Climate change: challenges &
the search for a
sustainable policy
Symposium Sustainable Energy
Eindhoven University of Technology
Designers association “Octave Levenspiel”
31 May 2005
Eindhoven, Netherlands
Vianney Schyns
Manager Climate & Energy Efficiency
Utility Support Group
Energy provider for DSM & SABIC
Clim. change tech.& policies Tue 31May05.PPT
Contents
• History of a successful change
– Political views early 21st century
– Shaping a carbon constrained economy
• Where we are today
– Technology & policy challenges
– Policy cap & trade emissions trading: fitness for purpose
– Electricity & opportunity cost
• Alternative policy: Performance Standard Rate (PSR)
– Policy objective: effective trading scheme
– How it works
2
History of a
successful change
How we might look back
in 2030
Political views beginning 21st century
• Climate change increasingly perceived as a potential
significant threat to our way of life
• 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 is … 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
Meaning for industrial actors
• Inefficient plants undertook improvement investments or
closed earlier than BAU (Business As Usual)
• Production shift to efficient plants (new or existing)
• Fast growth of gas for CHP (industrial heat use)
• Development & implementation innovative technologies
(reward front runners)
• Carbon sequestration
• Biomass
8
Climate change policy
Where we are today
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 …
= 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
• Immense support for renewables
– Spurs significant (too fast) growth; although also sudden changes:
wind in Denmark & NL (subsidy stop off-shore, 2005)
• Still much scope for CHP (Combined Heat & Power)
– EU wants to double penetration (9% to 18% in 2010), but …
allowances in Europe make no difference
• Acceleration need innovation (“clean, clever,
competitive” EU Council)
– Reward frontrunners with emission allowances & special support
• European Union started cap & trade scheme in 2005
– Theory of cap & trade is based on incorrect assumptions
– Challenge to reform the transposition of the Directive
13
Cap & trade: assumptions of the theory
• Scientific 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
Energy use
15
PSR: the conventional picture
Claim: no certainty of outcome
Emission
Allowances
under a PSR
Energy use
16
Reality of combined picture: law of physics
Emission breaks through cap if energy > forecast
Emission
Allowances
under a cap
Allowances
under a PSR
Energy use
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: the real picture
Emission
Forecasted energy use
Business as
usual
Energy use >
expected margin:
export emissions
or paying penalty
Emission
Cap
Maximum fuel switch electricity,
determines CO2-price
Very low
CO2-price
High CO2-price, possibly
> penalty price
Energy use
19
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
20
Transaction costs: cap & trade versus PSR (1)
• Cap & trade
– Allocation formulas often complicated
– Biggest debate Europe: how representative is a
historical reference period; reference periods differ in
all countries; therefore:
= Negotiations
= Serious competitive distortions across Europe
= Law suits
– Data collection & verification
• Transaction costs cap & trade
– Not negligible, but certainly bearable
21
Transaction costs: cap & trade versus PSR (2)
• 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
22
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
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: serious distortions
Limited incentive reduction investments: historic reference later
No incentive for closure: no allowances after same year or period
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
Example competitive distortions (1)
Shortage of allowances ammonia, efficiency EU average, production steady
at 1000 kton/year
140
Shortage kton CO2/year
120
100
80
Series1
60
40
20
0
1
2
3
Netherlands, UK, Germany
Ammonia excl. process emissions
Assumption: ammonia in trading scheme (not yet in UK, Germany)
26
Example competitive distortions (2)
Shortage of allowances ammonia, efficiency EU average, production DSM
Agro (2001 & 2002 happened to be low)
300
Shortage kton CO2/year
250
200
150
Series1
100
50
0
1
2
3
Netherlands, UK, Germany
Other historical reference periods: NL 2001 & 2001;
UK average best 5 years 1998-2003; Germany average 2000-2002;
27
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
28
Electricity & opportunity-cost principle
• Electricity
– No storage, no imports from overseas (regional markets)
– Severe demand fluctuations (day/night, weekend), reserve gas-fired
• Opportunity-cost principle under cap & trade
– Sell allowances when lowering production (no new sales contract)
– Allowances: generally free of charge for 95% of need
– Therefore: CO2-price fully in electricity cost-price, windfall profits
• Fundamental problems cap & trade electricity
– Polluter-earns principle
– Inhibitor of a competitive market: enhancement of frozen market
shares (market share winner must buy allowances)
– Trading scheme advantage turns into one-sector winner
• Root cause: frozen caps give opportunity
29
European merit order electricity (EU-15)
Short run
marginal
cost
€/MWh
Market price
indications in
regional markets
before emissions trading
60
Range European short run marginal cost
Italy
40
Oil
Netherlands
Germany, Belgium, France, UK
CCGT
20
OCGT
Gas
Boiler
Coal & lignite
Wind
Hydro
100
Source: IEA data
Nuclear
300
500
Installed capacity (GW)
30
1st substitution: influence on merit order
Short run
marginal
cost
€/MWh
1st substitution: Coal by Combined Cycle Gas Turbine
Range European short run marginal cost
CO2-price € 6/ton
60
40
Oil
OCGT
CCGT
20
Price increase
€ 3-6/MWh
Wind
Hydro
100
Source: IEA data
Gas
Boiler
Coal & lignite
Nuclear
300
500
Installed capacity (GW)
31
2nd substitution, same price difference coal - gas
Short run
marginal
cost
€/MWh
2nd substitution: Coal by gas boiler
Range European short run marginal cost
CO2-price € 22/ton
60
40
Oil
OCGT
CCGT
20
Price increase
€ 11-20/MWh
Wind
Hydro
100
Source: IEA data
Gas
Boiler
Coal & lignite
Nuclear
300
500
Installed capacity (GW)
32
Electricity windfall profits by cap & trade
€/ton CO2
Substitution price (coal € 2.3/GJ; gas € 3.5/GJ)
Electrity price increase by opportunity cost
Capacity hrs/year: Assume
ton CO2 Installed 8000 Load
per MWh
Hydro
Wind
Nuclear
Coal
CCGT average
Gas boiler
OCGT
Oil
37%
49%
40%
35%
40%
0
0
0
0,91
0,41
0,50
0,97
0,75
GW TWh Factor
120 960 0,5
15 120 0,2
120 960 0,8
150 1200 0,7
40 320 0,4
30 240 0,2
18 144 0,1
60 480 0,62
4424
Fuel Substitution
min
2,7
CO2
Opp.
Real CO2
Cost CCGT CO2 Cost Cost Cost
TWh Mton € mln TWh Mton € mln € mln € mln
480
0
480
0
0
0 1.314
24
0
24
0
0
0
66
768
0
pm 768
0
pm
0 2.102
840 768 18.798 700 640 15.665 -850 1.916
128
53 3.291 268 110 6.891 383
733
48
24 1.512
48
24 1.512
0
131
14,4
14
518 14,4
14
518
0
39
297 223 9.359 297 223 9.359
0
813
2600 1082 33.479 2600 1012 33.946 -467 7.114
CO2-reduction, sales to other sectors
Real cost of fuel switch (additional fuel costs)
Windfall profit (€ mln)
Fuel
6,64
€/MWh
(assumption: 100% grandfathering of allowances)
Revenues of CO2-sales
Total cash flow (€ mln)
€/ton CO2 22,26
€/MWh
min
11,2
max
20,4
CO2
Opp.
Opp.
Cost Boiler CO2 Cost Cost
Cost
€ mln TWh Mton € mln € mln € mln
2.915 480
0
0
0 5.396
146
24
0
0
0
270
4.664 768
0
pm
0 8.634
4.251 610 557,9 13.651 -4684 6.858
1.627 268 110,5 6.891 1285 3.013
291 138 69,68 4.347 1012 1.551
87
14 13,92
518
0
162
1.804 297 222,8 9.359
0 3.340
15.786 2600
975 34.767 -2387 29.223
Cost
€ mln
9.774
489
15.639
12.422
5.457
2.810
293
6.050
52.935
max
6,1
Opp. Substitution
-70
Fuel
-107
467
467
-37 additional
6.647 15.319
467
467
7.114 15.786
1.288 1.288
27.935 51.647
CCGT extra CO2-profit
2.387 2.387
30.322 54.034
• Windfall profit at € 20/ton CO2: € 20-30 billion/year
• Optimisation profit of the scheme at € 20/ton CO2: € 2.5 billion/year
Source: EU Commission
• Price below fuel + opportunity-cost: cut production & sell allowances
33
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”
34
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
36
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
37
PSR: incentive suited for purpose
Certainty of reward for reduction investments
PSR year 1
Allowances coupled to
production level
Emission
Key feature:
project reward,
independent
of future PSR
PSR year n
Allowances coupled to
production level
Emission at
same production level
38
PSR: incentive suited for purpose
Successful reward of carbon sequestration
PSR year 1
Allowances coupled to
production level
Emission
Key feature:
project reward,
independent
of future PSR
PSR year n
Allowances coupled to
production level
Example: clean coal plant
Emission at
same production level
39
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
40
Few PSRs: already 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
41
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%
42
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
43
Practical recommendations to start in 2008
• Consultants for data collection 2003 or 2004
– Electricity: emission & production incl. heat for CHP (6 months job)
– Steel: similar
– Probably already available: cement, refineries, steamcrackers,
ammonia, sugar, 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” with industry experience for main
products (fresh & independent views)
– Hire consultants for concrete jobs, no theoretical studies
44
Conclusion
• Major transform of EU scheme required to avoid
loss of real progress for 8 years, to ensure
compliance with:
– Worldwide environmental integrity
– Polluter-pays principle and competition rules, two
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, essential for
environmental results and in full support for the
Lisbon strategy in Europe as well as global welfare
45