What’s wrong with
EU greenhouse gas emissions trading
What’s the way to go?
European Chemical Industry
Outlook 2008 Conference
Hotel Amigo, Brussels, 18 June 2007
Vianney Schyns
Manager Climate & Energy Efficiency
Utility Support Group
Utility provider for a.o. DSM and SABIC
Contents
1. What’s wrong with present EU ETS rules
•
•
•
•
•
Free competition
Power price issue
New entrants & closures
Incentive to lower production – leakage
What mean historic data for individual allocations ?
2. Solution: performance-based allocation as the
alternative to auctioning
3. Annexes
What’s wrong with present
EU ETS rules?
Free competition
Power price impact
New entrants & closures
Incentive to lower production – leakage
What mean historic data for the future ?
What’s wrong with present ETS rules (1)
 Effective ETS: Scarcity of allowances sufficient ?
 Lesson learned: allocation method is equally vital (Grubb, Delbeke)
 Ex-ante grandfathering conflicts with free market
 Uncertain incentive for improvement, “updating” problem
 Short allocation new plants
 caused highly distorting transfer rules, barrier to entry
  example 1000 MWe coal-fired plant: € 250-300 mln incumbent
advantage
 Plant replacement without loss by closure, if more plants on a
site or if old plant stand-by
  example 1000 MWe coal-fired plant: € 200-250 mln/year
incumbent advantage
 Ex-ante grandfathering enhances market concentration
What’s wrong with present ETS rules (2)
• No sales below opportunity cost
• Selling allowances is then more profitable than producing
• Amazing impact on electricity profits by EU legislation
Economic rents:
 Period 1: perhaps
€ 15 billion/year average
 Period 2: double,
triple or even quadruple
 Competitiveness
European industry
strongly affected
What’s wrong with present ETS rules (3)
 Unsolvable dilemmas new entrants (NE) & closures (C)
(see e.g. also Grubb and Neuhoff, Stern, Egenhofer, Weishaar, Matthes, Schyns,
Ecofys report for the EU Commission)
 Theory: freeze allocation [all allowances after C & zero for NE]
 Zero for NE actually hinders low carbon investments/competitiveness
 Retaining allowances after C – how long? – is worse than transfer
rules, as we saw
 Withdrawal allowances after C: perverse incentive keeping inefficient
plants operational
 Most authors elaborate on these problems, but fail to
conclude that within ex-ante frozen caps solutions are
simply impossible  search for square circle
What’s wrong with present ETS rules (4)
 Lowering production no benefit for the environment
 J.H. Dales (1968): “Pollution in one region must never be reduced
by increasing pollution in another”
 Lowering production and importing goods = exporting the problem
leakage of emissions outside EU
 Not intended in aims of Directive
 Danger for CO2- and electricity intensive processes (cement, steel,
ammonia, aluminium, electrolysis, etc), but this must be seen as a
fundamental shortcoming
 See statement 21 May 2007 “Lowering Production is no Benefit for
the Environment, says European Industry”
Historic data for individual allocation (1)
Benchmarking with the adequate basis
Benchmark x „X“ = allowanced granted
The issue to define „X“:
•
decided in advance •
•
decided subsequently •
standard load factor
historic production
projected production
actual production
Question:
Would taxes ever by based on frozen history ?
Normal procedure:
 Final settlement based on correction to actual data
Historic data for individual allocation (2)
The quality of historic data
… with climate change instruments based on history?
Variations in annual load
factors over five years, found in
UK by NERA
Historic data for individual allocation (3)
The quality of historic data
What means a historic cap when many new plants enter the market?
• Many new power plants in Italy around 2009
What means a historic cap when an economy is strongly recovering?
• Growth in central Europe, e.g. Poland etc.
What means a historic cap when import or export of product changes?
• More electricity import NL from Germany – Is NL then doing well?
• New CHP in Luxembourg – Is Luxembourg doing bad?
 Problems become an obstacle in the long period 2012- 2020
 Insolvable consequences for new entrants and closures
 Leakage undesired part of the rules
Solution: performance-based allocation as
alternative to auctioning
Three steps:
(1) Define true benchmarks
(2) Ex-post adjustment to actual production
(3) Automatic guarantee of total cap
Key principles of benchmarking (1)
 What a CEO wants to know?
 He wants to know – e.g. with cost-price:
 Where his plants stand?; then
 Why? + What can be done about it?
 He refuses notions like “We are the best in the peer group of our [obsolete]
technology, or in our [small] scale, or in our plant vintage” (many
corrections make everyone equal)
 Key principle: benchmarks relate
 The product
… with
 the objective function – CO2 in the EU ETS
 Deviations shall be possible, but temporary and aimed to avoid
leakage outside EU (… objective function)
 Example: energy efficiency as objective function can avoid leakage by
switch to gas and shipping of carbon-rich fuels outside EU
Auctioning: clear incentive low carbon technologies, length trading
period irrelevant, but leakage & detrimental for competitiveness
High market liquidity
Buying allowances
Specific
energy use
or CO2
emission
Best
Practice
Weighted average
Incentive
Incentive
Decreasing efficiency order of plants
Performance-based trading: same incentive as auctioning, length
trading irrelevant, (hardly or) no leakage, good for competitiveness
High market liquidity
Buying allowances
Specific
energy use
or CO2
emission
Best
Practice
Free allocation
Selling allowances
Weighted average
Incentive
Incentive
benchmark
=
total
cap
Decreasing efficiency order of plants
Benchmarking: incentive to reduce emissions
 Incentive to reduce emissions is independent of the exact
value of benchmark in a certain year
Incentive = avoided purchases + sales of allowances
Example:
Investment to reduce emissions from 900 to 600 kg CO2 per unit
of product (in old plant or new plant)
• Year 1, BM = 750: incentive = 150 + 150 = 300
• Year n, BM = 700: incentive = 200 + 100 = 300
 Predictability of investment climate
Key principles of benchmarking (2)
 Same benchmarks for incumbents and new plants
 Avoid
= Distorting transfer rules
= Barriers to entry
= Enhanced market concentration
 Ensure
= Equal incentive for plant improvement & plant replacement
 No “maximisation” or “minimisation” rules
(NL 110% and 85% now)
A few benchmarks have already major coverage
Benchmarking Netherlands: about 90 PSRs
100%
Coverage
of
emissions
under the
EU ETS
Major chemicals (20-30 PSRs)
Refineries (1 PSR)
Cement (1-2 PSR)
Steel (5-7 PSRs)
Electricity (1 PSR) and
for CHP (Combined Heat
& Power) (1 additional PSR
for heat)
Policy recommendation:
include (co-)firing biomass
Suitable benchmark formula
Benchmark = WAE – CF x {WAE – BP}
Examples chemical industry prove it works
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.
Once defined, benchmarks are quite straightforward
Benchmarking in the product chain
Benchmarking with ex-post adjustment to actual production provides
incentives in the product chain … avoids “production subsidy” effect
(= higher electricity demand by lower electricity prices)
Electricity
Fuel
Electricity and
heat
generation
Fuel
Feed
Industrial
manufacturing plant
with use of
electricity and heat
Heat, from
CHP or from
boilers
… the efficiency of
the production of
electricity & heat
… the efficiency of
the use of (fuel),
electricity & heat
Product
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
• Automatic adjustments within an ex-ante agreed total cap
• More stringent benchmarks work exactly like auctioning (& cap & trade)
• System is self-adjusting; virtually no interest costs
2230
5
3
997
0,447
1002
Fixed
Annexes
What should be expected of emissions trading
• Effective rules allocation of allowances
– Robust, predictable
– Incentive for investments to reduce emissions, for low carbon
technologies
• Level playing field across Europe
• Stimulates activities, employment … Lisbon strategy …
competitiveness
• Fair & free competition
See for example:
•
•
PhD thesis 1992 Ass. Prof. Marjan Peeters, Maastricht University
PhD thesis 2006 Anja Pauksztat, Rheinisch-Westfälischen Technischen
Hochschule Aachen
• Note: each site must surrender after each year the allowances equal to
the direct emissions of that year (direct emissions scheme)
Facts EU GHG Emissions Trading Scheme
• Fast start by 1-1-2005: 1st 3-year period 2005-2007
• Biggest scheme ever worldwide, a great achievement
– 50% of EU emissions
– 12,000 installations (production sites)
– Fossil-fuelled electricity, cement, steel, refineries, paper & pulp,
glass, ceramics, major part of chemical industry
• Rules virtually unchanged for 2nd 5-year period 2008-2012
– Allocation: frozen cap, basis historic emissions 1)
• EU committed -20% in 2020 compared with 1990
• EU ETS confirmed as central instrument
1) “Historical grandfathering”
What are we heading to?
• Review of EU Directive for post 2012 period underway
– Other allocation rules: benchmarking and/or auctioning
– Will it be ex-ante frozen caps, or with ex-post following
production?
Further:
– Expansion participants: aviation (2010?), other sectors & gases
– Linking with other schemes: Norway, Switzerland, California –
Western Alliance, Regional Greenhouse Gas Initiative (RGGI)
North East USA, Japan, Korea, Canada, Australia …. ?
• Time schedule:
– End 2007: proposals EU Commission
– 2008-2009: co-decision procedure between EP and Council
Cap & trade historical grandfathering
Great influence of individual growth or shrinkage & weather
Benchmark curve of one product
Cap
Buying allowances
Specific
energy use
or CO2
emission
Best
Practice
Free allocation
Cap based
on historical
emissions
in theory
Decreasing efficiency order of plants
Cap & trade historical grandfathering
Actual allocation 1st trading period 2005-2007!
Cap
Buying allowances
Specific
energy use
or CO2
emission
Best
Practice
Free allocation
Cap & trading
position is
unpredictable
in practice
Decreasing efficiency order of plants
Distortion due to Emission Based Allocation
Reality check short / long of real cement installations (courtesy Holcim)
High emission is rewarded with
excess of initial allowances
15
10
Procent short / long position
Real situation with NAP 200507,
Emission Based Allocation
20
5
0
750
800
850
900
950
1'000
1'050
1'100
1'150
1'200
-5
-10
-15
Up to 40 % difference in initial
allowances for equal installations
-20
Low emission is punished with
-25
shortage of initial allowances
CO2 efficiency of installation
Basics of shortcomings present allocation
• Existing plants: allowances ex-ante frozen cap based on
historical emissions – rewarding pollution – frozen quantity,
whether production in- or decreases (“static, frozen economy”)
• New plants and debottleneckings: theory says buying (inhibits
efficient industry renewal); repair = allowances from a new
entrants’ reserve, also an ex-ante frozen cap (“plan-economy”)
• This principle = root cause of shortcomings, PLUS, as result:
– Insecurity investments in new plants (finite reserves)
– The allocation habit of few allowances for new plants versus many
allowances for existing plants : LACK OF EFFECTIVENESS to invest to
reduce emissions
– Repair: “transfer rules” (allowances closed plant to new efficient plant), but
new problem: high distortions, reinforcing market concentration
– Lowering production & selling freed allowances is declared equally
legitimate as investing to reduce emissions
Ex-ante rules prevent electricity liberalisation
• State interference prevents competitive market
– At gross margin of opportunity-cost, winning and losing market
share: zero sum game; at higher gross margin: distortions
– New entrants, vital for more competition, but ex-ante state decision
of operating hours determines 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 (1000 MWe coal-fired plant of € 1.1 billion,
distortion ~ € 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-28)
Cap & trade: market price > opportunity-cost
Companies A & B: same production, efficiency
and same quantity of allowances
A
Euros
for an
equal total
production
volume
Companies
A & B
Mark-up
Gross
margin
cash
flow
Opportunity
cost
A wins
market
share
from B
Cost of buying
allowances:
= distortion
Net profit
Net loss
B
Profit of
sales of
Allowances
= distortion
24€
46€
(2)
(3)
60€
84€
(3)
67€
Courtesy Cefic
(3)
(3)
57€
(3)
60€
(3)
28€
70€
(1)
(3)
49€
(3)
24€
(1)
32€
(1)
< 25€
(4)
World Map electricity prices (€/MWh)
20€
(1)
Sources:
(1) Presentation European Aluminium
Association HLG-Ad hoc 1 (Long
Term Contracts) -2005
(2) R.Tarjanne and K. Luostaninen,
Lappeenranta University of
technology (Long term contract) –
2003
(3) Platts Base load year 2007 (Platts 4
April 2006)
(4) Jean Maillard
Suitable benchmark formula
 Benchmark data of plants under the scheme (now EU)
Benchmark between average & best performance, e.g.
Benchmark = WAE – CF x (WAE – BP)
= WAE = Weighted Average Efficiency
= CF = Compliance Factor, to comply with total cap
= BP = proven Best Practice, proven means actual measured operational
data (or rather BP Group, for extra stimulation of innovation)
 Formula coincides with EU ETS Directive Annex III (3), average
emissions and achievable progress for each activity
 Industry opposes following alternatives
 Dutch/Flemish worldtop 10% – too short allocation, unstable outcome
 shape benchmark curve + incomplete participation
 Related only to BP (BP + X%) – too short allocation, contra-incentive
to improve BP, effectiveness & innovation
Equity of Performance Based Allocation (Benchmarking)
20
Gives the right signals:
15
Performance is rewarded, Polluters pay
10
Procent short / long position
Same installations
Performance Based Allocation
same total allocation,
same environmental result
Percent short / long of same cement installations as a function of CO2 efficiency
5
0
750
800
850
900
950
1'000
1'050
1'100
1'150
-5
-10
-15
-20
-25
-30
CO2 efficiency of installation
Discussion on differences between equal installations are
futile, compared to differences in case of grandfathering
1'200
Benchmark takes account of all energy carriers (1)
Many energy functions can
be done either with:
• Steam, or
• Electricity, or
• Natural gas or other fuel
CO2 ?
Production
plant
Feeds
Steam
Product(s)
Electricity
Natural gas ?
Other fuel ?
Benchmark takes this into
account:
Normalised calculation to (total)
primary energy – or total CO2
Benchmark for only fuel is
meaningless
Benchmarks for manufacturing
and (related) utility plants
Examples: chemical plants, refineries, paper plants, etc.
Benchmark takes account of all energy carriers (2)
Simplified scheme steamcracker
CO2
Feeds
(ethane,
LPG,
naphta,
gas oil,
etc.)
2/3 of the investment
Steam recovery
Furnaces with
heat recovery
to steam
Separations with
high power
compressors
Electricity
Methane from feedstock
Steam
Separation train can be:
• Efficient, with net-export
of steam of whole cracker
• Inefficient, steam import
• Both can be with the
same direct emission of
the cracker itself
Products
(ethylene, propylene, etc.)
Power train can be:
• Steam turbine driven
• Electric motor driven
• Combinations
High influence on
electricity & steam
balance, direct
emissions elsewhere
Benchmarks in a direct emissions scheme
Allocation = direct emission – emission {total plant – total BM}
CO2
Example:
• Net-import of secondary energy carriers:
Production
plant
Feeds
Product(s)
70 – {120 – 100} = 50
Plant worse than benchmark
Further examples:
• Zero net-import:
Steam
Electricity
Natural gas
Other fuels
Site utilities have also benchmarks
120 – {120 -100} = 100
Plant worse than benchmark
• Net-import:
70 – {90 – 100} = 80
Plant better than benchmark
Benchmarks in a direct emissions scheme
 Easy inclusion in an ETS
 No conceptual problem in a direct scheme and no legal problem with
Directive, on the contrary
 Allowances according to deviation with benchmark
 In formula:
A = RDE + RSE – Σ production x (REE/RCE – benchmark) x CCF
= RDE = Realised Direct Emission (ton CO2)
= RSE = Realised Sequestered Emissions (ton CO2)
= REE/RCE = Realised Energy (or CO2) Efficiency (GJ/ton product or ton
CO2/ton product)
= Benchmark = benchmark energy (or CO2) efficiency
= CCF = CO2 Conversion Factor (= 1.0 in case of CO2-benchmark)
 Note: Process emission is in this view included in the Best Practice
Misunderstandings power market cleared
• Fuel specific benchmarks: against objective function
= With ex-post: high fuel-switch prices, e.g. € 300-500/ton CO2
= Fuel switch limited with at least 50% (in case of 2 benchmarks)
= Coal plants without CCS encouraged (Carbon Capture & Storage)
• One electricity benchmark no deathblow coal-fired power
= Coal & lignite very important, climate policy means CCS !
= Cap & trade: opportunity-cost in power price (soft cost)
= 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
Fuel switch at same CO2-price as cap & trade & auctioning
In fact more gas if more new coal and less CHP (given a total cap)
We need a controlled transition (CCS needs time)
Legal aspects EC Treaty (1)
• Competition rules, art. 81-82
– Cartels, concerted practices prohibited
– Frozen cap & trade: works like cartel, winner of market share must
buy allowances, loser sells (= penalty payment winner to loser)
– But: no jurisprudence (yet) to prohibit this implementation
• State aid rules, art. 87-88
– State aid problems confirmed by EU Commission
– Alternative so far not taken into account, Commission prohibited
ex-post adjustment to actual production
– This state aid so far admitted, argument: interest for environment
• Either no support from art. 86: “In the case of public
undertakings and undertakings to which Member States grant special
or exclusive rights, Member States shall neither enact or maintain in
force any measure contrary to the rules in this Treaty, in particular …
art. 81-89”
Transition for a faster global trading scheme
Benchmark:
Specific
energy use
or CO2
emission
Benchmark China-India
Incentive low carbon technologies
the same in global trading scheme
Benchmark USA-Canada
Benchmark EU-Japan
Global benchmark
Transition period (with 3 or more BMs for same product) avoids
high cost in case of auctioning for regions with higher emissions per
unit of product (vital: BMs without differentiation new/old plants)
2008
2012
2017
2022
2027
2032
References
•
•
References of the author:
< http://www.dsm.com/en_US/html/sustainability/emission_trading.htm >
•
“Climate change challenges and the search for a sustainable policy”, 21 June
2005, 8th International Conference on Carbon Dioxide Utilisation (ICCDUVIII) 20-23 June 2005, Oslo, Norway.
“Options and consequences for the allocation of allowances to electricity
producers”, 21 December 2005, European Chemical Region Network (ECRN)
presidium meeting 21-22 December 2005, Maastricht, the Netherlands.
“Towards a simple, robust and predictable EU Emissions Trading Scheme –
Benchmarks from concept to practice”, 21 March 2006, presented to the
Dutch Ministry of Economic Affairs.
“The EU ETS is urgently in need of: effectiveness, level playing field,
competitiveness, fair & free competition”, 4th Congress of the ECRN, 10
November 2006, Tarragona, Spain, including:
– “One single benchmark for fossil-fuelled electricity in an Emissions
Trading Scheme: does it work, does it hurt and what about alternatives?”.
– “How to fit benchmarks with ex-post adjustments in the present EU
Emissions Trading Directive”.
•
•
•