Effectiveness of allocation options
and market clarity
in the EU ETS
Marcus Evans conference
London
22nd of January 2007
Vianney Schyns
Manager Climate & Energy Efficiency
Utility Support Group
Utility provider for a.o. DSM and SABIC
Contents
1. Shortcomings present cap & trade rules
2. Effect cap & trade on electricity
3. PSR
 Relevant EU data chemical industry
4. Market clarity cap & trade versus PSR
5. Benchmarks with ex-post adjustment to actual
production as an alternative to auctioning
Shortcomings present
implementation EU ETS Directive
The EU Emissions Trading Directive is the
centrepiece of EU Climate change policies, rightly
so, but structural improvements are urgently
needed
Basics of shortcomings present allocation
• Existing plants: ex-ante frozen cap based on
historical emissions – rewarding pollution – same
quantity allowances, whether production increases or
decreases (“static, frozen economy”)
• New plants and debottleneckings: also an ex-ante
frozen cap (“plan-economy”)
• This allocation principle = root cause of all shortcomings,
PLUS, mostly as a result of this:
– Insecurity investments in new plants (finite reserves)
– Highly distorting transfer rules
– New plants few versus existing plants many allowances: LACK OF
EFFECTIVENESS to invest to reduce emissions
EU ETS in UK Parliament 9 January 2007
• MP Mr Adrian Bailey sees 3 basic flaws:
– History of low efficiency rewarded with more credits.
– Production growth means buying of credits.
– Less efficient companies can compensate for their inability to
develop by selling unused allowances; by decoupling the
allowances’ system from energy efficiency and relating it purely to
levels of production the scheme has developed a number of
perverse incentives that hamper investment and production in the
UK while contributing little to the reduction of carbon emission.
• Steel industry advocates average oriented baseline, to be
multiplied by the volume of steel produced. That system
would reverse the existing perverse incentives.
Cap & trade & electricity
Killer of free market
Cap & trade: market price at opportunity-cost
Euros
for an
equal total
production
volume
Killer of a free, undistorted electricity market
No sales below opportunity-cost, selling allowances
more profitable than producing electricity
EU-induced windfall profits
Company A Cost of buying
allowances:
Companies
distortion
A & B
Gross
margin
cash
flow
Opportunity
cost
A wins
market
share
from B
Profit of
sales of
allowances
Ex-ante rules simply kill electricity liberalisation
• State interference prevents competitive market
– At gross margin of opportunity-cost, winning and losing market
share: zero sum game
– New entrants, vital for more competition, but ex-ante state decision
of operating hours determine profitability – plan economy
– Transfer rules protect incumbents: barrier to entry can be € 0.25
billion for a 1000 MWe power plant (4 years, or trading period)
– Even worse: incumbent does not apply for transfer rule and keeps
old plant stand-by (imagine 1000 MWe plant, ~ € 0.2 billion/year)
• Fight for allowances overrides fight for market share
• Price of system: economic rents – windfall profits
– Cause is the opportunity to sell allowances when not agreeing a
contract (opportunity-costs)
– Transfer of wealth to € 40-50 billion/year or double (EU)
Benchmarks with ex-post as an
alternative to auctioning
The structural and workable alternative of benchmarks
with ex-post adjustment to actual production, or
Performance Standard Rate – PSR
A few PSRs have major coverage
Benchmarking Netherlands: about 100 PSRs
100%
Coverage
of
emissions
under the
EU ETS
Major chemicals (10-20 PSRs)
Refineries (1 PSR)
Cement (1 PSR)
Steel (6-7 PSRs)
Electricity (1 PSR) and
for CHP (Combined Heat
& Power) (1 additional PSR
for heat)
Policy recommendation:
include (co-)firing biomass
PSR = WAE – CF x (WAE – BP)
Product 1
steep curve
Specific
energy use
or CO2
emission
Normalised curves
Weighted
average 1
Product 2
flat curve
PSR 1
Best
Practice
PSR 2
Weighted
average 2
Decreasing efficiency order of plants
Recent chemical EU efficiency data
EU bechmark data major chemicals
Product
Consultant
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
Weighted
EU Best
Efficiencies
PSR = WAE - CF x (WAE - BP)
EU average Practice
Electricity Heat
CF = Compliance Factor =
WAE
BP
15%
20%
GJ/ton
GJ/ton
Steamcrackers (1)
Solomon Associates
144,8
107,8
37,5%
90%
139,3
137,4
Pyrolosis gasoline (pygas)
Process Design Centre
1,3
0,6
42%
90%
1,2
1,2
Benzene extraction
Process Design Centre
3,8
2,2
42%
90%
3,6
3,5
Butadiene
Solomon Associates
9,72
7,3
37,5%
90%
9,4
9,2
MTBE
Process Design Centre
1,9
1,06
42%
90%
1,8
1,7
ldPE (low density polyethylene)
Phillip Townsend Associates
8,53
5,96
42%
90%
8,1
8,0
hdPE (high density polyethylene)
Phillip Townsend Associates
5,43
3,14
42%
90%
5,1
5,0
PP (polypropylene)
Phillip Townsend Associates
3,56
2,27
42%
90%
3,4
3,3
EPDM (ethylene propylene rubber) (2) Phillip Townsend Associates
32,22
28,0
42%
90%
31,6
31,4
PVC (polyvinyl chloride)
Process Design Centre
3,8
3,4
42%
90%
3,7
3,7
Nylon-6
Process Design Centre
10,0
5,71
42%
90%
9,4
9,1
Ammonia (3)
Plant Services International
13,13
7,23
40%
90%
12,2
11,9
Nitric acid
Process Design Centre
-0,12
-1,8
42%
90%
-0,4
-0,5
Fertiliser (Calcium Ammonium Nitrate)Process Design Centre
0,99
0,35
42%
90%
0,9
0,9
Urea
Plant Services International
5,06
3,06
42%
90%
4,8
4,7
Melamine (4)
Nexant
79,46
60,55
42%
90%
76,6
75,7
Caprolactam excl. cyclohexanon
Process Design Centre
8,7
-0,9
42%
90%
7,3
6,8
Acrylonitril (2)
Phillip Townsend Associates
-6,2
-8,3
42%
90%
-6,5
-6,6
Yeast
Process Design Centre
5,9
5,62
42%
90%
5,9
5,8
1) Solomon energy efficiency index (EEI) adjusted for supplemental feeds
2) WAE and BP are not EU but worldwide data (for confidentialilty reasons)
3) 20.67 GJ/ton feedstock energy (these process emissions fall outside the EU ETS)
4) These data include feedstock use which must be subtracted: 29.5 GJ/ton ammonia and 21.99 GJ/ton urea incl. ammonia use.
Typicals are: 3.2 ton urea and -0.9 ton ammonia, both per ton melamine. This gives WAE = 35.6 GJ/ton melamine and BP = 16.7 GJ/ton melamine.
Shell, Dow, SABIC advocate equal EEI (for example 136) steamcrackers
Benchmark with ex-post + guarantee total cap
Benchmark with ex-post electricity
(without contingency reserve)
FORECASTS
Start
Ex-post
over 2008
done in 2009
to 2010
Ex-post
over 2012
done in 2013
to 2014
Scenario with a higher production growth than forecasted
Second trading period
Third period
2008
2009
2010
2011
2012
Total
2013
Production fossil, TWh
2000
2034
2069
2104
2140
10346
Benchmark, ton CO2/MWh
0,600
0,590
0,580
0,570
0,561
Total cap, Mton CO2
1200
1200
1200
1200
1200
6000
Fixed
Fixed
Update production fossil, TWh
Ex-post, TWh
Ex-post, Mton
Allocation, Mton CO2
Benchmark, ton CO2/MWh
Total cap, Mton CO2
Update production fossil, TWh
Ex-post, TWh
Ex-post, Mton
Allocation, Mton CO2
Benchmark, ton CO2/MWh
Total cap, Mton CO2
2030
2034
1200
0,600
1200
Fixed
1200
0,590
1200
Fixed
2030
2045
1200
0,600
1200
Fixed
1200
0,590
1200
Fixed
2090
30
18
1194
0,571
1212
Fixed
2130
30
18
1194
0,571
1212
Fixed
2125
2155
1194
0,562
1194
1194
0,554
1194
2140
11
6
1191
0,563
1197
Fixed
2175
40
23
1168
0,538
1191
Fixed
2014
10434 Update forecast
6000
10520
6000
2190
25
14
986
0,450
1011
Fixed
2230
5
3
997
0,447
1002
Fixed
• Novel method guarantees total cap, as demanded by EU Directive
• Virtually no interest costs
• Easy & fast introduction possible on the basis of estimated benchmarks
(system is self-adjusting)
Market clarity cap & trade versus PSR
Shortage of allowances in cap & trade less
predictable than with PSR
Cap & trade historical grandfathering
Great influence of individual growth or shrinkage & weather
Cap
Buying allowances
Specific
energy use
or CO2
emission
Best
Practice
Free allocation
Cap based
on historical
emissions
Decreasing efficiency order of plants
Market clarity cap & trade versus PSR
Shortage to cap & PSR
250
Production & kton CO2
200
150
Production forecast
Production realisation
100
Cap
Shortage to cap
50
Allowances PSR realisation
0
Shortage to PSR
1
2
3
4
5
6
7
8
9
10
11
12
-50
-100
Time
Cap & trade: a planned shortage can turn into a surplus, or is forced into
surplus when selling allowances is more profitable than producing (leakage)
Benchmarks with ex-post adjustment to actual
production as an alternative to auctioning
Same incentive for low carbon
technologies
Auctioning is detrimental to EU
competitiveness
Auctioning EU: clear incentive low carbon technologies, length
trading period irrelevant, but leakage & detrimental for competitiveness
Total
cap
Buying allowances
Specific
energy use
or CO2
emission
Best
Practice
Free allocation
Weighted average
Incentive
Incentive
Decreasing efficiency order of plants
Performance Standard Rate trading: same incentive as auctioning,
length trading irrelevant, (hardly or) no leakage, good for competitiveness
Total
cap
Buying allowances
Specific
energy use
or CO2
emission
Best
Practice
Free allocation
Selling allowances
Weighted average
Incentive
PSR
=
total
cap
Incentive
Decreasing efficiency order of plants
Misunderstandings power market cleared
• Fuel specific benchmarks: against objective function
= High fuel-switch prices, e.g. € 300-500/ton CO2
= Coal power plants without CCS encouraged
• One electricity benchmark no deathblow coal-fired power
= Coal & lignite very important, climate policy means CCS !
= Opportunity-cost now in power price (soft cost)
= One benchmark with ex-post: CO2-cost in power price (real cost)
• Dash to gas with one benchmark?
= Does not depend on one benchmark, but on total cap
= In fact more gas if more new coal and less CHP (given total cap)
= We need a controlled transition (CCS needs time)
What may happen next?
NAPs can be modified
Legal case Germany against EU Commission
Starting with benchmarks is easy
Outlook post 2012
Outlook post 2012
• Post 2012 regime heads for benchmarking, auctioning or a
combination (away from historical grandfathering)
– Industry against auctioning (if no global participation)
– EU-wide instead of national “corrected” benchmarks
• HLG and EU Commission seek stimulating low carbon
technologies, e.g.
– CHP, Carbon Capture & Storage, efficiency & innovation
– Distorting transfer rules, solution: same benchmark
• Ex-ante (windfall profits and market distortions) or ex-post
– Regional (EU, USA, China, India, etc.) differentiated relative targets
option for global climate agreement – transition periods can be vital;
– Long-term (2020 or 2030) absolute caps carved in stone deter
participation, targets may be too strong or too soft (EU energy
package, experience Burden Sharing)
Transition for a faster global trading scheme
PSR:
Specific
energy use
or CO2
emission
PSR China-India
Incentive low carbon technologies
the same in global trading scheme
PSR USA-Canada
PSR EU-Japan
Global PSR
Transition period (with 3 or more PSRs) avoids high cost
in case of auctioning for regions with higher emissions per
unit of product (vital: PSRs without differentiation new/old plants)
2008
2012
2017
2022
2027
2032