CO 2 emissions trading Progress EU ETS in 2007 European Chemical Regions Network (ECRN) Competitive Chemical Regions in Europe 5th Congress of the European Chemical Regions Network Ludwigshafen, BASF-Gesellschaftshaus, Rhineland-Palatinate, Germany November 2007 Vianney Schyns Manager Climate & Energy Efficiency Utility Support Group Utility provider for a.o. DSM and SABIC

Contents 1.ECRNs vision on emissions trading 2.High Level Groups EU Commission 3.Present situation 4.Annex: Structural shortcoming present allocation rules 5.Annex: Structural solution benchmarks with ex- post adjustment to actual production

ECRNs vision on the instrument Greenhouse Gas emissions trading Maastricht Declaration, 22 December 2005 Tarragona Declaration, 9 November 2006 Major improvements still needed

ECRNs vision on GHG emissions trading Present flaws –Historical grandfathering not effective –Electricity windfall profits, bound to increase from 1 st period billion/year to 2 nd period billion/year loss of competitiveness –No level playing field –Finite new entrant reserves insecurity new plant & debottlenecking investments –Frozen ex-ante allocation enhances frozen market shares –Lack of stable long-term recognition of CHP Proposed solution, as alternative to auctioning –Benchmarks with ex-post adjustment to actual production –Guarantee of the total cap (novel method launched in Tarragona

High Level Groups HLG Competitiveness, Energy and the Environment HLG Chemical Industry Clear advice HLG CEE

HLG CEE and HLG Chemical industry High Level Group CEE members –Commissioners Verheugen, Kroes, Piebalgs and Dimas + representatives industry, NGOs and others The HLG CEE advice for EU ETS on 2 June 2006 –EU Commission & Member States to undertake (for implementation in 2 nd period, but this failed) =Stronger signal towards low carbon technologies =Competitiveness, reduce impact windfall profits =Level playing field new investments across EU =How can rules, notably for new entrants and closure, be more harmonised, incl. the possibility of using a benchmarking approach HLG CEE 30 October 2006 confirmed statements above HLG Chemicals: Member Reiner Haseloff, president ECRN

Present situation Historical grandfathering historical mistake Lowering production, no benefit for environment Industry wants benchmarks no (partial) auctioning Auctioning seems ideal for electricity facts tell a different story Recent legal cases

Historical grandfathering historical mistake Historical grandfathering was a historical mistake =Recognised by EU Commission, March rd Trading period: perhaps auctioning for electricity & (partial?) auctioning and/or benchmarking for industry EU Commission will come with a proposal for revised EU ETS Directive January 2008 – then co-decision EU Parliament & Council –Takes 1.5 – 2 years, is no decision for single Member State Benchmarking for allocation to operators =Ex-ante: based on historical production second historical mistake? =Ex-post: based on actual production

Lowering production … Lowering Production is no Benefit for the Environment, says European Industry Paper Alliance-Cefic-IFIEC, 21 May 2007, in line with ECRN –EU Commission declared end 2006 =Lowering production and selling freed allowances is equally legitimate than investing in emissions reductions and selling freed allowances –European Industry recalled founding father J.H. Dales (1968): =Pollution in one region must never be reduced by increasing pollution in another =Ex-ante allocation root cause of many distortions =Call for link to actual production =Italian representatives EU ETS review: intra-period updates

Benchmarks, no auctioning & solution windfalls Industry is against auctioning –Auctioning electricity =Electricity prices remain high bad for competitiveness / leakage =Windfall profits 1 st period 15 billion/year to 2 nd period 55 billion/year at CO 2 -price 30/ton =Full auctioning 3 rd period: windfalls still high (IFIEC paper 23 Nov 07) –Auctioning industry =Bad for competitiveness, leakage by production relocation –Call for benchmarks (ECRN, CEOs e.g. Jürgen Hambrecht BASF with Alain Perroy Cefic visit Verheugen 23 Nov 07) and solution windfall profits (letter European industry 16 Nov 07) –Auctioning with Border Adjustments at EU borders is not practical (huge bureaucracy), cannot be realised with few products only (it affects thousands of products)

Recent legal cases (1) UK against EU Commission (judged 23 November 2005) –EU Commission can only assess NAP against art. 10 & Annex III –No objection within 3 months = approval (e.g. rules of Germany, France, Italy, Luxembourg, Poland about guarantee new entrants) –A NAP can be changed after Commissions approval of an earlier notified NAP (no provisional notification needed) Germany against EU Commission (judged 7 Nov 2007) –Germany contested the prohibition of the EU Commission to apply ex- post adjustments (also in 1 st & 2 nd guidance note) –Germany asserts that the whole Directive – also art. 10 and Annex III – does not forbid ex-post, provided total cap ensured –Court of First Instance fully confirmed German case –Germany may apply ex-post in 2 nd period if case is won …

Quality of historic data for operators Variations in annual load factors over five years, found in UK by consultant NERA for UK government … with climate change instruments based on history? Historic production tells nothing about the future Link to actual production: Avoids distortions Avoids windfall profits Solves problems new entrants and closures, SEE ANNEX

Recent legal cases (2) What means a historic cap: many new plants enter the market? –Many new power plants in Italy around Germany.. NL What means a historic cap: import or export of product? –More electricity import NL from Germany – Is NL then doing well? –New CHP in Luxembourg – Is Luxembourg doing bad? Eight new legal cases –What means a historic cap: economy is strongly recovering? –Forecast of growth in central Europe, 8 legal cases European Court of Justice against EU Commission: Czech Republic, Estonia, Hungary, Latvia, Poland, Slovakia, Lithuania and Malta –Rumania and Bulgaria to follow? –Influence Burden Sharing on allocation is perverse Solution: benchmarks linked to actual production

Annex Structural shortcomings of present allocation rules in the EU ETS Environmental effectiveness Level playing field Competitiveness & electricity windfall profits Insolvable problems new entrants & closures

Basics of shortcomings present allocation Existing plants: ex-ante frozen cap based on historical emissions – rewarding pollution – same quantity allowances whether production increases or decreases New plants and debottleneckings: also an ex-ante frozen cap, which is plan-economy Systemic disincentive for efficient growth, reward of shrinkage This allocation principle = root cause of all shortcomings, PLUS, mostly as a result of this: –Insecurity investments in new plants (finite reserves) –Highly distorting transfer rules –New plants few versus existing plants many allowances: LACK OF EFFECTIVENESS to invest to reduce emissions

Summary shortcomings allocation Threat to reduce economic activities in Europe –Not producing & selling allowances can be more profitable –CARBON LEAKAGE without environmental justification Rules differ across Europe –NO LEVEL PLAYING FIELD No structural reward of early action, no equal standards, lower emissions can come into next historic reference –INNOVATION NOT STIMULATED, NO EFFECTIVENESS New entrants: thresholds, finite reserves –INVESTMENT INSECURITY Market share winners buy allowances, to losers sell –CARTEL, winners pay penalty to losers … no free market

Electricity windfall profits State interference prevents competitive market –New entrants, vital for more competition, but ex-ante state decision of operating hours determine profitability – plan economy –Transfer rules protect incumbents: barrier to entry can be 0.25 billion for a 1000 MWe power plant (4 years, or trading period) –Even worse: incumbent does not apply for transfer rule and keeps old plant stand-by (imagine 1000 MWe plant, ~ 0.2 billion/year) Fight for allowances overrides fight for market share Price of system: economic rents – windfall profits –Transfer of wealth 2 nd period 55 billion/year at 30/ton CO 2 (EU-27) –Even with full auctioning 3 rd trading period still 45 billion at 35/ton CO 2

(1) (2) (3) World Map electricity prices (/MWh) Sources: (1)Presentation European Aluminium Association HLG-Ad hoc 1 (Long Term Contracts) (2) R.Tarjanne and K. Luostaninen, Lappeenranta University of technology (Long term contract) – 2003 (3)Platts Base load year 2007 (Platts 4 April 2006) (4)Jean Maillard (3) < 25 (4) (4)

Present ETS rules: new entrants & closures Unsolvable dilemmas new entrants (NE) & closures (C) (see e.g. also Grubb and Neuhoff, Stern, Egenhofer, Weishaar, Matthes, Schyns, Ecofys report for the EU Commission) Theory: freeze allocation [all allowances after C & zero for NE] Zero for NE actually hinders low carbon investments/competitiveness Retaining allowances after C – how long? – is worse than transfer rules as it enhances market concentration Withdrawal allowances after C: perverse incentive keeping inefficient plants in operation Most authors elaborate these problems, but fail to conclude that within individual ex-ante frozen caps solutions are simply impossible search for squared circle

Annex Structural solution: benchmarks with ex-post Which benchmarks and how Guarantee of total cap

Benchmarks with ex-post Few benchmarks provide high coverage =E.g. electricity, cement, refineries, steamcrackers, etc. Real benchmarking is easier that often assumed =Output related, same BM for incumbents & new entrants Benchmarks with ex-post adjustments of production, solution for: =Leakage, level playing field, effectiveness, no insecurity for new entrants, no transfer rules, no windfall profits, free market without cartel problem =Works exactly as auctioning Two new studies launched at ECRN Tarragona =How to ensure total cap with ex-post =How does it work in the electricity market