Carbon 2007 -- A New Climate for Carbon Trading

8/14/2019 Carbon 2007 -- A New Climate for Carbon Trading

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All rights reserved 2007 Point Carbon

Carbon 2007A new climate for carbon trading

TO THE POINT

This report was published at Point Carbons 4th annual conerence, Carbon Market Insights 2007 in

Copenhagen 13 - 15 March 2007. For more inormation, see www.pointcarbon.com

13 March 2007

Global carbon markets were worth 22.5 billion in 2006.The market saw transactions or 1.6 billion

tonnes o CO2e. The EU ETS accounted or 62 per cent o the volume and over 80 per cent o

the value.

EU ETS saw 1 billion tonnes of CO2 transacted, worth 18.1 bn. This was 2.5 times higher than in2005. The OTC and exchanges dominated by 817 Mt and 14.6 billion.

Developing countries continue to deliver reductions. The CDM saw transactions or 523 Mt CO2e

in 2006, with a secondary market adding 40 Mt and a combined value o 3.9 billion.

Our reference scenario expects volumes in the carbon market to grow by 50% in 2007.We expect more

than 2.4 billion tonnes CO2e to transact over the year. Using current prices as a benchmark,

the extra volume marginally increases the total value to 23.6 billion.

65% of survey respondents say EU ETS have initiated internal abatement projects. This is a markedchange rom last years survey, where only 15% said the introduction o carbon trading had

initiated abatement.

EU ETS is main compliance strategy for 37% of survey respondents. Internal abatement andinvestment/trading o CDM/JI credits (both about 25%) are seen as the second most important

strategies. Relocation o production is only mentioned by a handul o respondents.

More condence in CDM/JI than one year ago. The CDM/JI market is a success, at least comparedto the 2006 survey. The project market is seen as more mature (although not a mature market),

and is resulting in cost-eective emission reductions.

Close to complete pass-through of carbon into power prices. The impact o the CO2 price has beenone o almost complete pass-through in the UK and German power markets, despite a slow

response to the introduction to the scheme or continental power prices. The impact on the

Nordic power market is primarily through the interconnection with Germany.

Import of credits from CDM/JI will not be enough to meet shortfall in EU ETS. Survey respondentsexpect levels o abatement in the EU ETS to higher in Phase II than in Phase I. Although the

system opens or substantial imports o credits rom CDM/JI, 82% o respondents nd that

this will not be enough to meet the shortall in Europe.

Survey nds 17/t for EUA price in 2010, 23/t in 2020. Survey respondents do not expect import ocredits to be enough to avoid domestic reductions in the EU ETS. Thus, the price o carbon

should refect uel-switching prices rather than the price o CDM/JI credits.

71% of respondents expect a global climate agreement post-2012, with a 60% likelihood that USA and

Australia will join. Only 9% o respondents do not expect a global agreement. China (36%) isseen as a more likely candidate than India (30%) in such an agreement.


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Carbon 2007

All rights reserved 2007 Point Carbonii

Carbon 2007

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

For citations, please reer to: Point Carbon (2007): Carbon 2007 - A new climate or carbon trading

Rine, K. and H. Hasselknippe (eds.) 62 pages.

About Point Carbon

Providing 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 services provide

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 CO2emissions market dynamics positions us as

the number one supplier o unrivalled market intelligence o 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 that 15,000 clients, including the worlds major energy companies,

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

rom English into Japanese, Mandarin, Portuguese, Polish, French, Spanish and Russian.

This year Point Carbons Carbon Market Insights (CMI07) will gather over 1,500 key players or the

carbon communitys most important annual conerence. Point Carbon also runs a number o high-level

networking events, workshops and training courses.

Point Carbon has ofces in Oslo (Head Ofce), Brussels, Kiev, London, Tokyo and Washington.


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All rights reserved 2007 Point Carboniii

13 March 2007

Executive Summary

This report presents an overview o the state o the carbon market in 2006, our outlook or 2007, and

expectations or the uture. The study is based on the results rom the largest ever survey on the carbonmarket, with 2,250 respondents to our web-based questionnaire. The results are complemented by analysis

undertaken by Point Carbon.

Point Carbon nds that the international carbon market in 2006 saw a total o 1.6 billion tonnes o carbon

dioxide equivalent (CO2e), worth approximately 22.5 billion in transactions. In comparison, the market in

2005 saw an estimated 799 Mt CO2e, worth 9.4 billion.

Our orecast or 2007 suggests that volumes in the market could reach 2.4 billion tonnes CO2e, which, at

current prices in the various market segments, would be valued at 23.6 bill ion. This would mark a marked

increase in volume combined with marginal growth in value, based on todays prices.

The EU Emissions Trading Scheme held the highest nancial value in 2006. In total, the brokered and

exchanged market saw 817 Mt CO2 changing hands, corresponding to 14.6 billion. Brokers did 71per cent

o this volume, whereas the ECX took over 75 per cent o the volume carried on exchanges. Point Carbon

urther estimates that the direct bilateral market (company-to-company, not through brokers or exchanges)doubled in size rom 100 Mt in 2005 to 200 Mt in 2006, with a value o 3.6 billion. The total volume in the

EU ETS in 2006 was just over one billion tonnes CO2, worth 18.1 billion.

We expect growth to continue in the EU ETS and orecast 1.5 billion tonnes CO2 in the OTC and exchange

segment alone in 2007, with another 200 Mt CO2 through bilateral deals. At current prices this would value

the EU ETS in 2007 at 18.5 billion. Last year showed clearly that prices could move up or down, and

liquidity could be impacted by a number o actors. Even so, the EU ETS has shown that it will remain a

multi-billion-euro market.

The Clean Development Mechanism (CDM) also grew in 2006, as well as the emergence o a secondary

market. Point Carbon nds that transactions in the primary market totalled 522 Mt CO 2e in 2006, with the

secondary market adding 40 Mt. Assuming payment on delivery and a 7 per cent discount rate, together

they are valued at 3.9 billion. The other project based mechanism, Joint Implementation (JI) reached just

21 Mt, 95 million in 2006 less than in 2005.

Our orecast or 2007 is or the primary CDM market to shrink or the rst time to 456 Mt CO2e, while the

secondary market more than doubles to 96 Mt CO2e. The combined value would be 4.3 billion at prevailing

prices. The JI market is also orecast to more than double to 45 Mt CO2e, worth 277 million.

The publication o the veried emissions data or 2005 was a major blow or the EU ETS, as the market

turned out to have been long allowances in 2005, and not short as previously thought. The surplus is

probably due to a combination o two actors; i) generous allocation and ii) internal abatement and eciency

improvements. The rst is by ar the most important. But have emission reductions taken place?

The results o our survey suggests that internal abatement projects are indeed taking place, with 65% orespondents stating that the EU ETS has resulted in internal abatement in their company. This is a striking

change rom last years survey, where 60% o respondents answered that the introduction o carbon trading

had not resulted in any internal abatement at all. Hence, i we take the survey results at ace value, large

emissions reductions due to internal abatement could be expected or 2006 compared to 2005.

Trading within the EU ETS is seen as the main strategy or compliance in Europe, or 37 % o the respondents.Internal abatement is considered the primary compliance strategy by 25 % o the respondents, with

utilisation o CDM/JI at around the same level. The CDM/JI market is a success, at least compared to the

2006 survey. The project market is seen as more mature (although not a mature market), and is resulting in

cost-eective emission reductions. In general, it seems that the respondents have more condence in the

CDM market now than just one year ago.


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Carbon 2007

What is the impact o carbon prices on the power market? We have looked at evidence o how the German,

UK and Nordic power markets have responded to date to the introduction o CO 2 pricing. We nd that, prior

to the start o EU ETS, the German spreads did not appear to actor in the market price or CO2 into the 2005contract. The increase in spreads rom the carbon pass-through occurred gradually, and it appeared that by the

end o 2005 the ull opportunity costs o carbon were being actored into the year-ahead contract. From this,

we conclude that despite a slow start to recognising the likely impact o the EU ETS on the market, German

orward power prices now appear to be pricing carbon ully into the price o power or uture delivery.

Throughout summer 2005 the carbon price was at a level sucient to encourage gas-red generation over coal-

red generation in the UK. However, ollowing the collapse in EUA prices at the beginning o May 2006, coal-red generation in the UK was consistently more competitive than gas throughout the summer. The exception to

this was or a limited time period at the end o September/beginning o October 2006, when commissioning o

new gas inrastructure in the UK pushed NBP gas prices down to levels where it was competitive to switch.

The Nordic market has showed a similar pattern to that seen in German prices, with the dark spread continuously

increasing in line with the CO2 price. As with Germany, the orward prices did at rst not seem to be ully pricing

in 100% o the CO2 price. The year-ahead contracts in the Nordic market have ollowed the behaviour o the

German market, with spread levels increasing and persisting at a high level ollowing the CO 2 readjustments

o prices. This suggests that the main impact o the EU ETS on the Nordic power market has been through the

trade with Germany which oten is seen as setting the marginal value o water in this system.

As o early March 2007, the European Commission had given its ruling on 14 out o the total 27 EU Member

States allocation plans. The EC has requested cuts in most o the plans so ar, refecting the importance placed

on the 2005 veried emissions in their assessment. The results o our survey show clearly that there is anexpectancy o much higher levels o internal abatement in the EU ETS in Phase II, with 70% o respondents

expecting more reductions in the EU ETS in the uture than what was seen in the 2005-2007 period.

The allocation plans speciy levels or import o credits rom CDM/JI project. The results o our survey suggest

that it is not enough to rely solely on imports, with 82% o respondents claiming that credit fows rom CDM/JI

will not be enough to eliminate the need or internal abatement in the EU ETS.

Survey respondents nd on average that the EUA price in 2010 will be about 17.5/t. Based on current orward

prices this is only slightly more than 1.5/t above the price or delivery in December 2010. Looking urther ahead,

our survey respondents expect the EUA price to increase in the post-2012 period, with an average expectation

o 23.1/t in 2020. The long-term price is seen as a decisive actor or long-term investment decisions or 30%

o respondents, and as an infuencing, but not decisive actor, or 45% o respondents.

The ongoing stalemate in the current post-2012 negotiations is as expected, with the lack o US engagement

constituting one principal reason or the impasse, along with general distrust between developing and developed

countries. Our analysis indicates a 72% likelihood that the next US President will support strong climate policy.

We are reasonably condent he or she will bring the US back to international climate negotiations. US re-

engagement will increase the likelihood o a new Protocol or the immediate period ater 2012.

71% o the survey respondents expect there to be an international climate agreement post-2012, with only 9%not expecting any agreement at all. USA and Australia are both seen as likely (60%) to join the new agreement,

and China (36%) is seen as a more likely candidate than India (30%). Emerging regional trading schemes are

expected to link to the EU ETS post-2012, where aviation and land transport are seen as the most likely sectors

to be included in Phase III.

Recent political developments and the positions o the most important US presidential candidates support ourview that a new and broader climate agreement is likely post-2012. US re-engagement and deepened Chinese

commitments will lead to comprehensive international emissions trading involving most major countries and

emitting companies expected to be ully operation rom 2018 and beyond. Consequently, we expect that we

will see the emergence o a truly global carbon market in the years to come.


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13 March 2007

While 2005 in many ways marked the birth o the

global carbon market, 2006 represented both a rudeawakening and a resh start. The European carbon

market came under massive criticism ollowing the

price collapse in April/May last year, when it became

clear that ar too many allowances had been handed

out by European governments. But the publicationo the 2005 data also provided the market and

policy-makers with something that had been lacking,

a set o reliable data to base political- and tradingdecisions on. It was time to all back, regroup and

take charge!

The publication o this report comes against abackdrop o record high public interest in climate

change and carbon trading. It seems that not one day

goes by without climate change being mentioned in

the media. Several things have contributed to this

new climate or climate change: The latest IPCC

report has concluded more strongly than beore thatman-made climate change is real and happening

now, as well as highlighted the dangers we ace i

we dont curb our emissions quickly.

A dierent but complementary view was oered by

the Stern report, comparing the costs o action tothe economic consequences o not acting on this

challenge. Finally, the movie An inconvenient truth

has been making the rounds on cinemas across the

world, reaching audiences that have so ar not paid

much attention to climate change, and even collecting

an Academy award to show or its success. Were ocourse both honoured and privileged to have Al Gore

with us or this years Carbon Market Insights.

The results rom the analysis going into this report

bring orward three important conclusions: Firstly,

the market is moving on despite there being severe

problems with the allocation o allowances in therst phase o the EUs emissions trading scheme.

The price collapse in the EU ETS resulted in massive

criticisms rom politicians and market participants

alike, not only because o the results but also the

way the results were revealed to the market.

The lessons rom the 2005 verication have not been

lost on (most) policy makers, and the allocations

or the next phase o the EU ETS are considerably

stricter than what has been the case so ar. The

publication o market sensitive inormation has alsotaken several steps orward, although there is still

some way to go beore the carbon market deals

with inormation release in the same way as moremature nancial markets.

Secondly, the results rom our survey suggest

that the EU ETS is starting to work as it should, by

initiating internal abatement and bringing companies

to the market to benet rom these abatements.Whereas last year only about 15% o respondents

answered that the EU ETS had initiated internalabatement projects in their company, a whole 65%

o respondents claimed it had done so this year.

We also nd that there are many more companies

now using the market actively, with about 36% orespondents citing trading in the EU ETS as their

prime strategy or meeting their emission targets.

The claims rom parts o European industry that

carbon restrictions will lead to relocations are

not supported by our survey, as this option wasmentioned by only a handul o respondents.

Finally, we now nd it increasingly likely that we will

see a truly global carbon market emerging soon.

Developments in USA and Australia suggest that wewill soon see operational emission trading schemes

established in these countries. With every one othese systems relying on oset opportunities rom

projects in other parts o the world, it is inevitable

that we will soon see the emergence o a common

carbon prices. It will still take some years beore we

see exactly what this market will look like, but itscontours are quickly becoming visible.

This report presents urther inormation about

these ndings, and a whole lot more. The analyses

presented here represent the essence o the work

that goes on in Point Carbon every day. The rapid

development in the carbon market has resulted inour analyses covering even more o the world than

it has done in the past, and we believe this report

represents the most comprehensive overview o

the carbon market to date. We hope you nd this

report both useul and interesting. We certainly hada great time making it.

Kristian Tangen

Director and Senior Partner

Point Carbon

Foreword


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All rights reserved 2007 Point Carbonvi

Carbon 2007

From the editors

This is the second issue o our annual report on the carbon market, providing an

overview o volumes and values, as well as our expectations or the uture. Moreimportantly, rather than just presenting what we think the uture will hold, this

report presents the answers rom the largest ever survey on the carbon market.

We are indebted to each and every one o the 2,250 individuals who took the

time to participate in the survey; this report would never have been possible

without you.

We would also like to thank everyone in Point Carbon or their contribution to

this report. The analysis that you have contributed throughout the past year hasserved as starting points or everything presented in this report. Special thanks

go to those who have contributed to our Carbon Market Analyst publication

series, sharing your knowledge on all things carbon, as well as the dierent

European power and gas markets. In particular, the continuous eorts o PointCarbons EU ETS and CDM & JI teams has made it possible or us to use our

comprehensive databases or the market analyses presented in this report.

Some o our colleagues deserve special mention or their contribution to this

report: Endre Tvinnereim and Andreas Arvanitakis or their contributions to the

Outlook or 2007 and the post-2012 section. Kevin Gould and Trevor Sikorski haveboth provided lots o input to the cross commodity chapter.

I you have any questions or comments to this report we would be delighted

to hear rom you, see the Colophon or contact details. We hope the report

provides you with a good insight to the carbon market, and that it will urtherenable your contribution towards a less carbon intensive uture.

Kjetil Rine and Henrik Hasselknippe

Editors


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All rights reserved 2007 Point Carbonvii

13 March 2007

1 Introduction

2 The Kyoto market: How does it work?

3 Carbon market activity in 2006

3.1 EU ETS

3.2 Kyoto markets

3.3 Other markets

4. Carbon across commodities

5 Outlook or 2007

5.1 EU ETS

5.2 Kyoto markets

5.3 Other markets

6. First Kyoto period and beyond

6.1 2008 - 2012

6.2 Post-2012

1

3

6

8

17

24

25

30

30

31

35

36

36

43

Table o contents


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All rights reserved 2007 Point Carbon1

1. IntroductionAlthough there is still another 10 months to go beorethe rst Kyoto commitment period starts, the global

carbon market is alive and kicking. Advocated by

unusual weather conditions worldwide, by the Stern

report published in November last year showing the

economical consequences o global warming, aswell as the US slowly re-entering the global carbon

arena ater years in hibernation, 2006 was the year

when climate change was on the top o the political

agenda. Putting value on greenhouse gas emissions

has now become mainstream thinking.

The present report, Carbon 2007, provides a detailedoverview o the global carbon market. Chapter 2

takes a top-down approach and look at how the

Kyoto market mechanisms are intended to work. This

includes the fexible project-based mechanism under

the Kyoto protocol (Clean Development Mechanism(CDM) and Joint Implementation (JI)) as well as

regional emissions trading schemes, with particular

ocus on the EU Emissions Trading Scheme (ETS).

Moreover, in chapter 3 particular attention is given

to volumes and values in the global carbon market

in 2006 as well as lessons learnt rom the previousyear. In chapter 4 we give a short overview o the

impact carbon prices have had on European power

markets. The remaining chapters look into the uture;

presenting the market outlook or 2007 (chapter 5),

expectations or the rst Kyoto period (chapter 6)

and possible outcomes or the international climate

regime post-2012 (chapter 6).

This report is based on a variety o sources. First, the

analyses that have gone into our publication seriesCarbon Market Analyst (CMA) are to some extent

refected in this report although the level o details

is lower here. As last year, a Carbon Market Survey

is carried out. Contrary to last year, we employed

a web-based survey sotware this year, contributing

to that a total o 2250 individuals responded to ourweb-survey, up rom 800 responses last year.

Who responded to this years Carbon Market

Survey? Figures 1.1-1.3 show the distribution o the

respondents to the web-survey. Less than 40% (50%

last year) o the respondents did not represent GHG

emitting industries, while about 25% representedonly small emission levels, i.e. below 0.5 Mt per

year. 12.5% o the respondents represented major

emitters, with more than 10Mt per year.

The share o non-emitters is also refected in thebreak-down o respondents on sectors, see Figure1.2. Service providers dominates the picture. and

0%

10%

20%

30%

40%

50%

60%

No

emissions

0 0.5 Mt 0.5 1.0

Mt

1 5 Mt 5 10 Mt > 10 Mt

Share

ofresponden

ts

2006 2007Source: Point Carbon

Figure 1.1 Some big, many smallRespondents to the survey, broken down on their companys annual emissions level. Comparison

o respondents in 2006 and 2007.

2250 participants in our web-surveythis year, up rom 800 in 2006

13 March 2007


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Carbon 2007

academics, governments and nance & banking

have their share o the respondents. In total, 24%

are covered by a CO2 regulation, while 42% o the

respondents are involved in the EU ETS.

The respondents are still dominated by those

standing outside o the trading sectors. That said,the relative share o respondents in the trading

sectors power & heat, industry and oil/gas/renerieshave increased compared to last year.

The geographical distribution o respondents

is more or less the same as in 2006, with only

one main dierence. There are relatively more

respondents rom the U.S. this time, increasingthe Other Annex-1 category to 30 %. Still, hal

o all the respondents come rom the EU, with 32

% rom Northwest Europe, 10% rom Central and

Eastern Europe, and 8% rom Southern Europe. In

addition, 6% were rom European countries not inthe EU. O the remaining respondents 20% were

rom industrialised countries, whereas another 20%

were rom developing countries, i.e. non-Annex I

countries.

0.0%

4.0%

8.0%

12.0%

16.0%

20.0%

Othe

r

Othe

rservic

eprovid

ers

CDM

/JIproje

ctdevelop

er

EUETS

company

with

EUA

alloc

ation

Academ

ics

Government

Finance

andb

ankin

g

Othe

rCDM

/JIrelat

edNG

O

EUETS

particip

antw

ithoutEUA

alloc

ation

Carbon

fund

Shareo

frespondents

Source: Point Carbon

Figure 1.2 Still mostly outside trading sectorsRespondents to the survey, broken down on sectors. Comparison o respondents to the 2006 and 2007 surveys.

0%

10%

20%

30%

40%

EU:

Northwest

Other

Annex-1

Non-Annex-

1

EU: CEE EU: South Europe:

Non-EU

Share

ofresponden

ts


Figure 1.3 European responsesComparison o respondents to the survey in 2006 and 2007,, broken down on geographic location. Annex 1

reers to industrialised countries as dened under UNFCCC. CEE: Central and Eastern Europe.


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13 March 2007

2. The Kyoto market: How doesit work?The international carbon market is a direct

consequence o the Kyoto protocol. While thereis carbon trading also in non-Kyoto countries, the

market is to all extents and purposes based on the

mechanisms specied in the Kyoto Protocol. How is

the carbon market structured?

The carbon markets sole mission is to place a coston carbon emissions, a value on emission reductions,

and to enable trade o the resulting allowances or

credits. There are our main mechanisms at play:

International Emission Trading

Clean Development Mechanism

Joint implementation

Regional/Domestic Emission Trading

All countries with a Kyoto-target will be issued withAssigned Amount Units (AAUs) that can be used

in international emissions trading under the Kyoto

Protocol. In order or a country to meet its target

it has to deliver allowances and credits equivalentto its emissions in the Kyoto period (2008-2012),

and will have to either buy AAUs rom othercountries or purchase credits rom projects under

the Clean Development Mechanism (CDM) or Joint

Implementation (JI).

The main theoretical supply o AAUs is expected to

come rom Eastern Europe, and Russia and Ukraine

in particular, as these countries have actual emissionsar below their Kyoto target (their assigned amount).

Thus, they can sell the surplus to countries that need

the allowances or compliance.

CDM and JI are oten reerred to as the project-

based fexible mechanisms under the Kyoto

Protocol. CDM rewards emission reduction projectsin developing countries with so-called Certied

Emissions Reduction (CERs), which can then be

used by governments to meet their Kyoto target, as

well as by the private sector or compliance under

regional emission trading schemes.

1.

2.

3.

4.

JI projects unction more or less in the same way,

rewarding emission reduction projects in developed

countries, i.e. countries with a Kyoto-target,

with Emission Reduction Units (ERUs). For both

mechanisms there are specic requirements thathave to be met, e.g. it has to be proven that the

emission reductions are real.

Finally, carbon allowances rom regional emission

trading systems are issued either based on a certain

cap (cap-and-trade) or on proven improvements

done rom a certain baseline (intensity-basedtrading). The EU Emissions Trading Scheme is the

only operational regional cap-and-trade scheme orCO2, where European Union Allowances (EUAs) are

the tradable units.

Figure 2.1 displays the structure o the carbonmarket in the 2008-2012 period. The market consists

o governments and private entities, and the rules

governing their trading relationships

The let side o the gure displays the governments

specied in the Kyoto Protocols Annex B, with

an emissions target or the 2008-2012 period.The demand side, i.e. the governmental purchase

programs, will maniest itsel in Western Europe,

Japan, Canada, and New Zealand that are legally

bound to control emissions. The supply side will beconcentrated in Eastern Europe.

Governments with demand or allowances inthe Kyoto period can also orward part o their

compliance to the private sector through emissions

trading schemes or other measures. In this report

we distinguish between the (currently) largest

operational regional CO2 trading scheme, the EU

ETS, and other planned or possible trading schemesin other countries.

The CDM/JI EU ETS linkage is responsible or

much o the recent increase in project credit

supply. Primarily because the EU ETS is the largest

operational trading scheme, but also due to the

perceived high prices o EUAs. Conversely, growingproject credit supply is keeping the EUA price lower

than what it would have been without such import

possibilities.

Consequently, European policy and market events

will have a proound infuence on the carbon market

How are countries meeting theKyoto challenge?

The carbon markets mission: Toplace a cost on carbon emissions


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Carbon 2007

Eastern EU members probably hesi-tant to sell large volumes o AAUs

Governments already buying carboncredits

elsewhere in the world through the CDM/JI link.

Outside the EU, however, CER/ERU demand is also

strong, notably rom Japanese utilities. It is also

possible that non-EU trading schemes, or instance

in New Zealand or Canada, will produce somecredit demand in the Kyoto period, although this is

currently ar rom certain.

Governments are already buying CERs and ERUs

in order to meet their Kyoto target. In act, mostcountries with a Kyoto target have drawn up carbon

procurement plans, with the largest programs in

Spain, Japan, the Netherlands and Italy.

However, i the costs or project investments in

CDM/JI increase, or i governments are orced

to purchase issued credits (trading at the highest

market price), the volume o the purchases will be

reduced. Strong EU ETS demand thus presents a

dilemma by stimulating new CDM/JI projects on the

one hand while lowering the purchasing power o

governments on the other.

Even with all their procurement plans lled, the

countries o Western Europe, Japan and Canada will

still on track to missing their Kyoto targets. However,the potential supply o AAUs rom Eastern Europe is

suciently abundant to put their carbon budgets in

the black. But is the supply o AAUs really there?

Most Eastern EU members will probably be hesitant

to oer substantial volumes o AAUs. This is partly

because they might need the surplus allowances

in the uture, but also because they are coveredby the EU ETS, which may present more lucrative

emissions trading opportunities.

Russia and Ukraine, however, might decide to sell

parts o their government allowances when they

become eligible or emissions trading (i.e. transero AAUs) in 2008-2009, see Figure 2.2.

CDM/JI

Gov. AAU sales

EU ETS

Internal trading,

abatement

JPN/CAN/NZ

Gov. Purchase

programmes Governments Private sector

= Supply

= Demand

Forwarding

compliance

Political framing decisions

Political framing decisions

Figure 2.1 How it works, at least in theory

The interplay o fexible mechanisms, purchasing programmes and trading schemes. Non-market

policies and overall allocations set the rame.


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13 March 2007

Green Investment Schemes (GIS)are politically palatable

Private sector AAU demand expec-ted to be limited

-5 -4 -3 -2 -1 0 1 2

Russia

Eastern Europe

Ukraine

Other

Canada

Japan

EU 15

Gt CO2e


Figure 2.2 Potential supply more than enoughNet short and long positions or countries and regions, i.e. when all policies and procurement plans have been

accounted or. Aggregated or the 5-year Kyoto period

On the other hand, there is not much o a demandside here either, despite the substantial shortall

amongst Kyoto countries. There are dicult issues

regarding public acceptance o trading so-called

hot air, i.e. excess permits arising rom declined

production not caused by intentional eorts to curb

emissions.

To make AAU trading more politically palatable,

thereore, Green Investment Schemes (GIS)

have been devised. In a GIS, income rom AAU

sales is earmarked or GHG reduction or general

environmental purposes. There is, however, no

regulation or how such earmarking could occur,nor is there an obligation on either buyer or seller to

undertake such greening.

Private sector AAU demand is expected to be limited

and conned to Japan (it is not allowed in the EU

ETS). Japanese entities are reportedly pursuing GIS

in Bulgaria and Romania and are planning to enter

Russia and Ukraine later.

The common actor or all the dierent market

segments described above is their link to CDM and

JI. Governments and companies alike, in all regions

o the world, will be able to use CERs and ERUs or

compliance.

Thus, these project based credits will act as thecarbon markets interconnector, ensuring that

there is at least indirect price linkage between thesystems, as the stream o credits will in theory go to

the system with the highest price. Although there

are no directly linked trading schemes as o yet,the projects in developing countries have already

resulted in a global carbon market, with implications

or governments and companies all over the world.


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Carbon 2007

3. Carbon market activity in 20062006 saw, as all previous years in the carbon market,a substantial growth in the traded volumes and

corresponding values. Table 3.1 shows the overall

numbers rom 2006, compared to 2005 as well as our

expectations or 2007. The total transacted volume

seen in the regulated carbon markets in 2006 was

1.6 billion tonnes o CO2 equivalent (CO2e), whilethe nancial value came in at 22.5 billion.

We estimate that the EU ETS saw a total volume o

1,017 million tonnes o CO2 in 2006. This includes

conrmed transactions or 583 Mt conducted over-thecounter (OTC) and 234 Mt on various carbon

exchanges, yielding a total o 817 Mt.

The remaining 200 Mt in the total volume is basedon our estimate o bilateral trades. As always, this

market segment is hard to pin down. Transactions

are less requent and larger in clip size than the

brokered or exchange-based segment, and they are

also almost always condential.

The rise in volume seen in the rst hal o 2006 ello during the third quarter, but rose to a new record

in the ourth quarter, refecting end-o-year trading

as well as increased volatility as the short-term price

began to decline.

The dropping value o rst phase allowances (or

delivery in 2006 or 2007) was coupled with growing

volume in the second phase (delivery in the 2008-

2012 period), which held its price level relatively well.For that reason the nancial value o the market did

not collapse with the rst phase. The brokered and

exchanged market totalled 14.6 billion in 2006.

Assuming a similar split between rst and second

phases in the bilateral segment as or the exchangeand brokered segments, the nancial value o bilateral

trades in 2006 is put at 3.6 billion throughout the

year, bringing the total estimated nancial value o

the European market in 2006 to 18.1 billion, over

2.5 times higher than 2005.

Total transactions in the Kyoto markets in 2006 are

estimated to be 584 Mt CO2e, worth 4 billion.

Compared to 2005, this is an increase o 36% in

volume and nearly 100% in nancial value. The JI

volume came in at 21 Mt, while the CDM market

transacted a total volume o 562 Mt including

secondary transactions.

O the total nancial value, the primary and secondary

CDM market saw a combined 3.9 billion in trade,

while the JI totalled just 95 million. JI volume andvalue both came in under 2005 levels (28 Mt and

96 million). This unusual development marks therst step backwards or carbon markets.

Carbon market saw 1.6 billion Mt,22.5 billion in 2006

Table 3.1: Reported volumes and value 2005, 2006, orecast 2007Reported and estimated volumes 2005 and 2006, together with orecasted volumes or 2007, in Mt CO2e and million . 7 %

discount rate employed or CDM and JI where price is at point o delivery. Prevailing carbon prices at time o writing or 2007

orecast.

2005 2006 2007

Final fgures Final fgures Forecast

[Mt] [ million] [Mt] [ million] [Mt] [ million]

EU ETS total

-OTC + exch.

- Bilateral

362

262

100

7,218

5,400

1,818

1,017

817

200

18,143

14,575

3,568

1,750

1,550

200

18,503

15,903

2600

Other ETSs 7.8 52 31 300 50 500

CDM 397 1,985 523 3,349 456 3,260

CDM 2nd 4 50 40 571 96 1,061

JI 28 96 21 95 45 277

Sum 799 9,401 1,632 22,458 2,397 23,601


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13 March 2007

Other carbon markets (in USA and Australia) have

gained in size since last year, although their share o

the global market was reduced in 2006 compared to

2005. The volume in 2006 was at 31 Mt CO2e, whilethe nancial value was at 300 million.

For 2007, we expect growth in all market segments

except or primary CDM. This brings our orecast or

global volumes to 2.4 billion tonnes o CO2e, almost

50 per cent up rom 2006. As has always been the

case in our Outlook series, which dates back to

February 2002, we do not attempt to orecast carbon

prices in 2007 in this report, instead using prevailing

market value at time o writing to give an illustrationo the potential nancial value o the market in 2007.

With the EU ETS price down rom last year, and the

wider eect that the EU prices have in the carbon

market, the total nancial value o carbon marketsgrows to a lesser extent rom 22.5 billion to 23.6billion.

0

500

1,000

1,500

2,000

2,500

2003 2004 2005 2006 2007

MtCO2e

CDM JI EU ETS OtherSource: Point Carbon

Figure 3.1 Stairway to 07Reported and estimated contracts 2003-2006, orecast or 2007, Mt CO2e.

Kyoto markets saw 583 Mt, worth4 billion in 2006

Physical volume (1,632 Mt CO2e)

CDM

34.5 %

EU ETS

62.4 %

JI

1.3 %

Other1.9 %


Figure 3.2: Still dominated by the EU ETSDistribution o the dierent market segments or physical volumes and nancial value in 2006.

Financial value (22.5 billion)

CDM

17.5 %

JI

0.4 %

EU ETS

80.8 %

Other

1.3 %


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Carbon 2007

3.1 EU ETS

The EU ETS is still the dominant emissions trading

scheme in the world. In 2006, it reached record

levels in transacted allowances, both in volumes andvalues. It was also a dramatic year with respect to

the reliability o the scheme, as the publication overied emissions data or 2005 showed that the EU

ETS was in act long allowances, and not short as

previously expected.

3.1.1 Volumes and values

Transactions in the EU ETS take place through

brokers (OTC), exchanges and bilateral trades. The

EU ETS saw transactions through brokers and on

exchanges totalling 817 Mt in 2006. O this, 583

Mt (71.4 per cent) was in the OTC market, with theremainder in the exchange-based market.

The European Climate Exchange (ECX) still carries

the largest volume o the exchanges, with over

three quarters o all exchange volumes (not including

exchange-or-physical, where OTC transactions are

cleared through the exchange). Powernext (13.3 per

cent), in second place, is still almost twice as large

as Nord Pool (7.4 per cent), while the only otherexchange with volume to speak o is the European

Energy Exchange (EEX) (3.6 per cent).

There was notable development towards relatively

more volume on exchanges in Q4, coinciding with

the declining Phase I price. Much o the increasecame through spot trading, possibly indicating more

industrial selling in this period, but also o course a

natural increase in trading activity was as the year-

end approached.

Most o the trades in 2006 were or Phase I delivery,

although the relative share o Phase II volumeincreased steadily throughout the year. In total over

the year, Phase II accounted or 24.4 per cent (199

0

50

100

150

200

250

300

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

MtCO2

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

mill

30%

-17%

36%

-5%

-30%

6%


Figure 3.3 Ups and downs in 2006Quarterly volumes and values in the EU ETS, Mt and million

More volume on exchanges in Q42006

0%

20%

40%

60%

80%

100%

2-Jan-06

2-Feb-06

2-Mar-06

2-Apr-06

2-May-06

2-Jun-06

2-Jul-06

2-Aug-06

2-Sep-06

2-Oct-06

2-Nov-06

2-Dec-06

OTC ExchangesSource: Point Carbon

Figure 3.4: Change towards exchanges?The relative shares o daily volumes or the brokered and

exchanged market in the EU ETS in 2006. Pure bilateral

trades not included


16/62

All rights reserved 2007 Point Carbon

13 March 2007

Mt) o the volumes done on exchanges and through

brokers. Most o this, 143 Mt came in the last halo the year.

In addition to the trading activity on exchanges and

through brokers there is a direct bilateral market,with transactions executed directly between two

companies. Estimating this bilateral market is dicult

as such deals are rarely, i ever, reported. In theCarbon Market Survey we asked the respondents to

give their opinion on how large this market could be.

O the 427 respondents that said they were in one

way or another active in the CO2 market, 26 per cent

estimated the bilateral market to be somewhere

between 10 and 25 per cent o total trading activity,

while another 24 per cent estimated it to be between

25 and 50 per cent.

Using the result o our survey as a starting point,

and taking a conservative approach, we estimate thedirect bilateral activity to account or 20 per cent o

all EU ETS trading activity in 2006, or about 200 Mt

CO2. Including this direct bilateral volume we nd

that the EU ETS traded a total o 1,017 Mt in 2006.

In nancial terms, the EU ETS volumes on exchanges

and through brokers totalled 14.6 billion last year,o which 10.8 billion came through allowances or

delivery in Phase I. This is about three times morethan the exchanged and brokered value rom the

previous year (5.4 billion), and a whopping two

hundred times more than in 2004.

The nancial value o the direct bilateral volume isdicult to assess, as there is no way o knowing

how much o it that was in Phase I delivery and how

much that was in Phase II. It is plausible that there

was a larger share o Phase II volumes in direct

company-to-company deals, as companies take newpositions in the coming trading phase, but in our

analysis we assume that the distribution between

0

5

10

15

20

25

30

35

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

MtCO2

ECX Powernext Nord Pool EEX

ECX 75.6%

Powernext 13.3%

Nord Pool 7.4%

EEX 3.6%

EXAA 0.1%


Figure 3.5: Still dominated by ECX

Monthly volumes o EUA trades in 2006 at the dierent carbon exchanges, in Mt CO2.

0%

10%

20%

30%

40%

0-10% 10-25% 25-50% 50-100% Do not know

Share

ofresponses


Figure 3.6 What the market thinksRespondents expectations o the relative size o the

bilateral market, limited to respondents that are actively

participating in the EU ETS market.

Most Phase II volumes traded insecond hal o 2006


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Carbon 2007

the phases is the same in the direct bilateral market

as in the brokered/exchanges market.

Using this split between vintages we nd that the

direct bilateral market saw values o 3.6 billion

throughout the year, bringing the total estimatednancial value o the European market in 2006 to

18.1 billion.

The development throughout the year shows that

volumes went down in the third quarter, both as

a result o stabilising prices ater the Phase I pricecrash in the second quarter, and the slow summer

months when trade activity is usually lower. In the

last quarter o 2006 the volumes went back up,

registering the highest quarterly level o activity

ever. This was a result o increased industrial selling

towards the end o the compliance year, as wellas interest in Phase II taking o in response to the

rst set o NAP announcements or the 2008-2012

period.

In nancial terms, the second hal o the year came

in with lower results as the Phase I price continuedits steady decline in value towards rock bottom.

3.1.2 What drives the EUA price?

The EUA price is, as in any market, set by supplyand demand. The supply is here determined by

the allowances and carbon credits available to the

market (EUAs, CERs and ERUs). Demand is set by

the amount o emissions through the year in relation

to the overall allocation. The demand is infuenced

by a number o actors, primarily undamentalslike weather (as temperature determines power/

heat demand and precipitation the potential or

hydropower production) and uel prices (as the

relative price dierential between coal and gas will

determine which o the uels that will be used orpower production). Relatively cheaper coal compared

to gas will increase GHG emissions as more power

production will be based on coal which emits moreGHGs per unit o output than gas. Higher CO2

emissions will increase the carbon price.

The Dec-07 contract (or delivery in December 2007)began the year at 22.70, and was traded by the

end o the year more than 16 lower at 6.55, the

years lowest value. Its highest value was on 19 April

at 31.58, just beore crashing on the haphazard

release o veried emissions data to 9.70 on 11

May, see Figure 3.7.

By the end o May the Dec-07 contract had

recovered, reaching 20 at one stage, and remained

in the high-teens or the middle quarters o the year.

This was put down to short-term demand by utilities

buying on the back o orward power sales. Much o

the supply was held back by industrials that either

did not have the appetite or capability to sell beorethey had ensured their own compliance.

As power companies nished hedging most o

their production or 2007, leading to a gradually

decreasing demand side, and more o the surplus

came to market as industrials entered the market,

the price o an allowance began to subside. In earlyNovember, the Dec-07 contract slipped below 10

and declined rom there. At the time o writing, the07-contract is traded at around 1. The EU ETS phase

I is or all practical purposes over and done with, and

unless there are enormous surprises in connectionwith the verication data or 2006, to be released in

April/May 2007, nothing will alter this picture.

The second-phase allowances broke ree rom

their correlation to rst-phase allowances nally

in October, as the Dec-08 contract responded to

credible signals rom the European Commissionthat it would ensure that the second phase was

short. The correlation between 07-contracts and 08-

contracts over the rst nine months o 2006 was

0.88, while the last three months saw a negativecorrelation at -0.74.

What were the main drivers or the price development

over the year? Fig 3.8 shows the development o theEUA Dec-07 price throughout 2006 in relation to the

impact rom uel and weather to the overall short

position, i.e. the impact on Point Carbons allowance

demand indicator E-t-C rom relative coal/gas prices

and temperature/precipitation. The correlation (R2)between the EUA price and the combined eect

rom uel and weather was 0.41 over the year as

a whole, while in 2005 it was 0.92. The individual

correlations to uel prices and weather were 0.46

(0.89 in 2005) and 0.35 (0.48 in 2005), respectively.

The correlation between the Dec-07 price andweather and uel or the entire year is relatively low

due to the price crash in April/May, which obviously

was not due to dramatically changes in uel prices

or weather, but rather the political publication o

veried emissions data.

It is evident rom the graph that the market is to alarge extent trading on changes in the undamentals.

Combined uel and weather correla-tion to EUA was 0.41 in 2006


18/62


13 March 2007

0

2

4

6

8

10

12

14

1-Feb-06

2-Mar-06

31-Mar-06

4-May-06

2-Jun-06

3-Jul-06

1-Aug-06

30-Aug-06

28-Sep-06

27-Oct-06

27-Nov-06

28-Dec-06

29-Jan-07

Millionton

nesCO2

0

4

8

12

16

20

24

28

32

/tonne

Volume EUA 07 EUA 08Source: Point Carbon's Carbon Market Trader

Figure 3.7 Daily volumes and pricesDaily prices or 07- and 08-contracts, as reported by Point Carbon together with daily volumes in

the OTC and exchanged markets.

0

5

10

15

20

25

30

35

02-

Jan

02-

Feb

02-

Mar

02-

Apr

02-

May

02-

Jun

02-

Jul

02-

Aug

02-

Sep

02-

Oct

02-

Nov

02-

Dec

/t

-30

-20

-10

0

10

20

30

40

50

MtCO2

EUA 2007 Fuel + weather (accumulated)Source: Point Carbon

1.1 -13.4: R2

= 0.57 1.1 -31.12: R2

= 0.41

1.6 -31.12: R2

= 0.98

Figure 3.8 Driven by weather, uel prices and verifcationEUA 07 in 2006, let axis in /t, compared to the changes to Point Carbons allowance demand indicator E-t-C rom uel

prices and weather, accumulated throughout 2006, right axis in Mt CO2.


19/62


Carbon 2007

From June to December the combined correlation or

weather and uel to the carbon price was 0.98, witha uel-correlation on 0.89, and weather-correlation

on 0.98. This is explained by the combination o

warm and wet weather throughout the period incombination with alling uel prices, leading the

downward trend o the EUA price.

It is also clear that the market is trading on dierentundamentals at dierent times. For instance,

during the period 1.1 13.4 the overall correlation

was 0.57, with a uel-EUA correlation o -0.15 and

weather-EUA correlation o 0.87. Hence, trading wasdone primarily on the weather during this period,

while at other times it was the development in oneor other o the uels that set the sentiment. The

0% 20% 40% 60% 80%

Political factors

CDM/JI supply

Fuel/other

commodity prices

Long-term prices

Other factors

Weather

Share of responses


Figure 3.10 Long-term price drivers in the EU ETSBased on responses rom our web-survey

0% 20% 40% 60% 80%

Political decisions

Fuel/power prices

Other factors

CDM/JI supply

Phase 2 EUA

prices

Weather

Share of responses


Figure 3. Short-term price drivers in the EU ETSBased on responses rom our web-survey


20/62


13 March 2007

publication o veried emissions data in April/May

broke all correlations between undamentals and

EUA price as the crash o the latter obviously did

neither infuence uel nor weather.

Do these developments conrm what market

participants see as the most important actors or

carbon price development? Figures 3.9 and 3.10

show the response rom Carbon Market Survey2007, compared to the survey carried out in 2006. A

striking dierence is that while the uel and powerprices were considered to be the most important

price determinant in our 2006 survey, ollowed by

political decisions, these actors have changedplaces in 2007.

A plausible explanation or this is the publication

o the verication data in May. Looking only at the

answers o those respondents directly regulated by

the EU ETS, the picture looks pretty much the same,

indicating that although undamentals like uel pricesand weather have seen a high correlation with the

EUA price over major parts o the year, the price

crash caused by the verication has indeed been the

most decisive actor or the EUA price level.Contrary to the correlation our data shows betweenweather and the EUA price, the survey shows that

the weather is not seen as a main actor or the EUA

price. Only 4 % consider the weather to be a main

price driver, less than hal o what was the case in

2006.

The prices or second phase allowances behave muchas the rst-phase price, with short-term responses

to the underlying energy complex combined with

policy signals on the allocation process. The ECs

decisions or the second phase are expected to

be done by this spring, but the nal allocation to

installations is likely to drag on at least until autumno 2007, given government tardiness and the odd

legal challenges to the ECs decisions. The surveyshows that political decisions are currently believed

to be the most important price driver also or Phase

II.

4.1.3 What did the verifcation show us?

The second year o the European emissions trading

market was noteworthy in many respects. First, andmost importantly, the realisation that the market

was indeed long in 2005 and the ollowing collapse

o carbon prices had its eect not only on the

behaviour o market participants, but also infuenced

the European Commissions decisions or Phase II.

So what did actually the verication data showus? Companies in the UK, Spain, Italy, Ireland and

Austria emitted more than their cap with a total

Political actors drive prices

-40 -30 -20 -10 0 10 20 30 40

POL

DEU

FRA

CZE

FIN

DNK

LTU

NLD

SVK

HUN

EST

SWE

BEL

LVA

LUX

PRT

SVN

GRC

AUT

IRL

ITA

ESP

UK

Mt CO2Source: Point Carbon/CITL

Figure 3.11 2005 verifcation results - country level

In MtCO2


21/62


Carbon 2007

decit o 47.4 Mt. Other countries had al located

more emission rights than actually used, 112.6 Mtin total, providing a net long position o 65.2 Mt or

EU-21. Figure 3.11 shows 2005 emissions to cap (E-

t-C), calculated as veried emissions minus the sum

o allowances allocated in each EU country, exceptrom Poland as ull installation level data are not

available at the time o writing.

Large countries like Germany and France were

considerably long, 21 Mt and 19 Mt, respectively,

being 4.3 % and 12.7 % below their caps. UK, onthe other hand were 27 Mt short, corresponding to

emissions being 12.6 % above the cap.

Turning to the sector level (without data or Poland),Figure 3.12 shows that across the EU, companies

in the power & heat sector emitted 36 Mt CO2

above their allowances. The main circumstances

infuencing emissions in this sector were abnormal

dry and cold conditions in Spain and Italy, above

normal precipitation in Scandinavia and record-highgas and EUA prices.

Moreover, all industry sectors had surpluses, adding

up to a net aggregate long position o 102 Mt or

non-power & heat sectors. Metals and Other

were the longest sectors in absolute terms (35.3 Mtand 26.3 Mt, respectively), while Pulp and paper

and Others were the sectors being longest relative

to their caps (21 % and 17 %, respectively).

The surplus is probably due to a combination o

two actors; i) generous allocation and ii) internalabatement and eciency improvements. The rst is

by ar the most important. Evidence suggests that

especially smaller industrials appear to have received

generous allowances. For installations emitting less

than 100 kt CO2 in 2005, the average surplus is 26

per cent o the cap.

But do reductions actually take place? There are

empirical evidence or some site specic reductions,such as increased energy eciency and own bio-uel

based power production (e.g. in the Pulp & Paper

sector). Closing o production, either permanently ortemporarily, is another reason or surplus emissions

as was moved production. But this would only

apply or a small handul o installations and not or

the industrial sectors in general.

For the metals sector the production levels in 2005

decreased in relation to the 2004 numbers, partlydue to high level o stocks in the supply chain.

Demand has increased again in 2006, which is

EU ETS was 97.2 Mt long in 2005

Figure 3.12 2005 verifcation results - sector level

In Mt CO2


22/62


13 March 2007

0% 10% 20% 30% 40% 50% 60% 70%

Yes

No

Do not know


Figure 3.13 Has the EU ETS initialised inernal abatement in your company?Based on responses rom our web-survey

0% 10% 20% 30% 40%

Trading within EU

ETS

Trading CDM/JI

Internal abatement

Other

Relocation

Share of responses


Figure 3.14 What is the primary carbon compliance strategy?Based on responses rom our web-survey


23/62


Carbon 2007

likely to bring with it higher emissions. Eciency

improvements have historically been made at a

number o installations, and there is not muchpotential or increased eciency.

In the other sectors there are also specic situations

which have lead to emission reductions. In the

Cement sector there is some evidence o increased

use o alternative uels, and repairs or replacements

o kilns during 2005. In the Chemical sector there hasbeen some disruption to production (in particular in

the UK) in Q4 2005, due to high gas prices. However,

in general the majority o the emission reductions

that have taken place cannot be explained by major

abatement initiatives arising rom the introduction o

the EU ETS.

What do the respondents to the survey think about

this? The dierence rom 2006 survey is striking as

last year 60% o respondents answered that EU

ETS had not initiated internal abatement projects in

the company, while only 15 % replied that it had. In2007, the situation is the opposite, with 65% o the

respondents claiming they have initialised internal

abatement projects as a result o the EU ETS and

only 15% have not. Hence, i we take the survey

results at ace value, large emissions reductions due

to internal abatement could be expected or 2006compared to 2005.

Turning to a broader compliance strategy or the

EU ETS participants, gure 3.14 illustrates what

survey respondents cite as their primary compliancestrategy. The main change rom last years survey isthat trading within the EU ETS is seen as the main

alternative, with 37 % o the respondents. Internal

abatement is considered the primary compliance

strategy by 25 % o the respondents, with utilisation

o CDM/JI at around the same level.

The EU ETS has been through some turbulence

during 2006. What is the standing o the EU ETSamong the respondents to the survey compared

to last year? Although the changes rom the 2006

survey is not striking, gure 3.15 indicates that

the EU ETS is considered less o a success nowthan what was the case in our 2006 survey. Fewer

respondents think that the EU ETS acilitates

emissions reductions and, most surprisingly, ewer

respondents think the EU ETS is a mature market

compared to one year ago. This last point is, however,

within the range o methodological uncertainty, andshould thereore be read with caution.

Trading is the primary carbon comli-ance strategy

0% 20% 40% 60% 80%

EU ETS is more

mature now than one

year ago

EU ETS facilitates

emissions reductions

EU ETS is the most

cost-efficient way to

reduce emissions

EU ETS is a success

EU ETS is a mature

market

Share of responses


Figure 3.15 Assessing the EU ETSBased on responses rom our web-survey


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13 March 2007

3.2 Kyoto markets in 2006

The Kyoto markets include projects under the

Clean Development Mechanisms (CDM) and JointImplementation, as well as Green Investment

Schemes (GIS). The latter involves the sale o

Assigned Amount Units (AAUs), the governmental

emissions trading unit under the Kyoto Protocol.

3.2.1 CDM in 2006

Transacted CDM volumes in 2006 ended at 563 Mt

CO2e in total, including primary (523 Mt CO2e) and

secondary transactions (40 Mt CO2e), constitutingmore than 96 per cent o the total project market

(CDM & JI). In total, the nancial value o the CDMtransactions in 2006 was 3.9 billion or CDM

transactions, including secondary transactions.

O the primary transactions, 436 Mt CO2e are

conrmed in our transaction database, while the

remaining 86 Mt CO2e are additional transactions

that we expect to have occurred. The additionaltransactions are included because we know that

the total volume o transactions is higher than only

those conrmed, and by combining Point Carbons

transaction database and project database we get a

reliable proxy or these additional transactions.The secondary CER market was limited in volumesin 2006. We have conrmed transactions totalling

34 Mt CO2e in our database, and estimate that a

total o 40 Mt CO2e were completed in 2006, worth

more than 500 million.

Volumes in primary transactions increased in Q1 andQ2 until the EU ETS price crash, then ell back in Q3,

as both sellers and buyers took a time-out to think

things through. Volumes increased again in Q4,

0

50

100

150

200

Q1 Q2 Q3 Q4

M

tCO2e

CDM J ISource: Point Carbon

Figure 3.16: Most towards the endQuarterly volumes o CDM and JI contracts in 2006, regis-

tered and estimated by Point Carbon, in Mt CO2e.

Private

58%

Funds

34%

Government

8%


Figure 3.17: Who are they and what do they want, Part IThe relative share o categories o CDM buyers (let) and project types (right) in 2006.

Renewable

energy

13%

HFC-23

33%

LULUCF

1%

Fugitive

emissions

7%Energy

efficiency7%

Waste

9%

Other/unknown

10%

N2O

21%


25/62


Carbon 2007

as condence in a sound second phase o EU ETS,

and to some extent demand rom governments and

Japanese companies increased.

The UK and Italy top the list o buyer countries.Italys high position stems rom ENELs procurement

o CERs rom HFC-23 and other projects in China,

as well as the Italian governments activity through

the World Bank. The chart o buyer countries refects

that more nancial institutions have become active

in the market a large chunk o the market activityout o the UK is nancial, not compliance-driven. This

is obviously also the case or Luxembourg (nancial

players registered there) and the US (primarily due

to the World Bank unds). Also, the Greenhouse

Gas Credit Aggregation Pools (GG-CAP) HFC-23purchases are the sole reason why Canada gures

on the list. Interestingly, Japan has only 3 per cent

o the buyers volume although their interest in themarket is reportedly still high.

The private sector is dominant on the buy-side (58

per cent), as increrasingly more companies see thevalue o project credits. In addition, new nancial

vehicles are established to cater to this market,

contributing to the unds segment o 34 per cent. In

general, companies with EU ETS compliance

and unds selling to such companies have also

had a much larger appetite or large-scale non-CO2projects. Moreover, European countries dominate

amongst governmental buyers. While there are

hints at more Japanese activity in the CDM market,our expectation o limited Canadian and Japanese

activity on the demand side has proven correct.

With regards to project types in 2006 orward CER

contracts, HFC-23 and adipic acid N2O projects

stole the show. Most o these types o projects

are now under contract, and we see the contours

o a more balanced picture between project types.The dominance o HFC-23 was ar clearer in 2005.

Renewables, energy eciency, waste (includinglandll gas capture) and ugitive emissions (including

coal mine methane) have all experienced growth in

2006, which is likely to continue.

China completely dominated the CDM sell side in2006, miles ahead o India and Brazil, bringing the

bulk o the HFC-23 and adipic acid N2O volumes to

the market. China elt condent enough in its role as

a dominant supplier to introduce and maintain a price

foor, which it raised rom 7/t to 8-9/t during the

year. With 70 per cent o the total contracted CDMvolume coming rom China, this is a very strong

price signal in a market that is still airly small.

China

70%

Malaysia

1%Egypt

2%

Other

12%

Brazil3%

India

12%


Figure 3.18: Made in ChinaThe relative share o CDM country sellers (let) and buyers (right) in 2006.

Italy

24%

Unknown/Other

11%

United

Kingdom36%

Spain

4%

USA

4%

Luxembourg

5%

Canada

13%

Japan

3%

Privates still the largest buyer oCDM contracts

China by ar the largest CDM sellingcountry


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13 March 2007

More transactions are done in India now than has

been the case or a while, mainly or two reasons.

Firstly, Indian sellers were renowned to be more

optimistic than others beore the EU price crash,

but the crash brought them back to the negotiatingtable.

Secondly, this development mirrors a more mature

market; many Indian sellers had sat on the ence,

in the belie that selling a mature asset yields more

revenue, and are now selling as their project is

registered or has had its rst issuance o credits.Apart rom the developments in China and India, the

picture is still ragmented on the sell side, which isinteresting in itsel: many more seller countries are

now represented in the market than previously.

The CDM market in 2006 can also be summed

up in other ways. First, market players learned

the hard way that there are real risks related tomethodologies, or instance the slashing o CERs

rom manure management projects and general

delays due to lack o UNFCCC sta, host country

approval (Thailand and Brazil), project perormancecompared to plans (especially landll gas) andExecutive Board approval (several projects rejected,

or delayed due to reviews).

Furthermore, the rules or Chinese host country

approval require project participants to reveal a CER

price, and it is not allowed to receive consultancy

revenues in CERs. This has orced project developers

to take buy side positions in order to be able toobtain CERs early and sell them or a prot later. This

will likely boost secondary CER market volumes in

the years to come. When some project developers

also start buying or their own books, many buyers

are likely to seek out project developers that dont

buy or their own books in order to obtain unbiasedadvice.

The prospect o non-Kyoto and non-EU ETS CERbuyers became more real in 2006. US and Australian

states urther developed or started implementing

trading schemes, and are reportedly planning toopen or submitting CERs or compliance. To the

extent this infuenced the current market at all,

this (together with the post-2012 negotiations)

strengthened the belie in a post-2012 CDM market,

and some very ew orward CER trades now include

Veried Emission Reductions (VERs) or CERs or thepost-2012 period.

3.2.2 JI in 2006

Point Carbon reckons that the JI project market

saw 20.5 Mt CO2e transacted in 2006. O that,

16.7 Mt CO2e represents conrmed transactions

registered in Point Carbons transaction database,

Government

61%

Funds

21%

Private

18%


Figure3.1: Who are they and what do they want, Part IIThe relative share o categories o JI buyers (let) and project types (right) in 2006.

Industrial

processes

22%

Renewable

37%

Unknown

2% Fuelswitching

2%Fugitive

emissions

6%

Waste

16%

ENEF

15%

Chinese price foor at 8-9/t providesa strong price signal


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Carbon 2007

while the remaining 3.8 Mt CO2e are estimated

using data rom Point Carbons project database

and regular contact with market participants. The

quarterly average was 5.1 Mt, with a somewhatsmaller volume o contracts in the second quarter

and higher volumes in Q4.

Reported ERU prices in 2006 were between 4.5

and 12.5. The price did not see any abrupt changes,

partly because JI is still dominated by governmental

buyers which have limits on their budgets and arenot very fexible with the prices they oer. They

also usually negotiate the price at early stages o

the projects, and the resulting price at the date o

contract signature does not necessarily refect the

latest market trends.

We estimate the total nancial value o JI transactions

to be 95.2 million in 2006 money (7 per cent

discount rate), almost exactly at the same level as in

2005. Taking only the conrmed JI transactions into

account, we end up with a volume-weighted unitprice o 6.5/t (5.1/t in 2005).

Governmental buyers still dominate the JI market,with 61 per cent o the purchases in 2006, although

there are other buyers also entering the picture. Funds

and private buyers both have market shares around

20 per cent. The situation changed dramatically in

CzechRepublic

21%

Romania

15%

Russia

15%

Ukraine

15%

Poland

6%

Others

11% Bulgaria

17%


Figure 3.20: From East to WestThe relative share o JI country sellers (let) and buyers (right) in 2006.

Table 3: CER prices throughout 2006Price o primary transactions at start and end o 2006, the range as well as the volume weighted

unit price or the year in total, in /tonne.

Start 2006 End 2006 Range Vol.weighted unit price

Price category 1 4 5 3.5 - 7 5.87

Price category 2 7 7 3.5 - 15 8.09

Price category 3 14 10 8 - 18 12.99

Price category 4 18 13 13 - 18 16.97

Austria

29%

Denmark

36%

Netherlands

13%

World Bank

12%

Others

10%

Average price or JI transactions in2006: 6.5/t


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13 March 2007

2006 rom 2005, when the governments covered

96 per cent o the buy-side in the JI market.

Still, in many cases, JI appears to be more avourable

or governmental buyers than or private. The most

active ERU buyers in 2006 were Denmark (36 percent o all JI transactions), Austria (29 per cent) and

the Netherlands (13 per cent). The most active sellers

were the Czech Republic (21 per cent) ollowed by

Bulgaria, Romania, Russia and Ukraine (15 per cent

each).

The most signicant project types among JI contracts

in 2006 in terms o volume were renewables (37

per cent), industrial processes (22 per cent), waste

(16 per cent) and energy eciency (15 per cent).

Renewable energy projects, although not big in size,

were numerous, with several biomass, wind andhydro projects.

Conversely, there were ew industrial processes

projects, represented by N2O reductions, which

brought relatively high volume to the market. Landll

gas recovery and energy eciency contributed

around 15 per cent o contracted volume each.

In addition to the act that some large deals thatwe had expected to be concluded in 2006, actually

were not contracted beore January 2007 (eg. one

10 Mt CO2e contract), there are at least our reasons

why the volume o JI transactions did not increase

in 2006, but ended approximately at the same level

as in 2005.

First, there is still considerable uncertainty related to

JI projects in Russia. Russia is potentially the largestseller o ERUs, but did not manage to establish its

JI procedures in 2006, and it took until the end othe year beore several key ministries reached an

agreement on the principles o JI guidelines.

Second, the regulatory inrastructure in Ukraine

was not resolved until the end o 2006 and, thus,or most o the 2006 it was still uncertain, with ew

projects receiving a Letter o Approval (LoA) rom

the Ukrainian government.

Third, the threat o EU ETS double counting rules

has been slowing JI transactions over 2006. Thedouble counting avoidance guidelines practically

rule out all uture projects in EU ETS trading sectors,

leaving mainly non-CO2 gases or JI. This signicantly

limited the scope or JI in host countries that recently

joined the EU. Finally, despite the increase o private

buyers, there is rather low interest rom the private

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

Political factors

EU ETS 08-12 price

Actual project costs

Governmental demand

CDM Methodology panel

Earlier deals

Other factors

Share of responses


Figure 3.21 Short-term price drivers or CDM and JIBased on responses rom our web-survey

Renewable JI projects biggest in2006

Procedural uncertainty limits JItransactions


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Carbon 2007

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

Political factors

EU ETS 08-12 price

Actual project costs

Governmental demand

CDM Methodology panel

Earlier deals

Other factors

Share of responses


Figure 3.22 Long-term price drivers or CDM and JIBased on responses rom our web-survey

0% 20% 40% 60% 80%

The CDM&JI market

facilitates emissions

reductions

The CDM&JI market is

more mature now than one

year ago

The CDM&JI market is the

most cost-efficient way toreduce emissions

The CDM&JI market is a

success

The CDM&JI market is a

mature market

Share of responses


Figure 3.23 Assessing the CDM/JI marketBased on responses rom our web-survey


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13 March 2007

Physical volumes (30.5 Mt CO2e)

NSW GGAS

66%

UK ETS2%

CCX

33%


Figure 3.24: And now or something completely dierent...The relative share o other carbon markets, physical volume and nancial value.

Financial value (300 million)

NSW GGAS

90%

CCX

9%

UK ETS

1%

sector as companies are still not amiliar with JI.

Investors preerred CDM which has established a

track record, while JI is only preparing its routines.

The Joint Implementation Supervisory Committee

(JISC) started its work in 2006 and ociallylaunched the JI Track 2 process on October 26

2006. Once the JI mechanism gets up and running

it is possible that we will see urther private sector

interest in credits rom Eastern Europe, but this is

still uncertain.

What drives the CDM/JI prices?

Reported orward CER prices in 2006 have variedbetween 3.5 and 20, and have clearly been

infuenced by the variations in the EUA-prices.Table 3 shows the ranges and variations seen in

Point Carbons CER orward price categories.

The price impact o the EU price crash came later

or category 1 and 2 deals than or category 3

deals. This is not too surprising as category 1 and2 deals are oten more closely linked to long-term

carbon nance structures or projects that are still

in early stages o development.

Also, many o them are done by governments,

which are less sensitive to short term EUA price

developments. Volume-weighted unit price in 2006was 8.32/tonne, up rom 6.70/tonne in 2005.

Secondary CER prices have allen relative to EUA

prices, as they were squeezed between primary

market prices o up to 10 and EUA 2008 prices o

around 15. The volume-weighted average price or

secondary transactions was 14.3/tonne in 2006.

What does the survey reveal o price drivers in

the CDM/JI market? Figures 3.21 and 3.22 show

what the respondents to our web-survey saw asthe most important price drivers in the short- and

long-term. The main change rom last year is that

political decisions have become ar more important,

with more than 40 % o the responses on the short-

term horizon, and above 50 % in the longer term

horizon, citing policy decisions as the key pricedriver. Interestingly, it is the political decisions in

developed countries and on the international arenathat constitute the majority o these responses, and

not the decisions taken by the CDM methodology

panel, which is seen as a less important price drivercompared to last year.

As CDM covers more than 90% o the entire project

market, it seems air to assume that the respondents

to the survey or the most part ocused on this market

when answering questions relevant or both CDMand JI, see Figure 3.23. For instance, a larger shareo the respondents thinks that the CDM/JI market

is a success, compared to the 2006 survey. This ts

well with the market results presented above. The

CDM market grows continuously, CERs are issued

Volume-weighted average CER price8.32/t in 2006


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Carbon 2007

on a regular basis, and the demand or these credits

increases as the EU ETS phase II is approaching. In

general, it seems that the respondents have more

condence in the CDM market now than just one

year ago.

3.3 Other markets

Several greenhouse gas emissions trading schemes

exist beyond the bounds o the Kyoto Protocol and

its spin-o markets. The Chicago Climate Exchange

is voluntary, although once a company has joined,

the cap is binding. The New South Wales scheme

in Australia imposes a mandatory cap on powersuppliers, but leaves the door open to local oset

projects.

The UK ETS expired at the end o 2006, with

compliance due in March 2007. Ocial data or the

2006 trading year is not released until May 2007.We have excluded the increasing voluntary sector

(osets or air travel, etc.), which is building in

size and dynamism, rom this report, but this willbe subject to an analysis by Point Carbon later this

year.

Last year saw an interesting development, as thetotal volume in the category o other emissions

markets grew our-old, rom 7.8 Mt CO2e in 2005

to 30.9 Mt CO2e in 2006. In nancial terms, the

increase was almost six-old, rom 52 million in

2005 to almost 300 million in 2006.

This sharp growth trend in these markets was putdown in part to the increased number o participants,

new members and vintages in the case o CCX, and

newly approved oset projects in the NSW scheme.

In the case o the latter, the new projects brought

supply and thereore volatility to a hitherto stagnant

market, urther increasing volume.

The New South Wales scheme in Australia, the only

mandatory scheme in this segment, still dominates

amongst the other trading schemes, with 66 per

cent o the total physical volume transerred, and 90

per cent o the nancial value.

There was also an advance in the average spot

price, rom A$12.80 to A$13.31 in 2005 and 2006

respectively. The volume o New South Wales

Greenhouse Gas Abatement Certicates (NGACs)

transerred on the registry tripled rom 6 million

in 2005 to 20 million in 2006. Accordingly, the

estimated nancial value jumped three-and-a-hal

times rom A$78.2 million (48.5 million) in 2005 to

A$268.3 million (160 million) in 2006.

The NSW scheme administrator registered just over

669 transactions over the course o 2006. February

was the busiest month again last year, ollowed by

December, with 84 and 70 transers each.

The Chicago Climate Exchange in the U.S. has growntenold in stature in a year when a rm domestic

ederal carbon policy has appeared on the horizon.

Its share o the other market grew rom 18%

o the volume in 2005 to 33% in 2006, and rom

5% o the nancial value in 2005 to 9% in 2006.

The Chicago Climate Exchange (CCX) continued itsgrowth path with 225 members at the end o 2006,

up rom 129 in 2005. With new vintages traded out

to 2010, there

Documents

Carbon 2007 -- A New Climate for Carbon Trading