IZA Presentation to Commission on Zinc Market

8/3/2019 IZA Presentation to Commission on Zinc Market

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European Commission

DG COMPETITION

State aid registry

1049 BrusselsSubmitted via e-mail [email protected].

Reference "HT 582"

New State aid Guidelines in the context of

the amended EU Emissions Trading Scheme

Response of the Zinc Industry sub-sector to the

Consultation paper

10 May 2011
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New State aid Guidelines in the context of

the amended EU Emissions Trading Scheme

Response of the Zinc Industry sub-sector to the

Consultation paper

QUESTIONNAIRE

ABOUT YOU

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Specific privacy statement: Contributions received, together with the identity of the

contributor, will be published on the Internet, unless the contributor objects to publication of

the personal data on the grounds that such publication would harm his or her legitimateinterests. In this case the contribution may be published in anonymous form. Otherwise the

contribution will not be published nor will, in principle, its content be taken into account.

Please provide your contact details below.

Name Frank Van Assche, Director European Affairs

Organisation Represented International Zinc Association Europe (IZA Europe)

Location Brussels, Belgium

E-mail address: [email protected]

The International Zinc Association Europe, IZA Europe, represents the European zinc

producers, provides information and promotes the benefits of zinc to key European

stakeholder groups, within the context of sustainable development.

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 increasesin 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 indirectemissions. 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 internationalcompetition at an economic disadvantage.
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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 requirementsin the Directive, are exposed to a significant risk of carbon leakage due to costs relatingto 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 metalproduction sub-sector is exposed to a significant risk of Carbon Leakage based on thecriteria set out in paragraph 15 and 16 of article 10a of Directive 2003/87 at NACE 4Code: 2743 Lead, Zinc and Tin production.

Although the zinc industry qualifies as a sector exposed to a significant risk of carbonleakage at the NACE 4 level, we believe that NACE is not the most appropriateclassification basis for compensation. As compensation would be allocated at aninstallation level, a classification that reflects this level for our sector, such as theProdcom code, would be more appropriate. Assessment at the NACE 4 level isproblematic for the primary zinc production industry as it is then included with othernon-ferrous metals which have quite different production processes and energyprofiles; and it is also included as part of the entire zinc sector, which in itself is verydiverse in terms of activities, processes and energy needs.

The response of the zinc industry sub-sector to this questionnaire is based on theprimary zinc production part of the zinc sector value chain only. That is, the response

relates to the conversion of zinc mining concentrates into refined metal by zincsmelters and refineries, but excludes mining and downstream processing.

Zinc smelting and/or refining, which will be termed zinc refining in the remainder ofthis document, is the process of converting zinc mine concentrates (ores that containzinc and have been concentrated to around 40-60% Zn) into pure zinc. There are twomethods of smelting zinc: the pyrometallurgical process and the hydrometallurgicalprocess.

Pyrometallurgical processes, such as Imperial Smelting Process (ISP), electrothermalor vertical retort, are thermal processes and consist of 3 main steps: sintering,reducing zinc oxide with coke to obtain metallic zinc and then purifying the zinc

product. ISP is the more common of these and represents less than 10% of the worldzinc production.

The hydrometallurgical process, also known as Roast-Leach-Electrowin (RLE)process, is an electrolytic process and consists of 3 major steps: roasting, leaching-purification and electrolysis. More than 80% of zinc is produced using the RLEprocess.

Nowadays, the RLE process is the most widely used since it is more energy efficient.Also, the amount of direct CO2 emissions from hydrometallurgical plants issignificantly less than from pyrometallurgical plants which use coke as energy source.Unless otherwise specified, zinc refinery data in this document will be based on theRLE production process.


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Zinc metal is a commodity and is traded daily on the London Metal Exchange (LME).Zinc refineries buy the zinc contained in raw materials (concentrates) and sell theirproducts (refined zinc metal) on the basis of the LME price. As a result, theirprofitability is not directly linked with the zinc market price but determined by thetreatment charges (TC), which are the rates payable by miners for processing theirconcentrates, and the conversion costs incurred in processing concentrates into metal.

Therefore, the global competitiveness of a zinc refinery will mainly depend on itsconversion costs, that is, the operating costs incurred for processing zinc concentratesinto zinc metal. The cost curve for the zinc industry is quite flat, meaning a smallincrease in conversion costs will significantly impact on the global competitiveness of aparticular refinery.

Energy costs, the majority of which is electricity, currently represents almost half of theconversion costs for EU zinc refineries, the balance being labour and other costs.

Figure 1: 2010 EU27 RLE Smelter Conversion Costs

Source: Brook Hunt a Wood Mackenzie Company

EU zinc refineries currently face higher electricity costs than non-EU producers (ReferFigure 2). Due to electricity being such a significant proportion of conversion costs,zinc refineries have and will continue to put a high level of focus on energy efficiencyimprovements.

Data source: Brook Hunt - a Wood MackenzieCompany

Total cash conversion costs include alloperational costs inside the fence, i.e. costsrelated to the conversion of concentrates tometal. It does not include any costs for rawmaterial, freight of concentrate or metal, salesor depreciation. The net-energy cost representsthe balance of refinery purchases and sales ofenergy. Other cost include maintenancematerials, consumables and on-site services.

The graph displays cash conversion costs ofrefineries running the (most energy efficient)electrolytic process, as 8085% of the worldsproduction comes from this type of process.


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Figure 2: Electricity Costs per Tonne of zinc produced in 2010

Source: Brook Hunt - a Wood Mackenzie Company

In terms of energy efficiency, the European zinc industry shows the lowest total energy

consumption per tonne of zinc production worldwide (Refer Figure 3).

Figure 3: Energy consumption of RLE refineries in 2010



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However, this leading position in energy efficiency cannot make up for the negativeimpact of high electricity costs on EU27 conversion costs. The pass-through ofindirect CO2 costs in electricity prices already has a significant impact on the globalcost competitiveness of EU primary zinc producers under ETS-2, which will onlybecome worse under ETS-3.

Figure 4: Weighted average cash conversion costs of RLE zinc refineries in 2010


GHG emissions from electricity production depend on the energy mix used andtherefore are strongly regionally bound. The energy mix in the EU has a morefavourable CO2 footprint than most other regions of the world.

Figure 5: CO2 footprint of electricity generation in various regions

Source: International Energy Agency


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Therefore, transferring production from EU to non-EU zinc refineries would result incarbon leakage as non-EU plants are on average more energy intensive and have ahigher CO2 content in the electricity they use. It should be recognised that evidence ofcarbon leakage risk begins when industry halts investments, loses market share andphases out production in the EU, not simply at the point of plant closure.

Burden sharing / efficiency of ETS-3

2. How do you reply to the view that granting compensation to some sectors of theeconomy 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 granting of compensation to the zinc industry would not necessarily lead to ahigher cost burden for other sectors of the EU economy as this depends on the CO2content of electricity generated in the region, over which the primary zinc productionhas no control.

Sectors covered by the EU ETS have a strong direct incentive to reduce the carbonintensity in their products, through the avoidance of having to purchase incrementalEUAs or the opportunity to sell surplus EUAs. This is the primary incentive to reducethe total GHG emissions under the EU ETS.

The incentive for consumers of any product in which the carbon price signal is passedthrough into the selling price under the EU ETS is to reduce demand (assuming thatthe demand for the product exhibits price elasticity). Logically a reduction in demandshould lead to a reduction in GHG emissions and thus reduce the value of EUAs andconsequently the cost burden on all ETS sectors.

Note that zinc refineries would not decrease their demand for electricity in light ofincreased electricity prices. Any decrease in electricity demand would translatedirectly into a decrease in production at a RLE zinc refinery as over 80% of electricityconsumption is related to the electrolysis stage where electricity is used to convertpurified zinc solution into zinc metal. As zinc refineries are highly capital intensive andrefineries compete globally on the cost of production, to be competitive, a refineryneeds to operate at maximum production levels. If input costs are high, such aselectricity, it is even more imperative that the refinery operates at maximum capacity.If electricity costs remain high in the longer term, the refinery becomes lesscompetitive, companies are less likely to reinvest in the installation and the risk ofclosure increases. If an EU installation would close, the downstream sector demand

for zinc metal would be satisified by imports from non-EU producers (Refer to ourresponse to Questions 6, 23 and 24). This would reduce the EU demand forelectricity, but would also lead to carbon leakage (Refer to our response to Question1).

Therefore, primary zinc producers do not, and to remain globally competitive, wouldnot reduce electricity consumption per se, as this would result in lower production andreduced competitiveness. Zinc producers focus on increasing electricity efficiency(within the physical limits of the electrolysis process). Zinc producers rely on (but havenot ability to directly influence as they purchase directly from the market) the electricityindustry reducing the CO2 footprint of electricity generated in order to meet the EUETS goals of reducing CO2 emissions.

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


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case electricity) and lead to an overall reduction in direct emissions in the powergeneration sector. Because of the global price setting for zinc metal, compensatingzinc primary producers for indirect CO2 costs in electricity prices will not contribute tothe insulation of any consumers further downstream from ETS indirect cost.

The intended effect of the compensation for indirect CO2 costs in electricity prices is to

prevent the closure of a large share of Europes basic industries in the absence of aglobal level playing field. If the closure of Europes basic industries is not prevented,there would be a reduction in electricity demand and in direct emissions from thesesectors. However, the percentage of overall European electricity consumption thatwould be eligible to receive compensation for the indirect costs under the New StateAid Guidelines is expected to be very small. Therefore the influence on the prices ofemission allowances and on burdens for other sectors will be negligible. However,the socio-economic impacts caused by the closure of EU27 zinc refineries, and theimpacts on the down-stream value chain, though not significant on an EU wide scale,would be very significant on a local and potentially a regional scale.

International context

3. To what extent are producers outside the EU also confronted with a cost for indirectemissions? Are you aware of the existence or imminent implementation (before 2013)

of emission trading systems, or emission reduction mechanisms with similar effect onproduction 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 asthe EU ETS?

At present, no other significant regions outside Europe are confronted with costsassociated with direct or indirect GHG emissions, or emission reduction mechanisms

with similar effect on production costs.

The Australian Government has indicated its intention to introduce an emissionstrading scheme, commencing initially as a C Tax, from mid 2012. However legislationrelating to this proposal is yet to be introduced into the Australian Parliament. Inprevious proposals for an emission trading scheme, the zinc smelting industry wasformally recognised as a trade-exposed energy intensive industry, which would qualifyfor transitional assistance given the absence of a level playing field globally on CO2costs.

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 underquestion 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 industrys turnover and value added. How large are the fixedcosts of operations? What investments are required to a new entrant and how much can

they represent of the new entrants turnover? Please indicate how much electricity costs


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contribute to the overall costs and, if appropriate, what percentage of which electricity

sources is used in your industry.

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.Production facilities in regions with higher conversion costs are less likely to attractfurther investment to upgrade or expand capacity.

As described under Question 1, the competitiveness of a zinc refinery will mainlydepend on its conversion costs and energy is the greatest proportion of conversioncosts for EU refineries. In 2010, energy represented on average 49% of EU zincrefinery conversion costs. Therefore, the primary differentiator between Zn producerswill be the cost of electricity. Only in Europe does the electricity price embed a CO2cost, therefore the risk of carbon leakage from Europe can only be mitigated bycompensating for the indirect CO2 cost incurred by European producers.

As electricity is a significant operating cost, zinc refineries have, and will continue to,have a high level of focus on energy efficiency. However, as described in the answer toQuestion 28, there is a physical limitation to energy reduction measures. Over 80% ofelectricity consumption is used in the electrolysis stage where dissolved zinc isconverted to zinc metal using electrical current and that conversion efficiency isgoverned by physical laws.

GHG emissions from electricity production depend on energy mix used and arestrongly regionally bound. Electricity sources used at a zinc refinery will reflect regionalgeneration sources and electro-intensive industries cannot influence the regionalenergy mix or investment by generators in renewable energy.

Existence of carbon leakage risk due to indirect emissions5. 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 due to EU Zn producers being faced with a uniquecost under the ETS that cannot be passed on to consumers. It is not relevant toattempt to ascertain a trigger price at which the risk of carbon leakage may occur asany CO2 price above zero will have a probability of risk of carbon leakage associatedwith it.

EU zinc producers already face higher electricity costs than elsewhere due to the CO2costs under ETS-2 (Refer: Figure 2). As EU zinc producers are more energy efficient(Figure 3) and the energy mix in the EU has a more favourable CO2 footprint thanmost other regions of the world (Refer: Figure 5), the risk of carbon leakage existsalready exists. Indirect CO2 costs under ETS-2 are already estimated to make up 13%of total zinc refinery conversion costs (based on a EUA cost of 15 /t CO2). Thereforeat prevailing CO2 costs in Europe the risk of carbon leakage is already both real andsignificant.

The risk will increase under ETS-3 as the higher EUA cost drives further EU electricityprice increases (Refer: Figure 4). At an increased EUA cost of 30 and 50 /t CO2, thiswould increase the impact of the pass through of CO2 costs in electricity prices to 23%

and 33 % of total zinc refinery conversion costs.


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Table 1: Impact of indirect CO2 costs on EU27 zinc refinery conversion costs

EUAs () 15 30 50

Electricity consumption (MWh/t) 4 4 4

CO emissions (t CO/MWh) 0,9 0,9 0,9

Total CO cost/t Zn () 54 108 180

Total CO cost/t Zn (USD, at a rate of 1.33 USD/) 72 144 239

Cash conversion cost (USD) - Excl EUAs 480 480 480

Cash 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, which is around23% of world output, the effect of carbon leakage due to pass through of indirect CO2costs under the EU ETS would be significant.

6. Please present the main factors of relocation decisions and/or the decision to shiftproduction 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 independentprocesses: Firstly, capacity increases to cover expected market growth or to replaceplant closures will be developed in areas with the best expected return on investedcapital; largely in countries outside Europe with lower electricity prices. Secondly, if no

further investments are made in existing plants in Europe, industry will slowly fadeaway with the consequent loss of: direct and indirect jobs, entire value chains, innovation capability, know-how, and new product development.

As well as poor economic outcomes for Europe, carbon leakage will mean that theultimate consequence is also poor environmental outcomes due to higher global CO2emissions.

The decisions taken within Europe on curtailment of production will be specific to theeconomic circumstances surrounding the installation. The primary driver for takingdecisions to curtail production in Europe or to construct new facilities outside Europewill be the cost of electricity and security of electricity supplies (availability of long termcontracts). In this context it should also be noted that not all this 'relocation' to lesscarbon constrained zones outside the EU would happen by EU companies, capacityclosures in EU are also likely to be replaced by Non-EU companies in Non-EUcountries.

The price of electricity in Europe is higher than that available outside Europe as adirect consequence of the EU ETS. The effects of this are already evident in that:

(1) large scale primary zinc production capacity increase investments are not being

made in the EU and no new primary zinc refinery has been built or majorrefurbishment undertaken on mainland Europe in the last 5 years; and


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(2) during a period of low metal prices from 2001 to 2004 (see LME price evolutionunder Question 10) there was a lot of pressure on European zinc metal producers.Due to their relatively higher energy consumption (and therefore higher conversioncosts, Refer Figures 6 and 7) the majority of zinc refineries using the ImperialSmelting Process (ISP) were uncompetitive and closed down (Refer Figure 8).

(3) During the recent global financial crisis, a number of zinc producers reducedproduction due to the lower demand and low zinc price. Some global companies,such as Nyrstar, preferentially closed or scaled back production in their Europeanplants compared to other plants, due to the higher energy costs in Europe (Nyrstarpress release on the temporary closure of the Balen plant, 26 November 2008).

Figure 6: Cash conversion costs of RLE electrolytic and ISP zinc refineries in Europe

The higher cost structure of ISP refineries compared to electrolytic (RLE) refineries ismainly the energy cost, as ISP refineries are more energy intensive than electrolyticones. During the period when the LME price was severely constraining refineryincome, energy costs were increasing relatively faster for ISP refineries, with nocapacity for cost pass through. This is a good example of an asymmetric shock.

Figure 7: Net Energy Costs of electrolytic and ISP refineries in Europe


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The landscape of the zinc metal industry in Europe has been marked not only by ISPand RLE closures, but also by consolidation as shown in Figure 8.

Figure 8: Changes in the European Zinc Industry capacity and ownership since 1990

This resulted in a total of 788,000 tons production capacity being taken out of theEuropean market over the period 2000 to 2007.

Table 2: European zinc refinery closures since 2004


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Figure 10: EU zinc market deficit results in increasing imports from non-EU countries

7. If (some) companies in the sector concerned were to relocate or to shift productionlocations 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 CO 2 pricing

mechanism? Please substantiate your answer.

Please refer to our response to Question 6 regarding the shifting or relocating pro-duction.

Outside of the EU, no country has a CO2 pricing mechanism, so this is not adetermining factor in where to site new facilities. The primary drivers in deciding whereto locate a new facility or invest in significant increases in existing production capacity,will be long-term availability of competitively priced power and regulatory stability.

Our urgent need for a transitional compensation is linked to the present imbalancescaused by the fact that no other competing primary zinc production regions will havesuch cost in their electricity prices in the near future.

8. Please provide your views on the extent to which carbon leakage has already occurredas a result of the introduction of ETS 1 or ETS 2. Please substantiate your answer in

concrete terms.

Introduction of the EU ETS schemes to date has put additional pressure on the EU 27primary zinc producers, which have seen their competitiveness progressively reduced.The impact of this has in some instances been a factor in the closure of several Znrefineries throughout Europe (Refer Table 2). In fact, 8 facilities closed in that periodresulting in an overall capacity loss of close to 800.000 Tonnes of zinc per year (seeFigure 8 and Table 2 here-above. This has been replaced by imports from non-EUsuppliers, which in general are from less energy efficient installations, using electricitywith a higher CO2 footprint. During the Global Financial crisis, one EU company(Nyrstar) reduced zinc production at EU production facilities more than elsewhere, dueto the relatively higher energy and therefore conversion costs in the EU.


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Carbon leakage has already occurred as a result of ETS 1 and 2:

Increases in electricity market prices occurred regardless that free allowances weregiven to the generation sector for a large proportion of their emissions. Renewal ofpower supply contracts at prices without emission allowance cost was therefore notpossible.

Long-term power supply arrangements are expiring (most have already), thus givingrise to exposure to higher prices due to CO2 costs.

Other installations may be able to continue with operations in the short-term until thenew state aid schemes are established. In any event, the lack of regulatory certaintyaround carbon leakage mitigation measures has probably already led to the firststages of carbon leakage as installation owners will be unwilling to take the risk ofcontinuing to invest in improving those facilities. This is also show by the lack ofinvestment in new or upgraded facilities over the last 5 years. The only way to mitigatethis is full compensation for the indirect costs. It should be recognised that evidence ofcarbon leakage risk begins when industry halts investments, loses market share andphases out production in the EU, not simply at the point of plant closure.

Despite the evidence given above, the aim of the revised EU ETS Directive is tomitigate the risk of carbon leakage occurring from 2013 onwards. The sub-sectorsidentified in this questionnaire are principally at risk of carbon leakage due to theindirect cost associated with the EU ETS. The Directive did not envisage a need todemonstrate that carbon leakage occurred during ETS 1 or ETS 2 as a result of theindirect CO2 associated with electricity purchase as precursor for providing State aidduring ETS 3.

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 fixedcosts 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 onpower generators is:

P = k * E

Where,

P = Power price increase for the year (/MWh)k = Marginal CO

2emission 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. Thezinc smelting industry competes globally on cost of production (conversion costs).Energy is the greatest proportion (49% in 2010) of EU zinc refineries conversion costs.In the case of zinc, indirect CO2 costs make up 12, 23 and 33% of the total cashconversion costs, using respectively 15, 30 and 50 /t CO2 assumption in ETS-3, asshown in Table 1 and Figure 4 previously.


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Profit margin

10. Please indicate the sector's profit margin. In particular, please quantify the estimatedimpact of the increase in CO2 costs related to electricity prices (comparing ETS-3 to

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 CO 2costs related to electricity prices on the sector operating costs and margins.

The primary zinc smelting and refining industry competes globally on the cost ofproduction; therefore a discussion of profit margin is not relevant in terms of EUindustry competitiveness or financial sustainability. Product prices are set on a globalexchange (LME) and reflect supply and demand, resulting in cyclical zinc prices, asshown in Figure 11.

Figure 11: Evolution of the LME zinc price since 1950

A primary zinc production facility sells its output at LME price; its sales price istherefore fixed. If the refinery is not able to get its conversion costs below the LMEprice level in the long-term it makes a loss and goes bankrupt. Smelter viability must beassessed 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 questionnaireare not relevant as they will vary tremendously from year to year during commoditycycles. More relevant to fulfilling the aim of the Directive in avoiding the risk of carbonleakage is the quantification of the competitive disadvantage resulting from impact ofthe CO2 price in power costs.

At an electricity consumption of 4 MWh/t of zinc produced, a marginal CO2 emissionfactor of 0.9 t/MWh and EUAs prices of 15, 30 and 50 /t.CO, the correspondingincrease in operating cost would be 54, 108 and 180 /t. respectively, or roughly 13,23 and 33 % of the total conversion cost (Refer Table 1 and Figure 4).

To remain globally competitive, the zinc industry needs full (100%) compensation forthe actual costs incurred due to CO2 cost pass-through in electricity prices. Anything

less will not reduce the risk of carbon leakage (refer Figure 12).


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13. How relevant is the physical proximity of the plants to the markets where theintermediate goods are bought from and to those where the final goods are sold?

Specific evidence relating to this point is made in the German Industry submission byWirtschaftsVereinigung Metalle (WVM). The Zinc Industry has also not experienced any

possibility to impose for any surcharge on the LME price due to its presence in the Germanmarket or any other European market. For the same product, all customers pay the sameprice. However, the presence of refineries has the advantage of facilitating the co-operationwith customers, thereby fostering among other things the development of new energy-efficient products as required by demanding environmentally conscious Europeancustomers.

Indeed, the proximity of customers allows better understanding their objectives andsupporting their needs through innovation. For example, the development of new alloys tofurther improve long-term corrosion protection of steel with thinner zinc coatings or thedevelopment of new thin wall die-casting technologies allowing the use of lighter parts withimproved technical performances.

The closure of European smelters would just lead to more imports of metal from non-EUcountries, with no real possibility to further help the downstream industry in their research forimproved material and/or technologies.

14. Please explain how these transport costs impact on possibility to relocate or shiftproduction 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 as they are not a significantportion of the product price, as discussed in Question 12.

Product differentiation

15. Please indicate whether the products of the sector are homogeneous or differentiatedbased on quality, marketing and branding or content.

The products produced by the zinc sub-sector highlighted in this questionnaire arehomogeneous commodities produced to a standard specified by the LME.

Service differentiation

16. Please indicate whether services provided at local level by your company matter foryour clients.

Whereas services provided to the clients such as just in time deliveries, technicalassistance and recovery of zinc residues for recycling, do matter for the clients; theprovision of these services does not enable differentiation in the price of thecommodity sold. The price for product zinc is set on a global exchange (LME).

17. Please indicate the share of your sales to clients in the same Member State, in other EUMember States, in non-EU States.


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Given that most countries often have only one (if any) primary zinc producer (ReferFigure 9), this information is confidential and not available. It would be up to eachcompany to provide this information, if it was considered as useful or necessary.

Substitutability of final products

18. Please provide information on the substitutability between the sector's products fromthe 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 with no price differentiation for material produced tointernational designation (LME) standards; it thus EU production can easily besubstituted by non-EU sources.

19. Please provide studies and reports that substantiate the claim that the level of EUproduction 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 illustrateyour claim with concrete observations from the (recent) past.

The price of refined zinc is set on global exchanges, such as the LME, which issensitive to the worldwide production/demand ratio. The zinc producers competeglobally on cost of production and the global cost curve for zinc production is relativelyflat. Therefore regional conversion cost increases, such as an increase in electricityprice due to the pass through of indirect CO2 costs under the EU ETS, can make asignificant difference to the global competitiveness of producers from that region.

As for all non-ferrous metals produced by the sub-sectors highlighted in thequestionnaire and traded in global markets, elasticity factors are not significant as theyonly reflect the sensitivity of the global demand to the commodity price. It will notreflect the impact of a differentiated application of EUAs on their operating costs andhence on their competitiveness, as these additional costs will not be transferred to themarket and will not affect the global demand.

It would be impossible to attempt to raise prices within Europe without significant lossof sales, which would ultimately result in complete displacement of Europeanproduction 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 industrialcompetitiveness in Germany, UBA Research Report 3707 41 501, 10/08, ISSN 1862-4359 Comparing the few estimates available for the various sectors, a very roughsector ranking in terms of demand elasticity would be (starting with highest absolutevalue): aluminium, steel, paper, cement.

20. Which non-EU countries would see the largest increase in production if the price of EUproduction were to rise due to ETS-3? Please substantiate your answer.

This would be where the conversion costs are lowest and regulatory regimes are

stable. As energy is the most significant proportion of conversion costs, increases inproduction are most likely to be seen in countries where it is possible to secure longterm power contracts at affordable prices.


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Overall demand elasticity

21. Please provide information on the elasticity of overall demand with respect to priceincreases in the sector concerned.

See response to Question 19

Market segmentation and industry structure

22. Please provide information on the characteristics of the market affected by the possibleincrease 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 (50%), zinc die-casting alloys(17%), brass and bronze (17%), semi-manufactured products (6%), zinc oxide (ZnO)and chemicals (6%) and others (4%).

Figure 13: Zinc Consumption by first and end-use

Source: International Lead Zinc Study Group

In general terms, all these markets can buy their zinc from LME warehouses or non-

EU suppliers and are thus not affected by the closure or lower capacities of EUproducers. Nevertheless, in the longer term, they will have access to less suppliersand will lose the direct contact and technical assistance from their EU suppliers,leading to a loss of EU expertise and competitiveness.

Demand Growth

23. Please provide information on the expected rate of growth of demand for the productconcerned over the next 10 years in total and by geographic macro-area.

The worldwide zinc consumption is expected to grow on a steady basis, mainly due tothe significant economic development expected in China and India. Zinc metalproduction will most probably follow closely this trend. (Refer Figure 14)


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Figure 14: Forecast zinc production and consumption over the next 10 years

Information on the regional forecasts is not available. Production forecasts dependprimarily on the competitiveness of the each individual producer. However, it can beseen from the following graphs that demand for refined zinc has always been higherthan local production. Imports from non-EU countries have filled the gap.

Fig 15: Evolution of the refined zinc production and consumption in the EU27

Import volumes & export volumes

24. Please indicate for the years 2005-2010, both at (i) world level and (ii) at the level ofthe 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.


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Figures 10 and 15 illustrate the evolution of zinc production and consumption duringthe period 1997-2007 and shows that imports have always been supplied theEuropean market deficit.

Figures 16 and 17 below give more details about the current import-export statistics forEurope in 2010.

Fig. 16: Imports into the EU27 from countries importing over 2000 tons/year.

Figure 17: Exports from EU27 to non-EU countries

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

The tariff imposed on zinc imports from non-EU countries is 2.5 %. However, severalcountries exporting zinc to the EU have gained import duty reductions or exemptionsthrough EU trade agreements (for example: S. Africa, Mediterranean countries, )


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Third country tariffs (relevant to EU NFM exports) also vary considerably and, whiletariffs generally were reduced under the WTO, there are still important markets whereduties 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 ofimports 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 our answer to Question 24.

While values are proportional to tonnages, it is not relevant to discuss values in thecase of commodities, as the price is fixed by the LME and can vary significantly fromduring the same year and between years.

Changing patterns of world trade27. Please indicate any changing patterns of world trade in the sector.

The evolution of zinc supply in the EU is shown in Figure 10, and that of the global andwestern world zinc supply is shown in Figure 18.

Fig 18: Zinc metal supply 1979-2009

Important changes in the pattern have occurred in the zinc industry in the last decade.

Indeed, the European producers share of the global market has been significantly

reduced, highlighting the progress made in Asian countries and the impact of closuresand lower investments in Europe. While European producers previously held a leading


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position in the global zinc market, China is clearly taking the lead, pushing the EU intosecond position.

Fig.19: Change in the global distribution of zinc metal supply

Substitutability of inputs

28. Please indicate whether the sector can reduce the energy intensity of the productionprocesses by inputting other factors of production.

The intensive use of electricity in the processes employed by the primary zincproduction sub-sector cannot be reduced by inputting other factors of production.

Further reduction of the total energy consumption by European RLE plants hasbecome rather marginal. Indeed, most (over 80%) of the electricity consumption isused in the zinc electrolysis stage, where conversion efficiency is governed by physicallaws.

According to Faradays law, the mass of a substance released on an electrode isdirectly 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 thecurrent was circulated.

Q .M I.t.M

m = =

F.n F.N

m = the mass of the substance (Zn metal) liberated at an electrodeQ = the total electric charge passed through the substance


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I = the electric current intensityt = the time during which current is appliedF = 96,485 C mol-1 is the Faraday constantM = 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 consumed due to physical parameters, (such as theresistivity factor induced by the presence of the electrolyte between electrodes duringelectrolysis) and cannot be reduced further. Therefore, further significant reductiontargets for indirect CO2 emissions are nearly impossible to achieve via zinc produceractions.

Market penetration rate for new technologies

29. Please indicate the adaptability of a sector to new lower-carbon technologies andproduction processes. Please substantiate your answer based on the existing capitalinfrastructure 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.

Currently there are no new primary zinc production technologies on the market orclose to market application. Any improvement depends on gradual improvement ofexisting technology and the best performance here is getting close to theoretical limits.

For primary zinc production, Roast-Leach-Electrolysis (RLE) production technology isthe most energy efficient and dominant process. It is also the most commonly used

process in the zinc industry (88% of production). Imperial Smelting Furnaces (ISF) areused for 7% of world production (only 1 ISF currently operating in the EU). Verticalretort (3%) and electrothermic (1%) are used only outside Europe see Figure 15.

There are currently no other industrial technologies available to produce zinc metal atlower energy consumption.

Global price setting mechanism

30. Please specify to what extent EU producers in the sector should be viewed as pricetakers. Are the products of the sector commodities, sold in global exchanges? Whatpercentage 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 potentialprices at global exchanges. Please substantiate your answer.

We highly appreciate the realistic view of DG Competition in focussing on global pricesetting mechanisms as criteria for eligibility.

The sub-sectors highlighted in this questionnaire produce commodities that are subjectto their selling price being determined by global exchanges. The primary exchangewhere these commodities are traded is the London Metal Exchange (LME). The LMEprovides a transparent forum for all trading activity and as a result helps to discoverwhat the price of material will be months and years ahead. This helps the physicalindustry 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 arerecognized and relied upon by industry throughout the world. The LME is a highly


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liquid market and in 2010 achieved volumes of 120.3 million lots, equivalent to $11.6trillion annually and $46 billion on an average business day

The LME trading volumes are multiples of the physical production of the commodities.For Zinc the volume of futures contracts traded on the exchange were 470 million tonsin 2010 (18.8 million lots of 25 tons), valued at US$ 1,0 trillion and representing 40.5

times the global zinc consumption (11.6 million tons) that year.Trading takes place across three trading platforms: through open-outcry trading in theRing, through an inter-office telephone market and through LME select, theExchanges electronic trading platform. The LME publishes a set of daily referenceprices that are based on the most liquid trading sessions of the day. They are used theworld over by industrial and financial participants for purposes of referencing, hedging,physical settlement, contract negotiations and margining and are indicators of wherethe market is at any point in time.

Attachments produced by the LME and others explain how prices are determined onthe exchange.

- Refer enclosed extracts from "Managing metals price risk with the London MetalExchange by Phillip Crowson and Ray Sampson.

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 togreen electricity are maintained. This is subtly different to statement above: financialsupport should maintain an incentive to reduce electricity consumption and stimulate ashift in demand from grey to green electricity.

The primary incentive to switch from grey to green electricity generation is alreadyembedded in the ETS by placing a carbon cost on fossil fuelled generation and the

various subsidies for renewable power generation. Financial support provided toeligible consumers for CO2 costs embedded in electricity prices can neither strengthennor weaken the incentive. Electricity is supplied to consumers at the same priceregardless of its source of production, and grey electricity cannot be distinguishedfrom green electricity. As a consumer of power we cannot change the mix provided inthe grid by the producers.

32. What level of aid reduction would help preserving an adequate incentive to reduceelectricity consumption? Please substantiate your answer.

As explained in our response to Question 2, the zinc refinery electricity consumption isdirectly related to production levels. Therefore while it is a goal to increase electricityefficiency, it is not a goal to reduce overall electricity use if this means decreased


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production. Reducing the level of aid will not give an extra incentive to reduceelectricity consumption. Compensation for indirect costs would, assuming it were to bebased on an electro-efficiency benchmark, maintain the incentive to reduce electricityconsumption and lead to an overall reduction in direct emissions. As electricity costsas already highlighted represent a large percentage of the total operating costs for thesub-sectors identified in this questionnaire there continues to be an incentive toimprove energy efficiency and to go beyond the benchmark.

33. Do you consider that requiring an own contribution would give an extra incentive toenergy users to be even more energy efficient (in addition to the efficiency benchmarks)

and that it would ensure the continued existence of incentives when benchmarksbecome relatively less ambitious over time? Please substantiate your answer.

See our response to Question 32. There is no need to reduce the level of aid as theown contribution is already embedded in the very high prices paid for electricity inEurope (even with full compensation for the CO2 element). Reduced profitability willreduce investment and slow down the introduction of process improvements. Reducingthe aid will thus increase the risk of carbon leakage.

34. Do you consider that requiring an own contribution would give an indirect incentive toelectricity producers to invest in less environmentally damaging generating

technologies? Please substantiate your answer.

See our response to Question 31. Reducing the aid will not enhance the bargainingpower in the European electricity markets of the sub-sectors identified in thisquestionnaire. Reducing the aid simply puts one of the primary intensions of theDirective at risk; that of mitigating carbon leakage.

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


Providing aid will not lead to aid dependency. On the contrary; temporary, fullcompensation could provide the basis for investment and stronger competitive positionfor the situation when a level global playing field is restored at a later stage. Aid shouldonly be provided whilst the absence of a binding international agreement (wherebyindustry would be subject to comparable carbon costs, also for indirect emissions) putscertain energy-intensive sectors and sub-sectors in Europe at an economicdisadvantage.

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


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SECTION C:BENCHMARKS

The ETS Directive1

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 technologiesand 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, inorder to calculate the maximum aid amount, benchmarks would be introduced linked to best

performing technique. The Commission will undertake a study to determine the efficiencybenchmarks for the relevant sectors.

36. What factors are in your view relevant to define a benchmark for your sector in order toincentivise 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 weredeveloped for direct emissions.

37. Please specify the electricity consumption per unit of production that should correspondto the most efficient available technologies for a certain sector. Please substantiate your

answer with data and sources.

Based on verified data from all European plants for the years 2007 and 2008 and ondefinition of boundaries, we can produce a benchmark depending on an agreeddefinition of the benchmark.

38. What is the level of your companys electricity efficiency? In your reply, pleasecompare it with other companies from your sector, notably with countries outside of theEU?

The EU zinc refineries are amongst the most energy efficient in the world (Refer Figure3). The differences in specific EU zinc producer energy efficiency are relatively small.

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

SECTION D:CO2 EMISSION FACTOR

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

1Article 10a(6) of the ETS Directive.


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on the grid (on the exchange or forward market), the average CO 2 intensity in the EU's total

electricity production could be used2.

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 usea 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 level of compensation must be based on the real CO2 cost passed through inelectricity prices.

This passed through CO2 cost differs according to the varying relevant powercontracts of the consuming company and hence have to be determined in differentways:

- for power purchased on markets, referenced by power exchanges;

- for situations where prices are not referenced to the power exchanges, like by tariffs;

- for self generation.

In the case of self generation or electricity contracts that explicitly specify the CO2content of the supplied power, the level of pass through is directly identified.

In the case of purchases on the grid or of tariffs, the appropriate level of CO2 factorneeds to be identified.

Applying the same method across all installations, whatever the situation, could lead tounder compensation in many cases, which would not mitigate the carbon leakage risk.The factor cannot be the ''average EU'' factor, which although it would not only alwayslead to under-compensation, it does not reflect the actual cost borne by an installationand therefore does not effectively mitigate the carbon leakage risk. This ''average EU''factor was included in an old document, the non-paper mentioned in thisquestionnaire. The European institutions, however, decided later explicitly that thisfactor would be changed to the relevant factor. The word 'relevant' is the right wordindeed. The relevant factor is the factor that is compensating the actual CO2 costsaccording to the different realities of the power consuming companies, as alreadydescribed.

Method 1: Where electricity is purchased on the grid, the CO2 factor of the marginal plantsetting the electricity price for the installation concerned is used

40. Do you consider that using the annual weighted average of the CO2 factor of themarginal power production in the relevant electricity market, which supplies the

beneficiary is the appropriate method? Please substantiate your answer.

2

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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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 toemission allowance cost in power purchased. Provided that emission factors arecalculated in the correct way, the following would be the best method (see also theresponse to questions 41 and 42).

It is generally accepted that in a competitive power market where prices are related tomarginal generation costs; therefore the increase in power prices is proportionate tothe 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 CO2emission factor for hour i (t/MWh)

The corresponding annual formula for base load would be:

P = k * Ek = i (ki * c i * Ei ) / i (c i * Ei )

Where,

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 CO2emission 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 marginalCO2 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 pricesetting 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


National regulators, system operators, markets operators, and/or power exchanges willbe able to identify the marginal plant technology responsible for setting the price in themajority 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 planttechnology responsible for setting the price and applying standard emissions factorsfor that technology should not lead to any confidentiality issues.

In some instances Method 1 applied in this manner may not be the most effective wayof setting the CO2 factor for a particular hour as:

Identifying the price setting technology may not always be possible acrossborders;

If the price setting technology is hydropower, identifying the relevant marginalCO2 pass through factor is not trivial as it will depend on the opportunity valueof selling the power in interconnected markets where CO2 emitting plant setsthe market price;


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Implicitly assuming that the same technology will be price setting with andwithout emission cost; and

In markets with portfolio bids, the price setting technology may only be inferredindirectly.

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

42. Would national regulators be able to identify the marginal plant when the price settingareas 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 theprice setting areas periodically, as the interconnection and generation infrastructure

evolve?

National regulators, system operators, markets operators, and/or power exchanges willbe able to identify the marginal plant technology responsible for setting the price innational and sub-national markets. Regulators should have the right to access to thisdata. For supra-national price setting, extensive exchange of data and/or co-operationon analysis is required.

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

Challenges caused by dynamic geographical diversity of price setting area can besolved by supplementing the analysis using a model based on Method 1, as referred toin the response to question 41. Commercial models are continuously updated to reflectavailable grid capacities and hence the actual degree of price influence betweenareas. The relevant pricing area split is model output. Such models will also be able togive 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 meritorder, 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, ifthe 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 pricesetting 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 estimatemarginal 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


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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 giveincentives 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 CO2costs embedded in power prices to/from eligible sectors. The compensation does thusnot provide any incentive to influence the merit order in any way. The introduction of acompensation scheme will not strengthen any incentive or opportunity to exercisemarket 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 verysmall, and generators would not have any incentive to change the way theirbusinesses are operated.

45. Do you consider that this method involves an excessive administrative burden, sincenational 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 itcan 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 theappropriate 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 marginalCO2 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 themarginal 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 MemberStates with greener electricity and under-compensation in Member States with greyelectricity? 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 countrys electricity sector turns out tohave little influence on the actual emission cost pass-through at the margin.


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48. Do you consider that this method has the advantage of simplicity, compared to Method1?

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 thegeographical 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 caseslead to under-compensation, and be grossly unfair for geographical pricing areas witha green production mix. Only a methodology based on the marginal pass throughfactor 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, irrespectiveof the actual terms of supply of electricity for the installation concerned, would best

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 forgreen electricity. Method 1 does not have any negative side effects related to thistype 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 carbonleakage.

See response to question 31 regarding maintaining incentives to switch to greenelectricity.

SECTION E:OTHER ISSUES

Do you have any additional comments on the above issues?

Key Points relating to this submission.

The answers to this questionnaire are specific to the zinc industry and complement theinformation provided by Eurometaux for the non-ferrous metals sector in general.

The information provided demonstrates that the zinc industry presents a significant riskof carbon leakage and is therefore eligible for aid for indirect emissions.

Zinc metal is a commodity and is traded daily on the London Metal Exchange (LME),

which provides a transparent forum for present and future zinc prices. The LME pricesare recognized as the reference prices by all industry participants. LME fixes the prices


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for all producers and users, so no single company can fix prices independent of theexchange price.

Furthermore, there is no differentiation among products from different supplier: one tonof metal can be replaced by the similar metal from another supplier. Since price is seton LME, higher regional costs (such as indirect CO2 costs) cannot be passed onto the

customer.Therefore, to be competitive, producers must minimize operating costs, (or conversioncosts), that is, the cost of processing zinc concentrates into zinc metal.

Zinc metal production is highly electricity intensive. Electricity costs represent thehighest proportion, almost half, of these conversion costs. As the EU RLE Zn refineriesface the highest electricity prices compared to all non-EU producers, the Europeanindustry thus made significant efforts to minimize its energy consumption. It is currentlythe most energy efficient in the world. The nature of the zinc production processmakes further electricity reductions impossible.

This explains why indirect CO2 costs, by increasing conversion costs, not only

deteriorate the global competitiveness of EU27 zinc producers but also put the sectorat high risk of carbon leakage.

Full compensation is thus needed to keep a profitable zinc industry in Europe andavoid carbon leakage.

Effective implementation of financial compensation for pass through of CO2 costsrequires actions at both DG Competition and Member State level, the former to ensurethat adequate state aid rules exist to assist sectors at risk of carbon leakage, and thelatter to actually provide the aid to affected installations. It is recognised that there isthe potential for Member States to respond to varying degrees which can causeinconsistencies, however at the moment all EU zinc refineries are at significant risk ofclosure, which would result in a poorer environmental outcome via carbon leakage.

Those Member States that do provide compensation will lessen the risk of closure forinstallations in their country until a global level playing field is established for CO2costs. Due to LME pricing and the fact that EU demand for zinc is greater than supply,compensation will not distort the EU market, that is, it will not impact on the price ableto be charged for product or allow a producer to gain market share.

IZA Europe additional comments

1. Urgent action needed at Member State and DG Competition level to make this only

available policy tool a success

The current budgetary situation in MS is very weak. It risks the state aid policy tool to be in-

effective to provide financial compensation in practice and to avoid further carbon leakage.

Effective solutions have to be found for this problem.

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 purchasingemission rights and passing it on in the electricity price is likely to increase even further in the future

as the EC is developing the nuclear crisis in Japan implies that EU will be ever more dependent on

fossil fuels to provide the necessary base-load power3. This will create a higher demand for emission

3 Already the nuclear crisis in Japan has had the effect to close down several nuclear reactors in Germany whichhas had a direct impact on the electricity price and the price of emission allowances.


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rights and lead to a significantly higher cost-burden that will seriously threaten energy-intensive

industries. On top of this the EC energy policy on grid lines and renewables is also developing even

higher costs for European (industrial) consumers.

The situation is the most striking in countries, such as in Scandinavia, which despite their very low-

carbon based electricity production, has a significant cost pass through of emissions rights as coal is

also there 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 in such cases is exacerbated

by the lack of auctioning revenues for the Member States as the low carbon based power does not

generate any revenues for the Nordic Member States. In this context it should be mentioned that it is

absolutely beyond our control what kind of electricity is available in the regional power market.

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 CO2which will reach unsustainable levels. This will potentially imply a loss of electricity intensiveindustries 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.

In this context, IZA Europe urges the EC to use all its legal and political 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 theDirective 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. 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 highcost-pass through but low chance of receiving compensation.

2. The sector assessments behind the Carbon Leakage list were inadequate and need serious

improvements: on both the cost pass through ability and the electricity prices

1.a Real cost pass through ability should be taken into account:

There is a lack of understanding of international commodity markets, which are the universal

reference for the selling prices of our products worldwide. This prevents us from passing on any

locally incurred operational costs, such as CO2 costs, both direct and indirect, the latter which arepass through in increased energy prices;

This incapacity to pass on costs forces us fully to internalize CO2 costs (direct and indirect),

which, without adequate protectionin the form of support for indirect costs and free allocationfor direct emissionswould wipe out most of the remaining European production of primarymetals, making Europe almost entirely dependent on imports;

It is not useful to take historical trade flows as a measure to show the risk of relocation, as they

are the reflexion of historic costs, when in the past many non-ferrous metal long term electricity

contracts had yet to expire, which most have by now. These contracts prevented the pass-through

of indirect costs into electricity prices. Given the state of the energy liberalisation process, notlong-term power contracts are likely to be offered by power generators anymore.


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1.b Electricity price impact should be improved:

The main model used for calculation of carbon leakage does not take into account the full effectof indirect emission cost for the consumers of electricity and the reasonable assumption that thiscost largely will be uncompensated. Compensation is left to governments with very tight state

finances. Moreover, the models used do not recognise the fact that in most other regions in the

world, prices for power to industry are unrelated to markets or CO2 cost, and will remain so forthe foreseeable future.

Proven inadequate track record: These models used by the Commission on electricity priceimpacts are where also used at the time at the beginning of ETS to hide the electricity price

increases for industry and society and the linked windfall profits for power generators, linked toETS, which did occur in reality as is very well recognized. Now these flawed assumptions and

models have been used again in this exercise and even also for the Low Carbon 2050 Road Maplater.

The experts recognize these problems in the meantime, but the decisions and discussions are still

based on the old wrong assessment. This has to improve.

We trust that you will call for a correction and a thorough, in-depth analysis of the policy options for

moving forward, and ensure that the Commission takes into account relevant information from allstakeholderswhen improving the assessments leading to concrete recommendations. We look

forward to participating in this process.

3. The ECs non-paper is not relevant for this consultation

The Commission's non paper submitted to the European Parliament and the Council on 19 November

2008 on indirect emissions is not relevant for this exercise per se as it pre-dates and differs from the

agreement made on the issue by the European Institutions.

It should not be included and taken into account in this consultation.

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

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

THANK YOU FOR RESPONDING TO THIS QUESTIONNAIRE.


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ANNEX

Commission's non paper submitted to the European Parliament and the Council on 19

November 2008 on indirect emissions

4

Indirect emissions

PROPOSED ASSESSMENT CRITERIA FOR STATE AID TO COMPENSATE FOR

ELECTRICITY COST INCREASES DUE TO PASS ON OF CO2 COSTS

This document presents an approach for measures to ensure that increases in electricity costs

resulting from pass-through of ETS-related CO2 costs can be compensated ("indirect

emissions"). It proposes a method to assess the compatibility of state aid schemes with

Community state aid rules.

It should be underlined that in the event that an international climate agreement is concluded,

the need for any compensation would have to be re-evaluated.

Aid could be reasoned to be necessary to achieve the environmental objective of the ETS

where the costs of ETS burden companies to an extent that they would leave the EU without

overall emission reductions (i.e. carbon leakage). The support should in principle only offer a

compensation for the part of the increase in electricity prices due to the ETS-related passthrough of CO2 costs from the electricity generator. The actual pass-on of CO2 costs of

electricity experienced by the installations depends on conditions of supply to the particularinstallation or the existence of non-emitting electricity sources at industrial sites i.e. standard

medium-term contracts, long-term contracts, regulated tariffs, direct supply from a dedicated,CO2 free power generation unit. Therefore the definition of the aid necessary seems only

possible through a case-by-case analysis at installation level.

In addition, companies concerned should pay a part of the increased CO 2 cost in order to

maintain an incentive to save energy and to stimulate a shift in demand from grey to green

electricity. Any support system should furthermore promote energy efficiency by linking the

extent of support to energy efficiency performance.

A scheme might be set up as follows:

If a Member State would like to provide such aid, it would have to notify a scheme to the

Commission. The Commission's assessment of the scheme would follow three steps:

Step 1: confirmation by the Member State that all intended beneficiaries are covered by a list

of (sub)sectors identified at EU level to be subject to risk of carbon leakage due to

CO2 costs of indirect emissions (necessity of the aid).

Step 2: confirmation by the Member State that at the level of each installation, CO 2 costs are

being passed on in electricity prices (necessity of the aid).

4

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Step 3: confirmation that the Member State will use a method to determine the compensation

that does not exceed the maximum allowed for each eligible installation, in order to

avoid overcompensation, avoid distortion on the common market and maintain the

environmental incentive of the ETS (proportionality of the aid).

Step 1: The measure must target beneficiaries for which risk of carbon leakage exists dueto increases in electricity costs

The Commission would establish a list of (sub)sectors exposed to the risk of carbon leakage

due to indirect emissions. The Commission would use the method that is being developed in

the context of direct emissions, but adapt this to take into account cost increases related toindirect emissions.

For the assessment of a state aid scheme, Member States would have to confirm that eachbeneficiary is covered by the list of (sub)sectors for indirect emissions established by the

Commission.

Step 2: Within sectors identified as being at risk of carbon leakage, aid can be granted only

to companies subject to pass on of CO2costs in electricity prices

In the