A step has been taken towards the European Union banning the labelling of fossil gas as 'sustainable' in the EU Taxonomy.
In January of this year, fossil gas-fired electricity generation was included in the EU Taxonomy as one of many activities that could potentially be considered 'green' if they met certain technical criteria. As expected, utility companies are facing significant difficulties in proving compliance, given the strict technical criteria set out in the regulation. Indeed, major European utility companies operating with fossil gas, including Endesa, Fortum Oyj and Verbund, were unable to demonstrate compliance with the Taxonomy criteria in their 2022 reports.
This development is notable as four non-governmental organisations have launched legal proceedings against the European Commission to prevent it from labelling fossil gas as 'sustainable' under the EU Taxonomy.
While the NGOs' point of view is understandable and would encourage the development of a sustainability framework that takes all views into account, the reality is that the inclusion of fossil gas will have a minimal impact on capital allocation decisions or investment portfolios, which is the primary goal of the EU Taxonomy.
Nuclear energy and fossil gas are included in EU Taxonomy reports in 2023.
On 1 January 2023, six new activities related to nuclear energy and fossil gas officially became part of the EU Taxonomy. Companies eligible for these activities can now claim compliance with the environmental objectives set out in the Taxonomy if these activities:
I) comply with technical criteria,
II) do no significant harm to other environmental objectives, and
III) maintain minimum social safeguards.
The new regulation affects not only companies but also investors: Financial market participants (asset managers) can now take into account activities related to fossil gas and nuclear energy when disclosing information on EU Taxonomy funds.
The article will examine the technical criteria for fossil gas generation and how their inclusion affects investor portfolios. We pay particular attention to activity 4.29, 'Electricity generation from fossil gaseous fuels', as it is both the largest (accounting for nearly 60% of the associated listed companies) and the most controversial activity in the new delegated act.
New disclosure for companies under the NFRD (Non-Financial Reporting Directive, adopted by the European Union in 2014).
Starting from January 2023, NFRD companies must report the percentage of their activities that are eligible for and aligned with the EU Taxonomy, including the extent to which they are aligned with the new nuclear and fossil gas activities.
In addition to the debate over whether fossil gas or nuclear energy should be considered green or even a transitionary measure, companies and market participants are facing uncertainty over how to interpret the technical criteria. This specific criterion related to gas-fired generation has perhaps caused the most debate:
I) 'the activity's direct GHG emissions are lower than 270 g CO2e/kWh of energy produced'.
or
II) 'the activity's annual direct GHG emissions do not exceed an average of 550 kg CO2e/kW of the facility's capacity over a 20-year period'.
The first threshold – 270 g CO2e/kWh – is clear. Yes, it is higher than the general threshold of 100 g CO2/kWh that applies to all other electricity generation technologies (a matter examined in detail by the Platform on Sustainable Finance), but at least it is easy to measure and compare. We can compare it with industry figures and conclude that only a few companies (if any) will be able to reach this threshold, as the carbon intensity of these technologies is in the 403-513 g CO2e/kWh range.
Thus, the main source of uncertainty is the 550 kg CO2e/kW threshold, which is measured as an average over the next 20 years. This threshold creates interpretative and methodological problems. In particular:
– The metric (which could measure efficiency or operating time and costs) is based on a multi-year average that, by definition, cannot be accurately measured until the full period has elapsed, forcing reporters to use estimates based on projected trajectories. These must include several assumptions related to future electricity demand, technological development and the regional electricity mix. These estimates will then have to be verified by independent third parties who, based on their own separate estimates, will certify whether they are sound.
– The metric is based on capacity, not production, so to a certain extent it benefits large, underutilised power plants that could now be adapted to the EU Taxonomy rather than being decommissioned. For example, the large Alessandro Volta power plant in Italy has a capacity of 3.6 GW. As this plant is underutilised (it operates only 30% of the time), it could meet the EU Taxonomy threshold because its carbon dioxide output is low compared to its capacity.
– Similarly, capacity-based measures produce very different results for a specific asset over time (utilisation can vary significantly from year to year (6)), making it difficult for investors to track and understand progress in green technology investment. For example, in one year a power plant may operate at 60% capacity, but in the next year at 40% capacity due to various external factors (such as the supply from other energy sources), with the result that the CO2 kg/kW value is lower, and the plant may go from 'non-compliant' to 'compliant' with the EU Taxonomy as it crosses the threshold from year to year.
How does this affect investors?
An important criterion for fossil gas-related activities, which is also shared with nuclear energy-related activities, is that the activity must take place within the European Economic Area. As a result, investors exposed to transactions with utility companies outside Europe will be subject to a so-called 'zero taxonomy' (Taxonomy-alignment) for these activities.
However, given the aforementioned uncertainty, it will be difficult to determine what alignment indicators European utility companies will ultimately report. Companies are expected to report little or no alignment with the EU Taxonomy because they (and their independent third-party verifiers) will follow the UN precautionary principle, which is embedded in European Union law and applicable to environmental regulations. This principle can be summarised as follows: 'When in doubt, err on the side of the planet.' More specifically, it shifts the burden of proof onto the 'producer or manufacturer, who can be required to demonstrate that there is no threat (to the environment)'.