Report of the working group on the modalities for the sale and auctioning of CO2 allowances

The European Union Emissions Trading Scheme (EU ETS) is based on the cap and trade principle. A cap, corresponding to an overall emission reduction objective, is set on the emissions of a number of industrial and energy sectors. Installations covered by the scheme must, indeed, surrender a number of allowances each year to the national authorities (on April 30th), each of which represents a metric tonne of CO2, corresponding to their emissions. The CO2 allowances can be freely traded on the market between the companies covered and other economic actors. Thus, an installation may choose either to reduce its emissions or buy allowances on the market from other installations and financial operators. The trading scheme thereby allows the cost of achieving emission reduction objectives to be minimised, by exploiting the lowest abatement costs within the European Union.

CO2 allowances are currently distributed free-of-charge by each Member State on a yearly basis to the installations included in the National Allocation Plan (NAP), which defines quantities issued to installations for the period 2008-2012. During this second phase of the ETS, Member States also had the possibility of selling a small number of allowances, up to 10% of the national budget defined within the framework of the National Allocation Plan. Allowances are electronically logged in a national register, which tracks allowance movements on the accounts of operators involved in the market. In France, this national register is kept by the Caisse des Dépôts et Consignations on behalf of the State. For 2008-2012, nearly 2.2 billion CO2 allowances have been allocated each year by the public authorities to installations within the ETS. As a result, a secondary carbon market has developed within the European Union.

The adoption of amended directive 2003/87/EC as part of the “energy and climate package” under the French presidency of the European Union opened the way to a third European ETS phase (2013-2020). The adoption of this directive has in-depth implications for the ETS. First of all, the level of constraint has been tightened: from 2013, the overall ETS emissions cap will indeed decrease linearly by -1.74% per year, to reach an overall objective of a 21% reduction in emissions by 2020 compared to 2005. Thus, 1.72 billion allowances will be issued annually in 2020. Secondly, the free allocation of allowances will become an exception: indeed, the issuance of allowances to companies through auctions will become the rule as from 2013. From 2013 onwards, companies from the electricity generation sector will have to acquire all their allowances either on the market or via auctions. Other industrial sectors will progressively see their share of free allowances diminish from 80% in 2013 to 30% in 2020. Only industrial sectors identified as being subject to a high risk of carbon leakage (relocation of production to countries which are not subject to CO2 constraints) will continue to benefit from free distribution of allowances during the third phase of the ETS on the basis of specific benchmarks. As things stand, the list of these sectors is not yet known, but is to be published by the European Commission before December 31st 2009.

The auctioning of CO2 allowances will represent a critical economic and financial challenge for Member States during the third phase of the EU ETS. First of all, the introduction of efficient auctioning procedures will be a necessary condition for the proper operation of the ETS and, eventually, of Member States reaching their mitigation targets. Secondly, the auctioning of CO2 allowances will involve significant revenues. Amended directive 2003/87/EC identifies drawing rights for each Member State from the overall volume of CO2 allowances put up for auction1. Thus, France received 5.35%, compared to 19.57% for Germany, the biggest allowance “issuer” amongst Member States. Expected revenues for public authorities from the auctioning of CO2 allowances will, therefore, amount to several billion euros per year for the largest Member States.

In order to face up to the challenge, the Government has asked a working group to consider the modalities for the sale and auctioning of CO2 allowances and to formulate recommendations for organising auctions in France. Under the presidency of Jean-Michel Charpin, Inspecteur général des Finances, the group was set up in April 2009, bringing together representatives from companies subject to the EU ETS, representatives from the financial sector, members of administrations, and university professors. The workgroup was also assisted in its work by presentations from qualified personalities and, in particular, representatives from other Member States’ administrations who had put in place CO2 sale or auction operations in the most recent period. The group held eight meetings.

Given the challenge that the public authorities face, the idea was to flesh out a number of general principles presiding over the auctioning of CO2 allowances, which have already been defined by Community legislation. As part of the energy and climate package, the Member States reached an agreement on four fundamental principles. The first is that of non- discrimination between market players in terms of access to auctions. This reflects a concern to ensure that all companies subject to the EU ETS can participate in the auctions including, in particular, small and medium sized enterprises (SMEs). The second principle is transparency and equality in terms of access to information. Putting this principle into practice, for example via suitable reporting processes for auction results, is a fundamental part of the robustness of an auctioning system so as to avoid any destabilisation of the secondary market. The third principle is the requirement to plan suitable monitoring and oversight procedures in place for the auctions and, at a later date, to consider a general carbon market regulation framework for Europe. Indeed, the market today is somewhere on the border between a commodities market and a financial instruments market. It now seems that an in-depth reflection on the means of ensuring proper functioning of this market is required so as, in particular, to prevent any anti-competitive or fraudulent activity. The very integrity of the European carbon market, and the trust of economic players in this crucial instrument for reaching the greenhouse gas emission reduction targets in France and Europe, is at stake. Fourthly, it also seems crucial that the modalities for auctioning allowances should respect two principles mentioned in article 10 of the revised directive 2003/87/EC: the predictability of applicable rules and the minimisation of participation costs for auctions participants.

The work of the workgroup anticipated the consultation of the European Commission on organising CO2 allowance auctions within the European Union from 2013 onwards. It sought, in particular, to shed light on the decision of the French public authorities as to the position that they will adopt as part of the Community negotiations on the regulations for organising auctions in end-2009 and early 2010. However, since the work of the group preceded those of the European Commission, the recommendations of the group do not cover wholly the questions listed by the European Commission in its June 3rd 2009 consultation paper. 

The recommendations formulated by the workgroup do, however, answer most of the operational and theoretical issues raised by setting up CO2 allowance auctions in France and within the European Union. In this respect, the report first provides a feedback on foreign experiences of CO2 allowance auctions as well as a brief update on the way the EU ETS operated in the recent period. The workgroup then formulates recommendations on the format of auctions, the operational modalities of their implementation and access to the auction process. The specific question of regulation and monitoring of auctions is also addressed in the report. Finally, the group formulates recommendations regarding France’s position regarding the creation of a Europe-wide auctioning platform.