Lessons Learned Market-Based Approaches: European Union The Mansfield Pacific Retreat Abyd Karmali 27 August 2003

2 Key Messages  Governments across the European Union are increasingly experimenting with market-based mechanisms to address environmental problems  EU will shortly launch world’s first international emissions trading market for greenhouse gases  EU-based companies have been encouraging a shift from command-and-control to more market- based approaches but are only now appreciating unanticipated impacts

3 Outline of Presentation  Overview of EU Market-Based Mechanisms  Case Study: EU Emissions Trading Scheme  Lessons Learned

4 Helping clients manage the world’s natural, physical, economic resources in a sustainable way Asset Acquisition & Deployment Wholesale power market and renewables energy analysis Transmission and interconnection assessment Asset valuation Due diligence Asset & portfolio optimisation A global environment, economics, and energy consulting firm Network Analysis Regulatory strategy Network benchmarking Network valuation Value of transmission Environment and Climate Change Management Regulatory analysis Environmental strategy Value-at-stake analysis Emissions trading analysis Market mechanisms design Corporate Responsibility Other Services Transport sector analysis Energy efficiency Information management systems Economic & community development Emergency management Strategic communications

5 Overview of EU Market-Based Mechanisms

6 Agencies in EU increasingly using market mechanisms  Tradable permit systems –France: tradable development rights for land preservation –Netherlands: tradable fishery quotas  Deposit-refund systems –Austria: electric bulbs –Denmark: beverage containers and lead batteries  Environmentally motivated subsidies –Sweden: grants for bio-fuels –UK: enhanced capital allowance for energy efficient technology

7 Heterogeneous policies used across EU for green energy  Providing direct financial incentives Investment-based: subsidies on green investments, tax rebates, and incentives Output-based: feed-in tariffs or preferential rates  Setting green energy quotas Tradable: certificates for green electricity produced Not-tradable: generators bid for capacity or are set portfolio quota

8 Case Study: EU Emissions Trading Scheme

9 EU ETS relies on ‘cap-and- trade’ approach  Limits are set on allowed emissions, the corresponding allowances can be freely traded amongst participating companies, so that:  Imposes direct cap on aggregate emissions – the source of the problem  Efficiency emerges from free trading  Market-based, lowest-cost ‘price of carbon’ emerges from the trading market  Also includes “baseline and credit” mechanism

10 Overview of EU Emission Trading Scheme Government (Member states determine allocations) Absolute Target Holders (>20MW generators) Verification Reporting Approval Projects (JI, CDM) Market

11 Strong underlying rationale for an emissions trading scheme Distance to target indicators (DTI): difference between (linear) targets and trends in 1999:

12 Typical company abatement cost curves highlight benefits Q1 = total negative cost level of emissions abatement; (1) = total cost savings to company Q2 = total cost-effective level of emissions abatement and (2) – (1) = net financial cost to company Cost/Price (£/tonne CO 2 e ) Level of GHG abatement (1) (2) US$10 (market price of GHG in trading system) QNQN QCQC Tonnes CO 2 e

13 EU ETS provides significant boost to the CDM markets  The Clean Development Mechanism provides companies opportunity to generate additional revenue  First two projects recently had their methodologies approved by the CDM Executive Board –Korea HFC emissions reduction project –Brazil landfill gas management project  CDM credits can be sold into the EU ETS starting in 2008

14 Lessons Learned

15 Short-term drivers of value for EU based-companies Markets for project-based reductions Government policies Stakeholder Concerns New revenue streams Operating costs Product prices Cashflows Sales Cost of capital Key drivers Value impacts Can value impact be assessed? Can be quantified and compared against transaction costs Can be quantified and competitiveness impacts analysed Indirect, anecdotal data only

16 Impact on UK power plant asset value from choice of allocation method Reference Case Value Index (Reference Value = 100)

17 Impact of market-clearing price on a German power plant asset value

18 Summary of Lessons Learned  Market-based mechanisms provide a new driver of value for companies operating in the EU  The critical interface between governments and companies relates to the method for allocating new forms of property rights –Companies need to be meaningfully engaged in the debate  Companies are only now realising the level of analysis required to fully appreciate the implications on their competitiveness

19 For More Information Abyd Karmali Director, ICF Consulting Hamilton House Mabledon Place Bloomsbury, London WC1H 9BB United Kingdom +44.(0)