The role of carbon markets in preventing dangerous climate change - Environmental Audit Committee Contents

Memorandum submitted by RWE nPower


  RWE npower, part of the RWE Group, owns and operates one of the largest and most diverse portfolios of power generating plant in the UK with over 9,000 megawatts (MW) of large gas, coal and oil-fired power stations and cogeneration plant. Our retail arm, npower, is one of the UK's leading suppliers of electricity and gas with around seven million customers. It serves the residential, small to medium enterprises and industrial and commercial sectors and offers competitive, advanced solutions for its customers.

As generators we have clearly been impacted by the introduction of emissions trading and our supply business is also closely involved in delivering measures to encourage the move towards a low-carbon economy.


    — We support the principle of emissions trading and believe that it provides the most cost-effective means of reducing greenhouse gas emissions.— The focus must be on ensuring the Emissions Trading Scheme (ETS) provides sufficient long-term clarity for investors including setting out the carbon trajectory and constraints beyond 2020. There are also a number of important details of the ETS for phase III that remain to be agreed. The priority must be for getting the design right now, rather than having to resort to intervention at a later date.

    — 100% auctioning for the electricity sector after 2012 is a major change from the current operation of the scheme. It is essential that auctions for phase III begin during 2011 to prevent potential price volatility or illiquidity in both the electricity and carbon markets.

    — A global carbon market will be important but premature linking of regional schemes could undermine delivery of UK and EU objectives.

    — JI/CDM projects are an important mechanism in the transition to a global carbon market. Project developers need certainty over future acceptability of credits from projects to ensure minimum disruption to the flow of investments in low-carbon technologies and the associated emission reductions in developing countries.

    — It is important that the UK carbon budgets recognise the link with the ETS and focus efforts on delivering reductions in the non-traded sector. Emissions trading schemes will not be the most effective tool for all emissions but it is important that other mechanisms provide the right signals to support choices that the consumer needs to make to reduce emissions.


  1.  RWE npower believes that emissions trading offers the potential to be a highly effective tool in reducing global emissions of greenhouse gases in an economically efficient manner. However, it is important that the design of schemes is robust over the life of major investments in low-carbon technologies and political intervention does not result in it becoming less likely that the objectives of emissions trading will be met. Whilst there is a clear need for a global price of carbon to provide long-term signals to investors and decision makers, the aim of any emissions trading scheme should be the reduction of emissions against clearly defined targets. The targets should drive the price of carbon rather than the price of carbon being an end in itself.

2.  While a global emissions trading could make an important contribution to delivering the global greenhouse gas stabilisation target, the momentum needed to make this happen is only likely to come about through the successful linking of compatible regional trading schemes. At present the focus should be on delivering an efficient European ETS, which can serve as a credible basis for a global model, prior to consideration of linkage to other schemes.

  3.  Emissions trading can and should play a central role in reducing emissions at UK, EU and global level, but there will be circumstances where it is not the most appropriate or cost-effective tool. In particular, it is difficult to see how diffuse sources of emissions such as household heating or road transport can be included in an emissions trading scheme without high administration costs. Other mechanisms such as taxation or regulation are a more appropriate means of providing the right signals to support choices that the consumer needs to make to reduce emissions.


  4.  Phase I of the EUETS began in 2005 and it rapidly became clear that allowances had been over-allocated resulting in a significant fall in the price of carbon. However the first phase was always seen as an introductory phase and although this phase could only deliver short-term carbon price signals, it did provide the basic structure for a successful emissions trading scheme and provided the information for setting meaningful caps for phase II and beyond.

5.  Phase II of the EUETS has been in place for a little over a year and over that period we have seen the price of allowances (EUAs) fall from a peak of €30/t to lows of around €8/t. However there is high liquidity in the scheme and the numbers of EUAs being traded are currently at an all time high. Clearly the economic downturn has had a significant impact on the carbon market, but it remains to be seen whether this is driven solely by short-term factors such as installations selling additional allowances, either because of lower forecasts of output or as a means of improving cash flow (allocations are made before the end of February and surrender of allowances for the previous year does not need to be completed until the end of April thus all installations effectively have a year's worth of allowances in hand).

  6.  Although the transition from phase I to phase II appears to have been successful there were two issues that caused concern. The first of these was the severe delay in issuing 2008 allowances and the lack of information available from the Regulator on this issue. In addition the design of auctions for phase II has led to some concern. The rules of the auction requiring direct participants to access the auction via Intermediaries has led to concerns around the bidding process. This would be of very significant concern if the rules continue into phase III when the electricity generators, as the largest compliance buyers, will need to purchase significant volumes of allowances via auctions.

  7.  Strong linkage between phase II and phase III is essential to provide a consistent signal on future carbon prices and, in a well functioning market, it would be expected that the reduction in the level of the cap in phase III would impact the price of carbon over both phase II and phase III. However, given that much of the detail relating to phase 3 remains to be finalised, including the impact of any international agreement, it is hardly surprising that phase 2 prices are currently driven mainly by short-term supply and demand.

  8.  Although the agreement last December on the revision of the EUETS Directive in relation to phase III of the scheme provides welcome clarification on the longer-term approach to the design of the scheme, which provides some increased certainty for investors, there are still a significant number of areas where the details of the regulations remain to be agreed. It is essential that phase III of the scheme delivers a transparent, well-designed market that can help to deliver global emissions reductions objectives over the long-term. This will be particularly important in the context of any global agreement. It is essential that all sectors are fully engaged with the scheme to ensure that the most cost-effective reductions are delivered in a timely fashion. As part of this, the rules relating to free allocation in the non-electricity sectors will need to be closely scrutinised to ensure a harmonised approach across all EU installations. Prior to a global agreement it is also critical that robust criteria are used to judge those sectors subject to international competition and subsequently qualify for 100% free allocation. Changes made in reaching final agreement on the Directive may have undermined the prospects for this. However, following global agreement, there should be a clear expectation that no sector will continue to receive free allocation.

  9.  Providing early clarity and certainty about phase III and beyond will help to deliver investment in low-carbon technologies provided investors are confident that the scheme will not be subject to further political interference. The threat of further intervention in EUETS, for example price floors and ceilings, will only serve to undermine confidence in the scheme. Related interventions, such as suggestions of premature emission performance standards for the power sector are also unnecessary and are to be strongly discouraged. Having set a cap and allocation rules in place under the ETS, the market should be left to deliver the necessary emissions reductions. Setting additional regulatory requirements on sectors covered by the ETS risks undermining its cost effectiveness.

  10.  The interaction between renewable energy targets and the ETS also has the potential to create uncertainty in the carbon market. The rate of delivery of new renewables capacity will impact on carbon emissions and hence the price of carbon. Uncertainty around future carbon prices as a consequence of uncertainty around delivery of renewables will lead to uncertainty in alternative low-carbon technologies which will require investors to have confidence in long-term carbon prices to 2020 and well beyond.

  11.  The regulations setting out the method for auctioning allowances in phase 3 have not yet been agreed. The timing and method of these auctions will be important for the electricity sector and the carbon market as a whole. The electricity sector needs to be able to buy allowances to cover forward sales of electricity up to three years before actual emissions from the station. As the electricity sector accounts for nearly 50% of total emissions covered by ETS there is the potential for very high demand for allowances during 2011 and onwards. We believe that it is essential that auctioning for phase 3 starts during 2011 to prevent price volatility in both carbon and electricity markets. Whilst we are pleased that the importance of this now appears to be recognised by both the European Commission and the UK Government, we still have concerns regarding the short timescale to develop the regulations and implement necessary administrative arrangements to allow auctions to start on time across all Member States.

  12.  We recognise that Government should decide on priority for the use of revenues derived from EUETS auctioning through the budgetary process. However, investment in measures to reduce emissions of greenhouse gases and mitigate climate change should be seen as a priority. We consider that the revenues raised from auctioning could be used to stimulate transition to a low-carbon economy, provided this is done without distorting the carbon market.


  13.  A global carbon market will be important for delivering global greenhouse gas emissions targets, but it is currently too early to assess which regional trading schemes have the potential to link to the EUETS. Premature linking driven by political expediency has the potential to damage the carbon market. Rigorous assessment of the compatibility of schemes will be needed before linking can happen and the timing of linkage needs to be signalled well in advance to the market.

14.  The Clean Development Mechanism or its equivalent has a crucial role to play in facilitating the transition to a global market. We recognise that there are issues with the credibility and sustainability of certain types of projects that are currently allowed under internal climate policy. However, any changes to the qualifying criteria should be resolved at UN level rather than through unilateral action by the EU. Project developers need early certainty over the future acceptability of credits from projects to ensure minimum disruption to the flow of investments in low-carbon technologies and the associated emission reductions in developing countries.


  15.  We were pleased that the report from the climate change committee recognised that the UK carbon budget for the sectors covered by the ETS should be determined by the ETS cap for the UK and that JI/CDM credits and EUAs purchased to balance emissions in excess of the cap should be recognised as valid in meeting UK targets. The UK carbon trajectory is fundamentally linked to ETS caps and this needs to be made clear in future reporting of UK carbon emissions.

16.  It is important that the process of accounting for emissions against UK carbon budgets is transparent and in particular the difference between actual emissions and net emissions covered by the ETS is made clear. The recent consultation on carbon accounting illustrated how complex this could be and it is important that there is confidence in how the UK is demonstrating that it is meeting its targets.

March 2009

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