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  1. EU ETS after one yearand prospects for the future Workshop 4 April NCM, Climate Change Policy Group

  2. Outline of presentation • Experiences so far • The second trading period • Links between the periods • Post-Kyoto

  3. High gas price UK Court ruling on UK NAP Last NAP approved ? Cold spells Imports of CDM credits Cuts in Italian NAP 69 Mt (9%) Cuts in Polish NAP 141,3 Mt (16,5%) Expectations are important! Mild weather Carbon price development 2005 Source: Point Carbon

  4. Observations and explanations • Allowance prices much higher than most expected before the system was launched • Potential explanations: • Changes in net demand due to: • Changes in allocation (supply) • ”Errors” in estimation of BAU emissions • Changes in underlying economic conditions • Changes in abatement costs • Changes in fuel prices • ”Errors” in estimation of MAC curves

  5. Changes in allocations • During review process cuts of almost 300 Mt were made • Poland: 141 Mt • Italy: 69 Mt • Czech rep: 31 Mt • France increased the allocations with ca. 100 Mt due to inclusion of more facilities • Late submissions and decisions

  6. Changes in allocations

  7. Other changes to net demand • Some differences in BAU estimates between submissions of national communications to UNFCCC and national allocation plans: • Higher estimates in NAPs • Economic conditions reduced emissions • Reduced steel production (8-10 Mt) • Labour market conflict in Finland (10 Mt) • Weather • Dry year in Spain • Hydro inflow reduced by 14 TWh, nuclear with 7 TWh • Wet in Nordic area • Hydro inflow 35 TWh above normal

  8. Abatement costs • Substantial changes in fuel prices • Affect cost of fuel switching • Large uncertainties about the actual abatements costs in different sectors

  9. Realized price effect Full price effect Marginal carbon cost Coal Gas Fuel switching depends on fuel prices Price Gas Coal Volume

  10. Fuel price developments during 2005

  11. Development of the market • Delays in national registries • Growing trade • Jan/Feb -05: 0.6 to 3 Mt/week • Nov/Dec – 05: 10 Mt/week • Total trade during 2005: 250 Mt

  12. MAC = Marginal abatement costs Max short-term abatement Supply curve 40 € MAC Pexp next period CER Carbon supply curve 2005-2007 Expectation: Lower price in next period P Allowances/gap

  13. Changes within EU ETS for Phase II • BUT mandatory inclusion of new sector/gases may affect the price • Aviation may be included in Phase II Price of allowances No opt out Little impact 10% auctioning Little/no impact 100€ penalty Little/no impact New gases/sectors Ambiguous price effect JI credits May reduce price

  14. Import of credits – uncertainties about supply • Nov. 15, 2005: 35 CDM projects registered (7.8 million CERs) • 400 projects at validation stage • 20 avaiting regitration • 57000 CERs issued into CDM registry • To 2012: 500 Mt CO2e not unlikely • But to whom? And when? • And JI from 2008

  15. The Kyoto period gap • Commission: • A number of countries not sufficiently on track • Unlikely that it can be closed without the ETS • Some MS will have to reduce – other keep unchanges • Allocation 6% below phase I (~130 Mt lower) • Imports of credits: Share to EU?

  16. Summary of price shapers Main price drivers: 2005 – 2007 Relative fuel prices First trading period Supply of CDM credits Expected price 2008 – 2012 Restrictions on imports Kyoto period Supply strategy AAUs Expected price Binding target? 2012 – … Beyond Kyoto Back-stop technology

  17. Preview of model results Allowance price

  18. Model simulations Workshop 4 April NCM, Climate Change Policy Group

  19. Model simulations for 2005-07 • Three cases • Base case with normal weather and actual fuel prices • Sensitivity with low gas prices in 2006 and 2007 • Sensitivity with actual events in 2005 • ECON’s carbon market model • Built on ECON’s European power market model • Added heat and industrial sectors in ETS • Covers the three year period 2005-07

  20. ECON Carbon market model

  21. Assumptions • Allocation of allowances • According to NAPs • Norwegian allowances added • Import of CERs • The level of import uncertain • Not analysed separately – but can be done through varying the gap • Economic growth • Assumptions based on ECON in-house analysis and forecasts from Deutsche Bank • Weather • Not modelled demadn varations due to weather, but analysed through sensitivity analysis

  22. Assumptions, cont. • Abatement costs and fuel prices • Power sector most important sector (in the short run) • Fuel prices based on observed spot prices for 2005 and forward prices for 2006 and 2007 • Seasonal variation in gas prices

  23. Assumptions, cont. • Generation and transmission capacities are actual capacities in 2005 and adjusted for known investments and closures in 2006 and 2007. • No endogenoues investments (short run) • Lower price elasticity of power demand in the short run (-0.2 to -0.4)

  24. Results – allowance priceBase case Allowance price

  25. Results – allowance priceSensitivity: Low gas price Allowance price

  26. Results – allowance priceSensitivity: Events in 2005 Allowance price

  27. The Kyoto period • No model simulations made • Simulations for 2005-07 indicate that a change in the gap (over three year) of 1 Mt change the allowance price with €0.1 • Price range: €15-70 • Without imports • MAC likely to be lower with more abatement possibilities

  28. Cost of CO2 emissions Fuel costs Different plants in different hours Short term power price effect Produce if: Power price > Marginal cost of fuel plus carbon Carbon allowances have an alternative market value Total capacity P>F+C: Sell power 100% free allocation: 100% windfall profit F<P<C: Sell credits P<F: Sell credits

  29. Effect on average price level Price Effect on average prices depends on capacity mix and load pattern Small effect Large effect No effect Small effect Volume

  30. Electricity price – base case

  31. Electricity price in Sweden 2005:

  32. Distortions of short-term price effects • Market power • Monopolists and oligopolists do not pass through the full marginal cost effect in bids • Withdrawal of allowances (within trading period) • Reduced emissions t1  reduced allocation t2: • Reduced value of selling credits/additional value of generating • ”Grandfathering” (between trading periods) • Emission level period 1 determines allocations period 2 (or 3)  Additional value of generating • Rules are not harmonized • Different rules in different countries affect trade

  33. Long term power price effect Invest if: Expected average price > Long-term marginal costs • ”Need” for allowances • What is BAU? • Benchmarking? • BAT? • Same allocation for all kWh • Long-term price effect: • Share of free allocations important • High share of free allocations • Smaller average price effect • Abatements on the supply side (more gas power) Purchase of Credits Long-term (expected) average price level Fuel costs (Expected) cost per kWh O&M costs Capital costs

  34. Allocation rules distort investment decisions • Outcome of free allocations: Investments are realized “too early” • Do not take into account the full cost • Distortion towards consumption • Reduced price effect reduces incentives for abatements and measures on the demand side • Distortion towards carbon-free capacity • Premium for fossil fuel plants (free allowances) • No premium for renewables and CO2 capture and storage • Distortion in choice between gas and coal? • DK: Same amount of free allowances NO • DE: Higher amount to coal YES

  35. Power price effects in the model • Full pass-through of marginal costs in short term (hourly) prices • Demand effects taken into account! • Different plants marginal in different hours  different cost increases in different hours • General pass-through: Average of all hours • Long-term pass-through determined by average cost effect on new plants • High share of free allowances: Small price effect  increased gas power investments and generation • Low share of free allowances: Large price effect  reduced consumption (and some new gas) • New investments and the gap • Assume free allowances are taken from NER and left-overs are cancelled

  36. Contacts Niclas Damsgaard Partner, ECON Analysis niclas.damsgaard@econ.se

  37. ECON – Contact information Oslo ECON Analysis Headquarter/ECON Management P.O.Box 5, N-0051 OSLO Biskop Gunnerus’ gate 14A Phone: +47 45 40 50 00 Fax: +47 22 42 00 40 (Analyse) Fax: +47 22 41 41 44 (Management) e-mail: oslo@econ.no Stavanger Kirkegaten 3 4006 STAVANGER Telefon: +47 45 40 50 00 e-post: stavanger@econ.no Stockholm Artillerigatan 42, 5 tr SE-114 45 STOCKHOLM Sweden Phone: +46 8 528 01 200 Fax: +46 8 528 01 220 e-mail : stockholm@econ.se Copenhagen Nansensgade 19, 6. sal DK-1366 København K DenmarkPhone: +45 33 91 40 45 Fax: +45 33 91 40 46 e-mail : copenhagen@econ.no Paris 18, rue de la Perle F-75 003 PARIS Frankrike Telefon: +33 1 45 78 70 03 Telefaks: +33 1 48 87 44 39 e-post: paris@econ.no