1. Trading Emissions Contracts
The Carbon Market
Trading Emissions Contracts
February 2009

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

3. 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?

4. Understanding Cap and Trade

5. 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

6. 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

7. 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

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

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

10. 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

11. Europe – global leadership position
Kyoto Implementation
Europe – global leadership position
Pre-Kyoto trading scheme (Phase I)
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%)
scheme being finalised

12. 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?

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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……

19. About ECX

20. 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

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

22. 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

23. 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….

24. 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

25. 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

26. 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 cent day-range
Implied volatility: ~45%

27. 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

28. 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

29. 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?

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

31. 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….

32. 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

33. Proud sponsors of the Catlin Artic Survey www.catlinarticsurvey.com
Proud sponsors of the Catlin Artic Survey

34. 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