The Commission's wide discretion to allow aid under Article 87(3)98 EC Treaty is only subject to the marginal control of the ECJ which ruled in Italy v Commission that the Commission had to take all relevant factors into account.99 The new Environmental guidelines100 that have been adopted on 23 January 2008 seek to correct market failures, promote sustainable development and raise levels of environmental protection.101 Besides command and control approaches that Member State governments can follow to enhance environmental protection, they can share the financial burden of private enterprises and thereby set positive incentives for investment in more environmentally friendly production. As was the case for its predecessor, it is the object and purpose of these guidelines to ensure that there will not be badly targeted or excessive State aid that distorts competition while failing to meet its environmental objectives.
In order to assess the compatibility of an aid measure with the common market the Commission balances the positive impact of the aid on the common interest against any negative side effects such as distortions of trade and competition.102 The Commission employs a three ties test, the so called 'balancing test'. It first examines if the objective belongs to a well-defined common interest and then examines whether the policy instrument is appropriate to address the market failure. In order to satisfy this criterion whether and under what conditions State aid may be regarded as necessary to ensure environmental protection, and whether the environmental gain is proportional to the amount of aid granted, are examined. Whether the environmental aid causes disproportionate effects on competition and economic growth or whether the overall balance of the aid is positive is evaluated in the last step of the test.
The previous Commission guidelines on State aid for environmental
98 Case 730/79 Philip Morris v. Commission  ECR 2671, para. 17; joined Cases 62/87 and 72/87 Exécutif Régional Wallon v. Commission  ECR 1573, para. 21; Case T-152/99 Hijos de Andrés Molina, SA v. Commission  ECR II-3049, para. 48; Case C-142/87 Belgium v. Commission  ECR I-959, para. 56; Case C-39/94 SFEI  ECR I-3547, para. 36; Case 78/76 Steinike v. Bundesamt für Ernährung und Forstwirtschaft  ECR 595, para. 8; Case C-156/98 Germany v. Commission  ECR I-6857, para. 67; Case C-303/88 Italian Republic v. Commission  ECR I-1433, para. 34. See also Woerdman, E. (2004) pp. 175ff.
99 Case C-261/89 Italy v. Commission  ECR I-1437, para. 20.
101 European Commission (2008) Environmental aid guidelines, paras. 5 and 6.
102 European Commission (2008) Environmental aid guidelines, para. 16.
protection103 were silent about tradable permit schemes and offered the Commission the choice between Articles 87(3)(b) and 87(3)(c) for the examination of the NAPs in the first trading period. The new guidelines offer more guidance and legal certainty. Tradable permit schemes fall under Article 87(3)(c) EC Treaty.104
The balancing test that is executed to examine whether a measure can benefit from the derogation under Article 87(3)(c)105 is supplemented by further specifications.106 The Commission emphasizes107 the environmental objective of the aid and underlines the importance of transparency and objectivity of the allocation methodology as well as its firm grounding on reliable data. Allocation methodologies may not favour certain undertakings or sectors and may not treat new entrants more favourably or create undue barriers to entry.
The methodology that has been applied for assessing State aid involvement in the NAPs under the EU ETS for the second trading period is described in paragraph 140 of the Commission's guidelines. For the trading period post 2012 it is noticeable that the Commission emphasizes economic analysis to ensure the prevention of passing on cost increases from tradable permit schemes to consumers and seeks to prevent the generation of windfall profits.108
In order to examine whether Competition law is able to lead to the selection of the least distortive allocation mechanism, proportionality is of particular importance. Here, whether the applied measure is proportional or excessive in relation to the objective sought is examined. If one of two comparable allocation mechanisms was less distortive to competition, the proportionality principle would in general work towards the selection of the least distortive system. Whether it indeed is effective does essentially depend on the degree of comparability between the allocation formats, and the arguments underlying the Member State's choice. If they are very political in nature, the Court may refrain from criticizing the government's selection.
It therefore follows that the degree of comparability of both PSR and grand-fathering has to be examined. The systems are comparable to the extent that neither burdens undertakings with direct financial expenditures and both fall within the category of free allocation mechanisms. They do, however, differ in
103 OJ C 37, 3.2.2001, p.3 have been repealed, see European Commission (2008) Environmental aid guidelines, para 12.
104 European Commission (2008) Environmental aid guidelines, para. 139.
105 European Commission (2008) Environmental aid guidelines, paras. 71-72.
106 European Commission (2008) Environmental aid guidelines, paras. 71-72, 139-141.
107 European Commission (2008) Environmental aid guidelines, para. 141.
108 European Commission (2008) Environmental aid guidelines, para. 141.
their design109 as in the distortions of competition they create, in particular regarding new entrants, unequal treatment, entrenchment of market shares, closure and transfer rules.110 While the former does not appear to be decisive from a proportionality point of view, the latter is. Grandfathering allows allocations which are tailor-made to the specific requirements of firms and thus entails different effects on undertakings that impact the level playing field, while the PSR system, in contrast, pursues a sectoral approach that may include several benchmarks for specific product groups. If the Court were to indeed differentiate between both systems, EC Competition law111 would not encourage the selection of the less distortive allocation format.
In comparison to grandfathering, the level of distortions of competition that are likely to be created by the PSR system is lower and consequently the environmental net benefit required to justify the application of a measure will be lower too. It therefore appears that with regard to the quid pro quo examination applied in the last stage of the balancing test a PSR system is preferable to a grandfathering system. It has therefore to be concluded that EC Competition law may not lead to the selection of the allocation mechanism that is least distortive.
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