Functioning of the EU Emission Trading Scheme

Dr. Brigitta Huckestein

Berlin, February 2018

Winter Academy 2018

Trading, Sales and Financing in the European Energy

Market and Industry

BASF – We create chemistry

Our chemistry is used in almost all industries

We combine economic success, social responsibility and environmental protection

Sales 2017: €64.5 billion

EBIT 2017: €8.5 billion

Employees (as of December 31, 2017): 114,000

6 Verbund sites and 352 other production sites

1

Reduction of greenhouse gas emissions with increased production

0

50

100

150

200

250

1990 1996 2002 2008 2014

Development since 1990

Index 1990 = 100%, BASF Group excl. oil and gas business

volume of sales product

absolute greenhouse gas emissions

specific greenhouse gas emissions

+102%

−50.2%

−75.4%

100

4

Outline

□ EU ETS targets

□ Carbon Leakage, Benchmarking and Free Allocation

□ Measuring, reporting & verification (MRV) /Trading

□ EU ETS: Fit for the Future ?

7

EU Roadmap for moving to a low carbon economy

Saving Greenhouse Gases by products is not enough to reach the EU climate targets 2050

Need to evaluate options in production

Different speeds for different sectors

Source: European Commission, The roadmap for transforming the EU into a competitive, low-carbon economy by 2050

-7%

-20% -54 bis -68%

-34 bis -40%

8

Climate protection products help to save the climate

6

ETS targets up to 2030

Mt CO2

-1.74% p.a.

ETS cap

Non-ETS -10% (2005-2020) - 30% (2005-2030)

ETS - 21% (2005-2020) - 43% (2005-2030)

-20% target -40%

target

1333

ETS Phase I/II ETS Phase III

GHG

cap

0

2000

4000

6000

1990 1995 2000 2005 2010 2015 2020 2025 2030

Free industry

allocation

- 556 2084 1816 -2.2% p.a.

-2,2 % p.a.

9

Strengthening of the EU ETS after 2020

Increase of the Linear Reduction Factor (LRF)

Voluntary cancellation of allowances

Market Stability Reserve (MSR) changes

Temporary doubling of the feeding rate: From 2019 to 2023, 24% of the total number of allowances in circulation will be put in the MSR

Feeding rate of 12% restored as of 2024 but then most likely a higher LRF!

Limited validity of MSR allowances: As of 2023, the number of allowances held in the MSR will be limited to the auction volume of the previous year; holdings above that amount will lose validity

First MSR review in 2021

Change from a purely volume based system to

a volume and (indirect) price driven system

10

Outline

EU ETS targets

Carbon Leakage, Benchmarking and Free Allocation

Measuring, reporting & verification (MRV) /Trading

EU ETS: Fit for the Future ?

11

Requirements for ETS in the industrial sector

Carbon Pricing through ETS to set incentives for emission

reduction

Advantages for GHG efficient production, disadvantages for GHG inefficient

production

Protection against carbon leakage

Industries in a globally competitive environment shall not be disadvantaged

Free allocation of certificates based on benchmarks Compensation of indirect costs (higher electricity prices)

Source: ETS Handbook

12

Structure of the ETS in Phase 4

15.5 Billion Allowances

Source: EU Commission 13

EU Emission Trading 2020 - 2030

Pro-duction

Bench-mark (BM)

Carbon Leakage Faktor

(CL)

Correction Factor =

Total number is limited

Regular adjustment (rolling average of 2 years, threshold 15%)

New Bench- marks

New CL list No differentiation between sectors

X X X

• Competitiveness until 2030 most likely kept • A change towards CO2-neutral Produktion requires investments,

which can are not re-financed via the ETS

Free Allocation

14

Carbon leakage rules

Sectors exposed: 100% free allocation of the benchmark

Less exposed sectors 3. Trading Period: 80% going down to 30 % 4. Trading period: 30 % phased-out after 2026 until 2030

Current carbon leakage list prolonged until 2020, < new list valid for 10 years

Quantitative assessment: Based on trade intensity multiplied with emission intensity (threshold: 0,2)

Qualitative assessment possible for sectors between 0,15 and 0,2 and a limited number of carbon leakage sectors (Prodcom)

15

ETS 2030: Carbon Leakage List

Σ kg CO2 (all installations)

Carbon Intensity = -----------------------------------------------------------

Σ EUR GVA (all companies which report under this NACE-Code)

16

How Carbon Intensity is calculated (and why qualitative assessment is essential)

Σ kg CO2 (all installations)

Carbon Intensity = -----------------------------------------------------------

Σ EUR GVA (all companies which report under this NACE-Code)

17

Benchmarks in the EU ETS

Source: ETS Handbook

18

Benchmark update

Update of benchmark values for all 54 benchmarks

Current benchmarks relate to 2007-2008

First benchmark update for 2021-2025 on the basis of 2016-2017 data

Second benchmark update for 2026-2030 on the basis of 2021-2022 data

Methodology:

Based on this data, determination of annual improvement rate for each benchmark (min.: 0,2% p.a.; max.: 1,6% p.a.)

Phase 3 benchmark values reduced with that annual rate applied over the period 2008-2023 and 2008-2028

Exception: hot metal benchmark will be reduced by 3% (0,2%) for 2021-2025 period

19

Product Benchmarks

Source: ETS Handbook

20

Values include both direct emissions (process and steam) and indirect emissions (electricity)

HVC = ethylene + propylene + contained butadiene + contained benzene + hydrogen (non fuel fraction) + acetylene as products

EU Cracker Product Benchmark

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0 0 20 10 30 40 50 60 70 80 90 100

CO2 emissions/Mt of HVC

Crackers %

Average

Cracker benchmark value (0.702 t CO2 / t HVC)

21

Fall Back Benchmarks

Source: ETS Handbook

22

EU ETS system for allocation of free certificates

Product-BM Heat-BM Fuel-BM Historic Emissions

Historic activity level

Product output of plant

Measurable heat consumption of plant

Fuel consumption of plant

Emissions

Benchmark GHG efficiency of process t CO2 / t product

GHG efficiency of heat generation t CO2 / TJ

GHG efficiency of fuel t CO2 / TJ

Benchmark Value

Individual values for 15 GHG intensive processes

62,3 t CO2 /TJ (natural gas fired boiler with 90% efficiency)

56,1 t CO2/TJ (emission factor for burning natural gas)

97% of historic emissions

Benchmarking methodologies

x

no no no

Heat Benchmark, Fuel Benchmark, Historic Emissions

are fall-back options

Product Benchmark is the first

priority: 70% of chemical industry

emissions stem from processes covered

Example: Chemical plants BASF SE Ludwigshafen: Percentage of emission certificates allocated according to respective methodology 62

%

33%

5%

23

Low-carbon funding mechanisms

Innovation Fund

Support carbon capture and storage (CCS) and renewables as well as breakthrough technologies in industry in all Member States

Initial endowment: 450 million allowances

400 million in 2021-2030 (NER 300 monetary leftovers/ 50 million from MSR)

Potential increase from free allocation 'buffer’, 50 million added after 2025

Commission to adopt a delegated act to set out further details

Modernisation Fund

Support modernisation of energy systems and just transition in 10 lower income Member States

25

Indirect cost compensation

State aid based compensation regime continued

Enhanced reporting and transparency provisions

Annual reporting in Q1 on compensation paid in year x-1

Member States should seek to use no more than 25% of auction revenue

If 25% exceeded, Member States to publish a report including relevant information on power prices for large industrial consumers benefiting from compensation

Enhanced reporting will apply as from 2018

Carbon Market Report: new chapter on indirect carbon cost compensation schemes already in 2017 report

26

Outline

EU ETS targets

Carbon Leakage, Benchmarking and Free Allocation

Measuring, reporting & verification (MRV) /Trading

EU ETS: Fit for the Future ?

27

Data flow of emission reporting

Operator collects data

External Verifier

Authority demands additional

data

MRV

Authority

Operator

4

3 Operator forwards the verified report to authority

1

Check and verification of data by external third party

2a

2b

Verifier approves amounts of emissions

Union registry

28

GHG emission data acquisition on an installation level

Input Output

Installation

Fuels

Raw materials

Electricity, heat

Greenhouse gases

Products including by-products and waste

Kind of data:

Accuracy of data:

Frequency:

Amount, carbon content

Detailed definition of requirements

(depending on source stream)

Continuously or discontinuously

(depending on installation)

29

Bureaucratic effort of ETS

Example: BASF SE Ludwigshafen

Large emitters with GHG emissions > 25000 t CO2e/a

Small emitters with GHG emissions ≤ 25000 t CO2e/a

0%

25%

50%

75%

100%

Number of

plants

Bureaucratic

effort for

operating

company

GHG

emissions

50%

50% 56%

44%

99%

1%

30

Key Learnings on Measuring, Reporting & Verification

Qualified and well-trained personnel required at

► operating company

► authorities

► external verifiers

Setup of well-functioning data flow / IT-structure is essential and takes time

Definition of methods to guarantee accuracy of measurement influences time and cost requirements at operators

To start a system requires much more than a political decision

31

Key basics of certificate trading

Open and harmonized market on European level

Low entrance barriers: only account at registry necessary

Various market players: utilities, industry participants, banks, traders

High liquidity: exchanges + bilateral over-the-counter

Banking and borrowing of certificates between years and trading phases possible: inter-temporal optimization of companies (phase I no banking and no borrowing)

Frequent auctions with almost no restrictions (minimum price etc.)

Future/forward products enabling market participants to optimize their positions (currently relevant for power production)

EU ETS market well functioning: Emission reduction target achieved at the most cost-efficient way.

32

Outline

EU ETS targets

Carbon Leakage, Benchmarking and Free Allocation

Measuring, reporting & verification (MRV) /Trading

EU ETS: Fit for the Future ?

33

EU ETS Developments

Target: Reduction of CO2 Emission in most cost-efficient way

Status: Currently around 2bn certificates less demand than scheduled supply target achieved at most cost-efficient way

(~ 5 EUR/t until phase 4 decision)

Ongoing discussions: Measures to increase price levels

2012 set aside (rejected)

2013 backloading (implemented in 2014)

2014 market stability reserve (MSR)

2017: Revision - MSR + cancellation of certificates

ETS Structure is changing: Faster emission reduction enforced

Last certificate even before 2057

Trading of certificates

34

As an energy intensive sector, where would you invest? Industry Policy

Low raw material costs

Low electricity costs

Increase of industrial production

New investments in energy intensive

sectors

Decrease of CO2-Emissions by

using more gas and efficient new

installations

Uncertainty about global level playing

field in climate policy

Uncertainty about free industry

allocation

Uncertainty about political motivated

interventions of the EU COM

(backloading, CSCF, MSR, …)

Policy of high electricity and raw

material prices

Decrease of industrial production

35

Cefic/Ecofys Roadmap: GHG emissions

GHG Emissions - Process - Combustion - Indirect

Reduction of GHG Emissions - Energy Efficiency Improvement - Fuel mix change - Decarbonisation of Electricity - N2O abatement - Carbon Capture and Storage

Reduction of GHG Emissions due to lack of growth

36

CO2 Reduction in the Chemical Industry DECHEMA Scenario calculations (w/o fuels production)

120 Mt

(Million t) /y

emission in

2050

Carbon neutrality possible with

New production installations

Enourmous amounts of electricity

High investment and continuously higher production costs

Comparable action in other world regions

120 Mt

(Million t) /y

emission in

2050

37

What is needed in the future?

Until 2030, the ETS with Carbon Leakage

protection measures is the key instrument for

climate protection measures

Options in the Non-ETS-Sector to be fully

exploited

Decarbonization in global production only

possible in a global context

Industry needs support, not addidional burden

38

A fair ETS saveguards production in Europe

1. Sufficient free allowances for the whole value chain

Compensate for differences

between non-EU- and EU Industry

2. Enable investments

Give a perspective for industrial

growth in Europe

3. Strengthen innovation

Realistic expectations about

timescales

39

Go for global Climate Protection

40

Thank you for your attention!

Contact:

BASF SE

Dr. Brigitta Huckestein

COM/EE

67056 Ludwigshafen

We help our customers to reduce their CO2 emissions

* CO2 equivalents = units for measuring the impact of greenhouse gas emissions on the greenhouse effect

Prevention of greenhouse gas emissions through the use of

BASF products 2016 (in million metric tons of CO2 equivalents)

1,110

570

Without using BASF’s products

Using BASF’s products

Emissions avoided: 540 (Attributable to BASF: 11%)

3

Energy and climate protection

* Excluding oil and gas production

- 40%

Greenhouse gas emissions

per metric ton of sales product by 2020 (baseline 2002)*

Energy efficiency

Coverage of our primary energy demand through certified energy management

systems (ISO 50001) at all relevant sites

90% Status 2016:

-37.2 %

Status 2016:

42.3 %

5