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Climate change and energy policy: a European perspective

Explore the European perspective on climate change and energy policies focusing on reducing GHG emissions, EU Emission Trading Scheme, Kyoto Protocol commitments, emission permits trading, auctioning vs. grandfathering, allocation criteria, and penalty system.

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Climate change and energy policy: a European perspective

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  1. Climate change and energy policy: a European perspective Simone Borghesi (University of Siena) 2009 International Energy Workshop Venice, 17-19/6/2009

  2. Energy system and climate change: overview • Current energy system largely based on the use of Fossil Fuels (80.3% of the world energy supply) • Two main drawbacks: • 1) exhaustible resources • 2) polluting resources → GHG emissions (80% from the energy system in the EU) • opinions deeply diverge on the urgency and optimal timing of the transition process

  3. Aim and structure of the presentation • EU climate and energy policies to reduce GHG emissions • The EU Emission Trading Scheme (EU-ETS) • EU speed of transition process towards renewable energy sources

  4. Kyoto Protocol: the EU commitments • Kyoto Protocol ratified by the EU on May 31, 2002 • Overall EU CO2 emissions reduction target (-8% by 2008-12) and different national emissions target However: still distant from the target, long way to go

  5. EU distance from the target Source: European Environment Agency(2006)

  6. Emission Trading (2003/87) Carbon emission permits Each member estabilishes a national emission scheme to determine the allocation criteriaof emission permits (mainly for free) and the share allocated to selected sectors in two periods (2005-’07 and 2008-’12). Sectors: energy activites (e.g. oil refineries); production and processing of ferrous metals; mineral industry; pulp and paper industry. Trading of emission permits within the EU. Penalties (art.16): 40€ (2005-2007) and 100€ (2008-2012) per tonne of CO2 emitted in excess of allowances at disposal

  7. EU-ETS: open issues • Criteria for permits allocation • Possible inconsistency between EU-ETS and national allocation plans • Penalty system • Instability of the EU-ETS market

  8. 1. Auctioning vs. grandfathering • Grandfathering tends to preserve status quo (reduces incentive to technological progress) • Grandfathering may create potential disparities in the permits market between large firms (that receive many initial permits to maintain their activity level) and small-medium enterprises • Different distributional effects: the allocation method does not affect the carbon price (for the potential emitter what matters is the opportunity cost of using the permit, whether received for free or through an auction), but it affects who is going to pocket the extra revenues, whether potential emitters or taxpayers • Grandfathering: scarcity rents to the recipient • Auction: scarcity rents to government that can use them to lower budget deficit, distortionary taxes and/or increase R&D in env. innovation

  9. 1. Auctioning vs. grandfathering • Auction may entail lower administrative costs and lower delays in the implementation (Cramton and Kerr, 2002) Grandfathering: long negotiations between government and interest groups to obtain the highest possible number of initial permits → Directive revision proposal: • Extension of the EU-ETS to further industries (e.g. aluminium and ammonia) and gases (nitrous oxide). • Higher share of emissions allocated through auctions rather than grandfathering; harmonization of allocation rules when permits given for free.

  10. 1. Role of the auction design • if auction is not properly designed it may favour market concentration: a few large firms initially buy most of the permits for strategic reasons • UK experience: in the UK ETS (world’s 1st large-scale GHG trading scheme, April 2002), sales very concentrated (65.7% from 4 largest sellers) despite very high number participants (1400 firms in over 40 industrial sectors the first 3 years). • The observed concentration of the permits supply likely to reflect concentration in auction outcome where some firms might have coordinated their behaviour to manipulate auction price (Smith and Swierzbinski, 2007)

  11. 2. EU-ETS vs. NAP: the “overallocation” issue • Most national allocation plans (NAP) allocated a number of emission permits well above the upper bound for each member state by the Kyoto Protocol during both 1st phase (2005-’07) and 2nd phase (2008-’12) (Gilbert et al., 2004; Sijm, 2005) • Causes: • political pressures from interest groups • strong uncertainty on the actual emissions level • Effect: sharp fall in the spot price of the emissions permits during 1st period → revision proposal: unique EU emission permits ceiling (rather than 27 national ceilings) that decreases every year during the third trading phase (2013-2020)

  12. 3. EU-ETS: the penalty system • Fees: F=40€ (1st phase: 2005-2007) and F=100€ (2nd phase: 2008-2012) per tonne of CO2 emitted in excess of the allowances at disposal. • price cap: safety net or distortion of the market? if price of carbon emission permits (Pp) rises above the fee (F), agents will prefer to pay the fee: Pp>F → Dp = 0 • Possible way out: set fee by a given percentage above the carbon price if the latter comes close to the fee originally established, i.e.: F = Pp(1+r) → penalty move along with the carbon price when the latter overcomes a given threshold, ensuring that the former lies always above the latter.

  13. 4. EU-ETS: market price volatility • price of carbon permits tripled in the period January-July 2005, then more than halved in April 2006 (cf. The Economist, 2006) • Causes: • Late data release and unexpected results • Price discovery on a new market (“learning phase”) but market instability in ETS not limited to initial phases: - US market for S02 allowances: start-up 1993, extreme price fluctuations in 2004-’06 (Ellerman and Joskov, 2008) • EU ETS: carbon price more than halved in the last year (from above 27 €/tonne in June 2008 to 13 €/tonne as of 12 June 2009). • Effects: uncertainty discourage investments in environmental friendly technologies

  14. EU renewable energy policies • Like Kyoto targets, EU renewable energy targets have been missed or likely to be missed • Directive on renewables (2001/77/CE) • renewable energy sources (solar, wind, biomass, geothermal etc…) up to 21% of electricity consumption and 12% of all energy consumption by 2010 (15% and 6.38%, respectively in 2005) • Directive on biofuels (2003/30/CE) • Targets: 2% of total transport fuels by 2005 (only 1% reached in the EU-25), 5,75% by 2010.

  15. EU energy and climate policy: recent and future developments European Commission, January 10, 2007 (approved by EU Council, March 8-9 2007): “Limiting global climate change to 2 degrees Celsius. The way ahead for 2020 and beyond” • EU unilateral commitment to cut GHG emissions by 20% by 2020 wrt 1990 (or by 30% if an international agreement on climate change reached). • EU target: 20% total energy from renewables by 2020 (10% from biofuels); 20% energy savings by 2020. The 20-20-20 plan attractive but feasible?

  16. Slow transition to renewable resources • In the EU-OECD countries the share of primary energy supply from renewable resources increased very slowly from 6.8% in 1990 to 7.6% in 2003 and expected to remain <10% in 2010 • Speed of transition process affected by price gap between exhaustible and renewable resources

  17. Slow transition to renewable resources However: • Some renewables already competitive with most FF-based power plants: • lowest cost of generating electricity = 25-45 US$/MWh (coal-fired and gas-fired power plants) vs. 30-40 US$/MWh for large hydro power plants and about 40-60 for wind generating technologies (IEA, 2005). • Even when cost renewables much higher (e.g. solar plants: 150 US$/MWh), market price signal distorted: • Negative externalities of FF not taken into account • Oligopolistic nature FF market • Government subsidies to FF (cf. Borghesi, International Journal Global Env. Issues, 2008; Borghesi and Vercelli, 2008, “Global Sustainability”, Palgrave-Macmillan)

  18. price renewable exhaustible time T’ T

  19. Conclusions • Acceleration and harmonization of the transition to renewable resources – Binding targets for member States – Normative framework for heating/cooling sectors (50% energy consumption in the EU) and for the transport sector • Harmonize national standard and certificate systems • Credible targets for “incredible results” • Reduce uncertainty on the reiteration of renewable energy policies (environmental priorities sensitive to government orientation) • Set feasible targets to avoid credibility and time-consistency problems

  20. Different speeds of transition process Photovoltaics: installed capacity (MWP) Source: EurObserv’er (2007).

  21. Different speeds of transition processThe case of biofuelsSource: European Commission (2006)

  22. EU electricity production from renewable sources (idroeletricity excluded) Source: European Commission (2006)

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