As Europe prepares for the start of the emissions trading system, it is clear that success is by no means guaranteed. Poland, the largest of the new member states, is geared up to play the waiting game.
The European Union (EU)-wide emissions trading system is scheduled to begin operation on January 1, 2005. Until then, both governments and companies in the energy sector, in old and new member states of the EU, are under great pressure to prepare for the start of the system. Success is by no means certain. Many governments in Europe lag significantly behind in providing the necessary legal framework to govern the trading system. Consequently, companies have to prepare to cope with regulation that is still in flux.
The allocation of allowances by means of National Allocation Plans (NAPs) has in most countries been conducted and while many plans are still awaiting acceptance by the European Commission, they allow an estimate of whether certain countries and sectors are likely to be in a seller or buyer position on the emerging market.
Poland, by far the largest of the new EU member states, provides perhaps the best reflection concerning how the new member states’ power sectors will be in a position to sell carbon dioxide (CO2) allowances to their European colleagues.
Emissions trading in Poland
The EU emissions trading system is to be introduced to facilitate the fulfillment of the eight per cent greenhouse gas (GHG) emission reduction target. The 15 old member states of the EU have jointly committed themselves under the Kyoto protocol to the United Nations Framework Convention on Climate Change (UNFCCC). Internally, the EU differentiated its total emission reduction target of eight per cent under the so-called ‘burden sharing agreement’ among the EU’s 15 member states in 1997, when the Kyoto protocol was signed.
As is the case for all new member countries to the EU, Poland is not part of the EU burden sharing agreement. Instead, it is committed internationally to its individual Kyoto target of a six per cent reduction of GHG emissions versus 1988 as base year. Poland negotiated this reduction target in Kyoto despite the fact that the actual emissions in 1997 were about 30 per cent below the 1988 value. While many old member countries are far from fulfilling their emission target, new members are likely to meet – or exceed – their respective commitments.
Figure 1. GHG-emission development vs. commitment in old and new EU member states
Poland, with the largest economy of the new member states, is also showing the largest potential surplus among this year’s EU entrants. This warrants a closer look at certificate and emission trends. Considering current CO2 emissions and emissions projections in Poland, it is small wonder that Polish companies showed a significantly lower degree of alarm concerning the introduction of CO2 emissions trading by January 1, 2005 than their Western neighbours. For one, Polish companies expect to receive an allocation above their current level of emissions, as the country will comfortably meet its international emission reduction targets in 2008-2012, even without active climate protection measures. Second, other issues such as the ongoing sector consolidation and privatization, as well as stringent sulphur dioxide (SO2) and nitrous oxide (NOx) reduction targets, are certain to have a larger influence on the sectors’ performance in the short to mid-term than CO2 emissions trading.
In Poland, active preparations for the CO2 emissions trading scheme only started in late 2003. First draft allocations, discussed with sector representatives from early April 2004, resulted in a NAP officially accepted by the government and submitted to the Commission on August 20, 2004. Currently, a bill on emissions trading as well as a set of six to eight by-laws is in preparation by the Ministry of the Environment. These will create the necessary legal framework for the trading system and hence need to be adopted by parliament before January 1, 2005.
The official version of the NAP, still awaiting acceptance by the Commission, contains the following key characteristics:
- The overall allocation will be performed according to the projected CO2 emissions of sectors under the system in 2005-2007. These projections estimate a 2.3 per cent annual increase comparing 2001 emissions with the 2005-2007 average. Hence, Polish companies in sum will not have to reduce their emissions.
- About 1400 installations from 14 sectors are subject to the system. This excludes a large number of small installations between 20-50 MW thermal capacity e.g. in mineral product industries, which are ‘opted-out’ due to their small size and their likely difficulties to cope with the system.
- Companies are allocated ‘base-allowances’ calculated on their expected emissions development plus additional allocations for early action, CHP production and planned new investments. In the case of the power sector, however, the ‘early action’ is not allocated on an individual basis but to the sector as a whole by means of a higher base allocation.
- Additionally, a reserve of 5.5 million t of CO2 per year is planned. From this reserve, belated applicants can still receive allocations until the end of August 2006. This provision was deemed necessary to adjust e.g. for possible mistakes/oversights during the hastened allocation process and to provide allowances to Joint Implementation (JI) projects currently under development.
- A transfer of unused allowances (‘banking’) is allowed from the first trading period of 2005-2007 into the second period 2008-2012. However, this provision only refers to allowances, which are set free by means of active emission reduction investment by their owner in Poland. Emissions that have merely been bought from other companies (domestic or international) can not be banked.
It remains to be seen whether this version of the Polish NAP will gain the acceptance of the European Commission, which has repeatedly stated its concern with regard to over-generous allocations. As was spelled out in the NAP guidelines published by the Commission in January 2004, meeting the Kyoto target is not the only criteria against which the NAP will be held. Realistic emissions development assessment, as well as sufficient attention to the potential to reduce emissions, is also to be looked at.
Figure 2. Emission development and objectives of Poland
The Polish authorities will argue, however, that Poland – and in particular its capital starved energy sector – should not be forced by the EU to exceed its Kyoto commitment. This appears to be a strong case, given that Poland already bore the tremendous cost of industry restructuring and its power sector is facing high investment needs to fulfil e.g. the SO2 emission limits stipulated in the EU accession treaty.
No matter how the EC judges the current NAP, it is clear that power, CHP and heat producers represent by far the most important players in the system, accounting for 50 per cent of covered installations and about 73 per cent of emissions. Polish energy producers are thus the most important potential sources of CO2 emissions certificates on the European markets.
Potential trading position
The allocation to the Polish power and heat sector in the Polish NAP is based on two assumptions concerning emission intensity and production growth in the course of the next few years. The trading position of the sector, i.e. the question whether companies will on average be able to sell off significant amounts of emissions, depends largely on the degree to which these key assumptions hold to be realistic.
With regard to emission intensity per unit of output, the Polish NAP assumes only a very marginal improvement of 0.3 per cent for the energy sector. The NAP mentions the lack of time for significant investment as the main reason for the marginal improvement. Also, no separate allowance for Early Action was made to individual professional power plants, which might partly justify the low improvement assumption as a retribution for past efforts.
With regard to production figures, the NAP assumes significant increases of 18.5 per cent (power), nine per cent (heat) and 12.1 per cent (CHP), respectively. These estimates are based on the strong growth of industrial production which Poland is currently experiencing. Assuming these estimates will be reached, Polish power and heat sector companies would have a surplus in emissions certificates amounting to about 12.8 million t of CO2 – that is, exactly the amount allocated to them as rewards for early actions and CHP utilization. Assuming an EU CO2 certificate price in the range of g5-10/t CO2, this would translate into a surplus allocation worth g64-128 million annually.
Figure 3. The power sector dominance in Poland’s allocation of CO2 emission allowances
More significant proceeds from potential certificate sales might be possible, if either emission intensities decline more strongly than assumed or if production fails to meet the aggressive growth scenario quoted by the NAP. There are two apparently realistic alternative scenarios, which describe circumstances under which the Polish power and heat sector might generate a significantly larger supply to the EU emissions trading market.
Alternative Scenario I (conservative): With regard to emission intensities, alternative scenario I assumes a stronger decline than stated in Poland’s NAP, as companies will:
- Implement small, low cost operational changes in the combustion process/fuel preparation to reduce CO2 emissions without major investment
- Increase renewable energy usage modestly, e.g. by means of co-firing biomass in conventional boilers
- Switch to gas fired capacity e.g. in municipal and industrial CHP and heat plants.
With regard to domestic production, a lower production than given in the NAP is assumed due to:
- Non-linear continuation of current growth rates, as the production spur after EU enlargement might level out
- Continued trend of industry to increase efficiency of electricity and gas usage.
Alternative Scenario II (optimistic):
- The incentive for selling CO2 emission certificates is strong enough for companies to optimize the combustion process with regard to minimizing CO2 emissions with some smaller investment, e.g. in monitoring technology and regulation software, but without major capital investment.
- Renewable energy usage increases significantly by means of co-firing biomass and also in stand-alone biomass plants, e.g. supported by targeted national and EU support mechanisms.
- International players with a presence in Poland will invest in emission reduction technology in the short term, as they can use the Polish banking provisions to transfer banked certificates during 2008-2012 to their Western plants.
- Switching to gas fired capacity becomes a trend supported strongly by growing interest of gas suppliers in developing the Polish market.
Domestic production is assumed to increase less significantly than in Alternative Scenario due to:
- Non-linear continuation of current growth rates
- Active efforts of industry to increase efficiency of electricity and gas usage to remain competitive
- Increasing competition by foreign generated electricity.
When assuming a conservative, alternative scenario of energy sector reactions to the CO2 emissions trading system, a total of 17.2 million t of CO2 annually would be available for sale by Polish energy sector companies. Assuming an estimated price of g10/t, this translates into a market volume of g172 million.
Figure 4. Scenarios of annual unused emission allowances in 2005-2007
If assuming an only slightly optimistic scenario, the total volume for sale might amount to 28.1 million t and a sales volume of g140-g280 million, more than double the amount of trading potential explicitly included in the NAP.
Nevertheless, no ‘gold-rush mood’ to sell free certificates can be detected in the Polish energy sector. Given the current dynamic growth rates of the Polish economy, which are reaching up to six per cent, sector representatives are likely to save a significant number of emission allowances for further periods – the provisions in the Polish NAP allowing banking of unused emissions certificates if the result of domestic investment support this possibility.
Hence, while Polish companies are likely to hold on to their allowances in the early phase of trading in 2005, there remains a significant potential for later sales, when growth prospects in Poland are more clear cut and the emerging European market prices for certificates provide increased certainty and potentially the incentive to sell. By then, Polish companies will also be sufficiently aware to become active business partners. While currently only the very large operators in the sector have sufficient knowledge to assess the risks and opportunities of the market, smaller operators can be expected to catch on quickly, once the opportunities are clear.