Prepared for National Coal Council

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Prepared for National Coal Council

EU ETS design overview •  Who’s covered: Power and industrial facilities; airlines

•  Emissions reduction target: 20% reduction from 1990 levels by 2020

•  Basic mechanics: •  Introduce a fixed number of emissions allowances into the market

each year

•  Obligated facilities have targets that they can meet by buying allowances or cutting emissions and selling allowances

•  Three phases: •  Phase I (2005-2007)—pilot phase

•  Phase II (2008-2012)—Kyoto phase

•  Phase III (2013-2020)—current phase 2

Prepared for National Coal Council

Phase I (2005-2007) •  Countries allocated allowances under national allocation plans

•  Nearly all allowances given to business free of charge

•  Non-compliance penalty set at €40/tonne

•  Unreliable emissions data led to an overallocation—prices plunged to zero

•  But pilot phase established trading infrastructure and allowed for better data collection

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Prepared for National Coal Council

Phase II (2008-2012) •  NAPs still used for allocations

•  Free allowance share falls to at least 90%

•  Kyoto Protocol offset introduced into market (CDM and JI)

•  Penalty for non-compliance increased to €100/tonne

•  Addressed overallocation by cutting supply by 6.5% from 2005 level

•  But 2008 Eurozone crisis and ensuing economic downturn reduced emissions—demand for allowances fell with price, again.

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Source: Bloomberg

Prepared for National Coal Council

Phase IIII (2013-2020) •  Under EU ETS Directive from 2008, significant reforms enacted:

•  Longer compliance timeframe

•  Centralized, EU-wide cap and allowance allocation (discarded NAPs)

•  Move away from free allocations toward full auctioning of allowances

•  International offset reduced to 50% of compliance obligation

•  But ongoing economic crisis continues to keep prices depressed, prompting calls for structural reforms

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Source: Bloomberg

Prepared for National Coal Council

EU ETS in practice: Challenges •  Price fluctuations: Data deficiencies and changes in economic

outlook have resulted in major price swings

•  Government intervention: The low carbon price has prompted efforts to intervene in the market to prop up prices

•  Carbon leakage: As energy-intensive industrial facilities see free allocations phased out, concerns over carbon leakage are likely to grow and could prompt renewed calls for a border carbon price for imports

•  Energy costs: The issue of Europe losing competitiveness in manufacturing is becoming more salient, and the ETS is in the crosshairs as a contributing factor

•  Fuel mix: Disadvantages coal in the fuel mix, but keeps coal in the game if prices are low; fuel-switching to renewables requires higher prices

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Prepared for National Coal Council

EU power prices challenging competitiveness

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Source: European Commission

Prepared for National Coal Council

EU ETS in practice: Challenges (cont’d) •  Political support: Various member states hold different positions, challenging

agreement on reforms (Poland)

•  Member-state policy: Some countries like the UK and France have considered separate carbon policies, challenging compliance

•  International linkages: Given limited schemes outside of EU and unique considerations for each program, linkages will prove challenging (Australia)

•  Eurozone crisis: In addition to sending prices lower, the crisis has tested political backing for the program and raised competitiveness concerns

•  Emissions reductions: Given low price and other challenges, not clear how much of a motivating factor the ETS has been

•  Trading fraud: Incidents of tax fraud and stolen credits arose in 2010

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Prepared for National Coal Council

EU emissions in decline since 1990

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Source: European Commission

Prepared for National Coal Council

ETS reforms •  Short-term fix: Backloading

•  Longer-term fixes: Structural reform; post-2020 targets

•  Backloading plan picks up steam •  Initial vote in April failed

•  Revisions to water down—delays auctioning 900 million allowances in 2013-2015 and reintroduce them in 2016-17

•  Passed in European Parliament on 3 July

•  Next step is passage in European Council—German position key

•  Structural reforms more challenging •  Change to 2020 cap highly unlikely

•  2030 targets debate likely pushed off until 2015 10

Prepared for National Coal Council

Lessons learned •  Commodity created by government decree will be exposed to government intervention

risk—program changes will cause price volatility and challenge predictability

•  Short compliance phases limit predictability for longer term corporate decision making

•  Accurate emissions data is key to ensuring adequate supply to meet targets and create a robust market

•  Robust oversight required to avoid trading fraud that distorts the market for companies trading for compliance purposes

•  Free allocations can create windfalls for some companies whose allocation exceeds their emissions

•  Economic fluctuations that are not baked into emissions caps could send prices low enough to fail to incentivize emissions reduction behaviors and investments

•  Utilities were better placed to trade on data compared to industrial companies

•  Although they lower compliance costs, offsets can prevent companies from undertaking mitigation, especially if offset prices are low

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