European Industrial Gases Industry Views on the draft Guidelines on State Aid for indirect emission cost

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1 , 1210, Brussels Tel: ; Fax: info@eiga.eu Interest Representative Register ID number: January 2012 European Industrial Gases Industry Views on the draft Guidelines on State Aid for indirect emission cost EIGA, the European Industrial Gases Association, represents producers of technical gases (such as Hydrogen, Oxygen and Nitrogen) in the EU. With this document, EIGA is responding to the Consultation opened by the European Commission (DG COMP) on Guidelines on certain State Aid measures in the context of the greenhouse gas emission allowance trading scheme post-2012 Although providing substantial energy and environmental benefits to the manufacturing industries that they serve, the activities of industrial gas companies are among the most energy intensive of industrial activities. Oxygen and Nitrogen are among the sub-sectors most impacted by indirect ETS-related costs relative to gross value added (GVA), respectively estimated at 58% and 59%. EIGA members supply industrial gases to a diverse range of customers, among the most significant of which are large consumers in the refining, chemical and iron and steel sectors. However, the production of industrial gases can either be outsourced or self-produced (i.e. internalised ) - which is why EIGA is calling to the EU to recognise for equality of treatment in the application of the EU ETS; this is required to ensure a level playing field and to avoid any risk of internal carbon leakage, a danger recognised in recital (23) of the Directive. The current drafting of the guidelines, by not calling specifically for equality of treatment between outsourced and internalised energy-intensive installations, may drive sectors eligible for state aid to re-internalise energy intensive production with damaging consequences for energy efficiency and for the environment, including bringing about an increase in greenhouse gas emissions. In particular a compensation mechanism based on a "fall-back benchmark" and baseline electricity production threatens to give an undue competitive advantage to the industrial installations which have internalised Oxygen or Nitrogen production. A) EIGA urges that the general principle of equality for outsourcing as called for in the Directive - be re-stated as a principle in the guidelines for environmental state aid, in order to provide a level playing field for Oxygen and Nitrogen production, whether internalised or outsourced. B) EIGA proposes to the Commission two different alternative approaches, each consistent with EIGA s primary request to be treated equally with its clients and with prevention of undue competitive distortion within sectors eligible for state aid:

2 1. Include the production of Oxygen and Nitrogen in the sectors eligible for receiving state aid. or 2. Ensure equality of treatment by calculating state aid to eligible sectors in a consistent way irrespective of whether any required Oxygen/Nitrogen is internalised or outsourced. This could be achieved by including - in the product-specific electricity benchmark and in the fall-back benchmark method - the impact of electricity costs associated with the efficient benchmark-based production of the required Oxygen/Nitrogen. By amending the guidelines to take into account either of these proposals, the European Commission would avoid the damaging consequences of penalisation of outsourced production of Oxygen and Nitrogen for the most advanced industrial companies that have chosen to seek the environmental and economic efficiency offered by outsourcing. Furthermore, our proposal would increase environmental protection without adversely affecting trading conditions, a key condition stated in Article 107(3)(c) of the TFEU on state aid for environmental protection. Finally, our proposal would strengthen the three main objectives of the guidelines: minimising the risk of carbon leakage; supporting purpose of the EU ETS in reducing emissions; minimising competition distortions in the internal market. Detail of EIGA position The industrial gases sector is one of the most energy-intensive sector The activities of industrial gas companies are among the most energy intensive of industrial activities. Electricity is one of the key raw materials in the operation of the plants of Industrial Gas companies. The share of energy in operations costs ranges from 50% to 80%. Operations costs are thus extremely sensitive to the market price for EUAs, in particular through the carbon component in power prices for Oxygen and Nitrogen production. EIGA presented an independent report produced by Deloitte to the Commission in October Based on an assumed electricity price of 80 euro per MWh with no additional CO2 emission cost, the Deloitte report assessed that for an Oxygen plant capital costs represent 25% of the total production costs, energy costs 65% and other variable costs (manpower, maintenance, etc) 10%. In terms of indirect additional cost induced by the EU ETS, Oxygen and Nitrogen are the subsectors most impacted with an indirect cost on gross value added (GVA), respectively estimated at 58% and 59% 1. 1 The derivation of this figure is according to the methodology provided by PricewaterhouseCoopers, and mandated by DG ENT to calculate the carbon intensity of the European Industrial sectors in It was presented under the heading EIGA PRESENTATION SPECIFICITIES OF THE INDUSTRIAL GAS SECTOR to Mrs. Tranholm-Schwarz, DG COMP, on Figures and data were provided by PwC, based on data publicly available in the scientific literature.

3 Exposure of the industrial gases industry to carbon leakage The Industrial Gases sector has a long history of developing gases applications and technologies that enhance the energy and environmental efficiencies of the manufacturing industries that it serves. EIGA members are supplying industrial gases to diversified customers, among the most significant of which are large consumers in the refining, chemical and iron and steel sectors. The electricity consumption of Oxygen and Nitrogen production represent a large part of the global electricity consumption of the customer installations (up to 25/30%). The production of industrial gases can either be outsourced or self-produced (i.e. internalised). When industrial gases production is outsourced, the enterprise contracts with a specialised company for the gases supply. In recent years, industrial gases production has been progressively outsourced by large consumers, outsourced supply now representing half of the demand of industrial gases in iron, steel and non-ferrous metals industries and almost 70% in the chemical industry, as shown in the table below: Percentage of IG production outsourced in EU by industry Oxygen Nitrogen Iron, steel and non-ferrous metals industries 47% 49% Chemical industry 69% 69% Source: Spiritus Consulting However, outsourced supply of Oxygen and Nitrogen - as provided by EIGA members - can be reinternalised at any time by major clients if an undue financial incentive - such as inequitable state aid - were to be provided. Since most of EIGA members major clients would be eligible for state aid under the current draft guidelines, there is a serious risk of creating a financial incentive to re-internalise their Oxygen/Nitrogen production should EIGA members not be similarly eligible for aid, thus triggering a market distortion that would result in an internal carbon leakage, as described below: The EU ETS directive recognises this situation and provides (recital 23) that: The rules should avoid undue distortions of competition between industrial activities carried out in installations operated in a single operator and production in outsourced installations. Furthermore, this type of market distortion would not be only limited to EIGA members and their clients, but could also come up within the eligible sectors: in the case, for instance, of an historical plant (with no incentive to re-internalise) and a new entrant plant (with an incentive to internalise its industrial gases production to maximize its extent of aid).

4 The industrial gases sector is providing environmental benefits to the EU industry Any distortion regarding state aid between outsourced and internalised Oxygen and Nitrogen production will result in re-internalisation of production. Industrial Gases specialists, by their aggregation of demand and marketing of co-products, offer a high overall level of environmental protection (e.g. an overall decrease in greenhouse gas emissions) that would be lost along with associated economic and energy efficiencies. The consequences of this distortion would be: 1. to reduce the economic and carbon efficiencies of the overall supply chain; and 2. to reduce the uptake of energy- and environmentally efficient industrial gas applications technologies developed by the Industrial Gases sector; and 3. to unfairly penalise the Industrial Gases sector itself; and 4. to increase costs to other sectors of industry that currently benefit from aggregation of their industrial gases requirements with those generally larger demands of sectors exposed to carbon leakage. The consequences of such distortion would be clearly against the objectives of the EU ETS Directive. Assessment of sectors and subsectors at Prodcom level The EU ETS directive (art. 10(a)6) provides that: Member States may also adopt financial measures in favour of sectors or sub-sectors determined to be exposed to a significant risk of carbon leakage due to costs relating to greenhouse gas emissions passed on in electricity prices, in order to compensate for those costs and where such financial measures are in accordance with state aid rules applicable and to be adopted in this area. Therefore, the Commission Decision of 24 December 2009 regarding the list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage has taken into account the sectors (NACE 4 level) and sub-sectors (PRODCOM 8 level). There is no obvious reason, in the guidelines for state aid for indirect emission costs, to limit the eligible sectors to those defined at NACE 4 level, since sub-sectors at PRODCOM 8 level are also deemed eligible according to the ETS directive and to the Commission decision of 24 December The sub-sectors at Prodcom level represent some externalized industrial activities such as industrial gases production. These sub-sectors and the externalized production represented within them can therefore legitimately be assessed for eligibility for financial compensation for indirect emissions through electricity prices, in the same way as they have been assessed during the establishment of the previously defined list of sectors exposed to carbon leakage. Ensuring a level playing field in the application of state aids The current drafting of the guidelines does not address our concerns on equality of treatment for outsourcing. Compensation given to eligible sectors will be based either on product-specific benchmarks that will not include the electricity consumption associated with production of Oxygen/Nitrogen, or on a "fallback mechanism" based on baseline electricity production that threatens to give an undue competitive advantage to the industrial installations with internalised Oxygen/Nitrogen production.

5 It has to be underlined that due to the number of PRODCOM subsectors lying within the NACE codes currently proposed to be eligible for state aid compensation and, indeed, the even greater number of significant individual production processes the fallback mechanism is likely to be the primary basis of calculation of the aid; The above solution would also meets the ambitions of DG Comp and also Member States that have shown support for maintaining the principles for equality of treatment. EIGA believes that the general principle of equality for outsourcing as called for in the Directive must be re-stated in the guidelines for environmental state aids, in order to provide a level playing field for Oxygen and Nitrogen production sites, whether internalised or outsourced. EIGA also proposes to the Commission two specific alternative mechanisms to achieve such equality, each mechanism consistent with EIGA s primary request to be treated equally with its clients: 1. Include the production of Oxygen and Nitrogen in the sectors eligible for receiving state aid. This way, EIGA will be able to ensure that Member States will be able to financially support EIGA's main client sectors and their outsourced gas suppliers, thus avoiding reinternalisation of Oxygen and Nitrogen production. Or 2. Ensure equality of treatment by calculating state aid to eligible sectors in a consistent way irrespective of whether any required Oxygen/Nitrogen is internalised or outsourced. This could be achieved by including - in the product-specific electricity benchmark and in the fall-back benchmark method - the impact of electricity costs associated with the efficient benchmark-based production of the required Oxygen/Nitrogen. Proposed amendments to Guidelines Current text 8. Furthermore, such State aid may result in significant distortions of competition in the internal market, in particular whenever undertakings in the same sector are treated differently in different Member States due to different budgetary constraints. Therefore, these Guidelines need to address three specific objectives: minimising the risk of carbon leakage, preserving the EU ETS incentives and minimising competition distortions in the internal market. baseline electricity consumption, in MWh, means the average electricity consumption at the installation over the reference period (baseline electricity consumption) for installations operating every year from 2005 to If the installation did not operate for at least one year from 2005 to 2011, the baseline Proposed amendments 8. Furthermore, such State aid may result in significant distortions of competition in the internal market, in particular whenever undertakings in the same sector are treated differently in different Member States due to different budgetary constraints, or industrial activities in installations operated by an operator are treated differently to production in out-sourced installations. Therefore, these Guidelines need to address three specific objectives: minimising the risk of carbon leakage, preserving the EU ETS incentives and minimising competition distortions in the internal market. baseline electricity consumption, in MWh, means the average electricity consumption at the installation including electricity consumption attributable to production in out-sourced installations over the reference period (baseline electricity consumption) for installations operating every year from

6 electricity consumption will be defined as yearly electricity consumption until there are four years of operation on record, and afterwards it will be defined as the average of the last three years for which operation has been recorded. fallback electricity consumption efficiency benchmark, in % and not product-specific, corresponds to the average reduction effort imposed by the application of the electricity consumption efficiency benchmarks (benchmark electricity consumption/ex-ante electricity consumption). It is applied for all products which fall within eligible sectors or subsectors but for which an electricity consumption efficiency benchmark is not defined to If the installation did not operate for at least one year from 2005 to 2011, the baseline electricity consumption will be defined as yearly electricity consumption until there are four years of operation on record, and afterwards it will be defined as the average of the last three years for which operation has been recorded. fallback electricity consumption efficiency benchmark, in % and not product-specific, corresponds to the average reduction effort imposed by the application of the electricity consumption efficiency benchmarks (benchmark electricity consumption/ex-ante electricity consumption). It is applied for all products which fall within eligible sectors or subsectors including electricity consumption attributable to production in outsourced installations but for which an electricity consumption efficiency benchmark is not defined. By amending the guidelines to take into account one of these proposals, the European Commission would avoid the damaging consequences of penalisation of outsourced production of Oxygen and Nitrogen for the most advanced industrial companies that have chosen to seek the environmental and economic efficiency offered by outsourcing. Furthermore, our proposal would increase environmental protection without adversely affecting trading conditions, a key condition stated in Article 107(3)(c) of the TFEU on state aid for environmental protection. Finally, our proposal would strengthen the three main objectives of the guidelines: minimising the risk of carbon leakage; supporting purpose of the EU ETS in reducing emissions; minimising competition distortions in the internal market.