Italy facing the EU Emissions Trading Scheme:
some scenarios by the ICE model
(POSTER)
by
Enzo Di Giulio
Stefania Migliavacca
Eni Corporate University - Scuola Mattei
Via S. Salvo, 1 - 20097 San Donato Milanese (MI), Italy
enzo.digiulio@ enicorporateuniversity.eni.it; tel. 0039.02.52057893; fax: 0039.02.520.57908
stefania.migliavacca@ enicorporateuniversity.eni.it; tel. 0039.02.52057914; fax: 0039.02.520.57908
This paper focuses on Italy in the context of the Kyoto Protocol. According to the Annex | to the last National
Allocation Plan (NAP), Italy’s emissions are 95 Mt. CO) eq. above the Kyoto target of -6.5%, i.e. 19% over
the goal. This paper proposes a critical analysis of the Government plan and NAP (National Allocation Plan)
based on the analysis of recent Italian energy history and a wide set of policy measures that have been
stated in formal documents and not implemented. The study is performed using the ICE (Italy's Carbon
Emissions) model. ICE generates energy and carbon emission paths up to 2020 and elaborates sensitivity
analysis on caps, carbon prices, and other variables. In particular, the research focuses on the Italian power
sector under alternative scenarios of emissions and caps.
A conclusion of our analysis is that a significant purchase of carbon credits on the international ET market is
necessary. Given the troubled Italian public finance situation, buying carbon credits could represent an
unplanned, and maybe not feasible, heavy burden.
The EU ETS and the two NAPs
The EU ETS was launched on J anuary 1, 2005 as a milestone of European climate policy towards the Kyoto
commitment and beyond. Member States have a certain degree of freedom in setting their caps (they submit
a National Allocation Plan to the Commission), even though the European Union recommends coherence
between the countries’ Kyoto target and the caps. Thus, the EU ETS can be seen both as an opportunity to
implement strict energy policies required at higher level (the EU) and as a proof of the countries’ real
willingness to reduce their emissions.
In preliminary Phase | (2005-2007), the EU ETS regulated CO, emissions from installations over 20 MW,
which means about 40% of EU emissions. Those emissions were capped at 6600 MtCO, over the three
years. Almost a quarter of all Phase | allowances were allocated to Germany, while Italy, Poland and the UK
received nearly 10% each. The power sector collected almost 55% of total allowances.
Actually, 2005 verified emissions were more than 3% below what had been allocated to countries that year
and preliminary verified 2006 emissions data suggest a long market for 2006 as well.
Given the experience of Phase |, it was expected that the caps in Phase II (2008-2012) would be tighter. So
far, the submitted NAPs set the average annual cap at 5.8% below 2005 verified emissions (EEA 2007).
Moreover, the penalty for non-compliance will rise from 40 to 100 Euros.
The first Italian NAP
Given the above mentioned data on Italy, a reasonable expectation was that the EU ETS could be used as
a tool for enforcing strong emissions cutting policies. During Phase I, such an expectation was disavowed by
reality. As showed in the next figures, for a number of reasons, the Italian caps were high and did not bring
the country much closer to its target
The first draft of the Italian National Allocation Plan for Phase | (NAP1) was presented at the end of April
2004. Then, in J uly, a revised NAP1 was issued. Only in February 2005, after extensive consultations, a
“final” version was submitted to the European Commission, who required a further revision. Finally, the
ultimate NAP1 was published in November 2005. As a consequence of this irresolute behaviour, Italy was
basically excluded from the first year of the European Carbon Market.
NAP 1 substantially revised the CIPE Resolution 2002, giving new reference figures about emissions’
inventory and forecast. The cap for each activity is calculated on the basis of sectorial growth rate
evaluation. We focus on the power sector since it is the major actor in EU ETS. The following table reports
the total amount of allocated allowances and the thermoelectric sector specific cap.
Tab 3: Allocated allowances Phase | (NAP 2005)
2005 2006 2007 annual verified emissions
average (average 2005-2006)
Total allocated allowances (MtCO2) 221.79 224.87 219.81 223.6 226.5
Thermoelectric (MtCO2) | 131.08 133.81 128.41 131.1 144.1
If we compare these values with the 1990 level of CO. emissions for EU ETS sectors (210.2 MtCO,
according to the same document), the Italian NAP 1 allows an emissions level which is on average 6% higher
than the 1990 one. It does not seem to be very “consistent” with a total 6.5% reduction required by the EU
Burden Sharing Agreement. 59% of the allocated allowances are collected by the thermoelectric sector.
Those caps resulted from a large process of negotiation and lobbying. Actually, even if they were judged
quite generous, verified emissions (2005-2006 average) exceed them (EEA 2007).
The second Italian NAP
The first draft of the second Italian National Allocation Plan for Phase Il (NAP2) was submitted to the
Commission in December 2006. Then, after the Commission's decision issued in May 2007, a new “Decision
Scheme” was published in J anuary 2008. At this moment, the last version of NAP2 is dated February 29,
2008 and entails the reductions required by the European Commission (-13.25 MtCO> per year). The caps
are listed below:
Tab. 4: Allocated allowances Phase II (NAP 2008)
2008 2009 2010 2011 2012 annual average
Total allocated allowances (MtCO2)* 200.68 | 192.43 | 185.37 173.68 171.34 184.7
Thermoelectric (MtCO) | 101.27 93.03 85.96 74.27 71.93 85.29
"Except the reserve for new entrants (16.93 per year)
The annual average allocated allowances have been strongly reduced if compared with NAP1 (-17,4%),
together with the relative weight of the thermoelectric sector (in NAP 2 it collects on average the 46% of the
total amount).
Even though Phase | caps were not very strict, Italian emissions have gone beyond. In Phase II caps are
really stringent but, considering the previous experience, we believe this won’t decrease CO. emissions.
That is why the evolution of carbon market and the price of allowances are definitely relevant for Italy.
To conclude, we would just underline how difficult is to cope with these documents, since each version
contains different figures. The following table compares some key points included in each document:
Tab 5: Comparing data from Italian Government official documents
Cipe 2002 Napl Nap2 (draft) Nap2
GHGs Emissions in 1990 (MtCO2eq) 521.0 508.0 519.79 519.5
yoto Target (MtCOeq) 487.1 475.0 486.01 485.7
GHGs Emissions in 2000 (MtCO2eq) 546.0 543.9 583.33° 580.7°
BAU Scenario to 2010 (MtCO2eq) 579.7 613.3 na. na
Distance from Kyoto target (MtC 0 2eq) 92.6° 138.3" 97.32" 95°
Scenario with P&M to 2010 (with CDM) (MtCO2eq) 528.1 563.7 na. na
Energy Industry Reference Scenario (MtCO2eq) 144.4 175.3 na. na
industry Reference Scenario (MtCO2eq) 80.2 83.6 na. na
[Transportation Reference Scenario (MtCO2eq) 134.7 136.8 na. na
Residences Reference Scenario (MtCO2eq) 68.0 68.0 na. na
[Total allocated allowances (wtco2/year) na. 223.6 eee. Pe
[Thermoelectric sector cap (MtC O2/year) 124.1 131.1 100.66 85.29
referred to 2004
» referred to 2000
including reserve for new entrants
As one can see from the table, figures changes more or less in each document. In relation to the forecast, a
certain degree of fluctuation could be normal but the continuous adjustment of past emissions (and,
consequently, of the target) is hardly credible. Furthermore, most of the declared policies have not been
implemented yet. According to the CIPE 2002, between 2003 and 2010 Italy should abate, at least, 51
MtCO> through already specified actions, but, as one can see from Fig. 1, the real situation is completely
different. Finally, ETS caps are quite fluctuant and for involved sectors this could be harmful.
The picture below compares these figures to official statistics from ENEA and EEA (ENEA 2006, EEA 2007).
Figures seem to be quite unclear but one thing is sure: Italy is absolutely not on the track to reach any
emissions reduction. In 2004 emissions were 19% over the target and the EEA scenario forecasts an
emissions surplus of about 20% in 2010.
Fig. 1: Italian GHGs emissions according to different documents and official statistics (MtCO2eq)
600
580
EEA forecast
560
540
520 rs =
= ca ENEA 2006
500
4380
460
1990 1995 2000 2005
2010
The ICE model
ICE (Italy's Carbon Emissions) is a System Dynamic model built to study the EU ETS scenario concerning
the Italian power sector. Actually ICE is part of a more complex model named IRED: IRED simulates different
scenarios about economic growth, energy demand and _ fuel mix for Italy in 2005-2030. Starting from these
scenarios, ICE derives figures on CO. emissions and trading for the electricity sector. The following picture
shows the basic structure of the two models.
Fig 2: IRED and ICE basic structure
(i Economic Growth
IRED EN
Energy Intensity &
Electricity Intensity,
Energy consumption &
Electricity consumption
*} European Energy Policy
Soo (20-20-20)
Fossil fuels Detailed cost
-—_ analysis
CO2 Emissions
(thermoelectric)
SS
x
(For a detailed description of IRED refer to Ballardin-Di Giulio-Migliavacca 2008)
As one can see from the picture, IRED’s key drivers are economic growth, primary energy intensity, and
Emissions Caps
(thermoelectric)
at = control variable
ICE model
electricity intensity. Economic development is set to take exogenous paths at 1%, 1.5%, and 2%, in line with
Italy's macroeconomic performances over the last 10 years. Italian primary energy intensity time series has
shown a upside-down-U-shaped curve peaking in the mid-Seventies. This indicator has then asymptotically
reached its steady state, hovering 0.09 Mtep per 2000 USD at Purchasing Power Parity (IEA data). 0.09 is,
hence, projected to be to future Italian primary energy intensity. Electricity intensity is interpolated
econometrically, provided its satisfactory linear fit. The model thus adopts three electricity intensity
scenarios. The more energy-intensive one projects the linear regression. The other two assume more
moderate expansions, having respectively 2/3 and 1/3 increase rates of the energy-intensive forecast.
Combining electricity intensity and economic growth, IRED simulates different fuel mix scenarios for power
generation. Since the power sector is the major actor in the EU ETS, this is a core element to estimate
carbon emissions level and then compare it to the sectorial cap. We consider different CO. price dynamics in
order to simulate diverse carbon market scenarios. ICE could also include hypothesis about Phase Ill, since
the time horizon runs to 2030.
Control variables are marked with a little sun symbol: the model can perform a large number of scenarios but
we focus only on a small sub-group. In particular we run the business as usual scenario under different
hypothesis concerning the power sector fuel mix:
e Constant fuel mix: the relative weight of each primary source is supposed to be constant (referring to
2005 National Energy Balance)
e Gas driven fuel mix: gas share is supposed to increase from 48 in 2005 to 52% in 2012
¢ Coal driven fuel mix: coal share is supposed to increase from 23 in 2005 to 30% in 2012
Another interesting sub group of scenarios is linked to the new European Energy Policy. As one can see
from Fig. 2, it would strongly influence consumption, fossil fuel mix, renewable energy share and carbon
emissions. In particular, we would remind that the last EU package on climate change sets two main targets:
e A reduction of at least 20% in greenhouse gases by 2020
e A 20% share of renewable energy in EU energy consumption by 2020
Moreover “the EU goal of saving 20% of energy consumption by 2020 through energy efficiency is a crucial
part of the puzzle” (European Commission, 2008). Reaching these targets would mean to start a revolution
in the European economic system, especially in the energy sector. As far as Italy is concerned, the recent
history suggests that there is no room for revolutionary energy policies. In such a context, implications for the
carbon market could be very huge. That is why we include a 202020 scenario in our model, even if it does
not sound realistic for Italy. To build this scenario we refer to the Italian Position Paper “Energy: issues and
challenges for Europe and for Italy” (2007). To comply with European targets, renewable energy should
reach the 17% of total primary energy in Italy: the Position Paper evaluates the total maximum theoretical
national potential for renewable energy at 2020.
Simulations
ICE base year is 2005 and simulations cover the period from 2005 to 2030. As we said before, the model
entails a large number of control variables. Three energy scenarios are at study:
Scenario 1: a business as usual scenario with a sensible natural gas share increase (BAU natural gas).
Scenario 2: a business as usual scenario with a sensible solid fuels share increase (BAU coal)
Scenario 3: the Position Paper scenario: to comply with the 2020 goal, renewable energy in power sector will
increase up to 17% of TPES. Renewable shares (solar, wind etc...) included in this scenario refer to the
Italian Position Paper while non-renewable’s share is determined residually.
For each of them, we focus on Phase II and apply three different hypothesis (A, B and C) on the CO; price:
Tab. 6: ICE model - different CO. price scenarios (Euro/tCO2)
Price Scenario A Price Scenario B Price Scenario C
2008 20 15 15
2009 20 20 20
2010 20 15 25
2011 20 10 35
2012 20 5 45
Scenario A entails a CO price that remains constant on average (20 Euros). In Scenario B we suppose that
for some reason there will be a large number of available allowances on the market. Consequently the price
will go down at the end of Phase Il. On the contrary, Scenario C assumes a short market, and therefore a
strong increase in carbon price.
Scenario 1
The following tables sum up the main assumptions and results of this first scenario. The GDP growth rate is
fixed at 1.5% per year. The share of renewable energy in power generation is supposed to be around 5% of
total primary energy supply. The non-renewable fuel mix in 2005 is based on the National Energy Balance;
from 2008 to 2012 we assume that the natural gas share will increase by 4%. From an environmental point
of view this is a good option to limit CO, emissions but could be more expansive (compared with Scenario 2)
and harmful for the security of supply. Electricity generation cost is about 0.06 Euro/kWh.
Specific fuel emissions coefficients are taken from NAP2 and refers to Best Available Technologies: to some
extent they could under-estimate emissions.
During Phase II, power sector's emissions will raise from 151 to 160.3 (+6.2%) while the cap will decrease
from 101.3 to 71.9 (-28%). Consequently the gap will grow very fast from 49.7 to 88.3. The model do not
consider CDM and J | projects since NAP 2 stated that they will be implemented in non-ETS sectors.
Tab. 7: Scenario 1 - main features
diectrety thermoelectric | Natural | 4, | Solid | COzemissions | EU ETS Emissions
pronicton production Gas fuels (a) caps (b) surplus (a-b)
TWh TWh % % % MtCO, MtCO2 MtCO2
base year
2005 303.44 253.61 0.48 0.29 0.23 144.45 131.08 13.37
2008 309.64 269.02 0.50 0.28 0.22 150.97 101.27 49.70
2009 315.97 274.36 0.50 0.28 0.22 153.24 93.03 60.21
2010 322.42 279.81 0.51 0.28 0.22 155.54 85.96 69.58
2011 328.99 285.37 0.51 0.27 0.21 157.90 74.27 83.63
2012 335.68 291.03 0.52 0.27 0.21 160.30 71.93 88.37
The total cost of trading for the power sector is presented in the next table: Scenario C is the worst one
because of the raising in CO> price. As far as Scenario B is concerned, we obtain a lower but still significant
cost (about 3.9 billions of Euros).
Scenario 1 - annual cost for Italian power sector under different price scenarios
ions of Euros 2008, discounted at 5%)
Price Scenario A Price Scenario B Price Scenario C
2008 994 746 746
2009 1147 1147 1147
2010 1262 947 1578
2011 1445 722 2528
2012 1454 364 3272
total 6302 3925 9270 ]
Since ICE allows simulations beyond 2012, one could perform a speculative scenario on Phase Ill (2013-
2017). For example, assuming that in five years the cap for power sector will decrease from 70 to 60
MtonC Oz, results are shown below:
Tab 9 - Phase Ill results assuming 20 €/tonCO2
ay thermoelectric C02 EU ETS caps Emissions Discounted annual
wedi production | emissions (a) | Phase ll (b) | surplus (a-b) | ‘pst ot mlowance
TWh TWh MICO, MtCO2 MICO? Millions Euros 2008
2013 356.54 296.81 162.78 70 3 1460
2014 363.75 302.71 165.24 67 98.08 1464
2015 37L11 308.72 167.78 65 103.01 1464
2016 378.60 314.85 170.38 62 107.99 1462
2017 386.23 321.10 173.02 60 113.02 1457
*discounted rate 5%, base year 2008
As electricity production from fossils grows, emissions goes up and the emissions surplus continue to
increase. The estimated annual average cost of ETS is about 1.46 Billion Euro 2008.
Scenario 2
Scenario 2 is based on the same macroeconomic assumption of Scenario 1. The distinctive feature is the
fuel mix: during Phase Il the share of solid fuels in power generation raise from 26 to 30%. As a
consequence, in the same years natural gas decreases from 46 to 43%.
The end result is a sharp increase in emissions due to the higher carbon intensity of solid fuels. The
difference between power sector emissions and the cap will increase from 54 to 98.8 MtCO, (+83%). On
average the gap is about 10% higher then in Scenario 1 and, accordingly to that, the cost of EU ETS will
increase by the same percentage.
Tab. 10: Scenario 2 - main features
thermoelectric Natural Solid CO2 EUETS Emissions surplus
production Gas Oil fuels emissions (a) caps (b) (a-b)
TWh % % % MtCO2 MtCO2 MtCO2
2008 269.02 0.46 | 0.28 0.26 155.28 101.27 54.01
2009 274.36 0.45 | 0.28 0.27 159.03 93.03 66.00
2010 279.81 0.44 | 0.28 0.28 162.86 85.96 76.90.
2011 285.37 0.44 | 0.27 0.29 166.77 74.27 92.50
2012 291.03 0.43 | 0.27 0.30 170.75 71.93 98.82
Tab. 11: Scenario 2 - annual cost for Italian power sector under different price scenarios
(Millions of Euros 2008, discounted at 5%)
Price Scenario A Price Scenario B Price Scenario C
2008 080 810 810
2009 1257 1257 1257
2010 1395 1046 1744
2011 1598 799 2797
2012 1626 406 3658
total 6956 4319 10266
Scenario 3
The third scenario complies with the 2020 European target about renewable energy. It is a highly challenging
goal, but at the same time it is a big opportunity for Member State to invest in R&D and to gain ground in this
sector at international level.
The model assumes that renewable energy will reach the 17% of Total Primary Energy Supply (TPES) in
2020, as required by the EU. This strong increase in renewable sources is concentrated in the power sector,
with relevant investment and operative cost. As a consequence, electricity generation from non renewable
sources decreases and total generation cost raises from 0.077 to 0.097 Euro/kWh during Phase Il.
Referring to the following table, thermoelectric production falls from 232 to 199.6 TWh in five years (-14%)
and fossil fuels mix is supposed constant.
Tab. 12: Scenario 3 - main features
thermoelectric Natural Solid CO, emissions EU ETS caps Emissions surplus
production Gas Oil_|_ fuels (a) (b) (a-b)
TWh % % % MtcO2 MtCO2 MtCO2
2008 232.11 0.48 | 0.29 0.23 133.19 101.27 31.92
2009 224.41 0.48 | 0.29 0.23 129.16 93.03 36.13
2010 216.43 0.48 | 0.29 0.23 124.98 85.96 39.02
2011 208.16 0.48 | 0.29 0.23 120.65 74.27 46.38
2012 199.61 0.48 | 0.29 0.23 116.17 71.93 44.24
CO, from power generations goes down by 13%, from 133.2 MtonCO> in 2008 to 116.2 MtonCO> in 2012.
Nevertheless, this reduction is not enough to comply with NAP2: the emissions surplus is still positive and
increases from 31.9 to 44.2 MtCO>.
Tab. 13: Scenario 3 - annual cost for Italian power sector under different price scenarios (Millions of Euros 2008,
discounted at 5%)
Price Scenario A Price Scenario B Price Scenario C
2008 638 479 479
2009 688 688 688
2010 708 531 885
2011 801 401 1402
2012 728 182 1638
totale 3564 2281 5092
On the one hand, total cost of EU ETS is the lowest compared with Scenario 1 and 2. On the other hand,
one should also consider the overall cost of implementation for scenario 3: expanding renewable energy
from 5 to 17% of TPES in less then 12 years would entail considerable costs (about this issue, see
Ballardin-Di Giulio-Migliavacca 2008 ). As a result overall electricity prices could sharply increase.
Conclusions
This paper aims to answer a big question: Italy, Kyoto and ETS, a missed chance? Even if the Kyoto
Commitment period and the EU ETS Phase Il are just at the beginning, we could try to guess an answer.
Our guess is based mainly on the recent Italian energy policy and on the forecasts by ICE model.
As far as the Italian Energy policy is concerned, one would say that Italy suffers from a wishful thinking
syndrome, that is thinking as true something that is desirable. In fact, there is a huge distance between the
policy stated in the official documents and real actions. So, the stated policies are interpreted as truly
realised while they are just simple declarations on paper. This creates a self deception mechanism. The EU
ETS preliminary phase has been quite a sad proof of the Italian willingness to pass from word to action. In
relation to the future, the ICE model gives a valid quantitative framework to support our analysis. As already
mentioned, the study focuses on the Italian power sector as a major responsible for CO, emissions. The
graph below summarize the sectorial emissions surplus in three different scenarios. The gap is always
positive and grows roughly when passing from Phase | to Phase Il. It is worth noting that Scenario 3 entails a
tough change in the energy sector (a sharp increase in renewable energy crowds out fossil fuels in electricity
generation) but it is not enough to comply with the EU ETS caps. In other words, it seems that in Italy there
is no hope of success for ETS.
Fig. 3: Power sector - gap between forecasted emissions and ETS cap (MtonCO2)
= = Scenario 2. ——Scenario 1 —%-Scenario 3 |
120
100 sistae
80 ee es
60 — ue
‘i . y, ot
» ees Cz,
0
2005 2006 2007 2008 2009 2010 2011 2012
ICE gives also a detailed picture of monetary costs of the second phase of EU ETS. The following table
sums up some useful numbers.
Tab 14: EU ETS - Phase II: total cumulated cost of allowances for Italian power sector under different scenarios
(Millions of Euros 2008, discounted at 5%)
Price Scenarios
Scenario A Scenario B Scenario C
3 2 Scenario 1 6302 3925 9270
5 § Scenario 2 6956 4319 10266
Scenario 3 3564 2281 5092
We report the cumulative cost. Scenario 1 and 2 are the most feasible: the cumulate expenditure goes from
3.9 to 10.2 Billions of Euros, depending on the market price of CO». In Scenario C, the CO2 price raise up to
45 Euro/tCO2 but we cannot exclude a short market and then higher prices.
If one considers also a third phase of trading (and then targets that go beyond 2012), the picture is even
worse: given the current European debate, Phase Ill would involve new plants and sectors, with more
stringent rules. Moreover, we cannot exclude that the price of carbon credits will be higher than 45
Euro/tC 02, due to the fact that other European countries will be in the same situation like Italy.
Anyway, given the troubled Italian public finance situation, buying carbon credits could represent an
unplanned, and maybe not feasible, heavy burden.
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