Sustainable Energy Technologies within the EU ETS Framework - The Cogen Perspective
11 February 2008

By Thomas Bouquet, Cogen Europe

The European Emissions Trading Scheme Directive, by creating an EU-wide framework for capping CO₂ emissions from stationary installations, was predicted to influence investment trends and help increase the penetration of low-emitting and renewable technologies.

As of early 2008, first-hand experience with the scheme, as well as analysts' forecasts, paint a less positive picture of the impact of the EU ETS on sustainable energy technology investment trends.

Renewable energy technologies, by falling outside the scope of the EU ETS, appeared to be the most straightforward answer for industry and power producers wishing to lower their CO₂ emissions. By displacing fossil combustion processes, installations would either fall below the 20 MW thermal input threshold (fossil fuels only) or would see their fossil-related CO₂ emissions reduced, and hence would have excess allowances to sell on the market.

However, very few renewable technologies have been able to capitalise on the incentives provided by the EU ETS.

Several reasons explain this state of affairs:

1. Many renewable technologies are ill-suited for industrial sites and processes (e.g. hydropower, wind or solar thermal)
2. Renewable energy technologies are often not competitive with their fossil alternatives and require long paybacks periods (e.g. solar photovoltaic)
3. Phase-1 EU ETS allowances prices have been too low to make most RES technologies competitive without public support.
4. Most installations received an overallocation of allowances during phase-1 of the EU ETS as a result of grandfathering and exaggerated projected growth factors.

The EU ETS has, however, had a positive impact on the penetration of biomass both in power plants and industrial installations.

Since 2005, we have seen a large number of installations upgrade their combustion equipment in order to allow for so-called co-firing of biomass and solid fossil-fuels (mainly coal).

This has been made possible for several reasons:

1. Biomass heat and biomass power are both relatively mature technologies with low operational risk
2. Biomass is a readily available and cheap fuel (although the price of biomass has increased substantially over the past few years)
3. The cost of adapting equipment to run on biomass is low
4. The impact in terms of reduced CO₂ emissions is important, making the shift to co-firing profitable despite relatively weak allowance prices.

Besides co-firing (mostly in large installations), a number of sites have also adopted biomass-only boilers that fall outside of the scope of the ETS. These biomass-only boilers, while slightly more costly than natural gas-fired boilers, are nonetheless attractive economically, especially as such investments are eligible for state aid. These biomass-only boilers are limited in size however and are often complementary to industrial natural-gas boilers.

With projected increased scarcity of allowances (i.e. under-allocation to installations) and expected increase in the price of EUAs in phases 2 and 3 (post-2012) under the EU ETS, biomass-based energy technologies are expected to continue to increase their share of the electricity and heat markets.

But while the EU ETS has proven, is proving and will continue to prove to be a strong driver for investments in biomass-based technology solution biomass resources are limited in Europe and this limited availability will eventually cap the growth potential of these technological solutions.

As an energy efficiency technique delivering unparalleled conversion efficiencies and hence CO₂ savings, cogeneration was expected to see its competitive position greatly enhanced by the introduction of the EU ETS scheme.

While phase-1 national allocation plans (NAPs) often included special provisions [1] rewarding cogeneration installations as a way to spur investments and maintain high utilisation rates for high efficiency cogeneration installations, the sheer level of over-allocation across sectors meant that such incentives had only a marginal impact on investment trend; a fact compounded by the design paradigm of the EU ETS which –by focusing on point source emissions- does not properly account for the displaced emissions by high efficiency cogeneration [2].

Besides the in-built difficulties facing cogeneration installations under the EU ETS scheme, investments have been hampered by the insufficient predictability of the scheme's impact.

The EU ETS scheme has been articulated over three distinct phases: phase-1 (2005-2007), serving as a three-year 'test' phase for the trading scheme, phase-2 (2008-2012), due to ensure EU compliance with the Union’s international commitments under the Kyoto Protocol and the post-2012 phase which had been left open-ended until recently and is now due to run from 1 January 2013 until 2020.

Industry has indicated that 3-year and 5-year time horizons are insufficient for multi-million investments in a capital intensive technology that is affected by public policies.

This fact has been compounded by the lengthy adoption of the so-called Cogeneration Directive 2004/8/EC, which resulted in a very uncertain legislative and regulatory framework for cogeneration installations across Europe and hindered investments over the course of several years.

At the time of writing, the legal framework for cogeneration installation (i.e. Directive 2004/8/EC) has been mostly clarified but entering phase-2 of the EU ETS, fewer Member States have included provisions safeguarding the preferential allocation to existing installations compared to phase-1 as a result of a European Commission-led efforts to curb over-allocation.

In the meantime, the 2013-2020 phase outlook, based on the European Commission’s proposal [COM(2006)16final] foresees full auctioning of allowances for power generation and the establishment of a Community-wide methodology for free allocation to other sectors until 2020.

High efficiency cogeneration installations will therefore benefit –on the heat side only- from similar treatment to industrial boilers. This will effectively put cogeneration installations at a disadvantage as cogeneration installations displace mid-merit fossil power plants but will have to compete on the electricity side with the entire generation portfolio of large utilities which include nuclear and renewables.

This, combined with the increased capita expenditure and operational (or site) risk will prove a strong deterrent to investment in high efficiency cogeneration installations, unless revenue recycling is adequate to overcome the financial obstacle and – most importantly - the psychological barrier that extra allowance purchases imposes on potential investors in cogeneration.

 

1. Allowed under the EU ETS as a way to reward “early action” and “clean technologies” (cf Annex of Directive 2003/87/EC).

2. A cogeneration installation, by producing both heat and electricity in one single process will typically avoid the production of electricity in a distant, centralised power plant. However, as the electricity is produced on-site, emissions at the plant level will increase, while the central power plant will see its demand reduced. Under the EU ETS, the high efficiency cogeneration installation will see its emissions increase and is likely to suffer from under-allocation while the power plant has extra allowances as a result of lower output. This fundamental flaw in the design of the ETSZ could be overcome through benchmarks for electricity and heat but only a handful of Member States have resorted to this solution in phases 1 and 2 and the Community-wide allocation methodology for phase-3 has yet to be defined.