Renewable Energy. Introduction 9 M A R C H

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1 9 M A R C H Renewable Energy Introduction Implementation of the Kyoto Protocol on 16 February 2005 heralded a wide range of comments on the reality of climate change and the appropriate policy response. Infratil has substantial investments in renewable energy with TrustPower and Energy Developments, and is positioned to benefit from local and international measures to reduce greenhouse gases. In this update Infratil: Looks at the growing international acceptance that the world s greenhouse gas levels represent an enduring challenge in this century to our grandchildren. Observes that carbon dioxide emissions are now an internationally priced commodity. Expresses the view that emission targets will be incrementally tightened for developed countries, and will gradually extend to include more countries, and that the price of carbon dioxide emissions has the potential to increase. Supports the New Zealand Government s greenhouse gas policy as a response intended to begin a broad based gradual transition to living in a carbon priced world.

2 Science Firming on Climate Change Atmospheric CO 2 In Uncharted Territory The concentration of carbon dioxide ( CO 2 ) in the atmosphere is now well above the levels over the last several hundred thousand years (which varied as the earth moved in and out of ice ages). 400 CARBON DIOXIDE OVER THE LAST 420,000 YEARS INFRATIL UPDATE 2 ISSUE 21 Climate warming CO2 (ppm) Departures in temperature (0C) from the 1961 to 1990 average , , , ,000 Present years before present Source: Climate Change 2001: The Scientific Basis - Summary of How Much Is The World Warming? IPCC Climate warming Atmospheric temperatures have risen in the last few decades. Assessments based on physical principles and model simulations indicate that natural processes alone are unlikely to explain the recently observed global warming or the observed changes in vertical temperature structure of the atmosphere. The climate system can take centuries to fully respond to a change in the greenhouse effect. The biggest delays are due to the huge amount of heat needed to warm the deep ocean and the time it takes for the ice sheets to adjust. GLOBAL TEMPERATURE CHANGES SINCE Source: Climate Change 2001: The Scientfic Basis - IPCC

3 Climate Change Last month, scientists at the Scripps Institution of Oceanography announced the first clear evidence of human-produced warming in the world s oceans. Tim Barnett, the project leader, said the debate over whether there is a global warming signal is over now, at least for rational people. In his recent address to the Institute for International Economics, Lord Browne the chief executive of BP said, what matters is the weight of evidence, which suggests that increasing carbon concentrations in the atmosphere could threaten the sustainability of the climate...there is a case for precautionary action on climate change because the evidence is strong. 3What makes climate vary? Some climate change can occur naturally, and human induced effects will be embedded in a background of natural changes. Slow variations in the Earth s orbit, which are well understood, have led to significant changes in climate over time-scales of thousands of years, such as the ice ages. Volcanic activity can inject large amounts of sulphur-containing gases into the stratosphere, which are transformed into sulphate aerosols. Individual eruptions can produce a large, but transitory, cooling of the Earth s surface and lower atmosphere over periods of a few years. Increases in the concentrations of greenhouse gases will reduce the efficiency with which the Earth s surface radiates to space. This tends to warm the lower atmosphere and surface. This is an enhancement of an effect that has operated in the Earth s atmosphere for millions of years due to the presence of naturally occurring greenhouse gases: water vapour, carbon dioxide, ozone, methane and nitrous oxide. INFRATIL UPDATE ISSUE 21 There is a lot of scientific consensus that human induced climate change is real, but there is still uncertainty over the magnitude of the effect. Greenhouse gases are entering the atmosphere faster than they are being removed, and it is forecast that stabilising the concentration of CO 2 at say 450ppm would require emissions to drop below 1990 levels within a few decades. Even after concentrations of CO 2 have been stabilised, global mean temperature will continue to increase for hundreds of years. If it is apparent that we have already destined future generations to further climate change, and that limiting it to safe levels requires major effort over decades, it would be difficult to justify to our grandchildren why we did not make a start. Debate over the science of global warming will be ongoing, but Infratil anticipates that the science will continue to support measures to reduce CO 2 emissions.

4 INFRATIL UPDATE 4 ISSUE 21 Control of CO2 Emissions Policy Response Control of CO 2 Emissions The Kyoto Protocol and the New Zealand Government s greenhouse policies are part of the first stage of a process to enable the control of CO 2 emissions. At this stage, CO 2 emissions from developing countries are not prevented from continuing to grow. However the scientific evidence indicates that arresting climate change will require total emissions to reduce. The growth in emissions from developing countries will have to be addressed. Although Kyoto is far from perfect, it does create the beginnings of a mechanism for rights to emit to be valued and for an international price to be established. By consumers and producers recognising that emissions have a real cost, it will be much easier to limit their growth. Countries such as Australia and the USA have decided to undertake their own entirely domestic measures to limit CO 2 emissions. They are concerned that local interests will not be prioritised in any global protocol or global market. Their CO 2 emissions may not end up any different from having gone it alone, but they would not have participated in the developing international market that rewards emission reductions. Examples of measures to limit emissions in non-kyoto countries: Australia: The federal Mandated Renewable Electricity Target policy - obligation on Australian retailers to purchase 2% of their electricity from additional renewable generation by The NSW Greenhouse Gas Abatement Certificates scheme - NSW retailers are obliged buy from cleaner generation so as to meet emissions targets. The Queensland Gas Electricity Certificate scheme - imposes an obligation on Queensland retailers to purchase 13% of generation from natural gas and coal seam and waste gas in preference to cheap Queensland coal. USA: 11 US states are working together to develop a regional cap-andtrade system for power plants. California requires the market share of renewable energy to increase by 1% a year to 20% by New York requires 25% renewable energy by 2013.

5 The European Emissions Trading Scheme International Pricing of CO2 Emissions The European Union has been one of the major supporters of the Kyoto Protocol and has committed to reduce average annual greenhouse gas emissions, between 2008 and 2012, to 8% below 1990 levels. Rather than waiting until the Kyoto commitments come into force in 2008, Europe has already set limits on the amount of greenhouse gases that can be emitted by large energy businesses, and introduced tradeable emissions rights that expose businesses to a market value for greenhouse gas emissions: Specific industries that emit CO 2 (energy, iron and steel, mineral, wood, pulp, paper and card) have each been granted a quota of emission rights by their government, which generally reflect past levels of emissions. The total number of emission rights allocated sets the total allowed amount of greenhouse gas emissions. The amount of emissions rights declines in future years. Any business that emits above its level of rights will pay a substantial penalty. The trading of these emission rights has led to a market becoming established with a market price for emitting greenhouse gases. The value of the rights depends on the generosity of the initial allocations, and the market s view of the cost of reducing CO 2 in the industries concerned. Measuring the quantity of emissions: Emission permits trade in units of a tonne of carbon dioxide equivalent 1 tco 2 -e. This is a tonne of carbon dioxide or an equivalent amount of any other greenhouse gas. Other greenhouse gases have different global warming potentials and different quantities that are equivalent to a tonne of carbon dioxide. For example: 1 tonne of methane = 21 tco 2 -e. 1 tonne of nitrous oxide = 310 CO 2 -e. Price per tonne of C0 2 EUROPEAN MARKET PRICE INDEX FOR TRADED CARBON Oct Nov Dec Jan Feb 05 The value of emission rights acts to reduce CO 2 emissions in two ways. Initially the large industries involved will note the value of reducing CO 2 and will seek ways to lower emissions so as to be able to sell some of their rights. Secondly businesses that have to buy additional rights will seek to pass the cost on so that some products will reflect the cost of their contribution to greenhouse gas emissions. Notably this market is functioning today across the European Union, and providing incentives to lower present emissions. NZ $ In the New Zealand context, it is worth noting that the European scheme has to function across separate nations each with their own tax systems and is narrowly focused on large energy users. Transport is a large contributor to greenhouse gas emissions, but is not part of the emission rights regime. Euro Source: The European Energy Exchange, EEX INFRATIL UPDATE 5 ISSUE 21

6 TRADING IN KYOTO CREDITS HAS ALSO STARTED INFRATIL UPDATE 6 ISSUE 21 Early Trading Every developed country that has signed up to Kyoto has CO2 targets for and has the ability to buy credits to help meet those targets. Because they are not parties to Kyoto, the United States and Australia cannot create such credits, but Canada and New Zealand can. Governments already buying credits The Dutch Government has been a major purchaser of permits produced in other countries, including New Zealand. The Netherlands has contracted to buy 530,000 tonnes of CO 2 credits from Meridian Energy. These have been granted by the New Zealand government to encourage construction of the Te Apiti wind project near the Manawatu Gorge. Other European Governments are also purchasing credits, which protects them from the risk of future prices being higher. How Relevant Are These Early Trades? These early schemes and the present commitments under the Kyoto Protocol will only have a minor effect on total greenhouse gas emissions, but they are establishing baselines and trading mechanisms. It is very unclear how future targets will evolve and how non-kyoto trade partners might face trade barriers to neutralise their open access to Kyoto constrained markets. However it is clear that: Carbon dioxide emissions are now an internationally priced commodity. Allowing emissions from the transport sector to continue to grow will require ongoing stretch in energy sector targets. Emissions reduction targets for developed countries will become more challenging, and that they will be gradually extended to more countries. Infratil considers that the price of carbon emissions has the potential to increase.

7 New Zealand New Zealand has committed under Kyoto to limit the average CO2 emissions during the first Kyoto period (2008 to 2012) to 1990 levels. If New Zealand does better than this target it may on-sell the excess credits to other Kyoto countries. If it does not meet the targets it will be obliged to purchase credits from other countries. Government forecasts are for New Zealand to have a net surplus of CO 2 credits. This is expected to arise because of the success of Government policies to reduce emissions and the increase in areas under forestry since (As new trees grow, they absorb CO 2 from the atmosphere.) There are however challenges to these forecasts - in particular: The likelihood of coal being used for electricity generation as natural gas reserves decline. The growth in transport fuel use. Reduced forestry planting. The present policy to reduce greenhouse gas emissions comprises: Price based measures (see page 8). Targeted projects to reduce emissions. (see page 9). National energy efficiency and conservation strategy. The New Zealand waste strategy. Local Government initiatives. Small to medium enterprises and business opportunities. Research. Area planted (000 ha) NEW LAND PLANTED IN PRODUCTION FOREST IN NEW ZEALAND Source: National Exotic Forest Description as at 1 April 2003 INFRATIL UPDATE 7 ISSUE 21 New Zealand is not yet finally committed to the second stage of Kyoto (beyond 2012) as the targets are yet to be negotiated. However more challenging targets are likely to be required. Under article 27 any signatory can withdraw from the Kyoto protocol after it has been in force for three years by giving a year s notice.

8 NZ PRICE BASED MEASURES Part of our Government s approach is to use price signals to encourage reduced emissions. INFRATIL UPDATE 8 ISSUE 21 Our Approach However, rather than using the European quota approach, New Zealand is to have an emissions charge that will be introduced by The level of the charge will reflect the world price for carbon dioxide emissions, but will be capped at $NZ25 per tonne of CO 2. The Government has committed to reduce other taxes by the net amount raised via the emissions charge. It is also negotiating exemptions for specific businesses whose international competitiveness is at risk because carbon taxes or pricing is not yet implemented in all the countries we trade with. In principle, use of either tradeable quotas or an emission charge is likely to have similar effects on the incentives to reduce emissions and on prices of goods and services that cause emissions. However an emission charge is simpler to administer than the quota system, as it avoids the complexity of determining the initial quota allocations and tracking the changes of ownership. An emission charge can also have a broader impact since it is impractical to extend a quota system to small scale emitters, such as domestic transport. If just one sector, such as energy, bears the brunt of carbon dioxide emissions reductions, prices in that sector will be disproportionately higher. Under an emissions rights regime, electricity prices and the value of renewable energy would likely be higher. Carbon taxes are not supported by the National Party, which favours tradeable emission permits. If tradeable permits were to be introduced instead of an emission charge it would be desirable to do so immediately. Otherwise existing businesses would be incentivised to increase emissions prior to the permits being introduced so as to be granted a high level of quota. This may jeopardise NZ meeting its targets, and would delay the process of adjustment towards production and consumption technologies with low emissions. Price Impacts of a 8/tC0 2 -e tax or $NZ cents per litre of petrol 0.9 cents per unit of electricity from coal 0.5 cents per unit of electricity from gas $31 per tonne of coal $7 per tonne of cement $30 per tonne of steel (New Zealand made) $24 per tonne of aluminium (New Zealand made)

9 NZ TARGETED PROJECTS TO REDUCE EMISSIONS An important component of the present policy is the Projects to Reduce Emissions programme (see Box). Under this mechanism the New Zealand Government assists selected projects by awarding credits, for emissions reductions, which can be sold internationally (e.g. to Europe). These credits are awarded to bring forward projects which reduce emissions but which otherwise would not be economically viable. NZ Projects to Reduce Emissions Proponents of particular emissions reducing projects bid in the number of credits they require for each project for it to be viable. The projects with the highest level of CO 2 reduction per credit are selected. There have been two tender rounds. The first tender round was held in 2003 and it granted 4 milllion credits to 15 projects. The second was held in 2004 and issued 6 million units to 24 projects which are expected to generate 7mt of CO 2 savings. The Government has issued 0.86 units for each tonne of CO 2 it expects to save. Zero emission electricity projects such as hydro and wind displace generation from thermal plants and hence save 625 tonnes CO 2 -e per GWh. TrustPower This mechanism is expected to achieve the allocation of 10 million emission credits to support projects that are expected to reduce emissions by 13 million tonnes equivalent. At 8/ tonne CO 2 -e, the market value of the 10 million credits would be NZ$ m. TrustPower has been an active participant in the scheme. It negotiated emission units for the Tararua II wind farm prior to the first tender round. (0.4 million tonne CO 2 -e saving ). It was granted 0.34 million units in the first tender round for enhancements to some of its existing hydro generation schemes. Trustpower also offered Tararua III (1.3 mt CO 2 e saving) and other hydro enhancements into subsequent tender rounds. The Tararua wind farm has an annual output of 130 GWh and would so save 130*5*625= 406kt CO 2 -e in the 5 year commitment period. Projects to Reduce Emissions INFRATIL UPDATE 9 ISSUE 21

10 Conclusions on NZ Goverment Policy The coming into force of the Kyoto protocol has unleashed a wide range of public pronouncements ranging from active support, resigned acceptance to outright rejection. INFRATIL UPDATE 10 ISSUE 21 Despite debate over aspects of the science and policy prescription, Infratil believes international pressures to limit greenhouse gas emissions will increase in future years. New Zealand needs to accept the reality of this and focus on policies that will enable it to survive and prosper in this environment. These policies need to recognise that greenhouse gas emissions have an internationally recognised cost. They should also position New Zealand for even more significant constraints in the future and recognise that it takes time to develop new technologies and change production and consumption patterns. A broad based tax on carbon is a sensible component of the policy mix. How Much Wind Generation Can New Zealand Handle? A predominately hydro system is well suited to handle the day to day variations in wind since when the wind is blowing hydro generation can be retained in storage for days when the wind isn t there. On the other hand, wind provides a relatively reliable energy contribution over a period of months, even in a dry year. Currently there is around 170 MW of wind generation in New Zealand. This is around 2% of installed capacity. Planned projects will more than double this to 400 MW or 4% by the end 0f In countries such as Denmark, Germany and Spain wind already makes up between 13% and 33% of their total generation capacity. The future level of wind generation in New Zealand will be ultimately limited by the availability of environmentally acceptable and economically viable sites. With its flexible hydro generation, NZ should be able to handle a total wind generation capacity of at least 10%. This would allow for another 600 MW or 5 to 10 wind farms beyond 2006.

11 Infratil Investments Moving Forward TrustPower Trustpower s generation is entirely renewable and Infratil is currently supporting TrustPower in building a development pipeline of selected wind and hydro opportunities in response to this. These projects, if viable, will benefit both the nation and TrustPower. The NZ development projects are zero emissions projects and qualify for the NZ Projects Mechanism and would benefit in the long term if prices for internationally traded carbon increase. Prospective investments in Australia are eligible for Renewable Electricity Certificates (RECs) under the Australian federal MRET scheme. The MRET scheme is a Kyoto-Plus mechanism which provides the equivalent of approximately $A40/MWh = $A44/tCO 2 -e support for wind projects. INFRATIL UPDATE 11 ISSUE 21 Energy Developments Energy Developments generation capacity includes: 208 MW of landfill gas generation projects in Australia, UK, Europe, Taiwan and the USA. Landfill gas is the methane rich gas emitted from organic waste dumped in landfills. 97 MW of coal mine waste gas generation projects in Australia. Coal seams release methane during mining. This flammable mine waste gas is a safety hazard in underground mines and must be expelled by mine ventilation or by direct drainage of the coal seams. Converting landfill and coal mine waste gas to electricity prevents methane emissions to the atmosphere and avoids carbon dioxide emissions from fossil fuel that might otherwise be used to generate electricity. Since methane is 20 times as potent a greenhouse gas as carbon dioxide, this type of project is particularly effective at reducing emissions.

12 Infratil Investments (cont) Although much of this capacity is in non-kyoto Australia, Energy Developments earns additional revenue from the explicit sale of green credits for the federal renewable energy target and for the New South Wales requirement to reduce electricity s greenhouse gas emissions. The recent results for the 6 months ending December 04 show Australian landfill gas to have earned AU$9.5m ($7.3m in 6 months to December 03) from selling green credits which is 19% (16% to December 03) of total revenue. Energy Developments has a development pipeline of methane destruction projects. As an example they have just announced an Australian Greenhouse Gas Abatement Programme grant of up to $15.4 million for its planned 32MW German Creek coal mine methane power project. This project will reduce greenhouse gas emissions by the equivalent of 1.1 mtco 2 per annum. Infratil places a priority on investments which can increase in value with a rise in the international value of carbon. Infratil will continue to focus on energy investments in well run companies, which have technologies and development options that reduce greenhouse gas emissions and which will continue to be profitable in the long run. INFRATIL UPDATE 12 ISSUE 21 Conclusions Whilst all reasonable care has been taken to ensure the facts stated are accurate, neither Infratil Limited, Morrison & Co Infrastructure Management Limited, nor any of their directors, officers or employees guarantee the accuracy or completeness of the information stated herein.