The publication of the UK government’s draft National Allocation

Plan (NAP) last month caused little surprise in both the emission

reduction targets outlined and the response from industry. The proposed

reduction in CO2 emissions of 20% by 2010, compared to the UK

Kyoto Protocol target of 12.5%, had been widely leaked beforehand while industry has largely been on the defence since the publication

of the energy white paper.

In addressing the draft NAP the first question to be asked is whether the targets outlined are actually achievable, which in theory they are. UK government policy targets a reduction of 15.3% by 2010,

which implies that the EU ETS only has to contribute a further 1% reduction to achieve the 16.3%

reduction target in Phase One. Of course, if the 16.3% target in Phase One is missed then realisation of

the 20% reduction target by 2010 becomes significantly more challenging.

Emission reduction is a politically sensitive issue and it is little surprise that transportation and domestic emissions are not included in the NAP. But if transportation, which contributes around 20% of UK emissions, was included the targets for industry, and in particular generation, would be less onerous and the backlash from industry more muted.

While the UK has set an ambitious target above its Kyoto commitment it is highly unlikely that other EU member states will follow suit and set similar reduction targets beyond their Kyoto targets. Recent history suggests that while the UK has been at the forefront of market initiatives, such as full gas and electricity deregulation, its European neighbours have not always followed suit, tending to adhere to the minimum required levels.

It is this perceived imbalance between the UK targets and the expected targets of the remaining EU Member States that is of particular concern to business organisations, arguing that the UK will be uncompetitive as a result of this imbalance. This becomes a more justifiable concern if the UK cannot efficiently achieve the targets laid out. And until other EU Member States, and in particular Germany which has the largest number of utilities, present their NAPs it may be premature to start the debate on European competitiveness.

The response to the draft NAP has, according to market participants, been muted. Although the price of EU allowances traded at u13 after publication brokers stressed this was not significant. Similarly the increase in base load electricity prices for winter-04 and Q1-05 is seen as more of a continuation of a pricing trend before the draft NAP was published, and the fall in coal prices probably had more to do with the Chinese New Year, and the coal market price being over done, than the draft NAP signalling a lack of confidence in coal-fired generation plant as a result of stringent emissions reductions.

Clearly electricity prices will rise as a result of the emission reduction targets, as they have since the EU ETS legislation was passed last year, and now that the draft NAP has been published analysts have been able to more accurately predict the impact, although until all EU NAPs are finalised by 31 March this impact will be liable to revision.

But taking the example of Ferrybridge, which

is allocated 5.05 million tCO2/y, according to one

analyst the impact may be as little as £0.75/MWh per year over Phase One assuming base load operation for 90% of the year. As the analyst noted, the plant could effectively mitigate this cost by cutting back overnight base load. The inference here is that

plant can reduce its compliance costs by changing its mode of operation.

The central theme of the draft NAP is to

incentivise the generation market to become more emissions efficient, which of course is the objective of a traded emissions market. By setting aside 5.7% of allowances (per year) in Phase One for new

generation entrants the government is incentivising the market to move away from coal and oil to gas and renewable energy sources. As of October 2003, according to DTI, coal accounted for 40.3% of

UK generation, compared to 38.0% for gas, and by the end of Phase One this share is expected to fall below that of gas and fall further in Phase Two

with the Large Combustion Plant directive taking

effect from 2007.

Taken as a whole the draft NAP is an ambitious, but ultimately achievable, policy. The concern is that by setting a high reduction target in Phase One it may limit the realisation of the overall 20% target by the end of Phase Two. For while the Phase One target is ambitious, if it is not met the reductions required in Phase Two will have to be revised upwards and may prove to be a target too far.

Since the UK outlined its targets and allocations the focus has swiftly turned to Germany, which had planned to announce its draft NAP this month.

But with growing disagreement between the

German government and industry on allocations it now seems likely industry will withdraw from the

talks on allocations. At the centre of the disagreement is the position of coal, which is central to

emissions reduction. Leading utility RWE wants

incentives aimed at promoting a switch from coal

to natural gas removed while E.On wants suitable compensation in the form of allowances to phase

out its nuclear plant. And at government level there appears to be a divergent view between the

economy and environment ministries on the level

of allowances required.

With the UK and Germany, two of the most

important EU energy markets, seemingly unable to provide a united front between government and

industry on emission allowances it does not necessarily bode well for the introduction of a EU Emissions Trading Scheme (ETS) in January 2005. For the ETS to work efficiently will require a

working consensus between EU governments and industry, which in turn requires ‘ratification’ of the

EU Member States NAPs by the European Commission. And with just over ten months until

the scheduled introduction of the ETS the concerns expressed by some observers that a January 2005 start date may be optimistic may unfortunately be proved correct.