Archive for September, 2010

Cancun and Beyond: Financing the Energy Future

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Pick up almost any article on climate change today and it won’t be too long before your attention is turned towards the subject of financing. There are also many conferences, seminars and workshops on financing, not to mention the UN High Level Advisory Group on Climate Change Financing. The Copenhagen Accord sets the ambition of $100 billion per annum in climate financing for developing countries by 2020.

But what exactly will be the target of such financing, what will it pay for and how might it be raised? Developed country national budgets are probably not the place to start given the deep deficits and consequent desire to enact spending cuts. Rather, the action needs to be in the carbon markets. 

The Reference Scenario in the IEA 2009 World Energy Outlook provides a useful starting point for this discussion. It shows that in non-OECD countries over the period 2010 to 2020 some 1000 GW of electricity generation will be constructed, of which 500 are coal, 200 are natural gas and the rest non-emitting (hydro, wind, solar, nuclear). Together with increasing energy use in transport, industry and buildings (direct consumption), total non-OECD emissions could rise by nearly 5 billion tonnes in the coming decade.

 

In a post shortly after Copenhagen, I showed the level of emissions actually needed in non-OECD countries to put the world on a 2 deg.C pathway, assuming developed countries were on an 80% reduction by 2050 pathway. Drawing on the data from that, it suggests that non-OECD emissions should be limited to a rise of something like 2+ GT over the period 2010 to 2020 and not the 5 GT in the IEA reference scenario. This suggests that two things have to happen;

  • Some 300 GW of the coal fired power stations planned for the next decade have to include CCS or be something else (e.g. wind, nuclear, CHP natural gas)
  • The increase in direct consumption of fuel needs to be curtailed through efficiency programmes in road transport, industry and buildings.

Arguably, much of the second bullet could be achieved through standards – for appliances, for buildings and vehicle efficiency. This doesn’t necessarily have to cost the countries in question any additional money, or at least not very much. It really requires a strong desire to tackle the issue, something that has become the norm in China today.

But changing the power generation mix or capturing the CO2 emissions will require the input of additional money. For example, while it is still early days for CCS, indications are that this is a ~$50 per tonne of CO2 technology. Any additional costs (vs. standard coal) for other generation technologies depend on a variety of factors such as the specific technology chosen, supply access (e.g. for natural gas) and even geography (e.g. for wind). Nevertheless, at $50 per tonne of CO2 much can be done (albeit recognising that carbon market policy will have to mature significantly for such levels to be reached). The proposed Copenhagen Accord financing is also quite substantial. With $30 billion committed for the period 2010-2012 rising to $100 billion per annum by 2020, it could be as much as $0.5 trillion in total (but for adaptation and mitigation – including forestry).

Switching 300 GW of coal (or capturing the emissions) as discussed above would likely account for a significant portion of this half trillion, but could reduce developing country energy emissions by as much as 1-1.5 GT per annum by 2020. Utilizing a “green bond” structure such as that currently proposed by IETA (International Emissions Trading Association) in combination with an active carbon market to take the flow of credits in the years following construction could deliver the necessary financing for such a shift. A very simple Discounted Cash Flow (DCF) shows that if each $1 billion invested realizes a reduction of 3 million tonnes of CO2 per annum at $50 per tonne over the subsequent 15 years, then the Internal rate of Return (IRR) is 12%.

But this means that the carbon markets in the late 2010s and through the 2020s must be capable of absorbing some 1-1.5 billion credits per annum from power sector projects in developing countries for this to work. Even more importantly, the existence and stability of these markets must be apparent to the investors by 2015 at the very latest and probably much sooner than that. It also means that the CDM, currently the only viable crediting mechanism available, needs to be substantially reformed, not only in scale such that it can tackle such a transformational change, but also in scope such that it recognizes a technology such as CCS and is more targeted at those parts of the abatement curve where this shift will take place.

The task above is very substantial and time is not on the side of it happening, but it almost certainly won’t happen if the negotiators in Cancun cannot begin to deliver in three key areas;

  1. Building on the carbon market architecture which underpins the Kyoto Protocol as they work towards a new international agreement. This in turn drives domestic legislation to a similar solution set.
  2. Reforming the CDM in both scale and scope, including access to technologies such as CCS.
  3. Recognising that private financing through carbon markets and supporting finance structures have the potential to transform the energy infrastructure that will be built in the coming decades.

But it isn’t just up to those in Cancun to get this going, much also has to happen on many domestic fronts in terms of carbon market development.

The other side of energy efficiency

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This week I attended the UK launch of the Roadmap to 2050, an initiative of the European Climate Foundation that charts a series of ambitious low emission pathways for the EU to follow over the next 40 years. I discussed the Roadmap in a previous posting. Like nearly all similar “roadmap” analyses, the Roadmap to 2050 calls for a step change in energy efficiency as one of the major component parts of its plan for Europe. They are right, it almost certainly has to happen, not just in the EU but globally. However, there are two sides to the energy efficiency debate and we tend to only talk about the one which results in lower energy demand as part of an emissions reduction strategy. The other side is quite the opposite.

It even has a name, the Jevons paradox, sometimes called the Jevons effect. Wikipedia will tell you that it is the proposition that technological progress that increases the efficiency with which a resource is used tends to increase (rather than decrease) the rate of consumption of that resource. In 1865, the English economist William Stanley Jevons observed that technological improvements that increased the efficiency of coal use led to the increased consumption of coal in a wide range of industries. He argued that, contrary to common intuition, technological improvements could not be relied upon to reduce fuel consumption.

The evidence supporting this effect is limited, in large part because of the difficulty in separating the direct and indirect effects of improving energy efficiency. For example, does an improvement in vehicle efficiency mean that the lower running costs result in more miles driven or does the money saved get put towards a more expensive holiday, perhaps including long distance air travel. Or does it simply result in a drop in energy demand within the economy which drives down prices (and in turn supports even more demand somewhere else).

There is plenty of anecdotal evidence. In my own case it relates to air conditioning and heating in Australia. I recall as a teenager when family friends bought a house that included a central air conditioning system – something largely unheard of in Australia in the 1970s. Owning it was one thing, but running it was another. They hardly ever did because of the high electricity bills. Today, air conditioning is quite common in Australia and the units are much more efficient. As such, the cost of running it isn’t such a big deal. The same is true of air conditioning in cars – once a luxury item in large cars with big power trains, it is now standard on almost every model and as such consumes fuel in all those vehicles.

There is also quite some academic discussion on the issue, but again the picture is mixed. A good summary paper on the issue is Jevons’ Paradox revisited: The evidence for backfire from improved energy efficiency. (2009) Sorrell, S. Some interesting data is presented (Fouquet and Pearson, 2006) which shows how the huge improvements in the lighting efficiency and the cost of lighting have driven demand ever higher, which of course raises the issue as to what happens as very efficient LED lighting becomes widely available.

But the author reaches the conclusion that “The case for Jevons’ Paradox is not based upon empirical estimates of rebound effects. Instead, it relies largely upon theoretical arguments, backed up by empirical evidence that is both suggestive and indirect. Disputes over the Paradox, therefore, hinge in part on competing theoretical assumptions. While historical experience demonstrates that substantial improvements in energy efficiency have occurred alongside increases in economic output, total factor productivity and overall energy consumption, this does not provide sufficient evidence for Jevons’ Paradox since the causal links between these trends remains unclear.”

However, this is quickly followed with some sound advice – “While rebound effects are difficult to study, they are not necessarily any more difficult than well-researched issues such as price-induced technical change. Their continued neglect may result as much from their uncomfortable implications as from a lack of methodological tools. Too much is at stake for this to continue.”

Perhaps the answer here is to simply accept the potential of the Jevons Paradox and recognize that it will play out globally as energy use expands with development and technological innovation. But we should also recognize that without the technological progress that creates the effect, billions of people globally may not see the rapid increase in their standard of living that they strive for, particularly in developing countries.

At the same time, it means that the focus on emission reduction / emission free energy technologies such as carbon capture and storage, wind, solar and biomass must be significantly stepped up not only to help meet growing energy needs but to do it while sharply reducing emissions.

Looking towards Cancun

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The unusual end-point to the Copenhagen climate conference last December and the rounds of UNFCCC negotiations that have followed in 2010 could lead even the most optimistic observer to the view that the international climate process is struggling. There is a growing consensus that Cancun is now a stepping stone to a potential agreement at COP 17 in South Africa in 2011 or perhaps at the Rio+20 Summit in 2012. But this feels increasingly like the state of play following the Bali Roadmap and the many meetings throughout 2008 and 2009 for the much anticipated agreement in Copenhagen. Perhaps in two years time we will all be looking towards COP 19 (2013) and COP 20 (2014) with the hope of the agreement coming then – although third time lucky is hardly a basis for solving a tough issue like climate change.

As noted in my posting in January, the national pledges made in Copenhagen, while representing a solid start, also demonstrate that reducing emissions globally to a level compatible with 2 degrees C is very challenging.

The current process is also somewhat arcane, focusing on issues such as technology transfer, climate funds, common but differentiated responsibilities and methodology templates and much less on the actual job at hand which is how best to reduce emissions. Is it time therefore to refocus the tremendous energy and persistence of the negotiators into a more pragmatic approach which might actually deliver a mitigation pathway to follow?

Changing tacks now could be very disruptive, but it is at least worth considering how else this particular problem might be addressed. One route forward would be to disassemble the issue into several component parts (remember the wedges), each of which could then be progressed, rather than seeking the all encompassing solution. Within each of the components, smaller agreements and clear milestones would define progress. Of course some chunky issues would remain, notably the financial one, but with a clearer plan of action these may become much easier to resolve.

Looking at the issue of emissions mitigation (adaptation remains another chunky part), there are really only five key components. They are (in no particular order):

  • Using energy more efficiently such that we consume less;
  • Using lower or zero carbon forms of energy;
  • Capturing and geologically storing CO2 emissions;
  • Managing the emissions of gases such as methane, HFCs and SF6;
  • Managing the carbon emissions impact of land use.

Breaking the problem up in this way also leads to potential solution sets and policy instruments.

One doesn’t have to look far to find a government grappling with the concept of energy efficiency, in fact pretty much every government on the planet has embraced the idea. Coordination of objectives, standardization and some application of targets could be a powerful enabler to accelerate action in this area. For example, it might well be much simpler for the United States and China to agree on a common approach to lighting and the switchover of technologies (e.g. incandescent to LED) than an acceptable set of targets for emission reduction in their economies. With a timetable agreed, other markets would doubtless follow and issues such as financing and technology transfer would become much more tangible. Say for example a smaller developing country agrees to adopt the same lighting timeline as China but wants to do a certain amount of the manufacturing locally. With a national timetable in place therefore underpinning demand, a major lighting technology provider would see a powerful incentive to build a facility in that country (technology transfer), even more so if an international loan guarantee or grant was on offer (financing).

Looking further down the list, the emissions of other greenhouse gases could be tackled more in the style of the Montreal Protocol. Certainly for HFCs, SF6 and similar gases a timetable approach is practical. This is more problematic for methane and N2O, particularly given the link with land use and agriculture, but at least in industrial instances a defined pathway could be set out. This has happened already to address the pre-1990s practice of venting methane at crude oil production facilities and similar changes have taken place in the chemicals industry to sharply reduce emissions of gases such as N2O.

Land use is increasingly being addressed as a separate issue anyway, simply look at the REDD+ discussions to see that taking place. Issues such as agricultural methane emissions could be included within this category.

That then leaves energy substitution and the application of carbon capture and storage as areas to be tackled. These can both be very effectively driven by a price of carbon, typically delivered directly through a cap and trade approach (notably in the power generation and large industrial sectors) or indirectly via a project mechanism linked to a cap and trade system. Focusing the project mechanism on substitution and CCS also makes it a much more effective instrument and largely addresses issues such as arbitrage (delivering credits into the market at vastly lower cost than the prevailing market price) and competitiveness (improving a competitors energy efficiency by paying it to do so) that hinder the existing structure of the CDM.

A word about CCS as well – some might argue that this is “just another technology” and therefore shouldn’t have any special mention. After all, why not mention wind or nuclear in the same section. The difference is that CCS is the only technology available to remove CO2 (carbon) from the atmosphere on a large scale in a short time and put it back where it was found. If you think about it, this is really what the whole climate change issue boils down to. Have a read of Jim Hansen’s latest book and you will see why – it is very likely that we have, collectively, already emitted too much. CCS can be applied directly at a coal fired power station to remove emissions before they occur or perhaps in a biomass power station which then gives an indirect draw down of emissions already in the atmosphere. Although not feasible today, CCS may eventually even be employed in the direct removal of CO2 from the atmosphere, but the thermodynamics of such a process don’t look very good at the moment.

Even if tools such as cap-and-trade aren’t in vogue, governments could still agree on measures that incentivize low carbon energy and trigger investment in CCS (e.g. an emissions performance standard).

All of this isn’t to imply that somehow the international discussion becomes easy, but it does at least offer the opportunity for segmented progress. A meeting such as Cancun may have little chance of a comprehensive global agreement, but there would doubtless be a great feeling of satisfaction and real progress if the negotiators left with, say, an international agreement on lighting and SF6 emissions in place and a pledge by three or four major economies to each sequester at least 50 million tonnes of CO2 by 2020.

The (not so) green energy race

Pick up almost any mainstream media publication today and there will doubtless be a story about the “green race”, the rapid growth of investment in renewable energy, sustainable transport and energy efficiency. It is certainly true that these areas have seen a stunning upswing in recent years, often backed by government mandates, fiscal support mechanisms and in some places a carbon price, but there is also another reality in play

Overall energy use continues to increase and the growth of fossil energy use continues to exceed that of non-fossil energy. One of the difficulties in assessing all this is that figures from the likes of the International Energy Agency (IEA) and other such bodies typically lag by two years, but nevertheless the data shows some interesting trends (all figures in EJ/annum).

 

The big question will be the shape of these trends post-recession and post $140 per barrel oil. While overall levels of energy growth continue to favour fossil energy, 2008 saw a noticeable growth drop in that sector and an upswing in the non-fossil sector. Both are likely to be a response to the high fossil energy prices in 2007 and 2008, the recession led demand drop for energy and the increasing support for renewable energy by governments. 

The same charts for electricity production show a very sharp response to the high fossil fuel prices in 2008 with year-on-year growth trends flipping. This broke a strong uptrend in the growth of fossil electricity generation.

 

As an aside, in Shell’s own Blueprints scenario which portrays a world dealing with climate change through the widespread use of economic instruments such as a carbon price, it is not until the early 2020’s that the absolute pace of growth (i.e. in EJ per annum not percent) in the non-fossil sector passes that in the fossil sector.

My thanks to my colleague Martin Haigh for supplying the figures for this post.