Introduction
 
This report analyses how the introduction of the EU Emissions Trading Scheme is influencing the way in which energy utilities will have to structure their generation and supply businesses between 2005-10. The purpose of the report is to offer utilities a set of actionable recommendations aimed at improving their efficiency and profitability in the new age of growing environmental pressures.
 

 
Scope
 
Geographic coverage includes EU25, with special focus on the six key liberalised markets: Germany, France, the UK, Italy, Spain and the Netherlands.
 
The scope of this study is the entire electricity value chain, although in-depth analysis centres on the core stages of power generation and supply.
 
The time frame covered includes the period between 2005-10, although some longer-term implications of emissions quotas are also considered.
 
Analysis in the report is based on Datamonitor's proprietary analytical models describing both the long-term and short-term power market equilibrium.
 
Highlights
 
On current trends, CO2 emission caps would result in a 500TWh annual power production shortfall in EU25 by 2010, with Italy likely to be particularly affected. As a result, member states will need to radically change their generation portfolios to satisfy the growing demand while decreasing the carbon content of power production.
 

 
Multiple strategies are available to utilities in how to pass on the costs of compliance with emissions caps onto their customers. In each case, the optimal cost assignment mechanism will depend on the structure of a utility's generation portfolio, its customer base and the severity of emissions reductions it is facing.
 

 
Carbon trading reinforces existing trends towards internationalisation of procurement and risk management activities by utilities. In the longer term, emissions quotas and the growth of renewable generation will require major investment in electricity networks.
 

 
Reasons to Purchase
 
Detailed analysis of the impact carbon emissions capping and trading will have on Europe's electricity sector between 2005-10.
 
Actionable recommendations to utilities on minimising the costs of compliance with emissions quotas and on passing those costs onto their customers.
 
Based on Datamonitor's proprietary models that identify the short- and long-term optimum solutions for coping with emissions quotas.

TABLE OF CONTENTS
 
CHAPTER 1 EXECUTIVE SUMMARY 3
 
This report identifies four key trends in EU power markets as a result of the introduction of carbon emissions trading in January 2005, and develops recommendations for how utilities should respond: 3
 
On current trends, by 2010 CO2 emission caps would result in a c.500TWh annual power production shortfall in EU25 4
 
EU members need to build more gas-powered capacity and buy additional emissions credits, Italy being the worst affected 5
 
Carbon trading reinforces existing trends towards internationalisation of procurement and risk management activities by utilities 6
 
Multiple strategies are available to utilities in passing the costs of compliance with emissions caps onto their customers 7
 
Recommendations 8
 
CHAPTER 2 INTRODUCTION 17
 
The report analyses the likely impact of the new EU emissions capping and trading regime on the region’s power utilities, and is aimed at senior utility company executives 17
 
What is this report about? 17
 
Why did we write this report? 17
 
Who is the target reader? 17
 
Report coverage includes all of the 25 EU member states, with special attention to the six key carbon-trading markets 18
 
Datamonitor identifies the most significant impact of EU ETS as being on generation and end-user supply 19
 
Report structure and contents 20
 
CHAPTER 3 POWER MARKET OVERVIEW 21
 
On current trends, by 2010 CO2 emission caps would result in a c.500TWh annual power production shortfall in EU25 21
 
By 2010, power demand in EU25 will have grown by 16% from the 2002 base, with southern Europe seeing the fastest growth 22
 
The share of thermal generation in EU25 is expected to remain stable between 2002-10, at 59% and 56% of the total respectively 23
 
Generating portfolios vary widely between the six key markets, from coal-dependent Germany to nuclear-dependent France 23
 
Between 2002-05 changes in the structure of generating capacity by country have remained small and incremental 24
 
By 2010, renewables will grow across the board, while Italy will finally have become less dependent on oil-fired capacity 25
 
Little overall change is predicted in CO2 emissions within the EU power generation sector between 2002-10 26
 
In 2010 the EU will remain dependent on thermal power, but the fuel mix within the thermal sector will change significantly 27
 
Producing more power through the existing generating mix to meet growing demand is inconsistent with the EU’s Kyoto commitment 28
 
CHAPTER 4 EMISSIONS TRADING FRAMEWORK 29
 
All of the key EU countries have challenging emissions reduction targets, which they may not be able to meet internally 29
 
EU ETS covers c.46% of the EU’s CO2 emissions 30
 
International trade in emissions credits can ease some of the pressure on the largest EU15 markets between 2005-10 31
 
The German NAP does not differentiate between power generation and industrial installations at the macro level. Compared to “business as usual”, Germany needs to save 97mt of CO2 per annum by 2010 32
 
The French NAP does not allocate enough quotas to new entrants into the power generation sector. Compared to “business as usual”, France needs to save 25mt of CO2 per annum by 2010 33
 
The UK NAP is based on self-imposed targets that exceed the country’s burden-sharing commitment. Compared to “business as usual”, the UK needs to save 54mt of CO2 per annum by 2010 34
 
The draft Italian NAP includes a generous allowance for new entrants into power generation. Compared to “business as usual”, Italy needs to save 30mt of CO2 per annum by 2010 35
 
The Spanish NAP has been changed to accommodate the coal-reliant generators. Compared to “business as usual”, Spain needs to save 90mt of CO2 per annum by 2010 36
 
The Dutch NAP looks to international carbon trade for meeting the country’s emissions requirements. Compared to “business as usual”, the Netherlands needs to save 20mt of CO2 per annum by 2002-10 37
 
CHAPTER 5 POWER GENERATION 39
 
EU members need to build more gas-powered capacity and buy additional emissions credits, Italy being the worst affected 39
 
EU ETS will require a major switch from coal to gas within the region’s power generation sector 40
 
Without carbon trade, national quotas would determine the long-term optimum fuel mix within conventional thermal generation 40
 
With trade in emissions allowances, long-term fuel prices determine whether a country is a net buyer or seller of emission credits 42
 
In the short term, relative fuel prices determine load factors of available generation capacity by fuel type, rather than the breakdown of total generation capacity 44
 
For most of the key EU markets, limiting the 2010 emissions credits shortfall requires substantial new CCGT capacity 47
 
Germany should build 8GW of gas-fired plant using it to replace lignite, and reconsider its nuclear phase-out plans 47
 
France should switch most of its coal-fired plant to gas, co-fire biomass, and buy 4mt of credits per annum 48
 
The UK should retain its nuclear capacity, build 11GW of gas-fired plant and buy 6mt of credits per annum 49
 
Even after building an extra 37GW of gas-fired capacity, Italy will need to buy some 17mt of emissions credits per annum 50
 
Spain should build 17GW of gas-fired plant and develop solar power, but will still need to buy 14mt of emissions per annum 51
 
The Netherlands should build 7GW of new gas-fired capacity, leaving it a net buyer of 4mt of emissions per annum 52
 
CHAPTER 6 PROCUREMENT, RISK MANAGEMENT AND NETWORKS 54
 
Carbon trading reinforces existing trends towards internationalisation of procurement and risk management activities by utilities 54
 
Management of carbon exposure is set to become central to utilities’ procurement and risk management strategies 55
 
The impact of emissions trading on network activities will remain limited in the medium term 56
 
CHAPTER 7 END-USER SUPPLY 58
 
Multiple strategies are available to utilities in passing the costs of compliance with emissions caps onto their customers 58
 
Utilities need to find optimal ways of assigning additional carbon costs to their customer base 59
 
Datamonitor has identified three alternative cost-assignment algorithms, each have its own relative advantages and disadvantages 59
 
The optimum carbon pricing strategy depends on utility’s retail volumes and on how optimal its generation portfolio already is 61
 
E.ON’s 2001 attempt to use the cost-reflective approach was ahead of its time, but could be successfully revived now 63
 
Cost-reflective carbon pricing requires careful planning and initially may be best suited for larger end-users 63
 
CHAPTER 8 RECOMMENDATIONS 65
 
Introduction 65
 
All four of the key market trends examined are pertinent to utilities and affect the whole range of their activities 65
 
CHAPTER 9 APPENDIX 67
 
Supplementary data 67
 
Demand Trends 68
 
Supply Trends 69
 
Emissions Trends 72
 
Research methodology 74
 
Research methodology 74
 
Further readings 74
 
SPP writing team 74
 
How to contact experts in your industry 75
 

 
LIST OF TABLES
 
Table 1: The main relative advantages and disadvantages of alternative carbon cost loading options 61
 
Table 2: EU power demand forecast, 2002-10 68
 
Table 3: EU power generation capacity by source, 2002 69
 
Table 4: EU power generation capacity by source, 2005f 70
 
Table 5: EU power generation capacity by source, 2010f 71
 
Table 6: EU CO2 emissions forecast, 2002-10 72
 
Table 7: Power generation CO2 emissions credits shortfall (surplus) on current trends, 2005-10 73
 

 

 
LIST OF FIGURES
 
Figure 1: Power demand (d) and supply (s) in the key EU markets, 2002-10 4
 
Figure 2: Overview of carbon balancing solutions in the 6 key markets, 2010 5
 
Figure 3: The impact of carbon management on utilities’ procurement and risk management function, 2005-10 6
 
Figure 4: Suitability of alternative carbon-pricing mechanisms in end-user supply 7
 
Figure 5: Markets covered in this report 18
 
Figure 6: Elements of the power value chain on which this report focuses 19
 
Figure 7: Electricity demand in the key EU markets, 2002-10 22
 
Figure 8: EU generation portfolio, 2002-10 23
 
Figure 9: Composition of the power generation portfolio, 2002 (key markets) 24
 
Figure 10: Composition of the power generation portfolio, 2005f (key markets) 25
 
Figure 11: Composition of the power generation portfolio, 2010f (key markets) 26
 
Figure 12: Power generation CO2 emissions in the key EU markets, 2002-10 27
 
Figure 13: Power demand (d) and supply (s) in the key EU markets, 2002-10 28
 
Figure 14: The EU Emissions Trading Scheme is but one step in achieving the Kyoto emission reduction targets 30
 
Figure 15: Power generation in relation to national CO2 emissions, 2005-10 31
 
Figure 16: German sector quotas vs. current trend, 2002-10 33
 
Figure 17: French sector quotas vs. current trend, 2002-10 34
 
Figure 18: UK sector quotas vs. current trend, 2002-10 35
 
Figure 19: Italian sector quotas vs. current trend, 2000-10 36
 
Figure 20: Spanish sector quotas vs. current trend, 2002-10 37
 
Figure 21: Dutch sector quotas vs. current trend, 2002-10 38
 
Figure 22: Long-term relative costs of gas- vs. coal-fired generation in relation to national emission quotas (without carbon trade) 42
 
Figure 23: Long-term relative costs of gas- vs. coal-fired generation in relation to national emission quotas (with carbon trade) 43
 
Figure 24: Datamonitor’s Power Dispatch model – an example 45
 
Figure 25: Summary of the process of deriving quantitative, country-specific recommendations 46
 
Figure 26: Suggested carbon balancing solution for Germany, 2005-10 48
 
Figure 27: Suggested carbon balancing solution for France, 2005-10 49
 
Figure 28: Suggested carbon balancing solution for the UK, 2005-10 50
 
Figure 29: Suggested carbon balancing solution for Italy, 2005-10 51
 
Figure 30: Suggested carbon balancing solution for Spain, 2005-10 52
 
Figure 31: Suggested carbon balancing solution for the Netherlands, 2005-10 53
 
Figure 32: The impact of carbon management on utilities’ procurement and risk management function, 2005-10 55
 
Figure 33: The impact of carbon management on investment in networks, 2005-15 57
 
Figure 34: Alternative carbon pricing options 60
 
Figure 35: Suitability of alternative carbon-pricing mechanisms in end-user supply 62
 
Figure 36: The E.ON MixPower product, October 2001 63