Lithuanian perspectives on EU GHG emission trading scheme in 2005-2007 Dalia Streimikiene Lithuanian energy institute Workshop “Understanding the Pilot Phase of EU ETS in EU 12 Member States,

Prague, June 6, 2008

Content • • • • • • •

History and development Allocation of allowances Development of EUA market Emissions and abatement Impact of GHG emission trading scheme Linkage (JI and CDM) Conclusions

• History and developments

History The Minister of Environment approved the National Allocation Plan for Greenhouse Gas Emission Allowances for 2005-2007 on 27 December 2004, according to which: 36.796 thousands allowances given to Lithuania were allocated in the following way: 34.404 thousands allowances were allocated to installations; 1.840 thousands – to the planned reserve for new installations; 552 thousands – for sale in the auction.

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Lithuanian GHG emissions GHG emissions, Mt

Projections of GHG emissions, Mt

Kytoto target, Mt

40

30

20

10

0

Current situation • GHG emission trends in Lithuania shows that GHG emissions have reduced significantly since 1990 and there are no problems with implementation of Kyoto targets. This is related with operation of Ignalina NPP which was the main power generation source in Lithuania. • The biggest fossil fuel based PP in Lithuania Lithuanian power plant was used mainly as reserve since 1993 then the fossil fuel prices were sharply increased. • In 2004 first unit of Ignalina NPP was closed however because of high fossil fuel prices Lithuanian power plant was operating also on low capacity and electricity import has increased though before Lithuania was net electricity exporter. • In 2010 the second unit of Ignalina NPP will be closed and because of the low electricity import capability fossil fuel based power plants including Lithuanian power plant will start to operate at full capacity. Expected increase of GHG emissions makes about 7 Mt in 2010 compared with 2009.

Implications for the future • Lithuania and other new MS (Poland, Czech Republic, Estonia, Hungary Latvia, Slovakia) have announced legal challenges against the EC due to reduced allocations. The requested amount was reduced by 47% for Lithuania. • Lithuanian NAP 2 was adopted by EC with these changes: the annual allocation of 8.8 Mt was approved instead of 16.7 Mt asked by Lithuania. The total quantity was reduced by 7.7 Mt per year and these quantities are subtracted from amount allocated in Ignalina NPP reserve. Ex-post adjustment was eliminated and more information on new entrants was requested. • Lithuania together with other Baltic States could face energy shortages if strict caps on GHG emissions will be imposed after 2012. As Baltic States heavily reliant on fossil fuels, the too tight a cap on GHG emissions could mean lowered electricity generation and Baltic countries have little opportunity to import electricity from other countries, due to a lack of transmission lines. • The planned closure of the INPP in Lithuania in 2010, which supplies 80 per cent of that country's electricity, means that the country also faces rising emissions from fossil-fuelled power plants.

Reduction by EC compared to verified emissions and NAPs 2 submitted MS ordered according to absolute reduction demanded by EC

Absolute reduction demanded by EC in NAPs 2008-2012 compared to NAPs submitted by MS, Mt

Absolute difference between 2005 verified emissions (including opt out and expansion of scope) and EC decision on cap 2008-2012, Mt

% reduction demanded by EC in NAPs 2008-2012 compared to NAPs submitted by MS

% difference between 2005 verified emissions (including opt out and expansion of scope) and EC decision on cap 2008-2012

POLAND

-76.10

-0.90

-26.74%

-0.43%

GERMANY

-28.90

-32.07

-6.00%

-6.61%

ESTONIA

-11.66

-0.21

-47.83%

-1.62%

LITHUANIA -7.80

2.14

-46.99%

32.11%

GREECE

-6.40

-2.22

-8.48%

-3.11%

LATVIA

-4.47

0.45

-57.52%

15.61%

SWEEDEN

-2.40

1.20

-9.52%

5.53%

FINLAND

-2.00

4.10

-5.05%

12.24%

• Allocation of allowances

NAP 2005-2007 • The NAP for 2005-2007 sets the total amount allowances for Lithuania – 36.796 MtCO2 eq. • 53 enterprises with 102 installations; • Allowances were distributed free of charge in the following parts: 40% in 2005, 30% in 2006 and 30% in 2007. • For energy enterprises 7 .217 MtCO2eq were allocated based on benchmarking; • The allowances for other industrial installations were based on historical GHG emissions in 1998 – 2002. • For new installations in energy sector 2500 t of allowances were allocated for 1 MW installed electricity capacity and 600 t of GHG emission allowances for 1 MW of installed thermal capacity.

Benchmarking •

1. 2. 3. 4. 5. 6.

The quantity of allowances issued to electric and thermal power generating installations, the main task of which is to supply power to the power and thermal grid and/or sell were calculated by multiplying the amount of energy planned to supply from comparative pollution unit per one unit of energy. The comparative pollution benchmark depends on the type of enterprise: The electric power planned to supply from condensed power stations: 0.576 t/MWh The electric power planned to supply from co-generation power stations with no possibility to burn natural gases: 0.779 t/MWh The electric power planned to supply from other existing co-generation power stations: 0.421 t/MWh The heat planned to supply when there are no possibilities to burn natural gases: 0.2885 t/MWh The heat planned to supply when there are possibilities to burn natural gases: 0.250 t/MWh.

Allocation in NAP 2005-2007, Mt Type of installation

Distributed

Distributed at no cost to energy enterprises Distributed at no cost to cement and lime producers Distributed at no cost to glass, brick and ceramic product manufacturers Distributed at no cost to oil processing companies Distributed at no cost to other industrial enterprises using fuel in order to generate energy for their own needs and also to paper factories Reserve for new entrants Distributed by an auction Total

21.711 3.770 0.570 6.623 1.730

1.840 0.552 36.796

Results of GHG trading in 2005-2007 Emissions in 2003, Mt

7.3

Allowed cap 2005-2007, Mt/year

12.3

Verified emissions in 2005, Mt

6.6

Verified emissions in 2006, Mt

6.5

Verified emissions in 2007, Mt

6.0

Difference between annual average 2005-2007 allocation and 2005 verified emissions, Mt/% Difference between annual average 2005-2007 allocation and 2006 verified emissions, Mt /%

5.7 /46.3%

Difference between annual average 2005-2007 allocation and 2007 verified emissions, Mt /%

6.2/51%

5.8/47%

Difference between 2005-2007 allocation and verified 2005-2007 17.7/48% emissions, Mt /% Proposed cap 2008-2012, Mt/year

16.6

Allowed cap 2008-2012, Mt/year

8.8

The main results of GHG trading in Lithuania 2005-2007 • • • •

Allocated allowances: 36.796 MtCO2 eq; Average annual allocations: 12.265 MtCO2 eq; Verified emissions: 19.119 MtCO2 eq; Average annual verified emissions: 6.373 MtCO2 eq; • Total overallocation: 17 677 MtCO2 eq or 5.9 MtCO2 eq;

Overallocation in EU in 2005

Results of verifications of 2005 • Companies in the UK, Spain, Italy, Ireland and Austria emitted more than their cap with a total deficit of 47.4 Mt. Other countries had allocated more emission rights than actually used, 112.6 Mt in total, providing a net long position of 65.2 Mt for EU-21. • Large countries like Germany and France were considerably long, 21 Mt and 19 Mt, respectively, being 4.3 % and 12.7 % below their caps. UK, on the other hand were 27 Mt short, corresponding to emissions being 12.6 % above the cap. • Across the EU, companies in the power & heat sector emitted 36 Mt CO2 above their allowances. The main circumstances influencing emissions in this sector were abnormal dry and cold conditions in Spain and Italy, above normal precipitation in Scandinavia and record-high gas and EUA prices. • Moreover, all industry sectors had surpluses, adding up to a net aggregate long position of 102 Mt for ‘non-power & heat’ sectors. • The surplus is probably due to a combination of two factors; i) generous allocation and ii) internal abatement and efficiency improvements. The first is by far the most important. Evidence suggests that especially smaller industrials appear to have received generous allowances. For installations emitting less than 100 kt CO2 in 2005, the average surplus is 26 per cent of the cap.

• Development of EAU market

The main EUA price drivers • The EUA price is set by supply and demand. The supply is determined by the allowances and carbon credits available to the market (EUAs, CERs and ERUs). • Demand is set by the amount of emissions through the year in relation to the overall allocation. • The demand is influenced by a weather (as temperature determines power/heat demand and precipitation the potential for hydropower production) and fuel prices (as the relative price differential between coal and gas will determine which of the fuels that will be used for power production). • Relatively cheaper coal compared to gas will increase GHG emissions as more power production will be based on coal which emits more GHGs per unit of output than gas. Higher CO2 emissions will increase the carbon price. • The correlation between the EUA price and the combined effect from fuel and weather was 0.41 over the year 2006 as a whole, while in 2005 it was 0.92. The correlation between the price and weather and fuel for the entire year is relatively low due to the price crash in April/May, which obviously was not due to dramatically changes in fuel prices or weather, but rather the political publication of verified emission data.

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Price of CO 2 allow ance, EU R/t

EUA price development

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EUA market in Lithuania 2005-2007 • In 2005-2006 Lithuanian enterprises did not use 10 Mt allowances, 9.692 Mt allowances out of which were transferred, and acquired additionally from other EU countries 575.0 thousands allowances. • During 2005-2006 a price of one allowance ranged from LTL 3 to LTL 103, and Lithuanian enterprises which sold 9.692 thousands allowances could have received income from LTL 29 to LTL 998 million. • During the preliminary study it was detected that it is not established as to which purpose the income of enterprises received for the sold allowances was used

EUA market in Lithuania 2005-2007 con’t • The only one EUA auction was held by LAAIF in Lithuania on 10th of September 2007. All amount of EUA (552,000 t) allowances was sold of the 10th of September market price. • A total volume of 552,000 EUAs was transacted at price of 0.06 EUR/per tonne, the total amount offered was sold for a total of 33,120 EUR.

• Emission and abatement

Results of State Control Review • State control collected information from 9 state and municipal enterprises participating in GHG emission trading seeking to identify how do they use sold emission allowances. Information of private enterprises was confidential; • Up to the end of 2007 8 enterprises (having 40% of total EUA or 14.7 Mt) sold 5,014 mln.(30%) EUA and received 118 mln. Lt income. • These enterprise used 12,3% of income for emission abatement and 72% were not used. • Total revenues not used for emission abatement would make 200 mln Lt in Lithuania. There is risk according State Control that these revenues will not be used for pollution reduction;

The main reasons of overallocation • Lithuanian power plant which received 7.394 Mt in total or 2.6 Mt/year allowances in 2005 it sold 1.300 Mt and received 44,835 mln. Lt profit and from the main activity received – 4,136 mln. Lt profit. Surrendered allowances -1,353 Mt. • This situation is caused by the fact that the closure of the first unit at Ignalina NPP in 2005 had no significant impact on GHG emission increase as was predicted in NAP because second unit at Ignalina NPPP was operating very efficiently in 2005 and the time spent for regular maintenance was very short. • Another factor was the increase in natural gas prices stipulated the increase of energy production costs and therefore the increase of electricity demand was covered not by increased energy production in Lithuanian power plants but by electricity import from Russia and Estonia.

Energy generation and GHG emissions • Electricity generation reduced from 19,3 TWh in 2004 to 14,8 TWh in 2005 and 12.5 TWh in 2006 or by 23% and 35% from 2004; • GHG emissions in electricity sector have increased from 3,85 Mt in 2004 to 3,96 Mt in 2005 and reduced to 3,8 Mt in 2006 and based on preliminary data to 3,7 Mt in 2007. • These trends indicates that carbon intensity of electricity generation was increasing from 0.199 t/TWh to 0,3 t/TWh in 2006 therefore the impact of GHG emission trading on GHG emission reduction in electricity sector was not significant.

New laws under preparation • Analysis performed indicated that in 2005 in Lithuania just 3 installations from total 93 installations included in GHG emission trading scheme emitted into atmosphere more than emission allowances they have been allocated for. • Such situation created the opinion between Lithuanian enterprises that GHG emission trading scheme is the form of EU subsidy to Lithuanian enterprises instead of obligation to reduce GHG emissions. • Lithuanian parliament is considering this year the Law on Climate Change where requirement for installations participating in GHG emission trading are set to use some percent of received income from sold allowances for emission reduction

• Impact of GHG emission trading

Impact on competitiveness of power sector • Increases or reductions in costs can be used as a measure of competitiveness. Therefore increasing costs result in falling productivity. An alternative measure is the change in output or GDP. These are an indicators of competitiveness or economic performance of companies, sectors or entire economies. • The second effect of energy intensity is related to the costs affects of non-ETS participants and is based on the fact that the system could induce higher electricity prices given opportunity cost reasoning of utilities. This refers to a special case of the general effect that for certain sectors or firms input prices may rise due to the introduction of an ETS. Such a rise of input prices is supposed to be especially relevant for electricity in the EU ETS case. • The more effectively prices can be passed on, the less companies or sectors will suffer from losses of sales due to an ETS. Determining factors in this context are the price elasticity of demand and the competitive situation. The less elasticity and competition the less impact the ETS will have on sales and output.

Porter hypothesis • The view that environmental regulation like an GHG trading scheme is merely a source of costs and thus entails competitive disadvantages for the affected firms is controversial. • The key argument against this is based on what is referred to as the 'Porter hypothesis'. • This hypothesis postulates that, in the long run, the objectives of environmental protection and commercial competitiveness are congruent with each other. • Specifically, Porter argues that a pioneering environmental policy role can create technological first mover advantages and make companies more innovative, placing them at an advantage vis-à-vis their foreign competitors. • The empirical evidence for the Porter hypothesis is mixed. Most studies tend at least to demonstrate that stricter environmental regulations do not result in a significant deterioration in competitiveness.

Models used for competitiveness analysis • A partial equilibrium models of the energy market PRIMES, POLES, GETS 3, SIMAC s and general equilibrium models DART, GTAP-E, GTAP-ECAT were used to evaluate the impact of GHG emission trading on competitiveness of economy and other sectors; • The results indicated that GHG trading provides for least productivity decline and efficiency gains comparing with other GHG mitigation tools in EU. Average cost reduction is 25% by POLES and up to 50% by PRIMES. • The loss of productivity because of GHG emission trading according GTAP is 0.36 per cent or If all the sectors are studied in aggregate, the reduction in output of 0.3 per cent is indicated by DART.

• Linkage (CDM and JI)

Implications of Kyoto mechanisms • The maximum percentage of CERs/ERUs that can be used in the trading period 2008-2012 stands at 13.6% of the amount of allowances to be allocated. • Total reserve for JI in Lithuania for 2008-2012 1 321 310 ERU; • With an oversupply of CERs and ERUs the marginal EU allowance (EUA) price will come down to the marginal CER price. CER prices after 2012 are expected to trade at 15 EUR/tonne or lower. This low EUA price will prevent most of the emission reduction from place in the EU ETS.

Main legal documents for JI • The Order “On the Approval of the Inter-institutional Allocation of Functions Relating to the Joint Implementation Mechanism for the Implementation of the UN FCCC Kyoto Protocol, Strategic Directions for the Implementation of this Mechanism and Recommendations for the Realization of Joint Implementation Projects” of the Ministry of Environment and Ministry of Economy of the Republic of Lithuania approved on 19 May 2004 establishes priority areas for JI: • Introduction of technologies based on production of electricity and heat (cogeneration) from renewable energy sources (wind and geothermal energy, solar energy, biomass, hydro-power, etc.); • Replacing one type of fuel (in energy or heating sector) with renewable and/or less pollutant fuels; • Increasing energy efficiency, including energy saving methods; • Production of energy from methane that is generated in agriculture and other sectors of economy and from gas obtained during oil production; • Planting of forests and other activities related to the development and protection of greenhouse absorbents and accumulators; 33 • Reducing pollutant emissions from transport vehicles in major cities

The Rules of carrying out JI projects • Approved by Order of Minister of Environment on 1 April 2005; • Track 1 procedures; • National institution –LEIF • Independent Entity- JI Supervisory committee (JISC) on 15 November r 2006 m started accreditation process of . Verifying institutions for JI: http://ji.unfccc.int/AIEs/ApplicAccr.html. • Handbook on procedures for Joint Implementation in the Baltic Sea Region should be used; 34

Approved JI projects in Lithuania • Lapes landfill gas utilisation for energy generation project, Project suplier- JSC “Ekoresursai” – project document approved on 14.12.2006; • Rudaiciai wind mill park, Project supplier JSC “Veju spektras”, Buyer of ERUS – Latvian company “E-kvotas”, approved on 18.07.2006 • Benaiciai wind mill park, Project suplier “ – JSC “Achema”, approved 19.09.2006 • JSC Achema N2O reduction project in UKL-7 installations, Project supplier – JSC “Achema”, approved on 08.01.2007 • JSC Achema N2O reduction in GP installations, Project suplier – JSC “Achema”, approved on 08.01.2007 • Reprocessing of raps for biofuels production, Project supplier – “JSC “Mestilla”, approved on 29.03.2007 • Sudenai and Landimai wind mill parks, Project supplier – JSC 35 “Vejo elektra”, approved on 21.02.2007

JI reserve 2008-2012: 1 321 310 ERU Project name Minoil flare gas project Lapes landfill gas utilization for energy generation Rūdaičių wind power stations park Benaičių wind power stations park Sud÷nų ir Lendimų wind power stations park Mockių wind power stations park Čiūtelių wind power stations park Kreiv÷nų wind power stations park Bioethanol production and biogas resort for energy production Kiauleikių, Kvecių and Liepyn÷s wind power stations park Lebartai wind Power stations park Total: Left:

Emission reduction (tCO2) 18.929 25.840 232.265 148.550 110.940 67.703 235.851 127.244 45.920 93.900 193.434 1.300.576 20.734

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Conclusions • Different approaches were used that are available in order to assess the impacts of the EU ETS on costs and competitiveness in Europe. • Analysis of existing simulation studies didn’t show the negative impact of GHG emissions trading on competitiveness of EU member states economies and power and other energy intensive sectors. • The choice of the reference scenario as the most critical issue for an appropriate analysis of the relevant approaches. However the effects of the scheme on costs and competitiveness are modest.

Conclusions • In 2008-2012 because of restrictions imposed in new NAPs and the fast economic growth in new MS the price of EAU may reach 30 EUR/t. • This will have impact on increased investments in use of renewable energy sources especially of biomass in energy sector and in increase of energy efficiency and also increase of energy prices to consumers. One of the possibilities to reduce burden on economy and to reduce EAU and energy price increase is application of Flexible Kyoto mechanism which are cheaper options to acquire greenhouse gas emission credits and to cover increased greenhouse gas emissions in the country. • Lithuania increased its JI reserve from just under 1 million EU allowances to 1.32 million allowances following a decision by the EC to cut the number of allowances it could allocate its industry in the second phase of the European scheme. • There are 11 JI projects proposed and 7 of them approved. The projects are expected to generate 1 300 576 carbon credits, leaving 20734 in the reserve.

Conclusions • The EU ETS has not yet delivered its real potential to reduce emissions in a cost effective way. The trading period 2005-2007 has seen an over-allocation with the EUA price collapsing as a result. • For the period 2008-2012 a more stringent cap has been set but the generous access to credits from JI and CDM will again limit the emission reductions taking place within the EU. Surveys find €17/t for EUA price in 2008-2012 and €23/t in 2020. • National based cap setting and allocation rules have lead to a non transparent, fragmented and inefficient implementation of the EU ETS. To maintain support for it in Europe, improvements in the EU ETS are of paramount importance. • The data from several MS (Estonia, Latvia, Lithuania and Poland) suggest that the JI reserves have simply been added to the overall allocation. Since an equivalent number of EUAs has not been subtracted from the ET-budget, double-counting has not been avoided and thus leads to inflated ET-budgets in these countries

Conclusions • In Lithuania just 3 installations from total 93 installations included in GHG emission trading scheme emitted into atmosphere more than emission allowances they have been allocated for. • Lithuanian enterprises treat GHG emission trading scheme as the form of EU subsidy to Lithuanian enterprises instead of obligation to reduce GHG emissions. • Lithuanian parliament is considering this year the Law on Climate Change where requirement for installations participating in GHG emission trading are set to use some percent of received income from sold allowances for emission reduction as audit carried by State Control indicated that just 12.3% of revenues generated from sold surplus of EUAs were used for pollution abatement. • Though received high profits from sold allowances Lithuanian heat producers asked State energy price commission to increase heat prices in almost all regions of Lithuania.