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ABSTRACT
Since 2013, power plants in the EU have been obliged to buy carbon permits instead of receiving them for free. However, in order to ease their energy transition, some Member States that meet certain conditions (mainly a high share of fossil fuels and low income) are allowed to continue to receive free allowances for existing power plants (Article 10c of the EU ETS Directive). In exchange, they must invest in modernizing their electricity sector and diversifying their energy supply. However, up to 70% of the conditional investments have been made in upgrading coal-fired units, which casts doubt on the effectiveness of the measure to increase energy diversification. This paper evaluates the effect that the so-called rule 10c has had on energy diversification. A synthetic control method is applied to aggregate data from Poland, one of the countries eligible for free allowances, to investigate how the lignite and wind share in electricity generation would have evolved had Poland not used the rule 10c derogation. Our results indicate that Poland’s energy diversification would have been the same if allowances had been auctioned instead of allocated for free. Therefore, the policy is only relevant in political terms and involves unjustified revenue loss for affected governments in favour of installations, i.e. subsidies. Our results suggest that rule 10c, as defined, does not incentivize investment in low carbon alternatives. The use of this transitional free allocation will continue to be available in phase IV (2021–2030) of the EU Emission Trading System (EU ETS).
Key policy insights
Application of the rule 10c derogation under the EU ETS, granting emission allowances for free to fossil fuel-reliant member states, has not achieved the intended goal of energy mix diversification in Poland.
Using a synthetic control method, we show that the lignite and wind share of electricity production in Poland would have followed the same trajectory if full auctioning, instead of free allocation, had been applied.
Because most conditional investments were used to retrofit coal-fired plants, the policy’s main contribution was to subsidize continued use of coal power.
The policy deprived affected governments of auction revenues that could have been used to ease decarbonization.
Acknowledgements
Financial support from the Spanish Ministerio de Ciencia y Innovación (PID2019-110397RA-I00) is gratefully acknowledged.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Notes
1 Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Lithuania, Poland and Romania
2 Bulgaria, Czech Republic, Hungary, Poland and Romania were eligible to apply rule 10c because of their high coal dependence.
3 The Coase theorem implies that in a setting of bilateral negotiations, under certain assumptions a range of efficient outcomes can be accomplished, regardless of the initial distribution of property rights. Considering clean air as a property whose right is traded on a carbon market, any initial endowment of tradable rights (for example in the form of EUAs) does not affect the market equilibrium in a cap-and-trade system. Hahn and Stavins (Citation2011) termed this the independence property.
4 It should be noted that the independence property is usually defined at the installation level, whereas we used aggregate data. However, the finding that technology adoption is independent from allocation method at the aggregate level is in line with the effect operating at the more micro level.
5 See Verde et al. (Citation2019) for a comprehensive literature review of allowance allocation in the EU ETS
6 Directive 2003/87/EC
7 Union for the Coordination of Transmission of Electricity.
8 Although Latvia and Malta were also entitled to make use of the derogation, they decided not to do so.
9 Recently, this period has been extended until at least 2030, in the context of the 2030 climate and energy
framework.
10 Poland did not become a formal EU member State until 2004. However, the integration process started with Poland’s application for membership in Athens in 1994.
11 Since the object of the analysis is to evaluate the effect of rule 10c, we use Poland as the treated unit and EU15 as controls, even though, strictly speaking, the latter were the countries experiencing a change in the allocation regime. Key to the validity of the method is that the model is able to resemble the outcome trajectories before 2013. The effect is the difference between the two trajectories after 2013.
13 A standardized energy unit, by definition a kilotonne of oil equivalent, is equal to 11.62 gigawatt hours (GWh).
14 All covariates are transformed into natural logarithms to account for non-linear relationships between the dependent and independent variable.
15 Contrary to the opinion of Cavallo et al. (Citation2013), among others, who reasoned that one may include all pre-treatment lags of the outcome variable as predictors, we follow the alternative put forth by Kaul et al. (Citation2015), using only the lag of the last pre-treatment period (2012) and another lag (2001).
16 Germany’s weight to constitute Poland’s synthetic control in the 2007 placebo test decreased to 0.5; while Greece and Portugal increased to 0.37 and 0.12, respectively
17 See the appendix for the corresponding tables for country weights and pre-2013 predictor means (Tables A2 and A3).
18 For wind share, we do not need to restrict the sample for this test as all countries have some positive wind share. We can therefore state the effect is not statistically significant.