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Mumbai 20th May 2010
Gensol Consultants Pvt. Ltd.
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ACKNOWLEDGEMENT
An honorable mention goes to all those who wish to remain unnamed from various government
and private organisations who have provided their guidance, support and valuable information.
Their cooperation and assistance has contributed tremendously towards the completion of this
report.
We also wish to extend our thanks for the inputs and insights of our team members- Mr. Jinesh
Amlani, Mr. Tumul Dwivedi, Mr. Gaurav Chauhan, Ms. Tishya Dwivedi, Mr. Ankur Bhatnagar and
Mr. Ankush Bajoria.
0F
1
* The findings and conclusions expressed in this report are the sole opinion of the authors. This report is not intended to
form the basis of an investment decision.
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Table of Contents:
1. Executive Summary.........................................................................................................................5
2. Overview of Carbon Market...........................................................................................................8
2.1 Kyoto Protocol....................................................................................................................................................................8
2.2 European Union Emission Trading Scheme...........................................................................................................9
2.3 Carbon Market Transactions..................................................................................................................................... 10
3. Carbon Market - Global balance of demand-supply ........................................................... 11
3.1 Kyoto Protocol Mechanisms ...................................................................................................................................11
3.1.1 Assigned Amount Units....................................................................................................................................12
3.1.2 Project-based Mechanisms................................................................................................................................ 13
3.1.3 Projection of CDM credits supply ...............................................................................................................14
3.2 EU Emission Trading Scheme ................................................................................................................................17
3.2.1 Emission targets and projections under EU ETS phase II ..............................................................17
3.2.2 EU ETS phase III - Carbon market driving force .................................................................................18
3.2.3 Net Demand-Supply under phase II ..............................................................................................................19
4. Other Emerging Schemes:............................................................................................................ 20
4.1 US Carbon Market..........................................................................................................................................................20
4.1.1 RGGI............................................................................................................................................................................20
4.1.2 Western Climate Initiative................................................................................................................................. 20
4.1.3 American Clean Energy and Security Act (ACES Act), 2009................................................................21
4.1.4 American Power Act, 2010................................................................................................................................21
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4.2 Tokyo ETS..........................................................................................................................................................................22
4.3 UK CRC Energy Efficiency Scheme:.........................................................................................................................23
4.4 REDD ..................................................................................................................................................................................23
5. International Aviation and Shipping Emissions ................................................................. 25
6. Post-2012 Market Frameworks................................................................................................. 27
6.1 Only EU ETS scenario ...................................................................................................................................................27
6.2 Extension of Kyoto with EUETS but without US Scenario.............................................................................27
6.3 Copenhagen accord scenario..................................................................................................................................... 28
7. Price Forecast................................................................................................................................. 30
Annexure 1: Methodology .................................................................................................................... 32
Annexure 2: Glossary ............................................................................................................................. 33
Bibliography.............................................................................................................................................. 35
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1. Executive Summary
This report provides an overview of the international carbon market its underlying structure,
dynamics and an analysis of the market forces shaping the carbon demand and supply, and theinteraction of these dynamics in influencing the carbon prices. Forecasts of demand, supply and
price are examined for Kyoto Protocol and EU ETS.
Carbon Market Structure
A consensus has emerged among scientists and policymakers that an increase in Greenhouse Gas
(GHG) emissions in the atmosphere is responsible for the extreme weather patterns and climate
change. As concerns about the potential impact of human induced climate change have increased,
policymakers around the world are looking for ways to reduce the carbon emissions associated with
human activity.
International efforts on combating climate change led to the negotiation of the Kyoto Protocol in 1997,
an international treaty committing the global community to reduce GHG emissions by an average of
5.2% below 1990 levels in the period 2008-2012.
To meet the binding emissions reductions agreed under the Kyoto Protocol, a number of nation states
have turned to a market-based policy approach of a cap and trade mechanism(CTM).
A Cap & Trade mechanism involves:
The setting of a limit on the level of emissions allowed by covered entities (factories, power
stations) regulated under the mechanism
An issuance by the government to the covered entities of carbon allowances in line with the
cap that can be used for compliance
A penalty that will apply to covered entities that do not submit sufficient carbonallowances/credits to meet their emissions over the compliance period
The Kyoto Protocol agreement has led to the development and introduction of a number of CTMs by
countries that are looking to meet their GHG reduction targets. The largest and the most liquid market
is the European Union Emission Trading Scheme (the EU ETS) that covers a number of large industrial
sectors in 27 countries across Europe.
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Till date, trading in the carbon market has been dominated by two specific carbon commodities. The
most highly traded are the allowances traded under the EU ETS these are called EU Allowances
(EUAs). The second carbon commodity is Certified Emission Reduction (CER) credits, which are offset
credits that are earned under GHG reduction projects that have been registered by the body thatadministers the Kyoto Protocol the United Nations Framework Convention on Climate Change (the
UNFCCC).
CERs are created under the Clean Development Mechanism (CDM), which allows investments in
programs or technology to reduce carbon emissions in developing countries and these credits can
then be traded to offset carbon emissions in developed countries.
Potential Demand Supply Scenario
On the supply side, expected supply of CDM and JI offsets by 2012 would range between 620 and 743
MtCO2e due to a combination of regulatory delays, the difficulty in obtaining financing for projects
in a challenging global financial environment, stricter regulations and the suspension of validators
at regular intervals.
On the demand side, the demand from EU ETS is majorly driven by the phase III where the banking
from phase II is allowed, use of international offsets (CERs and ERUs) and excess emission over cap
in phase II. The total demand for international offsets is around 1.389 billion units which could lead
to a net shortfall of 646 million units.
The expected demand for AAUs under the Kyoto Mechanism from some EU 15 countries can be
easily met through AAUs surplus of 8 billions units amid economic slowdown and estimations of
large surplus of AAUs with some central and eastern European countries.
Beyond 2012
Today, uncertainty over the regulatory framework post first Kyoto period (2008-2012), poses a threat
to the future of carbon market. The foundation of a post-2012 framework has been laid down at COP
15, Copenhagen, where many countries taken up non binding targets. This report analyses three
possible post 2012 scenarios.
First, only EU ETS scenario with no successor treaty to the Kyoto Protocol. In this scenario, limit will be
placed onimports of international offsets equal to the unused portion of the limit in Phase II and target
willbemet through internal abatement.
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Second, Extension of Kyoto Protocol without US scenario. In this scenario, EU ETS targets would be
raised from 20% to 30% under EU ETS phase III and a higher limit permitted on importing
international offsets.
Third, with current pledges under Copenhagen accord. Under this scenario, post 2012 demand from
project based mechanism could be 6.7 billion units, with most of the demand will come from EU and
US.
Price Forecast
Carbon Market is expected to be bullish in near future and price are most likely touch new highs by
the end of first commitment period in 2012. Carbon credits as of now seems to be undervalued
commodities and thus provides and ideal investment opportunity.
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2. Overview of Carbon Market
In response to threats and risks of climate change, a variety of initiatives and approaches aimed at
reducing GHG emissions have been adopted across different levels of human endeavor, fromcommunities, to cities, private firms, governments and from local level to a global level. Carbon market
forms a cornerstone of the regulatory response to climate change and emissions trading is one of the
key tools in supporting the transition into a global low-carbon economy.
2.1 Kyoto Protocol
The Kyoto Protocol, an international agreement signed in Dec. 1997 under UNFCCC has been
instrumental in the creation of an international carbon market. Under the Kyoto Protocol, GHG
emissions from 38 industrialized countries including economies in transition (EIT) and the EU-15
members have been capped and they have been legally bound to reduce their GHG emissions by
anaverageof 5.2%below 1990 levels over the first commitment period (CP1) 2008-2012.
Countries, under this mechanism, are broadly divided in two groups Annex 1 (developed economies
and economies in transition) and non-Annex 1 (developing countries).
The first commitment period (CP1) runs for five years, from 1 January 2008 to 31 December
2012 with sovereign governments being the regulated entities:
40 emissions-capped industrialized countries are listed in Annex 1 to the Kyoto protocol
and 38 of them (the USA and Canada have already withdrawn from the scheme) who have
accepted legally binding emission reduction commitments for CP1 have been listed in Annex
B of the Kyoto Protocol
Targets for Annex 1 countries (and the Annex B countries) Kyoto Protocol compliance
obligations are based on their GHG emissions over the five year CP1 period. Kyoto Protocol
units must be surrendered to match national emissions after the end of the CP1 period
The value of Assigned Amount Units (AAUs or Governmental carbon emission cap) issued to
some Annex 1 countries is equal to theirGHG compliance target forCP1
This market is driven by the compliance needs of the Annex 1 countries. Three instruments have
been developed under this scheme for enabling deficit Annex B countries to meet their emissions
targets
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Assigned Amount Units (AAUs) are allowances issued by the UNFCCC to Annex B
countries at the level of theirrespective Kyoto protocol targets. One allowance represents right
toemit one ton of CO2e
Clean Development Mechanism (CDM) facilitates the deployment of capital, technology,and capability from the developed world into GHG reducing projects in the developing world
that benefits from a low marginal cost of abatement. Credits from CDM projects are called
CERs. One CER is issued onone tCO2ereduction in host country
Joint Implementation (JI) may be carried out between two or more Annex I countries, and
involves sharing of capital, technology, and capability to deliver GHG reducing projects.
Credits from JI projects are called ERUs. An ERU is issued on one tCO2e reduction in host
country
2.2 European Union Emission Trading Scheme
To complement Kyoto Protocol targets, the European Union instituted an indigenous emission trading
scheme in 2005, known EU ETS. Although EU ETS is the principle EU policy instrument in addressing
global warming, it is not an exclusive policy tool as it does not cover 100%of the EUs GHG emissions.
This scheme presently spreads over distinct phases. Phase I of the EU ETS ran from 1 January 2005 to
31 December 2007 (3 years), with Phase II set to run in line with the Kyoto Protocols first
commitment period i.e. from 1 January 2008 to 31 December 2012. It is proposed that the Phase III
will run from 1 January 2013 to 31 December 2020 (8 years). EU ETS, which is a cap-and-trade
scheme, enforces emissions cap for regulated entities and grants the holder of one EU Allowance
(EUA) the right to emit one tonne of CO2. The amount of EUAs allocated to each regulated entity in the
scheme is set out in National Allocation Plans prepared by the member states and approved by the
European Commission.
In order to meet the emission cap, regulated entities can undertake internal abatement; or can
source allowances (EUAs) from other regulated entities, or they can source CERs from the developing
world via CDM, or ERUs from economies in transition via JI; however, the scheme has imposed a limit
of 1.389 billion tCO2e on the use of such international offsets. The EU ETS only covers around
40% of the total EU GHG emissions, focusing on the CO2 emissions from five major sectors viz.
Power and Heat Generation, Oil Refineries, Metals, Pulp & Paper, and, Energy Intensive Industry.
France and Netherlands unilaterally extended the scope of EU ETS in Phase II to include installations
emitting nitrous oxide (N2O).
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2.3 Carbon Market Transa
There is a wide variety of differe
which means that there is never
market has become a major are
have instituted structured carbo
desks seeking arbitrage opportu
carbon-related financial products
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tions
t carbon assets and a selection of different fl
one single price for carbon. Recently, a large
of focus for investment banks and hedge fu
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nities. This has resulted in creating a growi
and derivatives, including:
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ligation of a primary carbon asset to a second
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enue streams
Figure 1
f types of Carbon Assets and types of trans
st pricing fluctuations, delivery risks, advanc
ulatory schemes (such as EU ETS Phase III o
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e and reach of the international carbon marke
or forward delivery - any year up to compliance date (2008-12
hased directly from project owner
ers will sell in strips to break out risk into smaller packages
aranteed basis by credit-rated entity
elated performance risk - only credit risk
or forward delivery - any year up to compliance date (2008-12
at is bought or sold for immediate delivery
sued credits only so that trades can be settled quicklyre the most commonly quoted prices for carbon
lves delivery of one unit per year across a number of years
ers split out individual future delivery years into strips to am
s may also be used to hedge against other market fluctuation
cently due to low liquidity and high implied volatility
nsactions are EUA/CER and - less so - EUA/ERU swaps and car
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3. Carbon Market - Global balance of demand-supply
Demand and supply of carbon market depends on three market segments Kyoto Protocol
compliance, allowance-based (EU ETS), and voluntary carbon market over compliance periods.Demand and supply within each market segment are driven by:
Policies with respect to trading schemes and GHG quota allocations of Annex 1 countries;
Expectations regarding future policies and the shape of post-2012 regulatory schemes;
Factors affecting emission generation: economic growth rates, weather conditions, fuel
prices, and availability of low-emissions electricity;
The level of emission reduction through additional policies and measures such as
energy efficiency programs and renewable energy use done by developed countries;
Non-compliance policies such as voluntary GHG mitigation;
Global supply from the project-based Kyoto Mechanisms, and availability of
credits from large, low cost sources.
Specific drivers for the primary types of carbon asset project-based credits from the Kyoto
Mechanisms (CERs and ERUs) and allowance-based units (AAU) and their performance against
these factors have been discussedbelow.
3.1 Kyoto Protocol Mechanisms
The demand-side of Kyoto Protocol units (AAUs, CERs and ERUs), include the government demand from
nations where there is a shortfall of Kyoto Protocol compliance, and the private sector demand,
primarily from the EU ETS.
While, there are two key sources of Kyoto Protocol units on the supply-side: supply from Kyoto
Protocol party countries having a surplus - a group comprised principally of the post-Soviet
countries and supply from project-based mechanisms.
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3.1.1 Assigned Amount Units
Economic restructuring and shutting down of inefficient communist-era power plants and industrial
facilities have resulted on bringing down emissions since 1990 records and creating a huge surplus of
AAUs for some central and eastern European countries.
These AAU vendor countries include Russia, Ukraine, Poland, the Czech Republic, Latvia and Hungary.
In actual terms, around 46% of surplus AAUs lies with Russia, 30% with Ukraine and the remaining
24% lies with countries of the former Soviet Union in Eastern Europe.
Figure 2
Strict international emission trading eligibility standards and UNFCCCs rules specifying that a
percentage of AAUs held by surplus countries must be kept either in voluntary reserves or banked
for use in future periods act as limitations for estimating the supply of AAUs.
Developments in Russia and Ukraine will signal the likely volume of AAUs brought into the market
as these two nations together account for around 75% of the total surplus AAUs. These countries
are thought to be wary of flooding the market withAAUs and potentially driving a price crash.
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Figure 3
With eight billion surplus AAUs in the system, as shown in Figure 3 and estimations about up to
1.5 billion AAUs can be traded in the market by 2012, any Annex B countrys Kyoto Protocol
compliance shortfall can be easily met by purchasing AAUs, rather than employing domestic GHG
reduction measures or competing in the international market for Kyoto Protocol compliant CERs and
ERUs. Demand for additional AAUs from EU countries (due to their excess emission) is estimated
to be around 0.770 billion units by 2012, some 10% of the total AAU surplus. This demand is
expected to be limited due to recession in 2009 which resulted into sharp decline in emissions.
3.1.2 Project-based Mechanisms
The supply-side picture is shaped by the project pipeline for CDM and JI projects. Given the nature of
CDM, the supply of CERs will always meet its demand (current and future) based on the prevailing
primary market prices. However, there are three primary constraints due to which issuances have
been affected:
Tightening of UNFCCC rules and regulations making project eligibility and CER issuance
criteriamore stringent
Frequently suspension of validators like DNV, SGS and TUV SUD: Validators had number of
projects under validations and during their suspension time these projects were validated by
other entities tookmore than usual time to validate the project to ensure that all the rules are
duly met and they do not come underscrutiny by UNFCCC
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Both UN and validators
declining and projects are
Technical issues with pro
Joint Implementation project
registered or in the pipeline,
market.
3.1.3 Projection of CDM c
An analysis had been done on CE
the issuance and projects registra
A critical analysis of the figure
deficiency of CERs in the market.
In 2010, issuance is much
this year
After analyzing the issuan
March with an average of
declined to 4 million
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ave shortage of manpower, as a result of
going throughbottlenecks of pipeline
ects and less number of quality projects avai
still being under developmental stage and
he meager volume supply of ERUs have negli
edits supply
Rs issuance and projects registered. The foll
tion under CDM in different time frames:
Figure 4
4 and 5 highlight the declining issuance a
rom the above charts, following analysis can
below the average and thus it is expected th
ce per month, the maximum issuance takes pl
10 million CERs. But in 2010, the same month
hich issuance rate is
ability in the market
ithnot many projects
gible effect on the
wing chart represents
nd probable long run
e drawn:
t YoY issuance will fall
ce in the month of
issuance has been
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The rate of issuance h
registration. Thus, it ca
CER/project) had decline
Even if, 2009 was the go
issuance has been noticed
In the light of the existing constr
supply scenarios. We see differen
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Figure 5
s not been increasing in proportionate to
be concluded that the size of registered
od year in terms of total issuance per year
starting from May in the same year
ints on CDM supply, we have constructed a
pictures based variation in constraints on th
the rate of projects
projects (in terms of
but substantial cut in
odel to quantify CDM
CDM supply.
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Figure 6 show the three scenario
0.408 bn. The highly optimistic s
1.389 billion tCO2e are issued b
billion by the end of 2012. This
issuance of 1.05 billion by the en
less than 3 years against the curr
supply constraints, achieving suc
Medium and low optimistic scen
CERs respectively. Projecting th
representing a total issuance of
Figure 4, gives us the low optimis
expects that the supply will purs
million CERs/month. This rate s
registration and issuance rate.
Actual Issuance
till April 2010
CERs 408.81 Million
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Figure 6
split over time. The actual CER issuance as
enario represents that CERs equivalent to th
the end of 2010. This would require in tot
s seen as a highly unlikely scenario because
of 2012, required issuance rate stands at 19
ent average 5.5 million CERs/month in last 6
issuance would require tremendous efforts.
rio represents a total issuance of 0.715 billio
e average historic rate, gives us the Mediu
0.715 billion CERs. Factoring the periodic h
ic Scenario representing a total issuance of 0.
e medium scenario in which required rate o
ems achievable considering current project
Highly Optimistic
Case
Medium
Issuance Rate
Case
1.05 Billion 715 Million
n April 2010 stands at
entire EU ETS limit of
l CER issuance of 1.05
in order to meet total
million CERs/month in
years. Considering the
CERs and 0.62 billion
m optimistic Scenario
iccup trend as seen in
2 billion CERs. Author
issuance stands at 10
in pipeline, rejection,
Lower Issuance
Rate Case
620 Million
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3.2 EU Emission Trading Scheme
Under the mandatory EU ETS cap-and-trade scheme, understanding of the mechanism is critical to
accurately determine the demand and supply of allowances (the cap) and credits. In EU ETS, there
are three main drivers of demandand supply:
The ability to bank allowances from one compliance period to the next: linking compliance
periods by allowing banking encourages regulated entities to bank allowances into future
periods, broadly supporting the scheme allowance price
The size of limits on use of international units such as CERs/ERUs, for compliance
purposes: As prices of credits increase, the volume of internal abatement becomes
economically attractive
Sensitivity to external market factors, in particular the price of fuel (oil, coal, and gas): Its
the effect of the cost of switching between coal and gas for power generation companies.
Power producers keep on switching from coal to gas or oil as the prices of these
commodities move in international market. Subsequently it impacts carbon credit demand
(due to different emission factors of different fuels) to meet emission reduction targets
3.2.1 Emission targets and projections under EU ETS phase II
The EU ETS only covers around 40% of the total EU GHG emissions, focusing on the CO2 emissions
from heavy industry. Non-CO2 emissions from heavy industry, as well as GHG emissions from
households, agriculture and transport, including aviation, are not included in this scheme. Given the
global significance of GHG emissions from the power- generation sector, reducing emissions from the
European power sectormay therefore bededuced asone of the majoraim of the EU policy.
Figure 7 below shows the emission cap imposed under EU ETS phase II and the projections for the
expected total emissions from 2008 to 2012. The projections are split between the EU 15 and the other
EU countries.
Initial analysis of EU ETS Phase II reveals a net shortfall in the system of around 430 MtCO2 which
can be easily met by using international offsets, however, the actual net demand lies in the
framework of EU ETS phase III, supply of carbon credits from project based mechanism and the
spread between the EUA and CER price. In order to gain a much clearer picture of the net demand,
it is necessaryto understandthe framework of EU ETS phase III.
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Figure 7
3.2.2 EU ETS phase III - Carbon market driving force
On 23 January 2008 the European Commission set out its vision for the future of the EU ETS in an ETS
Review. The Review outlines a set of proposals to revise the framework of the ETS for Phase III, the
most important of which are:
Recommending the ETS cap for Phase III be set at 1,974 MtCO2e in 2013, witha linear decrease
to 1,720 MtCO2e by 2020
If no successor treaty to Kyoto is signed, the use of CERs/ERUs in Phase III will be restricted
to the total unused portion of the limit set for Phase II. This means that the limit set for Phase
II would become absolute, and only those CERs/ERUs not actually surrendered in Phase II
would be available for use in Phase III
If an international agreement is reached and it comes into force by 2013 and the EU agrees
to raise its emissions reduction target against 1990 levels from 20% to 30% then the
Review recommends provision of additional quotas of CERs/ERUs for Phase III
There will be no change to the provision allowing for unlimited banking of EUAs from one
phase of the scheme to the next. This means that any EUA not used in Phase II may be used at
face value in PhaseIII
Above features of phase III will encourages regulated entities to bank as much phase II allowances as
possible.
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3.2.3 Net Demand-Supply under phase II
The ability to bank allowances, known as bankability, from Phase II to Phase III has significant
implications on the pricing of Phase II EUAs. Further, the demand and supply dynamics in a trading
scheme with non-bankable phases is very different from bankable phases. Market expectations of a
tighter cap in Phase III may make Phase II EUAs more valuable to compliance buyers, amid
anticipation of additional scarcity of allowances in Phase III. This would force regulated entities to
utilize their international offset limits which is around 1.4 billion first through CERs and ERUs.
Figure 8
Figure 8 shows a summary of the expected compliance strategies reflecting the net supply of
CERs/ERUs till 2012, excess emission and bankable EUAs under phase II and unutilized limits of
meeting targets from international offsets.
In the above chart, considering a medium case scenario its expected that supply of CER/ERU will be
around 743 million and considering excess emissions in EU ETS it is expected that about 430 million
credits will be used to meet compliances and rest 313 million can be used to bank EUA as it is going to
be costlier than CER/ERU in Phase III, together with that an unused limit of 646 million will be
available in Phase III.
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4. Other Emerging Schemes:
4.1 US Carbon Market
A number of state-based and regional initiatives have emerged in America over the past few years for
implementing emissions trading programs and influencing federal schemes. The future of these
schemes and interest in carbon instruments issued by them will largely depend on their treatment
in upcoming legislation at the Federal level.
USA has many Bills on table that support emissions reduction in one or the other form. Demand for
carbon credits under a US cap-and-trade scheme will likely be subject to some limits on the use of
offsets for compliance, particularly international offsets.
Simulations suggest that international offsets could provide a source of relatively inexpensive credits
that would reduce GHG allowance prices and the compliance costs in a US Federal trading program. In
particular, allowing international project credits (such as CERs and ERUs) for compliance in a US
program could create a significant demand for these instruments if they are competitively priced
relative to the US allowances, the US offsets or both.
4.1.1 RGGI
The Regional Greenhouse Gas Initiative (RGGI) is the first mandatory, market-based effort in the
United States to reduce greenhouse gas emissions. Ten north-eastern and Mid-Atlantic states have
capped and will reduce CO2 emissions from the power sector 10% by 2018. Market activity in the
RGGI gathered steam in 2008 in preparation for the official 2009 start of operations, and interest has
grown significantly during the first half of this year.
Prices of RGGI Allowances (RGGA) is now reported to be around $3.90 per short tCO2e (3 per short
tCO2e) in a market that is likely to be bullish in its starting years. Analysts consider that likelyfungibility of RGGI Allowances into the federal system, along with the possibility of banking to later
RGGI phases, has possibly helped in keeping the price above the $1.86 auction reserve price.
4.1.2 Western Climate Initiative
The WCI covers a group of seven US states (Arizona, California, Montana, New Mexico, Oregon, Utah
and Washington) and four Canadian provinces (British Columbia, Manitoba, Ontario and Quebec),
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with an aggregate emissions target of 15% below 2005 levels by 2020. Other US and Mexican states
and Canadian provinces have joined as observers. Cap and trade would here again be a major
instrument, and transition modalities to a federal cap and trade scheme are now considered under the
W-M draft bill.
4.1.3 American Clean Energy and Security Act (ACES Act), 2009
On 26 June, 2009, the American Clean Energy and Security Act (ACES Act) was passed by the US House
of Representatives by a vote of 219 to 212. The bill contains five distinct titles: I) clean energy, II)
energy efficiency, III) reducing global warming pollution, IV) transitioning to a clean energy economy
and V) agriculture and forestry related offsets. Title I contains provisions related to a federal
renewable electricity and efficiency standard, carbon capture and storage technology, performance
standards for new coal-fuelled power plants, R&D support for electric vehicles, and support for
deployment of smart grid advancement. Title II includes provisions related to building, lighting,
appliance, and vehicle energy efficiency programs. Title IV includes provisions to preserve domestic
competitiveness and support workers, provide assistance to consumers, and support for domestic and
international adaptation initiatives. The following is a brief overview of the proposed GHG cap-and-
trade program contained in Title III and Title V.
The bill establishes emission caps that would reduce aggregate GHG emissions for all covered entities
to 3% below their 2005 levels in 2012, 17% below 2005 levels in 2020, 42% below 2005 levels in
2030, and 83% below 2005 levels in 2050. Commercial production and imports of HFCs would be
addressed under Title VI of the existing Clean Air Act and are covered under a separate cap. The bill
also establishes economy-wide goals for all sources, but it is not limited to those covered under the
cap-and-trade program. These goals are the same percentage reduction and timetables as the cap-
and-trade program, except that the 2020 target is 20% rather than 17% below 2005 levels.
4.1.4 American Power Act, 2010
Senators John Kerry and Joe Lieberman on 12 May, 2010 released the discussion draft of a
comprehensive bill intended to create jobs, enhance national security, spur clean energy innovation,
and protect the environment. The Kerry-Lieberman American Power Act (APA) will allow emitters to
use up to 2 billion offsets - 1.5 billion credits from domestically sourced projects and the rest from
international projects.
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Pledging to engage Senator colleagues, Senators Kerry, Graham, and Lieberman have been working
over the past several months to build consensus within the Senate to pass the legislation, which will
include:
A market-based solution to achieve pollution reduction targets regulated - in the short term in
the range of 17% and in the long term 80%below 2005 levels.
Investments to develop and deploy new clean energy technologies, including nuclear energy,
renewable energy, clean coal, and energy efficiency.
Increased domestic production of oil and natural gas onshore and offshore.
Transitional support for low- and middle-income families to ease costs and for businesses to
ensure compliance and avoid carbon leakage.
A mechanism to moderate the price of carbon to prevent market volatility and vigilant carbonmarket oversight.
Domestic andinternational offsets.
A strong, international agreement with real, measurable, verifiable and enforceable actions by all
nations, long-term financial assistance to developing countries, and enhanced technology cooperation
with intellectual property rights protection.
4.2 Tokyo ETS
Tokyo, in April 2010, introduced the world's first urban cap and trade program for around 1,400 large
installations, such as office buildings (1,100) and factories (400), where per annum consumption of
fuels, heat and electricity is 1,500 kiloliters or more. The scheme has two compliance periods of five
years each starting FY2010. The emission reduction target has been fixed at 6% for five years average
during first compliance period; the target shall increase to 17% reduction below base year emissions
during the second compliance period starting FY2015. Monitoring and reporting of emissions shall be
done annually
Further, all reductions exceeding the yearly obligation may be traded from the second year.
Offsets can be made done in the following ways:
Emission reductions from small and midsize installations within the Tokyo area
Emission reduction by energy-saving measures
Buyer can buy necessary amount without limit
Renewable Energy Certificates
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Solar (heat and light) energy, wind energy, geothermal energy, hydropower energy (under
1000kW), biomass energy (biomass rate 95% or above)
Emission reductions outside the Tokyo area but within Japan
Coverage: large installations with less than 150 thousand ton base year emission Large installations will be assumed to be covered under the Tokyo Cap-and-Trade Program,
and reduction exceeding the reduction obligation would be counted as offset credit
Buyer can only buy up to 1/3 of base year emission Offsets
All violators shall be imposed with a monetary fine of around 500 thousand yen plus they shall
be required to reduce 1.3 times the shortage.
4.3 UK CRC Energy Efficiency Scheme:
In order to achieve their GHG emission targets of at least 80% reduction by 2050 as compared to 1990
baseline, UK has launched a mandatory legal scheme that aims to improve energy efficiency and
reduce the amount of carbon dioxide (CO2 ) emitted. The CRC (Carbon Reduction Commitment)
scheme has begun in April 2010 and will affect large organizations in both the public and private
sector. Around 20,000 organizations that had at least one half hourly meters settled on the half hourly
market in 2008 will be required to participate in some way or the other under the CRC scheme. The
participants will have to monitor their emissions and purchase allowances, initially sold by
Government, for each tonne of CO2 they emit. The more CO2 an organization emits, the more
allowances it has to purchase.
During the introductory phase of three years, allowances will be sold at a fixed rate of 12 per tonne of
CO2. Following the initial sale period, participant organizations can buy or sell allowances by trading
on the secondary market.
Any entity that fails to comply with its legal obligations under the CRC will be subject to different
financial as well as criminal penalties.
4.4 REDD
Efforts to mitigate the dangers of climate change revolve around the overarching goal of holding the
average increase in global temperatures to well below 2C.
The Bali Action Plan, which emerged from COP13 in late 2007, officially put REDD back on the
UNFCCC agenda. But under the Action Plan, if REDD is to be included in the post-2012 framework,
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decisions about the scope of REDD, who will pay for it, and how a mechanism will be structured, yet to
be agreed upon.
Significant progress has been made under the Bali Plan as in the intervening period, a number of
REDD focused workshops have taken place; many countries have submitted proposals and a
negotiating text including various options for REDD, is now on the table. However, substantial work
remains if a coherent REDD mechanism is to be successfully included in the post-2012 agreement.
Over the past year, competing interests have led to a convergence toward a broader scope, referred to
as REDD+. There is little agreement as to which activities REDD+ would actually incorporates and how
it would be structured. A phased approach to REDD is favored by many countries as a way of
providing support to developing nations as they build their capacity to tackle and monitor emissions
from deforestation. The source of financing for REDD is an area where there are a range of different
proposals from governments.
In addition, there are questions raised by some governments as to how much REDD should
incorporate safeguards or benefits for broader forest values, such as biodiversity and livelihoods.
REDD policies must be consistent with national sustainable development objectives that promote
conservation and biodiversity, and protect the rights of local communities and indigenous peoples.
REDD is a vital component of the global emission reductions required. A global objective of zero netdeforestation through a 75% reduction in gross deforestation by 2020 should be adopted. To achieve
this, a reasonable scope for REDD must be established. Care should be taken that any activities
included under the scope of REDD can deliver real and verifiable emissions reductions.
It is vital that the final text of the post-2012 agreement include firm commitments from developed
countries to provide financial and technical support to developing countries, including for the early
phases of REDD. A phased approach should be agreed on by the UNFCCC, which ensures that
developing countries are provided with a support to build their capacity and test approaches to worktowards national REDD programmes. Finally, the post-2012 agreement should recognize the broader
values of forests and processes must be put in place to ensure that the impact of REDD projects on
biodiversity, indigenous peoples, and local communities is positive. It is essential that a robust,
effective REDD mechanism be formally adopted in the post-2012 UNFCCC framework. With
deforestation accounting for approximately 20% of global GHG emissions, it is clear that any solution
to the climate change problem must include a solution to deforestation. Getting REDD on ground
would quantify these emissions and thereby increasing demand of carbon credits.
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5. International Aviation and Shipping Emissions
GHG emissions from international aviation and maritime fuels, known as bunkers, account for nearly
10% of the climate problem and are growing rapidly. The EU has also proposed a specific globalagreement on reducing GHG emissions from aviation and shipping. International shipping emits 870
milliontonnes of CO2 each year which is more thanthe total emissions of UK orCanada.
Emissions have grown by more than 85% since 1990, the base year of the Kyoto Protocol. CO2
emissions from aviation exceed 730 million tonnes annually - up well over 45%since 1990. Additional
climate impacts from other exhaust gases and cloud effects are around double than those of CO2.
Overall, aviation is responsible for 4.9% of global warming today. International aviation emits more
CO2thanthe total emissions of France orAustralia.
In 1997, the Kyoto Protocol gave responsibility for these emissions to developed (Annex I) countries
working through the International Maritime Organization (IMO) and the International Civil Aviation
Organizations (ICAO).
These agencies failed to agree on any binding measures to control GHG emissions in the ensuing 12
years. Both these organizations have submitted proposals for only modest efficiency and operational
measures that too mostly voluntary orpartial in scope at COP15, Copenhagen
If left unmitigated, emissions from aviation and shipping are further expected to double or even triple
by 2050, forming by then a very significant proportion of a global carbon budget consistent with
keeping warming below 2 C.
UNFCCC could take the necessary action for controlling emissions from these sectors in two ways:
By including emissions in national totals of Annex I Parties, purely as an accounting measure.
This would be straightforward for aviation, where bunker fuel emissions are a good indicator
of activity.
By setting targets for the two sectors, and mandating IMO and ICAO to develop and agree on
global sectoral policies within a limited timeframe and subject to UNFCCC review.
Discussions in IMO and ICAO are currently deadlocked over whether policies should be global or
differentiated, voluntary or mandatory. Various ways to include emissions from international aviation
and shipping in the global climate framework that could raise substantial revenue for the adaptation
and the low-carbon development have been proposed, but not agreed.
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NGOs believe that the international transport policies should be mandatory and global since, the
sectors are inherently global in nature. IMO and ICAO have developed many global policies in other
areas that are neutral with respect to the nationality of the operator. Besides, global approaches are
themost environmentally robust and are instrumental in avoiding leakage.
Operators of all nationalities are treated equally in these proposals, to avoid competitive distortions
and in line with IMO and ICAO principles. Differentiation is applied in the use of revenues, thus
respecting the principle of Common but Differentiated Responsibilities (CBDR) which says that
revenues raised by global policies (levied mostly on well off consumers) should be spent on climate
protection in developingcountries.
Such policies could raise about $10 billion giving a real boost to efforts to finance a comprehensive
climate mitigation deal. As an effect of inclusion of shipping and aviation sectors in international
emissions demand of credits will raise considerably as national governments may ask airline and
shipping companies to compute their carbon foot printing and offset it against quality credits like
CER/ERU.
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6. Post-2012 Market Frameworks
Events like failed negotiations under the United Nations Framework Convention on Climate Change
(UNFCCC) at Copenhagen in December 2009 on binding emissions commitments, signing ofCopenhagen Accord with no legal binding emission targets, uncertainty in passing and
implementation of long awaited US climate bill and stringent targets under phase III of EUETS has
divided the future of carbon market mechanism into different scenarios. This report analyses these
scenarios in the perspective of how they will affect the project basedmechanisms.
6.1 Only EU ETS scenario
The European Commission has signaled, via its post-2012 proposal for the EU ETS, that additional
demand for CDM and JI credits will be contingent on a successor treaty to the Kyoto Protocol being
implemented. Under the European Commissions proposal, if there is no new international agreement,
the present limit on importing international units for compliance purposes within Phase II of the EU
ETS would be extended into the next compliance phase effectively placing a limit on imports equal to
the unused portion of the limit in Phase II.
This means that the volume of CERs and ERUs from CDM and JI projects which could be used across
Phases II and III would be capped at 1390 MtCO2e, the present Phase II limit.
With reference to Figure 8, its expected that supply of CER/ERU will be around 743 million.
Considering excess emissions in EU ETS, about 430 million credits will be used to meet compliances
and rest 313 million can be used to bank Phase II EUA, as full banking is allowed by EU commission
and EUA will be costlier than CER/ERU in Phase III, an unused limit of 646 million will be available in
Phase III.
6.2 Extension of Kyoto with EUETS but without US Scenario
If a new international agreement to succeed Kyoto Protocol comes into force, assuming that targets
taken under Copenhagen accord except EU remain same, then the EU ETS Phase III will have much
tougher emissions targets of 30% as compared to the current 20% imposed on regulated entities, and
a higher limit on importing international units. This will continue to drive the substantial activity in
the project-based mechanisms.
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Figure 9
6.3 Copenhagen accord scenario
The Copenhagen Accord, a political agreement struck by world leaders at COP 15,Copenhagen, calls on
participating countries to pledge specific actions that they will individually and conditionally
undertake to mitigate GHG emissions. This is for the first time ever that the entire worlds major
economies (US, Japan, Australia, etc.) have offered explicit international climate pledges.
Figure 10 Source: Bloomberg
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In case of Annex I countries, the nonbinding Accord calls for a quantified economy-wide emission
targets for 2020. In case of non-Annex I countries, it calls for nationally appropriate mitigation
actions, but does not specify what form they should take. (Least developed and small island countries
may undertake actions voluntarily and on the basis of support)
On 26 April, 2010, 96 parties (considering the 27 member states of the European Union as a single
party) had filed submissions with the U.N. climate change secretariat:
16 Annex I countries submitted 2020 emissions targets ;
36 non-Annex I countries submitted mitigation actions; and
44 other non-Annex I countries associated with the accord.
With current pledges, post 2012 demand from project based mechanism could be 6754 Mt
(Figure 10) which is twice that in the Kyoto Protocol period with major demand coming from
the EU and the US.
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7. Price Forecast
The price difference between EU
the Project based emission redAllowances (EUAs) the main reas
cost of carry associated with
Historically, CERs have been aver
Carbon emissions being directly
factors as the price drivers of Car
1. Crude Oil
2. Natural Gas
3. Power Prices
4. Demand & Supply of credi
5. Temperatures & Water le
6. Economic activity (GDP,
Confidence Indicator)
7. Euro-Dollar spread
It 'Pays' tobeEnvironment Friendly
s and CERs is called the EUA/CER Spread. I
uction units (CERs) are priced lower thanons being, CERs are considered as a supplem
UA. Thus CER prices are primarily, deri
gely priced at 80% of that of EUAs.
Figure 11
inked to the activities of a nation, we have i
on Credits.
ts
el
Productivity Index, Economic Sentiment
is generally seen that
the European Unionnt to the EUAs and the
ed from EUA prices.
dentified the following
Indicators, Industrial
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The impacts of above different f
theory behind the inclusion of fa
factors on carbon prices using
Regression Analysis to predict th
After performing the detailed
Hetroscadicity and Multicolineari
ones- Crude Oil, Power Prices and
An analysis of potential develo
evolution of the carbon market a
alternate post-2012 scenarios m
in post-2012. The factors driving
post-2012 been taken before 20
be fully on ground before 2013.
Figure 12 shows the projection o
Carbon Market is expected to be
the end of first commitment pe
commodities and thus provides a
It 'Pays' tobeEnvironment Friendly
ctors on Carbon prices are varied dependi
tor. This created a necessity for quantificatio
n appropriate quantification tool. We have
e carbon prices and determine the probability
ultiple Regression Analysis and adjusting
y, the factors have been further filtered out t
Gross Domestic Product.
ments post-2012 is important in underst
d likely price of carbon. However, according
ntioned in the report would affect the CER p
re-2013 prices remain more or less unaffect
3 because the implementation of the alterna
Figure 12
EUA and CER prices based on the Multi Line
bullish in near future and price are most lik
iod in 2012. Carbon credits as of now see
d ideal investment opportunity.
g on the fundamental
n of the effect of these
used Multiple Linear
of prediction.
for data errors like
three most influential
nding the longer run
to our research, all the
rices and demand only
d with any decision on
e scenarios would not
r Regression Analysis.
ly touch new highs by
s to be undervalued
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Annexure 1: Methodology
Accurately recording project-based transactions is becoming more difficult even for agencies such as
the World Bank as each year complexity of market and factors involved is increasing dramatically. Theauthor has analyzed the collected information from major carbon-industry publications and the
coverage of a wide range of market players to gain a broader view on trends of the market.
Author has focused on the regulatory compliance based markets (Kyoto Protocol & EU ETS);
therefore, the coverage of the voluntary segment of the market is not exhaustive. Only projects with
issued CERs are considered in the report database. Although the analysis of key inputs from IMF,
World Bank, UNEP Risoe and UNFCCC publications was done. Various statistical tools have been used
for projecting the future data. The accuracy of data exceeds 90% (confidence level) in most cases.
Since most of the data is from secondary sources, author do not hold responsibility of its correctness,
however these sources are considered to be most trusted across the globe, and hence we have
mentioned a tolerance range of (+/-) 10%. The author considers that the analysis in this report
provides a conservative estimate of the carbon market and provides a good representative view of the
carbon market.
Prices have been expressed in US Dollar ($) or Euro () or Sterling Pound () per tCO2e. All facts
presented in the report have been deduced after comprehensive processing of the data. This data was
collected from various sources and an optimum mix of all has been used; thus, individual data source
is not mentioned with every graph and table. Due courtesy has been given where ever the author has
used opinion/projections of other market players.
CDM supply data is based on facts and figures as per UNFCCC. Projects registered till March 2010 were
taken into consideration for YoY supply estimation.
Data of project-based markets, carbon credits, daily price and volume information on allowancesmarkets is available online. The readers are invited to do their own comprehensive due diligence of
the market prior to taking any financial position, and in this regard nothing in this report should be
seen as constituting advice to take a position on the market as a whole, or any component there-of.
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Annexure 2: Glossary
Assigned Amount Unit (AAU):Annex I Parties
are issued AAUs up to the level of their
assigned amount, corresponding to the
quantity of greenhouse gases they can release
in accordance with the Kyoto Protocol (Art. 3),
during the first commitment period of that
protocol (2008-12). AAUs equal one tCO2e.
Carbon Dioxide Equivalent (CO2e): The
universal unit of measurement used to indicate
the global warming potential of each of the six
greenhouse gases. Carbon dioxide a
naturally occurring gas that is a byproduct of
burning fossil fuels and biomass, land-use
changes, and other industrial processes is
the reference gas against which the other
greenhouse gases are measured.
Certified Emission Reductions (CERs): A unit
of greenhouse gas emission reductions issued
pursuant to the Clean Development Mechanism
of the Kyoto Protocol, and measured in metric
tonnes of carbon dioxide equivalent. One CER
represents a reduction of greenhouse gas
emissions of one tCO2e.
Emission Reductions (ERs): The measurable
reduction of release of greenhouse gases into
the atmosphere from a specified activity or
over a specified area, and a specified period of
time.
Emission Reduction Units (ERUs): A unit of
emission reductions issued pursuant to Joint
Implementation. This unit is equal to one
metric ton of carbon dioxide equivalent.
European Union Allowances (EUAs): the
allowances in use under the EU ETS. An EUA
unit is equal to one metric ton of carbon
dioxide equivalent.
Greenhouse gases (GHGs): These are the
gases released by human activity that are
responsible for climate change and global
warming. The six gases listed in Annex A of the
Kyoto Protocol are carbon dioxide (CO2),
methane (CH4), and nitrous oxide (N20), as
well as hydrofluorocarbons (HFC-23),
perfluorocarbons (PFCs), and sulfur
hexafluoride (SF6).
Land Use, Land-Use Change and Forestry
(LULUCF): A greenhouse gas inventory sector
that covers emissions and removal of
greenhouse gases resulting from direct human-
induced land use, land-use change and forestry
activities. Expanding forests reduce
atmospheric carbon dioxide; deforestation
releases additional carbon dioxide; various
agricultural activities may add to atmospheric
levels of methane and nitrous oxide.
National Allocation Plans (NAPs): The
documents, established by each Member State
and reviewed by the European Commission,
that specify the list of installations under the
EU ETS and their absolute emissions caps, the
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amount of CERs and ERUs that may be used by
these installations as well as other features
such as the size of the new entrants reserve
and the treatment of exiting installations or theprocess of allocation (free allocation or
auctioning).
Offsets: Offsets designate the emission
reductions from project-based activities that
can be used to meet compliance or corporate
citizenship objectives vis-- vis greenhouse
gas mitigation.
Project-Based Emission Reductions:
Emission reductions that occur from projects
pursuant to JI or CDM (as opposed to
emissions trading or transfer of assigned
amount units under Article 17 of the Kyoto
Protocol).
Reducing Emissions from Deforestation and
Forest Degradation (REDD): A set of
strategies and incentives (including
performance-based) for reducing emissions
from deforestation and degradation.
Regional Greenhouse Gas Initiative (RGGI):
RGGI targets CO2 emissions from power sector
in ten U.S. Northeast and Mid-Atlantic states,
with a target of 10% below current levels by
2020.
Registration: The formal acceptance by the
CDM Executive Board of a validated project as
a CDM project activity.
United Nations Framework Convention on
Climate Change (UNFCCC): The international
legal framework adopted in June 1992 at the
Rio Earth Summit to address climate change. It
commits the Parties to the UNFCCC to stabilize
human induced greenhouse gas emissions at
levels that would prevent dangerous manmade
interference with the climate system.
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Bibliography
UNFCCC
IMF
EU Commission
Carbon Market Data
World Bank Reports
Carbon Yatra
European Climate Exchange, London
Bluenext Exchange, Paris
Bloomberg New Energy Finance
WWF
Merrill Lynch
Goldman Sachs
Morgan Stanley Deutsche Bank
International Monetary Fund
European climate Exchange
BNP Paribas