Last month, the European Union announced its proposal for Phase 3 of the European Union Emissions Trading System (ETS), an expanded emissions cap and trade program that will add chemical manufacturers to its list of regulated industries by 2013. EU officials have declined to estimate the likely cost to newly-captured chemical manufacturers, but considering the government’s estimate that the larger proposal may cost €60 billion ($88 billion US) by 2020, chemical executives and investors have a strong incentive to monitor the progress of this proposal closely to ensure that any final decision is workable for an industry already struggling with record-high hydrocarbon feedstock and energy prices.

Perhaps more importantly, the Proposal gives no attention to the fact that under the current ETS implementation schedule, many chemical manufacturers will face ETS requirements for the first time, while simultaneously struggling to comply with yet another multi-billion dollar regulatory program known as “REACH” (Registration, Evaluation, Authorization and Restriction of Chemicals).

Individually, these programs may make policy sense. In combination, however, these two new programs, if not implemented carefully, may damage one of the EU’s most important industries. In today’s global economy, that would be bad news for the EU and for its trading partners.

ETS and the Chemical Industry

The ETS expansion proposal targets certain chemical manufacturing processes that generate large quantities of carbon dioxide or nitrous oxides, both potent greenhouse gases. The affected chemicals are used in a wide variety of products:

• carbon black (used in pigments and tire manufacturing),
• adipic acid (used in nylon and plastic manufacturing),
• nitric acid and ammonia (used in commercial fertilizer),
• hydrogen and synthesis-gas production (used in fuel cells and other energy applications),
• soda ash and sodium bicarbonate (used in glass, chemicals, and soap production), and
• organic chemicals produced through petrochemical cracking operations (used in a wide variety of industrial applications).

According to the proposal, in 2013, affected chemical manufacturers would need to reduce emissions by 20% from historic levels or purchase the allowances needed to cover excess emissions auction or on the market (currently trading at about €22 ($32 US) per ton). In later years, companies would have to make progressive reductions or purchase more allowances. The EU has downplayed the risk of competitive injury to EU’s chemical industry from the program, and has insisted that such concerns, if any, can be addressed during the implementation through increased allocation of free allowances to at-risk sectors.

REACH and the Chemical Industry

REACH is the most stringent chemical regulation established in any country to date, requiring manufacturers and importers to prepare detailed registration dossiers and conduct extensive testing and data sharing as a condition of access to the EU market. Chemicals with no prior history of use must complete the registration process before entering the EU market. For substances with a history of use in the EU, REACH establishes a three-phase registration schedule depending on the quantities of the substance imported or manufactured by the registrant:

• Substances imported or manufactured in quantities of more than 1,000 tons per year must complete registration by 2010.
• Substances imported or manufactured in quantities of between 100 and 1000 tons per year must complete registration by 2013.
• Substances imported or manufactured in quantities of 1 to 100 tons per year have until 2018 to complete registration.

REACH may establish a volume-based phase-in schedule in principle, but regulated manufacturers and importers, and non-EU trading partners, will have to dedicate management and legal resources to cross-registrant negotiations throughout the 10-year registration period (indeed, most registrants have already started planning). With an estimated 30,000 substances affected by REACH, the process may have a significant impact on the price and availability of many commonly-used products for years. The EU estimates that REACH will cost industry between €2.8 and €5.2 billion, and will likely hasten consolidation and concentration within the chemical industry as smaller producers are “crowded out” of the market. Indeed, many U.S. companies are still struggling to determine whether and how they can ensure that any substances used in exported products will be REACH-compliant by December 2008.

Avoiding a Mid-Course Collision

The EU is introducing two separate regulatory programs that have the ability to shake up the cost and supply structure for chemicals and chemical-containing products used worldwide. To date, there has been remarkably little discussion regarding how these two programs may work in tandem. Now is the time for affected companies and industries to assess their regulatory exposure under these dueling programs and to take the business and risk management steps needed to avoid a last minute regulatory (and business) crisis.

For further information about this topic, please contact Akin Gump.