the carbon market, a view from the trenches
DESCRIPTION
Presentation from TBLI CONFERENCE EUROPE 2008.TRANSCRIPT
The Carbon Market A view from the trenches
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Merchant & Private Banking | Global Markets |19/12/08 |
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Content
– The Carbon Market
– Cross Commodity Issues
– EUA vs. CER
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Why do we need greenhouse gas reduction?
The latest IPCC report is calling for a reduction of Greenhouse gases compared to 2000 by 24-40% till 2020 and 80-95% till 2050
Comment
Reduction goal of the Kyoto Protocol (-5.2% compared to 1990) seems not sufficient
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The Kyoto Protocol
The Kyoto protocol is the fundamental international agreement governing the global carbon market.
The European Union has established the EU ETS in response to its member states’ Kyoto obligations and to help its industry to prepare for the challenges and opportunities presented by global response to climate change.
Developing countries such as China & Brazil are not bound to reduce emissions by the Kyoto protocol but can use the Clean Development Mechanism (CDM) to reduce GHG emissions thus creating valuable carbon assets known as CERs (Certified Emission Reductions).
Comment
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JPN/CAN/NZ
Private sector
Forwarding compliance
EU ETS
How it works, in theory
Governments
Gov. AAU sales
Gov. procurementprogrammes
= Supply
= Demand
CDM/JI
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EU-ETS Market participant behaviour, Phase Two
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25
30
Jan05
Apr05
Jul05
Oct05
Jan06
Apr06
Jul06
Oct06
Jan07
Apr07
Jul07
Oct07
Jan08
Apr08
Jul08
dec07 dec08
price [EUR/tonCO2]
Phase Two follows Phase One
Phase Two detachement from Phase One on tighter allocations
utilities covering forward positions
oil market collapsing
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Content
– The Carbon Market
– Cross Commodity Issues
– EUA vs. CER
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All variants on the same theme:Cross Commodity relationship between
gas, coal, power and CO2 prices
Cross Commodity & CO2
Clean/Dirty Spark Spread
Clean/Dirty Dark Spread
Marginal Power Cost
Merit Order Optimisation
Switch Levels
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gas pricecomp
.
EUAcomp
.
coal pricecomp.
EUAcomp
.
EUA “switch level”EUAs high preference for gas
gas pricecomp
.
EUAcomp
.
coal pricecomp.
EUAcomp
.
pow
er p
rice
gas pricecomp
.
EUAcomp
.
coal pricecomp.
EUAcomp
.
EUAs low preference for coal
The theory of saving carbon in Europe
Clean Spread=Price power−Price coal/gas
η powerplant− Price EUA×Emission Factor coal/gas
η powerplant
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Content
– The Carbon Market
– Cross Commodity Issues
– EUA vs. CER
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EUA vs CER
Different ‘currencies’: in Europe, the EUAs (European Union Allowance) is the official currency of EU ETS.
CERs (Certified Emission Reductions) generated by developing countries are the carbon market’s international currency and can be used by any Annex-I countries to comply with their emission reduction obligation.
One EUA, in the same way as one CER represents the right to emit one tonne of carbon dioxide equivalent.
Two main differences:
• The EU ETS (European Trading Scheme) only covers carbon dioxide emissions while the CDM covers all Kyoto GHG emissions (see diagram left)
• The EU ETS has only one aggregate market while CDM is divided into a primary and a secondary markets where CERs have different pricing levels
EU ETS
CDM(e.g. China)
CERs
The table above summarizes the Global Warming Potential (GWP) of different GHGs (GreenHouse Gas) defined by the Kyoto protocol. CO2 is the weakest GHG. Instead, reducing one tonne of CH4 will lead to an equivalent reduction of 21 tonnes of CO2, thus generating potentially 21 tonnes of CERs.
23900SF6
6500-9200PFCs
150-11700HFCs
310N2O
21CH4 (methane)
1CO2
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Today’s Carbon Markets: CER/ERUs versus EUAs
(1)import limit and (2) ITL-CITL link
YESUse in EU-ETS Phase Two
primary, secondary (only CERs),different prices
one market, EU-ETSMarket
right to emit 1ton CO2eq.right to emit 1ton CO2Value
globalEU-ETSValidity
EUAs CERs/ERUs
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EUA vs CER
CERs or ERUs, the Kyoto credits linked to CDM and JI projects, also cover one ton of CO2 and are valid in the EU-ETS. For compliance purposes, an installation can use EUAs, CERs and/or ERUs.
Under Phase II of the EU ETS (2008-2012) the Governments have set a limit (%) on the use of project credits (CERs) at an installation level. This limit is based upon allocation not amount emitted.
There currently exists a price differential between EUAs and CERs, which is decreasing heavily at the moment. It is possible to take advantage of this discount, extracting additional value from your ‘free’ allocation without impacting your compliance obligations.
Why a Price Spread between EUA and CER ?
ITL-CITL link date. Non transparency of the CDM market, post-2012 uncertainty CERs are deemed to be higher risk Carbon Instruments. Cap on amount of CERs that can be used for compliance in the EU ETS of
about 13.4% of total allocations Other trading schemes may impose strict caps on CER imports in favour of
domestic reductions Reputational differences : internal abatement <> external emission
reductions
EUA price [EUR/tonCO2]
15 €17 €19 €21 €23 €25 €27 €29 €
Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08
EUA Dec08 CER Dec08
0 €1 €2 €3 €4 €5 €6 €7 €8 €9 €
10 €
Mar-08 Apr-08 May-08 J un-08 J ul-08 Aug-08
EUA CER Spread Dec08
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Volume Developments CERs
Total liquidity seems to have increased until July and started again to decrease in August.
The steep increase in liquidity was mainly due to the introduction of a CER contract on the ECX
A lot of brokered trades were afterwards cleared on the ECX. Real screen trades (green and red) are a lot less!
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J un-07 Sep-07 Dec-07 Mar-08 J un-08
Millio
ns
Total Daily volumes CERs
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J un-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 J un-08 Aug-08
Millions
ECX ICEFutures Screen
ECX ICEFutures Cleared
NordpoolForwards Screen
NordpoolForwards Cleared
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CDM market’s current status
China is expected to be the world’s largest pool of potential CDM projects.
A 50% market share for China in the CER market will mean generating over 1.5 billion tonnes of credits, saving 1.5 billion tonnes of CO2 equivalent emissions in China.
In addition, Fortis Intertrust has acted as custodian and escrow agent for the world’s biggest emission-reduction purchase deal to date, a USD 1 billion deal that will help two Chinese chemical companies reduce emissions.
Compared to China, India and Brazil are ‘matured markets’ for CDM with many more projects in all stages currently. However the average CER purchase price in these two countries also tends to be higher.
Currently, China is rated as A-, Brazil as BBB, India as A- by PointCarbon.
122
45
44
9
368
110
44
28
89
40
5
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1103
364
128
239
0% 20% 40% 60% 80% 100%
World
India
Brazil
China
CER issued CDM registered before issuance
LoA obtained before registration PDD written before LoA
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Nature of carbon finance for a typical CDM project
Capital Markets(Financial Institutions, Private Equity,
Hedge Funds...)
Equity and/or Debt
Ownership + Dividend and/or Principle +
Interest
Power Purchase
Agreement
Cash
Main product: Electricity
Global Carbon Market
By-product: CERs
Cash
CERs
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Structured Financing-Hedging transaction proposal: CER interest payment
FortisEnvironmental Markets
Fortis CIB
CDM project
Mezzanine Financing
Principle
Interest payment in CERs
+
the rest of ERPA CER purchase
Global Carbon Market
Cash
CERs Cash
Interest payment in cash
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CDM project’s risk assessment
Fortis Bank Environmental Markets has undertaken significant research in the field of CDM project risk assessment.
A thorough understanding and assessment of the CDM project’s delivery risk will enable us to maximize our investment return by constructing a diverse CERs portfolio in terms of technology, stage, size and geography.
Fortis Environmental Markets’ desk has developed a highly objective and auto-improving Delivery Risk Model to screen most CDM projects.
CountryRisk
OperationalRisk
CounterpartyRisk
TechnologicalRisk
DeliveryRisk
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Conclusion
Emissions trading works!
market is sufficiently liquid and rapidly growing
prices follow semi-logical trends based on fundamentals
emissions are reducedfuel switch in power sector, CO2 value taken into account in other sectors
Scheme considerably expanded in 2008
The US will be (partly) capped from 2010 and China and India have agreed to talk targets
The EU has taken a reduction cap of 20% by 2020, to be increased to 30% in case of a global carbon agreement
To date, many of the world’s premier institutional investors have invested in CDM projects. This
strong interest is mainly due to CDM projects’ unique return profile and superior diversification benefits due to its total lack of correlation with traditional securities market. Over time carbon finance, given enough investment certainty, will decrease the cost of delivering environmental results to the most efficient global abatement cost curve.
