Carbon TradingCarbon Trading
How does the EU Scheme function and how How does the EU Scheme function and how important is it?important is it?
Tony White
Head of ResearchClimate Change Capital
Agenda
• The European Emissions Trading Scheme• How it works• How will the markets react?
Burden sharing agreement
Country1990 Emissions
Reduction per burden share agreement
Spain 286,428 15.0%Italy 522,132 -6.5%Germany 1,222,765 -21.0%Belgium 143,125 -7.5%Netherlands 210,342 -6.0%
Denmark 69,360 -21.0%Austria 77,388 -13.0%
Ireland 53,430 13.0%
Portugal 65,106 27.0%UK 742,492 -12.5%Greece 104,755 25.0%
Luxembourg 10,836 -28.0%Finland 77,093 0.0%
Sweden 70,566 4.0%France 551,805 0.0%
4,207,623 -8.0% -20 -10 0 10 20 30 40
Denmark
Spain
Ireland
Austria
Belgium
Finland
Portugal
Netherlands
Greece
France
Italy
Luxembourg
Germany
United Kingdom
Sweden
EU15
Distance from target (%)
additional
existing
Allocation of “pain” GHG emission performance at 2001
Emissions Trading: Background
• Europe has many Directives that reduce GHG emissions
– Renewables
– CHP
– Burden Sharing Agreement
• Europe on track to overshoot objective by 7%
• Additional measures are forecast to reduce overshoot to 1%
– Labelling
– Energy Efficiency of Building
– Biofuels
• Trading should close the gap
European Greenhouse Gas Emissions
Source: European Environment Agency, November, 2003
EU15 without Kyoto
4117Mt2001
3877MtKyoto
Excess?
4223Mt2010e
346MtAdd’l measures292M
t
CDM supply?
50 Mt?ETS Phase I
Emissions reducing projects in “developing” countries
Setting National Allocation Plans
• 18,000 sites covered– Energy Production > 20MWth– Bricks & Ceramics– Metals– Paper & Board
• Fines if emissions > allowances– €40/tCO2e for 2005-2007; €100/tCO2e for 2008-2012– Payment does not remove obligation to deliver certificates
• Allocations– “free” allowances given to incumbents– >95% of allowances created for 1st period; 90% for second– up to member states to set method of allocation– Allowances consistent with Burden Sharing Targets for 2008-12?– Targets can assume of purchase of flexibility credits (CDM/JI)
Carbon management strategies for Phase I
• NAPs set on – BAU minus a bit for power– BAU for non-energy
Removes any immediate requirement from the non-power traded sector to trade
• Power sector can meet abatement target without investment
EU-25 Abatement Targets for EU ETS
-10
0
10
20
30
40
50
60
GermanyGreeceIreland
Italy LuxHollandPortugal
SpainSweden
UK
EU 15 Total
Czech EstoniaCyprusLatviaLithuaniaHungary
MaltaPolandSlovenia
SlovakTotal:
MtCO
2
NAPs have been set on the basis of BAU – a bit for power.
The “bit” appears to be around 50-60mtCO2e per annum.
2006
0
5
10
15
20
25
30
35
0 5 10 15 20 25 30 35
Allowance Price (€/tCO2e)
Change in Marginal Cost (€/MWhe)
coal
gas
oil
Impact on Marginal Generation Cost
Impact of low allocation price
Nuclear, Hydro, “take or pay” CCGTs
Coal
Marginal gas
Oil/OCGT
DemandGeneration
Price
Proportion of year
Demand
Price
Impact on Prices (competitive market)
Nuclear, Hydro, “take or pay” CCGTs
Oil/OCGT
DemandGeneration
Price
Proportion of year
Demand
Marginal gas
Coal
Gas-coal switch
Impact of higher allocation prices
The Gas – Coal Switch
Price drivers
Current prices suggest a price of under €10/tCO2e
Value of allowances will move to ensure coal consumption is reduced.
EU - 25 Abatement Cost Curve
0
2
4
6
8
10
12
14
16
18
20
13 23 33 43 58 73 88 103 118
Abatement in mt CO 2e
€/tCO
2e
Gas @€3.77/GJ
Coal $60/t
likely price range
abatement
Consequences
• EUETS will– Lead to higher energy prices– Prices <€10/tCO2e for Phase I– Power companies will be able to pass allowance costs through
to customers– Major electricity consumers operating in global markets will be at
a disadvantage (aluminium)
• Allocations – If markets are competitive, allowance prices will be reflected in
sales prices– Sell early then buy as needed?– Allocations just determine size of windfall profit!
EU abatement curve
0
5
10
15
20
25
13 23 33 43 58 73 88 103 118
MtCO2 abated against BAU
Euro/tCO2
Gas €3.12/GJ Coal $35/t
Gas €3.34/GJ Coal $35/t
Gas €3.34/GJ Coal $45/t
Gas €3.77/GJ Coal $45/t
Gas €3.77/GJ Coal $55/t
Gas 3.77€/GJ Coal $60/t
Gas €4.54/GJ Coal $60/t
?
What will drive allowance prices?
Expect strong link between allowance prices and relative fuel costs
….but what is happening!
Forward prices for allowances stable – despite dramatic movements in relative fuel prices.
Market currently driven by a view of policy (how many allowances issued), rather than fundamentals
source: TFS
0
25,000
50,000
75,000
100,000
125,000
150,000
175,000
200,000
225,000
250,000
275,000
02-Jul-0322-Sep-0310-Dec-0319-Jan-0404-Feb-0424-Mar-0401-Apr-0407-Apr-0415-Apr-0526-Apr-0429-Apr-0413-May-0402-Jun-0424-Jun-0401-Jul-0407-Jul-0413-Jul-0416-Jul-0423-Jul-0429-Jul-0405-Aug-0416-Aug-0420-Aug-0402-Sep-0407-Sep-0410-Sep-0415-Sep-0421-Sep-0424-Sep-0429-Sep-0404-Oct-0407-Oct-0413-Oct-0419-Oct-0422-Oct-0427-Oct-05
tons
00.511.522.533.544.555.566.577.588.599.51010.51111.51212.51313.514
€/t
Will there be liquid markets?
• Will the market be “efficient”?– Is there a sufficient deficit?– “non-economic” behaviour– pre-empting Phase II allocations– auction system for new entrant reserve?
• Are there barriers to new entrants?– tax, credit risk, accounting treatment– transaction costs – particularly registries– susceptibility to political interference– annual-only dealing?
Conclusion for Phase I
• Large scale action likely to be restricted to power sector• European power sector can meet abatement without
investment and will enjoy “windfall” profits• Non-energy sectors do not have to trade – but why give
up a windfall?• Trading may be limited before basis for Phase II
allowances are announced• A finance director may lose his job over allowance
liabilities
…and phase II?
Life will get tougher
EU15 with Kyoto
Non-EU hot air (optimal price?)
Add’l measures292M
t
19MtDomesticsinks
45Mt? ETS Phase I
CDM supply?
JI supply?Mt? ETS Phase II
800-1000Mt
4117Mt2001
260Mt
3877MtKyoto
Excess
4223Mt2010e
346MtDTTe
EUhot air
6532Mt2002
5905MtKyoto
6660Mt2010e
755MtDTTe
Add’l measures
473Mt
114Mt Domesticsinks
800-1200Mt
Russian hot air
200-400Mt
Ukrainianhot air
Current CDM supply30Mt (expected 200Mt)
JI supply?144Mt
EU15, Japan, Canada, Norway, NZ, Switzerland - buyers
EU accession countrieshot air
Hot Air could meet all DTTe (without USA)
If only 20% Additional Measures are realised CDM/JI supply insufficient to satisfy demand
Expect Russia to constrain supply to ensure Europe sets price
Where will it be? €10-15/tCO2e
All figures in annual CO2e
Kyoto Balances
Flexibility Capacity Development
• Projects approved the Executive Board and/or the Methodology Panel: 17.9Mt/yr
• Projects under consideration: 12.9Mt/yr
• Some countries (Netherlands, Spain) have been active in purchasing flexibility allowances
Recent development of CDM project pipeline
0
5
10
15
20
25
30
35
Jun-04 Jul-04 Aug-04 Sep-04
Oct-04
MtCO2e/year
Approved by CDM EB
Methodology approved
Methodology underconsideration
Total
Flexibility mechanisms
• If “additional measures” do not work, then demand for allowances would soar (10x?) if EU sticks to Kyoto
• Ratification of Kyoto brought in:– Supply of JI, “Hot Air”; and – Demand; Canada & Australia
• Consequences– Putin may be able to control supply of allowances
• Carbon market may be like diamonds or OPEC– Best to lock into relatively cheap “flexibility”
allowances
Conclusions
• Phase I– Learning period– Get systems, monitoring, verification in place– Windfalls– Determine strategy for Phase II
• Second phase – watch out!– Much tougher– Subject to Russian influence– Arrange access to cheap allowances