Boliden Kokkola Oy En

New State aid Guidelines in the context of the amended EU Emissions Trading Scheme

Response by Zinc smelter Boliden Kokkola Oy to the

Consultation paper

9 May2011

QUESTIONNAIRE ABOUT YOU

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Please provide your contact details below.

Name Panu Talonen; Manager R&D Organisation Represented Boliden Kokkola Oy Location Kokkola, Finland E-mail address: [email protected]

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Boliden Kokkola Oy agree with the statement and the provided information sent earlier by The International Zinc Association Europe (IZA Europe). This statement mainly lay on the statement sent by IZA added with some site specific information and arguments Boliden Kokkola Oy also want to show out regarding to New State aid guidelines and EU Emission Trading Scheme.

SECTION A: ELIGIBLE SECTORS FOR SUPPORT FOR INDIRECT EMISSION COSTS & INABILITY TO PASS-THROUGH A1 Sectors eligible for aid for indirect emission costs in ETS-3

According to the ETS Directive, the beneficiaries eligible for aid for indirect emissions should be those sectors for which a significant risk of carbon leakage exists due to increases in electricity costs (indirect emissions). In the non-paper addressed to the European Parliament and the Council, the Commission stated that it would identify at EU level a list of sectors deemed to be exposed to the risk of “carbon leakage” due to indirect emissions. The Commission also stated that it would use the method developed in the context of direct emissions, but adapt it in order to take into account cost increases related to indirect emissions. "Carbon leakage" could occur when, in the absence of binding international agreement, global greenhouse gas emissions increase in third countries where industry would not be subject to comparable carbon constraints and at the same time could put certain energy-intensive sectors and sub-sectors in the Community which are subject to international competition at an economic disadvantage.

Financial support should therefore be limited to those electricity intensive sectors which are unable to pass through the electricity cost increase stemming from CO2 to their customers into product prices without significant loss of market share and which are likely for this reason to relocate to less carbon-constrained zones outside the EU. 1. Please specify the sectors (at NACE 4 level) that, according to you and the requirements

in the Directive, are exposed to a significant risk of carbon leakage due to costs relating to greenhouse gas emissions passed on in electricity prices which will stem from ETS-3. According to Commission Decision of 24 December 2009 (2010/1/EU) the zinc metal production is exposed to a significant risk of Carbon Leakage based on the criteria set out in paragraph 15 and 16 of article 10a of Directive 2003/87 at NACE 4 Code: 2743 Lead, Zinc and Tin production, Boliden Kokkola Oy is located in Kokkola Finland and is the one and only Zn smelting operation in Finland. Boliden Kokkola is with 530 employees also one of the biggest private employers in Kokkola.

Zinc metal is a commodity and is traded daily on the London Metal Exchange (LME). Boliden Kokkola (later BKO) buy the zinc contained in the concentrates (input material) and sell the products (refined zinc metal) on the basis of the LME price. BKO’s profitability is not directly linked with the zinc market price but determined by the treatment charges (TC), which is the rate payable for processing concentrates, and the conversion costs incurred in processing concentrates into metal. Therefore, the

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competitiveness of a zinc refinery will mainly depend on its conversion costs, that is, the operating costs incurred for processing zinc concentrates into zinc metal.

BKO’s electricity costs currently represent over 40 % of the total conversion costs. If depreciations are taken into account the share of electricity costs in year 2010 was 43 %, if depreciations is not taken into account the share was 49 %. Cost distribution is defined below in figure 1.

Fig.1: Boliden Kokkola Oy Cost distribution in year 2010

Labour; 21 %

External services; 12 %

Depreciations; 12 %

Energy; 43 %

Other; 13 %

Labour; 23 %

External services; 13 %

Energy; 49 %

Other; 15 %

Total cash conversion costs include all operational costs “inside the fence”, i.e. costs related to the conversion of concentrates to metal. It does not include any costs for raw material, freight of concentrate or metal, sales or depreciation. A net-energy cost represents the balance of smelter purchases and sales of energy. “Other cost” include maintenance materials, consumables and on-site services.

Due to electricity being such a significant proportion of conversion costs, BKO, like other zinc refineries, will in the future put a high level of focus on energy efficiency improvements. Currently BKO is one of the most energy efficient Zn-producer in the world.

Fig.2: Electricity Costs per produced ton of zinc in 2000-2010 at BKO

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0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

€/t Z

n

Fig.3: Electricity Costs per produced ton of zinc in 2010

Source: Brook Hunt a Wood Mackenzie Company

Fig.4: Tankhouse power consumption of zinc smelters (kWh/t Zn)

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In terms of energy efficiency, the European zinc industry shows the lowest total energy consumption per tonne of zinc production worldwide and Boliden Kokkola Oy shows one of the lowest total energy consumption amongst all Zn-operations. BKO’s tankhouse power consumption in year 2010 was 3 325 kwh/t Zn.

Fig.5: Energy consumption of RLE (Roast-Leach-Electrolysis) smelters in 2010

Source: Brook Hunt a Wood Mackenzie Company

However, this leading position in energy efficiency cannot make up for the negative impact of high electricity costs on EU27 conversion costs. Indirect CO2 cost pass through in electricity prices therefore has a significant impact on the global cost competitiveness of EU producers already under ETS-2, which only become worse under ETS-3.

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Fig.6: Weighted average cash conversion costs of RLE zinc smelters in 2010 (per produced ton of saleable zinc)

Source: Brook Hunt a Wood Mackenzie Company

GHG emissions from electricity production depend on energy mix used and are strongly regionally bound. Boliden Kokkola Oy is located in Nordic countries and use The Nordic energy mix which has quite a favourable CO2 footprint compared to that of most other regions of Europe and world. BKO’s energy mix consist like following: Nuclear power 32 %, renewals 43 % and fossil fuels only 25 %. Due to the pricing mechanism of power market, the price of all power consumed would be affected by the CO2 cost, despite low CO2 intensity.

Fig.7: Shift in production away from EU27 RLE smelters would result in Carbon leakage

Source: International Energy Agency

Therefore, transferring production from EU to non-EU zinc refineries would result in carbon leakage as non-EU plants are on average more energy intensive and have a higher CO2 content in the electricity they use. Similar affect would result if BKO’s

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production was transferred to non-EU. Carbon leakage would be significant while BKO is one of the most energy efficient Zn-operations in the world and it has an energy mix with low CO2 intensity.

Burden sharing / efficiency of ETS-3 2. How do you reply to the view that granting compensation to some sectors of the

economy and insulating them from the EU ETS indirect costs would be at the expense of other sectors of the EU economy, which would have to make stricter emission reduction efforts or be under a larger cost burden, in view of the overall EU cap on emissions? The revised Directive 2009/29/EC in article 10a6 recognizes serious issues for energy-intensive industries due to the effect of indirect cost increases in the electricity price which is an unavoidable consequence of the emissions trading system. The effect of transferring the cost of purchasing emission rights and passing it on in the electricity price is likely to increase even further in the future as the nuclear crisis in Japan implies that EU will be ever more dependent on fossil fuels to provide the necessary base-load power1. This will create a higher demand for emission rights and lead to a significantly higher cost-burden that will seriously threaten energy-intensive industries. The situation is the most critical in Northern Europe, which despite its highly clean energy production, has a significant cost pass through of emissions rights as coal is typically the marginal price setting plant in the area. The cost of emissions trading is thus almost fully passed through to energy-intensive industries even though the majority of the power comes from CO2-free hydro and nuclear power production. The problem is exacerbated by the lack of auctioning revenues for the Member States as the clean power does not generate any revenues for the Nordic Member States. The measures included in the Directive to safeguard against the significant cost increase and resulting carbon leakage by allowing compensation of CO2 costs passed through in electricity prices for eligible sectors is highly inadequate unless it is mandatory enforced across the entire EU. It has to effectively protect industries which are electricity intensive for all CO2 costs in the electricity price irrespective of geographical location. Several industries buy clean power but pay the full cost of CO2 which will reach unsustainable levels. This will potentially imply a loss of electricity intensive industries in the regions where we have a stable supply of clean base-load power and where electricity intensive industries provide a key resource as a stable, predictable long term consumer providing stability to the electricity system. EC should use all its legal power to enforce Member States to adopt the indirect compensation system in order to fulfill the mandate of the ETS Directive to avoid further carbon leakage. If this may not be possible for any reasons, the mandate of the Directive and modified Guidelines should be used to enforce Member States to develop equivalent national or European measures to avoid further carbon leakage and de-industrialization of Europe for the eligible sectors. If the EC does not achieve equal implementation across the Community, the EU risks creating a system where electricity intensive industries that purchase clean power suffer a double-burden with a high cost-pass through but low chance of receiving compensation.

1 Already the nuclear crisis in Japan has had the effect to close down several nuclear reactors in Germany which

has had a direct impact on the electricity price and the price of emission allowances.

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Compensation for indirect costs would, assuming it were to be based on an electro-efficiency benchmark, maintain the incentive to reduce product consumption (in this case electricity) and lead to an overall reduction in direct emissions in the power generation sector. Because of the global price setting of their products, compensating electro-intensive industries such as BKO and other zinc metal producers for indirect CO2 costs in electricity prices will not contribute to the insulation of any consumers further downstream from ETS indirect cost.

The granting of compensation to electro intensive installations would not lead to a higher cost burden for other sectors of the EU economy. The reason is that the total European electricity costs for these consumers are already very high compared to other regions.

The intended effect of the compensation for indirect CO2 costs in electricity prices is preventing the closure of a large share of Europe’s basic industries in the absence of a global level playing field. If the closure of Europe’s basic industries is not prevented, there would be a reduction in electricity demand and in direct emissions from these sectors. However, the percentage of overall European electricity consumption that would be eligible to receive compensation for the indirect costs under the New State aid guidelines is expected to be very small and therefore the influence on the prices of emission allowances and on burdens for other sectors will be negligible.

International context 3. To what extent are producers outside the EU also confronted with a cost for indirect

emissions? Are you aware of the existence or imminent implementation (before 2013) of emission trading systems, or emission reduction mechanisms with similar effect on production costs as the EU ETS, in other parts of the world? Which emission reduction mechanisms, if any, should be viewed as having a similar effect on production costs as the EU ETS? According to BKO’s view, at present no other significant regions outside Europe are confronted with costs associated with direct or indirect GHG emissions, or emission reduction mechanisms with similar effect on production costs.

A2 Inability to pass-through increased indirect emission costs due to ETS-3

Please answer the questions below for each of the sectors you have identified under question 1. For all the questions, you are invited to also compare the situation today (under ETS-2) with the future situation under ETS-3. Information and data on sectors should, in principle, be provided at NACE 4 level. General cost structure 4. Is the sector in question capital intensive? Does the sector face (unrecoverable) sunk and exit costs? Please identify them and indicate how much they represent in terms of the industry’s turnover and value added. How large are the fixed costs of operations? What investments are required to a new entrant and how much can they represent of the new entrant’s turnover? Please indicate how much electricity costs contribute to the overall costs and, if appropriate, what percentage of which electricity sources is used in your industry.

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The zinc industry is highly capital intensive. Due to the cyclical nature of zinc prices, and the fact that zinc refineries compete globally on cost of production (‘conversion costs’) and not price, investment decisions are made for the medium to longer term. The competitiveness of a zinc smelter will mainly depend on its conversion costs and energy is the greatest proportion of conversion costs for BKO like also for other EU refineries. In 2010, energy represented for BKO 49 % (see figure 1) of conversion costs. Therefore, the primary differentiator between all Zn-producers will be the cost of electricity. Only in Europe does the price of electricity embed a CO2 cost, therefore the risk of carbon leakage from Europe can only be mitigated by compensating for the indirect CO2 cost.

As electricity is a significant operating cost, BKO and other zinc refineries have, and will continue, to have a high level of focus on energy efficiency, however there is a physical limitation to energy reduction measures. Almost 90 % of electricity consumption at BKO and other Zn refineries is used in the electrolysis stage where dissolved zinc is converted to zinc metal using electrical current. That conversion efficiency is governed by physical laws and at BKO there is not much potential for improvements anymore.

Existence of carbon leakage risk due to indirect emissions 5. Please explain, during the ETS-3, as from which level of CO2 price would you consider

that companies in your sector are faced with a real and significant carbon leakage risk due to indirect cost increase? Please substantiate your answer. The risk of carbon leakage arises when BKO and Zn-producers in Europe are faced with a unique cost under the ETS that cannot be passed on to consumers. It is not relevant to attempt to ascertain a “trigger price” at which the risk of carbon leakage may occur as any CO2 price above zero will have a probability of risk of carbon leakage associated with it. Due to the fact that BKO and other EU zinc producers being more energy efficient and the energy mix in the Nordic countries and EU having a more favourable CO2 footprint than most other regions of the world, the risk of carbon leakage exists.

Under ETS-2, indirect CO2 costs are estimated to make up 13% of total zinc smelter conversion costs (based on a EUA cost of 15 €/t CO2). At prevailing CO2 costs in Europe the risk of carbon leakage is already both real and significant. At an increased EUA cost of 30 and 50 €/t CO2, this would increase the impact of the pass through of CO2 costs in electricity prices to 23% and 33 % of total zinc smelter conversion costs. Table 1: Impact of indirect CO2 costs on EU27 RLE smelters conversion costs

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Electricity consumption (MWh/t) 4 4 4CO² emissions (t CO²/MWh) 0,9 0,9 0,9EUAs (€) 15 30 50Total CO² cost/t Zn (€) 54 108 180Total CO² cost/t Zn (USD, at a rate of 1.33 USD/€) 72 144 239Cash conversion cost (USD) - Excl EUAs 480 480 480Cash conversion cost (USD) - incl EUAs 552 624 719

Share of EUAs (%) 13 23 33

As the EU27 produces nearly two million tons of zinc metal annually (23% of world output) the effect of carbon leakage due to pass through of indirect CO2 costs under the EU ETS would be significant.

6. Please present the main factors of relocation decisions and/or the decision to shift

production to locations outside the EU in order of importance and explain which position the impact of CO2 prices (especially on profitability) in this respect. Please substantiate your answer. Relocation outside Europe is the long-term consequence of two rather independent processes: Firstly, capacity to cover expected market growth as well as replacing closures will be developed in areas with the best expected return on invested capital; largely in countries outside Europe with lower electricity prices. Secondly, no further investments will be made in Europe, and industry will slowly fade away with the con-sequent loss of:

• direct and indirect jobs, • entire value chains, • innovation capability, • know-how, and • new product development.

The ultimate consequence is higher global CO2 emissions.

The decisions taken within Europe on curtailment of production will be specific to the economic circumstances surrounding the installation. The primary driver for taking decisions to curtail production in Europe or to construct new facilities outside Europe will be the cost of electricity and the availability of long term contracts. The price of electricity in Europe is higher than that available outside Europe as a direct consequence of the EU ETS.

The effects of this is already evident in that needed investments are not made and no new primary zinc refinery has been built or major refurbishment undertaken on mainland Europe the last 5 years. Zinc smelting is the process of converting zinc concentrates (ores that contain zinc) into pure zinc. There are two methods of smelting zinc: the pyrometallurgical process and the electrolysis process. The pyrometallurgical process, known as Imperial Smelting Process (ISP), is a thermal process and consists in 3 steps: roasting, reducing zinc oxide using carbon, then distill the metallic zinc from the resulting mix in an atmosphere of carbon monoxide. The electrolytic process used by BKO and also known as Roast-

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Leach-Electrowin (RLE) process, is a hydrometallurgical process and consists of 3 major steps: roasting, leaching-purifcation and electrolysis. Nowadays, the RLE process is the most widely used since it is more energy efficient. Also, the amount of direct CO2 emissions is insignificant compared to the pyrometallurgical plants which use coke as energy source. A period of low prices during 2001 to 2004 (see LME price evolution under Q10) put a lot of pressure on European zinc metal producers. Because of their relatively higher operating costs, the ISP refineries were less competitive and the majority of them were closed down during those years. The reason for the higher cost structure of ISP refineries compared to electrolytic refineries is mainly the energy cost, as ISP refineries are more energy intensive than electrolytic ones. During the period when the LME price was severely constraining smelter income, energy costs were increasing relatively faster for ISP refineries, with no capacity for cost pass through. This is a good example of an asymmetric shock. The landscape of the zinc metal industry in Europe has been marked not only by ISP and RLE closures, but also by consolidation. Total of 788,000 tons production capacity being taken out of the European market since 2004. Table 2: European zinc smelters closures since 2004

Year Smelter Country Capacity (tonnes)

2003

2003

2004

2005

2005

2006

2008

2008

Crotone

Overpelt

Avonmouth

Noyelles Godault

Portevesme

Sudamin

Ruhr Zink

Espanola de Zinc

Italy

Belgium

UK

France

Italy

Germany

Germany

Spain

103 000

130 000

100 000

105 000

75 000

85 000

145 000

45 000

Total 788 000 The location of the remaining various refineries is shown below: Fig 8: Remaining Zinc Refineries in the EU27 in 2011

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The reduction in European zinc production capacity has left the EU 27 with a deficit market since 2006, a situation where local demand is not anymore satisfied with local supply. This situation is forecast to become even worse over the next five years. The production volume that disappeared from the EU market was more than replaced by imports from non-EU producers. 2007 was a record year with 606,000 tons of imports outweighing the market deficit of 119,000 tons. Even the 2,5% import tax which is due on zinc metal from most of the non-EU countries does not seem to have had a negative effect on import levels. Fig 9: The market deficit resulted in an increasing flow of imports from non-EU countries

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It is therefore utmost important to keep the remaining installations within the EU, particularly as a major part of their market is already taken over by imports, risking more dependency of other countries. In this context it should also be noted that not all European Industry is global enough or capital rich to 'relocate' to less carbon constrained zones outside the EU. In other words, capacity closures in EU are also likely to be replaced by Non-EU companies in Non-EU countries.

7. If (some) companies in the sector concerned were to relocate or to shift production

locations outside the EU, please specify to what locations this would likely be. Would it be to countries with a low carbon factor or rather to countries with no CO2 pricing mechanism? Please substantiate your answer. Outside of Europe, no country has a CO2 pricing mechanism, so this is not a determining factor in where to site new facilities. The primary drivers will be long-term availability of competitively priced power and regulatory stability. BKO however, acknowledge EU’s climate policies and have no particular preference for areas without carbon emission cost. Our demand for a transitional compensation is linked to the present imbalances caused by the fact that no other competing regions will have such cost in their electricity prices in the near future.

8. Please provide your views on the extent to which carbon leakage has already occurred as a result of the introduction of ETS 1 or ETS 2. Please substantiate your answer in concrete terms. Introduction of these schemes has put some additional pressure on the EU 27 zinc companies, which have seen their competitiveness further reduced. The impact of this has in some instances been leading to the closure of several Zn refineries. throughout Europe. In fact, 8 companies had to close in that period resulting in an overall capacity loss of close to 800.000 tons of zinc per year (see Table 2), replaced by imports from non-EU suppliers, less energy efficient.

The aim of the EU ETS Directive is to mitigate the risk of carbon leakage occurring from 2013 onwards. The sub-sectors identified in this questionnaire are principally at

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risk of carbon leakage due to the indirect cost associated with the EU ETS. The Directive did not envisage a need to demonstrate that carbon leakage occurred during ETS 1 or ETS 2 as a result of the indirect CO2 associated with electricity purchase as precursor for providing State aid during ETS 3.

Carbon leakage has already occurred as a result of ETS 1 and 2: a) Increases in electricity market prices occurred regardless that free allowances were given to the generation sector for a large proportion of their emissions. Renewal of power supply contracts at prices without emission allowance cost was therefore not possible. b) Long-term power supply arrangements are expiring (most have already), thus giving rise to exposure to higher prices due to CO2 costs.

Other installations may be able to continue with operations in the short-term until the new state aid schemes are established. In any event, the lack of regulatory certainty around carbon leakage mitigation measures has probably already led to the first stages of carbon leakage as installation owners will be unwilling to take the risk of continuing to invest in improving those facilities. This is also show by the lack of investment in new or upgraded facilities over the last 5 years. The only way to mitigate this is full compensation for the indirect costs.

Increase in indirect costs due to ETS-3 9. Please quantify the increase in costs which firms face due to electricity generation as

they comply with ETS-3. In your reply, please differentiate between impact on fixed costs and variable costs. Please also compare the situation today (under ETS-2) with the future situation under ETS-3. The increased cost for power consumers due to the imposition of emission cost on power generators is:

∆P = k * E

Where, ∆P = Power price increase for the year (€/MWh) k = Marginal CO2 emission factor for the year (t/MWh) E = Average emission allowance price for the year (€/t)

The fixed and variable cost elements are not relevant to cost competitiveness. The zinc smelting industry competes globally on cost of production (‘conversion costs’). Energy is the greatest proportion (49% in 2010) of BKO and other EU zinc refineries conversion costs. In the case of zinc, indirect CO2 costs make up 12, 23 and 33% of the total cash conversion costs, using respectively 15, 30 and 50 €/t CO2 assumption in ETS-3, as shown previous in Table 1 and Fig.6.

Profit margin 10. Please indicate the sector's profit margin. In particular, please quantify the estimated

impact of the increase in CO2 costs related to electricity prices (comparing ETS-3 to

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ETS-2) on your profits (e.g. using 15 and 30 EUR/t CO2 assumptions in ETS-3). Please specify on which segments of the sector's profits these indirect CO2 costs have an impact, and explain your reply. Please indicate the same as regards the impact of CO2 costs related to electricity prices on the sector operating costs and margins. The LME price is said to reflect the balance of supply and demand short and long-term. In the long-term it is also said to represent the refineries costs plus a profit margin. Zinc prices are cyclical due to global supply-demand balance.

Fig 10. Evolution of the LME price over a period of 50 years

A smelter sells its output at LME price; its sales price is therefore fixed. If the smelter is not able to get its costs below the LME price level in the long-term it makes a loss and goes bankrupt. Smelter viability must be assessed looking over a longer time period and the investment cycles are long term (10 to 15 years)

Therefore, absolute profit margins for the sub-sectors identified in this questionnaire are not relevant as they will vary tremendously from year to year during commodity cycles. More relevant to fulfilling the aim of the Directive in avoiding the risk of carbon leakage is the quantification of the competitive disadvantage resulting from impact of the CO2 price in power costs.

Assuming an electricity consumption of 4 MWh/t. of zinc produced, a marginal CO2 emissions factor of 0.9 t/MWh and EUAs prices of 15, 30 and 50 €/t.CO², the corresponding increase in production cost would be 54, 108 and 180 €/t. respectively, roughly 13, 23 and 33 % of the total conversion cost – see table 1.

Even with 70 % compensation, the effect is significant and will lead to carbon leakage

Fig. 11: Projected electricity costs for the EU zinc Industry

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11. As for direct CO2 costs, please quantify the total accumulated surplus of free allowances over actual emissions in the period 2008-2009 and estimated surplus for the rest of ETS-2nd Phase, if relevant. Not relevant as the sub-sectors identified in this questionnaire will not enter into the EU ETS until 2013.

Transport costs 12. Please indicate which transport costs the sector incurs. How significant are they with

respect to the turnover and value added of the sector? Is a significant share of production transported or are products sold close to the production site? How much transport costs are relevant for the use of intermediate goods? Please substantiate your answer. BKO is located at the west coast of Finland and main part of raw materials and products are transported by sea carriage. Products are transported by seaway and delivered further by trucks to customers around Europe. BKO’s all customers are located in EU. Transport costs of the zinc produced are not significant with respect to the turnover and value added of the sector (less than 1% of product price). Therefore transport costs do not represent a barrier to global competition.

13. How relevant is the physical proximity of the plants to the markets where the

intermediate goods are bought from and to those where the final goods are sold?

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Physical proximity of production is irrelevant as the zinc produced can be sold to customers or delivered to LME warehouses. These form common reference points for domestic and imported deliveries.

14. Please explain how these transport costs impact on possibility to relocate or shift production locations outside EU. Transportation costs for products sold are not relevant to the decision to curtail facilities in Europe or to build new facilities outside Europe.

Product differentiation 15. Please indicate whether the products of the sector are homogeneous or differentiated

based on quality, marketing and branding or content.

The products produced by the zinc sub-sector highlighted in this questionnaire are homogeneous commodities.

Service differentiation 16. Please indicate whether services provided at local level by your company matter for

your clients. Whereas services provided to the clients such as just in time deliveries, technical assistance and recovery of zinc residues for recycling, do matter for the clients, the provision of these services does not enable differentiation in the price of the commodity sold.

17. Please indicate the share of your sales to clients in the same Member State, in other EU Member States, in non-EU States. All clients of BKO are located in Europe, about 15 % of production is sold for Finnish customers.

Substitutability of final products 18. Please provide information on the substitutability between the sector's products from

the point of view of the clients. Are products from non-EU sources to be considered as close substitutes? Please substantiate your answer. Zinc metal is a commodity wide with no price differentiation for material produced to international designation standards; it thus can easily be substituted by non-EU sources.

19. Please provide studies and reports that substantiate the claim that the level of EU production is - or is not - highly price elastic, i.e. that an increase in prices of the EU producers would lead to a significant reduction of EU production. Please also illustrate your claim with concrete observations from the (recent) past. The price of refined zinc is set on global exchanges, such as the LME, which is sensitive to the worldwide production/demand ratio. The zinc producers compete globally on cost of production and the global cost curve for zinc production is relatively flat. Therefore regional conversion cost increases, such as an increase in electricity

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price due to the pass through of indirect CO2 costs under the EU ETS, can make a significant difference to the global competitiveness of producers from that region. As for all non-ferrous metals produced by the sub-sectors highlighted in the questionnaire and traded in global markets, elasticity factors are not significant as they only reflect the sensitivity of the global demand to the commodity price. It will not reflect the impact of a differentiated application of EUAs on their operating costs and hence on their competitiveness, as these additional costs will not be transferred to the market and will not affect the global demand. It would be impossible to attempt to raise prices within Europe without significant loss of sales, which would ultimately result in complete displacement of European production capacity by imports. See also notes on the functioning of the LME question 30. See also report Impacts of the EU Emissions Trading Scheme on the industrial competitiveness in Germany, UBA Research Report 3707 41 501, 10/08, ISSN 1862-4359 “Comparing the few estimates available for the various sectors, a very rough sector ranking in terms of demand elasticity would be (starting with highest absolute value): aluminium, steel, paper, cement”.

20. Which non-EU countries would see the largest increase in production if the price of EU

production were to rise due to ETS-3? Please substantiate your answer.

This would be countries where it is possible to get long term power contracts at affordable prices.

Overall demand elasticity 21. Please provide information on the elasticity of overall demand with respect to price

increases in the sector concerned. See response Q 19

Market segmentation and industry structure 22. Please provide information on the characteristics of the market affected by the possible

increase in CO2 costs, including the market size (outside and within the EU), the market share of the main companies in the relevant market, the degree of agglomeration and vertical or horizontal integration. The main markets for the zinc industry are galvanizing (54 %), brass and semi’s castings (12 %), zinc die-casting alloys (12 %), semi-manufactured products (9 %), ZnO and chemicals (9 %) and others (4 %). Fig12. Zinc Consumption by first and end-use

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In general terms, all these markets can buy their zinc from LME or non-EU suppliers and are thus not affected by the closure or lower capacities of EU producers. Nevertheless, on a longer term, they will have access to less suppliers and will lose the direct contact and assistance from their EU relations, leading to a loss of expertise and competitiveness against their non-EU counterparts.

Demand Growth 23. Please provide information on the expected rate of growth of demand for the product

concerned over the next 10 years in total and by geographic macro-area. The Worldwide Zn consumption is expected to grow on a steady basis, mainly due to the important market potential in China and India. The production will most probably follow closely this trend. Fig 13: Forecast of the consumption/production over the next 10 years

Information on the regional forecasts is not available and depends merely on the competitiveness of the each producer. However, it can be seen from the following graphs that demand for refined zinc has always been higher than local production. Imports from non-EU countries have filled the gap. Fig 14: Evolution of the refined zinc production and consumption in the EU27

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Import volumes & export volumes 24. Please indicate for the years 2005-2010, both at (i) world level and (ii) at the level of

the EU (a) the total annual level of production (in volumes and values), (b) the total market size, (c) the total annual level of imports into the EU, (d) the total annual level of exports out of the EU. If possible, please also provide a breakdown by Member State and for the exports and imports a breakdown by the 10 main countries of destination and origin, respectively. Fig. 9 and 14 here-above shows the evolution of zinc production and consumption during the period 1997-2007 and shows that imports have always been outweighing the European market deficit The graphs here-under show more details about the current import-export statistics for 2010 into and from Europe respectively. Fig. 15: Imports into the EU27 from countries importing over 2000 tons/year.

Fig.16: Exports from EU27–countries representing more than 2000 tons

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25. Does the sector in question face any import restrictions, in the form, for example, of EU import duties or export tariffs?

The tariff imposed on zinc imports from non-EU countries is 2.5 %. However, several countries exporting zinc to the EU have gained import duty reductions or exemptions through EU trade agreements (S. Africa, Mediterranean countries, …). Third country tariffs (relevant to EU NFM exports) also vary considerably and, while tariffs generally were reduced under the WTO, there are still important markets where duties remain and have even been increased again.

Extra- EU trade intensity 26. Please indicate the ratio between total of value of EU exports to non-EU and value of

imports from non- EU and the total market size for the EU in the period 2005-2010. Please indicate within which regions are the products of the sector traded.

See answer to question 24. While values are proportional to tonnages, it is not relevant to discuss values in the case of commodities, as the price is fixed by the LME and can vary significantly from one moment to the other in the same year.

Changing patterns of world trade 27. Please indicate any changing patterns of world trade in the sector.

Fig. 9 and the graph here-under shows the evolution of the global zinc supply in the world and the Western world respectively Fig 17: Zinc metal supply 1979-2009

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Important changes in the pattern have occurred in the zinc industry in the last decade. Indeed, the share of the European producers has been significantly reduced, highlighting the progress made in Asian countries, and the impact of closures and lower investments in Europe. While European producers used to have a leading position in the zinc market, China is clearly taking the lead, pushing the EU in the second position. Fig.18: Distribution of zinc metal supply

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Substitutability of inputs 28. Please indicate whether the sector can reduce the energy intensity of the production

processes by inputting other factors of production. The intensive use of electricity in the processes employed by the sub-sectors highlighted in this questionnaire cannot be reduced by inputting other factors of production. Further reduction of the total energy consumption by European RLE plants has become rather marginal. Indeed, most (over 80%) of the electricity consumption is used in the zinc electrolysis stage, where conversion efficiency is governed by physical laws.

According to Faradays law, the mass of a substance released on an electrode is directly proportional to the amount of electricity that was circulated by the electrolyte, that is, it is proportional to the intensity of the current and the time during which the current was circulated.

Q .M I.t.M m = = F.n F.N

m is the mass of the substance (Zn metal) liberated at an electrode Q is the total electric charge passed through the substance I is the electric current intensity t is the time during which current is applied F = 96,485 C mol-1 is the Faraday constant M is the molar mass of the substance

For Faraday's law, M, F, and z are constants, so that the larger the value of Q the larger m will be Currently the current efficiency for zinc electrolysis is at the level of 92-94 %.

The remaining 6 to 8 % are due to physical parameters, (such as the resistivity factor induced by the presence of the electrolyte between electrodes during electrolysis) and cannot be reduced further.Therefore, further significant reduction targets for indirect CO2 emissions are nearly impossible to achieve via zinc producer actions.

Market penetration rate for new technologies 29. Please indicate the adaptability of a sector to new lower-carbon technologies and

production processes. Please substantiate your answer based on the existing capital infrastructure of the sector, the maturity of the new technology (and costs) and the nature of the new technology (incremental or step-change). What is the market penetration rate for such technologies? Please substantiate your answer. There are currently no new technologies on the market or close to market application. Any improvement depends on gradual improvement of existing technology and the best performance here is getting close to theoretical limits.

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RLE Technology is the most energy efficient and dominant process. The Roast-Leach-Electrolysis (RLE) production process is the most used (88%) in the zinc industry. There are no other technologies currently to produce industrially zinc metal at lower energy consumption

Global price setting mechanism 30. Please specify to what extent EU producers in the sector should be viewed as price

takers. Are the products of the sector commodities, sold in global exchanges? What percentage of the sector (in volume and value) is sold in global exchanges? How does this global price mechanism function? Please specify the premiums on top of potential prices at global exchanges. Please substantiate your answer.

We highly appreciate the realistic view of DG COMP to focus on global price setting mechanisms as criteria for eligibility.

The sub-sectors highlighted in this questionnaire produce commodities that are subject to their selling price being determined by global exchanges. The primary exchange where these commodities are traded is the London Metal Exchange (LME). The LME provides a transparent forum for all trading activity and as a result helps to ‘discover’ what the price of material will be months and years ahead. This helps the physical industry to plan forward in a world subject to often severe and rapid price movements. Such is the liquidity at the Exchange that the prices ‘discovered’ at the LME are recognized and relied upon by industry throughout the world. The LME is a highly liquid market and in 2010 achieved volumes of 120.3 million lots, equivalent to $11.6 trillion annually and $46 billion on an average business day

The LME trading volumes are multiples of the physical production of the commodities. For Aluminium the volume of futures contracts traded on the exchange were 46.5 million lots in 2010. One lot is equal to 20 tonnes.

Trading takes place across three trading platforms: through open-outcry trading in the ‘Ring’, through an inter-office telephone market and through LME select, the Exchange’s electronic trading platform. The LME publishes a set of daily reference prices that are based on the most liquid trading sessions of the day. They are used the world over by industrial and financial participants for purposes of referencing, hedging, physical settlement, contract negotiations and margining and are indicators of where the market is at any point in time.

SECTION B: LEVEL OF SUPPORT

The ETS Directive, which enabled the transition from ETS-2 to ETS-3, allows for compensation of costs due to indirect emissions for the increase that results from the implementation of ETS-3 (due to tightening of the cap leading to expected increased CO2 prices). The Directive stipulates that financial support should maintain an incentive to reduce electricity consumption and stimulate a shift in demand from "grey" to "green" electricity. 31. How such an incentive could be maintained? Please substantiate your answer.

Recitals 24 and 27 of the Directive states that the aid should be granted such that “...EU ETS incentives to save energy and to stimulate a shift in demand from ‘grey’ to ‘green’ electricity are maintained. This is subtly different to statement above: “financial support

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should maintain an incentive to reduce electricity consumption and stimulate a shift in demand from ‘grey’ to ‘green’ electricity”.

The primary incentive to switch from ‘grey’ to ‘green’ electricity generation is already embedded in the ETS by placing a carbon cost on fossil fuelled generation and the various subsidies for renewable power generation. Financial support provided to eligible consumers for CO2 costs embedded in electricity prices can neither strengthen nor weaken the incentive. Electricity is supplied to consumers at the same price regardless of its source of production, and ‘grey’ electricity cannot be distinguished from ‘green’ electricity. As a consumer of power we cannot change the mix provided in the grid by the producers.

32. What level of aid reduction would help preserving an adequate incentive to reduce electricity consumption? Please substantiate your answer. Reducing the level of aid will not give an extra incentive to reduce electricity con-sumption. Compensation for indirect costs would, assuming it were to be based on an electro-efficiency benchmark, maintain the incentive to reduce electricity consumption and lead to an overall reduction in direct emissions. As electricity costs as already highlighted represent a large percentage of the total operating costs for the sub-sectors identified in this questionnaire there continues to be an incentive to improve energy efficiency and to go beyond the benchmark.

33. Do you consider that requiring an own contribution would give an extra incentive to energy users to be even more energy efficient (in addition to the efficiency benchmarks) and that it would ensure the continued existence of incentives when benchmarks become relatively less ambitious over time? Please substantiate your answer. See response to question 32. There is no need to reduce the level of aid as the “own contribution” is already embedded in the very high prices paid for electricity in Europe (even with full compensation for the CO2 element). Reduced profitability will reduce investment and slow down the introduction of new technologies. Reducing the aid will thus increase the risk of carbon leakage.

34. Do you consider that requiring an own contribution would give an indirect incentive to

electricity producers to invest in less environmentally damaging generating technologies? Please substantiate your answer. See response to question 31. Reducing the aid will not enhance the bargaining power in the European electricity markets of the sub-sectors identified in this questionnaire. Reducing the aid simply puts one of the primary intensions of the Directive at risk; that of mitigating carbon leakage.

35. How would you ensure that the support does not lead to aid dependency? Would

degressiveness in the level of support help preparing for a gradual phasing-out of the support over time in line with the temporary character of the support? Please substantiate your answer.

Providing aid will not lead to aid dependency. On the contrary; temporary, full compensation could provide the basis for investment and stronger competitive position

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for the situation when a level global playing field is restored at a later stage. Aid should only be provided whilst the absence of a binding international agreement (whereby industry would be subject to comparable carbon costs, also for indirect emissions) puts certain energy-intensive sectors and sub-sectors in Europe at an economic disadvantage.

A gradual reduction in the level of support over time simply puts one of the primary intensions of the Directive at risk; that of mitigating the risk of carbon leakage.

SECTION C: BENCHMARKS The ETS Directive2 foresees that aid for indirect emissions shall be based on ex-ante benchmarks of the indirect emissions of CO2 per unit of production. The ex-ante benchmarks shall be calculated for a given sector or subsector as the product of the electricity consumption per unit of production corresponding to the most efficient available technologies and of the CO2 emissions of the relevant European electricity production mix. In the non-paper addressed to the European Parliament and the Council, the Commission stated that, in order to calculate the maximum aid amount, benchmarks would be introduced linked to best performing technique. The Commission will undertake a study to determine the efficiency benchmarks for the relevant sectors. 36. What factors are in your view relevant to define a benchmark for your sector in order to

incentivise energy efficiency investments by beneficiaries? Electricity efficiency benchmarks should be based on electricity use per ton of production. They could be developed in the same way that product benchmarks were developed for direct emissions.

37. Please specify the electricity consumption per unit of production that should correspond

to the most efficient available technologies for a certain sector. Please substantiate your answer with data and sources.

38. What is the level of your company’s electricity efficiency? In your reply, please

compare it with other companies from your sector, notably with countries outside of the EU? When it comes to total energy consumption so BKO is according to Brook Hunt report one of the most energy efficient Zn-refiner in the world. BKO’s tankhouse power consumption in year 2010 was 3 325 kwh/t Zn, which is one of the lowest in comparison between European Zn-smelters.

The information at company level being confidential, it is up to the companies to provide this information if needed and useful.

SECTION D: CO2 EMISSION FACTOR 2 Article 10a(6) of the ETS Directive.

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The CO2 emission factor corresponds to the CO2 emissions per MWh of electricity generated. The question is what CO2 factor to use as a basis for calculating the compensation. In the non-paper to the EP and the Council, the Commission stated that the actual CO2 factor can in principle be identified from self-generation and electricity supply contracts that explicitly specify the level of pass through of the EUA price per MWh. Where electricity is purchased on the grid (on the exchange or forward market), the average CO2 intensity in the EU's total electricity production could be used3. Four methods are conceived hereinafter. The first three methods propose to use the actual CO2 factor from self-generation and electricity supply contracts and present different possibilities for the case where electricity is purchased on the grid. The fourth proposes to use a uniform CO2 factor in all cases. 39. Do you consider that one of the methods presented below should be used in all cases,

including in case of self-generation and in case of electricity supply contract that explicitly specifies the level of pass through? Please substantiate your answer. No. The four proposed methods should not be considered in case of self-generation and in case of electricity supply contracts that explicitly specifies the level of pass through, as they all could lead to under or over compensation. Under compensation will not mitigate the carbon leakage risk.

Method 1: Where electricity is purchased on the grid, the CO2 factor of the marginal plant

setting the electricity price for the installation concerned is used 40. Do you consider that using the annual weighted average of the CO2 factor of the

marginal power production in the relevant electricity market, which supplies the beneficiary is the appropriate method? Please substantiate your answer.

Yes. The aim of the calculation must be to establish the level of full compensation, i. e. a method that would compensate the consumers for the actual price increases due to emission allowance cost in power purchased. Provided that emission factors are calculated in the correct way, the following would be the best method (see also the response to questions 41 and 42).

It is generally accepted that in a competitive power market where prices are related to marginal generation costs; therefore the increase in power prices is proportionate to the allowance price. The formula below describes this relationship: ∆Pi = ki * Ei

Where, ∆Pi = Power price increase of hour i (€/MWh) Ei = Emission allowance price for hour i (€/t) ki = Marginal CO2 emission factor for hour i (t/MWh)

The corresponding annual formula for base load would be: ∆P = k * E

k = ∑i (ki * c i * Ei ) / ∑i (c i * Ei )

Where,

3 The average CO2 intensity in the EU's total electricity production is also referred in the formula in the non-paper for the maximum amount of aid that a Member State could provide for an installation.

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∆P = ∑i ∆Pi / 8760, Average power price increase for the year (€/MWh)

E = ∑i Ei/ 8760, Average emission allowance price for the year (€/t) k = Marginal CO2 emission factor for the year (t/MWh) ci = The consumption in hour i (t/MWh)

If we assume that emission allowance cost is constant through the year, the marginal CO2 emission factor for base load consumers would simply be a flat average of hourly emission factors.

41. Are national regulators always able to identify the marginal plant in the relevant price setting area? Do you consider that due to confidentiality issues or to lack of transparency of the market or of data, they may not be able to define it? Please substantiate your answer.

National regulators, system operators, markets operators, and/or power exchanges will be able to identify the marginal plant technology responsible for setting the price in the majority of hours of the year. Regulators should have the right to access to this data; in most countries such data will be made publicly available. Identifying the plant technology responsible for setting the price and applying standard emissions factors for that technology should not lead to any confidentiality issues.

In some instances Method 1 applied in this manner may not be the most effective way of setting the CO2 factor for a particular hour as: • Identifying the price setting technology may not always be possible across borders; • If the price setting technology is hydropower, identifying the relevant marginal CO2 pass through factor is not trivial as it will depend on the opportunity value of selling the power in interconnected markets where CO2 emitting plant sets the market price; • Implicitly assuming that the same technology will be price setting with and without emission cost; and • In markets with portfolio bids, the price setting technology may only be inferred indirectly.

By applying Method 1 through the use of a market model, however, anyone (including the national regulator) will be able to estimate the correct marginal cost increase due to emission allowance cost, without specifically having to identify marginal (price setting) technology hour by hour.

42. Would national regulators be able to identify the marginal plant when the price setting

areas do not correspond to the borders of each Member State, some being supra-national and sub-national? How would national regulators address the need to revise the price setting areas periodically, as the interconnection and generation infrastructure evolve? National regulators, system operators, markets operators, and/or power exchanges will be able to identify the marginal plant technology responsible for setting the price in national and sub-national markets. Regulators should have the right to access to this data. For supra-national price setting, extensive exchange of data and/or co-operation on analysis is required.

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Once the guidelines are in place for determining the base methodology for the granting of aid, it is clear that any aid provided would need to take into account the evolution of the CO2 cost embedded in power prices in the relevant market, including any effects due to developments in grid interconnections and generation assets.

Challenges caused by dynamic geographical diversity of price setting area can be solved by supplementing the analysis using a model based on Method 1, as referred to in the response to question 41. Commercial models are continuously updated to reflect available grid capacities and hence the actual degree of price influence between areas. The relevant pricing area split is model output. Such models will also be able to give separate emission factors for any area (sub or supra national) that is specified.

43. Do you consider that this method may result in over-compensation or in under-

compensation? If so, under which circumstances? In your reply, please take into account of the following scenarios:

a. the introduction of CO2 pricing will in some cases result in reversals of the merit order, for instance, when a gas plant is the marginal plant without CO2 pricing, but a coal plant becomes the marginal plant once CO2 costs are considered.

b. in price setting areas that do not correspond to the borders of a Member State, if the CO2 factor is based on the marginal plant in another Member State instead of the installation's price setting area within the country, companies in one price setting area may face conditions leading to over-compensation, whereas companies in other price setting area may not get enough compensation.

c. when a coal/gas fired power plant is used as an alternative back up for renewable energy production.

Method 1 supplemented with analysis derived from models will correctly estimate marginal costs taking into account the issues under a. b. and c. Back-up plants set the price when they are used, and the estimates will be correct, using the modified Method 1, without making any particular adaptations of the method. No under- or over-compensation will occur.

44. Do you think that this method would have the effect of incentivising grey electricity? In

particular, in the absence of perfectly competitive markets, this method may give incentives to electricity producers to influence the choice of marginal plant for the one that has the highest CO2 factor (the dirtiest) and therefore justify compensation on the basis of artificially higher CO2 costs. Please substantiate your answer. No. Electricity generators are neither paying nor receiving any compensation for CO2 costs embedded in power prices to/from eligible sectors. The compensation does thus not provide any incentive to influence the merit order in any way. The introduction of a compensation scheme will not strengthen any incentive or opportunity to exercise market power.

The percentage of overall European electricity consumption that would be eligible to receive compensation for the indirect costs under the new state aid guidelines is very small, and generators would not have any incentive to change the way their businesses are operated.

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45. Do you consider that this method involves an excessive administrative burden, since national regulatory authorities will have to provide the necessary data? If so, what alternative would you consider more appropriate? No. If the proposed application of Method 1 proves too complicated for any market it can easily be supplemented, using a model based approach.

Method 2: Where electricity is purchased on the grid, the average CO2 emission factor for

the EU is used 46. Do you consider that using the average CO2 emission factor at EU level is the

appropriate method? Please substantiate your answer. Please indicate whether you consider that another EU-wide factor should be used, and substantiate why you believe it would be more appropriate. The average CO2 emission factor in the EU is much lower than the actual marginal CO2 emission factor. Using Method 2 would lead to under-compensation in all cases, and will not mitigate the carbon leakage risk. Only a methodology based on the marginal pass through factor in the relevant market will address the issue correctly.

47. Do you consider that this method may involve over-compensation in some Member

States with greener electricity and under-compensation in Member States with grey electricity? Please substantiate your answer. No; see response to question 46. Applying Method 2 will lead to significant under-compensation in all cases. The greenness of a country’s electricity sector turns out to have little influence on the actual emission cost pass-through at the margin.

48. Do you consider that this method has the advantage of simplicity, compared to Method

1? It is certainly simpler but does not correctly address the nature of the issue.

Method 3: Where electricity is purchased on the grid, the CO2 emission factor for the

average plant in a geographical pricing area concerned is used 49. Do you agree that a method based on average CO2 intensity of a plant in the

geographical pricing area of the companies receiving aid, reflecting if possible consumption patterns of those companies (share of base-load and peak consumption) would be appropriate? Would such method more closely reflect needs of the companies than method 2? Please substantiate your answer.

Method 3 would be even less appropriate than Method 2. This would in most cases lead to under-compensation, and be grossly unfair for geographical pricing areas with a green production mix. Only a methodology based on the marginal pass through factor in the relevant market will address the issue correctly.

Method 4: The average CO2 emission factor for the EU is used, irrespective of the actual

terms of supply of electricity for the installation concerned. 50. Please respond to the view that an average CO2 emission factor for the EU, irrespective

of the actual terms of supply of electricity for the installation concerned, would best

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preserve the incentives for purchasers of electricity to switch to green electricity and to make use of the opportunities granted by the single EU market for electricity. Financial support to consumers can neither strengthen nor weaken the incentive for ‘green’ electricity. Method 1 does not have any negative side effects related to this type of incentive. Method 4 could therefore not have any advantages in this respect, while retaining all weaknesses of Methods 2 and 3 in not mitigating the risk of carbon leakage.

See response to question 31 regarding maintaining incentives to switch to ‘green’ electricity.

SECTION E: OTHER ISSUES Do you have any additional comments on the above issues?

Please provide copies of any documents or studies which may be relevant to support your submissions.

Please indicate whether the Commission services may contact you for further details on the information submitted, if required.

THANK YOU FOR RESPONDING TO THIS QUESTIONNAIRE.