The Compatibility of EU State Aid for Environmental Protection with the Polluter Pays Principle: In the Context of the EU Emissions Trading System

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The Compatibility of EU State Aid for

Environmental Protection with the

Polluter Pays Principle

In the Context of the EU Emissions Trading System

Angelica Arnqvist

Juridiska institutionen Examensarbete 30 hp. Inriktning: Europarätt Juristprogrammet (270 hp) Höstterminen 2018 Grupphandledare: Björn Lundqvist

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Abstract

This thesis, examines three research questions concerning the coherence between the European Union (EU) rules about State aid for environmental protection and the “polluter-pays-principle” (PPP) in the context of the free allocation practice in the European Union Emissions Trading System (EU ETS).

The aim of the first research question is to study whether the free allocation of emission rights within the EU ETS is compatible with the EU State aid rules. The conclusion to this research question is that the free allocation practice does fulfil the criteria to constitute State aid but that the Commission has permitted derogations against this prohibition, provided certain conditions such as necessity and proportionality are fulfilled.

The second research question is whether the free allocation method is compatible with the PPP. The PPP can be divided into an economic dimension and a legal dimension and it is concluded that the free allocation practice is contrary to at least the legal dimension of the PPP. According to the OECD, exceptions from the principle can be made but the EU has not established conditions for when such derogations from the PPP can be made.

The third research question concerns the compatibility between the EU State aid rules and the PPP. Generally there is no disharmony between the State aid rules and the PPP, since the PPP should not be seen as a mere prohibition against aid to polluters, but can also be considered a complement to State aid rules. However in the specific case of the free allocation rules in the EU ETS, State aid measures contrary to the PPP are carried out. Since the EU has not established conditions for whether derogations from the PPP can be made, it is concluded that the free allocation practice within the EU ETS does expose a disharmony between the PPP and the State aid rules. It is suggested that the EU clarifies the conditions for permitting derogations from the PPP, in preparation for the fourth phase of the EU ETS.

Keywords

Polluter Pays Principle, State Aid for Environmental Protection, European Union Emissions Trading System

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Abbreviations

ECJ European Court of Justice EU European Union

EU ETS European Union Emissions Trading System GHG Greenhouse gas

OECD Organisation for Economic Cooperation and Development PPP Polluter Pays Principle

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1. Introduction

The prohibition against State aid is one of the components within European law that should prevent distorted competition.1_{For some legitimate purposes though, the European Union (EU)}

has permitted derogations against this prohibition.2_{One such exception is for environmental}

causes.3_{Nevertheless, it is important that State aid for environmental causes does not contradict}

the polluter pays principle (PPP),4_{an environmental principle prescribing that “the costs of}

measures to deal with pollution should be borne by the polluter who causes the pollution”.5

An example of when there might be a conflict between State aid for environmental causes and the PPP is within the EU Emissions Trading System (EU ETS). In order to remedy for climate change due to greenhouse gases being emitted, the European Union set up the world’s first international emissions trading system in 2005. The aim of the emissions trading system is to reduce the total amount of greenhouse gases that is being emitted.6_{This aim is being achieved}

through a ‘cap and trade’ principle which means a cap is set on the total amount of greenhouse gases that can be emitted by those covered by the system. Within the cap, companies receive (free allocation) or buy (auctioning) emission allowances, also called carbon rights, which they can then trade with each other.7

This means the EU is handing out emission allowances for free to some sectors instead of the default method of auctioning. One of the reasons these carbon rights are allocated for free is to prevent carbon leakage, referring to the risk of these sectors relocating their factories to third

1_{Treaty on the Functioning of the European Union, 2012, OJ C 326/47, 26.10.2012, p.1 [cit. TFEU], Article}

107(1).

2_{Article 107(2) and Article 107(3), TFEU.}

3_{Communication from the Commission - Guidelines on State aid for environmental protection and energy}

2014-2020, OJ C 200, 28.6.2014, pp. 1-55 [cit. Guidelines on State aid for environmental protection and energy 2014-2020].

4_{Article 191(2), TFEU.}

5_{Guidelines on State aid for environmental protection and energy 2014-2020, para. 19, point 28.}

6_{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 275/32, 25.10.2003, pp. 32-46 [cit. ETS Directive 2003], Article 1.

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countries.8_{The question is whether the free allocation practice can be considered as some sort}

of State aid. Even if the free allocation would be allowed in accordance with the permitted derogations in Article 107(3) in the Treaty on the Functioning of the European Union (TFEU), the question remains whether the free allocation of emission allowances is also consistent with the PPP. If the free allocation of emission allowances is not compatible with the PPP, there might be a conflict between State aid for environmental protection and the PPP. According to Article 7 TFEU, the EU “shall ensure consistency between its policies and activities, taking all of its objectives into account and in accordance with the principle of conferral of powers.” Having Article 7 in mind, it is important that the EU State aid rules and the PPP are consistent with each other as they are both included in the TFEU. This research question about the compatibility between EU State aid rules and the PPP is especially relevant since the EU ETS is facing a fourth phase during the period 2021-2030 where free allocation of emission allowances will continue to be made.9

1.1 Purpose and research questions

This research paper investigates whether there is a disharmony between the EU State aid rules for environmental protection and the PPP. The analysis is conducted in relation to the free allocation rules of the EU ETS. The purpose is to clarify the legal framework enabling potential improvement in the face of the fourth phase of the EU ETS. The importance of this question stretches beyond the EU ETS since it is relevant also for other situations in the domain of State aid for environmental protection. In order to answer the overarching research question on the coherency between the EU State aid rules and the PPP, the analysis is carried out in the following three steps:

 Is the EU ETS compatible with the EU State aid rules?  Is the EU ETS compatible with the polluter pays principle?

8_{Communication from the Commission - Guidelines (2012/C 158/04) on certain State aid measures in the}

context of the greenhouse gas emission allowance trading scheme post-2012, OJ C 158, 5.6.2012, pp. 4-22 [cit. Guidelines on certain State aid measures in the context of the greenhouse gas emission allowance trading scheme post-2012], para. 23.

9_{Directive (EU) 2018/410 of the European Parliament and of the Council of 14 March 2018 amending}

Directive 2003/87/EC to enhance cost-effective emission reductions and low-carbon investments, and Decision (EU) 2015/1814, OJ L 76, 19.3.2018, pp. 3-27 [cit. ETS Directive 2018], states that the option for free allocation of emission allowances in the energy sector will continue until year 2030, para. 18.

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 Is there a disharmony between the EU State aid rules for environmental protection and

the polluter pays principle?

1.2 Specification of detailed research focus

The political discussions regarding the EU ETS is not covered in this paper. The reason for this specification is to focus the research question on the legal conflicts that potentially exist. Although the background to the development of the EU ETS is presented, the research question is targeting the current state. State aid is currently being given to several purposes in the scope of the EU ETS but the target of this thesis is on the aid given to undertakings in sectors and subsectors deemed to be exposed to a substantial risk of carbon leakage due to the increased indirect emission costs as a result of the EU ETS. This is because for other situations within the EU ETS where aid can be given, the potential incoherence with the polluter pays principle is not as clear. Furthermore, although international credits set up under the Kyoto Protocol10 could potentially be considered as aid comparable to the free allocation of emission allowances, these are not discussed here. The reason for this is to focus the analysis on the EU context.

1.3 Methodology and material

The methodology used in this thesis is the EU legal methodology. The EU legal methodology has similarities with the legal dogmatic methodology in the sense that they both have as its aim to determine the content of the law and that they are both restricted to the study of traditional sources when determining the content of a given legislation. The traditional sources in the legal dogmatic methodology are usually considered to be laws, cases, legislative history and legal doctrine.11_{In the EU legal methodology however, the EU’s general legal principles and soft}

law play important roles for interpretation of legislation as well. Even though soft law is non-binding, it does often have a normative effect and is therefore important as interpretation material.12 Hence, primary and secondary legislation, soft law, cases, general legal principles and legal doctrine, mainly from the EU, are considered. In order for EU law to get the same impact in all the member states, the study of EU law requires certain interpretation methods.

10_{United Nations, Kyoto Protocol to the United Nations Framework Convention on Climate Change, 10}

December 1997, U.N. Doc FCCC/CP/1997/7/Add. 1 [cit. Kyoto Protocol]. The Kyoto Protocol is an international agreement under the United Nations Framework Convention on Climate Change, setting internationally binding emission reduction targets for the Convention Parties.

11_{Korling, F. and Zamboni, M., Juridisk metodlära, 1:6 edition, Lund, Studentlitteratur AB, 2017, p. 28.} 12_{Ibid., pp. 125-128.}

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One such interpretation method is the teleological interpretation, which means a rule should be interpreted in the context of its purpose.13

In some instances, information from the web page of the European Commission is used. Since this is first-hand information from the European Commission, this source is determined credible. Doctrine is not confined to legal articles and books but econometric and empirical papers are also used where an empirical evaluation of a law or a legal concept contributes to the understanding of the efficiency of the law. Since the teleological interpretation method is important in the EU context, the empirical studies can be useful to evaluate whether a legislation has reached its objective. However, these empirical studies are not considered legal sources and therefore they cannot be used in determining the content of law. The use of empirical evidence is a common method in the legal sociological method14, thus there is an influence from this method but this is limited to one part of this thesis, i.e. section 2.4.

There are aspects of the research questions that have relevance outside of the EU, more specifically, the polluter pays principle, which is a global principle within environmental law. Thus, it is relevant to study sources from mainly the Organisation on Economic Cooperation and Development (OECD) when they have relevance to the research questions. The reason why sources from the OECD are used, despite the fact that they do not constitute legal sources within EU law, is because the OECD has had an important role for the introduction and interpretation of the PPP. The fact that international law outside of the EU is used does not mean that a comparative approach will be used in relation to this international law.

1.4 Disposition

The rest of the paper is organised as follows. Section two gives an overview of the EU ETS with an emphasis on the free allocation rules. In section three the first research question about the EU ETS in relation to the EU State aid rules is analysed. The second research question, which deals with the EU ETS compatibility with the PPP, is analysed in section four. In section five the third research question, about the coherency between the State aid rules and the PPP, is examined. In section six the conclusion is presented.

13_{Ibid., pp. 121-122.} 14_{Ibid., p. 222.}

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2. EU Emissions Trading System

2.1 Background of the EU Emissions Trading System

The EU Emissions Trading System (EU ETS) is the world’s first and most wide ranging international emissions trading system. It accounts for over three quarters of the international carbon trading and operates in all 28 EU countries as well as Iceland, Liechtenstein and Norway.15

The idea of the EU ETS is to make public goods (air) to private goods (emission allowances) and make these private goods tradable so that they get a market value.16_{Since natural resources}

generally are public goods, individuals and companies can consume it without paying for it. To remedy for this so called ‘tragedy of the commons’ where people will continue to pollute due to lack of sense of ownership or responsibility, the costs of these negative environmental impacts (also called external costs) need to be internalised in the product prices. One way to achieve this is using property rights, which can create incentives for internalisation of external costs.17_{By introducing emission rights, the EU ETS would thus work by making the negative}

impact of the greenhouse gas (GHG) emissions on the environment reflect in the polluter’s product prices, resulting in a greater sense of responsibility for the polluter.

Directive 2003/87/EC (ETS Directive 2003) defines the emission rights as “allowances”. An allowance in this scheme should be understood as “an allowance to emit one tonne of carbon dioxide equivalent during a specified period, which shall be valid only for the purposes of meeting the requirements of this Directive and shall be transferable in accordance with the provisions of this Directive”.18_{Thus, an emission right is defined as an allowance that authorises}

an entity to emit a certain amount of emissions during a specified period. The question of whether these allowances should be characterised as property rights or something else, has been up to discussion. The Commission is currently conducting a study on the legal nature of these

15_{European Commission, EU Emissions Trading System (EU ETS), 2018,}

https://ec.europa.eu/clima/policies/ets_en, (accessed 26 September 2018).

16_{Dales, J.H., “Pollution, property and prices: an essay in Policy-Making and Economics”, Canadian Journal}

of Political Science, vol. 2, no. 3, 1968, pp. 386-387.

17_{Demsetz, H., “Towards a theory of property rights”, American Economic Review, vol. 57, no. 2, 1967, p.}

348.

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EU ETS allowances.19_{According to some researchers, these allowances should not be seen as}

permanent, private property rights to avoid the situation where the government needs to compensate the polluter for “taking” these allowances when reducing the emission cap. An allowance should rather be seen as authorisation that can be limited or terminated by the government.20

The mechanism of the EU ETS is that a cap is set on the total amount of certain greenhouse gases emitted by installations covered by the system. Within the cap, companies receive or buy carbon rights that they can trade with each other. The cap is reduced over time, which ensures that the allowances have a value. After each year companies need to return enough allowances to cover their emissions during that year. If a company has emitted more than their number of allowances allow, fines (100 euros for each excess tonne of carbon dioxide emitted) are imposed. However, if a company reduces its emissions, it can keep the spare allowances for future needs, or alternatively sell them to another company. Generally, the compliance rate is high where around 99 percent of the emissions are covered by the allocated allowances each year.21

The EU ETS limits emissions from more than 11 000 heavy energy-using installations and airlines operating between the participating countries. Furthermore, it covers 45 percent of the EU’s total GHG emissions. The emissions covered are those that can be measured and verified with a high level of accuracy, and involve carbon dioxide, nitrous oxide and perfluorocarbons from certain sectors. Participation in the EU ETS is mandatory for the companies in the concerned sectors but there are exceptions. For example in some sectors, only plants above a certain size are included.22

19_{European Commission, Report from the Commission to the European Parliament and the Council: Report}

on the functioning of the European carbon market, COM(2017) 693 ﬁnal, Brussels [cit. Report on the functioning of the European carbon market, 2017], p. 30.

20_{Arcuri, A., Clo, S., & Woerdman, E., “Emissions Trading and the Polluter-Pays Principle: Do Polluters}

Pay under Grandfathering?”, Review of Law and Economics, vol. 4, no. 2, 2008 [cit. Arcuri, Clo & Woerdman], p. 571.

21_{Report on the functioning of the European carbon market, 2017, p. 35.}

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2.2 Origin and the different phases of the EU ETS

In order to get an understanding of the EU ETS and its current developments, it is important to understand its regulatory evolvement. In 1992, the United Nations Framework Convention on Climate Change (UNFCCC) was adopted. The objective of this international environmental treaty was to achieve “stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system”.23_In

Article 3.1, a provision was introduced, requiring industrialised countries (included in Annex 1 of the convention) to take the lead in combating climate change. Following up on the UNFCCC, the Kyoto Protocol was established in 1997, which set the first legally binding emissions reduction target caps for 37 industrialised countries.24

In order to meet these targets the EU issued the ETS Directive 2003. It was through this Directive, the scheme for gas emission allowances within the EU was established, where the main objective of the Directive was “to promote reductions of GHG emissions in a cost-effective and economically efficient manner”.25_{As opposed to the Kyoto Protocol this Directive}

dealt with trade between companies instead of trade between countries. This Directive has been

revised by Directive 2009/29/EC (ETS Directive 2009)26 and Directive (EU) 2018/410 (ETS

Directive 2018). The ETS Directive 2018 emphasises the principles of subsidiarity and proportionality in the implementation of the scheme.27_{The subsidiarity is necessary in order to}

achieve acceptance for the scheme throughout the internal market. Furthermore, the principle of proportionality states that only the elements that are essential for the functioning of the emissions scheme should be included in the Directive.

2.2.1 Phase one

The EU ETS was launched in 2005. Between the years 2005-2007, the EU ETS was in its first phase where a key feature was that almost all allowances were given to companies free of charge, based on their historical emissions, an allocation method called “grandfathering”. For

23_{Article 2, United Nations, United Nations Framework Convention on Climate Change, 9 May 1992, S.} Treaty Doc No. 102-38, 1771 U.N.T.S. 107 [cit. UNFCCC].

24_{Article 3(1) in the 1997 Kyoto Protocol commits the participating nations to reduce their GHG emissions}

by 5% compared to the 1990 levels during the period 2008-2012.

25_{Article 1, ETS Directive 2003.}

26 Directive 2009/29/EC of the European Parliament and of the Council of 23 April 2009 amending Directive

2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading scheme of the Community, OJ L 140, 5.6.2009, pp. 63-87 [cit. ETS Directive 2009].

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each trading period, Member States submitted a National Allocation Plan (NAP) to the Commission according to Article 9 in the ETS Directive 2003, in which they stated the total quantity of allowances that they intended to allocate for that period and how they proposed to allocate them. However, the ETS Directive 2003 does not state an upper limit on the total quantity of allowances allocated by Member States. As reliable emissions data was absent, the caps were set based on estimates in this phase. As a result, the amount of allowances issued exceeded emissions. Since supply far exceeded the demand, the price of allowances fell to zero in 2007.28 According to Article 11(3) in the ETS Directive 2003, the decisions of each Member State on the total quantity of allowances that it plans to allocate have to be in accordance with the State aid rules in the Treaty. However, the Directive does not contain any guidelines on the requirements of complacency to the State aid rules.

2.2.2 Phase two

The second phase took place during the years 2008-2012. This phase coincided with the Kyoto Protocol’s first commitment period. According to Article 3.1 of the Kyoto Protocol, industrialised countries were required to reduce their overall GHG emission levels by at least five percent below the 1990 levels during this first commitment period. To reach this target, the participating countries had concrete targets to meet, and for the EU the target was an 8 percent reduction. During this second phase of the EU ETS, the proportion of free allocation fell to 90 percent. In this phase, verified annual emissions data was available from the first phase and therefore the cap on allowances was reduced to better match the actual emissions. However, the financial crisis in 2008 led to reduced emissions which in turn led to a surplus of allowances. This decreased the carbon price throughout phase two.29

2.2.3 Phase three

The EU ETS is currently in its third phase, which spans over the years 2013-2020. While the ETS Directive 2003 governed the first two phases, mainly the revised ETS Directive 2009 now governs the third phase.30_{Some important changes from the two previous phases are that a}

single EU-wide cap on emissions replaces the national caps. Auctioning has become the default

28_{European Commission, Phases 1 and 2, 2018,}_{https://ec.europa.eu/clima/policies/ets/pre2013_en}_,

(accessed 9 September 2018).

29_Ibid.

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method for allocating allowances instead of the free allocation and more sectors and gases are included in the scheme.31

The single EU-wide cap means that the rules are fully harmonised but Member States are still required to prepare allocation plans called National Implementation Measures (NIMs), containing the allocations planned for each installation in the country. These NIM:s only determine the amount of allowances allocated to each installation but the allocation method is determined by the ETS Directive. The Member State is responsible for ensuring that allowances are auctioned out.32_{An estimate made in 2017 showed that the share of free allowances}

amounted to 43 percent of the total amount of emission allowances during the third phase.33

The slogan for the EU’s current comprehensive climate policy is “20-20-20 by 2020”, which refers to three different targets to be met by year 2020; a 20 percent reduction of GHG emissions from 1990 levels, a 20 percent share of total energy consumption from renewable energy, and a 20 percent improvement in energy efﬁciency.34_{The prediction is that in 2020 the emissions}

from sectors covered by the system will be 21 percent lower than in 2005.35

2.2.4 Phase four

The next phase of the EU ETS will take place during the period 2021-2030. The ETS Directive 2018 was established in order to achieve the EU’s 2030 emission reduction targets as stated in the 2030 climate and energy policy framework and as part of the EU’s commitment to the 2015 Paris Agreement.36 The ETS Directive 2018 stipulates that the default method for emission allocation will continue to be auctioning and that the EU-wide cap on emission allowances will be reduced at a higher yearly rate than previously. The free allocation measures will continue in the fourth phase to prevent the risk of carbon leakage as long as no comparable efforts are

32_{European Commission, EU ETS Handbook, Brussels, European Union, 2015, p. 26.}

https://ec.europa.eu/clima/publications_en#Ets [cit. EU ETS Handbook], (accessed 10 September 2018).

33_{Report on the functioning of the European carbon market, 2017, p. 12.}

34_{Guidelines on State aid for environmental protection and energy 2014-2020, preamble 3.} 35_{European Commission, EU Emissions Trading System (EU ETS), 2018,}

36_{United Nations, Paris Agreement on Climate Change, 13 December 2015, U.N. Doc.}

FCCC/CP/2015/10/Add.1 [cit. Paris Agreement]. The Paris Agreement is an agreement between the Parties of the UNFCCC to combat climate change. Article 2(1) in the agreement states the aim of keeping the global temperature rise this century well below 2 degrees Celsius above pre-industrial levels and to limit the temperature increase even further to 1.5 degrees Celsius above pre-industrial levels.

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undertaken internationally.37_{Nevertheless, the ETS Directive 2018 includes some new key}

provisions in order to prevent carbon leakage such as focusing the free allocation rules on energy intensive industries at the highest risk of carbon leakage. Under these revisions, the prediction is that emissions from sectors covered by the system will be 43 percent lower in 2030 compared to 2005.38

2.3 The allocation method of emission rights

The design of an emissions trading scheme is much influenced by the method of allocating the emission allowances. The allowances can either be allocated gratuitously or they can be sold/auctioned. The EU has opted for a hybrid program where some allowances are allocated at no charge and the rest is auctioned.

2.3.1 Auctioning

During the third trading period, auctioning became the default allocation method. Auctioning allows each company to assess the amount of allowance it needs to purchase to cover its projected emissions in a given period. This means the key decision making is left to the market. This way, auctioning can ensure a higher level of environmental and allocative efficiency, transparency and simplicity. Over-allocation of emission rights can be avoided and full auctioning of pollution costs can be ensured. Another advantage is that all industries are treated equally since the emission rights are allocated based on the same criteria, namely the level of pollution.39_{Problems with this allocation method though, are that it does not solve the issue of}

carbon leakage, and it may lead to discriminatory results in the sense that auctioning does not take into consideration the differences between companies. Different companies have different abatement costs and different opportunities in regards to the technical and financial resources to participate in auctions.40

37_{ETS Directive 2018, preamble 10.}

39_{De Gasperi, G.C., “Making State aid Control Greener: The EU Emissions Trading System and Its}

Compatibility with Article 107 TFEU”, European State Aid Law Quarterly, vol. 9, no. 4, 2010 [cit. De Gasperi], pp. 797-798.

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To ensure a harmonised non-discriminatory process, auctioning is governed by the Auctioning Regulation which specifies aspects such as timing and administration of the auctioning.41_One

measure that is being undertaken to reflect the different capacities of Member States is that some of the revenues from auctioning are redistributed to compensate for cost differences

between Member States.42_{Member States are free to determine how to use the revenue from}

the auctioning but according to Article 10(3) of the ETS Directive 2009, at least half of the revenues from auctioning should be used to combat climate change in the EU and third countries. For most of the Member States, the auctioning takes place on the auctioning platform

the European Energy Exchange.43

2.3.2 Free allocation

Due to the EU ETS, companies covered by the scheme face higher costs since they now need to pay for something that was previously free, namely the carbon rights. These costs can be either direct or indirect and the distinction between these is broadly that the direct costs refer to the costs associated with the direct emissions of the installation (e.g. purchase of carbon rights) whereas the indirect costs are emission costs passed on in electricity prices.44_{When a firm faces}

higher input costs, they have three options on how to react. Firstly, the higher costs can lead to reduced profit margins, or secondly, the companies can decrease the overall costs by improving the efficiency of their operations, or finally, they can pass on the costs onto the consumer by increasing the prices.45_{For companies in some sectors and subsectors however, none of these}

alternatives are easily available because they may operate in global markets and face stronger competitive pressure than other sectors.46_{This makes them vulnerable for cost changes and may}

41_{Commission Regulation (EU) No 1031/2010 of 12 November 2010 on the timing, administration and other}

aspects of auctioning of greenhouse gas emission allowances pursuant to Directive 2003/87/EC of the European Parliament and of the Council establishing a scheme for greenhouse gas emission allowances trading within the Community, OJ L 302, 18.11.2010, p.1.

42_{European Commission, Green paper: A 2030 framework for climate and energy policies, 2013,}

COM(2013) 169 final, Brussels [cit. Green paper: A 2030 framework for climate and energy policies, 2013], p. 12.

43_{Report on the functioning of the European carbon market, 2017, p. 16.} 44_{EU ETS Handbook, p. 60.}

45_{Laing, T., Sato, M., Grubb, M., and Comberti, C., “Assessing the effectiveness of the EU Emissions}

Trading Scheme”, Grantham Research Institute on Climate Change and the Environment, Working Paper no. 106, 2013 [cit. Laing, Sato, Grubb and Comberti], p.16.

46_{European Commission, Commission Staff Working Document: Impact Assessment Accompanying the}

Document Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions – A policy framework for climate and energy in the period from 2020 up to 2030, 2014 [cit. Impact assessment accompanying the policy framework for climate and energy in the period from 2020 up to 2030], p. 112.

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therefore relocate to somewhere where carbon costs are lower. The term carbon leakage in the setting of the EU ETS refers to this phenomenon where industries relocate to countries that are not covered by the EU ETS. By doing so they shift greenhouse gases to places beyond the EU regulator’s reach.47_{Carbon leakage may result in overall increased GHG emissions, which is}

contrary to the purpose of the EU ETS.

To prevent carbon leakage from happening, some emission rights are consequently allocated free of charge.48 If a sector or subsector fulfils the criteria in the ETS Directive, they are put on a carbon leakage list.49 This means that instead of buying emission allowances through an auctioning scheme, these companies receive a certain number of emission rights for free. During the first two phases, the free allocation was based on historical GHG emissions. This method was critisised since it favoured the polluters that had not taken early action to reduce emissions as it allowed them to emit more in relation to other polluters. In the third period, the allocation method is based on benchmarks, which means allowances are allocated based on the production performance rather than historical emissions.50_{The benchmarks are determined}

based on the average GHG reduction performance of the 10 percent best performing installations in a given sector.51_{To determine if a sector is at risk of carbon leakage, a}

combination of thresholds for carbon intensity and trade intensity as stipulated in Article 15 of ETS Directive 2009, is taken into account. Carbon intensity refers to how much carbon is used in a particular sector and trade intensity refers to how much a company trades with third countries.52_{Currently the free allocation of emission allowances takes place for sectors exposed}

to a significant risk of carbon leakage due to EU ETS allowance costs passed on in electricity prices as well as for the modernisation of the power sector.53

47_{ETS Directive 2009, preamble 24.}

48_{Ibid., Article 10a(6) states Member States can adopt financial measures in favour of sectors deemed to be}

exposed to a significant risk of carbon leakage due to increased indirect costs.

49_{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, 2014/746/EU, OJ L 308, 29.10.2014, p. 114-124 [cit. Carbon Leakage List, 2014].

50_{EU ETS Handbook, p. 40.} 51_{Ibid., p. 47.}

52_{Ibid., p. 63.}

53_{Guidelines on certain State aid measures in the context of the greenhouse gas emission allowance trading}

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2.4 Empirical studies

As mentioned in section 1.3, the aim of an EU legislation should always be the benchmark when interpreting the legislation in question. The aim of the EU ETS legislation including the free allocation rules is essentially to reduce emissions of greenhouse gases. It is therefore relevant to study whether the EU ETS actually works and if the threat of carbon leakage is credible or not. In this subsection, empirical analysis of the EU ETS and carbon leakage is presented in order to evaluate the efficiency of the scheme and the need for aid.

2.4.1 Does the EU ETS work?

The EU ETS has, as described above, historically encountered problems such as surpluses of emission allowances and low carbon prices. However, despite these problems the EU is on track to meet its reduction target for 2020. During the period, 1990-2015 EU emissions were reduced by 23 percent.54_{The environmental impact of the EU ETS can be assessed based on two primary}

objectives:55

1) Reduction in GHG emissions with a balance between cost and environmental benefits 2) Promotion of investment in carbon technologies

In the Green Paper issued by the European Commission in 2013, it was stated that the EU ETS had resulted in substantial emission reductions as the carbon price now had to be reflected in businesses’ operational and investment decisions. The EU ETS had however, not been a major driver towards long term investment in low carbon technologies due to the low carbon prices. Five years later, in 2018, the European Commission states that the progress on renewable energy and energy efficiency is the main driver behind the reduction in emissions in recent years.56_{This is confirmed by an economic study made by Calel and Dechezlepretre (2016),}

where companies participating in the EU ETS were compared to companies not participating in the EU ETS. Allowing for factors such as country, economic sector, size and innovation capacity, it was shown that the innovation in low-carbon technologies had increased much more

54_{European Commission, Progress made in cutting emissions, 2018,}

https://ec.europa.eu/clima/policies/strategies/progress_en (accessed 26 September 2018).

55_{Laing, Sato, Grubb, and Comberti, p.4.}

56_{European Commission, Progress made in cutting emissions, 2018,}

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for EU ETS companies than for non EU ETS companies.57_{Consequently, the EU ETS does}

seem to fulfil its function of reducing GHG emissions.

2.4.2 Is the threat of carbon leakage credible?

The aforementioned Green Paper issued by the Commission in 2013 is a report with the purpose of bringing forward questions to be discussed in preparation for the 2030 framework for climate and energy policies. One of the questions posed in this paper was what evidence there is for carbon leakage and how this evidence could be quantified. An empirical study was carried out on behalf of the European Commission, investigating if any evidence of carbon leakage could be found during the first two trading periods (years 2005-2012). The conclusion from the study was that no evidence for carbon leakage could be found. What could be observed in some sectors though, was increased imports and/or decreased exports. This could however be due to other factors such as global demand developments and input price differences. The free allocation of emission allowances was presumed to have played a role in preventing carbon leakage although, the free allocation also contributed to the fact that the number of allowances issued were bigger than the actual emissions. Commenting on this study, the industry argued that the free allocation did not protect against “investment leakage”. Investment leakage refers to investments taking place in other regions instead of within the EU due to perceived higher future costs related to the climate policy of the EU. It was not empirically possible to assert whether investment leakage had occurred or not since it could be the consequence of various factors not related to the ETS.58_{What is not entirely clear from this study is whether the absence}

of empirical evidence on carbon leakage is due to the fact that the risk of carbon leakage is low or if it is thanks to the free allocation practice.

The same year (2013) an economic study was conducted which concluded that the EU’s approach of excluding entire industries from permit auctions might not be efficient and that the relocation risk due to the current compensation rules could be maintained with less free allocation and more auctioning. The authors concluded that there is significant variation in the

57_{Calel, R., and Dechezlepretre, A., “Environmental Policy and Directed Technological Change: Evidence}

from the European Carbon Market”, The Review of Economics and Statistics, vol. 98, no. 1, 2016, pp. 173-191.

58_{Ecorys, Carbon Leakage Evidence Project: Factsheets for selected sectors, Rotterdam, 2013, pp. 11-12,} https://ec.europa.eu/clima/sites/clima/files/ets/allowances/leakage/docs/cl_evidence_factsheets_en.pdf

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vulnerability reported between sectors and firms. However, in none of the industries studied, the average firm will close down entirely to a non-European country.59

In another paper, it is argued that the free allocation does not have a great impact ensuring the competitiveness of the European industry relative to countries without CO2 controls. This is

because many participating sectors, such as the electricity sector are not directly exposed to foreign competition. Concerns of competitiveness may arise in sectors that face significant cost increases from participation in the EU ETS and are exposed to competition from outside the ETS. However, free allocation can only act as a temporary subsidy and does not fundamentally change the firm’s competitiveness in the longer term.60

It is worth mentioning that the discussion about carbon leakage does not refer to the application criteria of the EU rules about the prohibition against State aid. As analysed later in this thesis, one of the criteria for the EU rules about the prohibition against State aid to be applicable, is that it affects trade between Member States (Article 107(1) TFEU). State aid may affect trade between Member States but the risk of carbon leakage refers to the risk of companies relocating to third countries. The analysis of the risk of carbon leakage is to determine whether or not an exception to the prohibition against State aid can be made (Article 107(3) TFEU).

2.5 The EU ETS – Conclusion

The EU ETS has thus developed over the years and one of the biggest changes that has been carried out is to change the default method of allocation of emission rights. In the beginning free allocation of emission rights was the default method. In Article 10 of the ETS Directive 2003, Member States were required to allocate at least 95 percent of its allowances free of charge during the period 2005 - 2007. Thus, there was a ceiling on the proportion of allowances that would be auctioned. Now there is instead a minimum level on the proportion of allowances

59_{Martin, R., Muuls, M., de Preux, L.B. & Wagner, U.J., “Industry Compensation under Relocation Risk: A}

Firm-Level Analysis of the EU Emissions Trading Scheme”, National Bureau of Economic Research, Working Paper Series no. 19097, 2013, p. 3.

60_{Hepburn, C., Grubb, M., Neuhoff, K., Matthes, F. and Tse, M., “Auctioning of EU ETS Phase II}

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that should be auctioned.61_{Consequently, the demonstrated development is a transition from}

free allocation to auctioning.

61_{From 2021 the share of allowances to be auctioned shall be 57 % of the total number of allowances}

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3. EU ETS and State Aid

In this section the EU ETS compatibility with the EU rules about State aid is analysed. One of the cornerstones of the EU policies is to achieve and maintain the internal market. The internal market refers to an EU without internal borders. According to Article 26TFEU there should be no regulatory obstacles to the free movement of goods, persons, services and capital. To achieve this non-discriminating internal market, there are several measures that are prohibited between Member States and one such measure is State aid, as stated in Article 107 TFEU. There has been discussion about whether or not the free allocation of emission allowances constitute State aid. Not only does the beneficiary undertaking receive something that it would normally have to have paid for, it could also earn a profit on the allowances it does not need by selling them on the market (these profits are sometimes called “windfall profits”).62 However, the Commission has determined State aid in the form of free allowances to be compatible with the EU State aid rules under certain conditions (further elaborated on in section 3.2). To understand under what circumstances the free allocation can be deemed compatible with the EU State aid rules, this free allocation in relation to the State aid criteria is analysed below.

3.1 EU ETS compatibility with Article 107(1) TFEU

Article 107(1) TFEU states that “any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market”. As interpreted by the European Court of Justice (ECJ), a measure must fulfil four criteria for it to qualify as State aid. Firstly, it is an intervention by the State or through State resources. Secondly, the intervention is likely to affect trade between Member States. Thirdly, the recipient gets an advantage on a selective basis, for example that the aid is given to specific companies or sectors. Fourthly, competition is or may be distorted.63_{The reason why State aid is prohibited is that a company receiving}

government support gains an advantage over its competitors, which goes against the principle

62_{Seinen, A.T., “State aid aspects of the EU Emission Trading Scheme: the second trading period”, European}

Commission Competition Policy Newsletter, number 3, 2007, p. 104.

63_{Judgment of 24 July 2003, Altmark Trans v Nahverkehrsgesellschaft Altmark, C-280/00, EU:C:2003:415}

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of non-discrimination in accordance with the internal market.64_{The ETS Directive provides for}

special and temporary measures in the following areas:65

 Aid to companies in sectors exposed to a significant risk of carbon leakage due to EU ETS allowance costs passed on in electricity prices (indirect emission costs)

 Investment aid to highly efficient power plants

 Aid in the form of free allowances for the modernisation of electricity generation  Aid involved in the exclusion of certain small installations from the EU ETS if the GHG

emission reductions can be achieved at a lower cost outside the scope of the EU ETS. As mentioned in section 1.2, the analysis in this thesis concentrates on the aid to sectors exposed to the risk of carbon leakage due to the increased emission costs. Do these special and temporary measures involve State aid in the meaning of Article 107(1) TFEU? This question is analysed in relation to the four criteria set forth in Article 107(1) TFEU.

3.1.1 The State resources criterion

The first criterion stating that the aid must be granted by the State or through State resources has been analysed by the ECJ in the way that the aid must be granted directly or indirectly through State resources and that it must be imputable to the State.66_{As can be understood from}

the formulation in Article 107 TFEU, the notion of aid should be interpreted broadly and can consist of any form of assistance granted either by a public body or by a private body designated or established by the State.67_{It is not straightforward how the condition that the aid should be}

granted by the State or through State resources should be interpreted. Is this condition fulfilled even though the gratuitous allocation of allowances does not reduce the revenues for the Member States? The settled case law is that advantages that are granted free to undertakings that impose “an additional burden for the public authorities in the form of an exemption from the obligation to pay fines or other pecuniary penalties” fall within the scope of Article 107 TFEU.68_{There is a loss of revenue for the State when it chooses to grant allowances gratuitously}

64_{European Commission, State aid control, 2018,}

http://ec.europa.eu/competition/state_aid/overview/index_en.html (accessed 27 September).

scheme post-2012, para. 2.

66_{Judgment of 16 May 2002, Stardust, C-482/99, EU:C:2002:294, para. 24; and Judgment of 20 November}

2003, GEMO, C-126/01, EU:C:2003:622 [cit. GEMO, C-126/01], para. 24.

67_{Judgment of 13 March 2001, Preussen Elektra, C-379/98, EU:C:2001:160, para. 58.} 68_{Judgment of 17 June 1999, Piaggio, C-295/97, EU:C:1999:313, para. 42.}

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instead of selling them or auctioning them out. Thus, this loss of revenue of State resources constitutes a transfer of State resources.69

Nevertheless, it is not always easy to distinguish between a State aid and a traditional regulatory measure. In the Preussen Elektra case an obligation was imposed on private electricity supply undertakings to purchase electricity from renewable sources at fixed minimum prices.70 This gave rise to a financial burden to the undertakings which could potentially lead to loss of revenues to the State. However the Court ruled that the economic advantage given to the producers of renewable energy was not to be seen as a direct or indirect transfer of State resources, even though it could mean a loss of revenues to the State because there was no direct connection between the German State measure and the potential loss of revenues.71_{On the}

contrary, in the case of the EU ETS, the Member States have the choice of allocating allowances by granting them at no cost, selling or auctioning them. This foregoing of resources is regarded as a direct or indirect burden for the State.72_{In conclusion, the free allocation of emission}

allowances should be considered as an advantage granted by the State directly or indirectly through State resources.

Now can the free allocation of emission allowances be viewed as imputable to a State? In the beginning of the EU ETS history, the Member States were obliged to gratuitously allocate a certain amount of allowances.73_{Despite this, it was determined that the free allocation could be}

considered imputable to the State since the national authorities were given sufficient manoeuvre through the National Allocation Plans.74_{Now the amount of free allowances are decided based}

on harmonised rules.75_{However, it is still up to each Member State to submit to the Commission}

the list of installations (NIMs) in its territory covered by the EU ETS and any free allowances

69_{De Sadeleer, N., State aids and Environmental Protection : Time for Promoting the Polluter-Pays Principle,}

Nordic Journal of Environmental Law, no. 1, 2012 [cit. De Sadeleer], p. 10.

70_{Judgment of 13 March 2001, Preussen Elektra, C-379/98, EU:C:2001:160.} 71_{Ibid., para 66.}

72_{Opinion AG Mengozzi in Judgment of 8 September 2011, Commission v Netherlands, C-279/08P,}

EU:C:2011:551 [cit. Commission v Netherlands, C-279/08P], para. 92.

73_{Article 10, ETS Directive 2003.} 74_{De Sadeleer, p. 9.}

75_{Commission Decision of 27 April 2011 determining transitional Union-wide rules of harmonized free}

allocation of emission allowances pursuant to Article 10a of Directive 2003/87/EC of the European Parliament and of the Council (2011/278/EU).

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allocated to these installations.76_{The free allocation of allowances can therefore be determined}

to be imputable to the State. The first criterion in Article 107(1) TFEU is thus fulfilled.

3.1.2 The effect on trade criterion

For a measure to be a State intervention it must be liable to affect trade between Member States. This condition tends to be considered automatically fulfilled by the Commission. This is because a State aid strengthens the position of the recipient undertaking compared to its competitors in the internal market. That way, State aid is regarded as affecting trade between Member States.77_{The aid can be considered to have an effect on intra-community trade even}

though the recipient is not directly involved in trade across borders since a subsidy can make it more difficult for companies in other Member States to enter the market.78_{The ECJ has also}

stated that due to the interdependence between the markets in the Community, an aid might distort competition even though the beneficiary exports almost all of its production outside of the EU.79

The Commission is not required to carry out an economic analysis to demonstrate the actual effect that the aid has had on competition and trade. It is sufficient to show that trade might be affected. However, an effect on the trade between Member States cannot be merely hypothetical, it must be established why the measure is liable to have this effect, based on foreseeable effects of the measure.80_{Activities that have a purely local impact has been}

considered to have no such effect on trade between Member States. In the case of the EU ETS, the companies that receive emission rights gratuitously are not confined to companies supplying goods or services to a limited area, they are instead qualified based on whether they are active in a sector or subsector deemed to be exposed to a risk of carbon leakage.81_{Thus, this criterion}

of the measure having an effect between Member States is fulfilled in the context of the EU ETS.

76_{Art 11(1), ETS Directive 2009.}

77_{Judgment of 17 September 1980, Philip Morris Holland BV v Commission, C-730/79, EU:C:1980:209,}

para. 11.

78_{Altmark, C-280/00, para. 78.}

79_{Judgment of 21 March 1990, Belgium v Commission, C-142/87, EU:C:1990:125, para. 32.}

80_{Judgment of 6 July 1995, AITEC and others v Commission, Joined Cases 447/93, 448/93 and}

T-449/93, EU:T:1995:130, para. 141.

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3.1.3 The selectivity criterion

The third criterion is that the intervention gives the recipient an advantage on a selective basis, for example that aid is given only to companies in a specific industry or region. Thus, general measures, where there is no favouring of specific products or sectors cannot constitute State aid.82

The case Netherlands v Commission83 highlights the selectivity criterion in the setting of an emissions trading system. In this case, carbon rights were allocated for free to 250 large polluting facilities. Smaller polluting facilities on the other hand were imposed an emission ceiling without gratuitously receiving any carbon rights for free. The Court in the first instance ruled that the selectivity criterion was not fulfilled since the free allocation scheme had ecological considerations and that the aid receivers were selected in accordance with the general scheme of the emissions trading system.84 This judgment was objected by the ECJ where they concluded that the fact that a measure is undertaken for environmental concerns does not allow for exclusion of the selectivity criterion in Article 107(1) TFEU. It is not the cause of a measure that matters but rather the effect, the ECJ held. The differentiation between large polluting facilities and smaller ones was not acceptable despite the fact that all facilities were subject to the emission reduction obligations. Moreover, the ECJ stated in the same case that a differentiation based upon a purely quantitative criterion cannot be regarded as inherent in a system that aims to reduce pollution.85_{In the context of the EU ETS, some companies receive}

free allowances while some do not, depending on the risk of carbon leakage. Although the circumstances of the EU ETS differ slightly from the circumstances of the above mentioned emissions trading system in the Netherlands, the selectivity criterion must be considered to be fulfilled also in the case of the EU ETS.

Were the beneficiary undertakings receiving an advantage in the case described above? The number of allowances in the emissions trading scheme in question, was not decided beforehand, but were instead awarded according to how much reduction the undertakings could achieve in relation to the national standard. The costs of reducing the emissions to attain to national

82_{Judgment of 8 November 2001, Adria-Wien Pipeline, C-143/99, EU:C:2001:598, para. 35.} 83_{Commission v Netherlands, C-279/08P.}

84_{Judgment of 10 April 2008, Netherlands v Commission, T-233/04, EU:T:2008:102 [cit. Netherlands v}

Commission, T-233/04], para. 99.

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standards were considered to “fall within the charges to which the budget of the undertaking is normally subject”.86_{The ECJ ruled that the measure had to be considered an advantage for the}

recipient undertaking which would not have been obtained under normal conditions.87_This

technique of assessing whether an undertaking would have obtained a comparable advantage under “normal market conditions” in order to determine if the State intervention confers an advantage, is known as the “private sector test”.88_{If the State measure is an economically}

rational investment that could have been taken by a private investor, the measure is likely not to confer an advantage within the meaning of 107(1) TFEU. Under the EU ETS, emission rights can be sold regardless of whether they have been granted for free, sold or auctioned. That means the undertakings can receive an economic advantage from the emission allowance. There is support for the fact that free allocation of emission allowances provides an advantage under the meaning of Article 107(1) TFEU.89

3.1.4 The distortion on competition criterion

The fourth condition regarding the distortion of competition is often fulfilled. The aid can cause two potential distortions: product market distortions and location effects where the EU ETS is.90

In the GEMO case (further described in section 5), the Court held that measures from the French authorities in question were liable to distort competition since it relieved farmers and slaughterhouses from a financial burden.91_{However, there are exceptions, where State aid is}

not considered to distort trade. For small amounts of aid, the de minimis rules apply resulting in these aids not being considered to distort competition or trade.92_{The EU ETS free allocation}

practice generally does not fall within the scope of these de minimis rules. Since the free allocation rules do fulfil the criteria in Article 107 TFEU, the conclusion is that it constitutes State aid.

86_{Ibid., para. 89.}

87_{Netherlands v Commission, T-233/04, para. 63; and Commission v Netherlands, C-279/08P, para. 91.} 88_{Judgment of 29 April 1999, Spain v. Commission, C-342/96, EU:C:1999:210, para. 41.}

89_{De Sadeleer, p. 7.}

90_{See for example para. 98 in the Commission Decision (EU) 2017/1494 of 19 December 2016 on State aid}

for an investment contract for the biomass conversion of the first unit of the Drax power plant SA.38760 (2016/C) which the United Kingdom is planning to implement, OJ L 2017, 23.8.2017, pp. 1-19, where investment aid was given to electricity producers.

91_{GEMO, C-126/01, para. 33.}

92_{Commission Regulation (EC) No 360/2012 of 25 April 2012 on the application of Articles 107 and 108 of}

the Treaty on the Functioning of the European Union to de minimis aid granted to undertakings providing services of general economic interest, OJ L 114/8, 26.4.2012, pp. 8-13.

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3.2 EU ETS compatibility with Article 107(3) TFEU

Some exceptions to the prohibition against State aid can be made in order to achieve an objective of common interest, correct market failures or favour social and regional cohesion. These aids must be adequate and proportional to their objectives with a minimal distortion of competition.93_{According to Article 107(2) TFEU some categories of aid are deemed to be}

compatible with the internal market and according to 107(3) TFEU, there are categories of aid that may be compatible with the internal market. One such exception that may be considered compatible with the internal market is “aid to facilitate the development of certain economic activities or certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest” as stated in Article 107(3)(c). The free allocation of emission allowances has been determined to find its legal basis in Article 107(3)(c) under certain conditions.94

The Council Regulation No 2015/1588 of 13 July 2015 enables the Commission to adopt Block Exemption Regulations for State aid.95_{Consequently, the Commission has issued such General}

Block Exemption Regulation (GBER).96 This regulation covers a range of categories of aid and if these aids fulfil certain conditions, the Commission can declare them compatible with the Treaty without prior notification and approval. Environmental aid is in the scope of this regulation according to Article 1(c). In addition to the General Block Exemptions, the Commission has issued more specific guidelines where State aid is determined to be justified. For example, the General Block Exemptions do not address State aid in the form of free allocation of emission rights in the scope of the EU ETS but the Commission has issued Guidelines on State aid for environmental protection and energy 2014-2020 where aid in the form of tradable permits is included.97 _{The Commission has, furthermore, issued guidelines}

with conditions that must be met in order for State aid concerning GHG emission allowances,

93_{Commission of the European Communities, Consultation document: State aid Action Plan – Less and}

better targeted State aid: a roadmap for State aid reform 2005 – 2009, COM (2005) 107 final, Brussels,

paras. 10-11.

scheme post-2012, para. 22.

95_{Council Regulation (EU) No 2015/1588 of 13 July 2015 on the application of Articles 107 and 108 of the}

Treaty on the Functioning of the European Union to certain categories of horizontal State aid, OJ L 248, 24.9.2015, pp. 1-8.

96_{Commission Regulation (EU) No 651/2014 of 17 June 2014 declaring certain categories of aid compatible}

with the internal market in application of Articles 107 and 108 of the Treaty, OJ L 187, 26.6.2014, pp. 1-78.

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to be compatible with the internal market.98_{In Annex II of these Guidelines, the sectors and}

subsectors that are determined to be exposed to a significant risk of carbon leakage due to the EU ETS are listed. Aid to these sectors are permitted in order to compensate for the EU ETS allowance costs passed on in the electricity prices, if the conditions in the Guidelines are met.

The primary objective of State aid control within the EU ETS is to ensure that the State aid measures carried out result in a higher reduction of GHG emissions than would have been achieved without State aid. The State aid must be necessary (necessity of aid) to achieve the environmental objectives of the EU ETS as well as proportional (proportionality of the aid) so that the measures are limited to the minimum needed to achieve the environmental objectives without undue distortions of competition in the internal market.99_{Related to the proportionality}

criterion is that the aid should be temporary, which is also a condition established in the guidelines.100

3.3 EU ETS compatibility with the State aid rules - conclusion

The determination of whether something constitutes State aid according to Article 107(1) TFEU, should be done objectively. Thus, the cause of the aim should not be taken into account. An objective interpretation of 107(1) results in the conclusion that the free allocation of emission rights constitutes State aid. This means that the free allocation measures would be prohibited unless any of the exceptions apply. When assessing a measure’s compatibility with Articles 107(2) and 107(3) TFEU, the purpose of the measure should be taken into account.101

In this assessment, environmental objectives can be taken into account and the Commission has had a rather favourable approach when it comes to environmental considerations.102_The

conclusion is therefore that the free allocation of emission rights is consistent with the State aid rules based on the derogation permitted according to Article 107(3)(c) TFEU provided certain conditions in guidelines issued by the Commission are fulfilled.

scheme post-2012.

99_{Ibid., para. 5.}

100_{Para. 12 in these Guidelines on certain State aid measures in the context of the greenhouse gas emission}

allowance trading scheme post-2012.

101_{Opinion AG Jacobs in case GEMO, C-126/01, para. 73.}

102_{Van Calster, G., “Greening the EC’s State aid and tax regimes”, European Competition Law Review, vol.}

The Compatibility of EU State Aid for Environmental Protection with the Polluter Pays Principle: In the Context of the EU Emissions Trading System