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					   Living in a Carbon-based World:
CO2 and its impact on the EU Power
                            Sector
                           Gavin Bell
                          March 2010
First, a little about me...
       Ph.D. from Canterbury
           EMRG
       One of the many from Canty that ended up in Europe...
       Worked since 1999 in energy sector as consultant and in
        industry
           UK, Germany, Austria, Netherlands, Spain, Albania, Montinegro,
            Macedonia, Norway, Denmark, Czech Republic, Cuba
       Headed up the continental power market analysis team and
        the cross commodity analysis team at Statkraft
           Europe’s largest renewable generator
           Around 55 TWh annual production
       Currently CEO of Ably (plant data and analysis firm) and
        independent consultant
           Based in Norway since 2003


    2                                  ecovest limited                       26.09.2011
Key EU ETS Takeaways
       EU ETS market is part of an ”energy complex” involving
        power, fuels, CO2, and other commodity markets
           Each drives the other
           Increasingly, money cannot be made in one market only – you
            need to look at them all simultaneously
       CO2 will drive increasing internationalisation of energy
        markets, as CO2 markets interlink
           EU ETS in the forefront
       Any CO2 market is a political beast – politics drives the
        price and direction


    3                                 ecovest limited   26.09.2011
Outline
       EU ETS Overview
       A multi-commodity energy complex
       Short term interactions
       Long term interations and drivers
       Summary




    4                         ecovest limited   26.09.2011
EU ETS Overview
EU ETS – What is it?

Technically...                                    Really...
       Classic cap and trade system to              Commercially crucially important
        regulate CO2 emissions in the EU              market in the EU energy sector
        + EEA countries                              Driver of investments
       Absolute limit on CO2 emissions                    Impact on price
       Allowances distributed to facilities               CCS
        covered by the scheme                              CERs
           >12000 facilities                              Credit rating
           >4000 companies                          Hedging
       Participating facilities surrender an              Exposed to CO2
        allowance per tonne CO2 emitted                    Need to mitigate to manage risk
        during annual compliance periods
                                                     Trading
                                                           Direct opportunity to make money



    6                                     ecovest limited                             26.09.2011
ETS Summary
2005        2007   2008                         2012     2013                       2020
       Phase 1                Phase 2                             Phase 3++


  Trial Period              Kyoto Period                        Post-Kyoto Period
• 95% free          • Tighter limits based on phase 1     • 43% of EU emissions (incl.
  allowances          experience (6.5% below 2005)          Aviation, CCS)
• Allocation of     • 90% free allowances                 • Single EU Cap, reducing 1.74%
  permits done            • 3% Auctioning                   p.a.
  nationally              • 6% New Entrant Reserve        • Auctioning – 50% in 2013, 100%
  (National         • EEA included                          by 2027
  Allocation        • Allocation via NAPs                 • 100%(ish) auctioning in power
  Plans - NAPs)     • Can import credits from other         sector from 2013
                      flexible mechanisms                 • Links with 3rd Country
                          • Appx. 12% of total              schemes; harmonisation of
                                                            CDM/JI rules


 7                                     ecovest limited                            26.09.2011
Banking and borrowing
       Banking and borrowing allowed within a phase
       No banking or borrowing between phases 1 and 2
           A key reason for observed priced development
       Banking allowed from phase 2 to phase 3
           Linking prices in these two phases
           Especially important now phase 2 seems long
           No borrowing




    8                               ecovest limited        26.09.2011
Distribution of allowances
                                       Two key ”sectors”
                                            Power
Cement,
                                            Industry
 Lime,
               Other
                8%
                                       Behave differently in relation
 Glass                                  to ETS
 11%                      Public
                        Power and
                                       Industry
 Oil and                  Heat              Generally long
  Gas                      59%              Reduce emissions via
   9%                                        investment (med-long term)
    Metals
                                            Often annual or ”period” view
     11%
             Pulp and
                                       Power sector
              Paper                         Generally short
               2%                           CO2 price impacts dispatch
                                            Hedging of power production


9                          ecovest limited                         26.09.2011
 EU ETS History
                  35
                       Fuel bull
                                                                 Fuel bull
                  30     run
                                               2nd                 run
                                                                                            Financial crisis
                                              phase
                  25                                                                        Fuel bear run
                                             NAP cut
EUA Price (€/t)




                  20

                  15

                  10        2005
                           Verified                        Industrial length
                  5       emissions                       gradually in market               Oil, equities bull
                                                                                                   run
                  0
                         2005             2006             2007               2008                2009
                                   2005      2006      2007        2008      2009    2010

             10                                        ecovest limited                              26.09.2011
         A multi-commodity energy
                         complex
CO2 and Power (and fuels, currencies, interest rates etc etc)
Complex interactions driving markets

Coal                                            Coal
       Fuel   CO2   SRMC                               Fuel   CO2    SRMC
       8      10    33     Price of CO2                8      12     35


                           Price of gas
Gas                                             Gas
       Fuel   CO2   SRMC                               Fuel   CO2    SRMC
       20     10    39                                 15     12     31




                           Price of CO2

                           Price of gas


 12                           ecovest limited                 26.09.2011
CO2 and power market interaction

Short term                                        Long term
    The power stack                                 CO2 market is key driver in
        Stack driving emission levels                investment decisions
        ETS price impacting the stack
                                                     Power market investments
    Non-market external effects
                                                      (emitting vs non-emitting)
        Weather
            Driving power and heat demand            driver of future CO2 price
             and availability (hydro, wind)          CO2 price feed-through to
    Hedging, market psychology                       power price a driver of
    Energy complex                                   future power demand
        Oil a strong sentiment driver of
         power and CO2 (++)                          Future CO2 price driver of
    External economy (e.g. recent                    todays CO2 price (banking
     demand destruction)                              effect)

    13                                    ecovest limited                  26.09.2011
Question...




       What is correlation
       and what is causality?



14              ecovest limited   26.09.2011
Short term interaction
       The classic – fuel switching
                                                    Relationship between gas,
            Coal – gas fuel                          coal, and CO2 drives stack
SRMC




              switching                              and emissions
                                                    Other aspects reduce fuel
                                                     switch flexibility
        CO2 cost                                          Fuel contracts
                                                          Inflexibilities in fuel access
                                                          Don’t always get the fuel
                                                           switching you expect...

 nuke, wind              coal     gas, oil GT
               lignite          CCGT


       16                                ecovest limited                           26.09.2011
              Impact of fundamentals
                                                    Acc. Changes:
                      100                                                 30
                       80                           fuel prices &         28
                       60
                       40                             weather             26
                       20
                        0                                                 24
                      -20
Mill tonnes




                      -40                                                 22
                      -60                                                 20




                                                                                €/t
                      -80
                     -100                                                 18
                     -120
                     -140                                                 16
                     -160                                                 14
                     -180
                                                                          12
                            EUA Dec-08
                     -200
                     -220                                                 10
                     -240
                     -260                                                 8
                                8

                              08

                              08

                              08

                              08

                              08

                              09

                              09

                              09

                              09

                              09

                              09
                             00

                           20

                           20

                           20

                           20

                           20

                           20

                           20

                           20

                           20

                           20

                           20
                          .2

                        3.

                        5.

                        7.

                        9.

                        1.

                        1.

                        3.

                        5.

                        7.

                        9.

                        1.
                       01

                      .0

                      .0

                      .0

                      .0

                      .1

                      .0

                      .0

                      .0

                      .0

                      .0

                      .1
                 .
              02

                   02

                   02

                   02

                   02

                   02

                   02

                   02

                   02

                   02

                   02

                   02
                                                                    Source: Point Carbon



              17                         ecovest limited                26.09.2011
    But it’s not a ”tick the boxes” world...
              CO2 - EEX Spot Correlation                      Relationships are not
1,50                                                           straightforward, nor
1,00                                                           consistent
0,50                                                              Sometimes, CO2 can
0,00                                                               explain power price
  18.12.2008 28.03.2009 06.07.2009 14.10.2009 22.01.2010
-0,50                                                              movements, sometimes its,
-1,00                                                              say, coal and gas prices, or
                CO2 - Coal Correlation                             something entirely different
1,50
                                                              Often possible to know in
1,00
                                                               hindsight...
                                                               But forecasting is not easy
0,50
                                                           
0,00
  18.12.2008 28.03.2009 06.07.2009 14.10.2009 22.01.2010
-0,50
                                                              Q: What sort of analysis is
-1,00
                                                               useful...?

        18                                       ecovest limited                        26.09.2011
Hedging activities
    Hedging of production
     begins already 3 years ahead
                                           Year      CO2 volumes
    CO2 part of that hedge
                                           2010      250
    Thus, begin to hedge                  2011      700
     production in phase 3 of ETS          2012      1250
     from 2010 onwards                     Total     2200 Mt
        BUT – phase 3 allowances not
         yet available
        Via purchase of phase 2
         (2012) allowances for banking                      Could turn a long
                                                            phase 2 market
    Hedging demand can drive                               into a short one...
     prices

    19                             ecovest limited                       26.09.2011
Crude oil – key sentiment driver
              35                                                                    160

              30                                                                    140

                                                                                    120




                                                                                          Brent Crude ($/bbl)
              25
EUA (€/MWh)




                                                                                    100
              20
                                                                                    80
              15
                                                                                    60
              10
                                                                                    40
               5                                                                    20

               0                                                                    0
              14.11.2007   01.06.2008   18.12.2008 06.07.2009   22.01.2010   10.08.2010
                                           EUA    Brent Crude


20                                           ecovest limited
Economy driving demand in power and CO2
                                                           Significant demand
     2500
                                                            destruction as a result of
                                                            financial crisis – from 2008
                                                            to 2009:
                                                                 Germany: 6% decline
Mt




     2000
                                                                 France: 3% decline
                                                           Less demand for EUAs
                                                                 Lower price
     1500                                                        Pressure on power prices
            2008   2009   2010   2011         2012
                                                           Market is expected long in
                                 Source: Point Carbon
                                                            phase 2...

     21                                         ecovest limited                         26.09.2011
Phase 2 market balance
                                                               Market is long in phase 2
     400                                                             Including credits: 970 Mt
     300            short                                      In theory...
     200
                                                                     Price in phase 2 should
                                                                      equal discounted price in
                                                                      2013 (first year, phase 3)
Mt




     100

       0                                                             Prices today are lower than
                                                                      this...
 -100
                             long                              Anticipate at least that
 -200                                                           phase 3 will increasingly
           2008     2009   2010   2011      2012
                                                                impact phase 2 prices
     EUA Shortage    Credits available for EU ETS              What is driving phase 3
                                    Source: Point Carbon        price expectation?
     22                                             ecovest limited                        26.09.2011
Long term interaction
CO2 price in 2020 and beyond
    How can we assess the long term price?
        And thus today’s ”equilibrium” price level?
    Equilibrium model
        What price balances supply and demand
        That is, long term relationships between
            Power and CO2
            Industry and CO2
            CERs, other ETS schemes and the EU ETS
    Or... an educated guess – it is a political process after all
        What price needed to drive CCS?
        EU effectively target long term caps to achieve this price level...

    24                               ecovest limited                 26.09.2011
Phase 3 supply: political and commercial
process
    Steadily declining allowance cap
        21% below 2005 emissions in 2020
    Power sector (more-or-less) 100% short
    Industry reducing from 80% free allowances in 2013 to
     30% in 2020
    CERs/ERUs
        Supply depends on a ”post Kyoto” agreement
            No agreement, only Kyoto + ”bilaterals” CERs
        Credit limit of at least 11% of the phase 2 allocation
        Can choose when to use the credits (phase 2 or phase 3)
            But, max 1400 Mt in phase 2


    25                                ecovest limited          26.09.2011
Phase 3 demand: interation between
markets
    Power and heat
        Change in stack, through investments and retirements
            Expected future prices (fuels, capital costs, exhange rates, cost of
             money)
            Portfolio considerations
            Other mechanisms – e.g. Renewables directive
        Demand for power and heat
    Industry
        Economic growth
            Change in energy intensive industry in EU
        Change in carbon intensity


    26                                   ecovest limited                       26.09.2011
And the results...

Bottom up forecast                        ”Political” forecast...
                                         Plant investment         1100        €/kW
    Typical price forecast                  The CCS approach (or
                                         CCS investment
                                         WACC
                                                                  1100
                                                                   8%
                                                                              €/kW


     ranges for CO2 for 2020                  renewables or whatever...)
                                         Annualised                 €/kW/a
                                                                   113

                                              for, say, 2025
                                         Load factor              50 %

        Point Carbon 37 €/t             CCS capital cost        22 €/MWh

                                                   Additional capital cost
                                         Old load factor           75 %
        Barclays – 40 €/t long term     Plant capital cost                kr 7 €/MWh
                                                Reduction in efficiency
        Deutsche Bank 30 €t             Fuel cost                   75         €/t
                                                CO2 emissions11       saved €/MWh
        UBS – 20 €/t                    Efficiency, no CCS        44 %
                                         Efficiency,+ fuel cost assumptions
                                                CCS               34 %
        UK EAC – 22 €/t                            etc...
                                         Additional Gen. Cost
                                         Extra fuel cost
                                                                              7 €/MWh
                                                                            36 €/MWh

                                         CO2 price Around 50 €/t 49
                                                                    (2025)
                                                                   35
                                                    Discounts to 90 % €/t (2020)
                                         Capture rate
                                                saved
                                         CO2 cost                           36 €/MWh

                                         Difference                        0,00 €/MWh

    27                            ecovest limited                           26.09.2011
Summary
Summary
    CO2 (via ETS) integral part of EU energy markets
        Investment
        Hedging
        Trading
    Complex interactions between these markets
        Drive prices
        Significant and dynamic relationship between long and short
         term dynamics
    And don’t forget it is a political process
        Once there is an ETS, there’s a strong pressure for consistency
         and predictability

    29                            ecovest limited                26.09.2011
        Gavin Bell
     ecovest limited
Armauer Hansens gate 6a
   0455 Oslo, Norway
   tel: +47 950 27979
   bellgj@hotmail.com

				
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