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The competitive environment of the European electricity sector in the post-Kyoto scenarios

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This paper shows how the uncertainty associated to the absence of a post-Kyoto regime regarding Greenhouse Gas mitigation is affecting investments in mitigation activities in the EU electricity sector and, thus, future emissions levels. Based on a wide survey of EU power companies, the paper identifies the most likely post-Kyoto scenarios considered by these firms and how they are coping with such uncertainty in their current investment decisions. The major conclusion is that the non-existence of a post-Kyoto regime is having a negative effect on current business investment decisions in mitigation activities, increasing risk premiums and financing costs. All in all, the companies surveyed foresee post-Kyoto compliance regimes with emissions trading systems that would guarantee the continuity of the value of the reductions made beforehand, although they differ in their perceptions of the form that a post-Kyoto regime could take.
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Centre for Eco-Intelligent Management. Instituto de Empresa Business School. C/ Castellón de
la Plana 8. Madrid 28006, Spain. Tel: +0034 91 5689600. E-mail: Javier.Carrillo@ie.edu
** Department of Spanish and International Economics, Econometrics and Economic
Institutions. Universidad de Castilla-La Mancha. C/ Cobertizo de S. Pedro Mártir s/n. Toledo
45071, Spain Tel: +0034 925 268800. E-mail: pablo.rio@uclm.es
1 The authors are grateful to PricewaterhouseCoopers Spain for financial support to carry out
this study.
THE COMPETITIVE ENVIRONMENT OF THE EUROPEAN
ELECTRICITY SECTOR IN THE POST-KYOTO SCENARIOS1
Dr. Javier Carrillo * Dr. Pablo del Río** Dr. Totti Könnölä* Dr. Carlos García*
IE Working Paper WP06-26 14-12-2006
Abstract
This paper shows how the uncertainty associated to the absence of a post-
Kyoto regime regarding Greenhouse Gas mitigation is affecting
investments in mitigation activities in the EU electricity sector and, thus,
future emissions levels. Based on a wide survey of EU power companies,
the paper identifies the most likely post-Kyoto scenarios considered by
these firms and how they are coping with such uncertainty in their current
investment decisions. The major conclusion is that the non-existence of a
post-Kyoto regime is having a negative effect on current business
investment decisions in mitigation activities, increasing risk premiums and
financing costs. All in all, the companies surveyed foresee post-Kyoto
compliance regimes with emissions trading systems that would guarantee
the continuity of the value of the reductions made beforehand, although
they differ in their perceptions of the form that a post-Kyoto regime could
take.
Keywords
Post-Kyoto scenarios, EU electricity sector, investment decisions
IE Working Paper WP06/26 14/12/2006
1. INTRODUCTION
The regime for achievement in the period after the first Kyoto Protocol
period (“post-Kyoto”) is currently under discussion. The protocol itself
established that the negotiations over the commitments after 2012 should have
been started at the very latest in 2005 and been finished in 2005.
Although, in principle, this question should have been clarified in the
Conference of the Parties (COP) in Montreal at the end of last year, it was not
possible to arrive at a generic agreement by the industrialised nations with respect
to the need to “fix new commitments to limit emissions beyond 2012,” as well as
an express reference to the need to guarantee its continuation beyond 2012
(MINAM 2005).
However, the importance of knowing now and in better detail what the
said future regime will be is paramount, not only for environmental reasons but
also commercial. The stated generic and non-binding commitments do not go far
enough to guarantee a favourable climate for investment in new technologies and
in mitigation projects. The uncertainty over that regime already appears to be
affecting the carbon market and the taking of investment decisions in cleaner
technologies and projects. Investments in the electricity generation sector have a
useful life of decades and, consequently, their pay-back period extends beyond
2012.
It is particularly important in this context to identify under what
conditions and in what circumstances the Kyoto units coming from the projects
for reducing emissions that may be carried out in other countries will have value
after the year 2012. This question is highly relevant from the point of view of
potential investors, as it directly affects the profitability of investments already
made or to be made.
All this uncertainty has particularly negative effects in capital intensive
sectors, as is the case in the electricity generation sector in which investments
have to be made bearing in mind a time horizon of between 25 and 30 years.
Consequently, these companies would have to take into account in their decisions
whether there will be reduction objectives after 2012 and whether those
objectives will be very ambitious. According to IETA (2005), 60% of the return
on capital for an electricity generation plant started today will take place in the
years following 2012.
The absence of defined objectives and of a post-Kyoto regime and,
therefore, the absence of indications of price for the successful reduction of
emissions after 2012 affects the financing of reduction projects, increases the
provisions for risk and the costs of financing. Therefore, the investments need to
be informed as to what post-Kyoto scenario is most likely that leads to a
recognition of the market value of Kyoto units. In this sense, to identify which
amongst the possible post-Kyoto regimes are compatible with the deposit of
Kyoto units from the first to the second period provides essential information for
potential investors in these projects.
All in all, it is relevant to set out what sort of post-Kyoto regime is most
probable to result in being adopted. This report attempts to deal with this
question, identifying which post-Kyoto scenarios are most plausible for the
European electricity sector as well as the possible impact of those scenarios on
investment decisions in this sector. The determination of these issues is made by
an in-depth review of the literature on the subject as well as by a process of
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survey and direct interviews of the principal companies in the sector at a
European level.
This report is structured as follows. The following section identifies what
could be the major threads of a regime for post-Kyoto commitment; in particular
a series of probable scenarios is defined towards which this commitment regime
could evolve. The third section presents the results of the empirical study. Finally
the report closes with a conclusions section.
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2. THE POST-KYOTO REGIME
In this section the major threads of development towards a post Kyoto
regime are considered by means of the formulation of possible scenarios.
However, it is convenient to begin analysing which decisions have been taken
already with respect to the post Kyoto regime (section 2.1) in order to later clarify
what still has to be decided (section 2.2). Which of those decisions are, in theory,
more plausible is the subject of section 2.3, which establishes a series of possible
post-Kyoto scenarios. After the post-Kyoto regime has been defined, a key
question that concerns potential investors in measures and projects for reducing
emissions is the question of whether the designated Kyoto units obtained by
investments made before and after 2012 can be used in a post-Kyoto regime, in
other words, if they will have market value1. Section 2.4 is dedicated to this
question. Finally, on the assumption that the degree of involvement of companies
in the CDM (Clean Development Mechanism) provides information about the
opinion of the companies about the validity of the aforementioned Kyoto units in
a post-Kyoto regime, section 2.5 is dedicated to the identification of the different
possible degrees of involvement in the CDM.
2.1 What decisions have already been taken?
Two interrelated questions affect the profitability of investments in a post-
Kyoto scenario. On the one hand, the very existence of a post-Kyoto regime,
including the establishment of mitigation objectives. On the other hand the
possibility that Kyoto units generated before 2012 may have value, which is to
say, they could be used to meet possible reduction objectives after the year 2012.
This section tackles the first of these questions.
The first steps to follow in order to define a post-Kyoto regime are
established in the Kyoto Protocol itself. The Protocol itself establishes that the
negotiations about the post 2012 commitments would have to start at the latest in
2005 and finish in 2005.
The protocol includes two fundamental articles that demand that the post-
Kyoto regime discussions begin in 2005 (see Table 1). Article 3.9 requires that
the developed countries begin to consider the possibility of modifying their
objectives for the second commitment period. Article 9 requires that a complete
review of the Protocol take place in the second Meeting of the Parties in 2006.
Table 1. What does the Protocol say about a post-Kyoto regime?
Art. 3.9. Commitments for subsequent periods for Parties included in Annex I shall be established
in amendments to Annex B to this Protocol, which shall be adopted in accordance with the
provisions of Article 21, paragraph 7. The Conference of the Parties serving as the meeting of the
Parties to this Protocol shall initiate the consideration of such commitments at least seven years
before the end of the first commitment period referred to in paragraph 1 above.
Art. 9.1. The Conference of the Parties serving as the meeting of the Parties to this Protocol shall
1 The Kyoto reduction units arising from the (KFM) Kyoto Flexible Mechanisms which can be
interchanged are four: AAUs (Assigned Amount Units) initially assigned to each country in
Appendix B; ERUs (Emission Reduction Units) arising from Joint Implementation projects;
RMUs (Removal Units) arising from forestation or reforestation projects; and lastly CERs
(Certified Emission Reductions) arising from CDM (Clean Development Mechanism) projects.
All of these correspond to 1 metric tonne carbon equivalent.
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periodically review this Protocol in the light of the best available scientific information and
assessments on climate change and its impacts, as well as relevant technical, social and economic
information. Such reviews shall be coordinated with pertinent reviews under the Convention, in
particular those required by Article 4, paragraph 2 (d), and Article 7, paragraph 2 (a), of the
Convention. Based on these reviews, the Conference of the Parties serving as the meeting of the
Parties to this Protocol shall take appropriate action.
Art. 9.2. The first review shall take place at the second session of the Conference of the Parties
serving as the meeting of the Parties to this Protocol. Further reviews shall take place at regular
intervals and in a timely manner.
Although, in principle, this question would have to be clarified in the
latest Conference of the Parties (first Conference of the Parties on the quality of
Meeting of the Parties, COP-MOP 1) of the United Nations Framework
Convention on Climate Change (UNFCCC) held in Montreal in December 2005
it was not possible to arrive at a generic agreement by the industrialised nations
with respect to the need to “fix new commitments to limit emissions beyond
2012,” as well as an express reference to the need to guarantee its continuation
beyond 2012 (MINAM 2005). Table 2 summarises the two most relevant
decisions in this context.
Table 2. Decisions of the Montreal Summit about the post-Kyoto regime.
According to Decision 11, “Dialogue on long-term cooperative action to address climate
change by enhancing implementation of the Convention”, the Conference of the Parties:
1. Decides to become involved in talks (without prejudice to the holding of future negotiations,
undertaking of commitments, processes, frameworks or mandates under the Convention) to
exchange experiences and analyse strategic approaches to establish long term cooperation in
dealing with the problem of climate change which includes, amongst others, the following areas:
(a) Advances in the establishment of sustainable objectives.
(b) Performing actions relating to adaptation.
(c) Obtaining maximum potential from technology.
(d) Obtaining maximum potential from market instruments.
2. Decides furthermore that the talks will have the form of an open and voluntary exchange of
information and ideas to help the implementation of the Convention and will not open any
negotiation that will lead to new commitments;
3. Agrees that the talks will be informed by the best scientific information available and the
evaluation of climate change and its impacts performed by the Intergovernmental Panel on
Climate Change, as well as by other sources of relevant scientific, technical, social and economic
information;
4. Agrees moreover that the talks will have to allow the Parties to continue developing effective
and suitable, national and international responses to climate change and to serve as a forum for
identifying actions that promote research of, development of, distribution of and investment in the
cleanest technologies and infrastructures;
5. Additionally agrees that the talks would have to identify approaches that will support and
provide the conditions in order that developing countries may voluntarily take actions that
promote local sustainable development and mitigate climate change in a manner appropriate to
national circumstances, including specific actions for allowing the countries to adapt to climate
change;
6. Agrees the talks explore ways and means to promote access by developing countries to the
cleanest technologies, technologies for mitigation of climate change and for adaptation to the
same by the creation of support programmes and specific actions;
7. Decides that:
(a) The talks will be conducted under the direction of the Conference of the Parties and will take
place in up to four workshops (…), open to all Parties, and organised by the Secretariat.
(b) The talks will be led by two facilitators, one from a country included in Annex I to the
Convention and the other from a country not included in Annex I;
(c) The two facilitators will report on the talks and on the diversity of the ideas presented by the
Parties at the twelfth (November 2006) and thirteenth (December 2007) sessions of the
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Conference of the Parties);
8. Invites the Parties to sent to the Secretariat, no later than the 15th April 2006, their initial ideas
about the questions to be discussed in those talks and asks that the Secretariat should have these
ideas available for the first workshop;
9. Notes that the organisation of the discussions will require additional resources in order to allow
the participation of delegates from the Parties.
In Accordance with the Decision -/CMP.1. “Consideration of the commitments for
subsequent periods for the Parties in Annex I of the Convention under article 3, paragraph
9, of the Kyoto Protocol,” the Conference of the Parties:
1. Decides to initiate a process to consider additional commitments for the Parties included in
Annex I for the period following 2012 in accordance with article 3, paragraph 9 of the Protocol;
2. Decides furthermore that the process will have to start without delay and will be conducted by
a group of countries that are parties to the Protocol. This group will report back to each session of
the Conference of the Parties that serves as a Meeting of the Parties about the state of this process;
3. Agrees that the group will have to try to complete its work and its results will be adopted by the
Conference of the Parties that serves as a Meeting of the Parties to the Kyoto Protocol as soon as
possible and in time to ensure that a hiatus will not exist between the first and second
commitment periods;
4. Agrees moreover that this group will meet for the first time at the same time as the twenty
fourth session of the subsidiary bodies (May 2006) and that the subsequent meeting will be
organised in agreement with the timetable established by the group;
5. Invites the Parties to send to the Secretariat, on the 15th March, 2006, their ideas regarding
article 3, paragraph 9, of the Protocol in order to make them available to the group before its first
meeting.
The first result, called the Montreal Plan of Action (MPA), includes four
stages for the commencement of discussions about the post 2012 period. The first
two take place under the Protocol.
On the other hand, the Kyoto Protocol grants the Parties permission to use
the AAUs (Assigned Amount Units) that are not used in the first commitment
period during the second (article 3.13). This possibility is called “inter-period
credit”. Moreover the use of “intra-period credit” is allowed (that is to say the use
of Kyoto units within different years in the same commitment period).
Therefore, as the Protocol allows inter-period credit, if a mitigation
regime similar to the Protocol is put in place after 2012, then the Kyoto units
issued before 2012 can be used to meet the objectives of the second commitment
period. The existence of post-Kyoto objectives would immediately give value to
these Kyoto units.
However, in the event that after 2012 there were to be a regime different
from that of the Protocol, a significant uncertainty would exist over whether the
Kyoto units issued before 2012 would have any market value and the units
arising from CDM (Clean Development Mechanism) and JI (Joint
Implementation) projects after 2012. This could occur if after the end of that
period objectives didn’t exist and an emissions trading system were not
maintained. For example, the post Kyoto regime could be based on international
technology agreements, or on national, not harmonised, policies and measures. In
the event of these situations, the existence of market value for Kyoto units could
not be guaranteed.
2.2. What must still be decided?
The previous section shows that fundamental decisions still have to be
taken over the basic structure of the post-Kyoto regime. Just as with the current
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Kyoto regime, the post-Kyoto regime will be defined by various elements or
criteria and, within these, there will be various design alternatives. Agreement on
the post-Kyoto regime will depend on a combination of decisions about key
design elements of that regime. In this section we try to summarise the basic
options with respect to these key variables. Many of these variables are
interrelated, in the sense that the choice of one alternative in one category
conditions the choice of another alternative in a different category2. Figure 1
summarises the basic current options, based on the criteria considered, as well as
their remoteness or closeness to the alternatives chosen in the Kyoto Protocol
context.
Figure 1. Classification of post-Kyoto alternatives.
We go on to analyse the design alternatives within each of the three elements:
A) Commitments of the developed countries (Annex I) and the possibility of
trading emissions.
Within this criterion two extreme alternatives exist: absolute reduction
objectives (and emissions trading) and agreements based on policies and
measures (for example technology agreements) in which quantitative reduction
objectives do not exist but only the commitment to adopt certain mitigation
policies and measures.
2 Aside from those mentioned, other design questions exist which have not been tackled in this
study, by their nature excessively complex and uncertain at this point in the process. Amongst
them is the question of differentiation of objectives and the allocation of objectives. Various
alternatives exist in this sense (multi-stage approach, contraction and convergence, global triptych
approach, equality per capita, Brazilian proposal and allocations based on costs). For more
information see Philibert (2005).
Kyoto Structure
A
lternative to Kyoto Structure
Undertakings of Annex I countries
Participation of developing countries
Form in which the countries are involved in a mitigation agreement
Absolute
reduction
objectives
Absolute
reduction
objectives with
safety valve
Relative
reduction
objectives
Sector
Agreements National
P&M International
P&M
No reduction
objectives or
participation in
the CDM
Voluntary/
relative
reduction
objectives
Absolute/
obligatory
reduction
objectives
National/
International
P&M
Global
agreement of all
the countries in
the UNFCCC
(
to
p
down
)
National
mitigation
policies
(bottom up)
Agreements
between groups
of countries
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European countries defend the need for objective quantitative mitigation
objectives to be adopted. Once these objectives have been adopted, it is shown
that these objectives are achieved in the cheapest possible way with a system for
trading emissions (or with taxes, but this has more problems of political viability,
as mentioned later). Therefore, the agreement and the establishment of reduction
objectives results naturally in a system of trading emissions.
A fundamental question is the nature of these quantitative objectives. If
the countries are agreed on adopting quantitative objectives by country, several
options would exist, such as fixed and obligatory targets, dynamic objectives,
obligatory objectives with a ceiling on the prices of the emission permits, sector
objectives and mechanisms, action objectives, long term allowances and aid
packages and permits. Some of these possibilities will be considered later in the
definition of scenarios.
The alternative to quantitative approaches are qualitative approaches. As
is stated in document IETA (2005), “non-quantitative” in this context means that
a quantitative objective does not exist. In its place, there are different types of
objectives, some of which could be considered to be of a quantitative nature, like
taxes on carbon, or in percentage terms, like the distribution of a technology on a
specific date. More specifically, the following are usually considered to be the
main qualitative approaches: (1) trading without objectives; (2) policies and
measures; (3) technology agreements; (4) carbon taxes.
These approaches are not necessarily compatible with a system of trading
emissions. The U.S.A. and Australia defend an alternative qualitative approach.
These countries reject the establishment of objectives that in any case would be
“arbitrary”, very costly for their countries and largely ineffective at reducing
emissions if the system does not include the less-developed countries. For that
reason they propose “technology agreements”. Basically, this implies the creation
of a fund financed by the developed countries to support the development and
distribution of clean mitigation technologies both in the rich countries as in the
poor. It includes the idea of the mitigation technology transference towards the
poorest countries.
Also in this extreme there is the possibility that each country commits not
to reduce emissions directly, but to adopt a national series of policies and
measures to reduce emissions. The commitment in this case is not to reduce
emissions, but to adopt those measures (objective in procedure and not final).
Those policies could more or less be harmonized between countries, an option
that clashes with the position of countries like the U.S.A., that support non-
harmonization. This harmonization would therefore be the most unlikely option,
due to the difficulty that such a system would ever be implemented.
To summarise, the design alternatives within this element would be:
Absolute reduction objectives. Objective reduction of the total emissions
(tonnes of CO2e) are agreed. Each country can transfer the reduction obligation
to its companies. A market of emission permits is established in which the
companies fulfil their objectives at lowest cost, or they resort to the so called
Kyoto Mechanisms (Clean Development Mechanism and Joint Implementation).
This option would generate certainty as to reduction.
Absolute reduction objectives with safety valve. In the previous case, the
certainty about reduction is achieved at the cost of uncertainty about the cost of
reaching the reduction objective, since that cost depends on the level of the
emission permit prices: the greater the price, the greater the cost. One could then
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consider the introduction of a “safety valve” or “ceiling” to the emission permits.
Whenever the market price surpasses the maximum price, companies could buy
permits at that price. The money coming from those permits could be used in
emission reduction projects or to support the transference of less polluting
technologies to less-developed countries. The only problem with this alternative
is that it would not allow the objective to be reached if the market price of the
permit surpassed the maximum price given by the ceiling, as in that case
companies would not have to comply by giving (buying) permits, but simply by
paying the maximum price.
Relative reduction objectives. Some countries and companies have shown
their concern about the fact that, with absolute objectives, the cost is excessive in
a context in which less polluting technologies are adopted but an increase in
production generates an increase in emissions that cancels out that technological
effect. For that reason, they suggest the establishment of relative objectives, that
is to say, emissions per unit of product. The problem with this option is that it
does not create a guarantee of attaining a certain level of emissions.
Sector agreements. In this case, the possibility is considered of
establishing emissions reduction objectives in terms of individual sectors, at an
international level. Sector agreements have been proposed as a measure to avoid
the distortions of international competition that can be produced when different
countries deal differently in the same sector. Nevertheless, this deals with a
relatively recent approach that has other problems and where work needs to be
done on the details . It is not clear for example, to what extent this approach
would be compatible with the emissions trading.
National policies and measures. In this case, countries unilaterally adopt
mitigation policies and measures. The countries’ commitment is to apply those
policies, not to reach a certain objective of emissions reduction. Without the
existence of reduction objectives, this approach is not compatible with emissions
trading or with the Kyoto Flexible Mechanisms.
Harmonised policies and measures. Unlike the previous option, in this
case certain policies are agreed at an international level. In principle, this
approach is not compatible either with emissions trading, nor with the Kyoto
Flexible Mechanisms.
B) Participation of developing and less developed countries.
One of the main stumbling blocks to the advance of the international
agreement, behind the U.S.A.’s refusal to join the same, is that which results
from the lack of reduction commitments on the part of the less developed
countries, which predictably will experience a greater increase in emissions in the
coming years. It’s a question of a cul- de-sac: if the less developed countries do
not accept reduction commitments, the U.S.A. will never accept a world-wide
agreement; on the other hand, the poorest countries will never accept reduction
objectives, since they consider that the problem has been created by the richest
countries and that the main emitter at this time (U.S.A.) is not doing anything
about it. This implies that a world-wide agreement will leave out the U.S.A. and
will not envisage the commitment of less developed countries.
However, there could be an intermediate solution: that the poorest
countries were to accept reduction commitments, but of voluntary performance.
If they were to exceed their emission objectives (fixed at a level of emissions
reflecting the status quo), then they would not have to incur penalties. But if their
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emissions were below those objectives, they would receive as a result excess
emission permits that they could sell in the international emissions market to the
developed countries, obtaining in return extra income. This system of “carrot
without a stick” could be attractive for less-developed countries and would help
in mitigating the concerns of the U.S.A. and other advanced economies. In any
case, it does not seem very likely that the U.S.A. would be prepared to ratify this
“modified Kyoto” regime, to which we will return in the following section on the
framework of scenario number 3, given its almost “philosophical” opposition to a
regime of the Kyoto style and the efforts that it has made in the past to reject it.
C) Form in which the countries are involved in a mitigation agreement (top-down
versus bottom-up).
Within this last criterion two extreme alternatives can be considered:
either that there is not a post-Kyoto agreement (that is to say, only the EU and
some other country has voluntary reduction objectives), or a world-wide
agreement of all the countries within the framework of the UNFCCC (top-down).
An intermediate alternative would consist of one where there is no global
agreement, but a group of “environmentally conscious” countries (EU + Canada
+ Japan + New Zealand + Russia + some developing countries) carry out their
own national mitigation policies and, possibly, they bind those policies to those
adopted by other countries with reduction objectives and national systems of
emissions trading (bottom-up). The participation of the U.S.A. and Australia is
not foreseeable in either of these two last alternatives.
We move on next to going a little further into depth about the different
“degrees” of involvement of countries within this third and last design criterion
of the post-Kyoto framework, just as they will be included in the following
section dedicated to the scenarios. A first option would be an agreement similar
to the Kyoto one between almost all the countries of the world, except the U.S.A.
and Australia (scenario 1). A second option would consist of those countries that
have not ratified Kyoto (the U.S.A. and Australia) adopting those measures with
which they seem to be more in agreement (technology agreements). A third,
would be a small modification of Kyoto (scenario 3), by means of the
establishment of price ceilings for emission permits, mitigating therefore the
concern about a possible elevated total cost of performance. If the countries are
not agreed and carry out their own national policies of mitigation, several
possible modes would exist (scenarios 4 to 9). The countries which adopt a policy
of mitigation with reduction objectives and national emissions trading (as this is
the instrument that allows a cost-efficient achievement of the reduction
objectives) could reach agreement and accept a possible link and coordination
between their systems of national emissions trading. In any case, the process
would be gradual. In a first instance only national instruments would be
developed, with links between a very reduced group of countries. Later, other
countries would join the agreement.
A key question in this sense is: what would it take for some countries to
adopt objectives and national systems of emissions trading when other countries
do not do it? For the leaders of some countries it can be difficult to justify that
they are not doing anything to mitigate climate change, facing an electorate aware
of the problematic environment. That electorate not only demands them to take
measures, but to establish specific reduction objectives.
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It is also appropriate to ask why those aware countries would apply a
system of emissions trading and not another system. The reason is that it is
widely accepted that this system is the most cost effective to obtain a certain
reduction of emissions (alongside carbon taxes) and the countries do not want to
incur more costs than necessary to reach those objectives (even more so if only a
few countries have decided to adopt reduction commitments). With respect to
taxes, freely issued emission permits have the advantage of being more attractive
for the companies of the country, as they do not require a payment for all the
company’s emissions (as in the case of taxes), but only for those that surpass the
allowed limit and the permits which they have. However, if the permits were
given by means of auction, there would be practically no difference from a
system based on taxes.
2.3 The main post-Kyoto scenarios.
The combination of criteria or elements set out in the previous section can
give rise to a set of more or less reasonable scenarios. At the beginning of this
research project, nine possible basic post-Kyoto scenarios were identified, as a
result of the review of the literature on this question and the exchange of ideas
with some experts on climate change3. The organisation of these scenarios has
been made based on their distance from the present framework of the UNFCCC
and the Kyoto Protocol:
1) Kyoto continued. This scenario implies the extrapolation of the characteristics
of the present Kyoto regime to the post-Kyoto period. In this event, an agreement
would exist with absolute reduction objectives by country and the possibility of
meeting those objectives in a cost-effective way turning to international
emissions trading in commitment periods of 5 years. This agreement would take
place within the framework of the UNFCCC in an international negotiation
between countries. In this scenario the banking of units of Kyoto from one
commitment period to the following would be allowed and to the Kyoto Flexible
Mechanisms, and in particular the CDM, would have automatic continuity post-
Kyoto. This mechanism would have the same configuration as the present one,
although its application could improve adopting more top-down methodologies.
Bearing in mind its head-on rejection of this scenario, the U.S.A. and
Australia would continue to not participate in this regime, at least in the medium
term (until 2030). The developing countries, as well as the less developed (PVD)
would continue to not have objectives, although very lax objectives (such as the
status quo) could be established for any developing non-Annex I country with
relatively elevated levels of development and for developing countries with
significant growth in emissions.
On the other hand, several alternative criteria exist for the future
allocation of objectives to the countries of Annex I (the GDP per capita,
emissions per capita, emissions per unit of GDP, population, historical
responsibility - historical emissions, present absolute emissions, costs of
emissions reduction - identifying cheap alternatives by sector and country), as
well as several approaches in this allocation (multi-stage, contraction and
convergence, global triptych, Brazilian proposal). Nevertheless we did not
3 See the references at the end of this report.
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consider these possible alternatives, in the interests of greater clarity in the
questionnaire sent to the companies that are the subject of this study.
In general terms, this first scenario can be considered as the reference by
which to compare all the others. It is the one supported by the majority of the
literature about post-Kyoto, as well as by certain players on the international
stage.
2) Kyoto Plus (Kyoto + technology agreements). This second scenario is a
variation of the previous one, in the sense that the basic architecture of Kyoto
would stay. Absolute mitigation objectives would continue to exist for the
countries but, in addition, an agreement between the present Annex I countries
would be adopted to finance the development, the innovation, the diffusion and
the transfer of mitigation technologies4. The developed countries would
contribute to this fund, including the U.S.A. and Australia, since both nations
defend the adoption of technology agreements to involve the developing
countries in the mitigation.
3) Modified Kyoto. In this scenario suitable elements of the present Protocol
would stay, at the same time as fundamental aspects in the agreement would be
renegotiated. In a framework of global international negotiation under the
UNFCCC, it would be a question of explicitly correcting some of the problems
observed in the present Protocol, such as the non-participation of the developing
countries or the non-existence of a ceiling on the prices of emission permits, a
circumstance that results in uncertainty as to the cost of applying the Protocol.
Instead of absolute objectives, the application of relative objectives
(emissions per GDP unit) could be considered for example. If some absolute
objectives were kept, a ceiling on the cost of emission permits could be fixed that
would function as a type of “safety valve”. This ceiling would have to be agreed
internationally as, otherwise, international distortions between countries with
different ceilings would be generated. This agreement would allow the companies
in the Annex I countries to acquire emission permits at a determined price, an
option to which they would resort if the market price permits exceeded this
ceiling.
On the other hand, and in contrast to the previous scenarios, the
developing countries could have absolute reduction objectives, albeit voluntary.
That is to say, the developing countries would have voluntary emissions
objectives, that in the event of being exceeded would not carry negative
consequences for those countries, but that in the event of being exceeded would
not allow the corresponding developing country to sell in the international carbon
market the difference between its emissions and its objective, obtaining a benefit
thereby. This scheme would allow the non Annex I countries to have a positive
incentive (carrot) to control their emissions, at the same time as avoiding their
distrust (and rejection) of accepting objectives, as there would be no penalty for
breach. Another option that is usually considered is that of an allocation of
4 These agreements can be of different types: agreements in technology standards, R&D and
financing for technology distribution towards developing countries, or the creation of channels of
cooperation in technology development. Standards of power efficiency could be especially
interesting in the electrical sector.
IE Working Paper WP06/26 14/12/2006
12
objectives in relation to the developing countries that would reduce their concerns
about the damage to their economic development processes that the application of
absolute objectives could cause. A scenario could occur therefore with absolute
objectives for the developed countries, relative ones for the developing countries
or countries of average income, and voluntary objectives for the less developed
countries. Nevertheless, we consider that the practical application of these
objectives in relation to the developing countries would be very complex and we
consider it as improbable, keeping to the alternatives of obligatory absolute
objectives for the Annex I countries and voluntary ones for the countries outside
of Annex I.
4) Parallel Kyoto. This scenario would assume the application of a regime similar
to the Kyoto one for the Annex I countries that have currently ratified the
Protocol within the framework of the UNFCCC, and a parallel agreement by
those that reject the same (U.S.A. and Australia). In the light of certain initiatives
recently adopted in this sense, this agreement would be made between these two
last countries and some developing countries of Southeast Asia. This agreement,
parallel to the one made by the other countries, would be fundamentally based on
the negotiation of a technology agreement for the transfer of technology to those
developing countries. This one would be the most probable option. Another
possibility is that those countries agreed to assume gradual reduction objectives
(modest at the outset) and to be able to meet them through international emissions
trading. Initially, this recourse to emissions trading would take place between the
countries that had signed the parallel agreement, but in the medium or long term
it would not make sense to maintain two systems of emissions trading and both
would be integrated to create a single market for emissions trading. This last
alternative with reduction objectives for the countries in the parallel agreement is
quite improbable, as it would give rise to a system similar to the Kyoto one,
which has already been rejected by those nations.
5) Regional agreement. In this scenario, the application would be negotiated of
communal reduction objectives, differentiated between a small group of
countries, although not necessarily within the framework of the UNFCCC.
Unlike the Protocol, it would be a bottom-up process, in that a global agreement
would not exist. A certain number of ‘environmentally aware’ countries (EU,
other European, Canada, Japan, New Zealand and some developing countries)
would decide to adopt absolute reduction objectives just for them and to use
emissions trading to meet those objectives. The possibility would be left open for
other countries to join the agreement at a later date. The less developed countries
and most of the developing countries would not have objectives.
6) National links. Like in the previous case, a global agreement would not exist,
and not even an agreement between countries to adopt common objectives. This
scenario would imply that the international negotiations about the post-Kyoto
period fail. Nevertheless, some ‘aware’ countries would continue to be prepared
to unilaterally adopting a national climate change policy, with reduction
objectives and a system of national emissions trading to meet them in a cost-
effective way. These countries could be some of the EU, other European, Canada,
Japan or New Zealand, for example. This would give rise to the existence of a
series of national systems of emissions trading. Some countries could be
IE Working Paper WP06/26 14/12/2006
13
interested in joining their national system to that of another country, since this
could enable the meeting of its own objectives at a lower cost. For this, certain
conditions of compatibility between the systems that are to be integrated would
have to be met, such as equivalent penalties for breach, identical definition of
emission permits, etc. This initial link between two countries could be extended
to others, giving rise to an international system of emissions created by the sum
of individual countries, again in a bottom-up process. Obviously, this process
would be gradual. The link and coordination between national systems would be
compatible with the creation of an international fund to promote the adoption of
mitigation technologies and the involvement of the developing and less
developed countries.
7) International sector agreement. Some sectors of activity, reach an agreement
on international relative objectives. Two possibilities open up here: that
emissions trading (based on emission credits over the baseline) only between the
companies in the same sector at an international level (inefficient in costs,
improbable) or, more probable, that the companies can exchange the created
credits in an international emissions market (the companies whose emissions are
over the baseline can buy permits from other sectors). This last option presents a
problem in that it mixes different systems (cap-and-trade and credits based)5. It is
particularly interesting to analyze whether this approach is attractive to the
electricity sector in its two modes. Perhaps it makes more sense in other sectors
(cement, steel, aluminium), although not as much in the electricity sector since
the low level of electricity interconnections between countries makes
international competition difficult, precisely the problem that international sector
agreements try to correct. It would be necessary to consider whether the sector
objectives are absolute or relative (AAUs or credits).
8) National policies and measures (P&M). This scenario assumes a radical
change with respect to the present international system of fighting against the
climate change, to the extent that it implies the non-existence of an international
agreement, of quantitative objectives and, therefore, of an international system of
emissions trading to facilitate the achievement of them. We would be dealing
with a bottom-up process in which each country would only be committed to
adopting certain measures (that could include, but not necessarily, a national
emissions trading system) to control its emissions based on its national
circumstances6. In this scenario the developing and less developed countries
5 The systems of emissions trading can be cap-and-trade or based on credits, depending on
whether what is exchanged are emission permits or emissions reduction credits, respectively. In
the first, the emission permits are applied to all the emissions of the participants covered by the
system, while the “ceiling” refers to the emissions limit allocated to these participants during a
certain period. The permits are interchangeable between the participants and at the end of the
period they must present permits corresponding to the emissions during that period. In a system of
credits, these are granted for the achieved reductions of emissions below a previously defined
reference line.
6 Theoretically, however, it could be compatible with a framework like the Kyoto one. For
example, the countries are committed to reduce emissions with a specific objective and those
countries can not transfer those reduction objectives to the companies. They adopt national
policies and measures and the government is completely responsible not only to meet the
objectives, but to interchange emission permits with other countries and to buy CERs and ERUs.
Nevertheless, we must exclude this possibility, as once they have established reduction objectives
IE Working Paper WP06/26 14/12/2006
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could adopt, voluntarily, certain policies and measures that were advantageous to
the control of the emissions and, at the same time, would contribute to the
sustainable development of these countries (for example measures to facilitate
rural electrification in isolated zones through systems of distributed generation).
Also it would be compatible with agreements to promote technology transference
to these countries.
9) International policies and measures (P&M). The previous scenario could
evolve into the adoption of packages of national and international measures that
the countries would agree to implement, like, for example, a carbon tax or
international agreements of energy efficiency at the process level7. This one
would be largely a top-down process, since it would require an international
agreement. Like the previous scenario, it assumes a significant break from the
present regime of mitigation, since quantitative reduction objectives would not
exist, but only the commitment to apply certain policies at the international level
and in a manner more or less harmonized between countries8. That is to say, in
contrast to the previous one, it is a process in which multilaterally agreed
commitments are set. This approach could be compatible with the fixing of some
emissions objective (non-obligatory). In any case, the achievement would be
evaluated not in terms of reaching that objective, but in terms of the possibility
that the instituted P&M reach the objective. Although this approach may not
seem very realistic because it is so different from the present approach, it was
defended by the EU in Kyoto. It is very probable that this approach would also
have an element of “funding for technology development and the transfer of
mitigation technologies to developing countries” to which the more developed
countries contribute, in a similar way to the technology agreements considered in
the second scenario (Kyoto-Plus).
2.4. Compatibility of allowances between the first and second commitment
period of the Kyoto Protocol.9
As was mentioned in the introduction, a key question for potential
investors is whether the banking is possible of Kyoto units (AAUs, CERs and
ERUs) from the first commitment period of the Kyoto Protocol to a post-Kyoto
regime. In the case of a post-Kyoto regime that is really very similar to the Kyoto
one, this question is not considered, as the Protocol itself explicitly allows that
and the country has agreed to accept them, it has been demonstrated that the most cost-efficient
form to reach them is by trading between companies, not between governments.
7 The technology agreements considered above could also complement this P&M approach. In
fact, technology agreements can form part of almost any post-Kyoto regime. Carbon taxes are not
very viable in practice due to their low acceptability on the part of the countries in the
international community, both developed and developing. Which is to say, this is a very
unrealistic alternative.
8 The concept of obligatory P&M has received little attention in the literature. It is therefore more
appropriate to consider voluntary P&M. However, although voluntary in nature, the P&M can be
subject to commitments, with the advantage that governments will know perfectly what they are
committing themselves to. It can be difficult for governments to commit themselves to ambitious
national P&M if the rest of the countries do not adopt equally ambitious policies and, for that
reason, perhaps it makes more sense to engage in international P&M.
9 This section is based on the following paper, submitted to Climate Policy: Del Río, P. “Will
there be value for Kyoto units in a post-Kyoto regime?".
IE Working Paper WP06/26 14/12/2006
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banking. Therefore, this question of credit must be approached supposing a
commitment regime different from the one in the Protocol.
In this context, it is necessary to discuss two possibilities: (1) the
possibility of using the Kyoto units created in the first period of Kyoto in the
second period; (2) the possibility of using in the second period of commitment
Kyoto units issued in CDM and AC projects post 2008-2012, but which are the
result of projects registered in 2008-2012.
A) Will it be possible to use in the second period the Kyoto units created in the
first period?
In table 3 the possibilities of banking the mentioned credit are
summarized, considering the scenarios raised in the previous section. After the
table this question is considered briefly for each scenario.
Table 3. Possibility of using Kyoto units created in the first period during the second
Compatibility with the banking of Kyoto units from
the first period to the second
Scenario Possibility of
international
emissions trading AAUs CERs ERUs
1) Kyoto
continued YES YES YES YES
2) Kyoto Plus YES YES YES YES
3) Modified
Kyoto YES YES (difficulty if
relative
objectives)
YES (difficulty if
relative
objectives)
YES (difficulty if
relative
objectives)
4) Parallel Kyoto YES YES (not for non-
parallel Kyoto
signatory
countries unless
they decide)
YES (not for non-
parallel Kyoto
signatory
countries unless
they decide)
YES (not for non-
parallel Kyoto
signatory
countries unless
they decide)
5) Regional
agreement YES YES (not for
countries not
signed to the
agreement unless
they decide)
YES (not for
countries not
signed to the
agreement unless
they decide)
YES (not for
countries not
signed to the
agreement unless
they decide)
6) National links YES (depends on
link between
countries)
YES (depends on
the decision of
each country
accepting it and on
bilateral
agreements of
reciprocity
between the
countries)
YES (depends on
the decision of
each Annex I
country accepting
it)
YES (depends on
the decision of
each Annex I
country accepting
it)
7) International
sector agreement YES YES. More
difficult in the
case of “strict”
sector objectives
(Kyoto units of
companies in the
same sector for
commitment
intentions) and in
the case of
“relative” sector
objectives.
YES. More
difficult in the
case of “strict”
sector objectives
(Kyoto units of
companies in the
same sector for
commitment
intentions) and in
the case of
“relative” sector
objectives.*
YES. More
difficult in the
case of “strict”
sector objectives
(Kyoto units of
companies in the
same sector for
commitment
intentions) and in
the case of
“relative” sector
objectives.*
8) National P&M NO (except by
decision of the
country)
NO (except by
decision of the
country and
difficult
adjustments)
NO (except by
decision of the
country and
difficult
adjustments)
NO (except by
decision of the
country and
difficult
adjustments)
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16
9) International
P&M NO if reduction
objectives do not
exist (national or
international)**
NO if reduction
objectives do not
exist (national or
international)
NO if reduction
objectives do not
exist (national or
international)
NO if reduction
objectives do not
exist (national or
international)
* In this case a decision must be taken whether to accept or not CERs and ERUs bought from companies in
other sectors.
** It is possible to consider whether to introduce some element of trading in this approach. The unit to trade
would be directly related to the P&M in question. Meeting the objective with some type of Carbon trading
unit may be allowed. Only in the very hypothetical case that some type of emissions trading were allowed
could the banking of Kyoto units be accepted.
In scenario 1, being the continuation of Kyoto, inter-period banking is
explicitly allowed.
In scenario 2, the volume of trade would be less than in scenario 1
because the emissions themselves are reduced by the technology agreements. The
technology agreements can be installed as complementary to a regime of
emissions trading with reduction objectives. In the event of replacing a system of
emissions trading by a technology agreement, the banking of first period units
would be incompatible with this technology agreement. In other words, the
compatibility depends on how the system is designed. This conclusion may be
more general and applicable to other scenarios.
In scenario 3, one has to contemplate the possible difficulty of making the
use of AAUs, CERs and ERUs (that are units of reduction of absolute emissions,
although in the last two cases in relation to a baseline) compatible with the
existence of relative objectives (emissions by unit of product).
In scenario 4, the banking is technically viable and desirable for the
countries in the parallel regime. The countries outside this regime can also decide
to accept Kyoto units from the first commitment period to meet national
objectives (if they exist), but this depends on which mitigation measures these
countries apply and which emissions reduction objectives they adopt.
Similarly, in scenario 5 countries can decide if they will allow the use of
Kyoto units from the first commitment period to meet the objectives in the
regional agreement. Also countries outside this agreement can unilaterally decide
whether to accept those Kyoto units.
In scenario 6 each country can, unilaterally, decide whether it accepts
Kyoto units from the first commitment period of its own companies to meet the
national emission reduction objectives. To accept the Kyoto units of companies
from other countries depends on the decision to link the systems of two or more
countries and on the decision to accept those Kyoto units (bilateral reciprocity
agreement between countries).
The case of sector agreements, scenario 7, is somewhat more complex. In
this case we must distinguish two situations. On the one hand, there is no
problem in accepting the banking of the Kyoto units in the case in which
objectives exist for the sector and the companies of a sector can meet their sector
objectives by acquiring the Kyoto units of companies of other sectors.
Nevertheless, the situation is more problematic in “the strict” case, that is to say,
when sector objectives exist but it is not possible for the companies of a sector to
meet those objectives by acquiring Kyoto units from companies in other sectors.
In this case, the AAUs of the first commitment period coming from companies in
the same sector could be accepted to meet objectives after 2012, but not therefore
the AAUs from companies in other sectors. With respect to the other Kyoto units,
CERs and ERUs, a decision would have to be taken on whether only the CERs
IE Working Paper WP06/26 14/12/2006
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and ERUs of the companies of the sector of the first commitment period would
have to be accepted or if also the CERs and ERUs, of companies of other sectors
can be accepted. In both cases, to use the Kyoto units to meet the sector
objectives can be difficult if the latter are set in relative terms (that is to say,
emissions by unit of product).
As the scenarios 8 and 9 of policies and measures are not entirely
incompatible with the use of Kyoto units to meet the obligations derived from
those policies and measures, they could hypothetically, and based on the
necessary adjustments, be compatible with inter-period banking. In addition,
those P&M are compatible with the creation of a fund financed by Annex I
countries or developed countries to carry out emission reduction projects in
developing countries that generate emission reduction credits that can be used
somehow in the developed countries.
In general, it can be asserted that the closer the new international
mitigation architecture is to a regime like that of Kyoto, the fewer difficulties will
exist in allowing the banking. The existence of a system of international permits
trading of the cap-and-trade type and/ or of emissions reduction objectives by
country without a doubt makes the possibility of banking easier. To put it another
way, the less the mitigation policies are based on absolute reduction objectives
(for example, in technology agreements) and the less international the post-Kyoto
mitigation regime is (that is to say, the fewer participants it has), the lower the
probability that the first period Kyoto units will have market value and, in any
case, the greater the uncertainty as to that value.
B) Will it be possible to use Kyoto units from CDM and JI projects arising after
2008-2012, but which are the result of projects registered during 2008-2012 in
the second period?
A somewhat different question from the previous one but equally relevant
for investing companies is whether it will be possible to use the credits based on
projects from the Kyoto Flexible Mechanisms (CDM and JI) in a post-Kyoto
regime that have been registered in the first commitment period (or before the
decision about a post-Kyoto regime) and whose periods of accreditation extend
beyond 2012. That is to say, if the CERs and ERUs issued after 2012 will have a
market value then. Table 4 summarizes the options and possibilities in this case.
Table 4. Possibility of using Kyoto units issued on CDM and JI projects after the period 2008-
2012 in the second commitment period.
Scenario Possibility of using CERs
issued after 2012 Possibility of using ERUs
after 2012
1) Kyoto as usual YES YES
2) Kyoto Plus YES YES
3) Modified Kyoto YES (difficulty if relative
objectives and voluntary
objectives for non Annex I
countries *)
YES (difficulty if relative
objectives)
4) Parallel Kyoto YES (not for countries not
signing the agreement except by
decision of these)
YES (not for countries not
signing the agreement except by
decision of these)
5) Regional agreement YES (depends on the decision of
each country to accept it) YES (depends on the decision of
each country to accept it)
6) National links YES YES (depends on the decision of
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the involved countries to accept
it)
7) International sector
agreement YES (difficulty if relative
objectives) YES (difficulty if relative
objectives)
8) National P&M NO if no reduction objectives
exist NO if no reduction objectives
exist
9) International P&M NO if no reduction objectives
exist (national or international) NO if no reduction objectives
exist (national or international)
*In this case emission reductions could give rise to double accounting.
In the event that reduction objectives (policies and measures) did not
exist, the issue of CERs and ERUs would only be certain if the countries were
agreed on creating a fund that was intended for the acquisition of these Kyoto
units.
A technical complication can arise if it is tried to use Kyoto units to meet
relative objectives. In this event, necessary and pertinent adjustments would have
to be made
To assure a value for the credits, emission permits or allowances depends
on the existence of clear signals on the future of the climate change regime.
Considering that the international carbon market influences the decisions of
investment in less intensive carbon technologies, it is essential that a long term
incentive exists to carry out these investments, especially those that require long
periods for pay-back, like most of those that are carried out in the energy sector.
The possibility of using Kyoto units generated in a period to meet reduction
commitments in later periods forms part of this incentive. In addition, uncertainty
also arises as to the possibility itself of using the Kyoto units generated in
emission reduction projects (CDM and JI) after 2012 to meet future
commitments. In this sense, the present lack of definition of a post-Kyoto regime
generates uncertainty about whether those units will have a market value and this
is already affecting the execution of those projects10. Therefore, it is crucial for
companies to ensure that the emissions reductions after 2012 will have a value.
Governments have a fundamental role to play in this sense, as the existence of
that value depends on the existence of reduction objectives and, therefore, of
commitments and political negotiations.
Obviously the closer the new design to the architecture of the original
Kyoto, intra-period banking will be the more probable and compatible. In other
words, in a post-Kyoto regime in which reduction objectives are established,
compatibility with the banking of Kyoto units is immediate, as those objectives
act as a demand of Kyoto units. Those scenarios in which a system of emissions
trading is established are most probable, as a consensus exists (even in the
countries that have not ratified the Protocol) that the international trade of
emissions is a very attractive instrument for obtaining a certain objective of
reduction to a lower cost, when equalising the marginal costs between polluting
sources.
To put it another way, the closer the new model is to one of policies and
measures without reduction objectives, the lower will be the possibility of using
those Kyoto units.
Nevertheless, only in a very extreme case of applying policies and
measures is banking difficult. But even in this case of policies and measures it is
10 The exception is the EU ETS (European Union Emissions Trading System), as the EU has
decided that the system will continue after 2012.
IE Working Paper WP06/26 14/12/2006
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possible to establish a system of emissions trading. For example, if the countries
establish national measures of emissions reduction, nothing prevents the
instrument in use from being a national system of emissions trading. And the
country can accept their companies using Kyoto units from the previous period in
order to meet the commitment of the national system of emissions trading. Also it
could agree to the CDM and JI project credits that are being generated in the
post-Kyoto period being able to be used for the same purpose. For their part, if
several countries adopt a national system of emissions trading and decide to link
their systems, a regime similar to the Kyoto one could come about (bottom-up
process), the use of Kyoto units throughout the bubble of those countries being
possible.
Therefore, the most probable is that some type of agreement that makes
the banking of Kyoto units possible will exist. This would allow the reduction of
the cost of compliance with the objectives of the second period because banking
favours efficiency over time in allowing companies to decide when is better for
them to use those Kyoto units to meet their obligations. For example, the market
value of CERs is relatively low today and it is probable that it will remain at a
low level, although it may increase in 2008-2012. If countries agree more
demanding reduction objectives for later periods, it could be profitable for
companies not to use those CERs today and to postpone their use for a future
date.
On the one hand, technical difficulties do not exist, in general, in order for
banking to take place in most of the scenarios. On the other hand, given the
assessment that is very probable that some type of modality of emissions trading
will exist in the post-Kyoto regime, such banking is more probable. This depends
on an international decision of the participant countries in the post-Kyoto
agreement. As Kyoto units have a possible post-Kyoto value and some people
have decided to make investments and incur costs in advance, it is feasible that
there will be a recognition of these units post-Kyoto, the pressure of investing
companies being a fundamental element for recognition to happen.
2.5. Degrees of Involvement in the CDM
In the later empirical study we will try to identify what is the strategic
positioning of the European electricity companies with respect to the possible
regimes of post-Kyoto commitment. Without a doubt, certain decisions that
already are being taken can provide indications in this sense, indicating which of
the previous scenarios is more plausible for companies in this sector. Some of
those indications can be derived from the degree of involvement of the
companies in CDM. It is reasonable to assume that the greater the degree of
involvement in those investments, the greater is the confidence of the company in
the existence of a post-Kyoto regime in which the use of Kyoto units is allowed.
In this sense, in this study we considered the following degrees of
involvement, in the order of increasing degree:
(i) Payment on delivery. Simple agreement on the delivery of the CERs without
financing of the project on the part of the buyer. That is to say, the buyer is solely
committed to buy the CERs, but not to contribute financing to the project.
(ii) Involvement in Carbon Funds. Simple involvement in the financing of a
Carbon Fund.
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(iii) Financing of projects. Involvement in the financing of the project on the part
of the investor and agreement on the delivery of CERs, but without involvement
in the management of the project.
(iv) Project management. Actual involvement in the management of the project
by the investor. That is to say, the investor is in charge of the accomplishment of
the project. He contributes not only financial resources, but also human and
technical.
Our assumption is that a smaller involvement can reflect a greater concern
about the existence of a post-Kyoto regime (as well as the existence of political
risks in the host country). Obviously, some alternatives may not be mutually
exclusive (specifically, i and ii).
3. EMPIRICAL STUDY.
The main object of the empirical study consists of identifying those scenarios that
are more reasonable from the perspective of the European electricity sector at the
time of making its investment decisions and to measure the influence of those
scenarios on these decisions. For this a survey and interviews with the principal
companies in the sector at the European level were performed.
3.1. Design of the sample and participating companies
The European companies chosen for the survey were considered to be
important for the building of the Spanish companies’ strategies. Furthermore
several additional points were taken into consideration for the design of the
sample such as the size of the companies in terms of generation capacity (see
figure 2). In the first place, obviously the most important Spanish companies
were included. Secondly, the most important companies of Germany, Italy,
Belgium and of the Netherlands were considered fundamental due to their
influence in the European market. Thirdly, the companies in the market of United
Kingdom and Nordic countries were identified as interesting because of the
political context. France was not considered being least important in the Spanish
context due to its concentration on nuclear energy.
Figure 2. Capacity of Electricity Generation in the Whole of Europe, 2004
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Source: Vattenfall Annual Report 2005, p. 17
Starting from these considerations, the following list of 18 subject companies for
the survey was finalised. Altogether, they represent 53% of European generation
capacity.
Table 5. Companies invited to participate in the survey
Country Company
Generating
capacity (GW) in
Europe, 2004
Spain IBERDROLA 23
Spain ENDESA 32
Spain HC ENERGÍA 3
Spain UNION FENOSA 7
Germany RWE 44
Germany E.oN 45
Germany EnBW AG 14
Belgium ELECTRABEL 28
Italy ENEL SPA 45
Italy ENI SPA 3
Netherlands ESSENT 5
Netherlands NUON 4
Norway STATKRAFT 11
United Kingdom BRITISH ENERGY 12
United Kingdom SCOTTISH & SOUTHERN 10
United Kingdom SCOTTISH POWER 6
United Kingdom DRAX POWER LIMITED 4
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Sweden VATTENFALL AB 33
European generating capacity represented (GW and %) 329 (53 %*)
* The total generating capacity in EU15 was 626 GW in 2004.
(Source: Eurostat, 2006. Energy: Yearly statistics, Data 2004)
After a complicated process of identification of the most appropriate
spokesperson within each organization for the survey11, the representatives of the
companies were then invited via e-mail to participate in the study (see appendix
1). In this mail the objective of the survey was explained to the participants and
they were invited to complete the questionnaire online (see appendix 2) and to
propose an appropriate date for a personal interview by telephone. Also the
confidentiality of the survey was stressed and the possibility that they could
receive the results of the study later.
Once the invitations to participate in the study were delivered, the first
spontaneous answers on the part of some participant companies were received
and an intensive follow-up was conducted with the rest of the companies to
assure a greater number of answers. This process began in the month of June and
finished in October. The process was extended partly due to the coincidence with
European holidays, but also due to the difficulty in finding suitable contacts
within the organizations and, of course, to the complicated diaries of the
spokespersons. Each answer received required between 5 and 25 calls and
numerous e-mails.
After the receipt of each completed questionnaire, a telephone interview
was then conducted with the spokesperson of the company, in order to clarify the
answers received and to offer to the company the possibility of expanding on its
answers verbally. The interviews were recorded and reports of the most important
aspects were compiled. In some cases, the companies preferred to hold the
interview without sending the questionnaire beforehand. In all the cases, the
questionnaire was used as a guide to structure the later interview. The interviews
lasted between 15 and 50 minutes, depending on the time available to the
interviewee. In the third week of October, we decided to bring this process to an
end by proceeding to write up the results of the empirical part of the study. From
amongst the 18 companies identified in the sample, complete answers
(questionnaire and interview) were obtained from 11 companies (see table 6,
highlighted in bold), which represents 40% of the European generating capacity.
Table 6. Companies participating in the survey
Country Company Date of interview
Spain IBERDROLA 19/07/06
Spain ENDESA 27/10/06
Spain HC ENERGÍA -
Spain UNION FENOSA 05/10/06
11 In most of the cases the person responsible for the environment or for sustainability dealt with
us; in others, it was the strategy, project development, or institutional relations manager.
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Germany RWE 13/09/06
Germany E.oN 21/07/06
Germany EnBW AG -
Belgium ELECTRABEL 26/09/06
Italy ENEL SPA 17/10/06
Italy ENI SPA 22/09/06
Netherlands ESSENT 25/09/06
Netherlands NUON -
Norway STATKRAFT 06/09/06
United Kingdom BRITISH ENERGY -
United Kingdom SCOTTISH & SOUTHERN -
United Kingdom SCOTTISH POWER 29/08/06
United Kingdom DRAX POWER LIMITED -
Sweden VATTENFALL AB -
European generating capacity represented (GW and %) 249 (40%)
3.2. Design of questionnaire
Appendix 2 shows the electronic questionnaire that the participant companies in
the survey responded to and that served as guide to structure the later interviews.
Given the abundance of questionnaires that these companies receive every day
and the profile of the spokespeople, a brief and simple questionnaire was decided
upon, with the primary objective of guaranteeing the greatest possible response
rate. The later interview guaranteed the opportunity to expand the data obtained
from each company.
The questionnaire, semi-structured, is made up of three sections,
corresponding to three information requirements, within which the six questions
that we considered fundamental are distributed.
A) Questions 1 and 2 (multiple answer) try to determine the importance
given by the surveyed company to the Kyoto and post-Kyoto processes as
a determining factor in their competitive strategy and their immediate
investment decisions (generation mix until 2015) and in the medium and
long term (between 2015 and 2025).
B) Question 3 (open) tries to determine under what post-Kyoto scenarios the
surveyed company is planning its competitive strategy. Although
previously in this report nine possible scenarios were considered, finally it
was decided to suggest to the interviewees the following six more
probable scenarios, following the numeration used in section 2.4.: (1)
Kyoto continued; (3) modified Kyoto; (4) parallel Kyoto; (6) national
links; (8) national policies and measures; (9) international policies and
IE Working Paper WP06/26 14/12/2006
24
measures. This decision was taken in favour of a simpler survey, and to
guarantee a better response rate.
C) Question 4 (multiple answer) tries to determine the degree of involvement
of the surveyed company in CDM and JI projects. As we indicated
previously in section 2.5, it is reasonable to assume that the greater degree
of involvement in those investments, the greater the confidence of the
company on the existence of a post-Kyoto regime in which the use of
Kyoto units is allowed. Question 5 (open) enables confirmation of
whether this assumption is correct in the case of the surveyed company
and to what extent their decisions of investment in these projects are
being affected by that uncertainty.
Finally, question 6 leaves the possibility open for the interviewed
company to volunteer additional information on other aspects in which the post-
Kyoto process may be affecting its management decisions.
The remainder of this section describes the principle results obtained from
the survey.
3.3. Results obtained.
Table 7 summarises the quantitative results from the survey. The first
column includes the value of the response. The second column indicates
frequency, that is to say, the number of companies that chose that value. The last
column reports on the range of values used as a response.
Table 7. Principle quantitative results from the survey.
Value Frequency Range
Question #1. Changes in the generation mix now-2015 (-3 strong reduction / +3 strong growth)
1 1
0 7 Nuclear
-1 3
-1 to 1
2 1
1 4
Hydro
0 6
0 to 2
3 3
2 2
Gas
1 6
1 to 3
3 1
2 1
1 2
0 3
-1 1
-2 1
Coal and fuel-oil
-3 1
-3 to 3
3 6
2 2
Renewables (except Hydro)
1 3
1 to 3
Changes in generation mix 2015-2025 3 1 Nuclear
2 2 -3 to 3
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1 2
0 3
-3 1
3 1
1 2
Hydro
0 7
0 to 3
3 2
2 3
Gas
1 5
1 to 3
2 2
1 5
0 1
Coal and fuel-oil
-1 1
-1 to 2
3 4
2 1
1 4
Renewables (except Hydro)
0 1
0 to 3
1st 4
2nd 1
3rd 0
4th 3
5th 1
6th 1
Question #2. Post-Kyoto Ranking
in importance as the determining
factor in strategic competition
7th 1
1st to 7th
A 1
B 1
C 6
D 5
E 0
F 0
Question #3. Company vision of
the scenario post-Kyoto
Various 2
A to D
Payment on
delivery 6
Carbon funds 4
Financing the
project 3
Question #4. Involvement in
CDM (principle factor)
Project
management 3
All alternatives
Note: In some cases companies have responded with more than one alternative to a specific question, or
have preferred not to answer some questions.
Table 7 (question #1) shows the changes in the generation mix anticipated
in the first period (now-2015) and in the second period (2015-2025), making the
analysis by Technologies. The results show that the vast majority of companies
expect that nuclear generation remains constant in the first period. Nevertheless, a
significant number of them (more than half) hope for significant growth in
nuclear generation in the period 2015-2025.
With regard to hydro generation, the responses are practically uniform for
the two periods, pointing in the direction of a generation remaining the same. The
fact that a large proportion of the generation potential in this technology has
already been exploited undoubtedly contributes to this view.
IE Working Paper WP06/26 14/12/2006
26
According to those surveyed, two technologies will experience significant
growth. These are renewables and gas. The attraction of investment derived from
the policies for the promotion of renewables and the anticipated profitability from
generation with gas are without a doubt behind these answers.
Finally, an intermediate case is that of carbon and fuel-oil, which is
typified by the wide range of responses, especially in the first period. In this
period, whilst 4 of the companies forecast a growth in generation with these
sources, 3 of them consider that a reduction is most likely, and another 3
anticipate that generation will remain the same. In the second period, the majority
opinion is for growth in generation, maybe due to the potential that technologies
called clean coal can demonstrate.
As regards question #2, table 7 clearly shows that companies have very
heterogeneous opinions with regard to perception of the importance that the
Kyoto and post-Kyoto processes have as a determining factor for their strategic
competition and in their investment decisions. Nevertheless, for the majority of
companies surveyed, that factor has a significant influence: 5 rate it very highly
(1st and 2nd position); 3 give it average importance, (4th position); and the
remaining 3 place this factor at the end amongst the determining factors for their
investment decisions.
With regard to the range of probable post-Kyoto scenarios (question #3),
the heterogeneity is less, as there is a concentration of answers in scenarios C and
D, which indicates that the companies anticipate the continuance of restrictions
on carbon emissions, whether in the form of a system similar to Kyoto for
countries that have actually ratified the Protocol (scenario C), or in the form of
links between the European and other national systems on emission laws, but
without a global mitigation agreement (scenario D).
Finally, it is appropriate to highlight that the different perception of the
importance of a post-Kyoto regime and the possible Post-Kyoto scenarios
translates into an involvement that is quite heterogeneous in the Clean
Development Mechanism (question #4). Companies state that they do take part in
its different modes, although for the most part in the forms which require less
involvement by the company in that procedure (“payment on delivery” and
“carbon funds”). As we previously justified in this report, this result may be
considered as an indication of the uncertainty that companies feel about the
availability of a post-Kyoto regime in which the use of Kyoto units is permitted.
Nevertheless, the added information provided by table 7 does not allow
one to draw conclusions about what the relationships are between the different
categories in company terms and therefore, they conceal what the companies’
strategies are with regard to a post-Kyoto compliance system in response to their
perception of such a system. From the responses received to the survey, the basic
question is, whether it is possible to find guidelines in company terms that allow
perception to be related to the importance of the Kyoto and post-Kyoto systems,
as well as to the most plausible post-Kyoto scenarios, with the actions suggested
to reduce emissions in an investor context typified by the uncertainty about the
post-Kyoto system itself.
With this aim, it is useful to consider two basic variables:
(i) Degree of importance allocated to Kyoto and to post-Kyoto as a competitive
factor affecting the company’s investment decisions (question #2). One can
make a distinction here between two extremes: those companies that accord
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27
high importance to this element in relation to the rest of the aspects
considered and those companies that consider this factor has little relevance.
(ii)Type of answer in terms of company strategy in the light of the
challenge/uncertainty that post-Kyoto supposes. In this case we can
distinguish between those companies that consider a post-Kyoto system with
emission reduction objectives and emissions trading will be a reality and
therefore, they could be taking up positions in that market carrying out
mitigation actions (including full involvement in CDM projects) and those
that consider the uncertainties and risks that may arise from it justify adopting
a more cautious investment policy.
To identify possible post-Kyoto business patterns of action, it is
interesting to analyse up to what point the two variables are related. To analyse
this question we have prepared a chart (figure 3) where we place in the ordinate
axis the importance accorded to Kyoto/post-Kyoto as the competitive factor
affecting company investment decisions, according to the ranking established by
the companies themselves in question #2, whilst in the abscissa axis taking up a
position with regard to post-Kyoto, measured by the type of involvement in the
CDM (question #4)
Figure 3. Relation between the importance allocated to Kyoto/post-Kyoto and degree of
involvement in CDM.
*One company was not able to provide an exact ranking in any of the two categories under consideration,
although based on the replies given, it could be placed between box 1 and 2.
1
3
4
2
.
C6 (1,1)
.
C2 (2,1)
.
C7 (2,1)
.
C5
(1,2 y 4, 4)
.
C1 (1,6)
.
C9 (1,7)
.
C4 (3,5)
.
C10 (3,2)
.
C3 (4,4)
.
C11 (1,4)
High
importance
Low CDM
involvement
High CDM
involvement
Post-Kyoto importance
IE Working Paper WP06/26 14/12/2006
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We place the companies in the space created by the two axes. In order to
preserve confidentiality of the data provided by the companies surveyed, we have
replaced the name of the company by a number12.
The graphic shows that there is no homogenous pattern of perception and
behaviour that allows the two variables to be linked. A positioning through an
imaginary diagonal could therefore be expected that would cross the graphic from
the southwest box (4) to the northwest box (2). Nevertheless, it is possible to
appreciate a certain concentration in boxes 1 and 4 (7 of the 10 companies),
which indicates a relatively low involvement in CDM investments, and therefore,
the considerable uncertain effect that post-Kyoto may be playing in this sense. In
the same way, a similar concentration in boxes 1 and 2 (7 of the 10 companies) is
noted, showing graphically that the majority of the companies give plenty of
importance to Kyoto/post-Kyoto as an influencing factor in their investment
decisions. Therefore, it is appropriate to conclude that each company is a separate
case and takes their decisions to involve themselves in CDM based on many
variables, Kyoto/post-Kyoto being only one more amongst them.
We can also analyse the companies’ post-Kyoto (CDM) degree of
involvement in the light of their perception of possible post-Kyoto scenarios. In
this sense, it could be worth making the hypothesis that the greater probability
given to a scenario close to the current Kyoto system (that is to say, closest to
scenario A), the greater involvement can be anticipated in the CDM. That is to
say, a more proactive attitude could be anticipated facing post-Kyoto, given that
there could be more possibilities that investments made in emissions reduction
activities could have value in the future, by generating credits that could be used
to meet the emission reduction objectives and with a system for emissions trading
after 2012. Therefore, we have placed the companies in a double dimension,
bearing both variables in mind (figure 4).
Figure 4. Link between the perception of the post-Kyoto system and degree of involvement in
CDM.
12 We consider that the use of this information maintains the anonymity promised to companies
taking part, at the same time that it allows them to recognise themselves on the plan and compare
themselves with other companies, which will no doubt be useful to them.
IE Working Paper WP06/26 14/12/2006
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*Two companies have not been included in this graphic. One of them was not able to establish a ranking in
at least two of the questions. The other, in spite of giving a ranking to their post-Kyoto involvement (third
place) was not able to give a ranking to the various scenarios confirming that “they are considering several
scenarios, with the inclusion of aspects from the other scenarios.”
The results do not allow an unequivocal or generalised link to be made
between both variables, although unlike the previous case, companies placed in
box 1 predominate (more than half). This indicates to us that in spite of the fact
that companies consider that the most likely will be that they adopt a post-Kyoto
system similar (with more or less variations) to Kyoto, in which they may use the
credits for reduction of emissions, that does not lead to decisive action to position
themselves in the market. This confirms to us that in spite of that perception, the
uncertainties and risks associated with the ignorance about the specific system to
be adopted post-Kyoto are weighing heavily on investment decisions with regard
to the specific elements of design that this system will have. The absence of
companies in box 3 also warrants comment. This supports the validity of the
results, confirming that there is not one single company that considers the post-
Kyoto agreement will be very different from the Kyoto (without an emissions
trading system) and that is making heavy investments.
Taking account of the above conclusions regarding the impossibility of
identifying uniform patterns of perception and behaviour amongst companies, we
consider it is necessary to analyse in further depth the specific circumstances of
each company in order to identify the factors that are behind their positioning in
the graphic. Nevertheless, this analysis can be done company by company in
parallel with a classification exercise of the companies based on the three criteria
considered (importance given to Kyoto/post-Kyoto, involvement post-Kyoto and
perception of the most probable post-Kyoto scenario). The following four
categories coincide with the boxes in the first graphic.
1) High importance given to post-Kyoto, and low level of involvement in CDM.
This is the most frequent case amongst the companies surveyed. Five
companies are in this situation, specifically companies 2, 6, 7, 5 and 11. We give
1
3
4
2
.
C1 (1,A)
.
C7 (2,B)
.
C2 (2,CD)
.
C9 (1, CD)
.
C6 (1,D)
.
C5
(1,2 y 4,D)
.
C4 (3,CD)
.
C3 (4,C)
.
C11 (1, C)
Close to
scenario A
Close to
scenario F
Low CDM
involvement
High CDM
involvemen
t
IE Working Paper WP06/26 14/12/2006
30
attention below to the specific features of each company, through the information
obtained in the interviews, since they may provide an explanation of their
behaviour and positioning in the above graphics and in this classification.
Company 2. This company has high participation in renewable energies in its
generation mix and considers that environmental regulation is the principle
determining factor for future energy policies. Its perception is that the principle
features of Kyoto (such as the existence of quantitative objectives for the
countries, emissions trading system, cap-and-trade and an extension to other
countries of the responsibility for reduction of emissions) will be considered in
the future, and considers that the most probable is a C or D scenario. It also
considers that the evolution of post-Kyoto will be a crucial landmark for the
development of its business. However, one thing is that the company considers
that what happens after 2012 with regard to a mitigation system is important for
its business, and another is that there is a sufficiently clear and stable regulatory
framework for it to make decisive and drastic investments in mitigation
measures. In this sense, company 2 considers that to face any challenge and take
decisions in a post-Kyoto future, a clear and predictable regulation framework is
necessary. Therefore, there is no contradiction in its positioning.
Company 6. Although the existence of a mitigation system is important for this
company in making its investment decisions, it shows doubts that Kyoto is going
to be “successful”, that is to say, it shows doubts regarding its continuity.
Nevertheless, it does consider that the EU ETS will continue, its most likely
scenario being D. The weight of uncertainty on the decision of investing in
mitigation activities is serious for this company and refers both to the Kyoto
period and that subsequent to Kyoto. With regard to the post-Kyoto process, the
uncertainties are greater than with the Kyoto system, since there is no information
about the reduction objectives and on the continuity of the mechanisms in general
(international system for emissions trading, CDM…). That is to say, it is not
known if they may be able to use the credits in order to comply with some
hypothetical emissions ceilings. It is not known what the price of carbon will be,
and the uncertainty about factors that will affect that price is worrying (emissions
objectives, procedures for compliance with those objectives, supply and demand
of emission allowances). All the foregoing gives rise to a negative impact on
investment decisions. As the company confirms, a regulatory framework that it is
not even predictable and the absence of a stable regulation environment creates
conditions in which investments are delayed. The absence of stable indicators
has a very negative effect on investment. Nevertheless, company 6 considers that,
in spite of that, it is necessary to maintain a certain level of investment in CDM
“for what may happen”. That is to say, the uncertainty Works both ways: it is not
a question of not getting involved in those projects, but rather of keeping some
options open. This flexibility leads them to get involved in CDM in the form of
“payment on delivery”.
Company 7. This is a similar case to the previous once as it also considers that
Kyoto and post-Kyoto will have an important effect on the company’s investment
decisions, but observes an elevated level of uncertainty in the process which leads
them to adopt a cautious attitude. In fact, although the company considers that
there will be a “Kyoto 2”, (in the form of scenario B), it feels that the lack of
knowledge about the future price of CO2 and its impact on the price of electricity
(the company does not have CO2 emissions for the time being) makes them
decide on maintaining low level exposure to the risk, investing in CDM only in
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the form of “payment on delivery”, without any great involvement in that
mechanism. It is important to say that the absence of emissions in this company
makes them perceive Kyoto in a different way from the others. It has an
“opportunist” view of what Kyoto and post-Kyoto may produce for them in the
form of higher income without affecting their costs, in so far as they are not
obliged to reduce emissions for the time being.
Company 5. This company is somewhat different from the other three in this
category given that it gives less importance to Kyoto (fourth place) and,
nevertheless, its involvement in CDM is at a higher level, with activities in the
categories “payment on delivery” carbon funds and project management. Other
aspects (changes in nuclear policy, deregulation process and prices of petroleum,
in this order) are more important for this company in terms of influence in its
investment decisions. This positioning of company 5 may be due to it working
with various future scenarios, in a wide range that goes from the existence of
ambitious reduction objectives to the non-existence of a post-Kyoto system.
Therefore, its strategy consists of diversifying its investments in CDM, as already
mentioned, bearing in mind that different scenarios are possible.
Therefore, like the other companies in this category, it is also a victim of
the negative effect of uncertainty about mitigation activities. In spite of its greater
involvement, its response to this uncertainty is to delay heavy investments to
subsequent periods and making short-term investments.
Company 11. The same as with the previous company, this places the
Kyoto/post-Kyoto process at a medium level of importance, (fourth place) and, as
a result of the uncertainties about post-Kyoto, its level of involvement in the
CDM is low13. It perceives scenario C as the most likely. The company considers
that “the situation after 2012 will be rather similar to that of 2008-2012. The
countries in Annex I that have ratified the Kyoto Protocol will continue to have
quantifiable emissions reduction objectives and the basic instrument to achieve
the reductions proposed will be emissions trading. Just as now, there will be
various regional systems for emissions trading that will be interconnected. (…).
The United States and Australia will continue to focus the fight against climate
change towards improved technology within the heart of the Asia Pacific
Partnership. It is unlikely that developing countries are going to accept the
undertakings for emissions reductions.” They feel that the uncertainties relative to
the lack of definition of the post-Kyoto system (level of emissions reduction,
methods of allocation, limit on the use of CDM-JI credits, price of CO2, etc) have
an important influence on business decisions. The greatest uncertainty in this
company’s opinion is the acknowledgement of CDM-JI project credits after 2012.
This uncertainty becomes a reality to a large extent in the backing of the
“payment on delivery” method, in carbon funds and a lesser commitment to
financing and project management. In general terms, the post-Kyoto uncertainty
may be holding up the definition of an investment strategy beyond 2012. As the
company confirms, “nevertheless, if the situation is clarified and the level of risk
drops, it is likely that it will change the order of priority of these actions.”
13 In the opinion of company 11, “post-Kyoto is one of several variables influencing the
company’s strategy and decisions. Other factors, such as the price of fuel, nuclear policy and
renewables are just as important if not more so than Kyoto in decision making. It also has to be
pointed out that these variables are in turn interconnected with that happens post-Kyoto”.
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2) High importance given to post-Kyoto and elevated level of CDM involvement.
Company 10. This company is not very far away from companies in category 1.
The same as them, it gives high importance to post-Kyoto (after evolution of
petroleum prices), but it appears to go one step further in the degree of
involvement in CDM, with financing CDM projects as its priority activity,
although it also operates the “payment on delivery” method. They consider a
wide range of scenarios, but under the basic hypothesis that there will be
restrictions on carbon emissions post-2012, with the possibility that the USA
joins the process at a later date. Nevertheless, the same as the previous
companies, it is very concerned about the post-Kyoto uncertainty when it comes
to making investments, bearing in mind that the company is looking at time
horizons of 40 years. The uncertainty about CDM potential stands out in terms of
the volume of possible CO2 reductions, time scale and costs of reductions.
Furthermore, they mention the uncertainty about the effect of higher prices in
different areas of the business. Currently the company is reviewing its strategy
“that will be seen to be significantly influenced by the post-2012 uncertainty.”
The company underlines the importance not only of a post-Kyoto system, but
also of the national policies to be adopted in that period with regard to an
international mitigation system.
Company 8. As a result of the absence of a quantitative answer from this
company to several of the questions raised in the survey, difficulties exist in
placing it in any of the established quadrants. Nevertheless, it certainly is possible
to draw certain conclusions on its perception and activities from the interview
performed. In this sense, we could place it between quadrants 1 and 2. We can
deduce that it gives a high importance to Kyoto/post-Kyoto (as a result of the
importance it attaches to the fact that “Europe continues to be an international
leader in the fight against climate change”) and hopes for that reason that the
restrictions on carbon emissions will continue. However, as it admits an
important uncertainty about what will happen after 2012 (“what happens after
Kyoto is an open question”) and considers various possible scenarios, it is trying
to diversify risks being active in four types of CDM involvement.
3) Moderate importance given to post-Kyoto and high degree of involvement in
CDM.
Company 4. The company considers that there are several more important factors
than Kyoto in their investment decisions. In particular, the possible changes that
may take place in renewable energies policy, in regulated prices and the price of
petroleum, considering that the business of the company is oriented
fundamentally towards renewables and gas. In addition, they emphasize that the
preparation of a ranking is difficult, given that the competitive environment is
formed by a combination of and interrelation between various factors. Although
they foresee the existence of a post-Kyoto regime parallel to Kyoto (scenario B)
or, in the worst case scenario, a link between the EU ETS and other national
systems, they consider that the Kyoto process is fragile and subject to
uncertainties that can end in unexpected results (like the existence of benchmarks
or technology objectives like those of scenario F). But, in any case, they consider
that there will be restrictions on carbon emissions even in the absence of a post-
Kyoto mitigation regime, since the EU (or even its own country) will maintain
restrictions on carbon that will make renewables necessary (the main activity of
the company).
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Once again, the uncertainty provokes a diversified strategy of
participation in CDM (in the form of financing of projects and “payment on
delivery”) although, perhaps, something more daring than the companies in
categories 1 and 4. The main reason behind this more daring strategy is the effect
on its investment decisions resulting from the national mitigation policy that the
company expects to see even in absence of an international mitigation policy. The
opinion of the company is that the international climate change policy creates the
framework for a public policy for national activities.
Company 3. This company, which gives moderate importance to Kyoto (behind
the deregulation process, changes in the environmental policy of renewable
energies and other regulations, but considerably ahead of all other factors), is
placed halfway between quadrants 2 and 3 and it displays a significant
involvement in CDM in the form of management and financing of projects.
Although the company gives moderate importance to Kyoto, they are working on
the assumption of continuity of the Kyoto regime after 2012 and they even state
that “the continuity of Kyoto is necessary”. The high degree of involvement in
CDM is because the country in which the company’s activities are located is far
from fulfilling its objectives (that is to say, they are still more influenced by
Kyoto than by post-Kyoto). The expected shortage of permits as a result of a very
restricted national allocation, forces company 3 to search for allowances and
credits from outside its borders. Thus they consider “payment on delivery” is
excessively simple and that the company needs to involve itself more actively (a
more proactive attitude), looking for countries in which to invest in CDM,
controlling the product (which does not happen with “payment on delivery” and
carbon funds).
Curiously, the company does not consider that there will be great
economic risk in involving itself in the flexible mechanisms. Although different
perspectives exist within the company, the internalisation of the value of CO2 is a
reality and has caused a gradual change in the strategy of the company in this
sense.
4) Low importance given to post-Kyoto and low degree of involvement in CDM.
Company 1. Post-Kyoto and Kyoto occupy a position of little importance in
influencing the investment decisions of the company, higher only than the
influence of the deregulation process. Nevertheless, they consider that “there is
no going back” with respect to the existence of carbon emissions restrictions. In
its opinion, the most probable scenario is A but, even if there isn’t a global
mitigation regime, the EU certainly will have its own limits and will use a system
of emissions trading to achieve them, since it is the cheapest way of doing so.
Although for company 1 the process is irreversible, the continuity of the EU ETS
is inevitable and it is going to be necessary to buy CERs (with or without Kyoto),
the involvement in the Kyoto mechanisms is low profile. They allege that the
validity of the CERs in the post-Kyoto period is very uncertain. They emphasize
the difficulty of making long term investment decisions without knowing the
future context of carbon emissions restrictions.
Company 9. This company puts the Kyoto and post-Kyoto processes at the
bottom of the factors that influence the company’s investment decision, stating
that “emissions reductions will happen in any case”. It considers that there will be
continuity of carbon emissions restrictions, whether it be under a similar system
to Kyoto (scenario C) or by means of linkages of the EU ETS with other national
IE Working Paper WP06/26 14/12/2006
34
systems. Nevertheless, the involvement in CDM projects is very low, only in the
“payment on delivery” mode. They are not participating in nor have plans to do
so in other categories. The fundamental reason in this case is not so much the
possible uncertainty as to the existence and elements of a post-Kyoto regime (as
is the case with most of the other companies) as the low importance given to this
question in the company’s competitiveness. In addition, they say that the CO2
market is highly regulated and “the political influence makes it difficult to
manage.”
4. STUDY CONCLUSIONS.
The non-existence of a post-Kyoto regime, and therefore the practical
absence of sufficiently clear price indicators for emissions reductions achieved
beyond 2012, is having a negative effect on current business investment decisions
in mitigation activities, increasing risk premiums and financing costs.
As a result, the uncertainty about the post-Kyoto regime is causing a delay
in carrying out these mitigation activities which, in turn, will inhibit more
demanding emissions reduction commitments being accepted in the future.
Alternatively, in the event that they are adopted, they will then require a greater
reduction, that could ultimately imply higher costs for emissions reduction in
comparison with those that would arise from a more gradual reduction of the
same.14
Specifically, from the results of the surveys made in the context of this
project, one can deduce that, on the one hand, meeting the Kyoto objectives (as
well as those of a possible post-Kyoto regime) has in general a significant
influence on the companies’ investment decisions and that, on the other hand, the
uncertainty about the Post-Kyoto regime may already be affecting investments in
mitigation activities in the electricity sector.
The importance of knowing now, and in greater detail, what such a future
regime will be, is a determining factor, not only for environmental reasons, but
also from the business point of view. It is a priority for the post-Kyoto regime to
be established as soon as possible, in order to ensure that there is continuity in the
emissions reduction efforts.
In particular, investors need to be informed about what the most likely
post-Kyoto scenario is that will give rise to a post 2012 recognition of the market
value of Kyoto units coming from emissions reduction projects carried out in
other countries. In this sense, the discussion in this study about which from
amongst the possible post-Kyoto regimes is compatible with the banking of
Kyoto units from the first to the second period provides relevant information to
potential investors in these projects. The main conclusion reached in this sense is
that it is most likely there will be value for these units in the medium term, even
in the absence of a mitigation regime as a result of a global agreement. This is
due to the existence of the European Emissions Trading System (EU ETS) and to
its possible continuity in the medium term. The European electricity companies
that were surveyed foresee post-Kyoto compliance regimes with emissions
14 The existence of a stable mitigation regime has a favourable effect on carrying out mitigation
activities. In its turn, the greater the investments in such activities, the more likely it will be that
that regime will have continuity, as a result of the “pressure” effect prompted by the existence of
investments already made in mitigation activities which, at least in the case of the electricity
sector, have long-term returns.
IE Working Paper WP06/26 14/12/2006
35
trading systems that would guarantee the continuity of the value of the reductions
made beforehand.
As it would be appropriate to expect, meeting Kyoto and post-Kyoto
objectives has in general a significant influence on the investment decisions of
the companies in the European electricity sector. Practically all of the surveyed
companies expect a continuation of carbon emissions restrictions after 2012,
although they differ in their perceptions of the form that a post-Kyoto regime
could take. The vast majority consider the two following scenarios as the most
likely: (1) that known as “Parallel Kyoto”, a similar regime to Kyoto for the
Annex I countries that have currently ratified the Protocol under the framework
of the United Nations Framework Convention on Climate Change (UNFCCC),
and a parallel agreement of those that reject the same (USA and Australia). In the
light of certain recently adopted initiatives in this sense, this agreement would be
made between the two latter countries and some developing countries in south
East Asia. This parallel agreement to that of the other countries would be
fundamentally based on the negotiation of a technical agreement for technology
transfer to those developing countries; (2) a “regional agreements” scenario in
which the application of common objectives for reduction differentiated between
a small group of countries would be negotiated, although not necessarily in the
UNFCCC framework. Unlike the current Protocol, it would be a bottom-up
process, in which there would be no global agreement. A certain number of
“environmentally aware” countries (EU, other European, Canada, Japan, New
Zealand and some developing countries) would decide to adopt some absolute
reduction objectives, solely for them, and to use emissions trading to meet those
objectives. It would leave the possibility open that other countries join the
agreement at a later date. The less developed countries and the majority of
developing countries would not have objectives.
In any event, many of the companies surveyed consider it a possibility
that there will not be an international regime for post-Kyoto compliance, but,
even in that case, they are aware that they would have to control their emissions
due to the fact of being subject to the European Emissions Trading System (EU
ETS). In this sense, the possible absence of the USA in a post-Kyoto mitigation
regime does not seem to have very much influence over the European electricity
companies’ perception regarding the continuity of carbon emissions restrictions.
Nevertheless, the uncertainty about objectives and other elements of a
mitigation regime affect the value itself of those reductions. Some demanding
mitigation objectives would lead to a higher value of those Kyoto units that
would make it more profitable to carry out mitigation activities whose financial
feasibility is at the very threshold of profitability.
Therefore, significant progress has to be made in the definition of a post-
Kyoto regime, at least in two respects. It is now urgent to define and agree at an
international level not only the emissions reduction objectives, but also the
mitigation instruments that will be accepted for their compliance, and in
particular, it is necessary to guarantee the continuity of the international
emissions trading system foreseen in the Protocol itself, as it is an instrument that
facilitates the meeting of the mitigation objectives at a lower cost than other
direct regulatory instruments.
In this sense, in environmental terms, but also in business terms, it is
appropriate for the European Union, and Spain as part of it, to continue leading
the negotiation process in order to arrive as quickly as possible at an international
IE Working Paper WP06/26 14/12/2006
36
post-Kyoto mitigation agreement within the framework of the United Nations
Framework Convention on Climate Change (UNFCCC) that should contain those
two fundamental elements: objectives and instruments.
In the event that a global planetary agreement is reached, or even an
international agreement made up by a majority of developed countries (within
Annex I), it would be necessary to at least ensure the continuity of the European
(and national) mitigation policies, thereby guaranteeing the stability of the
mitigation regime. Specifically, objectives should be established at the EU level
at least up to 2020 and maintain the EU ETS in order to meet them. This
instrument is actually more relevant when it comes to providing investors with an
indication of the price of CO2.
Therefore, EU authorities must give an even more decisive signal about
the long term continuity of this system, irrespective of the agreements reached at
the international level within the heart of the UNFCCC. The Conference of the
Parties (first Conference of the Parties serving as the Meeting of Parties
COP/MOP 1) of the UNFCCC held in Montreal in December 2005, only reached
a generic commitment undertaken by the industrialised countries to “set new
emissions limitation commitments beyond 2012” and an express reference to the
need to guarantee continuity beyond 2012. The Conference of the Parties held
recently in Nairobi again only reached agreement that in 2008 a new review of
the Kyoto Protocol will be held, that could lead (or not) to the construction of a
post-Kyoto regime the following year. These generic and non-binding
commitments are not favourable to ensuring an attractive context for investment
in new technologies and in mitigation projects. It is necessary for them to
establish objectives sufficiently far in advance that provide a long term indication
regarding the price of carbon.
In this context of relative uncertainty, the predominating attitude amongst
the European electricity companies seems to have been to diversify their
activities of emissions control (including the purchase of European emission
permits and involvement in Clean Development Mechanisms CDM) based on the
costs of the different options, together with greater emphasis on profitable lines
of business, irrespective of emissions mitigation, but to which mitigation
provides an added motive for its realization (investment in combined cycle gas
and in renewables). In this sense, the policies for promoting renewable energies
seem to have continuity (at least in our country) and to ensure profitability levels
that for the time being are not being provided by climate change policies.
Keeping the greatest number of options open seems to be a logical
strategy in the context of uncertainty, that is to say, adapting to change. This
intermediate strategy allows companies to respond to the different future
mitigation scenarios, as of now still to be defined, without incurring elevated
costs that could arise from opting for an “extreme” strategy, if the final mitigation
scenario applied is in the end closer to the opposite extreme15. This pattern is
15 This may happen in two different situations: Either the company carries out the mitigation
activities now in a very decisive manner by investing heavily in measures, or decides not to do
anything. In the first case, the “extreme” risk is in the final scenario being one typified by the
absence of a mitigation regime, or by the existence of a mitigation regime with very lax objectives
for emissions reduction. In the second case, the extreme risk consists of not having taken
measures when the final scenario is one in which strong emissions reductions are required. The
adoption of the intermediate strategy reduces the risk of falling into one of these two situations.
IE Working Paper WP06/26 14/12/2006
37
clearly reflected in the results of this study in the case of investment in CDM
projects.
The importance that the Kyoto and post-Kyoto mitigation regimes seem to
have in the investment decisions of companies in the sector, together with their
conviction that there will be carbon emissions restrictions post 2012, would lead
one to think that investment in emissions reduction activities should be a priority
for companies, especially through greater involvement in CMD projects, either
by direct management or financing of projects. However, the uncertainty about
the existence of a post-Kyoto regime and the key elements of its design
(objectives, possibility of emissions trading, distribution of emission permits) is
clearly having a demotivating effect on carrying out mitigation activities that go
beyond 2012. This, together with the costs themselves of the transaction16 and
associated risks of carrying out CMD projects, leads the majority of companies to
not get overly involved in CMD projects, and to only do it in the form of
“payment on delivery” or through participation in carbon funds. This less
committed involvement allows companies to reduce their risk of non-compliance
in the event that there will finally be a post-Kyoto regime and, in any event,
allows them to comply in the cheapest way possible with the EU ETS. The post-
Kyoto uncertainty is leading companies to diversify their involvement in the
CDM, leaving doors open for any eventuality.
As it could not be done in any other way, the results of the study show
that the special features of each company and of the country where it operates
play an important role in its perception of the uncertainties and its position
regarding a possible post-Kyoto regime, and therefore, to a greater or lesser
extent, its inclination to carry out mitigation activities.
All in all, the absence of defined objects for a future post-Kyoto regime is
affecting the financing of reduction projects, increasing risk premiums financing
costs. If the intention is to achieve the objectives set in the current regime, then it
is urgent and vital to send out clearer signals to investors about their continuity.
16 Although efforts have recently been made by United Nations organisations to reduce the
transaction costs of the CDM projects, more must be done in this sense, with measures leading to
reduce the risk of these projects. There is no doubt that an international agreement on a post-
Kyoto mitigation regime would contribute significantly to reducing part of the risks associated
with the realization of these projects.
IE Working Paper WP06/26 14/12/2006
38
Appendix 1. Letter of invitation with access to the electronic survey form
IE Working Paper WP06/26 14/12/2006
39
Appendix 2. Electronic questionnaire
IE Working Paper WP06/26 14/12/2006
40
(App. 2. cont.)
IE Working Paper WP06/26 14/12/2006
41
(App. 2. cont.)
IE Working Paper WP06/26 14/12/2006
42
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International Climate Efforts Beyond 2012: A Survey of Approaches
  • Bodansky
  • Chou
Bodansky, Chou (2004). International Climate Efforts Beyond 2012: A Survey of Approaches. Pew Centre on Global Climate Change (USA)
Lessons, and Considerations for Greenhouse Gases
  • Experience
Experience, Lessons, and Considerations for Greenhouse Gases. Pew Centre on Global Climate Change (USA)
Beyond 2012 Evolution of the Kioto Protocol Regime. An Environmental and Development Economics Analysis Approaches for Future International Co-Operation
  • A Michaelowa
  • S Butzengeiger
  • M Jung
  • M C Dutchke
Michaelowa, A., Butzengeiger, S., Jung, M. and Dutchke, M. (2003). " Beyond 2012. Evolution of the Kioto Protocol Regime. An Environmental and Development Economics Analysis. " Expertise for the WBGU Special Report, Climate Protection Strategies for the 21st Century: Kioto and Beyond. WBGU website, http://www.wbgu.de/wbgu_sn2003_ex02.pdf Philibert, C. (2005). Approaches for Future International Co-Operation. IEA, Paris.
Gleneagles Plan of Action: Climate Change, Clean Energy and Sustainable Development
G8 (2005). Gleneagles Plan of Action: Climate Change, Clean Energy and Sustainable Development. G8 Gleneagles, July 2005.
Greenhouse Gas Market 2005: The rubber hits the road
IETA (2005). Greenhouse Gas Market 2005: The rubber hits the road. Geneve, Switzerland.