Insight Focus
- Adjusting companies’ free allocation of allowances takes more time than expected.
- Companies who are late surrendering allowances risk fines.
- The Commission is now proposing pushing back compliance deadlines.
The European Commission is expected to adjust the schedule for industrial companies to comply with the EU ETS rules from 2024, after new calculations to adjust companies’ free allocation of allowances have proved more time-consuming than expected and raised the risk of financial penalties for non-compliance.
From 2021, the annual handout of free EU emission Allowances (EUAs) to industrial companies has been subject to an adjustment if production levels at their factories changes by more than 15% on average over two years.
Industrial plants have been required since 2020 to submit reports detailing their production activity, which help determine whether the free issuance of EUAs needs to be adjusted.
The process of calculating potential changes to free allocation has proved to be a drawn-out process. In 2022, the French government had not issued all its free EUAs to industrials by the end of the year, and in 2023 the Irish and Finnish governments had yet to distribute any EUAs by the end of May.
The delay in handing out free EUAs creates a potential obstacle for some companies to manage their compliance in time, risking hefty penalties. Companies are assessed a fine of not less than €108/tonne for each EUA they have not surrendered in time, and must also make good the shortfall in the following year.
In previous years many companies have chosen to “borrow” EUAs from their current-year allocation to help pay for their compliance for the previous year, but with many EUAs now only arriving in installation accounts after the May 31 deadline, this has forced some emitters to purchase EUAs instead.
As part of its “Fit for 55” reforms to the EU ETS this year, the European Commission proposed to push back the deadlines for issuance of free EUAs and for the surrender of allowances to the end of June and the end of September respectively.
This three- and four-month shift would give member state governments more time to complete the calculation of any changes to free allocations, and still allow companies to “borrow” EUAs from their current-year issuance to pay off the prior year’s compliance.
While the details of the changes are being incorporated into national law and may take some time to complete, the Commission referred to the change in an announcement made in January, in which it said changes would only take effect in 2024.
The new deadlines will have some impact on the pattern of trading in the EU ETS. With the deadline for compliance now falling at the end of September, it will mean that the summer period between June and September forms the height of the demand season.
Historically the summer has seen trading activity slow due to the holiday period, and in recognition of this the Commission has reduced the volume of EUAs being sold at auction by 50% every August.
However, it’s likely that this annual reduction will need to end, since a drop in supply at the peak demand period would likely trigger considerable price volatility, experts have said.
In addition, the futures market may need to adjust some of its contracts to account for the new deadline. In previous years the March futures contract has typically been the second most-active contract after the December future, as the delivery of EUAs into March positions has taken place with enough time for buyers to transfer EUAs into the appropriate compliance accounts on the EU’s electronic registry.
However, the September futures contract expires in the last week of the month, and EUAs must be delivered no later than three days later; this may not be sufficiently early enough for buyers to carry out the required transfers before the compliance deadline.
ICE Endex, the market’s leading exchange, lists quarterly contracts (March, June, September and December) as much as one year ahead, but the August futures contract is only listed three months ahead of expiry.
Unless the August contract is extended to list up to a year ahead of expiry, market participants will need to choose between buying June futures and holding the physical EUAs for three months, or risking a late delivery by buying the September futures contract.
Neither the European Commission nor the futures exchanges have made any announcements regarding the change to the compliance timetable as yet, but it is likely that compliance companies and their service providers will need to make adjustments from next year.
