Institute for Sustainable Development and International Relations

41 rue du Four – 75006 Paris - France

www.iddri.org

Celine MARCY, IDDRI

Oliver Sartor (IDDRI)

Mathilde Mathieu (IDDRI)

Pablo del Rio Gonzalez (CSIC)

Sean Healy (Oeko Institut)

Verena Graichen (Oeko Institut)

Power market decarbonisation post-2020: what role for the EU ETS?

CEPS–Climate Strategies Event, Brussels, 17.09.2015

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Context (1/2)

• Increasing share of intermittent RES in the mix (Fig 1):• Disruptive for encumbents` business models

• Average costs of onshore wind and solar have fallen

• Questions about least cost integration and whether existing economic support framework is efficient.

• Carbon price is still too low to drive transformation of power sector (Fig 2).

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Context (2/2)

• Increasing emphasis on EU ETS as potential substitute for existing low carbon support mechanisms, e.g:

• Oct 2014 Council “EU ETS will be the main instrument to achieve [40% GHG] target”

• Energy Union F/W: “In line with the Environmental and Energy Aid Guidelines, renewable production needs to be supported through market-based schemes…”

• 2014 State Aid Guidelines: “…it is expected that in the period between 2020 and 2030 established renewable energy sources will become grid-competitive, implying that subsidies and exemptions from balancing responsibilities should be phased out in a degressive way. These Guidelines are consistent with that objective and will ensure the transition to a cost-effective delivery through market-based mechanisms.”

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Motivation of IDDRI / CS study

• We thus expect a lot of the ETS based on a limited evidence base:

• Efficient driver of fuel switching/some EE: yes

• Efficient driver of LC Investment: ???

• Is our faith in the cost-efficiency of the ETS for power market decarbonisation completely justified?

• If not, then what is the proper role of the EU ETS?

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Conventional view of ETS & mature LC technologies

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The high capex sensitivity of LC tech (1/4)

• The cost of capital of LC tech is much more decisive in the competitiveness of the investment.

• Capital costs depend on revenue risk.

• Revenue risk is high under existing power market design (limited forward contracting potential post-3 years)

• No natural hedge of fossil fuel costs.

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The high capex sensitivity of LC tech (2/4)

• CO2 price to make LC tech competitive depends on capital cost…

• But the capital cost depends on the type of support instrument!

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The high capex sensitivity of LC tech (3/4)

• Uncertain price premia above the market power price (like EU ETS carbon price) do not effectively mitigate revenue risk

• Thus, deployment costs tend to be higher than for FITs..

• Consistent finding throughout literature (IEA, 2011, Ragwitz 2007, Held 2010, etc)

FITs

TGCs

Source: Held, 2010

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The high capex sensitivity of LC tech (4/4)

• The conventional view therefore overlooks fact that the red line depends on type of support instrument.

• Use of ETS alone will tend to increase CO2 price needed all else equal. Thus not cost effective by itself.

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Impact of LC tech on market price formation

• « Grid parity » is a moving target.

• Exacerbates revenue risk for LC investors

• Marginal price of power includes CO2 price less often over time…

• Therefore, higher carbon price than CO2 externality cost needed to drive investment.

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Renewables integration requires coordination

• To cost-effectively deploy renewables we need to simultaneously:

• Develop market infrastructure

• Change market designs to coordinate adequacy, reliability, investment and sustainability more efficiently

• Develop and maintain reliable value chains for deployment

• Implies high degree of coordination in a limited timeframe.

• Suggests that managed rate of deployment of technology more efficient than an approach based on a carbon market price.

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Implications for policy

• The EU ETS is not the most cost-effective instrument for driving investments in mature low-carbon generation tech.

• There must be complementary policies to the ETS beyond 2020 to support low carbon investments.

• These policies should seek to hedge revenue risk.

• ETS cap should be adjusted accordingly.

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Relationship between ETS & other LC investment policies

• Complementary policies don’t necessrily need to be big subsidies over and above prices, but rather should provide price stabilisation of power price + CO2 externality cost.

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Decarbonising the residual thermal generation mix

• The carbon market demonstrated its capacity to drive fuel switching cost effectively

• Decarbonising the residual mix remains a massive challenge that will be difficult to do by direct regulation.

• CO2 market offers possibility for common incentives for all Member States within internal electricity market to move in a similar direction.

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Fuel switching potential at different carbon prices

• Enormous cost effective potential for fuel switching from coal to gas based on existing capacity alone with the right prices...

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But to do this the ETS needs to be calibrated correctly

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What defines a « mature » LC technology?

• The conventional view is based on the idea that a technology reaches maturity at some point.

• In practice technological maturity also depends on the maturity of the market environment in which it is deployed.

• Are one-size-fits-all approaches to the economics of deployment in all MS cost-efficient?