German emission caps roil industries
Posted on Sunday, September 17, 2006
NIEDERAUSSEM, Germany — Last year, to help combat global warming, Europe started charging industry for the right to spew hot air.
For the first time on such a scale, governments slapped limits on the carbon-dioxide emissions of power plants, steelworks and other factories. Companies exceeding the caps have to buy CO 2 “allowances” that trade on a European market.
Because CO 2 emissions now carry a cost, Germany’s largest utility, RWE AG, is spending to improve the efficiency of its aging coal-fired power plants, including its biggest power station in the country’s industrial heartland.
Carbon dioxide also is padding the profits of RWE and other utilities, because they have raised electricity rates to more than cover the new costs. Manufacturers that use a lot of juice are fuming.
“The utilities get a huge amount of windfall profits, and the energy users get windfall costs,” said Markus Weber, a manager responsible for CO 2-allowance trading at steelmaker ThyssenKrupp AG.
Germany’s experience with Europe’s new emission constraints holds important lessons for countries that want to curb emissions of CO 2, a product of fossil-fuel combustion that contributes to global warming. In Germany the caps are starting to have their intended environmental effect: They are prodding industry to burn fossil fuels more efficiently.
At the same time, the new rules have upset the business status quo. Industries, battling hard to bend the rules in their favor, created new winners and losers. The winners include utilities that can charge higher rates and profit from trading allowances — permits that give companies the right to emit carbon dioxide — at opportune moments. Losers include energy-intensive manufacturers.
Although the United States, the world’s biggest emitter of CO 2, has rejected the Kyoto Protocol, many U. S. business leaders see imposed carbon constraint as inevitable. Earlier this year Congress discussed how to structure such a nationwide cap. Last month California passed a law that will impose the United States’ first cap on global-warming emissions. Now the state has to figure out how to put that mandate into practice.
Europe’s caps have their roots in Kyoto, which requires industrialized countries in the agreement to cut annual global-warming emissions a collective 5 percent by 2012. To prepare, the European Union decided to run a road test to end in 2007 that levies caps on utilities and such energy-intensive industries as steel, cement and paper, which account for roughly half the EU’s total emissions. Each European country was allowed to pick its own emissions-reduction target, which then had to pass muster with the EU.
Germany, which accounts for the biggest chunk of emissions covered by the European Union mandate, has pledged a Kyoto-related emissions cut of 21 percent. Its pledge under the EU experiment is far smaller: The 1, 849 facilities covered by the caps have to cut more-recent emissions by 0. 4 percent. Scientists generally agree that neither Kyoto nor the EU experiment, both considered first steps only, do enough to meaningfully curb global warming.
In Germany companies scrambled to shape the rules to their benefit. Coal-dependent utilities protested government proposals that would have encouraged gas-fired power stations. (Burning coal to produce electricity emits about double the amount of CO 2 as that produced from burning gas. ) The utilities largely won the battle, helped by support from Germany’s economics minister at the time, who hailed from a coalrich region.
After pressure from manufacturers, Germany also scaled back emission cuts required of companies who emit most of their CO 2 in the course of making things, rather than from burning fuel. One byproduct of steelmaking, for example, is an industrial gas made up of about half CO 2. In their lobbying, some industries threatened to relocate to countries without emission constraints. When the scrambling ended, Germany’s CO 2 plan contained 58 combinations of emission rules from which companies could pick and choose.
Each allowance entitles its holder to emit one ton of CO 2. The price of the allowance is set on several exchanges around Europe; one is in the German city of Leipzig. The actual buying and selling is done by hundreds of traders sitting at computer screens. The market’s most active players are utilities, many of which have hired specialized traders. Bankers and independent brokers also trade, both speculatively and on behalf of corporate clients.
PRICE PLUNGE Throughout 2005 and early 2006, the price of European CO 2 allowances rose amid speculation that industry was having a tough time complying with the caps and therefore companies would need to buy more. In April, European countries began disclosing that their capped industries had emitted less CO 2 than permitted under their 2005 allowances. The price of CO 2 plummeted. In mid-May the EU confirmed that the EU as a whole ended 2005 with allowances to spare. The biggest surplus occurred in Germany.
One cause of the surplus was the rules allowing big emitters to snag relatively permissive CO 2 allocations, the German government says. Another factor was real energy-efficiency improvements.
“Emissions trading is working,” said Franzjosef Schafhausen, an environment ministry official who oversees the country’s CO 2-trading program. Companies “are thinking about possibilities to reduce their CO 2 emissions.”
One such company is the municipal utility in Wurzburg, a city of about 100, 000 people about an hour’s drive southeast of Frankfurt. The utility’s main power plant was built in 1954. In 2002, it faced a choice: Modernize the plant to reduce production costs or shut down its generators and buy power from the grid.
Though the details of Germany’s CO 2 cap had yet to be worked out, “we could assume it would be an advantage” to improve the plant’s efficiency, and that “it would be a disadvantage if we did nothing,” said Armin Lewetz, head of the utility’s power-generation company.
In 2003, the utility began switching its coal-fired boilers to gas-fired models. The project cost about $ 57 million, nearly half of which will be defrayed by a German government subsidy.
The plant received 319, 000 annual CO 2 allowances for 2005 on the basis of its prior life as a coal burner. Because of the switch, it emitted just 267, 000 tons of CO 2. It sold the extra 52, 000 allowances — plus several thousand allowances for 2006 — on the European market for a profit of about $ 1. 9 million.
Wurzburg’s gas-fired equipment produces more electricity than the coal-fired plant, so it can sell more electricity to the grid. It also is selling power at higher rates. Utilities across the country have raised prices to reflect added costs incurred — for example, from buying extra CO 2 allowances. They also can turn a profit from the initial allowances they received from the government, thanks to an accounting move: Even though the allowances are free, the utilities incorporate the value into the price of electricity. “It doesn’t matter if you get it free or not,” said Ralf Schafer, vice president for legal and compliance issues at the trading unit of RWE, the nation’s biggest utility. “It becomes part of your production cost.”
MAKING STEEL That has such manufacturers as ThyssenKrupp seething. ThyssenKrupp’s economic heart is the steelmaking complex in Duisburg, a company town at the confluence of the Ruhr and the Rhine rivers in western Germany. It sprawls across more than three square miles, comprising four blast furnaces and two steel mills. Inside the factory molten metal flows and orange sparks fly in a process whose basic steps haven’t changed much in a century. The world’s second-biggest steel plant, it cranks out more than 11 million tons of steel a year. The steel is sold far beyond Europe, so ThyssenKrupp faces competitors in countries that haven’t imposed CO 2 caps, including South Korea, home to the world’s biggest steel plant.
ThyssenKrupp’s Weber said wholesale electricity rates in Germany have risen 25 percent to 60 percent in the past few years. ThyssenKrupp blames the runup largely on the actions of a few dominant utilities.
A German energy-market regulator has said it is investigating whether utilities abused their market power to raise electricity rates. That inquiry hasn’t reached a conclusion. The German government already has said it will impose tougher emission-reduction requirements on utilities in 2008. In a report it justified the move because power plants “are seen to be generating ‘windfall profits’ as operators are taking into account the value of emission allowances allocated free of charge when establishing their product prices.”
ThyssenKrupp faces its own CO 2 cap under the German rules. The company says it can do little to reduce its emissions, most of which come from the chemical process in steel production, Weber said. Though the steel industry has chipped away at those “process emissions” over the years, “there’s a limit that you can’t go below, and we are getting closer to that limit,” he said.
ThyssenKrupp is looking abroad for help in meeting its CO 2 obligation. A unit of the company is selling equipment to three South Korean chemical plants that will reduce their emissions of nitrous oxide, a greenhouse gas believed to pose more danger to the atmosphere than CO 2. Under the EU cap-and-trade program, such projects produce credits that companies like ThyssenKrupp can buy to offset their emissions back home.
SUPPLY CHAIN An hour’s drive south of Duisburg is a triangular swath of countryside dominated by another German industrial giant: RWE. The company is in the location because of what sits just below the ground: massive quantities of lignite, a soft, wet coal. Spread across this roughly 120-square-mile triangle is a soup-tonuts operation that powers a good chunk of the German economy. It comprises three strip mines, four massive power plants and an RWE railroad.
Last year these plants burned about 90 million tons of lignite in cranking out 13 percent of all the electricity generated in Germany. They also emitted about 90 million tons of CO 2, or about 10 percent of Germany’s total. Lignite is among the most CO 2-intensive types of coal.
Many environmental advocates hope the CO 2 caps will force power companies to replace lignite with cleaner-burning fuels. Not RWE.
Lignite “is our holding in the bank,” said Theo Tippkoetter, the coordinator of RWE’s lignite power stations, standing at the Niederaussem plant. “We have the whole supply chain in our hands.”
RWE denies ThyssenKrupp’s assertion that German utilities have inappropriately exploited CO 2 to raise prices. The company says market prices have risen naturally because of the caps, other government mandates and higher fuel prices. Schafer, the RWE trading official, said companies that use large amounts of electricity could have protected themselves by negotiating longterm contracts.
“We offered them hedges, but they didn’t hedge with us,” Schafer said. “You can’t have the cake and eat it too.”
RWE, for its part, coughed out slightly more CO 2 last year than it was given allowances to emit. It is scrambling to burn its lignite more efficiently. Just before the caps took effect, RWE decided to invest about $ 191 million to improve a lignite plant in the village of Weisweiler, about 25 miles from Niederaussem. The company is bolting on to two lignite-fired power unit contraptions called “topping-gas turbines” — essentially turbo-chargers powered by natural gas that boosts the plant’s electrical output at a lower rate of CO 2 emissions.
At the Niederaussem plant, RWE plans to replace blades in two turbines with new, three-dimensional ones that use less energy. Refurbishing the turbines, along with other improvements, will cost nearly $ 149 million, Tippkoetter said. Without the CO 2 caps, the project would have taken eight to 10 years to pay off. Now the project may pay off in as little as two years, depending on the market price of CO 2.
The CO 2 limits have become part of daily business. In April, when European CO 2 prices peaked, an RWE manager told the Niederaussem operators to shut down the plant’s two oldest, and least efficient, units. The price surge meant they no longer made profits.
Within days, the market price of CO 2 fell back, and the Niederaussem plant got the go-ahead to restart the units.
“We have a clear signal,” said Joachim Loechte, a manager responsible for environmental affairs at RWE. “There will be a carbon-constrained world.”
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