Living in a Carbon-based World:
CO2 and its impact on the EU Power
Sector
Gavin Bell
March 2010
First, a little about me...
Ph.D. from Canterbury


EMRG
One of the many from Canty that ended up in Europe...
Worked since 1999 in energy sector as consultant and in
industry



UK, Germany, Austria, Netherlands, Spain, Albania, Montinegro,
Macedonia, Norway, Denmark, Czech Republic, Cuba
Headed up the continental power market analysis team and
the cross commodity analysis team at Statkraft



Europe’s largest renewable generator
Around 55 TWh annual production
Currently CEO of Ably (plant data and analysis firm) and
independent consultant


2
Based in Norway since 2003
ecovest limited
13.04.2015
Key EU ETS Takeaways
EU ETS market is part of an ”energy complex” involving
power, fuels, CO2, and other commodity markets



Each drives the other
Increasingly, money cannot be made in one market only – you
need to look at them all simultaneously
CO2 will drive increasing internationalisation of energy
markets, as CO2 markets interlink


EU ETS in the forefront
Any CO2 market is a political beast – politics drives the
price and direction

3
ecovest limited
13.04.2015
Outline
EU ETS Overview
A multi-commodity energy complex
Short term interactions
Long term interations and drivers
Summary





4
ecovest limited
13.04.2015
EU ETS Overview
EU ETS – What is it?
Technically...
Really...
Classic cap and trade system to
regulate CO2 emissions in the EU
+ EEA countries
Absolute limit on CO2 emissions
Allowances distributed to facilities
covered by the scheme





>12000 facilities
>4000 companies

Commercially crucially important
market in the EU energy sector
Driver of investments




Participating facilities surrender an
allowance per tonne CO2 emitted
during annual compliance periods



Hedging



Exposed to CO2
Need to mitigate to manage risk
Trading

6
Impact on price
CCS
CERs
Credit rating
ecovest limited
Direct opportunity to make money
13.04.2015
ETS Summary
2005
2007
Phase 1
Trial Period
• 95% free
allowances
• Allocation of
permits done
nationally
(National
Allocation
Plans - NAPs)
7
2008
2012
Phase 2
2013
2020
Phase 3++
Kyoto Period
Post-Kyoto Period
• Tighter limits based on phase 1
experience (6.5% below 2005)
• 90% free allowances
• 3% Auctioning
• 6% New Entrant Reserve
• EEA included
• Allocation via NAPs
• Can import credits from other
flexible mechanisms
• Appx. 12% of total
• 43% of EU emissions (incl.
Aviation, CCS)
• Single EU Cap, reducing 1.74%
p.a.
• Auctioning – 50% in 2013, 100%
by 2027
• 100%(ish) auctioning in power
sector from 2013
• Links with 3rd Country
schemes; harmonisation of
CDM/JI rules
ecovest limited
13.04.2015
Banking and borrowing
Banking and borrowing allowed within a phase
No banking or borrowing between phases 1 and 2



A key reason for observed priced development
Banking allowed from phase 2 to phase 3




8
Linking prices in these two phases
Especially important now phase 2 seems long
No borrowing
ecovest limited
13.04.2015
Distribution of allowances

Two key ”sectors”

Cement,
Lime,
Glass
11%

Other
8%
Public
Power and
Heat
59%
Oil and
Gas
9%
Metals
11%


Behave differently in relation
to ETS
Industry



Pulp and
Paper
2%

Generally long
Reduce emissions via
investment (med-long term)
Often annual or ”period” view
Power sector



9
Power
Industry
ecovest limited
Generally short
CO2 price impacts dispatch
Hedging of power production
13.04.2015
EU ETS History
35
30
Fuel bull
run
2nd
phase
NAP cut
25
EUA Price (€/t)
Fuel bull
run
Financial crisis
Fuel bear run
20
15
10
5
2005
Verified
emissions
Industrial length
gradually in market
Oil, equities bull
run
0
2005
2006
2005
10
2006
2007
2007
2008
2008
ecovest limited
2009
2009
2010
13.04.2015
A multi-commodity energy
complex
CO2 and Power (and fuels, currencies, interest rates etc etc)
Complex interactions driving markets
Coal
Coal
Fuel
CO2
SRMC
8
10
33
Price of CO2
Fuel
CO2
SRMC
8
12
35
Price of gas
Gas
Gas
Fuel
CO2
SRMC
Fuel
CO2
SRMC
20
10
39
15
12
31
Price of CO2
Price of gas
12
ecovest limited
13.04.2015
CO2 and power market interaction
Short term

The power stack



Stack driving emission levels
ETS price impacting the stack
Non-market external effects



Driving power and heat demand
and availability (hydro, wind)
Hedging, market psychology
Energy complex

Oil a strong sentiment driver of
power and CO2 (++)
External economy (e.g. recent
demand destruction)
13


Weather


Long term


CO2 market is key driver in
investment decisions
Power market investments
(emitting vs non-emitting)
driver of future CO2 price
CO2 price feed-through to
power price a driver of
future power demand
Future CO2 price driver of
todays CO2 price (banking
effect)
ecovest limited
13.04.2015
Question...
What is correlation
and what is causality?
14
ecovest limited
13.04.2015
Short term interaction
The classic – fuel switching

SRMC
Coal – gas fuel
switching

Relationship between gas,
coal, and CO2 drives stack
and emissions
Other aspects reduce fuel
switch flexibility

CO2 cost


nuke, wind
coal
lignite
16
Fuel contracts
Inflexibilities in fuel access
Don’t always get the fuel
switching you expect...
gas, oil GT
CCGT
ecovest limited
13.04.2015
Acc. Changes:
fuel prices &
weather
EUA Dec-08
02
.
01
.2
00
02
8
.0
3.
20
08
02
.0
5.
20
08
02
.0
7.
20
08
02
.0
9.
20
08
02
.1
1.
20
08
02
.0
1.
20
09
02
.0
3.
20
09
02
.0
5.
20
09
02
.0
7.
20
09
02
.0
9.
20
09
02
.1
1.
20
09
Mill tonnes
100
80
60
40
20
0
-20
-40
-60
-80
-100
-120
-140
-160
-180
-200
-220
-240
-260
17
ecovest limited
30
28
26
24
22
20
18
16
14
12
10
8
€/t
Impact of fundamentals
Source: Point Carbon
13.04.2015
But it’s not a ”tick the boxes” world...
1,00
Relationships are not
straightforward, nor
consistent
0,50


CO2 - EEX Spot Correlation
1,50
0,00
18.12.2008 28.03.2009 06.07.2009 14.10.2009 22.01.2010
-0,50
-1,00
CO2 - Coal Correlation

1,50
1,00
0,50

0,00
18.12.2008 28.03.2009 06.07.2009 14.10.2009 22.01.2010
-0,50
-1,00
18

Sometimes, CO2 can
explain power price
movements, sometimes its,
say, coal and gas prices, or
something entirely different
Often possible to know in
hindsight...
But forecasting is not easy
Q: What sort of analysis is
useful...?
ecovest limited
13.04.2015
Hedging activities



Hedging of production
begins already 3 years ahead
CO2 part of that hedge
Thus, begin to hedge
production in phase 3 of ETS
from 2010 onwards



BUT – phase 3 allowances not
yet available
Via purchase of phase 2
(2012) allowances for banking
Year
CO2 volumes
2010
250
2011
700
2012
1250
Total
2200 Mt
Hedging demand can drive
prices
19
ecovest limited
Could turn a long
phase 2 market
into a short one...
13.04.2015
35
160
30
140
120
EUA (€/MWh)
25
100
20
80
15
60
10
5
20
0
0
14.11.2007
20
40
01.06.2008
18.12.2008 06.07.2009
EUA
Brent Crude
ecovest limited
22.01.2010
10.08.2010
Brent Crude ($/bbl)
Crude oil – key sentiment driver
Economy driving demand in power and CO2

Mt
2500
Significant demand
destruction as a result of
financial crisis – from 2008
to 2009:

2000


Less demand for EUAs


1500
2008
2009
2010
2011
2012
Source: Point Carbon
21

Germany: 6% decline
France: 3% decline
Lower price
Pressure on power prices
Market is expected long in
phase 2...
ecovest limited
13.04.2015
Phase 2 market balance


400

short
300
100

0
-100

long
-200
2008
EUA Shortage
2009
2010
2011
2012
Credits available for EU ETS
Source: Point Carbon
22

Including credits: 970 Mt
In theory...

200
Mt
Market is long in phase 2
Price in phase 2 should
equal discounted price in
2013 (first year, phase 3)
Prices today are lower than
this...
Anticipate at least that
phase 3 will increasingly
impact phase 2 prices
What is driving phase 3
price expectation?
ecovest limited
13.04.2015
Long term interaction
CO2 price in 2020 and beyond

How can we assess the long term price?


And thus today’s ”equilibrium” price level?
Equilibrium model


What price balances supply and demand
That is, long term relationships between




Power and CO2
Industry and CO2
CERs, other ETS schemes and the EU ETS
Or... an educated guess – it is a political process after all


24
What price needed to drive CCS?
EU effectively target long term caps to achieve this price level...
ecovest limited
13.04.2015
Phase 3 supply: political and commercial
process

Steadily declining allowance cap




21% below 2005 emissions in 2020
Power sector (more-or-less) 100% short
Industry reducing from 80% free allowances in 2013 to
30% in 2020
CERs/ERUs

Supply depends on a ”post Kyoto” agreement



Credit limit of at least 11% of the phase 2 allocation
Can choose when to use the credits (phase 2 or phase 3)

25
No agreement, only Kyoto + ”bilaterals” CERs
But, max 1400 Mt in phase 2
ecovest limited
13.04.2015
Phase 3 demand: interation between
markets

Power and heat

Change in stack, through investments and retirements





Expected future prices (fuels, capital costs, exhange rates, cost of
money)
Portfolio considerations
Other mechanisms – e.g. Renewables directive
Demand for power and heat
Industry

Economic growth


26
Change in energy intensive industry in EU
Change in carbon intensity
ecovest limited
13.04.2015
And the results...
Bottom up forecast

”Political” forecast...
Typical price forecast
ranges for CO2 for 2020





Point Carbon 37 €/t
Barclays – 40 €/t long term
Deutsche Bank 30 €t
UBS – 20 €/t
UK EAC – 22 €/t
Plant investment
CCS investment
WACC
Annualised
Load factor
CCS capital cost

€/kW
€/kW
The CCS approach (or
€/kW/a
renewables or whatever...)
for, say, 2025
22 €/MWh
75 % cost
Additional capital
kr 7 €/MWh
 Reduction in efficiency
Fuel cost
75
€/t
 CO2 emissions11saved €/MWh
Efficiency, no CCS
44 %
 +
Efficiency,
CCSfuel cost assumptions
34 %
Additional Gen. Cost
7 €/MWh
etc...
Extra fuel cost
36 €/MWh
 Around 50 €/t 49
(2025)
CO2 price
Capture rate
90 %

Discounts
to
35 €/t (2020)
CO2 cost saved
36 €/MWh
Old load
 factor
Plant capital cost
Difference
27
1100
1100
8%
113
50 %
ecovest limited
0,00 €/MWh
13.04.2015
Summary
Summary

CO2 (via ETS) integral part of EU energy markets




Complex interactions between these markets



Investment
Hedging
Trading
Drive prices
Significant and dynamic relationship between long and short
term dynamics
And don’t forget it is a political process

29
Once there is an ETS, there’s a strong pressure for consistency
and predictability
ecovest limited
13.04.2015
Gavin Bell
ecovest limited
Armauer Hansens gate 6a
0455 Oslo, Norway
tel: +47 950 27979
bellgj@hotmail.com