Trading scheme policy design and international finance benefits

1. Trading scheme policy design and international finance benefits Variations on the PAT scheme design Integration with international finance mechanisms Date: 17 February 2010 Keith Regan

2. The PAT scheme is an innovative design • The focus on EE enables the targeting of both production and consumption without the “double counting” issues created within the EU ETS (in the PAT scheme, reduced consumption downstream does not automatically lead to an upstream benefit for the electricity generation sector) • The focus on energy efficiency allows the PAT scheme to tackle both energy production and consumption Power generator (upstream) Power consumer (downstream) Produces 100 MWh less electricity, but still has the same intensity target No ESCerts awarded Saves 100 MWh electricity through efficiency savings ESCerts awarded

3. The scheme’s “coverage” could be extended over time • The PAT scheme could be extended on a Mandatory basis over time, or even on a Voluntary basis Smallerinstallations Deepening Deepening Deepening Deepening PAT PAT PAT PAT Broadening Broadening Larger installations Power sector Iron and steel Cement Remaining 9 EI sectors The 7 non-PAT sectors Other non-EI industries

4. ESCerts & Energy Usage Allowances: Liquidity and volatility risk • The volume of Energy Usage Certificates in circulation and trade-able (the red area) would be higher than ESCerts issued for beating the target. This is likely to lead to greater trading liquidity in the market • When targeted efficiency savings increase over time, the savings expected in early years might be particularly small • When there is a deviation from expected performance (under/over achievement) that performance is a % of a larger number. Large volume deviations (compared to the commodity base) could cause volatility x 2 Energy saving target Implied energy usage target Actual energy used x 0.9 Energy intensity x volume of production Yr 1 Forecast Yr 1 Achieved Yr 1 Yr 2

5. Introducing liquidity into the trading system: Auctioning • In order to improve liquidity, the government of India could: • Denominate the scheme in Energy Usage allowances, allocating a proportion “ex-ante” • Auction (ex ante) either ESCerts or Energy Usage Allowances Additional advantages of auctioning: Use of auction revenue • Market purchases to support prices • Investment support for industry (e.g. matched investments, accelerated depreciation) Energy saving target Energy usage allowances 50% auction potential Auctioningallowances AuctioningESCerts

6. The rationale for considering international finance

7. The rationale for considering international finance MAC curve Cost of securing savings Energy saving investments resulting in a net benefit to industry Energy saving investments resulting in a net cost to industry Energy saving investments resulting in a net benefit to industry Energy saving investments resulting in a net cost to industry EU ETS Phase 1 and CCA target setting A Investment opportunities • In theory, projects with positive NPVs should already have been identified and undertaken. Historically this has not held true because of market imperfections (management awareness, capital availability) • When the cost of investment in energy efficiency projects outweighs the benefits of reduced energy costs (the blue block-shaded area) industry will demand PAT certificates, and the price will be positive

8. The rationale for considering international finance MAC curve Cost of securing savings Zero PATscheme price Positive PATscheme price Energy saving investments resulting in a net benefit to industry Energy saving investments resulting in a net cost to industry A Investment opportunities • In theory, projects with positive NPVs should already have been identified and undertaken. Historically this has not held true because of market imperfections (management awareness, capital availability) • When the cost of investment in energy efficiency projects outweighs the benefits of reduced energy costs (the blue block-shaded area) industry will demand PAT certificates, and the price will be positive • If there is to be an ESCert price >0, the PAT target (represented by the black vertical line) will need to be located in this blue-shaded area of the MAC curve. To use CDM language, the black line above could be said to represent the boundary between “additional” and non-additional projects • A positive ESCert price = a cost to industry = “additional” action = possibility of international finance

9. International Finance: Reducing costs for Indian industry • GOI set a PAT scheme energy saving target that results in a “cost of compliance” X • Over-achievement is achieved through tightening measures that push the ESCert price up to Y • International finance could be provided to support Indian industry make the additional investments required to go beyond the PAT targets • International finance (e.g. low carbon growth funds) • Offset-based Finance Target setby GOI “Over-achievement” Cost of securing savings Energy savings costs to industry as a result of the PAT scheme International finance to help support increase energy savings Y X C B Investment opportunities

10. Reducing the supply of ESCerts to “create” over-achievement • Allowing the banking of certificates from one phase into the next would shorten the current phase (but increase supply in the subsequent phase) • Allowing an international link where PAT scheme participants can exchange ESCerts for carbon credits (e.g. CERs) • Government of India buys and retires issued ESCerts during scheme operation • Government of India tightens the overall targets upfront or during a periodic review Target setby GOI Reduced supplyof ESCerts Cost of securing savings Energy savings costs to industry as a result of the PAT scheme International finance to help support increase energy savings Y X C B Investment opportunities Over-achievement mechanisms that could generate carbon offsets

11. A possible structure for securing international finance Government Of India Establishment of scheme Trading scheme administrator Allocation of ESCerts Installation 1 ESCerttrading Installation 2

12. A possible structure for securing international finance Domestic finance fund Internationalfinance Government Of India Optional creation of fund carbon credit pool / fund Establishment of scheme Markettightening through purchases Trading scheme administrator Allocation of ESCerts Installation 1 Soft loans / other finance ESCerttrading Installation 2