Climate change challenges &
the search for a
sustainable policy
Unity of fitness for Purpose,
Polluter-pays principle & level Playing field
8th International Conference on
Carbon Dioxide Utilization
ICCDU-VIII
20-23 June 2005
Oslo, Norway
Vianney Schyns
Manager Climate & Energy Efficiency
Utility Support Group
Energy provider for DSM & SABIC
Sustainable policy ICCDU 20June05.PPT
Contents
• History of a successful change
– Imagine we live in 2030, and imagine we were successful
• Where we are today: Cap & Trade
– Technology & policy challenges
– Cap & trade: negative unity of basic principles
= Fitness for Purpose, Polluter-pays principle & level Playing field
• Alternative: Performance Standard Rate (PSR)
– Policy objective: positive unity of basic principles
– How it works
2
History of a
successful change
How we might look back
in 2030
Political views beginning 21st century
• Climate change policies far from coherent
– Kyoto protocol nations adopted absolute caps
– USA & developing nations reluctant
• The riddle of absolute caps was questioned
– Would acceptance of an absolute cap be responsible behaviour for
a developing nation?
– What scientific method exists for establishing a cap?
– What is the influence of actor decisions on climate change when
building a new installation in country A or B?
4
Shaping a carbon constrained economy
• Consensus: in a carbon constrained world sustainable
progress needed in all fields e.g.
–
–
–
–
–
Energy efficiency
Carbon sequestration (capture & underground storage)
Biomass
Renewables
Nuclear (inherent safe & fusion)
• Needed was … and … and
– No single solution (yet) to curb greenhouse gas emissions
– Leaving coal & nuclear no realistic scenario
• Immense challenge: absolute lowering of emissions
while maintaining growth of worldwide welfare
5
The world of our grandchildren
• Welfare growth:
• Energy efficiency improvement:
50%
40%
– Buildings, installations, transportation
• Carbon sequestration:
30%
– Capture technology breakthroughs, international CO2 pipelines, 2nd
lifetime of coal & lignite using immense reserves
• Biomass economy:
20%
– New impulse to co-operation industrialised & industrialising nations
(sustainable plantations, concentrating technologies, use for electricity
plants, industrial raw materials, transportation)
• Comeback of other renewables
– Wind, solar, tidal
• Hydrogen
– Upcoming energy carrier
• Greenhouse gas emissions: -35%
6
Drastic policy changes
• Innovation priority 1
– Two drivers: emissions trading + support breakthrough technologies
• Kyoto targets adapted
– Caps for nations abandoned; worldwide sector & product targets
– First industry initiatives (Al, cement, steel, chemicals …) moving to
same requirements for similar plants in whatever nation
• One standard for electricity (kg CO2/MWh)
– Otherwise not to combine: carbon constraint, future for coal by
carbon sequestration and (co-firing) biomass, adequate CHP reward
• Fundamental obstacles CDM tackled
– Arbitrary baselines changed: harmonised standards (growing list)
7
Leading to concrete actions
For industrial actors
• Inefficient plants improved or closed earlier; production
shift to efficient plants (new & existing)
• Development & implementation innovative technologies
(reward front runners) & CHP (industrial heat use)
• Co-firing biomass & carbon sequestration
8
Where we are today:
Cap & Trade
Technology challenges
Policy challenges
Technology challenges
• Large improvement potential of most processes
– Exergy efficiency most often still 10%-20%
– Innovative processes: much lower capital investment, but …
= Takes time, huge efforts & risk taking
• Intensified carbon capture technologies (clean coal)
– Achieve € 20-25/ton CO2 for sequestration by 2015 or earlier
• Wind & solar need further development
– Subsidy currently at € 100-150/ton CO2 if all investments included
(grid, back-up capacity); solar x 2-3 more expensive
10
Vision on process intensification
11
Example of (new) PI equipment
•
Higee separators
– Application example: separations & extractions
(carbon capture?)
– Compact equipment, very short residence time
12
Policy challenges
• Still much scope for CHP (Combined Heat & Power)
– Double penetration desired (9% to 18% in 2010), but …
allowances in Europe make no difference
• Acceleration need innovation (“clean, clever, competitive”
approach adopted by EU Council)
– Reward frontrunners with emission allowances & special support
• Mindset
– Absolute caps for nations (now & post 2012)
= Is Luxembourg doing better than Spain?
– Absolute caps for companies (EU trading scheme)
13
Cap & trade: assumptions of the theory
• Scientific economic literature: advocates argue
cap & trade superior to PSR (Performance Standard
Rate)
• Cap & trade versus PSR would offer
– Certainty of environmental outcome
– Better or necessary for market liquidity
– Significant lower transaction costs
– Better or necessary for investments to reduce
emissions
• Postulation: assumptions are not based on facts
14
Cap & trade: the conventional picture
Emission
Claim: certainty of outcome
Allowances
under a cap
Production
15
PSR: the conventional picture
Claim: no certainty of outcome
Emission
Allowances
under a PSR
Production
16
Reality of combined picture: law of physics
Emission breaks through cap if production > forecast
Emission
Allowances
under a cap
Allowances
under a PSR
Production
17
Target setting
• Any target, via cap or PSR, must take account of
– Lead time of investments to reduce emissions
– Forecasted economic growth
• Cap & trade
– Postulation: there is no scientific method for a justified
target as an ex-ante cap
18
Cap & trade & historical grandfathering
Market liquidity: great influence of economic growth & weather
Specific
energy use
or CO2
emission
Cap
Allowances unrelated
to abatement cost
Cap based
on historical
emissions
Decreasing efficiency order of plants
19
Transaction costs: PSR versus cap & trade
• PSR
– Netherlands applied about 100 PSRs: big step forward
– Cost 1 PSR: € 25-40,000 (consultant + company efforts),
often shared (multiple producers); total € 2.5-4 mln
– Allocation: 5 year period x ~ 100 Mton = 500 Mton
– Additional costs: ~ € 5mln/500 Mton ~ € 0.01/ton CO2
• Transaction costs: additional for PSR
– Already low in one small country
– Note: Verification office 10 people (industry experience), also active
for data collection & annual emission verification
20
Cap & trade & historical grandfathering
Uncertainty of reward of projects to reduce emissions
Lower emission will be in future reference period
Emission
In the absence of the
reduction project, the
company had virtually
retained cap 1
Cap trading period 1
Project emission reduction
Emission at same
production level
Cap trading period 2 or 3
Production
21
Cap & trade: failure for carbon sequestration
Failure of allocation rules in all Member States
Emission
Cap trading period 1
Project emission reduction
Cap trading period 2 (or 3) or
immediately as new entrant
Emission at same
production level
22
Theory cap & trade: wrong assumptions
• Assumptions scientific literature of advocates of
cap & trade not based on facts
• Cap & trade versus PSR does not offer
– Certainty of environmental outcome
– Better market liquidity
– Significant lower transaction costs
– Clear incentive for reduction investments
– On the contrary … lack of purpose, major failure of the
theory
23
EC Treaty & EU Directive emissions trading
Requirements EC Treaty
• Principle of equal treatment
– Between: incumbents, new entrants, incumbents & new entrants
• Competition rules: free market
– Winners of market share not hindered (innovation)
• Polluter-pays principle
– Largest scheme ever of environment to economy
Requirements EU Directive emissions trading
• Environmental integrity
– Recital 3
• To promote reductions & energy efficiency such as CHP
– Article 1 & recital 20
Current allocations rules: no compliance
– Scheme was not allowed to be postponed – benefit of doubt
24
Policy challenge EU trading scheme
• Directive transposed as cap & trade
– Polluter-earns principle: historical grandfathering (most)
– Different rules in different Member States unlevel playing field
= Serious distortions by different reference periods, different C-factors
= Plants with same efficiency & production history: different allocations
–
–
–
–
Limited incentive reduction investments: historic reference later
Disincentive closure & shift to efficient plants: punishment
No or limited incentive for high efficiency new plants
Major uncertainty for new plants: limited new entrant reserve,
first-come-first-serve
• Trading scheme lost track of purpose, lack of incentive
25
Distortions: Steamcracker current worldtop efficiency
Purchases in kton CO2/year
240
160
Expected
2nd period
80
Covenant
1st period
Benchmarking
now
Netherlands
Sales
Germany
option
rule !
UK
France?
Spain?
Germany
normal rule
80
26
Distortions: Steamcracker average EU efficiency
Purchases in kton CO2/year
240
Expected
2nd period
160
Covenant BM
now
80
1st period
Germany
option
rule ??
Netherlands
Sales
UK
France?
Spain?
Germany
normal rule
80
27
Distortions: Steamcracker state-of-the-art efficiency
Purchases in kton CO2/year
240
Netherlands
160
Note: zero sales
or purchases
as new entrant
zero incentive
80
Expected
2nd period
1st period
Germany
option
rule !
UK
Sales
Maximised
from 113% to 110% worldtop
Covenant BM now
France?
Spain?
Germany
normal rule
80
28
Steamcracker bad performer (scale change !)
Purchases in kton CO2/year
450
Minimum allocation
Covenant BM now 85% of benchmark
300
Expected
1st period 2nd period
150
Germany
option
rule ??
Netherlands
Sales
UK
France?
Spain?
Germany
normal rule
150
29
Electricity & opportunity-cost principle
• Fundamental problems cap & trade electricity
• Root cause: frozen caps give opportunity(-cost)
• Fuel-switch major driver CO2-price
30
1st substitution: influence on merit order
Short run
marginal
cost
€/MWh
1st substitution: Coal by Combined Cycle Gas Turbine
Low price differential coal – gas
Regional
CO2-price € 7/ton
market prices
Opportunity-cost below long run marginal cost
60
40
OCGT
CCGT
20
Opportunity-cost
€ 3-6/MWh
Wind
Hydro
100
Source: IEA data
Gas
Boiler
Oil
Coal & lignite
Nuclear
300
500
Installed capacity (GW)
31
1nd substitution: influence on merit order
Short run
marginal
cost
€/MWh
1st substitution: Coal by Combined Cycle Gas Turbine
Higher price differential coal – gas
Regional
CO2-price € 21/ton
market prices
Opportunity-cost at about long run marginal cost
60
40
Oil
OCGT
CCGT
20
Opportunity-cost
€ 9-19/MWh
Wind
Hydro
100
Source: IEA data
Gas
Boiler
Coal & lignite
Nuclear
300
500
Installed capacity (GW)
32
1nd substitution: influence on merit order
Short run
marginal
cost
€/MWh
1st substitution: Coal by Combined Cycle Gas Turbine
Even higher price differential coal – gas
CO2-price € 30/ton
Regional
market prices Opportunity-cost above long run marginal cost
60
Oil
40
OCGT
CCGT
20
Opportunity-cost
€ 12-27/MWh
Wind
Hydro
100
Source: IEA data
Gas
Boiler
Coal & lignite
Nuclear
300
500
Installed capacity (GW)
33
Findings electricity and cap & trade
• Fuel + opportunity-cost (F + O)
– If market price < F + O: cut production & sell allowances
– F + O serve as a cushion for electricity market price
– When CO2-price further rise, market price is pushed up
• Competition rules & caps: frozen market shares
– Market share winner buys allowances, loser sells
– Zero sum game
– Violating competition rules: hindered free trade
• Windfall profits start at € 15-20/ton CO2
– Electricity one-sector winner of the scheme
34
Unity of basic principles under cap & trade
• Historical grandfathering without benchmark
– No fitness for purpose
– No polluter-pays principle
– No level playing field
 Unity = 3 x no
• Fitness for purpose drivers
(1) Meaningful CO2-price
(2) Clear volume incentive (efficiency differentiation)
• Efficiency differentiation denies sunk cost
– Sunk cost hinder unity of basic principles
– Sunk cost can therefore only be accommodated temporarily
35
Emerging recognition of purpose problem
• Fitness for purpose
– Reduction investments should never be regretted, but …
= Cap & trade: reduction becomes historical emission in future
• Problems with cap & trade
– Quotes of advocates of cap & trade (!)
= “No sensible company undertakes reduction investments on
the basis of current allocation methods”
– Peter Vis, EU Commission DG Environment
= “Reference 2005 for allowances 2008-2012 would be perverse”
= “Old reference should be taken, but this cannot go on for ever
… next step must be bold”
36
Alternative:
Performance Standard Rate
Policy objective: effective trading scheme
How it works
Policy objective: decoupling emission & growth
Business as usual
Emission
Energy
efficiency
Biomass,
carbon sequestration,
technology breakthroughs
Production growth
38
PSR: weather & growth secondary factors
Much better market liquidity: many buyers & sellers
Specific
energy use
or CO2
emission
High abatement
cost
Weighted
average
Buyers of
allowances
PSR
Sellers of
allowances
Low abatement
cost
Decreasing efficiency order of plants
39
PSR: incentive suited for purpose
Certainty of reward for reduction investments
Allowances
PSR year 1
Emission
Key feature:
project reward,
independent
of future PSR
Allowances
PSR year n
Emission at same
production level
Production
40
PSR: incentive suited for purpose
Successful reward of carbon sequestration
Allowances
PSR year 1
Emission
Key feature:
project reward,
independent
of future PSR
Allowances
PSR year n
Example: clean coal plant
Emission at same
production level
Production
41
Cornerstones of PSR
1. Start with major emitters: limited number of products
2. PSR not timely available: each operator starts with own
efficiency; establish PSR after first year
•
Predictable business environment, operator knows efficiency will be
rewarded, PSR will emerge soon
3. PSR just below average: otherwise market unable to
supply shortage of allowances
4. PSRs will gradually tighten: environmental purpose
5. Banking & lending: market stability (5% - 7%)
6. Recommendation independent “Climate Board”
similar as for monetary policy, making annual reviews, giving policy
advice and adjusting when needed
• PSR
• Banking & lending rate
42
Few PSRs: major coverage
100%
Coverage
of
emissions
under the
scheme
Major chemicals (10-20 PSRs)
Refineries (1 PSR)
Cement (1 or few PSRs)
Steel (4-5 PSRs)
Electricity (1 PSR) incl.
for CHP (Combined Heat
& Power)
Benchmarking in
the Netherlands:
100 PSRs
43
Benchmark formula for PSR
• Benchmark data: population under the scheme
– EU-25, future with Norway, Japan, South Korea, Canada, etc.
• PSR = WAE – CF x (WAE – BAT)
– WAE = Weighted Average Efficiency
– BAT = Best Available Technique (proven Best Practice)
– CF = Compliance Factor, equal for all PSRs, reflecting equal efforts
between different types of installations
• Compliance Factor
– 2008: CF = 3% (to create CO2 market price)
– 2012: possibly 15%-20%
44
PSR = WAE – CF x (WAE – BAT)
Product 1
steep curve
Normalised curves
Specific
energy use
or CO2
emission
Weighted
average 1
Product 2
flat curve
PSR 1
PSR 2
BAT
Weighted
average 2
Decreasing efficiency order of plants
45
Transition regime to accommodate sunk cost
Action to reduce emissions is rewarded immediately
PSR:
Specific
energy use
or CO2
emission
Starting efficiency installation A
PSR A
PSR
PSR B
Starting efficiency installation B
Transition period
2008
2010
2012
2015
2017
46
Sunk cost alternative
• Burden Sharing Agreement and EU-wide PSR cause
– Frictions for Member States with efficient industries
– Frictions for companies in Member States with low efficient industries
• Better alternative accommodating sunk cost
– Reallocate part of EU development funds
– Enables clear trading scheme
• Support for industrial renewal
– Lisbon strategy
– Global welfare
47
The way forward
• Consultants for data collection 2003 or 2004
– Electricity: emission & production incl. heat for CHP (6 months job)
– Steel: similar
– Probably available: cement, refineries, steamcrackers, ammonia, etc.
• Producers must accept: keep it simple
– No correction for secondary effects
• Major countries: not waiting but taking initiative
– Germany, UK, Italy, France, Spain, Scandinavia, etc.+ Benelux with
benchmark experience (not wait for completeness, expand gradually)
– Appoint high level “champions”, partly with industry experience, for
main products
48
Conclusion
• Major transform of EU scheme required to avoid loss
of real progress for 7.5 years, compliance with:
– Worldwide environmental integrity
– Unity of Fitness for Purpose, Polluter-pays
principle, & level Playing field, three acid tests for a
sustainable scheme when attracting new participants
such as Norway, Canada, South Korea, Japan & later
USA, China, India, etc.
– A predictable business environment, leading to
clear stimulation of innovation, in full support for the
Lisbon strategy in Europe as well as global welfare
49