Climate change challenges & the search for a sustainable policy Unity of fitness for Purpose,...

Climate change challenges & the search for a

sustainable policyUnity of fitness for Purpose,

Polluter-pays principle & level Playing field

Sustainable policy ICCDU 20June05.PPT

Vianney SchynsManager Climate & Energy EfficiencyUtility Support GroupEnergy provider for DSM & SABIC

8th International Conference on Carbon Dioxide Utilization ICCDU-VIII20-23 June 2005Oslo, Norway

2

Contents

• History of a successful change– Imagine we live in 2030, and imagine we were successful

• Where we are today: Cap & Trade– Technology & policy challenges– Cap & trade: negative unity of basic principles

= Fitness for Purpose, Polluter-pays principle & level Playing field

• Alternative: Performance Standard Rate (PSR)– Policy objective: positive unity of basic principles– How it works

History of asuccessful change

How we might look back

in 2030

4

Political views beginning 21st century

• Climate change policies far from coherent– Kyoto protocol nations adopted absolute caps– USA & developing nations reluctant

• The riddle of absolute caps was questioned– Would acceptance of an absolute cap be responsible behaviour

for a developing nation?– What scientific method exists for establishing a cap?– What is the influence of actor decisions on climate change when

building a new installation in country A or B?

5

Shaping a carbon constrained economy

• Consensus: in a carbon constrained world sustainable progress needed in all fields e.g.– Energy efficiency– Carbon sequestration (capture & underground storage)– Biomass– Renewables– Nuclear (inherent safe & fusion)

• Needed was … and … and– No single solution (yet) to curb greenhouse gas emissions– Leaving coal & nuclear no realistic scenario

• Immense challenge: absolute lowering of emissions while maintaining growth of worldwide welfare

6

The world of our grandchildren

• Welfare growth: 50%• Energy efficiency improvement: 40%

– Buildings, installations, transportation

• Carbon sequestration: 30% – Capture technology breakthroughs, international CO2 pipelines, 2nd

lifetime of coal & lignite using immense reserves

• Biomass economy: 20% – New impulse to co-operation industrialised & industrialising nations

(sustainable plantations, concentrating technologies, use for electricity plants, industrial raw materials, transportation)

• Comeback of other renewables – Wind, solar, tidal

• Hydrogen – Upcoming energy carrier

• Greenhouse gas emissions: -35%

7

Drastic policy changes

• Innovation priority 1– Two drivers: emissions trading + support breakthrough technologies

• Kyoto targets adapted– Caps for nations abandoned; worldwide sector & product targets– First industry initiatives (Al, cement, steel, chemicals …) moving to

same requirements for similar plants in whatever nation

• One standard for electricity (kg CO2/MWh)

– Otherwise not to combine: carbon constraint, future for coal by carbon sequestration and (co-firing) biomass, adequate CHP reward

• Fundamental obstacles CDM tackled– Arbitrary baselines changed: harmonised standards (growing list)

8

Leading to concrete actions

For industrial actors• Inefficient plants improved or closed earlier; production

shift to efficient plants (new & existing)

• Development & implementation innovative technologies (reward front runners) & CHP (industrial heat use)

• Co-firing biomass & carbon sequestration

Where we are today:Cap & Trade

Technology challenges

Policy challenges

10

Technology challenges

• Large improvement potential of most processes– Exergy efficiency most often still 10%-20%– Innovative processes: much lower capital investment, but …

= Takes time, huge efforts & risk taking

• Intensified carbon capture technologies (clean coal) – Achieve € 20-25/ton CO2 for sequestration by 2015 or earlier

• Wind & solar need further development– Subsidy currently at € 100-150/ton CO2 if all investments included

(grid, back-up capacity); solar x 2-3 more expensive

11

Vision on process intensification

12

Example of (new) PI equipment

• Higee separators– Application example: separations & extractions

(carbon capture?)– Compact equipment, very short residence time

13

Policy challenges

• Still much scope for CHP (Combined Heat & Power)

– Double penetration desired (9% to 18% in 2010), but … allowances in Europe make no difference

• Acceleration need innovation (“clean, clever, competitive” approach adopted by EU Council) – Reward frontrunners with emission allowances & special support

• Mindset – Absolute caps for nations (now & post 2012)

= Is Luxembourg doing better than Spain?

– Absolute caps for companies (EU trading scheme)

14

Cap & trade: assumptions of the theory

• Scientific economic literature: advocates argue cap & trade superior to PSR (Performance Standard Rate)

• Cap & trade versus PSR would offer– Certainty of environmental outcome– Better or necessary for market liquidity– Significant lower transaction costs– Better or necessary for investments to reduce

emissions

• Postulation: assumptions are not based on facts

15

Cap & trade: the conventional picture

Emission

Production

Allowances under a cap

Claim: certainty of outcome

16

PSR: the conventional picture

Emission

Production

Allowances under a PSR

Claim: no certainty of outcome

17

Reality of combined picture: law of physics

Emission

Production

Allowances under a PSR

Allowances under a cap

Emission breaks through cap if production > forecast

18

Target setting

• Any target, via cap or PSR, must take account of– Lead time of investments to reduce emissions– Forecasted economic growth

• Cap & trade– Postulation: there is no scientific method for a justified

target as an ex-ante cap

19

Cap & trade & historical grandfathering

Specificenergy useor CO2 emission

Decreasing efficiency order of plants

Cap

Allowances unrelatedto abatement cost

Cap basedon historicalemissions

Market liquidity: great influence of economic growth & weather

20

Transaction costs: PSR versus cap & trade

• PSR– Netherlands applied about 100 PSRs: big step forward– Cost 1 PSR: € 25-40,000 (consultant + company efforts),

often shared (multiple producers); total € 2.5-4 mln– Allocation: 5 year period x ~ 100 Mton = 500 Mton

– Additional costs: ~ € 5mln/500 Mton ~ € 0.01/ton CO2

• Transaction costs: additional for PSR– Already low in one small country

– Note: Verification office 10 people (industry experience), also active for data collection & annual emission verification

21

Cap & trade & historical grandfathering

Emission

Emission at same production level

Cap trading period 1

Cap trading period 2 or 3

In the absence of thereduction project, thecompany had virtuallyretained cap 1

Project emission reduction

Production

Uncertainty of reward of projects to reduce emissionsLower emission will be in future reference period

22

Cap & trade: failure for carbon sequestration

Emission


Cap trading period 1

Cap trading period 2 (or 3) or immediately as new entrant

Project emission reduction

Failure of allocation rules in all Member States

23

Theory cap & trade: wrong assumptions

• Assumptions scientific literature of advocates of cap & trade not based on facts

• Cap & trade versus PSR does not offer– Certainty of environmental outcome– Better market liquidity– Significant lower transaction costs– Clear incentive for reduction investments

– On the contrary … lack of purpose, major failure of the theory

24

EC Treaty & EU Directive emissions trading

Requirements EC Treaty• Principle of equal treatment

– Between: incumbents, new entrants, incumbents & new entrants • Competition rules: free market

– Winners of market share not hindered (innovation)• Polluter-pays principle

– Largest scheme ever of environment to economy

Requirements EU Directive emissions trading• Environmental integrity

– Recital 3• To promote reductions & energy efficiency such as CHP

– Article 1 & recital 20

Current allocations rules: no compliance – Scheme was not allowed to be postponed – benefit of doubt

25

Policy challenge EU trading scheme

• Directive transposed as cap & trade– Polluter-earns principle: historical grandfathering (most)– Different rules in different Member States unlevel playing field

= Serious distortions by different reference periods, different C-factors

= Plants with same efficiency & production history: different allocations

– Limited incentive reduction investments: historic reference later – Disincentive closure & shift to efficient plants: punishment– No or limited incentive for high efficiency new plants – Major uncertainty for new plants: limited new entrant reserve,

first-come-first-serve

• Trading scheme lost track of purpose, lack of incentive

26

Distortions: Steamcracker current worldtop efficiency

80

80

160

240

Sales

Purchases in kton CO2/year

Covenant Benchmarking now

Netherlands

1st period

Expected2nd period

UK Germanynormal rule

Germany option rule !

France?Spain?

27

Distortions: Steamcracker average EU efficiency

80

80

160

240

Sales


Covenant BM now

Netherlands

1st period

Expected2nd period


Germany option rule ??

France?Spain?

28

Distortions: Steamcracker state-of-the-art efficiency

80

80

160

240

Sales


Covenant BM now

Netherlands

1st period

Expected2nd period


Germany option rule !

France?Spain?

Note: zero sales or purchasesas new entrantzero incentive

Maximisedfrom 113% to 110% worldtop

29

Steamcracker bad performer (scale change !)

150

150

300

450

Sales


Covenant BM now

Netherlands

1st periodExpected2nd period


Germany option rule ??

France?Spain?

Minimum allocation85% of benchmark

30

Electricity & opportunity-cost principle

• Fundamental problems cap & trade electricity

• Root cause: frozen caps give opportunity(-cost)

• Fuel-switch major driver CO2-price

31

1st substitution: influence on merit order

20

40

60

Short runmarginalcost€/MWh

100 300 500Installed capacity (GW)Source: IEA data

HydroWind

Nuclear

Coal & lignite

CCGTGasBoiler

OCGT

OilOpportunity-cost€ 3-6/MWh

1st substitution: Coal by Combined Cycle Gas TurbineLow price differential coal – gasCO2-price € 7/tonOpportunity-cost below long run marginal cost

Regional market prices

32

1nd substitution: influence on merit order

20

40

60



HydroWind

Nuclear

Coal & lignite

CCGTGasBoiler

OCGT

Oil

Opportunity-cost€ 9-19/MWh

1st substitution: Coal by Combined Cycle Gas Turbine Higher price differential coal – gasCO2-price € 21/tonOpportunity-cost at about long run marginal cost


33

1nd substitution: influence on merit order

20

40

60



HydroWind

Nuclear

Coal & lignite

CCGTGasBoiler

OCGT

Oil

Opportunity-cost€ 12-27/MWh

1st substitution: Coal by Combined Cycle Gas Turbine Even higher price differential coal – gasCO2-price € 30/tonOpportunity-cost above long run marginal cost


34

Findings electricity and cap & trade

• Fuel + opportunity-cost (F + O)– If market price < F + O: cut production & sell allowances– F + O serve as a cushion for electricity market price

– When CO2-price further rise, market price is pushed up

• Competition rules & caps: frozen market shares– Market share winner buys allowances, loser sells– Zero sum game– Violating competition rules: hindered free trade

• Windfall profits start at € 15-20/ton CO2

– Electricity one-sector winner of the scheme

35

Unity of basic principles under cap & trade

• Historical grandfathering without benchmark– No fitness for purpose– No polluter-pays principle– No level playing fieldUnity = 3 x no

• Fitness for purpose drivers

(1) Meaningful CO2-price

(2) Clear volume incentive (efficiency differentiation)

• Efficiency differentiation denies sunk cost – Sunk cost hinder unity of basic principles– Sunk cost can therefore only be accommodated temporarily

36

Emerging recognition of purpose problem

• Fitness for purpose– Reduction investments should never be regretted, but …

= Cap & trade: reduction becomes historical emission in future

• Problems with cap & trade– Quotes of advocates of cap & trade (!)

= “No sensible company undertakes reduction investments on the basis of current allocation methods”

– Peter Vis, EU Commission DG Environment= “Reference 2005 for allowances 2008-2012 would be perverse”= “Old reference should be taken, but this cannot go on for ever

… next step must be bold”

Alternative:Performance Standard Rate

Policy objective: effective trading scheme

How it works

38

Policy objective: decoupling emission & growth

Emission

Production growth

Business as usual

Energy efficiency

Biomass,carbon sequestration,technology breakthroughs

39

PSR: weather & growth secondary factors

Specificenergy useor CO2

emission


Weightedaverage

Sellers ofallowances

Buyers ofallowances

PSR

High abatementcost

Low abatementcost

Much better market liquidity: many buyers & sellers

40

PSR: incentive suited for purpose

Emission


AllowancesPSR year 1

AllowancesPSR year n

Key feature:project reward,independent of future PSR

Certainty of reward for reduction investments

Production

41

PSR: incentive suited for purpose

Emission


AllowancesPSR year 1

AllowancesPSR year n

Key feature:project reward,independent of future PSR

Successful reward of carbon sequestration

Example: clean coal plant

Production

42

Cornerstones of PSR

1. Start with major emitters: limited number of products2. PSR not timely available: each operator starts with own

efficiency; establish PSR after first year• Predictable business environment, operator knows efficiency will be

rewarded, PSR will emerge soon

3. PSR just below average: otherwise market unable to supply shortage of allowances

4. PSRs will gradually tighten: environmental purpose5. Banking & lending: market stability (5% - 7%)6. Recommendation independent “Climate Board”

similar as for monetary policy, making annual reviews, giving policy advice and adjusting when needed

• PSR • Banking & lending rate

43

Few PSRs: major coverage

100%

Coverageofemissionsunder thescheme

Electricity (1 PSR) incl. for CHP (Combined Heat& Power)

Steel (4-5 PSRs)

Cement (1 or few PSRs)

Refineries (1 PSR)

Major chemicals (10-20 PSRs)

Benchmarking inthe Netherlands:100 PSRs

44

Benchmark formula for PSR

• Benchmark data: population under the scheme– EU-25, future with Norway, Japan, South Korea, Canada, etc.

• PSR = WAE – CF x (WAE – BAT)– WAE = Weighted Average Efficiency– BAT = Best Available Technique (proven Best Practice)– CF = Compliance Factor, equal for all PSRs, reflecting equal efforts

between different types of installations

• Compliance Factor– 2008: CF = 3% (to create CO2 market price)

– 2012: possibly 15%-20%

45

PSR = WAE – CF x (WAE – BAT)

Specificenergy useor CO2

emission


Weightedaverage 1

PSR 1

BAT

Product 1steep curve

Product 2flat curve

Normalised curves

Weighted average 2

PSR 2

46

Transition regime to accommodate sunk cost

PSR:Specificenergy useor CO2

emission

2008 2010 2012 2015

PSR

PSR A

PSR B

Transition period

Starting efficiency installation A

Starting efficiency installation B

2017

Action to reduce emissions is rewarded immediately

47

Sunk cost alternative

• Burden Sharing Agreement and EU-wide PSR cause– Frictions for Member States with efficient industries– Frictions for companies in Member States with low efficient

industries

• Better alternative accommodating sunk cost– Reallocate part of EU development funds– Enables clear trading scheme

• Support for industrial renewal– Lisbon strategy– Global welfare

48

The way forward

• Consultants for data collection 2003 or 2004 – Electricity: emission & production incl. heat for CHP (6 months job)– Steel: similar

– Probably available: cement, refineries, steamcrackers, ammonia, etc. • Producers must accept: keep it simple

– No correction for secondary effects

• Major countries: not waiting but taking initiative – Germany, UK, Italy, France, Spain, Scandinavia, etc.+ Benelux with

benchmark experience (not wait for completeness, expand gradually)– Appoint high level “champions”, partly with industry experience, for

main products

49

Conclusion • Major transform of EU scheme required to avoid loss

of real progress for 7.5 years, compliance with:– Worldwide environmental integrity– Unity of Fitness for Purpose, Polluter-pays

principle, & level Playing field, three acid tests for a sustainable scheme when attracting new participants such as Norway, Canada, South Korea, Japan & later USA, China, India, etc.

– A predictable business environment, leading to clear stimulation of innovation, in full support for the Lisbon strategy in Europe as well as global welfare

Climate change challenges & the search for a sustainable policy Unity of fitness for Purpose,...

Documents

Transcript of Climate change challenges & the search for a sustainable policy Unity of fitness for Purpose,...