INSIGHT: Look out for carbon trading induced costs

16 November 2007 15:59  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS news)--Chemical producers don’t like the EU’s cap and trade approach to climate control but have had to learn to live with it. Emissions trading could work, the argument goes, but the current system is flawed.

Chemicals makers are not alone. Europe’s emissions trading scheme (ETS) has been called many things, not many of them polite. It has been seen as widely open to abuse.

Of greatest concern to industrial firms has been the way in which power producers have made windfall profits on carbon dioxide allowances.

The situation defeats the ‘polluter pays’ principle, says chemicals trade group Cefic. It tilts the playing field to the disadvantage of Europe’s producers and encourages further chemical capacity growth outside the EU.

That will not change next year when the second stage of the ETS begins. It is likely to get worse.

High energy users particularly are expecting to be hit with higher prices. The European Commission (EC), keen to see better results from the ETS, has lowered the carbon caps allotted to Europe’s biggest carbon emitters.

So the region's power companies are expected to raise prices along with the expected rising cost of tradable carbon.

The scheme, under which European industries must surrender allowances equivalent to their CO2 emissions, will reach the end of phase one in December this year. Its effectiveness was dented by an over-generous provision of allowances and what some argued to be an inadequate policing of the system.

Already hit by a massive price increased over the past five years, high energy uses are fearful of more. Electricity prices in the UK this year are 220% higher than they were in 2002. Prices in Germany, France and Belgium are about 150% higher.

A large proportion of these increases are due to the pass-through of ETS costs. A study from the EU’s Competition Directorate published in April this year suggested that 29% of the electricity price in Germany, 18% in Spain, 17% in the Netherlands, 18% in the UK, 20% in Belgium and 8% in France was down to the ETS.

Cefic says that since CO2 allowances have largely been distributed free of charge, electricity producers have included the opportunity cost, rather than real costs, in their prices - leading to a transfer of wealth from consumers to producers without environmental benefit.

The entire industry is hit by higher power costs but chlor-alkali makers the most. To make one electrochemical unit (ECU), or one tonne of chlorine and 1.1 tonnes of caustic soda, they need about 3 MWh, thus magnifying any electricity cost increases.

The real worry now is that costs will rise still further from 1 January as the new phase of the ETS comes into play. From 1 January the cost of carbon, which currently is around €20/€22 per EU allowance (equivalent to one tonne of carbon dioxide), will be factored into the cost of Europe’s electricity.

High energy uses expect the playing field to be tilted further against them. Cefic’s Energy Intensive Users Group (EIUG) says that the price of carbon in 2008 is certain to be higher not only because of the new caps on allocation levels but also because of the ways in which allocations have already been made which has left some users already net short.

As it pushes up energy prices the EU’s cap and trade system also works against producers wanting to increase capacity - it is cheaper to do so outside Europe in parts of the world where no such Kyoto Protocol-driven manipulation of markets exist.

Chlor-alkali producers have had a tough 2007 and it does not look as though 2008 will be any easier. Against such a backdrop, vitally important investment decisions will not be made in Europe’s favour.

And while the high energy users suffer on the cost front, chemical producers start to fall under the cap and trade mechanism for the first time.

The major EU ethylene plants come under the cap and trade scheme from 2008 and the carbon allocations made on a national basis for the 2008/2012 period.

The EC has made across the board cuts in national allocations that will ultimately affect these producers.

One of the hottest topics of discussion in Brussels now is speculation on what carbon allocations will be made in the critical 2013-2020 period.

Many believe that the commission feels entitled to move to ensure that 20% plus cuts in emissions (compared with 1990) can be put in place then. The across the board cuts could be as high as 30%.

By that time the industry is rightly concerned as to who else globally will be subject to the ramifications of more serious carbon control.

Europe's producers will have worked under the burden of the ETS for 15 years. Which of their competitors will be subject to similar controls?

By: Nigel Davis
+44 20 8652 3214

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