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EU proposal to label gas as sustainable under the EU Taxonomy concerns experts – what does it mean for the industry?

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While supply pressures and high energy costs have created an energy crisis in Europe, a proposal to include certain gas and nuclear activities in the EU Taxonomy has become a hot topic of political debate in the EU.

If a proposal sent by the European Commission to the EU members on 31 December 2021 is adopted, the EU Taxonomy will include three groups of fossil gas activities: electricity generation, high-efficiency cogeneration and district heating/cooling, provided that strict emissions thresholds and further specific requirements are met.

However, an expert group that was requested to provide feedback on the proposal by 21 January 2022, is concerned that the draft proposal will undermine the sustainable Taxonomy framework and expresses concerns about how the draft criteria would work in practice. The expert group therefore recommends that more strict emissions requirements must apply to the gas activities to be included.

It should be noted that production and transportation of gas and the construction/development of gas fields and transportation facilities are not proposed to be included in the EU Taxonomy.

In this newsletter, we will look into the European Commission's draft proposal and the criticism raised by the expert group, as well as providing our thoughts on the potential impact on the gas industry.

The EU Taxonomy: Channelling capital towards sustainable investments

As part of the European Green Deal and the EU's ambitious goal to reduce its greenhouse emissions with 55% by 2030 and become climate neutral by 2050, the EU Taxonomy is a green classification system for sustainable economic activities aiming to channel private capital towards climate-positive investments using clear, science-based criteria. The EU Taxonomy covers economic activities within several industries that make a substantial contribution to at least one the EU's climate and environmental objectives, whilst doing no significant harm to any of the other objectives and also meet minimum social safeguards.

In order to qualify as "green" or "sustainable" under the EU Taxonomy, the relevant activity must fulfil very detailed technical screening criteria, which are industry-specific requirements established by the EU. By creating a common language and clear definitions of what constitute sustainable activities, the EU Taxonomy intends to help investors, companies and policy makers to direct future investments to activities that will help achieve the EU's environmental goals.

Further, the EU Taxonomy imposes mandatory disclosure obligations on some companies, investors and market participants, which are required to report on e.g. their share of Taxonomy-aligned activities. As a transparency tool, the EU Taxonomy will provide clarity on which activities are sustainable, and intends to facilitate more informed investment decisions.

The political issue related to gas: Is it green enough?

The first delegated act adopted by the EU in 2021, laying down technical screening criteria for sustainable economic activities, did not include any economic activities in the fossil gas and nuclear energy sectors. The potential inclusion of gas and nuclear activities in the EU Taxonomy has been heavily debated amongst the EU countries, which have diverging approaches on the future of gas and nuclear energy.

In 2021, the European Commission postponed the decision on whether to include some type of gas activities in the EU Taxonomy, announcing that further reflection was needed on how to assess the role of gas in the decarbonisation of the economy. Since then, there have been ongoing discussions and intensive lobbying on whether gas is sufficiently green to justify being included in the EU Taxonomy as a sustainable activity. Whereas natural gas emits approximately half of the CO2 emissions of coal when burned in power plants, infrastructure related to gas is also related with leaks of methane, which is a potent greenhouse gas.

Environmental organisations and research communities have argued that the potential inclusion of fossil gas activities in the EU Taxonomy is incompatible with e.g. limiting global warming to 1.5 degrees Celsius, being the goal of the Paris Agreement, and with the EU's 2030 climate goals – and further, that it dilutes the EU Taxonomy as a "gold standard" for private investors to determine which activities are truly sustainable.

The Commission's proposal must therefore be seen as representing a shift in the EU's previous somewhat reserved approach to open for the inclusion of fossil gas in the EU Taxonomy. In the proposal, the European Commission states that in the light of recent assessments, "it is necessary to recognise that the fossil gas and nuclear energy sectors can contribute to the decarbonisation of the Union's economy". However, the Commission emphasises that the proposal to include gas is intended to facilitate an accelerated phase-out of more emissions-intensive energy sources, including solid fuels, over a time-limited transitional period.

If the proposal by the European Commission is adopted, fossil gas could play a more significant role than previously expected in the decarbonisation of the European economy. However, the expert group's recent feedback and their concerns make the future of the proposal more uncertain.

Which type of gas activities are proposed to be covered by the EU Taxonomy?

The European Commission's proposal comprises technical screening criteria for thee fossil gas activities, namely:

  • Electricity generation: Construction or operation of electricity generation facilities that produce electricity using fossil gaseous fuels;
  • High-efficiency cogeneration: Construction, refurbishment, and operation of combined heat/cool and power generation facilities using gaseous fuels; and
  • District heating/cooling: Construction, refurbishment and operation of heat generation facilities that produce heat/cool using gaseous fuels connected to efficient district heating and cooling.

In order for these activities to qualify under the EU Taxonomy, there is–at least as a starting point–a fundamental condition that the life-cycle greenhouse gas emissions arising from the activity are lower than 100g CO2e/kWh. The calculation of the 100g threshold is based on the EU targets for future allowed emission from the power sector, and is also in line with the Paris Agreement. This requirement will normally not be possible to meet for power generation from fossil gas without implementing measures such as carbon capture and storage, as these criteria usually can only be met by renewable sources such as solar, wind and hydropower.

However, during a transitional period, the Commission opens up for less strict emissions thresholds to apply. For facilities where the construction permit related to the above-mentioned activities is granted before 31 December 2030, the performance of such activities may qualify if the direct greenhouse gas emissions are lower than 270g CO2e/kWh of the output energy, or the annual greenhouse gas emissions of the activity do not exceed an average of 550kg CO2 e/kW of the output energy of the facility's capacity over 20 years. Note that such activities are also proposed to be subject to a more detailed set of additional requirements, e.g. that the power generated by the activity may not yet be efficiently replaced by power from renewable energy sources, for the same capacity, and that the facility must replace an existing high-emitting fossil fuel generation facility.

In addition, the activity must comply with the so-called "do no significant harm"-requirements, which mainly consist of best practice requirements and several obligations related to assessment and documentation of relevant environmental aspects. The activity must also meet the minimum social safeguards.

The feedback from the EU Platform on Sustainable Finance

However, the feedback from the expert group given on 21 January 2022 is that including the proposed gas activities are not consistent with the Taxonomy framework and could not be considered sustainable within the meaning of the Taxonomy Regulation. Thus, the expert group recommends that the European Commission takes adequate time to act on the platform feedback to ensure consistency with the Taxonomy Regulation.

One of the expert group's recommendations is to remove the proposal to include gas activities with greenhouse gas emissions up to 270g CO2e/kWh until the end of 2030, as such activities do not ensure a substantial contribution to climate change mitigation. Instead, the expert group recommends that only gas activities complying with the very strict 100g CO2e/kWh emissions requirement shall be eligible under the EU Taxonomy.

If the expert group's concerns are taken into consideration when adopting the relevant regulation, it may be the case that only a very limited group of gas activities may qualify under the EU Taxonomy.

The impact of the EU Taxonomy on the gas industry

Pending adoption of the European Commission's proposal, the use of fossil gas may play a more important role in the shift towards a low-carbon European economy than previously expected. However, due to the EU members' diverging approaches and the expert group's concerns about opening up for less strict emissions requirements during a transitional phase, the exact requirements are not yet clear.

Although certain gas activities are set to be included in the EU Taxonomy in some form, it should be noted that the emissions requirements will be challenging to meet. This also includes the requirements during the transitional period until the end of 2030. Thus, in order to qualify as Taxonomy compliant, we may expect to see an increased development and use of carbon capture and storage, which may assist in decreasing the greenhouse gas emissions from the activity to a Taxonomy-compliant level.

As neither the production and transportation of gas nor the development of gas fields are covered by the European Commission's proposal, typical core activities of E&P companies will still not be covered by the EU Taxonomy. However, as investments in certain gas power plants may qualify as sustainable economic activities under the EU Taxonomy, the inclusion of some gas activities may increase the financial markets' interest in gas power plants in European countries such as Poland, and thereby also increase the demand for Norwegian gas. Hence, the proposal may indirectly contribute in securing future investments and project activity also on the Norwegian shelf, but the actual impact remains to be seen.

That being said, the EU Taxonomy is not a mandatory list of economic activities for investors to invest in, nor does it set mandatory requirements on environmental performance for companies or for financial products. Financial market participants can choose to invest in activities that have various degree of environmental performance, including activities that are not covered or do not comply with the EU Taxonomy criteria.

Further, the European Commission's proposes to amend the existing disclosure framework under the EU Taxonomy, by introducing specific disclosure requirements for non-financial and financial undertakings, which will be obliged to report information on the proportion of Taxonomy-aligned gas activities. Following the adoption of such disclosure requirements, companies in the gas sector must be prepared to be met by disclosure requirements and information requests from e.g. investors, banks, asset managers and insurers, in their respective agreements.

Further, companies of a certain size must also comply with such disclosure requirements and the scope of companies subject to various reporting and disclosure obligations, is likely to be extended in the near future. It should also be noted that the expert group in its feedback has made a remark that the draft disclosure arrangements are unsuitable for financial markets as they do not sufficiently distinguish the draft activities from other Taxonomy-aligned disclosures, and should be further reviewed.

Proactive companies may gain an edge on the opportunities that lie within the EU Taxonomy and stakeholders within the gas industry should therefore pay attention to the rapid development of the EU Taxonomy. Over time, it is expected that banks and other financial institutions will offer more favourable financing to companies that have a high degree of compliance with the Taxonomy and the EU Taxonomy could be a useful tool for companies to steer their business in the direction of sustainable operations.

The regulation is proposed to enter into force on 1 January 2023 for reporting purposes.

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