Not a gold pot: Free allocation of greenhouse gas emission allowances in Spain (C-566/11)

In its Judgment of 17 October 2013 in Joined cases C-566/11, C-567/11, C-580/11, C-591/11, C-620/11 and C-640/11 Iberdrola and Gas Natural, the Court of Justice of the EU has analysed and upheld a Spanish system whereby the remuneration of electricity production was reduced by an amount equivalent to the value of the emission allowances allocated free of charge to electricity producers in accordance with the 2005-2007 National Allocation Plan.
The rationale of the system (which actually manipulates/adjusts downwards the energy prices resulting from the Spanish wholesale electricity market) had been clearly spelled out by the Spanish executive, which clearly indicated that, given the fact that electricity producers opted for the incorporation as an additional production cost of the value of the emission allowances allocated free of charge, those prices needed to be adjusted to prevent an unfair enrichment or double whammy by energy producers.
In terms of Royal Decree-Law 3/2006, it was indeed justified to
[take] into account of the value of the [emission allowances] in the formation of prices in the wholesale electricity market is intended to reflect [that integration] by reducing, by equivalent amounts, the remuneration payable to the generating units concerned. Furthermore, the sharp increase in tariff deficit during 2006 makes it advisable to deduct the value of the emission allowances for the purposes of determining the amount of that deficit. The existing risk of high prices in the electricity-generation market, with their immediate and irreversible negative effects on end-consumers, justifies the urgent adoption of the provisions laid down in the present measure and the exceptional nature of those provisions (C-566/11 at para 17).
It is clear to see that, ultimately, the decision was aimed at avoiding a double transfer of resources to energy producers from the general budget and from consumers through tariff deficit compensation charges: first, by allocating emission allowances for free [which could then be immediately traded in the corresponding market or used as collaterial in financial deals; see Martín Baumeister & Sánchez Graells, (2012) "Algunas Reflexiones en Torno a Las Garantías Pignoraticias Sobre Derechos de Emisión de Gases de Efecto Invernadero y Su Ejecución" Revista de Derecho Bancario y Bursátil 127: 191-210] and, secondly, by also compensating higher tariff deficits (inflated) by the integration of the (non-zero, commercial) value of those emission rights in the wholesale energy prices.
However, the Spanish Supreme Court harboured doubts on the compatibility of this mechanism with Directive 2003/87. Indeed, according to the Tribunal Supremo, those measures could have the effect of neutralising the ‘free of charge’ nature of the initial allocation of emission allowances and undermining the very purpose of the scheme established by Directive 2003/87, which is to reduce greenhouse gas emissions by means of an economic incentive mechanism (C-566/11 at para 23).
In my view, the analysis that the CJEU carries out in order to analyse this complicated situation must be praised, both for its clarity and brevity:
33 The Spanish electricity producers in question have incorporated, in the selling prices that they offer on the wholesale electricity market, the value of the emission allowances, in the same way as any other production cost, even though those allowances had been allocated to them free of charge.
34 As the referring court explains, that practice is undoubtedly cogent from an economic point of view, in so far as an undertaking’s use of emission allowances allocated to it represents an implied cost, known as an ‘opportunity cost’, which consists in the income that the undertaking has forgone by not selling those allowances on the emission allowances market. However, the combination of that practice with the pricing system on the electricity generation market in Spain results in windfall profits for electricity producers.
 35 It should be noted that the on-the-day electricity trading market in Spain is a ‘marginalist’ market in which all producers whose offers have been accepted receive the same price, that is, the price offered by the operator of the last production unit to be admitted to the system. Since, during the period concerned, that marginal price was determined by the offers from operators of combined gas and steam power plants – technology attracting free emission allowances – the incorporation of the value of the allowances into the selling prices offered is passed on in the overall market price for electricity.
 36 Accordingly, the reduction in remuneration provided for in Ministerial Order ITC/3315/2007 applies not only to undertakings that have received emission allowances free of charge, but also to power plants that do not need allowances, such as hydroelectric and nuclear power plants, as the emission allowance value incorporated in the costs structure is passed on in the price for electricity, which is received by every producer active on the wholesale electricity market in Spain.
 37 Furthermore, as can be seen from the documents before the Court, the rules at issue in the main proceedings take into account factors other than the quantity of allowances allocated: in particular, the type of power plant and its emission factor. The reduction in remuneration for electricity production provided for under those rules is calculated in such a way that it absorbs only the extra charged as a result of the opportunity costs relating to emission allowances being incorporated in the price. This is confirmed by the fact that the levy is not incurred where power plant operators sell allowances allocated free of charge on the secondary market.
 38 Accordingly, the aim of the rules at issue in the main proceedings is not subsequently to impose a fee for the allocation of emission allowances, but to mitigate the effects of the windfall profits accrued through the allocation of emission allowances free of charge on the Spanish electricity market.
 39 It should be noted, in that regard, that the allocation of emission allowances free of charge under Article 10 of Directive 2003/87 was not intended as a way of granting subsidies to the producers concerned, but of reducing the economic impact of the immediate and unilateral introduction by the European Union of an emission allowances market, by preventing a loss of competitiveness in certain production sectors covered by that directive (C-566/11 at paras 33-39, emphasis added).
The CJEU recognises that, somehow, the Spanish price adjustment mechanism anticipates a correction which introduction was necessary in the revision of Directive 2003/87/EC:
insufficient competitive pressure to limit the extent to which the value of emission allowances is passed on in electricity prices has led electricity producers to make windfall profits. As can be seen from recitals 15 and 19 to Directive 2009/29, it is in order to eliminate windfall profits that, with effect from 2013, emission allowances are to be allocated by means of a full auctioning mechanism (C-566/11 at para 40).
Moreover, the CJEU stresses what, indeed, is the key to this case and, ultimately, indicates the problem of using 'free market' arguments in regulated industries such as energy production, where (wholesale) markets are actually a mere fiction:
since, on the Spanish electricity generation market, a single price is paid to all producers and the end consumer has no knowledge of the technology used to generate the electricity that he consumes and the tariff for which is set by the State, the extent to which electricity producers may pass on in prices the costs associated with the use of emission allowances has no impact on the reduction of emissions (C-566/11 at para 57, emphasis added).

Finally, in a very congruent manner, the CJEU has ruled that
Article 10 of 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 must be interpreted as not precluding application of national legislative measures, such as those at issue in the main proceedings, the purpose and effect of which are to reduce remuneration for electricity production by an amount equal to the increase in such remuneration brought about through the incorporation, in the selling prices offered on the wholesale electricity market, of the value of the emission allowances allocated free of charge( C-566/11 at para 59).
In my view, this a valuable Judgment and one that stresses the new rationality of the allocation scheme implemented by Directive 2009/29. Moreover, it makes clear (indirectly) that Member States must avoid granting unfair advantages and subsidies (ie State aid) to energy producers as a result of the the way they operate their greenhouse gas emission allowances allocation mechanims.