Climate change and incentives for energy technology innovation

Presentation to Ernst & YoungEnergy Training EventCambridge, 14 September 2003

Michael Grubb, Associated Director of Policy, The Carbon Trust

Visiting Professor of Climate Change and Energy Policy, Imperial College, London, &

Senior Research Associate, Department of Applied Economics, Cambridge University

Imperial College OF SCIENCE, TECHNOLOGY AND MEDICINE

Overview

• The international instruments - UNFCCC and Kyoto Protocol• The ‘Kyoto crisis’ of 2001-2 & implications• Elements of Bonn/Marrakesh Accords on

Implementing Kyoto• European implementation - overview • Economic instruments and European emissions trading directive• Technology and innovation incentives –

overview• The UK Programme

The international instruments:• The UN Framework Convention on

Climate Change (UNFCCC)• The Kyoto Protocol to the UNFCCC

UN Framework Convention on Climate Change

• Adopted 1992, Entered into force 1994, 181 Parties• Ultimate Objective: Stabilise atmospheric concentrations

at a level that would prevent ‘dangerous’ anthropogenic interference

• All Parties obliged to address climate change:– Formulate, implement, publish & regularly update national

plans .. – Communicate information related to implementation

• Industrialised countries (Annex I Parties)– Must demonstrate taking the lead – Adopt policies & take corresponding measures on the mitigation

of climate change– Aim to return greenhouse gas emissions to 1990 levels

• Annual Conference (COP) to review adequacy of action and propose additional measures if required

The Kyoto Protocol: core elements

• Binding commitments to limit greenhouse gas emissions for each industrialised country (‘Annex I’): specific binding commitments are a qualititative leap, bringing much complexity

• Defined for first ‘commitment period’ 2008-2012; subsequent periods to follow

• ‘Basket’ of six greenhouse gases (CO2 main), plus some allowance for sinks / land-use change and forestry

• Collective commitment, to reduce Annex I emissions to 5% below 1990 levels by first commitment period

• Range of other provisions concerning activities in developing countries, technology transfer, policies and measures, etc.

Kyoto’s first-period quantified commitments

Kyoto’s first-period quantified commitments

Region Percentage reduction

from 1990 levels

EU -8USA -7Japan -6Canada -6Australia +8Russia and Ukraine 0

Mechanisms for international transfer

• ‘Bubbling’ - used by the EU - to redistribute targets amongst a group of countries

• UK, -12.5%• Germany, -21% • France, 0• Greece, +25%

• Project-investment crediting amongst Annex I parties (‘Joint implementation’)

• The Clean Development Mechanism• Credits for investments in developing countries that

contribute towards sustainable development and reduce GHGs

• Emissions trading• Allows countries to ‘trade’ parts of their allowed

emissions

Structure of International Emissions TradeStructure of International Emissions Trade

Government A

Industry A Industry B

Government BAssigned amount

Register

Corporate allocation & authorisation

Register

Permit

The ‘Kyoto crisis’ of 2001-2 and its outcome

The Kyoto Crisis of 2000-1 �Nov 2000 Collapse of COP6 Hague negotiationsMar 2001 Whitman says ‘reviewing .. not walking away’, but

then Bush rejects Kyoto as ‘fatally flawed .. and unfair to America’

Apr - June Widespread assumption that Kyoto will collapse; but EU extracts promise of US non- interference if rest of world goes ahead

July No US counter-proposal; COP6 resumedBonn negotiations reach political agreement

Oct - Nov Still no US counter-proposal;Marrakesh COP7 finalises legal details

Nov 2001 All key parties indicate they expect to ratifyDec 2002 Canadian ratification brings tally to 100: only Russia still

needed

Why did most of world back Kyoto?

• Sound structure that any regime of binding commitments would need:– Multi-year target periods give scope for national variations in circumstances,

and for future development of responses– Multiple gases, some carbon sinks, international mechanisms make it

uniquely efficient agreement and create worldwide engagement

• Demonstration and momentum:– demonstrate that EU and others are serious– maintain institutional ‘learning by doing’– promote technological development– give private sector greater certainty and basis for investments– lay groundwork for next phase

• Political imperative: legitimacy of international system and a decade’s investment at stake

The Bonn-Marrkesh Agreement on implementing the Kyoto Protocol:

structural elements

• Finance– Climate change fund and LDC fund under the Convention – Adaptation fund under the Kyoto Protocol

• Carbon Sinks– Concessions on managed forests to Japan, Canada, Russian weaken

aggregate target c. 4% points equivalent– Other sinks included on comprehensive but carefully monitored basis

• Compliance– Reaffirmation of legally binding nature of KP– Enforcement branch, penalties for non-compliance

• Kyoto Mechanisms

Entry into force: Russia now holds the key ..

• Requires 55 countries to ratify (111 have now done so)

• .. Including 55% of industrialised countries’ CO2 emissions in 1990

– European Union-15 24.2%– Japan 8.5%– Canada 3.3%– Poland 3.0%– Other EU-Accession & Baltics 3.4%

Total as of Sept 2003 43.4%– Awaited: Russia 17.4%

• US 36.1%• Autralia 2.1%

Are the Russians coming ...?

• Russia benefits from Kyoto, but internal disputes: ‘hot air’ or real investment, longer term implications?

• Monday 8th Sept: Russian Min. Natural Resources passes Kyoto to Govt to initiate formal process

• Likely that Putin will pass it to Duma end of this month: Duma lined up for quick ratification (but its Russia, and the US is discouraging it ….)

• Focus will emerge on project mechanisms and use of revenues from emissions trading

• A new Europe-Russia climate-energy dialogue?– Prodi initiative– Reaction to US & fear of loss of Protocol

• Gas and energy investment will be the beneficiaries

EU & UK Implementation of climate / Kyoto goals: overview, and focus on emissions trading

Total EU greenhouse gas emissions in relation to the EU’s Kyoto target

96,0

92,0

98,4

80

90

100

110

120

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Inde

x

Greenhouse gas emissions Kyoto target path 2008-2012

Kyoto target 2008-2012 CO2 Emissions

Kyoto target

Progress of Individual Member States

-0,4

-30,7

-9,3

-8,4

-1,1

-0,3

-0,2

5,7

6,1

7,3

8,5

8,8

10,2

13,5

16,3

16,5

-40,0 -30,0 -20,0 -10,0 0,0 10,0 20,0

EU-15

Luxembourg

Germany

United Kingdom

Finland

Sw eden

France

Greece

Belgium

Italy

Austria

Netherlands

Portugal

Denmark

Ireland

Spain

Distance to target indicators (DTI): difference between (linear) targets and trends in 1999:

European Climate Change Programme (ECCP): Results

• Some 40 cost-effective policies and measures with an emission reduction potential of some 664 - 765 Mt CO2 eq (± twice EU target)

• Overall costs for EU target in 2010: 3.7 € bn / 0.06 % of GDP

‘Cost effective’ GHG reduction potential for sectors in EU to 2010

(including full implementation of the ACEA Agreement)

Marginal cost€20/tCO2 eq

Emissions1990 or 95Mt CO2

equivalent

Baselineemissions for2010 withexistingmeasures

Cost-effectivepotential beyondbaselineprojection for2010

Energy sector 1422 -6% -13%

Industry 757 -9% -12%Transport 753 31% -4%Households 447 0% -6%Services 176 14% -15%Agriculture 417 -5% -4%Waste 166 -18% -13%Total 4138 1% -9%

ECCP - Most promising measures

• EU wide emissions trading

• renewable energy sources

• energy performance of buildings

• energy-efficiency standards for equipment

• energy demand-side management

• combined heat and power generation

• containment / monitoring of fluorinated gases

• modal shift in transport (infrastructure use & charging)

Carbon / energy taxes in Europe

Ten European countries have energy or carbon taxes ...(CO2 tax : Denmark, Finland, France, Italy, Norway, Netherlands, Switzerland; Energy tax : Czech Republic, Germany, Netherlands, UK)

although tax levels differ ...(e.g., Finland: $19 / ton CO2, France : $25 - $35 / ton CO2, Switzerland : $125 / ton CO2)

applications vary . . . (e.g., Germany : diesel, heating oil, electricity; Norway: shipping fuels, landfill waste; UK : excise taxes on cars)

and exemptions / derogations are numerous :(e.g., Germany & UK : energy intensive industry; France: gas and cogeneration, Norway: major industry, oil and gas).

Trading instruments in Europe

• Many countries are exploring forms of trading :– GHG trades : Australia, Belgium, Canada, Denmark, European Union,

Finland, France, Germany, Ireland, Netherlands, Norway, Sweden, UK, USA.

– RES/Electricity: Australia, Belgium, Denmark, France, Germany, Italy, Netherlands, Sweden, UK, US

– JI/AIJ : Canada, Czech Republic, Japan, Netherlands, Norway, Sweden, USA

• Few have rules to link to international regimes• Start dates range from 2001 to 2008, with primary focus in

electricity and energy sectors, and point of application of permit relatively high-level

• Most are now aligning with / awaiting European Emissions Trading Directive

European Emissions Trading Directive(European Env Council, 9 Dec 2002,

as modified and passed by European Parliament, June 2003)

• Mandatory caps on CO2 from power plants and most industrial facilities of > 20MW thermal capacity

• Applies to all EU including Accession countries, covering about 45% of European CO2 emissions

Two phases: • 2005-7 precursor with national, force majeure and installation opt-out

provisions, non-compliance penalty 40 Euros / tCO2• 2008-12 compulsory, opt-in provisions for additional facilities &

non-CO2 gases, non-compliance penalty 100 Euros / tCO2• Voluntary pooling arrangements for both periods, with safeguards to ensure transparency. • Partial auctioning, max 5% precursor period and 10% 2008-12• Governments decide on allocation plan subject to Commission

oversight (based on agreed National Allocation Plan criteria)

Comparing the UK ETS & the EU ETS

• UK ETS– 2002-2006– Voluntary– No power generators– Indirect and direct

emissions– All six GHGs– Absolute & relative targets– Financial incentive– Open to most sectors– Open to projects

• EU ETS– 2005-2007, 2008-2012– Mandatory– Power generators– Only direct emissions from

large sources– Only CO2 for now– Only absolute targets

– Open to a limited number of sectors

– Project to be determined

2002 20052003 2004 2009 201020072006 2008 2012

EU ETS

1st period

Overlap

2013

UK ETS

1st period 2nd period????

UK CCLAs

2nd period

Kyoto

2011

Timing of EU trading relative to UK policies

Incentives for technology and innovation: an overview

Wide range of low carbon technology groups exist at various stages of the innovation chain

Note: Most technology groups have components at more than one stage of the innovation chain; for simplicity technologies shown at principle stage only

Source: Carbon Trust: Low Carbon Technology Assessment 2002

• Process Replacement

DiffusionCommercial

-isationDemon-strationApplied R&DBasic R&D

• Fuel Cells• Advanced CHP• Fusion

• Wave• Ultra-high

efficiency CCGT

• Product Replacement

• Offshore Wind• Biomass

(Electricity)• Solar PV

Energy Supply

Energy Demand

Enabling

Transport

• Photo-conversion

• Nuclear Fission• Onshore Wind• Biomass

(Heat)

• High efficiency powertrains

• Biodiesel• Ethanol

• Electricity Storage

• Hydrogen Distribution

• Buildings Services and Fabric

• Fuel Cells

• Hydrogen Production

• HVDC Transmission

• Product Improvement

• Process Improvement

• Intermediate energy vectors

• Smart Metering

• Ethanol(Ligo-cellulose)

• Syngas Fuels

Government

Driving forces and locus for intervention changes along the chain

Business Consumers

Policy Interventions

Investors

Investments

DiffusionCommercial

-isationDemon-stration

Applied R&D

Basic R&D

Product/ Technology Push

Market Pull

In building a low carbon economy, energy efficiency and renewables have several advantages

Characteristic Energy Efficiency Renewables

Large Potential

Cost Effective

Long-term Solution

Incremental

• PIU identified >100MtC by 2050

• Current economic potential in reduced costs >£12Bn/year

• Costs reducing rapidly as technologies mature

• PIU identified >50MtC by 2050

• Once implemented, benefits are captured for investment life-cycle

• Improvements driven by many end users

• Low risk as capacity can be added incrementally

• Not dependant on a finite fuel source

Climate policy in Europe is less technology-focused than in US, but wider effort across innovation chain

• Less aversion to government regulation• Environmental policy in 1980s heavily focused on technology

standards / ‘BAT / BATNEEC’ • Shift towards overall emission targets on grounds of efficiency

and innovation (UNECE agreements on NOx, SO2; Large Combustion Plant Directive)

• Fifth Environmental Action Plan marked decisive move towards market instruments

• Many member states deploy energy efficiency and market-based renewables incentives

• Innovation policy itself relatively low attention, BUT– European institutions play large role in R&D. Sixth EU R&D

Framework Programme features energy and environment strongly, big investment in the ‘hydrogen economy’

– EU governments well placed for action along the ‘innovation chain’

EU governments spurred by success - wind energy in Europe, 1990-2000

0

2000

4000

6000

8000

10000

12000

1990 1992 1994 1996 1998 2000

MW

e

Column 8

Other

Sweden

Spain

UK

Netherlands

Denmark

Germany

Technology and business engagement in the UK climate change programme

UK White Paper commitments are backed by a wide range of policy

instruments for the energy sector • Upstream energy (including generators)

– IPPC Directive (& LCPD)

• Non-domestic energy users:– CCL and CCLAs– IPPC Directive– UK ETS

• Electricity suppliers:– Renewables obligation (ROC)– Energy efficiency commitments (EEC)

Many instruments and support measures

are targeted at business • Energy tax on electricity, coal and gas

• Negotiated Agreements covering 6000 companies

– 80% rebate in return for meeting sector based emission reduction targets

Climate Change Levy

• Direct participation through voluntary cap and trade – 34 companies

• Participants from negotiated agreements

• “Project based” participation

Emissions Trading Scheme

Renewable Obligation

• Tradable certificates for renewable power– current 3% of power generation, rising to 10.6%

by 2010

Market Support

• Ofgem (Regulatory office)• Grants from Dept of Trade & Industry• The Carbon Trust

The interfaces are complex!

Energy efficiencycommitment

(EEC)

Renewables Obligation

(ROC)

UKETS

Flare consents

National trading

schemes

EU trading scheme

IET (PAAs)

JI projects (ERUs)

CDM projects (CERs)

Over 80% by value of current government interventionshave been in existence for <3 years

.. But the total is considerable - Climate change programme now involves about £1.3bn/yr

through wide range of instruments

0

10

20

30

40

50

60

70

80

90

100

Share

of

Sect

or

Fundin

g

Power

460

ROCs

CCL exemption (CHP/Renewables)

DTI Capital GrantsENERGIENREP - DTI Energy R&DNew OpportunitiesLCIP

Other

Industry

470

CCAs

ECAs

ETSEEBPpOther

Domestic

220

EEC - Energy Efficiency

Commitment

EST

Community Energy

Warm FrontPV Roof

Other

Transport

120

Road Tax

ESTLCIPNREP - DTI Other

LCIP

ETS

EEBPp

SA

15

Other

Total = £1.3Bn/year

<1 year

1-3 years

Note: Other includes Public/Commercial and AgricultureSource: CSA Energy Research Review Group, Feb 2002, DEFRA, DTI, DTLR Press Releases, CT Analysis

>3 years

A key challenge has been managing interface between policy and business

• Reflects consensus between business and Government on support for the UK climate change programme

• Independent company with secular Board - business, Government, NGOs, research community, trade unions

• Govt funding current c.£50m/yr deployed through a flexible range of financial and non-financial investment support

• Its objectives are,

– To ensure that UK business and public sector meet CO2 targets

– To improve competitiveness of UK industry through resource efficiency

– To help UK industry capture commercial value of low-C technologies

“The Carbon Trust will take the lead on low carbon technology and

innovation in this country and put Britain in the lead internationally”

The Prime Minister, October 2000

Carbon Trust is a business-led, government backed investment company set up to try and tackle this in context of wider UK programme

Carbon Trust programmes support investment in both diffusion and tech development

Develop new technologies

Deploy existing technologies

Low Carbon Innovation Prog. Direct investment in UK based

low-carbon technologies

~ £25m pa

Low Carbon Innovation Prog. Co-ordinate & broker

technologists and funding partners Advice, training & accreditation~ £20m pa

Enhanced Capital

Allowances

~£150m pa

Interest Free Loans

~ £10m fund

Financial support

Non-financial support

Inform policy makers

Towards a low-carbon

economy

Conclusions

• Climate change - real and serious challenge• Kyoto, the ‘only game in town’, has become a European-led test of

multilateralism in the face of US unilateralism, raising it to highest political levels

• Kyoto based upon principles of international economic instruments, leading to similar instruments at national levels

• The main debate has moved from international policy formation to implementation

• Design and compatibility of EU ETS key to this • UK implementation - a leading programme including investment incentives

totaling c.$2bn Euro/yr

• Supplementary overheads appended

Supplementary Overheads

Future CO2 emissions with Kyoto+: the impacts of global spillover

Year

1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100

0

2000

4000

6000

8000

10000

12000

14000CarbonemissionsMtC

FirstCommitment

Period

Developingcountryemissions

No spillover

Medium spillover

High spillover

Industrialised countryemissions (Kyoto -1% / yr)

UK policy development

• Early 1990s: consensus-building, easy wins, and spin-offs

• 1997/8 Labour government restructuring

• 2000 Climate Change Programme

• Scientific concern accepted• Advisory Committee on Business & Environment• Strengthening of Energy Efficiency Best Practice

Programme• Elec. Privatisation and the dash-for-gas• Non-fossil fuel obligation

• DETR under Deputy Prime Minister• Marshall Report on Economic Instruments

• Climate Change Levy announced in budget• Launch of negotiations on Climate Change

Agreements• ACBE Working Group on Emissions Trading• Business engagement & support spearheaded by

creation of Carbon Trust

CO2 constraints are likely to boost aggregate gas demand

% different in gross inland consumption for EU-15 (Mtoe)

for emissions level (relative to 1990)

Stabilise -6%

Solid Fuels -23.3 -40.4

Liquid fuels -4 -8.1

Natural Gas 2.9 5.1

Nuclear -1.1 -0.5

Electricity -2.2 -3.7

Renewable energy sources 8.6 21.1

Gas and security in the EU Green Paper

• New circumstances: internal market in energy, creation of DG-Tren, environment, rising security concerns

• ‘The EU must take better charge of its energy destiny … at present it has too few resources and instruments’ [EU Green Paper]

• Nuclear and coal ‘undesirables’• Energy efficiency and renewables are priorities, need

bigger incentives• gas prices should be delinked from oil• gas stocks needed?

Synergies and tensions … Climate, Security and Liberalisation

Liberalisation Environment Security

Stronger EU role:

‘take charge of destiny’ * ** **

Renewables * ** **

Decline of coal ** ** xx

Nuclear stagnation ** ? xx

Gas into transport ? * **

Gas into electricity ** ** x

Linking the climate levy, trading & negotiated agreements

Climate levy: all business but blunt

Negotiated Agreements

Emissions trading: large producers

Incentive to join - reduced rate (2) Funded

programmes

Incentive to negotiate - reduced rate (1)

Information / allocation

Efficiency & credibility

GHG coverage

Emission source IPPC CCL CCLA EUETS

CO2 from direct fossilfuel combustion

D D D D

CO2 from processsources

D D

Other GHGs fromprocess sources

D

CO2 from electricitygeneration

D &I

I I D

D = Directly affected; I = Indirectly affected

UK ETS internal interfaces

CCLAs with relative targets

CCLAs with absolute targets

Direct entrantswith absolute

targets (financial incentive)

Gateway

Emission reduction projects

credits

allowances