The emerging carbon market an introduction Presentation to the PCF/WBI Training Integrating Carbon Finance in Bank ’ s Work November 19, 2001 Franck Lecocq – DECRG / PCFplus Research

2 Early carbon market

3 Greenhouse gases emission reductions an unusual commodity Different “qualities” of ERs depending on the credibility of the baseline scenario Players are interested in different “brands” depending on their objectives Emission Reductions = Hypothetical baseline emissions - Effective emissions

4 Carbon prices in past transactions

5 Sellers Key motivations: –Gain additional revenue –Strategic positioning to take advantage of future demand for ERs (e.g. Costa-Rica) However, at prices much below $3/tCO 2 e, carbon finance has too small an impact on projects’ IRRs (except maybe for some forestry activities).

6 Motivations of buyers Regulations in place Expect regulations on GHG emissions in the future –Hedge against future costs –Influence future regulation –Learning –Strategic positioning “Green” factor –Hedge against risk of appearing bad –Differentiating products Governments Firms (large utilities, energy cies, etc.) Individuals

7 Quantities in past transactions Partial information available. Within OECD and EITs: MtCO 2 e have been transacted. In developing countries: Less activity but growing. Mostly government funded, but private activity growing. General trend towards sophistication: buyers clubs (PCF), traders, financial derivatives (options), integrated marketplaces, etc.

8 How may the market look like in coming years?

9 Emerging market drivers 1.Regulations constraining GHG emissions are being developed: –National policies (e.g. UK, The Netherlands) –Subnational regulations (e.g. some US States) –Regional initiatives (EU-wide trading) 2.Firms are increasingly taking action, in particular voluntary emission commitments 3.Parallel markets are emerging: e.g. carbon neutral certification.

10 Current or projected national policies Trading?Start-upProject-based mechanism? EU Yes 2005 At least from 2008 UK Yes Yes France Yes 2003? Yes Norway Yes 2005 or earlier Yes Germany No  Later Denmark Yes 2001 Yes Sweden Yes 2005 or later Yes Netherlands Ongoing work  Yes Finland Ongoing work  Yes Ireland Ongoing work  Ongoing work Australia Yes US dependent Yes USA Yes ? Yes Canada Yes US dependent  Japan Ongoing work  Yes New Zealand Yes Not decided Yes Russia No  Yes

11 The Netherlands Government funded Emission Reduction Unit Procurement Tender (ERU-PT) and Certified Emission Reduction Units Procurement Tender (CERUPT) Buy ERs in Eastern Europe (JI) and non-Annex B countries (CDM) respectively 2000 tender (completed): $19 M Average price for first tender: $7/tCO 2 e Second Tender ERUPT, First Tender CERUPT opened.

12 United Kingdom Climate Change Levy (April 2001) –Tax on energy use –Rebates in exchange for voluntary commitments –Benefits recycled in other corporate tax rebates Emission Trading (end of 2001) –On a voluntary basis for a limited range of companies –Projects outside UK are considered for 2002.

13 Regional regulations US/Canada Oregon: CO 2 emissions standard for new energy utilities. Price cap: $0.57/tCo2. Utilities can offset emissions using project based mechanisms. Washington: New plants must demonstrate the use of best available techniques for CO 2 emissions control. Massachusetts: CO 2 emissions cap for energy utilities effective in Utilities can offset excess emissions using project-based mechanisms. New-England + Eastern Canadian Provinces: -20% in 2020 compared to 1990.

14 Voluntary corporate commitments Rapid survey indicates 52 major companies representing 1 billion tCO 2 e emissions in 1999 have pledged to reduce GHG emissions by Resulting demand depends on the baseline. If we set baseline at 1999 emissions, we obtain a total demand of 500 MtCO 2 e over the next decade. At least eight have said they would use project based mechanisms.

15 Alcoa --25% below 1990 in 2010 BP Amoco 79.8Cumulative 2%/year below 1990  Chubu EPCo kgCo2/kWh in 2005 Dupont % below 1990 in 2010 Kaidanren level of 1990 in 2010 Kodak --20% below 1990 in 2004 Fortum 90.5 MtCo2e below baseline in 2010  IBM 4.1Cumulative 4%/year below 1998 until 2004 Intel 3.310% below 1995 in 2010 (PFCs) Johns.&Johns. 1.57% below 1990 in 2010 Motorola -- 50% below 1995 in 2010 (PFCs) Ontario PG 26 6% below 1990 in 2010  PEMEX 177-1% per year until 2010  Shell MtCo2e in 2002  Statoil MtCo2e below baseline in 2010  Suncor 5-1.5%/year until 2002 (-1%/year for )  Transalta  1999 EmissionsCommitment Internal Trading CDM/JI Voluntary corporate commitments

16 In addition, Canada and Australia have voluntary ER programs with very good coverage of key emitting sectors.

17 Chicago Climate Exchange 42 entities (mostly firms + Chicago and Mexico city) will agree on emission targets by the end of 2001 and start trading in Objectives: -2% below 1998 level in 2002, additional -1% period year between 2003 and Allows for offsets through project-based mechanisms.

18 Emerging carbon funds Prototype Carbon Fund +… About 5 private sector funds to capture JI/CDM Carbon credits in all investments. Handful of private equity funds also seeking carbon credit investors to raise IRR in deals. Major forestry funds thinking about C credits. New energy private equity and mutual funds might seek C credit deals if demand rises. Social funds use C as screening indicator.

19 Market for “carbon neutral” products and services Increasingly, individuals and private or public organizations are looking for credible ways to offset the emissions their activities cause. Some firms provide this service – Future Forests, 550ppm or Klima – and buy ERs. Typically market for third-party verified ERs (but not necessarily Kyoto compatible)

20 Conclusion The carbon market already exists, and is growing rapidly. With success in Bonn/Marrakesh, market for Kyoto compatible ERs (CDM, JI) and Emission Quotas (Trading) now likely to grow. However, demand for non-Kyoto ERs likely to remain strong because of US-based demand, climate neutral business activity and “green” motivation.

21 For more information State and Trends of the Carbon Market – Natsource Summary available at (PCFplus Research section). Full report available to Bank Staff on demand to PCF. Carbon Market Intelligence Report – EcoSecurities Two reports available at (PCFplus Research section). Third report expected Febr National Strategic Studies Explore ER supply opportunities for some of the Bank’s client countries. Available at

22 Annex: some insights on future prices and quantities

23 Demand and supply with Kyoto Total Annex B demand for ERs Mitigation within Annex B (domestic or via trading or JI) Hot Air  financial flow to Russia and EE CDM Market Domestic Carbon Sinks

24 Hot Air >

25 Volumes in Kyoto w/o the US Gross annual demand for ERs1400 – 2400MtCO 2 e between 2008 and Credits for hot air 950 – Credits for Annex B Sinks  330 (  200) = Net demand 0 – 1800 MtCO 2 e

26 Carbon Market Impact Hot-air and new Annex I sinks allowances depress CDM/JI market –W/o US, up to 100% of OECD needs may be met by hot air + sinks. Both CDM/JI “project-based” and “hot –air” (emissions trading) markets will be “policy-driven” –Hot air may be cheap but politically unpalatable –CDM/JI project-based more expensive and difficult but high quality and politically acceptable

27 Prices in Post CoP6 World With full competition, our market analysis suggests : –CDM trades from near zero up to $8/tCO 2 e –Range of $1.50-4/tCO2e more likely in our view –PCF currently pays $3-4/tCO2e Non-KP Market drivers are significant: OECD domestic regimes and Corporate Voluntary market