Memorandum submitted by RWE nPower
THE ROLE
OF CARBON
MARKETS IN
PREVENTING DANGEROUS
CLIMATE CHANGE
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.
KEY POINTS
— 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.
OVERVIEW
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.
THE EU EMISSIONS
TRADING SCHEME
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.
DEVELOPMENT OF
A GLOBAL
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.
UK CARBON BUDGETS
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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