Wake up! Reforming the EU Emission Trading Scheme (ETS): - - PowerPoint PPT Presentation

E N E R G Y

Wake up! Reforming the EU Emission Trading Scheme (ETS): Comparative evaluation of the different options

Launch event presentation

08/11/2016

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Table of Contents

2

I. Context, objectives and key messages of the study 2 II. Key issues with the current EC proposal for EU ETS reform 9 III. Fixing the EU ETS: Possible approaches for reform 15 IV. Conclusions and policy recommendations 22 V. Appendix 25

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• I. Context, objectives and key messages of the study

E N E R G Y

Strategy Policy and Regulation M&A and Due Diligence Competition Economics & State Aid Disputes (economical, commercial and technical)

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Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

E N E R G Y

A series of economic and political factors have led to a significant surplus of ETS allowances which requires urgent and decisive action

5

Source: http://www.eea.europa.eu/data-and-maps/data/data-viewers/emissions-trading-viewer

The EU established a pioneering CO2 Emissions Trading Scheme (ETS) in 2003 as the cornerstone of its climate change strategy Yet a series of economic and political factors have led to an imbalance of supply and demand and depressed carbon prices This risks increasing the costs of mitigating climate change as the ETS does not support investment in clean technologies The mere existence of the ETS is threatened as another decade of low prices would likely undermine its credibility and lead to the implementation of national policies

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

EU ETS emissions (stationary installations), 2005 – 2015

E N E R G Y

ETS reform options are currently discussed

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A current window of opportunity to reform the EU ETS, but closing in a few months

 Ongoing codecision process in Parliament and Council following proposal from Commission  Urgent action required before ETS loses credibility and national policies get implemented

Proposal from the Commission being discussed, supporting 3 structural reforms

 An increase in the speed of decline of the annual emissions cap from -1.74%/year to -2.20%/year  A Market Stability Reserve (MSR) which could park annually 12% of the surplus allowances accumulated in the previous years(i)  An enhanced carbon leakage framework to preserve the competitiveness of the European industry

Changed context since Commission tabled proposals

 Paris climate Agreement committing EU to pursue efforts towards a more ambitious +1.5°C target  Spread of uncoordinated Member States interventions to decarbonise their national electricity sector, displacing the EU ETS as the central tool to decarbonise the EU ETS sectors

2015- 2017

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives (i) MSR enacted through an EU decision – Not part of Directive revision

Context of the study

E N E R G Y

This study aims at assessing the impact of potential ETS reform

• ptions, and their effect on the power sector

7

Objectives of the study

 Identify the different underlying issues with the EU ETS  Use proprietary model of the ETS market to evaluate the impact of the EC’s proposed reform  Identify and model the impact of alternative approaches for ETS reform  Use proprietary power sector model to evaluate impact of the different options for ETS reform on the power sector

Study committee members

 Provide fact-based evidence by modelling the impact of different approaches for ETS reform  Derive policy recommendations and disseminate the study results with key stakeholders

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

E N E R G Y

Our impact assessment is based on an in-house ETS and EU power market model calibrated based on a robust set of assumptions

8

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives Note: The EU ETS modelling approach is inspired from the ZEPHYR model developed by Raphaël Trotignon & Boris Solier (Paris Dauphine University, Chaire Economie du Climat : http://www.chaireeconomieduclimat.org)

Our baseline scenario is based on the recent EC Reference Scenario 2016, and our power sector model is based on the latest announcements from TSOs, regulators and market participants FTI-CL EU ETS model factors in the inter-temporality and anticipations from the different market participants actually observed in the ETS market (myopic agents with 3-5 years horizon)

E N E R G Y

II. Key issues with the current EC proposal for EU ETS reform

E N E R G Y

The reform needs to be more ambitious if it is to tackle the different ETS issues and rebuild the credibility of the ETS

Short-term Long-term

Emissions below target – largely driven by complimentary policies Not in line with the goal of limiting global warming to 2°C, and a fortiori, with the ambition of limiting it to 1.5°C Too low to provide efficient signal for carbon abatement via coal-gas switching, and driving lock-in of fossil plants Too low to drive investment in clean technologies leading to continuation of need for targeted support for specific technologies Vulnerability to market shocks and overlap with complimentary policies

 Overlapping low carbon policies achieve mandated abatement at a high cost and

displace ETS-driven efficient abatement

Emissions Prices



X X X X

10 1 3 2 4

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

CO2 Synthetic assessment of the issues identified for ETS reform

Policies

• verlap

Other low carbon policies: RES, EE, mandated plant closures, etc.

ETS market ETS robustness

E N E R G Y

ETS emissions, 2015 – 2040

The current emissions trajectory is not in line with the objective of limiting global warming to +2°C

11

The EU ETS proposal is not in line with the EU 2050 objective of 80%-95% emissions reduction to stay below 2°C… “In order to set the cap equal to this level [90% emissions reduction by 2050], the LRF in the ETS would need to further increase to -2.4% until 2050” (EC, Impact

Assement 2014)

… and a fortiori, with the ambition of limiting it to 1.5°C as suggested by the Paris agreement

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives Source: European Commission, ”Impact assessment 2014 - A policy framework for climate and energy in the period from 2020 up to 2030“, p. 105

CO2

1

E N E R G Y

The EU ETS carbon price level is too low to drive investment in clean technologies (RES, nuclear, etc.) and avoid investments in fossil fuels technologies

• Estimates of the social cost of

carbon(i) range from about 20-70€/t in 2020, and 40-110€/t in 2030

ETS prices do not support investment in clean technologies, supporting an inefficient decarbonisation path

12

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives Note: (i) It is the marginal global damage costs of carbon emissions for Europe. Estimated as the NPV of climate change impacts in the long-term of one additional tonne of carbon emitted today.

EU ETS carbon price (real 2015), 2015 – 2040

2

The EU ETS carbon price level is too low to provide a reliable short-term economic signal for switching to low carbon technology in the power sector(ii)

• It only reaches the CO2 coal / gas

breakeven price in the 2030s(ii)

(ii) Given the range of efficiencies of existing plants, the fuel switch would be triggered between a range of CO2 price. Source: Knopf (2013), “The EMF28 Study on Scenarios for Transforming the European Energy System”.

E N E R G Y

Carbon prices below 20€/tonne by 2020 and 25€/tonne by 2025 would drive lock-in

• f

emissions via (re)investment in 187 GW of fossil technologies over 2025-2040 (52 GW

• f coal and lignite power plants lifetime

expansions and 137 GW of gas new capacity). Low carbon price would maintain significant carbon emitting technologies in the mix: about 360 GW

• f fossil fuel plants still in operation in

2040.

The ETS baseline scenario leads to a significant long-term lock-in of fossil generation capacity

13

Carbon emitting technologies capacity outlook, 2015 – 2040

360 GW of fossil plants still in operation in 2040

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives Note: (i) Plants compliant with emissions standards could be extended ;(ii) We use plant-specific information on all coal & lignite plants, from Platts, national registers, LCP dataset, Transitional National Plan and operators announcements. In case of no data, assumption of a standard lifetime of 50 years coherent with Germany G7 Coal analysis (September 2015).

2/3

137 GW of new gas investments 52 GW of coal and lignite life expansion investments

E N E R G Y

CO2

EU and national overlapping policies prevent the EU ETS to provide an efficient and credible signal to decarbonise

14

Allowance cap reduction to neutralize impact of RES-E and EE policies, 2021 – 2030 A number of overlapping policies have / will likely reduce the demand for carbon allowances, and thus threaten the ETS balance and strength

• f the price signal:

EU energy efficiency and (marginally) RES policy IED and nationally driven coal phase-out plans Overlapping policies often achieve mandated emission reductions at a higher cost than ETS- driven abatement

• 148 Mt in 2030

(11% of cap)

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

4

E N E R G Y

• III. Fixing the EU ETS: Possible approaches for reform

E N E R G Y

We have identified six types of options for a more ambitious reform, which we have analysed and assessed

Setting a higher Linear Reduction Factor (LRF) consistent with COP21 targets (above 2.2%) Without rebasing With rebasing

Option types Central parameters

• 2.6%
• Rebasing in 2021 on

projected 2018-2020 emissions (LRF@2.2%)

• Green club of countries

cancelling allowances with budget of 0.007% GDP(i)

• Cap reduced by amount of

emissions equivalent to EE & RES measures

• 20-50€/t growing at

5%+inflation p.a.

• 24% outtake rate

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

Parameters range in policy debate

• 1.74% - 2.8%
• Rebasing on 2016-2018 or 2018-2020

emissions

• No / One-off / Continuous

cancellations

• No compensation
• Compensation of national measures
• Compensation of EU measures
• No measure / Floor only / Cap & floor
• Strong or moderate growth of

cap/floor

• 12% / 24%
• 12% + % on oversupply above 833Mt

Developing voluntary allowance cancellation Adjustments of overlapping policies to neutralize the effect of Energy Efficiency, Renewable policies, IED, etc. Introducing a price corridor Increasing the Market Stability Reserve

• uttake rate (above 12%)

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(i) Similar effort as Swedish government measure recently announced

ETS

E N E R G Y

Each option structurally improves the ETS, but no single option addresses all the issues

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Positive impacts of options vs. current package

+

+

+ + +

6 options to address issues Solutions

Reduction of cap Voluntary allowance cancellation Adjustment for

• verlapping policies

Price corridor Stronger Market Stability Reserve

Performance against issues

ETS

Depends on calibration +

Short Term

Impact on issues

Long Term Robustness/ policy overlap

+

+

+

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

Limited short-term impact, due to market players’ limited foresight and gradual impact of reform. Growing impact as the market is drying up post-2020. Limited impact due to budget constraint Limited short-term impact if implemented as a gradual reduction in cap, because of market players’ limited foresight . Long term impact depend on implementation. Supports short-term carbon prices. Long term impact depends on calibration, in any case strengthening credibility of ETS and its robustness to potential future shocks. Positive short-term impact as stronger MSR rebalances market faster. Limited impact as stronger MSR does not alter supply and demand balance in the long term.

+ Depends on implementation

E N E R G Y

A range of combinations of reform options could comprehensively address the different issues of the ETS

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Baseline - EC Reform

(Re)investment in 187 GW of fossil technologies over 2025- 2040 360 GW of fossil plants still in

• peration in 2040.

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

Positive short term impact Positive long term impact Cost effective decarbonization:

Supports investment in clean technologies, prevents lock-in and favours coal-gas switching

Depends on calibration of floor / ceiling Depends on calibration of floor / ceiling

ETS

ETS ETS

ETS

Depends on implementation Depends on implementation

E N E R G Y

The Higher LRF option has growing impact as the market is drying up post-2020 The Rebasing has a more moderate impact The Adjustment for

• verlapping

policies, Price corridor and Stronger MSR options have limited impact in the long term as those options do not materially alter supply and demand balance in the long run as compared to baseline The Volontary cancellation option has limited scale due to budget constraint

Only Higher LRF and Rebasing options lead to lower emissions in line with the EU long-term climate targets

19

Emissions under ETS

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

CO2

E N E R G Y

Rebasing, Price corridor and Stronger MSR options support short-term carbon prices for decarbonization

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EU ETS carbon price (real 2015) The Higher LRF and Adjustment for

• verlapping policies options do not

foster coal-gas switching and investment in clean technologies in the short run, due to market participants’ limited foresight and gradual impact of reform The Rebasing, Price corridor and Stronger MSR options support short- term carbon prices, favouring coal-gas switching and investment in clean technologies The Volontary cancellation option has limited scale due to budget constraint

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

E N E R G Y

Reform options lead to up to 86 B€ additional auction revenues, that could, in part, further support compensations for carbon leakage risk

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Net revenue from auctions, 2015 - 2040

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives Methodology: Cash flows are computed as the annual revenue derived from the auction of allowances. Net revenue is defined as the net present value of cash flows over 2015 – 2040. Cash flows are discounted using a -0.7% real interest rate. https://data.oecd.org/interest/long-term-interest-rates.htm

Budget opportunities to further compensate European industry for carbon leakage risk

An appropriate treatment of the carbon leakage risk to is an essential pre- requisite of any ambitious ETS reform

E N E R G Y

• IV. Conclusions and policy recommendations

E N E R G Y

Conclusion: Wake up! The ETS reform needs to be more ambitious to salvage the ETS

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1 2 3 The ETS needs reform urgently  Window of opportunity  Context change: Paris climate agreement marks increased ambition  Credibility of ETS at stake: vicious circle  Decarbonization driven by national regulations and financial support for some specific technologies The Commission’s proposed ETS reform needs to be more ambitious  Inefficient and costly pathway to decarbonisation  EU long term emissions goal in danger  Price signal insufficient to avoid fossil fuel technology lock-in in the power sector We modelled six alternative

• ptions for ETS reform and their

combinations  Options addressing either short term or long term issues, EU or national scope: no silver bullet  We identified six combinations

• f options which could form the

basis of an ambitious yet realistic ETS reform

2016

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

✘ ✘

ETS

Loss of credibility National measures Expensive decarbonization

CO2

LRF Rebasing Green Club Corridor MSR+

ETS

Other policies

E N E R G Y

Thank you for your attention

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Contact for questions: Fabien bien Roques ues Senior Vice President FTI - COMPASS LEXECON +33 1 53 05 36 29 froques es@co compass assle lexecon.com con.com

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E N E R G Y

• V. Appendix

E N E R G Y

Comparison of options – Detailed indicators

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Only Rebasing, Corridor and Stronger MSR have a strong price impact in the short run – preventing high carbon technology lock-in. Rebasing and Corridor have a strong long-term impact on price – reflecting social cost of carbon. Only Higher LRF and Rebasing have a significant impact on long-term power sectors emissions – meeting EU targets

• f 90% reduction by

2050.

EC Baseline Higher LRF Rebasing Voluntary cancellation Adjustem ent Corridor Stronger MSR

CO2 emissions (Mt CO2-eq)

(% reduction compared to baseline)

2020 1,636 1,619

(1%)

1,606

(2%)

1,636

(0%)

1,609

(2%)

1,524

(7%)

1,530

(6%)

2030 1,241 1,172

(6%)

1,173

(5%)

1,216

(2%)

1,127

(9%)

1,200

(3%)

1,109

(11%)

2040 846 738

(13%)

786

(7%)

847

(0%)

834

(1%)

846

(0%)

842

(0%)

Emissions price (€/tCO2) 2020 4.7 5.9 9.4 4.7 6.5 20.0 10.3 2030 30.4 34.2 34.9 31.7 37.0 31.0 33.5 2040 59.1 92.1 75.1 58.4 58.4 56.8 56.4 Auction revenues (bn€) 2021- 2030 227 244 256 235 248 247 254 2031- 2040 381 446 415 381 378 369 382

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives

E N E R G Y

Power market dispatch model We use a dispatch model of the CO2 EU ETS power markets. It is calibrated to reproduce historical power market prices and generation level. For each year, we optimise market participants operational and investment /retirement decisions based on their expected costs and revenues. Modelling features Our power market model is designed to model renewable generation. Hourly wind & solar profiles are derived from our in-house methodology that converts consolidated wind speeds / solar radiation into power output. Hydro generation is derived from hydro thermal co-optimization algorithm embedded at the heart of Plexos.

FTI-CL electricity sector model

Power market model – Modelling approach

27

■ Demand ■ Fuel prices ■ Hourly Renewable profile ■ Plant build / retirement ■ Operating costs / constraints

Inputs European Power Market Dispatch model

■ Wholesale power prices and spreads at different granularities ■ Capacity price ■ Emissions ■ Fuel Consumption ■ System costs ■ Imports & Exports ■ Asset valuation ■ Policy and regulation comparison

Outputs

Utility Strategic Decision Power Market Dispatch model Asset Profitability module

Hourly generation dispatch Optimization of operational constraints Co-optimization of hydro and thermal generation Energy revenue Ancillary Services revenue Capacity revenue NPV analysis for: New entrant Mothballing Retirement Conversion

■ Regulated generation ■ Energy policy ■ Regulatory development in spot markets

Regulation

Fixing the ETS Conclusion Appendix Issues with proposal Context & objectives