The surrender of wrongly allocated greenhouse gas emission allowances

1. Introduction

The ArcelorMittal case relates to the question of whether the surrender of wrongly allocated greenhouse gas (GHG) emission allowances is compatible with Directive 2003/87/EC. ¹ Introduced in 2003 and launched in 2005, the EU emissions trading scheme (EU ETS) is considered one of the most important EU policies in the fight against climate change as it aims to reduce carbon dioxide and other GHG emissions by industries located in the EU. In line with the commitments arising from the Kyoto Protocol, the EU ETS is the first international emissions allowances trading scheme in the world. The system ‘contributes significantly to the achievement of the EU’s emissions reduction target for 2020’, ² namely to cut GHG emissions by 20 per cent compared to the levels recorded in 1990.

The Directive provides that any operator performing any activity listed in Annex I which result in emissions of GHGs, must hold a ‘greenhouse gas emission permit’ (Article 4 of Directive 2003/87/EC). Currently, the EU ETS covers approximately 11,000 power stations and manufacturing plants, as well as aviation activities in 31 countries (all EU Member States plus Iceland, Liechtenstein and Norway). In total, around 45 per cent of total EU GHG emissions are regulated by the EU ETS. ³

Compared to the traditional regulatory approach adopted in European environmental policies, characterised by so-called ‘command-and-control’ measures, the EU ETS introduces a ‘cap-and-trade’ mechanism. This market-based approach aims to create economic incentives for investment in low-emissions technologies. The ‘cap’ represents the ‘absolute quantity of greenhouse gases which can be emitted in the system to ensure the emission reduction target is met and corresponds to the number of allowances put in circulation over a trading phase’. ⁴ The amount of emissions ‘allowed’ by the cap decreases each year.

In line with the quantities foreseen under Member States’ ‘national allocation plans’ (NAP), ⁵ each year operators who obtained a GHG emission permit issued by the public authorities ⁶ receive a specific quantity of allowances. ⁷ Part of this is given for free; the rest is sold, mostly through auctions. At the end of every year, operators have to surrender ‘a number of allowances equal to the total emissions from that installation during the preceding calendar year’ (Article 12(3) of Directive 2003/87/EC).

If the operator manages to reduce its emissions, it can choose either to keep the ‘saved’ allowances to cover its future needs or sell them. If the required amount is not surrendered, the operator must buy allowances on the market and pay an ‘excess emission penalty’ of ‘€100 for each tonne of carbon dioxide’ unlawfully emitted into the atmosphere (Article 16(3) of Directive 2003/87/EC).

As a result, allowances acquire an economic value given that ‘there is a limited or capped supply and there is demand for them from those participants for whom the cost of making reductions are higher than for other participants’. ⁸ In other words, establishing a price for every tonne of carbon dioxide emitted provides an incentive for operators to reduce the emission of such gases.

2. Facts at the origin of the case

In 2008 ArcelorMittal received 405,365 GHG emission quotas free of charge from the Luxembourg authorities. These quotas were intended to cover emissions to be produced by the Schifflange steel plant from 1 January 2008 to 31 December 2012.

In October 2011 the steel plant in question closed down, but ArcelorMittal failed to inform the Luxembourg authorities of this fact. In February 2012, the authorities issued allowance quotas for the plant. Following this allocation, it took ArcelorMittal a further 61 days to inform the authorities of the indefinite closure of the steel plant.

This delay in informing the authorities breached Article 13(6) of Luxembourg’s Law of 23 December 2004, which provides that ‘any full or partial cessation of the operations of an installation must immediately be notified to the Minister’. ⁹ In the absence of such a notification, Article 13(6) provides that the Minister is empowered to order ‘the full or partial surrender of the unused allowances’. ¹⁰ The obligation to inform competent authorities is also provided for under Article 7 of Directive 2003/87/EC, which refers to ‘any changes planned in the nature or functioning, or an extension, of the installation which may require updating the greenhouse gas emissions permit’. The Directive does not provide for the possibility of ordering the surrender of the allowances where the notification obligation has been breached.

As a consequence, on December 2012 the Minister notified the decision to retroactively amend the NAP and required ArcelorMittal to surrender the quotas allocated to it for 2012.

ArcelorMittal contested the validity of the decision to surrender the allowances before the Administrative Court. This Court in turn referred a question on the constitutionality of Article 13(6) of Luxembourg’s Law 23 December 2004 to the Constitutional Court.

The questions submitted for a preliminary ruling to the Court of Justice mainly focused on two issues: the first concerns the compatibility with Directive 2003/87/EC of surrendering unused allowances in the event that they are not used as a consequence of total or partial cessation of the activities of the installation in relation to which the allowances were allocated. If the surrender was to be found compatible with EU law, the Constitutional Court also sought clarification on the classification of the allowances, namely their legal nature.

3. The surrender of erroneously allocated allowances

Under Luxembourg law, operators are required to notify the Minister of the full or partial cessation of the operations of an installation. ¹¹ The Luxemburg NAP stipulates that once the notification is received, no emission allowances are to be allocated for the following year. Where allowances are allocated to an installation, which is subsequently confirmed to have ceased operations, the Minister is authorised to order the surrender of the unused allowances. It could indeed happen that the operator suspends the activities of an installation without informing the authorities: in the present case, the operator notified the authorities only after the allocation of the allowances for the year following the cessation of the operations had been granted.

The first question addressed to the Court is whether the surrender of the unused allowances, which were allocated on the erroneous assumption that the installations were operational, is compatible with the Directive.

The reply to this question requires examining the underlying logic of the EU ETS mechanism, starting from the undisputed points. It is clear that the allocation of emission allowances is ‘conditional on the requirement that the installation to which the allowances are allocated must be operational’. ¹² Inactive installations are not capable of emitting emissions; it is evident that inactive installations do not require a ‘permit granting authorisation to emit greenhouse gases’, as regulated under Article 6 of Directive 2003/87/EC. Thus installations that have ceased operating and do not emit GHGs are not covered by Directive 2003/87/EC.

It is also commonly accepted that the smooth functioning and ultimate effectiveness of the EU ETS relies on the economic incentives that it offers. ¹³ Such a system aims at creating economic incentives to reduce pollution and GHG emissions. At the end of each year the operator shall ‘surrender allowances equal to the total emissions of the installation in each calendar year’. ¹⁴ The rationale of the system is indeed to encourage operators ‘to emit quantities of greenhouse gases that are less than the allowances originally allocated to him, in order to sell the surplus to another participant who has emitted more than his allowances’. ¹⁵ Conversely, if the operator produces more emissions than the amount authorised, it must purchase the additional allowances and pay a penalty. In other words, the system provides for the possibility of economic profits by reducing the emissions of an installation, which requires investing in energy-efficient technologies.

The economic value of the allowances is not established by the legislator, but rather determined by the market. An eventual decrease in the value of the allowances caused by their increased availability would therefore compromise the efficiency of the system. In other words, a stable market for allowances is essential if the general objective of reducing GHG emissions and promoting environmental protection is to be met. For this reason the system is ‘based on the strict accounting of the issue, holding, transfer and cancellation of allowances’ ¹⁶ and requires accurate national registries where the quantities and circumstances of the emissions allowances are reflected. From this perspective the economic logic and the principles of accuracy and accountability represent two sides of the same coin.

Article 7 of Directive 2003/87/EC requires operators to notify competent authorities of ‘any changes planned in the nature or the functioning of the installation which may require updating of the greenhouse emission permit’. In line with the economic logic as well as the principles of accuracy and accountability, the ECJ confirmed that the national provision requiring the notification of the full or partial cessation of the activities is the transposition of Article 7 of Directive 2003/87/EC.

Thus the only question that remains open is the compatibility with the Directive of the order to surrender the allowances allocated on the erroneous presumption that the installation was operational. AcerlorMittal contested such compatibility on the basis of a narrow interpretation of Directive 2003/87/EC; as the possibility of ‘compulsory’ surrender is not provided for in the Directive, the national provision is in breach of the Directive. In addition, AcerlorMittal claimed that once the allowances are allocated to the operator they should be considered as being proprietary. In this case, their surrender would represent an expropriation; as such, they would be subject to compensation.

Both the Advocate General and the ECJ rejected such a line of reasoning and concluded that Directive 2003/87/EC does not preclude the possibility of the competent authorities ordering the surrender of ‘unused’ allowances. While the arguments adopted by AcerlorMittal are focused on the act (that is, on the allowance and its nature) the Court and the Advocate General look at the activity (that is, the allocation of allowances by a public authority).

From this perspective, it is fundamental to consider that the administration acted on the basis of an erroneous assumption, namely that the installation was active. This error in the assessment of the actual situation at the origin of the exercise of public power is the result of the failure by the operator to notify the Minister of the suspension of their activities, as provided under Article 13(6) of Luxembourg’s Law of 23 December 2004. Had the operator done so, it would not have received the emission allowances for 2012, as provided under the NAP.

On the basis of these arguments, it is concluded that the surrender of emission allowances which should have never been allocated is in line with Directive 2003/87/EC. According to the ECJ, the failure to surrender such allowances would undermine ‘the requirement of strict accountability, accuracy and correlation between actual emission and those authorised’. ¹⁷ The Advocate General underlined that the absence of such measure would pose risks in relation to the ‘distortion of the market in emissions allowances’, as well as the attainment of the ‘objective of environmental protection which that market serves’. ¹⁸ Notwithstanding the slight difference in approach, as already highlighted, the requirements of strict accountability and accuracy are a prerequisite for preventing distortions of the market in emissions.

The arguments put forward in the present judgment demonstrate the influence of national administrative jurisprudence in the development of EU case law. Indeed, following a well-established principle in administrative law, if an administrative measure is based on an erroneous representation of the facts, there exists a public interest in removing such an act. Moreover, since the operator deliberately misled the administration, the latter is entitled to react without taking into consideration the interests of the operator. Indeed, in such a circumstance, the operator relinquishes its legitimate expectations to be protected by the legal order.

4. The question of the legal nature of emission allowances

The second question addressed to the Court refers to the legal nature or classification of emission allowances. This issue has gained increasing relevance due to the fact that the classification of allowances is not harmonised at EU level. This means, in accordance with the principle of subsidiarity, that EU Member States should address this issue in light of the national legal order. Nevertheless, as outlined by the Advocate General, ‘the approaches adopted are very diverse and range from the classification of emission allowances as administrative authorisation (quota granted, licences, permits, concessions) to their classification as property which may be acquired (with absolute title or through rights of use or other atypical rights jura in re) or merely as financial instruments’. ¹⁹

The emergence of different approaches at the national level is mainly due to the characteristics of the allowances regulated under Directive 2003/87/EC; whereas some are specific administrative licences, others are property rights. First of all the notion of ‘greenhouse gas emission permits’ within Directive 2003/87/EC evokes on its own the notion of an authorisation. In relation to certain activities covered by the Directive, the operator needs a permit to run an installation. In addition, the process of allocating, monitoring and verifying the allowances is managed by public authorities; as such, it is a ‘traditional centralised regulation’. ²⁰ These elements point to the classification of emission allowances as administrative authorisations, as defined at EU level.

In the context of the EU internal market, the notion of ‘prior authorisation’ is well established, since the establishment of a precondition for the exercise of any economic activity may potentially create a restriction of fundamental freedoms provided under the Treaty. In relation to the freedom to provide services within the Union, the notion of an ‘authorisation scheme’ has been defined as ‘any procedure under which a provider or recipient is in effect required to take steps in order to obtain from a competent authority a formal decision, or an implied decision, concerning access to a service activity or the exercise thereof’. ²¹ Since the rules of the EU internal market cover any discrimination and restriction to the exercise of the freedom to provide services, and the concept of an authorisation scheme represents a restriction, such a notion has a broad interpretation. Indeed it covers, inter alia, ‘the administrative procedures for granting authorisations, licences, approvals or concessions, and also the obligation, in order to be eligible to exercise the activity, to be registered as a member of a profession or entered in a register, roll or database, to be officially appointed to a body or to obtain a card attesting to membership of a particular profession’. ²² In this light, as the exercise of certain activities resulting in greenhouse emissions is subject to the holding of a permit issued by a competent authority, all the elements of the notion of administrative authorisation seem to be met.

Nonetheless such allowances are also transferable and have a direct economic value, as provided under Article 12 of Directive 2003/87/EC. It is well known that administrative authorisations cannot be transferred to other parties and do not have an economic value per se, even if they can be a prerequisite for the exercise of an economic activity. As a consequence, these elements would rather be in line with the classification of emission allowances as property rights.

Finally, emission allowances have been recently included in the list of financial instruments covered by the MiFID legal framework. ²³

It appears that the emission allowances represent a hybrid form of property, that could be referred to as ‘regulatory property’, ²⁴ where the ‘regulatory framework provides the necessary legal underpinnings for a transparent and liquid carbon market, whilst ensuring the market’s stability and integrity’. ²⁵

The importance of clarifying the legal nature of allowances has also been recognised by the European Court of Auditors. In September 2016, the Court of Auditors recommended that the Commission further examine this issue. For this reason, a Commission study on the legal nature of EU ETS allowances has recently been launched. ²⁶

As explained by the Advocate General, the classification of emission allowances is not merely theoretical question. If ‘emissions allowances are defined as property which may be owned (property rights or related rights) by the operator, the confiscation of that property by the public authorities might amount to expropriation’, according to the Advocate General, depending on the provisions within the national legal order. If ‘emissions allowances are classified as mere administrative licences or authorisations, the revocation of those licences or authorisations will certainly warrant different treatment’ ²⁷ provided for in national law.

In the absence of harmonisation at EU level and considering the divergent approaches adopted at national level, it is not surprising that neither the Advocate General nor the Court took a position in the definition of the nature of emission allowances. The judgment clarifies that the classification of emissions allowances as either property or administrative authorisations is covered by national law. This is distinct from the creation of emission allowances, which falls under EU law. ²⁸ Therefore, the legal nature of emission allowances is not relevant to the analysis of their creation, but rather whether the exercise of such a competence by a public authority is in line with Directive 2003/87/EC.

Following this approach, the present judgment introduces the notion of ‘act allocating the allowances’, ²⁹ which precedes and is distinct from the allowances. In this specific case, the act allocating the allowances is based on an error of the competent authority caused by the operator. By reason of such error, the act does not meet the requirements established under the Directive 2003/87/EC and is in breach of EU law. It is evident that a mistake in allocating the allowances cannot establish valid allowances. In other terms, the invalidity of one act affects the validity of all other subsequent acts based on the original one. Therefore, the Court concluded that the allowances in question ‘cannot be classified as emission allowances within the meaning of Article 3(a) of Directive 2003/87’. ³⁰

The line of reasoning followed in the present case provides an interesting reading of Directive 2003/87/EC, which gives importance to the process of allocation of emission allowances by public authorities, sanctioning the behaviours that would undermine the overall logic of the system.