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STATE AND TRENDS OF THE EUROPEAN CARBON MARKET APEX CONFERENCE Powernext SA

STATE AND TRENDS OF THE EUROPEAN CARBON MARKET APEX CONFERENCE Powernext SA Paris - October 15 & 16th. AGENDA. State of the EU Carbon market Global policy framework Key dates in the establishment of the EU ETS Price dynamics CO2 and energy prices The “ pass trough ” issue

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STATE AND TRENDS OF THE EUROPEAN CARBON MARKET APEX CONFERENCE Powernext SA

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  1. STATE AND TRENDS OF THE EUROPEAN CARBON MARKET APEX CONFERENCE Powernext SA Paris - October 15 & 16th

  2. AGENDA • State of the EU Carbon market • Global policy framework • Key dates in the establishment of the EU ETS • Price dynamics • CO2 and energy prices • The “pass trough” issue • Lessons learnt • Outlooks for phase II • Main changes in phase II • Functioning of a CDM project • CER estimated market size • Legal & technical issues on the CER underlying • Powernext results and perspectives • Market Model for EUAs and CERs • Powernext Carbon EUA market • Post 2012 issues

  3. STATE OF THE EU ETS

  4. Non CO2 CO2 Non ETS ETS Other Power sector 54 % 56 % Global policy framework • In order to help achieve its Kyoto targets, the EU a established an Emission TradingScheme (ETS) for its large industrials emitters • Participants: • All EU 27 countries • All electricity, ferrous metals, pulp & paper, cement and all facilities with installed capacity > 20MW • Member states develop National Allocation Plans (NAPs) by sector and installation • Installations receive allocations of EUAs below their business as usual requirement (2’094 Mt each year) and can either: • Reduce their emissions to equal their EUA allocation or… • Purchase additional EUAs in the market, or… • Purchase emissions-reductions certificates (CERs) to cover surplus emissions Breakdown of CO2 emissions in the EU-15 in 2005, and estimated % of emissions covered by ETS

  5. December: Publication of the Commission guidelines for phase III Key dates in the establishment of the EU ETS

  6. Price dynamics • Price on the market is mainly driven by: • Weather conditions • Economic activity • Energy prices • Institutions decisions • Price collapse in April 2006: • 1st publication of emissions data • Surplus of allowances (4% in 2005 and 1% in 2006) due to : • Over allocation • Abatements: to what extent? (fuel switch/ investments in low emitting technologies…) • No “banking” allowed between phase I and II

  7. CO2 and energy prices • With the system of CO2 allowances, electric power generators must now integrate the price of the allowance into the management of their existing power generation stations. • In the short term, their operating costs mainly consist of fuel prices. That is why power generation plants are managed on the basis of “spreads”, which constitute their operating cash flow. • If a power plant burns natural gas, the spread is called the “spark spread” • If it burns coal, the spread is called the “dark spread”. • The higher the “spread”, the more profitable the use of the power plant. • From now on, these spreads are to be corrected by the carbon value. • It’s the “clean spread”, which have now become the signals that guide the management of the fleet of existing power generation plants. • All other things being equal, the higher the price of carbon dioxide, the more the operators have an incentive to switch from the power plants with the highest emissions to those that produce fewer emissions.

  8. The “pass trough” issue Carbon contribution to electricity prices in several EU countries (€/MWh) • Lack of competition in the electricity sector allows utilities to “pass” the CO2 price in their prices (between 3 and 14 €/MWh) • Impacts mostly energy intensive industries who saw their energy bill increase by about 15%, paying not only for their own emissions (if caped) but also for utilities’ emissions Source: London Economics (2007) • The Commission should answer this issue in the Guidelines for phase III • Full auction for the electricity sector allowances ? • Auctioning allowances to power producers may not alter all electricity prices effects (and might even increase them again) • However, it would avoid the need for governmental allocation, its associated political issues and generate revenues for the governments

  9. Lessons learnt • Timeframe is too short • 3 and 5 years for phase I and II • Lack of visibility for new investments • It should be possible to bank allowances between 2 phases • Allocation issues: • Harmonization of allocation methodologies to avoid distortion amongst EU member states, especially for new entrants allocation and closure rules • The stringent monitoring and verification requirements • … have proved effective and valuable • … but raise questions about whether the threshold of 20MW thermal is too low, increasing transaction costs for small environmental gain • Information disclosure needs to be more frequent : the market had no idea there was an over supply until April 2006

  10. OUTLOOKS FOR PHASE II

  11. Main changes in phase II • EUAs are linked to European Member States allocation (Assigned Amount Units) • Stricter Commission decisions on NAPs : • 1st period total cap : 2 142,5 Mt/y • Proposed cap: 2 126,14 Mt/y • EU Decision: 1 927 Mt/y  -10% vs. proposed cap • Possibility to auction up to 10% of the total allocation (vs. 5% in phase I) • Safety valve: use of Kyoto credits for compliance (CERs from Clean Development Mechanism & ERUs from Joint Implementation) but limited to about 300 Mt/y (15% of total annual allocation) • CERs already represent a huge market French AAUs ~ 550 Mt/y EUA II ~132 Mt/y Part of the AAUs are converted in EUA II

  12. Functioning of a CDM project • Kyoto « flexibility mechanism » to facilitate the achievement of emissions reductions • The project developer must prove the project’s additionality Host party (non annex 1) No emission reduction commitment Investor party (annex 1) With a AAU stock AAU stock (CERs are additional) CER CER Planned Emissions Emissions BAU scenario Project scenario

  13. CER estimated market size Breakdown of registered projects (number) Breakdown of registered projects (volume of CER) • There are few HFC projects (fluoride gases) but they generate a large amount of credits (more than 40%) amongst registered projects. Indeed, HFC’s global warming potential (GWP) is 12 000 times higher than CO2. • As of today, more than 2 000 projects are being validated or already registered by the CDM Executive Board. • The flow of delivered credits should be about 175 M for 2007 and 250-300 Mt over the 2nd period. • At the end of August 2007 : • 763 projects were registered (~ 160 Mt/an) • 230 projects had issued credits = 70Mt • But these data only concern the primary market, a pre paid market where the buyers use CER for their own compliance.

  14. Legal and technical issues on the CER underlying • Legal issues: CERs are not fully fungible • Technical issues: the project type is not available in the Serial Number of the CER in CDM registry (only project identifier number) is only available on UNFCCC’s website (thanks to the project identifier number). • Market players can’t visualize the project type – automatically –such as big hydro dam • Back offices will have to reconcile each CER types for every transaction (serial number versus project identifier & UNFCCC list to find project type)

  15. POWERNEXT RESULTS AND PERSPECTIVES

  16. Market Model for EUAs and CERs • Powernext Carbon is: • EUA spot market launched in June 2005 • CER spot market (launch planned for the end of 2007) • Same market model for both instruments: • Trading on Global Vision from 9 to 5 pm • Real time Payment versus Delivery

  17. Competitive environment • Share between Exchanges and OTC market : 60/40 • Share between Futures and. Spot Markets : 80/20 • Share of Powernext : 60% among European spot CO2 Exchanges • Record volume in February 2007 (around 6Mt on Powernext Carbon) EUA Spot market EUA Futures market

  18. 1 22 2 1 1 3 2 2 1 1 19 1 4 8 1 6 Powernext Carbon EUA market • Variety within the members: worldwide banks, utilities, industrials, retailer, … Thanks to a flexible and simple market model & continuous implementations 74 European members

  19. Post 2012 issues • Review of the EU Directive expected for December 2007 • Directive may need adjustment for Phase III to address issues around: • perverse incentives (new entrants, closures) • allow for much greater auctioning: for the longer term, continuing free allocation will require greater institutional independence of allocation authorities. The logical solution to most problems with the EU ETS would be to work towards greater auctioning over time • potentially address competitiveness issues • Integration of the aviation sector from 2011 • Linkage with other cap and trade systems ?

  20. Contacts www.powernext.fr +33 1 73 03 96 00 information@powernext.fr

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