Carbon 2008: Post-2012 is now

8/14/2019 Carbon 2008: Post-2012 is now

1/60

All rights reserved 2008 Point Carbon

Carbon 2008Post-2012 is now

11 March 2008

TO THE POINT

This report was published at Point Carbons 5th annual conerence, Carbon Market Insights 2008 in

Copenhagen 11 - 13 March 2008. For more inormation, see www.pointcarbon.com

Global carbon markets worth 40 billion in 2007, up by 80 percent from 2006.The total traded

volume increased by 64 percent rom 1.6 Gt (1.6 billion tonnes) in 2006 to 2.7 Gt in

2007.

The EU emissions trading scheme saw a traded volume in 2007 of 1.6 Gt and a value of 28

billion.This represents a volume growth o 62 percent and a value growth o 55 percent

rom 2006. The EU ETS now holds 62 percent o the physical global carbon market and

70 percent o the nancial market.

The CDM market increased to 947 Mt and 12bn in 2007. This is an increase o 68 percent in

volume terms, and a staggering 200 percent in value terms rom 2006, constituting 35

percent o the physical market and 29 percent o the nancial market.

The market for secondary trading of CDM credits is the fastest growing segment. From limited

activity at the start o the year, over 2007 the market saw around 300 Mt o sCER

trades, much o this related to EUA-sCER swaps.

Two-thirds of survey respondents say EU ETS will result in internal abatement. Taken together,

our surveys in January and April 2007 and January-February 2008 indicate that at least

two-thirds o EU ETS companies are involved in or are planning emission reductions o

some kind.

Carbon prices important for investment decisions. 73 per cent o EU ETS survey respondentsagree that the carbon price is relevant to investment decisions. Only 6 percent say the

carbon price has no impact on new investments.

Survey respondents expect a carbon price of 24 in 2010, and 35/t in 2020. This is up 6 or the

2010 price and 10 or the 2020 price, compared to last year.

A federal US ETS likely, according to respondents. They expect it to be less strict than the

EU ETS Phase 2, however, despite the ambitious bills now beore the US Congress.

Borrowing could be widely used. Nearly hal o the survey respondents could borrow rom

2009 allocation to use or compliance in 2008.

Voluntary market is small and non-transparent. Only 10 percent o the respondents consider

the voluntary market to be transparent, yet 50 percent think it is more mature now thanone year ago.

Integrated global market by 2020? Seventy-three percent o our sample think that there

will be a global reerence carbon price in 2020.


2/60

All rights reserved 2008 Point Carbonii

Carbon 2008

All rights reserved 2008 Point Carbonii

About the report:This report was written and edited by Kjetil Rine, Endre Tvinnereim and Henrik Hasselknippe.

For citations, please reer to: Point Carbon (2008): Carbon 2008 - Post-2012 is now Rine, K., E.

Tvinnereim and H. Hasselknippe (eds.) 60 pages.

About Point CarbonProviding critical insights into energy and environmental markets

Point Carbon is a world-leading provider o independent news, analysis and consulting services

or European and global power, gas and carbon markets. Point Carbons comprehensive servicesprovide proessionals with market-moving inormation through monitoring undamental

inormation, key market players and business and policy developments.

Point Carbons in-depth knowledge o power, gas and CO2 emissions market dynamics

positions us as the number one supplier o unrivalled market intelligence on these markets.

Our sta includes experts in international and regional climate policy, mathematical and

economic modelling, orecasting methodologies, risk management and market reporting.

Point Carbon now has more than 15,000 clients, including the worlds major energy companies,

nancial institutions, organisations and governments, in over 150 countries. Reports are

translated rom English into Japanese, Chinese, Portuguese, Polish, French, Spanish and

Russian.

Every year, Point Carbons Carbon Market Insights conerences gather thousands o keyplayers or the carbon communitys most important annual conerences. Point Carbon also

runs a number o high-level networking events, workshops and training courses.


3/60

iii

Executive Summary


11 March 2008

This report presents an overview o the carbon market

in 2007, our outlook or 2008, and expectations orthe remainder o rst Kyoto period and beyond. It

is based on the results o the largest survey ever

conducted into the carbon market. We received 3

703 responses to our web-based questionnaire and 1

462 o the respondents trade or own European UnionAllowances (EUAs) or Certied Emission Reductions

(CERs). The survey results are complemented by

analysis undertaken by Point Carbon.

The global carbon market is consolidating at a time

o ever-increasing attention to climate change. Last

year was another record one in the market, with anincrease rom 1.6 bn tonnes in 2006 to 2.7 Gt in 2007.

The total traded volume increased by 64 percent. As

global temperatures and media coverage increase,

so does the volume o emission allowances and

credits.

In value term, the growth was even steeper in 2007.

The global carbon markets were worth more than

40 billion in 2007, up by 80 percent rom 2006.

The EU Emissions Trading Scheme (EU ETS) is stilldominating the global carbon market. EU ETS saw

a traded volume in 2007 o 1.6 Gt and a value o28 billion. This represents a volume growth o 62

percent and a value growth o 55 percent rom 2006.

The EU ETS now holds 62 percent o the physical

global carbon market and 70 percent o the nancial

market. The higher share o the value o EU ETScompared to the volume is due to the high prices in

EU ETS compared to other markets.

The CDM market comes second, both in volume

and value terms. It increased to 947 Mt and 12bn

in 2007. This is an increase o 68 percent in volume

terms, and an astonishing 199 percent in value termsrom 2006, constituting 35 percent o the physical

market and 29 percent o the nancial market.

The market or secondary trading o CDM credits is

the astest growing segment. From limited activity

at the start o the year, the market saw around 300Mt o sCER trades over the course o 2007, much o

this related to EUA-sCER swaps. This emphasises

the dominant position o EU ETS in the global carbon

market last year.

Traded volumes in the Joint Implementation (JI)

market almost doubled rom 21 Mt in 2006 to 38

Mt in 2007. Higher prices in 2007 compared to 2006

meant that the value o the JI segment more thantripled, rom 95m in 2006 to 326m in 2007.

The direct market participants were not, however, let

by themselves last year and there were signicant

activities in the political arena. The climate change

challenge was at the top o the political agenda, andthe UNFCCC summit in Bali in December succeeded

in starting negotiations on a post-2012 agreement,with the aim o signing the agreement at the COP

meeting in Copenhagen in 2009.

In our survey, we asked whether a global post-2012

climate agreement will be reached beore 2012.Around 70 percent o the respondents think there

will be an agreement. O these, 80 percent think

there will be a post-2012 agreement, regardless o

whether the US participates and around 60 percent

o the respondents (N=3013) think that the US willjoin an international agreement. Interestingly, more

than 75 percent believe that Canada is also likely to

join the agreement, despite currently being a long

way rom meeting its Kyoto target.

Second, the European Commission (EC) ruled on

the National Allocation Plans (NAPs) or Phase 2. Theoverall impression was that the EC had learnt rom

Phase 1 and was suciently tight on the EUA cap,

but that it was more generous when it came to the

credit limit. Hence, taking into account the amount

o carbon credits allowed to be used or compliancein Phase 2, it seemed that no emission reductions

were needed within the EU over the period.

This was to a large extent corrected in January 2008

when the EC proposed its revision o the EU ETS

Directive. I a satisactory international agreement

is not reached, the EC proposes that the credit limitor Phase 2 (2008-20012) should be valid or both

Phase 2 and Phase 3 combined (2008-2020). I,

however, a satisactory international agreement is

reached, the credit limit would be increased by hal

o the additional reduction eorts going rom the20 percent reduction scenario up to, at most, a 30

percent reduction rom the 1990 level.

A third crucial development in the political arena in

2007, which indeed will continue to develop in 2008

and beyond, was the emission trading initiatives

that are being taken on at both state and ederallevel in the US. RGGI will start on 1 January 2009


4/60

iv

Carbon 2008


(with some early auctions in 2008), while initiatives

in the West and Mid-West will take a ew moreyears to materialise. Most important, however, is

the Lieberman-Warner Bill now going through the

Senate. The bill suggests establishing an emission

trading scheme covering around 75 percent o GHG

emissions in the US, with a cap more than 2.5 timeshigher than in EU ETS Phase 2. This will decrease by

around 100 Mt a year towards 2050. I it becomes

a reality, this will be the largest emission tradingscheme in the world.

Moreover, the bill suggests allowing international

credits to be employed or compliance purposes,primarily EUAs and Kyoto credits. This indicates

that there will be a close bond between upcoming

regional emissions trading schemes and existing

schemes, primarily the EU ETS.

The carbon market is still, and will remain, a politicallydriven market, as supply and demand or credits

are determined to a signicant degree by political

decisions

The proposal or a ederal US ETS indicates a tighterscheme than we see in the EU ETS. It is interesting

then, that most o our survey respondents donot think that a ederal US ETS will be particularly

ambitious.

Two-thirds o our survey respondents say that EU

ETS will result in internal abatement. Taken together,

our surveys in January and April 2007 and January-February 2008 indicate that at least two-thirds o

EU ETS companies are involved in or are planning

emission reductions o some kind. These eorts are

yet to be seen in the veried emission data.

The respondents expect the EUA prices to rise

towards 2020. In Carbon Market Survey 2007, therespondents estimated that the EUA price in 2010

would be around 18/tonne. This year, the average

EUA price orecast or 2010 has increased by 6 to

24/tonne.

Going urther, the average EUA price in 2020 wasestimated by last years respondents to be 25/

tonne, while the 2020 price estimate given this year

has increased to 35/tonne. Thus, there is a bullish

impression o carbon market development in the

last year, both rom a short term (2010) and a long

term perspective (2020).

The importance o the carbon market or its

participants is clearly seen rom the long-terminvestment perspective. 73 per cent o EU ETS survey

respondents agree that the carbon price is relevant

to investment decisions. Only 6 percent say the

carbon price has no impact on new investments.

Besides the compliance markets, primarily connectedto the Kyoto Protocol, a voluntary carbon market has

emerged. Although it is still limited in size, only 10percent o the respondents to our survey nd the

voluntary market to be transparent.

Moreover, less than 30 percent think the voluntary

carbon market produces real emissions reductions,while more than 40 percent believe that the voluntary

carbon market poses a risk to the reputation o the

compliance markets. Having said that, a majority o

the respondents think that the voluntary market is

more mature now than it was a year ago.

It is air to say that the main activities and trades

in the carbon markets years ahead will be in

connection with compliance schemes - either

determined through an international agreement ornational or regional schems independent on an post-

2012 agreement.

Given the development o an increasingly interlinked

global carbon market, we asked our survey

recipients the ollowing question: Will there be a

global reerence price or CO2 emissions in the year

2020? The existence o such a price (regardless

o its level) would be a reliable indicator o policysuccess. Seventy-three percent o our sample think

that there will be a global reerence carbon price in

2020.


5/60

v

11 March 2008


Foreword

Developments witnessed over the past year, as

well as developments so ar in 2008, signal a newera or the carbon markets. We have now entered

the rst year o the rst commitment period under

the Kyoto protocol, and also the rst year o the

second phase o the EU emissions trading scheme.

Companies operating in the European carbon marketnow (at least in most cases) know their compliance

requirements until 2012, and can base their trading

and investment decisions both on day-to-day changesin undamentals and expectations about the uture.

The recent proposal rom the European Commission

also provides greater insight into the developmento the market until 2020, although the uncertainties

will remain or still some time.

When we published the previous version o this

report, in March 2007, we noted that climate change

and carbon markets were the subject o record

high public interest. Little did we know that the resto 2007 would bring with it even greater interest

rom media, decision makers, and the general

public. Particular mention should be given to the

Nobel Peace Prize being awarded jointly to theIntergovernmental Panel on Climate Change and AlGore, our keynote speaker at last years conerence.

We are both honoured and privileged to have

chairman o Nobel laureate IPCC, Dr. R. K. Pachauri,

with us or this years conerence.

The results rom our annual survey, and presented in

this report, highlight three things in particular. First,there seems to be a generally bullish sentiment on

carbon, not necessarily refected in current market

prices. Survey respondents now on average expect

the 2010 price to be 6 higher than they did a year

ago. The expectation or a 2020 price has increased

even more, and now stands 10 higher than it didlast year. In our view, this demonstrates that market

participants now realise that the EU ETS will ace

a real and considerable shortage, and that much o

this will have to be met through reductions taking

place in Europe.

Secondly, once again the survey respondents

seem optimistic that we are moving towards a

global carbon market and that the international

community will be able to agree on a new climate

agreement rom 2013 onwards. More than 70 percent o respondents see it as likely that a climate

agreement or the post-2012 period will be agreed

upon beore the end o the Kyoto period. In our view,

getting the United States on board will be vital or anew agreement. Interestingly, survey respondents

do not necessarily agree, with about 77 per cent

expecting an agreement to be reached regardless o

whether or not the U.S. participates. However, more

than hal o the respondents expect the U.S. to takeon reduction commitments and to participate in a

new agreement.

Finally, the results rom our survey conrm that carbon

prices are now seen as an important actor in the

operating and investment decisions o companies.

Over two-thirds o survey respondents claim thatthe EU ETS has caused emission reductions o

some kind, either already implemented or at the

planning stage. While this might be good news or

the development o greenhouse gas emissions in

Europe, we expect to see similar developments in

other places around the world in the years to come.Over 72 per cent o the survey respondents expect

there to be a global reerence price or carbon by

2020. As the world increasingly takes into account

the cost o emissions, and the value o reductions,the carbon market will continue to incentiviseinvestments in cleaner technology and emission

reductions. And in the end, that is what this market

is supposed to lead to.

You can read more about these ndings, and a lot

more, in this report. We believe that this report

presents the most up-to-date and comprehensiveanalysis or the carbon market as a whole. It certainly

represents the global analysis work that takes place

in Point Carbon every day, and we hope you will nd

it both interesting as well as inspirational.

Per-Otto Wold

CEO

Point Carbon


6/60

vi

Carbon 2008


1 Introduction

2 Carbon markets and policies in 2007

2.1 Overview

2.2 EU ETS

2.3 CDM

2.4 JI

2.5. Voluntary markets

3 Carbon markets towards 2012

3.1 Expectations for global 2008 volumes

and trends

3.2 EU ETS

3.3 CDM market in the Kyoto period

3.4 JI - existing market, deliveries now?

3.5 AAU - large potential, limited supply?

3.6 Regional Greenhouse Gas Initiative

(RGGI)

4 Carbon markets beyond 2012

4.1 Towards a new global climate

agreement

4.2 Carbon markets in North America

4.3 Other upcoming markets

4.4 Towards a global market?

1

3

3

6

17

19

20

23

23

24

33

36

37

39

41

41

44

46

47

Table o contents


7/60

1

11 March 2008


1. IntroductionThe initial year o the rst Kyoto commitment period(2008-2012) has now begun. Starting this year, the

countries listed in Annex B o the Kyoto Protocol

(apart rom the US) will have to measure, estimate

and account or their greenhouse gas (GHG)

emissions. Annex B comprises those countriesthat were considered industrialised in 1992, when

the UN Framework Convention on Climate Change

(UNFCCC) was negotiated.

Phase 2 o the EU Emissions Trading Scheme (EU

ETS) also commenced this year, and is scheduledto run alongside the rst Kyoto period. Moreover,January saw the release o the ECs proposal or the

structure o Phase 3, extending the EU ETS horizon

to 2020. With new nancial products and trading

strategies, the EU market is about to come o age.

And yet 2008 is not only the year o Kyoto. This year

we expect important developments in US carbonmarkets in particular. At the state level, we have just

seen the rst ever GHG compliance trade under the

ten-state Regional Greenhouse Gas Initiative (RGGI),

and expect much more to come.

At the ederal level, a comprehensive and ambitious

cap-and-trade is awaiting a Senate foor vote this

year, while all the 2008 presidential candidates

with a reasonable chance o winning are in support

o emissions trading as part o an active climateagenda.

This report is our third annual presentation o thestatus o the carbon market. We aim to provide a

comprehensive overview o all compliance markets

currently in operation, as well as other markets thatwe believe are imminent. Given the wealth o data

available or the Kyoto markets in particular the

EU ETS and Clean Development Mechanism (CDM)

these will be discussed in the greatest detail.

However, we will also consider the developments

that have been made in Japan, Russia, Ukraine,Australia and o course the US.

Our report includes inormation derived rom a

number o sources. The primary source is Point

Carbons annual Carbon Market Survey, whichran rom 18 January to 6 February 2008, using aweb-based survey tool. In total there were 3 703

respondents, compared to 2 250 last year and 800

0% 5% 10% 15% 20% 25% 30% 35% 40%

Company covered by CO2 regulation

other than EU ETS

Government

Other

Financial institution/bank

Company with emissions regulated

under the EU ETS

CER project developer/aggregator

Source: Point Carbon

Figure 1.1: Trading EUAs and CERsN=1462. Respondents saying they buy/sell/hold EUAs and/or CERs

1406 respondents buy, sell or holdEUAs or project credits

11 March 2008

3703 participants in our web-surveythis year, up rom 2250 in 2007


8/60

2

Carbon 2008


in 2006. O this years respondents, 1 462 (~40

percent) stated that they are involved in EuropeanUnion Allowance (EUA) or Certied Emission

Reduction (CER) trading, or own EUAs/CERs. Figure

1.1 below shows the distribution o respondents

among this subset.

O the 1 462 respondents holding or trading EUAs/CERs, 473 work or companies with emissions

regulated under the EU ETS, with about the same

number or CDM project developers/aggregators.

Some 220 respondents represent nancial

institutions.

Our typical respondent has a degree in eitherengineering or nance/economics, while 13 percent

hold a PhD. Two-thirds are between the ages o 25

and 44. The largest number o respondents is ound

in the US a total o 292; the other countries with

three-digit response totals are the UK (281), India

(142) and Germany (107). In total, 101 countries

are represented and almost 50 percent o therespondents are located in Europe.

In addition to the Carbon Market Survey 2008, this

report is based on Point Carbons in-depth analyses

o international climate policy and the carbon market

in our publication series: Carbon Market Analyst

(CMA), Carbon Market Monitor (CMM), CarbonMarket Brie (CMB) and Carbon Policy Update (CPU)

in particular; as well as on Point Carbons proprietary

databases, models and applications: Carbon Market

Trader (CMT) and Carbon Project Manager (CPM).

The outline o this report is as ollows:

Chapter 2 provides a review o carbon market

developments in 2007. We report traded volumes

and values, price drivers and evaluations o the EU

Almost 50 % o respondents locatedin Europe, down rom 55 % last year

Figure 1.2: Most o the respondents come rom...Top 15 countries (out o 101 with responses). N=2291.

12.7%

12.3%

6.2%

4.7%

4.1%

3.8%

3.8%

3.2%

2.8%

2.8%

2.7%

2.7%

2.4%

2.2%

2.1%

0 50 100 150 200 250 300 350

United States

United Kingdom

India

Germany

France

Australia

Canada

Brazil

Japan

Netherlands

Norway

Italy

Spain

China

Belgium


Carbon Market Survey 2008 is themain source o inormation


9/60

3

11 March 2008


ETS, CDM and Joint Implementation (JI) markets.

We also provide statistics on buyers, sellers and

project types in the CDM. The chapter ends with

a discussion o recent developments in voluntary

carbon markets, emphasising the US position.

Chapter 3 presents our expectations or the global

carbon market in the Kyoto period and or 2008 in

particular. We discuss the policies providing the

ramework or the EU ETS and much o the CDM and

JI markets, with a ocus on decisions and proposals

by the European Commission (EC). We also suggestwhat to expect rom the RGGI market in 2009, and

discuss the likelihood that Assigned Amount Units(AAUs) will start trading in 2008.

Chapter 4 looks at the emerging landscape o the

carbon world ater 2012. We begin by presentingour analysis o the events o the Bali conerence

in December 2007. Recognising that US action is

a sine qua non or serious international action on

climate change, we then outline domestic proposals

or emissions trading in the US, both at the ederal

and state level.

We also assess the likelihood o domestic emissions

trading in other countries, notably Japan. Finally, we

ask whether a global carbon market will exist in

2020, and i so, what the price o carbon might be12 years rom now.

2. Carbon markets and policies in2007

2.1 Overview

Climate change was at the top o the global agenda

in 2007, most notably ollowing publication o theIntergovernmental Panel on Climate Changes (IPCC)

ourth assessment report (4AR). The report stated

that climate change was unequivocal and made

it extremely dicult or anyone to remain a climate

sceptic.

Moreover, ormer Vice President Al Gores

documentary lm, An Inconvenient Truth, brought

the climate issue to the masses worldwide.

Governments across the world have been orced to

take action as a result o the change in public opinion

on climate change and increased media coverage.

2.1.1 The carbon markets

In the carbon market, equally important events have

taken place. The total traded volume in the globalcarbon market grew rom 1.6 Gt (1.6 billion tonnes) in

2006, to 2.7 Gt in 2007 an increase o 64 percent

(see Figure 2.1). The value o the carbon traded grew

even more, by 80 percent in the same period, rom22bn ($33bn) to 40bn ($60bn).

Figure 2.1: Stairway to 07

Annual contract volumes 2005-07 in billion tonnes (Gt) CO2 equivalen

0

1

2

3

4

5

2005 2006 2007

Annualvolum

e(Gt)

Other

JI

CDM total

EU ETS total


64%

104%

56%


10/60

4

Carbon 2008


ERU volumes almost doubled in the Joint

Implementation (JI) market, rom 21 Mt in 2006

to 38 Mt in 2007. Furthermore, higher ERU prices

meant that the value o the JI segment more than

tripled, rom 95m in 2006 to 326 in 2007.

Financial players joined the carbon market in orce in

2007. We have seen US hedge unds take positions

in the market, especially in options and long CER

positions. Towards the end o the year, NYMEX,

the worlds largest physical commodities utures

and options exchange, announced that it would

join the market by launching its own CO2 emissionproducts. This move by NYMEX indicates at least

two things: First, carbon trading is about to enter

the mainstream in the US. Second, major market

players are condent that GHG emission trading is

about to take o in the US, whether at the statelevel (RGGI, the West and Midwest), at the ederal

level, or both.

That being said, current activity in existing Australian

and US carbon markets did in act decrease rom2006 to 2007. Most signicantly, total traded value is

down 63 percent, to 186m in the mandatory New

The EU ETS is still by ar the largest carbon market

worldwide, with 62 percent o the physical market

and 70 percent o the nancial market (Figure 2.2).

The EU ETS grew over the course o 2007, with a

traded volume o 1.6 Gt and a value o 28m. Thisrepresents a volume growth o 62 percent and a

value growth o 55 percent rom 2006.

Activity within Kyotos fexible mechanisms

specically the Clean Development Mechanism(CDM) grew more than expected in 2007. In

total, the CDM market increased rom 563 Mt and

3.9bn in 2006 to 947 Mt and 12bn in 2007. Thisis an increase o 68 percent in volume terms, and

a staggering 199 percent in value terms rom 2006,

and in total constituting 35 percent o the physical

market and 29 percent o the nancial market.

Within the CDM, the growth o the secondary

CER (sCER) market has been the most impressive,starting in the rst months o 2007 and growing to

around 300 Mt over the whole year. This represents

a remarkable increase rom 2006, much o which is

related to EUA-CER swaps. With the growth in sCERtrading, the total CER market could well overtakethe EUA traded volume in 2009 or 2010.

CDM market increased to 947 Mtand 12bn in 2007

EU ETS still by ar the largest carbonmarket worldwide

Figure 2.2: Still dominated by the EU ETSDistribution o 2007 traded volume (let) and nancial value (right) across the main market

segments.

EU ETS

62%

CDM primary

22%

CDM secondary

13%

JI

1%

Other2%

Total volume: 2.7 Gt

EU ETS70%

CDM primary15%

CDM secondary14%

JI1%

Other0.5%

Total financial value: 40bn


11/60

5

11 March 2008


agreement will be accepted in the EU ETS up to a

limit.

In general, 2007 has been a good year or the

EC. Having had to endure criticisms over its initial

handling o the EU ETS, the Commission showeddetermination in cutting allocations and credit

limits in Phase 2 NAPs, as well as in pushing or

the inclusion o the aviation sector in the trading

scheme.

At the beginning o 2008, the EC also nally seemed

much more likely to succeed in harmonising thetotal EU cap and auction a much greater share o

allowances in Phase 3 an agenda it has been

promoting or years.

Outside the Kyoto markets, important progress

was made towards domestic emission trading, inthe US in particular. At the state level this is due

to the Regional Greenhouse Gas Initiative (RGGI),

the 10-state scheme due or launch in 2009, and in

the Western region led by Caliornia. A ederal cap-

and-trade bill sponsored by Senators Lieberman andWarner moved through both subcommittee andcommittee in November and December.

South Wales market and on the voluntary Chicago

Climate Exchange. With total volume almost

unchanged, this all is largely due to carbon price

drops in both markets and the all o the US dollar.

2.1.2 Carbon policies

Although we are just at the start o EU ETS Phase 2,

the ongoing review process or Phase 3 has alreadyproduced a number o concrete suggestions rom

the European Commission (EC). For example, it

already seems clear that the cap will be considerably

tighter than in Phase 2, as the overall emissions in

the EU ETS in 2020 are expected to be capped ataround 21 percent below the 2005 level.

In addition, the EC suggests reducing the level oree allocation linearly towards zero in 2020. All

allowances allocated to the power and heat sector

will be auctioned as early as 2013. Moreover, beore

a new international agreement is nalised, the

credit limit or the 2008-2012 period is eectively

extended to also cover the 2013-2020 period, and

no additional import o credits is permitted. Oncea uture international climate agreement has been

reached, CERs rom countries that have ratied the

EC suggest EU ETS emissions to be21 percent below 2005 level

No additional import o credits permit-

ted unless satisactory agreement

Figure 2.3: Ups and downs in 2007Quarterly volumes and values in the EU ETS 2007, million tonnes and million

0

50

100

150

200

250

300

350

400

450

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

MtCO2

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

mill

8%

17% -12%

80%

14%

3%



12/60

6

Carbon 2008


Crowning the events o the year, the Bali climate

summit produced a mandate to launch negotiations

or a global post-2012 ramework. At the summit,

all UNFCCC member countries including the US

agreed to negotiate a successor to the Kyotoprotocol.

This eat was made possible by a change in theUS position earlier in the year. The turnaround was

rst evidenced at the G-8 summit in June, whenthe Bush administration announced its intention to

return to the negotiating table.

While this decision may not be rooted in a hearteltdesire to take decisive action on climate issues, it

is certainly a positive step towards kick-starting the

international process under Bush.

I nothing else, laying the groundwork in this way will

make progress aster under the next administrationand progress with the Lieberman-Warner bill will

acilitate this. The new Australian Government is also

planning to speed up the introduction o a national

ETS.

2.2 EU ETS

The EU ETS was the main driving orce o the

global carbon market in 2007. This dominance wasunderlined by the trades in sCERs estimated at

around 17 percent o the market in 2007 as this

market is propelled by EUA sCER swaps. Although

the excitement o Phase 1 was long gone by 2007, it

was still an important year or the EU ETS.

The nal rulings o the National Allocation Plans(NAPs) were made, and the EU ETS review crucial

or the shape o Phase 3 was nalised. Hence, much

o the uncertainty or the uture phases o the EU

ETS was removed, although the nal agreement on

the Directive review is still at least 1 year away.

2.2.1 Volumes and values

2007 saw healthy growth in the OTC market and on

the exchanges, with a daily average traded volume

o around 5.6 Mt. As shown in Figure 2.1, volumeshave increased annually since 2005. The total volume

traded in the 2007 EU market, excluding exclusivedirect bilateral trades (company-to-company) , was 1

443m EUAs. O this, around 1 Gt (~70 percent) was

Australia and the US turned towardsclimate regime in 2007

Figure 2.4: No changes on the exchangesMonthly EUA volumes transacted on exchanges. Last years gures in parentheses.

0

5

10

15

20

25

30

35

40

45

50

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

MtCO2

ECX Powernext Nord Pool EEXSource: Point Carbon

ECX 86.7% (75.6%)

Powernext 5.5% (13.3%)

Nord Pool 6.3% (7.4%)

EEX 1.4% (3.1%)

EXAA 0.0% (0.1%)

Secondary CERs took around 17percent o the market in 2007


13/60

7

11 March 2008


traded in the brokered over-the-counter (OTC) market

and the remainder was traded on the exchanges.

Quarterly volumes were relatively stable, with a peak

in Q3, while the value o transactions increased asPhase 2 contracts took over and prices increased

see Figure 2.3.

O the exchanged volume, the London-based

European Climate Exchange (ECX) accounted or

377 Mt, or 87 percent. This was up rom 76 percentin 2006, thus cementing its dominance in this market see Figure 2.4. The other exchanges consequently

show lower volumes, but Oslo-based Nord Pool (6.3

percent) was the second largest in 2007, with the

French Powernext third, with 5.5 percent.

The share o the exchanges has increased in recentyears, with 20 percent o the market in 2005 and 30

percent in 2007. In addition to OTC transactions and

trades on the exchanges, there still is a signicant

volume traded bilaterally (company-to-company),

and the combined total o all transactions in 2007

was around 1 650 Mt.

2007 also marked the end o Phase 1 o the EU ETS,

alling rom a 4 level at the beginning o the year

to 0.03 in December. As seen rom Figure 2.5, the

ate o the EUA Phase 1 allowances was sealed asearly as April 2006 and reconrmed through the

verication o 2006 emissions in April 2007.

Since October 2006, Phase 2 contracts have been

the only ones that have deserved any attention. Over

the course o 2007, Dec 08 EUAs traded in a rangebetween 12.25 and 25.28. The contract closed

at 17.55 on the rst trading day o the year, then

declined to the years lowest point on 20 February.

The Dec 08 EUA then grew rapidly, at over 4 per

month, until the high o 25.28 was reached on 29

May. Subsequently it ell below 19 twice, in Julyand August, beore remaining largely within the

20-24 range or the rest o the year and closing at

22.43 on 31 December.

The decline in the EUA price early in the year was

caused by alling power and gas prices, which

produced lower coal-to-gas switching levels, as well

as by a mild (or even absent) winter that depressedboth Phase 1 and Phase 2 contracts.

European Climate Exchange (ECX)accounted or 87 percent o market

Figure 2.5: Volumes and prices in the EU ETS 2004-07Daily OTC prices using Point Carbons bid/oer methodology.

0

5

10

15

20

25

30

35

1/12/04 6/9/05 14/6/06 21/3/07 28/12/07

/to

nne

0

10

20

MillionEU

Astraded

Volume EUA 2007

EUA 2008 sCER08

Source: Point Carbon's Carbon Market Trader

Around 1 650 Mt traded in EU ETSin 2007, sCER excluded


14/60

8

Carbon 2008


Figure 2.6: UK carbon-adjusted dark and spark spreads in 2007Forward prices or delivery in Q2 and Q3, 2008. The chart shows the theoretical prots rom

standard coal and gas power plants, based on uel, power and carbon prices.

0

5

10

15

20

2-Jan-07 7-Mar-07 15-May-07 20-Jul-07 25-Sep-07 28-Nov-07

/M

Wh

0

5

10

15

20

25

30

/tonne

Dark spread summer 08 Spark spread summer 08 EUA Dec 08


Figure 2.7: German carbon-adjusted dark spreadForward prices or delivery in 2008. Dates: 11 Dec 2006 -- 20 Dec 2007

0

5

10

15

20

25

11-Dec-06 14-Mar-07 20-Jun-07 19-Sep-07 19-Dec-07

/MWh

0

5

10

15

20

25

30

/tonne

Clean dark spread Cal 08 EUA Dec 08



15/60

9

11 March 2008


As can be seen rom Figure 2.6, gas was in the money

against coal or most o 2007, and particularly in the

April-October period. Carbon-adjusted prots or coalgeneration (dark spreads) and gas generation (spark

spreads) or UK power delivered in the summer o

2008, traded mainly inside a band o 5-10/MWh

until mid-November, when both shot upwards.

The subsequent bull-run came on the back o a

lingering hot summer scare, pushing up Germanpower or Q3 2007 and Cal 08 delivery, and Dec 08

EUAs along with it. A strict ruling by the EC on the

Italian NAP, as well as other NAP cuts, boosted the

bullish sentiment as Phase 2 looked progressively

more likely to be short. In addition, there were

ears o a possible CER crunch in 2008, includingbut not limited to worries about delivery through the

international transaction log (ITL).

Ater the peak in May, the trading range narrowed

or the rest o the year, as the NAP process had

established the Phase 2 allocation while coal, gas,

oil and power prices balanced each other in keeping

the EUA stable.

Forward prices or delivery in Q2 and Q3, 2008. The

chart shows the theoretical prots rom standardcoal and gas power plants, based on uel, power and

carbon prices.

The German carbon-adjusted dark spread or the

2008 calendar year saw a dierent development,

declining steadily through the year, see Figure 2.7.The highest price o the year 19.10/MWh was

seen on 11 January. On 27 November, however,

the prot made by German generators o coal-red

power was down by more than two-thirds at 7.21/MWh, the years lowest price.

The vast majority o EUA trading activities in 2007

were orward contracts or Phase 2. Figure 2.8

shows the correlations between uel and Dec 08

EUA contracts. The Cal 08 contracts correlated quite

well with the Dec 08 EUA contracts, being 0.78

on average in 2007. Gas and oil correlations wereconsiderably lower at 0.42 and 0.26, respectively.

Correlation to Dec 07 contracts were absent as the

price or these was marginal throughout the year.

Cal08 and Dec08 EUA correlatedairly well in 2007

Figure 2.8: EUA price correlation with uel and powerCorrelations with the EUA December 2008 contract

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Dec-07

German cal 08

NBP summer 08

Crude oil frontmonth

Correlations:

Cal08: 0.78

NBP: 0.42

Crude oil: 0.26


16/60

10

Carbon 2008


The Dec 08 sCER closed at 15.70 on 21 May, whenour records began. It traded at a discount o more

than 7 to the Dec 08 EUA or most o June, withthe spread going as high as 7.98 on 4 June.

The average Dec 08 sCER price in 2007 was

16.37. The other OTC sCER contract tracked by

Point Carbon, the Kyoto strip or delivery each

December o the 2008-2012 period, traded at anaverage 16.50 during our seven months o records

in 2007. This indicates a real backwardation in the

sCER market, as the spread between the Dec 08 and

the Kyoto strip is much less than the cost o carry.

Indeed, the backwardation was absolute throughout

most o August, as the Dec 08 sCER was valuedabove the Kyoto strip. The most general explanation

or this phenomenon is concerns or a CER supply

crunch in 2008 and 2009, and good supply in later

years.

2.2.2 Does the EU ETS work?

The launch o the ECs proposal or a climate-

energy package clearly showed that in the uture

more emission reductions will take place in theEU, particularly i a satisactory international

agreement is reached ollowing the Kyoto Protocol.

This begs the ollowing questions: are companies

ready or this and do we see any signs o internalabatement due to EU ETS?

A series o questions that Point Carbon has beenasking annually since 2006 could prove instructive.

Respondents are asked to choose one alternative

on a scale rom 1 (completely disagree) to 5

(completely agree). We count options 4 and 5

as agreement, options 1 and 2 as disagreement,and the middle option 3 as neither agreement nor

disagreement see Figure 2.9.

The results are almost the same in 2008 as in 2006

and 2007. The only exception is the statement

EU ETS is a mature market, which has gained a

somewhat higher score this year (although it is stillairly low).

The answers to the question on emissions reductions

have not changed markedly in the last three years.

Obviously, in the case o the statement EU ETS

acilitates emissions reductions, the question is

where within the EU or in CDM/JI countries. This

Respondents: EU ETS signicant

more mature now than one year ago

Figure 2.9 Assessing the EU ETSShare o respondents agreeing with the given statements (options 4 and 5). The number o

respondents is between 800 (in 2006) and 3,479 (in 2008).

0% 20% 40% 60%

EU ETS is a success

EU ETS facilitates

emissions reductions [in

the EU]

EU ETS is the most cost-

efficient way to reduce

emissions [in the EU]

EU ETS is a mature market

2008

2007

2006



17/60

11

11 March 2008


Figure 2.10 Sector emissions-to-cap (E-t-C) in 2006 compared to 2005E-t-C calculated using veried emission data and aggregate installation-level caps in each sector.

Positive numbers signiy greater emissions than allowance allocation.

Figure 2.11: Changes in EU ETS emissions at country level, 2005-2006Top ve increases and decreases in absolute terms.


18/60

12

Carbon 2008


Figure 2.12: Compliance strategies in the EU ETSN=451. Companies with emissions covered by the EU ETS.

0% 10% 20% 30% 40% 50%

Other

A combination of the

above

Developing CDM/JI

projects

Trading

Reducing our own

emissions (internal

abatement)


year we made the question more specic, asking

whether EU ETS acilitates emissions reductions

in the EU. The answers were rather similar to

2006 and 2007, with more than 50 percent o the

respondents agreeing with this statement. But canthese emission reductions also be seen rom the

veried data rom 2006?

What do the verifcation data tell us?

The veried 2006 emissions increased to 2 028, up

22 Mt (1.1 percent) rom 2005. At the sector level,

2006 saw the same picture as in 2005: a shortpower sector and long industry sectors. The higher

emissions can be explained mainly by production

growth, but uel prices and weather also contributed.

Lower hydro production meant higher emissionsin the Nordic region, but the opposite situation in

Iberia.

Figure 2.10 compares 2005-2006 emissions

aggregated by sector or EU-23. O the 22 Mt

emissions growth rom 2005 to 2006, 12 Mt wereaccounted or by the sector comprising public

electricity and heat production (power and heat),

whereas an additional 10 Mt were emitted by the

industry sectors.

The metal and cement/lime/glass sectors emitted

7.5 Mt and 6 Mt more in 2006, respectively.

Installations in the oil and gas sector emitted 1.5 Mtless, others emitted 1.4 Mt less and the pulp and

paper sector emitted just 50 kt more in 2006 than in

2005. Despite the higher emissions, there was still a

comortable surplus o allowances in 2006.

Most countries that had surpluses in 2005 also

had surpluses in 2006, with Denmark as a notableexception. Figure 2.11 shows the countries with the

greatest changes in emissions rom 2005 to 2006.

More than hal o the countries included in the rst

phase 13 in total saw small changes that ell

between a reduction o 2 Mt and an increase o 3

Mt.

The increased emissions in Finland and Denmark

in particular, were due to low hydro levels in the

Nordic region in the rst three quarters o the year,

and consequently lower hydroelectric production.In the UK, coal consumption or power generation

20 percent o respondents use tra-ding as primary compliance strategy

Veried emissions increased 1.1

percent rom 2005 to 2006


19/60

13

11 March 2008


was 11 percent higher in 2006 than in 2005, growing

rom 33 to 37 percent o total electricity production.

Conversely, gas-red generation, which produces

less than hal the amount o emissions than coal,

was down by 8 percent.

Fuel price changes alone would explain only a small

part o the increase in emissions. NBP gas prices or

spot delivery went up our percent rom an average

40.27 pence per therm in 2005 to 41.94 pence per

therm in 2006. At the same time, API2 coal or

spot delivery in Europe was up ve percent romUS$ 60.72 on average in 2005, to US$ 63.77. These

changes are more or less in line with infation.

Unlike in 2005, when gas-red generation in the

UK was slightly more protable than coal-red

generation during the entire summer season, coal

was consistently in the money against gas throughout2006 in the UK. Coal-red generation was helped in

part by a reduction in the average summer carbon

price (Q2 and Q3) rom 21.04 in 2005 to 17.91 the

ollowing year. Given the relatively small changes inuel prices, the lower carbon prices are likely to haveplayed a substantial part in this role reversal.

On the surplus side, improved hydrology in Iberia

and France, combined with a mild winter as well

as a temperate summer in continental Europe,

account or the alling emissions in Portugal, Spain

and France. Spain in particular saw hydroelectricgeneration increase by 32 percent and combined

cycle gas-red generation go up by 30 percent,

while coal-red ell by 15 percent.

So ar, we have seen the role o undamentals

uel prices, demand and weather in infuencing

emission levels in 2006. However, emissions arealso a unction o company behaviour, notably o

eorts to reduce emissions. Such eorts need to be

ramped up in Phase 2 and Phase 3 o the scheme to

achieve tougher overall reduction targets. How will

this be done? How much o this has already begun

in Phase 1? What did companies do to comply in2007?

Generally speaking, compliance will be a result o

internal abatement, trading, osets development

and changes in production patterns. In Figure 2.12we display the responses to our question asking ora companys main compliance strategy. Aside rom

Figure 2.13: Has the EU ETS caused your company to reduce its own emissions?N=420 (2008) and 447 (2007). Companies covered by EU ETS (2008) or CO2 regulation in general

(2007)

0%

10%

20%

30%

40%

50%

The EU ETS has not

caused any emission

reductions in our

company

The EU ETS has

caused reductions to

be planned but not yet

started

The EU ETS has

already caused

emission reductions in

my company

Don't know (2008) /

not relevant (2007)

2007

2008


Fundamentals can to a large extentexplain the increase in 2006 emissions

Do we see any signes o internalabatement?


20/60

14

Carbon 2008


Table 2.1: Reported reduction activities by sector in the EU ETSReported emission reduction eorts by sector, weighted by 2005 emissions. The percentages indicate the share o companies

that have done something to reduce emissions in 2006, not the level o such reductions. Total volume represents the 2005

emissions o respondents installations.

the combination and other strategies, the most

requent is internal abatement. We will return to thisstrategy below.

Abatement

The veried emissions do not show indications o

large-scale abatement in the EU ETS. Emissions are

up in all sectors except or oil and gas. Nevertheless,

71 percent o the companies represented in a PointCarbon survey conducted in April 2007 had already

introduced some measures to reduce emissions

(Table 2.1). These measures were ound particularlyin the orm o uel switching or energy eciency.

We also asked about abatement in our 2007 and2008 carbon market surveys. The results o these

surveys are given in Figure 2.13. Compared to last

years survey, there is very little change in the share

o companies that report reducing or planning to

reduce emissions because o the EU ETS. Last year,

Sector Energy saving Fuel switch Process Output red.

Power&heat 31% 34% 23% 12%

Metals 19% 2% 54% 25%

Oil/gas 42% 10% 5% 42%

Cement/lime/glass 22% 37% 35% 5%

Pulp/paper 47% 21% 14% 17%

Other 38% 19% 13% 30%

Total 31% 27% 25% 17%

Figure 2.14: The EU ETS and current investments at company levelHas the price o carbon infuenced the degree o new investments in your company?

N=385/312. Companies covered by EU ETS (2008) or CO2 regulation in general (2007)

0% 10% 20% 30% 40% 50%

No

To some extent

Yes

2008 2007Source: Point Carbon


21/60

15

11 March 2008


Figure 2.15: The role o long-term carbon prices at industry levelHas the price o carbon infuenced the degree o new investments in your company?

N=385/312. Companies covered by EU ETS (2008) or CO2 regulation in general (2007)

0% 10% 20% 30% 40% 50% 60%

No importance

Influencing

calculation, but not

decisive

Decisive factor

2007 2008Source: Point Carbon

Figure 2.16: You can runHas your company considered moving production outside the EU ETS area because o carbon

costs? N=380. Companies covered by the EU ETS.

0% 20% 40% 60% 80% 100%

Yes, have already

moved production

Yes, have planned

to move production

Yes, are consideringmoving production

No



22/60


23/60

17

11 March 2008


2.3 CDM

Activity within Kyotos fexible mechanisms

specically the CDM grew signicantly in 2007,to 947 Mt and 12bn. Given that sCER prices are

much higher than in the primary market (16 vs.

10 in our calculations), the increased sCER volume

has signicantly boosted the total value o the CDM

market segment in 2007.

2.3.1 Primary CDM market

Some o the increased activity in the CDM market

is due to a tripling o issuance rates compared to

2006, with 76.6 m CERs having been issued in 2007.Although 2007 saw a signicant increase in infow

o new CDM projects, especially within renewables,

there is still a squeeze in terms o expected issuance

or the rst two years o the Kyoto commitment

period (2008-2009).

In early spring, the primary CER market prices or

immature projects sprung to about 9-11, but sincethen the price has been stable, perhaps increasing

slightly. The price movement was probably due toa sustained demand or primary CERs. In general,

prices in the primary CER market still depend

on project stage, project type and counterparty.

Registered projects etched around 12, while

issued CER attracted prices between 14 and 17.

Moreover, hydro projects traded at a slight discount

due to uncertainty over to what extent CERs romlarge hydro projects will be usable in EU ETS. Wind

projects, on the other hand, etched a slight premium

due to a good and stable perormance combined

with a high score on sustainability.

Gold Standard CERs traded at a premium o about

1-2 per tonne. One reason or this was healthy

demand combined with low supply, since only ourCDM projects have qualied under the standard so

ar.

Supply grew healthily over the year. The UNFCCC`s

pipeline o projects surpassed 2 800 projects in 2007,

compared to approximately 1 500 a year earlier.

However, two notable eatures were the constantdecline in size o projects and the increased infux o

small-scale renewable energy projects. Renewable

energy was the largest transacted project category

in 2007, accounting or 29 percent o total conrmedtransaction volume. Furthermore, energy eciencyalmost tripled its market share to 20 percent.

Figure 2.18: China in your handThe relative share o CDM country sellers (let) and buyers (right) in 2007

United Kingdom

46%

Japan

15%

Luxembourg

11%

Austria

3%

France

8%

Germany

7%

Other

10%

China

62%

Uzbekistan

2%

Other

7%

Mexico

4%

India

5%

Chile

2%

Brazil

8%

Indonesia

10%


Signicant increase in infow o newCDM projects in 2007

Still a squeeze o expected CER is-suance in 2008 and 2009


24/60

18

Carbon 2008


The losers were projects reducing industrial gas

emissions. HFC-23 and N2O destruction projects

ell rom a combined 54 percent o 2006 volume to

only 22 percent in 2007. This development should

be taken to heart by those who have previously

criticised the CDM or channelling money into low-cost industrial gas projects rather than renewables.

There was a lot o talk about the market acing a

signicant bottleneck due to the EB process when

several developers blamed the down-writing o their

portolios on the rigorous approval process. Theremay be some truth to this, but it is certainly not

the only actor. Low perormance rates or certainproject types combined with general project delays

have also contributed to the slow issuance rate.

That being said, without reorm o the approval

process, the market could see yet another year with

a low issuance volume. The year did, however, endon a promising note, with a deal in Bali or a thorough

review o the CDM process. Private buyers solidiy

their dominance, with 78 percent o conrmed CDM

transaction volume in 2007 see Figure 2.17. Thisis up rom 58 percent in 2006. These buyers eat into

the shares o carbon unds and governments alike,

both o which have seen their relative market share

cut in hal.

On the supply side, China is still bigger than all the

rest, although it has inched down rom 70 percent in

2006 to 62 percent o transaction volume last year see Figure 2.18. Brazils volume is somewhat up

on our last update, whereas Indias volume is down.

Interesting newcomers in this league o top seller

countries are Indonesia and Mexico.

The UK reigns supreme among buyer countries,

which indicates that a sizeable share o buyers

in 2007 were nancial institutions rather thancompliance buyers. Luxembourgs 11 percent

supports this inerence. Japan is second on the list

at 15 percent up rom a surprisingly low 3 percent

last year suggesting continued compliance

buying by the countrys government, power sector

and heavy industry.

2.3.2 Secondary CDM market

The gold rush or primary CERs continued throughout

the year as numerous new participants entered themarket and started competing or market share.

HFC-23 and N2O projects were con-siderably ewer in 2007 than in 2006

China still by ar the largest CDMselling country

Figure 2.19: Evaluations o the CDM market, 2006-2008Share o respondents agreeing with given statements. Note: 2007 and 2006 surveys ask about the

CDM/JI market as a whole. N= 3176/2016/777.

0% 20% 40% 60%

The CDM market is

mature

The CDM market is a

success

The CDM market is the

most cost-efficient way

to reduce emissions

The CDM market

facilitates emissions

reductions

2008

2007

2006



25/60

19

11 March 2008


But unsurprisingly it was the sCER market that

attracted most attention. Secondary CER trading

was established as a signicant market segment o

its own in the course o 2007, albeit one still lacking

the liquidity o the EUA market.

The sCER market has changed almost beyond

recognition over the past year, with an estimated

total traded volume o 350 Mt compared to 40 Mt

in 2006. The Dec 08 sCER contract began the year

at 14 but ell throughout the winter months with

a declining EUA-price to an all-time low 10.70 inFebruary. By the end o May the price had recovered,

peaking at 17.45.

Looking at the EUA-sCER spread, sCERs were trading

at 90 percent o the EUA price in the early months o

2007. Back then, many assumed that the two prices

would converge. However, recent volatility in the

EUA market saw only moderate reaction in the priceo issued CERs in the secondary market. On 31

December, Dec 08 sCERs were worth 76 percent o

the EUA price (around 17.13) while the 08-12 strip

spread was at 73 percent o the EUA price.The market also saw the rst CERs traded on anexchange, when Nord Pool launched a CER contract

in June.

Last year saw some major milestones in the CDM

market. The moment we all had been waiting or

nally arrived when the international transaction log(ITL) went online and linked the Japanese national

registry with the CDM registry. Immediately

ollowing this, the rst CER spot trade took place.

The event removed some o the uncertainty in the

CDM market, as the lack o a delivery path had

been one reason cited or the CER price discount

compared to EUA prices.

The CDM Executive Board (EB) made some important

decisions last year, the most notable o which was

the decision in June to nally approve the guidelines

and procedures or Programmes o Activities (PoAs),

and their surprising decision in September to approvethe supercritical coal methodology or using less

GHG intensive technologies or energy production

based on ossil uels. Both decisions sent positive

supply signals to the market. On the other hand, the

EBs lack o agreement on several proposed biouelmethodologies constituted signals in the opposite

direction.

Moreover, the UNFCCC secretariat received greater

resources and took on more people to help the EB

in 2007. This gave the EB more time and capacity

to scrutinise projects and the request or review

at both registration and issuance stage increasedsignicantly, with a total o 100 projects put on review

throughout the year, compared to 23 in 2006. Also,

the additionality criteria have been interpreted more

strictly by the EB than in previous years. Throughout

the year, a total o 43 projects were rejected.

How well does the CDM market work? For thethird time, we asked our respondents to provide a

general evaluation o the project market this yearwith specic questions about the CDM (and JI).

The results show continuity above all. Respondents

see some more maturity in the CDM market, butthe level is still low, with only 12 percent agreeing

(Figure 2.19). Hal the sample still disagrees with the

notion that the CDM market is mature.

2.4 JI

During 2007, 16 Emission Reduction Purchase

Agreements (ERPAs) with a total volume o 12.7Mt were conrmed by market players. The ERUs

or these contracts are generated by projects

represented by renewables, nitrous oxide, biomass,energy eciency and ugitive emissions types. It is

notable that the N2O projects account or one-third

o total volume, ollowed by renewables and landll

projects (19 and 13 percent respectively). Early-stagenegotiations have been reported by market players

in energy eciency and landll gas projects.

On average, ERU price ranges have increased

compared to the previous year, with the price range

across contracts becoming narrower. While citedERU prices or standard o-take contracts varied

rom 6 to 10 depending on project risk, sellers

expectations or the ERU price were higher due to

the signicant increase o CER prices throughoutthe past year.

In 2007, the numbers and volumes o projectssubmitted to the JI supervisory committee (JISC)

or verication were boosted. Overall, 84 projects

with a total volume o 117m ERUs were submitted

to the JI Supervisory Committee (JISC) or public

comment during 2007, taking the pipeline to a total

sCERs traded 350 Mt in 2007, uprom 40 Mt in 2006

N2O projects account or 1/3 o totalJI volume in 2007


26/60


27/60

21

11 March 2008


may use is more constrained than in the voluntary

market, which is largely unregulated. The voluntary

market, on the other hand, permits the use o creditssuch as veried emission reductions (VERs), non-

veried emission reductions (ERs) and prospective

emission reductions (PERs), as well as CERs, ERUs,EUAs and other credits and allowances generated

or the compliance market.

Our denition excludes trades between project

developers and nancial institutions, where the nal

purpose o trading is to supply compliance carbon

credits to compliance buyers. It also excludes

trades intended to ull agreements between theJapanese government and major companies to

reduce their GHG emission intensity, even though

these are termed voluntary. This is because these

agreements represent industry-wide commitments

intended as a strong alternative to binding targets inreaching Japans Kyoto goals, with a view to making

legislation unnecessary.

2.5.2 Volumes and values

Combining data rom brokers and voluntary oset

credit providers in the US and Europe, as well as

rom the voluntary Chicago Climate Exchange (CCX),

we nd that the voluntary market traded around 55

Mt CO2e in the rst three quarters o 2007. The total2007 volume was an estimated 75 Mt compared to

less than 20 Mt in 2006.

Our market size assessment indicates strong growth

in the voluntary carbon market. Furthermore, in our

survey, 45 percent thought that the voluntary market

had grown more mature over the past year (see

gure 2.22). On the negative side, only ten percent

thought o the voluntary market as transparent.

A majority o the transaction volume takes place in

the US, where more than 30 Mt have traded this year

to date, or about 60 percent o the total. The CCX

accounts or hal this volume, with the remainder

made up by the corporate voluntary market andthe consumer retail market. Carbon credit prices

in the US vary between $2/tonne and $15/tonne,

depending on project type.

2007 was the year in which North American market

players announced ambitious carbon strategies,

rom calculating ootprints to developing internal

abatement opportunities, or buying, building or

Total voluntary volume in 2007 esti-mated to 75 Mt

Prices range rom $2/tonne to $15/tonne or voluntary project credits

Figure 2.21: Much that separates, a little in common?The range o carbon credits available or purchase by voluntary market participants. Note that carbon credits

originally generated or compliance purposes could also end up in the voluntary market. NGAC = New South Wales

Greenhouse Gas Abatement Certicates.


28/60

22

Carbon 2008


partnering in developing oset projects. Estimatedtransactions involving new projects quadrupled in

2007. Subsequently, a ourold increase is expected

or oset credits registered in 2008, while the number

o projects rom new contractual agreements couldslow down or even decline.

Outside the US, the voluntary market is strongly

infuenced by the Kyoto market, with CDM and JI

project developers supplying VERs to voluntary

buyers. Some oset credit providers also oer CERs

or non-compliance purposes.

We estimate that voluntary CER transactions willtotal only 1-3 Mt in 2007, which means that there

will be no eect on CER prices. On the other hand,

i transparency and standards in the voluntary

market do not improve over time, CER demand rom

voluntary buyers could increase signicantly in the

coming years.

2.5.3 Supply

To satisy demand, developers are now scramblingto create new projects that meet standards

complementing or supplementing the CCX Carbon

Financial Instrument. Credits may not be available

yet, but the quality o the pipeline, in terms o

expected certication through the Voluntary Carbon

Standard, Gold Standard, CCB standard, etc, isresponding to market demand or osets rom

specic project types linked to established standards

and methodologies.

The voluntary US supply pipeline totals 140 Mt,

counting all projects or which we have data. Waste

methane and energy eciency projects dominate

the US pipeline in volume terms. Looking at Kyoto

projects, potential VER supply rom CDM projectshas a current maximum volume o 100 Mt to theend o 2007.

Voluntary markets have an impact on compliance

markets not only by trading the same or similar

credits, but also by providing models or emerging

compliance markets. In particular, the currentpipeline o US voluntary oset supply will infuence

the volume, type and quality o osets available to

the 10-state RGGI.

Current oset providers to the voluntary US market

also have a voice in the development o a uture US

cap-and-trade scheme. We may, or example, see a

greater emphasis placed on agricultural projects andcarbon capture and storage (CCS) in the US than is

currently the case in the CDM or EU ETS.

Finally, the quality o voluntary oset credits

worldwide will infuence public opinion and thereputation not just o the voluntary market, but o

emission trading in general. Forty percent o those

taking our 2008 survey share this concern, as

indicated in gure 2.18. Conversely, 28 percent think

there is no signicant reputational risk.

Figure 2.22: Voluntary carbon: Prospect or peril?Share o respondents agreeing with given statements. N=2998

0% 10% 20% 30% 40% 50%

The voluntary carbon market is transparent

The voluntary carbon market produces real

emissions reductions

The voluntary carbon market fosters

innovation in emission reduction methods

The voluntary carbon market poses a risk for

the reputation of the compliance markets

The voluntary carbon market is more mature

now than one year ago



29/60

23

11 March 2008


3. Carbon markets towards 2012The rst Kyoto commitment period, which endson 31 December 2012, is set to be dominated

by the EU ETS and CDM on the market side. The

interlinked EU ETS and CDM markets will see the

greatest cumulative volume and value, as they are

consolidating and getting more sophisticated. Inaddition, the next ve years will see the JI market

deliver its rst credits and possibly an emerging

market in national Kyoto allowances or AAUs.

Beyond Kyoto, the ten-state RGGI has already

produced the rst US compliance trade, and more

is expected.

3.1 Expectations or global 2008 volumesand trends

The total traded volume in global carbon markets

in 2007 was 2.7 Gt, valued at just over 40 bn. We

expect this to grow to 4.2 billion tonnes CO2e in

2008, up 56 percent rom 2007 see Figure 3.1.

The EU ETS maintains its position as the largest

market. Traded volume in the EU ETS is expectedto be 2.6 Gt in 2008. At current prices, this would

be equivalent to 63bn (US$ 92bn).

We expect that the general trend o increasingtraded volumes will continue as the global market

becomes more mature and sophisticated. An increase

in contract types, more players and markets and

greater competition between market players (such

as exchanges and brokers) will together generate

momentum or higher volumes. As a consequence,liquidity providers will be attracted to this market.

On the other hand, turbulence in global nancial

markets may contribute to less vigorous growth in

transacted volumes.

We expect that the 2008 carbon market will dier

rom 2007 in several ways. First, the EU ETS Phase

2 is considerably tighter than Phase 1. Moreover,the start o short-term prompt trading or Phase 2,

where only orward trading was seen previously,

is expected to contribute to increased traded

volumes.

Second, the EU climate and energy package,

launched on 23 January this year, has sent apotentially bearish long-term signal to the project

markets by placing uncertainty on the uture o

the Clean Development Mechanism (CDM). More

immediately, the reduced average credit limits onCER/ERU and the tight Phase 3 are expected todampen EUA-sCER swaps.

Carbon market expected to grow 56percent in 2008

Figure 3.1: Stairway to the frst Kyoto period, take 2Reported and estimated contracts 2005-07; orecast or 2008, Gt CO2e

0

1

2

3

4

5

2005 2006 2007 2008 (forecast)

Annualvolume(Gt

)

Other

JI

CDM total

EU ETS total


64%

104%

56%


30/60

24

Carbon 2008


Third, new policies in key countries such as the US

and Australia imply that we will see trading in newmarkets. This will be accelerated by the ongoing

negotiations under the Bali action plan.

3.2 EUA market

In the EU ETS, which covers about 2.1bn tonnes

CO2e annually o underlying assets, new nancial

instruments are developing and their use is

spreading. What are the main developments in

the EU ETS market rom a trading perspective?

What eects does the EU ETS have on company

behaviour when it comes to abatement, investment,production and other ways o managing emissions?

And beyond current bid/oer spreads, what prices

do compliance and nancial players oresee or the

period?

3.2.1 EU ETS in 2008

The 2007 volume in the OTC market and on the

exchanges corresponds to almost ve times the

annual Phase 2 shortage o about 300 Mt in thepower and heat sector. This gap needs to be lled

every year. We estimate that in 2008 this volume

will increase to about seven times the power and

heat gap.

There are several reasons why we expect this

growth. First, the tightness o the Phase 2 cap isexpected to increase the traded volume compared

to 2007, simply because more players are short o

allowances. Industrials that were long in Phase 1

are in general balanced or slightly in Phase 2, while

power and heat installations that were short inPhase 2 have now become even shorter.

Figure 3.2 displays the shortness o companies

covered by the EU ETS, as reported in our 2008

survey. Only 15 percent o the respondents expectto be long in Phase 2, that is, to have an allocation

that is sucient or compliance and surplus EUAs to

sell. About one-third expected to be in the powersector will need their ull allocation, credit limit and

extra EUAs. Shortness will mean more trading since

ewer can ignore the EU ETS. As a consequence,

Phase 2 volume will go up compared to Phase 1.

Second, a tighter cap gives higher volatility becauseprices become more sensitive to changes in

undamentals. This will be attractive to nancial

players as well as compliance traders, consequently

increasing the traded volume. As seen in Figure 3.3,

EU ETS to trade seven times powerand heat shortage in 2008

Figure 3.2: Long on shorts.EU ETS company allowances and credit limits compared to expected emissions in Phase 2. N=433.

Companies covered by EU ETS.

0% 10% 20% 30%

Allocation is sufficient for compliance. We will have

surplus EUAs to sell.

Allocation is sufficient for compliance. We have no

surplus EUAs.

Allocation + some of the credit limit needed for

compliance.

Allocation + full credit limit needed for compliance.

Allocation + full credit l imit needed. We also need to

buy EUAs.

Allocation + full credit l imit needed. We also need to

buy EUAs. We will have surplus CERs to sell/swap.

Don't know



31/60

25

11 March 2008


Figure 3.4: Rapid growth in optionsOptions volume (notional) on the ECX, January 2007 - January 2008. The volume includes options

traded on the exchange and options traded elsewhere but cleared on the exchange.

0

5

10

15

20

25

30

35

40

45

Jan-07

Feb-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

NotionaloptionsvolumeinEUAmillion

Source: ECX

Figure 3.3: Gearing up or a volatile 2008?EUA volatility and moving-average daily volume (OTC and exchanges) in 2007 and 2008 to date.

0

1

2

3

4

5

6

7

8

9

10

2/1/07

25/1/07

19/2/07

14/3/07

10/4/07

3/5/07

29/5/07

21/6/07

16/7/07

8/8/07

31/8/07

25/9/07

18/10/07

12/11/07

5/12/07

2/1/08

25/1/08

19/2/08

DailyEUA

volume(Mt).

0%

10%

20%

30%

40%

50%

60%

70%

Volatility

30-day MA volume EUA 40-day volatility



32/60

26

Carbon 2008


the 30-day moving average on daily volume in 2007

remained quite stable despite lower volatility in the

second hal o 2007, while it has increased in 2008

so ar, along with higher volatility.

Third, the act that Phase 2 has now begun implies

that there will be compliance buying on the prompt,

and undamentals such as uel prices and weather

will contribute to increased volatility. This, in turn, will

lead to higher volumes. Factors such as temperature,

wind, precipitation and power outages will have an

immediate impact on EUA prices.

Fourth, Phase 2 will involve signicantly more

auctions than Phase 1, which will contribute directly

to increased transaction volume.

Finally, option trading has increased rapidly in the

EUA market in the last ew months, especially in

January 2008 see Figure 3.4. The EUA options

market took o in 2007, with the ECX reporting a

notional volume o 58m EUA options (see Figure

3.3). This growth continued into January 2008, whichsaw 45m EUA options traded on the exchange.

Our survey results refect the penetration o options

in the carbon market. Figure 3.5 demonstrates

how 55 percent o our respondents in the EU ETS

and CDM markets have either entered or plan toenter the options market. CER project developers

and aggregators are the most active in the options

market almost two-thirds o this group state that

they have traded options or plan to do so. In the

EU ETS, this was the case or around hal o therespondents.

Options trading expected to growsignicantly in 2008

Figure 3.5: Options in the EUA and CER marketsHave you bought/sold or will you buy/sell EUA or CER

options? N=1,254. Respondents in the EUA/CER market.

0% 10% 20% 30% 40% 50%

Have not/will not

buy/sell options

Yes, will buy/sell

options

Yes, have bought/sold

options


Figure 3.6: The fnal cutComparable caps in Phase 1 and Phase 2. Includes EU27 and Norway

1,500

1,700

1,900

2,100

2,300

2,500

Phase 1 cap Phase 2 Submitted EC Cuts Final phase 2 cap BAU Emissions

Mt/year



33/60

27

11 March 2008


Figure 3.7: Willingness to buy/sell EUAs at various pricesN=311. Companies with emissions covered by the EU ETS.

0%

20%

40%

60%

80%

100%

0-10

10-15

15-20

20-25

25-30

30-35

35-50

50-100

>1

00

/tonne

Share

ofrespon

dents

would buy at max

would sell at min


Financials or companies with an EUA allocation may

either hedge their EUA positions directly through

options, or as part o structured EUA-sCER swap

deals. Options are attractive or liquidity providers,

as they do not require the provider to take a positionin the underlying commodity.

Option trading is expected to increase as volatility

grows, and the hedging and re-hedging o options

also produces signicant trading volume o EUA

orwards.

Despite the growth momentum in the EU ETS,

there are also actors pulling against the volume. For

instance, industrials are likely to reduce their EUA-

sCER swap trades due to the stricter credit limit

proposed by the EC. Viewed in isolation, this will

reduce the transacted volume.

On the other hand, less swap trading could mean a

higher EUA price, as ewer credits will be available in

the market. This could cause growth in volume that

outweighs the relative decline in EUA-sCER swaps.

Our 2008 orecast or the EU ETS is comparable tothe underlying assets, i.e. the total 2008 allocation.

In comparison, the turnover in mature markets, such

as the Nordic power market and the oil market, is 6-

700 percent. In this context the carbon market is stilla young market with a considerable upside.

3.2.2 Towards 2012 and beyond

In its rulings on Phase 2 national allocation plans,

which took place rom November 2006 to October

2007, the EC was unquestionably tough. As a

consequence, the caps in 2008-2012 are muchtighter than in Phase 1.

The initial shortage in the 2008-2012 period creates

a demand or real emission reductions, either at

home or in non-Annex 1 countries.

The overall cap or Phase 2 or EU-28 (EU-27+Norway)is currently at 2 103.5 Mt/year. In total, the EC has

cut the allocation by 245 Mt/year or 10.4 percent compared to the allocation suggested in the NAPs

(see Figure 3.7).

The largest cuts in volume terms have beenrequested in Poland (76 Mt), Germany (29 Mt) and

Bulgaria (25 Mt). The largest cuts in relative terms

have been requested in countries located in Eastern

Europe, with the three Baltic States (about hal) and

Bulgaria (37 percent) at the top o the list.

The credit limits, dened as the maximum CDM/JIvolumes that can be used or compliance purposes

in Phase 2, were set quite generously, as every

country was guaranteed a minimum 10 percent.

Table 3.1 shows the suggested caps by member


34/60

28

Carbon 2008


Table 1: The decided and undecided ones..The table shows the status or the Member States on whose NAPs the European Commission has

made a decision and or those countries where the EC has not yet made a decision. All in Mt/year.

COUNTRY NAP EC decision Reduction [Mt/%] Credit limit

AUT 32.8 30.7 2.1 (6 %) 10.0 %

BEL 63.3 58.5 4.8 (8%) 8.4 %

BGR 67.6 42.3 25.3 (37%) 12.6 %

CYP 7.1 5.5 1.6 (23%) 10.0 %

CZE 101.9 86.8 15.1 (15 %) 10.0 %

DEU 482.0 453.1 28.9 (6%) 22.0 %

DNK 24.5 24.5 0.0 (o%) 17.0 %

ESP 152.7 152.3 0.4 (0.3%) 20.0 %

EST 24.6 12.7 11.7 (48%) 0.0 %

FIN 39.6 37.6 2.0 (5%) 10.0 %

FRA 132.8 132.8 0.0 (0%) 13.5 %

GBR 246.2 246.2 0.0 (0%) 8.0 %

GRC 75.5 69.1 6.4 (8%) 9.0 %

HUN 30.7 26.9 3.8 (12%) 10.0 %

IRL 22.6 22.3 0.3 (1.3%) 10.0 %ITA 215.2 201.6 13.6 (6%) 15.0 %

LTU 16.6 8.8 7.8 (47%) 20.0 %

LUX 4.0 2.5 1.5 (38%) 10.0 %

LVA 7.7 3.4 4.3 (56%) 10.0 %

MAL 3.0 2.1 0.9 (30%) -

NLD 90.4 85.8 4.6 (5%) 10.0 %

NOR 15 15 0.0 (0%) 20.0 %

POL 284.6 208.5 76.1 (27%) 10.0 %

PRT 35.9 34.8 1.1 (3%) 10.0 %

ROM97.6 75.9 21.7 (22%) 10.0 %

SVK 41.3 32.6 8.7 (21%) 7.0 %

SVN 8.3 8.3 0.0 (0%) 15.8 %

SWE 25.2 22.8 2.4 (10 %) 10.0 %

TOTAL (EU28) 2348.4 2103.4 245 (10.4 %) n.a.


35/60

29

11 March 2008


state, the EC decision and the credit limit as

originally set beore the launch o the EC proposalon 23 January this year.

It is generally accepted that the EC did a good job insetting the caps, but was more generous in setting

the credit limit. Consequently, Phase 2 could in

theory produce no emissions reductions in Europe,

just credit imports rom CDM and JI countries.

The Commission corrected this through the EUETS review and the Phase 3 proposal in January

this year. The undamental balance o the EU ETS

in Phase 2 is now merged with that o Phase 3

(2013-2020). This is because EUAs can be banked

without limits rom one year to the next. Higher

Phase 3 prices should thus also translate into higherPhase 2 prices.

All the proposals in the EC energy and climate

package are to some extent related to the overall

EU climate and energy targets, i.e. a 20 percent

reduction in GHG emissions, a 20 percent share orenewables in nal energy consumption and a 20

percent increase in energy eciency. All targets

would be achieve

Carbon 2008: Post-2012 is now

Documents