NEWS STORY
30 September, 2004
Enviros Consulting paper highlights emissions could rise under the EU ETS
On the 1st January 2005, for the first time in history, industrial carbon dioxide (CO2) emissions will come under regulation through the introduction of the EU Emissions Trading Scheme (EU ETS). A new briefing paper published by Enviros Consulting sheds light on the effectiveness of the scheme in reducing emissions in Europe and the implications for affected businesses.
On the basis of the allowances allocated to existing facilities covered by the EU ETS, we forecast that European industry will be allowed to increase annual CO2 emissions by 5% during the first phase of the scheme (2005 to 2007) relative to their emissions in 2000. Additional allowances will also be available through reserves set aside for the construction of new plants. If all these reserve allowances are issued then emissions would be permitted to increase by an additional 6%. In total, the first phase of the scheme could therefore allow emissions to increase by up to 11% relative to 2000 levels. These increases are in stark contrast to the commitments of European Member States under the Kyoto Protocol which require a collective reduction in emissions across all EU 15 countries of 8% by 2010 from 1990 levels.
Our modelling suggests that business as usual industrial CO2 emissions will increase by around 7% between 2000 to 2006, representing an average shortfall against the basic allocation of 2%, or 65mtCO2 per year (note that this net balance figure is sensitive to assumptions about economic growth rates, as yet undeclared national allocations and future fuel prices). This shortfall would stimulate a moderate degree of market activity and, based on our analysis, would see prices settle in the region of 5/tonne. If however the growth in emissions is generated from new build plants this shortfall could be met entirely from reserve allowances. This would result in a significant reduction in market activity and even lower allowance prices.
Low allowance prices in the first phase of the scheme will provide little incentive to make investments in the technologies that will be necessary to meet national commitments under the Kyoto Protocol. Even if allowances are tightened in Phase II of the scheme (2008-2012) and allowance prices rise significantly, we doubt that even this will provide the stimulus necessary for businesses to make the required investments. This is principally due to the long asset lives of most capital assets in the energy sector (up to 30 years) compared to the relatively short period over which the EU ETS incentives will exist, and the perceived risks associated with tradable environmental instruments. Experience in the UK renewable sector, for example, shows that banks rarely give any weighting to the revenue from the sale of ROCs (Renewables Obligation Certificates) in their lending calculations for renewable energy projects.
Looking to Phase II of the scheme, assuming that countries will attempt to achieve their Kyoto targets then allocations will have to become much tighter. This has the potential to significantly increase allowance prices over the period 2008 2012 as the demand for credits starts to exceed the supply of low cost credits. Low cost credits can come from two principal sources: load factor switching in the power sector (turning up gas fired plants and turning down coal fired plants) and overseas projects (through the Kyoto Protocols Clean Development Mechanism and Joint Implementation instruments). Load factor switching has a finite limit, based on the installed gas fired generating capacity. CDM and JI, although in theory offer an infinite supply, the complex and time consuming administrative processes required to bring them to market has to date severely limited this source of supply. A number of other factors will have important influences on future allowance prices, in particular rules on banking and borrowing, but our base case analysis suggests that prices could potentially reach over 50t/CO2 in the latter half of Phase II, if no new capital investment is made a plausible scenario.
The somewhat ironic outcome therefore is that even with high allowance prices in Phase II, we do not predict that this will lead to material reductions in emissions across Europe. For this to happen, policy commitments to reducing CO2 need to be backed up with clear and unchanging legislation that sets out reduction targets for at least 15 years. This will allow a stable forward market to exist and against which investments in low carbon technologies can be financed.
These projections have been developed by Enviros Consulting using the Enviros EU Carbon Balances Model. Details about the EU Carbon Balances Model along with additional analysis and commentary are available in the full Executive Briefing, for a copy please contact Guy Turner or Charlie Donovan.
