The interaction of tradable instruments in renewable energy and climate change markets

December 2001 ECN-C--01-048

THE INTERACTION OF TRADABLE INSTRUMENTS IN RENEWABLE ENERGY AND CLIMATE

CHANGE MARKETS

Final Report

ECNM.G. Boots

G.J. SchaefferC. de Zoeten

CMURC. MitchellT. Anderson

RISØP.E. Morthorst

L. Nielsen

ZEWI. Kühn

W. BräuerM. Stronzik

UAMM. Gual

P. del RioA. Cadenas

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AcknowledgementThis report is the result of co-operation in the InTraCert project: ‘The Role of an Integrated TradableGreen Certificate System in a Liberalising Market’, funded by the European Commission in the FifthFramework Programme (contract no. NNE5/1999/428). The project is co-ordinated by the Nether-lands Energy Research Foundation (ECN). Other contractors are Zentrum für EuropäischeWirtschaftsforschung (ZEW) in Germany, RISØ National Laboratory in Denmark, UniversidadAutonoma de Madrid (UAM) in Spain and the Centre for Management under Regulation at the Uni-versity of Warwick (CMUR) in the UK.

Earlier output of the project consist of the ‘InTraCert Inception Report’ (available at ECN undernumber ECN-C--00-085), the ‘InTraCert Workshop Proceedings’ (not officially published, butavailable on request) and the ‘InTraCert Analysis Report’ (not officially published, but available onrequest).

This ‘Final Report’ integrates and summarises the work done in the analysis phase of the project,which was reported in detail in the ‘Analysis Report’. Moreover it compresses discussions within theproject team, which are reflected in the recommendations of this ‘Final Report’. Thus this ‘Final Re-port’ focuses on relevant issues with respect to the interaction between green certificates and carbonemissions trading. It will not deal with e.g. the cost-effectiveness of trade or explaining the KyotoProtocol once again. Information on these topics can be found in InTraCert’s earlier reports or inmany other references.

This report is published by ECN on behalf of team members under number ECN-C--01-048. TheECN-project number of this project is 77259. With reference to the report number additional copiescan be ordered (see the inside of the Cover of this report).

The funding by the EU does by no means imply that this report contains EU statements. The respon-sibility for the text, including its inevitable flaws, remains with the authors.

AbstractIn order to meet renewable energy targets, establishing a market for tradable green certificates(TGC) is a relevant instrument to use. Within the past few years green certificate markets havegained extensive interest in Europe and elsewhere, and markets seem to be appearing in a number ofcountries, among these the UK, Australia, Italy, Belgium (Flanders), Sweden and Denmark.

The main objective of the InTraCert project is to examine the potential and implications of estab-lishing such an international tradable green certificate system with respect to EU and national re-newable energy policies as well as climate change policies. Particular attention is paid to:1. the possibilities for establishing an EU-wide market for tradable green certificates to promote an

efficient deployment of renewables across the borders of the Member States,2. to expand the TGC market to include not only renewable power production, but also the pro-

duction of biogas and green heat,3. to analyse the interactions between TGC and other market instruments of the EU and Member

States, especially tradable emission permits (TEP) for the power industry,4. to investigate interactions and implications for national and EU GHG reduction policies,5. to clarify potential market distortions, trade-offs and other implications for renewable and GHG

reduction policies if the TGC and TEP-systems are not designed appropriately.

Analyses were performed for approaching optimal designs of TGC systems, including implicationsof different national systems with regard to penalties, tradability and system boundaries, aiming atguidelines for establishing a common EU TGC system. A number of scenarios outlines the possibleinteractions between the TGC-approach and tradable emission permits and the implications for ap-plying these instruments in reaching national GHG reduction targets. One of the major outcomes ofthe project is a comprehensive list of policy recommendations for implementing trading systems forrenewable energy and GHG emissions at the EU and/or at the national level.

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CONTENTSEXECUTIVE SUMMARY 5

S.1 Summary of the project 5S.2 Policy recommendations 6

1. INTRODUCTION 11

1.1 Green certificates 111.2 Carbon emissions trading 111.3 Research issues and overview of the report 12

2. KEY ISSUES IN TRADABLE GREEN CERTIFICATES AND EMISSIONS TRADINGSYSTEMS 14

2.1 Main issues in green certificate systems 142.2 Effects of different obligation and ‘action’ points in the supply chain 16

2.2.1 Price caps and penalties 172.2.2 Position of price cap in supply chain 182.2.3 Penalties for intermittent generation 20

2.3 Main issues emerging in emissions trading 21

3. INTEGRATION OF TRADING SYSTEMS AND OBLIGATIONS FOR RENEWABLEELECTRICITY AND CARBON 23

3.1 Interaction issues and options 233.1.1 Complete integration 243.1.2 Complete separation 293.1.3 Specified interaction 31

3.2 Interaction of green certificates with Flexible Mechanisms 363.2.1 Reciprocal effects between the renewable energy and the CO2 reduction

markets 363.2.2 Green certificates and international carbon trade 40

3.3 Technical issues of integration 413.3.1 Certification criteria 413.3.2 The order of project approval 413.3.3 The project cycle 42

3.4 Conclusion 44

4. DESIGNING TRADABLE SYSTEMS SERVING BOTH RENEWABLE ELECTRICITYAND CARBON TARGETS 45

4.1 Theoretical scenarios for linking CET and TGC 454.1.1 GHG credits are not attached to the TGC 464.1.2 GHG credits are attached to the TGC 494.1.3 Trade-offs between different reduction instruments 51

4.2 Green certificates and emission permits in national GHG strategies 524.2.1 Three cases for TGC and TEP quotas 534.2.2 Spot and TGC prices in international trade 55

4.3 Conclusion 57

5. RENEWABLE HEAT AND BIOGAS 59

5.1 Certificate units and conversion 605.1.1 Unit of the certificates issued 605.1.2 Conversion methods 62

5.2 Supply side of integrated certificates systems 635.2.1 A supply side based classification of integrated certificates systems 635.2.2 Evaluation of alternative options 645.2.3 Inferences on supply side considerations 67

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5.3 Demand side of integrated certificates systems 685.3.1 A demand side based classification of integrated certificates systems 685.3.2 Economical and political trade-offs 705.3.3 Inferences on demand side considerations 73

5.4 Conclusion 74

6. RECOMMENDATIONS 77

6.1 Experiences from comparable previous or on-going policy schemes 776.2 Relevant issues for creating a tradable green certificate market 776.3 Interactions with other policy instruments 786.4 A tradable green certificate market as an efficient instrument in achieving national

GHG reduction targets 79

REFERENCES 81

ABBREVIATIONS 82

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EXECUTIVE SUMMARY

S.1 Summary of the projectAccording to the Kyoto protocol the European Union has agreed on a common greenhouse gas(GHG) reduction of 8% during the period 2008-12 relative to 1990. Although this protocol isnot ratified, GHG issues are to an increasing extent at the core of the energy and environmentalpolicies of the European Union and its Member States. In the implementation of these GHG tar-gets, the development of renewable energy resources is expected to play an important role. In itsWhite Paper on a strategy for developing renewable energy the European Commission haslaunched a goal of covering 12% of the European Union’s gross inland energy consumption byrenewable energy supplies by 2010. In line with this, the European Commission has recentlyadopted a directive on the promotion of electricity supply from renewable energy sources (EC,2001a)1. This includes indicative targets for the share of renewable electricity (RES-E) in theindividual Member States in 2010, based on the percentage of each country’s consumption ofelectricity. Thus the RES-E Directive signals the need to include renewable energy technologiesas one of the serious options in achieving the targets for GHG reductions.

Among the available instruments to use in order to reach these targets for RES-E developmentis the establishment of a market for tradable green certificates (TGC). Within the past few yearsgreen certificate markets have gained an extensive interest in Europe and elsewhere, and mar-kets seem to be appearing in a number of countries, among these the UK, Australia, Italy, Bel-gium (Flanders), Sweden and Denmark.

The main objective of the InTraCert project is to examine the potential and implications of es-tablishing such an international tradable green certificate system with respect to EU and nationalrenewable energy policies as well as climate change policies. Particular attention is paid to:1. the possibilities for establishing an EU-wide market for tradable green certificates to pro-

mote an efficient deployment of renewables across the borders of the Member States,2. to expand the TGC market to include not only renewable power production, but also the

production of biogas and green heat,3. to analyse the interactions between TGC and other market instruments of the EU and Mem-

ber States, especially tradable emission permits (TEP) for the power industry,4. to investigate interactions and implications for national and EU GHG reduction policies,5. to clarify potential market distortions, trade-offs and other implications for renewable and

GHG reduction policies if the TGC and TEP systems are not designed appropriately.

In the project a comprehensive review of EU and national policies with regard to the deploy-ment of renewable energy sources (not exclusively the sources producing electricity) was un-dertaken with special emphasis put on the review of existing and planned trading systems forRES-E and GHG. Analyses were performed for approaching optimal designs of TGC systems,including implications of different national systems with regard to penalties, tradability andsystem boundaries, aiming at guidelines for establishing a common EU TGC system. Finally, anumber of scenarios outline the possible interactions between the TGC approach and tradableemission permits and the implications for applying these instruments in reaching national GHGreduction targets.

1 Referred to as RES-E Directive in this report.

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One of the major outcomes of the project is a comprehensive list of policy recommendations forimplementing trading systems for RES-E and GHG emissions at the EU and/or at the nationallevel.

S.2 Policy recommendationsThe policy recommendations from the InTraCert project are split into four main categories:1. experiences from comparable previous or on-going policy schemes,2. relevant issues for creating a tradable green certificate market,3. interactions with other policy instruments,4. a tradable green certificate market as an efficient instrument in achieving national GHG re-

duction targets.

In the following each of these categories will be treated separately.

Experiences from comparable previous or on-going policy schemesA number of countries have recently established or are in the transition phase of establishingtradable green certificate systems, among these can be mentioned the Netherlands, the UK, It-aly, Belgium (Flanders), Sweden and Denmark. But almost no TGC schemes have been in op-eration long enough, so experiences with this kind of market are very limited. However, someinteresting issues arise from the analysis:• An obligation by the government, on one or more actors (producers, suppliers and consum-

ers) in the energy supply/demand chain, to acquire a certain number of certificates within agiven period is the most plausible option, in the short and medium term, to promote TGCsystems.

• Transparency seems to be a very relevant attribute in green certificate systems. Providingcustomers with clear information about the energy they consume, and the effects it has onthe environment, may provide enough knowledge as to increase voluntary demand for RES-E in the medium and long-run.

• Co-ordinated institutional adjustment (national and European) of the conventional powerproduction industry is needed to create a well-functioning TGC system.

With regard to emission trading a number of experiences do exist, especially from the US. Twoapproaches have been used: the ‘allowance’ and the ‘credit’ systems, where the main differenceis that in the credit system only emission reductions above the reduction target can be traded,while all reductions can be traded in the allowance system. Comparing these two systems thefollowing observations are made:• Allowance trading programs have proven to be superior to credit trading in terms of eco-

nomic and environmental efficiency.• Simplicity appears to be a key element when designing emission-trading systems and close

attention must be given to the effectiveness of reporting methods in terms of cost and reli-ability.

• Transaction costs have played an important role in deploying trade of allowances. Credittrading has higher transaction costs, which may partly explain their poorer performance.

Relevant issues for creating a tradable green certificate marketDesigning TGC markets have been the objective for previous projects and therefore only newaspects, brought up during the InTraCert project, will be reported here.

As mentioned above a number of countries are on the way to establish TGC markets. Thus, al-though these countries have not chosen the same concept for establishing national green certifi-cate markets, nevertheless there seems to be a good starting point for establishing an interna-tional green certificate market. To create a cost-efficient TGC market the following observa-tions should be taken into account:

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• Although all the countries participating in the TGC market do not have to be part of thesame liberalised spot market for electricity, the prices of power should in general be at thesame level, not to bias the price-determination at the TGC market.

• The most efficient TGC market will be established if there is a harmonisation of actionpoints between the TGC systems, which means that minimum prices and price caps shouldbe kept within narrow ranges.

• Certification and validity of certificates should be harmonised between the participatingcountries. The certificates should include information on the renewable source, making itpossible for countries to exclude specific TGC without jeopardising the functioning of theoverall TGC system.

• Only the most efficient renewable technologies will be deployed by the TGC system. Thuscare should be taken to establish compatible support mechanisms to promote weaker renew-ables.

• MWh is recommended as the unit for the issued certificates. The MWh is an unambiguousunit for the production of electricity and the use of MWh seems already to be the interna-tional standard practice.

• To achieve the highest efficiency of the TGC system, the obligation should be put on thelowest level of the supply chain that is on the consumer.

• To prevent ‘lock-in’ in the demand for green certificates the obligations should be stated ingeneral energy terms. If green certificate suppliers are not forced to sell their certificateswithin a certain time limit, the demand obligation combined with a co-ordinated supplycould force the TGC price to a very high level. Two obvious ways to prevent ‘lock-in’ at thedemand side is to make the obligation less rigid, for example general instead of specific, andto limit the tradability of TGC in time.

When implementing a TGC system, it seems most practical to start with a national grid-basedsystem with specific certification for the different energy carriers or, as it often happens now, tostart with an electricity-only system. Gradually, some non-electricity options can be added.Later on, non-grid options can be included as well. This may happen either before or after someinternationalisation has occurred. In the longer term it is recommended that:• all renewable sources are included into an integrated certificate system, that is not only re-

newable electricity generation, but also gas and heat based on renewable sources,• when non-electricity options are included in the TGC system a problem of conversion

arises, e.g. using green gas to produce green power. Therefore it is recommended that bothconcepts of ‘redemption-for-conversion’ and ‘redemption-for-obligation’ be used in theTGC system. ‘Redemption-for-conversion’ means that existing certificates are exchangedfor new certificates and not handed over to fulfil an obligation. Therefore, some certificatesare ‘eliminated’, e.g. when used as an input in an energy conversion process, and some oth-ers can be ‘created’, e.g. when the output of the energy conversion is certified.

In the long term the aim should be to establish an international, production-based system withgeneral certification. On the other hand, this system should only be implemented, if it appears aclear improvement of the TGC system.

Interactions with other policy instrumentsThe InTraCert project has concentrated on analysing the interactions between TGC and tradableemission permits, but also interactions with the liberalised physical power market and withother Kyoto mechanisms have been treated.• If policies are in place that level out marginal CO2 abatement costs across the EU (a com-

mon tradable emission permit scheme based on the bidding concept), and the liberalisationprocess is finalised, the pricing of the commodity of green power can be left to the differentmarket places. Separate market prices for TGC and emission permits will emerge.

• In the Kyoto process the methodologies of baseline, benchmarking, monitoring problemsand procedures have been analysed and discussed for Joint Implementation projects. We

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suggest to follow the baseline definition that will eventually be agreed upon in the Kyotoprocess, and to harmonise the certification criteria and requirements for TGC and JI proj-ects.

• As long as no EU-wide CO2 emissions accounting regime is in place and the level of elec-tricity market liberalisation differs across the EU, significant distortions might appear on theTGC markets. Thus, if the reference price of power is not the same in all EU countries theTGC system does not secure that renewable sources are developed in the most cost-efficientmanner.

A tradable green certificate market as an efficient instrument in achieving nationalGHG reduction targetsBasically no CO2 credits are attached to the tradable green certificates and therefore the devel-opment of renewables will add to GHG reductions only where a fossil fuel-fired production issubstituted. International trade in certificates will only help ensuring that the targets for devel-oping renewable energy technologies are reached in the most cost-efficient way.

If an international TGC system is introduced separately into a liberalised power market context,those countries most ambitious in renewable target setting by increasing their TGC quotas willonly partly be gaining the CO2 reduction benefits themselves. How much they gain will totallybe determined by the marginal conditions at the power spot markets and the emission-coefficients of the domestically replaced power. Moreover, to fulfil their TGC quotas the mostambitious countries will have to buy certificates from the less ambitious countries, although thisonly contributes in fulfilling a national target for renewable development, not in reaching theirnational CO2 reduction targets. Therefore:• If one of the major objectives of introducing an international TGC system is to achieve na-

tional CO2 reductions, then a separate introduction of a green certificate system into an in-ternational liberalised electricity market can not be recommended.

Two remedies exist to improve the GHG reduction performance of a green certificate marketcombined with a liberalised power market: 1) Introducing an international market for tradableemission permits (TEP) for the power industry, 2) adding CO2 credits to the green certificates.Introducing an international market for tradable emission permits for the power industry is aninteresting possibility that, given certain conditions, goes well with an international TGC mar-ket:• In terms of achieving a national GHG reduction target, an optimal utilisation of the TGC

regulated renewable production will only take place if a co-ordinated adjustment of the TEPregulated conventional power production is undertaken. An increase in the national TGCquota has to be matched with a corresponding decrease in the national quota of tradableemission permits to fully utilise the renewable production in a national GHG reductionstrategy.

• Finally, it is important that the price of a green certificate in international trade reflects thevalue of the product. If the value does not correspond to the price this will bias the incen-tives for international trade in certificates. By using a tradable permit system based on thebidding (auction) procedure the costs of CO2 reduction will be fully reflected in the spotmarket price of electricity and therefore international trade in green certificates will beequivalent to a domestic development of renewables.

The second possibility to achieve a well-functioning TGC market in a liberalised power marketcontext is to add CO2 credits to the green certificates. This option is possible, but to state thecorrect volume of avoided emissions is difficult due to the complexity of the internationalpower market.

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Moreover:• If CO2 credits are added to the green certificates, care should be taken to avoid double

counting of emission reductions. CO2 credits attached to TGC will have to fit within a TEPsystem when, in parallel with the certificate system, a separate tradable permits market ex-ist, because in the TEP approach the cost of CO2 reduction will be included in the spot mar-ket price of electricity.

Thus, although there may be large economic and environmental benefits related to creating aninternational TGC market, great care should be taken in setting up this market, especially in re-lation to the physical power market and a tradable permits market, if these benefits should bereaped.

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1. INTRODUCTION

In the coming years the trend of liberalising and integrating energy markets within the EuropeanUnion will have to be combined with ambitious environmental goals. The design and imple-mentation of the policy measures and incentive schemes will have to exist within the energymarket. Incentive schemes for market penetration of renewable energy and carbon reduction arelikely to be most successful if they complement the liberalisation of international energy mar-kets.

1.1 Green certificatesGreen certificates2 have emerged as one way to stimulate the penetration of electricity producedwith renewable energy sources (RES-E) within the liberalising energy markets of the EU. Greencertificates are used to represent the ‘greenness’ or ‘renewableness’ of energy produced fromrenewable sources so that the sale of this ‘greenness’ can be detached from the sale of thephysical energy. Sale of the ‘greenness’ occurs when there is demand for it. Demand for GreenCertificates can emerge because of three main reasons:1. voluntary demand for ‘green energy’ from consumers,2. government obligation at some point in the supply chain,3. voluntary industry agreement on an obligation.

For the purposes of this report, we will deal mainly with the last two types of demand, as theyare likely to have the largest impact on the trade of green certificates and in practice function inthe same way. Voluntary green energy schemes (in most EU states) have a much smaller effect,although we will highlight those points at which they have a larger impact, such as the case ofinternational trade in green certificates.

Detaching the ‘greenness’ from the physical energy sale allows the development of renewableenergy schemes in the most economically attractive sites, ensuring that deployment targets forrenewable energy are met in a cost-effective manner. In order to function effectively a greencertificates scheme must be designed so that it is credible and transparent, does not impose anexcessive price burden on consumers and provides a sound basis for financing renewable energyschemes.

1.2 Carbon emissions tradingCarbon emissions trading (CET) systems are being developed in order to live up to the Kyotocommitments. Emissions trading is based on the idea that participants in an emission reductionscheme can lower the overall cost of meeting an agreed target by buying and selling emissionsallowances and/or credits. Furthermore, CET systems provide significant economic efficiencygains compared to other politically feasible alternatives and offer the possibility to attain envi-ronmental goals at a lower cost for participating sources (firms or countries). The trading ele-ment allows those with high emissions reduction costs to pay others (with low emissions reduc-tion costs) to carry out extra action on their behalf, so that the total amount of pollution from allparticipants stays within the agreed limit. In this sense, trans-boundary cost sharing is facilitatedsince the issue of ‘who pays for control’ remains separated from the issue of ‘who implementscontrol’.

2 Green certificates are also referred to as renewable certificates, renewable obligation certificates, renewable en-ergy credits, tickets and tags. We are using TGC as a generic term that includes all of these in this report.

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The EU has made a joint commitment under the Kyoto Protocol to an 8% reduction in GHGemissions by the 2008-2012-commitment period. The EU’s aggregate 8% commitment to GHGreductions was divided between Member States. There is a wide range of commitment levels inthe EU, which reflects many factors, including the current emissions total and the level of in-dustrial activity in each State. Some Member States also have their own internal commitmentsto Climate Change actions.

Under the Kyoto Protocol, three types of Flexible Mechanisms are included to allow countriesto meet their commitments jointly in order to minimise costs. They are:• Emissions Trading• Joint Implementation (JI)• The ‘Clean Development Mechanism’ (CDM).

Emissions Trading allows countries to buy and sell emissions allowances or credits from eachother. In this way, countries with high cost of GHG abatement actions can buy allowances orcredits from countries with lower abatement costs, who undertake GHG abatement actions inaddition to those required to meet their own targets in order to generate extra credits for sale.The Kyoto protocol is couched in terms of ‘Emission Reduction Units’ (ERU), ‘Certified Emis-sion Reductions’ (CER), ‘Assigned Amount Units’ (AAU) and ‘Part of Assigned Amounts(PAA) - all of which are defined under specific articles of the treaty.

Joint Implementation allows signatories to the protocol to agree joint abatement actions, whichwill result in an overall reduction of GHG emissions for the signatories as a unit. In particular, a‘donor’ country can finance an emissions reduction action in a ‘host’ country, receiving in re-turn for this a GHG emissions allowance it can use as part of meeting its own target. Under theKyoto protocol there are two types of Joint Implementation activities under consideration. One,under Article 6, is straightforward joint actions between two countries that have agreed targetsunder the protocol (i.e. two Annex 1 countries) - a type of ‘closed’ Joint Implementation. Theother involves one country with a GHG abatement target and a developing country that has noabatement targets - a type of ‘open’ Joint Implementation. This type of Joint Implementation isknown as the Clean Development Mechanism because the countries that provide the low-costabatement opportunities are all developing countries. The Clean Development Mechanism ishighly controversial.

1.3 Research issues and overview of the reportThe main issues regarding TGC and emissions trading systems will be discussed in Chapter 2.The deployment of renewable energy sources reduces CO2 emissions. However, there are manyother measures, often less expensive than renewables, that do the same. A CO2 reduction creditor a CO2 emission permit system has many implications for a renewable energy policy. On theother hand, there are many means of deploying renewables. Doing so by tradable green certifi-cates has a number of problems. When the TGC scheme is linked to climate change policies‘new’ benefits enter the current renewable energy ‘bubble’ which would not otherwise do so.Many questions arise, for example: will renewable energy generators receive a TGC and a CO2reduction credit? Would they be of the same ‘currency’ so that they are inter-changeable, i.e. agreen Euro? How will carbon emission tradables influence TGC and vice versa? Early investi-gations show that the design of the TGC or CET scheme (and in particular the structure of thetargets and penalties for failure to meet targets) will have a key impact on how those schemesachieve their aims. Chapter 3 focuses on the possible integration of obligations and trading sys-tems for RES-E and carbon.

As a consequence of liberalisation, deregulation and open access to energy transmission net-works, energy markets become more integrated in the EU. Thus, the interaction of tradable cer-

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tificates systems implemented in different countries is an important issue here. In stead of al-lowing for trade within a country, there is a tendency to trade across borders. A tradable certifi-cate system, implemented in just one or a few countries, would lead to unfair competition forenergy companies vis-à-vis their foreign competitors that do not face a green or CO2 certificateobligation. Different countries are likely to have different promotional mechanisms to some de-gree: they have different levels of renewable deployment with generation from different tech-nologies at different prices. In a liberalised electricity market, customers are free to choose theirsupplier. Customers may buy their electricity directly from the (international) spot market orfrom independent generators and thus avoid the certificate obligation. When a green certificatesystem is introduced EU-wide, the different stages of market liberalisation in the different EUcountries are also of importance. Utilities in a more protected market would have an advantageabove utilities in an open market, since they can pass-on the extra cost to their captive custom-ers. Thus, regardless of how much the EU or the national renewable energy industries wouldlike it, a standard means of support by Member States for renewables is unlikely. Therefore, aTGC system would have to grapple with implementing a CET system into this situation, whilehopefully improving the deployment of renewables. The designing of the scheme will have todecide on the barriers for trade, the eligibility of traders and timing of expansion. Moreover,how could international interaction with countries outside the EU (e.g. the US, China) takeplace? Chapter 4 takes these issues and the earlier analysis of Chapter 3 a step forward, trying toimprove the tradable schemes in order to serve both RES-E and CO2 targets.

Discussion and implementation plans for TGC focus almost entirely on the instrument as astimulus for the penetration of electricity produced with renewable energy sources. However, inorder to meet the renewable targets, it might be necessary to expand the TGC system to otherenergy carriers in the energy mix, in particular renewable heat and biogas (i.e. not necessarilyuse these to generate electricity). Therefore, Chapter 5 focuses on the integration of renewableheat and biogas into a TGC system. Finally, conclusions and recommendations are given inChapter 6.

We must stress at this point that the InTraCert project represents an investigation into the theo-retical interaction between tradable instruments in the energy and climate change markets. Assuch, it does not carry out a full analysis of how such markets are interacting in practice at thepresent time. And although the analysis within the project also involved an inventory of themany different trading systems for green certificates, carbon and environmental emissions thathave been or are going to be introduced at different levels, these ‘trading systems in practice’will not be described again in this final report.

Furthermore, our analysis is based on the steady state and does not include speculation on thedynamic effects of the market. We do, however, believe that the dynamics of this field are likelyto have considerable effect on issues such as the range of technologies deployed under anygiven renewable energy policy and the cost-effectiveness of the policies in combination. Webelieve that this subject should be considered by future studies.

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2. KEY ISSUES IN TRADABLE GREEN CERTIFICATES ANDEMISSIONS TRADING SYSTEMS

This chapter deals with tradable green certificates and carbon emissions trading separately,identifying the most important issues that arise when introducing them system. These issues willbe used in Chapter 3 to analyse integration between green certificates and emissions trading.

2.1 Main issues in green certificate systemsAlthough examples of TGC systems are becoming established worldwide, there are several is-sues that are still to be resolved. In this section we set out the major issues that have emergedfrom the early years of (mainly European) experience of TGC. These issues are:• national versus EU viewpoints• ‘transferability’ of TGC• boundaries of tradability• unforeseen effects due to national differences in implementation• financibility and impact on deployment• technical limitations of distribution grids• fungibility.

National versus European Union viewpointsOne of the most important issues is the question surrounding the extent to which national andEU targets interact. Under one scenario, Member States could set up their RES-E targets andsupport mechanisms in complete isolation from each other. At the other end of the scale, the EUcould have a completely integrated system of targets and support mechanisms for renewable en-ergy, with Member States participating on the basis of a ‘burden sharing’ agreement, with allo-cated national targets similar to those negotiated for greenhouse gas reduction. With the adop-tion in 2001 of the RES-E Directive on the promotion of renewable electricity, the EU and itsmembers have chosen the latter.

Most Member States are aiming to achieve, at least in these early stages, a minimum level ofnational deployment of RES-E. Although some of the emerging national TGC schemes allowfor the possibility of international trade, there is widespread commitment to domestic action onrenewable energy, regardless of the fact that, in purely economic terms, some countries may bebetter equipped to develop RES-E capacity than others. However, it is likely that in the future,when the cheaper RES-E options are exhausted in each country, economic considerations willbecome more important and international trade will emerge. Efforts to establish the means forsuch trade are continuing at the moment, e.g. via the RECS initiative. It is also possible that inthe future the EC will call for an EU-wide approach to trade in renewables.

Transferability of certificatesIn a sense, the former point is closely linked to the ‘transferability’ of certificates, i.e. the extentto which they can cross national boundaries. Carbon emission trading relies on the fact that anemission of CO2 has the same impact on global warming regardless of the place it is emitted.While RES-E can mitigate carbon emissions by displacing ‘brown’ generation, this is not itsonly impact on the environment. The question is if the other credits of RES-E (i.e. other than theadvantage of CO2 reduction) are attractive enough for countries to trade across borders.

Boundaries of tradabilityIn principle, every rule regulating the trades on TGC markets can be interpreted as a boundaryof tradability. A concrete trading system can be interpreted as totally defined by different

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boundaries of tradability. In this section boundaries of tradability are analysed on a generallevel. The question is which boundaries should be built into TGC systems.

Boundaries of tradability may be related to the instruments and the agents’ behaviours on themarkets or they may be related to the problems that need to be solved, namely promotion of re-newable energy. Some may be motivated by policy priorities and others by technical capacities.Boundaries of tradability may be build into concrete TGC systems for a variety of reasons. Forexample to limit speculation and increase competition, to secure a stable and well functioningmarket and to ease control.

One of the ideas behind tradable green certificates is to place investments in new renewable en-ergy sources where it is most profitable. Taking wind turbines as an example of profitability isdependent on the wind condition where raised. Since wind conditions are optimal in England,Ireland and Denmark and near coastal areas in general, it is important to be aware of limits tothe amounts of wind turbines placed. These limits are highly dependent on transmission capac-ity. Unless the regional prices of electricity from renewable energy sources reflect the maximumcapacities of the electricity systems, the ‘maximum’ renewable energy supply from a given areamay somehow be implemented as a boundary on the TGC tradability. There is a spatial bound-ary on the system. Another arguments for a spatial restriction on the tradability of green certifi-cates is that governments prefer domestic investments in green electricity production, for exam-ple because of positive employment effects (relative), security of energy supply, etc.

The aim of TGC is to stimulate the most profitable investments in green electricity productiongiven a specific target for green electricity production. Green electricity producers sell permitsto the consumers, who some way or the other are obliged to buy. The demand obligation of theconsumers can be formulated as an obligation to buy certificates representing (at least) a mini-mum percentage of the electricity consumption produced by renewables. The demand obliga-tion, which is time specific, does not in itself impose a time restriction on the supply of greencertificates. But if green certificate suppliers are not forced to sell their certificates within a cer-tain time limit, the demand obligation combined with a co-ordinated supply could force theTGC price to a very high level. This delivers arguments for penalties and price caps on TGC(see the section on price caps and penalties) or legislation that prevent co-ordinated supply.

One way of limiting the supply side’s possibilities to speculate against a demand side ‘lock up’as a result of a rigid demand obligation is to limit the TGC tradability in time. Other ways are toatomise the supply decisions or making the demand obligation less rigid. The possibility ofbuying and selling green certificates forward, selling on markets for futures or banking opens upfor, or ease, tradability in time.

Unforeseen effects due to differences in implementationThe following issues are relevant when international trade takes place between countries withdifferences in implementation of TGC schemes.1. Validity of certificates: TGC may be valid under different conditions in different countries.

Such conditions include the question of what constitutes renewable energy, what does thecertificate represent in the countries of origin and in the countries that purchase (i.e. ‘what isthe greenness’), and certificate lifetime.

2. Interactions with other support mechanisms: This includes other funding streams for RES-E, premium price systems and indirect support such as preferential grid access, preferentialtreatment under planning regulations etc. The point was examined extensively in a previousstudy (Schaeffer et al, 2000).

3. Electricity trading arrangements: The electricity trading arrangements in some EU MemberStates penalise any producer automatically for being intermittent. This means that RES-Eelectricity could be disadvantaged by the structure and operation of the supply industry it-self. This may well mean that in Member States without a purchase obligation for RES-E,the RES-E is not taken by the grid at all. Section 2.2 will be devoted to this particular issue.

16 ECN-C--01-048

4. Differences in ‘obligation’ point: Different actors will be subject to a RES-E obligation indifferent countries. It is possible that this will introduce some inefficiency into trading be-tween countries. However, to date, most countries propose that TGC should be issued to thegenerator of RES-E electricity, while the obligation is forced upon the supplier, so to someextent this harmonises the issue.

Financibility and impact on deploymentGreen Certificate systems are relatively new and so far there has been no assessment of theirimpact on deployment. One key question that has emerged in the early stages of TGC is: Howfinancible is RES-E under these new obligations? Will investors have confidence that contractswill be reliable when TGC may well be traded on a very volatile market, both at a national andinternational level?

This point is closely linked to the environment in which a TGC system operates. Financiers pre-fer a guaranteed price for the number of years covering the loan. TGC on its own do not providethis type of certainty.

Technical limitations of distribution gridsDelivery of electricity to a grid has local and regional impacts within the supply network andcannot be accepted by the grid unless there is some relatively local demand for it. More impor-tantly, renewable generation may add large costs for grid reinforcement. The question of whopays for this reinforcement and how, could stop distributed generation development in its tracks.Scotland, for example, has one of the best wind power resources in Europe. However, it is notpossible to exploit all the wind power in Scotland with a view to trading green certificates else-where in the EU without taking into account the fact that the electricity produced in Scotlandhas to match a portion of the demand on the UK grid. Similar questions may well emerge forgreen heat and gas trading systems once these become more widespread.

FungibilityAlthough the debate about green certificates began with electricity in mind, it has now expandedto cover green heat and gas and the interaction with greenhouse gas emissions trading. The fun-gibility between different types of certificates is a key issue for the field as a whole. We exam-ine this in the next chapters.

2.2 Effects of different obligation and ‘action’ points in the supply chainIn this section we examine the impacts that the configuration of obligation and ‘action’ pointscan have on the deployment of renewable energy. By ‘action’ point we mean a point in the sup-ply chain at which a particular support mechanism first acts. For example, an obligation on sup-pliers to purchase a certain fraction of their supply from renewable energy sources, can be saidto ‘act’ on the supplier even though the impacts of this pass along the supply chain, whereas arebate on an energy tax for an energy user can be said to ‘act’ first on the user.

In theory, the price of a TGC in any country will cover the marginal cost of production of RES-E over normal electricity. This is shown in Figure 2.1, where the amount of RES-E productionwithout a TGC system is Q1 (which corresponds to the amount that can be produced at the cur-rent electricity price Pel). The amount of RES-E (Q2) that can be produced when a TGC systemoperates depends on the price of the TGC: Ptgc. However, this situation can be affected in anumber of ways by the configuration of the trading system.

ECN-C--01-048 17

Amount of RES-Eproduced

Production costs ofRES-E

Pel

Q1

Ptgc

Q2

Figure 2.1 Simple marginal cost curve for RES-E production

2.2.1 Price caps and penaltiesIn addition to the income gained from the sale of Green Certificates or by passing on their costto consumers3 (a ‘positive’ incentive) most schemes will also contain some sort of penalty forfailing to reach targets for the supply or purchase of RES-E. It is likely that this will be a finan-cial penalty in most cases. Where this is at a fixed rate it will function as a price cap for greencertificates.

There are two kinds of penalties, which affect the behaviour of the agents differently. First,there are penalties for not acting as the law prescribes. These penalties are introduced to avoidcheating and illegal behaviour. Illegal behaviour is unacceptable to most of the agents and there-fore these penalties are quite effective in regulating behaviour. Other types of penalties are builtinto the TGC systems. For example penalties posed on the buyers for not having ‘enough’ cer-tificates (i.e. the minimum required amount of certificates). The size of the penalty will enterinto the economic analysis made by the agents. The buyers may interpret the penalty as a maxi-mum price (price cap) for green certificates. If the market based price of certificates exceeds thepenalty, the buyers will prefer to pay the penalty and not to buy certificates.

Governments may want to signal the maximum price it is willing to force the buyers of greencertificates to pay for the enlargement of the renewable energy production capacity - and decidethe maximum ‘premium’ to the owners of renewable energy production capacity. Governmentscan link a particular TGC system to other systems (for example other TGC systems) by relating

3 The cost of any support scheme for renewable energy or GHG is ultimately passed on to energy consumers. Toprevent the price burden becoming too great, it is therefore likely that many schemes will incorporate provisionfor a maximum price for green certificates or TEP or for the maximum price that can be passed on to consumers.This may take the form of a fixed penalty level.

18 ECN-C--01-048

a price cap for the ‘particular’ system to the TGC market price or price caps of the other sys-tems. Price caps (or maximum prices) on green certificates limit the expenses of the buyers andto customers, and limit the income of suppliers. Governments may have several arguments forintroducing price caps. They may, for example, be used to send signals to the market, which areaimed at reducing the extent of market uncertainties or reducing price speculation or expectederrors, etc. Governments may want also to signal the maximum price they are willing to imposeon purchasers and decide the maximum ‘premium’ to the owners of renewable energy produc-tion capacity.

Minimum prices ensure that sellers of green certificates receive at a least a minimum additionalincome from green electricity. This minimum price protects renewable energy suppliers fromthe effects of full competition and provides more certainty for financiers. Minimum prices arenot generally perceived to be relevant with respect to TEP systems. If governments wish thepolluters to pay a minimum price for emitting GHG they can tax emissions.

We first of all consider a situation in a country where there is an obligation on suppliers to sup-ply an amount of RES-E, coupled with a system of TGC. In such a system, a price cap for TGCmight be imposed so that the price burden to consumers can be controlled by the government. IfPtgc-max is a ‘cap’ price for the TGC, then Q2 represents the amount of RES-E that can be pro-duced when that cap price is in place (see Figure 2.2).



Pel

Q1

Ptgc- max

Q2

Figure 2.2 Relation of Ptgc-max and deployment (Q2)

2.2.2 Position of price cap in supply chainHowever, this simple version of the theory assumes that the ‘cap’ price for the TGC applies di-rectly to the TGC at the point of production, i.e. the price of the TGC is passed on to the pro-ducer. If the cap price is applied at another point in the supply chain, only a fraction of this willbe passed back to the producer of the TGC. The size of the fraction will depend on the balancebetween supply and demand (i.e. on the strength of the obligation). This is shown in Figure 2.3.

ECN-C--01-048 19



Pel

Q1

Ptgc- max

Q2

Ptgc-max/2

Q3

Figure 2.3 Example of impact of imposing price limit for TGC on suppliers

The maximum price for a TGC is Ptgc-max. This is paid to suppliers, who pass a fraction of thisback to producers. Recent estimates for the UK system, for example, estimate that producerswill receive, on average, 50% of the ‘value’ of the TGC in their contracts with suppliers. Thiswould indicate that, in this example, the maximum value of TGC to producers of RES-E isPtgc-max/2 and that the amount of RES-E that will be produced under this arrangement will beQ3 rather than Q2.

This indicates that a price cap should be applied at the point in the supply chain where it wouldhave the most impact on deployment of RES-E, i.e. the penalty or maximum price should be fedback as directly as possible to the producer of RES-E.

It is important to distinguish who collects the penalty. Figure 2.3 represents the situation wherethe maximum price for the TGC is paid into the TGC market. This reflects the situation wherethe penalty for non-compliance is the requirement that the supplier purchases TGC at a premiumprice. However, it is possible that a maximum price for a TGC would be set by a ‘fine’ or pen-alty payment imposed on non-complying actors (such as suppliers) which does not enter themarket. This means that the penalty sets the maximum price level for a TGC, but penalty pay-ments go to the co-ordinating agency and then elsewhere (e.g. to the Treasury or back to com-plying actors etc).

20 ECN-C--01-048


Production cost ofRES-E

Pel

Q1

Ptgc- max

Q2

Ptgc-max/-real2

Q3’

Ptgc-max-real

Cm

Q3

Figure 2.4 Impact of supply chain issues on price reach producers of RES-E

This has two main impacts:• The penalty price level will not be reached in the market, whatever the balance between

supply and demand is. The cost of participating in the market will be non-zero (i.e. someactors will choose to pay the penalty rather than pay the cost of equipping themselves toparticipate in the market - this may well be the case for smaller actors under the obligation).This reduces the payment reaching the RES-E producer still further (see Figure 2.4).

• The ‘buy-out’ option allows actors to remove themselves from the market, simultaneouslyremoving a tranche of the demand for RES-E for which the obligation was created in thefirst place.

A recommendation to draw from this might be that the system should be designed so that actorsthat choose to opt out of participating in the market created by the obligation should not be lostto the market altogether as this weakens demand for RES-E production.

2.2.3 Penalties for intermittent generationWith the liberalisation of energy markets, it is now no longer possible to define a fixed price Pelfor electricity. In electricity market arrangements where firm power is preferred over intermit-tent (which is often the case), the price for intermittent power is below that for firm power. AsRES-E production from sources such as wind power is intermittent, it is reasonable to predict acase in which the marginal cost of RES-E production is increased if a supply system is config-ured to favour firm power. Figure 2.5 shows the situation in which intermittent power, such asthat produced by wind power projects, is paid a lower price (Pel-inter) than is firm power (Pel-firm).

This has an immediate impact on the amount of RES-E production that is possible. With thesame TGC price, Ptgc, the amount of RES-E that can be produced moves down from Q2 to Q2’.This is likely to be the case in the UK when the new electricity trading arrangements are intro-duced in 2001.

ECN-C--01-048 21



Pel - firm

Q1

Ptgc

Q2

Pel- inter

Q1’ Q2’

Figure 2.5 Impact on targets of price differential for intermittent power production

From the broad analysis carried out above, we can conclude that when trade occurs betweenMember States with different ‘action points’ for their RES-E obligations, inefficiencies will beintroduced into the market. It is likely that, as the premium payment for the ‘greenness’ of therenewable produced energy is passed along the supply chain to producers, it will be reducedslightly as it passes through each stage of the chain. We therefore conclude that the most effi-cient market will operate if there is harmonisation of action points between TGC systems.

2.3 Main issues emerging in emissions tradingTrading of emissions allowances is highly complex, and during the early years of experience,several important issues have emerged. These are:• allocation of initial quotas/allowances,• baselines and additionality,• interaction with other environment policies,• monitoring and verification.

Allocation of initial quotas and allowancesThe initial allocation of emissions quotas and permits has been a major issue in trading schemesimplemented so far. In general, permits can either be distributed to companies free of charge orcan be sold. The first option recognises the historical ‘right to emit’ of the company, while thelatter does not. Where distribution takes place on the basis of historic emissions patterns, thedistribution method is known as ‘grandfathering’. There is one major problem with this ap-proach, however. It does not take into account the fact that plants may have reduced emissionsin the recent past - one way around this is to agree a ‘baseline year’ with the participants, butthis can itself be complex (see Chapter 4).

‘Benchmarking’ can also be used for some ‘free’ emissions allowance allocation - this is mostappropriate where applied to all the major actors in one relatively homogeneous industrial sec-

22 ECN-C--01-048

tor, such as cement and steel. Even if sale or auctioning of emissions permits is not adopted asthe primary method of allocation, experience of emissions trading so far has shown that it is inany case necessary to retain some of the pollution allowance for distribution at a later date,probably by auction. This allows new actors to enter the sector and can also provide market in-formation on the cost of emission reductions. If permits are distributed in an auction, a price capwill signal the maximum price at the auction. This may help reducing the resistance towardsauction, which this report favours as the distribution principle for permits, see Chapter 4.

Baselines and additionalityProjects qualifying for JI (in Annex 1 countries) and the CDM (in non-Annex 1 countries) mustbe able to demonstrate that they generate emissions reductions that are additional to thoseachieved in the ‘baseline’ scenario. This is an enormous area of discussion in the Conferences ofParties.

Interaction with other environment policiesThe trading of allowances for GHG emissions interacts strongly with other environmental in-struments. Some of these are directed towards climate change policy (such as favourable taxconditions for energy efficient business) and some are directed towards other environmental im-pacts. Carbon emissions trading systems can interact with other actions developed to achievegreenhouse gas emissions abatement. In particular, many EU countries have an ‘energy tax’which governments (in general) set up in order to encourage energy savings. Electricity (andsometimes other energy flows) from RES-E sources can often be exempt from such taxes. Thisis an additional level of support for RES-E, although it can be regarded as indirect in that it is anexemption from a burden on other energy sources, rather than a direct support mechanism. Oneof the requirements of the Kyoto protocol, however, is that carbon emissions that are tradedshould be free from other means of support. It is not clear whether RES-E generated CO2 re-ductions in countries with indirect forms of support for RES-E can therefore count towardsemissions reductions in other countries.

Monitoring and verificationThe credibility of any emissions trading system is closely linked to its system of monitoring andverification. The level of intervention required for this (and therefore its cost) depends on thesystem of trading adopted. The costs of monitoring and verification are not negligible. For ex-ample, in the US, the EPA found that the Acid Rain programme required full time staff of 150.Over the first five years of the programme, administrative costs were around $60 million. Thisequates roughly to $1.50 per ton of carbon reduction. In addition, programme participants wererequired to install monitoring equipment at an estimated cost of around $6 per kW of installedcapacity.

It is likely that carbon emissions trading will require verification via accounting and accredita-tion rather than emissions level monitoring. However, the other greenhouse gases, especially thethree halogenated gases covered by the Kyoto protocol (hydrofluorocarbons, perfluorocarbonsand sulphur hexafluoride) are likely to require extensive monitoring before they can be phasedinto trading schemes.

Credibility is also linked to transparent and effective compliance and enforcement procedures.Some of the prerequisites for accurate compliance and enforcement are:• Adequate monitoring, tracking and reporting.• Strong penalties - these should be ‘foreseeable and significantly exceed the cost of comply-

ing’. It is also suggested that repeated non-compliance could be sanctioned with exclusionfrom the trading system.

ECN-C--01-048 23

3. INTEGRATION OF TRADING SYSTEMS AND OBLIGATIONSFOR RENEWABLE ELECTRICITY AND CARBON

In this chapter we identify the ways in which obligation and trading systems for RES-E greencertificates and carbon emissions allowances/permits might interact. We begin by reviewing themain issues that emerged from Chapter 2. We then define the three main interaction options wewill be considering in this chapter. The impacts of these options at various levels have been ex-amined in detail, however here we restrict ourselves to the basic results of the analysis. Follow-ing this, we take what we believe to be the most likely interaction option for the EU and explainhow it is likely to interact with the Flexible Mechanisms of the Kyoto Protocol.

3.1 Interaction issues and optionsIn addition to the main issues identified in Chapter 2 on green certificates and carbon emissionstrading, there are four main issues that arise in discussions on the interaction between thesetopics. These are:• Is it rational to have an interaction between TGC and CET systems? This arises from the

question of whether the TGC already includes a CO2 abatement value and if so, what it is.• What are the technical issues of CO2 benefit assignment? What are RES-E project baselines

and how can these be calculated, especially for intermittent sources such as wind power?• What is the link between the interaction on certificate prices and allocation of goods (this

point again considers whether interaction between the two system is desirable or not)?• What is the effect on the deployment of RES-E?

We will examine these issues under a range of interaction scenarios.

While there are many possible ways in which trading systems for green certificates and carbonemissions allowances/permits might interact, we have considered only the three main interac-tion options. These are:• complete integration• complete separation• specified interaction.

For each option we consider the implications:• at a national level, i.e. assuming that trade happens only within the borders of a single state,• within a ‘green bubble’, i.e. within a set of states or actors that have agreed to trade under

certain conditions,• at an international level, i.e. assuming full international trade.

Since issues within the green bubble and at the international level are similar, they will be ad-dressed simultaneously in the following.

Where appropriate we will refer to how each interaction might contribute to (or detract from)stated policy aims for RES-E and climate change. We will examine how the interaction mightrelate to specific framework conditions within the EU and its Member States and comment onthe practicalities of the interaction options considered.

It is worth noting at this point that we believe that complete separation between the two types oftrading system is not likely to occur and that we are currently in a phase where a specified inter-action is being developed between the two trading ‘currencies’. While the two trading systemsmay merge in the future to a point where they may have achieved complete integration, we be-

24 ECN-C--01-048

lieve that the form of this will be determined by any specified interaction that occurs in themeantime. For this reason, we believe that the key to the future development of this field is theway in which the interaction between the two systems is worked out.

3.1.1 Complete integrationThis scenario can have several meanings, but for the purposes of this report it is taken to meanthat the TGC represents a calculable amount of carbon displacement and that its climate changevalue is therefore represented on the TGC certificate with the other necessary information.

While this is a strong theoretical basis for any interaction between TGC and CET, in practice itwould be difficult to implement and would depend on TGC linking very strongly with Kyotobaselines and mechanisms at all stages. In effect it would mean that TGC should be structuredin the same way as carbon allowances or emissions permits so that they stand alone under thissystem. However, they would also need a green ‘add-on’ in order to represent the additionalbenefits of RES-E in each state or region. This ‘add-on’ could take the format of the proposedRECS certificate or something similar.

Although this seems cumbersome, a slightly similar system of certification has already beenproposed for the UK, where renewable electricity is likely to receive two certificates. These arethe ‘Renewables Obligation Certificate’ (ROC), which is similar to a TGC and the ‘Levy Ex-emption Certificate’ (LEC), which certifies that the electricity qualifies for exemption from theUK’s Climate Change Levy (CCL) on business. Discussions have pointed out that the certifi-cates are very similar and that the ROC and LEC are like two parts of a ticket that can be de-tached from each other. However, the LEC can not in any way be regarded as a tradable GHGallowance, so this is not an exact example.

Although it seems unlikely that complete integration between TGC and CET systems will oc-cur, at least in the short term, we examine its implications at the three levels of interaction be-low.

NationalThe prospect of EU nations developing long-term trading systems for TGC and CET that do notcross borders is highly unlikely. However, in the early stages of the development of both tradingsystems, a national viewpoint is likely to take precedence over an international or EU-wideviewpoint. Many countries are developing both TGC and carbon emissions trading systems in-dependently. While many are monitoring developments elsewhere, especially with the Kyotoprotocol, a national viewpoint seems to predominate at this stage.

On a national basis this scenario means that climate change targets must be completely inte-grated with renewable energy targets and mechanisms and that the displacement of CO2 emis-sions from RES-E generation must be calculated in real time. This may, of course, be over ahighly variable time-scale. For example, an experimental trade in CO2 emissions reductionsproduced by a wind farm (between HEW in Germany and Trans-Alta in Canada) took averageGerman annual emissions as a baseline rather than calculated emissions over a shorter time-scale. This is in stark contrast to, for example, the 15 minute reporting cycle of the RECLAIMprogramme for the control of NOx and SOx in Southern California in the US.

As far as the integration of renewable energy and climate change targets is concerned, some EUcountries, such as Denmark, are at this end of the spectrum already, and have committed them-selves to a high renewable energy target precisely because of the CO2 emissions savings thiswill achieve. In many other EU countries, renewable energy policy is still running very much inparallel with climate change policy, with more harmonisation between policies emerging, as thesituation becomes clearer.

ECN-C--01-048 25

It seems obvious that complete harmonisation of TGC and CET systems could be one result ofclimate change policy becoming the priority for many nations. If this does happen, some Mem-ber States may reduce their efforts to promote renewable energy in the short term, relying in-stead on cheaper options for GHG reduction, such as energy saving and use of the Kyoto Flexi-ble Mechanisms.

Under this scenario, the framework conditions of the nation have a key impact on the perform-ance of TGC and CET systems. The same TGC system will have drastically different meaningsin different countries. Where, for example, there are problems with the planning system in acountry, a well-designed TGC system will still fail to inspire confidence in the financing com-munity. Although under this scenario we consider the situation where trade only takes placewithin national borders, the financing community can, of course, take investment opportunitiesin any country it wishes. This means that a country with high risk for renewable energy invest-ment (whether this is because of a weak TGC system or otherwise) is unlikely to be perceivedas bankable in terms of renewable energy projects.

The GHG emissions baselines of a state must be calculated in a way that satisfies the Kyotoagreement so that displaced CO2 by renewable energy is calculated in a transparent way. Atten-tion must be paid to the possibility of ‘double counting’ and leakage that might result from dif-ferent obligation points for actors, different types of obligation of different actors and trade be-tween them. This is a possibility in the UK, where the proposed emissions trading system in-volves both electricity producers and electricity users. Reduction in CO2 emissions by producersshould not be counted by users too.

In practice, close co-ordination between the agencies responsible for the two trading systems isalso essential. Many countries are considering the option that the same agency could be respon-sible for both systems. For example in the UK the regulator, OFGEM, will have responsibilityfor both the ROC and certification of renewable energy for exemption from the CCL.

Green bubbleThe green bubble scenario refers to the situation in which a group of countries (and sometimescompanies within countries) agree to act as a bubble for the purposes of trading TGC and GHGemissions allowances or emissions reduction units (ERU).

For countries to trade either TGC or ERU, they must reach an agreement on several main issues.These issues cover:• What does a TGC represent and how much of it can be transferred within the bubble?• How is the carbon displacement of renewable energy calculated (if this is necessary)?• What are baseline emissions for countries involved?• Are monitoring and verification systems adequate for both types of trade?• Do the monitoring and verification systems cover the possibility of any double counting and

leakage due to their interaction?

Companies that participate in trade within the bubble must (obviously) ensure that their nation-ally responsible agency recognises their trade. All trades of GHG emissions allowances willgenerally be in compliance with Kyoto requirements.

26 ECN-C--01-048

For the bubble to be seen to be operating in a fair way there may be a need for burden sharingwithin the bubble for renewable energy deployment. This has already happened within the EURES-E Directive. However, this may not be necessary if all participants merely aim to use tradewithin the bubble to meet nationally defined targets. If burden sharing does occur, it must takeinto account framework conditions such as:• differing levels of support (direct and indirect ) for renewables in participating countries,• different renewable resource levels,• marginal cost curves for deployment,• cost burden to consumers,• impact on grid stability,• political commitment to renewable energy amongst population.

Complete integration of TGC and CET trade requires a central monitoring body for both typesof trade. Protocols for trade must be agreed on by all participants and reporting must take intoaccount the requirements of the Kyoto protocol. In a sense this means that the bubble sets up anextra ‘layer’ of reporting, as it must always report to the EU (and probably national agencies) ontrades relating to GHG abatement. The fungibility of TGC with GHG credits must be defined byall bubble participants. This would be a difficult task, and would probably result in a very sim-ple set of definitions for renewable energy benefits, which may not represent their full impact. Itis also likely that interactions across different levels in the supply chain will result in less in-come for renewable energy producers (and therefore less bankable projects) as participants taketheir cut at each level of transaction.

InternationalFor the purposes of this paper, the ‘international’ scenario refers to the EU15, although we alsoconsider that future members of the EU will probably participate in TGC and CET trade on asimilar basis.

In the short to medium term the EU is unlikely to have a fully integrated approach to renewableenergy and climate change (or to CET and TGC). However, if integration does occur in the fu-ture, the key questions are likely to be similar to those listed for the ‘green bubble’ scenario, i.e.:• What does a TGC represent and how much of it can be transferred within the bubble?• How is the carbon displacement of renewable energy calculated (if this is necessary)?• What are baseline emissions for countries involved?• Are monitoring and verification systems adequate for both types of trade?• Do the monitoring and verification systems cover the possibility of any double counting and

leakage due to their interaction?

Decisions must also be taken on whether a minimum level of action must be taken at the na-tional level before trade is allowed. There are also still questions about whether the sale of TGCshould be linked to the sale of physical electricity, and what impact this may have if CO2 emis-sions are displaced by such a sale.

Table 3.1 gives an overview of the impacts at the different levels within the complete integra-tion scenario.

ECN-C--01-048 27

Table 3.1 Complete integration -potential impacts on key issuesIssue Impact

National Green bubble International1. TGC IssuesNational vs. EUviewpoint

Not applicable. Not strictly applicable althoughburden sharing within thebubble can become an issue.

Political agreements requiredon relative seniority of nationaland EU targets. Interactingburden-sharing agreementsrequired for RES-E deploymentand GHG reduction.

‘Transferability’ ofTGC

Not applicable. Must be agreed by allparticipants. Future participantsmust either be consulted at set-up or just accept pre-setconditions if they decide to jointhe bubble.

Must be agreed at politicallevel.

Unwanted effects ofimplementationdifferences

Possible in transition from oneform of support for renewableenergy to another.

Trading artefacts not relevant.

Possible in transition from earlyforms of support for renewableenergy to obligation basedmechanisms.

Could be caused by differencesbetween trading countries, e.g.differences in lifetimes, validityof sources, calculation on ‘grid’or ‘production’ basis.


Possible due to differencesbetween trading countries, e.g.differences in lifetimes, validityof sources, calculation on ‘grid’or ‘production’ basis.

Financibility andimpact ondeployment

Strongly dependent onframework conditions withinstate itself, e.g. planning, gridaccess, electricity marketstructure.

Strongly dependent onframework conditions withinstate itself.

Could result in differentcountries in bubble deployingrenewable energy atsignificantly different rates.

Risk of RES-E financingreduced as system becomesmore certain and liquidityincreases. However deploymentis still more likely in states withmore favourable frameworkconditions for RES-E.

Technical limitations Capacity of grid to take RES-Egiven stability requirements.

Capacity of grid to take RES-Egiven stability requirementsmust be considered.

Political decisions must betaken about whether trade ofTGC is allowed:

only if trade of electricitytakes place,

if the electricity could betraded,

separately from electricity.

Capacity of grid to take RES-Egiven stability requirements.

Capacity of interconnectors totransport sales of physical greenelectricity may be an issue.

Fungibility withCET

Can be defined to suit nationalpriorities.

Standard definition required forbubble as a whole.

Must be agreed at internationallevel, thus means that RES-Eimpacts must be assessed usingKyoto protocol.

28 ECN-C--01-048

Table 3.1 Complete integration -potential impacts on key issues (continued)Issue Impact

National Green bubble International2. CET IssuesAllocation of initialquotas/ allowances

Likely to be Kyoto-compliant,but within that to be tailored tonational priorities.

Likely to be Kyoto-compliant,but within that to be tailored tonational and bubble memberpriorities - possible source ofconflict and delay.

Likely to be Kyoto-compliant.Negotiation for this willprobably occur withincountries, but must also beagreed internationally.

Baselines andadditionality

Baselines likely to be Kyoto-compliant.

Additionality is defined innational terms.


Additionality defined atnational and bubble level.


Additionality must be definedinternationally.

Interaction with otherenvironment policies

Can be controlled to someextent at a national level.

Can be controlled to someextent at a national level.Likely to have more complexinteraction at bubble level.

Can be controlled to someextent at EU level.

Monitoring andverification

National body required - likelyto be Kyoto compliant.

International co-ordinationoffice required. Nationalbodies must be recognised bythis and report back -introduces an additional layerof administration.

All verification etc likely to beKyoto compliant.

EU body required introducesadditional level ofadministration and reporting.

Must be Kyoto compliant.

3. Interaction IssuesDefinition ofinteraction

Can be defined nationally. Must be agreed for bubble as awhole. Can be set by initialparticipants or by all potentialparticipants.

Fungibility must be defined atEU level

Technical issues ofCO2 credit assignment

Can be defined nationally. Sharing of CO2 benefits mustbe agreed at bubble level.

Must be defined at EU level.

Impact of interactionon prices anddistribution of goods

Interaction likely to increasecosts of GHG abatementoverall. Both CET and TGCprices decrease but TGC pricedoes not necessarily contain allof CO2 value.

Interaction likely to increasecosts of GHG abatementoverall, but less so than fortrade restricted to one countryonly. Cost of trade likely toincrease as complexity ofsystem increases.

If climate change targets aresenior to RES-E targets thenRES-E deployment willdecrease and the cost of GHGabatement will reduce. If RES-E targets are held in parallelwith climate change, then thecosts of GHG abatement willincrease overall.

Effect on deploymentof RES-E

Depends on national priorities.CET could reduce RES-Edeployment rates in short -tomedium term if RES-E targetsare not held strongly in parallelwith climate change targets.

Becomes more market drivenbut also depends on nationalpriorities. Countries may agreea minimum level of domesticaction is required before tradecan take place. CET is evenmore likely to reduce RES-Edeployment rates in short andmedium terms.

Depends on seniority given toRES-E and climate change. Ifclimate change dominates, thenRES-E deployment rates willreduce in short and mediumterms.

ECN-C--01-048 29

3.1.2 Complete separationIn this set of scenarios we consider the situation where TGC systems and CET systems do notinteract at all. This would be the case if it were decided that while renewable energy contributesto climate change aims, a TGC does not represent a carbon abatement value. This mode ofoperation has been discussed already within the TGC sector.

NationalUnder this scenario, there is no interaction between TGC and CET systems and trade takes placeonly at a national level. This scenario allows governments to decide what contribution the use ofrenewable energy will make to their climate change aims, and then to pursue the remainder oftheir GHG abatement targets via other actions, which can include CET and other Kyoto FlexibleMechanisms.

As international trade does not take place under this scenario, framework conditions do not havean impact on the relative rates of deployment in EU countries. However, the investmentcommunity is mobile over borders whether TGC are or not. This may mean that countries withmore favourable framework conditions for renewable energy see greater interest on the part ofinvestors.

Green bubbleIf TGC and CET systems are completely separate then the two types of certificate will be tradedseparately within the green bubble. Under such an arrangement it is possible that different‘bubbles’ will emerge for the two different systems. This means that one group of countries mayagree to trade CET while a different group agrees to trade TGC (the groups may, of course,overlap).

This scenario requires that the TGC is regarded as representing none of the climate changebenefit of renewable energy and will probably require that the rest of the ‘greenness’ is definedso that it is clear what is being traded. There must be an agreement on this at a national levelwithin the bubble in order for TGC to count against participant country’s obligations forrenewable energy. Again, this scenario requires burden sharing within the bubble, for which thesame factors should be taken into account as in Section 3.1.1.

This scenario requires that monitoring and verification is co-ordinated for both TGC and CETexchanges at a bubble level. However, it does not require that central monitoring agencies forTGC and CET notify each other of their respective certificate transfers. The co-ordinating bodyfor CET in such a bubble would in any case be required to report to the EC on any carbonallowance or ERU transfers that occurred.

InternationalThe international scenario again refers to the involvement of the EU15. The difference betweenthis scenario and the green bubble situation is that all agreements must be made at the EU level.This removes the possibility that separate groups might participate in the two types of trade andset the rules for this.

Burden-sharing agreements for renewable energy obligation systems and for CET systems mayinclude a requirement for a minimum level of domestic action before trade is allowed. In anearly consultation document, the EC mentioned a figure of 50% qualifying action on GHGabatement before CET would be allowed. This has not been repeated in later documents.

There must also be agreements at the EU level on issues such as the link between the sale of theTGC and the physical electricity and the level at which non-EU actions such as the CDM maybe used.

30 ECN-C--01-048

Some countries regard renewable energy as a key part of their climate change activities so theyare unlikely to detach TGC from CET in the same way as other countries (e.g. Denmark). Greenheat and gas are already being considered partly in terms of their climate change impacts insome EU states, so separating these out from other renewable energy TGC may be difficult.Also, the framework conditions include issues mentioned earlier in Section 3.1.1.

Although the two trading systems are separate in this situation, they must both be co-ordinatedat the EU level. The cost of grid stability must also be shared between all beneficiaries. Forexample, who pays for balancing power in one country when the TGC (but not the physicalelectricity) is sold to another country? Grid capacity issues must also be resolved at aninternational level, this includes the capacity of interconnectors between countries, and alsoissues relating to the benefits of grid reinforcement due to the inclusion of a renewable energyproject in the low-voltage grid. Although it seems impossible, the harmonisation of access toplanning permission for renewable energy projects across the EU could also be considered.

Table 3.2 gives and overview of the impact of the complete separation scenario at differentlevels.

Table 3.2 Complete separation-potential impacts on key issuesIssue Impact


Not applicable. Burden sharing process forbubble must be carried out forRES-E. In the meantime this hasbeen taken care of in the RES-EDirective.

The RES-E Directive providesfor burden sharing.


Not applicable. Political agreement is required. Must be agreed at EU level.



Possible in transition from oneform of support to another.

Possible due to differences inimplementation, e.g. obligationsat different points in supplychain, lifetime of certificates,banking and borrowing.

Possible in transition from oneform of support to another.

Possible due to differences inimplementation.



RES-E likely to be morefinancible if supported by strongcommon policy.

Market will be more liquid, butdeployment will occur more incountries with better frameworkconditions for RES-E.

RES-E likely to be morefinancible if supported bystrong EU policy.

Market will be more liquid, butdeployment will occur more incountries with better frameworkconditions for RES-E.



Requirement for the possibilityof trade in physical electricityvia interconnectors.



Fungibility withCET

Not applicable. Not applicable. Not applicable.

ECN-C--01-048 31

Table 3.2 Complete separation-potential impacts on key issues (continued)Issue Impact


Likely to be Kyoto-compliant,but within that to be tailored tonational priorities.

Likely to be Kyoto-compliant,but within that must benegotiated at bubble level -possible source of delay toimplementation.

Likely to be Kyoto-compliant,but within that must benegotiated at bubble level -possible source of delay toimplementation.



Additionality is defined innational terms.


Additionality must be definedby bubble-wide agreement.

Baselines to be Kyoto-compliant.

Additionality defined via EU-wide agreement.

Interaction withother environmentpolicies


Must be defined at bubble level,which may be easy to agree forfirst participant group, butdifficult to integrate lateentrants into scheme.

Must be defined at internationallevel, which may be easy toagree for first participant group,but difficult to integrate lateentrants into scheme.



Bubble-wide body required.Will have to be Kyotocompliant and also will besubject to EU rules. Introducesan extra level of administrationand reporting.

EU central body required.Countries will be reporting onKyoto targets anyway, so couldsave on administration task.

3. Interaction IssuesNot applicable. Not applicable. Not applicable.

3.1.3 Specified interactionBoth TGC and CET certificates are conceptual rather than physical units. It is because of thisthat the set of scenarios covered in this section represent the most likely interaction betweenCET and TGC systems in future, i.e. one which has been defined and agreed rather than discov-ered in a ‘scientific’ manner.

In some EU countries, renewable energy obligations or certificate systems and CET systems arebeing designed with the interaction made explicit from the start of the process. In others (suchas the UK) the two processes have gone on almost in parallel, with the interaction between themonly being considered once most of the system design has taken place. It is obvious that ex-tending this to a group of countries or to the EU as a whole compounds the level of complexityof the situation.

Interaction typeThe type of interaction considered also has a wide range. For example, in some instances, re-newable energy is regarded as having a direct impact on carbon production by the energy supplysystem. This means that, for example, the electricity supply system as a whole can reduce itscarbon output by switching to RES-E generation. However, in countries where a ‘cap and trade’system is being considered, only companies that already produce CO2 are allowed to participatein the CET system. Those that do not produce CO2 (such as RES-E generators) are excludedfrom the system by definition. Participants can use RES-E to reduce their CO2 outputs, but onlyon a ‘project’ basis, i.e. they can generate credits by installing a RES-E project in the same wayas they might for a JI or CDM project. It is not clear whether the power output from such proj-ects could also be sold into an RES-E obligation market. At this early stage, the second option

32 ECN-C--01-048

outlined above, i.e. interaction between the two systems only on a RES-E ‘project’ basis, seemsmore likely to emerge, but this is impossible to predict.

Different obliged actorsEven in countries where the design of CET and TGC systems is fairly advanced, the fact thatactors at different points in the supply chain are under obligation for the two systems can intro-duce the risk of double counting and leakage. For example, in the UK:• The TGC obligation will be on electricity suppliers.• The obligation to reduce energy consumption in order to qualify for exemption from the

CCL is on electricity users.• Such users can also buy RES-E, which is exempt from the levy (the users will not necessar-

ily pass on all of the levy exemption to suppliers, who will, of course, not pass on their en-tire share to the RES-E generators).

• CO2 emission caps will be placed on companies that produce CO2 directly through produc-tion processes in the form of an allowance of unit emissions per unit of production.

• Other companies will be placed under an absolute CO2 emissions cap and will be allowed totrade when they make reductions beyond this cap (this is a ‘cap-and-trade’ system).

• Companies with emissions allowances will be allowed to trade with each other and to buyemissions allowances from elsewhere in the UK, but will only be allowed to trade with the‘absolute’ sector via a ‘gateway’ which allows them to buy from but not sell into the ‘abso-lute’ sector market.

• Companies in the ‘absolute’ sector can trade with each other on a ‘cap and trade’ basis butcannot buy emissions from the allowance sector.

• All companies (either in the allowance or the cap-and-trade group) can use emissions re-duction projects, which can include RES-E generation projects, to generate further GHGabatement credits either in the UK or elsewhere, under the Kyoto rules.

At the moment it is not decided whether UK electricity generators will participate in CET on acap-and-trade or allowance basis, or a combination of these.

NationalThis scenario represents the situation that is currently in existence throughout the EU. Memberstates are at different stages in the design of TGC and CET systems and have largely gone aheadwith schemes that reflect their own national priorities. That said, discussions on how all thesesystems might interact in future are underway and the ‘green bubble’ scenario (see below)seems to be the one that will occur in the first phase of operation of most of these schemes.

The effect of a separate renewable energy policy and a climate change policy tends to reflect theway that renewable energy is treated within the country. If it is treated well, mechanisms whichdevelop from the Kyoto protocol will be additive. If it is treated poorly, trade will be under-mined. At this stage, national policy predominates over an EU viewpoint for both renewable en-ergy and climate change. Although the Kyoto burden sharing process has divided GHG abate-ment actions between Member States, most states also have their own nationally-defined targetsfor climate change and renewable energy deployment. In many cases, national CO2 reductiontargets are more ambitious than those agreed under the Kyoto protocol.

The conditions under which renewable energy sources are deployed vary widely across the EU.However, in this scenario, where there is little trade between states, the framework conditionsare a matter for national governments. However, it is worth noting that framework conditionshave a strong impact on the ‘bankability’ of renewable energy projects, which means that in-vestors may move their interest to countries with more favourable conditions.

ECN-C--01-048 33

In this scenario, national co-ordinating bodies for the two trading schemes must decide on theinteraction that will be allowed and how this will be monitored and verified. It may be that thesame body will be responsible for both systems.

Green bubbleAs we pointed out in the section above, most EU countries that are in the process of designingTGC and CET schemes do not at the moment trade in bulk with other countries, except for afew ‘sample’ trades which have been carried out in order to stimulate debate and to learn howthe process might operate. However, it seems likely that the green bubble scenario, where theinteraction between TGC and CET is strictly defined by agreement, will emerge as the statusquo once these national systems are in place, at least in the medium term.

The Kyoto agreement provides a useful rallying point when it comes to CET systems. As allnational schemes will endeavour to be valid under the Kyoto agreement, they will have a com-mon basis on which to agree exchange between national CET schemes. It is also useful to notethat the longest existing trading schemes for carbon emissions allowances have been imple-mented not by nations but by companies. The most notables of these are Shell and BP Amoco.RES-E obligation schemes are a little more problematic as most schemes that are proposed or inuse, in the case of the Netherlands, differ from each other in some way. The RECS initiative isone outcome of efforts to establish a common basis for international trade in TGC. Neverthe-less, the importance of the green bubble and the ‘learning-by-doing’ arrangements, which be-come established, are of utmost importance to a final international agreement so way down theline.

The green bubble spans the gap between policy and the market, in the way that bubble partici-pants may be countries themselves, may be companies (legal entities) within countries or acombination of these. This means that policy must be decided by bubble participants to ensurethat national priorities are met and not undermined by any of the actors involved. The key ques-tions for TGC systems, i.e. what do TGC represent and how ‘transferable’ are they over re-gional and national borders? This can only be decided at a political level. This means that theremust be a partnership between government and market actors in the development of a bubble-wide trading system.

One of the things that must be addressed by policy makers is the extent to which differentframework conditions can be taken into account to ensure transparency and an equitable distri-bution of environmental costs and benefits when trade takes place. Earlier studies on these is-sues suggested that national schemes for the support of RES-E should be ‘refunded’ if the envi-ronmental benefit is sold to another country, as it would not be fair for the population of onecountry to subsidise attainment of climate change targets in another. However, recent EC publi-cations on the future of renewable energy indicate that the EU will move towards a more levelplaying field in future as conditions for the support of RES-E themselves become harmonised.

With this scenario, the key point is that agreement is required on the definition of the interactionbetween TGC and CET tradables, as well as the two systems themselves and all the attendantpractical details.

InternationalThis scenario could possibly emerge after 2005, when the situation regarding the use of TGCsystems (and particularly their impact on deployment of renewable energy sources) becomesclearer. By that time, it should also be clear whether emissions trading is likely to play a signifi-cant role in the achievement of GHG abatement targets in the first Kyoto compliance period of2008 -2012.

The specified interaction between TGC and CET systems must be negotiated at the EU level.Burden sharing agreements for RES-E (see recent RES-E Directive) are a first step for this.

34 ECN-C--01-048

These may include some requirement for a minimum level of domestic action, which must beundertaken before trade is allowed. In the medium to long term the framework conditions forRES-E and GHG abatement are likely to be influence not only by national conditions but alsoby the configuration of the EU as a whole.

Table 3.3 gives and overview of the impact of the specified interaction scenario at different le-vels.

Table 3.3 Specified interaction - potential impacts on key issuesIssue Impact


Not applicable. Burden sharing process must becarried out for RES-E. Now thiswill also include interactionwith GHG abatement.

Likely to be a key definingissue in the medium to longterm.


Not applicable. Political agreement required,even if participation from somecountries is at the companyrather than national level.

Must be decided at EU level.


Possible if interaction is notdesigned correctly.


Must be identified and dealtwith via negotiations in earlystages.


Must be dealt with at EU level.




Interaction with CET couldhave strong positive or negativeimpacts on deploymentdepending on priority order.

RES-E likely to be morefinancible if supported bystrong bubble-wide agreementsthat are not subject to politicalrisk.

Market will be more liquid, butdeployment will still occurmore in countries with betterframework conditions.

Less dependent on frameworkconditions within states as thisscenario includes moreharmonisation at EU level ingeneral.




Capacity of grid to take RES-E.

Increase in demand for energy.Possible impacts due to marketliberalisation emerging.

Fungibility withCET

Defined to suit nationalpriorities.

Must be defined. Defined at EU level.

ECN-C--01-048 35

Table 3.3 Specified interaction - potential impacts on key issues (continued)Issue Impact


Likely to be Kyoto-compliant,but within that to be tailored tonational priorities

Likely to be Kyoto-compliant,but within that must benegotiated at bubble level, whichmay introduce the possibility ofdelays to implementation.

Kyoto-compliant, subject toagreement at EU level.



Additionality defined innational terms.


Additionality is defined bybubble agreements.


Additionality defined in EUterms.

Interaction withother environmentpolicies


Must be defined at bubble level,which may be easy to agree forfirst participant group butdifficult to integrate late entrantsinto the scheme.

Defined at EU level.



Bubble-wide body required -will have to be Kyoto compliantand also will be subject to EUrules - introduces an extra levelof administration and reporting.

EU body required (Kyotocompliant) to which all nationalbodies report.

3. Interaction IssuesDefinition ofinteraction

Must be agreed nationally.

Should allow progression to‘green bubble’ or fullinternational scenarios withoutextensive revision.

Must be carried out atgovernmental level for bubbleparticipants, even if only marketactors participate in somecountries.

Defined at EU level.

Technical issues ofCO2 creditassignment

Must be defined nationally.Depends on type of CETscheme chosen and what TGCrepresents at national level.

Subject to bubble agreements. Defined at EU level.

Impact of interactionon prices anddistribution of goods

Interaction likely to increasecosts of GHG abatement overallbecause of forced inclusion of‘higher cost’ RES-E option.CET prices decrease if RES-Edeployment is reflected inrequirement for less action byindustry. Portion of climatechange value may by ‘bought’by government via othermeasures, such as energy taxrebates.

Interaction likely to increasecosts of GHG abatement overall.Both CET and TGC pricesdecrease because of increasedoptions in supply base. Possibleproblems with artefacts due tonational systems that pass costsdown to consumersautomatically. E.g. automaticaccess for RES-E to the grid inone country may result inincreased deployment, givingrise to grid stability problemsthat are paid for by nationalenergy consumers.

Interaction likely to reducecosts of RES-E and GHGabatement combined, althoughit will increase costs of GHGabatement taken alone. CETprices decrease because TGCsystem fulfils some of the GHGabatement. TGC price reducesbecause of market efficiencies.

Effect ondeployment of RES-E

Depends on national priorities.CET could reduce RES-Edeployment rates in short tomedium term if RES-E targetsare not held strongly in parallelwith climate change targets.



36 ECN-C--01-048

3.2 Interaction of green certificates with Flexible MechanismsThis section examines the links between the green certificate market and the CO2 emission mar-ket, which introduces CO2 emissions reductions units (ERU). The CO2 market is seen only asERU trade in the electricity sector. Since the CO2 emission ceiling is assumed to be smaller thanthe business-as-usual emissions in the electricity sector, rational energy use and RES-E produc-tion must be enforced. We discuss two different designs of the RES-E market, which are distin-guished by the RES-E producers’ access to the conventional electricity market:• Closed coexistence. Closed coexistence is defined as the situation in which the commodity

of RES-E production must be bought by the grid operator at fixed feed-in tariffs reflectingmarginal avoided fuel costs, but not CO2 abatement costs. Certificate suppliers are RES-Eproducers, whereas the obliged actors (electricity supply companies, electricity consumers)are buyers. In this case, there would still be reciprocal effects between the CO2 and theRES-E markets despite the exclusion of RES-E operators from the conventional powermarket. This is because, in a closed system, the demand for CO2 related conventional elec-tricity production declines as a result of the realisation of projects on the green market; con-sequently demand for CO2 reductions in the electricity sector also declines.

• Open coexistence. Here we distinguish between two cases. In a first case, obliged actors notonly have to buy certificates but also the commodity of a RES-E producer. Certificates tradewill mainly appear between the obliged actors. In a second case, RES-E producers sell theircommodity to the conventional electricity market. Certificates trade occurs between RES-Eproducers and obliged actors.

3.2.1 Reciprocal effects between the renewable energy and the CO2 reduction marketsTargets for electricity from renewable energies are essentially made by the government as a re-sult of two environmental goals. Firstly, they should serve as a contribution to environmentalprotection, since energy from RES-E plants either do not produce or are neutral with respect toemission of carbon dioxide. Secondly, scarce energy resources such as coal, gas, oil and ura-nium should be saved through the increased use of renewable energy carriers in power genera-tion, so that the same resources can still be used by future generations.

In the area of CO2 emissions, it seems quite possible that sovereign reduction targets are set on anational level as a consequence of the agreed targets laid down in the Kyoto protocol. It is as-sumed that when these targets are implemented in a national trading system, a certain amount ofCO2 emission permits will be given to the obliged actors of the national CO2 regime. The vestedtotal amount of emissions is calculated from the total emissions in the base year minus the setreduction target4. This usually causes a shortage of emission rights, since it can be assumed withgrowing economies that the baseline emissions are over the emissions targets vested by the re-duction units. It is debatable whether the obligation of maintaining the emission target is carriedover to energy - and especially electricity - businesses, fuel merchants or industrial associations.Since the actors along the electricity upstream process are more or less able to pass CO2 reduc-tion costs along the production chain, electricity prices will reflect the same CO2 reduction costsno matter which actor in the production chain is the CO2 obliged actor.

Starting from the view of these isolated markets, the reciprocal effects that result from the si-multaneous existence of the green certificate market and the CO2 reduction market are the focusof the following examinations. In order to make the analysis of both markets comparable, RES-E quantities and prices are expressed in terms of its CO2 equivalents (disregarding of any diffi-culties related to this in practise).

4 If a different allocation method is chosen (auction) in stead of the assumed allocation free of charge (grandfa-thering), the subsequent analysis will still be valid, since market imperfections are abstracted.

ECN-C--01-048 37

Closed coexistenceIn this case, there would be reciprocal effects between the CET and TGC markets despite theexclusion of RES-E operators from the conventional power market, because the demand forCO2 related conventional electricity production declines as a result of the realisation of projectsin the green market. Consequently, demand for CO2 reductions in the electricity sector also de-clines. Demand for CO2 reductions (

2COQ′ ) will be equal to the difference between the original

CO2 reduction target (2COQ ) and the RES-E target (expressed in terms of CO2: )(2 SCOQ ). Thus

)(222 SCOCOCO QQQ −=′ , see Figure 3.1. The CO2 reductions related to the service ‘greenness’(S) are denoted as CO2(S) in the figure.

Assuming that RES-E producers will discover opportunities in the target for green power as op-posed to a pure contribution for the CO2 target, it is expected that more cost-effective measuresfor maintaining the CO2 target, such as rational energy use, will only be considered when theyare cheaper in the isolated CO2 reduction market (considering the reduced demand

2COQ′ ). Theright hand side of Figure 3.1 shows the corresponding price for TGC (expressed in terms ofCO2), )(2 SCOP . The price adjusts itself to renewable energies subsequent to the target default. Itis assumed that more RES-E would be deployed in a green certificate market than in an isolatedCO2 markets (striped area). Moreover, RES-E producers would not be able to bid on the CO2certificate market. Therefore, the remaining demand for CO2 reductions will be met exclusivelythrough rational energy use, denoted by CO2(R) in the figure. Consequently, the ERU pricewould sink compared with the isolated examination of the CO2 market. By constantly examin-ing the green target and the CO2 target, there are fewer opportunities for rational energy use op-tions (light grey area) than there are by the sole pursuance of the CO2 target. This result inhigher RES-E production, indicated at the right hand side of Figure 3.1 as a small, striped area.Due to the additional RES-E production obligation and a lower demand for rational energy use,leads to a lower price on the CO2 market (

2COP′ ). This is caused by the fact that on the CO2 mar-ket, the reductions from green power generation are made available ‘for free’. They are alreadycompletely covered by the green certificate market. For the RES-E operators nothing changescompared to the isolated examination of the green certificate market. The price for green certifi-cates and the situation of the obliged actors in a TGC regime remain unchanged.

38 ECN-C--01-048

MAC CO2 (S)

P CO2

Q‘ CO2

CO2 - reduction

Marginal abatement costs and ERUprice

0

MAC CO2 (R)

Q CO2 (S)

P‘ CO2

Aditional costsCompadred to the

Isolated CO2 market

P CO2 (s)

Q CO2 (S)

CO2 - market Green power

Figure 3.1 Reciprocal effects with closed coexistence

Open coexistenceOpen coexistence is defined as the situation in which the commodity of RES-E producers is soldat the clearing price of the conventional power market. By definition, this is the case if RES-Eproducers sell directly to the conventional power market. The definition also applies if theobliged actor must purchase both the green certificate and the commodity together, thereby cre-ating a separate green power market in addition to the existing conventional market. Neverthe-less, this green market design leads to the same certificate prices as in the design describedabove. This is due to the fact that, on the level of the obliged actor, conventional electricity atconventional power market price is replaced by green electricity. Therefore, these opportunitycosts are taken into account. With open coexistence and in contrast to closed coexistence, RES-E producers are paid a higher price for their commodity as a result of the incorporation of CO2abatement costs in the conventional power market price.

Due to competition on reimbursement within the green certificate system, RES-E producers areforced to bid for less (

22 )( COSCO PMAC ′− ) in an open coexistence in terms of the ERU price.

This results in a reduced green market price ( )(2 SCOP′ ). Both markets are integrated in Figure 3.2.The derived green certificate market is plotted on the bottom left of the figure.

RES-E producers who are already competitive on the CO2 market can bid on the green market atcost very close to zero in open coexistence. In this view, those on the demand side of green cer-tificate (obliged actors) have to pay less, because the price for green certificates reduces by thesame amount as on the CO2 market (

2COP′ ). Since RES-E operators are allowed to act on bothmarkets, it must be taken into consideration if they already (partially) finance themselvesthrough the certificate price ( )(2 SCOP′ , covering the greenness of the RES-E production but not

the CO2 credit). The most expensive RES-E producers bid at 2COP′ straight out. Suppliers who

initially are not able to supply their reductions competitively at 2COP′ on the CO2 market, can

ECN-C--01-048 39

offer this high price only if they are competing with RES-E producers, otherwise they will bepushed from the market. Since the financing through the CO2 market is required to break even,this group will bid at

2COP′ .

All competitive suppliers remain on their original cost curve and they will successfully stay inbusiness - even without the additional support possibility on renewable energies. As a result, thecourse of the accumulated marginal abatement cost curve ( )&(2 RSCOCMA ′ ) shifts downwardbetween certain points, because some suppliers can offer more favourably on the ERU marketthrough the green certificate market than they could in the isolated case when it comes to partialfinancing. The altered course of the curve is shown as a dashed line in Figure 3.2. Beyond pointB, only the costs are considered of those RES-E operators who receive no subsidy through therenewable energy obligation and therefore they can only offer on the isolated CO2 market. Thusthe accumulated marginal abatement cost curves run identically again. The price effect on theERU market in open coexistence is exactly the same as in closed coexistence, since the self-adjusting price must bring about the same CO2 reduction through rational energy use as inclosed coexistence. If the CO2 reduction target is larger than B, there is no price effect. In thiscase, the introduction of an obligation for renewable energies would not be necessary, sincethere would be enough competitive supply - at least in the politically desired amount.

MAC CO2 (S)

P CO2

Q CO2 CO2 - reduction

Marginal costAnd ERU price

0

MAC CO2 (R)MAC CO2 (S&R)

Q CO2 (S)

MAC CO2 (S) - P’ CO2

MAC‘ CO2 (S&R)

P’ CO2

B

P‘ CO2 (S)

Figure 3.2 ERU market in open coexistence with the green certificate market

The difference between open and closed coexistence is reflected in the value of the green cer-tificate market and the ERU market. Under closed coexistence, green certificates also credit acertain amount of CO2 reduction whereas in open coexistence all CO2 reductions are traded onthe CO2 market. Accordingly, the green certificate price under closed coexistence is expected tobe higher than under open coexistence. Since the market volume (MWh of green power) is thesame in both modes, green certificate market value is expected to be smaller under open coex-istence. This is an important issue since a feasible and transparent certificate market requires asufficient market value. The market value has to ensure that transaction costs play a minor roleand it has to raise sufficient interest by potential investors to ensure liquidity in the market. Un-der closed coexistence the market volume of the CO2 market is smaller compared to open coex-istence. However, it can be expected that the targets laid down in the Kyoto protocol ensure avery large CO2 market volume. Accordingly, this effect is supposed to play a minor role in theCO2 market.

40 ECN-C--01-048

A further issue arises when countries having implemented open and closed coexistence aretrading TGC internationally. If TGC are considered a homogeneous good, i.e. there is no differ-ence in TGC, inefficiencies can occur due to the different institutional settings. In order to fa-cilitate international TGC trade it is recommended that countries introducing green certificatemarkets decide to implement open or closed coexistence uniformly.

3.2.2 Green certificates and international carbon tradeIn this section, we broaden the scope to international trading. Since the production of greenpower goes hand in hand with a reduction in CO2 emissions, CDM an JI projects are affected bynational and international tradable green certificate regimes. In the following we discuss theeconomic implications of CDM and JI that arise for a country (country A) having implementedboth a CO2 and a green certificate market. Therefore, we distinguish whether country A is aninvestor or host of JI projects and whether the country is a purchaser or seller on the interna-tional TGC market. Accordingly, we will discuss four different international trade constellationsbetween country A and another country.1. Country A is JI investor and TGC purchaser, i.e. importer on both markets.2. Country A is JI host and TGC purchaser, i.e. exporter on ERU market and importer on TGC

market.3. Country A is JI investor and TGC seller, i.e. importer on ERU market and exporter on TGC

market.4. Country A is JI host and TGC seller, i.e. exporter on both markets.

Table 3.4 summarises the direction of price effects in the different market and trade regimes.Negative price effects compared to the no trade case are indicated with ‘-’, positive effects arerepresented by ‘+’ and ‘0’ denotes no price effects. If there are reverse effects ‘?’ indicates thatthere is no clear tendency for a price development due to international trade. Price effects areevaluated from the national perspective. In the table ‘Full international trade’ stands for the con-stellation where ERU and TGC are traded internationally whereas in the other trade modes ei-ther TGC or ERU are traded cross border. Under each trading mode it can be distinguishedwhether country A has established a national TGC system with open or closed coexistence.

Table 3.4 Price effects of different market and trade regimes in different types of countriesFull international trade ERU trade only TGC trade only

open closed open closed open closed

PA(ERU) ? ? - - + +Case 1ERU-importerTGC-importer PA(TGC) ? - + 0 - -

pA(ERU) + + + + + +Case 2ERU-exporterTGC-importer pA(TGC) - - - 0 - -

pA(ERU) - - - 0 - -Case 3ERU-importerTGC-exporter pA(TGC) + + + + + +

pA(ERU) ? ? + + - -Case 4ERU-exporterTGC-exporter pA(TGC) ? + - 0 + +

From the perspective of the obliged actor, price decreases are good news and price increases arebad news. If we analyse it in this way, we find that in e.g. Case 1 a country prefers closed coex-istence (shaded cells). In the other cases open coexistence is preferred.

ECN-C--01-048 41

From a government point of view increasing prices might be good news since an increasingprice compared to the no trade case is an indicator of increasing foreign investments. If thisway, governments will opt for the opposite coexistence mode than the obliged actors.

From Table 3.4 we can learn about the effects of an international TGC trade on national CO2markets. Due to trade, TGC prices usually decline in TGC investor (importing) countries, i.e.the country invests in green power projects abroad, decreasing carbon reduction costs there. Byinternational TGC trade, carbon reduction becomes more expensive in the TGC investor countrydue to less investment in national renewable energy projects. Accordingly, the national demandsfor ERU, and thus the national prices of ERU, are increasing. So from a climate-protection pointof view, TGC investor countries have little incentive to participate in an international TGC mar-ket. The opposite holds for TGC host (exporting) countries. Here only obliged actors in thegreen certificate system might oppose international trade due to increasing TGC prices. If CO2intensity of the TGC host country is smaller than in the TGC investor country, TGC trade leadsto less climate protection overall.

3.3 Technical issues of integrationIn this section, we examine the interactions between the instruments of TGC and CET by con-centrating on certification criteria, the order of project validation and accreditation, validationand monitoring (project cycle).

3.3.1 Certification criteriaFrom Section 3.2 we have learned that JI and TGC systems have reciprocal price effects due tothe fact that CO2 reduction is a joint product of green energy production. In order to keep re-newable energy project development simple it is helpful on the one hand to harmonise technicalcertification criteria for both systems and to clearly separate price relevant criteria where possi-ble. With respect to the latter it is important that TGC do not have a CO2 credit attached in orderto guarantee a transparent CO2 reduction price and a green certificate price that reflects green-ness without CO2 reduction. Otherwise, renewable energy projects would face difficulties in theJI process. Then it would be necessary to allocate CO2 reductions to the TGC certification proc-ess on the one hand and to the joint implementation project validation on the other, with severeimpacts on JI criteria such as financial additionality. With respect to technical issues it would behelpful if JI criteria and TGC criteria are as much compatible as possible. One could think of apositive list for JI projects that declare the same renewable energy technologies eligible as aninternational agreement on TGC does.

3.3.2 The order of project approvalIf harmonisation of criteria is successful, the following order of project approval seems to beappropriate:1. TGC approval2. JI approval.

If projects eligible to receive TGC still need financial support in order to become economicallyviable, financial additionality has to be proofed to validate the project as JI project. If the orderof approval was the other way round, a project not eligible, as JI project would still require acomplete TGC approval. Figure 3.3 sketches the appropriate order of project approval if boththe TGC and the JI mechanism are envisaged for project funding.

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TGC-approval

Financial additionality

JI-approval not JI-eligible

Standard JI- procedure

+ -

+ -

Figure 3.3 Appropriate order of approval

3.3.3 The project cycleConcerning JI and CDM it is heavily disputed how the process of validation, monitoring andcertification of a project to be eligible for credits should be designed. Figure 3.4 illustrates apossible solution featuring several steps that will be discussed subsequently.

The Project Cycle

Project

DesignValidation

Implementation /

Monitoring

Verification &

Certification

Projectparticipant

Third PartyThird PartyProject Participant

(Or Third Party)

Output:•Project Description•Baseline•Calculations•Mitigation Potential

& Environmentalimpacts

•Boundaries•Monitoring and

Verification Protocol

Main Input:•Performance Records•Baseline•Monitoring andVerification Protocol•Independent Tests

and Analysis

Output:•Monitoring of keycharacteristics

•Performance Reports•Laboratory Analysis•Purchasing Data

Main Input:•Baseline•Monitoring and

Verification Protocol

Corrections

Figure 3.4 The project cycle

Project designThe entities carrying out the project shall make available documentation including the:• project objectives (if possible in quantified terms),• identification of project parties and their responsibility and authority regarding project plan-

ning, implementation and operation,• agreement on credit-sharing,• project description,• monitoring and verification protocol.

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The project description shall clearly identify:• technology and methods used for emission abatement,• baseline emissions over the project’s estimated lifetime,• emission mitigation potential over the lifetime with documentation of technical calculations,• implementation plan including timeframe and responsibility for project activities,• financial calculations.

The monitoring and verification protocol should give details about the project’s verificationprocedures including when monitoring, reporting and verification should be performed and bywhom. It shall define to whom the data should be reported, which data and installations shouldbe accessible to the verifier, and which data sensitivities exist and how to deal with them.

ValidationValidation should ensure that the project description and the overall project objectives are con-sistent with criteria internationally agreed upon and that the calculated baseline is reliable.When new technology or methods are introduced during the project’s lifetime, new validationsshould be performed. Therefore, this step is a kind of an ex ante certification. With regard to theimportance of baselines, it seems appropriate that baselines should be certified, perhaps for afixed period, with reviews at appropriate intervals.

MonitoringDuring the implementation of the project, monitoring of project activities is conducted periodi-cally (e.g. annually) to ensure that performance is as designed. Several data collection and dataanalysis methods are available which vary in cost, precision and uncertainty. The data collectionmethods include engineering calculations, surveys, modelling, end-use metering on-site auditsand inspections, and collection of utility bill data. If measured data are not collected, then onemay rely on engineering calculations and stipulated (or default) reduction or production. Thelatter refer to two different types of stipulated savings methods 1) algorithms for calculating en-ergy savings for specific measures and 2) a set of criteria for using best engineering practices.The rationale for doing so is that the performance of some energy-efficiency measures is wellunderstood and may not be cost-effective to monitor. Data analysis methods include engineeringmethods, basic statistical models, and integrative methods. If the focus of the monitoring is anindividual source, then some methods will not be used (e.g. basic statistical models), since theyare more appropriate for a group of sources.

Verification and certificationA forth step is a periodic (e.g. annual) verification of the actual CO2 reductions and RES-E pro-duction that are achieved by the project. This would entail auditing data such as physical meas-urements that are done at the project site as well as of the equipment used for this purpose. Thenemissions data are compared with the baseline established and the computation of the resultingreductions. The verifier would also review compliance with established framework for projectmonitoring. These functions are also quite similar to what is done under established schemes,such as ISO or EMAS. Finally, the verifier would be expected to review and re-assess the basicproject assumptions at regular intervals, if this was required by the international framework. Areport would be issued after each verification. Certification is the formal step based on, and pos-sibly in conjunction with, the verification report.

TGC and JI approval have similar aspects that make TGC approval compatible with the JI proj-ect cycle. Monitoring (simple metering) and verification in the TGC system are compatible withthe validation-step in the JI project cycle as long as the JI process makes use of general base-lines for green power projects. So if a RES-E project is funded under both mechanisms there aresubstantial synergies between the two. Only if the emission baseline changes over time (due toe.g. nuclear phase-out) the JI-project cycle has additional requirements because the baseline hasto be re-assessed.

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3.4 ConclusionWe have analysed different institutional settings for the implementation of national green cer-tificate and carbon emissions trading systems in the light of international trade (mainly JointImplementation). For CO2 and green certificate markets we distinguished two types of coexis-tence that could be implemented on a national level. Open coexistence exists when the com-modity of green power is sold competitively to the conventional power market where CO2 obli-gations are already included in market prices of electricity. Closed coexistence is the institu-tional setting featuring fixed-feed-in tariffs for the commodity of green power based on avoidedfuel costs without crediting CO2 reduction. Both institutional settings were discussed as relevantoptions in the political process.

On the national level we found that both institutional settings lead to the same resource alloca-tion. Nevertheless they result in different market value. The green certificate market value isbigger in the closed coexistence mode since it also accounts for CO2 reductions whereas in theopen coexistence mode CO2 reduction is only credited on the CO2 market. Accordingly, the dif-ferent institutional settings result in different green certificate price levels. Therefore, the paral-lel existence of different national institutional settings will result in inefficient allocations ofgreen power projects if countries with different types of coexistence participate in an interna-tional green certificate trade.

If a substantial number of renewable power projects is supposed to be funded by the JI mecha-nism as well as by an international green certificate system, the potential synergies betweenthese two instruments can be used if both make use of common approval procedures as much aspossible. Open coexistence in the JI host country facilitates the project approval under bothmechanisms since the price for CO2 reduction and the price for the ‘remaining greenness’ areseparated best under this coexistence mode. For those projects it was recommended that TGCapproval should be followed by the JI approval.

Accordingly, a first recommendation is that, since different national TGC systems might lead toinefficient allocations under international TGC trade, the national institutional settings shouldbe harmonised. Secondly, in order to let green power projects make use of both the green cer-tificate system and JI it is important to ensure compatibility of international TGC trade and theKyoto mechanisms. We suggest to uniformly implementing open coexistence between the greencertificate market and the CO2 market at the national level to ensure that JI accounts for CO2 re-duction only and TGC for the other environmental benefits of green power production. In orderto make use of the synergies in the approval procedures for green certificates and JI projects, itwould be helpful to co-ordinate the European efforts in the process of GHG emissions trading,see e.g. the proposed emissions trading directive (EC, 2001b) and in the process of renewableenergy promotion (the RES-E Directive).

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4. DESIGNING TRADABLE SYSTEMS SERVING BOTHRENEWABLE ELECTRICITY AND CARBON TARGETS

4.1 Theoretical scenarios for linking CET and TGCThe analysis described here tries to answer two questions:1. Are green certificates going to be applicable only to renewable energy production or should

there be some kind of GHG reduction related to them as well? This possibility introduces aGHG reduction credit toward the purchase of certificates, and thus helps Member States tocomply with the national GHG reduction commitments.

2. Who is going to decide on binding targets for carbon emissions trading (CET) and forTGC? Would it be the EU on behalf of all Member States, or the individual states them-selves?

The overall goal for energy and environmental policy is assumed to be a reduction of green-house gases and that each Member State is committed to complying with a GHG reductioncommitment. With regard to CET, it is assumed that the GHG credits always follow the tradablepermits. Thus, for each Member State it is possible to increase the national GHG reduction tar-get by buying emissions permits. Of course, at the EU-level this will even out - those countriesabove the original reduction target will be equalised by those below.

Concerning the second question mentioned above, two possibilities exist: targets for CET(emission quotas) and for TGC (quotas for green certificates) are negotiated and fixed by theEU. This can be seen as part of an EU attempt to introduce GHG-emission reduction instru-ments on behalf of all Member States as is done in the proposed emissions trading directive.Alternatively, they may be set by the individual countries themselves, as part of each country’sown GHG reduction policy. Note that with the adoption of the RES-E Directive and the Kyotoburden sharing, binding targets have in practice already been set at the EU level. The analysis inthis section thus is of a theoretical nature.

Mixing the above-mentioned two possibilities for GHG credits in relation to green certificateswith the two possibilities for who will decide on the targets gives in total the four possible sce-narios shown in Table 4.1. In the remainder of this section, a short description is given for eachscenario. Next, an analysis of the scenarios is given in Section 4.1.1 and Section 4.1.2.

Table 4.1 Four cases for applying the two instruments: CET and TGCWho sets the targets?

National targets EU-targets

No Case 1 Case 2GHG credits related to TGC?

Yes Case 3 Case 4

Case 1This case represents the original intention behind the green certificate market, namely that theinternational trade in certificates will secure a cost-effective siting of renewable plants. The cer-tificate market is totally separated from the physical electricity market and no GHG credits areattached to certificates. The national authorities set targets for quotas and the development ofthese quotas for both CET and TGC are totally independent of the EU. The two instruments are

46 ECN-C--01-048

used by the individual Member States as any other instrument available to reach a national tar-get for GHG reduction. However, possibilities for the international trade of green certificatesand carbon emission permits do of course exist. No targets for CET and TGC are set at the EUlevel.

Case 2As in case 1 no GHG credits are attached to the green certificates in international trade. Thecertificates are used to meet a target for renewable energy production only. On behalf of theMember States, the EU sets targets for quotas and their development for both CET and TGC.These quotas are introduced to encourage the Member States to promote the development ofGHG reduction technologies. The targets are implemented as specific quotas for green certifi-cates and CO2 permits in the individual Member States. The EU targets might differ accordingto the potentials of the Member States to develop GHG reduction technologies. The binding tar-gets are fixed according to negotiations between the EC and the Member States. To reach thesetargets green certificates and CO2 permits can be traded among the Member States. Besides theEU imposed targets, no additional targets for CET and TGC are set at the national level.

Case 3The only difference between this case and case 1 is that GHG credits are attached to the greencertificates. Thus, trade will take place in certificates not only to meet the targets for renewableenergy production, but also because buying of certificates may help the Member States to com-ply with the Kyoto commitments for GHG reduction. In order to ease trade, the attached creditwill not be directly related to the substituted energy in those countries buying the certificates,but rather to an EU average for the power industry. As in case 1, the national authorities set tar-gets for carbon emissions and green certificates as part of their national policies for reducingGHG emissions. The issued emissions permits and green certificates are internationally trad-able. No targets for CET and TGC are set at the EU level.

Case 4In this final case, GHG credits are attached to the green certificates and the EU fixes the targetsfor quotas and the development of these quotas for both CET and TGC. Emissions permits andgreen certificates are internationally tradable. No additional targets for CET and TGC are set atthe national level.

4.1.1 GHG credits are not attached to the TGCThe results of the analysis for case 1 and case 2, where no GHG credits are attached to greencertificates, are summarised in Table 4.2.

Table 4.2 Will international trade take place when no GHG credits are attached to the greencertificates?

Trade in carbon emission permits Trade in green certificates

Case 1 Yes Limited

Case 2 Yes Some

If the overall goal is GHG reduction, then trade in green certificates will only have some rele-vance in reaching this GHG target simultaneously with the use of carbon emission quotas, if thequotas for green certificates are imposed on the Member States by a supranational authoritysuch as the EU. With regard to trade in carbon emission permits, this is highly relevant in bothcases, regardless of whether the target is set by the national authority or by EU. The relevanceof trade in carbon emission permits is due to the fact that, no matter if used as a national instru-ment or as an EU instrument, GHG credits are attached to the permits and thus trade ensuresthat the Member States achieve GHG reductions in the most cost-efficient way.

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International trade in green certificates is not of major importance in either case. In achievingthe least cost GHG reductions this instrument will be of limited value. Seen in a national contextgreen certificates might be important instruments in reaching the national targets for deployingrenewable energy, but the international trade will not be important, because it does not contrib-ute to a national GHG reduction.

Case 1The national targets for TGC and CET are fixed in an attempt to meet the GHG reduction targetas cost effectively as possible. Thus, it is important is to get a national implementation of re-newable technologies to gain the GHG credit. Therefore, the targets for green certificates shouldreflect the national possibilities for a cost-efficient deployment of renewables - a deploymentthat can compete with other GHG reduction possibilities such as CET. In the short term, a lim-ited international trade of green certificates might take place, due to unforeseen fluctuations(e.g. from wind power). In the long term it is expected that targets for national RES-E will bereduced if it seems impossible for a country to meet the initial RES-E target by implementingTGC nationally. There will be no interest in a permanent import of green certificates lackingGHG credits, i.e. international trade in certificates will have little significance.

Due to the attached GHG credits, international trade in emissions permits will be highly rele-vant. The national quotas for CET will have to be fixed with due regard to the country’s poten-tial for reducing GHG, especially in relation to other GHG reduction instruments available, in-cluding the green certificate market. A high quota for tradable permits will allow the country toexport permits, but at the same time the country will have to use other instruments to fulfil thenational GHG reduction target.

Case 2The main difference with respect to case 1, is that the view of the EU on a country’s potentialfor deploying renewable energy and for achieving CO2-reduction in the power industry mightdiffer from the country’s view. Moreover, when the development of these options in a MemberState lags behind the EU negotiated targets, the long-term targets might not be as easy to changeas would have been the case if these targets were set by the individual countries. Thus, the mainreasons for international trade in CET and TGC are that:1. The EU set targets for deploying renewables and developing CO2 reduction options in the

power industry differ from what is actually being implemented in the country.2. These EU targets are binding.3. A high penalty for not reaching these targets will have to be paid to the EU.

In the negotiations with the EU, each Member State will to a certain extent have an interest ingetting as high a CET-quota and as low a TGC-quota as possible. On the one hand, this ismainly due to the possibility to sell the surplus if the cost-efficient potential for developing re-newables and CO2 reduction power technologies in the country is above the national target setby the EU5. On the other hand, if the cost-efficient potential in the country lies below the EUfixed target, it will be important for the country to minimise the cost of purchasing the necessarycertificates and CO2 permits in order to meet the targets. But at the same time it is important forthe Member States that the quotas are appropriate, reflecting the costs and potentials of renew-ables and CO2 reduction options. Again, there will be no interest in a permanent import of greencertificates without any GHG credits attached. International trade in certificates will only takeplace if a domestic implementation of RES-E projects is not possible and if the certificates arepriced below the penalty price.

5 Of course, this will depend on the situation in the other Member States. Even though all countries are above theirTGC- targets and thus no TGC can be traded internationally, the deployment of renewables will add to GHG re-duction.

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Trade-offs between TGC and CETBefore moving to the cases where GHG credits are attached to the green certificates, some ofthe trade-offs between the TGC market (with no GHG credit attached to certificates) and theCET market will be explored. In general, the use of the two instruments might lead to conflictsat different levels.

In the situation of an international market for tradable emission permits, but only a nationalmarket for green certificates, optimality, in a national perspective, requires that:

Renewable energy in a country should be developed as long as the marginalcost of establishing the renewable plant is lower than the price of the producedenergy plus the marginal price of emissions permits, all calculated per unit ofenergy produced.

This means that renewable energy technologies should be developed as long as the additionalcosts of these technologies (the price of a national green certificate) is lower than the marginalprice of emission permits, which in this case is the alternative cost to domestic GHG reduction.Seen from a national viewpoint, this will be the least costly way of achieving the overall GHGreduction target; the value of the renewable plant being the energy produced and its substitutionof other GHG emitting energy production. If the additional cost of renewables exceeds the priceof CET, renewables should not be developed further when considering the GHG reduction per-spective. However, especially in the short term there may be other reasons for justifying a fur-ther development of renewable energy technologies.

Let us now move on and introduce international trade in TGC. It was already shown that inter-national trade in TGC in general would be limited if no GHG credits were attached to the cer-tificates. What would it take before international trade in certificates will be relevant and whatwould be the consequences for the domestic development of renewables? If international tradeof TGC is a possibility then:

Renewable energy in a country should be developed as long as the marginalcost of establishing the renewable plant is lower than the price of the producedenergy plus the marginal price of emissions permits plus the price of the greencertificate, all calculated per unit of energy produced.

Thus, if the price of the green certificate is lower than the marginal cost of establishing a newrenewable plant less the price of the produced energy and less the marginal price of emissionpermits (again calculated per unit of energy produced), then it will be cheaper for the country toimport certificates than to develop their own domestic renewable supply.

Comparing this statement with the previous one on undertaking the investment, the difference isthe price of a green certificate:

If trade in certificates is possible then the development of domestic renew-ables is taken further than would otherwise have been the case seen from anational perspective!

What will be the incentives for those people who are going to invest in these renewable plants?From the viewpoint of a potential investor in new renewable capacity, he or she should:

Undertake the investment as long as the marginal cost of establishing the re-newable plant is lower than the price of the produced energy plus the price ofgreen certificates, all calculated per unit of energy produced.

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If this development of renewable production is insufficient to cover the national TGC quota, theresidual certificates have to be imported or the penalty paid.

As can be seen from the statements given above, the incentives for the investors to develop re-newable energy are smaller than those for society at large, when international trade in certifi-cates is possible. Thus, there will be a discrepancy between the incentives at the level of societyand at the lever of the potential investor. This implies that using instruments as TGC (with noGHG credits attached) and CET in the above-mentioned way will not lead to an optimal strategyfor achieving the committed targets of reducing GHG emissions.

4.1.2 GHG credits are attached to the TGCThe results of the analysis for Case 3 and 4, when GHG credits are attached to green certificatesare summarised in Table 4.3.

Table 4.3 Will international trade take place when GHG credits are attached to greencertificates?

Trade in carbon emission permits Trade in green certificates

Case 3 Yes Yes

Case 4 Yes Yes

As shown, the results for TGC trade change completely when GHG credits are attached to thegreen certificates. Both instruments are now directly related to GHG reduction. The main ques-tion is not if there will be any trade in CET and TGC (because trade will take place in all cases),but rather what are the consequences of the relation between these two competing GHG reduc-tion instruments for the development of renewables and for international trade in CET andTGC?

Before going into the evaluation of the differences between the two cases, it may be worthstressing that the criteria for the optimal cost-effective use of GHG-reducing instruments actu-ally is:

The marginal cost per unit of GHG reduction achieved by those options im-plemented by the use of different instruments should be the same for each op-tion.

Therefore, the more accurately the country’s overall GHG target and quotas for TGC and CETreflect the country’s possibilities, the less need there is for international trade. However, if thecountry’s overall GHG-target is fixed either at a level that is too high or too low compared withthe domestic reduction possibilities6, then international trade with GHG credits becomes an in-strument on an equal footing with domestic GHG reduction.

Optimality requirements for a national GHG strategy are centred on:

A development of the different GHG reduction options in a country until themarginal costs, per unit of GHG-emission, of establishing these GHG reduc-tion options are equal and the overall GHG reduction target is reached.

6 Or if other barriers are present that prevent the implementation of the country specific potentials for GHG reduc-tions and thus prevent the fulfilment of the national GHG-target.

50 ECN-C--01-048

If international trade is possible, a development of the national GHG reductionoptions should take place as long as the marginal costs, per unit of GHG-emission, of establishing these options7 are lower than the marginal price ofthe traded emissions permits.

Looking only at the two instruments that are our main concern here, and assuming that the priceper unit of produced electricity for renewable technologies and for conventional technologiesare equal8, then the optimality requirements reduce to:

To reach an optimal GHG reduction strategy, the marginal price of green cer-tificates should be equal to that of tradable emissions permits, calculated perunit of GHG-emission.

With separate quotas for CET and TGC for all EU Member States, this will be the case only bycoincidence. In practice, the sum of the EU-quotas for TGC is set either too high or too lowcompared with the sum of tradable permits9. When it is too high, the marginal cost of TGC as aGHG reduction instrument will be too high compared with CET, and visa versa10. This willcertainly have some importance in those situations where the Member States can adjust thequotas themselves (see the detailed comments to Case 3 and 4 later on). Finally, it should bestated that the overall EU quota-setting for TGC and CET will be especially important seen inrelation to the development of other national GHG reduction options, which are not covered byTGC and CET.

How TGC are accredited for GHG reduction will be an equally important part of the conditionsfor competition among TGC and CET. In this section a simple version is adopted:

The GHG reduction credits are attached to the green certificates according tothe average emissions from electricity and heat generation based upon fossilfuels in the EU, calculated per unit of energy produced.

Thus, if a country has insufficient renewable energy supply for reaching its TGC target (i.e. anet importer of TGC) this net import will be treated as if an average of the EU supply of fossil-fuel generated electricity, heat was substituted, and accordingly the country would be accreditedwith the corresponding GHG reduction. In a similar way, countries that are net exporters ofTGC will have to add an amount of GHG emissions to their GHG balance corresponding to thenet export of certificates. This simple assumption has the advantage that, although no individualcountry ‘hits’ its own TGC quota by domestic renewable supply, the overall EU GHG emissionlevel will be unaffected if the total production of energy by renewable technologies in the EU isequal to the sum of all TGC quotas.

This assumption for GHG credits attached to TGC has some implications for trade:

The more the country’s real GHG reduction by implementing renewables dif-fers from the assumed EU-average, the more will trade in TGC be affected.

7 If any energy is produced, the price of energy (calculated per unit of GHG-emission) should be subtracted.8 E.g. assuming an EU electricity exchange and no bottlenecks in transmission and distribution of electricity across

the EU.9 Both have to be seen in comparison to the possibilities for developing renewable technologies and for undertak-

ing GHG reduction options in the tradable emissions permits regulated industry.10 Assuming that the TGC and CET markets are totally separated, i.e. it is not possible for power companies to fulfil

the CET-quota by buying TGC. Thus, the difference in price reflects the use of two separate markets in achievingone target.

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If the country’s own marginal possibilities for GHG reductions in implementing renewables aremore cost-effective than those of the EU-average, then the assumed EU-average emissions stan-dard will be a barrier to trade. More domestic renewables will be developed at the expense oftrade compared with a neutral situation. The opposite occurs if the country’s own marginal pos-sibilities are less cost-effective than those of the EU-average. Then the assumed EU-averageemissions standard will be an incentive to trade. More certificates will be traded at the expenseof the development of domestic renewables compared with a neutral situation.

The main difference between case 3 and 4 is related to the different possibilities for adjustingthe TGC and CET quotas, when it appears that the marginal costs of using these instruments areunequal and when the marginal costs of using other GHG reduction instruments - not coveredby TGC and CET - are out of line with the TGC and CET instruments.

Case 3When the national authorities fix the national targets for TGC and CET, the country has by itselfa possibility of changing these targets. This flexibility enables the country to arrive at the GHGreduction target as inexpensively as possible. For example, if the price of tradable permits liesabove the price of green certificates (calculated per unit of GHG-emission). The quota of TGCcould be increased, thus advancing the development of renewable capacity and increasing themarginal reduction cost of these renewables (including an increase in the price of certificates).Renewables would get a more important role in the GHG reduction strategy and marginal re-duction costs of the two GHG reduction possibilities would then be aligned.

In a similar way the marginal reduction costs of TGC and CET could be adjusted in comparisonwith those of using other instruments for implementing GHG reduction options. Because theoverall national GHG reduction targets are fixed, there may be a considerable trade in both CETand TGC depending on the marginal costs of implementing other specific national GHG reduc-tion options.

Case 4The main difference between this case and case 3 is that the quotas for TGC or CET are fixed ina negotiation with the EU, which presumably will reduce the medium to long-term possibilitiesfor changes. Thus, it can be expected that the flexibility that was mentioned in case 3 does notexist. If the quotas for TGC and CET are fixed, there are no possibilities to align the marginalreduction costs of the two instruments (which were possible in Case 3) and there are no possi-bilities to align the marginal costs with other GHG-reducing instruments. Again, internationaltrade in TGC and CET may be highly relevant, depending on the Member State’s specific TGCand CET targets compared with the domestic reduction options. But the cost-effectiveness ofreaching the overall national GHG reduction targets will probably be lower than in Case 3.

4.1.3 Trade-offs between different reduction instrumentsWe have touched upon the trade-offs between green certificates and tradable emission permits.This can be expanded to the following:

To reach an optimal GHG reduction strategy the marginal price of green cer-tificates should be equal to that of tradable emissions permits, which againshould be equal to the marginal reduction costs of other options, all calculatedper unit of GHG emission.

Thus, the optimal strategy requires that the marginal costs of these three categories of GHG re-duction possibilities be in line with each other. As shown, it might be necessary to frequentlyadjust the quotas for TGC and CET nationally as well as internationally (EU), in order to alignthe costs. In the long term, it is expected that alignment of the costs will be possible - especiallyin a system with national fixed quotas. In the short term, deviations of reduction costs between

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the different options must be expected - this will be the price to pay for using more reductioninstruments with separate and independent targets in the short run.

In the long term, the use of the different reduction instruments should adjust itself. If the priceof green certificates (calculated per unit of reduced GHG-emission) lies consistently above theprice of tradable emission permits, the quotas for developing renewables should be lower andeventually totally abandoned11. It must then be conceded that the development of renewable en-ergy technologies cannot compete with CO2 reduction options in the power industry when mar-ginal reduction costs of GHG emissions are to be considered. A similar development could takeplace in relation to reduction options other than CET and TGC. Of course, there may be alterna-tive reasons for accepting a TGC-price above the CET-price, although these are not related tothe reduction of GHG emissions12.

4.2 Green certificates and emission permits in national GHG strategiesA number of countries have committed themselves to reductions of their GHG emissions ac-cording to the Kyoto-protocol. In general these commitments are stated with reference to a na-tional emissions reduction goal, i.e. all greenhouse gases emitted within the national border willcount in the total national GHG inventory13. A main reason of promoting the development ofrenewables (e.g. through the TGC market) and of introducing emission regulations of the powermarket (e.g. through the TEP market) is to achieve contributions in reaching the overall GHGreduction target. In this section we will look at how these two instruments can and will interplayin the attempt to fulfil a national emission goal14.

The power sector consists of the domestic conventional power production (including possibleexport), the power production from renewable technologies and, possibly, import. Of these, theconventional and renewable productions will be covered by quota obligations. For the conven-tional power production future quotas for CO2 emissions will be fixed with due consideration toprevious power production and emissions from plants in this sector. Assuming that future emis-sions are kept within the prescribed quotas, these given quotas will determine this part of GHGemissions. The development of renewable electricity producing plants will be determined byquotas for TGC. Finally, import of electricity will be an unrestricted part of the electricity sup-ply, not covered by any quotas and not implying any GHG emissions15. At the same time con-ventional production, RES-E and import of electricity will be competing at the electricity spotmarket.

Thus, part of the power sector is regulated with in principle independent quotas. The Kyotocommitments are in general implemented through national quotas, including emissions from thetotal energy system and also from other sources (e.g. from agriculture). To reach an optimalstrategy for GHG reductions, the marginal reduction costs have to be equal across the sectors ofthe power industry and to be equal to those of the rest of the system as well.

In the following we will try to answer the question: How can the two instruments - TGC andTEP - be part of an optimal national GHG reduction strategy? The starting point for answeringthis question is illustrated in three cases for an initial situation for the use of TGC and TEP

11 Alternatively, the number of tradable emission permits could be reduced (lower quota).12 E.g. domestic industrial development related to the renewable industry and/or long-term perspectives for devel-

oping renewable energy technologies, which are not reflected in the marginal reduction costs today.13 Different correction approaches are still discussed with regard to export/import of electricity. Here it is assumed

that no corrections are applied.14 In relation to achieving a national GHG reduction target the interactions of a green certificate market with a trad-

able permits market are further analysed in section 4.1.15 With regard to GHG emissions it is assumed that export and import of electricity is the producing country’s own

responsibility – this implies that no emissions are accounted for by import.

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quotas and how these interact with the physical electricity market. The three cases are related tothe domestic electricity consumption and how the quotas for TGC and TEP cover this domesticconsumption.

4.2.1 Three cases for TGC and TEP quotasBase case: The physical electricity production from renewables, covered by the quota for TGC,and the conventional electricity production, covered by the quota for TEP, exactly match thedomestic electricity consumption. On a yearly basis there is no net export or import of electric-ity.

Export case: The physical electricity production from renewables and conventional plants ex-ceeds the domestic electricity consumption and on a yearly basis the country is a net exporter ofelectricity.

Import case: The physical electricity production from renewables and conventional plants is toosmall to cover the domestic electricity consumption and on a yearly basis the country is a netimporter of electricity.

These three cases form the basis for the following discussion of the role of TGC and TEP in na-tional GHG reduction strategies. The starting point for the analysis is the above-mentioned basecase illustrated in Figure 4.1.

Base case

Green electricityproduction coveredby TGC quota

Conventionalelectricity productioncovered by TEP quota

Domesticelectricityconsumption

Short-termfluctuations inrenewableelectricityproduction

Year 2Export

Export ofTradablepermits

Year 1

Year 2Coordinated

Export ofelectricity

Year 2TEP export

Figure 4.1 Base case: development of TGC and TEP quotas and impact on electricity supply

The initial situation for the base case (year 1) is a balance between the electricity produced byrenewables and conventional plants exactly covering the domestic electricity consumption. Foryear 2 three situations are illustrated in Figure 4.1.

Year 2 - export: The quota for TGC is increased and thus the production of green electricityfollowing the quota is increased as well. The TEP-quota for conventional produced electricity iskept at the same level and thus the total possibilities for electricity production exceeds theneeded domestic consumption16. The power producers utilise the emission quota to the limit and

16 For the sake of simplicity the domestic electricity consumption is kept at the same level. This has no influence onthe results of the analysis.

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thus the excess supply of electricity is exported. This means, that the increased production ofgreen power by renewables does not substitute any domestic electricity - no domestic GHGemissions are substituted. The increased electricity production by renewables do not contributeto reach the national GHG reduction target, but of course will substitute some kind of power inthe electricity importing country.

Year 2 - TEP export: Again the quota for TGC is increased, the production of green electricityfollowing the quota is increased as well and the TEP quota for conventional produced electricityis kept constant. But in this case the power companies decide to utilise only part of the TEPquota for production purposes, while the rest of the quota is traded internationally (export ofTEP). The result is that although the domestic conventional power production falls, the in-creased renewable electricity production has no effect on achieving the national GHG emissiontarget, because the traded permits are added to the national emissions account.

Year 2 - co-ordinated: In this case the green electricity production is again increased followingthe TGC-quota, but in a co-ordinated action the TEP quota is lowered (and thus the conven-tional electricity production is decreased) to match the needed supply to fulfil the domesticelectricity consumption. In this way the increase in renewable production totally substitutesconventional produced electricity and the increase in the TGC quota is fully reflected in theoverall emission reduction strategy. Of course, short-term fluctuations in the green productionmight occur (e.g. due to wind conditions), implying some years an export of electricity, otheryears an import. But in general with regard to national GHG reduction an optimal utilisation ofthe TGC regulated renewable production will only take place if a co-ordinated adjustment of theTEP regulated conventional power production is undertaken.

Figure 4.1 illustrated the initial balanced situation where the renewable and the conventionalpower production matched the domestic electricity consumption. Looking at an initial situationwith an export of electricity gives the same conclusions as above. An increase in the TGC quotahas to be matched with a corresponding decrease in the TEP quota to fully utilise the renewableproduction in a national GHG reduction strategy. The initial import case does add further to theunderstanding of the mechanisms and therefore is illustrated in Figure 4.2.

Green electricityproduction coveredby TGC quota

Conventionalelectricity productioncovered by TEP quota

Domesticelectricityconsumption

Import ofelectricity

Year 1

Import of

tradable permits

Import case

Year 2Import

Year 2TEP import

Figure 4.2 Import case: development of TGC and TEP quotas and impact on electricity supply

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In the import case the initial situation is shown as year 1 in Figure 4.2, where the green and theconventionally produced electricity is not enough to cover the domestic electricity consumption.A net import of electricity is required17.

Year 2 - import: The quota for TGC is increased, the production of green electricity followingthis quota is increased as well and the TEP quota for conventional produced electricity is keptconstant. The increase in renewable electricity production is followed by a corresponding re-duction in electricity import. There are no implications for GHG emissions at all.

Year 2 - TEP import: In this case the domestic power producers decide to buy tradable permitsabroad to allow for an increase of their power production; perhaps not only for fulfilling thedomestic electricity demand, but to export electricity as well. If this would be the case then theresult would be a matter of competitiveness between domestic conventional power productionand import. There will be no consequences for GHG emissions, because the traded permits arewithdrawn from the national GHG accounts.

The initial import case focuses on an important issue. In this situation the renewable production(regulated by the TGC quota) has exactly the same impact on GHG emissions as import ofelectricity. An increase in import co-ordinated by a corresponding decrease in domestic con-ventional power production (regulated by the TEP quota) will contribute to achieving the GHGreduction target, as would a similar increase in renewable production. How to reach the GHGreduction target in an optimal way then becomes a matter of price? Is it cheaper to achieve GHGreduction by importing electricity than by developing the renewable production?18

4.2.2 Spot and TGC prices in international tradeIn this section the pricing mechanisms in international trade at the green certificate and the trad-able permits markets are treated in relation to the physical spot market for electricity and thevalue of the reductions achieved in GHG emissions. The important question to answer is: ‘Whois actually paying for the achieved reduction in GHG emissions?’ This issue is in detail analysedin Morthorst (2001), where three different cases are described:1) International trade in TGC with no TEP scheme introduced.2) International trade in TGC combined with a tradable permit scheme based on grandfather-

ing.3) International trade in TGC combined with a tradable permit bidding system.

The important issue is whether the cost of CO2 reduction is included in the spot market price ofelectricity or not. If it is included, the TGC price will only reflect an additional cost componentfor achieving the national target for renewable development.19 If the cost of CO2 reduction is notincluded in the spot market price, then this will be a part of the TGC-price. In this case the TGCprice will be increased with the value of CO2 reduction compared with the first mentionedsituation. This has no consequences for a national implementation of renewables. It is irrelevantif investors in renewables get the revenues from the spot market sale of electricity or from sell-ing the TGC. But in international trade of TGC it is important. As no GHG credits are attachedto the TGC, other countries buying the certificates will have to pay a much higher price forachieving their renewable development target when the CO2 cost is not included in the spotmarket price of electricity.

17 It is assumed that no emissions are accounted for by import.18 Other advantages may be related to the development of renewables, e.g. sustainability.19 This “residual cost of renewable development” can partly be related to the concept of sustainability, including

long-term perspectives for developing renewable energy technologies, which are not reflected in the marginal re-duction costs today.

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The results of the analyses of the three cases from Morthorst (2001) are shortly summarised inthe following.

Case 1 - no tradable permit scheme: When no tradable permit scheme exists, the cost of CO2reduction neither totally nor partly will be included in the spot market price of electricity. Thusthe cost of importing certificates from abroad will be too high compared to a domestic imple-mentation of renewable technologies. International trade in TGC will be unfavourably biasedcompared with a domestic development of renewables.

Case 2 - tradable permits based on the grandfathering approach: Because the quotas in thegrandfathering approach are allotted for free to the power producers, only a minor part of thecost of CO2 reduction will be reflected in the spot market price of electricity. How much thespot market price-bid would increase due to the introduction of a TEP scheme based on grand-fathering will depend on the cost-conditions of the marginal suppliers to the spot market and cannot be determined beforehand. However, as emission quotas only are going to decrease margin-ally each year, only a fairly small marginal increase in the spot market price of electricity maybe expected. Thus, again the cost of importing certificates from abroad will be too high and itwill be more favourable to undertake a domestic implementation of renewables.

Case 3 - tradable permits based on a bidding procedure: In this system the power producershave to buy permits to cover all their emissions, not only the marginal part, as was the case inthe grandfathering system. In general this will imply that the spot market price of electricity willincrease approximately by the price of a tradable permit, reflecting the marginal cost of the nec-essary emissions reductions to achieve the TEP quotas. In international trade of certificates thesituation now is significantly changed compared with the grandfathering TEP system. Othercountries will now pay the same additional cost of achieving their renewable development tar-gets as will the home country of the renewable implementation. Thus, trade in certificates willnow be equivalent to a domestic implementation of renewables.

Thus, the main conclusion from this section is, that only by using the tradable permit systembased on the bidding approach, international trade in green certificates will be relevant. Other-wise the countries importing TGC will have to pay too high a price. Using the bidding-system,no other country will have to pay for CO2 reduction in the home-country of the renewable de-velopment, as would otherwise be the case if a TEP system based on grandfathering were intro-duced or, even worse, if no TEP system were introduced at all.

Of course, this has some implications for export and import of electricity as well. If the spotmarket price of electricity fully reflects the cost of CO2 reduction, as is the case when the TEPbidding procedure is used, then the price of imported electricity will be equal to the price of de-veloping renewables (excluding the ‘additional cost of renewable deployment’, which has to bejustified through other achieved benefits of renewables). This means that the use of importedelectricity will be equivalent to a domestic renewable development in a national GHG reductionstrategy. When the spot market price fully reflects the cost of CO2 reduction, an increase in ex-port of electricity20, although adding to the domestic GHG emissions, would not be harmful tothe overall GHG emission target if another GHG reduction option was undertaken at the sameor to a lower reduction cost. Of course, it is of utmost importance that the penalty for not com-plying with the tradable permit quota at least is at the level of the cost of the required GHG re-ductions.

If the full cost of CO2 reduction is not reflected in the spot market price of electricity, thecheapest way in terms of GHG reduction costs of achieving the power sectors contribution to

20 Through an increased TEP-quota or by exceeding the quota. If tradable permits were bought at the market tocover the increased export it would have no implications for GHG emissions.

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the GHG reduction target will be through an increased import of electricity. Though, it shouldbe observed that if the power capacity were available, of course there would be an economiccost in not utilising this capacity. Thus, there will be a trade-off between applying import ofelectricity as a GHG reduction instrument and an appropriate utilisation of the domestic powerproduction capacity. Similarly, if the full cost of CO2 reduction is not reflected in the spot mar-ket price of electricity, an increase in export adding to the national GHG emissions might be acostly way of increasing the revenues to the domestic power sector. In order to achieve theoverall GHG reduction target, another GHG reduction option has to be undertaken at a costlower than the market price for a tradable permit, which could be hard to find. Again, thereshould be a trade-off between the utilisation of the domestic power capacity and the possibilitiesfor achieving GHG reductions by other means outside the power industry. Finally, if the fullcost of CO2 reduction is not reflected in the spot market price of electricity it becomes evenmore important that the penalty for not complying with the tradable permit quota is appropriatefor excluding a less than optimal export of electricity.

4.3 ConclusionAccording to the agreed burden sharing in the EU, a number of Member States have to reducetheir emissions of greenhouse gases substantially. To achieve these reductions various nationaland international policy-instruments are applicable. Two international instruments have beenanalysed here: tradable green certificates (TGC) and tradable emissions permits (TEP). To acertain extent both TEP and TGC are related to the need for implementing greenhouse gas re-duction options and both are intended to be traded internationally. But with regard to the trad-able emission scheme, credits are attached directly to the emission permits, whilst this is not thecase for green certificates. The certificate market will influence greenhouse gas emissions onlythrough the development of renewable energy technologies that substitute national energy sup-ply produced by fossil fuel-fired plants.

An important conclusion is that if no GHG credits are attached to TGC there seems to be limitedor no incentives for a permanent trade in certificates. In the short term, a limited internationaltrade of TGC might take place, due to unforeseen fluctuations (e.g. from wind power). In thelong term, given the EU set targets for RES-E and these targets are accepted and binding for theMember States, some trade might take place in certificates since targets cannot easily be ad-justed to national developments. But in general, if no GHG credits are attached to the green cer-tificates there will be only limited incentives towards international trade in these. Finally, whenno GHG credits are attached to TGC the incentive-scheme will be biased for different levels ofagents. At the level of society at large there will be a greater incentive towards a domestic de-velopment of renewable energy technologies, than will be the case at the level of the potentialinvestors. Thus the application of TGC (with no GHG credits attached) and CET will not lead toan optimal strategy for GHG reduction.

If GHG credits were attached to the green certificates, the situation would be totally changed.Now both instruments are related to GHG reduction through international trade as well asthrough domestic implementation of reduction options. International trade certainly will takeplace, but what are the consequences of the relation between the two competing GHG reductioninstruments for the development of renewables and for international trade in carbon emissionsand TGC?

There is a possibility to achieve an optimal GHG reduction strategy using these two instrumentsin combination with other national reduction possibilities. The main problem however is thatmarginal reduction costs of all these categories of GHG reduction possibilities should be in linewith each other. Thus, it might be necessary to align the costs by frequently adjusting the quotasfor TGC and CET. In the long term, aligning the costs will be expectedly possible. In the shortterm, deviations of reduction costs between the different reduction options must be expected,

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which will be the price to pay for using more reduction instruments with separate and independ-ent targets in the short run.

With regard to national GHG reduction a main conclusion of this chapter is that an optimalutilisation of the TGC regulated renewable production will only take place if a co-ordinated ad-justment of the TEP regulated conventional power production is undertaken. An increase in theTGC quota has to be matched with a corresponding decrease in the TEP quota to fully utilise therenewable production in a GHG reduction strategy. Similarly, only by using a tradable permitsystem base on the bidding (auction) procedure will the costs of CO2 reduction be fully reflectedin the spot market price of electricity. And only by introducing this TEP system will interna-tional trade in green certificates be equivalent to a domestic development of renewables, be-cause the price of a green certificate will correspond to the ‘additional cost of renewable devel-opment’ no matter if the certificate is traded or not. Using a TEP approach based on grandfa-thering or, even worse, no TEP system at all, will make international trade in TGC irrelevant.

Adopting as a main assumption the introduction of a TEP bidding system, the following conclu-sions are drawn from this chapter:• In a GHG reduction strategy the use of electricity import is equivalent to a domestic devel-

opment of renewable energy production. An increase in electricity import co-ordinated by acorresponding decrease in domestic conventional power production (regulated by the TEPquota) will contribute to achieving the national GHG reduction target, as would a similar in-crease in renewable production.

• An increase in export of electricity in this situation, by increasing the TEP quota or by notcomplying to the quota, although adding to the domestic GHG emissions would not beharmful to the overall GHG emission target, if an other GHG reduction option was under-taken at the same or at lower reduction cost.

• If the full cost of CO2 reduction is not reflected in the spot market price of electricity, thecheapest way in terms of GHG reduction costs of achieving the power sector’s contributionto the GHG reduction target will be through an increased import of electricity. An increasein export adding to the national GHG emissions though, might be a costly way of increasingthe revenues to the domestic power sector, because an alternative GHG reduction optionhad to be undertaken at a cost lower than the market price for a tradable permit. This, ex-pectedly, would not be possible. In both cases it is important to observe that there will be atrade off between export/import of electricity in terms of GHG emission consequences andan appropriate utilisation of the domestic power capacity.

• Finally, it must be stated that although the green certificate market is introduced in combi-nation with a tradable permit bidding system, there still will be no incentives for interna-tional certificate trade on account of the need for national greenhouse gas reductions. In thepresent version of the green certificate market, no GHG credits are attached to certificatesand therefore no matter what kind of tradable permit scheme is adopted the development ofrenewables will add to GHG reductions only where a fossil fuel-fired production is substi-tuted. International trade in certificates will only help ensuring that the targets for develop-ing renewable energy technologies are reached in the most cost-efficient way.

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5. RENEWABLE HEAT AND BIOGAS

The discussion on tradable green certificates (TGC) mainly focuses on this new instrument as astimulus for the penetration of electricity produced from renewable sources. However, theWhite Paper on renewable energy of the European Commission (1997) envisaged that in orderto meet the target of 12% energy from renewable sources in 2010, it will be necessary to deployrenewable technologies based on gas and heat as well. Under these conditions, it would be sen-sible to expand the TGC system to all energy carriers in the energy mix, in particular green heatand biogas. A TGC system could be implemented to stimulate biogas, e.g. gas from biomass,‘green heat’, e.g. heat from solar boilers or heat from biomass plants, or bio-based motor fuels.For that matter, some Member State governments are about to introduce green certificates forgreen electricity, biogas and/or green heat (although generally details are still unknown). Whenall renewable forms participate, several issues are at stake, when designing a TGC system.

The following example shows that it can make quite a difference when green heat production isalso rewarded with green certificates. Consider an installation, processing and burning agricul-tural or municipal waste. At the moment, it is common practice to generate electricity with theproduced heat, with an efficiency of about 40%. However, if the heat would have been valuedas renewable and awarded with green certificates, the heat would perhaps have found a moreefficient use, e.g. by transporting it to a nearby residential area for district heating. The rewardfor the waste incineration installation in terms of certificates would be higher for the heat.

Several countries or states that will implement green certificate systems have plans to includealso non-electricity options in the certification scheme. Among these are the Netherlands, Aus-tralia, Texas and Flanders. The common feature of all these systems is that it is mainly designedfor renewable electricity. The certificate unit is expressed in kWh. Non-electricity options areincluded by issuing kWh-equivalent certificates based on an administrative conversion factor,which differs in each of the countries. In Australia, solar boilers will get certificates accordingto the quantity of electricity that would have been used for the same heat demand, assuming thatelectric boilers would have been used. In the Netherlands, green certificates (within the systemof Green Labels until December 2000) have been issued in kWh-equivalents for green gas,based on the CO2 content of a cubic meter of biogas, compared to the ‘average’ CO2 content ofkWh-production with the current electricity production mix in the country. In Texas, green gasreceives certificates in kWh-equivalents, assuming that the gas would have been converted intoelectricity in an average gas-fired power plant in the state.

In all the cases mentioned above, the conversion of the green value of one energy carrier intoanother is made at the point of production. In the market, only renewable electricity certificatesexpressed in kWh-equivalents exist. This might change however in the future. Heat pumps us-ing green electricity will then be able to produce 100% green heat, and will, if this heat is deliv-ered to a heat grid, be issued green certificates. In principle, these certificates could also be usedto sell green electricity or green gas to consumers.

Here, the focus is on the aspects that would change because of integration of different sources ofgreen energy into one system. For now, under the assumption that the choice of an integratedTGC system has already been made, the main apparent issues are about:• certificate units, exchange and conversion,• general certificates (one type of certificate for all energy carriers) versus specific certificates

(each energy carrier has its own certificate),• production-based versus grid-based issuing of certificates,• general obligation versus specific obligations, and the related market volumes.

These issues will be elaborated in the following sections.

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5.1 Certificate units and conversionWhen designing a TGC system, one may choose not to account for any conversion at all. Thiswould be the special case when specific (i.e. for each energy carrier) certificates are being is-sued and when they are denominated in the same units as their respective physical carriers. Thesame applies to the situation when there is no need expressed (or no permission given) to ex-change some types of certificates into each other. This particular ‘non-integration’ case has atleast two limitations. First, the green certificates would then only be redeemed in their originalunit, which means that there should also be specific obligations for each energy carrier. A com-prehensive discussion of the main advantages and disadvantages of separate obligations withseparate markets is reported in Section 5.3. Second, one common ‘currency exchange rate’seems to be still necessary if the TGC system is to deal equally (in the political sense) with allproducers of renewable energy. Given for example a CHP plant, where one would like to givecredit to green gas and green heat, some exchange/conversion becomes indispensable. It meansthat, independently of the choice of having general or specific certificates, one has to chooseone (or several) convenient unit(s) to work with, as well as a proper methodology to use them.These are the two issues at stake in the following sub-sections.

5.1.1 Unit of the certificates issuedThere are many possibilities to choose a unit for the certificates. In many cases, certificates arediscussed in terms of kWh (or MWh),, which is, of course, generally driven by the fact thatonly, or mainly green electricity certificates are considered. However, when green gas and greenheat are also involved, certificates may logically be stated in cubic meters or GJ. Moreover, re-newable energy targets are often stated in terms of ‘avoided GJ’, while the 12% EU target isbased on the Eurostat method of primary energy input, i.e. ‘primary GJ’. Finally, in order to re-veal the link of renewable energy with greenhouse gas issues and the Kyoto protocol, avoidedCO2 or CO2 equivalents might be used as a unit for green certificates. Some considerationswhen using a particular unit are given below.

kWhUsing kWh as a unit for all green certificates focuses on the electricity output of the RE produc-tion. For the technologies, producing electricity directly that is fed into the grid and easilymonitored, it would make sense to issue certificates in terms of kWh produced. Typical exam-ples of such technologies are hydro, wind, tidal/wave, PV and geothermal systems. This is al-ready standard practice and the volume of green heat and green gas produced is and will be verysmall compared with the volume of green electricity. Moreover, the kWh is an internationallyaccepted and unambiguous unit for the production of electricity, while for example the energycontent of a m3 for gas differs between countries, albeit that some countries also use kWh as thestandard unit for natural gas.

Avoided GJUsing avoided GJ as a basis to issue green certificates focuses on the replacement of fossil fuelsthat ‘would otherwise be consumed’. This seems a fair measurement for counting renewable en-ergy production or consumption. However, the way to calculate how much is actually avoidedbecomes the important issue. Reference or baseline technologies, reference periods or years andreference geographical (e.g. national or European wide) levels are needed. Since each of theseissues appears arguable, the whole method is converted into a complex issue on which prefera-bly international agreement should be reached.

CO2 equivalentsIf the reduction of GHG emissions is the main argument to stimulate renewable energy produc-tion and consumption, it would be reasonable to establish green certificates in terms of CO2equivalents. Issuing green certificates in kilograms of CO2 reduction, or rather CO2 displace-ment, focuses also on replacement of fossil fuels. Therefore, regarding the calculation, the same

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reasoning applies as with avoided GJ. Note that this might reduce the TGC value to the CO2value only and it would simplify the integration of renewable energy into a CO2 permit-tradingscheme.

Primary GJThe Eurostat method of counting primary energy input merely focuses on the energy input ofrenewable energy production. A big advantage is that it may be the greatest certainty one has,which means that any needed (international) agreement would be more easily achieved. How-ever, it does not account for efficiency losses during conversion of renewable energy into usefulelectricity, heat and gas. Total primary or potential heat content of e.g. landfill gas is generallylarger than the amount of energy from landfill gas that is applied effectively, because part of theextracted landfill gas is flared at the source. Thus, the use of primary GJ as a unit to issue cer-tificates over-estimates the amount of renewable energy produced / consumed, especially whenbio energy sources are concerned. This drawback can be removed by accounting for the net pro-duction of renewable energy or setting stricter obligations in order to achieve the same level ofdeployment. However, when flow sources such as wind power play an important role in a par-ticular country, the primary GJ method may result in an under-estimation of renewable energyproduction. After all, the metered kWh should be translated into a primary GJ measurement, forwhich again a baseline or reference is needed.

PracticalitiesAll green certificate systems that will be in place in the coming years will use kWh as the cur-rency unit. Any procedure to calculate currency unit equivalents should be transparent with re-spect to conversion of different certificates at the country border. Problems may arise, for in-stance, if in one country the amount of green certificates for one m3 of biogas is calculated bytaking the average conversion efficiency of gas-fired power stations, while in another country,this is done by comparing the CO2 content of biogas with the CO2 content of an average kWhfrom the overall electricity mix.

If the conversion procedures are not the same, countries within a ‘green bubble’ could agree onexchange rates at the border for green certificates for which the conversion calculations differ.The issues will become more important if the size of the bubble increases. There is also the op-tion of developing and adopting a ‘green protocol’ (like the http-protocol for the Internet) ableto calculate the right ‘exchange rates’ at the different borders. Such a protocol could also beused for international trade with countries outside the bubble. Some way or another, harmonisa-tion is (eventually) needed in a full international context.

The European Commission, for instance, may either try to harmonise the green certificate cur-rency unit and/or the conversion factors. The currency unit of the overall EU target is 12% ofthe gross energy consumption (in terms of primary GJ). But also renewable electricity targetsare indicated (in terms of GWh). Apart from that there are of course the Kyoto-targets in termsof CO2 reduction. A one-currency system would fit well with overall EU-targets for renewableenergy. If CO2 reduction is favoured as the currency unit, also exchange with the US, Australiaand other countries may be easier to establish.

Besides the choice for one or another unit to cope with all certificates, there is the possibility touse several units for several types of renewable energy simultaneously (e.g. kWh for electricitybut cubic meters for gas) and to ‘convert’ them only if and when needed. In both cases, certifi-cation happens early in the supply chain, i.e. as soon as production of renewable energy is iden-tified, and conversion happens as far downstream as possible. To be clear, in the first case, theadministrative conversion of green energy into one agreed unit is done at once when the certifi-cates are issued. This was also the case assumed in the section above, where the green electric-ity, green heat or green gas was administratively translated in a common unit immediately afterproduction. In the second case, however, certificates will be issued in the particular unit of the

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type of green energy and conversion will only be an issue in some specific cases. The next sec-tion is devoted to the issues that will then arise.

5.1.2 Conversion methodsIndependently of the choice of having general or specific certificates, one has to choose one (orseveral) convenient unit(s) to work with, as well as a proper methodology to use them. There-fore, two kinds of basic conversion methods are described which both imply a lot of (eventually,international) agreements to be achieved.

Administrative conversionGreen certificates that are defined in terms of kWh avoided GJ; primary GJ or CO2 reductioncan be translated from one unit into the other. But this is not the complete story about adminis-trative conversion. Since policy targets for renewable energy are usually stated in terms of apercentage of (future) consumption and since national consumption is often measured in termsof GJ, the targets and obligations will primarily be stated in GJ.

For administrative conversion, many clear agreements have to be made. De facto, administrativeconversion is already applied in some countries. The reference technologies that they often useplay an important role, especially when the CO2 content differs and emission factors are used asa reference. Which (average) content or emission per certificate unit to use? Those in the coun-try where the energy (and the certificate) is produced, or those in the country where the certifi-cate is consumed? The first option seems to be fair mainly from the point of view of the pro-ducer of renewable energy and it is not known beforehand where the certificate will be con-sumed. It seems too difficult to incorporate (and verify) all other countries’ references at themoment when the certificates are issued. Administrative conversion of the production of greenelectricity (GWh), heat (GJ) and gas (m3) into any reference unit should not be too problematic.But the main issue is that agreement should be achieved.

Physical conversionThe physical part of the conversion may, at first sight, bring most difficulties. Physical energyflows are not often delivered directly to final consumers: natural gas, for instance, might first beconverted to electricity and heat in a CHP plant, before being delivered as electricity and/or heatto the consumer. In the situation in which green certificates are issued for the production of allrenewable energy carriers, possibilities of conversion of one form of green certificate to anotherwill be numerous and should be taken into account in the TGC system.

Since physical conversion suffers the same problem of transparency about all referred conver-sion technologies as administrative conversion, the list of transparent (international) agreementswill just be lengthened. That this list indeed is too long becomes evident when one realises thateven when the input is not green, one may wish to ‘green’ it, which means, to add some greenvalue to this input. Consider, for instance, a CHP plant that runs on natural gas (de facto, no re-newable source). If the fuel input of this plant has been covered by the right (according to someagreements again) equivalent amount of green gas certificates, then this CHP plant might beconsidered to run on ‘renewable natural gas’, i.e., natural gas with an added green value. Theplant then produces, apart from the physical electricity and physical heat, also green electricitycertificates and/or green heat certificates.

Two assumptions made in the various examples are noteworthy; while the first is consequential,the second is imperative. First, it is assumed that there will be different certificates for electric-ity, heat and gas. Of course this is not necessarily the case. Even in the case of ‘general greencertificates’, one may wish to ‘add green value’ to an energy input (example: the electricity in-put of a heat pump) to produce green heat, which can again be separated in physical heat andgeneral green certificates. The second assumption, and key in these processes of physical con-

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version, is that the input certificates are actually ‘redeemed-for-conversion’ instead of ‘re-deemed-for-obligation’, before the new certificates related to the output are issued. Thus, ‘re-deemed-for-conversion’ means that existing certificates are exchanged for new certificates andnot handed over to fulfil an obligation. For the sake of clarity, to ‘green the fuel input’ meansthat the output is also ‘greened’ and will be eligible for receiving green certificates. Therefore,some certificates are ‘eliminated’ and some others can be ‘created’. Note that in the case of heatpumps, it is possible that there are more green certificates created than eliminated. With effi-ciencies lower than 100%, part of the greenness will get ‘lost’, as is the case with the physicalenergy. Note also that some green certificates, like those issued to biogas, will be mainly ‘standby’ or ‘provisional’ certificates in the sense of waiting for some ‘redemption-for-conversion’.This is because biogas is not immediately ‘consumed’ but used in e.g. power plants or used forheating. Note finally that green certificates can also be issued for electricity produced by con-ventional power plants. This can happen if the fuel input is covered by the consumption of greencertificates in terms of that fuel. Actors that deliver non-renewable energy to the grid and nev-ertheless wish to receive green certificates for that form of energy, have to prove that they con-sumed enough green certificates to cover their fuel input.

5.2 Supply side of integrated certificates systems

5.2.1 A supply side based classification of integrated certificates systemsAs noticed in e.g. Chapter 2, a choice has to be made concerning the point in the supply chainwhere green certificates should be issued. The issuing activity itself can be done immediatelyafter production or at the point where renewable energy is delivered to a grid. The TGC systemwill therefore be either ‘production-based’ or ‘grid-based’. The former approach is announcedin some of the national TGC systems that will start in the near future; the latter approach ishowever considered more frequently, e.g. in the Dutch green certificate system. Two main dif-ferences between these approaches, on which the analysis focuses, are the impact on the volumeof the market and the ability to administrate the system.

When designing the supply side of the market, it has to be decided whether to issue certificatesonly in one particular unit or whether every energy carrier will receive specific certificates. Thedistinction between general and specific certificates, together with the options of production andgrid-based issuing, leads to the categorisation in Figure 5.1.

General certificates Specific certificates

Grid-based issuing

Production-based issuing

Production-based generalsystem

Grid-basedgeneral system

Production-based specificsystem

Grid-basedspecific system

Figure 5.1 Categorisation of integrated green energy certificate systems

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The four categories are defined as follows:• Grid-based means that certificates are given to the entity that delivers renewable energy to a

public energy network (grid). This can be an electricity grid, gas pipeline network orsteam/heat distribution system.

• Production-based systems mean that certificates are given to the producer of renewable en-ergy, regardless whether the energy is delivered to a grid or used on the spot (stand-alone orbehind-the-meter).

• General certification means that green certificates for all sources and carriers are always is-sued in the same ‘currency’. The unit can be (equivalents of) kWh, primary GJ, avoided GJ,ton oil, m3 or any other unit in which energy flows are expressed, but also in ton CO2 re-duction (equivalents).

• Specific green certificates are awarded in the ‘currency’ in which their physical flow ismeasured (gas in m3, electricity in kWh, heat in GJ, gasoline in litres). Remember that someconversion of one form of specific certificates into another can take place, e.g. through ‘re-demption-for-conversion’. By ‘covering’ the fuel input (e.g. gas) of a conversion plant (e.g.a CHP plant), some specific green certificates are ‘eliminated’. The output therefore be-comes green and is eligible for receiving specific green certificates.

5.2.2 Evaluation of alternative optionsThe aforementioned four categories are evaluated against a set of criteria and in the context ofnational and international trade. Three criteria will be applied to evaluate each option. The firstis the set of ‘practicalities’ where one can find most technical possibilities and impossibilitiestoo. The second is the more economically oriented set of ‘framework conditions’ focusingmainly on transaction costs and administrative burden. The third is the politically oriented set ofobservations about the fitness of the proposed TGC system to relevant policy, mainly throughtargets and obligations.

GRID-BASED SYSTEMS WITH GENERAL CERTIFICATIONPracticalitiesThe advantage of the grid-based approach is that it avoids potential problems of double count-ing when one or more physical conversion processes occur. If green gas is delivered to the gasgrid, it gets green certificates, but if it is directly fed into a power plant, it does not get greencertificates. Instead the electricity, which is fed into the grid, gets green certificates. The amountof certificates for green electricity will be smaller as the efficiency is lower than 100%. This is aclear system (because tacitly accounting for implied efficiencies) that is also relatively easy tomeasure. The issues about calculations to administratively convert the green value of a specificenergy carrier into a one-currency certificate remain as exposed in Section 5.1. Moreover, ifthere is a clear way of administrative conversion of the green value of different renewable en-ergy flows into one ‘currency’ unit, this conversion can easily be handled in software, and isclear and transparent.

Framework conditionsGrid-based systems fit relatively easily in existing institutional frameworks. The system opera-tor or distribution companies measure input of physical energy anyway. They will either pass onthis information to the Issuing Body (IB), or, if they are IB themselves, they carry out the neces-sary calculations to convert the green value of the renewable energy flow into the general greencertificate currency unit. Framework conditions in an international context do not differ fromthe national level.

Policy for renewable energy and climate changeA potential advantage of general certification is that the currency unit can be made the same asthe unit in which the (inter-) national targets are stated. The difference between the policy targetand the renewable energy consumption can be easily established. Also, the target can be easily

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translated into an obligation (in terms of the appropriate energy unit) to create a market of the‘right’ size, i.e. in concordance with the policy target. The disadvantage of a grid-based systemis that not all renewable energy production and consumption is accounted for. The green valueof behind-the-meter options, like auto-consumption from CHP plants or heat pumps, is not val-ued in this approach. It means that the certificate system cannot be used as an accounting systemfor renewable energy and consequently the administrative burden increases. Moreover, the mar-ket might be thin when only grid-based production is awarded with certificates. The importanceof this problem, i.e. the (potential) share of non-grid options in renewable energy, might differper country.

GRID-BASED SYSTEMS WITH SPECIFIC CERTIFICATIONPracticalitiesWith regard to issuing the same advantages apply as in the case of the general grid-based sys-tem, in terms of avoiding double counting and transparency of the system. However, an addi-tional issue with practical implications is that green certificates can also be issued for electricityproduced by conventional power plants, as long as the fuel input is covered by the consumptionof green certificates in terms of that fuel. This means that an additional accounting and verifica-tion procedure is necessary. Actors that deliver non-renewable energy to the grid and still wantto receive green certificates for that form of energy, have to prove that they consumed (‘re-deemed-for-conversion’) enough green certificates that cover their fuel input. In principle thisshould not be too difficult to verify. International trading is pretty straightforward in such asystem. The only difficulty might be that the energy content of e.g. natural gas is not the same inall countries. If the energy content is indicated on the certificate, the ‘administrative conversion’is easily calculated.

Framework conditionsConversion can be expected to take place more often, and so the need for verification of conver-sion increases. This means more communication between the green certificate Central Moni-toring Office, the Issuing Body and the organisation that measures the input flow into the grid(the system operator).

Policy for renewable energy and climate changeThe different certificates consumed in a year can easily be calculated in terms of the units inwhich government targets are stated (e.g. avoided GJ, or CO2 reduction equivalents). To get anice match between a specific green certificate system and national targets (that are usually setin general terms), these targets could be sub-divided into targets for green gas, green heat andgreen electricity, and different obligations can be set. Just as for the former option, the disad-vantage of a grid-based system is that not all renewable energy production and consumption isaccounted for.

PRODUCTION-BASED SYSTEMS WITH GENERAL CERTIFICATIONPracticalitiesThe production-based approach is a lot more complex than the grid-based approach at the prac-tical level because it means that all stand-alone and behind-the-meter options have to be exam-ined. The production from stand-alone systems and behind-the-meter systems should be meas-ured, and this should be done in a certified way. For renewable electricity, some meters are al-ready on the market (e.g. because people like to know how much PV-electricity has been pro-duced for their home), but they need to be officially acknowledged by the Issuing Body, andcertified as such by an established certification organisation. For renewable heat, which appearsin a large variety of forms, this is much more difficult as these varied forms are usually not eas-ily measurable. An alternative solution for the metering problem is to define ‘proxies’ for cer-tain technologies in certain situations. For instance, if a heat pump is officially certified as hav-ing a seasonal performance factor (SPF) of 3, then the gas/electricity input in the heat pump canbe measured, and the output of green heat can be calculated according to this factor. For solarboilers, the expected average amount of energy delivered at a certain location (depending on the

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tilting angle and the shade factor) can be taken as the basis for the number of certificates to beissued. With regard to stand-alone renewable heat from biomass, at least the furnace shouldcomply with certain emission standards. Then, the energy content of the fuel could be deter-mined in a standardised/certified way.

The related issue is to establish the ownership of the certificates. This means, to find out to whocertificates will be issued e.g. in the case of renewable heat from biomass in wood stoves. Ide-ally, one would like to measure the heat output from such a wood stove, and issue certificatesfor that amount to the user of this stove. Two problems remain with this option. First, the heatoutput of a wood stove normally is just not measured (special measurement devices should bedeveloped for this, which is not very easy). This is an issue in countries where households usewood. Second, final consumers will not be expected to take part in green certificate trade, but asvoluntary purchasers of certificates. It is difficult to imagine how then they might be able to getthe rewards from the green credits. It might be easier to issue the certificates more upward in thesupply chain (e.g. to wood ‘producers’), so that the final consumer will just only notice a costadvantage.

A central issue is double counting. In the case that stand-alone and/or behind-the-meter produc-tion of renewable energy is included in the green certificate system, possibilities of physicalconversion of certificates will go far beyond that of the case of only grid-based production. Forexample, consider the green value of electricity produced by a solar home system in remote ar-eas can be used as input for a heat pump. Alternatively, ‘greened input’ (once more, in the senseof having purchased up to 100% covering with green certificates) can be used together with theneeded input electricity. Consequently, this heat pump will produce up to 100% renewable heat,and becomes eligible for receiving up to 100% green certificates. While many different, oftensequential, conversion processes may happen, much attention should be paid that certificates arenot credited twice, e.g. both for the production of biogas, and for the electricity and/or heat pro-duced with this gas. Electricity produced by biogas can only be issued green certificates if thebiogas used in the power plant has not yet received green certificates or if these have been re-deemed.

To demonstrate the way to avoid double counting and to deal with other difficulties, it isworthwhile to remember how the proposed system will perform physical conversion. By issuingcertificates at the moment of production of biogas, the green value of this gas flow is immedi-ately ‘detached’ from the physical flow. This means that, from that moment on, the physicalbiogas cannot be considered as renewable any longer, and cannot be used anymore to producerenewable electricity. Note that the electricity producer still can choose to purchase these greencertificates together with the physical gas, and to ‘redeem them for conversion’ in order to pro-duce e.g. renewable electricity. Therefore, even if the issue becomes more complex in the caseof production-based systems, double counting can be avoided in several ways. One provision isthat the certificates that are used ‘to green’ the input should be immediately taken out of themarket (but not redeemed-for-obligation) before new certificates for the energy output are beingissued.

Like the grid-based option with general certification, here again, the issues about calculations toadministratively convert the green value of a specific energy carrier into a one-currency certifi-cate remain as exposed in Section 5.1. However, as it is not expected that there will be a clearway of administrative conversion of the green value of different renewable energy flows intoone ‘currency’ unit, this conversion will be less easily handled.

Framework conditionsBecause measuring is not always done by existing institutions (as is the case in grid-based sys-tems where transmission operators do this job), communication forms and protocols betweenthe auto-producers and the Issuing Body have to be established, and appropriate verification

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procedures have to be designed. This would help a better monitoring of the total renewable en-ergy production, which is not achievable with a grid-based system.

Policy for renewable energy and climate changeProduction-based systems cover a larger part of the total renewable energy production than grid-based systems. These systems will not only monitor a larger part of the renewable potential butwill also stimulate this larger part. If the TGC system indeed has the expected impact on the de-ployment of new renewable energy, then this impact may even be increased in the wider pro-duction-based system. Moreover, general green certificates fit again better with existing, generalrenewable energy targets (or climate change targets) than specific certificates. The certificatesystem may also be used as an accounting system for renewable energy, and the administrativeburden may decrease. All renewable energy production, like auto-consumption from CHP-plants or heat pumps, can be accounted for (at least, if the producer of the renewable energywants to obtain such certified appreciation). Production-based general green certificate systemsseem to be the best choice with regard to reaching renewable energy and climate change policytargets.

PRODUCTION-BASED SYSTEMS WITH SPECIFIC CERTIFICATIONPracticalitiesIt goes without saying that most topics as examined for the former option will remain importantsince, here again, every renewable production source should be identified and measured. ‘Me-tering’ and the identification of ownership still may appear big issues for some particularsources. The mapped problems to avoid double counting appear somewhat less obscure than forthe option with general certification; with specific certification, it is easier to track all renewableenergy flows as this is done for each carrier. However, as demonstrated in the former section,the method of ‘redemption-for-conversion’ remains applicable here as well.

Framework conditionsHere again, because measuring is not always done by existing institutions (as is the case in grid-based systems where transmission operators do this job), communication forms and protocolsbetween the auto-producers and the Issuing Body have to be established, and appropriate verifi-cation procedures have to be designed. However, this problem becomes larger, as the option in-cludes all kinds of renewable production in all situations. Still the argument that this wouldanyway help a better monitoring of the total renewable energy production is valid.

Policy for renewable energy and climate changeHere again, production-based systems cover a larger part of the total renewable energy produc-tion than grid-based systems. These systems will not only monitor a larger part of the renewablepotential but will also stimulate this larger part (since they prize all the renewables sources). Anadditional advantage is that the certificate system may also be used as an accounting system forrenewable energy, and the administrative burden may decrease. Another advantage is that thevolume of certificates traded is large. However, specific green certificates do not fit exactly withgeneral renewable energy targets (or climate change targets), at least not in the form in whichmost of them are currently established.

5.2.3 Inferences on supply side considerationsFrom a practical point of view, grid-based systems are to be preferred. Production-based sys-tems bring a lot of practical issues and more uncertainties as to issuing and monitoring the cer-tificates. From a political point of view, general certificates systems are to be preferred, mainlybecause of the targets that are given in general terms. Because of existing framework conditions,the recommendation is to start relatively simple and to extend the TGC system later on. It seemsmost easy to start with a national grid-based system with specific certification or, as it happensright now often, to start with an electricity-only system. Gradually, some non-electricity options

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(possibly all calculated in kWh-equivalents in the first stage) can be added. Later on, non-gridoptions can be included. This may happen either before or after some internationalisation hasoccurred. It might be the case that specific certification enhances the process of harmonisation,as the number of agreements is reduced. Finally, after intensive discussions on harmonisation,the step to an international, production-based, system with general certification might be im-plemented, if this appears a clear improvement of the TGC system.

We feel that the more complicated production-based system with general certificates is more inline with general renewable energy and climate change policy. Then, it might be reasonable tostart relatively simple, for practical reasons, and to include the more complex issues gradually,to fit the green certificate system better with renewable energy and climate change policy. How-ever, it might also be the alternative case that renewable energy and climate change policy growtoward more practically designed targets. Thus, existing policy agendas should not receive moreemphasis just because of historically grown policy patterns.

In fact, all considerations will have to be ‘weighted’ against each other. Economical and politi-cal considerations should also be taken into account. Trade-offs between these considerationswill be a main subject in Section 5.3. What is important to note at the present stage is that it isnot possible to determine which TGC system should be chosen, mainly because not all the de-terminants have been taken into account.

5.3 Demand side of integrated certificates systems

5.3.1 A demand side based classification of integrated certificates systemsThe key feature of a green certificate system is the separation of the supply of ‘physical elec-tricity’ from the ‘greenness’ that is produced along with the physical electricity by renewableelectricity generation equipment. Both markets may function separately, and both will need theirown demand. While the demand for the physical electricity does not differ much from custom-ary goods, the demand for tradable green certificates may originate from several sources andmay be organised in noteworthy ways. Options to create or reinforce the demand for TGC canbe either a tendering process aiming at buying the TGC (certificates can be taken out of themarket by a tendering procedure initiated by the government), or a voluntary demand (for in-stance, by green pricing or tax exemption that affects this ‘voluntary’ demand). But the relevantoption in the framework of this study is an obligation, introduced by the government, to acquirea certain number of certificates within a certain period. The next sections deal only with thiscase of enforcing demand for green certificates through an obligation.

A choice has to be made concerning the point in the supply chain where the obligation shouldbe put. In the Italian TGC system the producer and importer of electricity face an obligation(Intracert inception report, 2000). In some other national TGC systems the obligation is put onthe consumer or supplier. Two main differences are the possibility to administrate the systemand the impact on the competitive position of the obliged actor. Another question when design-ing the demand side of the market, is whether to oblige the actor to ‘redeem-for-obligation’ gen-eral certificates (any green certificates would be convenient) or specific certificates for everyenergy carrier (each specific obligation would need its own certificates). This question, forwhich the technical aspects have already been examined, will mainly be analysed here as to theeconomic impact of the market.

Deciding on the different obliged actorsWhich group of actors will be subject to the obligation? All obligation cases are assumed towork on the basis of a percentage of the conventional energy production supplied or consumedin the reference period. The obliged actor can be one of the following positions in the supplychain: the producer, the supplier, or the consumer (see Figure 5.2.)

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ProducersIn the Italian TGC system, which started in 2001, producers and importers of electricity face theobligation. In most other national TGC systems the obligation is put on the consumers or sup-pliers. A valuable consequence of putting the obligation on the producer is that the need totransfer certificates to other actors is reduced to a minimum, since certificates are awarded toproducers. One should bear in mind that an obligation on producers must always be supportedby additional actions, for instance an obligation on suppliers to purchase the production fromrenewable energy schemes or a priority dispatch for renewable energy. It should be noted thatthere often exists an obligation to the transport or distribution grid to integrate the production ofsmall renewable energy suppliers. Regional or federal authorities establish the price at whichthey have to purchase. A disadvantage of this option is that if producers in one country meetsuch an obligation, they will have a competitive (price) disadvantage with regard to other pro-ducers in neighbouring countries that do not have such an obligation.

SuppliersSuppliers seem to be the suitable actors to undergo the obligation mainly because they are usedto measure energy flows. This case is most applied or discussed currently. It should be said atthis stage, that the analysis will be continued without the cases based on the suppliers, because ithas been found that the results do not differ significantly from results obtained with obligationsplaced on the consumers.

ConsumersObliging the final consumers is, at least in theory, the best choice. There would be no interna-tional, competitive disadvantage compared to an obligation at a higher level in the supply chain(see for instance Schaeffer et al., 1999 and 2000). Final consumers might fulfil their obligationthemselves, which implies large bureaucracy and difficult controlling procedures. They mightalso use the possibility, offered to them by suppliers, to pass on the implementation of the obli-gation to their suppliers. Policy makers might point out this possibility explicitly to the industryand remove legal and regulatory barriers for this when they exist. Having the consumers subjectto the obligation fits well with the ‘polluter pays’ principle.

Deciding on the aggregation of the obligationShould the obligation be differentiated for energy carriers (i.e., classes of energy form electric-ity, gas and heat) or aggregated for all energy carriers? The issue is indirectly related to thepracticalities already discussed. For example, the choice for a general obligation does not neces-sarily mean that general unit certificates have to be issued. But then, it would imply that admin-istrative exchange is well organised between the specific certificates, since the obliged actorwould be free to fulfil a general obligation with a mix of green energy certificates. Accordingly,the choice for specific carrier obligations would imply the issuing of specific certificates. Whilegenerality of the obligation is usually implied in the economic analysis, as well as in the officialtargets, specificity corresponds more to the developed practice up to now.

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General obligation Specific obligations

Upstream: producers

Downstream: consumers

Generalobligation onconsumers

Generalobligation onproducers

Specificobligations onconsumers

Specficobligations onproducers

Figure 5.2 Categorisation of obligations in an integrated green energy certificate system

5.3.2 Economical and political trade-offsThis section will examine the trade-offs between many potential economic benefits and practicalbenefits as they appear due to the implementation of an obligation. Of course, it will mainly fo-cus on these aspects that may significantly change under the assumption of one or other form ofintegration for the TGC system.

Cost-effectiveness as an economic considerationThe particular relation between the aggregation of the obligation and cost-effectiveness is quiteobvious. Suppose that every obliged actor of a specific energy carrier was asked to show a cer-tain percentage of green production, distribution or consumption. This would lead, dependingamong other things on who the obliged actor is, to an increase in the costs of compliance.

Assuming that the producer is the obliged actor, one accredited way to decrease the costs ofgreen energy generation is to allow the producers to buy certificates somewhere else where pro-duction and thus certificates are cheaper. This requires a minimum degree of ‘liquidity’ and of‘transparency’, in order to capitalise on cost differences between different producers of the sameenergy carrier.

One obvious way to increase the degrees (one for each specific TGC market) of liquidity is toallow exchange between the specific carriers obligations. This, in essence, means that the TGCsystem (with e.g. three TGC markets) is ‘reduced’ again to a general system. Due to the broaderexchange, one can then capitalise on an ever-greater variety of natural cost differences. Renew-able electricity developers and generators will have access to a wider market for TGC. Thishelps to give confidence to financial institutions and technology developers who rely on a long-term view in the market to reduce risk and therefore improve access to finance. Investmentcapital flows then to new renewables development in the most cost-effective locations out of arange of three energy carriers. To open the TGC market to all energy carriers should, theoreti-cally, balance out the prices of the different carrier certificates, and subsequently balance out, tosome extent, the prices of the different technologies. This is, in turn, expected to affect the in-vestments. However, with or without achievement of a level playing field, this will improvecost-effectiveness of compliance and encourage investments.

For actors further down the supply chain, like the suppliers or the consumers, outcomes are ex-pected to be rather similar even if they may appear with some lag. And this is in turn only thecase if improved competitiveness at the downstream level affects competitiveness at the up-stream level in the energy chain. As there is no certainty about the (pace of this) process, there isan inclination to select the producers as obliged actors.

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Consumers’ gain as a social considerationCost-effectiveness is also expected to increase acceptance by the obliged actors to fulfil theirobligations. A transparent and liquid TGC market is capable of bringing much greater choice toobliged actors, especially to obliged consumers and at the same time to voluntary green energyconsumers. This fits also the purpose of European energy market liberalisation, which is tobring greater choice and freedom and lower prices to European energy consumers.

This consumers’ gain is not merely an enumeration of costs for compliance to the obligation.Consumers might also call for more influence on the variety of renewable technologies. An ob-ligation that is articulated in a collection of specific obligations would fail to empower the TGCconsumers. However, an unconditionally aggregated obligation might reduce consumers’empowerment in the case they would not have all information about the renewable energysource. Thus, the obligation may be general, but the certificates should still indicate the sourceof the renewable energy.

While this examination seems to only point to the consumers’ gain, (increase in) empowering ofthe consumers will in turn impact other actors in the supply chain. Energy suppliers or distribu-tors would have to offer a variety of renewable energy sources and tariffs to customers. Subse-quently, the possibility to observe which specific type of energy consumers really prefer, wouldenable more accurate market segmentation and, in turn, a more effective selection of new in-vestments. This would increase the volume of the market for green power products because vol-untary demand increases. Such consumer empowerment is likely to be an important factor in thedevelopment of renewable energy markets in the coming years.

Potential ‘lock-in’ effects due to time-specific demand and free supplyThe aim of any obligation in a TGC system is to stimulate or enforce the demand for green cer-tificates by the obliged actor. While the obligation is set to enforce demand, there is no guaran-tee that demand and supply will match perfectly in the daily certificates market. Indeed, the de-mand obligation does not in itself impose a time restriction on the supply of green certificates.Thus, if green certificate suppliers are not forced to sell their certificates within a certain timelimit, the demand obligation combined with a strategic supply could force the TGC price to avery high level. In a TGC system that would merely interfere at the demand side of the market,demand ‘lock-in’ may occur. This delivers arguments for penalties and price caps on TGC (andpenalties to ‘opt out’ of the system) and/or legislation that prevent co-ordinated supply. There isan additional risk for lock-in at the demand side if consumers are asked to cope with three in-stead of one obligation. In theory, specific obligation can lead to excessive trade in the ‘other’carriers. The long-term argument that the three markets will adapt up to the point different cer-tificates reached a common price, can not easily be hold. The necessary switch mechanisms, bywhich consumers would substitute their carriers to reduce their (certificate) costs and/or bywhich producers move to carriers with a higher price, would be drastic.

Adaptation of the existing framework conditionsAny chosen TGC system will have to be implemented within an already existing situation. It iseasy to show that this implies new trade-offs between the implementation costs and the ex-pected advantages compared to the old situation. There is a necessity to switch from the existingframework to that of the TGC system with a general obligation, or to that of the TGC systemwith a specific obligation. Some of the existing situations may look, at first sight, quite distinctfrom the TGC system, such as that of a feed-in tariffs system. Since most of the feed-in tariffsystems recognise actual differences in costs between the different technologies, tariffs vary ac-cordingly. Adaptation to a TGC system means also adaptation to a different appreciation struc-ture. Investment in any renewable technology will receive another amount, which is the price ofthe green certificates on the market.

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The character of the obligation will affect the character of the demand on the market. Note oncemore that it is not the same as a demand for different specific technologies. In the case of gener-ality of the obligation, the effect on the energy structure due to the implementation of the TGCsystem is the greatest because of the inherent equal appreciation of all renewable investments.This tends to lower the earnings from the more expensive technologies; therefore, their specificmarkets will tend to shrink. In the case of specificity of the obligation, energy structures will beless affected because the possibility of three specific demands for three specific carriers reducesthe potential uniformity of the appreciation of the renewable investments. Note, however, thatthe inclination toward uniformity remains at least within each carrier: this is a group where alltechnologies, and thus all associated investments, receive the same earnings, which is the priceof the specific TGC on that part of the market.

In a large international TGC market, there are at least two opportunities for each renewabletechnology/carrier to improve its earnings. The first one is linked to cost-effectiveness due tothe greater choice for a (better) location of the new investments. The second one is indirectlylinked to consumers’ gain due to the greater differentiation in the (obliged and voluntary) de-mand for green certificates. However, to extend a TGC system to an international system, i.e. toallow cross-border trade in TGC is more complex. Certificate units and conversions betweenunits are relatively easy issues to decide upon in a national context. But internationalisation re-quires the policy makers in each country to go through a lengthy process of agreements, whichoften means a process of concessions too.

When a TGC system is already implemented, adaptation of the current, national system will im-ply some reaction of the renewable energy market and some reworking of the industry structure.For instance, current TGC systems that are electricity-only work de facto with an electricity ob-ligation. In this case, both the certification and the obligation are specific. To extend the systemto biogas and green heat as well then affects the whole energy system. The extent will dependon whether it is either a general obligation/demand system or a specific one. In turn, extendingthe system across borders might lessen the disadvantages of specificity of the obligation, mainlydue to the larger size of the three specific markets.

Conformity with the policy targetsAn important issue for the policy makers who establish renewable policy targets is to knowwhether new renewable production really will be added, conform to the targets. Then, the firstissue is to chart the difference, if any, between short- and long-term cost-effectiveness. Obvi-ously, governments essentially need the confidence of investors willing to start new generationof renewable energy. Evidently, investors look at the risk of generating green certificates thatwould not be sold on the TGC market. Therefore, two related questions are whether the behav-iour of the investors changes with the position of the obliged actor in the supply chain andwhether it changes with the degree of aggregation of the obligation.

In the short run, those producers who can provide TGC at the lowest price will be able to sell.As the revenues from sales determine the ‘returns to investments’ for the producers, they alsodetermine which mix of investments will be carried out. With (too) low supply in the TGC mar-ket, the price of the TGC may be high, which may be an incentive for producers to provide vari-ous renewable sources instead of only the cheapest technology. However, in a competitive TGCmarket, prices are low and governments have no guarantee about the mix of technologies. Thiscan be an issue for some governments with well-defined preferences. This issue relates to thelong-term costs of compliance, which typically should concern governments and the EU. Thereis expectedly a trade-off between the short-term cost-effectiveness (when the cheapest solutionsare chosen) and the long-term cost-effectiveness (when, in a dynamic way, some other solutionmay appear preferable).

A loss of ‘control’ on the mix of energy carriers by policy makers is expected in the case of ageneral obligation system. However, as they nonetheless have influence on the mix of technolo-

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gies to bring specified energy outputs, the situation is not really altered. Furthermore, evenwhen it is worth noting how the mix of technologies is various, it is impossible to state that anarrow range would be farther from long-term cost-effectiveness than a broader range. Indeed,there is no knowledge here about which (mix of) technologies happen to come close to the bestsituation in the future.

5.3.3 Inferences on demand side considerationsStrictly economical considerations (cost-effectiveness) have appeared a plea for the implemen-tation of a general obligation. This may happen in principle at any level of the supply chain, butwith less confidence at the level of the producers in the supply chain, as they may fail to incor-porate the preference of the consumers of green energy. Moreover, the obliged actor may nicelyco-operate when he feels free to fulfil his obligation with the mix of energy carriers he prefers.Therefore, the obligation may be general, but the certificates should still indicate the source ofthe renewable energy. Consumers’ empowerment may be an important goal to aim at when de-signing the TGC system.

Cost-effectiveness can be achieved mostly through size and liquidity in the TGC market. When-ever one of both is lacking, the other may compensate. For example, the need for additionalflexibility to achieve the economical benefits of a TGC market, is more pronounced in the caseof a specific obligation due to the reduced size of the market. This insufficiency may be re-moved by incorporating counteracting instruments that compensate for part of the shortage ofcost-effectiveness. Flexibility measures such as banking and borrowing may indeed increasecost-effectiveness of a TGC system. Banking causes the specific obligation to become moregeneral, at least with regard to ‘timing’. Furthermore, allowing ‘borrowing’ will endow theobliged actor with flexibility. Banking and borrowing, which are expected to reduce the price ofthe certificates and to help stabilise the TGC market, seem more compulsory when the obliga-tion is specific. This is mainly because the probability of friction between supply and demand isbigger in each specific TGC market, compared to a system with a general obligation. However,simplicity is reduced by the introduction of additional instruments. If the TGC market becomestoo complex, then one TGC system with a general obligation should be preferred.

Liquidity and transparency of a TGC market are also expected to improve the acceptance of theobliged actors to fulfil their obligations. Governments need upright co-operation from the partof the obliged actors. Therefore, governments will have to make up what the actors really prize:flexibility, simplicity, etc. Different actors may also define these features differently. If the as-sumption holds for a particular group of actors that they cherish most flexibility and low prices,acceptance will be greater with a general than a specific obligation system. An important under-standing is that integrating specific obligations (green electricity, green gas and green heat) inone obligation (or alternatively, allowing exchange of separate certificates) will increase theflexibility of reaching the obligation, and possibly the co-operation of the obliged actors. Thisholds also the other way around. Enlargement in cost-effectiveness and consumers’ gain signi-fies that the burden that the renewable energy target should depict, may be reconsidered. Forexample, increased cost-effectiveness may, other things being equal, carry on a more severe ob-ligation (possibly in the form of a higher percentage). Just as well, increased consumers’ gainmay signify that a higher obligation can be thought of.

As an all-embracing trade-off should not merely be considered for its social-economic dimen-sion as above, the required adaptations of the existing systems should also be considered. Whilegenerality of the obligation is considered more often in the economic analysis, as well as in theofficial targets, specificity corresponds more often with the developed practice up to now. Andthis has much to do with some practicalities. Unlike the case of a general obligation, when pol-icy makers have no control on the preferred mix of green electricity, green gas and green heat,specific obligations for each energy carrier empowers the government that would want a par-ticular distribution. This can even been realised when at the EU level, for instance, a general

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obligation is put, but the Member States still wish to deviate from this general obligation and,instead, choose for another subdivision of the general target. This would fit the European prin-ciple of subsidiarity. Central rules for certificates trade should be kept to a minimum set of crite-ria and principles, in order to respect subsidiarity and give maximum independence to MemberStates.

5.4 ConclusionIn this chapter central question is how green certificates for renewable (or green) heat and bio-gas could be in accordance with the more common notion of certificates for renewable electric-ity. The focus is on the aspects that would change because of integration of different green cer-tificates into one system. It is assumed that the choice for integrating green heat and biogas inthe TGC system has already been made. The main apparent issues analysed are:• certificates units, exchange and conversion,• general certificates (one type of certificate for all energy carriers) versus specific certificates

(each energy carrier has its own certificate),• production-based versus grid-based issuing of certificates,• general obligation versus specific obligations, and the related market volumes.

A well working tradable green certificates system should facilitate trade in certificates becauseit is trade in the ‘added environmental value’ of renewable energy generation, which is also inharmony with a liberalising energy sector. The topic ‘integration’ in relation to the TGC instru-ment may be divided in two main aspirations: integration of various green certificates in onesystem, and integration of various national systems.

As to the first aspiration, a good TGC system should enable as much as possible all forms of re-newable energy generation to participate in the TGC system. It should also improve acceptabil-ity by simplifying the way a TGC market can offer certificates tailored to the needs of differentmarket actors. Once this is established, then one can work out some mainly practical recom-mendations, and this will be done in the form a list of issues that have to be tacked when de-signing the TGC system. The next sections give the recommendations regarding the integrationof various renewable energy forms into a certificate system that follow from our analysis. As tothe second aspiration, note that few countries have anticipated the internationalisation of TGCin the design of their national systems, and even the information content of the certificate differsfrom one country to another. The final section will give some reflection on this issue.

Include all renewable energies into the certificate systemThe discussion on TGC mainly focuses on this new instrument as a stimulus for the penetrationof electricity produced from renewable sources. However, the White Paper on renewable energyof the European Commission (CEC, 1997) envisaged that in order to meet the target of 12% en-ergy from renewable sources in 2010, it will also be necessary to deploy renewable technologiesbased on gas and heat. Although the RES-E Directive only focuses on electricity, the envisageddirective on biofuels (EC, 2001c) indicates the importance of other renewable energy carriers.Under these conditions it would be sensible to expand the TGC system to all energy carriers inthe energy mix, in particular green heat and biogas. In fact, governments of some EU MemberStates are about to introduce green certificates for green electricity, biogas and/or green heat(although details of these are still unavailable).

Use kWh as the certificate unitThe use of kWh seems to be already international standard practice. The use of other units suchas ‘avoided GJ’ or CO2 brings tricky issues of ‘assumed displacements’ and ‘baselines’. ThekWh is an unambiguous unit for the production of electricity and in some countries also for gas,while the volume of green heat and green gas will be very small compared with the volume ofgreen electricity. Therefore m3 or GJ seem less appropriate. Primary GJ, another candidate unit,

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may overestimate or underestimate the production of renewable energy as it does not accountfor efficiency losses during conversion of renewable energy into useful electricity, heat or gas.No matter the outcome of these reflections, they can be viewed as ‘administrative conversion’for which clear but achievable agreements have to be made.

Use both ‘redemption-for-conversion’ and ‘redemption-for-obligation’Theoretically, delivered green certificates may contain all kinds of determined (even, predeter-mined) physical conversion factors so that it would be known (even beforehand) how much heatis represented by, for example, the original PV production (e.g. in kWh). There is, however, apractical problem to map all relevant information with the certificate. It does not seem sensibleto aim at recording all possible conversions.

‘Redemption-for-conversion’ means that existing certificates are exchanged for new certificatesand not handed over to fulfil an obligation. Therefore, some certificates are ‘eliminated’, e.g.when used as an input in an energy conversion process, and some others can be ‘created’, e.g.when the output of the energy conversion is certified. Note that only in the case of heat pumps,there are more green certificates created than eliminated. With efficiencies lower than 100%,part of the greenness will get ‘lost’, exactly as is the case with the physical energy. Thus, themost important benefit of using the early physical conversion (‘redemption-for-conversion’)method is that any particular efficiency of a plant used to convert energy is automatically ac-counted for.

Aim for production-based and general certificationWhen implementing a TGC system, it seems most practical to start with a national grid-basedsystem with specific certification for the different energy carriers or, as it often happens now, tostart with an electricity-only system. Gradually, some non-electricity options (possibly all cal-culated in kWh-equivalents in the first stage) can be added. Later on, non-grid options can beincluded. This may happen either before or after some internationalisation has occurred. Itmight be that specific certification enhances the process of harmonisation, as the number ofagreements (on the conversion factors and units) is reduced. Finally, the step to a harmonisedinternational, production-based system with general certification might be implemented, if thisappears a clear improvement of the TGC system.

The more complicated option of a production-based system with general certificates is more inline with general renewable energy and climate change policy. For practical reasons it might bereasonable to start relatively simple, e.g. renewable energy targets given in general energyterms, and to include the more complex issues gradually. However, it might also be the alterna-tive case that renewable energy and climate change policy grow toward more practically de-signed targets.

Put the obligation on the consumer and work on endorsementThe cost price effects of an obligation can be passed on to actors in the lower levels of the sup-ply chain. However, consumers cannot do this, even not when they contract suppliers to fulfiltheir obligation for them. The consumers will have to pay anyway for the greening of their con-sumption, which is in line with the ‘polluter pays’ principle. The alternative is to put the obliga-tion on the producers. The producers may fail to incorporate the preference of the consumers ofgreen energy for one or another energy carrier and/or technology. For long-term effectiveness ofthe TGC system, it is important to maximise its endorsement. This is achieved when the obligedactor is free to fulfil his obligation with the mix of energy carriers (and renewable technologies)he prefers. Note that, even in a system where the obligation is general, the certificates shouldstill indicate the source of the renewable energy. Potential buyers of certificates can decide,based on the information attached to the certificate and depending on the type of obligation theyhave (the obligation should specify which certificates are acceptable), which certificates to buy.

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Prevent TGC demand ‘lock-in’ by putting obligations in general energy termsWhen enforced by an obligation, the demand for green certificates is always time specific (evenwhen some banking or borrowing is allowed). However, this demand does not in itself impose atime restriction on the supply of green certificates. In general, if green certificate suppliers arenot forced to sell their certificates within a certain time limit, the demand obligation combinedwith a co-ordinated supply could force the TGC price to a very high level. If the demand is re-lated to a carrier-specific obligation, the discrepancy will even expand. Two obvious ways toprevent ‘lock-in’ at the demand side is to make the obligation less rigid, for example general in-stead of specific, and to limit the tradability of TGC in time.

Some considerations in an international contextThe application of the listed recommendations will largely depend on the inclination for acountry to work in an international TGC system. Some countries may prefer to start withoutwaiting until difficult, time demanding processes to achieve European harmonisation are fin-ished. Moreover, in the case a country just starts with its domestic system, it may indicatewhether it is willing to grow towards a harmonised system. From a domestic point of view, itdoes not make sense to indicate whether the electricity that is represented by the certificate hasreceived other kinds of support, like tax rebates or investment subsidies, since this is equal forall the renewable production installations. However, from an international perspective this kindof information can be essential. Either domestic certificates may only be accepted, or all certifi-cates, wherever they are produced, may be valid. If only domestically produced certificates arevalid, international trade in TGC is prevented. If foreign certificates are valid too, the possibilityto use foreign certificates to comply with a domestic obligation is depending on their availabil-ity on the market. The design of a fully harmonised system seems more complex due to the needto take into account national supply system characteristics and differing levels and modes ofsupport for renewable energy (which are sometimes indirect such as guaranteed grid access, fa-vourable planning conditions).

However, it may be the case that no full harmonisation of the institutional framework is neededto start a TGC system even at the level of EU-15. In this scenario, countries do not necessarilyhave to agree on what is traded. Countries may limit the import of TGC to what they judge ‘un-acceptable’, for instance excluding waste or large hydro, and allow other trade. It is howeverquestionable if this is allowed in an EU context. Moreover, countries may always reduce therisks of importing TGC that they would judge not suitable by increasing the quota that has to beperformed within their national borders (if they have any). Countries may also put some restric-tions on, for instance, support measures such as tax rebates or investment subsidies, but stillparticipate in certificate trade to some extent. These restrictions would then appear through thedetailed demand for green certificates, instead of generic demand. The TGC market would react(quickly if the detailed demand is large) to the disclosure of new, foreign preferences. Thesemixed situations of course would imply a decrease of the economic efficiency. However, it maybe helpful to get experience with international trading and make progress in TGC trade anyhow.It means that countries may choose for themselves to acknowledge each other’s certificates andtheir relative value. It is clear that for international trade to take place in the renewable energysector, some internationally agreed procedures for issuing certificates must be put in place inorder to ‘certify’ what is really produced. In a sense, this should merely be seen as a first steptoward full integration and harmonisation, toward a future in which all incentive measures, andmany other things, have been harmonised, in a bubble or at the EU-15 level. The main warningis that a national system should be designed together with its own transition period and method-ology developed for harmonising the national system with the proposed EU-15 system when itcomes that far.

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6. RECOMMENDATIONS

The policy recommendations following from the previous chapters and from the analysis in theInTraCert project are split into four main categories:1. experiences from comparable previous or on-going policy schemes,2. relevant issues for creating a tradable green certificate market,3. interactions with other policy instruments,4. a tradable green certificate market as an efficient instrument in achieving national GHG re-

duction targets.

In the following each of these categories will be treated separately.

6.1 Experiences from comparable previous or on-going policy schemesA number of countries have recently established or are in the transition phase of establishingtradable green certificate systems, among these can be mentioned the Netherlands, the UK,Australia, Italy, Belgium (Flanders), US, Sweden and Denmark. But almost no TGC-schemeshave been in operation long enough, so experiences with this kind of market are very limited.However, some interesting issues arise from their analysis:• An obligation by the government, on one or more actors (producers, suppliers and consum-

ers) in the energy supply/demand chain, to acquire a certain number of certificates within agiven period is the most plausible option, in the short and medium term, to promote TGCsystems.

• Transparency seems to be a very relevant attribute in green certificate systems. Providingcustomers with clear information about the energy they consume, and the effects it has ontheir environment, may provide enough knowledge as to increase voluntary demand for re-newable energy in the medium and long-run.

• Co-ordinated institutional adjustment (national and European) of the conventional powerproduction industry is needed to create a well-functioning TGC system.

With regard to emission trading a number of experiences do exist, especially from the US. Twoapproaches have been tried out: The ‘allowance’ and the ‘credit’ systems, where the main dif-ference is that in the credit-system only emission reductions above the reduction target can betraded, while all reductions can be traded in the allowance-system. Comparing these two sys-tems the following observations are made:• Allowance trading programs have proved to be superior to credit trading in terms of eco-

nomic and environmental efficiency.• Simplicity appears to be a key element when designing emission-trading systems and close

attention must be given to the effectiveness of reporting methods in terms of cost and reli-ability.

• Transaction costs seem to have played an important role in deploying trade of allowances.Credit trading has higher transaction costs, which may partly explain their poorer perform-ance.

6.2 Relevant issues for creating a tradable green certificate marketDesigning TGC markets have been the objective for previous projects and therefore only newaspects, brought up during the InTraCert project, will be reported here.

As mentioned above a number of countries are on the way to establish TGC markets. Thus al-though these countries have not chosen the same concept for establishing national green certifi-

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cate markets, nevertheless there seems to be a good starting point for establishing an interna-tional green certificate market. To create a cost-efficient TGC market the following observa-tions should be taken into account:• Although all the countries participating in the TGC market do not have to be part of the

same liberalised spot market for electricity, the prices of power should in general be at thesame level not to bias the price-determination at the TGC market.

• The most efficient TGC market will be established if there is a harmonisation of actionpoints between the TGC systems; that is, minimum prices and price caps should be keptwithin narrow ranges.

• Certification and validity of certificates should be harmonised between the participatingcountries. The certificates should include information on the renewable source, making itpossible for countries to exclude specific TGC without jeopardising the functioning of theoverall TGC system.

• Only the most efficient renewable technologies will be deployed by the TGC system. Thuscare should be taken to establish compatible support mechanisms to promote weaker renew-ables.

• MWh is recommended as the unit for the issued certificates. The MWh is an unambiguousunit for the production of electricity and the use of MWh seems already to be the interna-tional standard practice.

• To achieve the highest efficiency of the TGC system the obligation should be put on thelowest level of the supply chain that is on the consumer.

• To prevent ‘lock-in’ in the demand for green certificates the obligations should be stated ingeneral energy terms. If green certificate suppliers are not forced to sell their certificateswithin a certain time limit, the demand obligation combined with a co-ordinated supplycould force the TGC price to a very high level. Two obvious ways to prevent ‘lock-in’ at thedemand side is to make the obligation less rigid, for example general instead of specific, andto limit the tradability of TGC in time.

When implementing a TGC system, it seems most easy (practical) to start with a national grid-based system with specific certification for the different energy carriers or, as it often happensnow, to start with an electricity-only system. Gradually, some non-electricity options can beadded. Later on, non-grid options can be included as well. This may happen either before or af-ter some internationalisation has occurred. In the longer term it is recommended that:• All renewable sources are included into an integrated certificate system, that is not only re-

newable electricity generation, but also gas and heat based on renewable sources.• When non-electricity options are included in the TGC system a problem of conversion

arises, e.g. using green gas to produce green power. Therefore it is recommended that bothconcepts of ‘redemption-for-conversion’ and ‘redemption-for-obligation’ are used in theTGC system. ‘Redemption-for-conversion’ means that existing certificates are exchangedfor new certificates and not handed over to fulfil an obligation. Therefore, some certificatesare ‘eliminated’, e.g. when used as an input in an energy conversion process, and some oth-ers can be ‘created’, e.g. when the output of the energy conversion is certified.

In the long term the aim should be to establish an international, production-based system withgeneral certification. Though this system should only be implemented, if it appears a clear im-provement of the TGC system.

6.3 Interactions with other policy instrumentsThe InTraCert project has concentrated on analysing the interactions between TGC and tradableemission permits, but also interactions with the liberalised physical power market and withother Kyoto mechanisms have been treated.• If policies are in place that level out marginal CO2 abatement costs across the EU (a com-

mon tradable emission permit scheme based on the bidding concept), and the liberalisation

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process is finalised, the pricing of the commodity of green power can be left to the differentmarket places. Separate market prices for TGC and emission permits will emerge.

• In the Kyoto process the methodologies of baseline, benchmarking, monitoring problemsand procedures have been analysed and discussed for Joint Implementation projects. Wesuggest to follow the baseline definition that will eventually be agreed upon in the Kyotoprocess, and to harmonise the certification criteria and requirements for TGC and JI proj-ects.

• As long as no EU-wide CO2 emissions accounting regime is in place and the level of elec-tricity market liberalisation differs across the EU, significant distortions might appear on theTGC markets. Thus, if the reference price of power is not the same in all EU countries theTGC system does not secure that renewable sources are developed in the most cost-efficientmanner.

6.4 A tradable green certificate market as an efficient instrument in achievingnational GHG reduction targets

Basically no CO2 credits are attached to the tradable green certificates and therefore the devel-opment of renewables will add to GHG reductions only where a fossil fuel-fired production issubstituted. International trade in certificates will only help ensuring that the targets for devel-oping renewable energy technologies are reached in the most cost-efficient way.

If an international TGC system is introduced separately into a liberalised power market context,those countries most ambitious in renewable target setting by increasing their TGC-quotas willonly partly be gaining the CO2 reduction benefits themselves. How much they gain will totallybe determined by the marginal conditions at the power spot markets and the emission-coefficients of the domestically replaced power. Moreover, to fulfil their TGC-quotas the mostambitious countries will have to buy certificates from the less ambitious countries, although thisonly contributes in fulfilling a national target for renewable development, not in reaching theirnational CO2 reduction targets. Therefore:• If one of the major objectives of introducing an international TGC system is to achieve na-

tional CO2 reductions, then a separate introduction of a green certificate system into an in-ternational liberalised electricity market can not be recommended.

Two remedies exist to improve the GHG reduction performance of a green certificate marketcombined with a liberalised power market: 1) Introducing an international market for tradableemission permits (TEP) for the power industry. 2) Adding CO2 credits to the green certificates.Introducing an international market for tradable emission permits for the power industry is aninteresting possibility that, given certain conditions, goes well with an international TGC mar-ket:• In terms of achieving a national GHG reduction target, an optimal utilisation of the TGC-

regulated renewable production will only take place if a co-ordinated adjustment of theTEP-regulated conventional power production is undertaken. An increase in the nationalTGC quota has to be matched with a corresponding decrease in the national quota of trad-able emission permits to fully utilise the renewable production in a national GHG reductionstrategy.

• Finally, it is important that the price of a green certificate in international trade reflects thevalue of the product. If the value does not correspond to the price this will bias the incen-tives for international trade in certificates. By using a tradable permit system based on thebidding (auction) procedure the costs of CO2 reduction will be fully reflected in the spotmarket price of electricity and therefore international trade in green certificates will beequivalent to a domestic development of renewables.

The second possibility to get a well-functioning TGC market in a liberalised power marketcontext is to add CO2 credits to the green certificates. This option is possible, but to state the

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correct volume of avoided emissions is difficult due to the complexity of the internationalpower market without entering the Joint Implementation concept. Moreover:• If CO2 credits are added to the green certificates care should be taken to avoid double

counting of emission reductions. CO2 credits attached to TGC will have to fit within a TEPsystem when, in parallel with the certificate system, a separate tradable permits market ex-ist, because in the TEP approach the cost of CO2 reduction will be included in the spot mar-ket price of electricity.

Thus, although there may be large economic and environmental benefits related to creating aninternational TGC market, great care should be taken in setting up this market, especially in re-lation to the physical power market and a tradable permits market, if these benefits should bereaped.

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REFERENCES

EC (2001a): Directive 2001/77/EC on the promotion of electricity produced from renewableenergy sources in the internal electricity market. Brussels, Belgium, September 2001.

EC (2001b): Proposal for a Directive on establishing a framework for greenhouse gasemissions trading within the European Community. COM (2001)581, Brussels,Belgium, October 2001.

EC (2001c): Proposal for a Directive on the promotion of the use of biofuels for transport.COM (2001)547, Brussels, Belgium, November 2001.

Morthorst, P.E. (2001): Interactions of a tradable green certificate market with a tradablepermits market. Energy Policy 29 (2001) 345-353.

Schaeffer, G.J., M.G. Boots, T. Anderson, C. Mitchell, C. Timpe and M. Cames (2000): Optionsfor design of tradable green certificate systems. ECN-C--00-032. ECN, theNetherlands.

Schaeffer, G.J., M.G. Boots, T. Anderson, C. Mitchell, C. Timpe and M. Cames (1999): Theimplications of tradable green certificates for the deployment of renewable electricity.ECN-C--99-072. ECN, the Netherlands.

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ABBREVIATIONS

AAU Assigned Amount Unit(s)CCL Climate Change LevyCDM Clean Development MechanismCER Certified Emission Reduction(s)CET Carbon Emissions TradingCO2 Carbon DioxideEC European CommissionEPA Environmental Protection AgencyERU Emission Reduction Unit(s)EU European UnionGHG Greenhouse GasesJI Joint ImplementationLEC Levy Exemption CertificatePAA Part of Assigned Amount(s)RECS Renewable Energy Certificate SystemsRES-E Electricity supply from renewable energy sourcesROC Renewable Obligation CertificateTEP Tradable Emission Permit(s)TGC Tradable Green Certificate(s)UK United KingdomUS United States

The interaction of tradable instruments in renewable energy and climate change markets

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