Learning the trade

As dust begins to settle after the birth of the EU’s emissions trading scheme, the effects on the market are becoming clearer. One Dutch utility has taken steps to ensure it is ready to reap rewards from the unfolding potential.

Dr. Theo Fens and Berend Olde Rikkert, Capgemini Energy & Utilities Consulting Practice, The Netherlands

A few months into Europe’s emissions trading scheme (ETS) and the 15 EU countries committed have already managed to reduce emissions of the key six greenhouse gases to 2.9 per cent below the 1990 level.

On the surface this appears to be a good start but the latest projections suggest that measures so far implemented at a national and European level are unlikely to cut emissions levels by 2010 to more than one per cent below the 1990 ceiling – far short of the targeted eight per cent below 1990 levels by 2012.

While it is arguably too early to say whether the European ETS has been a success, it has certainly highlighted a number of weaknesses within the European energy market and is acting as a powerful force for change whose impact seems likely to go far wider than emissions management.

One of the most obvious impacts of the ETS was the rapid increase in the cost of carbon certificates. In April 2005, prices per certificate reached around €15, compared to around €7 in January and February.

Figure 1: Allocation of carbon dioxide emissions in the EU ETS area by country
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These price increases have been largely fuelled by the recent spell of cold weather across Europe which led to an increased demand for power. At the same time, an associated increase in demand for gas pushed up prices and prompted power generators across Europe to switch to spare capacity coal fired plants in a bid to meet the increased demand, while also controlling costs. This increased demand for the finite supply of carbon certificates pushed up their prices, a classic case of demand-induced inflation.

This spike in power usage caused by the cold spell would have happened with or without the European carbon trading scheme. What made this period particularly noticeable was the increased costs power generators had to bear. Through buying more carbon certificates at an inflated price in order to enable them to switch power generation to spare capacity in the form of coal fired production, the market encountered a new form of price pressure. It also exposed the lack of available peak level capacity across some European countries and highlighted the importance of security of energy supply.

Kyoto and the European emissions trading scheme are accelerating the need for security of supply issues to be addressed and new low emissions power generation plants to be developed in response. Failure to do so will see the sort of pricing and supply instability that was experienced across the EU during the recent cold spell becoming more the norm.

Stable prices

Given that the European Commission forecasts a 44 per cent increase in power consumption across Europe by 2020, if power prices are to remain stable, then a significant investment in low emissions power generation, such as nuclear and renewable energy, seems the most likely outcome if across the board increases in energy prices are to be avoided. If this capacity issue is not addressed, and we continue to rely on coal fired power generation, then the 50 per cent increase in the price of carbon certificates we have seen recently, will merely be the tip of the iceberg.

Coal fired generation will not meet existing energy requirements, let alone secure future power needs at a price acceptable to consumers, industry and politicians.

Countries that rely predominantly on coal fired power stations are finding the targets particularly tough and nuclear power is increasingly looking like the most viable long term solution to meet both the EU’s demand for power and its obligations under the Kyoto protocol. This has been exemplified not only by the installation of new nuclear capacity in Finland, but also by reopened societal discussion on the imminent decommissioning of nuclear capacity in France, Belgium and the UK. In The Netherlands a full political debate is ongoing to postpone the closure of the only Dutch nuclear power plant from 2013 to much further in the future.

So far, attempts to move to a more carbon friendly generation portfolio has resulted in notable growth in renewable generation, particularly of wind power in Spain and Denmark. The growth in other countries is more modest, but if planning applications are an indication, we should see a very substantial growth in countries such as the UK.

The introduction of the ETS and the recent increase in the cost of carbon certificates has also intensified the strain that both industry and governments are feeling in meeting the new emissions targets.

Immovable targets

The UK Government, as one notable example, has been trying to negotiate with Brussels to increase the amount of CO2 that British industry can produce from 736 million to 756 million tonnes of carbon dioxide over the next three years. The EU has so far refused to increase the UK’s limit but it illustrates the impact that emissions trading is having at a political level. The Polish government is now considering mounting its own challenge and more governments could be poised to follow. Similar discussions have been observed in The Netherlands where generators objected to their allocated emissions rights but, again, the EU refused to reduce the ceiling for emissions that it had already fixed.

Just months into the life of the ETS, the long term impact is still uncertain but analysis to date suggests that it will significantly change the way power is generated across the EU. It is fair to conclude that internalization of Kyoto costs into the electricity price will have a profound impact in making it more expensive. Given the impact of fast growing economies such as India and China, followed by Russia, and the onset of a GPEC (Gaspec, next to the Opec) energy will become a sellers market with its own price dynamics. This may cause a shift in the fuel mix as we know it today. It also makes the issue of security of supply and the importance of introducing price stability (which relies to a large extent on low emission spare power generation capacity) an urgent consideration.

Figure 2: Managing emissions under the EU ETS
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Discussions surrounding the next phase of the emissions trading scheme, due to run from 2008 to 2012, start this summer and we are likely to see governments and industry across the EU lobbying hard for more generous carbon emissions quotas. But while industry and national governments may be keen to ease the pressure on power prices and provide greater flexibility for generators and industry to deal with fluctuating supplies of gas and coal, the EU is unlikely to capitulate on its commitment to the Kyoto Protocol. The second round will almost certainly involve tougher cuts on carbon dioxide output and bring even more sectors under the umbrella of the mandatory scheme, including high CO2 producers such as the aluminium, chemicals and aviation industries and perhaps even marine transport.

In addition, the advent of NOx trading in The Netherlands may even instigate NOx trading in the EU, as air pollution awareness is gaining ground rapidly.

The numerous changes that we have seen in the first months of the European ETS are only the beginning of a process that could profoundly change the way the European power industry operates. Kyoto’s impact looks certain to extend far beyond the reduction of greenhouse gases.

The Dutch utility Essent is a prime example of how operational emissions management can counter the effects previously discussed.

With over 4.7 GW of mainly coal and gas fired generation capacity, Essent adopted an integrated approach to emission management that resulted in a company-wide implementation programme (EMIT) which has been in operation since 2003. A key element of this programme involved the design and implementation of operational processes, supported by Capgemini consultants.

Essent is a vertically integrated energy company, active in production, distribution, trade and sale and is the largest producer of renewable energy in the Netherlands. Its generation capacity includes wind farms, biomass plants, waste incineration, hydro and solar energy.

Essent decided to introduce a programme as it saw the potential of emissions trading to act as the best instrument to achieve cost effective emissions reductions. One of the utility’s key objectives was to manage and optimize compliance with the EU ETS with minimal costs and against acceptable risks.

The main objectives of this programme were:

  • To assess the financial, legal and operational consequences of the EU ETS
  • To be well prepared for and provide input to the discussions regarding national allocations
  • To comply with monitoring and reporting requirements
  • To establish an internal structure ensuring emissions and allowances are balanced.

Responsibility for the EMIT programme was placed with the Business Development unit and programme managers reported directly to division management. Staff throughout the company were involved in the programme from the start.

Trading targets

The EMIT programme focused on four major areas. Finance and risk, assessing the impact of emissions trading on financial processes / structures and risk management; registration and monitoring, complying with requirements regarding monitoring, reporting and verification of emissions; public affairs, providing input to the establishment of the National Allocation Plan, and assessing the consequences of the new regulations; and trading and business development, integrating emissions in the existing trading activities.

The approach of the EMIT programme proved effective for Essent in handling the challenges resulting from the introduction of the EU ETS. Firstly, providing input to discussion about the NAP in The Netherlands resulted in a national allocation plan which takes into account the key issues of early action and security of energy supply.

Secondly, the requirements for a monitoring protocol led to a thorough consideration of emissions data management in Essent’s generation units. As a result of this analysis, the need for a dedicated ICT solution emerged, and the EMIT programme was closely involved in the selection and implementation of integrated emission registration, monitoring and reporting software.

Figure 3: Emissions management can be modelled as a regular business process
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Thirdly, trading and risk management activities were established to trade the new asset and emissions rights. As such Essent took a central role in the preliminary emissions trading initiatives and pilot projects organized by the Dutch government.

Finally, great uncertainty about accounting principles for emission rights emerged. The allocation of knowledgeable staff during and after these discussions reduced the risk of late or wrong information.

By applying a structured and managed approach, Essent was able to manage the risks and opportunities of the EU ETS at an early stage and gain an informed insight into the impact on its operations.

As the EMIT programme highlighted the impacts of the EU ETS, Essent found that it above all, had to be flexible. Foremost, the company found that as environmental data has been monetarized and thus has to be treated accordingly, a change in mindset was essential.

Also, enhanced interdependencies between organizational units was necessary through new cross-organizational flows of goods, money and information. With regard to personnel, new roles and responsibilities were allocated in several organizational units

In order to manage and optimize emissions within the organization, an overall blueprint was necessary to describe the operational strategy of emissions management.

This blueprint aimed to develop transparent processes for emissions management and clarify who is responsible for each aspect. It was also created to provide a platform and reference for improving the quality and efficiency of emission management, while facilitating internal and external audits to ensure reliable and transparent ways of working.

In order to achieve the blueprint’s objectives and secure commitment within the organization within a limited timeframe, Capgemini worked with Essent to help design the EMIT programme.

Through interviews and workshops the main processes, such as emissions registration, trading and compliance, were identified and structured into one overall business process. Emissions management is now a core value and output, with legal compliance and financial results as the main deliverables of the emission management process.

Every sub process was defined in terms of the activities involved, the desired goal and the overall result. These processes were discussed and reviewed extensively to close any gaps and settle discrepancies that resulted from different interpretations by the staff involved.

Spreading clarity

The EMIT protocol was completed at the end of 2004. Maintenance and co-ordination tasks regarding the protocol and the main processes were assigned to individual managers and internal implementation and auditing activities have been set up, ensuring the compliance of the organization with the protocol. In parallel to the establishment of the EMIT protocol, the implementation and go-live of dedicated software took place for emissions registration, monitoring and reporting.

Awareness and understanding of the operational execution of emissions management has grown at management and operational levels and this has been enhanced by the availability of the process models on the company intranet.

The comprehensive process model is an excellent tool for performance tracking and improvement management. The model also forms the basis for further emissions management processes once stricter regulations based on ICCP or Kyoto come into force. Finally, the process model and the management principles of the protocol form the reference for internal and external audits.

After the project had been implemented it was concluded that while emissions management processes were often clear on a high level, the actual detailing and implementation formed a considerable challenge, especially in terms of managing data flows, flows of emission rights and flows of money between organizational entities. A structured and well managed approach for developing and communicating the process model has proven to be a key success factor in achieving the successful implementation of the Essent EMIT scheme.

Essent will now be able to focus more towards optimizing its position in the emission market in order to meet the challenge of delivering operational excellence in the daily practice of the EU ETS.

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