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The Making Of Emissions Trading Laws – Understanding The EU Legislative Process
Reed Smith LLP Peter Zaman European Union May 9 2013 Introduction Unlike most traded commodity markets, the market for trading carbon credits or emissions allowances in the EU is not one based on its utility, usage or consumption. A carbon credit is not used in manufacturing processes or consumed like power or grain. Its market is entirely an invention of policy as implemented through legislation and regulation with a view to reducing the carbon emissions in the EU. Any demand for a carbon credit or emission allowance (” allowances “), is also therefore a creation of those legislative and regulatory processes. That process has left the EU Emissions Trading Scheme (” EU ETS” ), today in its third phase,1 moribund with an over-supply of allowances.2 Although the EU ETS is a relatively new market, it has certainly had its share of teething problems. Some of these problems (e.g. VAT fraud and addressing security aspects from carbon registry hacking incidents) have been through a lack of foresight on the part of the European Commission (the ” Commission “) and the member states. Others, such as the over-supply problem, have been as a result of a combination of fewer allowances required through financial crisis-induced lower industrial output, and the lack of ambition on the part of the developed world (including the member states) to take on more stringent caps for its emissions output. In the case of each of these problems, the Commission’s response has been to propose more legislation to tweak, amend or revise its original legislation. We have seen three versions of a ‘new’ Registry Regulation3 between 2009 and 2011, and have just had a fourth new version in May 2013. As the Commission proposes various ‘fixes’ or applies band-aids to the various problems it has to address, it sometimes builds on bad policy with more bad policy. The inclusion of the aviation sector within the EU ETS and the subsequent ‘temporary’ exclusion for one year only, springs to mind as a good example of the Commission’s “band-aid” approach to legislative intervention. “Two wrongs don’t make a right” seems an apt description of much of the legislation recently introduced, including some that has been designed to have retrospective effect. Therefore, how does a participant in the carbon market manage risk and uncertainty arising from a volatile and unpredictable legislative process? Unlike any other market, in the EU ETS it becomes essential to understand the legislative process as part of the toolkit of risk management, used by risk managers looking after traders. The importance of understanding the legislative process and the price volatility that can be triggered from a knee-jerk reaction to minor steps in the legislative process, was most visibly seen in the Commission’s recent proposal known as the ‘Backloading’ proposal.4 We will use the ‘Backloading’ proposal as an example to illustrate the legislative process followed in the EU ETS. This client alert seeks to demystify the labyrinth that is the EU rule making process in the EU ETS.5 The Codecision Procedure The most commonly used procedure for making law in the EU is the codecision procedure.6 In the last legislative term (2004- 2009) a total of 447 codecision files were concluded. The first half of the seventh parliamentary term (2009-2011), confirms the trend of first reading agreements: 136 codecision files (78%) were concluded at first reading, 32 (18%) at second reading and 7 (4%) at third reading. With the considerable extension of the scope of the procedure under the Treaty of Lisbon, the number of codecision files is expected to increase in the future.7 Diagram 1 (below) provides a high-level overview of the codecision procedure (a more comprehensive flow diagram has been included at Appendix 1). The majority of EU legislation will not require that the full nine stages of the process be utilised. If the proposed legislation is well supported by the EU Parliament and the Council of the European Union then it is possible that that it will become law after having completed only stages one to five. Click here to view diagram. Stage1: The Commission Proposal The Commission has the right of initiative under the codecision procedure.8 The European Parliament (the ” Parliament “) and the Council of the European Union (the ” Council “) then examine the proposals and suggest amendments before voting on whether the law should pass. Although there are several ways in which the Parliament and the Council can examine laws, the most common method is the codecision procedure. The Commission will place its proposal before the Parliament and the Council simultaneously. Stage 2: First Reading in the Parliament The European Parliament delivers an opinion at first reading. This opinion is prepared at two levels: At parliamentary committee level At plenary level Parliamentary Committee When the Commission text reaches the Parliament, the parliamentary committee responsible (the ” lead committee “), is named along with any other committees that are asked for non-binding opinions. Within the lead committee, the political groups’ coordinators designate a rapporteur entrusted with the drafting of the report containing the proposed amendments, if any, put forward by the Parliament. The parliamentary committees meet several times to study the draft report prepared by the rapporteur, as well as amendments put forward by other MEPs. These parliamentary amendments, as well as those suggested by the individual committee, are put to the vote in the lead committee, on the basis of a simple majority. Only the lead committee9 will have a binding vote, and a simple majority is needed to approve the report before the Commission’s proposal can progress. During the equivalent committee process of the “Backloading” proposal, EU carbon prices slid 40% after the Industry, Research and Energy Committee (ITRE) opposed plans to support the proposal (in January), even though the ITRE’s role was only advisory and the vote was non-binding. This perhaps suggested an overreaction by the market or a limited understanding of the EU legislative process, or perhaps, a little of both. The lead committee11 subsequently voted in favour of the proposal with a stronger-than-expected margin.12 Adoption in Plenary Once the report is adopted at committee level, it then goes to plenary, as both the “Backloading” and “Stop-the-clock”13 proposals did on 16 April 2013. Additional amendments to the report, including amendments adopted in the parliamentary committee, may be tabled by political groups and put to the plenary’s vote. Ahead of the vote, the rapporteurs and shadow rapporteurs present their report, followed by the relevant Commissioner.14 In the first reading, following the opinions at the committee and plenary levels, a simple majority (i.e., majority of MEPs present during the vote) is required to adopt the amendments, either on an amendment-per-amendment basis or “en bloc.” First Reading in the Parliament – Examples of Process In focus: “Backloading” Proposal Rejected by a narrow margin 334 in favour 315 voting against 63 abstaining “Backloading” Proposal The “Backloading” proposal, as referred to in the media, conjoins two separate stages; only the first stage was subject to a plenary vote on 16 April 2013. The first stage, to amend the EU ETS Directive, did not receive the simple majority needed to take it to stage 4 of the legislative process. This has derailed the Commission’s stage 2 plans to implement the amendment to the “Auctioning Regulation.”15 With the rejection of the Commission’s proposal, the Commission could choose to maintain the proposal by going back to the lead committee for amendment to try and gain a position of support at committee level. Recent reports suggest that this will happen, perhaps following the German government’s support for the proposal. The Commission has not formally withdrawn its proposal, as it took the confusion caused during the voting process 16 on 16 April to conclude that the proposal may not be “dead in the water.” When introduced the Backloading Proposal will start from stage 2 above. In focus: “Stop-the-clock” proposal Support by a large margin 577 in favour 114 voting against 21 abstaining “Stop-the-clock” Proposal In contrast, during the same parliamentary session the Parliament voted in favour of and adopted the ‘Stop-the-clock’ proposal. The result of the plenary vote is already being negotiated with the Council (see stage 4 below) and majority support and adoption by the Council without amendment seems very likely. Stage 4: First Reading of the Council The Council examines the Commission’s initial proposal in parallel to the Parliament. This work is conducted within specific working parties, made up of representatives of the member states and chaired by the representative of the member state holding the presidency. The Commission attends these meetings and can provide expert advice. The Council, however, only finalises its position once it has sight of the Parliament’s first reading amendments and the Commission’s resulting amended proposal. If the Parliament has not adopted any amendments to the Commission’s proposal and the Council accepts the Commission’s proposal without alteration, the act will move on for its second reading in the Parliament. Even if the Parliament has introduced amendments, if they are uncontroversial then the Council can choose to approve the amendments by qualified majority (see Diagram 2) and just as in the scenario set out above, the outcome is an early first-reading agreement. Click here to view diagram. However, not all legislative proposals have a smooth ride through the codecision procedure, especially if they have been passed by only a narrow margin in the Parliament’s plenary vote. If the Council wishes to make amends to the adopted Parliament text, two sub-options are possible and are explored more fully in Appendix 1: a second reading will only be required if the Council position is not in line with the Commission’s amended proposal, then unanimity will be required to adopt its Common Position. The Council may amend the Commission proposal only by acting unanimously (except in Conciliation). However, in order to facilitate the Council’s vote with qualified majority, the Commission often amends its original proposal just before the adoption of the Council’s Common Position.17 During the whole first reading stage, neither the Parliament nor the Council are subject to any time limit by which they much conclude their first reading. Stage 5: Communication of the Common Position The next stage is a Commission communication on the Council Common Position, which is forwarded to the Parliament in tandem with the Council Common Position, and explains why the Commission has decided to support or oppose the Council Common Position. The Commission also comments on the Council’s reaction to Parliament’s amendments which it had supported in plenary at the first reading. Informal Trialogues When the co-legislators are seeking to conclude an agreement at first reading, it is often the case that they organise informal tripartite meetings attended by representatives of the Parliament (rapporteur and, where appropriate, shadow rapporteurs), the Council (chair of the working party), and the Commission (department responsible for the dossier and the Commission’s Secretariat-General). Stage 6: Second Reading in the Parliament A three-month time limit18 is imposed for the Parliament to take action on the basis of the Council Common Position. After the three month period to allow for scrutiny, provided there have been no objections passed, the legislative act can then be then submitted directly for the signature of the Presidents and Secretaries-General of the Parliament and of the Council, and is published in the Official Journal, ending the procedure. It is likely that the “Stop-the-clock” proposal, first proposed on 20 November 2012 and passing its first Parliamentary plenary vote on 16 April 2013 will move forward without amendment and become law by July 2013. However, as demonstrated by the “Backloading” proposal, not all proposed legislation will follow stages one to five of the codecision procedure without challenge. If the Parliament suggests amendments to the Council position at first reading then the proposed legislation will move on to stages six to nine of the codecision procedure (See Diagram 1). Final Stages (stages 7 to 9): Second Reading by the Council, Commission Opinion, Conciliation Procedure and Third Reading The Council has a further three months19 to approve the Parliament’s second reading text. The adoption procedure is broadly similar to that at first reading, but with substantial restrictions on the nature of the amendments that can be tabled at second reading.20 The plenary will make its position known on the basis of the amendments included in the recommendation adopted by the parliamentary committee and any amendments tabled in plenary by political groups. The plenary will then need to adopt amendments by absolute majority.21 If the Council, voting by a qualified majority on the Parliament’s amendments (see Diagram 2), and unanimously on those which have obtained the Commission’s negative opinion, approves all of the Parliament’s amendments no later than three months after receiving them, the act is deemed adopted. In all other cases, Conciliation must be initiated, the Conciliation Committee having to be convened within six weeks.22 Conciliation is rare in practice (see Appendix 1). Distinguishing Codecision from Comitology An important distinction must be drawn between when the codecision procedure is used to create new laws, exemplified by the “Stop-the-clock” and “Backloading” proposals, and when there is delegation to the process of “comitology”. Comitology is an example of EU implementing procedure, used when legislation has already been passed by codecision but requires further amendment to be fully implemented, exemplified by the new “Registry Regulation.”23 The “comitology” procedure applies to the adoption of measures of general scope designed to apply essential provisions of basic instruments, or if specified, to adapt, delete or amend certain non-essential provisions of that basic instrument. The Comitology Regulation 24 sets out uniform conditions for the implementation of legally binding European Union acts, those acts (” basic acts “) are to confer implementing powers on the Commission. It is for the legislator, in accordance with the criteria laid down in the TFEU,25 to decide in respect of each basic act, whether to confer implementing powers on the Commission. A basic act may provide for the application of the advisory procedure or the examination procedure, taking into account the nature or the impact of the implementing act required. The new Registry Regulation is an example of the examination procedure. The latest incarnation of the Registry Regulation was put to vote in the EU Climate Change Committee (the relevant comitology committee) on 24 January 2013, and it received a majority vote in favour. It was then forwarded by the Commission to both the Council and the Parliament, which have up to three months to oppose the measure. The measure was adopted, after the three-month period lapsed, on 2 May 2013.26 Conclusion The lessons learnt by the participants in the EU ETS are mostly through hard and often painful experience. Price volatility has often been extreme and, as a commodity to invest in, allowances have often not provided a risk-worthy return. In a market created by legislation, an understanding of how the EU goes about making the laws, regulations and rules that allow the EU ETS to exist and operate is therefore key to the market’s ability to attract investment in low-carbon abatement technology, and in altering the behaviour of large emitters. As a policy measure, the concept of cap-and-trade as the best tool to achieve a price on our carbon emissions is being challenged in the EU, at a time when other countries (e.g., Australian, South Korea and Kazakhstan) and regional schemes (e.g., California and Quebec) are adopting their own cap-and-trade schemes. The EU ETS, as the oldest and largest international scheme, has an important climate leadership role to play and its trials and tribulations will be lessons to others. For risk managers, a better appreciation of the significance of the price volatility driven by EU ETS legislative and regulatory activism will enable them to do their jobs more effectively. The problem for the market is that there are no market tools to hedge against the unpredictability of the legislator, although the effectiveness of lobbying as a tool in the EU legislative process, as seen in the “Backloading” proposal, appears to be increasing. Click here to view flowchart. Continue reading
Budget To Cost Farmers Inheritance Tax
09-05-2013 14:32 PM With almost every Budget delivered by a Chancellor, it is fair to say that the devil is in the detail rather than in the speech itself. The 2013 Budget was no exception. Hidden away in a Press Release issued after the Chancellor sat down was the intention to introduce legislation preventing the claiming of Inheritance Tax Relief on some loans. Whilst initially the approach does not seem unreasonable, a closer reading uncovers that these rules also have the potential to impact on those who have taken out loans to acquire assets that qualify for Business Property Relief and Agricultural Property Relief. For many years, owners of Farms and Landed Estates have looked to secure borrowing against assets which do not qualify for other forms of Inheritance Tax Relief. Classically, borrowing has been kept away from assets such as land that qualifies for Agricultural Property Relief and has been secured against investment assets, such as let property, where no Inheritance Tax Relief is available. It seems that HM Revenue & Customs are now proposing that a loan should only be deductible against the asset it was used to acquire when assessing an individual’s estate liable to Inheritance Tax. This means that if the purpose of taking out the debt was to acquire a block of land, the debt is deducted from the value of that land when calculating the value of a person’s estate, even if the land also benefits from Agricultural Property Relief. This move is likely to have significantly more effect than it would have done a generation ago given the amount of diversification that has taken place on a number of farms. Assuming that this proposal finds its way into legislation when the Finance Act receives Royal Asset, which is likely to be in July, owners of farming businesses would be well advised to revisit any Inheritance Tax planning they have already undertaken. Unlike other transaction based taxes, the liability to Inheritance Tax tends to ebb and flow as personal circumstances change. Therefore, regardless of this most recent proposed amendment to the legislation, it is good practice to regularly review both your Will and Inheritance Tax planning to ensure they are up to date and effective. Continue reading
Biomass: When Could Torrefaction Be Commercially Viable?
10 May 2013 Andrew Mourant The pros and cons of the roasting process – torrefaction – for biomass crops is now under scrutiny as never before by university research teams around the UK, as Andrew Mourant reports… WHAT DOES the next decade hold for exploiting biomass as a commercially viable energy crop? And is there a business future for pre-roasting crops such as willow and poplar so these can be used effectively alongside coal in power stations? The idea has been around for almost 40 years but has yet to take off commercially. Many unanswered questions still surround the science and economics, but the energy world is striving to close that knowledge gap. The roasting process – torrefaction – is now under scrutiny as never before by university research teams around the UK, and is a significant part of the Supergen Bioenergy hub project. This, a five-year programme, has just started gathering momentum having attracted a £3.5mn grant from the Energy and Physical Science Research Council (EPSRC) . Supergen, based at the University of Manchester, intends uniting the best brains of industry and academia. It’s looking far beyond the process of torrefaction, adopting a “whole systems” approach – from crop production to its use in power stations. It’s also examining social and economic impacts besides the science. The problems created by untreated biomass at power stations are well-documented. The material is burned alongside coal which is crushed to powder in huge mills before being blown into the burners. But while coal is easily ground, most biomass is springy and fibrous. This limits the amount that can be processed and used in co-firing. Some power stations have invested heavily in separate mills for cutting biomass so they can use more of it. Torrefaction, however, has the potential to make a huge difference to their operations. After biomass is roasted in an airless environment at about 280°C, moisture, along with some gases and volatile substances, is lost. What’s left is transformed into a harder fuel that’s easier to crush, move and store. It also has a longer shelf life. Shrouded in secrecy Much of the new research is a work in progress, one in which industry collaborators are reluctant to discuss their involvement. Drax , for example, working alongside the University of Leeds, was reluctant to answer detailed questions from Renewable Energy Focus, with a spokeswoman saying only: ‘a lot of what we do in this area is confidential’. Drax provides ‘some guidance on the direction which research takes… through sharing feedback on our findings… we provide a link to the real world of business and engineering,’ a spokeswoman said. But she declined to say if there had been significant discoveries about which crops work best for torrefaction; or if Drax has learned from commercially advanced operations such as Topell in Holland – the Netherlands leads the world in the business application of this type of torrefaction technology. Eon, another partner with Leeds University, was also unforthcoming about its role. What is known is that the university’s work is wide-ranging. It’s considering, for instance, whether or not torrefied biomass could be at risk of spontaneous combustion; also its potential explosiveness when roasted and ready for use. Environmental impact Meanwhile environmental impacts are being examined at Bath University by researcher Dr Paul Adams. “We’ve done a lot of work on the use of resources and energy,” he said. “You often find there’s a lot of ‘embodied’ energy in creating biomass, for instance using inorganic fertilisers on the crop feedstock. Producing these is quite energy-intensive. “There are hundreds of crops that can be used for torrefaction. But another approach is to use industrial bi-product from forestry sawmills or furniture manufacturers that would otherwise go into landfill, decompose aerobically and release methane. Its global warming potential is 25 times higher than that of CO2. “Our assessment looks at the whole system of where biomass feedstock is coming from – from cradle to grave. We’re not just interested in carbon, but for instance, water, which is used not only in crop cultivation but the industrial process. Another aspect to consider is the use of metal in creating a torrefaction plant.” Other scientists are examining what torrefaction means for CO2 emissions, among them Dr William Hall at Coventry University. “We’ve been looking at the burning temperature and time the process takes,” he says. “It’s been theoretical: we’ve used hardwood and softwood in applying the model. We found that the CO2 emissions are linked to the conditions – there’s quite a narrow window of temperature. If you stray outside that window, you can increase emissions rather than reducing them.” Dr Hall has published detailed findings in the Journal of the Energy Institute. His work took two approaches. The first was to look at use the latent heat of hot syngas for torrefaction (syngas is a mix of carbon monoxide, carbon dioxide and hydrogen produced from gasifying a carbon-containing fuel). “But that’s only possible when the gasification plant and torrefaction plant are on the same site,” says Dr Hall. “So we also considered what happens when you use the heat from volatile torrefaction products that have been combusted.” In terms of reducing CO2, Dr Hall concludes that the ideal torrefaction temperature is 280°C for hardwood and 300°C for softwood where syngas heat was used to heat pre-dried woodchips. When torrefaction volatiles provided the heat source, the optimum temperature dropped to 240°C and 260°C for hardwood and softwood respectively. “The downside to torrefaction is that mass is lost and therefore the energy yield is never 100%,” says Dr Hall. “There are many uncertainties remaining about the process.” So, although torrefied products have a greater energy density than other biomass and less energy is needed to grind it up in power stations, the power industry must decide whether that overall energy loss is worth the effort and expense. Explosive risks? The focus at Leeds is about building up a knowledge base of how fuels behave; the dusts; the explosive risks, says research team leader Professor Jenny Jones. “We’re looking to see if torrefied fuels can be stored outside – whether they’re at risk of self-heating spontaneous combustion,” she says. “At the moment power stations have to invest in underground storage for biomass. It’s a big capital investment. As torrefied biomass has been heat-treated, you’ve removed a lot of the material that moulds will attack and cause it to spontaneously ignite.” Dr Daniel Nowakowski, who’s based at Aston University and has studied torrefaction for over two years, agrees. “Removing moisture and some volatiles makes it less sensitive to degradation and also hydrophobic (water repellent),” he said. “It’s good for storage and handling – there are major cost-savings.” Dr Nowakowski and his team used a small experimental reactor to torrefy various crops including beech, willow and switch grass. Trials were conducted at temperatures ranging from 225–300°C, with torrefying times ranging from 30 minutes to two hours. Meantime, Professor Gordon Adams is leading the Leeds University study into explosiveness. One problem, he says, is finding sufficient torrefied material with which to experiment. “While Jenny Jones’s group is making small quantities, one test we do is in a metre cube explosion vessel and you need kilos for that,” he said. “We’d been working 18 months before we got one of the manufacturers to deliver 20kgs. Several companies are making it – it will be big business one day.” However, such is the commercial sensitivity, and with negotiations between suppliers and power companies underway, Professor Adams was unwilling to name the producer. The explosiveness test for torrefied biomass uses a pulverised material whisked up with air in an upright pyrex Hartmann tube. “In terms of how little you need to react with air, the indication is that biomass is very reactive compared with coal,” says Professor Adams. “There have been a number of biomass plant explosions. Burning torrefied biomass is do-able but it will release volatility sooner.” The dust clouds created by biomass tipped into storage silos presents a hazard against which the industry has always to be on guard. The dangers were underlined by a fire at a Npower biomass plant in Tilbury, Essex, in February that prevented it exporting power to the grid for four months. While Npower claimed the fire was caused by a “number of relatively minor events that, taken in isolation would not have escalated”, smouldering dust from wood pellets ignited by drafts of air were widely speculated to have been the cause. Npower says it has since improved safety measures at the site. Still some way to go Developing a biomass supply chain and infrastructure for industrial scale torrefaction ‘could probably take a decade to get into place’, says Professor Adams. It raises big logistical questions – transporting the bulky crop with its significant water content is cumbersome and costly. However pellet plants are now being built; and the pellets, which are dried during the process, are easier and cheaper to ship than raw biomass. In business terms, working out just where to build a torrefaction plant will be crucial. That’s a question Professor Adams, for one, still struggles to answer. “Do you place it at source (near the feedstock crop) or near the power station?” he wonders. “The size of a big-coal fired station is such that you would need a torrefaction plant of its own. No one knows what the economics will be.” Continue reading
