EU Court of First Instance Delivers Blow to European Commission Regulation of EU Emissions Trading Scheme

Last week the European Court of First Instance (CFI), the second highest court in the European Union, overturned two European Commission decisions that reduced the number of carbon credits that Estonia and Poland can distribute under the EU Emissions Trading System (ETS) between 2008-2012 to carbon emitters in those countries.

In Poland v. Commission, Case T-183/07 and Estonia v. Commission, Case T-263/07, the CFI issued a rebuke to the European Commission, noting that "by imposing...a ceiling on emission allowances to be allocated, the Commission exceeded its powers."

The European Commission, the EU institution that enforces the system, was quick to disagree with the CFI's decision. Barbara Helfferich, the environmental spokesperson for environmental matters, said, "We are extremely disappointed by the judgment," The Wall Street Journal reported ("EU Court Overturns Some Emission Caps," Sept. 24, 2009). The Commission has until Nov. 23 to appeal the decision to the European Court of Justice, the EU's highest court.

To fully understand the importance of this decision, some background about the ETS is necessary. In 2003, the European Union adopted legislation -- Directive 2003/87 of the European Parliament and of the Council of 13 October 2003 -- to establish a European Community-wide system for greenhouse gas emission allowance trading. Among other things, the legislation mandated that each EU Member State develop a "national allocation plan" (NAP) stating the total number of allowances it intended to allocate for each five-year ETS period. Under the legislation, the NAP was to be based on objective and transparent criteria applicable across the entire EU. When finished, the NAP was to be transmitted by each Member State to the European Commission, which had the right to reject it or any aspect of it if the NAP was incompatible with the criteria set out in the legislation.

In 2006 Poland and Estonia respectively transmitted their NAPs to the European Commission. The following year, the European Commission held that the NAPs were not in compliance with the legislation and directed the two countries to reduce the total number of emissions allowances the countries had proposed by 26.7 percent in Poland and 47.8 percent in Estonia. The two countries appealed the Commission's decisions to the CFI.

On Sept. 23, the CFI held that an EU member state alone has the authority to develop its NAP and to make the final decision about the number of emissions allowances it will allocate for each five-year period and the distribution of those allowances among its economic operators. The CFI confirmed that the European Commission has the power to review in respect to the NAPs, but that the power "is very restricted." The court went on to say, "Accordingly, the Commission is authorized to verify the conformity of the NAP notified by the Member State with the criteria set out in the [legislation] and to reject that plan on the grounds of incompatibility with those criteria and provisions."

However, the CFI went on to note that the Commission's decision to in essence reject an NAP on the basis of reasoning which consists "only in the evocation of doubts as to the reliability of the data used by Estonia and Poland" represented legal error on the Commission's part. The CFI also said:

"Further, it is for each Member State, not the Commission, to decide, on the basis of its NAP drawn up in accordance with the [legislation], on the total quantity of allowances it will allocate for the period in question, to initiate the process of allocation of those allowances to the operater of each installation and to rule on allocation of those allowances. Consequently, by imposing in the contested decisions allowance ceilings above which the NAP would be regarded as incompatible with the assessment criteria, the Commission substituted itself, in practice, for the Member States concerned. Therefore, those decisions have the effect of encroaching on the exclusive competence which the [legislation] confers on the Member States in deciding the total quantity of allowances which they will allocate in respect of each five-year period as from 1 January 2008."

The decision said that it was the duty of the Commission, in its exercise of the power of review, to explain in what ways the instruments used by a Member State in drawing up an NAP were incompatible with the criteria set forth in the legislation.

There were a number of significant reactions to the CFI's decision:

• The International Emissions Trading Association called "on all Member States to hold back from attempting to make use of a loophole that simply has to be closed for the carbon market, and European climate policy, to continue on a sound footing." The association, a leading voice in the business community in relation to carbon markets, went on to say:

"It is well understood that the success of the second phase of the EU ETS, and the avoidance of the over-supply that caused problems for the first [phase], was the firm control exercised by the European Commission on national authorities' proposals for emissions requirements. It now appears that the implementation of this control was not soundly based in law, a prospect that opens up the possibility of considerable additional supply coming onto the market in an uncoordinated fashion. Such an outcome would be contrary to decisions taken by the European Council about the level of European emissions reduction ambition."

• European Commission Environment Commissioner Stavros Dimas said, "We are currently examining the Court rulings on the Estonian and Polish NAPs in depth and are considering whether to appeal." He went on to say:

"The Court rulings...imply that the Commission has to take new NAP decisions in respect of Poland and Estonia. The originally notified national allocation plans cannot therefore be deemed to be acceptable as a result of today's judgments. Consequently and ahead of these decisions, those countries are not allowed to issue any additional allowances beyond those created in the EU ETS registry system. In preparing new decisions the Commission would base itself on the best available data. In this context the importance of the verified emissions for 2005 to 2008 should be noted. In the light of these data, it would appear unlikely that there would be any material difference concerning the total number of allowances consistent with the terms of the legislation. The actual 2008 emissions in Estonia and Poland correspond closely to those anticipated in the Commission Decisions on the Estonian and Poland NAPs and are therefore consistent with the assessments made by the Commission."

• An analyst with the firm Point Carbon, Henrik Hasselnkippe, told the New York Times ("Europe Loses a Ruling on Carbon Quotas," Sept. 24, 2009) that Poland, Estonia, and a handful of other countries may end up compromising with the European Commission on a figure that is mutually agreeable. One factor that might play a role in this negotiating strategy is that it is entirely possible that because of the economic downturn, the Commission could force the countries to accept even lower emissions allowance targets.

There are also important ramifications associated with the ruling:

• Carbon prices may not trend down as a result of the ruling. In fact, the price of EU carbon allowances actually rose -- as much as four percent for December permits -- last Friday, two days after the decision, ClimateWire reported today ("European Carbon Prices Surge After 2 Days of Confusion," Sept. 28, 2009). In the same story, an analyst at the carbon market analysis firm Orbeo said, "The European Commission is trying to show that the impact of the ruling will be limited. The market has digested the news now and is buying back a bit. Some utilities see the current price level as a good opportunity to buy before winter."
• The international credibility of the EU on reducing carbon emissions has been dented, to be sure, and the EU may face some cynicism from fellow participants at the Copenhagen UN Conference on Climate Change in December.
• Other EU countries, including but not limited to the Czech Republic and Italy may decide to challenge their own allocations.

This problem is unlikely to have any significant long-term impact, however, since the EU agreed last year that from 2012 forwards the Commission would retain the sole right to allocate emissions allowances. As Sanjeev Kumar from the WWF said, "It's a loss of fuss about nothing. The ruling only applies to phase two of the ETS (2008-2012], after which allocation is centralized," euobserver.com reported ("EU Court Slaps Down Brussels Attempts to Lower Eastern CO2 Emissions," Sept. 23, 2009).

Meanwhile, the EU appears close to considering legislation that would establish a minimum carbon tax. New Energy Finance, a U.K.-based news and briefing organization that follows clean energy and carbon markets and has seen a draft copy of the legislation, said, "The proposed directive introduces minimum levels of taxation on different types of fuels linked to the intensity of their emissions, to be effective from 2013. The tax would apply to fossil fuel users that fall outside the EU ETS, such as small installations," the Financial Times reported ("EU Carbon Tax?" Sept. 25, 2009). A handful of EU countries have enacted their own carbon tax systems.