The EU Energy and Climate Package

David Harrison, Jr., PhDSenior Vice President

Eighth Annual Workshop on Greenhouse Gas Emissions Trading sponsored by IEA, EPRI and IETA

Paris, 23 September 2008

Interactions between EU Policies and Targets and Implications for CO2 Price Uncertainty

Per KlevnäsConsultant

2

Agenda

Overview of the EU Energy and Climate Package

Policy instruments for the attainment of targets

Interactions and market impacts of policies

Impacts of uncertainty of meeting targets

Implications for market participants

Concluding remarks

3

20/20/20 Targets for EU Climate Policy

1. CO2: 20% reduction relative to 1990 – 30% with international agreement

2. Renewables: 20% of total energy consumption – implying some 40% of electricity production

3. Energy Efficiency: 20% reduction in energy consumption relative to “business as usual”

Targets seem motivated mainly by climate change concerns

Other objectives include energy security

4

Mix of Policies and Approaches is in Place to Achieve Targets

CO2 reductions mainly through proposed reformed EU ETS

– Aim of predictability and stable CO2 price through EU-wide and long-term cap

– Increased scope, harmonisation, and elimination of ”distortions”

Renewable Energy through binding national targets and Member State policies

– Patchy policy for transport and heat means focus on electricity

– Tradable green certificates (PL, SE, BE, IT, UK, etc.) and feed-in tariffs (DK, NO, DE, FR, IR, etc.)

– Potential EU-wide trade in certificates / guarantees of origin – but feasibility and relevance not clear (everyone’s target is ambitious)

5

Mix of Policies and Approaches is in Place to Achieve Targets

Energy efficiency through “indicative” national targets and action plans

– No agreement on EU-wide policy but interest in tradable white certificates (FR, IT, UK, etc.)

– Key role in policy mix – but unclear evidence for low-cost savings and checkered policy history

Patchwork of other policy indicate little consensus on ”market-based” approach

– CHP, CO2 standards for cars, heat sector renewables, biofuels for transport, microgeneration, support for nuclear, etc.

Multiple policies are in place

Interactions between policies add further complexity

6

Policy Interactions: Renewables and Energy Efficiency Affect the EU ETS

Lower ”BAU” CO2

emissions

Renewables policy

Lower fossil fuel burn

Energy efficiency policy

Reduced energy

consumption

EU ETS

7

Impact of RE/EE on CO2 (EUA) Market

RE/EE lowers emissions and cost of meeting given emissions cap

EUA price depends on success of renewables and EE policy

Marginal abatementcost curve

CO2 emissions (tCO2)

Marginal cost / EUA price (€/tCO2)

Emissions cap

BAU Emissions

Lower CO2 price with RES/EE policyEUA price

(RES/EE)

Emissions with RES/EE

EUA price

8

Policy Interactions Could Be Quantitatively Significant

Commission modelling suggests EU 2020 CO2 target could be met entirely through renewables and energy efficiency

Implication / unintended consequence: ”No need for CO2 price” ?

EU 27 CO2 emissions (MtCO2)

Sources: Eurostat, EC ’Impact assessment for Renewable Energy Roadmap’ SEC(2006) 1719, DG TREN ‘Scenarios on renewables and energy efficiency’

BAU forecast

CO2 2020 target

Green-X forecast

PRIMES forecast

3,000

3,250

3,500

3,750

4,000

4,250

4,500

2000 2005 2010 2015 2020

9

0

50

100

150

200

250

300

350

400

1990 1995 2000 2005 2010 2015 2020

EU27 Renewable energy (total, Mtoe)

But ... Achieving the Targets Looks a Tall Order

2,000

2,500

3,000

3,500

4,000

4,500

1990 1995 2000 2005 2010 2015 2020

DG TREN Baseline

2020 target

EU27 CO2 emissions (MtCO2)

1,000

1,200

1,400

1,600

1,800

2,000

2,200

1990 1995 2000 2005 2010 2015 2020

2020 target

DG TREN Baseline

EU27 Energy Consumption (Mtoe)

0

200

400

600

800

1,000

1,200

1,400

1,600

1990 1995 2000 2005 2010 2015 2020

2020 target

Current trend

DG TREN Baseline

EU27 Renewable electricity (TWh)

Sources: Eurostat, European Environment Agency, DG TREN, IEA and NERA calculations

2020 target

Current trend

DG TREN Baseline

10

Attainment of Past Targets Is Proving Elusive

2010 Target EU27 Renewable electricity (TWh)

0%

5%

10%

15%

20%

25%

1990 1995 2000 2005 2010

2010 Target EU27 Renewable energy (TWh)

0%

2%

4%

6%

8%

10%

12%

14%

1990 1995 2000 2005 2010

11

Additional Reasons Attainment of Targets Looks Uncertain

Much of past emissions reductions have been a cheap ride (e.g., “dash for gas”), but costs are increasing

Hope of low or even “negative-cost” reductions through energy efficiency may prove unrealistic

Resigned acceptance of high costs not universal in the EU

– Challenges to Phase II NAPs (modest cuts only), “Hungarian proposal” for EU ETS, “Polish proposal” for auctioning

12

Additional Reasons Attainment of Targets Looks Uncertain (contd.)

Revision of transport renewables targets likely given controversy over biofuels

Unease about industrial competitiveness implications of continued EU unilateral approach

Unclear consumer / voter tolerance of higher energy prices – cf. recent commodity price increases

Unclear how legally “binding” targets can be enforced on EU level (cf. budgetary rules)

Despite strong apparent current commitment, the attainment of the 20/20/20 targets is highly uncertain

13

Interactions and Uncertain Attainment of Targets Lead to Uncertain CO2 Price

Marginal abatementcost curve

CO2 emissions (tCO2)

Marginal cost / EUA price (€/tCO2)

Uncertain attainment of RE/EE targets leads to uncertain EUA prices

Note: Price uncertainty greater with firm CO2 cap

Possible CO2 prices with RE/EE policy

High price

Low price

Emissions cap

BAU Emissions

Possible emissions with RE/EE policy

14

Implications: Long-Term CO2 Price

Certainty May Be Elusive

Major apparent aim of recent (Jan 2008) EC proposals to reform EU ETS is to increase price EUA certainty

– Longer phases, set cap until 2020

– Introduce full banking and some borrowing

– Lay out rules for CDM/JI or similar credits

– Pre-defined allocation schedule until 2020

20/20/20 interactions may undermine these efforts:

– Modelling suggests very low CO2 prices possible if RE/EE targets were met

– Current trends, past performance, high cost suggest targets may not be met—but gulf between targets and results highly uncertain

Wide range of CO2 prices possible under 20/20/20 approach

15

Implications: Challenges for Current Assets and for Investment

Impacts on asset values, especially coal

– Renewables and energy efficiency imply shrinking market for conventional generation – but by how much?

– Uncertain CO2 price leads to uncertain generation and net revenues

“Caveat investor”

– Significant new capacity required in EU, but unclear how much will be met by renewables

– Planning for new fossil generation? Amount? Technology?

Auxiliary market effects also complicated by interactions

– E.g., competition for biomass resource, interaction with fuel prices

16

Concluding Remarks

Interactions of renewables/energy efficiency targets and policies with EU ETS risk compromising objective of CO2 price stability

– Attainment of RE/EE targets highly uncertain, leading to CO2 price uncertainty

Effects in “other direction” add further complications – level of CO2 prices influences attainment of RE and EE goals

General lesson: interactions of market-based and “command-and-control” approaches can yield unexpected results

– Relevant to a number of current policy proposals (EU, California, etc.)

Further analysis in NERA study of policy interactionshttp://ec.europa.eu/environment/climat/pdf/ec_green_final_report051117.pdfhttp://ec.europa.eu/environment/climat/pdf/ec_green_summary_report051117.pdf

Contact Us

David Harrison, Jr., PhD

Senior Vice PresidentBoston+1 617 621 2612david.harrison@nera.com

© Copyright 2008NERA UK Limited

All rights reserved.

Per Klevnäs

ConsultantLondon+44 20 7659 8848per.klevnas@nera.com