Memorandum submitted by EDF Energy
1. WHAT ARE
THE KEY
LESSONS TO
LEARN FROM
PHASE I OF
THE SCHEME?
EDF Energy is fully committed to tackling climate
change and believes the EU Emissions Trading Scheme (ETS) is an
important mechanism in the management of emissions across Europe.
The current scheme, in its present stage of development and structure
cannot drive the long term investments needed to make deep cuts
in carbon. The primary reason for this is that the policy timescales
of the EU ETS do not match the investment life cycles of the sector
and investors are unwilling to accept the regulatory uncertainty
surrounding future carbon dioxide abatement targets.
In Phase I, Government set unrealistic targets
for the electricity sector that could not be achieved through
abatement in the time available, requiring large scale purchasing
of allowances. The results in 2005 show that simply setting tight
caps for the electricity sector has not produced a reduction in
emissions but rather the purchasing of 36.5MtCO2 of
allowances from other Member States at a cost to the UK of around
€730 million. 15[15]
This is not delivering an environmental benefit as a result of
other Member States having set generous caps in Phase I.
In addition, offering "business as usual"
to other sectors in the UK does not provide sufficient incentive
for industry to effectively engage in the EU ETS and fully integrate
the cost of carbon into operational and investment decisions.
This approach is inconsistent with "Government's long
term objective to move away from free allocation of allowances
so that the full cost of carbon is taken into account by business
in making investment decisions" and operational decisions.
The EU ETS is currently being used by other sectors as a compliance
scheme.
2. HOW LIKELY
IS IT
THAT UK FIRMS
WOULD SUCCESSFULLY
REDUCE EMISSIONS
BY AT
LEAST 7MTC
BY 2012, IN
LINE WITH
THE PROPOSED
PHASE II NAP?
The EU ETS is designed to provide organisations
with flexibility. As such it allows the participants flexibility
to trade allowances and deliver the required overall emissions
reductions in the most cost-effective way possible. An efficiently
functioning scheme will not necessarily reduce CO2
emissions in the UK or deliver year-on-year CO2 emission
reductions in the UK.
EDF Energy believes the actual reduction Government
is seeking in Phase II is closer to 40 Mt of CO2 (11
MtC ) per annum compared to business as usual projections during
this period. This includes the annual reduction of 29.3 Mt CO2
(8 MtC) plus the 10 Mt CO2 (3 MtC) difference between
EDF Energy's business as usual projections and the Government's
updated energy projections for Phase II.
We do not believe this reduction is feasible
by 2012. The EU ETS, as presently constituted, does not provide
investors with certainty around the structure of EU ETS beyond
2012 and future abatement targets, and therefore is not capable
of sending the signals required to deliver investment in lower
carbon technologies in the UK and EU. The five year timescale
of Phase II does not match the investment life cycles of the sector,
hence investors are unwilling to accept the political and regulatory
uncertainty surrounding future CO2 abatement targets.
We also consider that the present EU ETS market
is too fragile and fragmented to provide long term price signals
or to sustain the necessary long term investment. In its current
form, it will continue as a clearing market and produce a reference
price for CO2.
The Government's proposal that all other sectors
will receive an allocation based on business as usual and that
the electricity sector will bear the burden of the total emissions
reduction against business as usual does not provide sufficient
incentive for other sectors to reduce emissions.
Given the lack of long-term signals to deliver
investment to fundamentally change the carbon footprint of the
electricity sector, emission reductions in the sector are likely
to be limited to fuel switching from coal to gas. EDF Energy forecasts
that gas prices could remain particularly high for the rest of
this decade resulting in limited fuel switching and CO2
reductions. Therefore, the only way the sector can meet the shortfall
in allowances is to purchase additional allowances in the market.
3. WHAT HAVE
BEEN THE
EFFECTS OF
THE METHOD
CHOSEN FOR
ALLOCATING ALLOWANCES
IN PHASE
I?
The allocation methodology adopted for Phase
I to distribute allowances within the sectors has created significant
market distortions within the electricity industry. In particular,
the use of a historic allocation methodology has under-allocated
to coal power stations fitted with FGD when compared with non-FGD
stations, because it failed to take into account the changing
generation patterns driven by tighter sulphur limits. These distortions
have created a significant commercial impact.
However, in Phase II the allocation methodology
selected for the electricity sector, ie standard benchmarks based
on plant category with the load factor adjusted for opted out
of the LCPD coal plant, will reduce these competitor distortions.
4. HAS THE
GOVERNMENT IDENTIFIED
THE CORRECT
PROPORTION OF
ALLOWANCES TO
BE AUCTIONED
IN PHASE
II? SHOULD THESE
BE DRAWN
SOLELY FROM
THE POWER
SECTOR'S
ALLOCATION? WHAT
WILL THE
EFFECT OF
THIS AUCTIONING
BE ON
INDUSTRY AND
THE PRICE
OF CARBON?
The EU ETS Directive states that Member States
shall allocate at least 90% of the allowances free in Phase II,
and therefore the maximum proportion of allowances the Government
can auction is 10%. In principle, EDF Energy agrees with up to
10% of allowances being auctioned. However, Government should
recognise the combination of a tight sector cap and a large contribution
of allowances to be auctioned will force the electricity sector
to purchase around 40% of allowances from the market compared
to business as usual projections. This is far higher than the
10% identified in the Directive and places a heavy burden on the
sector and on its customers.
EDF Energy believes that revenue generated through
the auctioning of allowances should be used to provide long term
certainty for participants within the sectors covered by EU ETS.
The policy mechanisms for providing certainty are discussed in
more detail under Question 9 of our response, below.
Electricity Sector
EDF Energy strongly disagrees with the allowances
to be auctioned being deducted solely from the electricity sector.
Allowances to be auctioned should be deducted from all sectors.
Offering business as usual to all other sectors does not provide
them with the incentive to internalise the cost of carbon or reduce
emissions. This is also inconsistent with "Government's
long term objective to move away from free allocation of allowances
so that the full cost of carbon is taken into account by business
in making investment decisions" and operational decisions.
Price of Carbon
Auctioning is an alternative method for allocation
or distributing allowances and forces operators to buy allowances
from the market, facilitating the internalisation of the cost
of carbon. Auctioning of core allowances will not change the overall
supply and demand balance within the EU, hence does not affect
the actual price of carbon.
5. WHAT HAVE
BEEN THE
EFFECTS OF
PHASE I SO
FAR ON
THE COMPETITIVENESS
OF:
1. business in the UK, and
2. business across the EU?
EDF Energy believes that business in UK and
across the EU has been affected by the introduction of EU ETS
through the increase in electricity prices due the integration
of carbon into wholesale electricity prices. However we do not
agree with statements by both industry and government that withdrawing
free allowances from industry sectors would expose them to more
European and International competition. 16[16]
As outlined in Table 2 of the Phase II EU ETS "Overall Regulatory
Impact Assessment (RIA)" 17[17]
and a recent Carbon Trust report, 18[18]
industrial sectors are exposed to different levels of international
and EU competition. The impact on competitiveness is dependent
on the following three key variables for any given sector or business:
— The ability to pass cost increases
through to consumers in an increased price of the sector's final
product; and
— The opportunities for abatement.
The RIA analysis19[19]
and a recent Carbon Trust report20[20]
acknowledge that the Aluminium sector would find it difficult
to pass through additional carbon costs. However, the reports
support our view that steel and cement are able to pass through
some of the cost of carbon, with other sectors such as the brewing
and petroleum sectors, engineering and vehicles, being able to
pass on the cost of carbon with little impact on their profitability.
6. WHAT ARE
THE KEY
ISSUES FOR
PHASE II IN
TERMS OF
ENSURING THAT
EMISSIONS REDUCTIONS
FROM EU STATES
ARE NOT
CANCELLED OUT
BY THE
TRANSFERRING OF
INDUSTRY TO
DEVELOPING ECONOMIES?
EDF Energy does not believe that Government
can "safe-guard" against industry moving to other countries.
There are new, competitive markets emerging within these countries
in which industry should and will continue to invest in. The issuance
of business as usual allowances and other incentive to these sectors
within the UK and EU will not:
— protect UK business from owners moving
their operations aboard. There are numerous other influences that
contribute to this decision on moving operations; and
— provide signals to investment within
the UK and Europe.
As outlined above, according to a recent Carbon
Trust report and the International Energy Agency (IEA) report
on Industrial Competitiveness under EU ETS, 21[21]
most sectors are able to pass on the cost of carbon with little
impact on their profitability; hence the EU ETS would not be the
driver for industry moving to developing economies. The non-ferrous
metal sector including aluminium is most vulnerable to increased
in electricity prices, has minimum opportunity for abatement and
would find it difficult to pass through additional carbon cost.
In Phase II, the Clean Development Mechanism
(CDM) provides an effective mechanism for transferring low carbon
technologies to developing countries to reduce their potential
carbon footprint.
7. HOW WELL
ARE THE
EU ETS AND THE
CLEAN DEVELOPMENT
MECHANISM WORKING
TOGETHER? WHAT
NEEDS TO
BE DONE
TO BETTER
INTEGRATE THESE
MARKETS? IS
THE CDM FUNDING
THE RIGHT
PROJECTS?
The EU ETS and CDM markets are currently working
in parallel. Participants are awaiting the finalisation of the
independent transaction log (ITL) to allow them to use carbon
credits generated from CDM projects for compliance. The ITL is
scheduled to be operational in mid-2007 hence CDM credits can
only be used for compliance in the final year of Phase I.
It should be recognised that both markets share
considerable political uncertainty due to lack of international
and EU long term frameworks. As discussed previously, this is
hindering potential investment of low carbon technologies within
the EU and is also hindering investment within developing countries.
CDM project developers are currently facing difficulties with
gaining forward contracts beyond 2012 to underwrite their investments.
We believe the linkage between the two markets
needs to be clearly managed going forward. CDM has an important
role to play in allowing developed countries to undertake emission
reducing projects in developing countries. It assists in the transfer
of capital to developing countries and bridging any gap between
realistic abatement and the EU target reductions, particularly
if targets are set at levels that cannot be achieved through abatement.
We believe that the limit on the use of project credits should
be consistent across Member States; however unlimited use of JI/CDM
project credits for compliance has the ability to create an oversupply
of project credits impacting on the balance of supply and demand,
resulting in the destabilisation of the EU ETS market.
Is CDM Funding the Right projects?
EDF Energy does not support the exclusion of
certain forms of low/carbon free technologies from CDM. Certain
large generation developments that are currently excluded have
the potential to make a considerable contribution in reducing
emissions compared to business as usual. By excluding these technology
options we need to be careful that we are not burdening countries
by developing projects with a carbon footprint that is unsustainable
in the long term.
8. HOW SHOULD
AVIATION BE
INCLUDED WITHIN
THE ETS? WHAT
ARE THE
LATEST INDICATIONS
OF WHEN
IT WILL
BE INCLUDED?
In principle, EDF Energy supports the expansion
of the sectors and types of greenhouse gases incorporated within
the EU ETS. We believe expansion criteria should be established
to provide a structured and methodical decision making process
for the inclusion of additional sectors and greenhouse gas within
the EU ETS. These criteria should include:
— The sectors ability to influence
and manage emissions profile including ability to abate emissions
at source through consumption and technology;
— Impact on market to ensure that inclusion
does not destabilise the existing scheme or undermine its effectiveness;
— Ability to accurately monitor and
report emissions; and
— Emissions that are from the installation
are above a de minimis emissions threshold, ie large emitters.
EDF Energy supports the UK and the Commission's
desire to manage and reduce emissions from the aviation industry.
Emissions from aviation are rapidly growing and are not expected
to fall in the short or medium term. EDF Energy believes that
a separate, dedicated emissions trading scheme should be introduced
for aviation industry. This scheme could be linked to the EU ETS
via a gateway that allows the aviation industry to purchase allowances
from the EU ETS. The aviation industry does have the potential
to create a drain on the EU ETS allowance with little emissions
reduction by the industry. Therefore we believe that the amount
of allowances the aviation industry could buy should be capped
at a level that ensures the aviation sector contributes to the
overall objective of halting climate change. This cap would also
create supply demand balance certainty for the market.
We also believe the scheme should initially
focus on CO2 emissions from the aviation industry.
Further work is required on the non-CO2 impacts of
aviation and the development of a monitoring and reporting standard
for non-CO2 gases emissions (specifically NOx).
This proposal could form the basis of international
scheme for aviation industry which is currently not subject to
commitment to reduce emissions. This would demonstrate the EU's
leadership in tackling climate change and engages one of the sectors
with the largest growth in greenhouse gas emissions.
9. THE ENVIRONMENT
SECRETARY HAS
SAID: "WE
WILL SUPPORT
THE COMMISSION
IN ITS
EFFORTS TO
ENFORCE TOUGH
CAPS". WHAT
EXACTLY SHOULD
THE GOVERNMENT
BE DOING
TO INFLUENCE
THIS?
EDF Energy supports the Government's efforts
to work with the Commission and other Member States in the development
of the Phase II National Allocation Plan. The carbon market does
require volume constraints to stimulate trading and provide sufficient
incentive for industry to effectively engage in the EU ETS and
therefore Member States and the sectors should not receive business
as usual allocations. We believe Government should continue to
work with the Commission and other Member States in ensuring that
all Member States are contributing to emissions reductions across
the EU.
However, establishing tough caps in UK and across
the Europe is not going to drive investment in low carbon technologies
and abatement to commence the transition to a low carbon economy.
The EU ETS, as presently constituted, is not capable of sending
the signals required to deliver investment in lower carbon technologies
in the UK and EU. Its current structure is not capable of underwriting
the investment needed to reduce CO2 emissions in the
electricity and other large industrial sector owing to the political
and regulatory uncertainty surrounding future carbon dioxide abatement
targets beyond 2012. Although considerable efforts are being made
to agree long term abatement targets across the EU (Phase III
and beyond), these are unlikely to be agreed in the near future.
This creates a void in political certainty and a significant hurdle
for early investment in low carbon technologies. We believe the
key priority for Government is providing political certainty for
investors on future carbon dioxide abatement targets.
EDF Energy believes that commercial market-based
instruments can be used to underpin the significant capital investment
required to lower the carbon intensity of the electricity sector.
This can be done without exposing the UK Government to unacceptable
financial risks by controlling the amount of CO2 reductions
the Government commits to in this way. These instruments can be
designed to reinforce the integrity of the EU ETS in the long
term within the framework of competitive and liberalised energy
markets, as advocated by the UK Government. We have outlined how
such a Carbon Hedge would work in practice in our response to
the Energy Review and we would be happy to provide further details
on this.
10. HOW WELL
INTEGRATED ARE
THE ETS AND
OTHER EU CLIMATE
CHANGE POLICIES?
The nature of climate change and its importance
places a huge responsibility on all areas of society to address
their impact. Current European polices are fragmented and do not
fully address the continued growth in emissions and energy consumption
from households, business and government. One of the key challenges
for the EU is to develop a comprehensive climate change programme
that engages all areas of society. While the UK Government's climate
change programme is comprehensive, it introduces numerous policy
measures with different prices of carbon, for example UK ETS.
CCL, LECs and CCA carbon price and EU ETS carbon prices. In the
UK, there is a need to streamline climate change policies to focus
specifically on carbon and a single price of carbon. It should
be recognised that the EU ETS is one tool in a suite of policy
measures that need to address climate change.
In addition, we believe there needs to be greater
consistency in the design and implementation of the various policy
instruments, regulations and Directives in Europe that seek to
address climate change, such as measures to encourage energy efficiency
and renewable energy sources.
11. WHAT WORK
NEEDS TO
BE DONE
NOW TO
HELP DESIGN
A THIRD
PHASE OF
THE EU ETS? HOW
CAN THE
EXPERIENCE OF
THE EU ETS BE
USED TO
HELP THE
DESIGN OF
A POST-2012
KYOTO MECHANISM?
EDF Energy sees the agreement of long term international
targets for greenhouse gas reductions and agreement on the design
and use of flexibility mechanisms over the next 25-30 years as
critical to mitigating climate change. Once these parameters are
established it is relatively straightforward to make the necessary
improvement in the administrative arrangements of the EU ETS.
These would include:
— Expansion of the trading scheme to
include other sectors and other greenhouse gases: the inclusion
of these sectors should proceed at a pace that does not compromise
the existing scheme and allows the market to adapt to changes.
— Length of future allocation periods:
these should as far as possible match the investment life cycles
of assets that will be needed to deliver the necessary shift in
the UK's carbon footprint. A 15 year allocation period post 2012
would be a minimum requirement, but other periods may be appropriate,
as long as sufficiently long term international targets have been
agreed.
— Level of auctioning: it should be
unavoidable that all business activities must be exposed to the
full costs of greenhouse gas emissions to encourage them to take
appropriate action on climate change. In our view this should
happen sooner rather than later.
— Harmonisation of allocation methodologies:
the importance of the allocation methodology disappears as we
move to full auctioning of allowances. However where the allocation
of free allowances remains it is important to harmonise methodologies
to prevent market distortions and establish parity with low carbon
or carbon free technologies.
— JI/CDM mechanisms: these must be
reviewed in the context of the international targets. They are
effective in transferring some capital to developing countries
but we need to be careful that we are not burdening countries
that are developing these projects with a carbon footprint that
is unsustainable in the long term.
— International targets: these are
fundamental, and different frameworks for developing targets might
be helpful in reducing the level of political risk. The level
of risk being taken by either the industrial investor or a national
Government, in the drive to lower greenhouse gas emissions, is
largely determined by the targets an individual country is willing
to sign up to in international agreements. Government is unlikely
to sign up to long term binding targets unilaterally and industry
will be guided by Government's position.
We strongly support the EU ETS and believe it
is an important policy measure in mitigating climate change. Its
current structure however is not capable of underwriting the investment
needed to reduce CO2 emissions in the electricity sector.
The primary reason for this is that the policy timescales of the
EU ETS do not match the investment life cycles of the sector and
investors are unwilling to accept the regulatory uncertainty surrounding
future carbon dioxide abatement targets.
October 2006
15 15 Assuming a price of €20 per tonne CO2. Back
16
16 Most sectors claim that the impact on profitability as a result
of auctioning would make the process prohibitively expensive (oil
and gas £22 million, pulp and paper £8 million, Steel
£46-£51 million). The cement sector considers that auctioning
would lead to a loss of 26% market share. Back
17
17 Table 1, page 36 of the Allocation Methodology RIA. Back
18
18 "The UK Climate Change Programme: Potential evolution
for business and the public sector"-www.thecarbontrust.co.uk/carbontrust/about/publications/CTC518<au0,0>
<xuCCPR2.pdf Back
19
19 Table 1, page 36 of the Allocation Methodology RIA. Back
20
20 "The UK Climate Change Programme: Potential evolution
for business and the public sector"-www.thecarbontrust.co.uk/carbontrust/about/publications/CTC518<au0,0>
<xuCCPR2.pdf Back
21
21 International Energy Agency (IEA) report on Industrial Competitiveness
under EU ETS, February 2005. Back
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