Vattenfall Capital Markets Day · • portfolio management and trading related services for Vattenfall • hedging strategies for the Vattenfall portfolio’s Market Access and Trading

© Vattenfall AB

Vattenfall Capital Markets Day

Emissions Trading

Presentation by

Erik Saether,Head of Vattenfall Trading Services

27 September, 2005

Capital Markets Day, 27 Sept. 2005© Vattenfall AB

2Content

• Vattenfall Trading Services: Roles and Responsibilities• The Emission Trading Scheme• Market Assessment

- Participants- Volumes- Price drivers

• CO2 Impact on the Merit Order• Future Price Effects

• Appendix


3Vattenfall Trading Services Vattenfall’s central trading platformService Provider• portfolio management and trading related services

for Vattenfall• hedging strategies for the Vattenfall portfolio’s

Market Access and Trading• Market Access for

- European and Nordic power markets- financial coal, CO2, green certificates, weather

• Trading on own behalf- cross border- interconnectors

Key Markets• Nordic, Germany, Poland,

France and the Netherlands Exchanges, where VTS trades( Nordpool, EEX, APX, Powernext)

Countries, where VTS has offices


4CO2 activities of Vattenfall

Execution

Focus on Portfolio Manage-

ment

Trading

MarketAccessMarketAccess

Cross BorderTrading

Cross BorderTrading

Portfolio Management

Analysis

ModelingModeling AnalysisAnalysis

Vattenfall Trading Services (VTS)

OrdersOrders

MandatesMandates

BU Heat (Poland)BU Heat (Poland)

BU M&G (Germany)BU M&G (Germany)

BU Heat (Nordic)BU Heat (Nordic)

RORCRORC

Reference Groups for Analysis and Projects Reference Groups for Analysis and Projects

Exchanges

Access to all ExchangesLow Transaction CostsCross-Netting Facilities

Intermediates

RORC Best Price Screen All Brokers on Direct Lines

Low Transaction Costs

Counterparts

All Major Counterparts Signed

SLAsSLAs

BU Heat (Germany)BU Heat (Germany)

Responsibility according to the national ETS legislation for every installation: • Application for EUA• Monitoring of emissions• EUA Return to Authority

• Identification of position• Portfolio strategy • Identification of position• Portfolio strategy

BU 1

BU 3

….

….

BU 4

BU 2

…

… …


5GHG emissions reduction targets

„Kyoto Gases“

• CO2 Carbon Dioxid

• CH4 Methane

• N2O

• HFC

• FC

• SF6

EU 15 Burden SharingKyoto-ProtocolCOP3 -12.1997

- 8 % -28 %

(LUX)

- 5,2 %„Kyoto Gases“

1990

2008 – 2012

UN Climate Convention06.1992

+ 27 %

(P)


6The EU emission trading scheme (EU ETS)

• One of the tools for greenhouse gas (GHG) emissions is a cap-and-tradesystem - the new EU ETS

• Included sectors:power and heat production, pulp and paper production, oil refineries,cement, lime and glass production

• Included GHG: only CO2 • ETS sectors represent roughly 45 % of the GHG emissions in the EU

• Objective of EU ETS:Emission reductions shall take place where it is most cost efficient

• First phase (2005-2007) NAPs represent a reduction of approx. 2.7% from“business as usual” emission levels (12,000 installations affected)

• Second Phase (2008-2012) should lead to a reduction in EU emissions to alevel 8% below the1990 rate and may include other sectors and other GHG’s


7Timeframe – EU and the global climate policy

Glo

bal C

limat

e re

gim

e

2005 2008 2009 2010 2011 2012 2013

Trading period 2008-2012

2006 2007 20182014 2015 2016 2017

Trading period2013-2017

2004

NAP-04 NAP-06

Trading period 2005-2007

NAP-11 NAP-16

EU´s

Tra

ding

Sys

tem

The Kyoto Protocol in force

First Kyoto Commitment period 2008-2012

Post-2012?

Negotiations start Post-2012?

no borrowingno banking

validity of EU ETS guidelines

Possible Second Kyoto period 2013-2017?


8Allocation 2005-07 to the installations of Vattenfall

Sweden• Negligible impact due to the hydro/nuclear generation mix.

Germany• Nearly all necessary allowances received for the 1st trading period 2005-

2007• Vattenfall’s “early actions” have been recognised in the German national

allocation plan• Large CHP portion with a reasonable allocation level

Poland• Necessary allowances received for the 1st trading period 2005 - 2007


9Market assessmentParticipants:• Utilities, Gas/Oil Companies and a growing number of Banks• 7 Brokers and 5 Exchanges offering Spot, Futures and Forwards.Volumes:• Traded volume 145 Mt in 2005.• OTC Market represents 50 % of volume traded up until August 2005. • Exchange traded volume is rising as market develops.• Spot Market expected to expand substantially once Registries/Accounts are in

place

First and Second Phase:

• First Phase - Trading has transformed from policy driven into Trading basedon fundamentals

• Second Phase - Trading is still pending - Policy and regulatory framework tobe decided


10Countries and sectors

Power and Heat Pulp and Paper MetalsOil and Gas Cement, lime, glass Others

Countries:

• UK• Germany• Denmark• Austria• France• Finland• the Netherlands

National Allocation Plans (EU 25) by Sector:

Approx. 50 participants are trading daily, mainly energy companies, banks and hedge fundsAverage trading volume: 1 million tons per day


11Price and volume development

0

5

10

15

20

25

30

01.12.04 01.01.05 01.02.05 01.03.05 01.04.05 01.05.05 01.06.05 01.07.05 01.08.05 01.09.05

Pric

e in

€/t

0

500.000

1.000.000

1.500.000

2.000.000

2.500.000

3.000.000

3.500.000

Vol

ume

in t

EUA`05-07 Volume in t EUA`05 Price in €/t


12CO2 price drivers

CO2Price

FXTechnical progress

Economic Growth

Physical Demand

Industrial ProductionFreight

ratesWeather

Reserves

CDM/JI

Phase II NAP

Fuel Prices

Policies

Fuel Switch

Regulatory Framework

Banking & Borrowing


13The price of CO2 allowances higher than anticipated

Possible reasons:

• Price is in principle set by marginal cost for abatement • Short term reductions achieved as a consequence of gas substituting coal.

High gas prices result in increased costs for reductions.• The trading period is very brief 2005 – 2007, which means no long term

investments• Uncertainties regarding EUA demands (no reliable statistics available)• Indicators of a larger allowances deficit than expected – NAP´s and draught• Some countries like Poland and Italy are still outside (still no valid NAPs),

only 10 countries have functioning registers • Players with a surplus are not yet active in the market• Lack of knowledge relating to the trading system among many players• CDM/JI not yet available, limited supply in the first period


14CO2 impact on continental power

HARDCOAL

GAS

Average Plant efficiency: 38% Average Plant efficiency: 50%

CO2 emissions per MWh: 0,89 t CO2 emissions per MWh: 0,40 t

Cost of CO2: Cost of CO2:

1 €/t equivalent to 0,89 €/MWh 1 €/t equivalent to 0,40 €/MWh

20 €/t equivalent to 17,80 €/MWh 20 €/t equivalent to 8,00 €/MWh


15Impact of CO2 prices on merit orderWithout cost of CO2

CoalGas

Oil

Lignite

Mar

gina

l cos

ts

Installed Capacity

CoalGas

Oil

Lignite

Mar

gina

l cos

tsInstalled Capacity

With cost of CO2

CO2CO2

CO2

CO2

• The need for allowances is dependent upon the amount of production

• The market value of allowances is part of the marginal costs of power plants

• The power plant production is offered with the higher marginal costs at the spot market

• If the marginal costs are higher than the spot price, the power plant reduces its production and sells the allowance instead.


16Gas to coal spread

CO2 - GasCoal Spread 2006

0,00

5,00

10,00

15,00

20,00

25,00

30,00

35,00

40,00

45,00

19.12.2004 18.01.2005 17.02.2005 19.03.2005 18.04.2005 18.05.2005 17.06.2005 17.07.2005 16.08.2005 15.09.2005 15.10.2005

€/M

Wh

CO2 (€/t)NBP-Coal


17Longer term price factors

Marginal abatement costPrice is in principle set by marginal cost for abatement

EUA Reserves The rules governing new entrant reserves are far from clear. A potential 60-180 Mt could potentially be allocated/deleted. Will allowance auction disrupt continuous trading in EU ETS?

Clean Development Mechanism Projects (CDM)Investment in mitigation projects and delivery of Carbon Credits will affect pricing. Current Status of projects suggest max. 25Mt supply of CERs into Phase I.

Joint Implementation (JI) Potential for Emission Reduction Projects is huge. Uncertainty of regulatory frameworks in big JI countries like Russia and Ukraine. No effect on Phase I pricing.

Actual CO2 PositionEmissions subject to weather during Phase 1. First reliable position estimate in April 2006. CO2 price is sensitive to position adjustments.

Phase II (2008-2012) Uncertainty of NAP, Inclusion of other Green House Gases and Industries(?)

© Vattenfall AB

Appendices


19Joint Implementation

• CO2 emission reducing projects in Annex I Countries (industrialized or in transition with a CO2 emission reductiontarget)

• Applied methodologies include efficiency improvement, fuel switch, reduction of agriculture-related emissions

• Project transforms AAUs into ERUs (Assigned Amount Units into Emission Reduction Units)

• ERUs have same value as EUAs (EU-Allowances)

• ERUs can only be used for compliance from 2008 to 2012


20Clean Development Mechanism

• CO2 emission reducing projects in Non-Annex I countries (no CO2 emission reducing target)

• Applied methodologies include destruction of methane, HFC23, N2O, and new biomass and small hydro plants

• Projects generate CERs (Certified Emission Reductions)

• CERs have same value as EUAs (EU-Allowance), but aregenerated not converted, i.e.no “AAU conversion”.

• ERUs can be used for compliance in both phases and beyond


21Accounting principles emission rights

• Received and purchased emission rights are reported as inventories

• In those cases where emission rights are received, or acquired, at a value lower than fair value, the inventory asset is reported at fair value and as deferred income (government grant) in the balance sheet

• The government grant is carried as income over the year and as carbon dioxide is emitted, a cost and a liability for the obligation to provide emission rights are reported

• The liability and inventory asset are valued in a uniform manner


22World energy related CO2 emissions by region

IEA – World Energy Outlook 2004


23CO2 capture and storage

Vattenfall´s R&D effort

The target is 20€/tons CO2

Commercially available around 2020

International co-operation

Development phase includes a pilot plant

Strong support from the Vattenfall Management

high expectations


24EU burden-sharing agreement


25Public power and heat sector is short 2005 - 2007

-100 -50 0 50 100 150 200 250 300 350 400

Total

Public Power and Heat

Pulp and Paper

Metals

Oil and Gas

Cement, Lime, Glass

Other

Mio. t CO2LONG SHORTSource: Carbon Market Trader, 01.08.05; own compilation


263% shortage 2005 - 2007

Source: Carbon Market Trader, 01.08.05; own compilation

0 1.000 2.000 3.000 4.000 5.000 6.000 7.000

Allocation

Forecast

Mio. t CO2

180 Mio. t

Market is short compared to forecasted emissions


27Electricity generation cost - uncertaintiesIncl 20 €/ton CO2, excl. taxes, CHP not shown.

0

10

20

30

40

50

60

70

80

Hydro

power

Nuclear e

xistin

gNucle

ar new

Natural ga

sCoal

CO2 fre

eBio

energ

yCoal

cond

Wind

power

Wave

energy

öre/

kWh

?

? CO2cost

Electricitycerificates


28The CO2 emissions trading systemincreases electricity price

HydroNuclear

TWh/year

CHP

Demand

Gas turbines

3002001000 400

Oil

Variable cost

Prices on the Nordic Market - Impact on electricity price from CO2 ETS

öre/kWh

5 €

10 €

20 €

Coal condensing

Price/ton CO2

(normal year)

(wet year)

(dry year)


29Theoretical mechanism of dispatch under ETS influence

Model – taking full (opportunity) cost into account

• The allowance-need depends directly on the production amount.

• The Market value of allowances is part of the marginal cost of power plants.

• The power plant production is offered at the spot market with the marginal cost including the market value of certificates

• In case of a switch in the merit order the power plant reduces its production. It gets its contribution margin by selling the allowances.

€/MWh

Strommarktpreis

Deckungsbeitrag 1 bei Verkauf der Zertifikate

Deckungsbeitrag 1 bei Erzeugung und Verkauf des Stromes

Zuw

achs

kost

en

des

Kra

ftwer

ksbl

ocke

sK

oste

n de

r E

mis

sion

srec

hte

Contribution margin in case of electricity sold

mar

gina

l cos

t of t

hepo

wer

pla

nt

cost

of t

heal

low

ance

s Contribution margin in case of allowances sold

Market price electricity

ETS will be taken into account irrespective of the allocation mechanism.Pricing mechanism is essential for function of the ETS system.


30Consequences for power plant operationMerit Order of Marginal Cost Depending on Price of Allowances

0,00

10,00

20,00

30,00

40,00

50,00

60,00

70,00

0 5 10 15 20 25 30 35 40 45 50EUR/t CO2

EUR

/MW

h

Lignite old

Hard Coal old

Lignite 2010

Hard Coal 2010

CCGT (without gas tax)

Every cross point leads to a switch in the merit order and another power plant operation


31Pricing at the Power Exchange (EEX, Nordpool)

An unavoidable price effect is a higher power market price.The price influence depends on marginal power plants in the region and other influences (fuel prices, demand …).


32Taking the opportunity cost into account for the purpose of electricity pricing - Case: 100% of allowances allocated for freeWithout taking CO2 into account With CO2

Marginal costs

Market price power

€/MWh

CM 1without CO2

Marginal costs

costs

EUA

€/MWh

CM 1 with CO2

Allowances have to be surrendered at full volume.Contribution margin = difference between market price and marginal cost.

Plant has to be switched off. Not used allowances are sold to the market.

Contribution margin without CO2 < Contribution margin with CO2Taking CO2 into account for electricity pricing purposes is economically rational.

Documents

Vattenfall Capital Markets Day · • portfolio management and trading related services for Vattenfall • hedging strategies for the Vattenfall portfolio’s Market Access and Trading