Opportunities and risks in carbon markets final

17th February 2011

Opportunities and Risks in Global Carbon Markets

About Markit

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About Markit

Markit is a leading global financial information services company with over 2,000 employees

We provide independent data, valuations and trade processing across all asset classes in order to enhance transparency, reduce risk and improve operational efficiency

Our client base includes the most significant institutional participants in the financial marketplace

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Company growth

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Markit – product and value proposition

By institution type By asset class

Alternative investment

Asset management

Banks

Consulting and advisory

Corporates

Fund administration

Commodities

Credit

Equities

Foreign exchange

Rates

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Markit accolades

Present Situation

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International Carbon Markets

Developed country commitments– Kyoto signatories to measure and reduce domestic emissions

Existing compliance markets– EU ETS to include CDM (CERs), Joint Implementation (ERUs) and

Allowances (EUAs)– Clean Development Mechanism (links to both EU ETS and international

Kyoto signatories)– New Zealand with NZUs– RGGI in the USA– New South Wales in Australia

Existing voluntary markets– International, independent standards providing robust emission reductions– International activity from corporations and institutions

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International Carbon Markets

MarketsVolume (MtCO2e) Value (US$ million)

2006 2007 2008 2009 2006 2007 2008 2009

Voluntary OTC market 14.3 43.1 54.0 51.0 58.5 262.9 420.0 326.0

CCX 10.3 22.9 69.2 41.0 38.8 72.4 306.7 50.0

Other Exchanges - 0.0 0.2 2.0 - 0.0 2.0 12.0

Total Voluntary 24.6 66.0 123.4 94.0 97.3 335.3 728.7 388.0

EU ETS 1,104.0 2,061.0 3,093.0 6,326.0 24,436.0 50,097.0 100,526.0 118,474.0

Primary CDM 537.0 551.0 404.0 211.0 5,804.0 7,426.0 6,511.0 2,678.0

Secondary CDM 25.0 240.0 1,072.0 1,055.0 445.0 5,451.0 26,277.0 17,543.0

Joint Implementation 16.0 41.0 25.0 26.0 141.0 499.0 367.0 354.0

Kyoto [AAU] - 0.0 23.0 155.0 - 0.0 276.0 2,003.0

New South Wales 20.0 25.0 31.0 34.0 225.0 224.0 183.0 117.0

RGGI - - 62.0 813.0 - - 241.0 2,667.0

Alberta's SGER - 1.5 3.3 5.0 - 13.7 34.0 61.0

Total Regulated 1,702.0 2,919.5 4,713.3 8,625.0 31,051.0 63,710.7 134,415.0 143,897.0

Total Global Market 1,726 2,985 4,836 8,719 31,148 64,046 135,143 144,285

Volume & Value of Carbon Trades 2006 - 2009

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Outcomes from Cancún – Avoiding Deforestation (REDD+)

Agreement on all three proposed phases of Reduced Emissions from Degradation and Deforestation (REDD+):

– REDD+ readiness– REDD+ implementation– Results-based payment-for-performance (phase 3). 

Includes a global goal for reducing emissions from deforestation, and allows for interim state-level REDD+ programs that have clear paths toward becoming national-level

Sustainable and large scale carbon markets financing to be explored before Durban (COP 17)

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Outcomes from Cancún – Avoiding Deforestation (REDD+)

Technical advisory group to the Convention has an action to decide on the monitoring, methods and safeguards needed to implement REDD+ in the next two years

REDD+ decision incorporates social and environmental safeguards including  transparency measures for protection for indigenous peoples. Critically important as they are best-suited to monitor and protect their land from deforestation.

Financing for REDD+ activities tied to these environmental and social safeguards.

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Outcomes from Cancún – Climate Finance

Establishment of a Green Climate Fund (GCF) to disburse funds devoted to climate mitigation and adaptation activities

– Priority demand of developing countries– Governed by a board of 24 members, with equal representation from

developed and developing countries– World Bank is interim trustee for the next three years and will manage

and deliver the funds under direction from the Board with clear administration and accounting guidelines

– Committed to $100 billion investment per annum by 2020

Reaffirmation of Copenhagen Accord commitment to deliver on ‘fast-start finance’ within three years

– Improved reporting; balanced focus on key themes, e.g. adaptation, mitigation and capacity building; priority to the most vulnerable nations

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Outcomes from Cancún – Climate Finance

Designation of a Standing Committee for the GCF to activate resources for long-term financing

– Discussion postponed to Durban or beyond, but must address: Ways to reach the targeted $100 billion per year climate funding by 2020, Inclusion and role of well-designed and transparent market mechanisms.  Role of governments in providing initial financing, that leads to scalable and

sustainable sources of finance via the private sector, as a response to government incentives

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Outcomes from Cancún – Monitoring, Reporting and Verification (MRV)

Essentially agreement on transparency and accountability– Directly connected to developed and developing countries’ mitigation

actions and for the financing of developing country actions– Compromise between the US and China was a significant facilitating

step

Commitments– Developed countries will enhance reporting of their mitigation actions

and will also improve reporting of financial, technological and capacity-building support to developing countries

– Developing countries will improve their reporting on emissions and actions

Links to the continuing development of Nationally Appropriate Mitigating Actions (NAMAs) which developing countries are committed to defining and implementing

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Outcomes from Cancún – Future of the Kyoto Protocol

Developed country parties to the Kyoto Protocol embraced a goal to reduce emissions by 25-40% below 1990 levels by 2020

– Without agreeing to a second round of emission reduction commitments after 2012

Japan and Russia announced they will not sign up for post-2012 obligations without the United States and major emerging economies taking on obligations too

Discussions deferred to continue prior to Durban– Goal of avoiding a gap between the first and second commitment periods– Decision on length of the second commitment period were also postponed

until Durban

Questioning of whether the CDM can continue without an agreed successor to the Kyoto Protocol

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Outcomes from Cancún – Key targets

No formalisation of the Copenhagen Accord’s pledges to set binding targets for emissions reduction either:

– through the second commitment period post Kyoto– through until 2050

Agreement on the need to take urgent action to meet goal of holding temperature increases below 2 degrees Celsius

– also agreed to a review and possible strengthening of the goal to 1.5 degrees Celsius, a key priority of small island states

Agreement on the need for ‘peaking emissions’– work in 2011 towards identifying a timeframe for when emissions at a

global level should reach their peak and begin declining

Opportunities

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Opportunities – REDD

Deforestation accounts for approximately 20% of global emissions (World Bank research)

Most densely forested countries are predominately developing– Central belt of sub tropical rainforest especially relevant– Presently a source of income– Pressures for alternative land use – agriculture, cattle, fuel, urbanisation...

Facilitating countries to extract the inherent value of native resources in a sustainable manner

– Developed countries invest in developing countries with native forest– Carbon assets generate income– Incentivises positive engagement with local communities delivering socio -

economic benefits

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Opportunities – REDD

Roles for all types of participation– International framework – led by the UNFCCC

Global agreement on action Drives commitment to funding Underpins cross border eligibility of carbon assets

– National schemes Establish forestry baselines Ensure ongoing MRV Ensure appropriate allocation of funds

– Sub-national schemes – state or regional level Ensure local engagement and governance Stimulates bottom up action

– Private sector – institutional investors and corporations Essentially for long-term funding, innovation and market stimulation Stimulates bottom up action

– Bilateral agreements between sovereignties Norway has committed $1billion to both Indonesia and Guyana

– Combining compliance and voluntary market mechanisms

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Opportunities – Technology

Renewable energy– Wind continuing to be rolled out with incremental increases in efficiency– Solar potentially most scalable, combining micro and large scale

generation – price parity is vital to it’s long term success– Hydropower – significant potential for small scale generation– Wave technology – remains very early stage

Energy efficiency initiatives– At point of power generation, e.g. fuel switching, carbon scrubbing

RWE targeting to reduce from 0.8 tCO2e per MW hour in 2009 to 0.45 tCO2e per MW hour in 2020

– At point of utilisation of power Monitoring, managing and reducing consumption – electricity, fuel, gas LED technology

– Adopted by governments, municipalities, companies and individuals

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Opportunities – Technology

Smart grid– Investment in transmission, distribution and metering systems in Europe

could reach $187 billion through the next 30 years (Goldman Sachs)– Opens up opportunities to import electricity from further– Storage of electricity is an important development

Future energy mix – renewables, coal, gas, biomass, nuclear– Europe is reaching a critical period in selecting how it will deliver short

and mid term power– Developing countries take decisions largely on cost, however additional

revenue streams offered by carbon markets counter this to a degree

Carbon Capture and Sequestration (CCS)– Key technological development to underpin continued use of coal as a

primary power source

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Opportunities – Technology

Waste management– Conversion to biofuels or power generation– Recycling of materials

Agricultural technology, as a means to:– Reduce emissions and provide additional revenue streams– Increase productivity– Reduce continuing trends in land use changes e.g. deforestation

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Opportunities – Finance

Government funding– Contribution to international funds e.g. GCF– Bilateral agreements with countries for specific actions e.g. Norway, Japan– International development banks

Institutional investment– Investment banks– Asset managers, Pension funds, Sovereign wealth funds– Hedge funds– High net worth individuals and family offices– Venture capital, Private equity– Corporate treasury

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Opportunities – Finance

International development agencies– World Bank and IFC– Inter American Development Bank (IADB)– Asian Development Bank (ADB)– KfW– Brazilian Development Bank (BNDES)... etc.

Combination of public and private investment to support international funds

– GCF needs to stimulate private investment as $100 billion per annum from governments will be spread very thinly

Loans and structured debt– Funding contingent on inclusion of environmental considerations– Repayment via carbon credits, feed in tariffs or other sustainable assets

and revenues

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Opportunities – Finance

Trading Activity– Emission reduction credits (CERs, ERUs, NZUs, VERs etc.)– Allowances (AAUs, EUAs etc.)– Futures and options (OTC and exchange)– Swaps– Other structured instruments, largely OTC

Green bonds, with underlying assets to include:– government backed via green or climate banks– municipal based on energy efficiency gains– forestry– project activity under recognised mechanisms

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Opportunities – Corporate Action

Companies can act immediately to embed and invest in sustainability:

– pre-compliance– consideration of the bottom line; e.g. energy efficiency saves money– creating new revenue opportunities– differentiation from competitors

Consumer engagement– branding– products and services– including carbon as a key business practice

Opportunity for all types and sizes of organisation– Utilities, petroleum, mining and industrial– Pharmaceuticals, consumer goods and food & beverage– Transport and aviation

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Opportunities – Emerging Markets

Significant schemes developing across the globe

Carbon market mechanisms at various levels– California (independently and as part of the Western Climate Initiative)– Australia (National Carbon Offset Scheme & Carbon Farming Initiative)– South Korea– Brazil– Governors’ Climate and Forestry Taskforce (3 US states, 5 Indonesian

states, 5 Brazilian States, 1 Nigerian state) - REDD focused

Specific national actions– Bilateral agreements – Japan and Norway

All will require a blend of technologies and financing

Potential to combine a top down, with a bottom up approach to progress towards an international carbon market

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Risks

Time– To implement the political decision making processes and underpin

global action– Left before the detrimental environmental impacts are profoundly worse

Political uncertainty– Overall Kyoto framework– Structure and role of the CDM post 2012 and in relation to emerging

regional frameworks– Green Climate Fund (GCF)

where will the investment arrive from how will funds be distributed

– Ascension of REDD+ into regional and international market mechanisms– Actions of nations, particularly China, US and countries with large forest

coverage e.g. Brazil

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Risks

Technology Risks– Ability of renewable energy to scale sufficiently– Ability of renewable energy to reach price parity with fossil fuels and role

of subsidies in the interim– Will CCS deliver and in time to make a difference?– What will be the chosen role of nuclear?– How will fuel sources such as biomass evolve alongside food and water

issues?

Private sector– Risk appetite for institutional and other investors to participate– Ability for markets to form transparently and in a robust manner– Influence of continuing increase in oil and other conventional fuel prices– Role of and engagement by international corporations– Engagement with consumers – how to do this effectively?

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Risks

Socio-Economic– Ensuring indigenous peoples have their rights protected as intended

under the broad agreements reached– If investment is not forthcoming do less developed countries have the

mechanism to mitigate and adapt for climate change?– Inefficiencies caused by emerging market challenges of balancing growth

and climate impact

Carbon market governance– Significant challenges faced by the EU ETS– Inconsistency in application of rules and regulations– Stimulating increased participation on a global level– Effectively managing rapidly evolving mechanisms– Linking the bottom up development of regional schemes with the top

down global political approach

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Risks

Confidence– in the objectives of mitigating climate change– in the carbon markets

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Thank you! Questions?

Hassen Bali

Vice President – Environmental Markets

Markit

[email protected]

www.markit.com

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Disclaimer

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