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FAQ: Germany relies on climate protection contracts (Carbon Contracts for Difference) - what do companies need to know?

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On Tuesday, Jan. 11, 2022, German Economics Minister Robert Habeck announced that he would significantly increase the pace of climate protection. According to the minister, Germany is missing its self-imposed goals of reducing CO2 emissions by 65% (compared to 1990) by 2030, which it set itself with the Climate Protection Act. Therefore, the rudder is to be turned this year with two packages of measures. One means is to be the so-called climate protection contracts (Carbon Contracts for Difference). Habeck wants to create legal and financial conditions for them to be used on a large scale. Although details still need to be worked out, the most critical questions about this instrument are answered below.

 

What are climate protection contracts (carbon contracts for difference) in principle?

They are contracts between the Federal Republic of Germany and industrial companies with which - in very simplified terms - investments by industry in CO2 reduction are subsidized by the state in the long term.
From the perspective of the German government, climate protection contracts offer the opportunity to bring forward the market introduction of climate-friendly processes in industry by cushioning the cost differences and risks (compared to proven climate-damaging technologies). This is based on the realization that technical plants and infrastructures often have a long service life and take years to pay off. Therefore, investing in "climate-damaging" infrastructure now because it is currently more cost-effective can have the effect of keeping it in operation for decades to come. Consequently, it would be better for companies to invest in climate-friendly, low-CO2 technologies or processes now - even if these investments are significantly more expensive than their more climate-damaging alternatives. So put, climate protection contracts should serve to (partially) offset these differential costs for companies through a subsidy from the state so that companies invest in the more climate-friendly technology right away. In addition, the German government believes that this also promotes the development of modern technologies.
As a rule, these will be public-law contracts within the meaning of sections 54 et seq. of the Administrative Procedure Act. Public-law contracts replace an administrative act. With them, the state and the citizen or company enter into a contractual relationship with mutual rights and obligations. Since the reduction of CO2 emissions is a state task for the protection of the basis of life (for future generations) according to the case-law of the German Federal Constitutional Court and the European Union also pursues this goal ("Green Deal"), it is a contract in the public interest. This fundamentally distinguishes the contractual relationship from contracts under civil law.
Although it is also conceivable that it could be structured as a civil law contract, this would probably not make sense due to tax implications (payment of sales tax?). The practice of the federal government remains to be seen here.

 

Why not work with classic elements of subsidy law?

The classic elements of subsidy law are, above all, grant notices, with which the state unilaterally grants subsidies for specific projects, often in the form of a non-repayable grant. This is classic project funding based on guidelines.
However, there are also grant agreements in practice. The EU, in particular, uses this means when giving subsidies. Two elements characterize climate protection contracts:
  • Clear contractual conditions characterize them through the means of performance and consideration ("I give you something so that you do something"). This is in line with the goal of climate protection contracts; a contractual character comes closer to this goal than a unilateral governmental decision. Moreover, a contract relies on voluntariness and the motivation of companies to act.

  • They are designed for a much more extended period, often decades, than the classic form of action of a grant notice.

Working with a contract, therefore, makes sense.

 

What will such a contract regulate in detail?

Here, orientation is possible based on a key points paper for the funding guideline Climate Protection Contracts to implement the pilot program "Carbon Contracts for Difference" of the Federal Ministry for the Environment from April 2021.
At their core, climate protection contracts are based on a mutual payment obligation between the contracting parties resulting from the difference between a contractually fixed price (strike price) for greenhouse gas emissions and its market price. The German government ultimately guarantees the differential costs between actual project-related abatement costs for emissions and the EU ETS prices according to specific parameters. The relevant parameters by which payment from the federal government will be measured could then be in the future:
  • The subsidized project reduced the emissions compared to a (more climate-damaging) reference technology.

  • The additional costs result from the difference between the more expensive climate-friendly technology and the more climate-damaging reference technology.

  • Concerning the cost of emission allowances, the difference between the actual costs of the process to be implemented and the reference process is taken into account in the payout, i.e., those costs incurred by the companies in real terms, taking into account the free allocation.


It does not sound straightforward, but in the end, it is based on empirically comprehensible calculations. In this way, the project-specific CO2 reduction costs can be determined as a primary parameter of the support provided by the climate protection contracts. The state thus subsidizes the additional costs of the climate-friendly investment.

 

What are the minimum contents of such a contract?

What the contracts will look like in the end is still open. However, the minimum contents are:
  • Contract duration and contract effect: The German government does not want to provide funding "forever," so the contract duration and the question of its effectiveness (in terms of payment obligation) must be defined. Climate protection contracts should be concluded for a period that gives companies sufficient planning security. Therefore, contract terms of 10 years and more are aimed for in practice.

  • Contract price or specific subsidy, object of grant: A fundamental design question is whether climate protection contracts should address only operating cost differences or investment cost differences. Recent statements by Economics Minister Habeck suggest that investment cost differences should also be compensated. Ultimately, however, the German government will still have to decide the specific funding object.

  • Further funding criteria: As a rule, further funding criteria are defined, such as whether only climate-friendly energy (e.g., from "green hydrogen," solar power, etc.) may be used to operate the plant as a condition of the funding. Here, the federal government has broad latitude.

  • Payment for Performance: The actual subsidy amounts accruing in each year depend, on the one hand, on the contract price defined for the respective year and, on the other hand, on the actual emission reductions generated. The details must be specified in the contract.

 

Who will be eligible to apply?

That is currently completely open. Eligible applicants will probably be industrial companies with a branch in Germany that have production facilities on an industrial scale or are planning to build them. They will be able to claim to fund the construction of new plants or the conversion of processes, whereas described above - significant CO2 savings can be expected. However, what will be subsidized and which projects will be eligible for a climate protection contract is still wholly open at present.

 

What legal problems remain?

Several legal issues need to be resolved before climate protection contracts can be fully effective. These include:
  • Budgetary law: climate protection contracts result in funding for ten years or more. Such long-term funding is not currently possible under German budgetary law, as it binds governments for a long time - even after new elections have long since taken place and government changes have come. Therefore, German Economics Minister Habeck wants to create new rules here.

  • EU state aid law: The form of the contracts must comply with EU state aid law. The EU state aid law was recently amended to promote green investments, but it remains legally clarified whether this has given climate protection contracts sufficient leeway. It cannot be ruled out that the EU Commission will also draw up a new state aid framework in this respect, as the instrumentation of these contracts to achieve the goals of the Green Deal may also be of interest throughout Europe.

  • Public procurement law and subsidy law: A secure legal framework must be developed (or at least the legal framework must be determined) according to which the tendering and awarding of these contracts can occur in practice. In addition, either a subsidy law regulation in the sense of regulation or (probably more likely) a directive must be worked out - or the German government coalition may even decide to work with a new legal regulation.

 

How is the awarding process carried out - who decides when a company may enter into a climate protection contract?

That is still open at the moment. But there will have to be a formal procedure if only to comply with European and German constitutional laws. In a pilot project in 2021, the Federal Environment Ministry envisaged a multi-stage award procedure with elements of competition law in the form of a call for tenders as the instrumental design for a pilot program of "climate protection contracts." In this context, formal and substantive criteria have been established for when funding will be provided and who will be awarded the contract. Therefore, there will be competitions and not every industrial company will be awarded a contract. The general rule will probably be: The more CO2 is saved in industrial production, the more likely an agreement will be awarded.

 

When will the contracts start?

Open. Habeck has announced that he intends to adopt an initial package of measures in the spring, with application starting in the summer. This could mean that the first climate protection contracts will be concluded from the second half of 2022.

 

How should companies plan now?

One thing is clear: there is no turning back from the plan to decarbonize the industry. Regardless of political circumstances, the European Union member states are legally obligated to do so by the Green Deal and the EU's Climate Change Act. Germany has also passed a climate protection law with even more ambitious targets. The German Federal Constitutional Court has also obliged the German government to take action. As a result, companies that still rely on new infrastructure with climate-damaging technologies will face solid legal barriers and economic burdens in the future.
On the other hand, those planning to invest in climate-friendly infrastructure now should consider waiting, if necessary. After all, it would be regrettable to lose out on millions in funding just because the measure has already been started. This applies until the Federal Ministry of Economics and Technology clarifies that an early start of an action, i.e., the beginning of the implementation of the project, can also lead to subsequent funding.
 
Dennis Hillemann and Tanja Ehls would be happy to advise you on the subject of climate protection contracts and other funding opportunities. At Fieldfisher, we advise you on all questions of subsidy law and support you in identifying suitable subsidies and in the application and implementation of the project.

 

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