Energy and emission – exposure to direct and indirect effects

As outlined in chapter 2.1.1.2 the gross financial effect of emission trading has a direct and an indirect component. A detailed breakdown of the exposure of the pulp and paper industry can be found in Fig. 29. All drivers are discussed in more detail in the following sections of this chapter.

Fig. 29: Exposure of the pulp and paper industry to effects of emission trading

The direct as well as indirect effects of emission trading on pulp and paper manufacturing costs heavily depend on the energy intensity of the respective process. The specific consumption of thermal and electrical energy in pulp and paper manufacturing is illustrated in Fig. 30. Chemical pulping – especially if the manufacturing of market pulp requires drying of the pulp – and paper manufacturing have a significant consumption of thermal energy. In

Gross financial effect

Direct effect

Indirect effect

Fibres Chemicals Fuels Electricity Fossil fuels Make-up chemicals

Price increase energy Price increase raw materials Administrative costs

Opport. costs of free allow.

Scarce allowances

Fossil fuels Make-up chemicals External Internal Gross

financial effect Gross financial effect

Direct effect Direct effect

Indirect effect Indirect effect

Fibres Fibres Chemicals Chemicals Fuels Fuels Electricity Electricity Fossil fuels Make-up chemicals Fossil fuels Fossil fuels Make-up chemicals Make-up chemicals

Price increase energy Price increase energy Price increase raw materials Price increase raw materials Administrative costs

Administrative costs

Opport. costs of free allow.

Opport. costs of free allow.

Scarce allowances Scarce allowances

Fossil fuels Make-up chemicals Fossil fuels Fossil fuels Make-up chemicals Make-up chemicals External Internal External External Internal Internal

contrast the heat consumption of fibre recovery is very limited – in some cases actually zero.

The heat balance of mechanical and thermo-mechanical pulping is even positive. Both processes require a remarkable amount of electrical energy for the defibration of the wood (chips) and transform it into thermal energy, 20-60% of which is recoverable in the form of steam or hot water.

Fig. 30: Energy intensity of pulp and paper manufacturing processes¹

Overall more than 85% of the thermal energy is consumed in the form of process steam. Most mills – especially the integrated mills with a more complex energy configuration – operate two grids of process steam: one of about 10 bar and a second one of about 3 bar steam pressure. Only a few mills get by with one pressure level. The remaining less than 15% (Teir et al., 2004) of thermal energy is consumed as direct heat (hot air) e.g., in the lime kiln of sulphate pulp mills (on average 1.9 GJ/t of sulphate pulp according to (STFI, 2000)) or in the drying hoods of paper mills.

1 Data from EU Reference Document on Best Available Techniques in the Pulp and Paper Industry (Commission of the European Communities, 2001)

0.0***

Thermo-mechan.

pulping Fibre 0.2 recovery

1.1

Coating

6.9 Paper

manu-facturing

0.3 3.0 Drying

Bleaching of chem.

pulp Chemical 7.9 pulping

0.0**

Mechan.

pulping

2.7***

0.3

0.3

0.8

0.2 0.1 0.3

1.8**

Thermal energy GJ/t*

Electrical energy MWh/t

Manufac-turing of raw pulp

Proces-sing of raw pulp

Manufac-turing of raw paper Proces-sing of raw paper

Min Max Min Max

1.0 1.2

2.5 3.5 0.0 0.0

0.0 0.0

0.0 0.3

5.5 7.5

0.2 0.5 6.4 9.4

Min Max Min Max

0.3 0.3

0.1 0.1 1.1 1.0

1.0 4.3

0.2 0.3

0.6 1.1

0.1 0.2 0.2 0.4

3.6 GJ = 1 MWh

20-50% of electrical energy recoverable as steam and hot water 50-60% of electrical energy recoverable as steam and hot water

*

**

***

Excess steam from mechanical work Excess steam from mechanical work

Looking at the supply of primary energy, fossil fuels and biomass are almost balanced. 50.8%

of heat originates from fossil fuels, 49.2% from biomass. As Fig. 31 shows, natural gas, fuel oil, and coal are the three major fossil fuels used in pulp and paper manufacturing. Among them natural gas, the fossil fuel with the lowest emission factor (tons of CO2 emission per GJ net calorific value), has a share of about three fourths, while the more CO2-intensive fuel oil (heavy fuel oil (HFO) and light fuel oil (LFO)) and coal account for less than one fourth.

Fig. 31: Sources of thermal energy and electricity in the European pulp and paper industry¹ In addition to these fossil fuels used as sources of thermal energy, make-up chemicals may cause additional CO2 emissions and, thereby, direct costs of emission trading. The chemical recovery system of sulphate pulping comprises a sodium loop and a calcium loop, both closely linked to each other. To make up for sodium losses, typically some fresh sodium carbonate (Na2CO3) is added in the sodium loop. With one intermediate step, the CO2 is transferred to the calcium loop and gets freed in the lime kiln. Although this emission is minor compared to the emission from combustion of fossil fuels used for heat generation, this fossil CO2 originating from sodium carbonate is subject to the European emission trading scheme. In contrast with this additional "input", CO2 can also be bound in a pulp or paper mill. If mills manufacture precipitated calcium carbonate (PCC, CaCO3) from lime kiln stack gases, fossil CO2 is fixed again and accordingly not counted as emission.

With emissions from fossil fuels and make-up chemicals, the drivers for the direct effects of scarce emission allowances and the opportunity costs of allowances received for free have been elucidated (see tree in Fig. 29). The administrative costs of emission trading are not

1 Data according to CEPI Annual Statistics 2005 (CEPI, 2006b) referring to 2004. More detailed breakdowns can be found for individual countries, e.g., for Germany in the annual report of the Verband Deutscher Papierfabriken (VDP, 2005).

49.2

6.2

38.2 Gas

Fuel oil 4.4

Coal 1.6 Other fossil fuels Biomass

0.4 Other

57.2

42.8 Internal generation Net

purchase Thermal energy

Shares of energy sources Percent

Electrical energy

Shares of energy sources Percent

specific to pulp and paper manufacturing. The theoretical considerations in chapter 2.1.1.2 provide sufficient background. Thus, the next section covers the drivers of indirect costs.

Here, the pulp and paper industry is exposed to price increases in raw materials and energy caused by emission trading. To assess the impact of price increases in fibre (wood, recovered paper, and pulp), chemicals, fuels and electricity, the cost structures of typical pulp and paper grades need to be understood. All other cost elements such as personnel, maintenance, depreciation and overhead are of no relevance when looking at the effects of emission trading.

For pulp manufacturing, the grades TMP (thermo-mechanical pulp) and NBSK (northern bleached softwood kraft pulp) have been selected and are displayed in Fig. 32.

Fig. 32: Cost structures of major pulp grades (examples)¹

While both grades, as typical representatives of mechanical respectively chemical pulp, have a 45% share of fibre costs on total costs in common, the shares of chemicals, fuels and electricity diverge fundamentally. TMP has basically no costs for chemicals and fuels but about 23% share of electricity costs, NBSK has significant costs for chemicals and fuels but no or even slightly negative costs for electricity. A TMP mill needs to purchase all electricity from the grid while a kraft pulp mill typically generates high pressure steam in the recovery boiler from burning black liquor (costs accounted here to fibre costs) and relaxes the steam with a back-pressure turbine down to conditions of process steam. In a state-of-the-art mill, the entire steam and electricity consumption is covered in this way. This explains the 40%

share of internal electricity generation displayed in Fig. 31. Some steam and electricity can

1 Cash cost data NBSK according to Paperloop's Cornerstone benchmarking (Paperloop, 2005). Cash cost data TMP according to Persson (2005). Add-on for non-cash cost comprising depreciation (10.2%), corporate (5%), and EBIT (4.2%), based on the average of the top 5 European pulp and paper companies (Stora Enso, 2005), (UPM, 2005), (m-real, 2005), (SCA, 2005), (Norske Skog, 2005).

95 48

0 0

27 170 41

211

87 78

448 361

31 1 206 47

TMP – Thermo-mechanical pulp EUR/t

NBSK – Northern bleached softwood kraft pulp EUR/t

Per-cent 46 10 7 0 18 81 19 100

Per-cent 45 0 0 23 13 81 19 100

Elec-tricity

Other cash costs

Total cash costs

Non cash costs

Total costs

Chemi-cals

Fuels Fibre

TMP – Thermo-mechanical pulp EUR/t

NBSK – Northern bleached softwood kraft pulp EUR/t

Per-cent 46 10 7 0 18 81 19 100

Per-cent 4646 1010 77 00 1818 8181 1919 100100

Per-cent 45 0 0 23 13 81 19 100

Per-cent 4545 00 00 2323 1313 8181 1919 100100

Elec-tricity

Other cash costs

Total cash costs

Non cash costs

Total costs

Chemi-cals

Fuels

Fibre

Elec-tricity

Other cash costs

Total cash costs

Non cash costs

Total costs

Chemi-cals

Fuels Fibre

even be sold (thus, potentially negative electricity costs).¹ Usually only a limited volume of external fuels is consumed (lime kiln).

The cost structures of paper grades differ less than those of pulp grades. Fig. 33 displays the cost breakdowns of newsprint and coated woodfree paper as examples. The costs of fibre (pulp) are the most significant of the four input factors with an indirect effect of emission trading. In both cases, chemicals, fuels, and electricity have shares between 2 and 18%. In the case of stand-alone paper mills, the steam is typically generated internally by combustion of different kinds of fossil fuels (e.g., natural gas, coal, oil), while the electricity is purchased from the grid. Cogeneration is rather an exception for a non-integrated paper mill.

Fig. 33: Cost structures of major paper grades (examples)²

With the cost structures, the "lengths of the levers" for the effects of price changes in raw materials and energy have been introduced in the previous section of this chapter. In the following section, the price development i.e., the "amplitude of the levers" will be touched on.

The first lever of the indirect effect is the fibre price, i.e., the price of wood or recovered paper for manufacturing pulp respectively the price of pulp for manufacturing paper. Both prices may be affected by the introduction of emission trading. While this is obvious for the

1 Very detailed calculations on the energy balances of sulphate pulp mills can be found in the "Final report KAM 1 Ecocyclic pulp mill" of several Scandinavian research institutions led by the STFI (2000).

2 Cash cost data according to Paperloop's Cornerstone benchmarking (Paperloop, 2005). Add-on for non-cash cost comprising depreciation (10.2%), corporate (5%), and EBIT (4.2%), based on the average of the top 5 European pulp and paper companies (Stora Enso (2005), UPM-Kymmene (2005), m-real (2005), SCA (2005), Norske Skog (2005)).

109

100 44 32 53

338 81

419

140 123

129

235 79 15

581

721 Newsprint

EUR/t

Coated woodfree EUR/t

Per-cent 33 18 11 2 17 81 19 100

Per-cent 24 10 8 13 26 81 19 100

Elec-tricity

Other cash costs

Total cash costs

Non cash costs

Total costs

Chemi-cals

Fuels Fibre

Newsprint EUR/t

Coated woodfree EUR/t

Per-cent 33 18 11 2 17 81 19 100

Per-cent 3333 1818 1111 22 1717 8181 1919 100100

Per-cent 24 10 8 13 26 81 19 100

Per-cent 2424 1010 88 1313 2626 8181 1919 100100

Elec-tricity

Other cash costs

Total cash costs

Non cash costs

Total costs

Chemi-cals

Fuels

Fibre

Elec-tricity

Other cash costs

Total cash costs

Non cash costs

Total costs

Chemi-cals

Fuels Fibre

pulp price (passing-on of the direct and indirect manufacturing cost increase originated by emission trading; according to chapter 2.1.1.2 to be classified as an indirect effect of the first order), the price increases in wood and potentially recovered paper, due to emission trading, require some explanation. They are indirect effects of the second order originating from the dual-nature of wood and recovered papers as raw materials and fuels. All fuels have different emission factors (tons of CO2 emission per GJ net calorific value; zero in the case of bio-fuels). Thus, the same relative scarcity of emission allowances results in different direct costs of emission trading per energy content. Generating steam and electricity from coal is burdened with higher emission trading costs (emission allowances employed multiplied by allowance price) than generating from fuel oil, natural gas or especially bio-fuels. Hence, assuming substitutability of fuels, and an unchanged demand function for primary energy and regionally closed markets, the differences in the CO2-burdens between all types of fossil fuels and bio-fuels should cause a price decline in fossil fuels and a price increase in bio-fuels.

Theoretically, the prices of fossil fuels could even decline down to a level at which the sum of the new price plus costs caused by emission trading equal the former price level (whether this price decline is actually observable will be discussed a few paragraphs below). By contrast, the prices of bio-fuels may increase at the same time. Power plants formerly relying on fossil fuels may switch to bio-fuels such as wood. Besides the saved costs of replaced fossil fuels, the entire value of the emission allowances freed by this switch may be used to purchase these bio-fuels ("additional paying power"). This is irrespective of the share of allowances that have been received for free compared to the share of allowances that have been purchased. It is rather important for the price increase of wood whether it was a competitive fuel compared to fossil fuels already ahead of the introduction of emission trading or gained competitiveness primarily from the said introduction¹. In the first case, the freed allowances entirely take effect on the wood price; in the second case, the allowances primarily provide competitiveness and only the excess allowances affect the wood price. A calculation published by the Finnish Forest Industries Federation illustrates the second case summarising (Finnish Forest Industries Federation, 2005, p. 1):

"The high price of emission allowances makes it uneconomical to use peat. If energy producers replace peat with emission-free bioenergy, they can sell the emission allowances they have received free-of-charge and use the income to secure wood for fuel use. The emission trading is increasing peat-burning power plants' ability to pay for timber. […] At 20 €/tonne of CO2, fibrewood starts to become fuel in Finland."

Although the use of peat for electricity generation is specific for Finland and less relevant for other European countries, similar effects occur everywhere, where coal – almost as CO2

1 Theoretically recovered paper should be affected in the same way as wood. However, two factors hinder the effect: (1) recovered paper is not entirely free of fossil CO2 as fillers contain fossil calcium carbonate. (2) The substitutability is limited by a self-commitment of the European paper industry to achieve a certain recycling rate. Accordingly, material recycling prevails over thermal use.

burdened as peat – is replaced by wood¹. Most lignite or hard coal-fired power plants allow co-burning of wood. Liquid and gaseous fossil fuels burned in other installations can be substituted rather in the mid and long term with the replacement of the existing power plants.

The development of German pulpwood prices within the seven-year period 2000-2006 is displayed in Fig. 34.

Fig. 34: Wood price development

After a relatively stable development of pulpwood prices in Germany between 2000 and mid 2003, prices reached a first peak in late 2003. One amongst several reasons for the peak was stockpiling by a major new kraft pulp mill in central Germany. At the time stockpiling was interrupted – though this is probably not the only reason – pulpwood prices levelled off and started to swing back to the former average price. However, the swing resulted in a continued price increase. Compared to the low mid 2004, German pulpwood price increased by 56.7%

until autumn 2006. This is a level 27.3% above the 2000 average. Vorher (2007) reports even significantly higher price increases for certain segments. For late winter 2007, he quotes a German beech pulpwood price of about 48 EUR/m³, approximately 104% above the average of 1996-2005. Chips for chemical pulping have increased by even 158%, for TMP by 93%.

Though, in spring 2007, the situation on the chip market levelled out somewhat. There is no doubt that numerous drivers influence pulpwood and chip prices. Some refer to physical use of wood, others to thermal use. Although most wood is still utilised as fibrous raw material

1 The Czech Republic provides a valuable example: in 2003/2004, wood was a fully competitive fuel compared to coal – due to a misguided use of political instruments. Electricity generation from co-burning of wood in power plants was subsidised to the same amount as in pure biomass power plants (green bonus of 1,520 CZK/MWh (≈ 48 EUR/MWh)). As this was used intensively by the utility companies, wood prices boomed causing a shortage for the pulp and paper industry. In this case, the introduction of emission trading would have caused an additional wood price increase. However, in order to correct this misguidance, the green bonus for co-burning was reduced again (500 CZK/MWh (≈ 16 EUR/MWh)), which caused a wood price reduction.

0 20 40 60 80 100 120 140 Pulpwood price

Germany, index, base year 2000

Date

2000 2001 2002 2003 2004 2005 2006

56.7%

27.3%

Stockpiling for new kraft pulp mill in central Germany

0 20 40 60 80 100 120 140 Pulpwood price

Germany, index, base year 2000

Date

2000 2001 2002 2003 2004 2005 2006

56.7%

27.3%

Stockpiling for new kraft pulp mill in central Germany

for building products and pulp, its usability as fuel tends to gain share of the entire consumption. Here emission trading is one influencing factor, globally increasing prices of fossil fuels and RES promotion are others. Mantau (2006) calculated for Germany 2004 a share of 29.8% thermal use of available wood raw material. For 2005, he assumes even 37.5%, whereas 18.0% originate from industrial or municipal combustion installations and 19.5% from households. At least the 18.0% share of combustion installations should be influenced by emission trading according to the above-mentioned reasons.

The second lever for the indirect effect of emission trading is the price of chemicals used for pulp and paper manufacturing. Although chemical installations are not subject to emission trading via the industry-route (according to EU Directive 2003/87/EC only refineries are subject to emission trading), the chemical industry may be affected due to their energy instal-lations and is affected by the electricity price increase. Thus, potential increases in chemicals prices can be classified as an indirect effect of second order.

The third lever for the indirect effect of emission trading is the price of fuels used for pulp and paper manufacturing. With regard to this lever, fossil fuels, internal bio-fuels – occurring as by-products in the processing of fibrous raw material – and external bio-fuels need to be differentiated.

As outlined above in the section on wood prices, theoretically the prices of fossil fuels should decrease to some degree with the introduction of emission trading. Assuming full substitutability of fuels, an unchanged demand function for primary energy, regionally closed markets, marginal replacement of fossil fuels by bio-fuels and competitive pricing for fossil fuels, the prices of fossil fuels should decline down to a level at which the sum of the new price plus costs caused by emission trading equal the former price level. In practice, however, it is hardly reasonable to assume the occurrence of this theoretical effect of second order (chapter 2.1.1.2). The assumptions of regionally closed markets and competitive pricing especially are not fulfilled. The prices for US Light Sweet Crude Oil and Australian Black Coal are not determined in the European Union. No special figures are required to demonstrate that the introduction of the European emission trading scheme in 2005 has not caused any decrease in prices for fossil primary energy. Thus, for all calculations made in this investigation, it is assumed that the prices of coal, oil, and gas are not affected by emission trading.

Another consideration is required referring to internal bio-fuels, such as e.g., bark, wood screening waste, black liquor or sludge. They occur as organic by-products in pulp and paper manufacturing, originating from the fibrous raw materials. As any change in the production ratio between the main product (e.g., pulp) and the by-product (e.g., black liquor) would cause changes in the main products properties and the value relation between the main product and

the by-product strongly favours the main product, the occurrence of internal bio-fuels can be regarded as unchangeable. Typically, the internal bio-fuels are allocated zero out-of-pocket costs – fibre and additional processing costs are accounted to raw materials – but significant value due to their energy content. This value, in turn, which increased with the introduction of emission trading needs to be counted against the raw material costs. Thus, emission trading has no effect on the costs of internal bio-fuels. They are regarded as being and remaining zero.

This is different with external bio-fuels such as e.g., bark, sawdust, waste wood etc. These fuels gained value with the introduction of emission trading, according to the rationale outlined with the effect on raw material prices.

The fourth lever for the indirect effect of emission trading is the price of electricity. As foreseen ahead of the start of emission trading and observed since then, the electricity price is strongly affected by emission trading. The mechanics behind this have been introduced in chapter 2.1.2.4 looking at the development allowance prices. According to the definition in chapter 2.1.1.2 the electricity price increase causes an indirect effect of the first order. The associations of the energy intensive industries¹ expected this development already in spring 2004, when EU emission trading Directive 2003/87/EC was adopted but most national allocation plans are still unpublished. Gammelin and Hecking (2005) reported in the Financial Times Deutschland of August 19^th 2005 about an internal RWE presentation which disclosed expectations of an additional profit of 300-350 million EUR caused by emission trading, based on 2005 allowance prices. Meanwhile, economists have calculated the so-called

"windfall profits", i.e., the additional electricity costs German electricity consumers pay due to the introduction of emission trading, respectively the additional earnings of utility companies, to 5.7 billion EUR for 2005 and expected 10.6, respectively 10.3 billion EUR for the years 2007 and 2008 (Schlemmermeier and Schwintowski, 2006).

The actual development of the electricity prices in Central Europe and Scandinavia is shown in Fig. 35.

1 See CEPI et al. (2004a), (2004b) and (2004c).

Fig. 35: Electricity price development¹

On both markets, the electricity prices dropped with liberalisation in 1997-1999 (Sweden, Norway, Finland, Denmark), respectively 1998/99 (Germany). Since 2000, the prices have increased significantly, reaching and exceeding pre-liberalisation levels again. With about 50.87 EUR/MWh, the average EEX spot market electricity price 2006 was 176% higher than the respective average 2000. The 2006 average on the Nordic market, 48.58 EUR/MWh, was even 281% above the 2000 level. However, price increases between 2000 and 2006 are characterised by double-digit but yet somewhat moderate growth during the first few years and extraordinary price increases in 2005 and 2006. The EEX price grew on average by 11.5% between 2000 and 2004 and made a 61.3% jump in 2005 compared to 2004 and another 10.6% increase in 2006 compared to 2005. Disregarding a weather-induced peak in 2002/2003, the Scandinavian market developed similarly: double-digit but still a somewhat moderate increase between 2000 and even 2005 of 18.1% but a boost of 65.9% between 2005 and 2006. On both markets, price increases have several explanatory variables, e.g., market structures, global fuel price increases, and emission trading. Although the latter is surely not the only reason for price increases in 2005 and 2006, representatives of utility companies in 2005 primarily referred to emission trading reasoning for price increases². The price decline in the Central European market is interesting following the two thirds price drop of emission allowances in April 2006. Here the graph in Fig. 35 even smoothes the real reaction to some degree, as it uses three-month average values. On the Scandinavian market, the effect was obviously much smaller. Though, this cannot be regarded as an indicator for the smaller influence of emission trading on electricity prices there.

Pulp and paper mills without internal electricity generation are fully exposed to this electricity price increase, unless hedging of the electricity price buffers the effect for a certain time.

Mechanical or thermo-mechanical pulp mills especially are severely affected. In the TMP mill

1 Data according to databases of EEX (2007a) and Nord Pool (2007)

2 E.g., RWE's CEO Harry Roels in Platts Emissions Daily of August 12^th 2005 (Anon., 2005c) 0

20 40 60 80

Electricity price EUR/MWh*

2000 2001 2002 2005 Date

EEX Nord Pool

2004 2003

Start of EU ETS 01.01.2005

Weighted 3-month average spot price (business days, daytime)

*

2002 dry year in Scandinavia; early start of cold winter

2006

EUA prices drop by almost two-thirds between 19.04.2006 and 02.05.2006

0 20 40 60 80

Electricity price EUR/MWh*

Electricity price EUR/MWh*

2000 2001 2002 2005 Date

EEX Nord Pool EEX EEX Nord Pool Nord Pool

2004 2003

Start of EU ETS 01.01.2005

Weighted 3-month average spot price (business days, daytime)

*

2002 dry year in Scandinavia; early start of cold winter 2002 dry year in Scandinavia; early start of cold winter 2002 dry year in Scandinavia; early start of cold winter

2006

EUA prices drop by almost two-thirds between 19.04.2006 and 02.05.2006 EUA prices drop by almost two-thirds between 19.04.2006 and 02.05.2006 EUA prices drop by almost two-thirds between 19.04.2006 and 02.05.2006

Im Dokument The Effects of Emission Trading on the Pulp and Paper Industry in Europe (Seite 86-96)