Trading Emissions Contracts

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Presentation transcript:

Trading Emissions Contracts The Carbon Market Trading Emissions Contracts February 2009

Contents Introduction Cap and Trade Kyoto mechanics ECX European market experience Conclusions

Why? If your house was on fire, would you try to put it out? The world is heating up, it is caused by humans (anthropogenic), and we have the chance to address it. The global cost of a Cap and Trade based solution is estimated at 2% of GDP – if we act now. If we don’t act, what legacy are we leaving to future generations?

Understanding Cap and Trade

The Cap Measure License Limit supply Creating a shortage in something that was always deemed to be limitless Requires great political leadership – those covered will naturally resist Has different resistance points depending on local factors Will never be truly fair – some people will suffer more than others

Cap – underlying philosophy Those who continue to pollute at the old levels will have to pay, and the charges will increase as the supply is squeezed. Over time this will make them LESS competitive Those who change early will be rewarded for their action. Over time they will become MORE competitive. The overall improvement is the quantum of the reduced supply

Trade 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

Cap and trade SIMPLE! Creates a cost and/or an opportunity

Kyoto Protocol – key points Divides world into two parts – Annex 1 countries (developed world) and non-Annex 1 countries Covers period 2008 -2012 Reduce Annex 1 emissions by (an average of) 5.2% below 1990 levels National caps applied – but multiple mechanisms for compliance

Kyoto Protocol flexible mechanisms Emissions Trading Annex I parties may trade emissions allowances at a national or regional level Clean Development Mechanism (CDM) Annex I parties may implement emission reduction projects in non-Annex I countries in order to meet their own emissions targets Joint Implementation (JI) Annex I parties may implement emission reduction projects in certain other Annex I countries in order to meet their own emissions targets BACK TO CONTENTS

Europe – global leadership position Kyoto Implementation Europe – global leadership position Pre-Kyoto trading scheme (Phase I) 2005-2007 Phase II coincides with Kyoto period EUETS legally binding across all 27 member states Average reduction of 8% (from 1990 levels) 12% of allowances can come from CDM (national limits ranging from 0 to 20%) 2013-2020 scheme being finalised

United States – failed to ratify agreement Kyoto Implementation United States – failed to ratify agreement The largest per-capita emitter of carbon, responsible for approximately one third of Annex 1 pollution Various regional initiatives – California, RGGI Voluntary (legally binding0 scheme managed by Chicago Climate Exchange Both Presidential candidates vocal supporters of cap and trade Possible post-Kyoto implementation 2013?

ROW – varied responses Kyoto Implementation Canada – scheme commencing 2010 Australia – scheme announced 2010 New Zealand – scheme to start 2009 (possible link to Australia) Japan – details not yet available

Performance against Kyoto targets Country Base year GHG emissions (mt CO2e) 2005 GHG emissions Change in GHG emissions base-2005 (%) Kyoto Protocol target as change from base (%) Difference (%) Australia 418.3 525.4 25.6 8 17.6 Belarus 127.4 75.6 -40.6 -8 -32.6 Canada 596.0 746.9 25.3 -6 31.3 Croatia 31.6 30.5 -3.4 -5 1.6 European Union 5133.4 4711.0 -8.2 -.2 Hungary 115.7 80.22 -30.7 -24.7 Iceland 3.4 3.7 10.5 10 .5 Japan 1272.0 1359.9 6.9 12.9 Liechtenstein .23 .27 17.4 25.4 Monaco .11 .10 -3.1 4.9 New Zealand 61.9 77.2 24.7 Norway 49.8 54.2 8.8 1 7.8 Poland 586.9 399.0 -32.0 -26.0 Russia 2989.8 2132.5 -28.7 Turkey 170.1 296.6 74.4 82.4 Ukraine 923.8 418.9 -54.7 United States 6229.0 7241.5 16.3 -7 23.3 Total 18,709.6 18,182.3 -2.8 -5.2 2.4

Post Kyoto Aiming for agreement in Copenhagen 2009 To cover period 2013 – 2020 20-30% reduction by Annex I countries (?) Number of CER’s to be allowed Commitment from non-Annex I

Corporate structure Richard Sandor key role Started late 1990’s (most market people saw issue as fringe) US was the leader – CCX set to be focal point – US failed to ratify Europe took centre stage ECX established 2004 Began operating 2005 – now centre of market CCX playing a major role in US Voluntary arena Plus continuing political role and operate markets in sulphur/nitrous oxide etc CCX will aim to be key US player when national system adopted

About ECX European Climate Exchange is the most liquid marketplace for trading CO2 EU Allowances (EUAs) under the EU Emissions Trading Scheme. ECX is part of the Climate Exchange plc group of companies, listed on AIM of the LSE ECX and ICE Futures Europe have a partnership where ECX manages marketing and product development for its carbon emissions contracts and ICE lists those products for trading on its electronic platform known as WebICE. ECX CFI (Carbon Financial Instrument) contracts are: Listed & traded on ICE Futures Europe electronic platform, a Recognized Investment Exchange Regulated by the Financial Services Authority Financially guaranteed by LCH.Clearnet

ECX Products ECX is a derivatives marketplace essentially for 2 products, each with equal value of one tonne of CO2: Firstly, EUAs are allocated allowances, issued by governments for free to companies under the EU ETS And secondly, CERS, which are project-based Certified Emission Reduction credits verified under the CDM – another one of the Kyoto flexible mechanisms, allowing industrialised countries to invest in projects that reduce emissions in developing countries. EUAs have traded on the exchange for over three years and are the most liquid contracts on ECX CERs were introduced this year and have seen extremely encouraging growth since their launch ECX has a partnership with ICE, the InterContinental Exchange, whereby ECX products are listed and traded on the ICE Futures Europe platform. ECX outsources all exchange functionalities to ICE Futures Europe, and is regulated through ICE, and all trades are guaranteed by the Clearing House. WITH JUST 2 PRODUCTS (we don’t see ourselves introducing any new contracts in near future) It leaves us to concentrate on building deeper liquidity in these markets - we can concentrate on marketing / relations / business development Our focus is on carbon only……

About ECX

Price and volume ECX EUA Futures Contracts • 94 million tonnes of CO2 traded in 2005 with a market value of €2.1 billion • 452 million tonnes of CO2 traded in 2006 with a market value of €9 billion • 1 billion tonnes of CO2 traded in 2007 with a market value of €17.5 billion

Open Interest ECX EUA Futures Contracts ECX EUA Futures Contracts Open Interest currently rests at 171 million tonnes

Volume ECX EUA Options Contracts 341 million tonnes of CO2 have traded in EUA options and 79 million tonnes of CER options on ECX / ICE Futures Europe

Who is the Market? So who trades these EUAs and CERs??? There is a range of different players that overlap to an extent The market is driven by companies under compliance – the Naturals/Physical players, hedging their exposure to carbon – eg Shell, Eon, the utility, Hedielberg Cement as an industrial Then there are the Speculators and Abitrageurs: most large European & US banks as well funds and prop shops – eg Saxon / Geneva Trading / Jane Street Capital Another emerging group might be called the Investors: there are banks offering a range of indices, including UBS / Barclays / Socgen….. and ETFs such as KlimaInvest / Airshares. These products are available to institutional investors and increasingly to retail clients. Although hedgers will always have high proportion of O.I., we envisage their proportion of overall trade to decrease, as you find in most mature commodity markets….

ICE Futures Members enabled to trade ECX Contracts Accord Energy Galp Energia Osterreichische Elektrizitatswirtschafts-AG ADM Investor Services International Gazprom Marketing & Trading R.J. O’Brien & Associates All Energy Trading Geneva Ireland Financial Trading Rand Financial Services All Options Curaçao Getco RBC Capital Markets Corporation Atel Trading GFI Securities RBS Sempra Energy Europe Bache Commodities GH Financials Royal Bank of Canada Europe Banc of America Securities Goldman Sachs International Sagacarbon Barclays Capital Grupo Santander Saxon Financials BG International HSBC Bank Schneider Trading BHF Bank ICAP Securities Schnell & Co. BNP Paribas Commodity Futures Infinium Capital Management Scottish Power Energy Management BP Gas Marketing IMC SEB Futures British Energy Trading Jane Street Capital Shell Energy Trading Carbon Capital Markets Jaypee International Shell Int. Trading & Shipping Company CEZ JP Morgan Securities Smartest Energy Citadel Derivatives Trading Jump Trading Spectron Energy Services Citadel Equity Fund KFW Starmark Trading Citigroup Global Markets KlimaInvest Statkraft Energi Climate Change Capital Limestone Trading Sucden UK Credit Suisse Securities Madison Tyler Trading Susquehanna Deutsche Bank Marex Financial TFS Derivatives Dresdner Bank Marquette Partners The Royal Bank of Scotland E&T Energie Marubeni Corporation ThyssenKrupp E.On UK Merrill Lynch Commodities Tibra Trading Europe EDF Trading Merrill Lynch International Tradelink EDP – Energias de Portugal MF Global Tullett Prebon Securities EGL Trading Mizuho Securities USA UBS Clearing & Execution Services ELECTRA Deutschland Morgan Stanley & Co International UBS Electrabel Natixis Commodity Markets Universal Data (UK) Endesa Generacion Newedge - Calyon Wachovia Bank First New York Securities Newedge – FIMAT XConnect Trading Fortis Bank Global Clearing Optiver VOF

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

EUA-CER Price Spread Trading this spread has been a popular strategy recently – it widened to over 9euros and has come back in to about 7 euros CERs at a discount because of Import limits for compliance ( UK 8% / Germany 22% ) and there is a CER registry problem within Europe, which will hopefully to rectified soon. However there is currently much bullishness around CERs: Less supply: Chinese Earthquake / bottlenecks at the CDM EB and with DOEs / UNEP have lowered their supply-side estimates More demand: Japan a major buyer / US may accept CERs for compliance into a forthcoming emissions trading scheme The 2 products are correlated but quite volatile: they typically trade in a 50-80 cent day-range Implied volatility: ~45%

EUA Price Correlations Regardless of what category of trader you might fit into, you will be considering various factors such as the weather, political influences, and the prices of other commodities. This chart shows that carbon is a commodity which fits naturally into the energy complex. Very close correlation with power in particular – over 90% correlation with German power. Nat gas goes up in relation to coal – carbon goes up…. WHY? Because expensive nat gas means coal may be more economical to burn as a fuel, and coal emits twice as much co2 as nat gas Correlations in 2008: Dec08 EUAs – UK NatGas (ICE) : 0.90 Dec08 EUAs – Nymex Crude Oil : 0.82 Very closely correlated with German Power

ICE ECX Screen Shot This screen illustrates the LIQUIDITY that I’m talking about: Tight bid/ask spread - typically 3 or 4 cents, very often 1 or 2 cents – this narrow spread is ensured by various market makers on the exchange Growing depth and size behind the front bids and offer Growing trading volumes on the screen Growing Open Interest ( EUA futures: 185m / CER futures 32 million ) Growing membership (plus 2 per month) / growing number of market participants EMISSIONS SIT ALONGSIDE OTHER ENERGY MARKETS (tabs across the top) – JUST A CLICK AWAY webICE is well distributed / in the afternoon you will see over 9000 users as US wakes up EUA / CER spread tool is the next feature to be added, facilitating trading this...... BACK TO CONTENTS

Where Next? Aus ETS EU ETS NZ ETS CERs bridge the Regional Schemes 445Mt EU ETS 2,080Mt NZ ETS 100Mt CERs bridge the Regional Schemes Japan ETS 1,272 Mt So what next?? All signs are pointing to more participants from more regions, more national schemes – could this lead to a global market?? Even China is making encouraging moves explorations towards cap-and-trade – with PetroChina (largest corporation in the country) pushing for an domestic emissions market, though a joint venture with Climate Exchange. With all the growing pains associated with Europe’s regional cap-and-trade scheme and all the regulatory differences between competing schemes, a global cap-and-trade seems distant, but by no means impossible – just as equities trading has become more global. And if these emerging trading schemes allow the UN Kyoto credits, CERs, to be imported for compliance, then these CERs could act as the glue that binds these regional carbon markets together. US ETS 5,760Mt Canada ETS 400Mt China/India?

Multiple roads to the same destination Behavioural change Renewable energy sources Voluntary markets (CSR and pre-mandatory) Mandatory cap & trade

Carbon – The Next Asset Class “Global greenhouse gas emissions markets are clearly the next great frontier in the commodities trading world” Commissioner Bart Chilton – US Commodity Futures Trading Commission, March 2008 There is now real Global Momentum for cap-and-trade: Every year more than 30 billion tonnes of carbon dioxide are pumped into the atmosphere, contributing to global warming. In 1997 the Kyoto Protocol set out targets to reduce emissions by 5% against 1990 levels. It laid out its so-called ‘flexible mechanisms’ to help countries to meet this target – one of which is Emissions Trading With its European Emissions Trading Scheme, or EU ETS, Europe has taken a leadership position: we are currently in its second phase, with phase 3 set to begin in 2013 However Europe is not alone: one of the issues that both US presidential candidates agree on is the full backing a Federal cap-and-trade scheme for GHG emissions. And there is already a thriving and liquid voluntary cap-and-trade market in the US – this voluntary scheme at CCX is in a good position to evolve into a mandatory scheme – hence the price of a tonne of CO2 on CCX has risen from less than $2 before Super-Tuesday to around $7 today. And the USA has cap-and-trade experience with other environmental markets such as trading Sulphur Dioxide and Nitrous Oxide (or Sox and Nox) to combat localised acid rain – so it is not coming into emissions trading from a standing start. In the next few years we are set to see similar emerging national schemes in Canada, New Zealand and Australia, and Japan is at last beginning to shape its own ETS. But back to Europe, where ECX operates….

Watch this space! IN SUMMARY: “The total global carbon market value could reach €2 trillion ($3.1 trillion) by 2020.” - POINT CARBON, May 2008 IN SUMMARY: Cap-and-trade is very straightforward. As long as we have an effective and meaningful cap, then the trade facilitates the cap; And ECX facilitates the trade. ECX is most LIQUID marketplace for exchange-traded carbon derivatives Carbon is a COMMODITY that fits naturally into the energy complex Market has huge POTENTIAL Some commentators say it could be the biggest of the commodity markets – this quote from Point Carbon, the leading news service in the carbon markets, gives a forecast of €2 trillion – in 2007 the market was worth just over €40 billion, so to hit this projection there is still immense growth to come – (50 times bigger) STILL EARLY DAYS: PEOPLE WHO SEE THE OPPORTUNITY IN TRADING CARBON NOW ARE THE EARLY MOVERS

Proud sponsors of the Catlin Artic Survey www.catlinarticsurvey.com www.ecx.eu Patrick.birley@ecx.eu Proud sponsors of the Catlin Artic Survey www.catlinarticsurvey.com

Other Information Authorised Data Vendors Codes for viewing live ECX CFI prices EUA Futures EUA Options CER Futures Bloomberg EMIT OMON CARA comdty CT<GO> Reuters 0#CFI: 0#CFI2Y 0#CERE: CMS UX  n/a n/a IDC <17>t, UX <17t>CERmy CQG Options UX QCER ICE Energy Live LUX n/a  E-Signal/ Future source