COAL AND THE EU ETS - TU...

COAL AND THE EU ETS Joost L.M. Kanen, Gryphon Carbon Consultancy 19 May 2014

6th Freiberg International Coal Gasification conference

Gryphon Carbon Consultancy

19 May 2014 6th Freiberg International Coal Gasification conference

!  Gryphon was founded in 2005 at the start of the EU ETS’ first trial phase that ran from 2005-2007, and after Russia had ratified the Kyoto Protocol.

!  JLM Kanen, Gryphon’s founder, wrote the book “Carbon Trading & Pricing” in 2005 to address the lack of understanding of emissions markets. Mr. Kanen was a negotiator on the Kyoto Protocol on behalf of the Netherlands in 1999-2000 and then already working on the design of the EU ETS.

!  Book showed massive data errors by the European Commission !  Gryphon focuses on 4 areas:

!  Carbon market research and analysis of underlying energy markets !  Carbon trading: intermediation and brokerage !  Green innovations, monetizing CO2 value of innovations that fall outside ETS !  Biomass trading

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What has been achieved so far?


!  First functioning carbon market in the world started by the EU in 2005

!  EU Emissions Trading System creates a price for pollution (now at €5,-/t) , for the first time as external effects previously were never priced

!  China follows and has started 7 regional carbon markets in 2013. !  Australia is starting up its carbon market !  California (CARB) and Canada (RGGI) have functioning regional

carbon markets !  For the first time in history pollution has a global price

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Some facts about the EU ETS


!  EU ETS only prices CO2, 1 of 8 greenhouse gases. Other gases have CO2 conversion factors into CO2 !  Markets are not perfect and need policy amendments to deal with adverse societal effects. !  The EU ETS includes roughly 13000 installations that emit 2 bln. tonnes of CO2 each year, roughly 45% of all EU

emissions. EU emits 4.5 bln tonnes each year, while the worldwide emissions are at 33 bln tonnes per year !  Roughly half the 2 bln. carbon allowances (EUA’s) will be auctioned to utilities, and of the other half industry

continues to receive 80% for free (% going down to 30% in 2020) to avoid carbon leakage. !  Sectors involved are electricity, steel, paper, glass, chemical, basically all combustion installations >20 MW.

!  Airlines now also participate (for EU flights) with their own carbon allowances (AEUAs) that are linked to the ETS. !  The EU ETS is an international European policy instrument used to achieve the EU 20/20/20 targets. !  The ETS achieved its -8% emissions target in 2012, and is likely to reach the -20% target for 2020 as well

!  The economic crisis has lowered emissions, this combined with national sustainable policies !  EU ETS has a 1.5 bln t. surplus from phase 2 (2008-2012) that was transferred into phase 3 (2013-2020)

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Market players in the carbon market


Tension

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National governments sell EUAs via auction at carbon exchanges

Interaction carbon & electricity markets


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!  Carbon & electricity markets are strongly interrelated, as prices in the electricity markets are set by the marginal cost price that now also includes the carbon cost (clean dark & spark spreads)

!  The merit order curve also shows the switching point at which the carbon price causes a switch between coal and gas in terms of profitability.

Merit order & grid priority


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Market price

nuclear coal gas Diesel oil

Load curve/ demand marginal cost supply wind

solar

Additional cost of carbon allowances / EUAs

Clean dark spread

Clean spark spread = 0

Switch price= the carbon price that equates the profit between coal & gas stations) = between €30-€50,-/t



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German Energiewende

demand marginal cost supply solar


wind


Grid priority for renewables

Gas is pushed out & switched off

Even coal can’t pay a high carbon price anymore

EUA price drops

Market price drops



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Day ahead power price =Market price

Clean spark spread= 0


Load curve/ demand Short run marginal cost supply

wind solar


Clean dark spread

Grid priority

EU ETS Design errors 1.  Caps placed at emitter level – who is the polluter? 2.  Oligopsonistic market structure 3.  Policy competition between national governments and the EU 4.  Too many financial players add little value, adds regulatory

burden. 5.  Carbon demand comes from firms not from installations. Now the

installations receive the carbon allowances 6.  Data errors at the European Environment Agency


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Policy competition - regulation

Regulated firms

EU aggregates national Kyoto obligations -8% in 2012

Policy Objectives: EU 20/20/20

Command & Control

Benchmarking Taxes Environmental markets

Policy Fish Trap

National policies EU policy Tension

EU ETS Kyoto German Energiewende

Carbon price

Carbon Markets = Financial markets?


!  Massive VAT fraud in previous caused by the fact that the EU taxes carbon allowances as services and not as goods (VAT shifted)

!  National authorities were lacking in knowledge of the carbon markets, and various national financial regulations were trailing the development of the EU Emissions Trading System in 2005

!  Spot OTC carbon trading is not FSA regulated only carbon futures & options traded via exchanges are qualified as financial instruments and regulated as such.

!  Carbon auctions are structured as 1 day futures to put these under FSA oversight.

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Oligopsony


!  There are a few big buyers of EUAs, mostly German utilities with pan-European presence, and many smaller industrial buyers

!  Oligopolistic structures in electricity markets is mirror image of oligopsonistic structure of the EU ETS.

!  Often these structures were created when electricity markets didn’t yet exist to have good negotiating position versus foreign fossil fuel suppliers (like Russia & Saudi Arabia).

!  This means few large buyers that have the power to negotiate very low prices for European Emissions Allowances.

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Carbon Value Chain

industry, national

electric utilities, domestic

consumers, globally

distribution The polluter pays – who is the polluter ?

Where should the cost of the emissions be placed ?

Industry pays twice ? For its own and for utility emissions ?

Caps

Caps

Carbon Leakage an issue ?


Caps

Caps

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Chines exports

Structural repair of the EU ETS


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!  In phase 3 the EU ETS will be repaired to address the structurally low EUA price, starting with the adoption of Backloading

!  Backloading involves supply reduction by postponing of the auctioning (by national governments of 900 million tonnes of EUAs from the yearly auction volumes from 2014-2016 to 2019-2020

!  Introduction of Market Stability Reserve Mechanism !  More ambitious CO2 reduction targets for phase 4 (2021-2030) !  Only CO2 as pan-European policy target, no longer the % sustainable electricity production

nor the the % improvement in energy efficiency will be used as EU targets !  Limiting inflow from UN credits (CERs, ERUs) !  Measures to address Carbon Leakage !  Possibly a minimum carbon auction price (like UK)

Market Stability Reserve mechanism


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!  Options: 1.  Permanent retirement of 0.5-1.5 bln. tonnes of allowances in 2020 2.  Market stability reserve mechanism, in which 0.5-1.2 bln allowances would be placed, which would be

reduced from the auction volumes (flexible auction volumes) 3.  Combination of the above

!  The planned market stability reserve aims to reduce the market surplus and lower carbon price volatility and will most likely have volume triggers (price triggers don’t have much support) and when these volume triggers are reached (at 400 mln. tonnes in the reserve, auction volumes will be lowered, at 1 bln tonnes the auction volumes will be increased)

!  The volume triggers will be based on verified emissions data, and the triggers points will be modified to a narrower band in phase 4.

!  The Market stability reserve mechanism is scheduled to start in 2017 (phase 3) and will cross into phase 4, bridging the two phases. The result will be a higher and band for the EUA price of between €10-€20/t in phase 4, we estimate.

Political pressures & EU unification


!  The EU Emissions Trading System is vulnerable to continuous political discussions that undermine the system stability

!  There are strong political lobbies linked to gas (Netherlands, UK (fracking gas)) and coal (Poland, Germany) as well as on behalf of industrial or financial sectors.

!  Stability is crucial for investments, and profitability of innovations !  EU internal political division, different national energy policies &

strategies interfere with effective EU ETS, especially now the electricity markets in Europe are more interconnected

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Coal & EU ETS !  Coal is doing well in the current EU ETS with very low

CO2 prices !  Coal combined with biomass gasification potentially a

good combination !  Coal gasification seems only viable in combination with

Carbon Capture & Storage !  CO2 price seems too low to warrant investing in IGCC

plants

Comparing IGCC 1

Source : BINE Informationsdienst 2006

Comparing IGCC 2

Source BINE Informationsdienst 2006

Coal technology monetization !  Combustion installations below 20MW are excluded

from the EU ETS !  How to bridge the gap, or how to capture carbon value

outside the EU ETS? !  Inside EU ETS: via new entrant reserve !  Inside EU ETS: via selling technology to installations inside

the ETS and receiving carbon allowances as payment ! Outside the EU ETS: capturing subsidies and green subsidies


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Carbon Capture and Storage !  CCS has long been promoted as an effective method

for capturing and storing CO2 in empty gas fields, so to keep pressure on the soil and return economic value to these fields

!  High costs make CCS ineffective until now, CCS needs CO prices of €80-€100/t to become economical

!  It seems unlikely that CCS will really become a viable option in the EU ETS


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Carbon prices


!  Carbon prices currently are very low (€5,00/t for EUAs and €0,15/t for CERs) !  Carbon prices can be leading (triggering CO2 savings) and following (dipping

because of CO2 savings from sustainable energy) as is the case now. !  The switch price for carbon (coal vs gas) seems to have become irrelevant and now

effectively forms an upper limit at around €50,-/t !  The most direct cause of the low carbon prices is the massive volume (1 bln tonnes)

of convertible & bankable Kyoto credits, CERs & ERUs, that have fed in the the EU ETS at the end of phase 2, and which represent two thirds of the 1.5 bln oversupply.

!  Low carbon prices reflect the impact of the economic crisis, but also the lack of unified European energy and industry policies that are still national domain

!  Prices are likely to rise after 2014, because of the various repair mechanisms that the EC has adopted

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EU ETS long/short ?


-2,500,000,000

-2,000,000,000

-1,500,000,000

-1,000,000,000

-500,000,000

0

500,000,000

1,000,000,000

1,500,000,000

2,000,000,000

2,500,000,000

2013 2014 2015 2016 2017 2018 2019 2020

EUA supply/demand balance 2013-2020

EUA supply EUA demand Long/short situation base scenario

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Carbon Price Development


0.00 €

2.00 €

4.00 €

6.00 €

8.00 €

10.00 €

12.00 €

14.00 €

16.00 €

2013 2014 2015 2016 2017 2018 2019 2020

EUA price forecast phase 3 2013-2020, source: Gryphon Feb 2014

base scenario - lowered auction volumes Scenario 2

May 12th EUA price €5,3/t

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Biography J.L.M. Kanen


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!  Drs. Joost Kanen is founder and director of Gryphon Carbon Consultancy B.V.; He studied financial economics at Tilburg University in the Netherlands. Previously he was negotiator on the Kyoto Protocol and on EU ETS design on behalf of the Dutch Government. He also worked in energy strategy and electricity market liberalization, among others at Reliant Energy Trading and Ernst & Young. He was actively engaged in the establishment of the first carbon market in the world, the EU Emissions Trading System.

!  Mr. Kanen is the author of the book “Carbon Trading and Pricing”, published in the UK in 2006 and translated into Japanese in 2008. His book revealed unique discoveries regarding errors in emissions data used by the EU.. He also established and leads the expert network, called the “Carbon Market Platform” with 1000 members (see Linkedin).

!  Contact: [email protected], tel. +31 6 28235018

Thank You for your attention !

COAL AND THE EU ETS


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