Jana Hays of Candole Partners -

This week, the Czech government is expected to decide whether or not to allocate free allowances under the EU Emissions Trading Scheme (ETS) to Czech power generators. At a time of painful budget cuts, Czech ministers are being asked by the environment minister to give up future revenues of more than €1.6bn, which amounts to almost half of the country's planned budget deficit for 2012.

The EU ETS Directive's article 10c allows for a derogation from the otherwise obligatory auction of all ETS allowances for power generation. In exchange, power generators are required to invest the equivalent value of free allowances in the modernisation of their assets to reduce emissions.

It is generally expected the Czech government will approve the allocation of free allowances despite the fact that full auctioning would bring an extra €1.6bn to the state budget. Contrary to the assertions of Czech government officials, the full auctioning of allowances will not lead to an additional increase in electricity prices for consumers. This is because the Czech electricity price is derived from the price on the German exchange, which will reflect in 2013 the full carbon cost regardless of the Czech government's decision to implement the 10c derogation article. Only Czech power generators would be hit financially by the full auctioning of allowances. Explicitly, the operating margin of CEZ, the country's dominant power producer, would decrease from highly above-average to slightly above-average.

If the Czech government is to ensure that the market value of the freely allocated allowances is used for its intended purpose as defined by the Directive, namely the modernisation of power generation, it must implement a set of control mechanisms, which include an investment plan and meaningful penalties for non-compliance. Unfortunately (or fortunately if you're CEZ), the proposed law is toothless.

Ghost writer

The draft law does not require generators to invest in line with an approved and Commission-reviewed investment plan. The ETS Directive requires generators to invest the value of free allowances into specific types of projects, such as fuel diversification and emissions reduction, with the member state enforcing the requirement. In the case of the Czech Republic, the environment ministry will be powerless even to request detailed reports of the generator's investments. This lack of control would allow power generators to fall behind on their investment plans and to accumulate the free allocation towards the end of the trading period when the price of CO2 is expected to be higher. The penalty for reporting false information about progress on investments is practically a reward - the generator would have to return the original value of allocated allowances indexed to inflation, even though the actual price of allowances is expected to be higher in the future.

In short, the environment ministry has drafted a law that ignores the principles of the Directive. Or did it draft the law? The document properties of the electronic file "Electricity Market Analysis", which is part of the Czech application to the Commission for the 10c derogation, reveals a subsidiary of CEZ, called CEZ Data, as the author of the document. Perhaps not surprisingly, the analysis shows that the free allocation would not harm competition in the Czech generation sector. It goes without saying that CEZ would be by far the biggest beneficiary of the free allowances.

It seems that the Czech government is not keen to enforce the EU ETS rules. We may hope that the Commission's review of the Czech free allocation will be more than a mere formality.