Transcript The Cambridge-MIT Institute Allocation of CO2 Emission Allowances Carnegie Mellon University October 2004 Karsten Neuhoff University of Cambridge In collaboration with Kim Keats, ICF Consulting, London. See also CMI working.

The
Cambridge-MIT
Institute
Allocation of CO2 Emission
Allowances
Carnegie Mellon University
October 2004
Karsten Neuhoff
University of Cambridge
In collaboration with Kim Keats, ICF Consulting, London.
See also CMI working paper 49 @ econ.cam.ac.uk/electricity
Outline
• CO2 emission reduction strategy
– Failure of voluntary commitments
– Effectiveness of price mechanism
– Separate environmental externalities from
technology policy (learning externalities)
• The European Emission Trading Scheme
• Impact of updating (conditional allowance allocation)
• Impact of free allowance allocation to new entrants
• Border tax adjustment to allow auction of allowances
and higher CO2 prices
2
European strategy to reduce CO2 emissions
• European Climate Change Program 2000
• Bonn/Marrakech/EU required delivery of
Kyoto targets
• After criticising US, policymakers had to show
action
• Failure of voluntary commitments in 1990
3
Instrument I: Industry self regulation
Example Germany
• CO2: 2000 industry promised 20 Mtones
reductions by 2005 –so far only increase
• Industry option to avoid renewables
legislation by achieving quota (1990)
• Education quotas at firm level
• Price stability with Euro introduction
• Self-regulation of energy sector
• Cigarette advertising/ product labelling
• Lacks sanctions: free riding in sector
failed
• BUT good to delay state intervention
4
Source: Kontraste.de, Axel Friedrich Umweltbundesamt
Development of Energy intensity from
1971 to 2000
Austria
Belgium
France
Germany
JPN
UK
USA
Mtoe/mld USD
0,5
0,4
0,3
0,2
0,1
0
1970
1980
1990
2000
Oil price spike in 1970’s increased energy efficiency far
more than climate debate of 1990’s.
Source: Miroslav Honzík, GDP is translated using PPP, Prices of 95
5
Instrument 2 … prices
The economy can change energy intensity
Cross-section relation between average energy intensity and average energy price 1993-99
1400
DEN
average energy price $/toe
1200
JPN
NOR
1000
AUT
ITA
800
LUX
SUI
Inertia?
SWE
600
UK
FIN
BEL
NZ
USA
400
HUN
TUR
KOR
MEX
SVK
CAN
POL
CZE
200
Best fit constant price elaticity of -1.0
(S.E. 0.14), R2 = 0.69 (Excl CEE)
0
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
average energy intensity (kg oil equivalent/$95 GDP)
Source: Nebwery 2003
0.90
1.00
6
Instruments CO2 price … increasing energy
costs
$/tCO2
Energy efficiency
measures
Allowance
price
t
7
Implied CO2 price varies widely between
sectors and countries
157 169
119 120 126
134 136
49 67 82 85 91 94 97 98 110
2010 Min.
2003 Min.
1993 Min.
UK
Germany
Denmark
Italy
France
Netherlands
Ireland
Finland
Spain
Belgium
Austria
Poland
Luxembourg
Greece
18 c/gln =
CO2 Price
E20/tonne
Sweden
180
160
140
120
100
80
60
40
20
0
US
taxation rate (cents/gallon)
Example: Diesel
Source: EU Commission (Stand 2002/Deutschland 2003); American Petroleum Institute 2004,
Energy Information Administration, 2004
8
And inertia / transaction costs need to be
addressed
• EU Commission Green Paper 2000:
technical potential for improved
energy efficiency of 40%
• EU Commission Green Paper:
“CCLA’s were far more
>18% potential for cost
likely to have taken action
effective improvements
to improve energy
efficiency …87% of CCLA
firms had taken action or
were planning to do so
compared with 42% of
non-CCLA firms”
Source: CBI/EEF review of CCL, October
2002
9
Instrument CO2 price … changing relative costs
$/tCO2
Renewables
Renewables without
technology support
for initial deployment
Allowance
price
t
CO2 pricing is unlikely to unlock new renewable technologies.
But reduces costs of strategic deployment programs.
10
Technology cost reductions with deployment
11
Technology Policy – separate from CO2 trading
• Renewable contribution
– Quotas EU commitment: 13.9% (97’) to 22%
(10’)
– Implemented using national policy
– So far only feed in delivered (DK, D, ES)
• Some renewable RDD programs
• Transport of energy / transport fuel
– H2, 2 bil.Euro in 6th framework/ in US $1.7 bil.
• Carbon Sequestration/nuclear perceived as
marginal
– Public concerns about leakage
Source: Directive 2001/77/EC , http://www.europa.eu.int/comm/energy/res/legislation/electricity_member_states_en.htm
12
Emission Trading Scheme and Kyoto
• ETS independent of Kyoto entering into force
• ETS set up to comply with Kyoto targets
• Russian signature (seems quite secure)
– Would start Kyoto
– Will Russia/Ukraine oversupply?
– CO2 allowance trade only at state level
– Review if member state import more than
6% of allowances.
– Limit imports to keep carbon price up
• US participation would increase carbon price
13
The ETS System: A Four Level Approach
EU MS 1...
Residential
Sector 1
…DE...
ET Sector
Sector X
Install. 1...
Sector n
…Install. X...
...EU MS n
Transport
Reserve
…Install. n
Cap defined by EU
Burden Sharing
Different cap options
(modeling, voluntary
agreements,
distance to target)
Different cap options
(Flat rate, sector
specific caps)
Different Allocation
options. Most likely:
common formula +
extra allocation
14
Ref: Matthes, Oeko Institute
Average cap and BAU emissions compared
to Kyoto commitment for 2006
Source: ECOFYS,
The BAU numbers are in most cases indicated in the National Allocation Plan. If BAU was not available in
NAP, but needed to be derived from other sources, this is indicated by using an open circle, instead of a
closed circle. If it was not possible to derive a BAU, no circle is given for that specific country.
15
Issues about the NAPs
• Incentive for countries to allocate more rights
– Value of rights for national industry/auction
– Impact on EU emission price -> cost of
inappropriate adjustment
• Objective of Commission to implement
mechanism on time (January 2005)
16
Allocation plans
• Political economy – buy in of companies
• SO2/NOx: In US – lump sum to incumbents.
• CO2: higher value + politicians equity concern
– Explicit updating
• NAPs defined till 2007, Kyoto till 2012
– Implicit updating regarding future allocation
• New Entrant provisions
– Regional competition or Coal support?
17
Empirical - Impact of CO2 allowances
A v e ra g e P rice
£ /M W h
P la n t M C
S yste m M C
M e rit O rd e r
CG
B
AG
G as
CC
B
AC
C oal
h /ye a r
18
Comparing marginal costs of coal and gasfired plant
T herm al efficiency (net H H V )
F uel p rice (£/M M B T u)
F uel co st (£/M W h)
V O M (£/M W h)
S R M C w ith o u t C O 2 (£ /M W h )
C O 2 em issio ns (tC O 2 /M W h)
A llo w ance p rice (£/tC O 2 )
A llo w ance co st (£/M W h)
S R M C w ith C O 2 (£ /M W h )
P u lv erised co a l p la n t
35%
1 .2 0
1 1 .7 0
4 .0 0
1 5 .7 0
930
6 .7 0
6 .2 0
2 1 .9 0
G a s-fired C C G T p la n t
50%
2 .3 0
1 5 .7 0
2 .0 0
1 7 .7 0
366
6 .7 0
2 .4 4
2 0 .1 3
19
Net cashflow impact with auctioned emission
rights
All figures in £/kWyr
(1) Energy sales revenue
(2) Fuel expense
(3) O&M expense
(4=1-2-3) Energy sales
margin
(5) Net purchases of CO2
allowances
(6=4-5) Operating margin
(7) Scarcity rent
(8=7+6) Total margin
Pulverised coal plant
BAU
€10/tCO2 Change
117.8
134.9
17.1
70.8
69.9
-0.9
33.1
33.1
0.0
Gas-fired CCGT plant
BAU
€10/tCO2 Change
131.1
164.5
33.4
95.9
106.8
11.0
21.7
21.7
0.0
13.8
31.9
18.1
13.5
35.9
22.4
0.0
33.1
33.1
0.0
17.5
17.5
13.8
13.7
27.5
-1.2
13.7
12.4
-15.1
0.0
-15.1
13.5
13.7
27.2
18.4
13.7
32.0
4.9
0.0
4.9
20
1 0 € /tC O 2
290
2 0 € /tC O 2
270
250
230
210
190
170
2 0 1 0 S ta tic
C O 2 /S O 2 /N O x
S O 2 /N O x
CO2
BAU
C O 2 /S O 2 /N O x
S O 2 /N O x
CO2
150
BAU
C O 2 e m is s io n s (M illio n to n n e s )
UK - change of CO2 emission with regulation
2 0 2 0 D yn a m ic
21
2 ,0 0 0
1 0 € /tC O 2
1 ,6 0 0
2 0 € /tC O 2
1 ,2 0 0
800
400
2 0 1 0 S ta tic
C O 2 /S O 2 /N O x
S O 2 /N O x
CO2
BAU
C O 2 /S O 2 /N O x
S O 2 /N O x
CO2
0
BAU
S O 2 e m is s io n s (k to n n e s )
UK - change of SO2 emission with regulation
2 0 2 0 D yn a m ic
22
UK - cost of implementing Carbon Constraint Static
S c a rc ity
F ixe d O & M
Tax
C O 2 a llo w a n c e s
E n e rg y
F u e l & V a ria b le
O&M
1 0 ,0 0 0
8 ,0 0 0
1385
240
230
6 ,0 0 0
220
4 ,0 0 0
C o n s u m e rs
G e n e ra to rs
G ra n d fa th e rin g
A u c tio n e d
C e rtific a te s
N o c o n s tra in t
G ra n d fa th e rin g
A u c tio n e d
C e rtific a te s
200
N o c o n s tra in t
0
G ra n d fa th e rin g
210
A u c tio n e d
C e rtific a te s
2 ,0 0 0
tC O 2
1840
250
N o c o n s tra in t
£ m illio n
1 2 ,0 0 0
C O 2 E m is s io n s
23
Impact of updating I
24
One time updating
Assume one time updating - pt+1 const
A’ = 0
A’->inf
A’ positive
… only price increase
… only emission increase
… both price and emission increase
25
Continuous updating
Future allowance price also increases, enhancing the
effect of updating on today’s allowance price.
26
Quantification of CO2 constraint
Assume A’->inf … government fixes allowance price
Calculate E’ as function of fuel switching etc.
27
Cost of implementing Carbon Constraint - Static
S c a rc ity
F ixe d O & M
Tax
C O 2 a llo w a n c e s
E n e rg y
F u e l & V a ria b le
O&M
1 0 ,0 0 0
8 ,0 0 0
1385
240
230
6 ,0 0 0
220
4 ,0 0 0
C o n s u m e rs
G e n e ra to rs
G ra n d fa th e rin g
A u c tio n e d
C e rtific a te s
N o c o n s tra in t
G ra n d fa th e rin g
A u c tio n e d
C e rtific a te s
200
N o c o n s tra in t
0
G ra n d fa th e rin g
210
A u c tio n e d
C e rtific a te s
2 ,0 0 0
tC O 2
1840
250
N o c o n s tra in t
£ m illio n
1 2 ,0 0 0
C O 2 E m is s io n s
28
Allocation of Allowances to new entrants
pmax
cm,2
Dmin
K1
Fixed costs:
cf,1
Dmax
K2
cf,2
(assume
29
Dmax-Dmin=1)
Impact of the amount of free allocation
pt=ct
30
Government strict on quota
dK2 /dμ>0 -> dK1/dμ >0 if
Scarcity value of capacity decreasing.
To ensure profitability of technology 1, dct/dμ > 0
• Investment in both technologies is increased (while
scarcity value positive)
• Allowance price and for dA/dct>0 emissions increase.
31
Government stabilises price
dK2 /dμ>0 -> dK1/dμ <0 if
Scarcity value of capacity decreasing.
dK2/dμ>0 dK1 /dμ <0 and d(K1 +K2)/dμ K’1+K’2>0
 emissions increase dct/du > 0
• Low emission technology is displaces by high emission
technology and total capacity increases.
• Allowance price and emissions are increased.
32
Impact of Allocation Rules on UK Wholesale
Prices
A ll-in P ric e (€ /M W h )
40
35
30
25
N o c lo s u re te s t/N o N E R
20
C lo s u re te s t/N o N E R
C lo s u re te s t/N E R
15
BAU
10
2004
2 0 0 5 -2 0 0 7
2 0 0 8 -2 0 1 2
2 0 1 3 -2 0 1 7
Price reflects energy-weighted average wholesale power price across UK assuming a CO2 price of 10€/tonne.
Source: ICF Consulting, March 2004.
33
Impact of competing countries not participating
• Concerns for competitiveness of EU industry
• Could particularly affect location decisions
• Hence provisions for allocation of allowances to
new entrants in NAPs (for 2005-2007)
– Distortions of technology choice (Germany)
– Distortions of location choice (between
countries)
– Long-term commitment reduces policy options
– How many reserves to retain for entrants?
• Updating provisions – reduce effectiveness
34
Requirement to implement stringent policy
• Emission trading only works if
– No updating: allowance price=opportunity cost
– Minimise allocation to new entrants
• EU Energy intensive industry will lobby against
high CO2 prices if they are unilateral
• US Energy intensive industry will increase lobby
against CO2 constraints if they can free ride
• We need border tax adjustment
35
Border Tax Adjustment for CO2 allowance costs
•
•
•
•
Reimburse exporter for allowance costs
Add import tax for avoided CO2 allowance costs
Allows for internalisation of externalities
Treatment similar to value added tax
– Other regions can apply it (e.g. Canada)
– But product not process based
• Focus on energy intensive component
– Small transaction costs
– Based on best available technology
– Simple monitoring / tariff setting
• WTO compatible
36
Conclusion
•
•
•
•
ETS in place and starting January 2005
Covers emissions from large installations
Technology policy separate (and needs to be)
To get industry buy in: Free allocation
– Politicians then required Updating
– New entrant allocation
• Result are likely
– Allowance prices look higher -> don’t be fooled!
– Distortions in investment decisions.
• Border tax adjustment could allow for higher CO2
price levels.
37