1 State and trends of the carbon market Updated September 20, 2001 Franck Lecocq – DECRG / PCFplus Research

2 Early stage of the carbon market

3 Greenhouse gases emission reductions an unusual commodity ERs become a commodity after certification. Before certification ERs are very heterogeneous depending on the plausibility of their baseline. Emission Reduction = Hypothetical baseline emissions - effective emissions

4 Carbon prices on past transactions

5 Motivations of early participants Sellers a new source of revenue. Buyers Belief that ultimately there will be constraints on GHG emissions Hedge against those compliance costs Buyers (large utilities, oil companies) also want to Learn about the market Strategic positioning

6 Early developments of the market 1997 to 2001 Partial information available. Within OECD and EITs: MtCO 2 e have been transacted. In developing countries: Less activity but growing. Mostly government funded, but private activity growing. General trend towards sophistication: buyers clubs (PCF), traders, financial derivatives (options), integrated marketplaces, etc.

7 Which future for the carbon market?

8 Two storylines Kyoto or Kyoto “light” Kyoto is the existing framework, but its future is uncertain. One possible outcome is Kyoto without the US. No agreement, at least for the next few years Does it mean the market will collapse? >

9 The Kyoto Protocol (1997) The Kyoto Protocol assigns greenhouse gases emission targets to Annex B countries between 2008 and 2012…Annex B countries …And defines three flexibility mechanisms to take profit of differences in marginal abatement costs: –Emission Trading –Joint Implementation –Clean Development Mechanism

10 Demand and supply under Kyoto scenarios Total Annex B demand for ERs Domestic carbon sinks Hot AirHot Air  financial flow to Russia and EE  Action within OECD Remainder  Russia and EE (trading and JI)  Developing countries (CDM)

11 Volumes with “full” Kyoto Gross annual demand for ERs2800 – 4800MtCO 2 e between 2008 and Credits for hot air 950 – Credits for Annex B Sinks 400 – 800 (?) = Net demand 0 – 3000 MtCO 2 e (assuming large Annex B sinks)

12 Volumes in Kyoto w/o the US Gross annual demand for ERs1400 – 2400MtCO 2 e between 2008 and Credits for hot air 950 – Credits for Annex B Sinks 100 – 400 = Net demand 0 – 1700 MtCO 2 e (assuming limited Annex B sinks)

13 Prices Very difficult to anticipate (uncertainties on abatement costs and rules governing mechanisms). Running CERT with the preceding volume assumptions yields prices in the range of: – $0 - $10/ tCO 2 e for “full” Kyoto.$0 - $10 – $0 - $2 / tCO 2 e w/o the US.

14 Consequences for Economies in Transition and non-Annex B countries Economies in Transition: Key element = hot air Net benefit of about $5b per year [ ] at $3/tCO 2 e. Developing countries: Model shows $2b – $4b transfers per year. But the demand for CDM is more uncertain. In particular, there is a very low demand for CDM if Kyoto w/o US.

15 Two storylines Kyoto or Kyoto “light” Kyoto is the existing framework, but its future is uncertain. One possible outcome is Kyoto without the US. No agreement, at least for the next few years Does it mean the market will collapse? >

16 Is Kyoto still relevant? Emerging market drivers Regulations constraining carbon emissions are being developed –National policies (UK, The Netherlands, etc.) –Subnational regulations (e.g. some US States) –Regional initiatives (EU-wide trading) Some firms are taking voluntary emission commitments (BP, Shell, Dupont, etc.)

17 Current or projected national policies Trading?Start-upProject-based mechanism? EU Yes 2005 At least from 2008 UK UK Yes Yes France Yes 2003? Yes Norway Yes 2005 or earlier Yes Germany No  Later Denmark Yes 2001 Yes Sweden Yes 2005 or later Yes Netherlands Netherlands Ongoing work  Yes Finland Ongoing work  Yes Ireland Ongoing work  Ongoing work Australia Yes US dependent Yes USA Yes ? Yes Canada Yes US dependent  Japan Ongoing work  Yes New Zealand Yes Not decided Yes Russia No  Yes `

18 Regional regulations in the US Oregon: CO 2 emissions standard for new energy utilities. Price cap: $0.57/tCo2. Utilities can offset emissions using project based mechanisms. Washington: New plants must demonstrate the use of best available techniques for CO 2 emissions control. Massachusetts: CO 2 emissions cap for energy utilities effective in Utilities can offset excess emissions using project-based mechanisms. Near future: New York?

19 Voluntary corporate commitments Rapid survey indicates 52 major companies representing 1 billion tCO 2 e emissions in 1999 have pledged to reduce GHG emissions by Resulting demand depends on the baseline. If we set baseline at 1999 emissions, we obtain a total demand of 500 MtCO 2 e over the next decade. At least eight have said they would use project based mechanisms.

20 Alcoa --25% below 1990 in 2010 BP Amoco 79.8Cumulative 2%/year below 1990  Chubu EPCo kgCo2/kWh in 2005 Dupont % below 1990 in 2010 Kodak --20% below 1990 in 2004 Fortum 90.5 MtCo2e below baseline in 2010  IBM 4.1Cumulative 4%/year below 1998 until 2004 Intel 3.310% below 1995 in 2010 (PFCs) Johns. & John, 1.57% below 1990 in 2010 Motorola -- 50% below 1995 in 2010 (PFCs) Ontario Pow.Gen. 26 6% below 1990 in 2010  PEMEX 177-1% per year until 2010  Shell MtCo2e in 2002  Statoil MtCo2e below baseline in 2010  Suncor 5-1.5%/year until 2002 (-1%/year for )  Transalta  1999 EmissionsCommitment Internal Trading CDM/JI Corporate voluntary commitments

21 In addition, Canada and Australia have voluntary ER programs with very good coverage of key emitting sectors.

22 Chicago Climate Exchange 25 Midwestern firms will agree on emission targets by the end of 2001 and start trading in % below 1998 level in 2002, additional –1% period year between 2003 and Allows for offsets through project-based mechanisms.

23 Emerging carbon funds Prototype Carbon Fund +… About 5 private sector funds to capture JI/CDM Carbon credits in all investments. Handful of private equity funds also seeking carbon credit investors to raise IRR in deals. Major forestry funds thinking about C credits. New energy private equity and mutual funds might seek C credit deals if demand rises. Social funds use C as screening indicator.

24 Conclusion The carbon market exists, and is developing rapidly. It is likely to keep growing up even if Kyoto fails (the question will then be to coordinate the emerging regulations and initiatives). It brings opportunities for EITs and non-Annex B countries

25 Annex B countries >

GHG Emission targets (100 = 1990) Australia108 Austria92 (87) Belgium92 (92.5) Bulgaria92 Canada94 Croatia95 Czech Republic 92 Denmark92 (79) Estonia92 Finland92 (100) France92 (100) Germany92 (79) Greece92 (125) Hungary94 Iceland110 Ireland92 (113) Italy92 (93.5) Japan94 Latvia92 Liechtenstein 92 Lithuania92 Luxembourg92 (72) Monaco92 Netherlands92 (94) New Zealand 100 Norway101 Poland94 Portugal92 (127) Romania92 Russian Federation 100 Slovakia92 Slovenia92 Spain92 (115) Sweden92 (104) Switzerland92 Ukraine100 UK92 (94) USA93

27 Discussion on the prices we obtain for Kyoto scenarios There are higher price estimates in the literature. The difference stems from: Higher sinks Volume of hot air has been revised upwards We assume a smooth market (e.g. limited transaction costs, full hot air accessibility) We only use a limited set of projections about abatement costs. >

28 The Netherlands Government funded Emission Reduction Unit Procurement Tender (ERU-PT). Buys ERs in Eastern Europe 2000 tender (completed): $19 M Average price for first tender: $7/tCO 2 e Next tender expected in October, 2001 >

29 United Kingdom Climate Change Levy (April 2001) –Tax on energy use –Rebates in exchange for voluntary commitments –Benefits recycled in other corporate tax rebates Emission Trading (end of 2001) –Concerns selected companies, on a voluntary basis –Projects outside UK are considered for >

30 Hot Air >