A recent FSR Debate[1] held on 4 May examined the key question of how policymakers and regulators can avoid carbon lock-in jeopardising the attainment of the European Union’s ambitious energy and climate targets. Carbon lock-in refers to situations where emissions-intensive energy assets continue to be used even when low-carbon and socially more beneficial assets are available. This is a controversial issue and one on which little has been written. This blog reflects the highlight of the debate – which can be accessed in full at:
https://www.youtube.com/watch?v=OrIorORKjbw.
Recent Regulatory Developments
The EC’s new Guidelines on climate energy and environmental state aid (the CEEAG) adopted in 2022, provide the framework for public authorities to support the European Green Deal objectives efficiently and with minimum distortions of competition. These Guidelines provide that when approving state aid for. ‘transition fuels’ such as natural gas, the Commission may require commitments to ensure the ‘lock in’ of fossil fuels is avoided and fossil fuel installations are compatible with the 2030 and 2050 targets. This may include for example commitments related to the future deployment of Carbon Capture and Storage (CCS). Although the issue of carbon lock-in was examined during the preparation of the new guidelines for State aid on climate energy and environmental protection, it was still a novel subject in terms of case practice at that time. The Commission’s guidelines do not define lock-in, and that this notion will need to be further developed and will evolve over time in case practice.[2]
The concept of ‘carbon lock-in’ is also topical in relation to the proposed Taxonomy Regulation. [3] Article 10(2)c states that an economic activity should not lead to the lock-in of carbon-intensive assets.[4] The definition of ‘transitional activities’ explicitly states the need to avoid environmentally harmful carbon lock in-effects. However, the draft taxonomy measures as well as the CEEAG allow for the greenfield construction of fossil-based energy infrastructure with ambitious targets for low-carbon/renewable phase-in only at a later stage.
Such forward-looking assumptions cannot of course be validated as of 2022, so that there is a clear risk of creating stranded fossil-based energy assets in Europe – going against the principle of avoiding stranded assets[5]. Asset stranding or extended operation at high emissions levels may result if insufficient quantities of low-carbon gaseous fuels are available. Negative consequences for financial market stability and concerns about greenwashing arise. Next to financial market impacts arising from stranded assets, there could be a risk of crowding out necessary investments in renewable energy generation capacities and development of alternative low-carbon technologies, given the ability to shift sustainable finance towards financing fossil gaseous fuels, particularly until 2030.
The question of how to avoid lock-in effects related to natural gas infrastructure as opposed to the most polluting fossil fuels such as coal or lignite is the most challenging as gas may still have a role in the energy transition, and this is already reflected in in the guidelines at para 129.[6]
The guidelines therefore put the onus on Member States to explain, in the context of any measure involving support for new investments in generation based on natural gas, how these proposed projects are compatible with the 2030 and 2050 targets and how lock-in will be avoided. That may be based on a national decarbonisation plan with binding targets, and may include binding commitments by the beneficiary to implement decarbonisation technologies including for example carbon capture projects, or a timetable for the replacement of natural gas with renewable or low-carbon gas, or the eventual closure of the plant on a timeline which is consistent with the Union’s climate targets. Caution should however be exercised against commitments involving CCS and CCU, especially as these technologies could actually be a driver of lock-in by shifting the attention away from more sustainable solutions such as energy efficiency measures. If binding commitments to implement CCUS are being made, they it should be accompanied by a binding and detailed implementation plan.
What steps can be taken?
In other words, considerable uncertainty remains as to what type of assets might be prone to lock-in. This is why economists are advising a set of ‘filter’ questions is asked that determines which projects should then be assessed on a more detailed level. These questions are first, is it a long-lived asset and second, does it have high direct or indirect emissions?
This is broadly the approach followed by the EBRD, for example. The EBRD has defined alignment with the Paris Agreement as having two criteria: consistency with a low-carbon pathway; and a low risk of carbon lock-in. Given that there is no one clear definition of carbon lock-in, the EBRD has developed its own of working definition of the concept. This centres around the notion of the existence of technical, economic, or institutional factors which lead to a high-carbon asset continuing to operate in an emissions-intensive way when there are technically and economically feasible alternatives that could replace it. In practice, when assessing the risk of carbon lock-in presented by a project, the EBRD starts by ruling out projects where it is relatively easy to demonstrate a very high or very low risk of carbon lock-in, coal being an example of the former. Conversely, the EBRD uses the EU Taxonomy for Sustainable Activities to identify projects that are very unlikely to create carbon lock-in.
Having conducted this first ‘filtering’ exercise, individual projects can be screened on the following basis.
Economic factors: once the investment cost of the asset has been sunk, will it be cheaper to continue running it instead of investing in a in a low-carbon substitute?
Market factors: is the operator of the asset likely to have market power? Do the contractual structures potentially create barriers to entry?
Political factors: is the asset is in a sector characterised by influential lobby groups? Would it provide (directly or indirectly) a large level of employment?
If the answer is yes to any of these questions, lock-in might be a risk and a more detailed explanation of why this asset would not lead to lock-in or the introduction of mitigating measures would be appropriate. Assessments of lock-in risks should be timely, pragmatic, and should avoid loopholes if they are to be effective. Further, these assessments should be part of initial project development, and not a mere ‘compliance hoop’ to jump through at the last minute. We need to think about how efforts to avoid carbon lock in are part of an integrated process for the institutions confronting this issue.
Energy regulators
Energy regulators too can play a more proactive role and to use the tools that they have at their disposal, including screening the various network development plans as well national and regional investment plans, as required under EU energy legislation, and based on cost-benefit analysis and better guidance on cross-border cost allocation. There is no clear guidance for energy regulators on how to approach lock-in in those plans but the tools and the approach to tackle this issue will probably evolve over time.
Conclusion
For the rest of 2022 and no doubt for much of 2023, energy security of supply and reducing dependence on imported Russian gas is likely to be the dominant issue, as confirmed by the recent REPowerEU plans. Inevitably the Commission may well have to relax its guidelines and allow state aid for investments to ensure diversification of gas supply, irrespective of whether they create a lock-in effect or not. This may mean that additional Commission guidance on the notion of carbon lock-in could be opportune.
[1] FSR website link: https://fsr.eui.eu/regulatory-responses-to-carbon-lock-in-takeaways-from-our-online-debate/
[2] See also in this context the EC’s guidance on the ‘Do no significant harm’ principle (DNSH) .The DNSH Technical Guidance (2021/C 58/01) sets out the guiding principles and modalities for the application of the DNSH principle in the context of the RRF will continue to be fully applicable, taking into consideration its specific characteristics. It also provides a ‘checklist’ to follow in the DNSH self-assessment to be included in the modified RRP (recovery and resilience plans) for each measure. See Regulation on the Recovery and Resilience Facility (‘RRF’)- Regulation (EU) 2021/241
[3] Where measures meet the taxonomy requirements, the State aid assessment can be simplified. In particular, in balancing the positive and negative effects of the aid, the Commission will pay particular attention to compliance with the ‘do no significant harm’ principle – see also below.
[4] Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 and COMMISSION DELEGATED REGULATION (EU) /… amending Delegated Regulation (EU) 2021/2139 as regards economic activities in certain energy sectors and Delegated Regulation (EU) 2021/2178 as regards specific public disclosures for those economic activities
C/2022/0631 final.
[5] See Art.19 1(i) of the Taxonomy Regulation.
[6] For investments in natural gas to be seen as having positive environmental effects, Member States must explain how they will ensure that the investment contributes to achieving the Union’s 2030 climate target and 2050 climate neutrality target. In particular, the Member States must explain how a lock in of this gas-fired energy generation or gas-fired production equipment will be avoided.
Author
Leigh Hancher, Professor of European Law, Tilburg and EUI, and Special Counsel at Baker Botts LLP
Thanks to Max Munchmeyer for his contributions on the article
