1. Providing critical insights into energy and environmental markets www.pointcarbon.com EU ETS: Calm, but for how long? Energy Risk Europe 2006 Atle Christiansen, Point Carbon London, 3 October 2006

2. Providing critical insights into energy and environmental markets www.pointcarbon.com Key questions Phase I (2005-2007) 1.Can price developments be accounted for? 2.Phase I is long, but why is it trading short? Phase II (2008-2012) 3.What are the key price drivers? 4.Will EU NAPs provide sufficient scarcity?

3. Providing critical insights into energy and environmental markets www.pointcarbon.com Can price developments be accounted for? Range bound: Fluctuating fuel prices Length to market Bear run: Softening fuel prices Bull market: Weather/fuel prices 250-300 Mt cut in NAPs Bull run: Weather/fuel prices Price collapse: Verified emissions data Range bound: Compliance buying Length to market Bull run: Length not to market Oversold? What now?

4. Providing critical insights into energy and environmental markets www.pointcarbon.com Fundamentally long, but trading as if it is short? Phase I is fundamentally long (Point Carbon’s view) –100 Mt surplus in 2005 –Ample supply of NERs (and possibly CERs)  Prices should approach transaction cost (”single digits”) So why is the market trading as if it is short? –Industry length does not come to market –Utilities are net short on daily basis –NERs are not currently available

5. Providing critical insights into energy and environmental markets www.pointcarbon.com Supply side: Where is the length?

6. Providing critical insights into energy and environmental markets www.pointcarbon.com Where is the length? NB! Poland not included (-32 Mt)

7. Providing critical insights into energy and environmental markets www.pointcarbon.com Where is the length?

8. Providing critical insights into energy and environmental markets www.pointcarbon.com Why has industry length not come to market? Compliance is key –Do not optimise carbon portfolio ”Hedge” risk of being short –Penalty regime (€40/t) –Production variability Policy uncertainty –Concerns over impact on Phase II allocation Lack of market access? –14 Mt surplus for installations with cap <50k

9. Providing critical insights into energy and environmental markets www.pointcarbon.com 2005: Long in theory, but balanced in practice?

10. Providing critical insights into energy and environmental markets www.pointcarbon.com Demand side: Short, but for how long?

11. Providing critical insights into energy and environmental markets www.pointcarbon.com How much have utilities already covered? 2005: Aggregate shortage 83 Mt –65 Mt in UK, Spain and Italy 2006: Estimated short >100 Mt –Dry conditions in Scandinavia and Iberia –Increased coal burn UK and German power production Compliance/hedging strategies –Some borrowed for compliance in 2005 –Some hedge prompt AND forward exposure Compliance purchasing for Phase I has probably peaked  May see weakening of demand side Q2 2007

12. Providing critical insights into energy and environmental markets www.pointcarbon.com Trading short, but for how long? Reference scenario: Supply outstrips demand Q2 2007

13. Providing critical insights into energy and environmental markets www.pointcarbon.com Outlook for Phase II Market structure and key price drivers

14. Providing critical insights into energy and environmental markets www.pointcarbon.com Market structure

15. Providing critical insights into energy and environmental markets www.pointcarbon.com Strong demand if unchecked Business-as-usual scenario Aggregated 5 year shortage 2008-2012

16. Providing critical insights into energy and environmental markets www.pointcarbon.com But supply may be plentiful Does NOT mean that prices will go to zero! Potential AAU supply is 7-8 Gt Potential CER/ERU supply is 1-3 Gt

17. Providing critical insights into energy and environmental markets www.pointcarbon.com Time for a NAP?

18. Providing critical insights into energy and environmental markets www.pointcarbon.com NAP timeline Early Oct 2006: First EC decision on NAPs expected (?) Early July 2006: German and Polish NAPs submitted 6 Sept 2006: 11 MS submitted NAPs Spring 2007: NAP process completed? 30 June 2006: Only Estonia submitted NAP by deadline 31 Dec 2006: Formal EC deadline

19. Providing critical insights into energy and environmental markets www.pointcarbon.com How will the Commission assess the NAPs? Key criterion is achievement of Kyoto target –ETS + Other policies + Procurement = ”on track” to Kyoto? –”Excessive use” of 2005 verified emissions data Countries on track to Kyoto (13 MS): –Cap not above verified 2005 emissions Countries not on track to Kyoto (12 MS): –Cap below verified 2005 emissions Bulgaria and Romania? –No verified emission figures

20. Providing critical insights into energy and environmental markets www.pointcarbon.com NAP status: The good, the maybes and the ugly Within an acceptable range Likely to be rejected by EC Likely to be accepted by EC 1 -4 -19-4 -32 -7 -6 -5 10 -12 1.5 -0.1 -3 -21 27 7 -0.5 -3 -0.4 Czech Republic and Denmark have not submitted drafts. Links to Norway and Iceland through EEA agreement? -14 -11 ? ?

21. Providing critical insights into energy and environmental markets www.pointcarbon.com Where are the battlegrounds? Heavyweights: Poland and France –51 Mt surplus in 2005 –Lax drafts (Poland +40 Mt from Phase I) –Banking? Middleweights: Czech Republic and Denmark –25 Mt surplus in 2005 –Still without drafts Welterweights: Baltics, Netherlands and Slovakia –23 Mt surplus in 2005 –All have proposed to increase cap

22. Providing critical insights into energy and environmental markets www.pointcarbon.com Huge potential supply of CERs/ERUs 0 100 200 300 400 Spain Germany Poland Italy UK France Ireland Netherlands Greece Belgium Austria Czech Rep Sweden Portugal Finland Denmark Norway Slovakia Hungary Estonia Lithuania Slovenia Luxembourg Latvia Million CER/ERU Power & Heat limitTotal limit Source: Point Carbon Total CER/ERU limits Phase II (5 years) All sectors: 1.5 Gt* Power & heat: 0.8 Mt* *Based on Point Carbon’s estimated caps/limits

23. Providing critical insights into energy and environmental markets www.pointcarbon.com Phase II: Bullish or bearish? Bullish: Strong demand if unchecked –Projected shortage of 5 Gt (EU15+JPN+CAN) –Policies and measures might not deliver –Demand from US/AUS? Bearish: Supply is plentiful –Potential 7-11 Gt from AAUs/CERs/ERUs EU ETS NAPs are crucial –Need shortage of 200-300 Mt/year –Mixed signals so far Let’s get ready to rumble TM...

24. Providing critical insights into energy and environmental markets www.pointcarbon.com Concluding remarks Can price developments be accounted for? –YES, driven by fundamentals and policy If Phase I is long, why is it (at times) trading short? –Length does not come to market –Utilities net short on a daily basis Phase II: What are the key price drivers? –CERs (AAUs) and NAPs Will NAPs provide sufficient scarcity? –Perhaps....

25. Providing critical insights into energy and environmental markets www.pointcarbon.com Thank you for the attention For more information: www.pointcarbon.com acc@pointcarbon.com