Memorandum submitted by Drax Power Limited
SUMMARY
1. The EU ETS aims to provide installations
with a stable, functional carbon market, which provides economic
market signals for the abatement of carbon in both the EU and
globally via Clean Development Mechanism (CDM) investment. To
date, the EU ETS has assisted in encouraging emitters, principally
those in the Large Electricity Producer (LEP) sector, to invest
in cost effective abatement technologies within the EU, such as
the turbine upgrade and the biomass co-firing projects at Drax
Power Station.
2. The EU ETS has provided support to the
EU in meeting its Kyoto targets by providing economic signals
that have underpinned the curtailment of carbon emissions from
developing nations via the CDM, with some 1.4 billion tonnes of
carbon abatement being directly attributable to the operation
of the EU ETS. This is significant evidence of the role that the
carbon market can play in the mitigation of climate change.
3. However, a question mark now hangs over
the future of the CDM as a result of the recent agreement reached
by the EU on the new EU ETS Directive. After 2012, there will
be reduced access to the CDM for EU ETS installations, which means:
(a) the flexibility afforded to installations
in meeting their compliance targets will be severely impaired;
and
(b) a major source of investment in sustainable
technologies for developing countries will be affected.
4. The EU ETS has been designed as a traded
carbon market, which means that it will be affected by global
market conditions. The recent price movements are due to a decrease
in demand for carbon allowances, whilst carbon intensive industries
experience a slump in demand for their products. It would be of
grave concern to Drax if the Government were to remove, or reduce,
its support from a traded carbon market, as a result of the market
working correctly.
5. The LEP sector requires long-term stability
in regulation to develop the necessary confidence to invest. Hence,
the Phase 3 auctioning regime must be developed and communicated
as soon as possible, in order to provide greater certainty to
investors. The power generation sector will be subject to 100%
auctioning from 2013, which means that auctioning arrangements
must be established well in advance of 2013, in order to prevent
an adverse affect on liquidity in the power market.
INTRODUCTION
6. Drax Power Limited ("Drax")
is the operating subsidiary of Drax Group plc and the owner and
operator of Drax Power Station, the largest, cleanest and most
efficient coal-fired power station in the UK. With a capacity
of some 4,000MW, Drax Power Station is twice the size of the next
largest power station in the UK.
7. We believe we have an important part
to play in managing the transition of the UK towards a low-carbon
economy. At Drax Power Station our focus is on co-?ring and thermal
efficiency improvement. On co-firing, we aim to produce 12.5%
of our output from renewable biomass materials by mid 2010, which
will save around two and a half million tonnes of CO2 each year.
At the centre of our thermal efficiency programme is the £100
million upgrade of the high and low pressure turbines of each
of our six generating units. We are now over a third of the way
through the upgrade project and already saving over one-third
of a million tonnes of CO2 emissions a year. On completion of
the upgrade in 2011, we will see an improvement in our overall
baseload efficiency of 5%, taking it towards 40%, and an annual
saving of one million tonnes of CO2.
8. Drax is pleased to have the opportunity
to participate in the Committee's inquiry into the role of the
carbon market. As a large compliance buyer in the carbon market,
Drax should like to provide some context to the inquiry by offering
observations on the general role of the carbon market and its
influence on global carbon abatement.
SUCCESS OF
THE EU ETS TO
DATE
9. The EU ETS provides installations with
a functional carbon market that provides economic market signals
for the abatement of carbon in both the EU and globally via CDM
investment. It has encouraged emitters, principally those in the
LEP sector, to invest in abatement technologies within the EU
and has delivered a carbon trading platform that provides participants
with:
— access to EUA, CER and ERU credits;
— price transparency; and
— risk management tools that encompass,
spot and forward futures and option contracts.
10. The process to move away from the EU's
dependence on fossil fuels will take many years. Progress is being
made, particularly in the LEP sector, where the EU ETS continues
to make a major contribution to both commercial and strategic
decision making; this will continue, provided that the market
is structured in a way that engenders investor confidence in the
long term.
11. In addition, the EU ETS has enabled
the EU to meet its Kyoto targets by underpinning the curtailment
of carbon emissions by developing nations. Some 1.4 billion tonnes
of abatement in developing nations will be directly linked to
the operation of the EU ETS. This is significant evidence of the
role that a fully functional carbon market can play in the mitigation
of climate change and in mobilising developing nations to curtail
their carbon emissions via the CDM scheme.
12. In little over three years, the CDM
has registered more than 1,400 projects, with the latest forecasts
projecting the issuance of CERs across the first commitment period
(to the end of 2012) to be more than the equivalent of 2.9 billion
tonnes of CO2. As such, it is clear that the scheme has been successful
in encouraging investment in the developing world, as well as
cutting GHG emissions globally.
13. Whilst the CDM has clearly demonstrated
itself to have effectively and efficiently met all of its objectives,
a question mark hangs over its future as a result of the recent
agreement reached by the EU on the new EU ETS Directive. After
2012, there will be reduced access to the CDM for EU ETS installations,
meaning:
(a) the flexibility of such installations in
meeting their compliance targets will be severely impaired; and
(b) a major source of investment in sustainable
technologies for developing countries will be affected.
14. The results that have been seen in the
developing world via CDM are at risk of being undermined if the
carbon market itself is endangered.
PROMOTION OF
INVESTMENT
15. In order to ensure a progressive reduction
of global emissions, it is imperative that compliance buyers are
able to make strategic long-term decisions on their investments.
The EU ETS and CDM have the potential to provide investors with
the regulatory certainty required to make such strategic decisions,
provided that Member States continue to work towards greater harmonisation
and ensure that the details of arrangements for future phases
are provided to the market, in a timely and transparent manner.
16. A successful emissions trading scheme
should provide participants with medium to long-term signals that
allow them to determine the appropriate balance of allowance trading
and investment in abatement technologies, both within the EU and
globally via investment in developing countries. It should be
noted that any uncertainty and a lack of stability in the EU ETS
and the processes that support the scheme will have a detrimental
effect on investor confidence, at a time when the Government is
striving to encourage investment on an unprecedented scale.
17. However, whilst the EU ETS was designed
to deliver the EU's Kyoto targets and to encourage the most efficient
route to carbon abatement, it may not necessarily be the most
efficient tool for encouraging investment in new renewable technologies
or in Carbon Capture and Storage (CCS). In terms of incentives
for renewables, it is important not to confuse:
(a) the objectives of carbon abatement and Kyoto
targets that the EU ETS aims to aid; and
(b) the Renewables Obligation (RO) mechanism
that aims to encourage investment in renewable technologies.
18. If UK Government wishes to encourage
greater investment in renewable technologies, it may need to focus
on greater incentives from the RO, not changes to the EU ETS.
CARBON TAX
VERSUS TRADED
MARKET
19. It is important to understand that the
EU ETS has been designed as a carbon market; by definition,
such a market shall be affected by global market conditions. It
must be noted that the recent price movements in the carbon market
are due to the decrease in the demand for carbon allowances.
Whilst carbon intensive industries, such as the steel and glass
industries, experience a slump in demand for their products, it
makes sense that their requirement for carbon allowances will
diminish. Such issues will lead to these industries selling their
excess carbon allowances in the carbon market, in turn causing
a decrease in the price of EUAs (as demonstrated by the market).
20. However, the inverse is also true, in
that as demand rises, so does the price; we have seen this over
the last year with prices in the region of €30/te during
July 2008. The key point here is that Phases 2 and 3 have been
designed to ensure that there is an undersupply of EUAs between
now and 2020, unlike Phase 1 where there was a gross oversupply.
It is expected that as each sector recovers, the demand for carbon
allowances will increase; this will not just be an increase in
demand from individual industrial sectors, it will also be an
increase in demand from the power generation sector that such
industries rely upon.
21. The carbon market allows companies to
see price signals over multiple compliance periods / EU ETS Phases,
allowing them to decide on the optimum time to invest in carbon
abatement technologies. In fact, as the global economic situation
improves, it is conceivable that the cost of abatement (in terms
of materials and construction) will be lower than that at the
time when the EUA price was last in the region of €30/te.
The recent movement in EUA price should not be perceived as a
fault in the carbon market; the recent change in EUA price only
serves to demonstrate that the market works.
22. As the EU ETS platform continues to
develop, it is important that any changes to the scheme should
be made in an evolutionary manner. Whilst Drax understands that
the EU ETS should remain under constant scrutiny, it should be
noted that talk of a whole-scale change from a traded market to
a taxation regime undermines confidence in the emissions market,
the abatement investment that it aims to promote and the funding
of investment and research into new abatement technologies that
are based upon the future EUA price.
23. It would be of grave concern to Drax
if the Government would consider a move away from the traded market
to a tax regime as a result of the market working correctly (ie
responding to changes in supply and demand for carbon allowances).
The UK has been a key promoter of a global carbon market, with
nations such as the United States, Canada and Australia now looking
to link carbon trading schemes in a global effort to reduce emissions.
Talk of a carbon tax, which serves to increase government revenue
rather than promote carbon abatement, undermines the progress
already made in moving towards a truly global carbon trading scheme.
24. Whilst Drax believes that it is not
the market that is at fault, there may be an issue with the fragmented
administration of the carbon market and the incentives for green
technologies (such as through the RO), as there appears to be
confusion over the objectives of each scheme. Rather than a whole-scale
change to the carbon trading arrangements, it may be worth conducting
an investigation into the concept of a central "carbon
bank" that is charged with the management / role of the carbon
market for all Member States. A more holistic approach
to determining how the carbon market and revenue recycling system
should work may provide a more efficient carbon market, which
in turn will lead to a more efficient approach to carbon abatement.
AUCTIONING
25. Clear rules on Phase 3 auctioning must
be communicated as soon as possible, in order to provide greater
certainty to investors. This is especially important for the power
generation sector, which will be subject to 100% auctioning from
2013. Arrangements for Phase 3 auctioning must be established
well in advance of 2013 in order to prevent an adverse affect
on liquidity in the power market. If there is any delay in Phase
3 auctioning, adequate provisions must be put in place (following
stakeholder consultation) to ensure that EUAs are accessible to
all installations.
CONCLUSIONS
26. In conclusion:
(a) The process to move away from the EU's dependence
on fossil fuels will take many years. The continuance of the EU
ETS would facilitate future commercial and strategic decision
making for market participants with regards to carbon abatement.
(b) The EU ETS has provided support to the EU
in meeting its Kyoto targets, with some 1.4 billion tonnes of
carbon abatement in developing nations being directly linked to
the operation of the EU ETS via the CDM scheme. Such results are
at risk of being undermined if the carbon market itself is endangered.
(c) Price decreases witnessed in the carbon market
are a reflection of the decrease in demand for EUAs. The current
economic downturn has not only reduced demand, but has also prompted
industrial users to sell their excess allowances, which in turn
has contributed to a decrease in price. This only serves to demonstrate
that the design of the EU ETS has produced a functional market.
(d) Phases 2 and 3 have been designed to ensure
that there is an undersupply of EUAs between now and 2020; therefore,
it is expected that as each sector recovers from the economic
downturn, the demand for carbon allowances will increase.
(e) Timely decisions are required regarding the
arrangements of future EU ETS phases, in order to provide investors
with the regulatory certainty required to make long-term strategic
carbon abatement decisions. However, it is important not to confuse
the objectives of differing schemes, such as the EU ETS and the
RO mechanism; if UK Government wishes to encourage greater investment
in renewable technologies, it may need to focus on greater incentives
from the RO mechanism, not changes to the EU ETS.
March 2009
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