effectiveness of the EU ETS for small emitters, at the start of phase 3 (2013-
2020), Member States were allowed, but not obliged to exclude installations with a rated thermal 
input below 35 MW which reported emissions of less than 25.000 tCO2 for the years 2008-2010 
and  hospitals  provided  that  they  could  demonstrate  that  their  installations  were  subject  to 
equivalent  measures.  Additional  flexibility  for  installations  with  low  emissions  was  also 
introduced  in  the  implementing  legislation  on  monitoring,  reporting  and  verification.  Small 
emitters  may  thus,  for  example,  submit  a  simplified  monitoring  plan  and  are  exempt  from  a 
number of documentation requirements. 

However,  the  use  of  this  option  to  exclude  small  emitters  provided  by  the  ETS  Directive, 
however,  is  currently  limited.  Only  installations  notified  by  the  Member  States  to  the 
Commission  until  30  September  2011  can  be  excluded.  Unless  their  emissions  exceed  the 
threshold  of  25.000  tonnes  in  a  given  year,  they  remain  excluded  in  future  trading  periods,  but 
Member States do not have the possibility to exclude additional installations in later periods. In 
2011,  most  Member  States  have  chosen  not  to  use  this  option221  so  they  cannot  exclude 
installations in phase 3, nor in later periods. 

While not many Member States are using the option, there remains an unequal relation between 
the  contribution  of  certain  installations  to  overall  emissions  and  their  transaction  costs.  Other 
measures  applying  to  installations  with  low  emissions  can  reduce  not  only  the  administrative 

220 In contrast to compliance costs relating to the need to buy allowances to cover annual emissions. 
221  Seven  Member  States  use  this  option.  These  are  Croatia,  France,  Germany,  Italy,  Slovenia,  Spain,  and  United 
Kingdom. Iceland is also making use of this option. 

163 

 
 
 
 
 
                                                           
burden on the operators, but also enhance the cost-effectiveness of the emission reductions they 
nevertheless have to realise. Care had to be taken when designing alternative measures. To ensure 
that  the  excluded  installations  contribute  to  the  overall  emission  reduction  targets  of  the  EU, 
equivalence  in  terms  of  environmental  integrity  needs  to  be  ensured.  To  avoid  distortions  of 
competition  within  the  national  boundaries  or  across  EU  the  costs  per  ton  of  CO2  emitted  for 
excluded installations and the ones that remain under ETS should be similar.  

6.2.2.  Operational policy objective 

The  operational  policy  objective  relates  to  maintaining  the  cost-effectiveness  of  the  system, 
including for installation with low emissions and to provide a possibility for small emitters to find 
the  most  cost-efficient  system  for  the  regulation  of  the  greenhouse  gas  emissions  they  emit. 
While  it is  important  to  preserve  the  environmental integrity  of  the  system  to  achieve  the  EU's 
agreed emission reduction targets, it is equally important to ensure that these emission reductions 
are realised in a cost-efficient manner. 

6.2.3.  Policy options 

The  main  options  that  are  assessed  relate  to  the  continuation  of  the  possibility  for  the  Member 
States  to  exclude  small  emitters  whilst  ensuring  that  the  equivalent  measures  taken  at  Member 
States level are coherent so as to avoid distortions of competition. In this regard, it is proposed to 
maintain the definition of small emitters in the ETS Directive, i.e. the thresholds on the basis of 
which  installations  are  deemed  to  be  covered  by  the  EU  ETS.  These  thresholds,  and  thus  the 
environmental  effectiveness,  were  subject  of  considerable  discussion  and  analysis  ahead  of  the 
previous  ETS  revision  in  2008.  While  most  stakeholders  agree  that  Member  States  should 
continue  to  have  the  possibility  to  exclude  small  emitters,  only  a  few  argue  for  changing  the 
thresholds. Some would like to change them upwards, others downwards. The lessons learnt from 
the application of the exclusion also do not indicate that the thresholds need changing (see Annex 
4.3). 

Baseline: Maintain exclusion only for installations already excluded in phase 3 (2013-2020). 

Option 1: Continuation of the current option as set out in Article 27 of the ETS Directive with a 
renewed possibility for Member States to decide towards 2020 whether they would like to make 
use of this option and exclude additional installations from the ETS. 

Option 2: As in option 1, Member States would be again given the possibility to make use of the 
option  towards  2020;  with  a  view  to  avoid  fragmentation  of  national  equivalent  measures  and 
their  potential  rejection,  the  ETS  Directive  would  define  in  more  detail  these  measures.  This 
option entails more precision regarding the measures applying to installations (such as taxation or 
a  levy  based  on  an  annual  emissions  target)  so  as  increase  transparency  and  avoid  market 
distortions.  

6.2.3.1.  Assessment of the options 

The impacts of the two options can be described as follows: 

Environmental effectiveness: When excluding installations with low emissions from the ETS, a 
variation  in  the  level  of  contribution  to  emission  reductions  poses  the  biggest  risk  in  terms  of 
environmental integrity. Under the baseline and both options, Member States would be required 
to put in place measures ensuring that excluded installations contribute to an equivalent extent to 
emission reductions as if they remained under the ETS. All options are thus expected to deliver 
the same environmental effectiveness. 

Administrative  costs:  Operators  of  installations  included  in  the  ETS  incur  a  large  range  of 
administrative costs that mainly relate to fees for the use of the registry – different in the Member 

164 

 
 
States – as well as costs for compliance, in particular for monitoring, reporting and verification of 
emissions.  In  general,  costs  vary  depending  on  the  size  and  the  complexity  of  the  installation 
concerned. Under the baseline scenario, administrative costs for excluded installations cannot be 
entirely  avoided. As indicated above,  the operators of excluded installations  remain required to 
monitor  and  report  emissions,  in  line  with  the  simplified  rules  on  monitoring  and  reporting  for 
small emitters included in the ETS, to ensure equivalence of the measures and to control that the 
conditions for exclusion are still fulfilled. Savings in terms of administrative costs can therefore 
in  particular  be  realised  with  regard  to  the  registry  costs  and  with  regard  to  the  required  third-
party verification of emissions. While the savings per installation are likely to be similar under all 
options, it is expected that the overall amount of cost reductions emerging from option 1 and 2 
would  be  higher  since  Member  States  may  exclude  additional  installations  from  the  ETS.  It  is 
however likely that option 2 achieves a more comparable level of cost savings across the Member 
States  due  to the greater harmonised approach regarding  the  measures that  apply  instead  of the 
ETS. 

Impact on competitiveness, competition and internal market: As indicated above, transaction 
costs are considerably higher for small installations than for larger installations. This difference in 
transaction  costs  generally  implies,  in  particular  in  heterogeneous  sectors  that  encompass 
installations  of  different  sizes  that  distortions  of  competition  may  arise.  Considering  that  the 
measures  put  in  place  by  Member  States  since  2013  require  equivalent  environmental  efforts 
from  the  operators  excluded  whilst  reducing  administrative  costs,  the  competitiveness  of  small 
emitters  has  already  been  strengthened.  Since  option  1  would  provide  Member  States  with 
another possibility to exclude small emitters and has thus the potential to reduce the transaction 
costs for additional installations, it is likely to strengthen the competitive situation of more small 
emitters than is currently the case. Option 2 would have the same effect. 

The  impact  on  competition  and  the  internal  market  mainly  depends  on  the  equivalence  of  the 
economic  incentives  to  reduce  emissions  provided  by  the  alternative  measures  that  Member 
States  put  in  place  and  the  costs  per  ton  of  CO2  emitted.  If  these  differ  either  compared  to 
competitors  of  the  same  sector  who  remain  included  in  the  ETS  or  compared  to  competitors 
located  in  a  Member  State  not  providing  for  the  option  of  being  excluded,  distortions  of 
competition  and  of  the  internal  market  may  arise.  In  the  current  situation,  Member  States  have 
taken similar approaches when defining equivalent measures or the Commission has rejected any 
measures,  which  could  not  be  deemed  equivalent.  Option  1  would  allow  Member  States  to 
exclude additional installations, but also to revisit within the framework set by Article 27 of the 
ETS  Directive  the  equivalent  measures.  Avoiding  any  adverse  impact  on  competition  and  the 
internal  market  would  again  need  to  be  ensured  when  the  corresponding  applications  are 
approved by the Commission. Option 2 would provide for more harmonised rules on equivalent 
measures and therefore tackle the root cause for any distortions of competition that may arise due 
to the exclusion of certain installations from the ETS. 

Employment: It is likely that the sector most affected by the exclusion of additional installations 
pursuant to option 1 and 2 compared to the baseline is the verification business. Impacts for other 
sectors are negligible.  

No major economic and other social impacts can be expected. 

6.2.3.2.  Comparing the options 

With  respect  to  the  objective  of  maintaining  the  cost-effectiveness  of  the  system  also  for 
installations with low emissions, both option 1 and 2 would be effective since they allow Member 
States to remove a number of installations from the ETS besides those that are already excluded. 
The baseline would not provide this possibility and limit exclusions to those having already made 

165 

 
 
use of this option. In terms of efficiency, both options entail new costs compared to the baseline 
if Member States pursue further opt-outs since Member States would have to select installations 
for  exclusion.  While  the  efficiency  of  option  1  would  depend  on  the  concrete  provisions  that 
Member States would put in place and may require a new learning process for operators, option 2 
would  ensure  a  higher  degree  of  harmonisation  and  thus  relieve  the  operators  concerned  from 
administrative  burden  to  the  same  or  at  least  similar  extent  in  the  Member  States.  In  terms  of 
coherence,  both  options  1  and  2  would  require  Commission  scrutiny  and  approval  of  the 
applications  from  Member  States  as  well  as  some  degree  of  oversight  regarding  the 
implementation in the Member States. With regard to other EU policies, it is thus unlikely that 
they have any negative impacts. 

Table 20: Comparison of the options in relation to relevant problems and objectives 

Effectiveness 

Administrative 
costs 

Competitiveness, 
competition and 
internal market 

Employment 

Coherence 

Baseline 

Option 1: 
renewed 
exclusion  

Option 2: 
renewed 
exclusion with 
harmonised 
equivalent 
measures 

0/+ 

+ 

+ 

0/+ 

+ 

+ 

+ 

++ 

++ 

0 

0 

0 

+ 

+ 

+ 

6.3. 

Guaranteeing a robust and secure EU ETS (registry fees) 

6.3.1.  Problem definition and general objective 

In 2005, at the start of the EU ETS, 25 Member State registries and the Community Independent 
Transaction Log  ('CITL')  were  put  in  place  to  hold  accounts  for  installations, record  allowance 
transactions, annual verified emissions from installations and verify each year whether the total 
cap is respected. These registries have initially operated successfully and efficiently. However in 
2010 and 2011, several national registries reported security incidents involving phishing attacks 
on  operators  and  unauthorised  access  to  accounts.  Thereafter,  the  Commission  and  Member 
States took immediate measures by means of adopting enhanced security requirements. 

To  improve  the  cost-effectiveness  of  this  system  that  required  the  maintenance  of  a  costly  and 
secure IT-infrastructure in each Member State and at the Commission, it was decided to set up a 
Union-wide single registry (Union registry) for the EU ETS and shift important responsibilities to 
the EU level. In addition, the Commission also accepted to consolidate in place of the Member 
States  the  operations  of  the  national  registries  relating  to  the  Kyoto  Protocol  obligations  of  the 
Member States so as to allow the full consolidation of all former national registries. As successor 
of the CITL, today the European Union Transaction Log (EUTL) automatically checks, records, 
and authorises all transactions that take place between accounts in the Union registry. 

The  Union  registry  is  successfully  and  securely  operational  since  June  2012.  It  is  managed 
efficiently  and  directly  controlled  by  the  Commission  in  close  cooperation  with  the  Member 
States. While compared to a situation with 28 Member State registries and 3 EEA-EFTA states 

166 

 
 
 
 
registries222 that would otherwise be necessary today, the Union registry delivers its services at a 
lower cost to the regulated community, both in terms of IT infrastructure and human resources.  

Since 2012, the overall annual costs of the Union registry were  around €6 million. These  costs 
relate to IT development, support and services, staff as well as infrastructure and security and are 
currently fully borne by the  general EU budget. This is because the legal framework of the EU 
registry  specifically  foresees  that  Member  States  are  allowed  to  charge  the  operators  fees,  but 
does  not  currently  provide  for  EU-level  costs  being  covered  by  such  fees  or  being  shared  by 
Member  States.  However,  over  the  past  years,  the  EU  budget  has  been  subject  to  different 
constraints,  including  budgetary  constraints  in  the  Member  States.  The  annual  EU  budget  is 
adopted each year within the ceilings set by the Multi-annual Financial Framework and covers a 
bulk of activities in different policy areas. 

The  Union  registry  needs  a  stable  and  reliable  financial  source.  Together  with  the  EUTL,  it 
constitutes  the  backbone  of  the  emissions  trading  system  without  which  the  environmental 
integrity  of  the  EU  ETS  could  not  be  maintained.  Despite  their  essential  role  in  the  EU  ETS 
accounting, these IT systems are often perceived as a technical feature. Hence, they are facing the 
risk  of  being  relegated  to  the  background  compared  to  other  policy  initiatives  put  forward  in 
budgetary negotiations. It thus cannot be excluded that new priorities prevent the implementation 
of registry policy priorities in certain years. Therefore, to ensure financial continuity, sustainable 
funding sources should be considered. 

Considering  the  crucial  importance  of  the  Union  registry,  it  is  paramount  to  guarantee  its 
adequate  financing  on  a  sustained  basis.  The  annual  EU  budgeting  procedure  may  not  be 
appropriate in this regard. In order to ensure continued improvement of the system, in particular 
with  regard  to  technological  development  and  potential  security  threats,  the  system  should  in 
financial terms run as a self-sufficient system and not being dependent on the available budget at 
EU-level. As the details of a registry system are currently laid down in the relevant Commission 
Regulation  on  the  registry  required  by  the  ETS  Directive,  the  revision  of  the  Directive  should 
limit  itself  to  the  framework  provisions  provided  in  the  ETS  Directive.  Detailed  rules  of  the 
registries system should continue to be provided by Commission regulation. 

6.3.2.  Operational policy objectives 

The policy objectives are:  

  Sustainable and reliable finance the Union registry system, such that the Commission is 
able to provide the same level of service to operators and Member States both in terms of 
robust and secure infrastructure and human resources, without being dependent on the EU 
budget and changing budget and expenditure patterns. 

  To provide the Union registry with an independent financial envelope reflecting the EU's 
commitment to  maintain a secure and stable registry infrastructure underpinning the EU 
carbon  market,  and  thereby  supporting  cost-efficient  emission  reductions  through 
emissions trading. 

6.3.3.  Policy options 

The main options are assessed are: 

  Baseline: Maintain the financing of the Union registry by the general EU budget. 

222 Iceland, Norway and Liechtenstein also participate in the EU ETS and use the infrastructure of the Union registry. 

167 

 
 
 
                                                           
  Option  1:  Share  EU-level  costs  relating  to  the  operation  of  the  Union  registry  between 

Member States  

  Option 2: Charge the operators as users of the Union registry to cover EU-level costs of 

the Union registry 

6.3.3.1.  Screening of the options 

With respect to the objective of maintaining sustainable financing of the Union registry with an 
independent  financial  envelope,  both  options  1  and  2  would  be  effective  since  they  would  de-
couple  the  financing  from  the  EU  budget.  The  baseline  would  not  change  this.  Both  options 
would  not  necessarily  incur  new  costs,  but  shift  costs  from  the  EU  budget  to  either  Member 
States or operators. Only the baseline would preserve the status quo. It needs to borne in mind, 
however, that the EU ETS generates income for Member States through the revenues of auctions 
and through registry-related fees, which are already high in certain Member States. Instead, under 
option 2, operators would face additional costs and potentially face further administrative burden. 
It  could  not  be  excluded  that  operators  are  charged  twice  for  the  same  service,  once  by  the 
Member State and  once by the Commission.  This  may  in  particular impact small  and  medium-
sized enterprises under the EU ETS who may then face disproportionate costs compared to larger 
businesses. The baseline and option 1 would not adversely affect other EU policies or objectives. 
Option 2 may be difficult to reconcile with the Commission's aim to lower administrative burden 
and costs for EU industries, in particular for small and medium-sized enterprise as set out in the 
Small Business Act for Europe223. 

Consequently,  option  2  is  discarded,  while  option  1  compared  to  the  baseline  will  be  further 
analysed. 

6.3.3.2.  Analysis of impacts 

Under the baseline option, the dependency of the Union registry on funding from the general EU 
budget would remain. Funding would not be stable, but would need to be continuously secured 
each year with the risk of coming increasingly under pressure because of budgetary cuts running 
the risk of compromising the security of the registry and being exposed to undue vulnerabilities. 

Option  1  would  fully  recognise  the  nature  of  the  Union  registry  as  a  system  that  serves  the 
operators under the EU ETS, but also the Member States. It would establish the basis for financial 
independence of the Union registry from the EU budget and thus support that the EU ETS runs as 
a financially more autonomous system. Since Member States would be required to share the EU-
level costs of the Union registry, this would have an impact on their national budgets. Member 
States  currently  have  around  €3.5  billion  revenues  from  auctioning  allowances  under  the  EU 
ETS.  Current  Union  registry  costs  of  €6  million  therefore  constitute  a  tiny  fraction  of  these 
revenues.  The  Directive  specifically  foresees  Member  States  using  auction  revenue  to  cover 
administrative expenses of the management of the EU ETS224. 

Option 1 bears the risk that Member States pass on their share of the costs of the Union registry 
to the operators. While this cannot entirely be excluded, the incentive for Member States seems to 
be rather low. Revenues from auctions give Member States a source of income from the EU ETS 
which they can use to cover their shares of the Union registry costs. The Directive could establish 
a  specific  link  between  the  auction  revenues  and  the  costs  of  the  Union  registry.  At  the  same 
time, the Commission regulation laying down detailed rules on the Union registry could provide 
that these costs may not be directly recovered from the operators. 

223 COM(2008)394 
224 Article 10(3)(i) 

168 

 
 
                                                           
No major impacts on competitiveness, competition and the internal market or economic and other 
social impacts can be expected. 

Table 21: Comparing the options in relation to relevant problems and objectives 

Stable financing of 
the Union registry  

Administrative 
costs/ burden 

Member States' 
auction rights 

EU budget 

Baseline  

1: 
Option 
Member 
States 
sharing  EU-level 
costs 

- 

++ 

- 

(EU level) 

0/- 

(MS level) 

0 

0/- 

- 

+ 

169 

 
 
 
 
7. 

IMPACTS  OF  DIFFERENT  OPTION  PACKAGES  FOR  FREE  ALLOCATION  ON  INDIVIDUAL 
SECTORS  

Detailed analysis of the economic impacts of the 40% greenhouse gas emission reduction target, 
including sectoral impacts, was carried out in 2014 and is presented in the Impact Assessment for 
the  2030  Climate  and  Energy  Framework.  The  analysis  concluded  that  free  allocation  of 
allowances  is  an  effective  tool  to  reduce  the  risk  of  carbon  leakage.  It  also  notes  that 
understanding  different  levels  of  cost  pass-through  is  crucial  for  well  targeted  carbon  leakage 
measures  that  provide  adequate  safeguards,  but  avoid  over-compensation  of  industry  for  costs 
recovered in the market. 

The  analysis  below  estimates  the  impacts  of  option  packages  on  the  biggest  industrial  sectors 
included in the EU ETS225, and compares the outcome under each option package to 'Baseline B'. 
Figure  11  shows  the  ranking  of  sectors  in  terms  of  emissions  in  the  EU  ETS  and  their  carbon 
leakage status according to the present carbon leakage list in phase 3. 

Figure 11: Ranking of sectors in terms of emissions in EU ETS 

Certain elements of the free allocation provisions may be determined in implementing legislation 
and furthermore the quantities to be provided depend on future data. The following analysis uses 
some assumptions for the carbon leakage status of sectors, technological progress and production 
level  changes  based  on  the  best  available  data at the time  of  the  analysis.  The  results  therefore 
have to be regarded as purely indicative. 

225 The five sectors with the highest amount of emissions are analysed: iron and steel, cement, refineries, chemicals 
and fertilisers. These five sectors account for around three quarters of industry emissions covered by the EU ETS. 

170 

 
 
 
                                                           
7.1. 

Effect of carbon leakage groups on sectors 

Option packages 'Baseline A' and 'Simple' do not foresee differentiation among sectors in terms 
of level of carbon leakage risk. All installations receive 30% of the 'gross' free allocation226 under 
'Baseline A', and 90% under the 'Simple' option package. 

The  other  three  option  packages  foresee  a  differentiation  among  sectors,  and  correspondingly 
different levels of free allocation. 

'Baseline B' and 'Baseline Bbis' reflect the continuation of the current approach where sectors are 
either deemed to be exposed to a significant risk of carbon leakage (in which case they are added 
to  the  'carbon  leakage  list'),  or  not.  Under  these  option  packages,  it  is  expected that  the carbon 
leakage list would continue to include sectors covering the vast majority of industrial emissions, 
and consequently the demand for free allocation, the so called 'gross' free allocation, would result 
in a higher risk of applying the correction factor.  

'Baseline  Bbis'  delivers  similar  results  as  'Baseline  B'  except  for  those  sectors  with  very  low 
carbon intensity that will change into the 'low' risk group.This will have a very small impact on 
the  fross  free  allocation  as  these  sectors  together  represent  around  2%  of  total  industrial 
emissions. In order to avoid repetition to the extent feasible, the outcome of the 'Baseline Bbis' 
package  is  spelled  out  separately  in  the  analysis  below  only  for  those  aspects  where  there  are 
differences compared to the 'Baseline B'. 

The 'Limited changes' and 'Targeted' option packages translate into four carbon leakage groups: 
'Very  High',  'High',  'Medium'  and  'Low'  level  of  carbon  leakage  risk.  The  two  graphs  below 
illustrate these two approaches and indicate in which group the biggest sectors would be based on 
2009-2011 data227. For the purposes of this analysis, carbon leakage factors of 100%, 80%, 60% 
and  30%  is  applied  for  the  'Very  high',  'High',  'Medium'  and  'Low'  carbon  leakage  groups, 
respectively.  

While  the  current  classification  of  sectors  into  risk  groups  is  based  on  quantitative  criteria  at 
sector  level,  the  final  composition  of  the  carbon  leakage  groups  may  also  be  affected  by 
assessments  at  sub-sector  level  (individual  assessments  of  products  within  sectors,  leading  to 
parts  of  certain  sectors  eventually  ending  up  in  a  higher  carbon  leakage  group)  or  possible 
assessments  based  on  qualitative  criteria228  (again  leading  to  a  classification  in  a  higher  risk 
group).  Consequently,  the  sectoral  analysis  results  presented  in  this  annex  for  the  'Limited 
changes'  and  'Targeted'  packages  are  lower  bound  estimates  for  the  expected  level  of  free 
allocation (see also discussion below in this annex). 

226 The amount of free allocation determined by applying the benchmark values to the production data, before the 
application of any further relevant factors, such as, for example, the carbon leakage factor. 
227 For the Aluminium, Fertilisers and Inorganic chemicals sectors the effect of ETS scope change as of 2013 is taken 
into account, as these sectors have been heavily affected by this scope extension. The graphs are purely indicative, as 
any actual assessment against the criteria will be based on more recent (for the time being: future) data. Furthermore, 
this analysis takes into account the NACE rev.2 classification (valid since 2008) without prejudice to future revisions 
of these classifications 
228 To avoid the cross sectoral correction factor (see point (b) below), some quantified limitations to the eligibility for 
qualitative assessments might need to be introduced.  

171 

 
 
                                                           
Figure 12: Indicative carbon leakage groups in the 'Limited changes' option package based on 2009-
2011 data 

Figure  13: Indicative carbon leakage groups in the  'Targeted' option package based on 2009-2011 
data 

The  following  two  tables  demonstrate  the  level  of  differentiation  by  the  four  option  packages 
with more than one group.  

below indicates how many sectors, and what share of 'gross' free allocation and gross value added 
(GVA) would  be in the different groups following a  sectoral  analysis based on the quantitative 
criteria foreseen in these packages. 

172 

 
 
 
 
Table  22 below indicates  how  many sectors,  and what share  of  'gross'  free  allocation and  gross 
value added (GVA) would be in the different groups following a sectoral analysis based on the 
quantitative criteria foreseen in these packages. 

Table  22:  Estimated  number  of  sectors,  share  of  gross  free  allocation  and  GVA  in  the  different 
groups 

Baseline B 

# 
sectors 

'gross' 
alloca-
tion 

Baseline Bbis 

GVA 

# 
sectors 

'gross' 
alloca-
tion 

GVA 

Limited changes 
'gross' 
alloca-
tion 

# sectors 

Very High 

150 

95% 

66% 

54 

93% 

18% 

High 

Medium 

Low 

86 

5% 

34% 

182 

7% 

82% 

178 

Targeted  

# 
sectors 

5 

9 

21 

201 

'gross' 
alloca-
tion 

33% 

49% 

11% 

8% 

GVA 

2% 

5% 

5% 

88% 

GVA 

2% 

5% 

10% 

83% 

4 

12 

42 

33% 

32% 

32% 

3% 

The table below shows in which group the 15 industrial sectors with the highest emissions would 
be, based on 2009-2011 data, for the option packages containing more than one carbon leakage 
group229.  In  Baseline  B  and  Bbis  'on'  means  included  in  the  carbon  leakage  list,  'off'  means 
excluded. 

Table 23: Estimated carbon leakage status at sectoral level based on past data 

Code  Activity description 

24.10 

Manufacture of basic iron and steel and of ferro-
alloys  

23.51  Manufacture of cement 

19.20  Manufacture of refined petroleum products 

20.14  Manufacture of other organic basic chemicals 

20.15 

Manufacture of fertilisers and nitrogen 
compounds 

06.10 

Extraction of crude petroleum 

23.52  Manufacture of lime and plaster 

17.12  Manufacture of paper and paperboard 

24.42 

Aluminium production 

23.32 

Manufacture of bricks, tiles and construction 
products, in baked clay 

23.13  Manufacture of hollow glass 

20.13  Manufacture of other inorganic basic chemicals 

20.11  Manufacture of industrial gases 

10.81  Manufacture of sugar 

23.31  Manufacture of ceramic tiles and flags 

Baseline B 

Baseline 
Bbis 

Limited 
changes 

Targeted 

On 

On 

On 

On 

On 

On 

On 

On 

On 

Off 

On 

On 

On 

On 

On 

On 

On 

On 

On 

On 

On 

On 

On 

On 

Off 

On 

On 

On 

On 

On 

Very high 

Very high 

Medium 

High 

High 

High 

High 

High 

Very high 

Very high 

Medium 

Medium 

Medium 

Medium 

High 

High 

Very high 

Very high 

Medium 

Low 

High 

High 

Medium 

High 

High 

Medium 

High 

Low 

Medium 

High 

229  As  said  above,  the  table  is  only  indicative,  as  any  actual  assessment  against  the  criteria  will  be  based  on  more 
recent (for the time being future) data. In addition, parts of sectors will be in a higher carbon leakage group based on 
assessments at sub-sector (Prodcom) level. 

173 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                           
7.2. 

Cross sectoral correction factor 

It is estimated that three out of the six option packages are not likely to trigger a correction factor 
in phase 4:  

 

In 'Baseline A' all installations would receive 30% of their 'gross' allocation for free, and 
thus only a relatively limited share of the allowances available for free allocation would 
be actually allocated. The correction factor would not be triggered in this case. 

  The  'Limited  changes'  and  the  'Targeted'  would  lead  to  a  relatively  focused  allocation 
system230 and therefore the correction factor would not be triggered in these cases either. 

Under  'Baseline  B'  and  'Baseline  Bbis'  the  total  amount  of  "gross  allocation"  is  estimated  to 
exceed  significantly  the  amount  available,  by  an  average  factor  of  some  10-20%  over  phase 4, 
leading to some 30% by 2030. 

Also under the 'Simple' package the total amount of "gross allocation" is estimated to exceed the 
amount  available,  but  to  a  lesser  extent.  The  correction  factor  could  be  triggered  from  around 
2024 onwards in this case, with an average of some 5-10% over phase 4 and reaching some 20% 
by 2030. 

In  conclusion,  it  is  estimated  that  in  three  of  the  six  option  packages  (Baseline  A,  Limited 
changes and Targeted) a correction factor in phase 4 may be avoided.   

7.3. 

Estimated level of free allocation for biggest sectors in phase 4 

The estimated level  of free  allocation resulting  from the option packages is  analysed below for 
the main ETS sectors. The analysis is done on the sectoral level, and therefore the end-result for 
individual  installations  might  be  different.  The  sectoral  level  results  presented  below  are 
indicative  of  the  estimated  situation  for  the  average  installations  in  each  sector.  More  efficient 
installations  are  expected  to  have  a  better  outcome,  while  installations  less  efficient  than  the 
average can have a less favourable outcome than what is indicated below. 

The graph below illustrates the estimated combined effect of the carbon leakage groups and the 
correction factor based on 2009-11 data231.  

230 For the purposes of the analysis it is assumed that  some quantified limitations to the eligibility for assessments 
based on the qualitative criteria will be introduced.  
231  See  point  (a)  and  (b)  above.  As  data  from  the  (currently:  future)  baseline  period  for  any  actual  future  carbon 
leakage  assessment  are  not  yet  available  at  the  time  this  estimation  is  prepared,  the  graphs  should  be  interpreted 
purely as a rough indicator of the possible outcome of the option packages. The final outcome of the actual carbon 
leakage  assessment,  i.e.  to  which  group  each  sector  will  belong,  can  be  similar  to  the  situation  illustrated  by  the 
graphs below in case the main indicator values (emission intensity and trade intensity) in the future will be similar to 
the ones based on 2009-11 data. 

174 

 
 
                                                           
Figure  14:  Estimated  combined  effect  of  carbon  leakage  groups  and  the  correction  factor  under 
different option packages232 

Free  allocation  depends,  in  addition  to  the  effects  of  carbon  leakage  groups  and  a  potential 
correction  factor,  also  on  benchmarks.  The  combined  effect  of  these  three  elements  is  assessed 
below, and the estimated free allocation per sector is compared to the estimated emissions233.  

In the 'Simple', 'Limited changes' and 'Targeted' packages free allocation is closely aligned with 
actual  production levels.  This implies  that in  case production in a sector  increases compared to 
the  baseline  level,  both  emissions  and  free  allocation  will  increase.  Similarly,  in  case  of  a 
production decrease, both emissions and free allocation will decrease. 

Therefore, under the 'Limited changes' and 'Targeted' packages, the difference between emissions 
and free allocation is predominantly driven by the stringency of the benchmarks234 and the carbon 
leakage factor. In the 'Simple' package, the difference between emissions and free allocation will 
depend  on the stringency of the updated benchmarks235, the 90%  carbon leakage  factor  applied 
for all sectors, and the correction factor. 

232  The  table  is  of  a  purely  indicative  nature,  as  any  actual  assessment  against  the  carbon  leakage  criteria  will  be 
based on more recent (for the time being future) data. In addition, the final composition of the carbon leakage groups 
might  also  be  shaped  by  assessments  at  sub-sector  (Prodcom)  level  and  possibly  also  assessments  based  on 
qualitative criteria. 
233 Future  emissions of sectors are based on the estimate in  the Impact Assessment for the Communication on the 
climate  and  energy  policy  framework  up  to  2030,  SWD(2014)15.  This  includes  output  growth  changes  consistent 
with  the  modelling  done  for  the  2030  Climate  and  Energy  framework,  including  assumptions  for  factors  such  as 
technological development. 
234  I.e.  the  difference  between  the  average  emission  intensity  of  production  in  a  sector  vs.  the  average  emission 
intensity of the 10% best performers in the same sector. 
235 i.e. the relation between the average emission intensity in a sector vs. the updated benchmark value 

175 

 
 
 
                                                           
Finally, as under current rules, sectors may be re-classified in a higher carbon leakage group as a 
result  of  assessments  based  on  qualitative  criteria,  and  sub-sectors  may  be  re-classified  in  a 
higher  carbon  leakage  group  as  a  result  of  Prodcom-level  assessments.  However,  due  to  data 
limitations, the outcome of analyses based on qualitative criteria and Prodcom-level assessments 
is currently difficult to assess. Consequently, the sectoral analysis results presented in this annex 
are  lower  bound  estimates  for  the  expected  level  of  free  allocation  under  the  'Limited  changes' 
and 'Targeted' packages236.  

One  general  result  valid  for  all  sectors  is  that  the  legal  baseline  ('Baseline  A')  would  lead  to 
substantially lower free allocation compared to 'Baseline B'. It is estimated that less than a third 
of the sectors' emissions would be covered by free allocation under 'Baseline A'. The results from 
'Baseline Bbis' are similar to 'Baseline B' except for those ca.100 sectors that would be removed 
from  the  current  carbon  leakage  list,  but  as  noted  above,  the  total  quantity  of  emissions  from 
these sectors is small, in the order of 2% of industrial emissions.  

Therefore,  the  outcome  of  the  'Baseline  A'  and  'Baseline  Bbis'  packages  is  not  separately 
described  per  sector  below.  The  estimations  on  how  large  share  of  the  respective  sector's 
emissions  will be  covered, outlined below, are determined from the values  in  Figure 14 above, 
combined with estimations on the stringency of the benchmarks. 

Iron and steel sector 

The iron and steel sector would be in the 'Very high' carbon leakage group under both 'Limited 
changes' and 'Targeted' packages237. 

Overall,  the  steel  sector  is  expected  to  receive  the  highest  free  allocation  under  the  'Limited 
changes' and 'Targeted' packages, and a significantly higher free allocation than under 'Baseline 
B',  as  these  packages  would  put  the  sector  in  the  100%  group  but  still  not  trigger  a  correction 
factor since some other sectors receive somewhat less than in Baseline B. Free allocation under 
the 'Simple' package is estimated to be similar to the outcome of 'Baseline B'.  
Free allocation is expected to cover at least some two-thirds of the sector's emissions eligible238 
for free allocation,  including  also the additional emissions  (due to  the higher carbon content of 
waste gases than that of natural gas) taking place in installations importing waste gases from the 
steel sector, under all the four packages discussed above.  

Cement sector 

The cement sector would be in the 'Medium' carbon leakage group under the 'Limited changes' 
package, and in the 'High' group under the 'Targeted' package based on historic data239.  

236 The possibility of product-level assessments does not affect the outcome of the other option packages for the 
sectors analysed in detail: under 'Baseline B' all of them are on the carbon leakage list anyway, and under the 
'Simple' package there is no carbon leakage differentiation  
237 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the steel sector would 
be reduced by 12% on average if recalculated based on new performance data. It is also assumed that production will 
moderately increase compared to 2014 level (last available data at the time of the analysis), but will not reach avg. 
2005-08 levels by 2017.  
238  Emissions  from  electricity  production  are  not  eligible  for  free  allocation  with  the  exception  of  emissions 
exceeding the emissions related to the fuel replaced by waste gases. 
239 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the cement sector 
would be reduced by 6% on average if recalculated based on new performance data. It is also assumed that 
production will moderately increase compared to 2014 level (last available data at the time of the analysis), but will 
not reach avg. 2005-08 levels by 2017.  

176 

 
 
 
                                                           
Overall, the cement sector is expected to receive the highest free allocation under the 'Baseline B', 
'Simple' and 'Targeted' packages. The 'Limited changes' package is expected to offer a somewhat 
lower  free  allocation  to  this  sector  due  to  the  sector  possibly  being  in  the  'Medium'  carbon 
leakage group.  

Nevertheless, free allocation is expected to cover the majority of the sector's emissions under all 
four packages. 

Refineries 

The refineries sector would be in the 'High' carbon leakage group under both  'Limited changes' 
and ''Targeted' packages based on historic data240.  

Overall, the refineries sector is expected to receive a similar level of free allocation under all four 
option  packages  described,  with  the  'Simple'  package  possibly  offering  somewhat  higher  free 
allocation than the other packages. Free allocation is expected to cover at least some two-thirds  
of the sector's emissions under all four packages. 

Chemicals 

The  chemical  sectors  would  also  be  in  the  'High'  carbon  leakage  group  under  both  'Limited 
changes' and 'Targeted' packages241.  

Overall, the chemicals sector is estimated to receive a somewhat higher free allocation under the 
'Simple' package than under the other option packages. At the same time, the difference between 
the estimated free allocation under the four packages is limited. In case some chemical products 
would  be  re-classified  to  the  'Very  high'  carbon  leakage  group  following  product  level 
assessments (which is deemed probable), the free allocation offered by the 'Limited changes' and 
'Targeted'  packages  could  be  higher  than  free  allocation  under  the  'Baseline  B'  and  'Simple' 
packages.  

Free allocation is expected to cover at least some three-quarters of the sector's emissions under all 
four packages. 

Fertilisers 

The fertilisers and nitrogen compounds sector would be in the 'Very high' carbon leakage group 
under both 'Limited changes' and 'Targeted' packages242. 

Overall, the fertilisers sector is expected to receive the highest level of free allocation under the 
'Limited changes' and 'Targeted' packages, and significantly higher than under 'Baseline B'. The 
'Simple' package is estimated to have a similar outcome as 'Baseline B'.  

Free allocation is expected to cover at least some three-quarters of the sector's emissions under all 
four packages.  

240 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the refineries sector 
would be reduced by 15% if recalculated based on new performance data. 
241 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the chemicals sector 
would be reduced by 15% on average if recalculated based on new performance data. It is also assumed that 
production levels in 2013-17 will be similar to those experienced in the baseline years in phase 3.  
242 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the fertilisers sector 
would be reduced by 15% on average if recalculated based on new performance data (a significant reduction is 
assumed for the nitric acid benchmark due to the significant reductions of N2O emissions experienced in recent 
years, and a moderate reduction is assumed for the ammonia benchmark). It is also assumed that production levels in 
2013-17 will be similar to those experienced in the baseline years in phase 3.  

177 

 
 
                                                           
Glass 

The hollow glass sector would be in the 'High' carbon leakage group under the 'Limited changes' 
package,  and  in  the  'Medium'  group  under  the  'Targeted'  package,  whereas  the  flat  galss  sector 
would be in the 'High' group in both cases based on historic data243.  

Overall, glass production is expected to receive the highest free allocation under the 'Baseline B', 
'Simple' and 'Limited changes' packages. The 'Targeted' package is expected to offer a somewhat 
lower free allocation due to the hollow glass sector possibly being in the 'Medium' carbon leakage 
group. 

Free allocation is  expected to  cover  at least some two-thirds of the sector's emissions  under all 
four packages.  

Paper 

The paper sector would be in the 'High' carbon leakage group under both 'Limited changes' the 
'Targeted' packages244. 

Overall,  the  paper  sector  is  expected  to  receive  the  highest  free  allocation  under  the  'Simple' 
option package. The 'Limited changes' and 'Targeted' packages are estimated to offer somewhat 
lower free allocation than 'Baseline B'. Nevertheless, free allocation is estimated to cover at least 
some 90% of the sector's emissions under all four packages, due to a high use of biomass.  

Aluminium 

The  aluminium  sector  would  be  in  the  'Very  high'  carbon  leakage  group  under  both  'Limited 
changes' and 'Targeted' packages245. 

Overall, the aluminium sector is expected to receive the highest free allocation under the 'Limited 
changes'  and  'Targeted'  packages,  and  under  both  packages  the  sector  is  expected  to  receive  a 
significantly higher free allocation than under 'Baseline B', as these packages would not trigger a 
correction  factor.  Free  allocation  under  the  'Simple'  package  is  estimated  to  be  similar  to  the 
outcome of 'Baseline B'.  

Free allocation is expected to cover at least some three-quarters of the sector's emissions.  

General findings for all sectors covered by EU ETS 

It can be concluded that the 'Simple' package offers a similar level of free allocation as 'Baseline 
B' for the industry sectors currently on the carbon leakage list. In the 'Simple' package there are 
some  limited  differences  among  sectors  in  terms  of  free  allocation  compared  to  'Baseline  B', 
because  of  the  different  effects  of  the  flat-rate  benchmark  update  for  different  sectors,  due  to 
different  rates  of  emission  intensity  reductions  resulting  from  technological  improvements  and 
investment cycles. 

243 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the glass sector would 
be reduced by 6% on average if recalculated based on new performance data. It is also assumed that production 
levels in 2013-17 will be similar to those experienced in the baseline years in phase 3.  
244 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the paper sector 
would be reduced by 15% on average if recalculated based on new performance data. It is also assumed that the 
average production levels in 2013-17 will be similar to those experienced in the baseline years in phase 3.  
245 For the purposes of the analysis it is assumed that the values of the benchmarks relevant for the aluminium sector 
would be reduced by 6% on average if recalculated based on new performance data. It is also assumed that the 
average production levels in 2013-17 will be similar to those experienced in the baseline years in phase 3. 

178 

 
 
 
                                                           
At the same time, the 'Simple' option package would lead to significantly higher free allocation 
than 'Baseline B' for those sectors currently not on the carbon leakage list, such as district heating 
and some other services (e.g. gas compression, storage and transport). 

For  the  'Limited  changes'  and  the  'Targeted'  packages  the  level  of  free  allocation  compared  to 
'Baseline  B'  highly  depends  on  the  carbon  leakage  group  of  a  sector.  Both  packages  lead  to  a 
higher  free  allocation  than  'Baseline  B'  for  the  sectors  in  the  'Very  high'  group,  because  it  is 
estimated that no correction factor would apply due to the more targeted approach.  

For  sectors  (and  sub-sectors)  in  the  'High'  carbon  leakage  group,  the  total  amount  of  free 
allocation under the 'Limited changes' and the 'Targeted' packages would be similar to allocation 
under 'Baseline B'. This is because the difference in carbon leakage factors (80% instead of 100% 
under  'Baseline  B')  is  estimated  to  be  in  the  same  order  of  magnitude  as  the  estimated  average 
correction  factor  under  'Baseline  B'  over  phase  4.  The  distribution  of  free  allocation  within  the 
period  would  be  different  though:  somewhat  lower  level  of  free  allocation  at  the  beginning  of 
phase  4  under  these  two  option  packages  than  what  'Baseline  B'  would  offer,  and  vice  versa 
towards the end of the phase. 

For sectors (and sub-sectors) in the 'Medium' and 'Low' groups, free allocation under the 'Limited 
changes'  and  the  'Targeted'  packages  would  be  lower  or  significantly  lower,  respectively,  than 
under 'Baseline B' provided that they would be on the carbon leakage list under 'Baseline B'. For 
sectors not on the carbon leakage list, such as district heating, free allocation would be similar for 
the 'Low' group, and higher for the 'Medium' group. 

7.4. 

Estimated compliance cost per sector, taking into account cost pass through 

The total cost of allowances to be purchased by sectors can be estimated based on the difference 
between emissions and free allocation as well as the expected carbon price.  

The compliance costs borne by sectors are also affected by the share of costs passed through by 
sectors  to  their  customers.  In  other  words:  the  actual  compliance  cost  for  sectors  is  ultimately 
dependent on their ability to pass through carbon costs to their customers without losing market 
share.  Furthermore  the  ETS  Directive  already  recognises  that  the  level  of  carbon  leakage  risk 
possibly faced by sectors depends on the extent to which it is possible for these sectors to pass 
through their costs without losing market share.  

Although  there  is  general  understanding  that  most  carbon-intensive  sectors  are  able  to  pass 
through at least a part of the carbon costs, it remains at this stage difficult to quantify the exact 
rate  of  costs  passed  through  per  sectors  or  products.  In  addition,  the  ability  of  sectors  to  pass 
through costs might not be stable over time: as market conditions change, the extent to which it is 
possible to pass on costs by sectors might also change. 

A  thorough  overview  of  available  empirical  evidence,  complemented  by  recent  research 
(described in section 7.3.5.1. and Annex 9), illustrates a wide range of different cost pass-through 
rates  for  different  industrial  sectors  and  different  products.  These  empirical  data  based  on  10 
years of operation of the EU ETS are indicative of the potential cost pass-through in the future.  

It  is  recognized  that  some  industrial  sectors  may  face  increasing  competitive  pressure  on  the 
international  markets,  potentially  making  it  more  challenging  for  them  to  sustain  existing  pass-
through rates. At the same time, it is reasonable to assume that climate policies will become more 
significant in third countries over time, which could lead to increased, or at least stable, cost pass-
through rates.  

Following  the  sectoral  analysis  above,  it  seems  that  free  allocation  will  not  fully  cover  sectors' 
emissions.  At  the  same  time,  while  the  difference  between free  allocation  and  emissions  varies 

179 

 
 
across option packages and sectors, in most cases the free allowances are estimated to cover the 
majority of projected emissions. 

Considering that a share of carbon costs is likely to be passed through, this significantly reduce 
the total compliance costs. Combined with free allocation, several sectors can be expected to have 
hardly  any  direct  carbon  costs  under  most  option  packages.  There  may  even  be  a  risk  that  the 
compliance  costs  are  more  than  fully  alleviated  which  might  lead  to  windfall  profits  in  some 
cases. 

The two-step analysis below covers the biggest sectors.  
First,  the  difference  between  forecasted  emissions246  and  free  allocation  is  estimated,  and 
multiplied  by  an  expected  average  carbon  price  in  phase  4  (€  25).  This  indicates  the  estimated 
maximum compliance cost per sector, i.e. in case they are not able to pass through any carbon 
costs  to  their  customers.  This  estimated  maximum  compliance  cost  is  also  compared  to  the 
sector's present turnover247 as an indication of the relative importance of compliance costs in the 
overall cost structure of the sector concerned. 

As  a  second  step,  the  same  indicators  are  calculated  based  on  the  lowest  estimated  cost  pass-
through rates found in existing literature248. Given the methodological difficulties to estimate the 
cost pass-through rates per sector, these results should be regarded only as indicative. 

Iron and steel sector 

Assuming  no  ability  to  pass  on  any  carbon  costs  to  its  consumers,  the  iron  and  steel  sector  is 
estimated to face direct carbon costs of some € 1.5 billion per year on average in phase 4 in the 
'Baseline B' scenario. This equals to around 1% of the sector's turnover. 

The  'Simple'  package  is  estimated  to  lead  to  some  € 100 million  per  year  savings  compared  to 
'Baseline B'.  

The  'Limited  changes'  and  ‘Targeted’  packages  are  estimated  to  lead  to  a  saving  of  some 
€ 650 million  per  year  compared  to  'Baseline  B'  for  the  sector,  due  to  the  increased  free 
allocation, decreasing maximum direct carbon costs to ca. 0.5%-0.6% of the turnover.  

Using  the  weighted  average  minimum  cost  pass-through  rate  identified in  the  literature  for  the 
sector, the sector is expected to be able to pass-through all its compliance costs to its customers. 

Cement sector 

Assuming no ability to pass on any carbon costs to its consumers, i.e. in the worst case scenario 
for the sector, the cement sector is estimated to face compliance costs of some € 680 million per 
year on average in phase 4 in the 'Baseline B' scenario. This equals to around 4% of the sector's 
turnover. 

The 'Simple' package is estimated to lead to some € 80 million per year additional costs compared 
to 'Baseline B', leading to some € 760 million, or 4.5% of the turnover in total.  

The  'Limited  changes'  package  is  estimated  to  lead  to  maximum  some  € 580  million  additional 
costs  per  year,  increasing  compliance  costs  up  to  about 7.6%  of  the  turnover.  The  'Targeted' 

246  Emission  forecasts  are  based  on  the  Impact  Assessment  accompanying  the  policy  framework  for  climate  and 
energy in the period from 2020 up to 2030 
247  For  this  analysis,  the  average  2011-2012  turnover  is  used,  i.e.  data  from  the  two  most  recent  years  for  which 
Eurostat data on turnover are available at the time of the analysis. The option of also comparing the compliance costs 
with Profit margins have been considered, but due to its large variations over the year it was deemed not to be an 
adequate indicator. 
248 For more information please see Table 33 in Annex 9. 

180 

 
 
                                                           
package  is  estimated  to  lead  to  additional  costs  of  some  € 80  million  per  year  for  the  sector, 
compared to 'Baseline B', increasing compliance costs to some 4.5% of the turnover.  

Using  the  weighted  average  minimum  cost  pass-through  rate  identified in  the  literature  for  the 
sector (35%), the compliance costs the sector might be facing are estimated to maximum about 
€ 270 million, or 1.6% of the turnover, under the 'Limited changes' option package249. Under the 
other  option  packages  the  sector  would  be  estimated  to  pass  on  all  compliance  costs  to  its 
customers, using the cost pass-through rates found in literature for the estimation.  

Refineries 

Assuming  no  ability  to  pass  on  any  carbon  costs  to  its  consumers,  the  oil  refining  sector  is 
estimated to face direct carbon costs of some € 950 million per year on average in phase 4 in the 
'Baseline B' scenario. This equals to around 0.1% of the sector's turnover. 

The 'Simple' option package is estimated to lead to a saving of about € 130 million for the sector 
compared to 'Baseline B'.  

The 'Limited changes' and the 'Targeted' packages are expected to lead to some € 50 million and 
some € 80 million additional costs per year, respectively. Compliance costs are expected to stay 
below 0.2% of the turnover in both cases.  

Using  the  weighted  average  minimum  cost  pass-through  rate  identified  in  the literature  for  the 
sector, the sector is expected to be able to pass on all compliance costs to its customers under all 
four option packages. 

Chemicals 

Assuming  no  ability  to  pass  on  any  carbon  costs  to  its  consumers,  the  chemicals  sector  is 
expected to face direct carbon costs of some € 290 million per year on average in phase 4 in the 
'Baseline B' scenario. This equals to around 0.2% of the sector's turnover. 

The 'Simple', 'Limited changes' and 'Targeted' packages are estimated to lead to similar results as 
'Baseline B', with direct carbon costs reaching some 0.2% of the sector's turnover in all cases.  

Using  the  lowest  cost  pass-through  rate  identified  in  the  literature  for  the  sector,  the  sector  is 
expected  to  be  able  to  pass  on  all  compliance  costs  to  its  customers  under  all  four  option 
packages.  

Fertilisers 

Assuming no ability to pass on any carbon costs to its consumers, the fertilisers sector is expected 
to face compliance costs of some € 250 million per year on average in phase 4 in the 'Baseline B' 
scenario. This amounts to around 1% of the sector's turnover. 

The 'Simple' option package is expected to lead to a saving of some € 40 million per year for the 
sector compared to 'Baseline B'. The 'Limited changes' and 'Targeted' packages are  expected to 
lead to some € 130 and € 120 million savings per year, respectively, thanks to the increased free 
allocation, decreasing compliance costs to some 0.5% of the turnover.  

Using  the  weighted  average  minimum  cost  pass-through  rate  identified in  the  literature  for  the 
sector, which is 0, the results are identical.  

249 This is the high estimate. In reality, clinker production might be added to a higher carbon leakage group at 
Prodcom-level, leading to higher free allocation for the sector – and consequently lower compliance costs under this 
options package, as well.  

181 

 
 
                                                           
Glass 

Assuming no ability to pass on any carbon costs to its consumers, the glass sector is estimated to 
face direct carbon costs of some € 90 million per year on average in phase 4 in the 'Baseline B' 
scenario. This equals to around 0.4% of the sector's turnover. 

The  'Simple'  and  'Limited  changes'  packages  are  estimated  to  lead  to  additional  costs  of  some 
€ 10 million per year compared to 'Baseline B'. The compliance costs would reach some 0.5% of 
the sector's turnover in these cases.  

The 'Targeted' package is estimated to lead to additional costs of some € 50 million per year for 
the sector compared to 'Baseline B', increasing compliance costs to some 0.7% of the turnover. 

Using  the  weighted  average  minimum  cost  pass-through  rate  identified in  the  literature  for  the 
sector,  the  sector  is  estimated  to  be  able  to  pass  on  the  majority  of  compliance  costs  to  its 
customers under all four option packages. Nevertheless, the sector is estimated not to be able to 
pass on some € 60 million per year (some 0.3% of the turnover) under the ‘Targeted’ package, if 
using the lowest cost pass-through rate identified in literature. 

Paper 

Assuming  no  ability  to  pass  on  any  carbon  costs  to  its  consumers,  the  paper  and  paperboard 
sector is estimated to face compliance costs of some € 30 million per year on average in phase 4 
in the 'Baseline B' scenario. This amounts to less than 0.1% of the sector's turnover. 

Compliance costs of the sector are estimated to stay below 0.1% of the sector’s turnover under all 
four option packages, thanks to the extensive use of biomass. 
Using the lowest cost pass-through rate identified in the literature for the sector, which is 0250, 
the results are identical.  

Aluminium 

Assuming  no  ability  to  pass  on  any  carbon  costs  to  its  consumers,  the  aluminium  sector  is 
estimated to face direct carbon costs of some € 70 million per year on average in phase 4 in the 
'Baseline B' scenario. This amounts to around 0.2% of the sector's turnover. 

The 'Simple' option package is estimated to lead to additional costs of some € 10 million per year 
compared to 'Baseline B'. The 'Limited changes' and 'Targeted' packages are estimated to lead to 
some  € 50  million  savings  per  year,  thanks  to  the  increased  free  allocation,  decreasing 
compliance costs to below 0.1% of the turnover.  
Using the lowest cost pass-through rate identified in the literature for the sector, which is 0251, 
the results are identical.  

In conclusion, for seven of the eight sectors analysed (excluding cement), compliance costs are 
estimated up to 1% of turnover under all option packages, assuming no cost pass through. Using 
the conservative assumption of the lowest cost pass-through rate from the literature, the part of 
the  compliance  costs  faced  by  sectors  (i.e.  not  passed-through  to  custumers)  is  lower,  in  many 
cases  even  fully absorbed by  the customers. Using the highest cost pass-through rates  found in 
literature, all sectors analysed would be expected to gain windfall profits. 

250 Data for paper sector  not included in Table 33 in Annex 9 
251 Data for aluminium sector  not included in Table 33 in Annex 9 

182 

 
 
 
 
                                                           
Table  24  Overview  table  on  estimated  compliance  cost  per  sector,  taking  into  account  cost  pass-
through rates  

Additional 
compliance 
cost252 
compared to 
Baseline B 
(million €) 
0 
-100 
-680 
-630 
0 
80 
580 
80 
0 
-130 
50 
80 
0 
-80 
40 
50 
0 
-40 
-130 
-120 
0 
10 
10 
50 

% of 
turnover 

Without Cost pass 
through rates 
compliance 
cost 
(million €) 
1.530 
1.430 
850 
900 
680 
760 
1.260 
760 
950 
820 
1000 
1.030 
290 
200 
320 
340 
250 
210 
110 
130 
85 
95 
95 
140 

1,0% 
0,9% 
0,5% 
0,6% 
4,1% 
4,5% 
7,6% 
4,5% 
0,1% 
0,1% 
0,2% 
0,2% 
0,2% 
0,1% 
0,2% 
0,2% 
1,0% 
0,8% 
0,4% 
0,5% 
0,4% 
0,5% 
0,5% 
0,7% 

% of 
turnover 

With lowest cost pass 
through rates 
compliance 
cost 
(million €) 
-1.300 
-1.400 
-1.990 
-1.930 
-310 
-240 
270 
-230 
-190 
-320 
-140 
-110 
-100 
-190 
-70 
-50 
120 
80 
-20 
0 
10 
20 
20 
60 

-0,8% 
-0,9% 
-1,2% 
-1,2% 
-1,9% 
-1,4% 
1,6% 
-1,4% 
0,0% 
-0,1% 
0,0% 
0,0% 
-0,1% 
-0,1% 
0,0% 
0,0% 
0,5% 
0,3% 
-0,1% 
0,0% 
0,0% 
0,1% 
0,1% 
0,3% 

0 
-40 
20 
20 

0 
10 
-50 
-50 

30 
-10 
40 
50 

70 
80 
10 
20 

0,0% 
0,0% 
0,1% 
0,1% 

0,2% 
0,2% 
0,0% 
0,0% 

30 
-10 
40 
50 

70 
80 
10 
20 

0,0% 
0,0% 
0,1% 
0,1% 

0,2% 
0,2% 
0,0% 
0,0% 

Steel 

Cement 

Baseline B 
Simple 
Limited changes 
Targeted 
Baseline B 
Simple 
Limited changes 
Targeted 

Refineries  Baseline B 

Simple 
Limited changes 
Targeted 

Chemicals  Baseline B 

Simple 
Limited changes 
Targeted 

Fertilisers  Baseline B 

Glass 

Paper 

Simple 
Limited changes 
Targeted 
Baseline B 
Simple 
Limited changes 
Targeted 
Baseline B 
Simple 
Limited changes 
Targeted 

Aluminium  Baseline B 

Simple 
Limited changes 
Targeted 

7.5. 

Sensitivity analysis 

A sensitivity analysis is performed on two parameters. 

252 Negative values indicate savings 

183 

 
 
 
  
  
  
 
 
  
 
 
  
 
 
  
 
 
  
 
 
  
 
 
 
 
 
 
 
 
 
 
                                                           
1) Carbon price. The estimates presented above are based on an estimated average price of € 25 
over  phase  4.  The  sensitivity  analysis  is  performed  for  a  price  range  of  € 10 and  € 40  (i.e.  +/- 
€ 15). The results indicate that compliance costs to be faced by sectors are estimated to stay under 
2% of turnover for four (out of eigth) of the sectors analysed, and would reach some 12% of the 
turnover  for  the  cement  sector  in  the  worst  case  scenario  in  case  the  sector  is  not  able  to  pass 
through any carbon costs to its customers.  

Table  25  Sensitivity  analysis  of  compliance  costs  compared  to  sector  turnover  at  different  carbon 
prices 

With lowest cost pass-through 
rate 
€ 25 
-0,8% 
-0,9% 
-1,2% 
-1,2% 
-1,9% 
-1,4% 
1,6% 
-1,4% 
0,0% 
-0,1% 
0,0% 
0,0% 
-0,1% 
-0,1% 
0,0% 
0,0% 
0,5% 
0,3% 
-0,1% 
0,0% 
-0,1% 
-0,1% 
-0,1% 
-0,1% 
0,0% 
0,0% 
0,1% 
0,1% 
0,2% 
0,2% 
0,0% 
0,0% 

€ 40 
-1,3% 
-1,4% 
-2,0% 
-1,9% 
-3,0% 
-2,3% 
2,6% 
-2,2% 
0,0% 
-0,1% 
0,0% 
0,0% 
-0,1% 
-0,2% 
-0,1% 
0,0% 
0,7% 
0,5% 
-0,1% 
0,0% 
-0,2% 
-0,1% 
-0,1% 
-0,1% 
0,1% 
0,0% 
0,1% 
0,1% 
0,3% 
0,3% 
0,1% 
0,1% 

€ 10 
-0,3% 
-0,3% 
-0,5% 
-0,5% 
-0,7% 
-0,6% 
0,7% 
-0,6% 
0,0% 
0,0% 
0,0% 
0,0% 
0,0% 
0,0% 
0,0% 
0,0% 
0,2% 
0,1% 
0,0% 
0,0% 
-0,1% 
0,0% 
0,0% 
0,0% 
0,0% 
0,0% 
0,0% 
0,0% 
0,1% 
0,1% 
0,0% 
0,0% 

Without cost pass-through 

Steel 

Cement 

Refineries 

Chemicals 

Fertilisers 

Glass 

Paper 

Baseline B 
Simple 
Limited changes 
Targeted 

Baseline B 
Simple 
Limited changes 
Targeted 

Baseline B 
Simple 
Limited changes 
Targeted 

Baseline B 
Simple 
Limited changes 
Targeted 

Baseline B 
Simple 
Limited changes 
Targeted 

Baseline B 
Simple 
Limited changes 
Targeted 

Baseline B 
Simple 
Limited changes 
Targeted 

Aluminium  Baseline B 

Simple 
Limited changes 
Targeted 

€ 10 
0,4% 
0,4% 
0,2% 
0,2% 
1,6% 
1,8% 
3,0% 
1,8% 
0,1% 
0,1% 
0,1% 
0,1% 
0,1% 
0,0% 
0,1% 
0,1% 
0,4% 
0,3% 
0,2% 
0,2% 
0,2% 
0,2% 
0,2% 
0,3% 
0,0% 
0,0% 
0,0% 
0,0% 
0,1% 
0,1% 
0,0% 
0,0% 

€ 40 
1,5% 
1,4% 
0,8% 
0,9% 
6,5% 
7,3% 
12,1% 
7,3% 
0,2% 
0,2% 
0,2% 
0,3% 
0,2% 
0,2% 
0,3% 
0,3% 
1,5% 
1,3% 
0,7% 
0,8% 
0,7% 
0,8% 
0,7% 
1,1% 
0,1% 
0,0% 
0,1% 
0,1% 
0,3% 
0,3% 
0,1% 
0,1% 

€ 25 
1,0% 
0,9% 
0,5% 
0,6% 
4,1% 
4,5% 
7,6% 
4,5% 
0,1% 
0,1% 
0,2% 
0,2% 
0,2% 
0,1% 
0,2% 
0,2% 
1,0% 
0,8% 
0,4% 
0,5% 
0,4% 
0,5% 
0,5% 
0,7% 
0,0% 
0,0% 
0,1% 
0,1% 
0,2% 
0,2% 
0,0% 
0,0% 

184 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2)  Production  levels.  Since  in  the  'Simple',  'Limited  changes'  and  'Targeted'  packages  free 
allocation is closely aligned with actual production levels, under these packages the changes of 
production  level  will  influence  less  the  relative  outcome  of  compliance  costs  compared  to 
turnover. This is because in case production in a sector increases compared to the baseline level, 
emissions,  free  allocation  and  turnover  will  all  increase.  Similarly,  in  case  of  a  production 
decrease, emissions, free allocation and turnover will all decrease. 

It can thus be concluded that the results are not sensitive for production level changes. 

Finally,  the  dissemination  of  new  technologies  over  time  may  well  result  in  a  step-change  in 
some sectors and will in general bring down costs. However, it is difficult to estimate when such 
technologies  would  be  generally  available  for  sectors,  and  therefore  no  sensitivity  analysis  is 
performed on the effect of possible future breakthrough technological improvements. 

185 

 
 
 
8. 

IMPACTS OF DIFFERENT OPTION PACKAGES FOR FREE ALLOCATION: ADMINISTRATIVE 
BURDEN AND SOCIAL IMPACTS 

8.1. 

Analysis of administrative burden 

For the purpose of the impact assessment, administrative costs are defined as the costs incurred 
by  operators  and  regulators  to  maintain  the  system.  These  do  not  include  compliance  costs 
required for purchasing allowances.  

A  summary  of  the administrative  cost  assessment  is  available  below,  focusing  on  the  operators 
and regulators (public authorities) at Member State and Community level, compared to 'Baseline 
B'.  

In  terms  of  methodology,  the  level  of  administrative  complexity  was  quantified  using  the  EU 
Standard Cost Model. The assignment of sectors and sub-sectors into carbon leakage groups is a 
one-off exercise based on European statistics. Based on previous experience, it can be estimated 
that  this  requires  resources  in  the  order  of  magnitude  of  up  to  2  million  €  (same  order  of 
magnitude as NIMs data check, see below). 

It  can  be  assumed  that  the  update  of  benchmark  values  (either  by  uniform  factors  or  collected 
performance  data)  has  hardly  any  impact  on  administrative  costs  if  the  data  collection  is 
combined with the NIMs data collection. 

Table 26: Estimated administrative costs for additional NIMs exercises: 

Activity 
data collection & 
reporting 

Actor 

No of 
actors 

No. cost 
units 

unit  

unit cost 

total cost 

installation 

11.000 

10  person-day 

 € 300 

 € 33.000.000  

verification 
data check & allocation 
decision 
data check & (non-) 
rejection 

installation 
Competent 
authorities 

Commission 

11.000 

28 

1 

Total costs 

10 

2  person-day 
person-
year 
person-
year 

10 

 € 800 

 € 17.600.000  

 € 100.000  

 € 28.000.000  

 € 150.000  

 € 1.500.000  

 € 80.100.000  

186 

 
 
 
 
 
 
 
Table 27: Estimated additional annual administrative costs for production level adjustments 

Activity for annual 
adjustments 

data collection & 
reporting 

verification 
data check & allocation 
decision 
data check & (non-) 
rejection 
Total annual costs for 
annual adjustments 
Activity for capacity 
changes 
data collection & 
reporting 

verification 
data check & allocation 
decision 
data check & (non-) 
rejection 
Total annual costs for 
capacity changes 
Activity for partial 
cessations 
data collection & 
reporting 

verification 
data check & allocation 
decision 
data check & (non-) 
rejection 
Total annual costs for 
partial cessations 

Actor 

No. of 
actors 

No. cost 
units 

unit 

unit cost 

total cost 

installation 

2.000  

installation 
Competent 
authorities 

Commission 

2.000  

28 

1 

installation 

installation 
Competent 
authorities 

Commission 

installation 

installation 
Competent 
authorities 

Commission 

300  

100  

28 

1 

 500  

500  

28 

1 

person-
day 
person-
day 
person-
year 
person-
year 

2 

0,5 

2 

2 

person-
day 
person-
day 
person-
year 
person-
year 

10 

5 

1 

1 

person-
day 
person-
day 
person-
year 
person-
year 

2 

0,5 

1 

0,5 

 €  300  

 € 1.200.000  

 € 800  

 € 800.000  

 € 100.000  

 € 5.600.000  

 € 150.000  

 € 300.000  

 € 7.900.000  

 € 300  

 € 900.000  

 € 800  

 € 400.000  

 €100.000  

 € 2.800.000  

 € 150.000  

 € 150.000  

 € 4.250.000  

 € 300  

 € 300.000  

 € 800  

 € 200.000  

 € 100.000  

 € 2.800.000  

 € 150.000  

 € 75.000  

 € 3.375.000  

187 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Table 28: Estimated administrative costs for harmonised rules for indirect cost compensation (additional 
costs compared to national compensation currently applied in 6 MSs as baseline) 

Activity 
data collection & 
reporting 

Actor 

installation 

verification 
data check & 
compensation decision 

installation 
Competent 
authorities 

approval 

Commission 

No of 
actors 

No. cost 
units 

unit  

unit cost 

total cost 

700 

700 

22 

1 

5  person-day 

 € 300 

 € 1.050.000  

2 

2  person-day 
person-
year 
person-
year 

2 

 € 800 

 € 1.120.000  

 € 100.000  

 € 4.400.000  

 € 150.000  

 € 300.000  

 € 6.870.000  

Total one-off costs 

Annual adjustments 
data collection & 
reporting (capacity 
changes) 
verification (capacity 
changes) 
data check & 
compensation decision 
(capacity changes & 
allowance price) 

installation 

70 

2  person-day 

 € 300 

€ 42.000 

installation 

70  0.5 

person-day 

 € 800 

€ 28.000 

Competent 
authorities 

22  1 

approval 

Commission 

1  0.2 

Total annual costs 

Total costs 

person-
year 
person-
year 

 € 100.000  

€ 2.200.000 

 € 150.000  

€ 30.000 

€ 2.300.000 

€ 27.570.000 

In conclusion, the option packages 'limited changes' and 'targeted' lead to higher costs compared 
to  baseline  B  (82  million  €  for  'limited  changes'  and  110  million  €  for  'Targeted')  reflecting  a 
higher  level  of  administrative  complexity  (due  to  additional  NIMs  exercise).  The  annual 
adjustment  for  significant  production  level  changes  is  not  expected  to  trigger  substantial 
additional  administrative  costs  as  they  replace  the  activities  required  for  baseline  B  (capacity 
changes and partial cessations). For that reason, the administrative costs of the ''Simple' package' 
and baseline B are not expected to differ significantly. The 'Targeted' package shows the highest 
administrative complexity due to the mandatory financial support for indirect cost compensation. 

8.2. 

Analysis of social impacts 

8.2.1.  Employment 

In order to put the analysis into context, the figure below demonstrates the level of employment 
by selected energy-intensive industries in the Member States. 

188 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Figure 15: Employment in selected energy-intensive industries 

Source: Eurostat 

For the assessment of impacts of different policy option packages on employment in the sectors 
concerned, following method is applied253: 

  Consideration of direct costs for all sectors as compared to 'Baseline B'. A sector-specific 
analysis  is  not  considered  feasible  and  proportionate  given  the  expected  rather  limited 
impacts. 

  Two main impacts on employment are considered: the results of additional carbon costs 
absorbed by the sectors, and the results of decreasing sales due to passing through of costs 
in higher prices (i.e. costs not absorbed by the sector). 

  Data  on  employment,  labour  costs  and  cost  pass  through  for  the  most  relevant  sectors 
covered by the ETS sectors are considered to be a good estimate of the related figures for 
the ETS sectors as a whole. 
Impacts  of  direct  costs  on  production  levels  are  estimated  using  the  price  elasticity  of 
demand. Changes in production levels lead to changes in employment. 

 

  Estimating the impacts of direct costs not passed through is very difficult as these costs 
could be absorbed by companies – depending on their individual profitability and business 
strategy – reducing profits and/ or labour costs by reducing employment. For the purpose 
of  this  impact  assessment,  it  is  assumed  that  100%  of  the  additional  costs  after  the 
provision  of  free  allowances  are  absorbed  through  reducing  employment.  This  is  a high 
estimate of the real impacts. 

This methodology is expected to deliver estimates at the high end of the likely order of magnitude 
of the impacts due to the rather simplifying underlying assumptions, e.g. that labour costs could 
be easily reduced in reaction to costs not passed through. 

253 A detailed description of the methodology and data used is provided in the ICF International, Umweltbundesamt, 
SQ Consult, Ecologic Institut, Vivid Economics and ZEW on-going work.  

189 

 
 
 
 
                                                           
The results of these estimates are summarised for costs passed through and not passed through in 
the two following tables. 

Table  29:  Estimated  employment  impacts  of  policy  option  packages  compared  to  baseline  B  from  the  pass 
through of additional costs (annual average for 2021 – 2030, underlying assumptions in italics) 

Baseline A 

Simple 

Limited 
changes 

Targeted 

7668 

78% 

5981 

-1263 

78% 

-985 

-883 

78% 

-689 

-658 

78% 

-513 

0.43% 

-0.07% 

-0.05% 

-0.04% 

-0.336 

-0.336 

-0.336 

-0.336 

-2010 

-4180 

331 

688 

231 

481 

172 

359 

-0.10% 

0.02% 

0.01% 

0.01% 

Additional direct 
costs (M€) 

% of costs passed 
through 

Costs passed 
through (M€) 

Increase in costs 
(prices) in % 

Demand price 
elasticity 

Changes in sales 
(M€) 

Changes in jobs 
from cost pass 
through 

Changes in jobs 
as % of total jobs 

Table  30:  High  estimate  of  employment  impacts  of  policy  option  packages  compared  to  baseline  B  from 
additional costs absorbed (annual average for 2021 – 2030, underlying assumptions in italics) 

Baseline A 

Simple 

7668 

22% 

1687 

-29211 

-1263 

22% 

-278 

4811 

Limited 
changes 

-883 

22% 

-194 

3364 

Targeted 

-658 

22% 

-145 

2507 

-0.73% 

0.12% 

0.08% 

0.06% 

Additional direct 
costs (M€) 

% of costs absorbed 

Costs absorbed (M€) 

Changes in jobs 
from costs absorbed 
(high estimate) 

Changes in jobs as 
% of total jobs 

The  total  employment  impact  is  estimated  by  summing  the  two  employment  impacts  described 
above. The employment impact is largely determined by the choices made by the companies to 

190 

 
 
 
 
 
 
absorb  those  costs  that  cannot  be  passed  on  through  higher  prices.  It  should  also  be  noted  that 
underlying assumptions for the figures in Table 30 lead to rather high estimates. 

Nevertheless, the estimated impacts are very limited. For the option packages 'Simple',  'Limited 
changes'  and  'Targeted',  small  positive  impacts  on  employment  compared  to  baseline  B  are 
expected in the order of magnitude of up to 5000 jobs, representing an increase of 0.1%. 

The  employment  impact  of  Baseline  A  is  slightly  negative  reflecting  the  additional  cost  for 
companies. In the worst case where all absorbed costs are reflected in a reduction in wages, the 
option results in a loss of employment of some 30,000 jobs as average of the 2021 – 2030 period, 
equivalent to 0.8%. 

In  the  lower  estimate  case,  where  all  absorbed  costs  are  reflected  in  changed  profits,  the  total 
employment  impact  will  reflect  the  consequences  of  the  costs  passed  through.  In  this  case,  the 
employment impacts are negligible.  

8.2.2.  Energy prices for households 

The focus of this assessment is on  energy prices in terms of  heat (in particular district heating) 
rather than electricity, as these policy option packages do not directly affect the power sector.   

For  the  assessment  of  impacts  of  policy  option  packages  on  heat  prices  for  private  households 
following method is applied254: 

  Forecast of heat demand based on results from the PRIMES model (Reference Scenario 

2013); 

  Application of heat benchmark and applicable carbon leakage factor for the heat producer 

(lowest carbon leakage group); 

  Use of heat prices from Euroheat 2013 country survey, with prices scaled up to average 

during Phase 4 period using natural gas price trends from above document; and 

  Full cost pass through assumed. 

The results compared to package Baseline B are presented in table below.  

Table 31: Analysis of impacts of policy option packages on the district heating sector 2021-30   

Parameter 

Units 

Baseline B  Baseline A  Simple 

Limited 
changes 

Targeted 

EU heat production 

EU heat prices (baseline) 

Mtoe/yr 

PJ/yr 

€/GJ 

56 

2352 

28 

Heat benchmark 

tCO2/TJ 

53.0 

56 

2352 

28 

62.3 

56 

2352 

28 

53.0 

56 

2352 

28 

53.0 

Avg. carbon leakage factor 

Avg. cross sector 
correction factor 

% 

% 

Free allocation 

MtCO2/yr 

32 

30% 

30% 

90% 

30% 

15% 

0% 

44 

7% 

104 

0% 

37 

56 

2352 

28 

51.7 

9% 

0% 

11 

254 A detailed description of the methodology and data used is provided in the ICF International, Umweltbundesamt, 
SQ Consult, Ecologic Institut, Vivid Economics and ZEW on-going work. 

191 

 
 
                                                           
Parameter 

Units 

Baseline B  Baseline A  Simple 

Limited 
changes 

Targeted 

Value of free allocation 

€M/yr 

795 

1099 

2608 

935 

274 

Difference in free 
allocation vs Baseline B 

Impact on heat prices vs 
Baseline B 

Impact on heat prices vs 
Baseline B 

€M/yr 

€/GJ 

% of price 

- 

- 

- 

+304 

+1814 

+140 

-521 

-0.13 

-0.77 

-0.06 

+0.22 

-0.5% 

-2.8% 

-0.2% 

+0.8% 

Overall, the estimated impacts of the 'Simple' and 'Limited changes' option packages, as well as 
of baseline A compared to Baseline B, are reductions in heat prices of € 0.77/GJ (almost 3% of 
baseline price) for 'Simple' and less significant reductions for 'Limited changes' and baseline A. 
Only the 'Targeted' package is expected to increase the heat prices of € 0.22/GJ (0.8% of baseline 
price).  

The  'Simple'  option  package  results  in  the  highest  reduction  due  to  the  significantly  more 
generous carbon leakage factor compared to Baseline B which outweighs the effect of a reduced 
benchmark value. The limited cost reduction for 'Limited changes' and  Baseline A results from 
the fact that no cross-sectoral correction factor is expected for these options. 

The  'Targeted' option package  only grants  very limited  free allocation to district  heating due to 
the declining carbon leakage factor, which is on average only 9% in phase 4. 

192 

 
 
9. 

LITERATURE REVIEW ON COST-PASS THROUGH RATES

255 

The cost pass-through rate can be generally described as the change in output price in response to 
a change in input costs and serves in the literature as a means to assess competitiveness effects 
and  potential  output  or  carbon  leakage.  Cost  pass-through  influences  two  main  elements  of 
competitiveness: profit margins and market shares (IEA, 2008). 

The discussion about cost pass-through in product prices started shortly after the introduction of 
the EU ETS in 2005. Already in 2005, Sijm et al. (2005) conducted empirical analysis showing 
that the opportunity costs of freely obtained allowances in the electricity market seemed to have 
been  passed  through  to  consumers  resulting  in  windfall  profits  for  electricity  producers.  These, 
and  other,  studies  have  resulted  in  the  decision  (made  in  2008)  that  in  Phase  3  electricity 
producers would no longer receive free allowances.  

Since  the  publication  of  the  revised  EU  ETS  Directive  in  2009,  a  few  empirical  studies  have 
indicated that not only power producers but also energy intensive industries would pass through 
the opportunity costs of their freely obtained allowances into the product prices. While this initial 
research efforts show results that are relevant for the way the EU ETS addresses carbon leakage, 
they are also preliminary and suffer from  methodological  and data issues.  However, they show 
that to some extent cost pass-through of freely obtained allowances seemed to have happened in 
the industry as well.  

The  literature  overview  in  this  Annex  is  oriented  on  cost  pass-through  in  the  EU  ETS,  with  a 
special emphasis on cost pass-through in industrial sectors. This literature can be categorized in 
three different areas:  

i. 
ii. 
iii. 

Theoretical studies on cost pass-through; 
Ex-ante empirical studies on cost pass-through; and 
Ex-post empirical studies on cost pass-through. 

The theoretical studies often deal with  the conditions under which  firms can  pass through their 
costs and the impact of a change in these conditions on the cost pass-through rates.  

Empirical assessments for cost pass-through have been attempted from different angles: 

  ex-ante  research,  which  employs  calibrated  partial  or  general  economic  models  to 

simulate the impact of hypothetical carbon pricing; 

  ex-post  studies,  which  use  econometrics  and  other  tools,  including  industry  surveys,  to 

assess historical cost pass-through. 

Ex-ante modelling studies aim to assess the future effect of unilateral climate policies and mostly 
have  the  advantage  to  account  for  (global)  economic  interaction  (in  case  of  whole  economy 
models) or include detailed technology choices to meet a given demand (partial models). Unless 
they  are  macro-econometric  models  they  require  data  for  one  base  year  only  and  are  based  on 
number  of  specific  assumptions  relating  to  producer  and  consumer  behaviour  (supply  and 
demand  elasticities)  and  production  technologies  (input  substitution,  technological  progress) 
which in themselves influence the outcome of the modelling exercise.  

In  contrast,  ex-post  studies  have  the  benefit  of  using  historical  data  to  assess  real-world 
phenomena.  Ex-post  studies  would  either  require  an  econometric  approach  to  reveal  the  cost 
pass-through  ratio  or  to  use  surveys.  Both  of  these  methods  have  their  pros  and  cons. 

255 Based on the Interim Report of the Study on different pass-through factors to assess the impact of the EU ETS 
carbon cost,, CE Delft, Oko-Institut, 2015 (ongoing work) 

193 

 
 
 
                                                           
Econometric approaches tend to be precise but require a sufficiently large set of either time series 
or cross-sectional data and a careful specification of the model equations. Moreover, econometric 
analysis  is  oriented  on  hypothesis  testing  which  may  limit  interpretations.  Most  of  the 
econometric analysis is involved in rejecting the null hypothesis of no-cost pass-through. If this 
hypothesis  is  rejected,  it  is  clear  that  there  is  evidence  of  cost  pass-through.  However,  if  this 
hypothesis is not rejected it is not a direct evidence that the costs are not passed through.  

The alternative would be to apply qualitative methods such as surveys and interviews. These are 
capable of capturing key trends or developments that are often more difficult to obtain via the use 
of  simplified  indicators.  However,  depending  upon  the  research  question,  the  advantage  of 
qualitative approaches can also be a limitation as it is difficult to make assumptions beyond the 
opinions  captured  for  a  specific  group  of  participants.  Moreover,  strategic  behaviour  in 
responding and adverse selection are among the two most important problems that plague studies 
based on surveys.  

9.1. 

Theoretical studies on cost pass-through  

Cost pass-through is a widely debated topic in the field of unilateral climate policies. First, this is 
because unilateral climate policies may impose costs to industries which would make them less 
competitive. Unilateral climate policies may then lead to impacts on profit margins and/or market 
shares.  If  costs  are  not  passed  through,  then  firms  need  to  bear  the  additional  costs  and  their 
profits will fall potentially affecting investment decisions and competitiveness in the longer term. 
If  costs  are  passed  through  and  result  in  higher  product  prices,  this  may  affect  production  and 
competitiveness  (market  shares)  as  follows:  domestic  demand  may  be  lost  as  consumers  may 
decide to buy alternative and less expensive domestic substitutes or imported products (only the 
latter effect is associated with carbon leakage); and export shares may be lost to countries that are 
not subject to comparable policies (Graichen et al., 2008).  

However, cost pass-through has most fiercely been discussed in relation to opportunity costs of 
free  allowances.  It  has  been  argued  that  companies  that  receive  free  allowances  up  to  the 
benchmark  would  still  pass  through  the  opportunity  costs  of  these  allowances  forward  into 
product prices. From an economic perspective this may even seem rational. Firms are engaged in 
marginal cost pricing (and not in average cost pricing). Firms that price in an additional unit of 
production may therefore, on average, need to pass in the carbon costs as the ETS guarantees that 
there is an individual carbon constraint for each company. In economic theory, one could show 
that firms that do not pass through the marginal costs of production increases have a larger risk of 
being uncompetitive (see e.g. CE Delft, 2010).  

This  result  can  be  generalized  to  the  fact  that,  according  to  economic  theory  under  perfect 
competition,  industries  should  pass-through  their  costs.  However,  the  amount  and  conditions 
under which firms pass through their costs may be dependent on a number of conditions.  

Cost pass-through rates depend on the market structure and the elasticities of demand and supply 
(Sijm et al., 2009). Extending the theoretical discussion further to estimate cost pass-through for 
unilateral  cost  increases,  CE  Delft  (2010)  argues  in  the  context  of  the  EU  ETS  that  even  if 
initially  the  additional  carbon  cost  is  fully  passed  through,  the  impact  of  imports  from  other 
countries will ultimately lower the total price increase in sectors that are exposed to international 
competition. This argument is based upon the ‘Law of One Price’ principle, which assumes that 
markets are perfectly integrated with identical commodities having the same price internationally. 
However, as indicated by Armington (1969) perfectly integrated markets rarely occur as products 
produced in different countries are often imperfect substitutes due to product differentiation and 
transportation costs. 

194 

 
 
In the real world of less than perfect competition (and less than perfectly integrated markets and 
uncertainty  over  supply  and  demand  elasticities)  an  empirical  analysis  is  necessary  in  order  to 
translate theory of cost pass-through into reality.  

Sijm  (2009),  CE  Delft  (2010b)  and  Varma  et  al.,  (2012)  outlined  the  main  factors  influencing 
whether, and to which extent, costs may be passed-through: 

  Market structure (or market power) refers to the number of firms in the market and the 
level  of  state  intervention  either  by  regulation  or  direct  ownership.  The  structure  of  the 
market  determines  the  level  of  competition  between  firms  and  influences  the  ability  of 
firms  to  pass  on  additional  CO2  costs  without  losing  market  share.  Sijm  et  al.  (2009) 
derive  the  result  that  in  general  cost  pass-through  in  competitive  markets  can  be  higher 
than in monopolistic markets. The monopolist aims to maximize profits and is therefore 
willing to sacrifice output. On oligopolistic markets the ability to pass-through the costs 
will depend on the pricing strategy and the utilisation rates (CE Delft, 2010b). If capacity 
is fully utilized, full cost pass-through is likely. It is also conceivable that price increases 
are not immediately passed over to the customers, but price decreases of inputs are then 
used as balancing mechanism (Conforti, 2004). 

  Supply  and  demand  elasticities  refer  to  the  degree  to  which  supply  or  demand  of  a 
product responds to  a  change  in  price.  If the demand elasticity  of a product is zero (i.e. 
rigid  demand)  then  additional  CO2  costs  can  be  passed  through  with  no  risk  of  a  firm 
losing market share.256 

  Exposure to international trade may also influences the ability of a firm to pass-through 
additional  CO2  costs  (Varma  et  al.,  2012).  For  example,  if  the  exposure  of  a  firm  to 
international  trade  is  low,  higher  product  prices  due  to  passing  through  additional  costs 
may  not  impact  the  competitiveness  of  the  firm.  However,  the  trade  exposure  might 
actually differ within the EU, as  for production located in  the centre of the EU demand 
might  exclusively  be  within  the  EU  while  for  production  located  at  the  periphery 
competition with less expensive production units outside the EU is much stronger.  

Reinaud  (2008)  provides  an  overview  of  further  factors  driving  cost  pass-through:  market 
tightness,  for  example,  refers  to  the  availability  of  production  capacity  outside  of  the  EU  for 
supply  to  the  EU.  Spare  capacity  outside  of  the  EU  might  be  employed  to  provide  cheaper 
products  if  European  producers  pass-through  cost.  On  the  other  hand,  if  foreign  production 
capacity  is  tight  domestic  cost  pass-through  might  not  affect  the  market  share  of  European 
producers.  Furthermore,  demand  and  supply  cycles  affect  the  ability  to  pass-through  costs:  In 
case demand exceeds supply (positive cycle) companies may pass-through cost. Independent of 
carbon  policies, 
industry  commodities  prices  have  shown  cyclical  variations.  Product 
differentiation is closely related to the above mentioned demand elasticities and also affects cost 
pass-through.  If  products  are  homogenous,  then  demand  will  react  sensitive  to  any  change  in 
price whereas in the case of specialty products, higher prices may not divert demand. Similarly, 
contractual  agreements  might  inhibit  cost  pass-through  for  the  term  of  the  contract,  but 
companies may take account of this and agree to shorter term contracts only.  

9.2. 

Ex-ante empirical studies on the EU ETS 

The majority of ex-ante studies in the literature in the context of the EU ETS tend to focus on the 
economic effects of the unilateral climate policy, in particular on impacts on regulated industrial 
sectors (i.e. iron and  steel, cement and aluminium).  Ex-ante top-down modelling analyses were 

256  

Under iso-elastic demand curves, cost pass-through can be higher than 100%.  

195 

 
 
                                                           
used  in  the  Energy  and  Climate  package  (2008)  impact  assessment  to  assess  effects  on  GDP, 
value  added,  employment,  structural  changes  and  trade  in  response  to  a  more  stringent  cap  on 
ETS  emissions.  Bottom-up  modelling  was  used  to  derive  industry  specific  results  on  the  future 
energy  mix,  technology  choice  and  sectoral  production.  Moreover,  modelling  exercises  are 
devoted to assessing the risk of output or carbon leakage with the estimates showing a substantial 
range depending upon the modelling approach adopted, the underlying assumptions applied (i.e. 
trade  elasticities,  carbon  price)  and  the  specific  design  of  the  policy  scenario  (i.e.  emission 
reduction  target,  inclusion  of  preventative  measures)  (Kuik  and  Hofkes  (2010),  Carbon  Trust 
(2010), Ponssard and Walker (2008), Demailly and Quirion (2006), Demailly and Quirion (2008), 
Summerton et al. (2010)).  

been 

studies 

ex-ante 

in  response 

have 
to  unilateral  carbon  pricing.  Most  studies 

cost  
Not  many 
pass-through  rates 
into 
competitiveness  and  subsequent  potential  carbon  leakage  and  only  indirectly  touch  the  issue  of 
cost  pass-through  by  either  assuming  specific  pass-through  rates  or  taking  assumptions  on 
elasticities  for  demand,  supply  and  trade  and  for  the  market  structure.  Most  recently  Vivid 
Economics (2014), however, provided an estimation of cost pass-through rates based upon an ex-
ante analysis using a bottom-up partial modelling approach.  

assessing 
look 

explicitly 

devoted 

to 

Ex-ante studies outside the EU tend to develop scenarios for climate policies and their impact on 
specific  sectors,  such  as  Bassi  and  Yudken  (2009)  for  the  chemicals  sector  in  the  US  or 
Morgenstern et al. (2007) for the manufacturing sector in the US. 

To keep the focus of this literature review explicitly on cost pass-through rates we only highlight 
the approaches and results from those ex-ante studies that provide explicit estimates of cost pass-
through although we are aware that the literature on carbon leakage rates is closely linked. There 
are two studies that have provided empirical estimates of cost pass-through rates among a variety 
of sectors: McKinsey (2006) and Vivid Economics (2014).  

An initial assessment of cost pass-through rates was provided by McKinsey (2006) in a study that 
was  meant  to  provide  input  for  the  design  of  Phase  2  of  the  EU  ETS.  In  McKinsey  (2006)  a 
change  of  the  international  competitiveness  is  taken  as  a  change  in  operating  margin 
approximated  by  the  percentage  cost  increases  of  the  end  products.  Assuming  a  competitive 
power market with a full pass-through of CO2 costs into electricity prices and assuming that 95% 
of  the  required  allowances  are  grandfathered,  McKinsey  investigated  to  what  extent  the 
additional carbon costs could be passed through in product prices. Without detailed information 
how  they  arrived  at  their  conclusions,  they  presented  a  range  of  cost  pass-through  ratios  for  a 
number of sectors 257.  

A  more  recent  and  more  comprehensive  study  estimating  cost  pass-through,  output  and 
production leakage rates has been conducted by Vivid Economics (2014) based upon an ex-ante 
analysis using bottom up models. They analyse 24 sectors (thereof ten in detail) and specifically 
model cost pass-through as a function of the inside markets share (that is, market share of firms 
affected  by  the  cost  change)  and  an  indicator  for  market  structure  which  they  call  inverse 
competitiveness  and  which  yields  higher  cost  pass-through  as  the  market  becomes  perfectly 
competitive and  which  reduces  pass-through  as  the  market  becomes  first  oligopolistic  and  then 
collusive.  

257  Steel: BOF: 6% , EAF 66% of the additional cost can be passed through to customers;  Pulp & paper production: 
50% of the additional costs can be passed through in chemical pulping;  0 to 20% for paper from integrated processes 
can be passed through to customers. Cement from dry process: 0 to 15% of the additional cost can be passed through 
to customers. Refining:  25 to 75% of the additional cost can be passed through to customers. Aluminium: 0% of the 
additional cost can be passed through to customers. 

196 

 
 
                                                           
They conclude that cost pass-through rates vary significantly by sector. Specifically, “the rate of  
cost pass-through is one if there are no outside firms and the market is perfectly competitive. As 
inside firms are introduced, the cost pass-through rate falls. If margins are high for the number of 
firms  present,  the  cost  pass-through  rate  falls  further.  Less  than  perfect  competition  occurs  in 
most  markets,  and  may  reflect  a  concentration  of  ownership  of  firms  (many  firms  having  the 
same owner, that is, being associated firms), product differentiation, or a small number of firms” 
(Vivid Economics, 2014).  

In  particular,  they  find  that  the  aluminium  sector  is  associated  with  low  levels  of  cost  pass-
through  (absorb  more  than  80%  of  the  cost  increase)  due  to  the  fact  that  the  commodity  is  1) 
traded on a global market 2) has a very low weight to value ratio and 3) there is sufficient global 
capacity. In contrast, the malt sector is identified as being able to fully pass-through their carbon 
costs as a consequence of the absence of non-EU competition. As shown in  

Figure  16, the majority of the other sectors considered in the  study were estimated to have cost 
pass-through rates above 75%, however it is noted within the study that high pass-through rates 
do  not  necessarily  prevent  firms  from  experiencing  cost  shocks  that  impact  upon  their 
competitiveness.  In  addition,  simplified  assumptions  within  the  modelling  (i.e.  all  firms  treated 
the same regardless of geographical location) means that in reality cost pass-through rates may be 
lower  for  firms  located  on  the  coast  or  nearer  to  non-EU  borders.  The  authors  stress  that  their 
results represent upper bound estimates. 

Figure 16 
reduced and full detail (2020, € 15/tCO2) 

Cost pass-through rates derived by Vivid Economics (2014) in sectors investigated in 

Note:   RIMM refers to their Reduced Industrial Market Model while FIMM refers to their Full Industrial Market 
Model. 

9.3. 

Ex-post empirical studies for the EU ETS 

Given  the  relatively  short  time  period  that  the  EU  ETS  has  been  in  operation,  the  amount  of 
empirical  data  remains  limited  but  is  growing  and  recently  published  articles  have  been 
attempting to verify the findings of ex-ante modelling. Based upon different sources of empirical 
data (i.e. trade data, employment data, qualitative data) and different ex-post analysis techniques 
(i.e. econometric analysis, surveys) several authors have attempted to assess the impact of the EU 

197 

 
 
 
 
ETS  on  various  aspects  of  competitiveness  (i.e.  trade,  employment,  innovation)  and  leakage, 
including cost pass-through.  

Based upon empirical data from the first two phases of the EU ETS attempts have been made in 
the literature (Alexeeva-Talebi, 2010; Oberndorfer et. al., 2010; CE Delft, 2010; Walker, 2008) to 
estimate  the  extent  to  which  costs  have  been  passed  through  into  product  prices.  These  price 
based studies either look into the correlation of industry-specific input costs and prices (cost-price 
approach) or into the correlation of industry-specific prices in the EU versus countries outside of 
the EU (e.g. USA) and carbon prices (market equilibrium approach). While prices on output are 
usually available on a monthly or even weekly basis, input costs for specific industries are more 
challenging to obtain.  

Applying the cost-price approach, Alexeeva-Talebi (2010) finds that producers of cement, lime & 
plaster  are  capable  of  passing  through  the  majority  of  additional  costs  and  also  identify  a  wide 
range of cost pass-through rates that exist across the different sectors (i.e. 0 to 75%), see Table 32 
In  another  study,  Aleexeva-Talebi  (2011)  estimates  that  EU  refineries  fully  passed-through  the 
price of allowances on petrol prices between 2005 and 2007.   

Using  the  same  approach,  Oberndorfer  et  al.  (2010)  show  for  the  UK  that  industries  passed-
through additional costs in a wide range from 0% (container glass) up to 100% (LPDE) and more 
(ceramic goods), using weekly data for 2005-2006 for refineries and monthly data for the period 
2001-2007 for others. A pass-through rate of larger than 100% might result from certain market 
characteristics and can be interpreted as a complete pass-through of policy induced carbon costs.  

The  studies  by  Alexeeva-Talebi  (2010)  and  Oberndorfer  et  al.  (2010)  calculate  different  cost 
pass-through rates for hollow glass, which reflects the use of different data, different lengths of 
their time series and/or different specification of their estimated equations (i.e. which input costs 
the authors consider in their estimation on the one hand side and which commodity prices (retail, 
consumer) are to be explained). Walker (2008) also employs the cost-price approach to look into 
cost  pass-through  for  the  cement  sector  in  various  EU  MS.  He  finds  that  cost  pass-through  is 
lowest in countries on the periphery Portugal (0%), Italy (<10%) and Greece (<11%) and higher 
in more centrally located countries as well as UK. These studies and their results are summarised 
in Table 32.  

Employing  the  market  equilibrium  approach  and  monthly  price  data  from  2001  until  2009  CE 
Delft (2010) finds that energy-intensive industries such as iron and steel, refining and chemicals 
actually passed through a large fraction of the allowances price to product prices, compare Table 
32. 

Other ex-post econometric studies do not specifically tackle cost pass-through rates but estimate 
the impact of the EU ETS on employment, output or revenue using panel or cross sectional data 
(e.g. Abrell et al. 2011; Commins et al., 2011; Anger and Oberndorfer, 2008), and are not further 
investigated in this review.  

Another  strand  of  literature  employs  survey  or  interview  techniques  with  individual  firms  to 
assess  the  effects  of  the  EU  ETS.  These  surveys  or  interviews  usually  cover  a  wide  range  of 
implementation, 
questions  related 
organisational set-up to shifts in production or capacity utilization, effects on profit, production 
location  or  carbon  leakage.  Explicit  questions  on  cost  pass-through  were  not  addressed  or 
answered. A very nice and comprehensive summary of these studies can be found for example in 
Dechezlepêtre et al. (2014). 

the  EU  ETS  ranging  from  abatement  activities, 

to 

198 

 
 
Table 32 

Estimate of cost pass-through rates from ex-post econometric studies 

Study 

Study scope  Method 

Regression 

Alexeeva-Talebi 
(2010) 

Cost pass-
through in 
energy 
intensive 
industries 

Econometric 
analysis 

Cost approach: 
domestic producer 
price as function of 
foreign producer 
prices and domestic 
costs (labor, material, 
electricity - carbon 
price not included 

Dependent 
variable 
Domestic 
producer price 
index 

Alexeeva-Talebi 
(2011) 

Cost pass- 
through in EU 
petroleum 
markets 

Econometric 
analysis 

Cost approach, output 
price as function of 
EUA, oil price, 
exchange rate 

domestic 
output price: 
Euro-95-
unleaded petrol 

CE Delft (2010)  Cost pass-
through in 
energy 
intensive 
industries 

Econometric 
analysis 

Output price 
EU 

Market approach: 
assumes that price of 
inputs and output are 
globally linked 
through trade flows, 
thus prices in 
different regions 
depend on each other 

Walker (2008) 

Cost pass-
through in 
cement 

Econometric 
analysis 

Cost approach 

output price 

Explanatory 
variable 

  Import producer 
price index CIF 

(4-digit level) 

  Labor costs: 
gross wages 

indexed  

(2-digit level) 

  Energy: 

electricity 

producer price 

index 

  Material cost 

index 
Input prices: 
- EUA 
- Crude oil price 
(Brent) 
- Exchange rate" 

Output price USA, 
long-term 
equilibrium bw EU 
and US product 
prices, CO2 price, 
exchange rate, 
crude oil price, 
DOW Jonas and 
AEX stock indices 
input prices 

Oberndorfer 
(2010) 

Cost pass-
through in 
energy 
intensive 

Econometric 
analysis 

Cost approach: for 
products other than 
diesel and gasoline 
carbon price not 

Output price 

Input prices/costs 
(see column data 
and data sources) 

199 

Country 

Time Period 

Sector 

Sector/Product 

DE 

Monthly data 
from January 
1995 to 
December 2008 

Paper 

Chemicals 

Glass 

Cement 

Paper and Paperboard 
Household and toilet paper 
Dyes and pigments 
Other basic inorganic chemicals 
Fertilizer and nitrogen compounds 
Plastic in primary forms 
Perfumes and toilet preparations 
Other rubber products 
Hollow glass 
Glass Fibres 
Other glass, processed, incl. 
Cement Lime and Plaster 

AT, BE, 
CZ, DK, 
FR, DE, 
GR, HU, 
IT, LT, 
NL, PT, 
ES, SE 
EU 

France 
Germany 
Italy 
UK 
Greece 
Portugal 
Spain 
UK; 
EU for 
chemicals 

Four weekly 
data: phase 1, 
16/09/2005 to 
22/03/2007, 
second trading 
period Jan2008 
to 2012 (Dec.??) 
Weekly (monthly 
for steel) data 
from 2001 to 
2009 (Chemicals 
from 2005 to 
2009); CO2 price 
second quarter 
2005 to 2009 

Refineries 

EU-95 unleaded petrol 

Refineries 

Chemicals 

Steel 

Gasoline 
Diesel 
Polyethylene (PE) 
Polystyrene (PS) 
Polyvinylchloride (PVC) 
Hot rolled coil 
Cold rolled coil 

Annual 1995-
2004 

Cement 

Weekly data on 
gasoline and 
diesel for 2005-
2006; glass and 

Refineries 

Chemicals 

Diesel 
Gasoline 
LPDE 
Ammonium 

Cost pass -
through 
0% 
>38% 
37% 
10% 
16% 
42% 
0% 
75% 
>60% 
27% 
24% 
73% 

likely full 
(100%) 

500% 
350% 
100% 
33% 
100% 
120% 
110% 

<30% 
<30% 
<10% 
<31% 
<11% 
0% 
<37% 
50% 
75% 
100% 
50% 

 
 
 
  
  
  
  
  
  
  
Study 

Study scope  Method 

Regression 

Dependent 
variable 

Explanatory 
variable 

Country 

Time Period 

Sector 

Sector/Product 

industries 

included (cost shock 
on other input costs) 

ceramics; 
chemicals 
monthly data 
2001-2007  

Glass 

Ceramics 

Hollow glass 
Container glass 
Ceramic goods 
Ceramic bricks 

Cost pass -
through 
20-25% 
0% 
>100% 
30-40% 

200 

 
 
In terms of methodological approach, the empirical literature on measuring cost pass-through in 
product prices  of energy intensive sectors in EU ETS, can  roughly be demarcated by whether a 
cost-price  approach  is  used  or  whether  a  market  equilibrium  approach  is  used.  Examples  of  the 
former  are  Alexeeva-Talebi  (2011,  2010),  Oberndorfer  (2010)  and  Walker  (2006).  Examples  of 
the latter are CE Delft (2010a, b). For both approaches, a measure of the elasticity of the price of 
an  output  in  an  energy  intensive  sector  with  respect  to  the  price  of  CO2  is  estimated  using 
econometrics  techniques  on  ex  post  data.  To obtain  an  indicator  for  the  extent  of  cost  pass-
through,  this  elasticity  then  is  compared  to  a  measure  for  the  CO2  intensity  of  production.  The 
indicator for the extent of pass-through of CO2 costs into product prices can be calculated as the 
ratio of the estimated elasticity divided by the CO2 intensity in production.  

9.4. 

Conclusions 

Cost  pass-through  has  been  analysed  primarily in  the  context  of  unilateral climate policies.  The 
topic of cost pass-through has been analysed from a theoretical, ex-ante and ex-post perspective. 
From  a  theoretical  perspective,  cost  pass-through  is  likely  for  profit  maximizing  firms,  but  the 
exact cost pass-through rates may depend on market power, elasticities of demand and supply and 
international  competition.  Most  of  the  economic  models  (e.g.  E3ME,  Ginfors,  GEM  E-3)  that 
have been used in the climate-policy arena indeed assume that costs can be fully passed through, 
independent of  whether these  are accounting  costs or  opportunity  costs. A  few studies  have  ex-
ante bottom-up analysed to what extent cost pass-through is likely. These studies show that there 
seems to be some room for cost pass-through but that this is below the 100%.  

Five  of  the  presented  studies  have  provided  evidence  for  cost  pass-through  from  an  ex-post 
perspective using econometric techniques. The studies show that a correlation analysis aiming at 
singling  out  the  effect  of  CO2  pricing  on  product  prices  still  provides  a  major  challenge. 
However, across all studies, it is evident that costs have  been passed  through  in the majority  of 
sectors, with the exact pass-through rates varying across studies.  

The table below presents a weighted average of cost pass-through rates from ex-ante and ex-post 
literature. Based on the literature review, several factors can be considered to influence the extent 
of cost pass-through: 

  Market Conditions, such as the amount of competition in the markets, trade intensities of 
the sectors that operate in these markets, price differentials in input-costs between EU and 
non-EU companies (e.g. energy costs) and/or price differentials in output prices. 

  Demand elasticities refer to the degree to which supply or demand of a product responds to 
a  change  in  price.  If  the  demand  elasticity  of  a  product  is  zero  (i.e.  rigid  demand)  then 
additional CO2 costs can be passed through with no risk of a firm losing market share. 

  Exposure  to  international  trade  also  influences  the  ability  of  a  firm  to  pass-through 

additional CO2 costs. 

  Product characteristics, such  as  costs  of  shipment  of  these products  (to  analyse  transport 

costs).  

  Capacitity  utilization  rates,  e.g.  expressed  as  utilisation  rates  (actual  production  over 

maximum production possible given technologies).   

201 

 
 
 
 
Overview  of  the  range  of  average  cost  pass-through  in  selected  sectors  from 

Table 33 
literature  
Sector 

Product 

Minimum  Maximum 

and 

steel 

Flat products 

60% 

100% 

Iron 
sector 

Cement 

Long products 

Portland 
white cement 

cement, 

66% 

35% 

Glass 

Container glass 

20% 

Hollow  and  other 
glass 

30% 

80% 

70% 

50% 

80% 

Refineries 

Petrol 

60% 

120% 

Diesel 

40% 

70% 

Petrochemicals 

Plastics,  PE,  PVC, 
PS 

25% 

80% 

Fertilizers 

Fertilizer 
nitrogen 
compounds 

and 

0% 

75% 

# 
of 
studies 
3 

2 

4 

2 

3 

5 

4 

3 

2 

Estimated in 

McKinsey(2006);  Vivid 
Economics  (2014);  CE 
Delft (2010) 
McKinsey(2006);  Vivid 
Economics (2014) 
McKinsey  (2006);  Vivid 
(2014); 
Economics 
Walker (2008); Alexeevi-
Talebi (2010) 
Vivid Economics  (2014); 
Oberndorfer (2010) 
Vivid Economics  (2014); 
Oberndorfer 
(2010); 
Alexeevi-Talebi (2010) 
McKinsey(2006);  Vivid 
Economics  (2014);  CE 
Delft  (2010);  Alexeevi-
Talebi 
(2011); 
Oberndorfer (2010) 
McKinsey  (2006);  Vivid 
Economics  (2014);  CE 
Delft 
(2010); 
Oberndorfer (2010) 
Delft 
CE 
Alexeevi-Talebi 
Oberndorfer (2010) 
Alexeevi-Talebi 
Oberndorfer (2010) 

(2010); 
(2010), 

(2010), 

The  values  from  this  table  must  be  interpreted  with  caution.  They  provide  a  range  of  average 
expected cost pass rates through based on a review of the literature. In this literature both ex-ante 
and ex-post estimates have been treated as a single observation from which an average has been 
calculated.  No  attempt  has  been  made  to  correct  for  the  number  of  regression  estimates  in  the 
literature.  

The literature also shows that actual cost pass-through rates – even within sectors - may greatly 
vary from product to product and country to country.  

202 

 
 
 
 
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Norwegian  electricity  market’.  Energy  economics,  Volume  34,  Issue  6,  November  2012,  Pages 
2003-2012. 

Morgenstern,  R.D.;  Aldy,  J.E.;  Herrnstadt,  E.M.;  Ho,  M.;  Pizer,  W.A.  (2007)  Competitiveness 
Impacts  on  Carbon  Dioxide  Pricing  Policies  on  Manufacturing;  Resources  for  the  Future: 
Washington, DC, USA. 

Sijm, J. et al (2009): The impact of power market structure on the pass-through of CO2 emissions 
trading costs to electricity prices – A theoretical approach. Energy Economics, Elsevier, Vol. 34, 
1143-1152 
Issue 
www.webmeets.com/files/papers/EAERE/2009/613/Sijm,%20Hobbs%20and%20Chen%20%282
009%29%20EAERE%20paper%20.pdf 

Pages 

2012, 

July 

4, 

204 

 
 
 
 
Summerton,  P.  et  al.  (2010):  Assessment  of  the  degree  of  carbon  leakage  in  light  of  an 
international agreement on climate change. A report for the Department of Ener-gy and Climate 
Change 
DECC 
www.decc.gov.uk/assets/decc/what%20we%20do/global%20climate%20change%20and%20ener
gy/tackling%20climate%20change/emissions%20trading/eu_ets/news/471-carbon-leakage-ce-
report.pdf  

Jouvet & Soulier (2013)  ‘An overview of CO2 cost pass-through to electricity prices in Europe’, 
Energy Policy, Volume 61, October 2013, Pages 1370-1376 

Varma,  Adarsh;  Milnes,  Rob;  Miller,  Karen;  Williams,  Evan;  Bruyn,  Sander  de;  Brinke,  Linda 
(2012):  BIS  cumulative  impacts  of  energy  and  climate  change  policies  on  carbon  leakage. 
Department for Business, Innovation and Skills, checked on 11/30/2014. 

Vivid  Economics,  Ecofys  (2014):  Carbon  Leakage  Prospects  Under  Phase  III  EU  ETS.  Vivid 
Economics, Ecofys, checked on 10/29/2014. 

Walker, N. (2008): An Empirical Approach to Quantify the Impact of EU Emissions Trading on 
Cement Industry Competitiveness. University College Dublin. 
http://www.ucd.ie/gpep/publications/archivedworkingpapers/2006/06-10.pdf  

Zachmann and von Hirschhausen (2008) ‘First evidence of asymmetric cost pass-through of EU 
emission  allowances:  Examining  wholesale  electricity  prices  in  Germany’.  Economic  letters, 
Volume 99, Issue 3, June 2008, Pages 465-469 

205 

 
 
 
 
 
10. 

DESCRIPTION  OF  FINANCIAL  BARRIERS  FOR  ENERGY  SECTOR:  POWER  GENERATION, 
ENERGY EFFICIENCY AND NETWORKS  

Energy networks 

Investments  in  energy  networks  are  primarily  made  by  regulated  network  companies:  (i) 
Transmission  System  Operators  (TSOs)  invest  in  the  high-voltage  transmission  network,  or  gas 
transmission  network;  and  (ii)  Distribution  System  Operators  (DSOs)  invest  in  the  distribution 
network.  Typically  both  invest  under  a  so-called  regulated  asset  base  model,  i.e.  once  an 
investment  is  approved  by  the  regulator,  network  user  charges  should  be  set  at  a  level  that  will 
cover depreciation and a return on the regulatory asset value. 

Investments  in  energy  networks  face  a  mix  of  regulatory,  technical  and  financial  barriers.  The 
technical barriers relate to companies not always having the capacity to prepare and structure high 
quality  projects  to  the  satisfaction  of  financial  institutions.  The  financial  barriers  relate  to  the 
financial  viability  of  the  projects,  which  may  be  affected  by  the  financial  situation  of  some  of 
these companies and the lack of co-financing means, particularly in lower income Member States. 

In this context, it is useful to highlight barriers concerning rehabilitating district heating networks 
(and associated investments in CHP). Particularly in low-income Member States, these networks 
typically suffer from high heat losses but investments are nevertheless limited due to the difficult 
financial  situation  of  the  district  heating  companies  (which  is  aggravated  by  falling  demand  as 
users  may  switch  to  other  sources  like  individual  boilers).  However,  beneficiaries  struggle  in 
some  cases  to  scale  the project  to  the  financial capacity  of  the  promoter,  as  well  as  prepare  the 
project with sufficient quality to achieve financial close. 

Concerning cross border connections, national TSOs are usually less disposed to invest given the 
additional  difficulties  in  terms  of  coordination,  justification,  permitting  and  social  acceptance, 
which translates into higher risk for an identical rate of return.  
Energy efficiency  

For energy efficiency, the barriers are predominantly financial and could be addressed with credit 
enhancement  mechanisms  (i.e.  financial  instruments)  to  facilitate  the  provision  of  finance  to 
projects. 

Energy  efficiency  improvements  in  particular  in  buildings  do  not  generally  entail  technically 
complex  investments,  but  the  projects  are  highly  fragmented  across  multiple  and  often  small 
beneficiaries. The fragmentation problem can be mitigated through, for instance, national schemes 
to  help  municipalities  and  other  responsible  public  sector  entities  to  group/pool  investments. 
However, public authorities particularly in lower income Member States may lack the capacity to 
set up such schemes by themselves. Technical assistance (i.e. grants) is therefore required to help 
across all stages of the project – from identification to monitoring of the impacts after completion. 

them  attractive 

to  apartment  and  house  owners.  Cash  constraints  and 

The lack of incentives barrier is more complex. Even though there is a strong economic rationale 
for the investment – the financial pay-back period for this type of investments is often too long to 
make 
limited 
creditworthiness,  in  particular  in  lower  income  groups  (and  hence  most  relevant  in  low-income 
countries) can imply that loans cannot be provided on terms that are agreeable to both financial 
institutions and borrowers without some form of public intervention (i.e. financial instruments). In 
some  cases  even  a  preferential  (subsidised)  interest  rate  on  a  loan  for  comprehensive  dwelling 
renovation  may  not  be  sufficient  for  the  final  beneficiaries  and  an  investment  grant  may  be 
required. 

206 

 
 
 
 
 
In the case of small-scale energy efficiency investments in SMEs, the same type of reasoning used 
for buildings applies: the projects may be highly desirable from the economic point of view but 
not  necessarily  so  attractive  from  the  purely  financial  point  of  view  due  to  the  long  pay-back 
periods,  or  other  investment  priorities  that  do  not  take  into  account  the  full  energy  efficiency 
benefits. 

Power Generation  

Power generation investments – both in renewable and conventional technologies – are made by 
private  companies  acting  within  a  liberalised  European  energy  market,  even  if  existing  support 
systems have tended to shelter renewable power generation from market dynamics. 

Investments in power generation tend to be medium to large scale infrastructure projects. Power 
generation  projects  can  be  delayed  or  deterred  through:  (i)  financial  constraints  of  large  energy 
companies; (ii) regulatory uncertainty, currently impacting on new RES investment and, to some 
extent, to disinvestment decisions on conventionals ; (iii) permitting risk from public opposition 
which in particular tend to delay investment decisions; (iv) technology risks and associated costs; 
and  (v)  uncertainty  of  revenues  due  to  the  unpredictable  load  factors  for  conventional 
technologies.   

Reduction in demand, coupled with lower wholesale prices, has hindered the ability of companies 
to recover capital costs, leading companies to mothball plant and write down losses. It remains to 
be  seen  how  wholesale  prices  evolve  over  the  medium  term,  together  with  policy  development 
concerning  capacity  markets.  However,  in  the  short  term,  many  corporates  face  balance  sheet 
constraints  which  prevent  undertaking  new  investment  in  power  generation  –  renewable  or 
conventional.  Lower income Member States are in  a particularly difficult situation as  they have 
increasingly  obsolete  conventional  generation  fleets.  The  investment  challenge  is  further 
aggravated  for  such  Member  States  by  the  relative  underdevelopment  of  their  financial  markets 
and hence possible scarcity of financiers. 

RES  projects,  which  tend  to  be  more  capital  intensive  than  conventional  technologies,  are 
particularly  exposed  to  regulatory  risk  regarding  future  revenue  streams.  Reduction  of  the 
incentives over the last few years (e.g. in terms of the level of the feed-in tariff) including in some 
Member  States  through  retroactive  changes  (i.e.  affecting  projects  already  in  operation)  has 
undermined investors’ confidence and impacted the cost of capital of projects.  

Looking forward to the period 2021 to 2030, as technology costs fall, it is expected that support 
schemes will increase the degree of exposure of projects to wholesale reliance on support schemes 
largely  outside  of  the  electricity  market  will  diminish.  For  continuous  investment  in  RES  an 
increase of the carbon price under the ETS will become more important. Projects are likely to be 
more exposed to wholesale prices, in many cases offset by long-term power purchase agreements. 
Securing such agreements may be a challenge for smaller independent power producers. 

207 

 
 
 
 
 
11. 

IMPACTS OF CREATING THE MODERNISATION FUND COMPARED TO THE BASELINE  

The environmental, social and economic implications of the creation of the Modernisation Fund 
are  driven  by  the  European  Council  decision  which  determined  the  number  of  allowances 
allocated for the creation of the fund, the criteria based on which Member States are determined 
as  eligible,  the  methodology  for  allocation  among  Member  States  and  the  type  of  project 
supported. 

This  section  assesses  the  impacts  of  the  creation  of  the  Modernisation  Fund  compared  to  the 
baseline scenario.  

Economic Impacts 

Based  on  analysis  for  the  2030  climate  and  energy  impact  assessment,  the  average  investment 
needs  (excluding  the  transport  sector)  for  the decade  2021-2030  for  the  10  beneficiary  Member 
States is € 28.6 billion per year. Approximately 15% of the total investment needs relate to power 
grids  and  networks,  26%  of  the  investments  are  for  power  generation,  including  for  renewable 
energy sources, while the remaining 59% are for energy efficiency improvements in buildings and 
in  industry.  Out  of  the  total  €  28.6  billion  per  year,  approximately  €  8.4  billion  per  year  is 
additional due to the 2030 climate and energy framework while the remaining amount reflects the 
need  to  energy  system  modernisation  to  replace  ageing  infrastructure,  even  without  ambitious 
climate and energy policies. 

The Modernisation Fund is expected to have positive economic impact in the beneficiary Member 
States  as  it  will  facilitate  investments  in  energy  efficiency  and  modernisation  of  the  energy 
systems.  In  order  to  optimise  the  use  of  the  available  financial  support,  the  setting  up  of  the 
Modernisation  Fund  needs  to  be  accompanied  by  an  enabling  regulatory  environment,  well-
functioning  energy  market  and  a  strengthened  carbon  market,  which  would  mobilize  private 
investments. 

The  Modernisation  Fund  will  be  created  with  the  proceeds  of  2%  of  EU  ETS  allowances,  or 
roughly  310  million  allowances  that  will  be  available  for  the  decade  2021-2030.  The  European 
Council  concluded  that  the  beneficiary  Member  States  will  receive  a  share  of  the  allowances 
based  on  50%  2013  GDP  and  50%  verified  emissions.  Table  34  compares  allowances  to  be 
allocated  to  the  Member  States  under  the  baseline  scenario  and  the  option  of  creating  the 
Modernisation Fund. This  clearly indicates that the beneficiary Member States  receive  from the 
remaining 18 EU Member States some 223 million allowances over 2021-2030, representing a 2.5 
fold increase. On individual basis, the beneficiary Member States receive between 4 million and 
98  million  additional  allowances  for  support  their  energy  modernisation  and  improve  energy 
efficiency, which represents between 135% and 690% increase compared to the baseline.  

208 

 
 
 
 
 
 
Table 34: Comparison under baseline and creation of the Modernisation Fund for allocation of 2% 
of total allowances, 2021-2030258 

Member State 
Bulgaria 
Czech Republic 
Estonia 
Croatia 
Latvia 
Lithuania 
Hungary 
Poland 
Romania 
Slovakia 
Total 10 beneficiary Member States 
Total 18 remaining Member states 

Mn allowances 
under baseline, 
2021-2030 
7,7 
14,2 
2,4 
1,5 
0,6 
1,2 
4,3 
37 
13,7 
4,6 
87,2 
222,8 

Mn allowances 
under MF 
creation, 2021-
2030 
18,1 
48,3 
8,6 
9,7 
4,5 
8,0 
22,1 
134,6 
37,1 
19,0 
310,0 
0,0 

Change in Mn 
between 
baseline and 
MF creation 
10,4 
34,1 
6,2 
8,2 
3,9 
6,8 
17,8 
97,6 
23,4 
14,4 
222,8 
-222,8 

% Change 
between 
baseline and 
MF creation 
135% 
240% 
258% 
547% 
650% 
567% 
414% 
264% 
171% 
313% 
256% 
-100% 

The quantitative estimate of the funds available based on an allocation per country indicates that 7 
out  of  10  beneficiary  Member  States  would  have  a  share  of  7%  or  less  of  the  total  allocation 
available  for  the  Modernisation  Fund  (See  Table  35).  This  would  translate  to  relatively  small 
proceeds on an annual basis and the effective administration of the proceeds to make a tangible 
contribution to modernisation becomes critical. 

Table 35: Modernisation Fund allocation shares per beneficiary Member States, 2021-2030 

% of Total MF Allowances 

Member State 
Bulgaria 

Czech Republic 

Estonia 

Croatia 

Latvia 

Lithuania 

Hungary 

Poland 

Romania 

Slovakia 

Total 10 beneficiary Member States 

5,84% 
15,59% 
2,78% 
3,14% 
1,44% 
2,57% 
7,12% 
43,41% 
11,98% 
6,13% 

100% 

In  addition  to  the  number  of  allocated  allowances,  there  are  two  aspects  that  affect  the  level  of 
investments triggered through the Modernisation Fund: 1) the amount of proceeds raised through 

258 Under the baseline scenario, the 2% of the total allowances (310 million allowances) are distributed according to 
the distribution methodology for allowances to be auctioned as indicated by the European Council, namely: 10% are 
redistributed from Member States with high per capita income to those with low per capita; the remaining 90% of the 
allowances are distributed on the basis of the Member State's share of verified emissions under the EU ETS. Under 
the MF creation scenario, the allowances from the Modernisation Fund are allocated among the beneficiary Member 
States based on 50% GDP (Eurostat, 2013 market prices) and 50% verified emissions. 

209 

 
 
 
 
 
                                                           
the monetisation of the EU ETS allowances for the creation of the Modernisation Fund; and 2) the 
way the these proceeds are used, which will impact how much will be invested in projects. 

The proceeds raised from the monetisation of the allowances are uncertain and will depend on the 
underlying  carbon  price  at  the  time  the  allowances  are  monetized.  Given  the  uncertainties 
involved, only a broad estimate can be given. Based on the current prevailing carbon price, this 
could result in proceeds of around € 2.1 billion. Most market analysts expect higher carbon prices 
in 2021 to 2030 so this amount could be higher (e.g. € 7.75 billion assuming average carbon price 
of € 25). 

The  estimated  range  for  the  proceeds  covers  less  than  3%  of  the  total  investment  needs  in  the 
beneficiary  Member  States  for  2021-2030,  thus  there  is  no  risk  that  it  would  crowd  out  other 
sources  of  funding.  On  the  other  side,  the  estimated  range  covers  between  3%  and  9%  of  the 
additional  investments  needed  related  to  the  2030  climate  and  energy  framework.  With  these 
proceeds,  the  Modernisation  Fund  is  expected  to  mobilise  additional  private  capital  to  realise 
larger number of investments. The eventual level of leveraged investments depends on the chosen 
governance  structure,  the  type  of  eligible  investments  and  the  type  of  instrument  used  to  fund 
these.  

The  Modernisation  Fund  would  trigger  important  investments  in  the  beneficiary Member  States 
that would contribute towards the key aspects of creating a strong European Energy Union with a 
forward  looking  climate  policy.  It  is  expected  to  contribute  not  only  towards  cost-effectively 
reaching  the  2030  climate  and  energy  objectives,  but  also  towards  diversifying  the  energy  mix, 
improving  security  of  supply  and  lowering  import  dependency,  key  aspects  identified  in  the 
European Energy Union strategy. This may be a particular important for the beneficiary Member 
States. Most of the beneficiary Member States have among the highest energy intensity, ranging 
between  1.5  to  4.3  times  the  EU  average259.  Accordingly,  these  beneficiary  Member  States 
generally have among the highest greenhouse gas intensity ranging between 1.4 and 4.4 the EU 
average260. Additionally, these Member States are more vulnerable to energy security of supply 
concerns since they are less integrated and connected and more exposed to a single supplier.261  

Beyond  an  effect  on  the  energy  sector  in  the  lower  income  Member  States,  the  Modernisation 
Fund and the investments it triggers will have an important indirect effect on the economies of the 
beneficiary Member States. It will help the citizens and businesses in the lower income Member 
States  have  access  to  competitive,  secure  and  sustainable  sources  of  energy  is  fundamental  to 
economic growth and competitiveness.  

Environmental Impacts 

The Modernisation Fund is expected to have a positive environmental impact in the beneficiary 
Member  States262.  Through  facilitating  investments  in  energy  efficiency,  the  fund  would 
contribute to lowering greenhouse gas emissions in the beneficiary Member States under the non-
ETS sectors. The fund would also address modernising the power sector, which is covered by the 
EU ETS. Since the EU ETS cap sets a binding ceiling on the emissions within the sectors covered 
by  the  system,  the  Modernisation  Fund  would  not  impact  in  absolute  terms  the  EU  level 
greenhouse  gas  emission  reduction,  which  would  be  achieved  in  any  case.  The  creation  of  the 
Modernisation Fund has additional environmental and health benefits for the beneficiary Member 

259  Based  on  2013  Eurostat  data  on  gross  inland  consumption  of  energy  divided  by  GDP  (kg  of  oil  equivalent  per 
1000 EUR). 
260 Based on 2012 EEA data. 
261  The  European  Energy  Security  Strategy  communication  identified  the  Baltic  states  and  Eastern  Europe  as 
particularly vulnerable to security of supply issues. COM(2014) 330 final. 
262 The environmental benefits would depend on the types of projects selected in the fund. The overall impact of the 
fund should be in line with other EU policies such as air pollution. 

210 

 
 
 
 
                                                           
States.  Through  lowering  fossil  fuel  consumption,  health  conditions  in  the  beneficiary  Member 
States will be improved through lower emission of pollutants. Additionally, lower emission of air 
pollution also lowers the costs to control them.  

The  Impact  Assessment  of  the  2030  climate  and  energy  framework  estimated  the  monetized 
health benefits from achieving the 2030 climate and energy objectives and the decrease in costs of 
air pollution control compared to the reference scenario of continuing with existing policies. The 
estimates (see Table 36 and Table 37) demonstrate that achieving the 2030 climate objectives has 
a  larger  positive  benefit  on  health  and  reducing  air  pollution  costs  in  the  beneficiary  Member 
States compared to EU average. 

Table 36: Monetised health benefits in 2030 as a percentage of GDP  

Health benefits 
in 2030 as % of 
GDP 

EU28 

Bulgaria 

Czech Republic 

Estonia 

Croatia 

Latvia 

Lithuania 

Hungary 

Poland 

Romania 

Slovakia 

2030 policy scenarios deviation from the Reference Scenario level, in percentage points 

Range scenarios with -40% GHG reduction 

Min. 

0,03% 

0,18% 

0,06% 

0,00% 

0,04% 

0,03% 

0,04% 

0,08% 

0,15% 

0,15% 

0,05% 

Max. 

0,18% 

0,86% 

0,46% 

0,25% 

0,25% 

0,36% 

0,34% 

0,47% 

1,59% 

0,92% 

0,33% 

Source: Mortality impacts based on IIASA (2013), Health benefit valuation uses valuation of mortality (value of life 
year lost) used for the Thematic Strategy on Air Pollution of €57700 (low estimate) and €133000 (High estimate). 

Table 37: Reduced air pollution control costs by 2030 as a percentage of GDP 

2030 reduced percentage points 
air pollution control 
costs as % of 
GDP 

EU28 

Bulgaria 

Czech Republic 

Estonia 

Croatia 

Latvia 

Lithuania 

Hungary 

Poland 

Romania 

Slovakia 

2030 policy scenarios deviation from the Reference Scenario level, in 
2030 reduced air percentage points 

Minimum for 
GHG -40% 
scenarios 
0.01% 
0.08% 
-0.01% 
-0.01% 
0.00% 
0.01% 
0.01% 
0.01% 
0.05% 
0.04% 
0.00% 

Maximum for 
GHG- 40% 
scenarios 
0.02% 
0.18% 
0.03% 
0.08% 
0.03% 
0.08% 
0.05% 
0.03% 
0.07% 
0.07% 
0.02% 

Therefore, through contributing towards realizing investments to facilitate the transition towards a 
low  carbon  economy  for  the  beneficiary  Member  States,  the  Modernisation  Fund  can  help 

211 

 
 
 
 
realizing cost effectively these important environmental benefits, resulting in significant savings 
of monetized health benefits and prevented air pollution costs.  

Social Impacts 

The Modernisation Fund is expected to have a positive impact on job creation in the beneficiary 
Member States.  

The  Impact  Assessment  of  the  2030  climate  and  energy  framework  estimated  the  employment 
impacts  of  additional  investments  in  the  power  sector  and  retrofitting  energy  efficiency  in 
buildings, key sectors that would contribute towards lower greenhouse gas emissions.  

The sectoral assessment evaluated how many jobs will be created in key sectors directly through 
the  investments  to  achieve  the  2030  climate  and  energy  objectives263.  Table  38  present  the 
expected  effect  on  employment  at  EU  level.  The  largest  increases  in  employment  are  related  to 
investments realized for energy efficiency, representing a 49% increase compared to the reference 
scenario.  The  increase  in  jobs  for  renewable  energy  sources  reflects  the  shift  in  investments  to 
renewables from conventional energy sources, which see some decline in employment. 

Table  38:  EU28  jobs  associated  with  investments  in  the  power  sector  and  energy  efficiency,  2011-
2030 

Average annual employment 2011-2030 related to 
investments  

Referenc
e 

GHG 
40% 

Change compared to 
Reference 
GHG 40% 

('000) 

('000) 

('000) 

% change 

Nuclear 

Wind 

Solar 

Coal 

Oil 

Gas 

Biomass 

Total Power Generation Investments 

Residential 

Tertiary 

Total Energy Efficiency Investments 
Total 

46 

152 

69 

26 

2 

31 

18 

345 

295 

110 

405 
750 

47 

170 

72 

26 

2 

26 

21 

365 

408 

196 

604 
968 

1 

18 

3 

1 

-0 

-5 

3 

20 

113 

86 

199 
219 

2% 

12% 

4% 

2% 

-13% 

-17% 

16% 

6% 

38% 

78% 

49% 
29% 

Since  the  Modernisation  Fund  would  contribute  to  realizing  investments  to  facilitate  the  energy 
sector  modernisation  and  improve  energy  efficiency  in  the  beneficiary  Member  States,  it  is 
expected to have a positive impact on employment for the beneficiary Member States. The final 
impact will depend on the amount of realized investments and at what specific sectors these are 
targeted at. 

263 It does not include impact on operational expenditure in the power sector and the resulting job changes. 

212 

 
 
 
 
 
                                                           
12. 

MORE COMPREHENSIVE OVERVIEW OF IMPACTS FOR DIFFERENT OPTIONS FOR CREATING THE MODERNISATION FUND  

The  table  below  gives  a  more  detailed  overview  of  the  assessment  of  the  relevant  impacts  for  different  options  assessed  for  the  creation  of  the 
Modernisation Fund, as described in Chapter 8. 

Table 39: Overview of impacts for different options for creating the Modernisation Fund 

Instruments 

EU-added value 

Small-scale projects 

Role of actors 

Transparency 

Market distortions 

Option 
1 

Both financial 
instruments and 
grants available but 
more likely use of 
grants  

Support tailored to 
national priorities with 
risk of sub optimal 
diversification within 
beneficiary MS 

Local banks with 
better knowledge of 
risk profile of small 
scale projects 

Risk of misalignment 
with internal rules of 
EIB; strong 
alignment with 
national priorities 

Beneficiary MS 
discretion in 
investments 
decisions has 
potential to distort 
the EU energy 
market 

Risk of more 
limited 
transparency 

Fragmented 
national approach 
complicates 
investments by 
international 
investors 

Grants: Centralized 
organization of calls 
for proposals with 
EIB due diligence 
expertise and 
achieving scale 

Fragmented set up of 
financial 
instruments. 

Option 
2 

Increased use of 
financial instruments 

Grants: as option 1 

Financial 
instruments: 
Enhanced EIB role, 
achieving scale and 
risk diversification 

EU-value added 
projects more likely, 
while national priorities 
still considered 

Work with 
intermediaries for 
small scale projects. 
Allows aggregating 
small scale projects to 
diversify risks across 
beneficiary MS 

Balanced role for all 
actors ensures 
alignment of interest 
at EU and MS level 

Better transparency 
through EU level 
monitoring 
mechanisms 

More clarity and 
visibility through 
standard approach 
on project selection 
for investors 

Less distortive as 
specific investment 
decisions are 
delegated to the 
Commission and the 
EIB 

Option 
3 

Grants would limit 
leverage and private 
investments, with 

Combination of COM 
with project pipeline 
approval by beneficiary 

Targeted calls for 
proposals for small 
scale projects 

Strong role for the 
Commission with 
beneficiary MS 

High level of 
transparency in 
setting fund rules in 

Grants have higher 
potential to distort 
competition but grant 

213 

Administrative 
burden 
Higher burden to set up 
financial instruments, 
further increased due to 
fragmented national 
approach 

Lower administrative 
burden for national 
project promoters, in 
particular addressing 
small scale projects 

Higher burden to set up 
financial instruments 
but standardized 
approach  

Small scale promoters 
work with local 
intermediaries, but 
setting up intermediary 
structures may increase 
burden at fund level 
More limited 
administrative burden 
related only to 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
only certain limited 
sectors covered 

Grants: as option 1 

Member States ensures 
EU value added and 
addressing national 
priorities 

Assumed no 
financial instruments 

involvement 
addresses national 
and EU level 
considerations 

implementing 
legislation 

Clear investment 
criteria and 
simplified rules for 
investors 

schemes are less 
distortive as 
decisions are 
delegated to the 
Commission 

organizing calls for 
proposals and pre-
approving a project 
pipeline 

Targeted calls for small 
scale projects 

214 

 
 
 
 
 
 
 
 
 
13. 

TIMING  AND  APPROACH  TO  THE  MONETISATION  OF  ALLOWANCES  FOR  THE 
INNOVATION FUND AND MODERNISATION FUND 

The resources for the Innovation Fund will be 400 million allowances between 2021 and 2030 and 
the resources of the Modernisation Fund will be provided by 2% of the allowances over the same 
period (about 310 million allowances).   

The following operational aspects can affect the outcomes of this monetisation: 

-  When the allowances are monetised: starting before or in 2021. 

-  How the volume of the monetisation is distributed: concentrated in a few years or evenly 

spread out (e.g. between 2021-2030) 

The timing and the approach used to monetise the allowances can affect the level of funds raised 
as well as the potential impact on the carbon market. Furthermore, the timing of the monetisation 
can have consequences for when the Funds can become operational because sufficient certainty 
about the available funding may be needed in advance to be able to take firm decisions involving 
financial commitments.  

Existing experience using the NER 300 

To monetise the allowances providing the resources for the NER 300, the EIB sold 210,55 million 
allowances  between  December  2011  and  September  2012  and  the  remaining  89.45  million 
allowances between November 2013 and April 2014264, through a mixture of "Over The Counter 
(OTC)" transactions, screen trades, and auctions. This mixture was inter alia used as no auction 
platforms were operational at the time the monetisation was initiated. 

This early monetisation was deemed necessary to provide certainty about the available resources 
and to allow the necessary calls for proposals to take place before end 2015, as foreseen in Article 
10a (8) the ETS Directive. The EIB carried out the monetisation and sale of these allowances. The 
cooperation agreement between the Commission and the EIB foresaw that the EIB "shall perform 
the monetisation of allowances with the objective of minimising any impact on the market for EU 
emission allowances". To this end, the agreement required the monetisation method to respect five 
principles265.  Beyond  this,  while  it  is  not  possible  to  quantify  the  direct  price  impact  of  the 
monetisation of the 300 million allowances from the NER 300 during 2012 and 2013 the addition 
of  these  300  million  allowances  contributed  to  additional  supply  on  the  market  at  a  time  of  a 
growing imbalance between supply and demand.  

264 EIB, NER 300 Monetisation Monthly reports, http://www.eib.org/attachments/ner_summary_report_en.pdf   
 265Cooperation  agreement  on  the  implementation  of  Commission  Decision  C(2010)  7499  between  the  European 
Commission and the European Investment Bank  (2010/C 358/01) 
(2010/C  358/01)  "  (a)  Monetisation  of  at  least  200  million  allowances  shall  be  concluded  no  later  than  10  months 
after the allowances have been transferred to the EIB and made available for the settlement of transactions. 
(b) Monetisation shall take place periodically at least every second week. Monetisation volumes should be spread as 
evenly as possible over the monetisation period. Volumes and timing of monetisation may be adjusted to minimise 
any impact on the secondary market; 
(c) The EIB shall ensure that the monetisation prices do not deviate significantly from the relevant secondary market 
prices over the monetisation period; 
(d) Reports setting out at least the overall volume and aggregated prices of the monetisation shall be published on the 
website of the EIB on a monthly basis, within two weeks of the end of each month over the monetisation period; 
(e)  Monetisation  shall  be  effected  in  accordance  with  applicable  laws  in  respect  of  money-laundering,  terrorist 
financing and market abuse and accordingly counterparties acting on the EIB's behalf shall be required to demonstrate 
their compliance with such laws. 

215 

 
 
 
 
 
                                                           
Issues to consider in relation to the timing of the monetisation 

The following considerations are relevant to the timing: 

-  Monetising  allowances  via  auctions  can  ensure  a  high  level  of  transparency  and 
predictability for market participants, based on the provisions in the ETS Directive and the 
Auctioning Regulation.  

-  Monetising allowances involves a price risk, because the carbon price varies over time. An 
even spread of the monetisation over a longer period of time can minimise this price risk 
compared to a tighter concentration during a shorter time period. 

-  For  the  Modernisation  Fund,  a  timely  start  of  the  support  to  investments  has  been 
underlined  by  many  of  the  Member  States  concerned,  with  a  view  to  the  high  level  of 
investment  required  in  the  energy  sector  and  the  contribution  such  modernisation  can 
make to delivering the 2030 targets. 

-  Starting  the  operation  for  the  Innovation  Fund  in  2021  would  reduce  the  period  during 
which  no  support  is  provided  for  low  carbon  innovation  at  a  European  level  when 
compared to a later start. This would be in line with a more consistent provision of support 
for  decarbonisation.  At  the  same  time,  experience  with  the  NER  300  mechanism  shows 
that because of the time required to reach a final investment decision and for projects to 
become operational, it will take several years before the benefits from the Innovation Fund 
can be reaped.  

-  An  even  distribution  of  the  volume  of  allowances  being  monetised  would  have  a  lower 
impact  on  the  carbon  price  compared  to  an  approach  involving  the  monetisation  of 
allowances at an early stage ("front-loading"). 

Based  on  these  four  considerations,  the  monetisation  through  auctioning  of  a  steady  amount 
between  2021  and  2030  would  allow  for  a  minimal  price  risk.  The  level  of  funds  raised  would 
then be expected to reflect the average secondary market price during these years.  

The quantity of allowances to be monetised is shown compared to an estimate of the total quantity 
to be auctioned below, both in absolute numbers and as a percentage. (Please note that for ease of 
viewing, the vertical axis starts at 700m allowances in the graph showing absolute figures). The 
Modernisation Fund allowances are assumed here to be spread evenly over the years 2021-2030. 
The quantity of allowances to be monetised for the Innovation Fund is varied between 10% and 
25% per year, resulting in the monetisation of 40-100 million additional allowances on a yearly 
basis.  (Note  that  this  estimate  does  not  take  into  account  the  possible  effects  of  the  Market 
Stability Reserve, which if agreed could lead to reductions to the amount being auctioned in the 
years considered. As a result, the relative impact of monetisation for the Innovation Fund could be 
higher.) 

216 

 
 
 
 
 
Use of auctions for monetisation 

With regard to the Modernisation Fund, the European Council Conclusions of October 2014 (2.7) 
state that the allowances should be auctioned according to the 'same principles and modalities as 
for  other  allowances'.  These  principles  and  modalities  are  set  out  in  the  provisions  of  the 
Auctioning Regulation. Consequently, making use of these as well for the Innovation Fund would 
allow  for a  consistent  approach.  The  large  volume  of  allowances that  are  auctioned  through  the 
Common  Auction  Platform  allow  for  an  even  spread  over  the  year  (about  140  auctions  per 
annum),  thus  reducing  the  (price)  risk  for  each  individual  auction  -  for  example,  if  the  auction 
result is impacted by a low level of participation on a given auction day, or a price drop on that 
day - in particular in a situation of volatile market prices. Spreading the fixed costs over a higher 

217 

 
 
 
 
 
 
 
 
number  of  allowances  also  ensures  that  the  administrative  costs  per  allowance  auctioned  are 
minimised.  Auctioning  is  therefore  considered  to  be  the  most  suitable  approach  for  the 
monetisation of the allowances for both the Innovation Fund and the Modernisation Fund. 

Level of monetisation in relation to financial commitments   

To  be  able  to  make  the  financial  commitments  involved  in  awarding  grants  or  providing  other 
forms  of  financial  support  to  companies,  sufficient  certainty  is  required  concerning  the  level  of 
available funding.   

If  full  certainty  in  advance  is  required,  the  auctioning  of  a  steady  amount  of  allowances  on  an 
annual basis would allow for the practical organisation of a more limited number of 2-4 calls for 
proposals  between  2021  and  2030  only  after  the  monetisation  of  the  same  proportion  of 
allowances has taken place. More calls would result in a lower amount of funds to be awarded per 
round;  while  a  low  number  of  calls  in  combination  with  a  start  of  the  Innovation Fund  in  2021 
would  result  in  a  higher  proportion  of  the  funds  being  awarded  early  in  the  period  2021-2030. 
Assuming  that  part  of  the  work  related  to  organising  a  call  for  proposals  must  be  carried  out 
independently of the number of proposals submitted, a higher number of calls is expected to result 
in  a somewhat higher overall administrative burden. At the same time  more calls  give potential 
bidders for funds more flexibility to choose when to apply for funds. 

If all calls involve an equal number of allowances, organising 2-4 calls would imply total funds 
corresponding to 25%-50% of the allowances. The proportion of allowances monetised per year 
will then determine the time needed to monetise a corresponding share of the allowances. In other 
words, a higher number of calls for proposals would then reduce the percentage of allowances that 
needs to be monetised at an early stage. This is illustrated below. If 4 calls would be organised, 
each  call  would  involve  100  million  allowances.  If  monetisation  would  be  spread  evenly  over 
2021-2030,  10%  of  the  allowances  would  be  monetised  each  year  and  it  would  take  3  years  to 
monetise  a  corresponding  share  of  the  allowances.  If  25%  are  monetised  every  year,  the  same 
level is reached in one year. If by contrast 2 calls are organised, each call will involve 200 million 
allowances and it takes twice as long to monetise this amount of allowances.  

Degree of uncertainty in relation to the type of support provided 

If  support  is  provided  via  a  financial  instrument,  such  as  a  loan,  equity  or  guarantee,  the 
monetisation of the allowances for the Innovation Fund would  not  be tied to  a fixed number of 
calls for proposals, but would rather take place in proportion to the commitment of funds. Such a 
"first come, first served" basis for the operation of the Innovation Fund could in theory provide for 

218 

 
 
 
 
 
a higher flexibility regarding the timing of the monetisation process, allowing it to be carried out 
as  the  application  pipeline  develops.  While  this  would  reduce  the  need  to  monetise  allowances 
long  before  the  funds  are  disbursed,  a  disadvantage  would  be  that  it  could  lead  to  lower 
predictability  with  regard  to  the  timing  and  volume  of  allowances  being  monetised,  resulting  in 
uncertainty for the market. If there is a high take up of the support offered, a correspondingly high 
number  of  allowances  may  still  need  to  be  monetised  early  on.  For  the  Modernisation  Fund, 
depending  on  whether  this  is  operationalised  using  financial  instruments  or  grants,  similar 
considerations apply as for the Innovation Fund, although the total number of allowances is about 
90m lower. 

Solutions for an early start of the Innovation Fund 

Given  the  time  limits  that  apply  to  the  NER  300  mechanism,  a  start  of  the  Innovation  Fund  in 
2021  would  minimize  the  time  period  between  the  two  support  mechanisms  for  low  carbon 
innovation. To allow for this, two possible solutions could be considered: 

1.  Monetisation from 2021 onwards, with a high % of allowances monetised per year and netting 

to prevent a rise in the total auctioning quantity  

2.  Initiate first call ahead of monetisation  

Monetisation from 2021 onwards, but with a relatively high % of allowances monetised per year 
could also allow for a start in 2021. However, this would introduce the risk of a higher potential 
market impact because of the "front loading" of the allowances when compared to an even spread 
of the monetisation over 2021-2030. An approach to mitigate this impact would be to introduce a 
link to the number of allowances to be auctioned on behalf of Member States, ensuring the total 
quantity being auctioned in any year remains stable. This "netting" of the number of allowances 
would  ensure  that  the  number  of  allowances  in  circulation  would  not  temporarily  increase  as  a 
result of front loading. However, the potential price risk relating to the level of funds raised would 
still  remain  higher  compared  to  an even  distribution  of  the  monetisation  of  the  allowances  over 
2021-2030.  This  is  shown  below  in  a  stylised  example,  taking  into  account  the  Modernisation 
fund.  (Note  that  this  estimate  does  not  take  into  account  the  possible  effects  of  the  Market 
Stability Reserve, which if agreed could lead to reductions to the amount being auctioned in the 
years considered. As a result, the relative impact of monetisation for the Innovation Fund could be 
higher.) 

219 

 
 
 
 
As explained above, with a view to guarantee that sufficient funds will be available to honour the 
financial commitments, the financial value of the monetised allowances should be known before 
these resources are committed to individual projects. However, it could nevertheless be envisaged 
to  start  the  first  call  before  the  monetisation  of  allowances.  This  first  call  could  be  undertaken 
with  a  pre-defined  financial  commitment  at  or  below  expected  market  value  of  allowances.  In 
particular if the first call is based on a small share of total allowances (e.g. 100 million or less) the 
risk of not being able to honour the financial commitments for the first call will be very small, if 
not  zero:  in  case  that  the  auctioning  of  the  first  100  million  allowances  achieves  lower  than 
expected revenues it would still be possible to draw on the auctioning revenues of the remaining 
300  million  allowances.  In  the  worst  case,  the  volume  of  the  last  call  would  be  reduced  by  the 
amount of allowances that were necessary to finance the shortfall of the first call. 

Finally, it could be considered to increase the volume of the calls over time (e.g. a distribution of 
75, 85, 100, 140 million over the period from 2021 to 2030). This "staggered approach" could also 
reduce  the  price  impact  of  a  concentrated  monetisation  (in  view  of  expected  reduction  of  the 
surplus over time as the MSR becomes fully operational).    

For the Modernisation Fund, similar dynamics apply with regard to the need to balance a timely 
start  with  minimal  impact  on  the  carbon  market  and  a  low  price  risk,  although  the  quantity  of 
allowances is smaller. 

Potential interactions between monetisation and the Market Stability Reserve 

If the Market Stability Reserve (MSR) is operational during the period in which the allowances 
for the Innovation and Modernisation Fund are monetised, it can reduce the effect of any potential 
front  loading.  However,  this  effect  will  only  partially  compensate  for  the  extra  volume,  as  the 
MSR reduces the number of allowances to auction by 12% of the total number of allowances in 
circulation, and this reduction applies to the quantity to be auctioned with a time lag. As a result, 
if the monetisation is considered to represent an extra volume of allowances being added to the 
total number of allowances in circulation, the additional reduction as a result of the MSR will be 
limited  and  it  will  not  happen  directly.  The  year  in  which  the  MSR  comes  into  effect  will  also 
influence the extent to which it interacts with the monetisation of the allowances. 

220 

 
 
 
 
 
Aspects which are not varied: form of support provided: monetisation versus allowances 

One  possible  alternative  to  monetisation  applicable  only  to  the  Innovation  Fund  would  be  to 
provide the support in the form of free allowances rather than money. While this would avoid the 
need to monetise the allowances to have advance certainty with regard to the available funds, this 
would result in a number of important disadvantages. It would involve a transfer of an additional 
form of (price risk) in relation to the value of the allowances to the project sponsor, which would 
be counterproductive given that the Innovation Fund aims to address financial barriers related to a 
high  level  risk  for  low  carbon  investments.  Furthermore,  such  an  approach  may  have  the 
unintended effect of favouring larger existing companies over small or new companies, as these 
are  generally  better  able  to  manage  price  risks  given  their  better  understanding  of  the  carbon 
market. Finally, risk managers in companies who need to account for the uncertain future value of 
such allowances may be expected to apply discounts, limiting the expected investment which can 
be triggered by using a given number of allowances when compared to providing direct funding. 
Given the risk nature of innovative low-carbon investments and the degree of risk aversion such 
discounts  can  be  quite  considerable  and  the  higher  the  discount  the  lower  the  amount  of 
innovation triggered by the available 300 million  allowances. Such an approach is therefore not 
further developed in this Impact Assessment. 

221 

 
 
 
 
14. 

SENSITIVITY ANALYSIS FOR POSSIBLE FUNDING RATES FOR THE INNOVATION FUND 

 As is described in the chapter on low carbon funding mechanisms (section 8.1.3.4), changing the 
existing funding rate of 50% of the additional costs applied in the NER 300 could be considered 
for the Innovation Fund. However, as the existing information of the application of the NER300 
programme is limited to only a few years of implementation and in scope when compared to the 
proposed Innovation Fund, it is not possible to simulate the effect of higher funding rates based on 
current experience with the NER 300. The specific needs should therefore be assessed separately 
for RES, CCS and industry through more extensive market testing in the context of preparing the 
implementing  legislation  for  the  Innovation  Fund.  Comparing  a  range  of  options  which  include 
varying  the  current  maximum  rate  of  50%  to  an  increased  maximum  rate  75%  can  give  a  first 
indication of the potential range of effects.  

To give a first assessment of what outcomes this could produce in minimal funding requirements 
for the project sponsors technology categories that could be supported by the Innovation Fund, the 
resulting  costs to  be  borne  by  the  project  sponsor  are  shown  for  a range  of  funding  rates  in  the 
graphs below. The graphs show that with an increasing funding rate, the relative and absolute size 
of the funds that have to be provided by the project sponsor is reduced. 

Sensitivity of costs for project sponsor for RES projects 

s
n
o

i
l
l
i

M

e
z
i
s

t
c
e
j
o
r
P

200
180
160
140
120
100
80
60
40
20
0

50%

55%

60%
65%
Funding rate 

70%

75%

222 

 
 
 
 
 
 
 
 
 
 
 
300

Sensitivity of costs for project sponsor for industry 
projects 

s
n
o

i
l
l
i

M

e
z
i
s

t
c
e
j
o
r
P

200

100

0

s
n
o

i
l
l
i

M

e
z
i
s

t
c
e
j
o
r
P

2.000

1.500

1.000

500

0

Industry average
costs to be covered
by IF

Industry average
costs to be covered
by project sponsor

50% 55% 60% 65% 70% 75%
Funding rate 

Sensitivity of costs for project sponsor for CCS 
projects 

CCS average
costs to be
covered by IF

CCS average
costs to be
covered by
project
sponsor

50% 55% 60% 65% 70% 75%
Funding rate 

The tables below show the underlying costs. Estimates were based266 on NER 300 project costs for 
renewables and CCS, while for industry a stylised example is given assuming a total cost of €200 
mln. To give an upper or lower range, the estimated amount was varied by +/- 20%. 

In practice, the experience is that the NER 300 average covers more than 30 projects, including 
many projects that are much smaller in scale and have also been awarded funding under NER 300. 
Such smaller projects can also be facilitated under the Innovation Fund, for example by wider use 
of the existing derogations for capacity thresholds for small scale projects. 

266 For renewables, the total relevant project costs were estimated using the average costs awarded under the existing 
NER 300 mechanism, varied by +/- 20% to give a lower and upper bound. Total costs are assumed to be twice the 
additional costs. This should thus be considered a  conservative estimate  of the costs that  may need to be raised by 
project sponsors. 

223 

 
 
 
 
 
 
 
 
 
 
                                                           
 
 
 
 
 
 
 
Table 40: Sensitivity of amount to raise by RES, CCS or industry project sponsor to funding rates 
and project size 

maximum rate  
of funding 

50% 
55% 
60% 
65% 
70% 
75% 

maximum 
rate of 
funding 

50% 
55% 
60% 
65% 
70% 
75% 

Amount to raise by sponsor  
(million Euro) 
Average 
RES 

Lower bound 
RES  
(-20%) 
120 
116 
112 
108 
104 
100 

150 
145 
140 
135 
130 
125 

Upper bound 
RES   
(+20%) 
180 
174 
168 
162 
156 
150 

Amount to raise by sponsor 
(million Euro) 
Average 
industry 

Upper bound 
industry 
(+20%) 

Lower bound 
Industry  
(-20%) 

180 
174 
168 
162 
156 
150 

225 
218 
210 
203 
195 
188 

270 
261 
252 
243 
234 
225 

Finally, a rough estimate of the 15% "funding cap" limit can be estimated for a range of possible 
carbon prices.  

Table 41: Sensitivity of 15% to price of carbon 

Price of carbon  
(EUR / allowance)  
Total available IF 
funding  
(400+50m allowances) 
15% of total  
(million EUR) 

10 

15 

20 

25 

4.500  6.750  9.000  11.250 

675 

1.013  1.350  1.688 

224 

 
 
 
 
 
 
 
 
 
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15. 

OPTIONS FOR UNALLOCATED ALLOWANCES  

In the agreement on the Market Stability Reserve (MSR) co-legislators decided that unallocated 
allowances  should  be  transferred  into  the  MSR  in  2020.  The  Commission  undertook  to  review 
options for the further use of unallocated allowances from phase 3. This concerns allowances that 
could  have  been  allocated  for  free  in  phase  3,  but  have  in  practice  remained  unused.  Market 
analysts267 estimate that around 550 to 700 million allowances could remain unallocated by 2020. 

There are three main sources of unallocated allowances:  

  Allowances  that  remain  unallocated  because  of  the  closure  or  partial  cessation  of 
installations:  In  2013,  some  35  million  allowances  remained  unallocated  due  to  partial 
cessations and significant capacity reductions268.  

  5% of the overall amount of allowances in phase 3 was set aside for new entrants (i.e. new 
installations  or  new  capacities  in  existing  installations)  and,  based  on  the  experience  to 
date  it seems a significant  share of this  will not be used  by  new entrants. As of January 
2015,  some  70  million  allowances  have  been  used269  from  the  roughly 480  million 
allowances available for new entrants.  

  A  third  category  of  de  facto  "unallocated"  allowances  stems  from  the  application  of  a 
carbon leakage factor for sectors not on the carbon leakage list270, which the legislator has 
not directed to the MSR. Based on the current composition of the carbon leakage list some 
145 million allowances would accumulate under this header by 2020.  

Options for further us of these unallocated allowances are analysed below: 

Policy options 

Baseline:  Unallocated  allowances  remain  in  the  Market  Stability  Reserve  and  are  subject  to 
general MSR release rules. 

Option  1:  use  for  new  entrants  in  phase  4.  Unallocated  allowances  are  used  to  set  up  a  New 
Entrants  Reserve  –  which  is  currently  not  foreseen  by  the  EU  ETS  Directive  –  to  provide  free 
allowances  for  new  investments  and  production  increases  in  phase  4.  Allowances  from  partial 
cessations and closures in phase 4 feed back into the reserve to improve its flexibility (see section 
7.3.3.) 

Option  2:  supplement  existing  resources  to  support  low  carbon  innovation.  Unallocated 
allowances are used to supplement existing resources to support innovative low-carbon projects, 
including industrial innovation projects.  
Following  the  call  of  the  co-legislators271,  50  million  allowances  could  be  added  to  the  400 
million  allowances  already  foreseen  for  the  Innovation  Fund.  These  resources  could  be 

267 Bloomberg New Energy Finance, Thomson Reuters, ICIS 
268 http://ec.europa.eu/clima/policies/ets/cap/allocation/docs/status_table_ner_cessation_2013_en.pdf  
269 Including allowances to be handed out up to 2020 to new entrants based on the decisions made until January 2015. 
For further details please see: http://ec.europa.eu/clima/policies/ets/cap/allocation/docs/status_table_ner_en.pdf  
270  Sectors  not  on  the  carbon  leakage  list  received  80%  of  their  allowances  for  free  in  2013,  a  proportion  that 
decreases in linear fashion each year to 30% in 2020.  
271 Co-legislators requested the Commission to consider the possibility to use up to 50 million unallocated allowances 
for  such  purposes  with  projects  in  all  Member  States  including  small-scale  projects  (see  recital  3b  of  the  Market 
Stability Reserve draft decision 
http://www.europarl.europa.eu/meetdocs/2014_2019/documents/envi/dv/ets_msr_annex_/ets_msr_annex_en.pdf ).  

225 

 
 
 
 
                                                           
 
supplemented by funds left over from the NER 300 programme, i.e. funds from asset management 
and any funding becoming available from cancelled projects272.  

A first call for proposals under the Innovation Fund could be organised with the remaining funds 
from  the  NER300  programme  as  well  as  the  proceeds  from  the  monetisation  of  the  50  million 
allowances,  once  the  legislative  framework  and  the  management  structures  for  the  Innovation 
Fund are in place but still before 2021. 

Option 3:  use for indirect  cost compensation in phase 4. Unallocated allowances are used  to 
compensate indirect carbon costs (via increased electricity prices) of energy intensive industry.  

3a:  recycling  industries  are  eligible  for  compensation  in  order  to  promote  the  circular 
economy. 

3b: sectors exposed to the risk of carbon leakage due to indirect carbon costs are eligible 
for compensation. 

Option 4: cancel unallocated allowances. Unallocated allowances are cancelled. 

The outlined options are not mutually exclusive as it is possible to  split the available amount of 
unallocated allowances between the different options and it is also possible to keep the baseline 
for part of the unallocated allowances.   

Comparison between the options 

Based on the agreement by co-legislators, unallocated allowances  will be placed  in  the MSR  in 
2020, preventing an auction supply peak at the end of phase 3. 

Several  stakeholder  groups  have  suggested  differing  possibilities  to  use  the  unallocated 
allowances. Some call for using the unallocated allowances to further reinforce measures against 
the risk of carbon leakage, while others would favour strengthening the environmental ambition 
either directly through the cancellation of these allowances or indirectly by using these resources 
to co-finance innovative projects. 

The main dimensions for assessing the options are: avoiding negative impacts on the functioning 
of  the  market  stability  reserve,  environmental  impacts,  further  protection  against  the  risk  of 
carbon leakage (no undue costs for most efficient installations) and administrative complexity. 

Table 42: Comparison of options for further action with unallocated allowances 

Impact on MSR 
functioning 

Environmental 
impact 

No undue costs for 
most efficient 
installations 

No increased 
administrative 
complexity 

Baseline 

Option 1. 

Option 2. 

Option 3a 

Option 3b 

Option 4. 

0 

- 

-- 

- 

- 

+ 

0 

0 

+ 

+ 

0 

++ 

0 

+ 

0 

0/+ 

0/+ 

0 

0 

0 

0 

-- 

-- 

0 

Option  1  has  a  low  impact  on  the  functioning  of  the  MSR,  as  unallocated  allowances  would 
gradually be put in circulation in phase 4, i.e. throughout a period of ten years under this option 

272 The amount of funds returned from cancelled projects would be known in July 2018 when the deadline for making 
the final investment decision for the NER 300 projects will have expired. 

226 

 
 
 
 
 
 
                                                           
(in line with the additional needs for free allocation due to industrial growth). It can increase the 
protection  against  the  risk  of  carbon  leakage,  as  fewer  phase  4  allowances  would  need  to  be 
reserved  for  new  entrants,  thus  lowering  the  magnitude  or  contributing  to  avoid  the  need  for 
applying a correction factor to free allocation beyond 2020. The option has no further differences 
compared to the Baseline (the additional administrative complexity is deemed insignificant). 

Option 2 is light in terms of administrative burden because the unallocated allowances would just 
be  transferred  into  the  Innovation  Fund  and  no  additional  administrative  procedures  would  be 
necessary.  An  early  call  in  this  decade  would  limit  the  gap  between  the  current  NER300 
programme  and  the  start  of  the  Innovation  Fund273.  All  Member  States  would  be  in  an  equal 
position to apply for funding.  

A balanced approach is however needed with regard to the time of monetising the allowances in 
such a way as to provide certainty of available funds, while also minimising the negative impact 
on the functioning of the MSR. 

Option  3  is  similar  to  option  1  in  terms  of  having  only  a  low  impact  on  the  functioning  of  the 
MSR compared to the baseline, as unallocated allowances would gradually be put in circulation in 
phase 4 in this option, as well. The promotion of recycling is in line with the circular economy 
objectives and is considered to be more environmentally beneficial compared to the same level of 
compensation to  all electro-intensive industries, so  option 3a receives a better score than option 
3b274. The cost impact on installations depends on whether or not Member States already use State 
to compensate indirect carbon costs. In case that Member States already provide State aid, there 
may only be a substitution effect and the total amount of compensation remains unchanged for the 
companies. If the additional amount is used to top up existing measures there will be a positive 
effect on cost compensation.   

However,  a  compensation  of  indirect  costs  out  of  unallocated  allowances,  which  is  provided  in 
addition to the existing State aid programmes, leads to the biggest administrative complexity (due 
to reasons detailed in Annex 5) and risks creating double regulation. 

Option 4  positively  impacts  the  functioning  of  the  MSR,  as  under  this  option  unallocated 
allowances are cancelled permanently and thus their coming to the market is avoided. This option 
somewhat increases the environmental benefits delivered by the EU ETS. 

273  This  was  highlighted  by  stakeholders  as  an  issue  to  be  addressed  in  the  context  of  setting  up  of  the  Innovation 
Fund. 
274  Providing  increased  compensation  to  recycling  could  also  lead  to  more  reductions  of  unintended  market 
distortions, as providing a higher level compensation for indirect costs assumed by recycling industries reduces the 
disadvantage they encounter in some sectors (e.g. steel) vis-à-vis primary producers, which are entitled to a very high 
level of compensation for their direct carbon costs. 

227