Implications and Opportunities for European Business in a Carbon constrained Economy

1. Implications and Opportunities for European Business in a Carbon constrained Economy Vincent Dessain, Executive Director, Europe Research Center, Harvard Business School

2. Introduction GHG Emissions – The overall picture B.1 GHG’s major emitters B.2 Potential Buyers-Potential Sellers ? B.3 Emissions Trading: Lowest-Cost Method of Reducing GHGs B.4 The implications of a Carbon-Constrained Economy on Market Dynamics EU Emissions Trading Scope C.1 EU 15: Targeted Sectors in EU Emissions Trading Directive C.2 EU Emissions Trading Scheme C.3 EU Emissions Trading Principles C.4 National Allocation Plans Principles C.5 Will the allocations be generous enough Summary

3. D. The electricity producers – an example D.1 Electricity Production D.2 Power Production Distribution D.3 Cumulative Production D.4 5 biggest CO2 emitters in Europe D.5 Price of Electricity D.6 Impact of EU ETS on Power Companies Valuations Trading experiences and expectations E.1 A U.S. Example: SO2 under clean air act of 1990 E.2 UK ETS experiment E.3 How will CO2 allowances trade? E.4 CO2 expected price 2008 - 2012 E.5 Strategies adopted by market players Summary (continued)

4. Observations in this presentation are based on initial discussions with EU commission officials, government representatives and market participants This presentation only expresses the author’s personal views and not the school’s Following further analysis of EU emissions trading market, we may develop a research project that looks at the criteria of success to effective design of a new market Introduction

5. GHG’s major emitters(Year 2000) (MTON CO2 Equiv) Source: Adapted from UNFCCC

6. Potential Buyers-Potential Sellers ? Source: Adapted from UE DG Environment

7. Potential Buyers – Potential Sellers (continued) Source: Adapted from UE DG Environment

8. Emissions Trading: Lowest-Cost Method of Reducing GHGs Source: Viewpoint/The Marsh & McLennan Companies Journal/Volume XXXII No. 1 2003

9. The implications of a Carbon-Constrained Economy on Market Dynamics Source: Viewpoint/The Marsh & McLennan Companies Journal/Volume XXXII No. 1 2003

10. EU 15: Targeted Sectors in EU Emissions Trading Directive Source: Adapted from environmental-finance magazine

11. EU Emissions Trading Scheme Source: Adapted from environmental-finance magazine

12. To become largest CAP and Trade Program worldwide NAP’s ready for review by EU commission by March 1-31, 2004 Warm-up phase 2005-2007: Learning by doing Five year mandatory Kyoto phase from 2008-2012 Start with CO2 expanding to other GHG Sector pooling with trustee appointment possible Informal multinational pooling also possible EU Emissions Trading Principles

13. Emissions (historical base) seem to be the only viable metric rather than input, output or capacity Two stage process reconciling top down, bottom-up In warm-up phase: free of charge 95%, 5% by auction For 2008 – 2012: 90% free of charge, 10% that can be auctioned New entrants will need to buy from the market National Allocation Plans Principles

14. Will the allocations be generous enough? Carbon constraint (Mton CO2) 10% surplus over b-a-u In between Kyoto & National targets Source: Adapted from DKW

15. C02 emission per type of production In grams Hydro Nuclear Wind Combined Natural Coal Lignite per KW/h cycle gas CO2 emission per par kWh 4 6 3 à 22 427 883 978 1 120 Source :Adapted from ACV Study– CDC Report Electricity Production

16. Power Production Distribution Source: Annual Reports

17. Cumulative Production Fuel, Coal, Gas (TWh) Enel RWE E.ON Endesa EDP Iberdrola Electrabel Verbund Source: CDC Reports

18. 5 biggest CO2 emitters in Europe Source: CDC Reports

19. Price of Electricity Source: Vattenfall

20. Impact of EU ETS on Power Companies Valuations Verbund EDP EDF Endesa Vattenfall EVN Suez E.ON Electrabel Iberdrola RWE Enel Source: CDC Reports

21. Principle of Allowances under CAP and Trade system Allocated "free" to incumbents, "bankable" and "fully tradable"   Market started to become reasonably efficient by 1994 Market prices much lower than expected Relatively efficient private market developed in four years 1993: Third party brokers start to disclose prices Transactions cost from $ 3.50 per allowance per trade to $ 1.50 per allowance per trade (1994 – 1996) Bid-ask spreads go from $ 20 in 1994 to $ 1.50 in 1997 Active SWAPS markets developed A U.S. Example: SO2 under clean air act of 1990

22. 34 participants, voluntary and capped, 400 trading accounts, 300,000 – 1000,000 allowances traded, through 150-200 trades Few bidding strategies where company decides on amount of emission reductions achievable through a project, the average cost of each ton of emission reduction and the price at which they would drop out of auction Several participants had not yet developed a precise analysis of their abatement cost through a marginal abatement cost curve UK ETS experiment

23. How will CO2 allowances trade? Allowance Allocation Economic Conditions Germany hot cold year UK growth Accession MS fuel costs 0 5 10 15 20 25 0 5 10 15 20 25 30 CO2 price (€/tonne) CO2 price (€/tonne) Source: Adapted from DRK

24. CO2 expected price 2008 - 2012 Market Source Expected price (€ton CO2) Ecofys 20 - 42 EU CO2 Mc Kinsey 18 - 25 Emission EU 20 – 83 Certificate Penalty* 100 CDM Ecofys 5-7 JI Ecofys 5-10 * The penalty does not release the operator from the obligation to surrender its allowances Source: Adapted from BA Power - Strategic Planning

25. Case 1: Market price higher than abatement marginal cost Strategy: Reduce emissions more than your target and sell extra allowances Case 2: Market price lower than abatement marginal cost Strategy: Buy allowances to reduce total cost to meet reduction target Case 3: Market price equal to abatement marginal cost Strategy: Reduce emissions at break-even point Case 4: Two main choices to meet your emissions target Target: Either purchase allowances on the market or reduce emissions (production reduction, fuel switch or technology investment) Strategies adopted by market players