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TO THE POINT
The world’s largest ever carbon market survey More than 800 participants in our web-survey and 67 in-depth
interviews, combined with Point Carbon’s proprietary databases and market intelligence services, makes
this the most comprehensive carbon market report to date.
Global carbon market transactions worth €9.4 billion in 2005. The EU ETS did an estimated 362 Mt CO2, at an
estimated financial value of €7.2 billion. 93% of the volumes in the project market came through CDM, at
397 Mt CO2e, €1.9 billion. JI did 28 Mt, €95 million.
China is largest CDM seller. More than 70% of CDM volumes came from a few large HFC-23 reduction
projects in China. There are also several projects in India and Brazil.
CDM buy side is dominated by private sector. Driven by high EU ETS prices together with an increasing
number of carbon funds.
Japan enters market in earnest. The European private sector activity will continue to dominate the market,
but Japanese public and private sector will add further to demand for project credits in 2006. Canada is
conspicuous by its absence from the market.
The EU ETS is a qualified success. The weekly turnover in EU ETS has been increasing steadily. The market
is reacting to fundamentals, although policy (non-)decisions also still constitute a price driver. 45% of
survey respondents found the EU ETS to be a success.
CDM/JI still has some way to go. Only 7% of survey respondents find the project market to be mature, and
only 22% find them to be a success.
The cost of carbon cannot fully explain the increase in power prices. Increasing fuel prices, increased
demand, as well as generators’ strategies have also contributed to power price increases. The impact of
carbon costs on power prices, and vice versa, has created new interplays between energy commodities
and strengthened energy market interactions.
Market is still best option for world to make transition to low-carbon economy. Unlike technology-based
alternatives, the carbon market places a cost on emissions and a value on reductions, and leads to large
scale reductions in the near term.
This report was published at Point Carbon’s 3rd annual conference, Carbon Market Insights 2006 in
Copenhagen 28 February - 2 March 2006. For more information, see www.pointcarbon.com
The company has expanded rapidly in recent years and now has an international team of more
than 60 employees. The competencies of our staff include international and regional climate
policy; mathematical and economic modelling; forecasting methodologies; methods for expert
evaluation and energy industries analysis.
The in-depth knowledge of power, gas and CO2 emissions market dynamics positions Point
Carbon as the number-one supplier of analysis on price-driving fundamentals for European
energy and environmental markets.
Executive Summary
This report has been based on a number of different sources. First, Point Carbon’s proprietary databases
give an overview of the number of projects and their volumes. Our carbon project database contains at total
of 2,769 projects, and is to our knowledge the world’s largest. In addition, our web-based survey attracted
800 respondents, and we have further conducted in-depth interviews with 67 selected key market players.
Point Carbon estimates that the international carbon market in 2005 transacted a total of 799 Mt CO2-
equivalents worth approximately €9,400 million. In comparison, the market in 2004 saw an estimated 94 Mt
CO2e, worth €377 million.
The EU Emissions Trading Scheme saw the largest financial values in the previous year. In total, the brokered
and exchanged market did 262 Mt CO2, corresponding to €5.4 billion. Brokers did 79% of this volume,
whereas the ECX was by far the largest exchange, with 63.4% of the exchanged volume. Point Carbon
further estimates that the direct bilateral market (company-to-company, not through brokers or exchanges)
did 100 Mt, €1.8 billion in 2005. Annualised turnover increased to over 12% (OTC and exchange volumes
only).
The Clean Development Mechanism (CDM) remains the largest market segment in terms of volume. Point
Carbon estimates that emission reduction purchase agreements (ERPAs) corresponding to 397 Mt CO2e
were entered into in 2005. Assuming payment on delivery and a 7% discount rate, this is valued at €1.9
billion. The other project based mechanism, Joint Implementation (JI) did 28 Mt, €96 million. There is also
a small market for secondary CDM trading, this is expected to increase in the future, but is currently held
back by transaction log delays.
Other market remain insignificant in the larger picture, at 7.8 Mt, €52 million. The largest of these is the
NSW scheme in Australia, accounting for 93% of the financial value in this segment.
2004 2005
[Mt] [€ million] [Mt] [€ million]
EU ETS total 17 127 362 7,218
- OTC + exch. 9.7 n.a. 262 5,400
- Bilateral 7.3 n.a. 100 1,818
CDM 60 188 397 1,985
CDM 2nd 0 0 4 50
JI 9 27 28 96
Other 7.9 34 7.8 52
Sum 94 377 799 9,401
Executive Summary
But does the system work? We have seen very little evidence of actual fuel-switching or internal abatement
taking place. On the other hand, the market is working effectively, with reliable price discovery and increasing
volatility. Furthermore, the EU ETS is leading to substantial private sector investments in CDM, and to some
extent JI. In balance, we find that the EU ETS is a qualified success after its first year of operation. Survey
participants agree with us on this, at least to some extent. 45% of the respondents find that the EU ETS is
already a success. Only 22% think the same of the CDM/JI markets. However, only a handful of people find
the markets to be mature, 10% for EU ETS and 7% for CDM/JI.
One of the shortcomings of the EU ETS relates to the way the EC and Member States release information
to the market. With carbon now acting as hard currency, it would be wise to look to financial markets to
see how information is distributed. The European Commission has shown that it has a more important
role in emissions trading than other parts of EU’s environmental policy, and can be expected to meet this
challenge. Nevertheless, the market has shown that it can work even with asymmetric information
The introduction of carbon costs on power producers’ operation has also created new complexities with
other energy commodities, in particular power prices. The cross commodity impacts have also strengthened
interactions energy markets. We expect the debate on carbon’s impact on power prices to continue in 2006.
However, carbon costs cannot fully explain the increases in power prices. Increasing fuel prices, in particular
for gas, through 2005 have also contributed significantly. Also, increasing demand for power has an impact,
as well as generators’ trading strategies.
The survey respondents are bullish on prices. Only 20% expect the EUA price in one year to be lower than
it was in December 2005. More than 70% expect the price of an issued CER to increase over the same
time period. The market expects tighter allocations for EU ETS phase 2. Only 8% expect the allocation
for the next round to be looser than in the current phase. 25% expect it to be much tighter. Furthermore,
24% expect there to be more internal abatement in the next phase. It is also evident that carbon costs are
now taken into account for new investments. More than 40% see carbon costs as very important for new
investments in their industry.
CDM is set to be the project mechanism of choice, also in the future. Developing countries are indeed
taking their participation in the market seriously, and are years ahead of large JI sellers when it comes
to project approval frameworks. It also seems clear that the CDM will survive even without a successor
agreement to the Kyoto Protocol.
Technology based alternatives to the Kyoto Protocol are expected to be pushed forwards as viable options
for the future international climate cooperation. However, we do not find there to be much substance
in these plans. For an agreement to work it is essential that there is a price on carbon, and a value on
reductions, thus incentivising private sector investments in new technologies. Currently, the carbon
market remains the best option for enabling the transfer to a less carbon-intensive global economy.
Foreword
In many ways, the year 2005 marks the birth of a and markets have become correlated in ways they
global carbon market. The unexpected high price have never been before – driven by the carbon
of allowances in Europe caught most players by market – requiring a broader spectre of factors to
surprise. During a period of a few months, carbon be taken into account when assessing trading and
trading suddenly came on the agenda in boardrooms investment strategies.
across Europe. This report attempts to document
how the sudden emergence of a global carbon Finally, evidence suggests that the carbon market
market has unfolded, and how it has affected leads to large-scale emission reductions. While
emitters of greenhouse gases – and their markets limited abatement appears to have taken place in
– in ways that few anticipated one year ago. Europe so far, there is no doubt that the unexpectedly
high European carbon price has been pivotal in
It has been a massive effort making this report. More terms of generating investments in projects under
than 800 readers responded to Point Carbon’s web- the Clean Development Mechanism.
poll carried out in November-December 2005. The
web-poll was complimented by in-depth interviews Until six months ago, we in Point Carbon were
with more than 60 key players: traders, industry pessimistic about the reductions that would be
representatives and service providers. Also, our daily generated by such projects. But the explosive
recording of carbon transactions has been invaluable growth lately has changed our minds. Credits
for documenting how the market has developed. from abatement projects under CDM and JI today
have the prospect of becoming a major avenue for
When analysing the results from the survey and ensuring compliance with the Kyoto Protocol.
the transaction data, three important conclusions
spring to light. Firstly, although the value of the Moreover, these projects often bring about
carbon market increased by 2500% from 2004 to economic, social and environmental benefits for the
€9.4bn in 2005, and now involves players in close local communities: e.g. close to half of the 2,769
to 150 countries, it is still early days. Traded volumes JI and CDM projects registered in Point Carbon’s
compared to the underlying volume are still far below database utilise renewable energy.
what we can observe in other markets.
You will find more about these trends – and a number
Moreover, among the participants there is a of others – in the present report, which we plan to
widespread feeling of the market being immature, provide as an annual publication.
e.g. only approximately 10 per cent of the respondents
agreed to our poll’s statement of the EU ETS being A considerable amount of work has gone into making
a mature market. Through the involvement of more it and we believe it represents the most thoroughly
players – and an increasing internationalisation of the researched overview of the global market. Hopefully,
market – volumes can be expected to grow rapidly it will provide you with a useful source of reference
also in the years to come. and we hope you will enjoy reading it as much as we
have enjoyed making it.
Secondly, strong links to the energy markets
are evident. The carbon market has significantly Kristian Tangen
increased power prices, and the development of the Director Research & Advisory
power markets strongly impact carbon prices. This Point Carbon
should come as no surprise as power production is
major source of greenhouse gases emissions.
This report had not been possible without the contribution of numerous people.
First and foremost, we would like to thank the 800 persons who participated
in our web-survey, as well as the 67 key market players who took the time to be
interviewed on the phone. As you will see, your inputs have been invaluable in
the making of this report.
Thanks also go to everyone at Point Carbon, for their tireless efforts in maintaining
our proprietary databases and models. It is only due to your combined efforts
that we have been able to put this report together. Our CDM and JI team have
contributed through the development of the Carbon Project Manager, which has
been used frequently throughout during the making of this report. Our EU ETS
team has contributed through the Carbon Market Trader. And the Power & Gas
team has contributed analysis and thinking on the chapter focusing on carbon-
power complexities.
Some of our colleagues deserve special thanks and attention for their contribution
to this report: Kristian Tangen for guidance and overall coordination. Anders
Skogen for setting up the web-survey. Miles Austin and Therese Karlseng for
calling around to more than one hundred people in the carbon market. Anne
Katrin Brevik for sparring and comments on the power/carbon debacle. Liza
Baeza for giving a helping hand with the layout and design. And finally, Kevin
Gould and Kjell Olav Kristiansen for providing valuable comments in the final
stages.
We hope that you find this report interesting and that it is useful for your
continued work in the carbon market. As this is the first annual report of this
kind, we encourage you to give us comments and feedback through the regular
channels (see Colophone). We look forward to meeting you all at our conference,
and look forward to producing another version of this report in 2007.
Table of contents
1 Introduction 1
3.1 EU ETS 9
4.1 EU ETS 15
carbon
6.1 Higher spot prices 33
6.2 Explaining increasing spot prices 34
6.3 New complexities arising 38
7 What does the future hold? 40
7.1 Globally - still political uncertainties 40
7.2 Where to now for EU ETS 41
6.1 CDM and JI - long term investments? 44
6.1 Towards a truly global market 45
Colophone 51
60 %
50 %
Share of respondents
40 %
30 %
20 %
10 %
0%
No 0-0.5 Mt/yr 0.5-1Mt/yr 1-5 Mt/yr 5-10 Mt/yr +10Mt/yr
emissions
Source: Point Carbon
35 %
30 %
Share of respondents
25 %
20 %
15 %
10 %
5%
0%
Service Other Power & Industry Gov.mnt Oil/gas
prov. Heat
respondents did not represent GHG emitting as 23% claimed that they would be engaging in
industries, while about 25% represented only small trading soon, but as many as 47% said they were
emission levels, i.e. below 0.5 Mt per year. 7.5% of not trading at all. Of the ones who were trading, 9%
the respondents represented major emitters, with were active in the EU ETS and 8% in both EUAs and
more than 10Mt per year. CDM/JI. 11% said they did CDM/JI trading only.
40 %
35 %
Share of respondents
30 %
25 %
20 %
15 %
10 %
5%
0%
EU: Other Non-Annex- EU: CEE EU: South Europe:
Northwest Annex-1 1 Non-EU
50 %
40 %
Share of responses
30 %
20 %
10 %
0%
No Will be soon CDM/JI EUA Both EUA
and CDM/JI
Source: Point Carbon
2. What is the carbon market? had ratified the Protocol, corresponding to 61.6%
of total Annex I parties 1990 emissions. USA and
In brief,the carbon market can be explained as
Australia are noteworthy for being the only major
the market resulting from buying and selling of
industrialised countries not to ratify Kyoto.
emission allowances and reduction credits in order
to enable countries and companies meet their GHG
While the Kyoto Protocol does not impose
emission targets. Another way of looking at it is that
emission reduction commitments on developing
it introduces a price for carbon - placing a cost on
countries, they play a crucial role in the international
emissions and a value on reductions. This chapter
carbon market. Countries, and also companies, can
gives a brief introduction to the concepts underlying
invest in emission reduction projects in non-Annex
the carbon market, focusing on countries’ Kyoto
I countries and receive carbon credits in return for
targets and the structure of the market mechanisms
the resulting reductions. As we will show later in
that can help achieve them.
this report, developing countries are indeed already
participating in a meaningful way – contrary to what
When the Kyoto Protocol was agreed in 1997, a
has been argued by some opponents of the Kyoto
total of 39 industrialised countries (referred to in
Protocol.
treaty terminology as Annex B countries) were given
specific emission limitations for the 2008 to 2012
period. It did, however, take a number of years and How are countries meeting the
subsequent multilateral climate negotiations under Kyoto challenge?
the UN umbrella before all the technicalities of the
agreement were in place.
In an issue of CMA “Kyoto progress: Will countries
meet their targets?” (12 September 2005), we
Table 2.1 shows a selection of countries with
analysed how various countries were approaching
significant GHG emissions and their respective
their international climate commitment. The analysis
Kyoto targets. As of 14 February 2006, 161 states
was based on the latest available national reports
and regional economic integration organizations
on GHG emissions, reported figures for historic
emissions growth, and projections on countries’ lately, with a 15 Mt increase from the previous year
future emission growth. Using 2010 as the reference reported for 2003.
year for the Kyoto period we estimated what the
countries’ full five year shortfall would be without any Given these short positions, we might ask: How
new policies, domestic trading systems, or carbon can countries with such significant short positions
procurement funds, denoting this as the business- meet their targets? From the governmental point
as-usual (BAU) scenario. Figure 2.1 illustrates the of view, there are essentially three categories of
BAU short positions for the most significant buyer options: (1) Establish domestic emission trading
countries/regions aggregated for the whole Kyoto systems, (2) implement domestic non-market based
period (2008-12). policies, and (3) establish procurement programmes
for purchases of allowances or credits from other
In terms of BAU emissions, the EU15 bubble has countries. See also Table 2.2.
by far the largest gap to fill in terms of tonnage.
However, this should be viewed cautiously as it
is merely 12.5% above the EU15’s Kyoto target,
Emissions trading stimulates private
while Canada and Japan are projected to have BAU
sector reductions
emissions of 46% and 29% above their targets
respectively. Overall BAU gap leaves countries 5,540 The emission trading systems aims to stimulate the
Mt short in the first Kyoto period. private sector to reduce emissions through internal
abatement, external procurement, and trading. What
is common for the governmental and corporate
Countries BAU gap is 5,540 Mt for strategies is that they can both utilise credits from
five-year Kyoto period CDM and JI projects to meet their commitments.
EU 15
Japan
Canada
Other
Table 2.2 Governmental and corporate strategies for meeting Kyoto targets
for being in compliance with the Kyoto targets. For policies for domestic abatement – constitute the
instance, approximately 44 % of GHG emissions political framing conditions that are decisive for how
within the EU are covered by the EU ETS. the market mechanisms actually work.
CDM/JI
= Supply Forwarding
compliance
= Demand
Sweden
Switzerland
UK
Netherlands
France
Germany
Denmark
Belgium
Greece
Finland
New Zealand
Austria
Ireland
Portugal
Norway
Japan
Canada
Italy
Spain
-10 % -5 % 0% 5% 10 % 15 % 20 % 25 %
Bottom of the league are Spain, Italy, Canada and leaving them with substantial emission allowance
Japan who all, it seems, will miss their targets by 20 (AAUs) to sell. These countries, located in Central
per cent or more unless drastic action is taken. Still, and Eastern Europe, are also prime candidates for
there is little reason for other countries to be smug, JI projects, as it is less costly to reduce emissions
almost all of the countries covered in the study have here than in Western Europe, Canada or Japan.
yet to develop credible policies and measures that Finally, there are about 100 non-Annex I countries
will help them meet their Kyoto targets. which can qualify as hosts for CDM projects, and
which could produce substantial reduction volumes
Overall, our analysis finds that these measures that could be sold to emission-craving industrialised
might potentially reduce the Kyoto gap with some countries.
50 % from the shortfall presented in figure 1.
Still, major buyer countries experience a 2,740 Mt Without going into too much detail on the analysis, it
shortfall for the five-year period, or 548 Mt per year is clear that the potential supply in the carbon market
in the Kyoto period even when taking measures into is considerably larger than the aggregated demand.
account, leaving them 9.5% above their collective Figure 2.4 shows the net supply and demand in the
Kyoto target. 5-year Kyoto period, as estimated by Point Carbon.
In particular, Russia has the potential to export
An updated analysis on countries’ Kyoto progress significant amounts of allowances, although it is far
will be presented in a forthcoming issue of Carbon from certain that they will do so. Our forecast for the
Market Analyst, set for publication in early April 2006. CDM market also shows that developing countries
Moreover, the carbon policies in non-EU countries will contribute substantial amounts, which could
will be further analysed in the CMA “Carbon around grow even higher than what we indicate here. Point
the world”, scheduled for March 2006 Carbon monitors the situation in the major seller
countries on a continuous basis and will publish
The above analysis clearly shows that the demand several in-depth analyses on how their behaviour will
for allowances or credits is real. What then about impact on volumes and prices in the global carbon
supply? Several of the countries with Kyoto targets market.
experienced economic downturn in the 1990s,
EU 15
Japan
Canada
Other
Ukraine
Eastern Europe
Russia
-5 -4 -3 -2 -1 0 1 2
Gt CO2e
Source: Point Carbon
600
500
400
Mt
300
200
100
0
DEU GBR POL ITA ESP FRA CZE NLD GRC BEL FIN PRT DNK
Source: Point Carbon 1990 2003 CAP
45
40
35
30
25
Mt
20
15
10
0
AUT HUN SVK SWE IRL EST LTU SVN CYP LVA LUX MAL
4 000
3 500
3 000
2 500
Mt
2 000
1 500
1 000
500
0
Power & Metals Cement, Oil & gas Pulp and Others
heat Lime & paper
Glass
Source: Point Carbon
Figures 3.1-2 also show calculated CO2- emissions Within each MS the allowances are allocated to
for the years 1990 and 2003 in the sectors now existing installations in five main sectors. Figure 3.3
covered by the EU ETS. The majority of the countries illustrates the distribution of allowances between
have had to reduce their emissions compared to these. The power & heat sector is by far the largest
their 2003 level. sector, accounting for 55 % of all allowances in the
system, making the EU ETS primarily dependant on
activities and changes within this sector.
100
80
60
%
40
20
0
< 1 Mt 1 Mt < x < 10 Mt > 10 Mt
Source: Point Carbon Allowances Installations
Close to 10,000 installations now have of view, it does not make any difference whether
commitments within the EU ETS. Figure 8 illustrates NERs are made available through new installations
the distribution of allowances and installations or through auctions; they represent net supply to
categorised relative to the size of the installations. the market in any case.
According to the currently available installation lists,
there are 92 large installations with an allocation 3.2 CDM and JI
of more than 10 Mt CO2e in the 3-year period 05- While the EU ETS is a consequence of countries
07. Together these account for only 0.9 % of the taking on their Kyoto commitments, the two project
total number of installations but for a whopping based mechanisms are actually specified in the
34% of the total allowances. At the other end of the Kyoto Protocol itself.
scale, we find that there are close to 9,000 small
installations emitting less than 1 Mt CO2e, totalling CDM is the only mechanism under the Kyoto Protocol
only 19% of the allowances but more than 90% of involving countries that are not subject to binding
all installations. However, it is the medium sized greenhouse gas emission caps by the protocol – so-
emitters, between 1 and 10 Mt, which have the called non-Annex I countries, primarily consisting
largest amounts of allowances, accounting for 47% of developing nations. Under the CDM, investors
of the total amount. from Annex I states, i.e. industrialised countries,
receive Certified Emissions Reduction units (CERs)
Medium-sized emitters account for for the actual amount of greenhouse gas emissions
47% of total allocation reduction achieved through an emission reduction
project, subject to host country agreement. CERs
can be produced from projects initiated after
In addition to allocating allowances to existing 2000, and although most current projects are only
installations, the MSs have in their NAPs set aside contracted until 2012, there is no specific end date
some allowances for new installations, the so called for the mechanism itself.
New Entrant Reserves (NER). Based on the current
version of MS NAPs, the total potential supply of
allowances from NERs for the 05-07 period is Additionality is key component of
between 120 – 180 Mt. Unused NERs might be CDM
made available to the market later in the first trading
period. There are basically two options for how the A key component of the CDM is the requirement of
NER surplus is dealt with, either by sale or auction, additionality. CER units generated under the CDM
or cancellation. From a demand and supply point will only be recognised when the reductions of
Design docs. Methodology Hence, the track 1 system leaves much more up
methodology rejected to the host nation than does track 2 and the CDM.
Track 1 JI projects are still, however, required to
Approval, substantiate additionality.
Non-approval
Executive Board
While the above describes the project market in very
Failure broad terms, it is in fact a highly complicated market,
Implementation Delay with several steps and bureaucratic processes to go
through before credits are issued and can be used
for compliance purposes. Figure 3.5 shows a very
Certification Uncertified
simplified picture of the different steps needed for
a CDM project to produce credits, and some of the
CER risks involved at different stages. In this context, the
process for JI track 2 can be assumed to be fairly
similar, although there will be different institutions
involved.
greenhouse gas emissions are additional to any that
would occur in the absence of the certified project
activity.
Increased regulatory certainty lead
to jump in CDM/JI activity
JI is the sister mechanism of CDM, allowing for GHG
emission reduction projects to be carried out jointly As expected, the increased regulatory certainty
between two or more developed Annex I countries, following Kyoto ratification by Russia, and
where one will act as investor/buyer and the other subsequent entry into force of the Protocol, as well
as host/seller. These projects will result in so-called as the registration of the first CDM project on 18
Emission Reduction Units (ERUs), which can then November 2004 has lead to a jump in CDM activity.
be used for compliance by countries or companies. In addition to this come the improvements to the
Although a test programme for JI has existed since processes of the CDM Executive Board and the
1999, the actual transfer of allowances will not begin Methodology Panel.
until 2008.
This can be seen clearly from the number of
Two broad categories under JI - Track proposed CDM projects registered in Point Carbon’s
1 is very simplified database, which more than doubled throughout the
year, from 980 to 1965 projects. Currently, there are
2,256 CDM projects in the database. A significant
There are two broad categories under the JI, called share of the increased number of projects has come
track 1 and track 2. Whereas track 2 is essentially in a few select countries. Figure 3.6 shows the
the same as the CDM (see above) with strong number of projects in the Point Carbon database for
additionality requirements, track 1 is a very simplified selected countries at the end of 2004 compared to
procedure. The issuance of ERUs from a track 1 mid-December 2005.
initiative can be done provided the following criteria
are fulfilled by both buyer and seller:
350
300
250
Number of Projects
200
150
100
50
0
Chile
Philippines
Mexico
India
China
Brazil
Panama
Vietnam
Argentina
Indonesia
2004 2005
[Mt] [€ million] [Mt] [€ million]
EU ETS total 17 127 362 7,218
- OTC + exch. 9.7 n.a. 262 5,400
- Bilateral 7.3 n.a. 100 1,818
CDM 60 188 397 1,985
CDM 2nd 0 0 4 50
JI 9 27 28 96
Other 7.9 34 7.8 52
Sum 94 377 799 9,401
What? Point Carbon’s methodology for estimating and forecasting the carbon market has been in use since our
first publications in 2001. The methodology differs from that seen in other market assessments, e.g. by the
World Bank. One reason for this difference is that our proprietary transaction database registers only broker
transactions/contracts and signed Emission Reduction Purchase Agreements (ERPAs) that are reported to us.
This will produce a different, and in our view more accurate, result than also including volumes in term sheets.
We also differentiate between reported contracts/transactions and an estimated “hidden” market; notably
bilateral deals in EU ETS and undisclosed contracts in CDM and JI.
How much? The time value of money makes the value of a contract different from signing to delivery. This is
especially evident for forward streams such as CDM/JI projects with long lifetimes and distant deliveries. For
the purpose of illustration, we discount all contract values to the year they were signed using a 7% discount
rate, based on their proposed deliveries. For simplicity, we assume all payment to be done on delivery, although
some contracts have partial up-front payments.
The carbon market has historically been fragmented, and although the vast majority of trading activity now
takes place in the EU ETS, CDM and JI segments, there are still some deals involving greenhouse gas credits
that we do not include in our analysis and forecast. This might be the case if no actual contract has been signed
or transaction has taken place, or if there is no standardised tradable unit involved in a transaction.
Included
Kyoto markets: CDM, JI, AAU
Mandatory emissions trading: EU ETS, UK ETS, New South Wales (Australia)
Voluntary emissions trading: CCX (USA)
For the EU ETS we report transactions in the brokered (OTC) market and the volumes on exchanges. However,
we do not include clearing (e.g. exchange for physical) of OTC contracts through exchanges. In addition, we
estimate the size of the pure bilateral market (outside brokers and exchanges).
For CDM and JI we include only emission reductions purchase agreements (ERPAs) signed by both Seller(s)
and Buyer(s). We furthermore only report contracts based on future delivery, as there will be no liquid spot
market until the International Transaction Log (ITL) is up and running in April 2007, at the earliest. We also
include forward sales of issued/approved and non-issued/approved CERs/ERUs in the secondary market. In
addition, we include auctions of CERs through the New Values platform, and transactions of Carbon Credit
Notes through the Johannesburg Stock Exchange.
Not included
Domestic project tenders: Programs where companies can apply to their government in order to receive
emission credits or allowances based on specific projects, e.g. in the past this has applied to New Zealand’s
PRE Tender. Although these programs might result in the allocation of actual credits or allowances that can
be traded on the market, the initial allocation of the credits from the government to the company or project
developer is not counted as a transaction. If the project volumes are sold on to a buyer we count the volumes
once that contract is registered.
There are also US states with caps on emissions and plans for trading, but as long as there is no activity in
these potential markets they will not be included.
Various voluntary programs: Several voluntary programs exist where companies or organisations engage in
deals that include transfers of carbon credits, e.g the Oregon Climate Trust, which uses its funds to acquire
emission reductions from a number of sources. These credits are normally not transferable to operational
trading systems. There is also a growing retail sector, selling various carbon credits to companies, organisations
and individuals. Typical retail initiatives include e.g. programs for offsetting emissions from air travel.
Various stand-alone deals: Some companies have undertaken carbon credits deals that are so far not related
to any program or system. Many of these are done for company internal emission requirements, or used for
Corporate Social Responsibility reporting purposes. If these credits are sold to any operational system they are
reported under that market segment.
120 2 500
7%
100 14%
137% 2 000
80 94%
1 500
Mt CO2
€ mill
60
46% 1 000
40 185
20 500
0 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Source: Point Carbon
responses are spread somewhat evenly, there are exactly how much is traded bilaterally, this provides
some indications that the majority see the bilateral at least some transparency on what the company-
market as being somewhere between 10% and to-company market might look like.
50%.
Based on this response we estimate that the 4.1.1 What drives the EUA price?
bilateral market in 2005 was 100 Mt, or 27.6% of Prices increased significantly in the first half of
the total volume. Although bilateral trading will have 2005, going from about €7/t in February to almost
occurred at different times throughout the year, €30/t in July, before ranging from €20/t to €24/t for
by applying the average price through the year we the second half. Figure 4.6 shows the daily prices
find that the bilateral market in 2005 corresponds as reported by Point Carbon together with daily
to €1.8 billion. While we will certainly never know volumes in the OTC and exchanged markets.
3- b
ay
n
ar
ct
Ju
Ap
No
De
Ja
Ju
Au
Se
Fe
M
O
M
3-
3-
3-
3-
3-
3-
3-
3-
Source: Point Carbon OTC Exchanges The E-t-C will change on a continuous basis due to
a number of factors, but in particular: weather, as
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
temperature determines power/heat demand and Have we seen evidence of the market reacting to
precipitation the potential for hydropower production; these fundamentals? In fact, the first year of the EU
and fuel prices, as the relative price for coal and gas ETS has shown that the market is indeed responding
will determine which of the fuels will be used for to changes in fuel prices and weather. Nevertheless,
power production. In other words, if the winter is policy decisions still have the potential to shift prices.
cold and the gas-to-coal price differential widens, See Point Carbon’s Carbon Market Analyst “After the
emissions will increase as more power is consumed NAPs” from 3 November 2005 for a full discussion
and coal, which emits more GHGs per unit of output on which policy events we anticipate to impact on
than gas, is the preferred fuel source. Thus, carbon price development in the future.
prices will also increase. A different situation would
occur in a mild and wet summer, where there is Market is responding to
less demand for power and the rainfall increases the fundamentals and policy events
potential for hydropower production.
3500 30
28
3000 26
2500 24
22
2000 20
ktCO2
18
€/t
1500 16
14
1000 12
500 10
8
0 6
24-Nov-05
23-Dec-05
3-Jan-05
4-Apr-05
3-May-05
29-Jul-05
29-Aug-05
1-Feb-05
26-Oct-05
2-Mar-05
1-Jun-05
30-Jun-05
27-Sep-05
35 140
R2 = 0,92
30 120
100
25
80
20
Mt CO2
€/t
60
15
40
10
20
5 0
0 -20
8-Aug
8-Sep
8-Feb
8-Mar
8-Apr
8-May
8-Jun
8-Jul
8-Oct
8-Nov
8-Dec
“switching prices” in the UK are well above the What do market participants see as the most
EUA prices. Hence, one would need higher EUA important factors for carbon price development?
prices and/or lower gas prices to trigger substantial Fig 4.8 shows the response from our survey, where
switching from coal to gas. it is evident that fuel prices are seen as the most
important price determinant. Appoximately 45 % of
Majority of trading due to power the respondents considered fuel prices as the most
generators’ activities important factor, while more than 20 % considered
it to be the second most important factor. It is also
interesting to note that political factors are seen to
Not only does the price relation to fundamentals tell be the second most important factor in the short
us that the market has found reliable price indicators, term. Many of the political factors should already
it also shows to some extent which sectors that are have been cleared at this stage, but it is evident that
active in the market. The Power & Heat sector, which this politically created market still looks to policy for
is where the overall shortage has been placed, is announcements on supply, and to some extent also
used to trading on a daily basis, and importantly, demand.
is used to trading based on weather and fuel price
changes. Although there are some (larger) industrial It would clearly be a positive development if the
companies with their own trading departments, the importance of politics was reduced and replaced by
majority of trading activity - and price development a more predictable fundamental both as a risk and a
- in 2005 was due to power generators trading price driver. This will probably happen as the EU ETS
strategies. matures and confidence in its continuation accrues
and the outcome of legal and regulatory tussles
This dominance by the power sector has been used between the commission and MSs becomes more
by many to criticise the system, in particular in light predictable.
of the impact carbon costs have had on power
prices. As we will touch upon later in this report, Fuel prices most important in short-
the increased spot prices in the German and Nordic term perspective
power markets can to a large extent be explained by
the introduction of emissions trading. There are, however, political developments that
cannot be expected to be solved in the immediate
Political factors
Weather
CDM/JI supply
Long-term prices
Other factors
0% 20 % 40 % 60 % 80 %
Share of responses
Most important factor
Source: Point Carbon Second most important factor
Political factors
CDM/JI supply
Weather
Long-term prices
Other factors
0% 20 % 40 % 60 % 80 %
Share of responses
Most important factor
Source: Point Carbon Second most important factor
300
250
200
Mt CO2e
150
100
50
0
a
a
il
a
I)
ia
az
di
in
ric
ic
w
(J
As
er
Ch
In
Br
no
Af
e
Am
er
p
nk
ro
th
/U
Eu
O
er
er
th
th
O
O
this has contributed to the demand for project CDM market to have totalled 4 Mt, €50 million in
credits. The increasing number of carbon funds has 2005.
added further to the demand. This sector includes
governmental procurement funds, private sector Exchanges are also beginning to offer CDM related
investment vehicles, and private-public funds (e.g. contracts. Carbon credit notes are being traded at the
all World Bank funds). Point Carbon will return later in JSE Securities Exchange, providing a carbon based
2006 with an updated review of the different funds investor product, for delivery in 2008. However, the
that are available for private sector investment. volumes have so far been measly, as only just below
While CDM investments is now increasingly being 20,000 tonnes were reported transacted in 2005,
dominated by private investors and funds, JI is still corresponding to around €200,000. Interestingly
mainly attracting governmental buyers. though, prices for carbon credit notes at JSE remain
substantially below EUA prices, currently trading at
about €14/t. The other exchange option, with Asian
Carbon funds add further to demand Carbon and New Values offering CER auctions on
their platform, saw around 1.5 million traded in 2005.
Figure 4.12 shows an overview of buyer’s in the Point Carbon does not register the CDM volumes
CDM and JI market, together with a breakdown of through New Values separately, and this has already
volumes on project type. As funds here include both been included in the 397 Mt total.
private sector and government investments, it is
clear that the private sector is by far the dominant
CDM investor. In terms of project types the large 4.2.1 What drives the CDM/JI prices?
volumes involved with the decomposition of HFC- Prices for both CDM and JI project contracts
23, a by-product in the production of the refrigerant increased during 2005. This can mainly be explained
HCFC-22, accounted for almost two thirds of the by increased demand from EU ETS companies
total volumes in the project market in 2005. and the numerous carbon funds that became fully
operational for purchasing credits. However, prices
In addition to the direct project market, with ERPA differ a lot from contract to contract, mainly based
contracts, there is a considerable secondary market, on the distribution of risk between buyer and seller.
where contracts for future delivery of CERs, not
necessarily with a specific project attached, are Moreover, mature projects are in general more
entered into. However, this is primarily a company- expensive than projects that have not yet reached
to-company market, although some such contracts the Project Design Document level. Also, delivery
are offered through brokers, and it is difficult to get is becoming more important. The price for credits
full overview of what is transacted in this market delivered before the end of the EU ETS’ 2005-
segment. Point Carbon estimates the secondary 2007 period are currently fetching a premium . See
Political factors
Earlier deals
Other factors
AAU prices
0% 20 % 40 % 60 %
Share of responses
Most important factor
Source: Point Carbon Second most important factor
Political factors
AAU prices
Earlier deals
Other factors
0% 20 % 40 % 60 %
Share of responses
Most important factor
Source: Point Carbon Second most important factor
Box 4.3 for an overview of Point Carbon’s contract estimated €52 million. Figure 11 shows the volumes
categories for CDM projects. and value of these markets in 2005.
Figures 4,13 and 4.14 show what the respondents We do not expect very significant growth in these
to our web-survey saw as the most important markets. The UK ETS is in its final year, and the
price drivers in the short- and long-term. Decisions NSW scheme remains pretty stable from year to
by the CDM Methodology Panel are seen as very year. If any growth is to take place, CCX is the most
important in the short term, as this is primarily what likely candidate, as US companies might seize the
determines whether a specific project will qualify for opportunity to gain carbon trading experience and
CDM or not. It is also clear that the link between environmental credentials at the same time.
EUA prices and CDM/JI contracts are viewed by
many as a relevant issue. Increasing EU ETS prices
will tend to increase demand for imported credits,
Other markets saw 7.8 Mt,
and this will also increase the prices paid for said
estimated to be worth €52 million
credits.
UK ETS
4.3 Other markets The UK ETS continues to cling to a straw. Point Carbon
estimates that approximately 300,000 tonnes CO2
Although the carbon market now to all extent is
were transacted over the year, corresponding to a
focused on EU ETS and Kyoto instruments, there are
financial size of some GBP750,000 (€1.09 million
still some other operational greenhouse gas trading
estimated).
systems that should be considered.
CCX
5%
AUS NSW
AUS NSW 93 %
78 %
Source: Point Carbon
USA
The Chicago Climate Exchange grew considerably
in 2005, from 77 to 129 members. Furthermore,
the participants agreed to extend the programme
for four more years, with a new tentative end date
in 2010. Last year was also the busiest year yet
for the exchange, although it remains a relatively
illiquid market. In total the market saw 1.43 Mt CO2
transacted, corresponding to US$2.83 million (€2.37
million estimated).
5. Does it really work? But the carbon market is to some extent much more
than just environmental policy. The issuance of
As the previous chapters have shown, the carbon
EUAs to more than 10,000 installations throughout
market is now to all extents a fully operational
Europe has in fact created a whole new currency,
commodity market. Volumes are large, but there
which can be used as hard capital. In total, the 3-
is still room for considerable growth. Prices are
year allocation is currently valued at more than €153
reacting to fundamentals, although policy decisions
bn. The recent guidance for phase 2 indicates that
still impact from time to time. All in all, the carbon
the full 5-year allocation for the 2008-2012 period
market is a multi-billion euro industry which results
would be some 2.063 bn allowances per year, which
in emission reductions that will help countries meet
given current prices for Dec 2008 delivery values the
their Kyoto targets. But does it really work the way
underlying assets in that phase at more than €220
it should?
bn. It is obvious that certain operational procedures
must be in place when dealing with amounts of
There are still several shortcomings to the EU ETS,
this magnitude. It might, in fact, be worth looking
although they are primarily due to regulatory delays
at financial markets to see how they deal with
in Member State governments. In particular, the
announcements that will have direct impacts on
continuing uncertainty surrounding some national
the market. For example, if a decision which could
allocation plans (NAPs) is a problem for the market in
provide a market signal is to be delivered, let’s say
general, but to a much greater degree for companies
a meeting of the National Bank to adjust interest
in the countries still lacking complete plans. At the
rates, it must be clearly specified in advance exactly
time of writing, Italy, Poland and Hungary have all
when and how that message is to be delivered.
failed to publish installation levels NAPs, more than
1 year after the start of the trading system. The
Is this the case in the carbon market today? Alas,
same goes for Luxembourg, Malta and Cyprus,
it is not. A decision which could have clear market
although these countries were never expected to be
implications is rarely announced clearly in advance.
of particular importance to the trading activity in the
At times important decisions have caught both the
market
market and observers by surprise. The situation
which we have seen in the past, where decisions
Still several shortcomings to EU ETS are unannounced and documents are leaked to,
from and between Member States and business
organisations, is not preferable in the long-run -
Furthermore, a number of countries have been
although it is definitely interesting for journalists and
almost criminally slow in putting up their registries,
market analysts alike.
pushing very close to having infringement
procedures opened due to the lack of proper
Of course, there are differences between the
operations. Only a few countries actually met the
carbon market and other financial markets. For
deadline set by the Commission, leaving major parts
instance, interest rates are usually not a matter of
of the market operating without registries for large
negotiation. Also, it is probably too much to ask the
parts of the year. In early January 2006, a total of
EC’s environmental directorate to change their entire
7 national registries were listed as “not operating”,
modus operandi. Policy documents will always be
while all others were listed as “partially operational”.
leaked, and processes in governments will often
Although “partially” here means that the registries
take more time than expected.
to all extent and purposes are sufficiently up and
running, at least to meet the requirements of the
market today, it is clear that the registry situation still Market works even with assymetric
needs considerable improvement. information
The lack of registries has been quoted by many
Nevertheless, it is worth pointing out that the market
throughout the year as a reason for why some
works, albeit not effectively, in this situation. This
companies, in particular potentially large sellers in
proves that the market can work even if information
Central and Eastern Europe, have stayed away from
is asymmetric. However, it does not take away the
the market. Many buyers prefer spot trading with
need for sufficient safeguard measures to be put in
CEE players, due to credit lines. This implies that
place so that the carbon market will know in advance
we will see more action from that region in 2006.
Figure 5.1 Has the EU ETS triggered internal abatement projects in your company?
Based on responses from our web-survey
60 %
Share of responses
40 %
20 %
0%
Yes No Do not know
Source:
Point Carbon Industry Oil/gas/refineries Power & heat
exactly when and how decisions are communicated. need to reduce emissions, or import considerable
If this is done within both the EC and the Member additional allowances and/or credits – through the
States it will help to increase the effectiveness of New Entrant Reserve (NER) and/or CDM –in order
the market even further. The EC’s track record in this to be in balance for the 3-year period. Even with our
field should indicate that they will be able to deal current assessment on the potential supply through
with this, as well as the other challenges ahead. NER and CDM, the market will still be short. It is,
however, important to point out that the results of
Leaving aside whatever problems that remain with this analysis changes with relative fuel prices and
the market and uncertainties about policy issues weather conditions.
regarding phase 2, to what extent has the EU ETS
been effective in its first year of operation?
40% of industrial respondents say
The environmental effectiveness of the EU ETS ETS lead to internal abatement
must be seen in relation to whether the system
will succeed in meeting the overarching goal: How do market participants view the effect of the
to reduce greenhouse gas emissions. This is in EU ETS for their own operations? Fig 5.1 shows the
reality defined by the cap, and whether the system response from industrial players participating in our
reduces emissions from a business-as-usual path. web-survey. More than 40% of participants from
Of course, it also assumes that the system works; the industrial sector said that the EU ETS has lead
that companies stay in compliance and those failing to internal abatement projects being carried out in
to do so are penalised accordingly. their company. While the relative share of positive
responses was lower for the oil/gas sector and the
The EU ETS will undoubtedly reduce emissions. power & heat sector, in more than 25% of the cases
As we have shown, most countries had to reduce the EU ETS has lead to reductions.
their allocation in relation to their 2003 emissions.
In sum, the EU ETS sectors had to reduce about 40 However, internal abatement is only one of the
Mt, or 120 Mt for the three-year period, in relation to pillars in the corporate emission reduction strategy.
2003 emissions. Companies can also purchase allowances and
credits in the market. Or, in extreme cases, they can
Furthermore, Point Carbon’s allowance demand choose to relocate their entire business to a country
indicator, Emissions-to-Cap (E-t-C), indicates that where emission limitations do not apply.
based on current EUA prices the system would
Figure 5.2 What is your primary strategy for complying with EU ETS?
Based on responses from our web-survey
40 %
Share of responses
20 %
0%
Internal Trading Trading Relocation Other
abatement CDM/JI within EU
ETS
Source: Point
Carbon Industry Oil/gas/refineries Power & heat
Figure 5.2 shows the different strategies chosen There is, alas, no universal definition of liquidity, or at
by the industrial players participating in the web- least what constitutes sufficient liquidity. A working
survey. About half of the respondents from the definition is that a market is liquid if participants
industrial sector said that internal abatement was can quickly execute (large-volume) transactions at
their primary strategy, while only 18% of the power low costs with minimal impact on market prices.
& heat respondents saw this as their first choice. To do this it will be necessary to have a sufficient
These results further show that the power sector number of participants with sufficient volumes at
is primarily looking to the EU ETS, and also CDM/JI, each side of the bid/offer spread. In reality, however,
as their best carbon strategy. This is in line with our it will also require accurate, reliable and timely price
other analyses, which show that the carbon market discovery. As we have shown earlier in this report,
is to a large extent dominated by the power sector. It the market is indeed reacting to fundamentals.
is also interesting to point out that only a very small This provides certainty that prices are not being
minority of respondents pointed to relocation as an randomly set, or at a minimum that the underlying
option, indicating that there is little actual evidence reasons are measurable, unlike the case most often
of carbon leakage taking place. is with policy decisions. In addition, there are now
a wide number of market service providers, giving
Little actual evidence of carbon participants access to reliable and timely prices.
leakage taking place This leads us to conclude that the market is already
meeting the necessary requirements in terms of
price discovery.
However, just meeting the targets will not be enough
for emissions trading to be judged a success. It will
also be crucial to determine the manner in which Is the EU ETS liquid?
these reductions have been achieved. Establishing
an effective and liquid marketplace is a necessary The remaining question is then whether we have
(but not sufficient) condition for achieving economic seen sufficient volumes in the market. As this is the
(cost) and institutional effectiveness. But when is first compliance year of the EU ETS, there is little
a market liquid, or at least liquid enough? Can we data for a comparative analysis. However, there are
look to other markets to find reliable indicators for other environmental markets that provide some
liquidity that may be used for the EU ETS? historical data. In particular, the US SO2 market is
a prime candidate for comparing the liquidity of the
45 %
40 %
35 %
30 %
25 %
20 %
15 %
10 %
5%
0%
01.12.04
01.01.05
01.02.05
01.03.05
01.04.05
01.05.05
01.06.05
01.07.05
01.08.05
01.09.05
01.10.05
01.11.05
01.12.05
01.01.06
Source: Point Carbon
EU ETS. This market has seen turnover increasing even without full participation throughout the year.
from 10% in 1995 (the first year of the market) to In sum, we find that the EU ETS is already a qualified
70% in 1998 (the most liquid year to date). Average success.
turnover in the period 1995 to 2003 was 50% per
year. 45% finds EU ETS a success, only
22% thinks the same of CDM/JI
How does the EU ETS fare in comparison? In the
first year of operation the market has seen annual Do survey participants agree with us? To some
turnover of 12.4% of total underlying assets (2005 extent, yes. Figure 5.4 shows that the market finds
allocation, not including NER). However, looking at the EU the EU ETS to be more mature than it was
the development throughout the year, it is clear that a year ago (67% agree), but that only a handful of
liquidity has picked up as the market has matured. respondents (10%) find it to be a mature market. In
One way to measure this is to look at how much was other words, the market still has some way to go
transacted in a week in relation to a “weekly cap”, before it reaches puberty. However, the market is
i.e. the 5 day rolling average. This volatility measure already seen as a success (45%), and 55% find that
has increased steadily, reaching more than 30% at if facilitates emission reductions. Furthermore, 47%
periods in the last 3 months. This clearly shows that of the respondents saw it as the most cost-effective
the market is becoming increasingly more liquid, way of reducing emissions.
and that more participants and more volumes have
come to the market during the year. The situation is somewhat different for the CDM and
JI markets. While half of the respondents thought it
The EU ETS is already a qualified a more mature market than one year ago, as many
success as 21% disagreed with this. Also, only 7% found
it to be a mature market. Importantly, while the
project markets are viewed as cost-effective ways of
As we have shown previously, there are still some achieving actual reductions, only 22% thought that
improvements that can be made in terms of bringing the project market was a success.
all parties to market. Nevertheless, even with these
shortcomings still present, we argue that the market One of the main criticisms towards the EU ETS has
now has real price discovery, reacts to changes in been its impact on power prices. We will discuss
fundamentals, and enjoys several reliable market this in more detail in the next chapter.
service providers. In addition, liquidity is increasing,
EU ETS facilitates
emissions reductions
EU ETS is a success
0% 20 % 40 % 60 % 80 %
Source: Point Carbon Disagree Agree
0% 20 % 40 % 60 % 80 %
60
50
40
30
20
10
0
2001 2002 2003 2004 2005 2006 2007 2008
them here to give some rough idea on how power We see that power prices in general made a big jump
prices have developed so far in this decade. in 2005, and forward curves continue this upward
trend in 2006-08. Moreover, the annual averages
The average annual EEX spot price showed a indicate that the EEX region experienced a more
moderate year-on-year increase to 2004, followed significant price growth than the Nordic region. Can
by a steep growth from 2004 to 2005. The average the rise in the EEX spot prices in 2005 be attributed
price for 2001 – 2004 is 26.2 €/MWh, while it was to the introduction of the EU ETS? Or is it the fuel
46.0 €/MWh in 2005, representing a 75.0 % growth prices? And why does the Nord Pool spot prices
(61.4 % from 2004 to 2005). The forward contracts in 2005 seem to have been less affected by the
for 2006 – 2008 have further followed the bullish EU ETS market. It is of course difficult to consider
development of increasing power prices. As seen prices in the Nordic region without looking at the
from Table 1, the development in Germany is also hydrology situation. To what extent have reservoir
found in other European exchange markets, with a levels impacted on Nordic power prices? We will
57.6 % growth on average from 2004 to 2005. discuss these factors in some detail in the following
sections.
Spot prices have increased
throughout Europe 6.2 Explaining increasing spot prices
As already mentioned, the European wholesale
The development in the Nord Pool region shows a electricity market is far from fully liberalised, although
somewhat different trend. In 2001 the spot price there are considerable regional differences. The
was lower than the EEX price, while it increased, Nordic countries (the Nord Pool region) have moved
even above the EEX level, during the 2002 and 2003, quickly towards a truly competitive power market,
before leveling off in 2004 and 2005. The average while there is still a strong oligopolistic structure
price for 2001 – 2004 is 28.9 €/MWh, while it was in Germany. Within this context we will seek to
29.3 €/MWh in 2005, indicating a 1.40 % increase explain why we have seen the increasing spot and
(1.43 % from 2004 to 2005). The forward contracts forward prices in 2005-2008 in the Nord Pool and
for 2006 – 2008 are at an even higher level than in EEX region.
2005.
Coal
CCGT
0 10 20 30 40 50 60
80
60
40
20
0
Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05
Source: Point Carbon and EEX EEX Base SRMC Coal SRMC coal incl. CO2
plant with efficiency rate of 39% (including fuel cost, maximum 13.5 % of the total installed capacity is
CO2 allowance and operating and maintenance exposed to the EU ETS market and the cap on CO2
costs). During the summer of 2005, SRMC reached emissions.
a peak of €50/MWh, due to rapidly increasing CO2
allowance prices. However, this cannot fully explain Due to the high hydro power fraction in the Nord Pool
the peaks in power prices. region, there has traditionally been a high correlation
between the total energy reservoir and spot prices.
Increasing gas prices explain some
For instance, the average correlation in 1996-2004
of the power price increase was 0.85, while the 52 weeks rolling correlation
between the two quantities was between 0.6 and
Increasing fuel prices, in particular for gas, through 0.95 from 1996-2004.
this period will also go some way to explain the
increased power prices. But this is also only one Figure 6.4 illustrates that there seems to be a
part of the explanation of the increasing power level-shift in the relationship between the energy
prices. Gas fired plants in Germany are seldom the reservoir levels and spot prices from January 2005.
marginal price setting power producer - with only There was a marked divergence between reservoir
a minor share of power plants in Germany being levels and the spot price, before correlation was
gas-fired - and are on the margin only for parts of re-established, although at different levels than
a 24 hour period. In addition to the significance of in previous years. As figure 4 shows, such energy
carbon- and fuel prices to the spot prices, increased reservoirs had previously resulted in spot prices in
consumption in peak periods and potential imperfect the 100-150 NOK/MWh area (12-19 €/MWh). What
market conditions, with few other than large actors is the contribution from the EU ETS to this?
being able to control the market, are explanations to
the observed development in spot prices. The increasing spot prices in 2005, as well as the
level shift in correlation between reservoir levels and
6.2.2 Nord Pool prices, can partly be explained by the direct influence
of carbon costs to Nordic producers. However, since
How has the Nordic market been hit by the EU ETS?
only 13 % (at a maximum) of the generation stack is
The supply side in the Nord Pool market consists
based on fossil fuel-based thermal production, there
of a substantial share of hydro power. Moreover,
are other reasons for the relatively high NP spot economical to export power from the Nordic region
prices in 2005. to the German market.
800 -150
700 -130
-110
600
-90
500
NOK/MWh
Deviation
-70
400
-50
300
-30
200
-10
100 10
0 30
96
96
96
97
97
98
98
99
99
01
01
01
02
02
03
03
04
04
05
05
0
0
Spot price
Source: Point Carbon and NordPool Energy Reservoir, deviation from Normal
50 %
Share of respondents
40 %
30 %
20 %
10 %
0%
r g s g g g g
he itie
din d in din din din
Ot traod tra l tra tra l tra
r m s i k a
weom Ga O
Sto
c Co
Porc
the
O
Source: Point Carbon
carbon traders have a background in power or fuel thus increasing demand for allowances. This leads
trading, see Figure 6.5. Although the carbon market us to argue that the introduction of the EU ETS
to some extent operates on its own logic, it is clear could amplify price volatilities in the power market,
that having many traders thinking along the lines for both upwards and downwards price movement.
they have done in previous positions will add further
to the correlation between prices and commodities.
Power prices impacted by climate
policy uncertainty
6.3 New complexities arising
As seen above, the EU ETS hits both the NP and EEX Given the new carbon-power interplay, it is clear that
regions, although somewhat differently. The main power prices are also now influenced by uncertainties
explanations for the differences are the fuel mix, relating to climate policies and the carbon market.
the cross-border trading capacities and possibilities, In particular the inflow of carbon credits, primarily
weather conditions, as well as the fuel prices. In through New Entrant Reserves (NERs) and Certified
an already complex power market situation, carbon Emission Reductions (CER), is significant to the
now enters the picture, creating new complexities carbon price. Increased supply of these will reduce
and interplay between commodities. the price on EUAs and consequently also on power.
Thorough discussions on this can be found in
previous issues of Point Carbon’s Carbon Market
Many carbon traders with power Analyst, for instance “After the NAPs” (3 November
market background 2005) and “Opening the floodgates” (16 December
2005)
In addition to increasing the power price, the EU ETS If these interplays continue also in the future,
could raise the volatility for power prices, through the carbon market will over time add a new and
a so-called “double whammy” effect. During mild more complex dimension to the European energy
winters or cold summers power prices and volumes markets, where energy markets will be impacted by
decrease because of reduced energy consumption. the global climate policy agenda and international
The opposite situation is found for cold winters and market for allowances and credits. This trend will
warm summers. But the same fundamentals apply to become paramount towards 2008 as the EU ETS
the carbon market (see Chapter 4), where increased will increasingly be impacted by policy events and
power demand leads to increasing emissions, and market developments outside Europe.
7. What does the future hold? Still, there is a difference between a theoretical
supply and political reality. It is still uncertain exactly
Trading is already well under way in the second year
how many allowances that will be available from
of the EU ETS, and new projects are coming into
Russia and Ukraine, and how they will come to
the CDM and JI pipelines on a regular basis. But
the market. In a previous issue of CMA (“Will the
where will the carbon market go in the future? The
giants awake?” 22 March 2005) we concluded that
market for EUAs with 2008 delivery has not yet fully
the majority of these AAUs would be sold through
taken off, and there are very few CDM/JI projects
political deals in a non-commoditised market. In our
that extend beyond 2012. What are the challenges
view this conclusion still stands.
and opportunities that market participants will face
in the years ahead?
More emphasis on JI and GIS
This chapter will explore some of the major
developments expected to take place in the market
There will certainly be more emphasis on JI and
in the near-term future, and discuss whether they
Green Investment Scheme options in the years to
will have any significant implications for current
come, but the developments in Russia and Ukraine
market activity.
so far do not indicate that there will be a market
based on supply and demand for AAUs, where a
7.1 Globally - still political uncertainties true reference price emerges. We will continue to
As we have discussed already, there is a potential monitor the situation in these countries and return
surplus of allowances in the Kyoto period. In particular, with an updated issue of the CMA where we look
the two giants on the sell side – Russia and Ukraine at countries’ and companies’ options for buying
- will have more than enough emissions to meet allowances on the eastern front.
what is left when/if domestic options and CDM/JI
are exhausted. In fact, Russia and Ukraine can meet Nevertheless, the behaviour of both seller and buyer
all other countries’ current carbon requirements countries alike will depend on the expectations for
and will still have large amounts of allowances left a future climate agreement. While the future of the
over, which they can then bank into a commitment international climate cooperation is still being hotly
period from 2013. Adding also the expected surplus debated, there are strong signals from the recent
in other Central and Eastern European countries we climate talks to indicate that at least the process
find that the potential supply would be about three towards an agreement for the post-2012 period is
times higher than the current Kyoto shortfall. in safe hands.
Fig 7.1 Where will the EU ETS price be one year from now?
Based on responses from our web-survey
60 %
Share of responses
40 %
20 %
0%
Lower than today At same level as Higher than
today today
Source: Point Carbon
climate round since Marrakech/Bonn (COP6/COP6 economy. As Point Carbon has reported in several
bis). other publications, we do not see the AP6 as a
viable solution to the global climate problem. It sets
Everything should now be in place for countries to no target for emissions, a measurement for success
start talks on a second commitment period under is not in place, and it does not place a cost on
the Kyoto Protocol, starting in 2013. Furthermore, emissions or a value on reductions. While it certainly
a number of countries have signalled that their will generate headlines in 2006, we don’t expect the
domestic initiatives will have a lifetime well beyond actual output in terms of emission reductions to
2012, clearly indicating that carbon emissions will amount to much.
have a cost (and reductions a value) also from 2013
and onwards. This must now be taken into account In sum, the most pessimistic expectations for
by anyone undertaking new investments in industry international climate policy in 2005 were not met.
and the power sector, even if the regions where the And the alternative solutions to the Kyoto/UNFCCC
investments will take place do not currently operate process have yet to produce anything that resembles
under carbon restrictions. Certain non-Annex I more than just a talk-shop. The issue of climate
countries have also arisen as prime candidates for change has gained increasing attention throughout
taking on reduction targets in the future, such as the world, both through the G8 process and the
South Korea, Mexico, South Africa and Argentina. UNFCCC negotiations, as well as the AP6. Although
the turn towards technology in the rhetoric of many
key players can be expected to continue also in
No real substance in Asia-Pacific 2006, it is now clear that this will not stand in the
climate partnership way of real progress under the UN umbrella.
2008-2012 allocation. It should be mentioned that become public in mid-May 2006, after which it is
Point Carbon is currently developing an 08-12 model possible that the market could experience a shift
of Carbon Market Trader, our premium service in price levels – either up or down - if the outcome
to the most active players in the market. Further of the first year reporting is markedly different from
information on the second phase of EU ETS and what the market expected.
long-term carbon prices will also be available in later
issues of Point Carbon’s CMA publication. The other crucial event this year is the submission
of the allocation plans for the 2008-2012 period.
Figure 7.1 shows the survey respondents’ The NAP 2 processes are to be finalised by 30 June
expectations of an EUA price one year from now. 06, but the experience from the previous allocation
Note that the majority of respondents answered round suggests that several countries might miss
the survey in December 2005, when prices ranged this deadline. A more likely scenario is that the
in the low €20/t. As many as 51% said that they overall allocations for phase 2 will be finalised by
expected the price one year down the road to be the end of 2006. The uncertainty related to NAP
higher than what it was at the time. Only 20% said 2 is confirmed both in our web survey and by the
they expected it be lower. interviewees in the phone survey. If the decisions
regarding the new NAPs are further delayed this will
51% expect prices to increase over also provide the market actors with reluctance and
next year uncertainty, possibly impacting on both prices and
liquidity.
Of course, as we have already shown, the price of
carbon depends to a large extent on fuel prices How has the market developed so far in 2006? Since
and power demand. While the survey did not go the beginning of the year there has been increasing
into detail on which factors that would lead to the liquidity, with 91 Mt traded by 10 February, as well
different prices one year from now, it is clear that as increasing prices, going from just below €22/t at
there is a general feeling of the market being overall end of December 2005 to just below €28/t in early
short. The first checkpoint for this assumption will February. Based on this, what do we expect from
be the first true-up period. As companies submit the market for the rest of the year? First, it is clear
allowances and verified emission reports for 2005 that 2006 could easily see very large volumes being
it will give some indications on how short (or long) transacted. With daily volumes of more than 3 Mt, as
the market was in 2005. This data is expected to we have seen so far this year, and the expectations
30
% reduction from phase 1
25
20
15
10
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Fig 7.3 What do you expect from the allocation process 2008-2012?
Based on responses to our web-survey
50 %
40 %
Share of responses
30 %
20 %
10 %
0%
Much looser Somewhat Like the 05- Somewhat Much tighter
than today looser than 07 period tighter than than today
today today
Source: Point Carbon
Fig 7.4 How important is the long-term carbon price for new investments in your industry?
Based on web-survey. Limited to respondents representing GHG emitting industries.
40 %
Share of responses
20 %
0%
1 - Not 2 3 4 5 - Very
important important
of more players coming to market as the remaining States are expected to reduce their overall caps quite
registries come online, we could easily see almost a significantly, unless they can show to substantiated
tripling of volumes in 2006. Prices will of course be budgets and plans for procurement of credits or
an important factor in this forecast, and if the price allowances from overseas. The EC guidance states
movement is too great in either direction it is likely that no country will be allowed to increase their caps
to lead to reduced liquidity. from the first phase, and that countries which are
not on track to meet their Kyoto targets will have
There is, however, a big question that looms large on to transpose their Kyoto commitment down to the
the horison: What will be the outcome of the NAP ETS sectors, without changing the overall coverage
process for phase 2. The recent guidance by the of the sectors.
EC sends a strong signal that a number of Member
Fig 7.5 What level of internal abatement initiatives do you foresee in EU ETS 2008-2012
compared to 2005-2007?
Based on web-survey.
60 %
50 %
Share of responses
40 %
30 %
20 %
10 %
0%
Lower than 05-07 About the same as Higher than in the 05-
05-07 07 period
Source: Point Carbon
Figure 7.2 shows the countries that will have to The long-term carbon price is not only important
reduce the most from their phase 1 allocations if in terms of internal abatement, but must be taken
they do not engage in procurement of credits and into consideration when investment decisions
allowances. It should be pointed out that some of or company strategies are made. The survey
the countries in Figure 7.2 already have operational respondents representing sectors under the EU
procurement programs, e.g. Denmark and Austria, ETS answered overwhelmingly that long-term
and that their caps will not necessarily be reduced carbon prices were important when considering
by as much as this figure indicates. new investments in their industry, see Figure 7.5.
It is clear in this respect that it will be important
The expectation of reduced allocations is also to develop a long-term price signal that will allow
shared by our survey respondents, see Figure 7.3. companies to internalise these expectations into
A majority of 54% of the respondents expect the their own operations.
allocation for phase 2 to be somewhat tighter than
today, whereas 25% expect it to be much higher. With the current political climate and the close
Only 8% expected it to be looser than in phase 1. relationship that is developing between carbon-
and power prices we find it unlikely that the EU
Only 8% expect looser allocations in will meet the Western European shortfall only by
Phase 2 than in Phase 1 strengthening the caps under EU ETS for the Kyoto
period. Instead, we expect that most countries
in Western Europe will realise that they need to
This is further reflected in participants’ expectations strengthen their carbon procurement budgets. This
for internal abatement to take place in the 2008-2012 is, however, not as easy as it might sound. The CDM
period compared to the current phase of EU ETS, market still has some way to go before it is fully up
see Figure 7.4. Only 3% of the survey respondents to speed, and the JI market has yet to be put into
expect there to be less internal abatement initiatives operation. In the following section we will look more
in the future, and as many as 24% expect there to closely at our expectations for the project market.
be more abatement in the 08-12 period than in 05-07.
To some extent this will be a natural consequence
of companies having had more time to adjust to
7.3 CDM/JI - long term investments?
operating under carbon constraints, but it might also The higher than expected EUA prices have
reflect an expectation of higher prices. dramatically increased the private sector’s appetite
for credits from CDM and JI. This has lead us to
Fig 7.6 Where is the price of an issued CER one year from now?
Based on responses to our web-survey
80 %
Share of responses
60 %
40 %
20 %
0%
Lower than today As today Higher than today
change our perceptions for the project market. The countries are years ahead of what we see for the
currently massive investments in JI and CDM imply largest potential sellers under the Kyoto Protocol,
that the project based mechanisms are posed to be e.g. Russia and Ukraine
significant mechanisms for compliance under the
Kyoto Protocol.
CDM will survive even without
The increased activity has also reduced the Kyoto successor
concentration in the market, both on the sell and buy
side, and there is now a plethora of organisations Still, even with the investments currently taking
involved with the projects market. The strong place, we will be far from realising the potential
private sector involvement has also lead to discovery under the Kyoto Protocol. We are nowhere close to
of large-scale reductions potentials that few were implementing all marginal projects, and there will still
aware of some years ago, such as HFC and N2O. be a considerable potential for low-cost reductions
The significantly increased funding for the Executive in many years to come. It seems clear that the CDM
Board, together with streamlining of procedures, will survive even without a successor agreement to
has further drastically reduced transaction costs and the Kyoto Protocol. However, it is more uncertain
risks for investors. whether JI will. In any case, the negotiations of
post-2012 commitments will be on the back of the
More than 70% expect CER prices certainty that significant credit volumes will be
to increase over next year provided by on-going projects.
Carbon glossary
A Bull
Someone who thinks market prices will rise.
Business As Usual Scenario (BAU)
AA and AAU, see Assigned Amount and Assigned A business as usual scenario is a policy neutral
Amount Units. reference case of future emissions, i.e. projections
Additionality of future emission levels in the absence of changes
Under the Kyoto Protocol, certificates from JI and in current policies, economics and technology.
the CDM (see explanations below) will be awarded
only to project-based activities where emissions
reductions are “additional to those that otherwise C
would occur”. The issue has to be elaborated further
by the Parties to the Kyoto Protocol, and on the basis Cap and Trade
of practical experiences. A Cap and Trade system is an emissions trading
Annex B Countries system, where total emissions are limited or
Annex B countries are the 39 emissions-capped ‘capped’. The Kyoto Protocol is a cap and trade
countries listed in Annex B of the Kyoto Protocol. system in the sense that emissions from Annex
Annex I Countries B countries are capped and that excess permits
Annex I countries are the 36 countries and economies might be traded. However, normally cap and trade
in transition listed in Annex I of the UNFCCC. Belarus systems will not include mechanisms such as the
and Turkey are listed in Annex I but not Annex B; CDM, which will allow for more permits to enter the
and Croatia, Liechtenstein, Monaco and Slovenia system, i.e. beyond the cap.
are listed in Annex B but not Annex I. In practice, Carbon Dioxide Equivalent (CO2e)
however, Annex I of the UNFCCC and Annex B of This is a measurement unit used to indicate the
the Kyoto Protocol are often used interchangeably. global warming potential (GWP) of greenhouse
Annex II Countries gases. Carbon dioxide is the reference gas against
Annex II of the UNFCCC includes all original OECD which other greenhouse gases are measured.
member countries plus the European Union. CDM, see Clean Development Mechanism.
Assigned Amount (AA) and Assigned Amount Units CDM EB, see Clean Development Mechanism
(AAUs) Executive Board.
The assigned amount is the total amount of CERs, see Certified Emission Reductions.
greenhouse gas that each Annex B country is Certification
allowed to emit during the first commitment period The certification process is the phase of a CDM or
(see explanation below) of the Kyoto Protocol. An JI project when permits are issued on the basis of
Assigned Amount Unit (AAU) is a tradable unit of 1 calculated emissions reductions and verification,
tCO2e. possibly by a third party.
Certified Emission Reductions (CERs)
CERs are permits generated through the CDM.
B Clean Development Mechanism (CDM)
The CDM is a mechanism for project-based emission
Backwardation reduction activities in developing countries.
A market condition in which a futures price is lower in Certificates will be generated through the CDM from
the distant delivery months than in the near delivery projects that lead to certifiable emissions reductions
months. The opposite of contango (see below). that would otherwise not occur.
Baseline and Baseline Scenario Clean Development Mechanism (CDM) Executive Board
The baseline represents forecasted emissions (EB)
under a business-as-usual (BAU) scenario, often The CDM EB is accountable to the Conference of the
referred to as the ‘baseline scenario’ i.e. expected Parties to the Kyoto Protocol (see below). It registers
emissions if the emission reduction activities were validated project activities as CDM projects.
not implemented. Commitment Period
BAU, see Business As Usual Scenario. The five-year Kyoto Protocol Commitment Period is
Bear scheduled to run from calendar year 2008 to calendar
Someone who thinks market prices will decline. year-end 2012.
F K
Financial additionality Kyoto Protocol
CDM projects have to be financially additional, which The Kyoto Protocol originated at COP-3 to the
means that the projects that Annex I countries UNFCCC in Kyoto, Japan, December 1997. It specifies
support within the framework of the CDM should emission obligations for the Annex B countries and
not be financed by official development aid, but that defines the three so-called Kyoto mechanisms: JI,
Carbon glossary S
CDM and emissions trading. It entered into force on
16 February 2006 Supplementarity
A requirement in the Kyoto Protocol stating that
emissions trading should be a supplement to
M domestic action. It reflects the request of the
European Union to limit the use of the Kyoto Protocol
flexibility mechanisms. It is still not determined how
MAC, see Marginal Abatement Cost.
supplementarity should be interpreted.
Marginal Abatement Cost (MAC)
The marginal abatement cost is the cost of reducing
emissions with one additional unit. Aggregated U
marginal costs over a number of projects or activities
define the marginal abatement cost curve.
Memorandum of Understanding (MoU) United Nations Framework Convention on Climate
A MoU is an agreement between two parties that Change (UNFCCC)
aims to formally recognise a joint desire to ultimately The UNFCCC was established 1992 at the Rio Earth
conclude an agreement or to achieve goals jointly. Summit. It is the overall framework guiding the
It may or may not have legal backing of sanction, international climate negotiations. Its main objective
depending upon how it is constructed. MoUs are is “stabilisation of greenhouse gas concentrations
often used as a basis for CDM/JI projects. in the atmosphere at a level that would prevent
dangerous anthropogenic (man-made) interference
with the climate system”.
N
National Authorities and Designated National V
Authorities
The national authority is the official body representing Verification
the Government which takes part in the arrangement In order for AIJ, CDM and JI projects to have a
of CDM/JI projects. For JI host countries, the national formalised validation of an emission reduction
authority approves the projects and issues the stream, a recognised independent third party must
emission reduction units. For CDM host countries, confirm that claimed emissions reduction activity
the designated national authority issues a non- has occurred.
objection letter necessary for the project approval.
Non-Annex I countries
Annex I is an Annex in the UNFCCC listing those
countries that are signatories to the Convention and
committed to emission reductions. The Non-Annex
I countries are developing countries, and they have
no emission reduction targets.
P
Permit
Permits are often used for denoting the tradable
units under the Kyoto Protocol, i.e. AAUs, ERU or
CERs.
Project Design Document (PDD)
Document completed by project developers in order
to register their project under the CDM.
Recent reports
14.02.06 Outlook for 2006
An overview of activity in the global carbon market in 2005, together with our forecast for 2006.
We expect growth to continue in all market segments and find that the financial value of the
market could more than triple this year.
Upcoming reports
Carbon around the world: An overview of carbon trading outside the EU ETS. What are the
prospects for a market developiong in Canada or Japan? What about USA or Australia? How
will this impact on prices?
Kyoto progress update: What is the overall supply and demand under the Kyoto market. Which
countries will meet their commitments, and who still has some way to go? This analysis will set
the stage for our long term price forecast.
EU ETS phase II: Allocations under the EU ETS phase II will be crucial in shaping the carbon
market in the medium term. What will be the price implications of the NAPs that are currently
being drafted in EU member states?
Long term carbon prices: What will carbon prices be in the period to 2020? What will be
the main price drivers? How could international climate negotiations develop? Where will
the supply of allowances come from? Who will have the greatest demand for credits and
allowances?