CARBON MARKET FRAMEWORK Nives Nared, Ministry of Agriculture and Environment, Slovenia

Theory: Carbon trade as EI Not administrative requirements, but trade driven Enables portfolio of bussines decisions Cost efficient GHG emissions reductions Minimazing influence on global international competition As a response to Kyoto Protocol requirements

Why a Carbon Market? Cost effective achievement of environmental goals, due to considerable differences in costs for limiting GHG emissions Price signal towards low carbon technologies, Price created as a result of reduction possibilities, Win win potential: emissions reduction & economic benefit As GHGs settle in the atmosphere, it does not matter where emissions are reduced

Why a Carbon Market? Brings buyers and sellers together thereby creating a price formation mechanism Provides transparency and liquidity Allows active financial risk management Facilitates the monetisation of excess credits

Kyoto Protocol - basics Two general categories: –developed countries, referred to as Annex 1 countries (who have accepted GHG emission reduction obligations); and –developing countries, referred to as Non-Annex 1 countries (who have no GHG emission reduction obligations). Any Annex 1 country that fails to meet its Kyoto target will be penalized by having its reduction targets decreased by 30% in the next period. By , Annex 1 countries have to reduce their GHG emissions by around 5% below their 1990 levels (for many countries, such as the EU member states, this corresponds to some 15% below their expected GHG emissions in 2008). Reduction targets expire in Kyoto Protocol includes "flexible mechanisms" which allow Annex 1 economies to meet their GHG targets by purchasing GHG emission reductions from elsewhere. These can be bought either from financial exchanges (such as the new EU Emissions Trading Scheme) or from projects which reduce emissions in non-Annex 1 economies under the Clean Development Mechanism (CDM), or in other Annex-1 countries under the JI.

6 Parties to KP Annex I Non-Annex I Not ratified

Kyoto flex mechanisms Clean Development Mechanism: –Aims to assist non-Annex I countries achieve sustainable development –Annex I countries with emission caps pay to implement projects to achieve emission reductions in developing countries. Credits (CERs) issues based on emission reductions of project. Joint Implementation –Annex I country assists another Annex I country to implement projects to reduce emissions. International Emissions Trading –Trade of emissions allowances or reduction credits. Aim is to reduce total costs of achieving collective emissions reductions. Total amount of emissions reductions of Annex I countries does not change.

Kyoto & its flexibility mechanisms Non Annex IAnnex I EA Emission Allowance Market JI Joint Implementation CDMCDM CDMCDM CDMCDM 3 flexibility mechanisms

JI projects create ERUs What is JI about: Annex I Party (with a commitment inscribed in Annex B of the Kyoto Protocol) may implement an emission-reducing project or a project that enhances removals by sinks in the territory of another Annex I Party (with a commitment inscribed in Annex B of the Kyoto Protocol) and count the resulting emission reduction units (ERUs) towards meeting its own Kyoto target. Eligibility criteria: Projects must result in: “real, measurable and long-term benefits related to the mitigation of climate change”. “reductions in emissions that are additional to any that would occur in the absence of the certified project activity”.

CDM projects create CERs What is CDM about: allows governments or private entities in rich countries to set up emission reduction projects in developing countries to promote sustainable development in developing countries, and to allow industrialized countries to earn emissions credits from their investments in emission-reducing projects in developing countries Eligibility criteria: Projects must assist Non-Annex I Parties (developing countries) “in achieving sustainable development and contributing to the ultimate objective of the Convention” Projects must result in: “real, measurable and long-term benefits related to the mitigation of climate change”. “reductions in emissions that are additional to any that would occur in the absence of the certified project activity”.

European Union NON-ANNEX 1 COUNTRY ANNEX 1 COUNTRY € invested in CDM project CERs for Kyoto Compliance

International ET 3rd flexible mechanism under Kyoto Protocol Annex B countries will have the option of buying or selling some portion of their "assigned amount units" (AAUs) Countries/companies with high internal emission reduction costs would be expected to buy “rights to emit” from countries/companies with low internal emission reduction costs

Structure of the Carbon Market Kyoto compliance (Annex 1 Governments) EU Emissions Trading Scheme JI & CDM Retail Domestic trading schemes e.g. UK ETS, NSW GHG abatement scheme, Chicago Climate Exchange, Canada domestic scheme, Japan? Voluntary EU, Canada, Japan & New Zealand

Carbon markets

Carbon market -unmature, still fairly new, but fast growing, “under development” -fungibility -started as not organised, unregulated -brokers, commodity stock exchanges entered the market -EU ETS to be a regulated market as from 2013

What is traded -EU Emission trading: EUA, EUAA, -Trading in project based credits: CERs, ERUs, -International trading: AAUs -Other trading shemes: other allowances -But both the Kyoto Protocol and the EU ETS mix ‘cap- and-trade’ allowances and project-based credits, and try to make them mutually exchangeable

The carbon market trend  A large preponderance of Allowances (especially EU-ETS)  A boom of secondary market (brokers, traders, banks, etc.)

EU ETS as part of Carbon market -EU as the first mover in the evolution of carbon market -biggest global mandatory systematic market, compliance participants, 40% EU GHG emissions -to be linked with other emerging trading shemes worldwide

What is traded where? -currency traded is the EU allowance -legal nature of EUA -EUA is a right to emmit 1 ton CO 2 -trading is not regulated by the Directive -trading takes place between companies, with the help of market intermediaries (“over-the-counter”) and at organised exchanges (Amsterdam, Paris, Vienna, Leipzig, Oslo etc.)

HOW do EUA get to the market ? -till now mostly free of charge “via” national allocation plans -some auctioning by some MS (UK, Austria, Ireland, Greece)

Who can trade? any person (legal or physical) can hold and trade with EU allowances only legal requirement: open account in the registry

How can CERs and ERUs be used in the ETS? under the EU ETS each installation is required to surrender a number of allowances corresponding to their verified emission volume for each calendar year in the event that an installation has insufficient allowances for compliance, the shortage can be covered by: –purchasing additional EUA from the market –surrendering a specified number of CERs, ERUs from its operator’s holding account

Real life situation on the carbon market Carbon trading strongly reliant on financial markets infrastructure –trade in financial instruments amounting to some 90% of total volume –security incidents led to even greater prominence of the financial segment –gradual shift from brokers to exchanges (brokers originated 33% of transacted volume in 2010 from 65% in 2007) –approx. 89% of OTC volumes are cleared on exchanges –less than 10% of the OTC trade is spot Market is maturing and growing in size –20-fold increase from 2006 to 2010 only Supervision so far existent only in financial segment

Market price fluctuations

Price Drivers Macro –Political will –National developments –Economic (growth/recession) –Innovation Micro –Demand and Supply –Oil price –Coal price –Gas price –Weather/temperature –Interest rates –Other markets

EUA trading to be regulated EU allowance would be classified as financial instruments Proposal of Amendment to Markets in Financial Instruments Directive Cost of frauds : VAT = 5 Bns € ; EUA threfts = 50 M€. Real challenge : the Governance, not the Costs

Where Next? US ETS 5,760Mt EU ETS 2,080Mt Aus ETS 445Mt NZ ETS 100Mt Japan ETS 1,272 Mt China/India? Canada ETS 400Mt CERs bridge the Regional Schemes

EU vision: Concrete steps forward Build an international carbon market To drive investments and achieve mitigation objectives at least costs To generate important financial flows to developing countries Concrete steps: Link compatible domestic cap-and-trade systems to develop an OECD-wide market New sector-wide market mechanisms for (advanced) DCs as a step towards cap-and-trade systems Reform and better focus the CDM Outcome from Cancun: positive developments (i.e. standardised baselines, CCS in CDM), but a lot of work ahead on new market mechanisms