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Trading in the ETS

A look at the opportunities for compliance companies

- 5 and 6 November 2013, Wuhan, Hubei, China -

Introduction ACT

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Agenda

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Trading in the ETS

• Factors that influence the CO2 allowance price • Factors that influence the CER price • Mechanisms of trading

- OTC - Through an Exchange

• Buying and selling allowances - Spot transactions - Futures/forward transactions

• Opportunities for compliance parties

- Optimizing the CO2 portfolio - Managing market risk

Factors That Influence the CO2 Allowance Price

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Price forecasts...

October 2011

October 2012

Factors That Influence the CO2 Allowance Price

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And the actual price development...

€ 5,00

Factors That Influence the CO2 Allowance Price

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CO2 price

(1) Allocation of allowances (2) Banking of allowances (3) Commodity prices (4) Fuel switching (5)Macro economic conditions (6) Weather (7) Regulatory issues

Factors That Influence the CO2 Allowance Price

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(1) Allocation of allowances • The main reason behind this structural change in the price of carbon may be found in the ratio of allocated allowances to actual emissions -> how much allowances does a company receive? (2) Banking of allowances • Banking means that participants can carry over of allowances from one phase to the next phase -> Companies need certainty on the validity of their allowances

Factors That Influence the CO2 Allowance Price

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(3) Commodity prices • The influence of oil, gas en coal prices

(4) Fuel switching • The marginal fuel-switching costs from carbon intensive sources such as coal to lower carbon intensive sources such as gas

-> CO2 emission factor of Gas is smaller than Coal

(5) Macroeconomic conditions • General economic conditions influence production levels, which in turn results in a supply and demand balancing of CO2

prices

(6) Weather • The weather plays an important role in shaping the price of CO2

- Extreme temperatures increase the need for heating and cooling - Rainfall, wind and sun can influence the production levels from alternative electricity sources

Factors That Influence the CO2 Allowance Price

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(7) Regulatory issues • In the EU-ETS regulatory uncertainty about intervention in the ETS (also known as backloading) is currently the main driver of CO2 prices • Renewable energy policy and subsidies influence price

Factors that influence the CER price

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CER price forecast...

October 2012

Source: Pointcarbon

Factors that influence the CER price

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And the actual price development...

€ 0,55

Factors that influence the CER price

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Market • New sectors (aviation) • New participants (linkage to other schemes, such as New Zealand) • Regulatory rules of EU-ETS (how much CERs can be used to offset emissions?) • Countries which use CERs to reach their Kyoto targets • Carbon funds CER supply • New methodologies • ERU credits which can be used as a supplement for CER’s in the EU-ETS • Low CER price -> lower incentive to invest in CER projects -> less supply

Mechanisms of Trading

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In the EU-ETS trading of allowances is done in two ways: - OTC (Over the Counter) - Through an Exchange

OTC An OTC trade is a trade done directly between 2 parties as opposed to a centralized exchange. Such a trade can be bilateral or brokered: Bilateral OTC deal Brokered OTC deal

Mechanisms of Trading

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Emission Allowance Exchanges

• ICE: Intercontinental Exchange

- Most liquid exchange - Spot and Futures - EUA, CER and ERU

•EEX: European Energy Exchange

- The common platform for the auctioning of EUAs by the large majority of countries participating in the EU- ETS

-> in Europe only a small percentage of the companies covered in the ETS are members of an Exchange.

Buying and Selling CO2 Allowances

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Spot and Futures/Forward transactions Spot transaction Is the purchase or the sale of CO2 allowances with immediate settlement. This means that CO2 allowances are delivered and paid for directly. Benefits: - Fast settlement - Small counterparty risk Drawbacks: - Immediate cash out

Buying and Selling CO2 Allowances

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Spot versus Futures/Forward transactions Futures transaction Under a futures contract the buyer is obliged to purchase (and the seller to sell) CO2 allowances at a fixed price and date in the future. Benefits: - Standardized contract - More liquidity as it is traded on the exchange - Hedging position - Leverage Drawbacks: - Margin requirements - Higher risk because of leverage Forward transaction Non-standardized contract under which the buyer is obliged to purchase (and the seller to sell) CO2 allowances at a fixed price and date in the future. Benefits: - Tailor-made - Hedging position Drawbacks: - Counterparty risk - Poor liquidity

Opportunities for Compliance Companies

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The ETS offers different opportunities and structures which companies can use to optimize their CO2 portfolio and manage the market risk. Optimizing the CO2 portfolio: • Using (C)CERs

-Premium swap -Ratio swap - Outright (C)CER purchase - Repo (Repurchase agreement)

Managing market risk: • Fixing prices

Opportunities for Compliance Companies

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EUA – CER premium swap: Receive premium • Company A has an allocation of 1.000.000 EUAs • Within the ETS it is allowed to offset your emissions with CER’s based on 10% of the allocation Allocation: 1.000.000 EUAs CER limit: 100.000 CERs EUA price: € 5,00 CER price: € 0,50 Premium: € 4,50 Premium receivable: CER limit x € 4,50 € 450.000,00 The amount of allowances in the portfolio remains the same -> Most suitable for companies which have a surplus of allowances

Opportunities for Compliance Companies

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EUA – CER ratio swap: Receive extra allowances • Company A has an allocation of 1.000.000 EUAs • Within the scheme it is allowed to offset the emissions with CERs based on 10% of the allocation Total allocation NAP phase II: 1.000.000 CER Limit: 100.000 EUA price: € 5,00 CER price: € 0,50 Premium: € 4,50 Swap ratio: 1:10 Amount EUAs to sell: 10.000 Amount CERs to buy: 100.000 Amount extra allowances created in portfolio: 90.000 Company A receives extra allowances in the portfolio without spending money -> Most suitable for companies which expect a small shortage of allowances

Opportunities for Compliance Companies

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Outright CER purchase • Company A has an allocation of 1.000.000 EUAs • Within the scheme it is allowed to offset the emissions with CERs based on 10% of the allocation Allocation: 1.000.000 EUAs CER limit: 100.000 CERs CER price: € 0,50 Buy CERs: 100.000 x € 0,50 € 50.000,00 This transaction creates the maximum allowances at the most cost efficient manner -> Most suitable for companies which expect a significant shortage of allowances

Opportunities for Compliance Companies

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Repo (repurchase agreement) When the market is in contango and thus the future price of a CO2 allowance (EUA) is higher than the spot price: • Sell on spot (directly) EUA allowances • And buy back EUA allowances with delivery in the future

-> This way you can ‘borrow’ money from your own stock of EUAs in your portfolio -> You buy back the EUAs just before you need to surrender them for compliance -> Only worth when the forward curve is less then cost of borrowing for the company An example will follow...

Opportunities for Compliance Companies

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Repo (repurchase agreement) Example

Company A received 1.000.000 EUAs and has internal borrowing cost at 6%

Year EUA price Increase in %

Spot (now) € 5,00

December 2014 € 5,15 3 %

December 2015 € 5,35 3,9 %

• Sell on spot 1.000.000 @ € 5,00 • Buy back in December 2014 1.000.000 @ € 5,15 • Receive € 5.000.000 from the spot sale of EUAs directly • The ‘interest rate’ on this transaction is the difference between the December 2014 and the spot price

-> so when internal borrowing cost are more than 3% this transaction would mean an optimization of the company’s lending structure

Opportunities for Compliance Companies

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Managing market risk There are a number of structures which can be used in order to protect against price volatility

Structure Reason behind Pros Cons

Fixing price through a forward transaction -Easy to budget -No direct cash outflow

Provides protection against extreme price movements

Limits potential in case price moves in the opposite direction

Setting a cap and a floor (maximum and minimum price set) Example, floor at € 2,00 and cap at € 4,50

Minimize hedging cost while allowing gains from favourable price movements

Flexibility in choosing moment to buy (within the cap and floor)

-Limits opportunities in both ways. - Buying price always between cap and floor

Opportunities for Compliance Companies

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PR and marketing (C)CER’s can also be used as a marketing tool: • Offset emissions with allowances from a renewable energy project within your community • Invest directly in renewable energy projects within your community

Conclusion

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Most of our clients looked at the ETS as an administrative burden which hampers there daily business...

-> However, by helping our clients understand the ETS and by showing them the different opportunities available, they are now using the ETS as a source of value.

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Thank for your attention!

Any questions?

Nick Soeteman Carbon trading

DIRECT + 31 20 8911 252 MOBILE + 31 646 008 345 EMAIL nsoeteman@ac-trading.eu

Amsterdam Capital Trading Herengracht 469 1017 BS Amsterdam The Netherlands www.ac-trading.eu