Archive for November, 2010

Revisiting a carbon price

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This week the new Australian Government will sit down again with various society representatives to restart the discussion on emissions policy, with a particular focus on the delivery of a carbon price signal into the economy.  These meetings will take place over the next year as a number of policy ideas are considered, but given we are at the start of the process this presents an opportunity to look again at the options. Of course a carbon price is one part of a broader policy framework, which needs to cover a number of very different sectors and also respond to commercial realities such as the development and demonstration of emerging technologies. Whatever the result, the policy approach adopted needs to trigger the implementation of emission reduction projects throughout the economy, with the lowest cost result being delivered by doing the most attractive projects first and progressively moving from left to right across the abatement curve.


This isn’t the first time Australia has visited the climate policy issue, but it is clear that the subject remains high on the national agenda, not just because of the pressing nature of the underlying problem but also, somewhat ironically, because a number of countries in the region, both trade competitors and customers, are starting to move forward with new policy ideas. Although there is no immediate threat, Australia runs the risk of longer term price exposure simply because of the actions of others. Inaction is therefore not an option.

The goal of a carbon price is to create a change in the economy, whereby the market begins to differentiate between goods and services on the basis of their carbon footprint. The carbon price, initially experienced by the emitter or fuel provider (e.g. by paying a tax or purchasing allowances from the government), is passed through to the consumers of the products provided. The result is that the cost of most goods and services will rise, but a new cost ranking will emerge which in turn will change the purchasing patterns of consumers. Products with a high carbon footprint will be less competitive, either forcing their removal from the market or driving the manufacturer to invest in projects to lower the footprint. The extra costs borne by the consumer need to be offset – this would be done by the government recycling the funds its raises from the pricing mechanism back to the consumer through some other mechanism, e.g. a personal tax reduction, a decrease in sales tax / VAT / GST etc..

 In terms of the carbon price itself, there are really only four direct options:

  1. A cap-and-trade system. This is the approach now operating in the power and industrial sectors in the EU. By design it delivers a specific environmental outcome (through the overall cap) and does so at the lowest overall cost to the economy by driving participants to progressively implement projects from left to right across the abatement curve. Once mature, allowances are typically auctioned by the government into the market with the funds being recycled back to the consumers purchasing the goods and services from the sectors covered by the system. Early on, as the economy begins adjusting to the carbon pricing mechanism, the government may allocate some or all of the allowances for free.
  2. A carbon tax. This operates in much the same way as a cap-and-trade approach, although is arguably less efficient in delivering a clear environmental outcome. There is no cap. But it does establish the new capital flow through the economy and does force price differentiation on the basis of relative carbon footprints and market response.
  3. A baseline-and-credit approach. In this approach the government establishes a baseline emissions for each sector on a CO2/unit of production basis. The participants can earn credits by exceeding the baseline or have to surrender credits if they fall short. The credits are tradeable and can be banked as in the cap-and-trade approach. However, there are a number of drawbacks with such an approach;
    1. The environmental outcome in terms of absolute emissions is uncertain as it depends on the level of production.
    2. It is complex to manage as it requires accurate benchmarking across many different sectors. Because of the trade of credits, benchmarks should also represent an equivalent effort when comparing sectors.
    3. With credits only issued after a given period of emissions, forward trade becomes very limited. The resulting market lacks liquidity which in turn means poor price discovery.
  4. The approach doesn’t set up the same flow through the economy as illustrated above. One reason is that there is no immediate constraint on emissions as production increases, which can mean a weak price signal. There is also no net change in the cost of goods and services, but only a limited redistribution around a mean. It is unlikely that whole sectors will lose market share (e.g. cement against some other building product) as each sector really only competes with its own benchmark. As such, the market plays much less of a role in driving change.

  5. A project mechanism. This is operating today in many developing countries as they use the carbon price opportunity delivered through the CDM to start the process of reducing emissions through targeted projects. However, it is not a mechanism to decarbonise the economy on a large scale, with say the national government operating as the credit purchaser. It effectively reverses the capital flow shown above. The government buys from the emitters, which means it must raise taxes to extract this money from the consumer. The consumer might get some of this back through a lower cost of goods and services as efficiency should have increased as a result of the projects but it means that the market does not determine the way forward – rather the government does through its selection of projects to fund. It will also be a major exercise for the government to establish the necessary evaluation boards to assess projects etc. Finally, this approach will result in a somewhat random attack on the abatement curve, rather than the comprehensive and ordered attack that a carbon price, ideally via cap-and-trade, would deliver.

There is also the indirect approach, in other words creating an implicit carbon price within certain sectors of the economy by implementing a regulation of some kind. There is huge scope here, but each regulation will typically target a specific point on the abatement curve, rather than the more ordered left to right approach that delivers a lowest cost outcome. Examples include low carbon fuel standards, efficiency standards, renewable energy requirements, emission performance standards and so on. However, it is well suited to some sectors where a direct response to a carbon price may be limited.

A particular disadvantage of this approach is that it is often done in tandem with a direct carbon price mechanism, such as cap-and-trade, for example the renewable energy standard in the EU that operates in the same space as the emissions trading system (ETS). The two are not really compatible in that the renewables requirement results in certain projects to taking place that are further up the carbon abatement curve than would otherwise be the case with the ETS acting on its own. This results in two outcomes – it forces the carbon price to a lower level than it would normally be and it drives up the total cost of the solution for the economy as a whole.

In the wake of a deep recession and in the midst of a tough political environment, governments without comprehensive climate policy may well look to a variety of proxy approaches to deliver emission reductions across the economy. These will certainly deliver something, but matching the efficiency and order imposed by establishing a very market responsive approach will be difficult. It will also cost the economy more than is necessary, a difficult route to justify in the current global economic conditions.

Value for money in tough times?

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As the United Kingdom and many other economies contemplate the need for new power generation capacity, a range of options are clearly available. Much has been made in recent years of the potential for offshore wind in the UK and some believe that this should even be the cornerstone of the UK power industry.

There are two issues that will really drive the offshore wind industry in the coming years – cost and capacity (or potential).

The capacity issue has been widely discussed and there is little doubt about the significant potential of onshore, offshore and deep offshore wind in the UK, but also recognizing the limits due to planning approval and intermittency. The cost issue is less widely discussed and in difficult economic times this is arguably where the focus should be. With the need to meet the UK’s 2020 emissions targets as a given,  what is the most cost effective way of achieving this?

Today in the EU the price of CO2 hovers around €15, driven to some extent by the cost of gas vs. coal, but it is also the long term value of the allowances in future years of the ETS that is holding up the price today. This isn’t sufficient to bridge the cost gap for wind, but nevertheless both offshore and onshore wind projects proceed, driven by the various renewable energy targets in EU Member States, which in turn are fed by the EU wide 20% renewable energy by 2020 target. Without these targets the CO2 price would be higher in the EU as they are forcing a particular outcome which is not necessarily the next best option along the abatement curve. That also means the overall cost to society of meeting the 2020 emissions target is raised.

In the UK, an April 2009 government report showed that the levelised cost of offshore wind could be £144 / MWh. In looking at this further, the first  question is whether wind is meeting incremental demand (i.e.  you need to build new wind turbines or if not, something else like gas CCGT) or whether it is substituting existing demand (in which case you could argue that we’re paying for wind to close down gas or coal and only saving the fuel cost). It is probably incremental demand, since the UK does need new build anyway. In the case of new build in the UK, a recent analysis by the IEA puts new gas CCGT around 50 GBP / MWh and coal at 60 GBP / MWh (long run marginal cost). The IEA also give the UK’s 2007 electricity as being 0.90 t CO2 / MWh for coal and 0.38 t CO2 / MWh for gas.

Therefore, if wind is backing out new coal fired power stations, the abatement cost = (144 – 60) / 0.90 = 90 GBP / t CO2 = 140 USD / t CO2 (assuming 1 GBP = 1.5 USD). But if instead, wind is actually slowing the uptake of natural gas as the next best option along the abatement curve then the cost = (144 – 50) / 0.38 = 250 GBP / t CO2 = 370 USD / t CO2.

So at least in the short to medium term, the push for certain renewable energy sources is having an economic impact. As I illustrated in my post last week, quick uptake of natural gas is one way of meeting the 2020 targets, although on its own it is not a long term solution to managing emissions – it will have to be combined with CCS to do that.

Recently, a study by Redpoint for the Energy Networks Association Gas Futures Group, concluded;

  • There are credible and robust scenarios in which gas could play a major ongoing role in the United Kingdom energy mix while meeting both the 2050 carbon targets and the 2020 renewable energy targets. Managing CO2 emissions under these scenarios would require the successful development and roll-out of Carbon Capture and Storage (CCS) technology, supported by the deployment of biomethane injection into the gas distribution network, roll-out of district heating, and / or the usage of combined electricity and gas “dual fuel” systems for domestic heating.
  • Pathways with ongoing gas use could offer a cost-effective solution for a low-carbon transition relative to scenarios with higher levels of electrification. Our baseline assumptions indicate potential savings of almost £700bn over the 2010 to 2050 period on a Net Present Value (NPV) basis – around £20,000 per household or £10,000 per person – with consequential benefits for consumers, the economy, and the competitiveness of UK industry. Sensitivity analysis indicates that cost savings are still present under assumptions of higher commodity price trajectories and faster technology learning rates, although the difference in costs is reduced relative to the baseline.

As noted by Redpoint, these calculations of course depend on the longer term view of energy prices. If high, it makes the case for wind more compelling, particularly as the cost of new wind continues to fall as the technology matures. But basing a renewable energy strategy on the assumption of ever increasing energy prices may not be the prudent thing to do during challenging economic times.

My thanks to my colleague Martin Haigh in the Shell Energy Scenario Team for helping with this post.

Short and long term strategies

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I have been at the first Doha Carbon and Energy Forum this week, organized by Qatar Petroleum and the Qatar Foundation with support from ExxonMobil. The event focused on steps that could be taken in Qatar and the region to begin to address the issue of carbon emissions. Sessions on carbon capture and storage, energy efficiency and alternative energy each produced a set of proposals to take forward.

There is no doubt that the Gulf region is very aware of the issue of climate change and its implications, particularly the potential economic impact going forward as the world looks to alternative energy sources. In Qatar there is also a feeling of optimism because of the very substantial natural gas reserves there. But there is also a realization that a very well thought through strategic approach will be required to capitalize on the long term value of the resource in an increasingly carbon constrained world.

In the short to medium term natural gas offers a real opportunity for nations to quickly get to grips with emissions targets and begin to see reductions within the economy. This is showing up very clearly in the USA, where rapidly increasing shale-gas production, in combination with tougher emission standards in the coal sector (other than CO2 that is)  is pushing the USA towards its 17% Copenhagen Accord target even without the benefit of federal carbon emissions legislation. A quick “back of the envelope” calculation shows that if the USA replaces 120 GW of coal fired power generating capacity (about a third of the fleet) with natural gas, in combination with the tough new laws on vehicle efficiency, it can, at least on paper, meet its 2020 target. There are a few ifs and buts here of course, with the key ones being as follows;

  • The background to the coal to gas switch is discussed in a previous posting, “A Focus on the USA – Coal and Natural Gas”.
  • On-road vehicle efficiency needs to improve by about 10 mpg at constant miles driven. In 2005 average on-road vehicle efficiency remained around 20 mpg, so that means about 30 mpg by 2020. In theory this is possible given vehicle turnover and the new mileage standards.
  • Other emissions across the economy need to remain the same – e.g. emissions from industry and homes.

The early evidence is that the change is already underway in the power sector, which has seen a sharp drop in CO2 intensity over the last three years.

Such a strategy pays off handsomely in the medium term and offers natural gas the position as a transition fuel to a low carbon economy. But this is not sustainable in the longer term as emission reduction targets become much tougher. This is why the USA, for example, needs emissions legislation now, not so much for the period up to 2020 which is now largely set, but for the energy mix in the decades afterwards which will be set by decisions made in the next 5-10 years.

Similarly, for a country such as Qatar with a large natural gas resource base, carbon constraints around the world offer opportunity now, but will be challenging later on. The forum in Doha recognized this and proposed an increased focus on carbon capture and storage and the role that it could play in allowing natural gas to remain a key part of the global energy mix for much of this century – in other words to be as much a destination fuel as it is a transition fuel. The development of a Gulf region CCS Technology Platform with a focus on CCS+NG demonstration plants was tabled as a potential way forward.

So much is now written about electric car development and particularly the push in China for this mode of transport that I now have expectations of seeing something on the street, but the reality is different.

Such is the story in Shanghai, where I am attending the Annual Council Meeting of the World Business Council for Sustainable Development (WBCSD). This is a remarkable city, with a Maglev train that travels at 431 km/hour to and from the airport (sadly only at 300 km/hour in off-peak times when I happened to use it), vast (and somewhat empty) highways, a first rate underground transit system and an almost brand new financial centre, built around the third tallest building in the world. But no electric cars (that I saw).

Nevertheless, electricity is making inroads into the personal transport system. Electric motorbikes are everywhere and appear to be in the majority when compared to conventional gasoline motor bikes. A simpler and presumably cheaper version of this is the electric assisted pedal bike. These are all eerily silent vehicles, gliding along the road at modest speed. The only warning the pedestrian gets is the horn or, somewhat too late, the sound of rubber on bitumen rolling along.

An extensive report on the scale of the industry and the technology behind these vehicles has been produced by Argonne National Laboratory in the United States. Key findings of the 2009 report are as follows:

  • In 2006, 20 million E-bikes were made in China. At present, China has 50 million battery-operated bicycles on the road, of which a very small percentage operate on Li-ion batteries. The rest of them use lead acid batteries. In China, about 2,500 companies produce electric two- or three-wheeled vehicles. All of the large companies producing electric vehicles (EVs) have E-bike models that are powered by Li-ion batteries, but the performance-to-price ratio for those E-bikes is still not compatible with that for E-bikes powered by lead acid batteries.
  • There are 10,000 enterprises, both large and small, involved in the Chinese national production of electric bikes. Small and mid-sized companies accounted for 35% of total national bike production in 2007. Most of the E-bikes use lead acid batteries, yet in 2007, the entire industrial production of Li-ion batteries for electric bicycles had surpassed 100,000 ETWs. In 2007, China exported about 395,000 electric bicycles; exports to Japan, the United States, and the European Union (EU) numbered 203,300, which was 58% of production.
  • As an example, Shenzhen BAK Battery Co., Ltd. (BAK), produces 600,000 cells per day for cell phones, 150,000 cells (18650 type) per day for notebooks, and 20,000 polymer Li-ion battery cells per day for electric vehicles and electric bikes. Li-ion power batteries for E-bikes are still in the research stage; these batteries use four 2.5-A•h cells in parallel and then 11 cells in series to make a 10-A•h, 36-V battery pack. The range is 45–50 km per charge. BAK has patents for protective boards for the Li-ion battery pack. The positive material is LiFePO4.

What is visibly missing is the conventional bicycle (but there are some), once the primary mode of transport in China. I assume that as Chinese city centres have deurbanized to make way for office and industrial developments and urbanization has moved further out, the distances involved for daily transit of the population have defeated cyclists.

Meanwhile, all that is seemingly missing in Shanghai is appearing in London, of all places. With inner-London boroughs reurbanizing, bicycles are back in force, recently further supported by the city bikes provided by London Transport. Electric cars are just starting to appear and recharging infrastructure can be found in a few inner city streets and in some shopping mall carparks. I recently even rode on a trial electric bus service from Paddington Station to Bank, provided as an extension of the Heathrow Express rail service.