Paying the green energy bill

On Thursday the 1^st of March, the government of the Walloon region (the South of Belgium) adapted the green electricity targets. By 2016, 30,4% of all electricity consumed in Wallonia is to be green. This is a near doubling of the current target for 2012 which is at 15,75%.  These targets are to be viewed in the light of the green certificate systems that Belgium’s regions apply to promote the production of green electricity.

First, let me explain the basics of a green certificate system. Every producer of green electricity receives a green certificate for every MWh of electricity produced by its windmill, solar panel, biofuel-fired power station, etc.  Energy suppliers are to prove that a certain percentage of the electricity that they supply to end consumers has been produced from renewable sources. They do this by submitting green certificates to the authorities. They get these certificates for the green power stations that they own themselves or they buy them from others. As such, a green power producer that is not an energy supplier gets an extra source of income by selling green certificates to energy suppliers. The revenue on certificates is even the largest source of income on green power, more than the power sales. A Flemish, a Walloon and a Brussels market for green certificates have developed.

The prices in these market are limited to the upside and the downside by two further measures. On the upside, we have the penalty that suppliers are to pay when they don’t submit enough certificates.  This is 125 euro for Flanders and 100 euro for Wallonia. On the downside, there is the price that grid operators are obliged to pay for certificates. When the system was conceived, green energy investors expressed their worries that in case of over-supply of certificates (i.e. when the production of green power exceeds the target), the prices would collapse to zero. They argued that this risk would keep anyone from investing in green energy. The legislators therefore added an obligation for grid operators to buy the certificates at a certain price, e.g. 90 euro for a windmill built in Flanders after 1/1/2010. To add to the complexity, the minimum prices have been diversified according to the technologies. For solar panels, the minimum price was put above the penalty price, at a staggering 450 euro per MWh at the beginning (this has been brought down recently).  Owners of solar panels never sell their certificates to suppliers, they always sell them to the grid operators. These sell them on to the suppliers at the much lower market price, bearing the loss between the minimum price and the market. This loss is then passed on to the end consumer through increasing grid fees. This system gave birth to a heavy discussion as adverseries of green electricity argued that people that put solar panels on their rooftops have these paid for by their neighbours.

For a long time, the prices of green certificates were stable, at around 110 euro per MWh. However, we recently saw a collapse of the prices. The reason is over-supply. The system has been more succesful than anyone had ever imagined. Initial resistance to windmill construction has declined a lot recently, solar panels became the favorite investment of house-owning Belgians and the government was very lenient in applying the tag ‘green’ to biofuel projects. Above all, the economics were wonderful. A windmill has a payback period of less than three years if you can sell certificates at 100 euro. Solar panels’ payback got reduced to five years. That’s excellent investment. As over-supply causes prices to collapse, everyone starts to sell the certificates to the grid operators, increasing the bill for the end consumer. Some even prefer not to wait (as they need the cash immediately) and sell below the minimum price to suppliers.

The governments of both regions are looking for solutions for the chaos currently caused by over-supply of certificates. The Walloon region is taking the obvious solution, i.e. raising the targets. What will this mean for economic development in that region? More green electricity will mean higher costs of electricity for the end consumer. Ever since the creation of the green certificate system, the cost of buying the certificates is passed through to the end consumer. Wit a 30,4% green electricity target, the green electricity bill for an end consumer will rise to 24 to 30 euro per MWh by 2016.  It is remarkable that at a moment when the federal government is taking a reckless measure to reduce the energy bill for end consumers (see my previous blog), the Walloon government adopts a green power policy that is sure to increase it, without giving much thought to alternatives. Moreover, Wallonia wants to add to the regulatory uncertainty of pricing energy in Belgium by obliging suppliers to pass through the real cost of buying green certificates, an obligation which we think is completely impossible to enforce. We are still waiting for the exact details of the Walloon regulation, but it looks like bad news for the consumers of power in that region (and good news for the investors in green energy).

The Flemish government seems to be more sensitive about the energy cost-increasing consequences of the certificates system. It wants to rethink the whole system, a laudable initiative. I realize that every subsidizing system will produce unwanted side-effects. The certificates system has been an attempt to minimize these by introducing a market element. I think that this attempt has massively failed, due to the following reasons:

1. This is not a ‘natural’ market but a ‘constructed’ market, hence, prone to construction flaws. It has become clear that due to the construction of this particular market there are only two scenarios. Either we get a very stable price near the penalty price in case of shortage, or we get a rapidly collapsing price when there is over-supply. There is no such thing as the equilibrium price that the market rationalists that created this system thought of. The stable price reduces the added value of the market element. The possibility of collapsing creates uncertainty for investors. What does the element of ‘market’ add for the investor but uncertainty over future subsidy revenue? For many years, the price was so stable, that you could rightfully argue: why don’t we just give the 110 euro’s? Why do the green power investors have to go through the trouble of finding a buyer, keeping track of prices, etc.? The extra value that you could get by ‘playing the market’ added only marginally to the profitability of your green energy investment. Therefore, most of the investors don’t even bother and make a long-term agreement with an energy supplier.
2. Investment costs in renewable technology drop. If the certificate prices remain stable, this means that the technologies get over-subsidized. Windmills are currently turning in more than 15% annual return. I don’t think that these machines wouldn’t have been built if the return had been 7 or 8%. This over-subsidizing is a waste of money, money paid by the energy consumers.
3. The governments try to counter this by reducing the minimum prices paid by grid operators. However, in the shortage scenario this is ineffective. Producers sell at the higher market prices to suppliers that pass through these costs to energy consumers. In the collapse scenario the lower minimum prices make the market drop even deeper.
4. Reducing the penalties is impossible. This would drive down the certificate prices for everyone, also the people that invested in windmills many years ago, when investment costs were much higher. They would rightfully claim that the government defaults on its obligations to create a stable investment climate for green energy.
5. The passing through of certificates costs disturbs the functioning of the Belgian retail electricity market. At this moment, for example, it is the company that bought green certificates at the lowest price that wins most electricity contracts. Supplying electricity in Belgium comes down to trying to make the right bets on the development of the green certificate market.

In the late nineties, when the Kyoto protocol was hammered out and our climate policies conceptualized, ‘market mechanisms’ were conceived by proponents of the rational market theory as a panacea for reducing the cost of reducing carbon impact. The European Trading System of carbon emission rights is a good example of the application of this market mechanism. Emissions trading has failed, as I have argued before in this blog (see my entries of 6/7/2011, 31/1/2011, 2/12/2009 and 28/8/2009).  From the above, it should be clear that certificates trading is also failing to deliver a stable, low-cost subsidies system for promoting green electricity. This is not because markets are not efficient or always fail. It is because too much in these market is constructed. The problem isn’t that the laws of supply and demand do not function. It is that supply and demand in these markets are constructs, they are artificially created and the design flaws in their creation have unwanted side effects.

I recommend the Flemish government to get back to basics. Investors want stability. Society wants cost-efficiency. I think that a simple direct subsidy system is the most effective way of achieving this double goal. A subsidy is a subsidy, point. Just award an annual aid amount to every new green energy project (production of heat included), guaranteed for a period of 10 or 15 years. Yearly adapt the subsidies to the evolution of the investment costs. Oblige the green investors to share the information on investment costs with your administration so that they can make a correct assessment of that evolution and drive the adaptations. Work together with other European governments on this price observatory. Aim to give investors of green electricity a stable return of 7 to 8% on their renewable energy investment. Have the average market price for the energy that they produce deducted from the annual aids. Pass through the cost of these subsidies to the end consumers in a clear and transparent green energy tax. Create a system of tax reduction for energy-intensive industries.

As a father of two children, I can only cheer for the rapid development of green energy in my country. However, as an advisor to energy consumers and producers of green energy, I dissaprove the inefficiency and unnecessary complexity of the current certificates systems.

 

In French:

 

Jeudi 1er Mars, le gouvernement de la région wallonne a approuvé en troisième lecture un arrêté fixant les objectifs d’électricité verte pour les prochaines années. D’ici 2016, 30.4% de l’électricité consommée en Wallonie devra être verte. Il s’agit pratiquement d’un doublement par- rapport à l’objectif de 2012, fixé à 15.75%. Ce  texte s’intègre dans le cadre du système de certificats verts appliqué par les régions belges pour promouvoir la production d’électricité renouvelable.

Dans un premier temps, détaillons les règles liées aux certificats verts. Chaque producteur d’électricité verte reçoit un certificat vert pour chaque MWh produit par ses éoliennes, ses panneaux solaires, etc. Les fournisseurs d’énergie doivent prouver qu’un certain pourcentage d’électricité fournie au consommateur final a été produit à partir de sources renouvelables. Pour ce faire,  ils sont tenus de soumettre en retour des certificats verts aux autorités. Ceux-ci peuvent être obtenus à partir de leur propre production d’électricité renouvelable, ou par l’achat à un tiers dans le cas échéant. Ainsi, un producteur d’électricité verte, qui n’est pas un fournisseur d’énergie, peut se voir crédité de revenus supplémentaires en vendant ses certificats aux différents fournisseurs. Ce revenu peut même être supérieur à celui lié à la vente de l’électricité produite. Un marché wallon, flamand et bruxellois s’est alors développé sur ce principe.

Les prix de marché sont contenus dans un intervalle, dont les bornes sont définies par deux principes. D’un côté, la valeur maximale correspond à la pénalité que les fournisseurs doivent payer lorsqu’ils ne sont pas en mesure de soumettre assez de certificats et dont la  somme est fixée à 125€ en Flandres et à 100€ en Wallonie. A l’opposé, le prix minimal correspond au prix auquel les gestionnaires de réseau sont tenus de racheter les certificats.

Lorsque le système fut conçu, les investisseurs ont exprimé leurs craintes face à un éventuel effondrement des prix en cas de sur-allocation des certificats (c’est-à-dire lorsque la production d’énergie verte dépasserait  les quotas fixés). Ils affirmèrent que ce risque dissuaderait quiconque d’investir dans l’énergie verte. Les législateurs ont alors modifié le texte, en obligeant les gestionnaires de réseau à acheter les certificats à un certain montant (par exemple à 90€ pour une installation éolienne construite en Flandres avant le 1er janvier 2012). La complexité du système a été renforcée par des prix d’achats dépendants du mode de production. Pour les panneaux solaires, le prix minimum a été fixé bien au-delà de la pénalité, initialement au prix édifiant de 450€ par MWh (ce prix a été diminué récemment).  En conséquence, les propriétaires de ces installations ne vendent jamais leurs certificats aux fournisseurs, mais toujours aux gestionnaires de réseaux. Ces derniers les revendent ensuite aux fournisseurs au prix du marché, supportant la perte avec le tarif d’achat. Cette perte est ensuite répercutée au client final via une augmentation des tarifs de réseau. Un tel système a donné naissance à de vives discussions, dans la mesure où les adversaires de ce système affirmèrent que les personnes installant des panneaux solaires sur leur toit avaient été indirectement financées par leurs voisins.

 

 

 

 

 

 

 

Les prix des certificats verts ont été stables pendant une longue période, aux alentours de 110€ par MWh. Cependant, une rupture a été observée récemment, en raison d’une sur-abondance de certificats. La réussite de ce système a dépassé les espérances. Les vives oppositions contre la construction d’éoliennes se sont adoucies, les panneaux solaires sont devenus l’investissement préféré des belges et le gouvernement s’est montré très souple en accordant la mention “verte” aux biocarburants. Les investissements étaient très rentables. Par exemple, avec un tarif d’achat de 100€ par certificat, le retour sur investissement est inférieur à 3 ans pour une installation éolienne. En cas de sur-abondance, lorsque le prix s’écroule, les certificats sont alors vendus aux gestionnaires de réseau, augmentant ainsi la facture du consommateur final. Comme certains ne souhaitent cependant pas attendre (afin de toucher l’argent immédiatement), des certificats sont vendus en-dessous du prix minimum aux fournisseurs.

Chaque gouvernement cherche des solutions pour mettre fin au chaos engendré par cette sur-abondance de certificats. La région wallonne s’est engagée sur la voie la plus évidente, en augmentant les quotas. Quelle va être la conséquence sur le développement économique de cette région? Plus d’électricité verte se veut synonyme d’une facture plus élevée pour le consommateur final. Depuis la création de ce système, les coûts ont toujours été supportés par le consommateur final. En se fixant pour cible 30.4% d’électricité verte en 2016, il faut s’attendre à une augmentation de 24 à 30€ par MWh. Alors que le gouvernement fédéral prend des mesures insouciantes pour réduire la facture énergétique des consommateurs (voir le blog précédent),  la région wallonne adopte curieusement une politique impliquant une hausse des prix, sans réellement prêter attention aux autres alternatives possibles. La Wallonie  favorise également les incertitudes liées au prix en contraignant les fournisseurs à répercuter le prix réel du certificat vert au consommateur, obligation qui est de notre point de vue impossible à appliquer et à contrôler.

A l’heure actuelle, les détails de l’arrêté ne sont pas encore connus, mais cela s’annonce comme étant un coup dur pour les consommateurs d’électricité dans cette région (et une bonne nouvelle pour les investisseurs dans les énergies vertes). Le gouvernement flamand semble être plus raisonnable face aux conséquences d’une augmentation des prix des certificats. Il veut repenser le système, ce qui est une initiative louable. Je suis conscient que chaque système subventionné possède son lot d’effets indésirables. Le système de certificats a donc été une tentative visant à les réduire, au travers de la mise en place d’un marché. Je suis cependant persuadé qu’il s’agit d’un échec majeur, pour les raisons suivantes:

1)    Ce n’est pas un marché “naturel”, mais un marché construit de toute pièce, sujet à des défauts de construction. Il est désormais clair que depuis la mise en place de ce marché, il ne peut y avoir que deux scénarios. Soit le prix est très stable et proche de la pénalité (en cas de pénurie de certificats), soit le prix s’effondre (en cas de sur-abondance). Le prix d’équilibre imaginé par les économistes n’existe pas. Un prix stable réduit la valeur ajoutée du marché. Un possible effondrement crée des incertitudes pour les investisseurs. Que peut bien ajouter le “marché” hormis des incertitudes sur les revenus? Pendant des années, le prix était si stable qu’il est possible de se demander à juste titre  « pourquoi ne pas accorder simplement 110€? » Pourquoi les investisseurs  doivent-il passer par la recherche d’un acheteur, suivre l’évolution des prix, etc.? Le profit additionnel  que vous pourriez obtenir en ‘jouant” sur le marché n’est qu’une part marginale de la profitabilité de votre investissement. En conséquence, la plupart des investisseurs concluent tout simplement un contrat long terme avec un fournisseur en énergie.

2)    Le coût des technologies vertes diminue. Si les certificats se maintiennent à un prix stable, cela signifie que la technologie devient trop subventionnée. Le taux de rentabilité d’une éolienne est actuellement supérieur à 15%. Je ne pense pas qu’elles auraient construites si ce taux avait été de 8%. Ces subventions trop fortes constituent un gaspillage d’argent, supporté par les consommateurs.

 

3)    Les gouvernements tentent de contrer cela en réduisant les prix minimum payés par les gestionnaires de réseau. Cependant, dans le scénario de pénurie de certificats, ceci est inefficace. Les producteurs vendent alors les certificats au prix de marché aux fournisseurs (à un prix plus élevé), et ce prix est répercuté au consommateur. Dans le scénario opposé, un prix plus faible ne verra que s’effondrer davantage le marché.

 

4)    Réduire la pénalité est impossible. Ceci tirerait les prix des certificats vers le bas pour tout le monde, y compris pour ceux qui ont, lorsque l’investissement était plus important il y a quelques années, investis dans les installations éoliennes. Ceci reviendrait à proclamer (à juste titre) l’échec du gouvernement dans ses obligations de mise en place d’un marché stable.

 

5)    La modification du prix des certificats perturbe le bon fonctionnement du marché de détail belge. En ce moment, par exemple, c’est le fournisseur qui achètera les certificats au meilleur prix qui remportera la plupart des appels d’offres. Etre fournisseur en Belgique consiste à faire les meilleurs pronostics sur le développement du marché des certificats.

 

A la fin des années 90, lorsque le protocole de Kyoto fut négocié et nos politiques climatiques conceptualisées, les mécanismes de marché furent conçus par les défenseurs de la rationalité des marchés, et décris comme étant la panacée pour optimiser les coûts liés à la décarbonisation. Le système communautaire d’échange de quotas d’émission est un bon exemple de l’application de ces mécanismes. Ce marché est un échec, comme détaillé auparavant dans ce blog (voir les références   6/7/2011, 31/1/2011, 2/12/2009 et 28/8/2009). Il faut impérativement souligner  que ce système d’échange de certificats ne parvient pas à fournir des subventions stables au meilleur coût pour promouvoir l’électricité verte. Ceci n’est pas dû au fait que  les marchés ne sont  pas efficaces, ou sont voués à l’échec: la raison principale est la construction du marché en elle-même. Le problème n’est pas que la loi offre-demande ne fonctionne pas. L’offre et la demande sont ici artificiellement crées, et les défauts de construction ont des effets indésirables.

Je recommande au gouvernement flamand de revenir aux fondamentaux. Les investisseurs veulent de la stabilité. La société souhaite  un système optimal en termes de coût et d’efficacité. Je pense qu’un simple système de subventions est la façon la plus efficace d’atteindre ce double objectif.

Accordez simplement un certain montant pour encourager le développement de nouveaux projets verts (incluant la production de chaleur), garanti pour une période de 10 à 15 ans. Adaptez chaque année la subvention pour tenir compte de l’évolution des coûts d’investissement. Obligez les investisseurs à partager ces informations afin de tendre vers une évaluation correcte des évolutions et procédez aux adaptations. Permettez aux investisseurs d’avoir un taux de retour de 7 ou 8%. Déduisez le prix de marché moyen pour l’énergie produite en fonction de l’aide annuelle. Répercutez les coûts de ces subventions au consommateur au travers d’une taxe claire et transparente. Créez un système de réduction des taxes pour les industries électro-intensives.

En tant que père de deux enfants, je ne peux que me féliciter du rapide développement des énergies vertes dans mon pays. Cependant, en tant que conseiller auprès des consommateurs et producteurs d’énergie verte, je désapprouve l’inefficacité et la vaine complexité du système de certificats actuel.

 

In Dutch:

Wie betaalt de groene stroomrekening?

Op donderdag 1 maart, heeft de Waalse regering de doelstellingen voor groene stroom aangepast. Tegen 2016 moet 30,4% van alle verbruikte elektriciteit in Wallonië groene stroom zijn. Dit is ongeveer een verdubbeling van de doelstelling van 2012, waarvoor het percentage op 15,75% werd vastgelegd. Deze targets moeten worden gezien in het licht van het systeem voor groene stroom certificaten die de gewesten hanteren om de productie van groene stroom te promoten.

Sta mij toe eerst de grondbeginselen uit te leggen van het groene stroom certificatensysteem. Elke producent van groene stroom ontvangt een certificaat voor elke geproduceerde MWh komende van windmolens, zonnepanelen, bio-energie centrales,…
Energieleveranciers moeten bewijzen dat een bepaald percentage van hun geleverde energie geproduceerd werd vanuit hernieuwbare energie. Ze doen dit door middel van het afleveren van groene stroom certificaten aan de autoriteiten. Ze halen de groene stroom certificaten uit de groene stroom centrales die ze bezitten enerzijds en anderzijds kopen ze ook de groene stroom certificaten van de Groene stroom producenten. Zodoende kan een groene stroom producent die geen energieleverancier is een extra bron van inkomsten aanboren door het verkopen van groene stroom certificaten aan energieleveranciers. Het is zelfs zo dat de inkomsten uit groene stroom certificaten de grootste bron van inkomsten zijn, groter nog dan de verkoop van energie. Zo is er een Vlaamse, Waalse en Brusselse nieuwe markt ontstaan.

De prijsschommelingen in deze markt zijn aan de boven- en onderkant gelimiteerd door 2 zaken. Voor de bovengrens speelt de boete die de leveranciers moeten betalen als ze niet genoeg certificaten inleveren. Voor Vlaanderen is dit 125 euro en voor Wallonië 100 euro. Voor de ondergrens is er de prijs die de distributienetbeheerders moeten betalen voor de certificaten. Toen het systeem in werking werd gesteld, waarschuwden de investeerders in groene energie voor een prijscrash in geval van overaanbod van de certificaten (d.w.z. wanneer er meer groene stroom wordt geproduceerd dan voorzien). Ze argumenteerden dat mede door dit risico elke investeerder er zich van zou weerhouden om te investeren in groene energie. De wetgever besliste dan maar om de netbeheerders te verplichten om de certificaten tegen een bepaalde prijs te kopen (bvb. 90 euro voor een windmolen gebouwd na 1/1/2010). Om het nog wat ingewikkelder te maken, werd voor stroom uit zonnepanelen in het begin de minimum prijs boven de boeteprijs gesteld op 450 MWh (deze werd recent verlaagd). De eigenaars van zonnepanelen verkopen hun certificaten nooit aan de leverancier, maar aan de distributienetbeheerders. Op hun beurt verkopen de distributienetbeheerders aan een veel lager markttarief met verlies, als gevolg van het verschil tussen de minimumprijs en de marktprijs. Dit verlies wordt doorgeschoven naar de eindgebruiker d.m.v. het verhogen van de nettarieven. Zo komt het dat er hevige discussies ontstaan waarbij de tegenstanders van groene stroom beweren dat zij de zonnepanelen op het dak van hun buren betalen.

Gedurende een hele periode was de prijs van groene stroom certificaten stabiel rond de 110 euro per MWh. Recent zagen we de prijs echter in elkaar zakken. De reden? Overaanbod. Het systeem is succesvoller gebleken dan iemand ooit voor mogelijk had gehouden. Er is veel minder weerstand tegen de constructie van windmolens en zonnepanelen zijn de favoriete investeringen geworden van alle Belgische woonhuisbezitters. Daarnaast was de regering wel heel mild in het labelen van biobrandstofprojecten als zijnde “groen”.

Windmolens hebben een terugverdientijd van minder dan 3 jaar en als je certificaten kan verkopen aan 100 euro, dan zijn de investeringen op zonnepanelen op 5 jaar terugverdiend. Een prima investering dus. Doordat de prijzen dreigen in te storten door het overaanbod, begint iedereen zijn certificaten te verkopen aan de netbeheerders, die op hun beurt de rekening van de eindgebruikers laten doorstijgen. Sommigen wachten zelfs niet (omdat ze het geld onmiddellijk nodig hebben) en verkopen certificaten onder de minimumprijs aan de leveranciers.

Zowel de Waalse als de Vlaamse regering zijn op zoek naar oplossingen voor deze chaotische toestand. De Waalse regering neemt een op zich voor de hand liggende beslissing, namelijk het optrekken van de targets. Wat zal dat betekenen voor de economische ontwikkeling in deze regie? Meer groene stroom,  betekent hogere elektriciteitskosten voor de eindgebruiker. Al van in het begin wordt de eindafrekening van de kost voor de aankoop van groene stroom doorgeschoven naar de eindgebruiker. Met een doelstelling van 30,4% voor de productie van groene stroom, zal de rekening voor de eindgebruiker stijgen tot 24 – 30 euro per MWh tegen 2016.

Het is opmerkelijk dat op het moment dat een federale regering ongeziene maatregelen neemt om de energiefactuur voor de eindgebruikers te laten dalen (zie vorige blog), de Waalse regering beslist om een politiek te voeren die er zeker toe zal bijdragen de rekening te laten stijgen, zonder ook maar goed na te denken over alternatieven. Daarenboven, voegt de Waalse regering nog wat meer onduidelijkheid toe door de leveranciers te verplichten om de werkelijke kosten voor het kopen van groene certificaten door te rekenen. Een verplichting die mijns inziens onmogelijk kan doorgedrukt worden. We wachten nog op de precieze details van de Waalse regulering, maar het ziet er naar uit dat dit slecht nieuws is voor de energieverbruikers in Wallonië (en goed nieuws voor de investeerders in groene stroom).

De Vlaamse regering blijkt in elk geval omzichtiger om te springen met de stijging van de energiefactuur. Ze wil het hele systeem herbekijken. Ik ben van oordeel dat elk subsidiesysteem ongewilde neveneffecten zal veroorzaken. Het certificatensysteem was een poging om deze effecten te minimaliseren door er een marktelement aan te koppelen. Ik denk dat deze poging volledig mislukt is, omwille van volgende redenen.

1. Dit is geen natuurlijke markt, maar een geconstrueerde markt en bijgevolg heel erg vatbaar voor constructiefouten. Het is duidelijk geworden dat door deze constructie de markt maar twee mogelijke scenario’s heeft. Of we krijgen een heel stabiele prijs vlak onder de “boeteprijs” in geval van schaarste, of we krijgen een prijscrash bij overproductie. Er kan onmogelijk een fictief marktevenwicht gecreëerd worden door marktspecialisten. De stabiele prijs reduceert de toegevoegde waarde van het marktelement. De mogelijkheid tot ineenstorten van de markt zorgt voor onzekerheid voor investeerders. Welke toegevoegde waarde kan de markt brengen naast de onzekerheid over de toekomstige subsidie-inkomsten?
   Gedurende heel wat jaren was de prijs zo stabiel dat men gemakkelijk kon zeggen: “Waarom geven we niet gewoon die 110 euro?” Waarom moeten de groene stroom investeerders moeite doen om een koper te vinden, prijzen op te volgen,…?
   De extra waarde die kon verkregen worden door te “spelen” op de markt was slechts minimaal in verhouding tot de winstgevendheid van de investering in groene energie. Dus ze deden de moeite niet en dat resulteerde in lange termijn overeenkomsten met energieleveranciers.
2. Investeringskosten voor hernieuwbare energie dalen. Als de prijs van de certificaten stabiel blijft betekent dit oversubsidiëring. De jaarlijkse return voor windmolens ligt momenteel op 15%. Ik denk niet dat deze molens niet zouden geplaatst geweest zijn moest de return slechts 7 of 8% geweest zijn. Deze oversubsidiëring is geldverspilling gefinancierd door de consument.
3. De overheid probeert dit tegen te gaan door de minimumprijs die betaald moet worden door de netbeheerders te verlagen. Deze korte termijn remedie is echter niet efficiënt. Producenten verkopen tegen hogere marktprijzen aan de leveranciers en zij schuiven op hun beurt de kosten door naar de consument. En in het scenario van de prijscrash zakken de minimumprijzen zelfs nog dieper weg.
4. De boetes verlagen is onmogelijk. Dit zou de prijs van de certificaten naar beneden halen voor iedereen. Ook voor degene die lang geleden al in windmolens investeerden en de investeringen veel duurder waren. Ze zouden terecht uitschreeuwen dat de overheid zijn verplichting om een stabiel klimaat te creëren voor de investeringen in groene stroom niet nakomt.
5. Het doorgeven van de certificaten verstoort de werking van de Belgische retailmarkt in stroom.  Op dit moment rijft die onderneming die de certificaten op hun laagste waarde heeft gekocht het meest elektriciteitscontracten binnen. Elektriciteit leveren in België komt er dus op neer om zo goed mogelijk in te zetten op de ontwikkeling van de markt van groenestroomcertificaten.

Eind jaren negentig, bij de onderhandeling van het Kyoto akkoord en het ontwerp van het klimaatbeleid, ontwikkelden voorstanders van de rationele markt theorie bepaalde marktmechanismes als een soort wondermiddel om de kost van koolstofdioxide-uitstoot te verlagen. Het Europees systeem van emissiehandel voor de uitstoot van koolstof is hiervan een mooi voorbeeld. Dit mechanisme heeft gefaald, (zie mijn vorige blogs 6/7/2011, 31/1/2011 en 2/12/2009 en 28/8/2009). Uit het voorgaande moeten we concluderen dat ook de handel in groene stroom certificaten niet resulteert in een stabiel beleid voor het promoten van groene stroom. Het probleem is niet dat de basisprincipes van vraag en aanbod niet werken, maar het systeem is gewoon té kunstmatig opgebouwd. De kunstmatige creatie van dit specifieke vraag en aanbod systeem veroorzaakt ongewilde neveneffecten.

Ik zou de Vlaamse regering adviseren om opnieuw te beginnen bij het begin. Investeerders willen stabiliteit. De maatschappij wil een systeem met een goede verhouding tussen kosten en baten. Een subsidie is een subsidie, punt. Bied een jaarlijkse steun aan elk nieuw groen “project” (inclusief de productie van warmte), gedurende een periode van 10 – 15 jaar. Maar pas die subsidie jaarlijks aan naargelang de investeringskost. Verplicht de investeerders om die investeringsinformatie met u te delen. Zodoende kunnen de ontwikkelingen hier correct worden ingeschat en bijgestuurd. Werk samen met andere Europese overheden voor deze prijsopvolging. Focus er op dat groene stroominvesteerders een vaste return hebben van 7 – 8%. Verminder de jaarlijkse steun naargelang de gemiddelde marktprijs van de geproduceerde groene energie. Schuif de kosten van de subsidies door naar de eindgebruiker onder de vorm van een duidelijke transparante energiebelasting. En creëer een systeem van belastingsvermindering voor de energieverslindende industrieën.

Zijnde een vader van 2 kinderen, kan ik alleen maar blij zijn met de snelle ontwikkeling van de groene energie. Anderzijds als consultant voor energieverbruikers en groene stroomproducenten, keur ik de inefficiëntie en de onnodige complexiteit van het huidige certificatensysteem grondig af.

Filed under: Belgium, emission trading, Energy policy, Energy technology

ETS is really becoming absurd

I was shocked these past days by two pieces of really jaw-dropping news about emissions trading in Europe:

1. A Dutch client told me that as paper manufacturers, they fear that the new phase allocation rules will oblige them to shut down their cogeneration unit.
2. Peter Vis, an official of the EU Commission expressed his worries that a directive that would oblige ETS companies to improve energy efficiency would undermine ETS prices.

This news confirms my worst fears about ETS. It has become a goal in itself and the people involved in it seem to have completely forgotten that ETS is only a means to reach a more important goal: reducing carbon emissions. As I have said before in this blog, carbon emission trading is largely a failure. The main flaw is the fact that the two trading phases that we have had so far were over-allocated. This led to very low carbon prices. This means that the price of carbon is not stimulating carbon reduction measures. The EU Commission understands this and is anxious about not having over-allocation for the next trading phase, and we can understand this. However, if this means that they become scared that energy efficiency improvements reduce carbon emissions, this is absolutely absurd.

Ad 1: If you reduce the allocation of emission rights to a company that runs a cogen unit, it becomes economically sensible for this company to shut down the cogen unit. By doing so, the company will reduce its gas consumption and hence its carbon emissions, which reduces the cost for buying extra rights. It will then buy its electricity from a power company. Anybody with some basic understanding of energy efficiency will understand that the end result is an increase in overall carbon emissions.  Having an on-site cogeneration unit is the more energy efficient way of producing paper. If ETS causes paper manufacturers to fall back on less energy efficient production methods, it completely misses its goals.

I know that supporters of ETS will argue that the increased demand of grid electricity will cause carbon and electricity prices to go up, so that ultimately the paper manufacturer might be forced to start up the cogen again. In theory this is true, but this argument misses two points: 1. The adaptation of carbon and electricity prices will not be one-on-one, as the paper manufacturer is just one of the many emitters of carbon dioxide and just one of the many clients of the power producers, 2. There will be serious time lags between the decisions to shut down or start up the cogen and the price reactions.

This argument is actually a good illustration of why ETS is going wrong. It is a good policy in theory, but when you practically apply it, you run into a multitude of difficulties. ETS is a good example of a too optimistic application of the efficient markets hypothesis. This hypothesis assumes that all market participants have real-time access to all supply and demand information. Hence, the price is always a correct representation of supply and demand balance at that moment. In reality, there are serious time lags in the access to information. The owner of the paper company will decide to shut down his cogen based on carbon prices and electricity prices at that moment. Prices will adapt over a few months. It will take the paper manufacturer another few months to realize this and to take the decision to start up the cogen again. Supply and demand data of carbon dioxide emissions are simply too chaotic for anyone to have an accurate and timely view on them. Therefore, prices are based on assumptions about supply and demand, not the real data. That is the reason why ETS has failed, and will continue to fail, to give a consistent and reliable price signal.

Ad 2: I was not present at the conference where Mr. Vis made his comments and I hope that his words were misrepresented in the press. However, Euractiv quotes him as saying: “We’re big supporters of energy efficiency,” he said, “but we have to be careful not to undermine a system that is in place now – the ETS – which is a global leader”. So if I understand Mr. Vis correctly, he would be unhappy if companies cut their carbon emissions so much that emissions drop below allocations, causing prices to fall. He is chief of staff of the EU’s Climate Commissioner!

I understand part of Mr. Vis’ argument. It is indeed confusing to have two policies in place that have the same goal of reducing carbon emissions by industrial companies. The one, ETS, wants a market based approach to stimulate reduced emissions. The other, an energy efficiency directive, is a command and control approach to oblige companies to reduce. Mr. Vis is right about the fact that the EU needs to choose which approach. However, is he right in assuming that the market-based approach is so much better?

If he fears that the command and control approach will lead to emissions dropping below ETS allocations, he admits that obliging efficiency improvements is the more effective policy. If we adopt that approach, carbon emissions will drop more than with ETS, that is what Mr. Vis is saying. Well, Mr. Vis, isn’t that a good thing for the climate? Isn’t your boss supposed to protect the climate rather than the ETS? Shouldn’t you promote the more effective policies?

Mr. Vis will probably argue that ETS is more cost-effective.  I am not so sure about that. ETS has been around now for the past six years, and it has been nothing more than an operation that transferred money from the electricity consumers to the electricity producers, without any real contribution to reducing carbon emissions.  I wouldn’t exactly call that cost-effective.  Billions of euros have already been spent on emissions trading. By electricity consumers that saw their power price rise due to emission rights prices. By investors that took wrong bets. By participants in the ETS to deal with the administrative burden that it imposes on them. A massive waste of money.

Of course, this waste has been due to the over-allocation. But will ETS be cost-effective in case of a shortage of emission rights? The ETS theorists assume – once again, based on the efficient market hypothesis – that in the end total emissions will completely match the allocation. This supposes a degree of rationality and access to information that is simply not there. Who will decide, on the 31^st of December of the last year of the trading phase, how much all the participants in ETS should consume, so that the emissions match the allocation? Theorists even assume that this will lead to some sort of equilibrium price, something that I don’t even understand from a theoretical point of view. What many theorists fail to understand, is that in ETS the supply side of the equation is static. The overall amount of emission rights that are available is fixed in the initial allocation. This is very different from other markets. It means that there is no cap on how high prices can rise. And this is a potentially very dangerous situation. In case of a real shortage of allocations, I think that there are two probable scenarios:

1. Everybody realizes very soon in the trading phase that there is a shortage and starts to buy emission rights. We get a massive price spike, which leads to increases in electricity prices that cripple the EU economy. The resulting economic crisis causes emissions to drop below allocations, causing a price crash by the end of the trading period.
2. The large majority of ETS participants that have less than 100.000 tons of emissions, continue to be very passive about emissions trading. They realize only very late in the trading phase that they have shortages of emission rights. By 2012 there is a massive scramble for rights that are not there.

I sincerely hope that I am wrong, but I am very scared that if the EU indeed manages to impose a short allocation on the market, we will see an extreme price spike. This will cause an economic crisis in Europe. Is that what you call cost-effective, Mr. Vis?

There are many reasons why Brussels can be dubbed ‘The capital of absurdity’. The commission’s fundamentalist approach to ETS is one of them. Another one is the absurdist character of Belgian surreal painting, of which René Magritte is the best example. Writing this blog made me think of Magritte’s painting “Golconda”. We can only hope that the authors of EU climate policy come back down to earth before they unleash ineffective, economy-wrecking policy on us.

Filed under: Climate change, emission trading, Energy policy

Why emission trading should be suspended permanently

Emission trading has been suspended for more than a week now and it is not clear yet when the market will open again. The reason is fraud, again we should say. What has happened?

Underlying the carbon market in Europe is a system of national registries. If you are a company that is participating in the emission trading, you get an account in this registry. The emission rights that you get from the government (your allocation) are then put into this account. If you make a trade, for example you sell rights, they will move from your account to the account of your counterparty. The whole system is run over the internet. Smart fraudsters have found a way of hacking the registries. They get into people’s accounts, grab the rights that are there, transfer them to their own account and rapidly sell them in the spot market. By doing this, they have recently made some 30 million euro’s. The registries of Austria, Czech republic and Greece were affected.

I think it’s not surprising that this happens. Emission rights are money and where there is money there is fraud. Moreover, the market was created from scratch in 2005, which is also true for the IT-infrastructure that is to support it. That probably explains the loopholes in the security systems. The authorities are now ramping the security up and are refusing to re-open the registries for rights transfers before they have everything tested. This standstill is not without consequences. If there is no possibility of transferring rights from one account to another, there is no possibility of spot market trading. Therefore there has been no more spot market trading since the suspension. How long can this last?

Regular readers of this blog will know that my enthusiasm for emissions trading is very low. It is a classical example of a great idea that turns into a bad practice for several reasons:

1. Emission trading creates an immense amount of organizational difficulties. Protection against fraud is a good example of that. But also for the participating companies, the system creates an important extra administrative workload. They have to lobby for allocations, manage the account in the national registry, report on emissions, have those reports audited, manage trades, etc. I can hardly imagine that this paperwork is beneficial to the environment.
2. Both trading periods in ETS were over-allocated. As long as the system is over-allocated, it is not contributing to the reduction of emissions of carbon dioxide. It creates an extra – unasked for – source of income for those that have laid their hands on the excess emission rights. And it creates an extra cost for electricity consumers as power producers hedge the costs of emission rights by incorporating them in their pricing.
3. And even if allocations were short, I still doubt whether emission trading would contribute to reducing carbon dioxide emissions. I’ve discussed this with a client last Thursday. He asked me what my prognosis for long term emission rights prices is. The only sensible thing I could answer was ‘somewhere between zero and infinity’. And he responded, ‘Well that is why we don’t take into account savings on emission rights when we make a decision on investment in increased energy efficiency’. The price signal is too shaky to be significant.

Emission trading has missed its goal (reducing emissions of carbon dioxide), has created unnecessary administration and has also been a source of financial fraud at several occasions. What more does it take to make this suspension permanent?

There are a few thousand people winning money by having a job as a consultant, trader, broker, software developer, auditor, journalist etc. in the emission rights market. They will do all they can to keep this monster alive that they have contributed in creating. The EU has prided itself about the creation of emission trading across the planet. Admitting that it is a failure isn’t very easy. But is it really so hard for common sense to win? How much more money needs to get lost?

Filed under: Climate change, emission trading, The market today

The Copenhagen (lack of) accord

The word ‘accord’ is relative to the Italian word “accordare” or the French word “s’accorder”. Both words mean reaching an agreement. Well, if the world is honest, it will have to admit that the climate summit in Copenhagen (COP15) has mostly unveiled the deep disagreement about how to curb man-made climate change. Disagreements between three main parties:

1. The developed countries. Most of the carbon dioxide currently in the air came out of their chimneys. And they are still the world’s largest emitters. Still, there are large differences in their willingness to accept that historical responsibility. Europeans propose the most ambitious emission cuts. President Obama acted like a real leader on this issue when he arrived late on the summit. But he cannot make true on this leadership if his own country (the second largest per capita emitter) doesn’t commit to larger cuts. And with so many of his countrymen in the non-believers camp regarding climate change, he needs to thread carefully. After all, the US is a democracy …

2. The emerging economies. I recently saw a documentary about the Indian countryside. Hundreds of millions of people still live there without the comfort of electricity. This makes you understand how hard it is for these countries to commit to emission cuts. They claim their right to development, which, unfortunately, comes with larger emissions of carbon dioxide. If the average Chinese family would own two cars, like families in developed countries do, this would mean a disaster in terms of carbon dioxide emissions. But why would the Chinese have less right to drive cars than US or Belgian citizens?

3. The least developed countries. They have the lowest per capita emissions. And like emerging economies, they claim their right to development and more emissions. Moreover, they will probably suffer most from the effects of global warming. Flooding in Bangladesh, droughts in Africa, hurricanes in Central-America, many of the world’s poorest people happen to live in areas that risk serious effects of rising temperatures and seas. Yes, raising dykes will be painful for the budget of the Netherlands. But that pain looks puny when compared to the Bangladeshi that will have to run for higher ground because his government has no money to build any protections. The developed countries came to Copenhagen to ask for money. Not only the Kyoto money aimed at cleaning up development but also bare money to pay for the consequences of global warming.

International politics is a dirty game. And it is money that is at stake here. Hence the difficulty of these negotiations. According to David Milliband, the British minister present in Copenhagen, the talks have even shown the limits of the UN’s capacities as a facilitator of such international negotiations. He called it ‘a chaotic process dogged by procedural games’. This was well illustrated by the most remarkable TV footage coming from Copenhagen. The leaders of the US, China, India, Brazil and other countries crammed together in a much too small meeting room to hammer out what became the final deal. Mrs. Clinton was almost sitting on Mr. Obama’s lap! What a contrast with the huge stage in the central conference room. But it worked and some sort of deal was reached.

A deal that lacks ambition, it is true. There are no binding targets for countries. No sanctions if targets are not met. There is no clarity of how the Copenhagen Green Climate Fund that is to organize payments to the least developed countries ($100 billion per year) will be funded. And there is no timetable for tabling a more ambitious deal. Yet, even this toothless deal was too much for many countries to sign it. They ‘took note’ of it. Of course, the people in the small room did there best to look happy with what they had produced. They highlighted the achievements of the Copenhagen accord. The fact that all countries, China included, had agreed to have their emissions verified. This does indeed create the possibility of a more rational debate on emissions in the future. And then there is always that last excuse: “some deal is better than no deal”. But all of them must have realized how extremely difficult it will continue to be for the world to deal successfully with man-made climate change. The root cause of the problem, energy consumption, is simply too much linked to economic development. This will always make it difficult for politicians to take tough decisions on reductions.

The question remains what the result of Copenhagen will be. On the ground, we see a lot going on. Development of technologies such as renewable energy or electric cars is moving fast. Will this dynamism be thwarted by the lack of a world-wide policy framework to support it? Or is the development to strong to be stopped?

Copenhagen also presents Europe with an important dilemma. The EU has again acted as the Jeanne d’Arc of climate change abatement. Saintly and ready to attack fiercely (30% reduction by 2020!). But is Europe willing to end up in the fires of the global warming caused by other, less ambitious countries? If Europe continues with an ambitious climate policy and it can finally hammer out an emissions trading system with real teeth, the price of electricity in Europe could easily rise by 50%. Is Europe willing to do that to its citizens and its economy after Copenhagen? The market seems to think that it won’t. The first trading day after Copenhagen, European emission rights prices fell by 5%.

Filed under: Climate change, emission trading

Two and a halve years ago in Copenhagen

We are one week before the crucial Copenhagen summit on a post-Kyoto climate policy and the prospects of getting a real deal are looking a little bit less bleak. The US and China show a little bit more enthusiasm for entering into a binding commitment for reducing greenhouse gas emissions. Last week the presidents of both countries even announced that they will personally attend the event in Copenhagen. That adds a little bit more show business to what looks set to become the biggest show geopolitics has ever seen. Mr. Obama and Mr. Hu Jintao will join thousands of other delegates in the Bella Center in Denmark’s capital. Every step that they take will be followed by hundreds of camera’s. Outside, the complete Danish police force will be mobilized to keep protesters away from the world’s leaders. But even that is not enough. Denmark has asked Sweden to send some cops across the Oresund for reinforcement.

Two and a halve years ago, I was in the Bella Center myself. And it was for a conference on climate change. PointCarbon, the leading information source on carbon markets, uses the well-equipped conference center for its yearly gatherings of everyone that has something to do with trading carbon. I was completely awestruck by the size of the event. More than a thousand delegates flocked into conference rooms, around lunch buffets, toilet rooms. It is amazing in what short period of time, climate change abatement has become an industry of such considerable size. Despite that, it was at this conference that I came to the conclusion that emission trading wasn’t contributing much to climate change abatement. The doubts which I already had regarding emissions trading were confirmed. In several contributions by price forecasters at this conference, speakers assumed that carbon dioxide emissions would continue growing at the same rate as before emissions trading was introduced. By asserting this, the speakers confirmed what I feared: that emissions trading was missing its goal of reducing emissions by industrial polluters.

Originally, I was an enthusiast for cap and trade. From a theoretical point of view, it is clear that it is the most cost efficient way of reducing industrial carbon output. By making pollution tradable and thus giving it a price, emission reduction projects would be launched where they are cheapest. To put it simply. If the price of emission rights is 20 euro per ton, and if for company A the cost of reducing emissions is less than 20 euro per ton on a yearly basis, it has an economic incentive to invest in the reduction. Company B with a more expensive project costing more than 20 euro per ton on a yearly basis will not invest. Company B will buy  the excess rights of company A. But on the road from this nice and neat little theory to practical implementation, some huge roadblocks pop up:

1/ Setting the original amount of emission rights that each company gets (allocation) is an extremely thorny issue.

2/ Implementing emissions trading entails huge complexity.

3/ Price volatility tends to be high, which means that the price signal to invest in emission reduction is confusing.

4/ Design errors can cause extreme price behavior.

5/ The only benefactors so far of the system have been the electricity producers, not the environment.

1. Allocation

Allocation unleashes some of man’s most primitive economic instincts. The algebra is pretty simple. If we go back to our previous example, both company A and company B have only one interest: getting as much emission rights as possible. For company A it means that they can sell more rights. For company B it means that they will have to buy less. But for both, the amount of money is exactly the same. If the price of emission rights is 20 euro per ton, they both win 20 euro for every extra emission right that they get allocated. For company A in terms of extra rights that they can sell, for company B in terms of avoided costs for buying rights. The essence of economic behavior is to do everything that is possible to maximize profits. Therefore, it is completely rational that companies will do whatever they can to get as much emission rights as possible. The allocating authority is like the rich Westerner handing out dollars in a third world village, with a huge bunch of children fighting to get as much as possible. Only idealism could be a reason for a company not to try to get their hands on more emission rights than they actually need. I have met with one or two companies that have shown such idealism when rights were allocated for the periods of 2005 – 2007 and 2008 – 2012. Just imagine their frustration when they find out that the companies that have followed their more primitive economic instincts have won a lot of money.

The result of this is clear: over-allocation. In the files that they compile for getting rights allocated, companies will typically exaggerate their prospects for production growth (‘I need more rights, because my output will grow by ten percent every year’). If a majority of companies does this, the result is a global over-allocation. It has occurred in the first trading period, with emission rights prices reduced to practically zero. It has occurred again in the second trading period. Prices haven’t fallen to zero yet, as holders of excess emission rights hold on to them, hoping that they will be able to sell them at higher prices in a next phase (emission rights are bankable as of this trading period, meaning that you can hold and use them post-2012).

Many will blame the economic crisis for the over-allocation in the phase 2008 – 2012. That applies only partly. According to our analysis, it was already clear from the onset that the market would be over-allocated again. A Fortis report in 2007 pointed out that the market would see a shortage of approximately 1% in that period if emissions would continue to grow as they had done before. We never believed that this would occur. We are talking to many of the companies involved in emission trading and many of them are talking to us about their programs for reducing their energy consumption. We can see the gas consumptions of companies going down. What is even more frightening about that Fortis report, is that nobody seemed to care that emission trading is completely missing its target if emissions just continue to grow as if nothing had happened. Shouldn’t the conclusion be that we better stop trading emissions if it doesn’t result in substantial emission cuts? Anyway, carbon emissions were going down before the economic crisis occurred whereas the allocation was based on a world without emission reduction. Hence, the second phase was over-allocated from the start. The economic downturn has only enlarged the gap.

Greed is the reason for over-allocation. This greed will be sensible in the coming Copenhagen negotiations. Countries fight to get as much rights to emit as they can. European countries have shown most idealism so far. The American president seems willing to join them, but is held back by his congress and senate. Developing countries like China or India are so happy that they are catching up with development levels elsewhere, that the idea of limiting that development for the good of the planet looks absurd to them. Moreover, they use the justified argument that 90% of the carbon dioxide already in the atmosphere was emitted by the developed countries. It’s up to the polluters to clean up, they scream. Just like companies making up their allocation file, many countries in Copenhagen will have only one objective: getting a larger chunk of the carbon pie.

To soothe his congress and senate, Mr. Obama is using an old trick in carbon dioxide policy: making tough reduction commitments for dates very far into the future. This postponement behavior is one of the reasons why environmentalist are thinking about protesting against rather than joining in the Copenhagen talks. But from a pragmatic point of view, I think this is a good policy. It has worked for Europe.

2/ Implementation complexity

During the Carbon Insights meeting that I attended, another thing that struck me, was the speed at which the carbon market had developed into a complex knowledge field of its own. I asked the question to one speaker: ‘If we would go to the center of the city, arbitrarily pick up some people and bring them into this room. How long would it take before they start realizing that what we are discussing is climate change abatement?’. Implementing emissions trading is complicated. It demands a lot of legislative work. The economics of the market demand the development of new trading practices. But just try explaining what a ‘CER – EUA swap’ exactly is to a layman, as I have done frequently in the past years. You will understand that this complexity isn’t exactly helpful in achieving the goal of abating climate change.

I am speaking against my own interests if I deride this complexity. Complex matters create the need for specialists, for consultants. The EU emissions trading directive has given birth to a whole new industry. There are now a few thousand people running around in a shiny suit, which they earn in this emissions trading market. For many of them, putting the effectiveness of emissions trading into question is beyond comprehension. The problem is that they live on a cloud, far away from the reality of climate change abatement. That reality has nothing to do with the technical details of emissions trading. It’s got everything to do with a company boss deciding whether to build a cogeneration unit or not.

Many people that I’ve talked with in Copenhagen, were very far removed from such industrial decision-making. Most people involved in emissions trading have a banking background rather than an industrial background. Moreover, industrials are showing apathy towards the system. Approximately two thirds of all emission rights are held by purely industrial companies and one third by utilities. Those industrial companies are e.g. food processing,  textile or other manufacturing industries with an allocation of less than 20.000 emission rights per year. For them, the emissions trading scheme is just another compliance issue. They just want to avoid having to purchase extra emission rights, which they consider to be a ‘fine’. So they hold on to their allocated emission rights until it is clear how much their real emissions will be, which is at the end of the trading period (end of 2007, end of 2012). Over the past years I have talked with many of these companies. They all told the same story. We are long on emission rights, but we keep them for a rainy day. What is remarkable is that many traders in this market seem to ignore this crucial piece of fundamental information. Theorists and bankers also underestimate the prediction uncertainty that these companies face. Their production could rise by 15 – 20% next year, creating the need for extra emission rights. The environmental manager doesn’t want to risk having sold these extra rights so he does nothing and the excess rights only reach the market by the end of the trading period.

This apathy of two thirds of the market has a remarkable result on the pricing. The excess quantities of emission rights have mostly been allocated to these industrial companies. The utilities, which have developed much more active trading practices, mostly have shortages. So you see a market which is generally long, but with only the short parties active. The result is that everybody starts to believe that the market is short. This clearly happened during the first trading period. The market started with a massive bull run as the utilities started to buy the extra rights that they needed. The banking world jumped in and accelerated the pace at which prices rose. The bull case was firmly supported, no reports came out warning that the market could have been over-allocated. It took until the beginning of 2006, when companies started to report their real emissions for 2005, before reality became clear. And it came with a bang. The carbon trading community had gathered in Cologne the day the first reports came out that allocations were too large. I wasn’t there, but I’ve heard from people attending it that everybody was running away in panic to get rid of his long positions on emission rights. The result was a rapid meltdown of emission rights prices. To my big surprise, the same was repeated for the second trading phase. In 2008, the market was again buzzing with rumors that the market was short and the price again hit 30 euro per ton. No wonder, again we observed that those sitting on the excess allocations were not present in the market place. But it is striking that this market has been fooled into the same mistake twice.

3/ Price volatility

One and a half year ago, the price of emission rights was around 30 euro per ton, today it is around 13,5 euro. That is big volatility. For those that entered the market at 30 in 2005, the situation was even more dramatic, the price came down to almost 0. Price volatility in this market has been very high, making it a place where investors can make big bets. It is therefore no surprise that so many speculators found their way to it, which increased volatility even more.

Let’s look again to what it all comes down to: an industrial company owner that has to take a decision to make an investment in e.g. a cogeneration and the impact of emissions trading on this decision. Don’t forget why emissions trading was created. To give that man an extra incentive to decide in favor of building the cogeneration rather than a traditional boiler house. If he wants to take into account this extra incentive, his obvious question will be: ‘how much money will I win on emission rights in the next ten years’. Our answer to that question is: ‘anything between 0 and 100 euro per ton of carbon dioxide emissions’. (And even then we are not correct, we should say, anything between 0 and infinity, as I will explain in paragraph 4.)  For that potential investor of cogeneration, this is not exactly a strong extra incentive. Uncertainty regarding the expected return is rather a disincentive for investment. Moreover, if you adopt a risk management approach to your investment decision, you will rather take the 0 than the 100 euro per ton into account. This is the exact answer that I’ve heard from many managers taking decisions on energy savings investments, ‘If it has a value, it will come as a bonus, but for taking the decision, I don’t attribute any value to emission rights savings’.

Because of this volatility and the resulting price confusion, I would say that emissions trading hasn’t kept one extra gram of carbon dioxide out of the air. Companies are not investing in measures to reduce carbon dioxide emissions because of the price of carbon in the emission rights market. They are doing so because they adopt Kyoto or sustainable development policies, because of the rising price of energy, because of other regulations such as voluntary reduction schemes or environmental policy, because of subsidies, etc. So far, I haven’t met with one company that says ‘we are reducing our climate change impact because of the emissions trading system’. The price signal of emission rights markets is simply too confusing for this to occur.

4/ Design errors

In both trading periods we have witnessed over-allocation. The result is a run-off of prices. In the first trading period the price fell all the way to 0. The rights could not be banked into the second period, meaning that after the first trading period was over, they lost their value. Therefore, if you had any excess rights, you had but one option: selling the rights for any amount of money that you could get for it. This isn’t happening yet in the second phase, even if most market participants are convinced that the market is again over-allocated. The reason is that banking is possible now. If the price drops too low, holders of excess rights might choose to keep them beyond 2012, hoping that prices will be higher then. This has kept the price at a level above 10 euro per ton up until now. But again, we should take into account that the holders of excess rights are not active in the market. The big question is what they will do with those surplus rights when the end of 2012 gets near.

So far, we haven’t seen a market with a shortage of emission rights. In my opinion this would lead to extreme price behavior with prices rising to absurdly high levels. The emission trading system has been designed with the false assumption that the market could reach an equilibrium. There is supposed to be some equilibrium price at which companies invest in exactly so much emission reduction that the amount of emissions exactly matches the amount of allocations. Nice in theory, but completely impossible in practice. Participants in the emissions trading market simply don’t have the necessary and timely information to collectively take the decisions to make this equilibrium possible. The result is that there will always be a surplus or a shortage of emission rights compared to the allocated volume. We have witnessed what has happened when there is a surplus. But what happens when there is a shortage?

When designing the EU Emissions Trading Scheme, policymakers have introduced a fine for those emissions for which no rights have been delivered to the authorities. If you have an emission of 20.000 tons, and you deliver only 18.000 tons to the authorities, you will pay a fine of 100 euro per ton, i.e. 200.000 euros. Normally, this 100 euro per ton should serve as a cap on emission rights prices. If the price of emission rights would rise over 100 euro, companies with shortages would choose to pay the fine rather than buying extra rights. The design default with the EU ETS is that companies that pay the fine are not relieved of their obligation to deliver the missing emission rights to the authorities. The (theoretical, I have to admit) result of this is appalling. If an overall shortage of emission rights would occur, companies would scramble to buy the rights that are not there. In theory the price would rise to infinite. In theory, this would create a strong incentive for investment in reducing emissions. But it takes several years for those investments to have results. By then the trading period would be over. So, in practice, we would see that prices rise very high as the deadline of the trading period (which will be 2017 for the third period) approaches. This would probably cause the need for authorities to intervene. But if you take into account the effect of emission rights prices on the price of a vital utility, electricity, you understand the huge disruptive effect this could have on the EU’s economy.

5/ Effect on electricity markets

The production of electricity with fossil fuels is the largest single source of carbon dioxide emissions. It is therefore not surprising that one third of all rights have been allocated to such fossil-fuel fired power stations. Why these power stations have generally been allocated less emission rights than they actually emit needs a little bit more explanation. The first phase allocation plan of the UK said quite literally why most countries have opted for creating shortages of emission rights in the power sector. It said that companies in the power sector cannot move to countries with less stringent allocation regimes. Therefore, the shortages were rather created in this sector, than e.g. in the aluminium production.

As of the start of emissions trading, electricity consumers started complaining about the effect of emissions trading on electricity prices. And indeed, we have also witnessed all those days during which rising emission prices went hand in hand with rising power prices. The reason for this is obvious. In open energy markets, the price of electricity is set based on marginal cost pricing. The last MWh sets the price for all MWh’s. And if you have an overall shortage of e.g. 30% (like some Western European utilities claim) you never have emission rights for that last MWh. It means that your marginal cost will always include the price for buying emission rights as if you haven’t received any allocations at all. The result of this is clear. Utilities such as cited above have received free allocations for 70% of their emissions, but they can sell the corresponding MWh’s as if they had to pay for emission rights for every single one of them. The result is a massive windfall profit. It’s ugly but it is a logical consequence of marginal cost pricing, a principle which is always applied in any free energy market in any place of the world. The main consequence of emissions trading then is a massive transfer of money towards utilities. To their benefit, this sector can claim that they have made big investments in recent years in building renewable energy production. But again, this was mostly due to other policies, such as subsidies or environmental permit policies, rather than emissions trading itself. In countries with emissions trading but without other policies to support the development of renewable energy, you simply see a lot less investment in renewable energy. The booms occur in e.g. Germany and Spain, both countries with a very generous policy of subsidies or subsidy-like payment schemes.

Conclusion

Over-allocation, unwanted complexity, price-volatility resulting in a confusing price signal for investment, a dangerous design error that could lead to devastating price rises and rising electricity prices, that’s not exactly what we expected from emissions trading. The simple conclusion that instead of leading to emission reduction investments, the system has created a windfall profit for the electricity sector should be sufficient to conclude that the system is failing on a massive scale. Still, two and a halve years ago in Copenhagen, I heard nobody less than Al Gore – a man that I greatly admire – congratulate Europe for introducing emissions trading. And I’m pretty sure that next week the same utterances of satisfaction about emission trading will be repeated again at the same place. How is it possible that the truth about emissions trading is sipping through so slowly? Is that truth too inconvenient?

To a large extent, it is. Again and again, I am surprised to find out in internet forums that many US citizens still put the human-induced climate change hypothesis in question. In any discussion on introducing a new renewable technology e.g. Americans pop up to call Kyoto policy a UN-led conspiracy against the US and it’s energy-devouring habits. If you have to operate in such a context, I can imagine that for an American environmentalist a discussion on the effectiveness of emissions trading must seem like Walhalla. Moreover, many outsiders confuse emissions trading with other pieces of European emission abatement policy. As I have said before, measures such as subsidies have caused consumption reduction and renewable energy to flourish in Europe. Today, I have had solar panels installed on top of my roof. Apart from my idealism, I mainly did this because I can get 450 euro per MWh produced with them, thanks to the Belgian system of green certificates. This policy is highly effective, as I see more and more rooftops covered with solar panels in my (unfortunately rainy and cloudy) country. This has nothing to do with emissions trading, which, I admit, is probably more efficient.

Let’s hope that Copenhagen will bring about a solid post-Kyoto climate change abatement policy. Maybe that could create the atmosphere for a rational discussion on what to do with emissions trading for it to become more effective.

Filed under: Climate change, emission trading

Why emission trading fails

The Dutch economic daily ‘Financieel Dagblad’ published an article by Sven Stevenson that declares that EU emission trading is failing to help curbing carbon dioxide emissions. For those who can read Dutch, you can find the blog entry here. The author is actually expressing what many involved in the European market for trading carbon dioxide emission rights know for some time now. The system isn’t working like it should. It hasn’t avoided the emission of a single gram of carbon dioxide. The price signal that emission rights send to potential investors in emission abatement technology is much too confusing. Such investments are made on a long term scale. How can you count on any emission rights cost savings if the price is jumping up and down all the time? Many projects in renewable energy and energy savings are currently running in Europe. Some reasons for investing in them are:

-          other policies such as voluntary reduction agreements, feed-in tariffs for renewable energy, tax reductions in return for savings programs, etc.

-          the rising cost of energy,

-          protecting competitiveness by raising efficiency in energy-intensive industries,

-          the public mood, building a sustainable business is ‘hip’.

Some of these are connected with emission trading. In countries such as Belgium or the Netherlands the mechanism for allocating the initial emission rights is connected with the voluntary reduction agreements. Moreover, having to comply with emission trading regulation has forced the companies concerned to consider their carbon dioxide emissions and energy consumption policies. But this means that renewable energy and energy savings investments come as a side-effect of emission trading policy. And this was not the aim, the aim was that the emission rights market would give a clear and direct financial signal to companies to cut their emissions. And that is clearly not the case at this moment.

I remember 2003 – 2004, when we were preparing for the first phase of emission trading. I was a big enthusiast of the idea of emission trading. And indeed, in theory, the idea of introducing a market mechanism for solving an environmental issue looks great. Every professor agreed. The market mechanism would ensure the overall efficiency of individual company’s efforts to curb emissions. Those companies that could reduce at the lowest cost would do so first, so that the overall cost would be reduced. The efficient market hypothesis, which presumes that markets produce rational results, supported this idea.

Five years later, I see so many flaws in the functioning of the emission trading scheme, that I have lost all enthusiasm. The fundamental problem is, I think, a time-scale issue. A market, such as the one for emission rights, is essentially short-term. The price shifts up and down constantly, reacting on the ‘news’, the latest information available. The aim is to give an incentive to companies to make investment decisions. Those decisions are essentially long term. So, bringing together a market mechanism with investment decision-making, means that you actually add an important market risk element to the investment decision. An energy manager that proposes an energy savings investment can no longer say: ‘the return on that investment will be 10%’, he has to say, if the emission rights price is low, it will be 5%, if it is high it could rise to 20%. And uncertainty over the return is not exactly something that promotes investment decisions.

On top of that fundamental issue, there are multiple practical issues that make emission trading for carbon dioxide extremely difficult to implement:

1. The allocation is an extremely thorny issue. Carbon dioxide emissions rise together with energy consumption which (until now) has risen along with economical development. I agree that improving efficiency produces beneficial economic effects. But if you limit the amount of carbon dioxide that a company or a country can emit, you also limit its potential growth. If its sales grow faster than the efficiency improvement rate, the overall emissions will go up. Companies that see their sales grow will hit the roof of their allocations and will have to buy the extra rights to be able to continue to grow. That is how individual companies experience their emission rights allocations. That is also how countries experience it. Therefore, the negotiations over the initial allocations are extremely hard. Everybody wants to get a piece of the pie that is as large as possible, as they want to create maximum room for economic growth. In a political context, the allocations are the result of compromises. And if you compromise a little bit here, and a little bit there, the result is: over-allocation. If everybody gets a larger piece of pie, the pie becomes larger.
2. Controlling the emissions demands an extensive administrative apparatus. This is one of the more tangible results for many participants in the emission trading scheme: the huge amount of time that they spend on administration and reporting.
3. Spot, future, exchange-traded, OTC, short-selling, put options, CER to EUA swap, etc. I could go on and on spitting out jargon that serves to understand how this market works. The conclusion is: it is very complicated to comprehend this market. For consultants such as us, this should be good news. But I have seen over and over again that the large majority of participants in the emission trading scheme simply give up and don’t take the trouble of understanding it.
4. The EU system has a fundamental flaw to it, namely that companies cannot opt to just pay the fine (100 euro for every missing emission right). If a company fails to enter the same amount of rights as its reported emissions, it is obliged to pay the fine ánd submit the missing emission rights anyway. So far, over-allocations have produced collapsing prices. But just imagine what would happen if a real shortage of emission rights would occur. Companies would have to scramble for emission rights that are not there. This would produce extreme price rises. Can you imagine what the reaction if the public would be if a steel mill has to shut down and put 3.000 workers on the street because the price of emission rights has become sky high?

Auctioning initial emission rights instead of allocating them for free would solve the big allocation problem. But it will not solve the other problems. And it will not avoid the uncertainty over future prices. Which means that the emission rights market will continue giving a confusing signal to companies on whether to invest in renewable energy and/or energy savings. Can we remedy these ills? Or should we rather conclude that after almost five years of experimenting with emission rights, it has become clear that it is not the ideal tool for climate policy that many have supposed it was? Should we start looking for something else?

Filed under: Climate change, emission trading

The truth about second phase ETS

Read in a Montel report on the commodity markets this week:

“The downward correction for carbon still makes sense,” said an analyst at a large European utility, as oil prices were trading above USD 72/bbl. “Phase two of the EU ETS [EU emissions trading scheme] is oversupplied and the only bullish straw is banking to phase three. But this phase is highly uncertain; the CO2 price will largely depend on what comes from the negotiation in Copenhagen [in December]. So EUA banking is in fact speculation on the outcome of political negotiation,” he added.

It looks like participants in the carbon market are starting to realize that we might be facing over-supply again. Indeed, the possibility of holding on to your rights and using them in the post 2012 period (banking) will avoid that the price drops back to 0 euro per tonne levels like we saw for first phase rights. When the price hits a certain bottom, people will no longer bother to sell their rights and hold on to them. But that we have to consider over-supply again is remarkable. At the beginning of July 2008, phase II emission rights prices hit their highest level so far above 30 euro per tonne. Market participants at that point were mostly convinced that a real shortage of emission rights would occur as allocations had be far lower than real emissions. We have always been doubtful about this, as many analysts underestimated:

- The effect of falling energy demand. Most of them considered that the emission of carbon dioxide would just continue to grow like it had always done.
- The influx of emission rights from CDM projects (up to 10% – so-called CER’s).

Of course, the economic downturn is what will probably cause total emissions to drop below the total amount of emission rights that has been awarded. But I think that industry’s efforts to lower energy consumption and the CER-situation are also contributing to the excess of emission rights and that this has been underestimated all along.

Three and a half years are still to go, and we will only now for sure whether phase II was over-supplied or not by the end of 2012. If it would indeed be true that this phase has again been over-allocated, some serious questions arise:

1. Is it possible to have an effective allocation policy in an EU context?
2. For five years, the emission rights price will not help in pushing industries to decrease their carbon dioxide emissions. How will this affect the overall carbon dioxide emission reduction of the EU?
3. Does it make any sense to continue with emission rights trading if it isn’t contributing to reducing emissions?
4. Can the EU continue to act as ‘best of the class’ in international climate change negotiations?
5. What lessons should be drawn from this by other countries that are considering an emission trading scheme such as the US?

Filed under: Climate change, emission trading

Has change come to climate change?

It looks like the US is definitely heading towards emission trading. US Congress is preparing to pass a bill that would introduce a cap-and-trade system to abate climate change in the world’s largest emitter of carbon dioxide. The fact that congressmen from states with huge stakes in coal production have supported the bill, looks like a firm indicator that this bill might pass. If it does, Obama will deliver the kind of change that the Climate Change community expected from him. He will have brought his country to adopt a policy that is in line with what most people from other countries consider to be acceptable. Whatever the details of the actual system and its targets, this is indeed changing the world’s approach to climate change. Just consider what an immense difference this is with the previous administration where energy policy was written by representatives of the energy industry.

Mr. Obama might have an unique opportunity to bring about a fundamental change in the American society. So far the US was the only country in the world that didn’t manage to fuel its growth by using its energy more efficiently. In the American mindset energy consumption was expected to grow in a linear fashion to overall economic growth. American cars in 2000 were no more fuel efficient than they were in 1980. On the contrary, Americans started driving around in gas-guzzling military vehicles in city environments! As prices rose to record levels, US citizens have started to understand the irrationality of this behavior. Since 2008, the US has started to consume less oil. And even if prices have fallen recently, the economic crisis supports this evolution towards a more fuel efficient society. The fact that the US car manufacturers have such big problems shows that the US consumers are no longer willing to accept the thrifty fuel-spending behavior their models try to lure them into.

The discussions on the US emission trading policy sound very familiar to me, and make me think of 2003 – 2004 when the details of the EU policy were hammered out:

1. By postponing them for a far distant future (beyond presidential terms), it becomes politically possible to commit on ambitious targets. The US will cut its carbon dioxide emission by a hefty 83% … by 2050. For the more near future (2020) the target is less ambitious: -17%.
2. For industry this target is too ambitious, for environmentalists it is not ambitious enough. This shows that such figures are what they should always be: a compromise.

The details of US emission trading will become clear in the next months. Policymakers will have the advantage of being able to look at the EU system for lessons learned. They might consider the following:

1. Take care of the effect of emission trading on electricity prices. You do not want the electricity consumer to pay the bill for cleaning up the atmosphere. The fact that the proposed bill states that utilities will get 35% of their rights free-of-charge, indicates that US policymakers are concerned about this.
2. Beware of design flaws in the system. A big flaw in the EU system is that participants that emit more than the rights that they hold, cannot choose to pay a fine instead of entering (purchased) emission right. If a real shortage in emission rights would occur in the EU system, prices for rights could rise infinitely as participants scramble for rights that are not available. Maybe we will see this happen for the first time in 2012. By giving participants the possibility to pay a fine for those rights that they don’t enter, you would put a cap on this.
3. The most difficult part of emission trading scheme design is the allocation process. In Europe this has led to enormous strife between countries and industry sectors. Moreover, the allocation process doesn’t appear to be fair. In many countries, it appears to be so complicated that individual firms can obtain more rights than they should. But is extermely difficult to find the right balance between arbitrary allocation and allocation that takes into account the particular situation of a company. Auctioning the initial rights might be the best way of solving this problem, but it has important economic repercussions.

Talking about these flaws in the EU emission trading system brings me to the last remark. The initiatives of the Obama administration might inspire the modesty EU policymakers need to cure the ills of their system. In the future: they will no longer be able to use the argument ‘at least we are doing something about climate change’, as a response to criticism about the EU system. Let’s hope that the US system works better, so that they are forced to adapt ours.

Filed under: Climate change, emission trading, US