News from the UK Press indicates that ArcelorMittal, Europe’s major steel producer currently stands to benefit from a €1.15 billion windfall from European “carbon credits” given to it under the European emissions trading scheme (ETS). An investigation has revealed that ArcelorMittal has been given far more carbon permits than it needs. In fact, it apparently has the largest allocation of any organisation in Europe. ArcelorMittal is now free to sell its surplus permits on the market or to hoard them for future use. Either way, the company will have gained assets worth around €1.15 billion at today’s prices by 2012. The eventual value could be much greater. Each carbon permit is currently worth about €13.50, but the European Union has said it wants to drive this price above €30.00.

Turning our attention to cement, the reduced cement production in the European Union as, a result of the fall in construction activity, has also enabled local cement producers to sell significant CO2 emission allowances.  Last year Lafarge made a €85m gain by selling such allowances to other polluters, such as the power generating industry. In the first nine months of this year, the company gained €77m from the sale of emission allowances. This compares with nothing, or virtually nothing, in 2007. The appearance of excess allowances last year had much to with the reduced cement production in Great Britain and Spain.

Holcim, which generated no meaningful profit from the sale of CO2 emission allowances last year, has booked gains of €40m in the first nine months of 2009, of which €36m came in the third quarter.

HeidelbergCement both bought and sold emission rights last year, generating a net profit of €50m compared with a €25m net gain in the previous year. Though HeidelbergCement was a net seller of emission permits last year, in certain countries it did have to purchase CO2 emission permits.

Buzzi Unicem provides a good illustration of the unpredictability of such incomes. The group made €6.4m from the sale of emission allowances last year, but nothing in the year before, as prices were too low to make it worthwhile doing such deals. However, in previous years, the sale of such allowances have been an important source of profit, providing €24.6m in 2006 and €26.4m, at that stage all coming from the four countries of Germany, the Czech Republic, Poland and Luxembourg.

If one adds in all the other European major producers, Italcementi, Cemex, CRH and the remaining independents, total sales could well have reached the €200m level to date. Extrapolating this to 2012, assuming continuing low demand levels for cement throughout much of Europe, it is not inconceivable that the European cement industry could also net close to €0.5 billion of unused credits for the 2008-2012 period.

Clearly this cannot be allowed to continue, and it has been suggested that from 2013 onwards, all emission permits should have to be bought at auctions. However such a move, industry lobbyists argue, might force the closure of most of the European cement industry, especially if cement and clinker imports are allowed to enter the European Union unchecked, or at least, if not heavily taxed. Instead, the industry has won its campaign to be recognised as vulnerable to carbon leakage (the final decision is due to be published on 23 December 2009).

What happens after that will depend on the European Commission which must decide on what volume of emission allowances are to be allocated to the European cement industry for Phase 3 (2013-2020). This depends on the allocation process and which benchmarks are used to determine the free allowances. The most likely approach is an efficiency benchmark multiplied by historical production. Ecofys, the consultant engaged to advise the Commission, proposed a production efficiency benchmark, based on clinker, of 0.78t CO2 / tonne clinker. However, there is disagreement, even within the industry, as to whether the benchmark should be applied to clinker (favoured by the majority for its simplicity), or to cement. Secondly, which historical reference period should be applied in order to calculate the allocation volumes? Take 2005-07, a period of relatively high demand growth, and the allocation level could be too generous. Take 2008-09, and the opposite is true.

Other crucial issues also need to be resolved, such as whether imports can somehow be incorporated into the ETS without running into conflict with the WTO. Ideally, the allocation mechanism will succeed in creating the required level playing field for European cement producers to remain competitive and not be displaced by low cost imports (with a higher carbon footprint).

Ultimately, a decision is due in 2010, by which time the European authorities will have resolved these arguments and incorporated whatever adjustments are required following the outcome of the climate negotiations in Copenhagen. In the end, the devil will be in the detail. Get it wrong and Europe will have to watch its cement industry steadily relocate to off-shore locations across the Mediterranean and beyond, or else enjoy unjustified windfall profits from over-allocation. Get it right and the ETS may have a chance of doing what it initially set out to do: create a viable market mechanism to achieve a cost effective reduction of CO2 emissions and stimulate innovation into low-CO2 technology.