Diseño eléctrico

From the discussion of future price developments in Chapter 3.3, it is likely that prices at the start of 2006 are going to be similar to levels seen in the market today. There are a number of factors that could give rise to a wider distribution of carbon prices as 2006 progresses and throughout the rest of the first EU ETS period. Without making a prediction as to whether prices are likely to increase or decrease, it seems prudent for a government to sell a significant quantity of allowances early in 2006 to lock-in some fixed revenue and to limit the downside risk of lower revenues from potentially lower prices throughout the phase. This would make the sales process less exposed to risk in the event of a collapse in prices in the later part of the first trading period.

The PaR analysis is a useful tool for quantifying the risk of deferring sales and the results indicate that a sale of volume in early 2006 would significantly reduce the chance of losing more than €30m (compared to strategy 1) in contrast to selling the allowances evenly throughout the period. The early sale of volume will, however, limit the volume that can be sold later in the period and this will limit the potential upside of revenues if prices increase. This then relates the key question of how to much to sell initially to the balance of risk and reward.

The question of how much to sell initially is also connected to the practical considerations of the time it would take to sell a certain volume without influencing the markets given the current liquidity levels. Whilst this is covered in more detail in the next chapter, it is worth stating in this section that selling the full 5 million tonnes through exchanges and OTC would take 2 – 4 months by which time it is possible that prices will have moved.

The discussion of possible higher revenues through active management also affects the initial volume sold. The PaR analysis incorporating the effects of active portfolio management gives an indication of the lowest 10% of revenues for a number of different initial sales volumes.

The conclusion of how much to sell initially is based on finding the appropriate balance of limiting risk exposure of the total portfolio revenue whilst retaining some volume for potential revenue gain through both active management and potentially higher prices in the true-up period. A sale

Volume of upfront sales (mt) 0.0 1.0 2.0 3.0 4.0 5.025

Mean (€m) 110.6 108.9 107.2 105.5 103.8 102.1

Std Dev (€m) 37.5 30.1 23.2 17.3 13.8 11.6

Lowest 10% returns (€m) 43.1 54.6 65.5 74.6 79.6 81.7

Volume of upfront sales (mt) 2.0 2.2 2.4 2.6 2.8 3.0

Mean (€m) 107.2 106.9 106.5 106.2 105.9 105.5

Std Dev (€m) 23.2 21.9 20.7 19.5 18.4 17.3

Lowest 10% returns (€m) 65.5 67.5 69.4 71.3 73.0 74.6

Volume of upfront sales (mt) 0.0 1.0 2.0 3.0 4.0 5.025

Mean (€m) 110.6 108.9 107.2 105.5 103.8 102.1

Std Dev (€m) 37.5 30.1 23.2 17.3 13.8 11.6

Lowest 10% returns (€m) 43.1 54.6 65.5 74.6 79.6 81.7

Volume of upfront sales (mt) 2.0 2.2 2.4 2.6 2.8 3.0

Mean (€m) 107.2 106.9 106.5 106.2 105.9 105.5

Std Dev (€m) 23.2 21.9 20.7 19.5 18.4 17.3

of between 2 – 3 million tonnes seems an appropriate balance between risk and reward considering the Danish government’s position on risk. Selling 2.5mt would mean the risk of losing more than €30m was less than 5% and the average of the lowest 10% revenue returns would be around €70m. Without considering the potential upside from holding 2 -3 million tonnes for later sales, the Danish government needs to assess whether this is an acceptable lower revenue limit. The revenue also needs to be considered alongside the political risks from misjudging the market. The upside potential is significant with 2 – 3 million tonnes, as this can either be sold in even volumes throughout the rest of the period, or some volume could then be withheld for sale during the true-up. However, our model and analysis of exposure levels provide the Danish government with a tool to make its own judgement on the appropriate level of sales during the internal decision process which will succeed this report. Figure 5.11 breaks down the figures in more detail for the range of 2 to 3 million tonnes.

Having decided on the volume to sell, there are several factors that lead to the conclusion that it would be advantageous to sell as early as possible in 2006, although this is not as important as generally selling volume as soon as possible to reduce revenue exposure to future price fluctuations. Firstly, there is a clear linkage between temperature and allowance prices which traders have been able to exploit. There have been higher EUA prices during cold snaps but this tends to be a short term effect. When temperatures decrease, heating demand increases and so power generation increases. Many power producers need to adhere to strict risk limits and need to purchase the extra allowances required for increased generation. This short-term increase in demand for allowances puts an upward pressure on EUA prices. It may be possible to take advantage of colder weather, and hence higher prices, in early 2006.

Secondly, gas prices – particularly in the UK – are typically higher in winter than summer whilst coal prices are less seasonal more stable throughout the year. There is a correlation between carbon prices and the difference between cost of gas and coal generation. The logic behind this is that coal-to-gas fuel switching is the main form of abatement in phase 1 of the EU ETS and carbon is priced accordingly to facilitate this fuel switch. This relationship is not as simple as this are there are other factors that affect whether fuel switching will occur, but in general high gas prices relative to coal prices will support a higher carbon price.

The final reason for an early sale is that operators are required to submit allowances equal to their 2005 emissions at the end of April 2006. The market is currently pricing in an assumed shortfall of allowances but this is based on an estimate of 2005 emissions. The actual emissions may be significantly different to expectations and this would change the supply/demand balance of the market. This would cause a corresponding shift in EUA prices as the market corrects itself with a better view of emissions for the remainder of the period. It is impossible to say whether the price will increase or decrease in May, when emissions data is reported. As the early sale of allowances is intended as a risk mitigation measure, it would be best to sell early volume before this period of increased price volatility.

Whilst the factors above will also to some extent apply to the following winter, there will be other price drivers that could offset higher winter prices. The first recommendation to sell a

significant quantity of allowances is consequently of foremost importance as this will lock in some early profit and reduce the variation of the total portfolio revenue.

The rest of the sales strategy is then focussed on when to sell the remaining volume and whether to employ static (pre-programmed) or dynamic sales methods. As more historic emissions data is available and more trends emerge, analysts will have a better understanding of how long/short the market is and what is the most likely scenario for the true-up period. We recommend selling throughout the rest of the period by splitting the remaining volume into two equal parts, the first part designated for sale during 2006 and the second part to be sold in 2007. By doing this, there is the potential to hold back some of the 2007 sale volume for sale during the “true-up” period following further analysis of the market during 2006 and early 2007. For a pre-programmed static sale, spreading the volume over a wide time span will mean the price achieved from the sales will be more indicative of the average price over the period rather than for a narrower time period. For a dynamic strategy, the longer period of time over which to sell the allowance volume, the more flexibility there is to take advantage of price movements and thus higher potential revenues.

We also advise using a dynamic sales strategy for some or all of the remaining volume. Based on the nature of this market, we believe that active management of the portfolio (or parts of the portfolio) combined with careful selection of advisors is likely to increase expected revenues of the allowances over and beyond what can be achieved by static sales strategies. Dynamic strategies can be used in combination with static sales strategies. One model could involve an initial sale of a significant volume while the remaining volume is dedicated to active management by a trustee. Another strategy could be to leave the management of the whole portfolio to a trustee and make one part of the portfolio subject to a pre-programmed sales schedule and the remaining part subject to much higher flexibility.

The decision to sell at least some of the volume through active management is driven by the presumption that this will increase expected revenues. The exact volume that is sold in this way, or how this is combined with static sales, is related to the question of how the sales are organised i.e. through government channels, trustees or a combination. This question is addressed in chapter 7.

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Figure 5.12 shows a timeline summary of the recommendations described above. There are several other activities that need to be considered in addition to the sales. Firstly, a public announcement from the Danish government may be considered at the start of next year. Section 7.6 discusses this in more detail. Secondly, it is possible to begin sales of the initial volume in early 2006 whilst planning the detailed strategy for the sale of remaining volume. One of the criteria for selling a significant initial volume is to sell it as early as possible and this could be initiated before a strategy has been finalised for the remaining volume. The final activity is

market monitoring or analysis throughout the period as this will determine if volume is held back for sale during the “true-up” period in early 2008.

Figure 5.12. Schematic of timeline for sales strategy

2006 2007 2008

“True-up”

Sell significant quantity Q106

Half of remaining volume for sale in 2006

Half of remaining volume for sale in 2007

Potential to hold back 2007 volume until 2008

“true-up” period

Better view of true-up potential during 2007

Public announcement of sale Plan strategy for sale of

remaining volume

Execute sale of remaining volume through chosen strategy (monthly volumes)

Monitor market to determine sale volume split between 2007 and 2008 (“true-up”)

2006 2007 2008

“True-up”

Sell significant quantity Q106

Half of remaining volume for sale in 2006

Half of remaining volume for sale in 2007

Potential to hold back 2007 volume until 2008

“true-up” period

Better view of true-up potential during 2007

Public announcement of sale Plan strategy for sale of

remaining volume

Execute sale of remaining volume through chosen strategy (monthly volumes)

Monitor market to determine sale volume split between 2007 and 2008 (“true-up”)