Chemical companies must get ready for Phase III of the EU Emission Trading System

Prepare for the ETS storm

08 January 2010 12:47  [Source: ICB]

As the third phase of the EU's Emission Trading System looms, companies need to brace themselves for the tighter regime

IN 2013, Phase III of the EU Emission Trading System (ETS) will come into force, bringing with it significant changes for the chemical industry, not least the need to buy and trade EU allowances (EUAs).


 Rex Features/Chris Eyles

Chemical companies have had a fairly easy time under the early years of the ETS, and have generally been given more EUAs than they needed. But in Phase III, most sectors of the chemical industry will face a stricter regime.

The overall European emissions cap will be cut by 11% compared with Phase II (2008-2012) and companies will no longer receive 100% of their allocations free. Nonpower companies, such as chemical firms, will have to buy 20% of their EUAs in 2013, increasing to 70% by 2020.

The only companies that will be exempt from this process are those that are subject to "carbon leakage" - the risk that strong international competition might force them to relocate from the EU to countries with less stringent greenhouse gas emission (GHG) constraints.

Colors and preparations for ceramics, the finishing of textiles and industrial gases are three sectors in which the chemical industry is involved that have already made the grade.

However, as of press time, the European Commission had not published the final list of sectors. And there are many other aspects of this legislation that remain unclear, says Mauricio Bermudez Neubauer, London-based carbon markets manager at global consultancy Accenture.

For example, legislators agreed that the directive should be looked at again after the Copenhagen climate summit to see whether revisions need to be made in the light of any international agreement to cut emissions.

"We now know that there will be no legally binding treaty and no new protocol [stemming from] Copenhagen," says Bermudez Neubauer, signaling that the industry could be in for a long wait until the final face of Phase III is set in stone.

Nonetheless, he says the overall message of the market post-2012 is one of "tightening" and advises firms to start a process of "asset optimization and risk management."

He says: "Most chemical companies will move from a long to a short position in 2012-2020. They are sitting on credits right now, but they should be looking at using them to finance emissions-reducing technology or bank them, rather than selling them."

But for the moment, companies seem to be concentrating on the uncertainties hanging over the ETS, rather than how they will manage future changes.

A spokeswoman from German chemical major BASF agrees with Bermudez Neubauer's reasoning that, should the company have a surplus of allowances left over from Phase II, "the respective certificates will probably be transferred to the third trading period.

"Under the present EU resolutions, 75-90% of our EU GHG emissions - roughly 50% of our global emissions - will be included in the trading system." This means that "BASF may be required to purchase 3m-10m certificates on an annual average from 2013-2020," she adds.

This could put a significant "three-digit million-euro sum" cost burden on the company. However, the spokeswoman warns all this is conjecture, given that "for the third trading period, the regulatory framework of the EU ETS is still uncertain in many relevant issues." Moreover, she insists that BASF will "not trade allowances as a separate business activity."

Jean Morch, director of health and the environment at French specialty chemical company Arkema, says: "If energy savings are not enough to make up the difference, Arkema will have to buy quotas on the market or by auction."

But, he cautions: "Bearing in mind its activities, the group will remain a modest buyer on this market. Our energy procurement division manages these quotas and, given the volumes involved, this is not a trading activity."

Morch also notes that "detailed rules regarding free allocations from 2013 have yet to be laid down by the authorities."

In terms of how companies will manage their EUA exposure in Phase III, "not one answer fits all - all chemical companies will not set up trading capabilities," says Bermudez Neubauer.

While there are undoubtedly uncertainties hanging over the ETS, he says all companies should already be considering emissions cuts as a key strategic issue, highlighting that post-Copenhagen, ETSs are likely to pop up around the world.


Isabel Save/London

As the world attempted to strike a new climate change deal in Copenhagen, the European carbon market - the largest mandatory cap-and-trade system in the world - seemed to be experiencing the calm before the storm.

Market analysts have predicted that EU allowances (EUAs), the main carbon credits used for compliance, would take a price tumble this past autumn.

This is because industrial manufacturers are sitting on a huge surplus of EUAs. Brussels decided to hand out most of the EUAs free at the start of the trading period, with emission caps for companies based on historic emissions. These caps were supposed to be slightly lower than if the companies had just continued business as usual.

Now, companies hit by the recession find that they actually received more EUAs than they need to cover their own emissions - and can hence offload a surplus in the market. As industrial companies usually hedge in the autumn, emissions traders had been braced for a sudden supply surge in the fourth quarter (Q4) of 2009, driving down prices.

But this has not happened. The benchmark EUA contract, expiring in December 2010, has been remarkably steady since the beginning of summer. On average, the contract has closed at €14-15/tonne of CO2 equivalent since June - in contrast to single-digit lows in Q1 2009.

What has supported prices? The main buyers have remained power producers and banks. Utilities received the fewest EUAs out of all sectors covered by the emissions trading system and many of them still have to cover shortfalls.

These shortfalls are set to grow, as power suppliers will have to buy all their required allowances at auction after 2013 - so it makes sense to buy cheaply and bank them.

In addition, most European power suppliers hedge the cost of forward power sales one to three years ahead - and these costs include carbon allowances.

Banks, for their part, have the long-term trading strategy to take up long positions on EUAs now, in anticipation of higher prices down the line, in a more carbon-restricted world.

Whether the price of EUAs remains stable going into 2010 now depends largely on the implications of the Copenhagen summit.

There will be one EU-wide cap on the number of emission allowances, instead of 27 national caps, which will decrease along a linear trend line.

A much larger share of allowances will be auctioned instead of allocated free of charge. Electricity producers will need to buy 100% of their CO2 emission permits at auction by 2020.

Harmonized rules governing free allocation will be introduced.

A number of new industries, including aluminum and ammonia producers, will be included in the ETS, as well as two further gases - nitrous oxide and perfluorocarbons.

For more on emissions trading, visit ICIS Heren

By: Philippa Jones
+44 20 8652 3214

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