CO2 emissions trading Progress EU ETS in 2007

European Chemical Regions Network (ECRN)“Competitive Chemical Regions in Europe”

5th Congress of the European Chemical Regions NetworkLudwigshafen, BASF-Gesellschaftshaus,

Rhineland-Palatinate, Germany 29-30 November 2007

Vianney SchynsManager Climate & Energy Efficiency

Utility Support GroupUtility provider for a.o. DSM and SABIC

Contents

1. ECRN’s vision on emissions trading

2. High Level Groups EU Commission

3. Present situation

4. Annex: Structural shortcoming present allocation rules

5. Annex: Structural solution benchmarks with ex-post adjustment to actual production

ECRN’s vision on the instrument Greenhouse Gas emissions trading

Maastricht Declaration, 22 December 2005

Tarragona Declaration, 9 November 2006

“Major improvements still needed”

ECRN’s vision on GHG emissions trading

• Present flaws– Historical grandfathering not effective– Electricity windfall profits, bound to increase from 1st period 2005-

2007 € 15 billion/year to 2nd period 2008-2012 € 55 billion/year loss of competitiveness

– No level playing field– Finite new entrant reserves insecurity new plant &

debottlenecking investments– Frozen ex-ante allocation enhances frozen market shares– Lack of stable long-term recognition of CHP

• Proposed solution, as alternative to auctioning– Benchmarks with ex-post adjustment to actual production– Guarantee of the total cap (novel method launched in Tarragona

High Level GroupsHLG Competitiveness, Energy and the

EnvironmentHLG Chemical Industry

Clear advice HLG CEE

HLG CEE and HLG Chemical industry

• High Level Group CEE members– Commissioners Verheugen, Kroes, Piebalgs and Dimas +

representatives industry, NGOs and others

• The HLG CEE advice for EU ETS on 2 June 2006– EU Commission & Member States to undertake (for

implementation in 2nd period, but this failed)= Stronger signal towards low carbon technologies= Competitiveness, reduce impact windfall profits= Level playing field new investments across EU= How can rules, notably for new entrants and closure, be more

harmonised, incl. the possibility of using a benchmarking approach

• HLG CEE 30 October 2006 confirmed statements above• HLG Chemicals: Member Reiner Haseloff, president

ECRN

Present situation

Historical grandfathering historical mistakeLowering production, no benefit for environment

Industry wants benchmarks no (partial) auctioningAuctioning seems ideal for electricity facts tell a

different storyRecent legal cases

Historical grandfathering Historical grandfathering historical mistake historical mistake

• Historical grandfathering was a historical mistake= Recognised by EU Commission, March 2007

• 3rd Trading period: perhaps auctioning for electricity & (partial?) auctioning and/or benchmarking for industry

• EU Commission will come with a proposal for revised EU ETS Directive January 2008 – then co-decision EU Parliament & Council – Takes 1.5 – 2 years, is no decision for single Member State

• Benchmarking for allocation to operators= Ex-ante: based on historical production second historical

mistake?

= Ex-post: based on actual production

Lowering production …Lowering production …

• “Lowering Production is no Benefit for the Environment, says European Industry”Paper Alliance-Cefic-IFIEC, 21 May 2007, in line with ECRN

– EU Commission declared end 2006= Lowering production and selling freed allowances is equally legitimate

than investing in emissions reductions and selling freed allowances

– European Industry recalled founding father J.H. Dales (1968): = “Pollution in one region must never be reduced by increasing pollution

in another”

= Ex-ante allocation root cause of many distortions

= Call for link to actual production

= Italian representatives EU ETS review: “intra-period updates”

Benchmarks, no auctioning & solution “windfalls”Benchmarks, no auctioning & solution “windfalls”

• Industry is against auctioning

– Auctioning electricity= Electricity prices remain high bad for competitiveness / leakage= Windfall profits 1st period € 15 billion/year to 2nd period € 55 billion/year

at CO2-price 30/ton= Full auctioning 3rd period: windfalls still high (IFIEC paper 23 Nov 07)

– Auctioning industry= Bad for competitiveness, “leakage” by production relocation

– Call for benchmarks (ECRN, CEOs e.g. Jürgen Hambrecht BASF with Alain Perroy Cefic visit Verheugen 23 Nov 07) and solution windfall profits (letter European industry 16 Nov 07)

– Auctioning with Border Adjustments at EU borders is not practical (huge bureaucracy), cannot be realised with few products only (it affects thousands of products)

Recent legal cases (1)

• UK against EU Commission (judged 23 November 2005)– EU Commission can only assess NAP against art. 10 & Annex III– No objection within 3 months = approval (e.g. rules of Germany, France,

Italy, Luxembourg, Poland about guarantee new entrants)– A NAP can be changed after Commission’s approval of an earlier notified

NAP (no “provisional” notification needed)

• Germany against EU Commission (judged 7 Nov 2007)– Germany contested the prohibition of the EU Commission to apply ex-

post adjustments (also in 1st & 2nd guidance note)– Germany asserts that the whole Directive – also art. 10 and Annex III –

does not forbid ex-post, provided total cap ensured– Court of First Instance fully confirmed German case– Germany may apply ex-post in 2nd period if case is won …

Quality of historic data for operatorsQuality of historic data for operators

Variations in annual load factors over five years, found in

UK by consultant NERAfor UK government

… with climate change instruments based on history?

Historic production tells nothing about the futureHistoric production tells nothing about the future

Link to actual production: Avoids distortions Avoids windfall profits Solves problems new entrants and closures, SEE ANNEX

Recent legal cases (2)

• What means a historic cap: many new plants enter the market?– Many new power plants in Italy around 2009 .. Germany .. NL

• What means a historic cap: import or export of product?– More electricity import NL from Germany – Is NL then doing well?– New CHP in Luxembourg – Is Luxembourg doing bad?

• Eight new legal cases– What means a historic cap: economy is strongly recovering?– Forecast of growth in central Europe, 8 legal cases European Court of

Justice against EU Commission: Czech Republic, Estonia, Hungary, Latvia, Poland, Slovakia, Lithuania and Malta

– Rumania and Bulgaria to follow?

– Influence Burden Sharing on allocation is perverse

• Solution: benchmarks linked to actual production

AnnexStructural shortcomings of present allocation

rules in the EU ETS

Environmental effectivenessLevel playing field

Competitiveness & electricity windfall profitsInsolvable problems new entrants & closures

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

• New plants and debottleneckings: also an ex-ante frozen cap, which is plan-economy

• Systemic “disincentive for efficient growth”, “reward of shrinkage”

• 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

Summary shortcomings allocation

• Threat to reduce economic activities in Europe– Not producing & selling allowances can be more profitable– CARBON LEAKAGE without environmental justification

• Rules differ across Europe– NO LEVEL PLAYING FIELD

• No structural reward of early action, no equal standards, lower emissions can come into next historic reference– INNOVATION NOT STIMULATED, NO EFFECTIVENESS

• New entrants: thresholds, finite reserves– INVESTMENT INSECURITY

• Market share winners buy allowances, to losers sell– CARTEL, winners pay penalty to losers … no free market

Electricity windfall profits

• State interference prevents competitive market– 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

– Transfer of wealth 2nd period € 55 billion/year at € 30/ton CO2 (EU-27)

– Even with full auctioning 3rd trading period 2013-2020 still € 45 billion at € 35/ton CO2

28€28€

20€20€

24€24€

32€32€

49€49€

60€60€

84€84€

46€46€ 24€24€

57€57€

70€70€(1)

(1)

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(2)

(3)

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World Map electricity prices (€/MWh)

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

(3)

60€60€(3) 67€67€

(3)

< 25€< 25€ (4)(4)

Present ETS rules: new entrants & closuresPresent ETS rules: new entrants & closures

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 it enhances market concentration Withdrawal allowances after C: perverse incentive keeping inefficient

plants in operation

Most authors elaborate these problems, but fail to conclude that within individual ex-ante frozen caps solutions are simply impossible search for squared circle

AnnexStructural solution: benchmarks with ex-post

Which benchmarks and how

Guarantee of total cap

Benchmarks with ex-post

• Few benchmarks provide high coverage= E.g. electricity, cement, refineries, steamcrackers, etc.

• Real benchmarking is easier that often assumed= Output related, same BM for incumbents & new entrants

• Benchmarks with ex-post adjustments of production, solution for:

= Leakage, level playing field, effectiveness, no insecurity for new entrants, no transfer rules, no windfall profits, free market without cartel problem

= Works exactly as auctioning

• Two new studies launched at ECRN Tarragona= How to ensure total cap with ex-post= How does it work in the electricity market