Living in a Carbon-based World: CO2 and its impact on the EU Power Sector Gavin Bell March 2010

Living in a Carbon-based World: CO2 and its impact on the EU

PowerSectorGavin Bell

March 2010

First, a little about me...

18.04.23ecovest limited2

Ph.D. from Canterbury EMRG

One of the many from Canty that ended up in Europe...

Worked since 1999 in energy sector as consultant and in industry UK, Germany, Austria, Netherlands, Spain, Albania,

Montinegro, Macedonia, Norway, Denmark, Czech Republic, Cuba

Headed up the continental power market analysis team and the cross commodity analysis team at Statkraft Europe’s largest renewable generator Around 55 TWh annual production

Currently CEO of Ably (plant data and analysis firm) and independent consultant Based in Norway since 2003

Key EU ETS Takeaways

18.04.23ecovest limited3

EU ETS market is part of an ”energy complex” involving power, fuels, CO2, and other commodity markets Each drives the other Increasingly, money cannot be made in one

market only – you need to look at them all simultaneously

CO2 will drive increasing internationalisation of energy markets, as CO2 markets interlink EU ETS in the forefront

Any CO2 market is a political beast – politics drives the price and direction

Outline

4

EU ETS Overview A multi-commodity energy complex Short term interactions Long term interations and drivers Summary

ecovest limited 18.04.23

EU ETS Overview

EU ETS – What is it?

Technically... Really...

6

Classic cap and trade system to regulate CO2 emissions in the EU + EEA countries

Absolute limit on CO2 emissions

Allowances distributed to facilities covered by the scheme >12000 facilities >4000 companies

Participating facilities surrender an allowance per tonne CO2 emitted during annual compliance periods

Commercially crucially important market in the EU energy sector

Driver of investments Impact on price CCS CERs Credit rating

Hedging Exposed to CO2 Need to mitigate to manage

risk Trading

Direct opportunity to make money


ETS Summary

Phase 3++Phase 3++Phase 2Phase 2Phase 1Phase 1

2005 2007 2008 2012 2013

Post-Kyoto Period

2020

• 43% of EU emissions (incl. Aviation, CCS)

• Single EU Cap, reducing 1.74% p.a.

• Auctioning – 50% in 2013, 100% by 2027

• 100%(ish) auctioning in power sector from 2013

• Links with 3rd Country schemes; harmonisation of CDM/JI rules

• 95% free allowances

• Allocation of permits done nationally (National Allocation Plans - NAPs)

• Tighter limits based on phase 1 experience (6.5% below 2005)

• 90% free allowances• 3% Auctioning• 6% New Entrant

Reserve• EEA included• Allocation via NAPs• Can import credits from

other flexible mechanisms

• Appx. 12% of total

Kyoto PeriodTrial Period

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Banking and borrowing Banking and borrowing allowed within a phase No banking or borrowing between phases 1

and 2 A key reason for observed priced development

Banking allowed from phase 2 to phase 3 Linking prices in these two phases Especially important now phase 2 seems long No borrowing


Distribution of allowances

Metals11%

Pulp and Paper

2%

Oil and Gas9%

Cement, Lime, Glass11%

Other8%

Public Power and

Heat59%

Two key ”sectors” Power Industry

Behave differently in relation to ETS

Industry Generally long Reduce emissions via

investment (med-long term)

Often annual or ”period” view

Power sector Generally short CO2 price impacts dispatch Hedging of power

production


0

5

10

15

20

25

30

35

EUA

Pri

ce (€

/t)

2005 2006 2007 2008 2009 2010

EU ETS History

10

2005 2006 2007 2008 2009

Fuel bull run

2005 Verifie

d emissi

ons

2nd phase NAP cut

Fuel bull run Financial

crisisFuel bear

run

Industrial length

gradually in market

Oil, equities bull run


A multi-commodity energy complex

CO2 and Power (and fuels, currencies, interest rates etc etc)

Coal

Coal

GasGas

Complex interactions driving markets

Fuel CO2

SRMC

8 10 33

Fuel CO2

SRMC

20 10 39

Price of CO2

Price of gas

Coal

Coal

GasGas

Fuel CO2

SRMC

8 12 35

Fuel CO2

SRMC

15 12 31

Price of CO2

Price of gas


CO2 and power market interaction

Short term Long term The power stack

Stack driving emission levels ETS price impacting the stack

Non-market external effects Weather

Driving power and heat demand and availability (hydro, wind)

Hedging, market psychology Energy complex

Oil a strong sentiment driver of power and CO2 (++)

External economy (e.g. recent demand destruction)

CO2 market is key driver in investment decisions

Power market investments (emitting vs non-emitting) driver of future CO2 price

CO2 price feed-through to power price a driver of future power demand

Future CO2 price driver of todays CO2 price (banking effect)


Question...

14

?What is correlation and what is causality?


Short term interaction

The classic – fuel switching

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Relationship between gas, coal, and CO2 drives stack and emissions

Other aspects reduce fuel switch flexibility Fuel contracts Inflexibilities in fuel

access Don’t always get the

fuel switching you expect...

coalCCGT

gas, oil GTlignite

nuke, wind

Coal – gas fuel

switching

CO2 cost

SR

MC


-260-240-220-200-180-160-140-120-100

-80-60-40-20

020406080

100

Mill

tonnes

8

10

12

14

16

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20

22

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26

28

30

€/t

Impact of fundamentals

EUA Dec-08

Acc. Changes: fuel prices &

weather


Source: Point Carbon

But it’s not a ”tick the boxes” world... Relationships are not

straightforward, nor consistent Sometimes, CO2 can

explain power price movements, sometimes its, say, coal and gas prices, or something entirely different

Often possible to know in hindsight...

But forecasting is not easy

Q: What sort of analysis is useful...?-1,00

-0,50

0,00

0,50

1,00

1,50

18.12.2008 28.03.2009 06.07.2009 14.10.2009 22.01.2010

CO2 - Coal Correlation-1,00

-0,50

0,00

0,50

1,00

1,50

18.12.2008 28.03.2009 06.07.2009 14.10.2009 22.01.2010

CO2 - EEX Spot Correlation


Hedging activities

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Hedging of production begins already 3 years ahead

CO2 part of that hedge Thus, begin to hedge

production in phase 3 of ETS from 2010 onwards BUT – phase 3 allowances

not yet available Via purchase of phase 2

(2012) allowances for banking

Hedging demand can drive prices

Year CO2 volumes

2010 250

2011 700

2012 1250

Total 2200 Mt

Could turn a long phase 2 market into a short one...


Crude oil – key sentiment driver

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40

60

80

100

120

140

160

0

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14.11.2007 01.06.2008 18.12.2008 06.07.2009 22.01.2010 10.08.2010

Bren

t Cru

de (

$/bb

l)

EUA

(€/M

Wh)

EUA Brent Crude

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Economy driving demand in power and CO2

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Significant demand destruction as a result of financial crisis – from 2008 to 2009: Germany: 6% decline France: 3% decline

Less demand for EUAs Lower price Pressure on power

prices Market is expected

long in phase 2...

1500

2000

2500

2008 2009 2010 2011 2012

Mt



Phase 2 market balance

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Market is long in phase 2 Including credits: 970 Mt

In theory... Price in phase 2 should

equal discounted price in 2013 (first year, phase 3)

Prices today are lower than this...

Anticipate at least that phase 3 will increasingly impact phase 2 prices

What is driving phase 3 price expectation?

-200

-100

0

100

200

300

400

2008 2009 2010 2011 2012

Mt

EUA Shortage Credits available for EU ETS

shortshort

longlong



Long term interaction

CO2 price in 2020 and beyond

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How can we assess the long term price? And thus today’s ”equilibrium” price level?

Equilibrium model What price balances supply and demand That is, long term relationships between

Power and CO2 Industry and CO2 CERs, other ETS schemes and the EU ETS

Or... an educated guess – it is a political process after all What price needed to drive CCS? EU effectively target long term caps to achieve this

price level...


Phase 3 supply: political and commercial process

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Steadily declining allowance cap 21% below 2005 emissions in 2020

Power sector (more-or-less) 100% short Industry reducing from 80% free allowances in

2013 to 30% in 2020 CERs/ERUs

Supply depends on a ”post Kyoto” agreement No agreement, only Kyoto + ”bilaterals” CERs

Credit limit of at least 11% of the phase 2 allocation Can choose when to use the credits (phase 2 or

phase 3) But, max 1400 Mt in phase 2


Phase 3 demand: interation between markets

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Power and heat Change in stack, through investments and

retirements Expected future prices (fuels, capital costs, exhange

rates, cost of money) Portfolio considerations Other mechanisms – e.g. Renewables directive

Demand for power and heat Industry

Economic growth Change in energy intensive industry in EU

Change in carbon intensity


And the results...

Bottom up forecast ”Political” forecast...

27

Typical price forecast ranges for CO2 for 2020 Point Carbon 37 €/t Barclays – 40 €/t long

term Deutsche Bank 30 €t UBS – 20 €/t UK EAC – 22 €/t

The CCS approach (or renewables or whatever...) for, say, 2025 Additional capital cost Reduction in efficiency CO2 emissions saved + fuel cost assumptions

etc... Around 50 €/t (2025) Discounts to 35 €/t

(2020)

Plant investment 1100 €/kWCCS investment 1100 €/kWWACC 8 %Annualised 113 €/kW/aLoad factor 50 %CCS capital cost 22 €/MWh

Old load factor 75 %Plant capital cost kr 7 €/MWh

Fuel cost 75 €/t11 €/MWh

Efficiency, no CCS 44 %Efficiency, CCS 34 %Additional Gen. Cost 7 €/MWhExtra fuel cost 36 €/MWh

CO2 price 49Capture rate 90 %CO2 cost saved 36 €/MWh

Difference 0,00 €/MWh


Summary

Summary

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CO2 (via ETS) integral part of EU energy markets Investment Hedging Trading

Complex interactions between these markets Drive prices Significant and dynamic relationship between long

and short term dynamics And don’t forget it is a political process

Once there is an ETS, there’s a strong pressure for consistency and predictability


Gavin Bellecovest limited

Armauer Hansens gate 6a0455 Oslo, Norwaytel: +47 950 [email protected]

Documents

Living in a Carbon-based World: CO2 and its impact on the EU Power Sector Gavin Bell March 2010