Carbon leakage presentation by integer efma 5 jan 2011

Carbon leakage in the European fertilizer industry due to ETS III carbon charges Fertilizers Europe Task Force on Climate Change and Low Carbon Economy Brussels 5 January 20011 Brussels,

January 2011

Carbon leakage and the European fertilizer industry

Integer capabilities • Our main areas of business are Environment & Emissions (40%) and Fertilizers (35%).

(35%) • We maintain databases of fertilizer company and division financial results (annual and quarterly), and fertilizer plant production configuration and cost. These databases are used to support the publication of regular reports including a new quarterly report on nitrogen fertilizer production costs • Our core expertise is the assessment of full production costs. We use published financial results (“top down”) and engineering configuration and raw material prices (“bottom up”) to conduct this analysis. We use engineering and market/commercial information.

• We regularly prepare bankable investment studies for new or revamp projects, and market studies and forecasts for fertilizer producers • We have several Russian and Arabic speakers in our team and extensive contacts at producers in Russia, Ukraine, Belarus, and North Africa • We ran a conference “Energy Intensive Industries & Climate Change” in Brussels in November 2008 which was attended by 300 people

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Carbon leakage and the European fertilizer industry

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Key findings of December 2010 report In this report we show that DG CLIMA’s proposed free allowance benchmarks for ammonia and nitric acid will result in carbon leakage.

Our starting O t ti assumption ti iis th thatt carbon b lleakage k would ld b be an undesirable d i bl effect ff t off th the EEmissions i i TTrading di Scheme III. We demonstrate that: • Ammonium nitrate, Europe’s most important fertilizer, is affected by both the ammonia benchmark and the nitric acid benchmark. Carbon costs on these products will have a cumulative impact on the producers d off ammonium i nitrate. i • The proposed benchmarks on ammonia and nitric acid will result in substantial carbon costs for European fertilizer producers relative to historical profit margins.

• The burden of additional carbon costs will affect the competitiveness of European fertilizer manufacture and will result in reduced ammonium nitrate production and plant closures. As a result, production will increase at plants outside the scope of ETS III which have spare AN capacity, especially in Russia, where there is higher carbon intensity of production and insufficient regulatory or commercial framework to prompt investment in abatement measures.

• IF European ammonium nitrate production is closed and farmers are supplied with ammonium nitrate produced in an external country such as Russia, then total emissions of greenhouse gases will increase and carbon leakage will occur.

• Non-Selective Catalytic Reduction (NSCR) is not considered to be BAT for N2O abatement in nitric acid production according to IPPC and therefore in principle cannot be installed in European fertilizer plants.

• Even if Fertilizers Europe’s proposed benchmarks for ammonia and nitric acid are adopted, carbon leakage is still likely to occur.

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Main areas of focus for ETS III research

O workk with Our ith Fertilizers F tili Europe E has h focused f d on three th main i areas: • Assessment of the GHG emissions from ammonium nitrate production in external countries with available capacity to export to Europe.

• Analysis of the likely economic and business impact of ETS III related carbon charges on European ammonium nitrate production • The Th success or failure f il off CDM and d JI projects j t in i fertilizer f tili production d ti under d UNFCCC

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Carbon leakage and the European fertilizer industry

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This chart outlines the CO2e emissions from AN plants in Belarus, Russia, Ukraine and Egypt. p gyp tCO2e/t AN Russian and Ukrainian producers will ill emit it over twice t i as much CO2e as the average European producer in 2013

4.5 4.0

As can be seen, all four of the external countries countries’ CO2 emissions from ammonia production exceed those in Europe. (x axis = capacity)

3.5 30 3.0 2.5

Average ABATED Emissions from E European AN plants (ex NSCR): 1.26tCO2e/t AN

2.0 1.5 1.0 0.5 0.0 Grodno KCCW Berezniki NAK Dorogobuzh g Meleuz Mendeleyvsk Kemerovo Rossosh Novgorod Cherepovets Angarsk January 2011

Combined effect of Commission’ss Commission ammonia and nitric acid benchmarks 0.92tCO2e/t AN Nevinn KUAZ Rivne Abu Qir* Semadco Stirol Delta Severodonetsk Kima Cherkassy Source: Integer, 2010 Nitrogen Costs Study

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This chart outlines the CO2 emissions from AMMONIA plants in Belarus, Russia, Ukraine and d Egypt.

Tonne CO2/tonne NH3

3.5 3.0

As can be seen, all four of the external countries countries’ CO2 emissions from ammonia production exceed those in Europe. (x axis = capacity)

2.5

Average off FFertilizers A tili Europe members’ ammonia plants

2.0

Commission’s proposed benchmark: 1.619 tCO2/tNH3

1.5 1.0 05 0.5 0.0

Grodno Novgorod NAK Meleuz KCCW Stirol Severodonetsk Abu Qir Semadco Nevinn Kemerovo KUAZ Berezniki Rivne Cherkassyy Delta Dorogobuzh Mendeleyvsk Angarsk Rossosh Source: Integer, 2010 Nitrogen Costs Study Cherepovets January 2011

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This chart outlines the CO2e emissions from NITRIC ACID plants in Belarus, Russia, Ukraine and Egypt.

Tonne CO2e/tonne HNO3

3.5 3.0

As can be seen, all four of the external countries’ CO2 emissions from ammonia production exceed those in Europe. (x axis = capacity)

2.5

With abatement, nitric acid production in Europe will have extremely low N2O emissions compared to external suppliers.

2.0 1.5 Average ABATED Emissions from European nitric acid Plants (ex NSCR)

1.0 0.5

Commissions C i i proposed d Benchmark: 0.302t CO2e/tHNO3

0.0

Grodno Kemerovo KCCW Berezniki NAK Nevinn Cherkassy Stirol Kima1 Dorogobuzh Novgorod Mendeleyvsk KUAZ Rivne Semadco1 Cherepovets p Angarsk g Severodonetsk Delta1 Rossosh Abu Qir* Source: Integer, 2010 Nitrogen Costs Study

January 2011

* Uhde EnviNox installed 2006 1N2O abatement currently being installed under CDM

Carbon leakage and the European fertilizer industry

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If capacity is relocated to RUSSIA from the 3rd & 4th quartiles, up to 2.9 million tpy of extra CO2e will ill be b generated d 3.5

Tonne es CO2e/tonn ne AN

3.0 2.5

Projected emissions from ammonium nitrate production in 2013

CO2e increase = Avg. per tonne increase (Q3,Q4) (Q3 Q4) x spare capacity

We do not anticipate that there will be any reduction of CO2e from Russian AN production in 2013 compared p to p present dayy emissions.

There is neither commercial nor regulatory incentives for the installation of N2O abatement in Russia.

+1 73 tCO2e/t AN +1.73

2.0 1.5 1.0 0.5 0.0 Europe, 1st quartile

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Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

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Index: Average profits compared to carbon charges (1999 (1999-2007) 2007) Index 100 = Historical profit (1999-2007) 180 160

Carbon costs for p proposed p DG CLIMA benchmarks

140 120 100 80 60 40 20 0

Europe, 1st quartile

Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

Historical profits (1999-2007 year) Post-2012 profit/loss with ETS III cost ETS III cost (Carbon charge at â‚Ź30 and cost of abatement) January 2011

Carbon leakage and the European fertilizer industry

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Average profits (1999-2007) compared to carbon charges â‚Ź/tonne AN 55 50

Carbon costs for proposed DG CLIMA benchmarks

45 40 35 30 25 20 15 10 5 0

Europe, 1st quartile

Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

Historical profits (1999-2007 year) Post-2012 profit/loss with ETS III cost ETS III cost (Carbon charge at â‚Ź30 and cost of abatement) January 2011

Carbon leakage and the European fertilizer industry

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Historic profits by quartile (1999-2007) compared to expected carbon charge â‚Ź/tonne AN 55 50 45 40 35 30 25 20 15 10 5 0 -5 -10 -15 -20

Europe, 1st quartile

Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

Historical profits (1999-2007 year) Post-2012 profit/loss with ETS III cost ETS III cost (Carbon charge at â‚Ź30 and cost of abatement) January 2011

Carbon leakage and the European fertilizer industry

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The additional costs associated with ETS III will have a severe impact on profitability of European ammonium nitrate production and result in closures

• €30 per tonne is our assessment of the average historic profit levels for European ammonium nitrate production. This level of profits represents a ROS of 19% (based on prices for the period 1999-2007).

• Integer’s g p previous research* shows that ammonium nitrate producers p need to achieve pre-tax profits of at least €48 per tonne (ROS of 30% at average historic prices) to achieve an acceptable investment return and therefore be sustainable (12% ROCE). The gap between actual and required profitability has resulted in closures of what could have become p capacity p y in the last 15 yyears much needed and competitive • At the Commission’s proposed benchmarks, new ETS III-related costs would reduce profits by €10-18 per tonne, a significant cost compared to historic profitability.

• ETS III at the current free-allowance f benchmarks will result in closure off up to 50% of European ammonium nitrate production that could otherwise be economically sustainable.

Source: * Profitability requirements in the European ammonium nitrate sector, sector December 2007 2007, Tim Cheyne Cheyne, Oliver Hatfield Hatfield, Integer Research. Updated in December 2009 for Oral Hearing with DG Trade.

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Average profits for the period 1999-2009 are higher due to record prices in 2008 â‚Ź/tonne AN 70 60

Carbon costs for p proposed p DG CLIMA benchmarks

50 40 30 20 10 0 -10 10

Europe, 1st quartile

Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

Historical profits (1999-2009) Post-2012 profit/loss with ETS III cost ETS III cost (Carbon charge at â‚Ź30 and cost of abatement) January 2011

Carbon leakage and the European fertilizer industry

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Profits by quartile for the period 1999-2009 â‚Ź/tonne AN 70

Carbon C b costs t ffor proposed d DG CLIMA benchmarks

60 50 40 30 20 10 0 -10 10

Europe, 1st quartile

Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

Historical profits (1999-2009) Post-2012 profit/loss with ETS III cost ETS III cost (Carbon charge at â‚Ź30 and cost of abatement) January 2011

Carbon leakage and the European fertilizer industry

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Average profits in 2010 are not a reflection of business over the cycle â‚Ź/tonne AN 90 80

Carbon costs for p proposed p DG CLIMA benchmarks

70 60 50 40 30 20 10 0

Europe, 1st quartile

Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

2010 profits Post-2012 profit/loss with ETS III cost ETS III cost (Carbon charge at â‚Ź30 and cost of abatement) January 2011

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Profits by quartile: 2010 â‚Ź/tonne AN 90

Carbon costs for proposed DG CLIMA benchmarks

80 70 60 50 40 30 20 10 0

Europe, 1st quartile

Europe, 2nd quartile

Europe, 3rd quartile

Europe, 4th quartile

Russia

2010 profits Post-2012 profit/loss with ETS III cost ETS III cost (Carbon charge at â‚Ź30 and cost of abatement) January 2011

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Solutions?

• The steepness of the two benchmark curves and the exposure of fertilizers to carbon leakage (due to energy and trade intensity) means that a free emission allowance based on a strict benchmark cannot prevent carbon leakage. The benchmarks cannot be set high enough to prevent leakage.

• A border adjustment, taking account of carbon footprint, is a possible solution.

• This would require regular technical audits of external producers. These audits would need to be periodic so that efficiency improvements and investments were reflected in lower border adjustments. There would also need to be an acceptable international framework for these charges – such as fair treatment of developing countries as defined by Kyoto etc.

• Border adjustments would need to apply to finished products (AN, urea, CAN, UAN) as well as ammonia • Member states will receive ETS revenues as outlined in the directive. These can be used to support plants that are unable to implement abatement technologies, at a high risk of closure, and where closure would lead to carbon leakage. This will be a negotiation at national level.

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Fossil fuels: CO2 emissions factors

CO2 Emissions Factors Fuel

tCO2/TJ

Natural gas

56.6

LPG (mainly propane and butane)

64.0

Naptha

73.3

Residual fuel oil

77.2

Anthracite coal

97.7

Source: ETC/ACC Technical Paper 2003/10 (Anke Herold)

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Overview of main report

The aim of this report is to assess the likelihood of carbon leakage in the European nitrogen fertilizer sector under the Emissions Trading Scheme phase III as currently proposed. We develop our analysis as follows: • In the introductory section we set the scene, explaining the importance of a nitrogen fertilizer industry in European food production, and the counterproductive effect that carbon leakage would have for greenhouse gas emissions and European fertilizer production production.

• In Section 1 we highlight that the nitrogen fertilizer industry is the most exposed industry to carbon leakage, and ammonium nitrate, the most widely used nitrogen fertilizer, is subject to two benchmarks. Both benchmark curves are particularly steep compared to other sectors.

• Sect Section o 2 co covers e s the t e technology tec o ogy choices c o ces for o reducing educ g N2O eemissions, ss o s, aand d tthe e eeffectiveness ect e ess of o each eac method. et od • In Section 3, we analyse the attractiveness of the European ammonium nitrate market to external producers, the capability of these producers to export to Europe, and the resulting effect on overall GHG emissions.

• Producers in countries near to Europe have less or no obligation to reduce GHG emissions, as summarised in Section 4.

• In Section 5, we assess the economic implications of the costs of compliance with ETS III at a carbon cost of €30 per tonne CO2e. We show that the carbon costs (including abatement) will severely reduce profitability and lead to plant closures and carbon leakage.

• The appendices contain our supporting data, references, arguments, and key calculations.

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