Carbon Market Outlook 2010

8/8/2019 Carbon Market Outlook 2010

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Carbon Market Outlook 2010

Mumbai 20th May 2010

Gensol Consultants Pvt. Ltd.


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2 | It 'Pays' tobeEnvironment Friendly

ACKNOWLEDGEMENT

An honorable mention goes to all those who wish to remain unnamed from various government

and private organisations who have provided their guidance, support and valuable information.

Their cooperation and assistance has contributed tremendously towards the completion of this

report.

We also wish to extend our thanks for the inputs and insights of our team members- Mr. Jinesh

Amlani, Mr. Tumul Dwivedi, Mr. Gaurav Chauhan, Ms. Tishya Dwivedi, Mr. Ankur Bhatnagar and

Mr. Ankush Bajoria.

0F

1

* The findings and conclusions expressed in this report are the sole opinion of the authors. This report is not intended to

form the basis of an investment decision.


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Table of Contents:

1. Executive Summary.........................................................................................................................5

2. Overview of Carbon Market...........................................................................................................8

2.1 Kyoto Protocol....................................................................................................................................................................8

2.2 European Union Emission Trading Scheme...........................................................................................................9

2.3 Carbon Market Transactions..................................................................................................................................... 10

3. Carbon Market - Global balance of demand-supply ........................................................... 11

3.1 Kyoto Protocol Mechanisms ...................................................................................................................................11

3.1.1 Assigned Amount Units....................................................................................................................................12

3.1.2 Project-based Mechanisms................................................................................................................................ 13

3.1.3 Projection of CDM credits supply ...............................................................................................................14

3.2 EU Emission Trading Scheme ................................................................................................................................17

3.2.1 Emission targets and projections under EU ETS phase II ..............................................................17

3.2.2 EU ETS phase III - Carbon market driving force .................................................................................18

3.2.3 Net Demand-Supply under phase II ..............................................................................................................19

4. Other Emerging Schemes:............................................................................................................ 20

4.1 US Carbon Market..........................................................................................................................................................20

4.1.1 RGGI............................................................................................................................................................................20

4.1.2 Western Climate Initiative................................................................................................................................. 20

4.1.3 American Clean Energy and Security Act (ACES Act), 2009................................................................21

4.1.4 American Power Act, 2010................................................................................................................................21


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4.2 Tokyo ETS..........................................................................................................................................................................22

4.3 UK CRC Energy Efficiency Scheme:.........................................................................................................................23

4.4 REDD ..................................................................................................................................................................................23

5. International Aviation and Shipping Emissions ................................................................. 25

6. Post-2012 Market Frameworks................................................................................................. 27

6.1 Only EU ETS scenario ...................................................................................................................................................27

6.2 Extension of Kyoto with EUETS but without US Scenario.............................................................................27

6.3 Copenhagen accord scenario..................................................................................................................................... 28

7. Price Forecast................................................................................................................................. 30

Annexure 1: Methodology .................................................................................................................... 32

Annexure 2: Glossary ............................................................................................................................. 33

Bibliography.............................................................................................................................................. 35


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1. Executive Summary

This report provides an overview of the international carbon market its underlying structure,

dynamics and an analysis of the market forces shaping the carbon demand and supply, and theinteraction of these dynamics in influencing the carbon prices. Forecasts of demand, supply and

price are examined for Kyoto Protocol and EU ETS.

Carbon Market Structure

A consensus has emerged among scientists and policymakers that an increase in Greenhouse Gas

(GHG) emissions in the atmosphere is responsible for the extreme weather patterns and climate

change. As concerns about the potential impact of human induced climate change have increased,

policymakers around the world are looking for ways to reduce the carbon emissions associated with

human activity.

International efforts on combating climate change led to the negotiation of the Kyoto Protocol in 1997,

an international treaty committing the global community to reduce GHG emissions by an average of

5.2% below 1990 levels in the period 2008-2012.

To meet the binding emissions reductions agreed under the Kyoto Protocol, a number of nation states

have turned to a market-based policy approach of a cap and trade mechanism(CTM).

A Cap & Trade mechanism involves:

The setting of a limit on the level of emissions allowed by covered entities (factories, power

stations) regulated under the mechanism

An issuance by the government to the covered entities of carbon allowances in line with the

cap that can be used for compliance

A penalty that will apply to covered entities that do not submit sufficient carbonallowances/credits to meet their emissions over the compliance period

The Kyoto Protocol agreement has led to the development and introduction of a number of CTMs by

countries that are looking to meet their GHG reduction targets. The largest and the most liquid market

is the European Union Emission Trading Scheme (the EU ETS) that covers a number of large industrial

sectors in 27 countries across Europe.


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Till date, trading in the carbon market has been dominated by two specific carbon commodities. The

most highly traded are the allowances traded under the EU ETS these are called EU Allowances

(EUAs). The second carbon commodity is Certified Emission Reduction (CER) credits, which are offset

credits that are earned under GHG reduction projects that have been registered by the body thatadministers the Kyoto Protocol the United Nations Framework Convention on Climate Change (the

UNFCCC).

CERs are created under the Clean Development Mechanism (CDM), which allows investments in

programs or technology to reduce carbon emissions in developing countries and these credits can

then be traded to offset carbon emissions in developed countries.

Potential Demand Supply Scenario

On the supply side, expected supply of CDM and JI offsets by 2012 would range between 620 and 743

MtCO2e due to a combination of regulatory delays, the difficulty in obtaining financing for projects

in a challenging global financial environment, stricter regulations and the suspension of validators

at regular intervals.

On the demand side, the demand from EU ETS is majorly driven by the phase III where the banking

from phase II is allowed, use of international offsets (CERs and ERUs) and excess emission over cap

in phase II. The total demand for international offsets is around 1.389 billion units which could lead

to a net shortfall of 646 million units.

The expected demand for AAUs under the Kyoto Mechanism from some EU 15 countries can be

easily met through AAUs surplus of 8 billions units amid economic slowdown and estimations of

large surplus of AAUs with some central and eastern European countries.

Beyond 2012

Today, uncertainty over the regulatory framework post first Kyoto period (2008-2012), poses a threat

to the future of carbon market. The foundation of a post-2012 framework has been laid down at COP

15, Copenhagen, where many countries taken up non binding targets. This report analyses three

possible post 2012 scenarios.

First, only EU ETS scenario with no successor treaty to the Kyoto Protocol. In this scenario, limit will be

placed onimports of international offsets equal to the unused portion of the limit in Phase II and target

willbemet through internal abatement.


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Second, Extension of Kyoto Protocol without US scenario. In this scenario, EU ETS targets would be

raised from 20% to 30% under EU ETS phase III and a higher limit permitted on importing

international offsets.

Third, with current pledges under Copenhagen accord. Under this scenario, post 2012 demand from

project based mechanism could be 6.7 billion units, with most of the demand will come from EU and

US.

Price Forecast

Carbon Market is expected to be bullish in near future and price are most likely touch new highs by

the end of first commitment period in 2012. Carbon credits as of now seems to be undervalued

commodities and thus provides and ideal investment opportunity.


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2. Overview of Carbon Market

In response to threats and risks of climate change, a variety of initiatives and approaches aimed at

reducing GHG emissions have been adopted across different levels of human endeavor, fromcommunities, to cities, private firms, governments and from local level to a global level. Carbon market

forms a cornerstone of the regulatory response to climate change and emissions trading is one of the

key tools in supporting the transition into a global low-carbon economy.

2.1 Kyoto Protocol

The Kyoto Protocol, an international agreement signed in Dec. 1997 under UNFCCC has been

instrumental in the creation of an international carbon market. Under the Kyoto Protocol, GHG

emissions from 38 industrialized countries including economies in transition (EIT) and the EU-15

members have been capped and they have been legally bound to reduce their GHG emissions by

anaverageof 5.2%below 1990 levels over the first commitment period (CP1) 2008-2012.

Countries, under this mechanism, are broadly divided in two groups Annex 1 (developed economies

and economies in transition) and non-Annex 1 (developing countries).

The first commitment period (CP1) runs for five years, from 1 January 2008 to 31 December

2012 with sovereign governments being the regulated entities:

40 emissions-capped industrialized countries are listed in Annex 1 to the Kyoto protocol

and 38 of them (the USA and Canada have already withdrawn from the scheme) who have

accepted legally binding emission reduction commitments for CP1 have been listed in Annex

B of the Kyoto Protocol

Targets for Annex 1 countries (and the Annex B countries) Kyoto Protocol compliance

obligations are based on their GHG emissions over the five year CP1 period. Kyoto Protocol

units must be surrendered to match national emissions after the end of the CP1 period

The value of Assigned Amount Units (AAUs or Governmental carbon emission cap) issued to

some Annex 1 countries is equal to theirGHG compliance target forCP1

This market is driven by the compliance needs of the Annex 1 countries. Three instruments have

been developed under this scheme for enabling deficit Annex B countries to meet their emissions

targets


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Assigned Amount Units (AAUs) are allowances issued by the UNFCCC to Annex B

countries at the level of theirrespective Kyoto protocol targets. One allowance represents right

toemit one ton of CO2e

Clean Development Mechanism (CDM) facilitates the deployment of capital, technology,and capability from the developed world into GHG reducing projects in the developing world

that benefits from a low marginal cost of abatement. Credits from CDM projects are called

CERs. One CER is issued onone tCO2ereduction in host country

Joint Implementation (JI) may be carried out between two or more Annex I countries, and

involves sharing of capital, technology, and capability to deliver GHG reducing projects.

Credits from JI projects are called ERUs. An ERU is issued on one tCO2e reduction in host

country

2.2 European Union Emission Trading Scheme

To complement Kyoto Protocol targets, the European Union instituted an indigenous emission trading

scheme in 2005, known EU ETS. Although EU ETS is the principle EU policy instrument in addressing

global warming, it is not an exclusive policy tool as it does not cover 100%of the EUs GHG emissions.

This scheme presently spreads over distinct phases. Phase I of the EU ETS ran from 1 January 2005 to

31 December 2007 (3 years), with Phase II set to run in line with the Kyoto Protocols first

commitment period i.e. from 1 January 2008 to 31 December 2012. It is proposed that the Phase III

will run from 1 January 2013 to 31 December 2020 (8 years). EU ETS, which is a cap-and-trade

scheme, enforces emissions cap for regulated entities and grants the holder of one EU Allowance

(EUA) the right to emit one tonne of CO2. The amount of EUAs allocated to each regulated entity in the

scheme is set out in National Allocation Plans prepared by the member states and approved by the

European Commission.

In order to meet the emission cap, regulated entities can undertake internal abatement; or can

source allowances (EUAs) from other regulated entities, or they can source CERs from the developing

world via CDM, or ERUs from economies in transition via JI; however, the scheme has imposed a limit

of 1.389 billion tCO2e on the use of such international offsets. The EU ETS only covers around

40% of the total EU GHG emissions, focusing on the CO2 emissions from five major sectors viz.

Power and Heat Generation, Oil Refineries, Metals, Pulp & Paper, and, Energy Intensive Industry.

France and Netherlands unilaterally extended the scope of EU ETS in Phase II to include installations

emitting nitrous oxide (N2O).


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10 |

2.3 Carbon Market Transa

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Figure 1

f types of Carbon Assets and types of trans

st pricing fluctuations, delivery risks, advanc

ulatory schemes (such as EU ETS Phase III o

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e and reach of the international carbon marke

or forward delivery - any year up to compliance date (2008-12

hased directly from project owner

ers will sell in strips to break out risk into smaller packages

aranteed basis by credit-rated entity

elated performance risk - only credit risk

or forward delivery - any year up to compliance date (2008-12

at is bought or sold for immediate delivery

sued credits only so that trades can be settled quicklyre the most commonly quoted prices for carbon

lves delivery of one unit per year across a number of years

ers split out individual future delivery years into strips to am

s may also be used to hedge against other market fluctuation

cently due to low liquidity and high implied volatility

nsactions are EUA/CER and - less so - EUA/ERU swaps and car

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3. Carbon Market - Global balance of demand-supply

Demand and supply of carbon market depends on three market segments Kyoto Protocol

compliance, allowance-based (EU ETS), and voluntary carbon market over compliance periods.Demand and supply within each market segment are driven by:

Policies with respect to trading schemes and GHG quota allocations of Annex 1 countries;

Expectations regarding future policies and the shape of post-2012 regulatory schemes;

Factors affecting emission generation: economic growth rates, weather conditions, fuel

prices, and availability of low-emissions electricity;

The level of emission reduction through additional policies and measures such as

energy efficiency programs and renewable energy use done by developed countries;

Non-compliance policies such as voluntary GHG mitigation;

Global supply from the project-based Kyoto Mechanisms, and availability of

credits from large, low cost sources.

Specific drivers for the primary types of carbon asset project-based credits from the Kyoto

Mechanisms (CERs and ERUs) and allowance-based units (AAU) and their performance against

these factors have been discussedbelow.

3.1 Kyoto Protocol Mechanisms

The demand-side of Kyoto Protocol units (AAUs, CERs and ERUs), include the government demand from

nations where there is a shortfall of Kyoto Protocol compliance, and the private sector demand,

primarily from the EU ETS.

While, there are two key sources of Kyoto Protocol units on the supply-side: supply from Kyoto

Protocol party countries having a surplus - a group comprised principally of the post-Soviet

countries and supply from project-based mechanisms.


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3.1.1 Assigned Amount Units

Economic restructuring and shutting down of inefficient communist-era power plants and industrial

facilities have resulted on bringing down emissions since 1990 records and creating a huge surplus of

AAUs for some central and eastern European countries.

These AAU vendor countries include Russia, Ukraine, Poland, the Czech Republic, Latvia and Hungary.

In actual terms, around 46% of surplus AAUs lies with Russia, 30% with Ukraine and the remaining

24% lies with countries of the former Soviet Union in Eastern Europe.

Figure 2

Strict international emission trading eligibility standards and UNFCCCs rules specifying that a

percentage of AAUs held by surplus countries must be kept either in voluntary reserves or banked

for use in future periods act as limitations for estimating the supply of AAUs.

Developments in Russia and Ukraine will signal the likely volume of AAUs brought into the market

as these two nations together account for around 75% of the total surplus AAUs. These countries

are thought to be wary of flooding the market withAAUs and potentially driving a price crash.


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Figure 3

With eight billion surplus AAUs in the system, as shown in Figure 3 and estimations about up to

1.5 billion AAUs can be traded in the market by 2012, any Annex B countrys Kyoto Protocol

compliance shortfall can be easily met by purchasing AAUs, rather than employing domestic GHG

reduction measures or competing in the international market for Kyoto Protocol compliant CERs and

ERUs. Demand for additional AAUs from EU countries (due to their excess emission) is estimated

to be around 0.770 billion units by 2012, some 10% of the total AAU surplus. This demand is

expected to be limited due to recession in 2009 which resulted into sharp decline in emissions.

3.1.2 Project-based Mechanisms

The supply-side picture is shaped by the project pipeline for CDM and JI projects. Given the nature of

CDM, the supply of CERs will always meet its demand (current and future) based on the prevailing

primary market prices. However, there are three primary constraints due to which issuances have

been affected:

Tightening of UNFCCC rules and regulations making project eligibility and CER issuance

criteriamore stringent

Frequently suspension of validators like DNV, SGS and TUV SUD: Validators had number of

projects under validations and during their suspension time these projects were validated by

other entities tookmore than usual time to validate the project to ensure that all the rules are

duly met and they do not come underscrutiny by UNFCCC


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14 |

Both UN and validators

declining and projects are

Technical issues with pro

Joint Implementation project

registered or in the pipeline,

market.

3.1.3 Projection of CDM c

An analysis had been done on CE

the issuance and projects registra

A critical analysis of the figure

deficiency of CERs in the market.

In 2010, issuance is much

this year

After analyzing the issuan

March with an average of

declined to 4 million


ave shortage of manpower, as a result of

going throughbottlenecks of pipeline

ects and less number of quality projects avai

still being under developmental stage and

he meager volume supply of ERUs have negli

edits supply

Rs issuance and projects registered. The foll

tion under CDM in different time frames:

Figure 4

4 and 5 highlight the declining issuance a

rom the above charts, following analysis can

below the average and thus it is expected th

ce per month, the maximum issuance takes pl

10 million CERs. But in 2010, the same month

hich issuance rate is

ability in the market

ithnot many projects

gible effect on the

wing chart represents

nd probable long run

e drawn:

t YoY issuance will fall

ce in the month of

issuance has been


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15 |

The rate of issuance h

registration. Thus, it ca

CER/project) had decline

Even if, 2009 was the go

issuance has been noticed

In the light of the existing constr

supply scenarios. We see differen


Figure 5

s not been increasing in proportionate to

be concluded that the size of registered

od year in terms of total issuance per year

starting from May in the same year

ints on CDM supply, we have constructed a

pictures based variation in constraints on th

the rate of projects

projects (in terms of

but substantial cut in

odel to quantify CDM

CDM supply.


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16 |

Figure 6 show the three scenario

0.408 bn. The highly optimistic s

1.389 billion tCO2e are issued b

billion by the end of 2012. This

issuance of 1.05 billion by the en

less than 3 years against the curr

supply constraints, achieving suc

Medium and low optimistic scen

CERs respectively. Projecting th

representing a total issuance of

Figure 4, gives us the low optimis

expects that the supply will purs

million CERs/month. This rate s

registration and issuance rate.

Actual Issuance

till April 2010

CERs 408.81 Million


Figure 6

split over time. The actual CER issuance as

enario represents that CERs equivalent to th

the end of 2010. This would require in tot

s seen as a highly unlikely scenario because

of 2012, required issuance rate stands at 19

ent average 5.5 million CERs/month in last 6

issuance would require tremendous efforts.

rio represents a total issuance of 0.715 billio

e average historic rate, gives us the Mediu

0.715 billion CERs. Factoring the periodic h

ic Scenario representing a total issuance of 0.

e medium scenario in which required rate o

ems achievable considering current project

Highly Optimistic

Case

Medium

Issuance Rate

Case

1.05 Billion 715 Million

n April 2010 stands at

entire EU ETS limit of

l CER issuance of 1.05

in order to meet total

million CERs/month in

years. Considering the

CERs and 0.62 billion

m optimistic Scenario

iccup trend as seen in

2 billion CERs. Author

issuance stands at 10

in pipeline, rejection,

Lower Issuance

Rate Case

620 Million


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3.2 EU Emission Trading Scheme

Under the mandatory EU ETS cap-and-trade scheme, understanding of the mechanism is critical to

accurately determine the demand and supply of allowances (the cap) and credits. In EU ETS, there

are three main drivers of demandand supply:

The ability to bank allowances from one compliance period to the next: linking compliance

periods by allowing banking encourages regulated entities to bank allowances into future

periods, broadly supporting the scheme allowance price

The size of limits on use of international units such as CERs/ERUs, for compliance

purposes: As prices of credits increase, the volume of internal abatement becomes

economically attractive

Sensitivity to external market factors, in particular the price of fuel (oil, coal, and gas): Its

the effect of the cost of switching between coal and gas for power generation companies.

Power producers keep on switching from coal to gas or oil as the prices of these

commodities move in international market. Subsequently it impacts carbon credit demand

(due to different emission factors of different fuels) to meet emission reduction targets

3.2.1 Emission targets and projections under EU ETS phase II

The EU ETS only covers around 40% of the total EU GHG emissions, focusing on the CO2 emissions

from heavy industry. Non-CO2 emissions from heavy industry, as well as GHG emissions from

households, agriculture and transport, including aviation, are not included in this scheme. Given the

global significance of GHG emissions from the power- generation sector, reducing emissions from the

European power sectormay therefore bededuced asone of the majoraim of the EU policy.

Figure 7 below shows the emission cap imposed under EU ETS phase II and the projections for the

expected total emissions from 2008 to 2012. The projections are split between the EU 15 and the other

EU countries.

Initial analysis of EU ETS Phase II reveals a net shortfall in the system of around 430 MtCO2 which

can be easily met by using international offsets, however, the actual net demand lies in the

framework of EU ETS phase III, supply of carbon credits from project based mechanism and the

spread between the EUA and CER price. In order to gain a much clearer picture of the net demand,

it is necessaryto understandthe framework of EU ETS phase III.


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Figure 7

3.2.2 EU ETS phase III - Carbon market driving force

On 23 January 2008 the European Commission set out its vision for the future of the EU ETS in an ETS

Review. The Review outlines a set of proposals to revise the framework of the ETS for Phase III, the

most important of which are:

Recommending the ETS cap for Phase III be set at 1,974 MtCO2e in 2013, witha linear decrease

to 1,720 MtCO2e by 2020

If no successor treaty to Kyoto is signed, the use of CERs/ERUs in Phase III will be restricted

to the total unused portion of the limit set for Phase II. This means that the limit set for Phase

II would become absolute, and only those CERs/ERUs not actually surrendered in Phase II

would be available for use in Phase III

If an international agreement is reached and it comes into force by 2013 and the EU agrees

to raise its emissions reduction target against 1990 levels from 20% to 30% then the

Review recommends provision of additional quotas of CERs/ERUs for Phase III

There will be no change to the provision allowing for unlimited banking of EUAs from one

phase of the scheme to the next. This means that any EUA not used in Phase II may be used at

face value in PhaseIII

Above features of phase III will encourages regulated entities to bank as much phase II allowances as

possible.


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3.2.3 Net Demand-Supply under phase II

The ability to bank allowances, known as bankability, from Phase II to Phase III has significant

implications on the pricing of Phase II EUAs. Further, the demand and supply dynamics in a trading

scheme with non-bankable phases is very different from bankable phases. Market expectations of a

tighter cap in Phase III may make Phase II EUAs more valuable to compliance buyers, amid

anticipation of additional scarcity of allowances in Phase III. This would force regulated entities to

utilize their international offset limits which is around 1.4 billion first through CERs and ERUs.

Figure 8

Figure 8 shows a summary of the expected compliance strategies reflecting the net supply of

CERs/ERUs till 2012, excess emission and bankable EUAs under phase II and unutilized limits of

meeting targets from international offsets.

In the above chart, considering a medium case scenario its expected that supply of CER/ERU will be

around 743 million and considering excess emissions in EU ETS it is expected that about 430 million

credits will be used to meet compliances and rest 313 million can be used to bank EUA as it is going to

be costlier than CER/ERU in Phase III, together with that an unused limit of 646 million will be

available in Phase III.


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4. Other Emerging Schemes:

4.1 US Carbon Market

A number of state-based and regional initiatives have emerged in America over the past few years for

implementing emissions trading programs and influencing federal schemes. The future of these

schemes and interest in carbon instruments issued by them will largely depend on their treatment

in upcoming legislation at the Federal level.

USA has many Bills on table that support emissions reduction in one or the other form. Demand for

carbon credits under a US cap-and-trade scheme will likely be subject to some limits on the use of

offsets for compliance, particularly international offsets.

Simulations suggest that international offsets could provide a source of relatively inexpensive credits

that would reduce GHG allowance prices and the compliance costs in a US Federal trading program. In

particular, allowing international project credits (such as CERs and ERUs) for compliance in a US

program could create a significant demand for these instruments if they are competitively priced

relative to the US allowances, the US offsets or both.

4.1.1 RGGI

The Regional Greenhouse Gas Initiative (RGGI) is the first mandatory, market-based effort in the

United States to reduce greenhouse gas emissions. Ten north-eastern and Mid-Atlantic states have

capped and will reduce CO2 emissions from the power sector 10% by 2018. Market activity in the

RGGI gathered steam in 2008 in preparation for the official 2009 start of operations, and interest has

grown significantly during the first half of this year.

Prices of RGGI Allowances (RGGA) is now reported to be around $3.90 per short tCO2e (3 per short

tCO2e) in a market that is likely to be bullish in its starting years. Analysts consider that likelyfungibility of RGGI Allowances into the federal system, along with the possibility of banking to later

RGGI phases, has possibly helped in keeping the price above the $1.86 auction reserve price.

4.1.2 Western Climate Initiative

The WCI covers a group of seven US states (Arizona, California, Montana, New Mexico, Oregon, Utah

and Washington) and four Canadian provinces (British Columbia, Manitoba, Ontario and Quebec),


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with an aggregate emissions target of 15% below 2005 levels by 2020. Other US and Mexican states

and Canadian provinces have joined as observers. Cap and trade would here again be a major

instrument, and transition modalities to a federal cap and trade scheme are now considered under the

W-M draft bill.

4.1.3 American Clean Energy and Security Act (ACES Act), 2009

On 26 June, 2009, the American Clean Energy and Security Act (ACES Act) was passed by the US House

of Representatives by a vote of 219 to 212. The bill contains five distinct titles: I) clean energy, II)

energy efficiency, III) reducing global warming pollution, IV) transitioning to a clean energy economy

and V) agriculture and forestry related offsets. Title I contains provisions related to a federal

renewable electricity and efficiency standard, carbon capture and storage technology, performance

standards for new coal-fuelled power plants, R&D support for electric vehicles, and support for

deployment of smart grid advancement. Title II includes provisions related to building, lighting,

appliance, and vehicle energy efficiency programs. Title IV includes provisions to preserve domestic

competitiveness and support workers, provide assistance to consumers, and support for domestic and

international adaptation initiatives. The following is a brief overview of the proposed GHG cap-and-

trade program contained in Title III and Title V.

The bill establishes emission caps that would reduce aggregate GHG emissions for all covered entities

to 3% below their 2005 levels in 2012, 17% below 2005 levels in 2020, 42% below 2005 levels in

2030, and 83% below 2005 levels in 2050. Commercial production and imports of HFCs would be

addressed under Title VI of the existing Clean Air Act and are covered under a separate cap. The bill

also establishes economy-wide goals for all sources, but it is not limited to those covered under the

cap-and-trade program. These goals are the same percentage reduction and timetables as the cap-

and-trade program, except that the 2020 target is 20% rather than 17% below 2005 levels.

4.1.4 American Power Act, 2010

Senators John Kerry and Joe Lieberman on 12 May, 2010 released the discussion draft of a

comprehensive bill intended to create jobs, enhance national security, spur clean energy innovation,

and protect the environment. The Kerry-Lieberman American Power Act (APA) will allow emitters to

use up to 2 billion offsets - 1.5 billion credits from domestically sourced projects and the rest from

international projects.


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Pledging to engage Senator colleagues, Senators Kerry, Graham, and Lieberman have been working

over the past several months to build consensus within the Senate to pass the legislation, which will

include:

A market-based solution to achieve pollution reduction targets regulated - in the short term in

the range of 17% and in the long term 80%below 2005 levels.

Investments to develop and deploy new clean energy technologies, including nuclear energy,

renewable energy, clean coal, and energy efficiency.

Increased domestic production of oil and natural gas onshore and offshore.

Transitional support for low- and middle-income families to ease costs and for businesses to

ensure compliance and avoid carbon leakage.

A mechanism to moderate the price of carbon to prevent market volatility and vigilant carbonmarket oversight.

Domestic andinternational offsets.

A strong, international agreement with real, measurable, verifiable and enforceable actions by all

nations, long-term financial assistance to developing countries, and enhanced technology cooperation

with intellectual property rights protection.

4.2 Tokyo ETS

Tokyo, in April 2010, introduced the world's first urban cap and trade program for around 1,400 large

installations, such as office buildings (1,100) and factories (400), where per annum consumption of

fuels, heat and electricity is 1,500 kiloliters or more. The scheme has two compliance periods of five

years each starting FY2010. The emission reduction target has been fixed at 6% for five years average

during first compliance period; the target shall increase to 17% reduction below base year emissions

during the second compliance period starting FY2015. Monitoring and reporting of emissions shall be

done annually

Further, all reductions exceeding the yearly obligation may be traded from the second year.

Offsets can be made done in the following ways:

Emission reductions from small and midsize installations within the Tokyo area

Emission reduction by energy-saving measures

Buyer can buy necessary amount without limit

Renewable Energy Certificates


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Solar (heat and light) energy, wind energy, geothermal energy, hydropower energy (under

1000kW), biomass energy (biomass rate 95% or above)

Emission reductions outside the Tokyo area but within Japan

Coverage: large installations with less than 150 thousand ton base year emission Large installations will be assumed to be covered under the Tokyo Cap-and-Trade Program,

and reduction exceeding the reduction obligation would be counted as offset credit

Buyer can only buy up to 1/3 of base year emission Offsets

All violators shall be imposed with a monetary fine of around 500 thousand yen plus they shall

be required to reduce 1.3 times the shortage.

4.3 UK CRC Energy Efficiency Scheme:

In order to achieve their GHG emission targets of at least 80% reduction by 2050 as compared to 1990

baseline, UK has launched a mandatory legal scheme that aims to improve energy efficiency and

reduce the amount of carbon dioxide (CO2 ) emitted. The CRC (Carbon Reduction Commitment)

scheme has begun in April 2010 and will affect large organizations in both the public and private

sector. Around 20,000 organizations that had at least one half hourly meters settled on the half hourly

market in 2008 will be required to participate in some way or the other under the CRC scheme. The

participants will have to monitor their emissions and purchase allowances, initially sold by

Government, for each tonne of CO2 they emit. The more CO2 an organization emits, the more

allowances it has to purchase.

During the introductory phase of three years, allowances will be sold at a fixed rate of 12 per tonne of

CO2. Following the initial sale period, participant organizations can buy or sell allowances by trading

on the secondary market.

Any entity that fails to comply with its legal obligations under the CRC will be subject to different

financial as well as criminal penalties.

4.4 REDD

Efforts to mitigate the dangers of climate change revolve around the overarching goal of holding the

average increase in global temperatures to well below 2C.

The Bali Action Plan, which emerged from COP13 in late 2007, officially put REDD back on the

UNFCCC agenda. But under the Action Plan, if REDD is to be included in the post-2012 framework,


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decisions about the scope of REDD, who will pay for it, and how a mechanism will be structured, yet to

be agreed upon.

Significant progress has been made under the Bali Plan as in the intervening period, a number of

REDD focused workshops have taken place; many countries have submitted proposals and a

negotiating text including various options for REDD, is now on the table. However, substantial work

remains if a coherent REDD mechanism is to be successfully included in the post-2012 agreement.

Over the past year, competing interests have led to a convergence toward a broader scope, referred to

as REDD+. There is little agreement as to which activities REDD+ would actually incorporates and how

it would be structured. A phased approach to REDD is favored by many countries as a way of

providing support to developing nations as they build their capacity to tackle and monitor emissions

from deforestation. The source of financing for REDD is an area where there are a range of different

proposals from governments.

In addition, there are questions raised by some governments as to how much REDD should

incorporate safeguards or benefits for broader forest values, such as biodiversity and livelihoods.

REDD policies must be consistent with national sustainable development objectives that promote

conservation and biodiversity, and protect the rights of local communities and indigenous peoples.

REDD is a vital component of the global emission reductions required. A global objective of zero netdeforestation through a 75% reduction in gross deforestation by 2020 should be adopted. To achieve

this, a reasonable scope for REDD must be established. Care should be taken that any activities

included under the scope of REDD can deliver real and verifiable emissions reductions.

It is vital that the final text of the post-2012 agreement include firm commitments from developed

countries to provide financial and technical support to developing countries, including for the early

phases of REDD. A phased approach should be agreed on by the UNFCCC, which ensures that

developing countries are provided with a support to build their capacity and test approaches to worktowards national REDD programmes. Finally, the post-2012 agreement should recognize the broader

values of forests and processes must be put in place to ensure that the impact of REDD projects on

biodiversity, indigenous peoples, and local communities is positive. It is essential that a robust,

effective REDD mechanism be formally adopted in the post-2012 UNFCCC framework. With

deforestation accounting for approximately 20% of global GHG emissions, it is clear that any solution

to the climate change problem must include a solution to deforestation. Getting REDD on ground

would quantify these emissions and thereby increasing demand of carbon credits.


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5. International Aviation and Shipping Emissions

GHG emissions from international aviation and maritime fuels, known as bunkers, account for nearly

10% of the climate problem and are growing rapidly. The EU has also proposed a specific globalagreement on reducing GHG emissions from aviation and shipping. International shipping emits 870

milliontonnes of CO2 each year which is more thanthe total emissions of UK orCanada.

Emissions have grown by more than 85% since 1990, the base year of the Kyoto Protocol. CO2

emissions from aviation exceed 730 million tonnes annually - up well over 45%since 1990. Additional

climate impacts from other exhaust gases and cloud effects are around double than those of CO2.

Overall, aviation is responsible for 4.9% of global warming today. International aviation emits more

CO2thanthe total emissions of France orAustralia.

In 1997, the Kyoto Protocol gave responsibility for these emissions to developed (Annex I) countries

working through the International Maritime Organization (IMO) and the International Civil Aviation

Organizations (ICAO).

These agencies failed to agree on any binding measures to control GHG emissions in the ensuing 12

years. Both these organizations have submitted proposals for only modest efficiency and operational

measures that too mostly voluntary orpartial in scope at COP15, Copenhagen

If left unmitigated, emissions from aviation and shipping are further expected to double or even triple

by 2050, forming by then a very significant proportion of a global carbon budget consistent with

keeping warming below 2 C.

UNFCCC could take the necessary action for controlling emissions from these sectors in two ways:

By including emissions in national totals of Annex I Parties, purely as an accounting measure.

This would be straightforward for aviation, where bunker fuel emissions are a good indicator

of activity.

By setting targets for the two sectors, and mandating IMO and ICAO to develop and agree on

global sectoral policies within a limited timeframe and subject to UNFCCC review.

Discussions in IMO and ICAO are currently deadlocked over whether policies should be global or

differentiated, voluntary or mandatory. Various ways to include emissions from international aviation

and shipping in the global climate framework that could raise substantial revenue for the adaptation

and the low-carbon development have been proposed, but not agreed.


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NGOs believe that the international transport policies should be mandatory and global since, the

sectors are inherently global in nature. IMO and ICAO have developed many global policies in other

areas that are neutral with respect to the nationality of the operator. Besides, global approaches are

themost environmentally robust and are instrumental in avoiding leakage.

Operators of all nationalities are treated equally in these proposals, to avoid competitive distortions

and in line with IMO and ICAO principles. Differentiation is applied in the use of revenues, thus

respecting the principle of Common but Differentiated Responsibilities (CBDR) which says that

revenues raised by global policies (levied mostly on well off consumers) should be spent on climate

protection in developingcountries.

Such policies could raise about $10 billion giving a real boost to efforts to finance a comprehensive

climate mitigation deal. As an effect of inclusion of shipping and aviation sectors in international

emissions demand of credits will raise considerably as national governments may ask airline and

shipping companies to compute their carbon foot printing and offset it against quality credits like

CER/ERU.


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6. Post-2012 Market Frameworks

Events like failed negotiations under the United Nations Framework Convention on Climate Change

(UNFCCC) at Copenhagen in December 2009 on binding emissions commitments, signing ofCopenhagen Accord with no legal binding emission targets, uncertainty in passing and

implementation of long awaited US climate bill and stringent targets under phase III of EUETS has

divided the future of carbon market mechanism into different scenarios. This report analyses these

scenarios in the perspective of how they will affect the project basedmechanisms.

6.1 Only EU ETS scenario

The European Commission has signaled, via its post-2012 proposal for the EU ETS, that additional

demand for CDM and JI credits will be contingent on a successor treaty to the Kyoto Protocol being

implemented. Under the European Commissions proposal, if there is no new international agreement,

the present limit on importing international units for compliance purposes within Phase II of the EU

ETS would be extended into the next compliance phase effectively placing a limit on imports equal to

the unused portion of the limit in Phase II.

This means that the volume of CERs and ERUs from CDM and JI projects which could be used across

Phases II and III would be capped at 1390 MtCO2e, the present Phase II limit.

With reference to Figure 8, its expected that supply of CER/ERU will be around 743 million.

Considering excess emissions in EU ETS, about 430 million credits will be used to meet compliances

and rest 313 million can be used to bank Phase II EUA, as full banking is allowed by EU commission

and EUA will be costlier than CER/ERU in Phase III, an unused limit of 646 million will be available in

Phase III.

6.2 Extension of Kyoto with EUETS but without US Scenario

If a new international agreement to succeed Kyoto Protocol comes into force, assuming that targets

taken under Copenhagen accord except EU remain same, then the EU ETS Phase III will have much

tougher emissions targets of 30% as compared to the current 20% imposed on regulated entities, and

a higher limit on importing international units. This will continue to drive the substantial activity in

the project-based mechanisms.


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Figure 9

6.3 Copenhagen accord scenario

The Copenhagen Accord, a political agreement struck by world leaders at COP 15,Copenhagen, calls on

participating countries to pledge specific actions that they will individually and conditionally

undertake to mitigate GHG emissions. This is for the first time ever that the entire worlds major

economies (US, Japan, Australia, etc.) have offered explicit international climate pledges.

Figure 10 Source: Bloomberg


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In case of Annex I countries, the nonbinding Accord calls for a quantified economy-wide emission

targets for 2020. In case of non-Annex I countries, it calls for nationally appropriate mitigation

actions, but does not specify what form they should take. (Least developed and small island countries

may undertake actions voluntarily and on the basis of support)

On 26 April, 2010, 96 parties (considering the 27 member states of the European Union as a single

party) had filed submissions with the U.N. climate change secretariat:

16 Annex I countries submitted 2020 emissions targets ;

36 non-Annex I countries submitted mitigation actions; and

44 other non-Annex I countries associated with the accord.

With current pledges, post 2012 demand from project based mechanism could be 6754 Mt

(Figure 10) which is twice that in the Kyoto Protocol period with major demand coming from

the EU and the US.


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30 |

7. Price Forecast

The price difference between EU

the Project based emission redAllowances (EUAs) the main reas

cost of carry associated with

Historically, CERs have been aver

Carbon emissions being directly

factors as the price drivers of Car

1. Crude Oil

2. Natural Gas

3. Power Prices

4. Demand & Supply of credi

5. Temperatures & Water le

6. Economic activity (GDP,

Confidence Indicator)

7. Euro-Dollar spread


s and CERs is called the EUA/CER Spread. I

uction units (CERs) are priced lower thanons being, CERs are considered as a supplem

UA. Thus CER prices are primarily, deri

gely priced at 80% of that of EUAs.

Figure 11

inked to the activities of a nation, we have i

on Credits.

ts

el

Productivity Index, Economic Sentiment

is generally seen that

the European Unionnt to the EUAs and the

ed from EUA prices.

dentified the following

Indicators, Industrial


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31 |

The impacts of above different f

theory behind the inclusion of fa

factors on carbon prices using

Regression Analysis to predict th

After performing the detailed

Hetroscadicity and Multicolineari

ones- Crude Oil, Power Prices and

An analysis of potential develo

evolution of the carbon market a

alternate post-2012 scenarios m

in post-2012. The factors driving

post-2012 been taken before 20

be fully on ground before 2013.

Figure 12 shows the projection o

Carbon Market is expected to be

the end of first commitment pe

commodities and thus provides a


ctors on Carbon prices are varied dependi

tor. This created a necessity for quantificatio

n appropriate quantification tool. We have

e carbon prices and determine the probability

ultiple Regression Analysis and adjusting

y, the factors have been further filtered out t

Gross Domestic Product.

ments post-2012 is important in underst

d likely price of carbon. However, according

ntioned in the report would affect the CER p

re-2013 prices remain more or less unaffect

3 because the implementation of the alterna

Figure 12

EUA and CER prices based on the Multi Line

bullish in near future and price are most lik

iod in 2012. Carbon credits as of now see

d ideal investment opportunity.

g on the fundamental

n of the effect of these

used Multiple Linear

of prediction.

for data errors like

three most influential

nding the longer run

to our research, all the

rices and demand only

d with any decision on

e scenarios would not

r Regression Analysis.

ly touch new highs by

s to be undervalued


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Annexure 1: Methodology

Accurately recording project-based transactions is becoming more difficult even for agencies such as

the World Bank as each year complexity of market and factors involved is increasing dramatically. Theauthor has analyzed the collected information from major carbon-industry publications and the

coverage of a wide range of market players to gain a broader view on trends of the market.

Author has focused on the regulatory compliance based markets (Kyoto Protocol & EU ETS);

therefore, the coverage of the voluntary segment of the market is not exhaustive. Only projects with

issued CERs are considered in the report database. Although the analysis of key inputs from IMF,

World Bank, UNEP Risoe and UNFCCC publications was done. Various statistical tools have been used

for projecting the future data. The accuracy of data exceeds 90% (confidence level) in most cases.

Since most of the data is from secondary sources, author do not hold responsibility of its correctness,

however these sources are considered to be most trusted across the globe, and hence we have

mentioned a tolerance range of (+/-) 10%. The author considers that the analysis in this report

provides a conservative estimate of the carbon market and provides a good representative view of the

carbon market.

Prices have been expressed in US Dollar ($) or Euro () or Sterling Pound () per tCO2e. All facts

presented in the report have been deduced after comprehensive processing of the data. This data was

collected from various sources and an optimum mix of all has been used; thus, individual data source

is not mentioned with every graph and table. Due courtesy has been given where ever the author has

used opinion/projections of other market players.

CDM supply data is based on facts and figures as per UNFCCC. Projects registered till March 2010 were

taken into consideration for YoY supply estimation.

Data of project-based markets, carbon credits, daily price and volume information on allowancesmarkets is available online. The readers are invited to do their own comprehensive due diligence of

the market prior to taking any financial position, and in this regard nothing in this report should be

seen as constituting advice to take a position on the market as a whole, or any component there-of.


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Annexure 2: Glossary

Assigned Amount Unit (AAU):Annex I Parties

are issued AAUs up to the level of their

assigned amount, corresponding to the

quantity of greenhouse gases they can release

in accordance with the Kyoto Protocol (Art. 3),

during the first commitment period of that

protocol (2008-12). AAUs equal one tCO2e.

Carbon Dioxide Equivalent (CO2e): The

universal unit of measurement used to indicate

the global warming potential of each of the six

greenhouse gases. Carbon dioxide a

naturally occurring gas that is a byproduct of

burning fossil fuels and biomass, land-use

changes, and other industrial processes is

the reference gas against which the other

greenhouse gases are measured.

Certified Emission Reductions (CERs): A unit

of greenhouse gas emission reductions issued

pursuant to the Clean Development Mechanism

of the Kyoto Protocol, and measured in metric

tonnes of carbon dioxide equivalent. One CER

represents a reduction of greenhouse gas

emissions of one tCO2e.

Emission Reductions (ERs): The measurable

reduction of release of greenhouse gases into

the atmosphere from a specified activity or

over a specified area, and a specified period of

time.

Emission Reduction Units (ERUs): A unit of

emission reductions issued pursuant to Joint

Implementation. This unit is equal to one

metric ton of carbon dioxide equivalent.

European Union Allowances (EUAs): the

allowances in use under the EU ETS. An EUA

unit is equal to one metric ton of carbon

dioxide equivalent.

Greenhouse gases (GHGs): These are the

gases released by human activity that are

responsible for climate change and global

warming. The six gases listed in Annex A of the

Kyoto Protocol are carbon dioxide (CO2),

methane (CH4), and nitrous oxide (N20), as

well as hydrofluorocarbons (HFC-23),

perfluorocarbons (PFCs), and sulfur

hexafluoride (SF6).

Land Use, Land-Use Change and Forestry

(LULUCF): A greenhouse gas inventory sector

that covers emissions and removal of

greenhouse gases resulting from direct human-

induced land use, land-use change and forestry

activities. Expanding forests reduce

atmospheric carbon dioxide; deforestation

releases additional carbon dioxide; various

agricultural activities may add to atmospheric

levels of methane and nitrous oxide.

National Allocation Plans (NAPs): The

documents, established by each Member State

and reviewed by the European Commission,

that specify the list of installations under the

EU ETS and their absolute emissions caps, the


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amount of CERs and ERUs that may be used by

these installations as well as other features

such as the size of the new entrants reserve

and the treatment of exiting installations or theprocess of allocation (free allocation or

auctioning).

Offsets: Offsets designate the emission

reductions from project-based activities that

can be used to meet compliance or corporate

citizenship objectives vis-- vis greenhouse

gas mitigation.

Project-Based Emission Reductions:

Emission reductions that occur from projects

pursuant to JI or CDM (as opposed to

emissions trading or transfer of assigned

amount units under Article 17 of the Kyoto

Protocol).

Reducing Emissions from Deforestation and

Forest Degradation (REDD): A set of

strategies and incentives (including

performance-based) for reducing emissions

from deforestation and degradation.

Regional Greenhouse Gas Initiative (RGGI):

RGGI targets CO2 emissions from power sector

in ten U.S. Northeast and Mid-Atlantic states,

with a target of 10% below current levels by

2020.

Registration: The formal acceptance by the

CDM Executive Board of a validated project as

a CDM project activity.

United Nations Framework Convention on

Climate Change (UNFCCC): The international

legal framework adopted in June 1992 at the

Rio Earth Summit to address climate change. It

commits the Parties to the UNFCCC to stabilize

human induced greenhouse gas emissions at

levels that would prevent dangerous manmade

interference with the climate system.


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Bibliography

UNFCCC

IMF

EU Commission

Carbon Market Data

World Bank Reports

Carbon Yatra

European Climate Exchange, London

Bluenext Exchange, Paris

Bloomberg New Energy Finance

WWF

Merrill Lynch

Goldman Sachs

Morgan Stanley Deutsche Bank

International Monetary Fund

European climate Exchange

BNP Paribas

Documents

Carbon Market Outlook 2010