Carbon mitigation strategies in the heat and power sector and the efficiency of the European Union emission trading scheme (EU ETS)

Transcription

1 Carbon mitigation strategies in the heat and power sector and the efficiency of the European Union emission trading scheme (EU ETS) Anders Sandoff, Gabriela Schaad and Jon Williamsson Industrial and Financial Management & Logistics, School of Business, Economics and Law, University of Gothenburg, SE Gothenburg, Sweden Discussant: Håkan Pihl, Lund University Abstract The European Union committed itself to reduce greenhouse gas emissions with 20% below 1990-levels by 2020, and the EU ETS is the main instrument to reach this goal. Emission trading reallocates emission reductions among installations in a long-run cost-minimizing manner, while offering flexibility to companies to develop a carbon mitigation strategy that suits their individual needs. The power sector is a key industry for carbon mitigation, generating roughly 70% of CO2 emissions regulated under the scheme. In the third trading period, power companies face a stiffened allowance regime and will no longer receive any free allocation. This paper examines the carbon mitigation strategies of Swedish heat and power companies, facing zero allocation already in the second trading period. Data from these companies have been singled out from two surveys conducted in 2006 and 2009 investigating the Swedish Trading Sectors participants climate strategies under the EU ETS. Three areas are of interest to draw conclusions on the efficiency of the scheme: the organization of allowance management, the use of compensatory measures and corporate carbon mitigation strategies. It is concluded that although there are developments to be seen in both emission reductions and allowance management, there are few indications that this is a result of a stiffer allocation regime. Surprisingly, the biggest change observed lays in the increased efficiency handling the system. It can be concluded that the EU ETS has a number of unintended effects, mostly due to the fact that the theoretical assumptions of the model do not stand up to the conditions of management. Companies take advantage of the operating flexibility provided by the scheme rather than of its potential for long-run cost reallocation. Based on the results from the Swedish sample, it can be questioned whether the stiffened allowance regime will have any significant effect on carbon mitigation strategies of energy companies in the rest of Europe.

2 1. Introduction The European Emission Trading Scheme (EU ETS) is the European Union s most important policy tool to reduce its greenhouse gas emissions (GHG) in accordance with the 2020 targets and the commitments made under the Kyoto Protocol (EU, 2003, 2008a). The scheme currently includes more than energy-intensive installations from a broad range of industries, covering close to 40% of the EU's GHG emissions (EU, 2008b). Its aim is to reduce GHG emissions in a cost-efficient way by allowing for emission allowances to be traded under a given cap. The size of the cap determines environmental effectiveness, whereas the distribution of allowances affects participants competitiveness (IPCC, 2007). After a pilot phase from , the scheme is now well into its second trading period, involving a tighter cap of emissions allowances (EC, 2008). A market-based approach to environmental policy highlights the role of price signals as incentives to alter the behavior of polluting firms (Hanemann, 2010). The market price for emission allowances reflects the abatement costs of the companies subject to the scheme, whereas putting a price on carbon creates incentives for a shift towards low-carbon technologies, processes and products (Schleich & Betz, 2005). Emission trading reallocates emission reductions among installations in a long-run cost-minimizing manner (Hanemann, 2009), while offering flexibility to companies as to the timing of investments and the choice of technology (Hahn & Stavins, 1992). This offers considerable managerial discretion for companies to develop a carbon mitigation strategy that suits their individual needs (Sandoff & Schaad, 2009; Kolk & Pinkse, 2005). Corporate strategies related to climate change policy in general, and emission trading in particular, are frequently discussed referring to specific industry sectors, given that companies from the same industry often take similar positions for economic and political reasons (e.g. Pinkse, 2007; Laurikka & Koljonen, 2006). Moreover, they largely produce and market the same products and/or services and, as a result, share many economic and technological characteristics (Levy & Kolk, 2002). The power sector is a key industry for the mitigation of greenhouse gases. While the generation of electricity and heat accounted for 41% of CO 2 emissions worldwide in 2008 (OECD & IEA, 2010), the power sector generated approximately 70% of CO 2 emissions in the EU ETS in that year (EU, 2010a). Whereas most industries received emission allowances for free based on recent historical emissions, many member states allocated fewer allowances to power sector companies relative to their past 2

3 emissions. This was motivated by the fact that the sector is less exposed to competition from non-european countries and the belief that the power sector has the ability to abate emissions at a lower cost compared to other sectors (Convery et al., 2008). In the third trading period, the regime for power companies will be stiffened and full auctioning will apply for the sector (EC, 2010b). The absence of free allowance allocation will presumably change the valuation regime for emission allowances from one based on opportunity costs to one based on real cash outlay. Such a carbon-constrained business environment could magnify the negative impact of the EU ETS on firm profitability, if no actions are taken. To maintain competitiveness, power companies will be urgently required to formulate a carbon mitigation strategy that reflects the companies individual resource base and capabilities. The corporate responses to the stiffer allowance regime will not only be central to achieving EU s emission targets, but also to the cost-efficiency of the scheme. It is thus important to investigate the potential carbon mitigation strategies power sector companies may pursue when facing this new reality and the implications this might have on the efficiency of the system. This paper contributes to the scarce empirical literature on how power sector companies respond to the compliance requirements imposed by the EU ETS. The focus lies on Sweden, where heat and power companies have been faced with zero allowance allocation already in the second trading period 1. By investigating the responses of Swedish heat and power sector companies to the EU ETS in the first and the second trading period, we aim at elucidating the carbon mitigation strategies pursued in response to the changed allowance regime. We further intend to examine the role emission trading plays in such strategies and the likely implications for the efficiency of the EU ETS. We aim at drawing conclusions as to whether or not the changed valuation regime created additional incentives to reduce emissions, and if this change had any positive impact on the cost-efficiency of the system. The rest of the paper is structured as follows: the next section gives a short overview on energy and climate policy in the EU and Sweden. Subsequently, section 3 accounts for the research design and data used. In section 4, the results are presented and analyzed. The paper closes with a discussion and the conclusions drawn. 1 With the exception of a few new installations. 3

4 2. Swedish energy and climate policy Within the framework of the Kyoto Protocol the European Union committed itself to reduce greenhouse gas emissions by 8 % from 1990-levels until 2012, and the EU ETS is the main instrument to reach this goal. In addition, a climate and energy package was agreed upon in December 2008, putting forward the targets. Accordingly, 20% of EU s energy consumption should come from renewable resources by 2020 (EC, 2010), and for the part of Sweden an increase of renewables from 40% to 49% is suggested (SEPA, 2008). Furthermore, the EU emission reduction goal is further sharpened aiming at a cut of at least 20% below 1990-levels by 2020, and lastly, energy efficiency should be increased by 20% until 2020 (EC, 2008). Sweden is seen as a predecessor in mitigating its impact on the natural environment. Since the mid-1990s Sweden has pursued a path of ecological modernization with the aim to transform the Swedish welfare state into a green welfare state (Eckersley 2004). Especially the implementation of ecologically sustainable development gained momentum. In 1997, Sweden adopted a bill on Sustainable Energy Supply (Cabinet Bill 1996/97:84) which set the base for the transformation of the energy system and drew up principles for the environmental and climate agenda in the years to come. In particular, increased renewable electricity generation was encouraged with a focus on biomass and wind (EREC 2004). An important element of Swedish environmental policy is the tax burden shift in favor of green taxes initiated in 2001 ( grön skatteväxling ), increasing taxes on environmentally harmful consumption (Government Offices of Sweden, 2009a). The ambitious environmental and climate policies also aimed at demonstrating that it is possible to combine proactive climate policies with economic growth (Ministry of the Environment, 2007). These efforts resulted in the desired effects; greenhouse gas emissions lay seven percent below 1990-levels in 2005, whereas the economy has grown by 36 percent during the same period. In addition, Sweden had the highest proportion of renewable energy in the EU in 2006 and by then CO 2 emissions from the Swedish stationary energy sector had decreased by 5 % from 1990-levels (SEA, 2008a). Sweden is today seen as a leading country within Europe when it comes to developing sustainable energy systems based on biofuels (Wimmerstedt, 1999; Ericsson and Nilsson, 2004). The wide-spread use and continuous expansion of district heating (Reidhav & Werner, 4

5 2008; Ericsson et al., 2004) is seen as a major contributing factor 2 to this development, given that biomass, waste and recycled heat from electricity production and industrial activities make up 70% of the fuels and energy used in CHP (combined heat and power production) and heat production (SDHA 2011). In 2008, only 17% of fuels used in district heating were fossil, including 6% peat. (SEA 2010). Industrial waste heat Heat pumps Electricity Oil products Biomass, waste and peat Coal and Coke Natural gas Figure 1 Fuels and energy sources in CHP and heat production (p 14, SEA, 2010) The success of Swedish climate policy is accredited to the use of economic instruments. Notably, these have contributed to increasing the use of biofuels and district heating (Ministry of the Environment, 2007). Taxes and charges have traditionally been the most important instruments to influence the development of the energy sector (Sandoff et al., 2007). In 1991, 2 District heating is the most common form of heating in apartment buildings, commercial and public premises (about 76 % and 59 % respectively in 2006, corresponding to a total of 37 TWh) (SEA, 2008b) 5

6 Sweden introduced a CO 2 tax as one of the first countries in the world 3. In later years, marketbased policy instruments, which are generally seen as more cost-efficient, have gained importance (Gov bill 2001/02:143). In 2003, green electricity certificates were introduced to stimulate the generation of electricity from renewable sources such as wind power, hydro power and biofuel-based CHP. This scheme has recently been extended to 2030, creating better long-term investment conditions for renewable energy (SEPA, 2011). Together, these measures have contributed to the phase-out of fossil based power production plants (condensing or gas turbine) so that they only make up 0.3% of the Swedish electricity production in 2009 (SEA, 2010). Swedish government further has the vision to achieve a sustainable and resource-efficient energy supply without net emissions of greenhouse gases by 2050 (Government Offices of Sweden, 2009b). As shown, the Swedish heat and power sector has for some time been steered towards cutting CO 2 emissions and has succeeded in reducing its carbon footprint significantly. Initially, the EU ETS can be thought of as reinforcing existing policies. In the first trading period, Swedish heat and power companies were allocated emission allowances corresponding to 80% of their historical emissions. In contrast, zero allocation in the second trading period assumingly created a more acute situation, making carbon strategies a prominent issue 4. It should however be noted that, given Sweden running an ambitious climate policy over a long period, the marginal cost for additional emission abatement is high (OECD, 2011). Nevertheless, measures taken by the energy sector are likely to continue to play a crucial role in the transformation of the overall energy system towards sustainability. 2.1 Competitive setting and allowance pricing in district heating companies District heating companies are not subject to direct short term competition because their technological base has the characteristic of a natural monopoly. This means that the company is relatively free to implement the price changes it sees necessary. The situation should be comparable to the one observed in the European electricity market, where electricity producers transfer a significant part of the costs of freely allocated CO 2 emission allowances to their customers (p.2, Sijm et al., 2008). The change of valuation regime, from opportunity costs to real cash outlay, will most probably have consequences on the price 3 Carbon tax amounted to SEK 1.05/kg CO 2 in 2010 (Samakovlis, 2011). Electricity production is, however, exempt from CO 2 tax, whereas combined heat and power production receives a tax reduction of 79 percent. (EMI, 2007). 4 It should be noted that electricity producers are seen to have greater possibilities to burden their customers with additional costs caused by the EU ETS, compared to district heating providers. A shortage in emission allowances does thus not necessarily lead to emission reduction measures, even if these should be cheaper. 6

7 level. Even though some of the allowance value might already have been incorporated in the district heating price, it is reasonable to assume that the transfer will be increased once the change of valuation regime is established. The conditions are similar to what one can expect taking place in the electricity market, albeit without extensive opportunities for windfall profits. 3. Methodology 3.1 Research design and analysis of missing data The data used in this paper is based on two investigations; the first was commissioned by the Swedish Environmental Protection Agency in 2006 and the second by the Swedish Energy Agency in Data was collected by means of web surveys sent to all Swedish companies subject to the EU ETS in 2006 and 2009 based on the list of installations included in the scheme. Prior to constructing the first survey, a number of interviews were held with allowance managers from industry and energy sector companies to gain an understanding of relevant corporate issues emanating from the EU ETS. Subsequently, survey questions were elaborated jointly with the agencies involved. For the second survey, comments received and lessons drawn from the first survey were carefully considered. The questionnaires for the two surveys were constructed with different web-tools but had similar layouts and mechanics. The survey contained 51 questions in 2006 and 65 questions in In addition to a number of background questions, both surveys were structured around three basic themes: the organization of allowance management, allowance trading and carbon mitigation strategies. For both surveys, respondents were given a period of three months to reply to the questionnaire. At any time during this period, they could revise their replies by logging into their individual questionnaire. Respondents who had not entered their replies were given two reminders. For the purposes of this study, companies classified as traditional energy companies have been screened out from the original population. The sample was thoroughly examined in order to eliminate industry and other companies that are not mainly providers of heat and power, thereby creating a sample as homogenous as possible 5. The final population of energy sector companies comprised 116 companies in 2006 and 115 companies in 2009, representing 52% of the total population in both surveys, and the response rate within this sector was 48% 5 Moreover, investigating the heat and power sector only, enables us to analyze the data in the light of lessons learned in earlier trading schemes aimed at the sector which have been running for a longer period, such as the U.S. sulfur dioxide (SO2) scheme operational since

8 in 2006 and 54% in the following survey. The respondents were thus 56 companies in 2006 and 62 companies in Table 3.1 below shows that the group of small companies was underrepresented in the 2006 survey, while medium and large companies were overrepresented. Hence, the distribution of respondents is somewhat skewed towards medium-sized and large companies. However, the imbalance is not severe enough to endanger the quality of the results in general. Table 3.1 Distribution and response rate of heat and power companies according to size Classification Class definition Distribution of total population Distribution of respondents Size Small (0-100) 41 % 33 % 27 % 29 % (gross turnover, MSEK) Medium ( ) 49 % 57 % 59 % 58 % Large (>1000) 10 % 10 % 14 % 13 % The correspondence of the sample with the population was further analyzed in terms of average and median gross turnover, both for the entire sample and for each of the three size categories (Table 3.2). For 2006, the sample exhibits a higher average turnover, mainly explained by the respondents in the class of large companies. In 2009, the opposite is true when the average turnover is lower; again this is explained by the respondents in the class of large companies. Table 3.2 Distribution of gross turnover in total and according to size (MSEK) 2006 Total Small Medium Large Population/Sample Pop./Sample Pop./Sample Pop./Sample Min 18/19 Max 42021/42021 Mean 831/ /54 285/ /9484 Median 130/154 60/60 200/ / Total Small Medium Large Population/Sample Pop./Sample Pop./Sample Pop./Sample Min 0.8/0.8 Max 32121/5000 Mean 850/617 48/54 342/ /3267 Median 177/180 44/50 246/ /3564 However, considering the median turnover, these differences are rather marginal and should not impose any problems when interpreting the results. The results section contains 20 questions from the first survey and 28 questions from the second. Hence, eight questions in the second survey have no corresponding question in the first. Where questions differed in their wording between the first and the second survey, this is indicated in a footnote. The internal response rate for the questions used in this paper was 8

9 close to 97%, except for questions regarding emissions trading in the 2006 survey, where the response rate fell to approximately 45%. 4. Results and analysis 4.1 Climate change perceptions and drivers for mitigation As an important foundation for allowance management and carbon mitigation strategies of Swedish heat and power companies, we first look at the perception of climate change and its importance for business. Despite growing certainty regarding the underlying science and intense political efforts to mitigate climate change, the potential impact of the phenomenon on corporations, markets and technologies remains uncertain (e.g. Pinkse & Kolk, 2009). Companies frequently have difficulties to assess what really is at stake. Whether an environmental issue is framed as a threat or an opportunity by managers has an impact on actions taken and strategies adopted by companies (Sharma, 2000). Managers who perceive climate change to involve mainly risks, may tend to rely more on compensatory measures than internal abatement. Compensatory measures do not require the management of organizational changes to the same extent as the implementation of new processes or production technology (Kolk & Pinkse, 2005). In contrast, companies that see opportunities arising from climate change may focus more on internal measures and may be more willing to take the risk of investing in new technology, partly because they see this as essential for longterm survival (Kolk & Pinkse, 2005). Implicit in these interpretations is the assumption that risk is seen as holding a larger amount of uncertainty of the consequences of climate change than the perception of opportunities does. In our surveys the energy companies were asked whether they perceive global climate change mainly as a threat or an opportunity for their competitiveness 6 (Table 1). In 2006, slightly more than half of the energy companies, particularly large ones, framed the political efforts connected to climate change as involving both risks and possibilities for their competitiveness. Only 22% saw these efforts as offering mostly opportunities. In 2009, 57% of energy companies perceived climate change as an opportunity. Less than a third of respondents framed the issues in terms of both risks and opportunities. The results indicate that the respondents experience less uncertainty about the consequences of climate change in 2009 than in (Table 1) 6 In 2006, the question referred to whether the political efforts to combat climate change represent a risk or a possibility for the company s competitiveness, which is however seen as intimately linked to the 2009 question relating to the threat and opportunities arising from climate change. 9

10 When asked about whether or not it is important for the company s competitiveness to manage climate-related issues well (2009 survey only), a large majority considered this capability as very important or important (46% and 36% respectively). Only 5% of respondents regarded this to be of no importance for their competitive position. To judge from Table 2, climate change mitigation can nowadays be considered to be a prominent issue on the managerial agenda. (Table 2) In addition, the most important drivers for reducing the company s CO 2 emissions were investigated in the 2009 survey (Table 3). Companies were asked to rank a number of potential factors influencing emission reduction efforts. Taking into consideration the results for the three most important factors, companies graded taxes and other environmental policy tools as the most important driver for reducing their CO 2 emissions, followed by the price for emission allowances. The management s environmental commitment is a slightly more important driver than energy costs. In sum, the compound of policy tools exerts the greatest influence on emission reductions, but also management commitment to environmental issues and energy cost savings are important drivers. (Table 3) A major explanation to the participants acute consciousness of how climate change affects them and the importance placed on managing related issues well may be found in the fact that climate-related issues have been high on the public agenda throughout the investigated period. However, it is reasonable to assume that these results are augmented by the shift from opportunity-based consequences to real cash flow consequences since it is now a real cost item. In the next section we proceed to aspects linked to the actual management of EU ETS in organizational and strategic terms. 4.2 Organization of allowance management This section investigates company responses to the EU ETS in terms of carbon-related goals and other climate-related measures, the scope of administrative input and how responsibilities connected to allowance management issues are distributed within the companies. By studying the organization of allowance management over time we improve the understanding of how the EU ETS affects companies in terms of objectives, workload and the internal coordination of management tasks and responsibilities. 10

11 Taking stock of emissions and setting environmental objectives, e.g. to reduce emissions of CO 2, usually foregoes the actual emission reduction and can be seen as a first step towards a more sophisticated carbon mitigation strategy (Kolk & Pinkse, 2005). In the surveys, companies were asked if they have concrete objectives for a reduction of CO 2 emissions (Table 4). Quite naturally, this was less common in 2006 than in The percentage of companies with concrete objective increased from 31% to 56% over the period. Surprisingly, it is more common in both years for small and medium-sized companies to have concrete CO 2 reduction objectives than for large companies. When asked about the scope and type of such objectives (2009 survey), 36% of the respondents reported company-wide objectives, 11% plant-specific objectives, 7% applied output-related objectives and 5% objectives related to product category or business line. (Table 4) Furthermore, 46% of the respondents calculated average emissions of CO 2 per unit of production, e.g. kgco 2 /MWh electricity. This was almost as common practice in small companies (44%) as in large ones (56%). The responses show, however, that common reporting practice on carbon emissions has not yet evolved. As pointed out by Kolk et al. (2008) further commensuration of carbon disclosure practices is necessary. The most common metric used was kgco 2 /MWh, followed by g/kwh. Further, the metric referred to heat production in most cases, followed by produced energy. The range of emissions ratios spanned from 0,004 kgco 2 /KWh to 159 kgco 2 /MWh, which is low compared to the average ratio for European power producers of approx. 400 kgco 2 /MWh (Eurelectric, 2010) 7. Furthermore, more than half of the companies worked with internal policies to reduce emissions from e.g. travelling, the corporate car fleet and energy use. Not surprising, large companies adopted such practices to a larger extent than smaller ones (Large: 67%, Medium: 56%, Small: 36%). Heat and power companies have a number of possibilities to manage and foster the transition towards a more sustainable energy supply. The companies were asked if they work with a number of possible measures to mitigate their impact on the climate (Table 5). Most strikingly, 57% of the companies invested in biomass-fired combined heat and power 7 Please note that the responses of the Swedish sample are not robust enough to calculate an average emission ratio. Widerberg & Wråke (2009) however calculated an average for the CO 2 intensity in Swedish electricity generation between at 10,53 kgco 2 /MWh. 11

12 production (CHP). Even, more than a third of small companies have done or are currently doing so. Investments in wind power occurred in 30% of the companies. However, while 56% of the large companies were investing in wind power, none of the small companies did so. Earlier studies of the SO 2 trading system report that the system had virtually no effect in promoting the use of renewable sources of electricity (Hanemann, 2009). To the contrary, investments in renewable energy production are widespread in companies subject to the EU ETS according to our sample. However, in view of the mix of policy tools directed at energy companies these investments are not necessarily an effect of the trading scheme. Furthermore, also the usage of industrial waste heat is common; in average 48% make use of waste heat. This is most frequently found in medium-sized companies. Furthermore, efforts to develop new technologies can be seen as extremely important to manage the transition towards a carbon-neutral energy system, and, from a corporate perspective, to gain a competitive advantage. Rightly so, 67% of large companies worked with research and development. As expected, the possibilities for medium-sized and small companies to engage in R&D are limited. As can be seen in Table 5, medium-sized companies are in average involved in 1,7 measures and large companies in 2,5. (Table 5) To form an opinion on the efficiency of EU ETS, it is of interest to know how labor-intense the administration of the system is and if learning occurred over time, resulting in a reduction of resources required for administration. Accordingly, respondents were asked about the compliance burden in terms of man hours spent per month (Table 6) and the number of people involved in the daily running of the allowance system (Table 7). Four main compliancerelated activities were identified: the measurement and verification of CO 2 emissions, allowance trading, reporting, and general allowance administration. In total, respondents spent on average roughly 35 hours/month on compliance-related activities in The largest part, 16 hours in average, was spent on measurement and verification. The other three tasks each took between six and eight hours per month. By the end of 2009, the average time spent on compliance-related activities had dropped to half, 17 hours. Measurement and verification now took in average just over 10 hours and the remaining activities between nearly two to roughly three hours each. This is a significant efficiency improvement, showing that participants over time learned how to handle these tasks in a time-saving manner. When looking at company size, small companies had decreased their average administrative input from 22 hours in 2006 to 12 hours in 2009, medium-sized from nearly 23 hours to 17 hours 12

13 and large companies from 116 hours to 32,5 hours. It should, however, be noted that in the 2006 sample of large companies one third consisted of very large companies, pushing up 2006 averages. Table 6 indicates that median values mostly lay below average values for 2006 and However, when comparing the medians for the total administrative time for EU ETS, these lay at 15,5 hours in 2006 and 10 hours for 2009, still indicating a noteworthy reduction. (Table 6) Regarding the number of persons involved in the tasks connected to the allowance system, there is little variation both across company size and over time (Table 7). On average, in nearly 75% of companies, two to four persons handle the tasks required according to both surveys. In approximately half of the large companies, between five and 25 persons were involved in both instances. Only one company reported more than 25 people being involved. (Table 7) Companies further have to make choices as to the organization of their allowance management in terms of tasks and responsibilities assigned to certain departments or functions. The way allowance management is organized and responsibilities are allocated gives an indication of the role and importance of the system for its participants. Changes over time might occur as a result of shifting priorities or for practical reasons. Following Sandoff & Schaad (2009), we investigated how responsibilities have been assigned with respect to four EU ETS related management tasks. Firstly, regarding the overall management of the allowance system (Table 8); secondly, with regard to emission reduction measures (Table 9); thirdly, regarding the decision to buy or sell emission allowances (Table 10), and lastly, relating to the actual trading of emission allowances (Table 11). Table 8 shows that the most common organizational units carrying the overall responsibility for the management of EU ETS tasks in 2006 were the production department (36%) and the management (33%). The former was more dominant in medium-sized companies and the latter in small companies. In large companies, none of the suggested departments dominated. In 2009, the management carried overall responsibility most frequently in small and mediumsized companies (44%, respectively 42%), while in 44% of large companies overall responsibility was borne by the production department. Hence, in medium-sized companies, a shift in responsibility from the production department to management could be observed, 13

14 which may indicate that the EU ETS became more important for the competitiveness of the firm and thus required more management attention. (Table 8) The management and the production department are the units most frequently responsible for emission reduction measures according to both surveys. Both in 2006 and 2009, the management was responsible for emission-reducing measures in 67% of small and 64% of medium-sized companies. Frequently, management and the production department assumed this responsibility jointly. The production department was the preferred option in large companies with 83% of responses in 2006 and 100% in 2009 (Table 9). (Table 9) Next, we asked which department takes the decisions whether to buy or sell allowances (Table 10). In 2006, the management took this decision in 65% of companies. Notable again is that this is the preferred option of small and medium-sized companies only (87% and 69% respectively). Large companies assigned this responsibility mostly to the trading or risk management unit. Management still mostly takes decisions whether to buy or sell allowances in 2009; however, the production department gained in importance regarding this decision, particularly in large companies. (Table 10) Which department performs the actual trading of emission allowances was asked next (Table 11). In 2006, the management was dominant in performing this activity in small and mediumsized companies, whereas the trading unit took care of emission trading in all large companies. In 2009, the picture changed somewhat with several units being involved. While the preferences from 2006 were still dominant, also the finance department is involved in a third of companies. In half of the companies, more than one department is involved, most commonly management and the finance department. (Table 11) Summing up, there appears to be a greater need to have knowledge on and control of emissions in the 2nd trading period. It is also obvious that companies have learned to administer the tasks related to EU ETS in a time-efficient manner. In addition, investments in renewable technologies and other measures to promote a sustainable energy supply are 14

15 frequently pursued. Relating to responsibilities, management and the production department are central nodes for the supervision, coordination and decision making relating to the EU ETS. Nevertheless, while small and medium-sized companies often make similar choices as to who assumes responsibilities, large companies frequently chose different solutions. 4.3 The use of compensatory measures Given that Swedish heat and power companies received free emission allowances corresponding to 80 % of their historical emissions during the 1st trading period and, as a rule, no free allowance allocation in the 2nd period, the valuation regime for emission allowances presumably changed from one based on opportunity costs to one based on real cash outlay. Furthermore, as allowances could not be banked between the 1st and the 2nd trading period, it can be expected that most firms experience an allowance deficit in the 2nd trading period. We asked companies if they had been allocated sufficient emission allowances for the then current trading period to conduct business as usual (Table 12). In 2006, 35% of companies replied that their allowance allocation was sufficient, compared to 65% who believed that it was insufficient to conduct business as usual. As expected, the share of companies who perceived allowance allocation to be sufficient fell in the 2nd trading period. Only 12% of respondents believed so. Three out of four companies had not received any allocation and 12% answered that the allowances received for free were insufficient. However, 55% of large companies were allocated emission allowances, although some of them indicated that the allocation did not cover business as usual. (Table 12) In principle, companies can choose to either buy or make emission reductions (Margolis & Walsh, 2003). Either emission allowances are purchased on the market (or by way of bilateral agreements) or internal measures are taken to reduce emissions. Obviously, these measures can be combined, i.e. part of the emissions can be reduced internally and the remaining shortfall covered via the market. According to theory, internal abatement costs are compared with the allowance price to determine which action to pursue (Hanemann, 2009). In this section we investigate to what extent companies engage in compensatory measures to handle an allowance deficit, i.e. purchase allowances via the market or bilaterally, or engage in the project-based mechanisms under the Kyoto Protocol, the Carbon Disclosure Mechanism (CDM) and Joint Implementation (JI), thereby getting additional allowances. 15

16 To begin with, companies were asked whether or not they were planning to take any measures in response to a potential shortage of allowances (Table 13). In 2006, 68% of companies reported that they planned to take measures, compared to 27% who did not do so, and 5% who did not know. In 2009, the share of companies planning to take some measures was lower, 45%, with a somewhat higher share in medium-sized companies (54%). A similar share of companies from all size groups, 32%, did not plan to do so, and 23%, predominantly small companies, did not know. The higher share of companies not planning to take any action might point at the fact that firms expect that sufficient measures have been taken in the previous trading period to minimize the impact of the EU ETS. This implies that the change of valuation regime did not increase the incentives for planning further actions. Considering that almost a fourth of companies do not know whether or not they were going to take any measures, it may be suggested that there is considerable uncertainty regarding the impact of EU ETS in the short run. Hence, firms experience difficulties in assessing whether or not taking measures is appropriate, and if so, what kind of measure. (Table 13) Subsequently, companies were asked how they were planning to cover a potential shortage of allowances in the next trading period by indicating the most important compliance measure from a number of options (Table 14). As indicated, at an aggregate level, the choice of compliance measure can give an indication of the efficiency of the scheme. This choice is interesting in the light of earlier discussions on autarchic behavior (Kreutzer, 2006), i.e. when firms do not comply with their emission cap by way of arm s-length transactions on a market, but revert to internal measures (such as reducing emissions, the use of banked allowances from prior allocation, or the reallocation of allowances between different installations). Autarchic behavior has an impact on the cost-effectiveness of the scheme, if gains from trade are not sufficiently exploited (Hanemann, 2010). For compliance purposes, basically four measures are available: (1) purchasing allowances on a CO 2 -exchange or bilaterally, (2) reducing CO 2 emissions internally, (3) investing in CDM/JI projects and, (4) reallocating allowances internally between installations located in different countries within the EU ETS. A fifth option, (5) the saving of allowances from the prior trading period, was added for the 2009 survey. According to the 2006 survey, the most important measure projected for the period was to reduce emissions internally (44%), followed by purchasing allowances on the market (26%). Internal emission reductions were preferred by 64% of the small and 44% of the medium-sized companies. Half of the large companies saw the purchase 16

17 of allowances as the most important measure, whereas 25% considered the internal reallocation of allowances between installations in different countries as most important 8. In 2009, a large share of companies sees no need to take action or does not yet know. For those who intend to take action, the most important measure to handle a deficit in the next trading period continues to be reducing emissions internally 9, with 25% of responses. The share was highest among medium-sized companies (37%). Overall, 15% preferred purchasing allowances at a CO 2 -exchange/bilaterally. Internal reductions and market measures were equally important for 5%. (Table 14) Next we look at trading activities in terms of type of transaction (Table 15), trading frequency (Table 16) and volumes traded (Table 17). The first survey reveals that companies trading activities had been very modest by the middle of the 1st trading period. Only 43% of the respondents had been trading at all. A share of 21% had only sold allowances, whereas 13% only purchased, and 9% conducted both sales and purchases. As expected, involvement in the market had increased significantly by Nearly all participants had been trading; 59% had only or mostly purchased allowances. The changed regime becomes obvious in that solely 3% of respondents had mostly or only sold, while 36% had both purchased and sold allowances. Small companies most commonly purchased allowances (69%), whereas large companies most frequently both purchased and sold (67%). (Table 15) As shown in Table 16, also trading frequency was low in the initial period. In 2006, 75% of companies traded only a few times per year. Half of the large companies, however, traded once per month. Although, as shown, more companies engaged in trade in 2009, the trading pattern remains largely the same; 85% traded a few times per year only, whereas 67% of large companies traded once a month. (Table 16) 8 Please note that, at the time of the 2006 survey, companies did not know what allocation to expect in the 2nd trading period, as national allocation plans still were under elaboration. 9 It should be noted that in 2009 companies were asked to indicate the respective shares of the shortfall that they expected would be covered by each of the measures. The measure attracting the largest share was then taken as the most important one. As some companies indicated equal largest shares, a new category reflecting this was added. 17

18 Table 17 indicates that trading volumes overall were modest. In 2006, 70% of transactions by the respondents typically involved between one and five contracts (of 1000 emission rights each), compared to 75% in For 50% of large companies a typical trade included 11 or more contracts in This share fell to 44% in (Table 17) Companies were further asked to indicate their main trading strategy in terms of a number of pre-stated strategies or expressions of strategies (Table 18). In 2006, the two preferred strategies were to trade so that predicted emissions from the first trading period always are covered and to trade so that predicted emissions from current year always are covered, each used by 29% of companies. These strategies can be seen to aim at risk reduction. In 2009, 31% of companies preferred to trade so that predicted emissions from the current year in principle always are covered followed by 26% that preferably wait until the end of the year to buy allowances. As many as 20% did not have any predetermined trading strategy. Hence, trading strategies seem to be more short-term oriented and emphasize flexibility. This may reflect the fact that there is ex ante uncertainty as to the amount of emissions for a given period, which results in trading at the end of the compliance period, when actual emissions become known (Hanemann, 2009). (Table 18) Engaging in the project-based mechanisms CDM/JI is another possible compensatory measure to handle an allowance shortfall. Table 19 illustrates that this was, however, little used. In 2006, none of the respondents had directly invested in any emission reducing project, while two companies had invested in a carbon fund. In 2009, one company was directly engaged in a CDM/JI project, two companies had invested in a carbon fund, and 15% of respondents had purchased reduction units 10 from CDM or JI projects. (Table 19) In the third trading period, power sector companies will be able to purchase allowances directly from auctions. When asked (in 2009) how they plan to cover their allowance need in the third trading period, 38% of companies intended, however, to make use of the existing 10 Plant operators can use reduction units to a certain extent as specified in the national allocation plan. CDMprojects produce so-called Certified Emission Reductions (CERs) and JI projects yield Emission Reduction Units (ERUs) (Directive 2004/101/EC). 18

19 CO 2 exchanges. A minor share planned to purchase some or most of the allowances needed directly from auctions. More than half of companies (53%) had not yet decided on that question (Table 20). (Table 20) To sum up, compensatory measures play a minor role in companies carbon mitigation strategies, although the nearby absence of sales transactions in 2009 reflects that companies primarily have an allowance shortage. Internal emission reductions remain the preferred option also in the 2 nd trading period for those who saw a need to take action. Knowing that Sweden to a large degree already has harvested the low hanging fruit (cf. Hart & Ahuja, 1996) in terms of emission reductions (OECD, 2011), and given relatively modest allowance prices, it can be questioned to what extent companies compare the allowance price with their internal abatement costs to find the most cost-efficient solution. Earlier studies indicate that companies sometimes control emissions although it would have been more economical to purchase allowances (Coggins & Swinton, 1996; Swinton, 2002, 2004). Furthermore, neither auctions nor CDM/JI have attracted much interest from energy sector companies so far. 4.4 Carbon mitigation strategies This section analyzes the actions of the heat and power companies in terms of carbon mitigation strategies. Earlier research (Weinhofer & Hoffmann, 2010) conceptualized corporate carbon strategies as focusing on one or a combination of three strategic emission objectives. CO 2 compensation concentrates on actions taken to balance or offset carbon emissions by acquiring additional carbon emission capacity, i.e. allowances, or investing in emission offsetting projects such as CDM and JI, which was explored in the previous section. CO 2 reduction focuses on internal measures to reduce emissions. For instance, companies alter production processes and products to curb their CO 2 emissions. Carbon independence involves actions to substitute carbon resources with renewable resources, i.e. fuel switching and related measures. A first question addressed was if the EU ETS has had an impact on emission reduction measures in the companies installations subject to the scheme. According to the first survey (Table 21), the majority of large companies and 29% of medium-sized companies had already implemented emission reduction measures by mid-2006 as a result of the scheme. A large share of companies (43%) had not taken any such measures yet, but was planning to do so. In 25% of companies, no such plans existed. 19

20 (Table 21) When asking how EU ETS impacted emission reduction measures in the companies installations in 2009, the results were rather unexpected (Table 22). As many as 55% of companies stated that the system had not led to any emission reduction measures in their installations subject to the scheme. Fifteen percent were planning emission reduction measures and 22% each were either implementing such measures in the 2nd trading period or had done so in the 1st trading period. (Table 22) Companies widespread opinion that EU ETS had not led to emission reduction measures in their installations can be interpreted in the light of earlier results (see Table 3) on the most important drivers to reduce emissions, showing that taxes and other environmental policy tools were perceived as more influential than the price of emission allowances. It can thus be questioned whether EU ETS has any significant impact on emission reductions, at least given the persistently modest price levels previous to the 2009 survey 11. In 2009, the companies were further asked if they were in agreement with a number of statements. A share of 61% of respondents agreed partly or fully with the statement emission trading reduces CO 2 emissions in our company, while 39% disagreed. Opinions were divided on the statement emission trading is a stronger policy tool than a CO 2 tax in order to limit CO2 emissions in our business activities; 41% of respondents disagreed with the statement contra 41% that did partly or fully agree with the statement. The remaining 18% did not have an opinion on the issue. (Table 23) As shown in Table 24, the principal measure to reduce emissions in the companies in the 1st trading period was, with 69% of respondents, developing and implementing new production processes, including the switching of fuels and raw materials. This was most important for all companies irrespective of size. In 2009, switching fuels and raw materials, which then was a separate response option, was the dominant principal measure in 52% of responses, pointing at a widespread preference for carbon independence. Developing and producing new products was the dominant measure for 15% of respondents in 2006 and 0% in Increasing the 11 The average EUA price during the first trading period was 16/t CO2 (Convery et al., 2008), whereas the weightedaverage EUA price was 12.89/t CO2 in 2009 (Commodities Now, 2011). 20

21 efficiency of existing production processes was most important in 13% of companies in 2006 and 17% in The two latter measures are most closely associated with a CO 2 reduction strategy, which hence was the main strategy in roughly a fourth of companies. Reducing the production volume in order to reduce emissions was very uncommon. (Table 24) A further issue investigated in 2009 was to what extent companies are likely to be able to reduce carbon emissions in their installations subject to EU ETS by 2020 with the help of the above-mentioned measures (Table 25). The potential of switching fuels and raw materials is largest with 45% in average. Large companies even find it likely that they can reduce their emissions by 52% using this measure. The development and implementation of new production processes can lead to reductions of up to 26% of emissions in the installations, again with a higher share in large companies. Efficiency increases in existing production processes have the least potential with 12% in average. Summing up these estimates results in an overall reduction potential of 83% of current emissions in average, and 92% for large companies, employing all of these measures. Even if the overall CO 2 emissions from the Swedish heat and power sector are minor compared to the rest of Europe, their reduction by more than 80% indicates that considerable efforts are likely to be taken by 2020 to phase out fossil fuels. (Table 25) Another interesting question is whether or not the long-term allowance price has any importance for the companies investments in Sweden (Table 26). In 2006, 53% of respondents stated that the long-term allowance price was important or very important for their investments in Sweden. This was even the case in 63% of large companies. Overall, only 25% replied that it was of no or little importance, with a higher share in small companies. This picture changed considerably in the later survey. In 2009, only 26% of companies considered the long-term allowance price to be important or very important for their investments in Sweden, although still 38% of large companies thought so. In all, 64% of respondents did not place any or only some importance on the long-term allowance price. This share was somewhat lower in large companies. (Table 26) 21