Jos Sijm

CO2 cost pass-through and windfall profits in the power sector

Abstract In order to cover their CO2 emissions, power companies receive most of the required EU ETS allowances for free. In line with economic theory, these companies pass on the costs of these allowances in the price of electricity. This article analyses the implications of the EU ETS for the power sector, notably the impact of free allocation of CO2 emission allowances on the price of electricity and the profitability of power generation. As well as some theoretical reflections, the article presents empirical and model estimates of CO2 cost pass-through for Germany and The Netherlands, indicating that pass-through rates vary between 60 and 100% of CO2 costs, depending on the carbon intensity of the marginal production unit and various other market- or technology-specific factors. As a result, power companies realize substantial windfall profits, as indicated by the empirical and model estimates presented in the article.

The interaction between the EU emissions trading scheme and national energy policies

Abstract National energy policies usually have a significant impact on the sectoral and overall CO2 emissions of an EU Member State. Once the proposed EU emissions trading scheme (EU ETS) becomes operational, however, the CO2 performance of these policies, i.e. their effectiveness and efficiency in reducing CO2 emissions, will differ depending on whether they affect fossil fuel use by the participating or non-participating sectors of this scheme. This article discusses in particular the CO2 performance of national energy policies affecting the participating sectors of the EU ETS. A major conclusion is that once the EU ETS becomes operational, the effectiveness of all other policies to reduce CO2 emissions of the participating sectors becomes zero. Moreover, in a perfect economy with no market failures, these policies will lead to a lower CO2 efficiency and less optimal market operations of the EU ETS. Hence, in such a situation, this coexistence of policy instruments cannot be justified from a CO2 efficiency point of view. It will be argued, however, that there are three reasons why the joint use of the EU ETS and policies affecting the fossil fuel use of the participating sectors may be justified: (1) improving the design of the EU ETS, (2) correcting for market failures, and (3) meeting other policy objectives besides CO2 efficiency. The ideas expressed in this article are illustrated by a detailed numerical example on the interaction between emissions trading and national energy policies. The article concludes with a summary of its major findings and policy implications.

Implications of announced phase II national allocation plans for the EU ETS

Abstract We quantified the volume of free allowances that different national allocation plans proposed to allocate to existing and new installations, with specific reference to the power sector. Most countries continue to allocate based on historic emissions, contrary to hopes for improved allocation methods, with allocations to installations frequently based on 2005 emission data; this may strengthen the belief in the private sector that emissions in the coming years will influence their subsequent allowance allocation. Allocations to new installations provide high and frequently fuel-differentiated subsidies, risking significant distortions to investment choices. Thus, in addition to supplying a long market in aggregate, proposed allocation plans reveal continuing diverse problems, including perverse incentives. To ensure the effectiveness of the EU ETS in the future, the private sector will need to be shown credible evidence that free allowance allocation will be drastically reduced post-2012, or that these problems will be addressed in some other way.

Differentiation of mitigation commitments: the multi-sector convergence approach

This paper presents a new sector-based framework-called the multi-sector convergence approach-for negotiating binding national GHG mitigation targets after the first budget period defined by the Kyoto Protocol (2008-2012). The major characteristics of this approach are that: (i) it is based on the distinction of different sectors within the national economy; (ii) it prescribes that, in principle, the amount of per capita emission assignments should ultimately converge to the same level for all countries; (iii) it accounts for differences in national circumstances by offering the opportunity to grant additional emission allowances to countries facing specific circumstances that justify higher emission assignments; and (iv) it offers a framework for negotiating mitigation commitments among parties of the UNFCCC, including a (gradual) participation of developing countries that pass a certain threshold level of per capita emissions. In addition to briefly discussing the underlying principles of promising proposals to differentiate future GHG mitigation commitments, the paper outlines the methodology and major characteristics of the multi-sector convergence (MSC) approach, followed by some numerical illustrations. The paper is concluded by a preliminary assessment of the MSC approach.

Developing a sectoral new market mechanism: : insights from theoretical analysis and country showcases

Parties to the United Nations Framework Convention on Climate Change (UNFCCC) have decided to establish a ‘new market-based mechanism’ (NMM) to promote mitigation across ‘broad segments’ of developing countries economies but have so far defined only some broad outlines of how it is to function. This article identifies key design options of the NMM based on a survey of the literature and reviews them against a range of assessment criteria. Furthermore, potential application of the NMM is analysed for five country-sector combinations. The analysis finds that lack of data and of institutions that could manage the NMM are key bottlenecks. In addition, the analysis reveals the existence of substantial no-regret reduction potential, suggesting that sectors may not be sensitive to the market incentives from an NMM. Governmental capacity building and Nationally Appropriate Mitigation Actions (NAMAs) might be more appropriate in the short term, preparing the ground for the adoption of market-based approaches at a later stage. NMM pilots could be based on supported NAMAs but should ideally generate tradable and compliance-grade emission credits in order to fully simulate the real-life conditions of an NMM. Policy relevance The Doha conference identified ‘possible elements’ of the NMM to be addressed in the development of the NMMs modalities and procedures. This article identifies available options for these possible elements and reviews these options against a number of criteria, including environmental effectiveness, economic efficiency, political and administrative efficiency, and others. On this basis the article identifies options that are best suited to fulfil the main aims of the NMM as decided at the Durban conference, ‘to enhance the cost-effectiveness of, and to promote, mitigation actions’. In addition, the article analysis potential application of the NMM for five country-sector combinations. The analysis assesses the emission reduction potential that could be mobilized through the NMM as well as the institutional market readiness of the sectors. Finally, the article synthesizes the challenges ahead for the NMM that have emerged from the analysis and suggests possible ways forward.

Mind the gap: Challenges and policy options for cross-border transmission network investments

Cross-border transmission network investment requirements are expected to increase, in order to strengthen internal market integration and reach the renewable deployment policy target across Europe. This paper discusses the governance of cross-border transmission network infrastructure using four building blocks: network planning, ownership, financing and cost allocation. Firstly, the key characteristics of current regulatory arrangements and challenges faced are identified for each building block. Options are proposed jointly to address the identified challenges.

Greenhouse Gas Emissions Trading in the Electricity Sector: Model Formulation and Case Studies

Models formulated as complementarity problems have been applied previously to assess the potential for market power and costs of environmental regulation in transmission-constrained electricity markets. One emerging use of these models is to study the impacts of cap-and-trade (C&T) policies on electricity markets. In this chapter, we first summarize the theoretical background on the choice of environmental instruments to regulate emissions from the power sector. The chapter then presents a mathematical formulation of a power market that incorporates a carbon dioxide C&T program. We illustrate the capability of the model by presenting the results from two analyses. The first analysis examines the impact of the European Union Emissions Trading Scheme (EU ETS) on the northwestern European electricity market. The second study investigates the energy and emissions implications of Maryland’s decision to join the Regional Greenhouse Gas Initiative (RGGI) by nesting a regional power sector model within a national model. In both cases, the larger firms in the electric market are modeled as Cournot oligopolists who pursue a quantity strategy while at the same time they act competitively in the C&T programs and transmission markets. We demonstrate how complementarity-based power market models can be easily modified to incorporate details of alternative policy designs.