The UK is the first EU member state to publish its draft National Allocation Plan for emissions trading. The plan has implications for generators and energy users alike, reports Siân Green.

In January the UK government published its draft National Allocation Plan (NAP), setting out how greenhouse gas emission allowances will be allocated under the European Union’s (EU) Emissions Trading Scheme (ETS). The UK is the first EU member state to publish its NAP, and has set itself tough targets that go beyond what is required by the Kyoto Protocol.

The UK’s draft NAP indicates the number of emissions allowances which will be issued in the first phase of the EU ETS, running from 2005 to 2007, and how allowances will be allocated among the different emitting installations. Initially, the ETS will only cover emissions of carbon dioxide (CO2) – one of the main greenhouse gases.

Click here to enlarge image

In publishing its NAP, the UK government has reaffirmed its commitment to reducing CO2 emissions by 20 per cent over 1990 levels by 2010. Under the Kyoto Protocol, the UK has committed to reduce its greenhouse gas emissions (including CO2) to 12.5 per cent below 1990 levels by 2008-2012 as part of the EU burden sharing agreement.

The NAP was welcomed by environmental groups, including Friends of the Earth and WWF, which said that in laying down plans to exceed its Kyoto obligations, the UK has set the standard for other EU member states to follow. Industry groups criticized the plans, however, stating that the proposed level of CO2 emissions reductions were extreme, and would place an unnecessary burden on UK business and industry.

The initial allocation of allowances for the first phase of the ETS equate to an overall reduction in UK CO2 emissions of 16.3 per cent by 2010. However, the overall level of allowances to be allocated in phase two of the scheme, which runs from 2008-2012, will be strengthened to be consistent with achieving the target of a 20 per cent reduction by 2010.

In total, the UK government will allocate 714.5m tonnes of CO2 in phase one of the ETS. Of this, 94.3 per cent will be allocated to existing installations, while the remainder will be set aside for new entrants. Installations that close during the first phase of the scheme will give up their entitlement to future allocations of allowances, and allowances not used during the first phase of the ETS cannot be banked and used during the second phase.

The ETS covers 46 per cent of the UK’s CO2 emissions across a variety of sectors including power generation, iron and steel, pulp and paper, and oil refining. However, under the UK’s NAP, most of the emissions cuts will come from the power sector. This is because the UK government believes that there is a relatively large scope for low-cost abatement opportunities in the power generation sector, and that the sector is subject to limited international competition. Total allowances allocated to the power sector in phase one of the scheme equate to 438.7m tonnes of CO2, equivalent to 84 per cent of current sectoral emissions.

This places a large burden on the power generation sector and has possible implications for energy costs, security of supply and investment decisions. Large energy users will face increasing costs. According to the UK government, industrial electricity prices are expected to rise by six per cent as a result of the ETS, based on a CO2 price of g5-25/tonne. Electricity prices for households will rise by three per cent.

Any installation that does not possess sufficient allowances to cover its emissions will incur a financial penalty. In the first phase, this will be set at g40 per allowance (1 t of CO2); in the second phase, the penalty rises to g100/allowance. Payment of the penalty does not relieve the installation of its obligation to meet its emissions target – any shortfall is rolled over to the next year.

According to Citibank, Innogy will need to make emissions cuts of 26 per cent to meet its obligations, while Powergen will need to make a 19 per cent cut. Both companies will be able to shift production from coal to gas power plants to achieve part of these savings, but will have to buy permits and/or increase levels of non-fossil generation in order to cover the shortfall.

German utilities will also find that the ETS has a significant impact on their business. Germany has not yet published its NAP, but the fact that it derives about half of its electricity from coal fired power plants means that its utilities are among the largest emitters of CO2 in Europe. It is also planning to phase out nuclear power over the next 20 years.

According to PriceWaterhouseCoopers, RWE is Europe’s largest emitter of CO2, while E.On is ranked fourth. Analysis by Citibank has shown that RWE may have to cut emissions by 15m tonnes by 2012, equivalent to 12 per cent of its 2002 CO2 emissions. If RWE decided to maintain its production from its fossil fuel-based plant, the additional cost burden would be around g150m ($168m) based on a traded allowance price of g10/allowance.

Germany’s dependence on coal is likely to mean that it will not go beyond its Kyoto target in its NAP. The German government is reported to be keen to maintain its current fuel mix, and to safeguard the role of coal as an alternative to nuclear energy. The use of brown coal also limits the country’s dependence on imported oil and gas and therefore enhances security of supply.