The need for North Sea operators (and asset partners) to buy the vast majority of their carbon allowances at auction or in the market within just a few years could hamper recovery of the UK’s oil&gas reserves.
Offshore oil&gas installations require a lot of energy in order to operate safely and efficiently. This inevitably means that they can emit large volumes of carbon dioxide (CO) as a result of burning gas to create electrical and mechanical energy.
The EU Emissions Trading Scheme (EU ETS) seeks to limit the amount of CO emitted by heavy industries such as power generation (by far the largest emitter), iron and steel, oil&gas (upstream and downstream) and cement.
Phase II of the EU ETS began on January 1, 2008, and lasts for five years until the end of 2012, the same as the Kyoto period.
Phase III lasts eight years – 2013-20 – and will be considerably tougher than Phase II because it will be the EU’s main instrument for delivering industry’s share of the EU’s target of a 20% reduction in emissions of greenhouse gases (GHGs) by 2020 – but it, of course, only concerns CO.
The revised directive covering Phase III was approved by the European Council and Parliament in Brussels during December 2008, along with the three other parts of the European Commission’s climate change and energy package (carbon capture and storage, renewable energy and “burden sharing”).
While Phase II involves a modest amount of auctioning of allowances, Phase III will increase this substantially, imposing additional costs on business. Generally across Europe, 20% of allowances will be auctioned in 2013, rising to 70% in 2020 and 100% in 2027. The remainder of allowances will be allocated free to the installations in each industry ranked in accordance with their efficiency – the top 10% of installations will receive the most free allowances and all others will be given free allowances relative to their efficiency.
However, industries subject to so-called “carbon leakage” – that is, detrimentally exposed to international competition – are allocated free allowances. This includes upstream oil&gas, so why, then, do the rules for Phase III of the EU ETS threaten recovery of the UK’s oil&gas reserves?
There are two reasons.
Firstly, qualification for free allowances under the carbon-leakage argument does not apply to electricity generation. UK offshore installations, with the exception of the Beatrice field, are not connected to the grid, so are left with no option but to generate their own electricity. For this activity, whether the electricity is for own consumption or sale to others, all allowances will have to be bought at auction or, subsequently, in the market from 2013 onwards.
Electricity production accounts for about 50% of the industry’s total CO emissions, so this rule has a dramatic effect on the proportion of allowances that must be purchased by UK North Sea operators.
Overall, with electricity generation of this scale, and even with emissions from other activities qualifying as subject to carbon leakage, it has been estimated that most offshore installations are going to receive only about 15-20% of their allowances free over the period covering Phase III. The remainder will have to be bought at auction or in the market.
Secondly, if an international agreement to follow Kyoto is reached at a conference to be held in Copenhagen in December 2009, the EU intends to increase the reduction in emissions of CO to be achieved by the EU during Phases I, II and III of the ETS from 21% to about 30%.
This will be extremely difficult and is likely to be accompanied by the curtailment or abandonment of the carbon-leakage concept, increasing costs for business further.
The industry is concerned that the increase in operating costs due to the requirement for companies to buy the vast majority of their carbon allowances at auction or in the market will reduce competitiveness of our oil&gas fields, cut short current production and deter future investment in projects.
The potential consequences of Phase III have been estimated by Oil & Gas UK to be 600-950million barrels oil equivalent of UKCS production forgone, never to be recovered.
Even upon achievement of the Government’s target to source 15% of our energy from renewables in 2020, we will still rely on oil&gas for 70% of our needs at that time.
What we do not produce ourselves will have to be imported at great cost to the economy. If the industry is to maximise production of the UK’s indigenous oil&gas reserves and help secure energy supplies, the Government should recognise the risks posed by Phase III and work to restore the competitiveness of UK offshore projects with all the tools at its disposal.
David Odling is Oil & Gas UK’s energy policy manager
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