Global Carbon Quarterly Q3 2009

8/14/2019 Global Carbon Quarterly Q3 2009

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September 2009 Global Carbon Quarterly Q3 2009

Executive Summary

With the worst of the financial crisis now firmly in the past, politicians may

be forgiven for believing that life will get a little easier. Many however are

finding that managing an economy out of recession was less taxing than the

decisions they now face on how to tackle climate change commitments to

reduce emissions made in the next year will have profound and long lasting

effects on their economies. In spite of the difficulties, governments are

showing some signs of wanting to come to an agreement, but with such

high stakes they are being very cautious and taking their time.Two pre-sessional meetings remain before the Copenhagen negotiations on 7-18 December, but

much work is still to be done on key sections of the draft text. There will certainly be reform of the

CDM, but the emission targets remain open. These can best be inferred from parties unilateral

actions and statements which taken together would be meaningful. They may not be enough to hit

the 20C temperature increase scientists say we need, but they would certainly lead to a significant

need for new investment and firm carbon prices in Europe, the US, Japan and Australia. Overall

we see the early signs of a consensus, although it may not fully emerge until sometime in 2010.

For this to happen the US has to be in the game and pass its cap and trade bill or an equivalent

piece of legislation. It is highly unlikely that other developed countries, perhaps with the exception

of Europe, will agree to meaningful reductions in emissions without the US involved a second

time. With health reforms taking up much of the Senate timetable a decision on the bill is now

unlikely this side of Copenhagen. This means that commitments from the other major parties at

Copenhagen are still likely to be conditional with the real hard talking happening in 2010.

India has joined China as a developing country that acknowledges it has a role to play in

combating climate change. Hard emissions targets for these countries are still very unlikely but

increasing emphasis is being placed on sectoral crediting as a means of encouraging them to

invest more in reducing the energy intensity of their economies.

Meanwhile, the existing carbon markets have been remarkably buoyant in the face of the

recession so much so that we see material risk of a price decline towards the end of 2009.

Figure 1: Carbon price projections from fundamentals/tCO2

Source: New Energy Finance

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CERs EUAs US Federal Scheme: Base Case

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Contents

Executive Summary 11.Global developments 21.1. Climate science and

events 21.2. Policy 41.3. Outlook for

international

negotiations 61.4. Long Term Outlook 82.Markets 92.1. International Market 92.2. Europe 122.3. North America 162.4. Australia 192.5. Developing

Countries 21


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1. Global developments

1.1. Climate science and events

This section on climate is a new addition to our GCQ report. We have included it because we

believe it is important for company strategists to understand the scientific information which is

driving climate change policy. Changes in the science, or the way in which it is presented or

perceived could be early indicators of changes in policy direction. We also cover some recentextreme weather events as we are mindful that politicians also make decisions based on recent

experiences, no matter how irrelevant they may be in the big scheme of things.

There is a growing consensus in the scientific community around the reality of climate change, and

new findings continue to influence the policy debate. The latest developments in climate science and

the public perception of climate change may have a disproportionate impact on policy in the medium

and long term owing to the potential significance of this years Copenhagen negotiations.

Awareness in the US was awoken by the Hurricane Katrina disaster in 2005. Whether or not this was

partly caused by climate change, Katrina brought a realisation in the US that dangerous climate

events can be hugely costly even to modern developed countries. In 2006 the Stern Review in the

UK, through its combined review of the science and economics of climate change, substantially raised

the profile of this issue adding momentum to the policy debate.

The past year has been relatively quiet in terms of headline-grabbing climate news, while the global

financial and economic crisis has been a more immediate concern. However, climate developmentshave remained sufficiently prominent that the Copenhagen negotiations should retain an urgency that

will be crucial if the negotiating parties are to craft a satisfactory global agreement.

Extreme weather events

Forest and bush fires in 2009 have

devastated vast tracts of land in Australia,

with some 200 casualties, California and

Greece. A causal link between climate

change and recent years fires is tenuous, but

the combination of high temperatures, low

humidity and drought conditions does in

general increase the risk of fires starting up.

Scientists expect the amount of land

destroyed and the frequency of these eventsto rise in the years to come.

Climate science

Two conferences in September probed the

latest findings in climate science. The most

widely discussed consequences of climate

change surround the direct effects of rising temperatures, but earth scientists raised the alarm

regarding the potential effects on geology at Climate Forcing of Geological and Geomorpholoical

Hazards in London increased torrential rainfall may accelerate erosion in countries such as the UK

and the disappearance of ice sheets at the poles causes underwater landslides.

At the World Climate Conference in September scientists discussed how decadal variability inherent

to the climate system (e.g. the North-Atlantic oscillation) could imply a temporary cooling phase

which may take place over the next decade. If observations confirm this hypothesis, support for

stringent carbon policy may weaken as politicians respond to present days experiences rather thanscientific forecasts.

Figure 3 illustrates the degree of medium-term climate variability that appears to occur in the global

climate.1 This shows that for much of the time the global average temperature may fall over multiple

years, even if global warming is set to force a 4C rise in the global average temperature by 2100. For

example, the historical temperature record shows that the period from 1975-2008 was subject to an

unprecedented level of rapid warming, but across some long periods the globe actually got slightly

1The curve marked Typical Climate Variability was generated by an autoregressive model suggested by Mojib Latif, Leibniz Institute of

Marine Sciences, Kiel University, Germany, in his presentation titled Advancing Climate Prediction Science Decadal Prediction.

Figure 2: Californian forest fires capture media and

public attention

Random fluctuations in

worlds climate could mask

long term climate trends. Will

politicians be swayed byrecent experiences or listen

to the scientific forecasters?


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cooler (1977-1985, 1981-1989, 1998-2008).2 Brokering a global agreement to tackle global warming

is recognised as a huge challenge. The issue of decadal climate variability could make it all the more

difficult if the media and public perceptions latch onto medium-term phenomena that suggest an end

to the long-term warming trend.

Figure 3: Medium-term climate phenomena could mask the long-term trendRealistic global average temperature variability (C)


Geoengineering

Also in September the Royal Society released a report examining technical solutions that may be

available if governments fail to muster sufficient emissions reductions to keep the increase in

temperature below 2C. The report highlights geoengineering approaches to counteracting the effects

of climate change.

Most of the scientific community has tended to view geoengineering with scepticism, but this report

signals a constructive attitude towards the field and a desire from the Royal Society to be fully

involved in the assessment and development of realistic options. A distinction is made between

solutions aiming at reducing the incoming solar radiation through reflection techniques (Solar

Radiation Management) as opposed to Carbon Dioxide Removal (see Figure 4). The two approaches

could both be applied to reduce global temperatures, but they act on different time scales and would

interact differently with other aspects of the environment.

The techniques for Solar Radiation Management include injecting small reflective particles into the

upper layers of the atmosphere and mirrors in space. These would involves large risks of adverse

interactions with other parts of the climate system and the environment, although they have the

advantages of potentially rapid implementation and should affect temperatures in a short time.

On the other hand, Carbon Dioxide Removal aims at lowering the concentration of carbon dioxide in

the atmosphere to tackle the cause of climate change directly. This has yet to be demonstrated at

scale, would affect climate change more slowly than Solar Radiation Management and none of the

new approaches to Carbon Dioxide Removal competes on a per-tCO2 cost basis with abatement

measures usually discussed on the mitigation side. However, in principle Carbon Dioxide Removal

techniques could be funded by a carbon price if technical advances made them preferable to reducing

emissions.

The reports main conclusion is that geoengineering is no substitute for emissions reductions at the

current time, although government policy should directly fund further geoengineering research

because these techniques could be valuable in the future. Parties to the UNFCCC should makeincreased efforts towards mitigating and adapting to climate change and, in particular to agreeing to

global emissions reductions of at least 50% of 1990 levels by 2050 and more thereafter. Nothing now

known about geoengineering options gives any reason to diminish these efforts.

2See D. R. Easterling and M. F. Wehner, Is the climate warming or cooling?, Geophysical Letters, vol. 36, L08706.

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Typical climate variability

Trend

Geo-engineering research

continues but supporters

admit it is no substitute for

reducing emissions at source


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Figure 4: Geoengineering to avoid large temperature changes

(a) Carbon dioxide removal (b) Solar radiation management

Source: New Energy Finance, Royal Society

1.2. Policy

International negotiations at Copenhagen in December may produce a global agreement that

significantly shapes international policies to tackle climate change through to 2020 and beyond. At

this stage in the negotiations our view is that some form agreement will be reached outlining a

framework for binding caps on developed countries emissions. However, the route to agreement will

not be smooth and the level of 2020 reductions will be less ambitious than the levels that scientists

have been calling for.

Developed countries converge

The outlook for a global agreement looked bleak following limited progress at last years December

talks, but there have been positive signs throughout 2009. Despite the global financial crisis, and in

some cases as a direct consequence of it, developed country governments have made clear

statements of intent on climate change mitigation including substantial shares of their stimulus

packages being directed at the green sector. Proposals for legislation on new domestic climate

change initiatives are being debated in parliaments including the USA, Japan, Australia and South

Korea. Convergence in developed countries positions on the issue partly reflects their aims to

compete in green technology leadership over the coming decades. Assuming that material emissions

reductions are finally mandated internationally, those showing early ambition are likely to benefit

disproportionately in the long run from the business opportunities associated with this transition.

With the US likely to be the most influential negotiating party, the Democrats drive towards domestic

climate legislation should sit easily alongside international targets. However, Obamas health bill has

delayed developments in Congress, while the relative absence of a dramatic weather event the US in

2009 has contributed to a reduced sense of urgency on this issue in political circles and some parts of

the press. Domestic US legislation may not be passed before Copenhagen, so a degree of

uncertainty will hang over Obamas teams approach in December. Nevertheless, the latest amended

form of the Waxman-Markey bill should be the blueprint for the US position at Copenhagen.

Similarly the legislation for Australias Carbon Pollution Reduction Scheme (CPRS) has been beset

by delays as the governing Labour Party struggles with a less than dominant position in the Australianupper house. However, it still seems likely that the CPRS bill will pass in November, removing

ambiguity from Australias negotiating position just in time for Copenhagen (see Section 2.4).

Political change is now also underway in Japan where the newly elected government of the

Democratic Party of Japan (DPJ) will strengthen Japanese emission reduction efforts compared to

the currently stated 2020 target of an 8% reduction on 1990 levels. The DPJ ran on a manifesto of

ambitious green policies including a commitment to a potential 25% reduction on 1990 levels by 2020

(30% on a 2005 baseline) The election pledge would put Japanese ambition on a par with the

demands of developing countries. The full 25% target may not necessarily be adopted, It is likely that

international credit purchasing would satisfy a large proportion of the 25% target as it otherwise

requires Japan to reduce emissions by a third in eleven years in an efficient industrial economy which

Solar radiation management (SRM)

Increase radiationreflected(cloud albedo SRM)

Increaseradiation

reflected

(surface-based SRM)

EARTH

Incomingsolarradiation

Atmosphere

EARTH

Incomingsolarradiation

Atmosphere

Increaseradiationreflected

(space-based SRM)

Some form of agreement in

Copenhagen is likely but it

will be nowhere as robust

and as stringent as the

scientists would like

Developed countries have

much to gain from a stable

international policy

background.

Carbon dioxide removal

Iron fertilisationenhanced weathering

Afforestation biomass /biomass fuel with carbonsequestration /enhanced weathering

Carbonstorage

CO2 capturefrom ambient air

sea bed

soil


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has exhausted the majority of cheap abatement options. In any event, Japanese commitment to the

25% target (or other ambitious targets) will be contingent upon agreement at Copenhagen. This may

be similar to conditions attached to the EUs moving to a 30% target on 1990 levels and Australia

moving to 25% on 2005 levels by 2020.

Developing countries demand stiff targets for others

There remains no prospect of developing countries accepting quantitative caps on emissions in the

near or medium term. The dominant perspective among their representatives is that net reductions

should occur at the global level by means of ambitious cuts from developed countries whiledeveloping countries emissions continue to grow.

Bridging the gap between the positions of China and the US may be the key to a broader global

agreement. At the current time there is a material difference between them, although a Memorandum

of Understanding signed on 28 July stated the desire for cooperation on support for clean energy

technologies and a redoubling of efforts to find common ground for a deal at Copenhagen. The US is

unlikely to be able to compromise on its own emissions reduction targets; a repeat of the Kyoto

debacle where Congress failed to ratify the treaty would be a major embarrassment. However, it

seems more probable that Chinas initially extreme position has been chosen as a platform for

bargaining to gain on other issues. China may compromise on the absolute level of caps.

Developing countries are reluctant to adopt specific targets themselves

The acknowledgment that some form of coordinated action is required marks a change in the stance

of India and chimes with other statements from China that developing countries have a responsible

role to play in negotiations. This change in developing country attitudes is reflected in recentstatement by Indias Prime Minister: We are not able to undertake quantified emission reduction

targets but we are also quite clear that as citizens of the global economy we have an obligation to do

our bit to control emissions and therefore all countries have an obligation to be prepared to depart

from business as usual.

South Korea is the first country considered as developing under the Kyoto Protocol to announce a

quantified emission reduction target for the second commitment period. On 4 August President Lee

Myung-bak outlined three possible emission reduction targets, allowing for a 21%, 27% or 30%

departure from projected BAU growth in 2020.

Targets are not the only issue

Developing countries may be brought to the table by clauses of an international agreement that

promise large capital flows from developed to developing economies. The existing Clean

Development Mechanism (CDM) is one such initiative, where emission reduction projects in

developing countries can qualify for Certified Emission Reductions (CERs) that are then bought bydeveloped country actors as contributions to their own emission reduction targets. Multiple aspects of

the CDM are up for discussion.

The Copenhagen negotiations will include talks around new sectors that may be included under the

CDM. There is broad support for CER crediting for Carbon Capture and Storage (CCS) projects in

developing countries. More contentious topics will be whether or not to include forestry projects and

new nuclear power. While parties are divided on these points (see Figure 5) they are of relatively low

importance with respect to whether or not a global agreement can be secured.

Figure 5: Support for inclusion of new sectors under the CDM


The larger question around international crediting is the absolute volume of credits that may be

purchased by developed countries and the levels of other financial aid to support climate change

mitigation and adaption flowing from developed to developing countries.

In a position paper released in May, China demanded between 0.5-1% of developed country GDP to

finance adaptation, mitigation and technology transfer in developing countries. More recently the

Peoples University of Beijing published a study that material abatement in China could cost as much

as $438bn/yr by 2030 or 7.5% of GDP. India is yet to apply a specific value to the financial assistance

Japan

EU

USA

China

India

Forestry CCS Nuclear

There is still a perception

among developing countries

that they could be the losersat international climate if they

fail to secure recognition of

their needs for further

economic development.

The good news is that

developed and developing

countries alike agreed to theprinciple of limiting global

warming to 2C or less at a

meeting of the Major

Economies Forum (MEF) in

July...


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required but is adamant that funds should be publically provided and not reliant on the revenue

generated through the carbon market as is advocated by developed economies. Similarly, African

leaders agreed in August to ask for a substantial level of aid at Copenhagen in consideration of costs

to Africa incurred by global warming, for which Africa itself has almost no responsibility. The African

negotiating position will demand a net $67 billion in annual payments from developed countries.

Figure 6: Financial assistance

% of developed countries GDP


1.3. Outlook for international negotiations

Considering the similar levels of emissions reductions relative to the recent 2005 baseline, this looks

an increasingly promising basis for agreement at Copenhagen among developed countries. That said,

negotiating parties are leaving it late to find common ground. The UN led climate talks in Bonn on 14

August focussed on identifying areas of convergence and divergence rather than securing

agreement. Parties have yet to enter negotiating mode despite the looming deadline at

Copenhagen. If material progress is not made starting with the next round of talks in Bangkok, the

likelihood of a meaningful agreement in Copenhagen will fall to a critical level.

Table 1: Upcoming talks and meetings

Date Meeting Location Host Overview Projected outcomes

28 Sep-9Oct

4th

UN-ledclimate talksfor AWG-LCAand AWG-KP

Bangkok,Thailand

UNFCCC In these pre-sessionalmeetings, negotiators aimto produce and approve asmuch draft text as possible

ahead of COP15 inCopenhagen. Thesemeetings are likely tofocus develop lay outpossible proposals andoptions, but little materialdecision making isexpected.

Parties could make methodologicaland administrative headway on CDMreform, new technologies and newsectors (aviation and shipping).

Discussions will touch on the corecomponents of a post 2012agreement, though movement ontargets and financial assistance isunlikely ahead of Copenhagen.

2-6 Nov 5th UN-ledclimate talksfor AWG-LCAand AWG-KP

Barcelona,Spain

UNFCCC

7-18 Dec COP15 andmeetings forall subsidiarybodies

Copenhagen, Denmark

UNFCCC The official deadline foragreeing a post-2012agreement to replaceKyoto

Success at Copenhagen is largelydependent on what the US can offerand whether China agrees. If the USis unsuccessful in passing anydomestic legislation beforeCopenhagen, parties may just sign awatered down agreement withnumbers to be negotiated later

Source: New Energy Finance, various

Figure 7 illustrates key parties current negotiating positions on axes of targets and volumes: The

points for developed countries indicate their own reduction targets and their positions on the volume

of additional reduction credits that should be allowed in an international scheme. Points for

developing countries indicate their demands for reductions from developed countries. The circles are

sized based on country GDPs, indicating the relative weight that each negotiating party brings to the

table, with the red circle (Copenhagen) showing the weighted average position. Directions of

expected movement ahead of Copenhagen are indicated with dotted arrows.

Japan

EU

USA

China

India

Privatefunding

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

Across OECD countries the

past year has seen a shift

towards unilateral actions to

impose stringent caps on

domestic emissions.


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Figure 7: Major party positions Developed country target (% on 2005 baseline)


1) The stand-off on reduction targets between developed and developing countries is most likely to

be resolved by concessions on other issues.

The most important feature of a post 2012 agreement will be the developed country emission

reduction targets. Figure 7 shows the range proposed by major negotiating parties. Developing

country positions have shown signs of softening, while developed countries have relatively little room

for manoeuvre. Concessions on other issues may buy the support of developing countries.

2) The 2020 targets of developed countries from a 2005 baseline appear to be converging.

There appears to be a growing agreement on the part of developed countries on reduction targets to

2020 in the 13-17% range on 2005 emissions, while targets for Europe, Australia and Japan could be

even higher if a more comprehensive agreement involving developing countries is reached.

3) Financial support for developing countries may be the key area for concessions.

The main area for concessions appears to be financial assistance for developing countries, on which

point the parties negotiating positions are currently widely distributed. The amount and source of

financial assistance will prove critical particularly in terms of softening Chinas position in negotiations.

Indeed, Chinas initially extreme position on targets may have been taken to allow for compromise in

future rounds. Financial assistance sourced from public funds is the area where developed countries

can give ground. EU finance experts maintain that developing nations will need 100billion/year to

fund mitigation activity and a further 20-50billion to fund adaption. However, they are yet to confirm

the role that the EU will play in providing said funding.

4) The main determinant of the carbon price post-2012 is the supply of international offsets ..

A high volume of international credits at low prices would clearly reduce costs by reducing the volume

of abatement that is actually undertaken locally in developed countries. The other implication of a high

volume of international credits would be relatively lax domestic policies in the developing world,because emissions reductions may only qualify as offsets if they are additional to projects stimulated

by other policies.

5) with no-lose sectoral targets to become the preferred mechanism, perhaps from 2015.

The additionality requirements of CDM continue to pose problems for developing countries (see

Section 2.5) where domestic initiatives risk reducing revenue from international carbon crediting.

Equally, representatives of developed countries are concerned that to date some certified reductions

under the CDM may not in fact have been genuine. Therefore sectoral targets appear the preferred

mechanism for both developed and developing countries in the medium to long term. However,

International supply of credits

Carbon price (/t)

0%

4%

8%

12%

16%

20%

24%

28%

32%

36%

40%

44%

48%

100 -120

80 -100

60 -80

40 -60

20 -40

0 -20

Large volume of

cheap credits

Low volume of

expensive credits

EU

(14%)

US

(14%)

JPN

(15%)

AU

RU

CHNIN BR MX

Copenhagen


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dealing with the details on this complex topic means that sectoral targets are still unlikely to be in

place ahead of 2015, even if agreement on this issue is reached at Copenhagen.

1.4. Long Term Outlook

New Energy Finances Global Carbon Strategy Report presents four scenarios for carbon market

development, demand for abatement, carbon prices and economic impacts around the world on a

timescale running to 2050. The four scenarios considered of strategic interest are:

1) Global Greenery A world in which governments focus on climate change mitigation takingaction coordinated at the global level.

2) Coal Rules A world in which energy concerns are focused more on security of supply than on

climate change, although what action still occurs is coordinated at the global level, with support

for clean coal being a particular feature.

3) Clean Tech Governments are motivated to tackle climate change but globally coordinated

action proves difficult to broker. Instead there is a focus on support for technology transfer and

maximising the generation of green collar jobs.

4) Energy Autarky Energy is used as a political weapon in a more nationalistic fractured world with

pressures on security of supply, as the need to reduce emissions moves down the political

agenda.

Detailed descriptions and analysis of these scenarios is provided in the Global Carbon Strategy

Report. In terms of the volume of abatement forced on by carbon markets, the highest demand for

abatement arises under Global Greenery, followed by Coal Rules, Clean Tech and Energy Autarky in

that order. Looking forward from Q3 2009, we have identified a set of signposts that indicate the

scenario towards which the real world seems headed (see Table 2).

Table 2: Scenario signposts

Global Greenery Coal Rules Clean Tech Energy Autarky

Meaningful agreement inCopenhagen

Modest oil and gasprices (stability in theMiddle East)

America joins globalagreement

Renewable energy costs

dont fall very rapidlySignificant environmentalevents to spur publicsupport

Strong US leadership

Fast economic recovery

Developing countries onsectoral targets

Security of supply issues(Middle East unsettledsupply of fuel)

International agreement

Commodity boom

China massive boom

Developing world willingto participate

Acknowledgement thatclimate change is aglobal issue

No deal in Copenhagendue to disengagement ofUSA and China from theprocess

No focus on forestry

Desire for local greenjobs is strong

Increase in local adverse

effects issue with localSOX and NOX pollution

Surface temperature risenot driven by GHG levels

Loss of faith in climatechange

Middle East unrest

Supply shock /commodities bubble

Weak economy

Concerns aboutcompetitiveness vs Asia

Primary focus oneconomy and Jobs

International default onemissions reduction


A meaningful agreement seems likely at present, either at Copenhagen in 2009 or in 2010 (already

shaped by the Copenhagen negotiations). Hence scenarios based on globally coordinated action

(Global Greenery and Coal Rules) seem most relevant.

Differentiating between these two scenarios, the wider states of the economy in general and energy

commodity markets in particular will be important. The economic recovery now looks to beprogressing at a rate that would have been considered optimistic 3-6 months earlier. This may push

the world towards the relatively healthy conditions of the Global Greenery scenario, especially if the

US takes a strong line on climate legislation and provides global leadership. However, a fast early

recovery could yet lead to a repeat of the commodities boom of 2008. If this combines with security of

supply concerns the expected direction of movement would be towards Coal Rules, in which coal

emerges as the most important source of energy for the twenty-first century.

Carbon market mechanisms

seem central to future

mitigation efforts as the

global economy recoversalong with a general mood of

internationalism


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2. Markets

2.1. International Market

The Kyoto Protocol, agreed in 1997 and entering into force in 2005, established an international

system for trading carbon emissions. To meet targets, countries that over-emit can either buy

emission permits known as Assigned Amount Units (AAUs) from surplus countries, most notably

Russia and Ukraine, or purchase project-based offset credits known as Certified Emission Reductions

(CERs) and Emission Reduction Units (ERUs).

Market update

There continues to be a robust stream of investment into the Clean Development Mechanism (CDM)

for projects to generate CERs. This comes despite the relatively bearish market at present and the

potentially even more bearish fundamentals. 101 new projects were submitted to the UNFCCC in

August. This signals optimism in the market countering this years decline in demand associated with

the recession and rising uncertainty over the future eligibility of CERs in the post-2012 period.

With regard to the pre-2012 period, new project submissions are unlikely to affect the supply of CERs

for the Kyoto compliance period significantly. This is because the project approval process has been

characterised by extremely long delays (see Table 3). Few new projects will be processed quickly

enough to begin issuing CERs before 2012.

Table 3: Average time delays to the CDM project approval process, by year (days)

2005 2006 2007 2008 2009

Validation to registration request 194 210 260 358 374

Registration request to registration 54 75 103 171 196

Registration to first issuance 151 166 319 509 612


As of 1 August a total of 319 MtCO2e of CERs had been issued by the EB to 535 currently issuing

projects. Figure 8 shows issuances to date split by technology, where high global warming potential

projects of HFC, N2O and PFCs continue to dominate, accounting for 77% of issuance to date.

Figure 8: Cumulative CER issuances to date by technology (up to 1 August 2009)MtCO2e


Limited UNFCCC capacity for processing verification requests delays the entry of projects to the CER

market. In general, there is widespread demand for streamlining of this system. As the delivery

deadline for Dec 09 CERs draws nearer market participants will become increasingly apprehensive

over delays as they could affect contracted guarantees and credit delivery obligations.

There are also ongoing concerns regarding determining the additionality of CDM projects that are

progressing through the verification process. In the long-run this is more significant than the issue of

delays. Officially, project developers must demonstrate that the emission reductions from their CDM

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2005 2006 2007 2008 2009

Agriculture & Waste Fugitive High GWP Industry Renewable Energy

The CDM has continued to

grow in 2009


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projects would not have been achieved in the absence of revenue from selling CERs. The challenges

in this area are highlighted by the recent suspension of SGS UK for non-compliance with CDM

procedures, echoing the temporary suspension of the Det Norske Veritas in 2008.

Such temporary suspensions do not materially change the flow of projects into the CDM in the

medium term once the verifiers are reinstated, but applying the theory of additionality has been

recognised as a weakness of the CDM. This continues to affect CDM investments in developing

countries and remains a regular discussion point at international talks. Indeed, projections of the

supply of CERs have lately been revised downwards due to new domestic initiatives, such as feed-in

tariffs in developing countries, which mean that fewer projects are deemed to be additional (see

Section 2.5).

The August climate talks in Bonn included discussions of country and technology ranking schemes for

CERs, which, once elaborated, may provide a basis for project developers to rank project types

according to their post-2012 eligibility risk.

In general, aside from the question of eligibility and the type of projects that are awarded credits, the

other main factor in the development of the international market is the level of demand that will

emerge. Optimistic signals in this regard came lately from New Zealand and South Korea both

announcing 2020 reduction targets which boost likely demand for emissions reductions in this period.

Alongside the CDM, the Joint Implementation (JI) continues to see far lower activity than the CDM.

Developers can engage with JI to generate Emission Reduction Units (ERUs) from activities within

Annex I countries, which have similar value to CERs. However, we project the total number of ERUs

that may be issued by 2012 at around 213 MtCO2e, considerably below the number of issuances that

have already occurred in CDM.

Prices and volumes

The Dec-09 CER market moved sideways from the close of July into the first three weeks of August,

trading at an average of 12.6/t, although it gained some ground from 17 August to hit a 7 month high

of 13.4/t on 24 August. Gains in the CER market have largely tracked EUAs.

Figure 9: Historic CER prices and volumes/tCO2 MtCO2

Source: ECX

Outlook to 2012

1) Thus far carbon markets have been fairly resilient in the face of recession, but the bears are still

growling in the background.Fundamentals remain bearish for the Kyoto period as the recession has slashed emissions in the EU

ETS, which is the main demand centre for CERs (see Section 2.2). Although CER prices are far

below their 2008 levels, we continue to see substantial downside risk in the next couple of years.

Government interventions such as the Chinese price floor may be insufficient to stabilise prices in the

event of short-term downward run.3

3Chinas National Development and Reform Commission has sought to provide a floor for CER prices by withholding approval from

projects where a primary CER purchase agreement is not secured at a price of at least 8/tCO2e.

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CER prices may have further

to fall in the near-term


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2) In the immediate future, CERs are vulnerable to the market for hot air.

Those nations holding long AAU positions, primarily in Central and Eastern Europe are facing

extremely challenging fiscal conditions, which has increased their desire to raise funds through the

sale of these surplus credits. AAU trades or hot air are not viewed favourably since they mostly arise

due to over-allocation of emissions for the Kyoto period rather than due to additional emissions

reductions. However, there are likely to be further AAU deals following those reported in our Q2

Global Carbon Quarterly, which restricts the likely extent of sovereign demand for CERs.

3) Increasingly the international carbon market is a space for strategic investors with a medium or

long term outlook.

Our near-term bearishness reflects the likely delay to much known demand to the post 2012 period.

However, developments over the past year still point at the international market playing a larger role

in the future with new demand centres likely to emerge. Recognition of this situation is demonstrated

in the healthy flow of ongoing CDM investment as the market continues to grow, albeit at a slower

pace than in the last couple of years.

Outlook beyond 2012

1) There will be many reforms to international carbon credits, probably including no-lose sectoral

targets for developing countries.

All sides want reform of international crediting. CDM project developers seek clarity on project risk

and shortening the delay between operations and issuance of credits. At the same time politicians

and many buyers seek more direct assurances that the credits they pay for represent real

contributions to reducing global emissions. Thirdly, parties in developing countries seek a system in

which they are not penalised for introducing domestic policies. No-lose sectoral targets involve

issuance of credits via developing country governments to companies in sectors where targets for

emissions reductions have been exceeded. The targets are no-lose since missing the target incurs

no penalty. No-lose sectoral targets seem address concerns on all sides of the negotiations, so we

expect some form of no-lose sectoral targets mechanism to be introduced for the post-2012 period.

2) US policy is a mixed bag for the international carbon market.

The most likely scenarios for the US now all involve wide coverage of cap-and-trade schemes. These

will allow substantial volumes of offset credits because scheme designers seek to avoid high prices

while introducing targets that are ambitious in view of the relative lack of US effort since 1990.

Alongside international credits the US will allow large volumes of domestic credits, mostly from

agriculture and forestry schemes. The US should therefore ensure that the international marketremains viable, but it will not drive sufficient prices to go beyond the low-hanging-fruit of abatement in

developing countries.

Outlook for international carbon prices

This bearish outlook is because data revealing the full extent of the decline in industrial output and

consequent falls in emissions have emerged gradually throughout the year, even while there are now

signs that economic recovery may already be underway in some countries. Additionally, Japanese

domestic policies seem to be reducing emissions demand as they work towards their 15% domestic

reduction target. Alongside the EU ETS, the Japanese government is one of the main sources of CER

demand in the near term.

In the longer term demand from US cap-and-trade schemes whether federal or regional is likely to

be by far the largest source of demand volume towards 2020. However, the US government is

preoccupied with minimising the cost of compliance for participants in order to gain sufficient support

to pass their proposal (see Section 2.3). Hence prices are unlikely to rise dramatically as the US

favours relatively large volumes of cheap domestic offsets or forestry credits (both domestic and

international). Therefore, in our base case view of the CER market we project a gradual rise in prices

to roughly 16/tCO2e in 2020.

In the long term international

crediting will remain important

In the near term the outlook

for prices has become slightly

more bearish since Q2.


12/23





Figure 10: Projected CER prices and supply/tCO2 MtCO2

Source: ECX

2.2. Europe

The EU Emissions Trading Scheme (EU ETS) commenced in 2005 covering power stations and largeindustrial installations in Europe including almost 50% of GHG emissions in the EU. Currently the EU

ETS covers around 2.1bn tonnes of emissions annually. Participants must submit allowances

matching their emissions. Mostly EU Allowance Units (EUAs) are used, although a small volume of

CERs can also be submitted for compliance. Due to the size of the scheme, the EU ETS is currently

the main source of demand for CERs. Phase I from 2005 to 2007 laid the groundwork by showing that

emissions could be accurately measured and recorded, although it did not drive material emission

reductions. Phase II of the EU ETS from 2008 to 2012 could drive larger emissions reductions,

because the caps are below the trend in emissions based on accurate historic data.

Market update

With the key features of the EU ETS already set for the 2012-2020 period, developments in this

market in 2009 have been less focused on policy and more on basic supply and demand

fundamentals. However, the EUA market continues to be dominated by uncertainty. Since February

the market price has recovered to a level higher than most analysts believe is supported by

fundamentals. There are various stories in the market aiming to justify the current level.

One theory is that the market could be supported by forward hedging of carbon allowances by utilities

to back up forward power sales. According to the theory, utilities may be purchasing large volumes of

EUAs that have already been issued to fully hedge power trades for later periods where there is a

shortage of counter-parties for the corresponding EUA vintages. In theory, this could lead to an

artificial shortage of EUAs. However, analysis of this theory suggests that utilities normal hedging

activities are insufficient to push market prices much above fundamentals. Indeed, forward auctioning

of post-2012 EUAs begins in 2011 and should be sufficient to eliminate any material effect that might

otherwise have occurred.

Another observation is the greater correlation between EUA movements and equities during H1 2009,

as the EUA-gas correlation collapsed. The recovery in EUAs resembled a similar recovery in equities,

reflecting generally optimistic sentiment. However, gas has not risen in line with other markets and

throughout 2009 evidence of the scale of emissions reductions caused by the recession has

continued to grow, so arguably the extent of the recovery in EUA prices may not be rational.The application of EU ETS policy on New Entrant Reserves (NER) has also provided some support to

the EUA market in the near term, as NER that is not allocated could in principle reduce the supply of

EUAs. However, the withheld allowances are extremely unlikely to change the fundamentals,

because member state governments are expected to auction any remainder for revenue. In fact, the

latest CITL data show that 187 MtCO2 of NER has already been allocated. New Energy Finance

analysis suggests that most of the NER will be allocated by 2012; this area of uncertainty should

shrink over the next 18 months (see Figure 11). However, this would still leave a substantial volume

(some 243 MtCO2) being auctioned towards the end of Phase II, which might produce a downward

price shock if market participants have not anticipated this supply being made available.

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Figure 11: Cumulative issuance of NER if allocation continues at current rateMtCO2

Source: CITL, New Energy Finance

It will be critical for EUA prices throughout Phase II to understand to what extent EU ETS participants

will bank EUAs into Phase III. In particular, the action of industrial companies that may not actively

engage with the scheme is a source of uncertainty. The majority of industrials are long EUAs (their

BAU emissions are in many cases far below their allocations). If they horde allowances far into PhaseIII towards 2020 this could have the effect of withholding from the market a substantial fraction of the

entire EU ETS cap (see Figure 12).

Figure 12: Total industrial sector BAU emissions (excluding aviation)MtCO2e


We expect steel to be the first major industry sector to emerge from the economic recession, albeit at

a slow pace until 2010. Steel production from European works was on an upward trend throughout

June-August according to the World Steel Association. The recovery in steel production may soon be

boosted by the large government spending programmes put forward at the beginning of 2009 to

tackle the economic recession. The cement sector, by contrast, is likely to remain sluggish in the

remainder of 2009 and 2010 because of the weak state of some of Europes biggest construction

markets. This includes Spain, where a housing bubble in residential buildings burst in late 2007, andthe UK, where house prices appear even now (i.e. September) to have barely stabilised. We estimate

that cement and lime production will decrease by 25% in 2009, not recovering to its 2008 levels until

2012 at the earliest.

Prices and volumes

In early June EUAs dipped on rumours that the recovery in prices had gone too far. The rumours of

over-valuation have remained but EUAs recovered in the summer months, hitting 15.4/tCO2 on 21

August, the highest closing price since 11 May 2009.

3302244

66

88110

2008 2009 2010 2011 2012 Total Phase II

Total Phase II NER = 573

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Figure 13: Historic EUA prices and volumes/tCO2 MtCO2

Source: ECX

Outlook to 2012

1) Phase II of the EU ETS is a more resilient market than Phase I

Following the successful emissions measurement and verification exercise in Phase I from 2005 to

2007, the Phase II caps were carefully calibrated to levels that under normal circumstances wouldhave begun to force emissions reductions within the EU ETS. Unlike in Phase I, the rebound in prices

from February 2009 was able to occur partly because current EUAs are bankable into later periods so

there is a good chance that they will eventually be needed at some time in the future. Indeed, the

market has survived the worst financial crisis in a generation, one of the outcomes of which may

actually have been to increase industrial engagement with the market and hence boost liquidity as

some industrials traded EUAs for the first time in spring to ease their cash-flow situations.

2) but the market, characterised by chaotic trading activity, is by no means mature.

Since February the EUA market has been infected with optimism emanating from equities. However,

for most of this period developments in EUA fundamentals have been bearish. Several benchmark

coal-gas fuel-switching prices, which were far above EUAs throughout 2008, have dipped below the

EUA price at times in the past quarter. Throughout 2008, European gas contracts had the highest

correlations with EUAs, but this year the correlation with gas has collapsed.

Apparently, traders are searching for patterns to latch on to, with little confidence in whether themarket is under- or over-priced. This reflects the relatively complex dynamics of the EU ETS

especially the price elasticity of emissions.4 It is to be expected that, with time, experience will

eventually move the EUA price to a level at which traders have greater confidence in the key drivers.

For now, traders gut instincts may be just as important as any analytical drivers.

3) The dynamics of banking into Phase III of the EU ETS are key to pre-2012 fundamentals.

A key lesson from Phase I was that there is no need for a carbon price unless emissions would

otherwise be above the cap. However, the current carbon price depends on the expectation of rising

above the cap several years into the future in Phase III.

The 2009 price of EUAs reflects the opportunity cost of taking emissions allowances away from a

war-chest of hoarded allowances that will be of greater value in later years. In other words, the

current price depends on the level of banking into Phase III.

Participants differ in the rationale behind their banking strategies, with some actively banking while

others passively fail to sell their free allocations in Phase II. In both cases, the temptation to improvecash flow today rather than wait for uncertain returns in several years time means that EUA prices

pre-2012 are likely to remain muted.

Outlook beyond 2012

1) The EU ETS remains a beacon of long-term policy certainty against a chaotic background of

global developments.

In both previous Global Carbon Quarterly reports we highlighted the unparalleled degree of certainty

in European regulations. Following the Climate and Energy Package in December 2008, the EU ETS

4Depending on ones perspective, this can be described as the abatement supply curve or the emissions allowance demand curve.

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emissions trading


15/23





should continue to exist whatever may occur at international talks. The targets are more likely to

tighten than to loosen in what may remain the worlds largest emissions trading block by value all the

way through to 2020.

2) Across Europe momentum continues to build in support of carbon pricing and possible expansion

of the EU ETS.

The EU is set to remain a leader in the implementation of carbon pricing mechanisms. The French

government appears set to impose a new carbon tax on transport and fuel, beginning at a modest

level similar to current market EUA prices and rising to 100/t in 2030 and 200/t in 2050 (if advice ofan independent government committee is followed). The carbon tax should cover sectors not

currently within the EU ETS, most notably road transport. This indicates the technical possibility of

including a wider range of sectors within the EU ETS itself. The French tax would be similar to

Swedens carbon tax, which has demonstrated the potential for material emissions reductions while

maintaining healthy economic growth (10% emissions reductions with 50% net economic growth

since 1990). Indeed, it is apt that the Swedish presidency of the EU coincides with Copenhagen; this

may contribute to a relatively ambitious approach at the forthcoming negotiations.

Outlook for European carbon prices

New Energy Finance has a proprietary European Carbon Model for assessing the fundamental price

level for EUAs. In general, we currently see substantial downside risk on EUA prices for the pre-2012

period. Key uncontentious factors in our bearish view are the fall in European emissions due to the

recession and the persistent decline in gas prices from the historic highs of 2008.

However, the level at which we see the fundamental price does also depend on more complicatedassumptions regarding the level of banking and borrowing that may be realistic. Our model is able to

project prices similar to the current market if we assume that the market undertakes sufficient banking

of EUAs to smooth over all of the differences in supply and demand between now and 2020. In this

projection we see some 1.9 GtCO2 of EUAs being banked from Phase II into Phase III, with a total

value in 2012 of some 35 billion.

Our base case view on fundamental EUA prices is more bearish than above, because we do not

believe that the market will produce such a large volume of banking. We see a significant volume of

EUAs, almost 1.0 GtCO2, to be banked from Phase II into Phase III, with a 2012 market value of

around 9 billion. We believe this is a more realistic projection as it makes more sense from a risk

management perspective that such large banking positions are unlikely to be taken on in a market

where the long-term payback is fraught with uncertainty.

Figure 14 shows our base case view on EUA fundamentals. Although we see minimal fundamental

support for material carbon prices before 2013, we do nonetheless expect prices to rise substantially

after that, especially in the second half of the decade.

The current market price is well above our near-term fundamental forecast. It may be that market

sentiment imposes a price floor for practical purposes around the level of 10/tCO2. However, it is

likely that industrial participants may instigate further waves of surplus credit sales in the months

ahead, as many still face tough times with installations either mothballed or running at low output

levels. This is the most likely mechanism by which a downward price correction might occur at some

point in the next couple of years.

Figure 14: Projected EUA prices and EU ETS abatement/tCO2 MtCO2


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2.3. North America

The election of President Obama and a Congress dominated by Democrats heralded sizable shifts in

US policy on many fronts including climate change. With climate change legislation moving at all

levels of government and the US again actively engaging in international climate talks, 2009 could

have seen clarification on the US commitment to reducing emissions including federal cap-and-trade

legislation. Confirmation of the new US position with the passage of federal domestic climate

legislation is now likely to be delayed until early 2010.

Market update

The inability of Congress to pass health care reform set back the legislative timeline for passing

federal cap-and-trade as the Senate moved its mark-up deadline from 28 September to indefinite.

Behind closed doors the Senate is also discussing what is known as Plan B, which shelves cap-and-

trade and pursues the energy portion of the bill in light of the November 2010 mid-term elections. The

political window for passing cap-and-trade is narrowing but an early 2010 Senate passage should

leave enough time for a joint Senate and House conference agreement on the final terms of the bill,

after which it must pass both houses again.

The politics of cap-and-trade are more challenging in the Senate than in the House of

Representatives. Gathering the 60 votes necessary for the smooth passage of the bill will be a

challenge. The view of New Energy Finance is that a bill is more likely than not to be passed, but this

will require further softening of the scheme beyond the concessions already agreed in the House: As

many of the Senate swing-voters are key members in relevant Senate committees, we anticipate that

the mark-up will be a good guide to the final bill and it may already be possible to anticipate how thevoting situation will develop. The emission reduction target provided for under Waxman Markey will

probably be softened from a 17% reduction on 2005 levels by 2020 to around 14%.

Most of the swing voters are Blue Dog Democrats (i.e. Democratic Senators from traditionally

Republican states) who therefore hold significant clout for the federal cap-and-trade debate regional

interests override party allegiances for many Senators on this issue. The chief objectives of Blue

Dogs are: i) to maintain agriculture concessions struck in the House; ii) to reduce overall programme

costs; iii) to protect manufacturing and industry from international competition; iv) to improve

allocation apportionment to ensure equitable impacts on states; and v) to increase Carbon Capture

and Storage (CCS) incentives and allocation to coal dependent states.

60 out of 100 Senate votes would be a filibuster-proof majority, without which passage of the bill will

be extremely difficult. Only 43 Senators have so far indicated clear support for the bill. Concessions

on agriculture struck in the House enable the sector to supply offsets while not being subject to

mandatory targets. These concessions evidently need to be maintained by the Senate, and further

concessions across a range of other issues are required if Waxman-Markey is to have any chance ofgaining another 17 Senators to pass the bill within 2009 or even early 2010. 19 Senators (15

Democrats and 4 Republicans) could vote either way depending on concessions. We expect

amendments in five areas may secure smooth passage of the bill (see Figure 15).

Figure 15: How to collect 60 votes in the US Senate# of Senate Votes


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federal cap-and-trade bill


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1) Costs Most of the options to reduce scheme costs, such as offset programmes, have already

been exploited to the maximum extent that seems realistic. The remaining options are weakening the

near-term target and increasing free allocations; a price cap is also not out of the question. Many

Senators are concerned that the existing bill has insufficient price controls.

2) International competition Democratic Senators from rust belt states support a carbon tariff to

protect trade-exposed industry from international competitors not subject to emission caps, e.g. China

and India. A delicate balance must be struck on this matter to avoid international criticism.

3) Market oversight The Commodity Futures Trade Commission (CFTC) may be charged withregulating all carbon markets. On the other hand, we expect the Senate to reject the most extreme

proposals to ban all derivatives trading in a federal carbon market.

4) Coal Most Senators on the fence represent coal dependent states so more CCS funding, in

addition to what is included in the existing bill, is likely to further bolster support for the bill.

5) Oil & Gas Benefits and incentives to extract recently discovered shale gas deposits may become

essential to gain support from Senators representing states with untapped shale gas reserves.

However, we do not expect concessions on the issue of Arctic National Wildlife Refuge drilling, which

would ensure support from both Alaskan Senators.

Regional programmes

At the federal level, Canada continues to play wait-and-see. However, at the province level, Quebec

passed legislation to implement cap-and-trade by 2012. The legislation enables linkages with other

provinces and regional cap-and-trade programmes under development. Similar legislation in Ontario

is likely to pass in the next few months.Representatives from the three North American regional programmes met on 23 June to discuss

potential linkages. Together the Regional Greenhouse Gas Initiative (RGGI), Western Climate

Initiative (WCI) and Midwestern Greenhouse Gas Reduction Accord (MGGRA) should cover most of

the economy across 21 US states and four Canadian provinces, representing roughly one third of US

and Canadian emissions. Figure 16 indicates the sectoral coverage and targets of these schemesand the possible form of a linked programme.

Figure 16: Regional programmes and possible unified programmeReduction from 2005 levels by 2018 (RGGI) or 2020 (other programmes)


There are technical hurdles if these initially distinct schemes are to be linked, but linkage may be

relatively straightforward to achieve politically compared to passing a federal cap-and-trade bill. The

main result of linkage talks is a display of support for cap-and-trade, which lends momentum to the

federal bill passing through Congress. The secondary implication of the talks is that, even if a federal

bill fails, a substantial portion of North America may still be covered by cap-and-trade.

Prices and volumes

The only programme already in operation is the RGGI, in which the cap is higher than expected

emissions for the entire duration of the scheme through to 2018 a situation which is widely

acknowledged. There are two main reasons for the non-zero price in this market. Many allowances

0%

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Sector coverage

Linked

programme

RGGI

WCI

MGGRA

Power + Industry + Res / Com + Transport


18/23





are auctioned with a reserve price of $1.86/t, and there is an expectation that RGGI allowances may

be eligible for compliance in a future federal scheme. Nevertheless, prices have gradually declined

towards the reserve price since the first trades in August 2008 (see Figure 17).

Figure 17: Historic RGGI prices and volumes$/tCO2

MtCO2

Source: Chicago Climate Futures Exchange

Outlook to 20121) RGGI is likely to remain the only active scheme through until 2012.

RGGI continues to be an interesting learning exercise although the dip in emissions brought by the

recession has reduced the relevance of what was already an over-allocated programme. It would be

highly surprising if material carbon prices were to emerge at any time under the existing framework.

2) The pre-compliance market continues to grow.

US-based landfill gas offsets verified to the Climate Action Reserve (CAR) dominate the pre-

compliance market. Over the summer months New Energy Finance tracked over 2.7MtCO2e of US-

based landfill gas CAR offsets traded on the OTC market for an average of $6.7/tCO2e, 19% higher

than the average voluntary offset price over the same period. Also emerging as a strong pre-

compliance play are North American-based forestry offsets as 0.6MtCO2e traded over the summer

months at $6.8/tCO2e. We anticipate trading activity of US-based methane and forestry related

offsets to continue and any significant movement in prices and volumes is predicated on the

perceived likelihood of Congress passing US cap-and-trade.

Outlook beyond 2012

Despite the chaotic political process, the long-term term outlook for North American carbon policy is

less uncertain than it seems considering the likely medium-term outcomes for business.

1) A federal US cap-and-trade bill is unlikely to be passed this year

The scope of amendments that are required to garner support for a quick implementation of cap-and-

trade are probably just to broad for a bill to pass this year, especially given the delays that have

already occurred.

2) but there are indications of the shape a final bill may take ...

Should a federal cap-and-trade bill be passed, we expect a programme starting in 2013 targeting

emission reductions of 14% below 2005 levels by 2020 and 80% by 2050. We project demand for

emission reductions in the region of 612MtCO2e per year by 2020 and 1,706MtCO2e by 2030.

3) and we expect that it will be passed in 2010, with the main features clear by end-2009.

The Waxman-Markey floor debate should still get underway before the end of 2009, and many of the

necessary amendments may be in place by the end of the year. This is a core piece of Democratic

legislation which will be pushed hard and so should still pass in 2010, though there is plenty of horse-

trading to come.

4) Even if a federal bill fails, we still expect most of North America to be covered by cap-and-trade.

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The regional schemes look set to go ahead if Waxman-Markey and all subsequent federal bills fail to

pass. In this case we still expect roughly a third of US states and six Canadian provinces to be

covered by regional schemes soon after 2012, and these are highly likely to be linked. A linkage of

multiple programmes will foster market inefficiencies as state and province emission regulations vary

in application and stringency, and EPA point source regulation will only further complicate regulatory

compliance.

Outlook for North American carbon prices

In our base case for North American carbon prices we continue to model a US federal scheme. Theslight softening of likely scheme design in view of political developments leads us to downwardly

revise our price view, though we still expect a range of 15-20/tCO2 towards 2020 (see Figure 18).

Figure 18: Federal base case: projected prices and domestic abatement$/tCO2 MtCO2e


2.4. Australia

The Australian Carbon Pollution Reduction Scheme (CPRS) is a cap-and-trade scheme due to

commence in July 2011. The latest proposals involve medium-term emissions targets in the range of

5%, 15% or 25% below 2000 levels by 2020. Compliance participants will need to submit permits

covering their recorded emissions consisting of Australian Emissions Units (AEUs) and/or

international credits. Participants will have unrestricted access to international credits imported from

the CDM and JI, so the upside price risk is less than in other compliance markets, while the CPRSmay be an important demand centre for the international market.

Market update

On 13 August the Senate voted to block the governments CPRS bill by a majority of 42 votes to 30.

This was unsurprising as the Rudd Government holds just 32 of the 76 seats, while both the Greens

and the opposition Coalition consisting of the National and Liberal parties had beforehand stated their

intentions to vote the bill down.

Malcolm Turnbull, leader of the Coalition, appears to be in a no-win situation and is struggling to

negotiate safe passage for himself and his party through the governments climate change agenda.

On the one hand defeat of the CPRS legislation in August means that he cannot oppose the bill again

in the Senate in November without enabling Rudd to dissolve both houses of parliament and call an

early general election.5

Recent polls show the government ahead 57% to 43% on a two-party

preferred basis and Prime Minister Kevin Rudd commanding a 66% approval rating which suggest

that an early election could prove painful for the opposition.6

On the other hand, Turnbull cannot support the CPRS without risking a challenge to his leadership or

putting the unity of the Coalition in jeopardy which remains divided between those who support

emissions trading in principle and those who are highly cynical of anthropogenic climate change and

the governments policies to address it.

5The government can dissolve both houses of parliament and call a general election in an act called a double dissolution, if the senate

rejects legislation in two sittings at least three months apart.6

Newspoll 2009, http://www.newspoll.com.au/cgi-bin/polling/display_poll_data.pl, 28 July

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Turnbull tried to resolve the situation by appeasing the sceptics while supporting the bill. He declared

his conditional support subject to the following concessions:

Trade exposed industries to receive full compensation for higher energy costs and a mechanism

to ensure that increases in electricity prices are no greater than comparable countries

Exclusion agriculture from the scheme and the inclusion of agricultural offsets

Exclusion of coal mining from the scheme

Better incentives to encourage voluntary action

Better incentives to realise the potential of increased energy efficiency

Implementation of a regular review by an expert independent body, to ensure that the CPRS does

not disadvantage Australian industries and workers relative to America

Since no amendments reflecting these conditions were tabled in the Senate, these points could not

be included in the debate. However, the Coalition is now preparing amendments for the government

to consider when this issue is revisited again in November and we believe that a compromise can be

reached which would see the CPRS enacted before the end of this year.

Rudd has stated that he does not want to call an election, but if Tunbull fails to deliver a united

Coalition in support of an amended CPRS then the government will have little option.

Outlook to 2012

1) An amended CPRS bill will eventually pass and may be in place before Copenhagen.

The question is no-longer if there will be an emissions trading scheme in Australia, but when will the

legislation pass and what will it look like? The Rudd government is willing to compromise further to

get its scheme through, so it is possible that we will see a resolution before the end of the year. This

is likely to mean more free allocations to industry and possibly the inclusion of domestic offsets from

agriculture.

2) Australian power companies are already preparing for the realities of the CPRS.

Initially the CPRS is set for a soft start with a fixed price in 2011/2012. However, power companies

would ideally like to hedge their exposure to carbon price variability in 2012/13 and beyond by

purchasing around 250MtCO2e of allowances forward. However, our analysis suggests that only

approximately 60MtCO2e will be made available through government auction in this period. To

manage this shortfall, power companies wil start to look to acquire allowances from other sources.

The most viable credits are Kyoto period CERs, which are currently available in large quantities, and

offsets from domestic forestry projects.

Outlook beyond 2012

The CPRS outlook beyond 2012 depends substantially on developments in the international market.

CPRS participants are likely to be heavily active in the CDM and other future forms of international

projects beyond 2012 (see Section 2.1.

Outlook for Australian carbon prices

Since market participants can import CERs into the CPRS without limit, the AEU price will be strongly

influenced by the international market. This is particularly potent considering the low cost coal that

drives Australias economy. Our current projections suggest that CERs will be such an attractive

abatement option for Australian firms that over 50% of the emission reductions required under the

CPRS cap will be satisfied in this way. This picture could however still shift if large volumes of cheap

domestic forestry credits are mobilised and sold into the market below the CER price point.


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Figure 19: Projected CPRS prices and abatementA$/tCO2e MtCO2e


2.5. Developing Countries

The role of developing countries in carbon markets has primarily been as suppliers of credits through

the CDM on the basis of emission reduction projects that satisfy additionality criteria. Aside from

these projects, representation of developing countries at climate change negotiations continues to beled by the largest nations, especially by China and India, which are resistant to adopting binding GHG

emissions targets. However, some major steps are being taken by other countries at national level to

implement carbon market instruments. Most notable are the developments in Mexico and Brazil,

where domestic cap-and-trade schemes have been proposed.

Market update

Over the past quarter a further 42 MtCO2e of CERs have been issued, some 54% coming from China

where issuance rates have accelerated, while India, South Korea and Brazil each accounted for 12-

15% of new issuances.

Despite the healthy rate at which CERs are being issued for Chinese projects, H1 2009 saw an

increased rate of new renewable energy projects in China being rejected by the Executive Board (EB)

of the CDM. Various aspects in the assessment of additionality for Chinese renewable energy

projects have been tightened in this time. Firstly, project proposals are being rejected increasingly

where they state fractions of generated power going to the grid for consumption that seemunrealistically low. For example, for hydro projects the EB seems now to reject any project that claims

to supply less than 85% of generated energy to the grid. Quoting an underestimate can be a way of

downplaying likely revenues, thereby making schemes seem less viable and hence more additional.

Furthermore, in July the National Development and Reform Commission lowered the average grid

emissions factor for 2009 by 11% compared to the 2008 value. Electrical generation volumes from

renewable energy projects are multiplied by the average grid emissions factor to calculate the

resultant CER volumes. The drop is for three main reasons: a change in the emissions factor

assumed for coal plant, an increase in renewables capacity, and the decommissioning of old coal-

fired facilities. This reduces our projection of CER supply from new Chinese CDM projects in power-

generation sectors by 80MtCO2 through to 2020.

0

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2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

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25CPRS projected abatement AEU price projections

Additionality is a complex

issue for developing

countries


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Figure 20: Geographical split of CER issuances to date

Source: UNFCCC

Another factor that may inhibit growth in Chinese CDM from renewable energy is domestic

government support, although one sector unlikely to be penalised is small hydro. China is aiming to

implement small hydro projects at 2GW per year to hit a 75GW target for 2020. Small hydro is

unusually well suited to the CDM as it is easy to find new proje

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Global Carbon Quarterly Q3 2009