Energyforum

"Even though policy makers in Europe are inducing companies to put everything into gas and to forget about coal, at least until carbon capture and storage has been developed to an industrial level, we're not sure they will stick to this when they realize it is causing power prices to go through the roof," said Alan Svoboda, the company's head of sales and trading.

"If we add the CO2 price's impact on power to the high cost of fuel, this might be unbearable for the policy makers to sustain." Traditionally a nuclear- and lignite-fired power producer, CEZ has altered its generation strategy to include a 51% cut in lignite-fired generation by 2013 and a 19% increase in capacity at its existing nuclear power reactors in 2007-2012.

Speaking at WBR's 12th Power Generation Strategy conference in Prague, Svoboda said it was no longer "financially attractive or justifiable" for CEZ to maintain or expand its generation of coal-fired power plants. "If we could have certainty that policy makers will stick to current plans, then we could reduce coal production more dramatically and put everything into gas," he added.

Power producers need CO2 prices of Eur50-80/ton to induce them to switch from coal to gas, he said.

GENERATION SHIFT NEEDED

"If gas prices rise to catch up with coal prices this might lead to power prices that do not allow for a continuation of current CO2 policy in Europe. We therefore have to diversify our fleet," he said.

The EU's statement that it will not allow any free allocation of EU Allowances, and that it will curtail the import of JI/CDM credits from outside the EU in the third phase of the emissions trading scheme, is a concern for the CEZ manager. "This is to force EU power producers to change their generation strategy and at first glance it seems like a good policy.

But we're actually talking about new investment and not just about switching between existing generation assets," Svoboda said. "If you invest in new gas plants, which will most of the time be the marginal plant in the system, it means that you can be reasonably confident that the variable costs will be covered.

So power prices will look a little bit like the cost of gas and will reflect the cost of CO2 you have to buy on the market. However there is no extra money left for the investment and the capacity costs. "And if you can't invest more money abroad in order to cover the gap, you'll have to pay the Eur40-60/ton price tag of the CO2 credit."

CEZ can import 10% of its emissions from outside the EU via JI/CDM projects. "That's about 22 million tons and we have already purchased more than half of that. We are going to develop the other half as well," Svoboda said.

The question for producers is how to use the import capacity of JI/CDM credits. According to Svoboda there are two main options. One is to hedge on the price spread between the EU ETS credit and the CERs, which is currently about Eur10/ton. This means buying CERs, selling CO2 and locking in the Eur10/ton margin.

BUY NOW, USE LATER

The other option is to buy CERs, bring them into the EU ETS system and leave them as a reserve for the third period.

"This would mean you would get something for Eur15/ton, avoid the temptation to turn it into a Eur10/ton profit and leave it on your books to be used again to make, potentially, the Eur40-50/ton cost of CO2 credits in the next period," Svoboda said.

CEZ started with the "financial gain strategy" and is now accumulating credits for the next period, he added. The policy of tightening CO2 credits will cause power prices to go up significantly because CO2 prices will increase. If there should also be incentive to build new power plants, you need to cover not only variable costs buts also the fixed cost component and that's going to be the main price driver," Svoboda said.

"We have enough time to adjust before 2013, but the biggest risk is that the policy makers decide to change their plan and we will have to alter our strategy again."