Memorandum submitted by E.ON UK
SUMMARY
In the EU, the EU Emissions Trading Scheme (EU
ETS) has been adopted to ensure that emissions across the EU from
the sectors covered do not exceed a level consistent with the
EU's overall climate change targets.
Concerns about the effectiveness of the EU ETS
could be addressed by moving to a tighter EU emissions cap for
the third trading period which begins in 2013, and extending the
period from 2020 to 2030 or later. This would significantly sharpen
price signals and ensure these were maintained over the longer
timescales needed for new investments.
Emissions Performance Standards (EPSs) have
drawbacks of their own. Any reductions in CO2 emissions
achieved through the implementation of an EPS in the UK additional
to those that would have been achieved through the EU ETS would
be entirely offset by higher emissions elsewhere in the EU within
the overall EU ETS cap, so there will be no net reduction in EU
emissions.
An EPS can also create new risks which can substantially
increase the discount rates applied to new investments, and ultimately
determine whether an investment proceeds or not. The fundamental
problem is whether companies will be confident that the market
or the energy policy framework will fund the required investment
to achieve the EPS.
These risks need to be addressed if an EPS is
to play a role. There is no point having an EPS which energy companies
are unable to meet because they are not confident of their ability
to recover the costs involved. This issue has already been recognised
in the US.
An EPS will not drive the development of carbon
capture and storage (CCS) technology at all unless investors believe
they will recover the costs associated with the investment needed.
The key issue then is less the EPS but more whether there will
be sufficient incentives to support the required investment to
deliver CCS.
The main risk for security of supply arises
from the effect of implementing an EPS without establishing first
whether the necessary investment is capable of being funded by
the market or by Government policies. This means that consideration
of EPSs and electricity market reform need to be considered together.
We agree that Government should also consider
the case for demonstrating CCS on gas-fired plant, although in
our view the priority is to demonstrate CCS on coal as new coal
plant is already required to fit CCS and this has much wider international
relevance.
OVERVIEW
1. EPSs have been adopted in California
and a number of other states in the western US to ensure that
CO2 emissions from new baseload power stations or imports
from outside the state are below a given level, typically 1100lbCO2/kWh
(499kgCO2/kWh). The EPS does not apply to new capacity
operating at load factors below 60%, so allows the construction
of higher carbon plant which might be needed to maintain security
of supply during periods of high demand. The level of the EPS
prevents the construction of new coal plants, while still permitting
the construction of gas-fired CCGTs and appears intended to shift
the fossil fuel mix over time to a lower carbon content as new
plant is built. However, while the measure is designed to incentivise
developers to come forward with low carbon generation, it does
not appear to have been focused primarily at incentivising development
of CCS. There are also no state proposals to set an EPS which
requires CCS on new gas plant.
2. In the EU, the EU ETS has been adopted
to ensure that emissions across the EU from the sectors covered
do not exceed a level consistent with the EU's overall climate
change targets. This approach is consistent with a single European
market, and leaves the market to identify the most economic options
for achieving the reduction targets, taking account of other factors
such as security of supply and affordability for consumers. This
approach has merit from a climate change perspective given the
need to achieve climate change, security of supply and affordability
goals together.
3. Broadly speaking, support for an EPS
in the UK has reflected a lack of confidence by NGOs initially,
and subsequently by the Climate Change Committee, in the ability
of the EU ETS to provide sufficient incentives to support the
delivery of new low carbon generation and to ensure that CO2
emissions from the UK power sector are sufficiently restricted
to meet the UK's national targets, which go beyond those set at
EU level. This is understandable, given the limited economic incentives
so far provided by the EU ETS, but these concerns could be addressed
by moving to a tighter EU emissions cap for the third trading
period which begins in 2013, and extending the period from 2020
to 2030 or later. This would significantly sharpen price signals
and ensure these were maintained over the longer timescales needed
for new investments.
4. EPSs also bring their own set of problems.
First, at the EU level, any reductions in CO2 emissions
achieved through the implementation of an EPS in the UK additional
to those that would have been achieved through the EU ETS would
be entirely offset by higher emissions elsewhere in the EU within
the overall cap. This will raise the overall cost to the EU of
achieving the target as the emission reductions achieved in the
UK could probably have been achieved at lower cost elsewhere.
In other words implementation of an EPS in the UK will not give
rise to lower net CO2 emissions globally, although
proponents may argue that there are indirect effects from the
UK taking a position which prohibits the construction of unabated
coal plants.
5. Second, from the perspective of an investor
in new generating capacity, an EPS can create new risks which
can substantially increase the discount rates applied to new investments,
and ultimately determine whether an investment proceeds or not.
The fundamental problem is whether companies will be confident
that the market or the energy policy framework will fund the required
investment to achieve the EPS and equally, if it is later tightened
further, whether it will be able to fund that. To the extent that
this depends on the development of a technology such as CCS, which
is yet to be demonstrated at commercial scale and which has an
uncertain cost, the risks associated with any investment will
be substantially higher.
6. This problem becomes more severe if an
EPS is set at a level which requires CCS on gas as well as coal
as energy companies would not have the option to invest in unabated
gas-fired CCGTs.
7. These risks need to be addressed if an
EPS is to play a role. There is no point having an EPS which energy
companies are unable to meet because they are not confident of
their ability to recover the costs involved. While companies would
continue to be able to invest in renewable or nuclear capacity,
it will deter investment in the more flexible new coal and CCS
capacity or new gas-fired plant which will be required to maintain
security of energy supply from 2017 onwards.
8. This factor was recognised in the US
in the work done by the US Climate Action Partnership (USCAP).
USCAP comprised leading industrial brands, including utilities,
and environmental organisations. It came together before the US
election to seek to devise a route-map to a US legislative programme
on climate change. They collectively devised a blueprint covering
a range of issues, in which coal was a major consideration. The
parties agreed a package comprising of three points of a triangle:
An EPS for new coal-fired plant; and
Enhanced financing package seeing CCS
through from demonstration to deployment.
9. Importantly, USCAP made the different
parts of the triangle conditional on one another - thereby ensuring
the package was not unpicked. Therefore, when they suggested an
EPS of 1100lbCO2/MWh for all plant permitted after
2015 and 800lbCO2/MWh for those permitted after 2020,
these EPS steps were conditional on the government adopting the
USCAP financing proposals. If the finance was not in place for
some reason, the EPS would be delayed until it was.
10. The following paragraphs respond to
the specific questions raised by the Committee.
What are the factors that ought to be considered
in setting the level for an Emissions Performance Standard (EPS)
and what would be an appropriate level for the UK? Should the
level be changed over time?
11. Consideration needs to be given to a
wide range of factors. What is the basic policy intentis
it simply to prevent construction of unabated coal plant or is
it also to incentivise lower carbon technologies including CCS?
If the latter, is the technology commercially available to deliver
the EPS and, if not, what are the prospects of it becoming available
and by when? What is the right timescale for introduction to allow
companies to factor the requirement into investment decisions?
The form it takesis it in gCO2/kWh or, say,
a limit on annual operating hoursalso needs to be addressed
as does the period of operation over which it is applied. For
example, is the EPS applied continuously or averaged over a longer
period to provide some flexibility? In our view, the cost of compliance
needs to be understood before setting an EPS (and this will not
be known for some years until we have successfully demonstrated
CCS technology), as well as whether the electricity market and
the policy framework within which it operates will incentivise
the required investments. This may not be clear until the process
of electricity market reform is complete and the costs
of compliance are known.
12. Whether an EPS should be tightened over
time depends on the policy goal. If a decision is taken to introduce
an EPS, it could either be set at a fixed level to prevent construction
of higher carbon plant with the EU ETS driving investment below
that level. Alternatively, if the EPS is adopted as the main driver,
it could be tightened over time as and when CCS technology becomes
available and as CCS costs reduces, subject to the market and
the policy framework incentivising the necessary investment. However,
energy companies would want to be clear what future requirements
will apply to proposed new plants before they take an investment
decision. The EPS should not be changed for new plants after the
investment has been committed, unless the investor can fully recover
the related costs.
What benefit would an EPS bring beyond the emissions
reductions already set to take place under the ETS?
13. We have already pointed out that any
reduction in emissions achieved in the UK would be offset by higher
emissions elsewhere in the EU within the overall EU ETS cap. From
a purely national perspective, it is difficult to say what benefit,
if any, the UK would secure in terms of lower emissions from implementing
an EPS compared to the EU ETS, not least because this depends
on what assumptions are made about future carbon prices and the
level of the EPS. If the EPS is set at a level which requires
CCS on coal but not on gas, this would only lead to lower emissions
if the EU ETS carbon price and relative coal and gas prices otherwise
incentivised unabated coal plant. Of course it is possible to
set an EPS which prevents construction of any unabated coal or
gas plant. While this would avoid the emissions from the unabated
plant which would otherwise have been built, the emission savings
from an EPS need to be considered against the impact on power
prices and security of supply.
14. Overall these outcomes could be achieved
more efficiently by tightening the EU ETS cap which would give
rise to a higher carbon price in which case the effect would be
EU wide and the cost of delivering lower emissions would be spread
more evenly across Member States. It could also be achieved by
introducing more effective policies to incentivise construction
of nuclear plants or CCS which would achieve the desired goal
of accelerating investment in low carbon plant, accelerating the
closure of existing plant and disincentivising investment in new
unabated coal plant without imposing an EPS. This should be the
goal of the Government's electricity market reform process.
How effective is an EPS likely to be in driving
forward the development of CCS technology? Should the UK's CCS
demonstration programme cover gas-fired as well as coal-fired
power stations?
15. An EPS will not drive the development
of CCS technology at all unless investors believe they will recover
the costs associated with the investment needed. The key issue
then is less the EPS but more whether there will be sufficient
incentives to support the required investment to deliver CCS.
16. The recommendation by the Climate Change
Committee (CCC) that the Government should seriously consider
including CCS gas demonstration reflects the view that gas-fired
plant may make up a significant proportion of new capacity operating
in the 2020s, that some of this will need to be retrofitted with
CCS to achieve its recommended goal of largely decarbonising the
power sector by 2030, and that new gas-fired plant with CCS may
be a more economic option than coal with CCS particularly for
plant operating flexibly at relatively low load factors. We agree
that the Government should consider this issue in more detail
and should consult fully before reaching a decision.
17. The issue on gas CCS is perhaps more
one of timing than whether CCS should be demonstrated on gas in
principle. For coal, there is a requirement already that any new
coal plant has a CCS demonstration project and an expectation
that new coal plant would be retrofitted with CCS by 2025. In
addition, from an international perspective, the priority is to
fit CCS to new coal plant, which is still accounting for the majority
of new build in developing countries such as China, rather than
gas. All these arguments suggest that gas CCS demonstration should
proceed later than for coal with the common engineering lessons
from coal CCS demonstration then applied to gas.
18. For gas, the CCC is not arguing that
new gas plant should have to be fitted with CCS until 2020. It
is also not arguing that retrofit should be mandated on gas plants
commissioned before that date, which would risk chilling any proposed
investment between now and then. This raises the question of whether
it is actually sensible to demonstrate gas CCS now, when
no CCS would be operating on gas plant until 2020 at the earliest.
19. The volume of new gas plant that will
in fact be built from 2020 and the need for gas CCS will depend
in part on relative coal, gas and carbon prices at the time which
are of course highly uncertain but may become somewhat clearer
by the mid 2010s. How much new nuclear and renewable plant is
operational in the 2020s will also be an important factor in determining
the future role of gas plant on the UK system and whether CCS
on gas plant will be required to achieve the CCC's target of largely
decarbonising the power sector by 2030.
20. The CCC view that a new gas-fired plant
with CCS may have lower levelised costs than a new coal plant
with CCS needs to be assessed more fully. This view is based on
the Mott Macdonald report published by DECC on 1 June 2010 but
is particularly dependent on assumptions about the relative price
of gas and coal for power generation in the future. Relative capital
costs are also a significant factor and in our view the report
may underestimate the capital cost of a gas-fired plant with CCS.
The following "phase diagram" gives our very rough estimate
of what plant is the cheapest to build against varying gas and
CO2 prices assuming a constant price of coal.

21. There would also need to be a discussion
about whether we should be supporting pre or post combustion on
gas, or indeed oxy-fuel combustion. Oxy-fuel combustion currently
appears likely to be the best option for gas in the long-term
but it is the least advanced technology. These issues need to
be fully debated before a decision is reached by DECC on whether
supporting gas CCS now through the CCS levy is value for money
for the consumer.
Could the introduction of an EPS pose any risks
to the UK's long-term agendas on energy security and climate change?
22. The main risk for security of supply
arises from the effect of implementing an EPS without establishing
first whether the necessary investment is capable of being funded
by the market or by Government policies. This would lead to power
plant investments, whether on coal or gas, depending on the level
of EPS, being deferred until this has been resolved. This also
applies to CCS demonstration projects on new plants as investors
will want to know how CCS retrofit requirements subsequent to
the demonstration will be funded. This means that consideration
of EPSs and electricity market reform need to be considered together.
Without this an EPS would disincentivise investment in new fossil
(gas or coal) plant and could lead to an increased dependence
on nuclear and intermittent renewables generation which are less
able to operate flexibly to meet variable electricity demand which
could significantly reduce energy security.
23. We have already pointed out that an
EPS is a fundamentally different approach from emissions trading.
We are concerned that the increasing focus on an EPS approach
will lead to undermining of the EU ETS which is the principal
policy mechanism for tackling CO2 emissions and that
EU efforts to reduce emissions will be undermined.
What is the likely impact of an EPS on domestic
energy prices?
24. This depends entirely on what assumptions
are made about the extent of investment required to deliver an
EPS, the level of the EPS set, what plant it is applied to, the
extent to which the investment is incentivised by the carbon price
or additional incentives such as the CCS levy, and the level of
electricity prices had an EPS not been introduced. If the EPS
is set at a level which requires more CCS than under current policy,
then the effect will be to raise power prices and prices to the
domestic consumer.
25. Assuming no policy interventions to
fund CCS, investors would in principle only invest in fossil plant
with CCS if they believed wholesale power market prices allowed
them to recover the cost of the relevant investment. On this basis,
and as a very rough estimate, power prices would need to rise
by at least 25% to deliver this outcome for first of a kind CCS
plant, although this would fall as CCS costs declined. As power
prices account for about half of retail prices to domestic consumers,
this would lead to an increase in domestic prices of at least
12%. However, wholesale prices would only rise to this level if
fossil and CCS plant were the lowest cost new capacity available.
In practice new nuclear is likely to be significantly cheaper
so market prices would not rise to this level. This means that
additional support would be needed to fund fossil plant with CCS.
The estimated maximum impact on domestic bills of the Government's
CCS demonstration programme is around 2-3% but this only covers
the cost of around four projects of around 300-500MW each.
Are any other European countries considering an
EPS? If so, should the standards be harmonized?
26. Not that we are aware of, although the
issue has been discussed in the European Parliament. The EU's
principal policy measure for reducing CO2 emissions
is through the EU ETS. The Industrial Emissions Directive in fact
prohibits Member States from imposing plant specific CO2
limits under the IPPC regime as the EU ETS is intended to be the
main driver. Given the lack of wider interest by Member State
governments and the Commission's view that the EU ETS is the priority,
we see no need to harmonise EPS standards.
Could unilateral action by the UK to introduce
an EPS contribute towards global climate negotiations in Cancun
in November 2010?
Can greater use of Emissions Performance Standards
internationally help promote agreement on global efforts to address
climate change?
27. While the commitment not to permit the
operation of unabated coal plant could have a modest impact, it
could also be seen as a demonstration of a lack of confidence
in the EU ETS and emissions trading. The EU and the UK have hitherto
aimed to extend the use of emissions trading from the EU to encompass
other countries. The EPS is a fundamentally different approach.
The international community would perhaps be more impressed by
seeing CCS demonstration proceeding on a commercial scale than
statements of policy intent.
September 2010
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