Kyoto Flexible mechanism in EEC - case Slovakia

J. Balajka Profing s.r.o. Bratislava

The objective of present workshop is to flesh-out some critical issues of JI in Central and Eastern European countries. These countries should represent the host countries for JI projects. There are following critical issues connected with flexible mechanism application in these countries:

1. Will country comply its commitment in the Kyoto Protocol framework? How large emission off-set should be preserved, considering the uncertainties of future energy development as well as the possibility of emission banking for Post-Kyoto period?
2. Which sector and GHG will be dominant in emission trading?
3. Which type of project and technology should be subject for emission trading and its abatement potential?
4. Which flexible mechanism type will be more suitable for GHG mitigation option - JI or AT?
5. JI project baseline versus national baseline.
6. Abatement cost and project ranking
7. Conflict in interest of individual player: Ministry of Environment, project owner, foreign investors, domestic public energy utilities, coal lobby and social issues, etc.

This paper try to discuss above issues, using the experiences gained in Slovakia

1. GHG emission scenarios

The energy related CO2 and energy sector represents the dominant GHG and sector for emission trading in countries with economy in transition. On the other side CO2 emission trajectory represents the large uncertainty, considering the proceeding transformation process. The econometric methods can be hardly used to design the energy consumption and CO2 scenarios. At this condition, the sensitivity analyses represent one possible way how to design CO2 baseline in these countries. The approach what happen if, based on expert estimation can create several trajectories and comparing with Kyoto commitments the possible CO2 emission offset can be adjusted. In special case of Slovakia the CO2 energy related emission cap was established, based on the GHG scenarios in other sector gained at preparation of previous 2nd National Communication. This cap was compared with three scenarios, selected as most probably results of sensitivity analyses.

1. BAU - Business as usual scenario
2. Low scenario reflecting the impact of existing environmental legislation aiming to decrease the basic pollutants (SO2, NOx, CO and solid particulate), that stimulates the fuel switch (coal to gas and oil to gas)
3. High scenario with the final energy demand of main energy users (metallurgy and other energy intensive technologies) on the level of year 1990.

The figure indicates, that even at high scenario some CO2 offset can be achieved.. On the other side low scenario is not able to assure the Post-Kyoto emission stabilisation.

Fig. 2 Baseline scenarios

2. GHG mitigation measures

The previous section indicates, that even at high scenario the CO2 emission will not exceed the Kyoto commitments and it opens the door for emission trading. Considering the situation in Slovakia, the following mitigation options were selected for analyses:

1. Fuel switch to the fuel with lower carbon content per energy units
2. Installation of CC with heat and electricity cogeneration
3. Implementation of renewable source.
4. Thermal insulation in apartment houses and public buildings
5. Increase share of public transport related to the individual road transport.

The option 1 is equal to low scenario. The potentials of individual options and their penetration rate were established on the base of accepted governmental policy (Energy Policy). It enables to create the Scenario with measures. Fig 2 illustrates the impact of individual option on the CO2 abatement.

Fig. 2 Baseline scenarios

3. JI and ERU's allocation.

The JI and AT are two possible options of Kyoto flexible mechanism. While the JI is more project oriented, the AT will be realized on the national level. From the first look it is obvious that measures like thermal building insulation and measure in transportation sector can be organized on the national or regional level (local government, communities). Therefore AT seems to fit better for these options.

The options as fuel switch, renewable sources and CC implementation are typical project oriented one and seem to be suitable for JI. The economic entity, where JI has to be realised, needs the investment money for project and emission trading is one of the possible financial resource. The investor needs in this case some ERU's, that has to be added for host national emission balance and subtract from the investor country one. There are some measures, characterised by the fact, that ERU's allocation is in the same entity as that where project is realised. There are for example fuel switch, implementation of renewable sources, etc. The baseline determination and ERU's and abatement cost calculation are quite easy in this case., More complicated situation is in projects where ERU's creation is in other entity and/or sector. Let us see for example the project with CC implementation that represents the repowering of existing industrial heating plants. The project baseline has to be adjusted on the same indicator for example heat demand,. The fuel consumption at and simultaneously CO2 emission in cogeneration project will be higher as at the case of heat supply only. This emission increase has to be override by the emission decrease in public power plant sector and should be caused by the decline of electricity supply from public grid into industrial sector. The CO2 emission decrease will be very dependent on the fuel mix in public power plant. If this electricity demand decline in industrial sector will be accompanied by the electricity import decrease and/or electricity export increase only, the total CO2 balance on the national level will be increased. The problem is, that project owner will try to present as high as possible ERU's at project estimation in order to obtain higher financial income from emission trading. On the other hand the public power plant utility has not any interest to decrease CO2 in its sources if it will cut its profit due decrease of electricity generation level.

The ERU equivalent created from grid electricity decline can be calculated by the several ways:

1. On the average of fuel mix from in public electricity supply system
2. On the average of thermal power plant fuel mix excluding the base load sources, preferable nuclear.
3. On the base of fuel from power plant being standing on the end of loading order. e.g. the power plant with highest variable cost.
4. In some JI project the European fuel mix was used, considering the open electricity market in EU after its extension (including that of host countries for JI)..
5. More sophisticated approach is based on the use of some models, for example WASP, ENPEP, DECADES, MARKAL etc.

The next figure illustrates the impact of CC implementation in industrial energy sector, as the results of modelling with ENPEP/BALANCE model.

Fig. 3 The change of CO2 emission at CC implementation
in industrial energy sector.

The excess electricity generation in CC with cogeneration will influence not only the grid electricity demand but the yearly load profile of public power plants. It influences the CO2 abatement level of project too. The problem will be more complicated in the case of open electricity market and deregulated electricity system. It is clear, that estimation of project based on CC with cogeneration is not single valued and some discussion on this topic seems be very useful in this workshop framework.

4. National and project baseline

In order to expressed the effect of individual measures, the selection of baseline plays most important role. The area graph on fig. 2 indicates its effect in accordance with its ranking on the diagram (from top to down). The down border of individual measure represents the baseline for the following measure one. The selected measure ranking is in accordance with Energy Policy. In the case of individual JI project, the both players, e.g. investor and project owner will try to expressed its ERU on as high as possible baseline. Let see the case of biomass use as fuel, replacing the coal combustion in existing heating plant of 100 MWt capacity. The coal contains more as 1% S and at this condition is not able to comply SO2 stack concentration limit e.g. 1700 mgSO2.Nm-3. If JI will be not realised, the FGD implementation or fuel switch from coal to gas has to be applied. Considering the yearly 4000 h operation the FGD implementation is not economic feasible and fuel switch is the most proper option. Next table compare the yearly CO2 emission level at the coal, gas and wood option. It indicates, that in the case of gas option as baseline, the approximately half ERU's level is achieved comparing with coal option as baseline.

Table 1 CO2 emission level at different fuel in heating plants.

Fuel	h/year	MWt	efficiency	TJ/year	kgCO2/GJ	ktCO2/year	CO2kt/year
brown coal	4000	100	78%	142.5	98.4	14.0	14.0
NG	4000	100	88%	126.3	58.6	7.4	7.4
wood	4000	100	75%	148.1	0	0.0

It is clear, that for project owner the coal baseline is more convenient and can bring larger financial resources from emission trading. The same interest is of investor, because at the same investment money the large volume of ERU's can be transfer. The position of MoE could be quite different. The environmental legislation that forces the energy producer to fuel switch is presented as accepted political issue to CO2 abatement, and should be included in national baseline for additional measures. There is question which baseline will be accepted by MoE at JI project approval.

The other confusing point of JI project baseline is competition of demand side and supply side projects. . Let us consider the same heat sources, that supply the heat in residential area. Due the Demand Side Option (DSO) - thermal building insulation the average load declines from 100 to 70 MWt. As is seen, it decreases the abatement level for fuel switch measure of 30%. On the other side also the type of fuel combustion influences the impact of DSO. In the case of coal as fuel, impact of thermal insulation will be 4.2kt/year. In the case of gas it will be 2.2 kt/year and at application of JI based on the wood use the impact of DSO will not bring any effect. There is question how allocate the ERU's at two simultaneously applied processes?

5. Abatement cost on the project and national level

There are several approaches to calculate abatement cost. One of them represents Marginal Abatement Cost MAC as the cost of last CO2 tonne abatement. The other one, recommended by World Bank to GEF projects, is so called Incremental Cost IC representing by the common formula:

IC = NPV project - NPV baseline / CO2 emission baseline - CO2 emission project

While MAC can be calculated with the use of sophisticated programme (ENPEP, MARKAL) on the national level, the incremental cost is more proper for JI due its project oriented character. As is seen from above formula, the baseline definition will play again very important role. Let us look again on the previous project with biomass implementation. The abatement cost will be very dependent on the baseline.

As was stated above, the baseline will be different at the different fuel and different heat demand. The later is dependent on the fact if simultaneously DSO e.g. thermal building insulation is implemented. The next table gives the results of abatement cost calculation of in table 1 and 2 presented cases, e.g. different fuel and different heat demand at biomass use as JI project. The 100 MWt heat source with 129 USD/kWt investment cost and 15% discount rate were considered.. The fuel cost and its price escalation are in agreement with data proposed in Energy Policy of SR.

Table 3 Abatement cost of JI project

DSO - thermal insulation	Baseline fuel	NPV	CO2	IC
		'000'USD	kt	USD/t
is not implemented	coal	2720	181.7	15.0
	gas	-3313	95.9	-34.5
implemented	coal	9591	127.2	75.4
	gas	5367	67.2	79.9

It is seen, that lowest abatement cost is achieved at the case of NG as the baseline fuels. The decrease of heat demand will bring the turn over to the positive and highest value..

In order to ranking the individual measures type on the national level, the cost curves use to be designed,. Some examples of cost curves in the Slovakia case are on the figure 4 and 5, The cost curves were designed for the higher and lower range of abatement cost values, considering uncertainties of technology investment cost and project baselines.

Comments:

I nd. energy represents the industrial HP and CHP DH centralised district heat supply GT in DH Geothermal energy for centralised DH supply Public CHP Cogeneration plants of regional public utilities, JI project consider replacement of existing coal CHP by CC with cogeneration

The difference in abatement cost indicates uncertainties, that can arise at project assessment on the national bases. Despite that, the projects based on the biomass use seem to be most proper as JI projects. On the other hand, implementation of CC indicates highest abatement cost, as is seen from above cost curves. We must realise, that abatement cost of CC implementation will not reflect real private cost of this project type. In abatement cost calculation is not included the grid electricity price relation that is most important issue at decision making process. Therefore CC in industrial energy will be implemented outside JI framework and the impact on emission level will be dependent on the grid electricity fuel mix.

6. JI or AT?

The above mentioned uncertainties connected with the technical and economical background of JI projects create some fundamental question - Is JI better option for country with economy in transition as other option like AT?
The next table summarises the main feature and its difference between JI and AT.

Considering the special condition of country in transition, the following issues should be taken in consideration too?

1. The lack of investment resources, needed by the start of project gives preference to the JI over AT.
2. The financial income can be drowned in the case of AT in national budget.
3. There are not many large JI projects in small size countries. On the other hand large JI potential is in many small projects characterised by large transaction cost comparing with the total financial resources gained from emission trading. From this point of view AT represents some advantage.
4. Together with transaction cost, each JI project represents the large bureaucratic bottleneck, specially for small size project one.
5. As is seen from previous analysis, the reliable project baseline can be designed for supply side projects with the same allocation of financial resources and emission reduction. On the other hand the simultaneously implemented demand side projects can decrease the supply side JI project impact too..
6. The baseline of JI depends on the economical activity, that prediction is very difficult in labile economical environment of countries in transition.

Considering all pro and contra what should be better JI or AT?. There are two ways that represents to compromise between JI and AT.

1. Establishing the emission cap for decisive CO2 emission sources. It gives the possibility for domestic and international CO2 trading and simplifies the process of monitoring and governmental control. The experiences from USA SO2 trade can be applied here. The problem is in the determination of this cap - will be used grandfathering approach or cap will be sized according some special indicators (production output, etc.)?
2. Similarly as in the case of some just establishing Carbon Fund ( WB and/or others), it is possible to create this fund on the national basis. The fund can give the loan for the project owner on the beginning of project. Loan can be pay back by the CO2 credits or repayment. The later will be applied, if yearly emission decrease will not be proved. Fund can sell credit to the foreign or domestic customers. Nevertheless governmental approval will be needed in the case of credit transfer in abroad for individual year, depending on the CO2 national balance. Some compromise between repayment and credit transfer can be applied. The problem is to collect money at the beginning of fund creation in country with economy in transition and foreign investment will be in any case needed.