Archive for July, 2012

A year ago as the EU ETS price showed clear signs of a second step change downwards (in 2008/9 from €25 to €15 then in 2011 from €15 to €7), the EU Commission was resolute in its view that the mechanism was working, that it was responding to changes in the market and that all was well in the house of emissions trading. Rightly or wrongly, that view was backed by most of the major industry and business groups as well, to the extent that even if the Commission had thought that action was necessary it had absolutely no mandate for action. 

But a year is a very long time in business and politics and this week, with the backing and support of many business groups, the EU Commission released its first concrete thinking on the state of the emissions market and began the political process necessary to attempt to address the problems.

The initial report (with the somewhat long title “Information provided on the functioning of the EU Emissions Trading System, the volumes of greenhouse gas emission allowances auctioned and freely allocated and the impact on the surplus of allowances in the period up to 2020″) spells out in pretty stark terms the scale of the allowance surplus that now weighs down the price. It also highlights the fact that it won’t be until well into the 2020s that this shows any real sign of going away through the natural development of the system and its declining cap. The report then lays out a course of action, with three proposed levels of severity examined. 

That course of action involves skewing the allowance distribution in Phase III, such that less allowances are auctioned in the early years (2013 to 2016) and more are auctioned in the later years (2017-2020) – but the total number of allowances to be released remains unchanged, which means that there is no overall change in the surplus position that is forecast for 2020. The proposal is called “backloading”. The Commission has limited power in this area and even this step has required them to propose a very minor change in the Emissions Trading Directive to clarify the role that they have in the carbon market.

 

The largest backloading proposed is (quoting the Commission working paper):

 ”a reduction by 1.2 billion in the first three years of phase 3. This would result in a large reduction in the surplus in 2013. Nevertheless the reduction in the surplus remains significantly below the increase experienced in 2011 and expected over 2012. By 2015 the surplus would be below 1 billion unused allowances compared to a case where no changes in the auction time profile were implemented. After 2015 the auctioned amounts would actually increase significantly, resulting in an issuance of allowances well above future emission levels. This would drive a re-emergence of the surplus. Total annual issuance in the period 2016 to 2019 would be higher than in any year in phase 2 bar 2012. The decrease in auctioned volumes early in phase 3 would require drawing on the existing surpluses to make available the necessary allowances to the market to comply with emissions. This type of change of the auction time profile is thus likely to give strong temporary support to prices in 2013 to 2015, but would put downward pressure on prices in the second half of phase 3.”

At best, the move buys time and gives the Commission some breathing room to gain agreement on the necessary Phase IV parameters (rate of cap decline, possible use of auction reserve pricing, sectoral coverage, free allocation levels etc.), but doesn’t inflame the whole ETS target debate by proposing a full set aside and cancellation of allowances. This latter step is what is really needed, but may be politically too big a bite to chew on given the recent animosity over the Low Carbon Roadmap to 2030 and beyond. As such the Commission has opted for something that it thinks can be done today, rather than fighting the bigger fight over targets which it will have to do anyway in the context of Phase IV. Better leave it for that discussion!!

It is important to reflect on the role of the business community in all this. None of this would have happened were it not for a shift in position from opposition to market intervention to support. This isn’t to say that all business groups support such a move, but today many do. The catalyst for support was the gradual realisation that if the ETS failed to trigger a change in the (power sector) investment profile going forward, governments would inevitably make the decisions for business by applying mandates.

Some business groups remain opposed to intervention, but these now appear to be the ones that have always opposed action to reduce CO2 emissions. While they claim to support the ETS, they strongly argue the case that the market should be left to its own devices. The real agenda is often very different. With the high levels of free allocation that have existed during Phases I and II, the businesses involved are more than happy with the status quo which requires little more than administrative compliance (it certainly doesn’t require emissions reduction through projects and investment).

The battle isn’t over yet and much remains to be done, but this week saw an important step forward and one that hopefully leads to the restoration of the ETS as the primary driver for emission reduction investments across Europe.

With the recent passage of the Energy Efficiency Directive through the key EU parliamentary committee on Industry, Research and Energy (ITRE), it is clear that the idea of managing emissions, improving energy security and increasing the competitiveness of the economy through managing energy efficiency remains a key policy objective. The Directive has only one more stage to pass: a vote in the whole plenary in September. The Directive obliges Member States to prepare a long-term strategy to increase the energy efficiency of their entire building sector by 2050 and to set up an energy efficiency obligation scheme that ensures that utilities reach 1.1 – 1.5% energy saving of their end-users. In addition, the Directive aims to stimulate technologies such as Combined Heat and Power in the utilities sector.

In fact many commentators and policymakers continue to believe that energy efficiency alone can address much of the CO2 problem – and that it can do so at very low cost (or even negative cost), at least compared to a ‘do nothing case’.  But  any successful policy toward mitigation of CO2 emissions must centre on CO2 pricing. Energy efficiency can only be a contributory factor and, in some circumstances, can even have a negative long-term impact if the centrality of CO2 pricing is not recognised.

The impact of energy efficiency policy on CO2 emissions is explored in a paper by a Shell colleague, Jonathan Sample and was recently published in The European Energy Review, but also attached here [The Limits of Energy Efficiency]. The paper looks at the issue of energy efficiency and examines some of the established beliefs about its benefits and impacts. It highlights some important missing nuances in the logic linking efficiency improvements with reductions in CO2 emissions and argues that in the absence of a credible price on CO2 emissions, the effectiveness of energy efficiency measures is greatly reduced. In fact, in some cases they may even make the problem of CO2 emissions worse in the long term.

The key to understanding the impact of energy efficiency on CO2 emissions lies in the long-term competition between the costs of using fossil fuels on the one hand, and of using non-fossil fuels (the latter of which, in this paper, includes fossil-based fuels using CCS technology) on the other. Specifically, innovations that improve the efficiency with which fossil fuel is converted into energy service, but which don’t do the same for non-fossil fuels,  make fossil fuels fundamentally more affordable compared to non-fossil fuels, even though they reduce the rate of consumption in the short term. An example of this is a policy which encourages improvements in (internal combustion) vehicle efficiency. In the paper, this is referred to as a “carbon-augmenting” policy (versus a carbon-neutral policy).

Consider the example of a driver who initially uses a 30 mpg (miles per gallon) car to drive 300 miles per week when gasoline costs $4/gallon. If at some point in the future, that same driver acquires a car that achieves 60 mpg, he can carry on driving the same distance per week even if the price of gasoline were to rise to $8/gallon (all other things being equal).

At first sight, the improvement in efficiency seems a good thing: after all, there has been an immediate improvement in the driver’s living standards, as driving is now cheaper than it was before. So how might there be a problem? The greater affordability of fossil fuels caused by such improvements in energy efficiency serves to increase the future supply of fossil fuels – again a matter that Jevons brought up. The increased efficiency of the car effectively has made it profitable to produce oil with higher extraction costs without causing the driver to drive fewer miles. In the short term, the increase in productivity, net income and wealth, which is brought about by higher efficiency, contributes an additional boost to energy affordability (this ‘income effect’ will not be considered further in this paper, however).

In the long run, then, the initial halving in the rate of consumption from replacing a 30mpg car with a 60mpg car does not represent a reduction in CO2 emissions: instead of avoided emissions, it may represent only a postponement, plus a long-term addition to the stock of economically extractable resources.

CO2 pricing (through measures such as cap-and-trade or taxation) is the key to unlocking the full potential of energy efficiency to reduce CO2 emissions. In the absence of an offsetting price on CO2 emissions, measures to encourage (specifically carbon-augmenting) energy efficiency can lead to higher ultimate/potential emissions. However, where an offsetting CO2 price is applied, this can be avoided. Importantly, where there is an increase in carbon-augmenting efficiency, it is the price placed on CO2 emissions that leads to the offsetting reduction in economically extractable fossil fuels. In other words, it is the CO2 price, which does most of the work to avoid emissions, and not the efficiency increase. Unless such a price on CO2 emissions is established, carbon-augmenting energy efficiency increases should not be viewed as an “alternative” or equivalent means of reducing CO2 emissions.

In the short term, more effective and less risky options than energy efficiency measures are available in the form of transitions such as coal-to-gas switching. The effectiveness of energy efficiency measures (particularly in their carbon-augmenting form) will be greatly constrained until a CO2 pricing system is in place. Before this comes about, it is necessary to pursue more realistic, yet cost-effective alternatives.

The current spate of very hot weather across much of the USA (and not forgetting the balmy “winter” days in many states back in the early part of the year) raises the question of the role of climate change in relation to such extremes. Of course long term changes in the climate and the occurrence of daily and weekly weather events are very different things, with the latter being the direct result of chaotic movement within the atmosphere. But weather does follow some pattern and over the longer term these patterns can be influenced by a shift in the climate.

A few months back I commented on a paper written by James Hansen which examined this issue in some detail. As illustrated in the figure below, Hansen showed that the distribution of seasonal temperature has indeed shifted, leading to an increase in anomalous events. An important change is the emergence of a category of summertime extremely hot outliers, more than three standard deviations (σ) warmer than the 1951-1980 baseline.  This hot extreme, which covered much less than 1% of Earth’s surface in the base period, now typically covers about 10% of the land area.  He concluded that extreme heat waves, such as that in Texas and Oklahoma in 2011, Moscow in 2010 and now the US heat wave (which has seen thousands of temperature records topple), were “caused” by global warming, because their likelihood was negligible prior to the recent rapid global warming.

 

Hansen produced an analysis of temperature data which showed this phenomena was indeed happening. Given the current interest in the issue from friends and colleagues in the USA I thought I would try to see what I could establish by doing my own analysis. Long term US temperature data is readily available for download, so I loaded 110  years (1902-2011) of New York Central Park temperature data into Excel and did some number crunching. I looked at the summer period only (June, July and August) and focused on the maximum daytime temperature in °F. I divided the data into two parts, pre 1950 and post 1950. The respective distribution curves are shown in the chart below. 

There is certainly a shift in the distribution curves, although it is quite small. The median temperature in the pre-1950 data is 82, whereas in the post 1950 data it is 83. But even such a small shift changes the probability of a very hot day. The chart below shows that while the probability of an 80°F day has barely shifted, the chance of a 95°F day has risen from 1.8% to 2.3%, or about a quarter. 

Even such a small shift can have a noticeable impact. A chance of 1.8% means that before 1950 there were about 2 summer days with a maximum temperature of 95°F,  but since 1950 there has been an extra day every two years. Another way of looking at this is to examine the incidence of heat waves in New York. In the chart below, I have counted the number of days where that day and the previous three days were 90°F or above. Adding a trend line to the graph shows that over 110 years the number of “heat wave” days has increased from one to over three, or alternatively a single annual four day heat wave in 1900 to at least two per year by 2010 or one lasting more than a week (and there are other combinations as well).

 

Finally, a more marked change shows up when comparing the period from 1902-1925 with the period 1990-2011. Now the chance of a 95°F day in the summer has about doubled!! The Post 1990 distribution is also starting to show the appearance of very hot days (more than 100°F), which hardly existed prior to 1925.