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Carbon 2007A new climate for carbon trading
TO THE POINT
This report was published at Point Carbons 4th annual conerence, Carbon Market Insights 2007 in
Copenhagen 13 - 15 March 2007. For more inormation, see www.pointcarbon.com
13 March 2007
Global carbon markets were worth 22.5 billion in 2006.The market saw transactions or 1.6 billion
tonnes o CO2e. The EU ETS accounted or 62 per cent o the volume and over 80 per cent o
the value.
EU ETS saw 1 billion tonnes of CO2 transacted, worth 18.1 bn. This was 2.5 times higher than in2005. The OTC and exchanges dominated by 817 Mt and 14.6 billion.
Developing countries continue to deliver reductions. The CDM saw transactions or 523 Mt CO2e
in 2006, with a secondary market adding 40 Mt and a combined value o 3.9 billion.
Our reference scenario expects volumes in the carbon market to grow by 50% in 2007.We expect more
than 2.4 billion tonnes CO2e to transact over the year. Using current prices as a benchmark,
the extra volume marginally increases the total value to 23.6 billion.
65% of survey respondents say EU ETS have initiated internal abatement projects. This is a markedchange rom last years survey, where only 15% said the introduction o carbon trading had
initiated abatement.
EU ETS is main compliance strategy for 37% of survey respondents. Internal abatement andinvestment/trading o CDM/JI credits (both about 25%) are seen as the second most important
strategies. Relocation o production is only mentioned by a handul o respondents.
More condence in CDM/JI than one year ago. The CDM/JI market is a success, at least comparedto the 2006 survey. The project market is seen as more mature (although not a mature market),
and is resulting in cost-eective emission reductions.
Close to complete pass-through of carbon into power prices. The impact o the CO2 price has beenone o almost complete pass-through in the UK and German power markets, despite a slow
response to the introduction to the scheme or continental power prices. The impact on the
Nordic power market is primarily through the interconnection with Germany.
Import of credits from CDM/JI will not be enough to meet shortfall in EU ETS. Survey respondentsexpect levels o abatement in the EU ETS to higher in Phase II than in Phase I. Although the
system opens or substantial imports o credits rom CDM/JI, 82% o respondents nd that
this will not be enough to meet the shortall in Europe.
Survey nds 17/t for EUA price in 2010, 23/t in 2020. Survey respondents do not expect import ocredits to be enough to avoid domestic reductions in the EU ETS. Thus, the price o carbon
should refect uel-switching prices rather than the price o CDM/JI credits.
71% of respondents expect a global climate agreement post-2012, with a 60% likelihood that USA and
Australia will join. Only 9% o respondents do not expect a global agreement. China (36%) isseen as a more likely candidate than India (30%) in such an agreement.
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Carbon 2007
All rights reserved 2007 Point Carbonii
Carbon 2007
About the report:This report was written and edited by Kjetil Rine and Henrik Hasselknippe.
For citations, please reer to: Point Carbon (2007): Carbon 2007 - A new climate or carbon trading
Rine, K. and H. Hasselknippe (eds.) 62 pages.
About Point Carbon
Providing critical insights into energy and environmental markets
Point Carbon is a world-leading provider o independent news, analysis and consulting services or
European and global power, gas and carbon markets. Point Carbons comprehensive services provide
proessionals with market-moving inormation through monitoring undamental inormation, key
market players and business and policy developments.
Point Carbons in-depth knowledge o power, gas and CO2emissions market dynamics positions us as
the number one supplier o unrivalled market intelligence o these markets. Our sta includes experts
in international and regional climate policy, mathematical and economic modelling, orecasting
methodologies, risk management and market reporting.
Point Carbon now has more that 15,000 clients, including the worlds major energy companies,
fnancial institutions, organisations and governments, in over 150 countries. Reports are translated
rom English into Japanese, Mandarin, Portuguese, Polish, French, Spanish and Russian.
This year Point Carbons Carbon Market Insights (CMI07) will gather over 1,500 key players or the
carbon communitys most important annual conerence. Point Carbon also runs a number o high-level
networking events, workshops and training courses.
Point Carbon has ofces in Oslo (Head Ofce), Brussels, Kiev, London, Tokyo and Washington.
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Executive Summary
This report presents an overview o the state o the carbon market in 2006, our outlook or 2007, and
expectations or the uture. The study is based on the results rom the largest ever survey on the carbonmarket, with 2,250 respondents to our web-based questionnaire. The results are complemented by analysis
undertaken by Point Carbon.
Point Carbon nds that the international carbon market in 2006 saw a total o 1.6 billion tonnes o carbon
dioxide equivalent (CO2e), worth approximately 22.5 billion in transactions. In comparison, the market in
2005 saw an estimated 799 Mt CO2e, worth 9.4 billion.
Our orecast or 2007 suggests that volumes in the market could reach 2.4 billion tonnes CO2e, which, at
current prices in the various market segments, would be valued at 23.6 bill ion. This would mark a marked
increase in volume combined with marginal growth in value, based on todays prices.
The EU Emissions Trading Scheme held the highest nancial value in 2006. In total, the brokered and
exchanged market saw 817 Mt CO2 changing hands, corresponding to 14.6 billion. Brokers did 71per cent
o this volume, whereas the ECX took over 75 per cent o the volume carried on exchanges. Point Carbon
urther estimates that the direct bilateral market (company-to-company, not through brokers or exchanges)doubled in size rom 100 Mt in 2005 to 200 Mt in 2006, with a value o 3.6 billion. The total volume in the
EU ETS in 2006 was just over one billion tonnes CO2, worth 18.1 billion.
We expect growth to continue in the EU ETS and orecast 1.5 billion tonnes CO2 in the OTC and exchange
segment alone in 2007, with another 200 Mt CO2 through bilateral deals. At current prices this would value
the EU ETS in 2007 at 18.5 billion. Last year showed clearly that prices could move up or down, and
liquidity could be impacted by a number o actors. Even so, the EU ETS has shown that it will remain a
multi-billion-euro market.
The Clean Development Mechanism (CDM) also grew in 2006, as well as the emergence o a secondary
market. Point Carbon nds that transactions in the primary market totalled 522 Mt CO 2e in 2006, with the
secondary market adding 40 Mt. Assuming payment on delivery and a 7 per cent discount rate, together
they are valued at 3.9 billion. The other project based mechanism, Joint Implementation (JI) reached just
21 Mt, 95 million in 2006 less than in 2005.
Our orecast or 2007 is or the primary CDM market to shrink or the rst time to 456 Mt CO2e, while the
secondary market more than doubles to 96 Mt CO2e. The combined value would be 4.3 billion at prevailing
prices. The JI market is also orecast to more than double to 45 Mt CO2e, worth 277 million.
The publication o the veried emissions data or 2005 was a major blow or the EU ETS, as the market
turned out to have been long allowances in 2005, and not short as previously thought. The surplus is
probably due to a combination o two actors; i) generous allocation and ii) internal abatement and eciency
improvements. The rst is by ar the most important. But have emission reductions taken place?
The results o our survey suggests that internal abatement projects are indeed taking place, with 65% orespondents stating that the EU ETS has resulted in internal abatement in their company. This is a striking
change rom last years survey, where 60% o respondents answered that the introduction o carbon trading
had not resulted in any internal abatement at all. Hence, i we take the survey results at ace value, large
emissions reductions due to internal abatement could be expected or 2006 compared to 2005.
Trading within the EU ETS is seen as the main strategy or compliance in Europe, or 37 % o the respondents.Internal abatement is considered the primary compliance strategy by 25 % o the respondents, with
utilisation o CDM/JI at around the same level. The CDM/JI market is a success, at least compared to the
2006 survey. The project market is seen as more mature (although not a mature market), and is resulting in
cost-eective emission reductions. In general, it seems that the respondents have more condence in the
CDM market now than just one year ago.
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What is the impact o carbon prices on the power market? We have looked at evidence o how the German,
UK and Nordic power markets have responded to date to the introduction o CO 2 pricing. We nd that, prior
to the start o EU ETS, the German spreads did not appear to actor in the market price or CO2 into the 2005contract. The increase in spreads rom the carbon pass-through occurred gradually, and it appeared that by the
end o 2005 the ull opportunity costs o carbon were being actored into the year-ahead contract. From this,
we conclude that despite a slow start to recognising the likely impact o the EU ETS on the market, German
orward power prices now appear to be pricing carbon ully into the price o power or uture delivery.
Throughout summer 2005 the carbon price was at a level sucient to encourage gas-red generation over coal-
red generation in the UK. However, ollowing the collapse in EUA prices at the beginning o May 2006, coal-red generation in the UK was consistently more competitive than gas throughout the summer. The exception to
this was or a limited time period at the end o September/beginning o October 2006, when commissioning o
new gas inrastructure in the UK pushed NBP gas prices down to levels where it was competitive to switch.
The Nordic market has showed a similar pattern to that seen in German prices, with the dark spread continuously
increasing in line with the CO2 price. As with Germany, the orward prices did at rst not seem to be ully pricing
in 100% o the CO2 price. The year-ahead contracts in the Nordic market have ollowed the behaviour o the
German market, with spread levels increasing and persisting at a high level ollowing the CO 2 readjustments
o prices. This suggests that the main impact o the EU ETS on the Nordic power market has been through the
trade with Germany which oten is seen as setting the marginal value o water in this system.
As o early March 2007, the European Commission had given its ruling on 14 out o the total 27 EU Member
States allocation plans. The EC has requested cuts in most o the plans so ar, refecting the importance placed
on the 2005 veried emissions in their assessment. The results o our survey show clearly that there is anexpectancy o much higher levels o internal abatement in the EU ETS in Phase II, with 70% o respondents
expecting more reductions in the EU ETS in the uture than what was seen in the 2005-2007 period.
The allocation plans speciy levels or import o credits rom CDM/JI project. The results o our survey suggest
that it is not enough to rely solely on imports, with 82% o respondents claiming that credit fows rom CDM/JI
will not be enough to eliminate the need or internal abatement in the EU ETS.
Survey respondents nd on average that the EUA price in 2010 will be about 17.5/t. Based on current orward
prices this is only slightly more than 1.5/t above the price or delivery in December 2010. Looking urther ahead,
our survey respondents expect the EUA price to increase in the post-2012 period, with an average expectation
o 23.1/t in 2020. The long-term price is seen as a decisive actor or long-term investment decisions or 30%
o respondents, and as an infuencing, but not decisive actor, or 45% o respondents.
The ongoing stalemate in the current post-2012 negotiations is as expected, with the lack o US engagement
constituting one principal reason or the impasse, along with general distrust between developing and developed
countries. Our analysis indicates a 72% likelihood that the next US President will support strong climate policy.
We are reasonably condent he or she will bring the US back to international climate negotiations. US re-
engagement will increase the likelihood o a new Protocol or the immediate period ater 2012.
71% o the survey respondents expect there to be an international climate agreement post-2012, with only 9%not expecting any agreement at all. USA and Australia are both seen as likely (60%) to join the new agreement,
and China (36%) is seen as a more likely candidate than India (30%). Emerging regional trading schemes are
expected to link to the EU ETS post-2012, where aviation and land transport are seen as the most likely sectors
to be included in Phase III.
Recent political developments and the positions o the most important US presidential candidates support ourview that a new and broader climate agreement is likely post-2012. US re-engagement and deepened Chinese
commitments will lead to comprehensive international emissions trading involving most major countries and
emitting companies expected to be ully operation rom 2018 and beyond. Consequently, we expect that we
will see the emergence o a truly global carbon market in the years to come.
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While 2005 in many ways marked the birth o the
global carbon market, 2006 represented both a rudeawakening and a resh start. The European carbon
market came under massive criticism ollowing the
price collapse in April/May last year, when it became
clear that ar too many allowances had been handed
out by European governments. But the publicationo the 2005 data also provided the market and
policy-makers with something that had been lacking,
a set o reliable data to base political- and tradingdecisions on. It was time to all back, regroup and
take charge!
The publication o this report comes against abackdrop o record high public interest in climate
change and carbon trading. It seems that not one day
goes by without climate change being mentioned in
the media. Several things have contributed to this
new climate or climate change: The latest IPCC
report has concluded more strongly than beore thatman-made climate change is real and happening
now, as well as highlighted the dangers we ace i
we dont curb our emissions quickly.
A dierent but complementary view was oered by
the Stern report, comparing the costs o action tothe economic consequences o not acting on this
challenge. Finally, the movie An inconvenient truth
has been making the rounds on cinemas across the
world, reaching audiences that have so ar not paid
much attention to climate change, and even collecting
an Academy award to show or its success. Were ocourse both honoured and privileged to have Al Gore
with us or this years Carbon Market Insights.
The results rom the analysis going into this report
bring orward three important conclusions: Firstly,
the market is moving on despite there being severe
problems with the allocation o allowances in therst phase o the EUs emissions trading scheme.
The price collapse in the EU ETS resulted in massive
criticisms rom politicians and market participants
alike, not only because o the results but also the
way the results were revealed to the market.
The lessons rom the 2005 verication have not been
lost on (most) policy makers, and the allocations
or the next phase o the EU ETS are considerably
stricter than what has been the case so ar. The
publication o market sensitive inormation has alsotaken several steps orward, although there is still
some way to go beore the carbon market deals
with inormation release in the same way as moremature nancial markets.
Secondly, the results rom our survey suggest
that the EU ETS is starting to work as it should, by
initiating internal abatement and bringing companies
to the market to benet rom these abatements.Whereas last year only about 15% o respondents
answered that the EU ETS had initiated internalabatement projects in their company, a whole 65%
o respondents claimed it had done so this year.
We also nd that there are many more companies
now using the market actively, with about 36% orespondents citing trading in the EU ETS as their
prime strategy or meeting their emission targets.
The claims rom parts o European industry that
carbon restrictions will lead to relocations are
not supported by our survey, as this option wasmentioned by only a handul o respondents.
Finally, we now nd it increasingly likely that we will
see a truly global carbon market emerging soon.
Developments in USA and Australia suggest that wewill soon see operational emission trading schemes
established in these countries. With every one othese systems relying on oset opportunities rom
projects in other parts o the world, it is inevitable
that we will soon see the emergence o a common
carbon prices. It will still take some years beore we
see exactly what this market will look like, but itscontours are quickly becoming visible.
This report presents urther inormation about
these ndings, and a whole lot more. The analyses
presented here represent the essence o the work
that goes on in Point Carbon every day. The rapid
development in the carbon market has resulted inour analyses covering even more o the world than
it has done in the past, and we believe this report
represents the most comprehensive overview o
the carbon market to date. We hope you nd this
report both useul and interesting. We certainly hada great time making it.
Kristian Tangen
Director and Senior Partner
Point Carbon
Foreword
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Carbon 2007
From the editors
This is the second issue o our annual report on the carbon market, providing an
overview o volumes and values, as well as our expectations or the uture. Moreimportantly, rather than just presenting what we think the uture will hold, this
report presents the answers rom the largest ever survey on the carbon market.
We are indebted to each and every one o the 2,250 individuals who took the
time to participate in the survey; this report would never have been possible
without you.
We would also like to thank everyone in Point Carbon or their contribution to
this report. The analysis that you have contributed throughout the past year hasserved as starting points or everything presented in this report. Special thanks
go to those who have contributed to our Carbon Market Analyst publication
series, sharing your knowledge on all things carbon, as well as the dierent
European power and gas markets. In particular, the continuous eorts o PointCarbons EU ETS and CDM & JI teams has made it possible or us to use our
comprehensive databases or the market analyses presented in this report.
Some o our colleagues deserve special mention or their contribution to this
report: Endre Tvinnereim and Andreas Arvanitakis or their contributions to the
Outlook or 2007 and the post-2012 section. Kevin Gould and Trevor Sikorski haveboth provided lots o input to the cross commodity chapter.
I you have any questions or comments to this report we would be delighted
to hear rom you, see the Colophon or contact details. We hope the report
provides you with a good insight to the carbon market, and that it will urtherenable your contribution towards a less carbon intensive uture.
Kjetil Rine and Henrik Hasselknippe
Editors
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1 Introduction
2 The Kyoto market: How does it work?
3 Carbon market activity in 2006
3.1 EU ETS
3.2 Kyoto markets
3.3 Other markets
4. Carbon across commodities
5 Outlook or 2007
5.1 EU ETS
5.2 Kyoto markets
5.3 Other markets
6. First Kyoto period and beyond
6.1 2008 - 2012
6.2 Post-2012
1
3
6
8
17
24
25
30
30
31
35
36
36
43
Table o contents
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1. IntroductionAlthough there is still another 10 months to go beorethe rst Kyoto commitment period starts, the global
carbon market is alive and kicking. Advocated by
unusual weather conditions worldwide, by the Stern
report published in November last year showing the
economical consequences o global warming, aswell as the US slowly re-entering the global carbon
arena ater years in hibernation, 2006 was the year
when climate change was on the top o the political
agenda. Putting value on greenhouse gas emissions
has now become mainstream thinking.
The present report, Carbon 2007, provides a detailedoverview o the global carbon market. Chapter 2
takes a top-down approach and look at how the
Kyoto market mechanisms are intended to work. This
includes the fexible project-based mechanism under
the Kyoto protocol (Clean Development Mechanism(CDM) and Joint Implementation (JI)) as well as
regional emissions trading schemes, with particular
ocus on the EU Emissions Trading Scheme (ETS).
Moreover, in chapter 3 particular attention is given
to volumes and values in the global carbon market
in 2006 as well as lessons learnt rom the previousyear. In chapter 4 we give a short overview o the
impact carbon prices have had on European power
markets. The remaining chapters look into the uture;
presenting the market outlook or 2007 (chapter 5),
expectations or the rst Kyoto period (chapter 6)
and possible outcomes or the international climate
regime post-2012 (chapter 6).
This report is based on a variety o sources. First, the
analyses that have gone into our publication seriesCarbon Market Analyst (CMA) are to some extent
refected in this report although the level o details
is lower here. As last year, a Carbon Market Survey
is carried out. Contrary to last year, we employed
a web-based survey sotware this year, contributing
to that a total o 2250 individuals responded to ourweb-survey, up rom 800 responses last year.
Who responded to this years Carbon Market
Survey? Figures 1.1-1.3 show the distribution o the
respondents to the web-survey. Less than 40% (50%
last year) o the respondents did not represent GHG
emitting industries, while about 25% representedonly small emission levels, i.e. below 0.5 Mt per
year. 12.5% o the respondents represented major
emitters, with more than 10Mt per year.
The share o non-emitters is also refected in thebreak-down o respondents on sectors, see Figure1.2. Service providers dominates the picture. and
0%
10%
20%
30%
40%
50%
60%
No
emissions
0 0.5 Mt 0.5 1.0
Mt
1 5 Mt 5 10 Mt > 10 Mt
Share
ofresponden
ts
2006 2007Source: Point Carbon
Figure 1.1 Some big, many smallRespondents to the survey, broken down on their companys annual emissions level. Comparison
o respondents in 2006 and 2007.
2250 participants in our web-surveythis year, up rom 800 in 2006
13 March 2007
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Carbon 2007
academics, governments and nance & banking
have their share o the respondents. In total, 24%
are covered by a CO2 regulation, while 42% o the
respondents are involved in the EU ETS.
The respondents are still dominated by those
standing outside o the trading sectors. That said,the relative share o respondents in the trading
sectors power & heat, industry and oil/gas/renerieshave increased compared to last year.
The geographical distribution o respondents
is more or less the same as in 2006, with only
one main dierence. There are relatively more
respondents rom the U.S. this time, increasingthe Other Annex-1 category to 30 %. Still, hal
o all the respondents come rom the EU, with 32
% rom Northwest Europe, 10% rom Central and
Eastern Europe, and 8% rom Southern Europe. In
addition, 6% were rom European countries not inthe EU. O the remaining respondents 20% were
rom industrialised countries, whereas another 20%
were rom developing countries, i.e. non-Annex I
countries.
0.0%
4.0%
8.0%
12.0%
16.0%
20.0%
Othe
r
Othe
rservic
eprovid
ers
CDM
/JIproje
ctdevelop
er
EUETS
company
with
EUA
alloc
ation
Academ
ics
Government
Finance
andb
ankin
g
Othe
rCDM
/JIrelat
edNG
O
EUETS
particip
antw
ithoutEUA
alloc
ation
Carbon
fund
Shareo
frespondents
Source: Point Carbon
Figure 1.2 Still mostly outside trading sectorsRespondents to the survey, broken down on sectors. Comparison o respondents to the 2006 and 2007 surveys.
0%
10%
20%
30%
40%
EU:
Northwest
Other
Annex-1
Non-Annex-
1
EU: CEE EU: South Europe:
Non-EU
Share
ofresponden
ts
2006 2007Source: Point Carbon
Figure 1.3 European responsesComparison o respondents to the survey in 2006 and 2007,, broken down on geographic location. Annex 1
reers to industrialised countries as dened under UNFCCC. CEE: Central and Eastern Europe.
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2. The Kyoto market: How doesit work?The international carbon market is a direct
consequence o the Kyoto protocol. While thereis carbon trading also in non-Kyoto countries, the
market is to all extents and purposes based on the
mechanisms specied in the Kyoto Protocol. How is
the carbon market structured?
The carbon markets sole mission is to place a coston carbon emissions, a value on emission reductions,
and to enable trade o the resulting allowances or
credits. There are our main mechanisms at play:
International Emission Trading
Clean Development Mechanism
Joint implementation
Regional/Domestic Emission Trading
All countries with a Kyoto-target will be issued withAssigned Amount Units (AAUs) that can be used
in international emissions trading under the Kyoto
Protocol. In order or a country to meet its target
it has to deliver allowances and credits equivalentto its emissions in the Kyoto period (2008-2012),
and will have to either buy AAUs rom othercountries or purchase credits rom projects under
the Clean Development Mechanism (CDM) or Joint
Implementation (JI).
The main theoretical supply o AAUs is expected to
come rom Eastern Europe, and Russia and Ukraine
in particular, as these countries have actual emissionsar below their Kyoto target (their assigned amount).
Thus, they can sell the surplus to countries that need
the allowances or compliance.
CDM and JI are oten reerred to as the project-
based fexible mechanisms under the Kyoto
Protocol. CDM rewards emission reduction projectsin developing countries with so-called Certied
Emissions Reduction (CERs), which can then be
used by governments to meet their Kyoto target, as
well as by the private sector or compliance under
regional emission trading schemes.
1.
2.
3.
4.
JI projects unction more or less in the same way,
rewarding emission reduction projects in developed
countries, i.e. countries with a Kyoto-target,
with Emission Reduction Units (ERUs). For both
mechanisms there are specic requirements thathave to be met, e.g. it has to be proven that the
emission reductions are real.
Finally, carbon allowances rom regional emission
trading systems are issued either based on a certain
cap (cap-and-trade) or on proven improvements
done rom a certain baseline (intensity-basedtrading). The EU Emissions Trading Scheme is the
only operational regional cap-and-trade scheme orCO2, where European Union Allowances (EUAs) are
the tradable units.
Figure 2.1 displays the structure o the carbonmarket in the 2008-2012 period. The market consists
o governments and private entities, and the rules
governing their trading relationships
The let side o the gure displays the governments
specied in the Kyoto Protocols Annex B, with
an emissions target or the 2008-2012 period.The demand side, i.e. the governmental purchase
programs, will maniest itsel in Western Europe,
Japan, Canada, and New Zealand that are legally
bound to control emissions. The supply side will beconcentrated in Eastern Europe.
Governments with demand or allowances inthe Kyoto period can also orward part o their
compliance to the private sector through emissions
trading schemes or other measures. In this report
we distinguish between the (currently) largest
operational regional CO2 trading scheme, the EU
ETS, and other planned or possible trading schemesin other countries.
The CDM/JI EU ETS linkage is responsible or
much o the recent increase in project credit
supply. Primarily because the EU ETS is the largest
operational trading scheme, but also due to the
perceived high prices o EUAs. Conversely, growingproject credit supply is keeping the EUA price lower
than what it would have been without such import
possibilities.
Consequently, European policy and market events
will have a proound infuence on the carbon market
How are countries meeting theKyoto challenge?
The carbon markets mission: Toplace a cost on carbon emissions
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Carbon 2007
Eastern EU members probably hesi-tant to sell large volumes o AAUs
Governments already buying carboncredits
elsewhere in the world through the CDM/JI link.
Outside the EU, however, CER/ERU demand is also
strong, notably rom Japanese utilities. It is also
possible that non-EU trading schemes, or instance
in New Zealand or Canada, will produce somecredit demand in the Kyoto period, although this is
currently ar rom certain.
Governments are already buying CERs and ERUs
in order to meet their Kyoto target. In act, mostcountries with a Kyoto target have drawn up carbon
procurement plans, with the largest programs in
Spain, Japan, the Netherlands and Italy.
However, i the costs or project investments in
CDM/JI increase, or i governments are orced
to purchase issued credits (trading at the highest
market price), the volume o the purchases will be
reduced. Strong EU ETS demand thus presents a
dilemma by stimulating new CDM/JI projects on the
one hand while lowering the purchasing power o
governments on the other.
Even with all their procurement plans lled, the
countries o Western Europe, Japan and Canada will
still on track to missing their Kyoto targets. However,the potential supply o AAUs rom Eastern Europe is
suciently abundant to put their carbon budgets in
the black. But is the supply o AAUs really there?
Most Eastern EU members will probably be hesitant
to oer substantial volumes o AAUs. This is partly
because they might need the surplus allowances
in the uture, but also because they are coveredby the EU ETS, which may present more lucrative
emissions trading opportunities.
Russia and Ukraine, however, might decide to sell
parts o their government allowances when they
become eligible or emissions trading (i.e. transero AAUs) in 2008-2009, see Figure 2.2.
CDM/JI
Gov. AAU sales
EU ETS
Internal trading,
abatement
JPN/CAN/NZ
Gov. Purchase
programmes Governments Private sector
= Supply
= Demand
Forwarding
compliance
Political framing decisions
Political framing decisions
Figure 2.1 How it works, at least in theory
The interplay o fexible mechanisms, purchasing programmes and trading schemes. Non-market
policies and overall allocations set the rame.
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Green Investment Schemes (GIS)are politically palatable
Private sector AAU demand expec-ted to be limited
-5 -4 -3 -2 -1 0 1 2
Russia
Eastern Europe
Ukraine
Other
Canada
Japan
EU 15
Gt CO2e
Source: Point Carbon
Figure 2.2 Potential supply more than enoughNet short and long positions or countries and regions, i.e. when all policies and procurement plans have been
accounted or. Aggregated or the 5-year Kyoto period
On the other hand, there is not much o a demandside here either, despite the substantial shortall
amongst Kyoto countries. There are dicult issues
regarding public acceptance o trading so-called
hot air, i.e. excess permits arising rom declined
production not caused by intentional eorts to curb
emissions.
To make AAU trading more politically palatable,
thereore, Green Investment Schemes (GIS)
have been devised. In a GIS, income rom AAU
sales is earmarked or GHG reduction or general
environmental purposes. There is, however, no
regulation or how such earmarking could occur,nor is there an obligation on either buyer or seller to
undertake such greening.
Private sector AAU demand is expected to be limited
and conned to Japan (it is not allowed in the EU
ETS). Japanese entities are reportedly pursuing GIS
in Bulgaria and Romania and are planning to enter
Russia and Ukraine later.
The common actor or all the dierent market
segments described above is their link to CDM and
JI. Governments and companies alike, in all regions
o the world, will be able to use CERs and ERUs or
compliance.
Thus, these project based credits will act as thecarbon markets interconnector, ensuring that
there is at least indirect price linkage between thesystems, as the stream o credits will in theory go to
the system with the highest price. Although there
are no directly linked trading schemes as o yet,the projects in developing countries have already
resulted in a global carbon market, with implications
or governments and companies all over the world.
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Carbon 2007
3. Carbon market activity in 20062006 saw, as all previous years in the carbon market,a substantial growth in the traded volumes and
corresponding values. Table 3.1 shows the overall
numbers rom 2006, compared to 2005 as well as our
expectations or 2007. The total transacted volume
seen in the regulated carbon markets in 2006 was
1.6 billion tonnes o CO2 equivalent (CO2e), whilethe nancial value came in at 22.5 billion.
We estimate that the EU ETS saw a total volume o
1,017 million tonnes o CO2 in 2006. This includes
conrmed transactions or 583 Mt conducted over-thecounter (OTC) and 234 Mt on various carbon
exchanges, yielding a total o 817 Mt.
The remaining 200 Mt in the total volume is basedon our estimate o bilateral trades. As always, this
market segment is hard to pin down. Transactions
are less requent and larger in clip size than the
brokered or exchange-based segment, and they are
also almost always condential.
The rise in volume seen in the rst hal o 2006 ello during the third quarter, but rose to a new record
in the ourth quarter, refecting end-o-year trading
as well as increased volatility as the short-term price
began to decline.
The dropping value o rst phase allowances (or
delivery in 2006 or 2007) was coupled with growing
volume in the second phase (delivery in the 2008-
2012 period), which held its price level relatively well.For that reason the nancial value o the market did
not collapse with the rst phase. The brokered and
exchanged market totalled 14.6 billion in 2006.
Assuming a similar split between rst and second
phases in the bilateral segment as or the exchangeand brokered segments, the nancial value o bilateral
trades in 2006 is put at 3.6 billion throughout the
year, bringing the total estimated nancial value o
the European market in 2006 to 18.1 billion, over
2.5 times higher than 2005.
Total transactions in the Kyoto markets in 2006 are
estimated to be 584 Mt CO2e, worth 4 billion.
Compared to 2005, this is an increase o 36% in
volume and nearly 100% in nancial value. The JI
volume came in at 21 Mt, while the CDM market
transacted a total volume o 562 Mt including
secondary transactions.
O the total nancial value, the primary and secondary
CDM market saw a combined 3.9 billion in trade,
while the JI totalled just 95 million. JI volume andvalue both came in under 2005 levels (28 Mt and
96 million). This unusual development marks therst step backwards or carbon markets.
Carbon market saw 1.6 billion Mt,22.5 billion in 2006
Table 3.1: Reported volumes and value 2005, 2006, orecast 2007Reported and estimated volumes 2005 and 2006, together with orecasted volumes or 2007, in Mt CO2e and million . 7 %
discount rate employed or CDM and JI where price is at point o delivery. Prevailing carbon prices at time o writing or 2007
orecast.
2005 2006 2007
Final fgures Final fgures Forecast
[Mt] [ million] [Mt] [ million] [Mt] [ million]
EU ETS total
-OTC + exch.
- Bilateral
362
262
100
7,218
5,400
1,818
1,017
817
200
18,143
14,575
3,568
1,750
1,550
200
18,503
15,903
2600
Other ETSs 7.8 52 31 300 50 500
CDM 397 1,985 523 3,349 456 3,260
CDM 2nd 4 50 40 571 96 1,061
JI 28 96 21 95 45 277
Sum 799 9,401 1,632 22,458 2,397 23,601
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Other carbon markets (in USA and Australia) have
gained in size since last year, although their share o
the global market was reduced in 2006 compared to
2005. The volume in 2006 was at 31 Mt CO2e, whilethe nancial value was at 300 million.
For 2007, we expect growth in all market segments
except or primary CDM. This brings our orecast or
global volumes to 2.4 billion tonnes o CO2e, almost
50 per cent up rom 2006. As has always been the
case in our Outlook series, which dates back to
February 2002, we do not attempt to orecast carbon
prices in 2007 in this report, instead using prevailing
market value at time o writing to give an illustrationo the potential nancial value o the market in 2007.
With the EU ETS price down rom last year, and the
wider eect that the EU prices have in the carbon
market, the total nancial value o carbon marketsgrows to a lesser extent rom 22.5 billion to 23.6billion.
0
500
1,000
1,500
2,000
2,500
2003 2004 2005 2006 2007
MtCO2e
CDM JI EU ETS OtherSource: Point Carbon
Figure 3.1 Stairway to 07Reported and estimated contracts 2003-2006, orecast or 2007, Mt CO2e.
Kyoto markets saw 583 Mt, worth4 billion in 2006
Physical volume (1,632 Mt CO2e)
CDM
34.5 %
EU ETS
62.4 %
JI
1.3 %
Other1.9 %
Source: Point Carbon
Figure 3.2: Still dominated by the EU ETSDistribution o the dierent market segments or physical volumes and nancial value in 2006.
Financial value (22.5 billion)
CDM
17.5 %
JI
0.4 %
EU ETS
80.8 %
Other
1.3 %
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3.1 EU ETS
The EU ETS is still the dominant emissions trading
scheme in the world. In 2006, it reached record
levels in transacted allowances, both in volumes andvalues. It was also a dramatic year with respect to
the reliability o the scheme, as the publication overied emissions data or 2005 showed that the EU
ETS was in act long allowances, and not short as
previously expected.
3.1.1 Volumes and values
Transactions in the EU ETS take place through
brokers (OTC), exchanges and bilateral trades. The
EU ETS saw transactions through brokers and on
exchanges totalling 817 Mt in 2006. O this, 583
Mt (71.4 per cent) was in the OTC market, with theremainder in the exchange-based market.
The European Climate Exchange (ECX) still carries
the largest volume o the exchanges, with over
three quarters o all exchange volumes (not including
exchange-or-physical, where OTC transactions are
cleared through the exchange). Powernext (13.3 per
cent), in second place, is still almost twice as large
as Nord Pool (7.4 per cent), while the only otherexchange with volume to speak o is the European
Energy Exchange (EEX) (3.6 per cent).
There was notable development towards relatively
more volume on exchanges in Q4, coinciding with
the declining Phase I price. Much o the increasecame through spot trading, possibly indicating more
industrial selling in this period, but also o course a
natural increase in trading activity was as the year-
end approached.
Most o the trades in 2006 were or Phase I delivery,
although the relative share o Phase II volumeincreased steadily throughout the year. In total over
the year, Phase II accounted or 24.4 per cent (199
0
50
100
150
200
250
300
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
MtCO2
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
mill
30%
-17%
36%
-5%
-30%
6%
Source: Point Carbon
Figure 3.3 Ups and downs in 2006Quarterly volumes and values in the EU ETS, Mt and million
More volume on exchanges in Q42006
0%
20%
40%
60%
80%
100%
2-Jan-06
2-Feb-06
2-Mar-06
2-Apr-06
2-May-06
2-Jun-06
2-Jul-06
2-Aug-06
2-Sep-06
2-Oct-06
2-Nov-06
2-Dec-06
OTC ExchangesSource: Point Carbon
Figure 3.4: Change towards exchanges?The relative shares o daily volumes or the brokered and
exchanged market in the EU ETS in 2006. Pure bilateral
trades not included
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Mt) o the volumes done on exchanges and through
brokers. Most o this, 143 Mt came in the last halo the year.
In addition to the trading activity on exchanges and
through brokers there is a direct bilateral market,with transactions executed directly between two
companies. Estimating this bilateral market is dicult
as such deals are rarely, i ever, reported. In theCarbon Market Survey we asked the respondents to
give their opinion on how large this market could be.
O the 427 respondents that said they were in one
way or another active in the CO2 market, 26 per cent
estimated the bilateral market to be somewhere
between 10 and 25 per cent o total trading activity,
while another 24 per cent estimated it to be between
25 and 50 per cent.
Using the result o our survey as a starting point,
and taking a conservative approach, we estimate thedirect bilateral activity to account or 20 per cent o
all EU ETS trading activity in 2006, or about 200 Mt
CO2. Including this direct bilateral volume we nd
that the EU ETS traded a total o 1,017 Mt in 2006.
In nancial terms, the EU ETS volumes on exchanges
and through brokers totalled 14.6 billion last year,o which 10.8 billion came through allowances or
delivery in Phase I. This is about three times morethan the exchanged and brokered value rom the
previous year (5.4 billion), and a whopping two
hundred times more than in 2004.
The nancial value o the direct bilateral volume isdicult to assess, as there is no way o knowing
how much o it that was in Phase I delivery and how
much that was in Phase II. It is plausible that there
was a larger share o Phase II volumes in direct
company-to-company deals, as companies take newpositions in the coming trading phase, but in our
analysis we assume that the distribution between
0
5
10
15
20
25
30
35
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
MtCO2
ECX Powernext Nord Pool EEX
ECX 75.6%
Powernext 13.3%
Nord Pool 7.4%
EEX 3.6%
EXAA 0.1%
Source: Point Carbon
Figure 3.5: Still dominated by ECX
Monthly volumes o EUA trades in 2006 at the dierent carbon exchanges, in Mt CO2.
0%
10%
20%
30%
40%
0-10% 10-25% 25-50% 50-100% Do not know
Share
ofresponses
Source: Point Carbon
Figure 3.6 What the market thinksRespondents expectations o the relative size o the
bilateral market, limited to respondents that are actively
participating in the EU ETS market.
Most Phase II volumes traded insecond hal o 2006
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Carbon 2007
the phases is the same in the direct bilateral market
as in the brokered/exchanges market.
Using this split between vintages we nd that the
direct bilateral market saw values o 3.6 billion
throughout the year, bringing the total estimatednancial value o the European market in 2006 to
18.1 billion.
The development throughout the year shows that
volumes went down in the third quarter, both as
a result o stabilising prices ater the Phase I pricecrash in the second quarter, and the slow summer
months when trade activity is usually lower. In the
last quarter o 2006 the volumes went back up,
registering the highest quarterly level o activity
ever. This was a result o increased industrial selling
towards the end o the compliance year, as wellas interest in Phase II taking o in response to the
rst set o NAP announcements or the 2008-2012
period.
In nancial terms, the second hal o the year came
in with lower results as the Phase I price continuedits steady decline in value towards rock bottom.
3.1.2 What drives the EUA price?
The EUA price is, as in any market, set by supplyand demand. The supply is here determined by
the allowances and carbon credits available to the
market (EUAs, CERs and ERUs). Demand is set by
the amount o emissions through the year in relation
to the overall allocation. The demand is infuenced
by a number o actors, primarily undamentalslike weather (as temperature determines power/
heat demand and precipitation the potential or
hydropower production) and uel prices (as the
relative price dierential between coal and gas will
determine which o the uels that will be used orpower production). Relatively cheaper coal compared
to gas will increase GHG emissions as more power
production will be based on coal which emits moreGHGs per unit o output than gas. Higher CO2
emissions will increase the carbon price.
The Dec-07 contract (or delivery in December 2007)began the year at 22.70, and was traded by the
end o the year more than 16 lower at 6.55, the
years lowest value. Its highest value was on 19 April
at 31.58, just beore crashing on the haphazard
release o veried emissions data to 9.70 on 11
May, see Figure 3.7.
By the end o May the Dec-07 contract had
recovered, reaching 20 at one stage, and remained
in the high-teens or the middle quarters o the year.
This was put down to short-term demand by utilities
buying on the back o orward power sales. Much o
the supply was held back by industrials that either
did not have the appetite or capability to sell beorethey had ensured their own compliance.
As power companies nished hedging most o
their production or 2007, leading to a gradually
decreasing demand side, and more o the surplus
came to market as industrials entered the market,
the price o an allowance began to subside. In earlyNovember, the Dec-07 contract slipped below 10
and declined rom there. At the time o writing, the07-contract is traded at around 1. The EU ETS phase
I is or all practical purposes over and done with, and
unless there are enormous surprises in connectionwith the verication data or 2006, to be released in
April/May 2007, nothing will alter this picture.
The second-phase allowances broke ree rom
their correlation to rst-phase allowances nally
in October, as the Dec-08 contract responded to
credible signals rom the European Commissionthat it would ensure that the second phase was
short. The correlation between 07-contracts and 08-
contracts over the rst nine months o 2006 was
0.88, while the last three months saw a negativecorrelation at -0.74.
What were the main drivers or the price development
over the year? Fig 3.8 shows the development o theEUA Dec-07 price throughout 2006 in relation to the
impact rom uel and weather to the overall short
position, i.e. the impact on Point Carbons allowance
demand indicator E-t-C rom relative coal/gas prices
and temperature/precipitation. The correlation (R2)between the EUA price and the combined eect
rom uel and weather was 0.41 over the year as
a whole, while in 2005 it was 0.92. The individual
correlations to uel prices and weather were 0.46
(0.89 in 2005) and 0.35 (0.48 in 2005), respectively.
The correlation between the Dec-07 price andweather and uel or the entire year is relatively low
due to the price crash in April/May, which obviously
was not due to dramatically changes in uel prices
or weather, but rather the political publication o
veried emissions data.
It is evident rom the graph that the market is to alarge extent trading on changes in the undamentals.
Combined uel and weather correla-tion to EUA was 0.41 in 2006
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0
2
4
6
8
10
12
14
1-Feb-06
2-Mar-06
31-Mar-06
4-May-06
2-Jun-06
3-Jul-06
1-Aug-06
30-Aug-06
28-Sep-06
27-Oct-06
27-Nov-06
28-Dec-06
29-Jan-07
Millionton
nesCO2
0
4
8
12
16
20
24
28
32
/tonne
Volume EUA 07 EUA 08Source: Point Carbon's Carbon Market Trader
Figure 3.7 Daily volumes and pricesDaily prices or 07- and 08-contracts, as reported by Point Carbon together with daily volumes in
the OTC and exchanged markets.
0
5
10
15
20
25
30
35
02-
Jan
02-
Feb
02-
Mar
02-
Apr
02-
May
02-
Jun
02-
Jul
02-
Aug
02-
Sep
02-
Oct
02-
Nov
02-
Dec
/t
-30
-20
-10
0
10
20
30
40
50
MtCO2
EUA 2007 Fuel + weather (accumulated)Source: Point Carbon
1.1 -13.4: R2
= 0.57 1.1 -31.12: R2
= 0.41
1.6 -31.12: R2
= 0.98
Figure 3.8 Driven by weather, uel prices and verifcationEUA 07 in 2006, let axis in /t, compared to the changes to Point Carbons allowance demand indicator E-t-C rom uel
prices and weather, accumulated throughout 2006, right axis in Mt CO2.
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Carbon 2007
From June to December the combined correlation or
weather and uel to the carbon price was 0.98, witha uel-correlation on 0.89, and weather-correlation
on 0.98. This is explained by the combination o
warm and wet weather throughout the period incombination with alling uel prices, leading the
downward trend o the EUA price.
It is also clear that the market is trading on dierentundamentals at dierent times. For instance,
during the period 1.1 13.4 the overall correlation
was 0.57, with a uel-EUA correlation o -0.15 and
weather-EUA correlation o 0.87. Hence, trading wasdone primarily on the weather during this period,
while at other times it was the development in oneor other o the uels that set the sentiment. The
0% 20% 40% 60% 80%
Political factors
CDM/JI supply
Fuel/other
commodity prices
Long-term prices
Other factors
Weather
Share of responses
2006 2007Source: Point Carbon
Figure 3.10 Long-term price drivers in the EU ETSBased on responses rom our web-survey
0% 20% 40% 60% 80%
Political decisions
Fuel/power prices
Other factors
CDM/JI supply
Phase 2 EUA
prices
Weather
Share of responses
2006 2007Source: Point Carbon
Figure 3. Short-term price drivers in the EU ETSBased on responses rom our web-survey
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publication o veried emissions data in April/May
broke all correlations between undamentals and
EUA price as the crash o the latter obviously did
neither infuence uel nor weather.
Do these developments conrm what market
participants see as the most important actors or
carbon price development? Figures 3.9 and 3.10
show the response rom Carbon Market Survey2007, compared to the survey carried out in 2006. A
striking dierence is that while the uel and powerprices were considered to be the most important
price determinant in our 2006 survey, ollowed by
political decisions, these actors have changedplaces in 2007.
A plausible explanation or this is the publication
o the verication data in May. Looking only at the
answers o those respondents directly regulated by
the EU ETS, the picture looks pretty much the same,
indicating that although undamentals like uel pricesand weather have seen a high correlation with the
EUA price over major parts o the year, the price
crash caused by the verication has indeed been the
most decisive actor or the EUA price level.Contrary to the correlation our data shows betweenweather and the EUA price, the survey shows that
the weather is not seen as a main actor or the EUA
price. Only 4 % consider the weather to be a main
price driver, less than hal o what was the case in
2006.
The prices or second phase allowances behave muchas the rst-phase price, with short-term responses
to the underlying energy complex combined with
policy signals on the allocation process. The ECs
decisions or the second phase are expected to
be done by this spring, but the nal allocation to
installations is likely to drag on at least until autumno 2007, given government tardiness and the odd
legal challenges to the ECs decisions. The surveyshows that political decisions are currently believed
to be the most important price driver also or Phase
II.
4.1.3 What did the verifcation show us?
The second year o the European emissions trading
market was noteworthy in many respects. First, andmost importantly, the realisation that the market
was indeed long in 2005 and the ollowing collapse
o carbon prices had its eect not only on the
behaviour o market participants, but also infuenced
the European Commissions decisions or Phase II.
So what did actually the verication data showus? Companies in the UK, Spain, Italy, Ireland and
Austria emitted more than their cap with a total
Political actors drive prices
-40 -30 -20 -10 0 10 20 30 40
POL
DEU
FRA
CZE
FIN
DNK
LTU
NLD
SVK
HUN
EST
SWE
BEL
LVA
LUX
PRT
SVN
GRC
AUT
IRL
ITA
ESP
UK
Mt CO2Source: Point Carbon/CITL
Figure 3.11 2005 verifcation results - country level
In MtCO2
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Carbon 2007
decit o 47.4 Mt. Other countries had al located
more emission rights than actually used, 112.6 Mtin total, providing a net long position o 65.2 Mt or
EU-21. Figure 3.11 shows 2005 emissions to cap (E-
t-C), calculated as veried emissions minus the sum
o allowances allocated in each EU country, exceptrom Poland as ull installation level data are not
available at the time o writing.
Large countries like Germany and France were
considerably long, 21 Mt and 19 Mt, respectively,
being 4.3 % and 12.7 % below their caps. UK, onthe other hand were 27 Mt short, corresponding to
emissions being 12.6 % above the cap.
Turning to the sector level (without data or Poland),Figure 3.12 shows that across the EU, companies
in the power & heat sector emitted 36 Mt CO2
above their allowances. The main circumstances
infuencing emissions in this sector were abnormal
dry and cold conditions in Spain and Italy, above
normal precipitation in Scandinavia and record-highgas and EUA prices.
Moreover, all industry sectors had surpluses, adding
up to a net aggregate long position o 102 Mt or
non-power & heat sectors. Metals and Other
were the longest sectors in absolute terms (35.3 Mtand 26.3 Mt, respectively), while Pulp and paper
and Others were the sectors being longest relative
to their caps (21 % and 17 %, respectively).
The surplus is probably due to a combination o
two actors; i) generous allocation and ii) internalabatement and eciency improvements. The rst is
by ar the most important. Evidence suggests that
especially smaller industrials appear to have received
generous allowances. For installations emitting less
than 100 kt CO2 in 2005, the average surplus is 26
per cent o the cap.
But do reductions actually take place? There are
empirical evidence or some site specic reductions,such as increased energy eciency and own bio-uel
based power production (e.g. in the Pulp & Paper
sector). Closing o production, either permanently ortemporarily, is another reason or surplus emissions
as was moved production. But this would only
apply or a small handul o installations and not or
the industrial sectors in general.
For the metals sector the production levels in 2005
decreased in relation to the 2004 numbers, partlydue to high level o stocks in the supply chain.
Demand has increased again in 2006, which is
EU ETS was 97.2 Mt long in 2005
Figure 3.12 2005 verifcation results - sector level
In Mt CO2
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0% 10% 20% 30% 40% 50% 60% 70%
Yes
No
Do not know
2006 2007Source: Point Carbon
Figure 3.13 Has the EU ETS initialised inernal abatement in your company?Based on responses rom our web-survey
0% 10% 20% 30% 40%
Trading within EU
ETS
Trading CDM/JI
Internal abatement
Other
Relocation
Share of responses
2006 2007Source: Point Carbon
Figure 3.14 What is the primary carbon compliance strategy?Based on responses rom our web-survey
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likely to bring with it higher emissions. Eciency
improvements have historically been made at a
number o installations, and there is not muchpotential or increased eciency.
In the other sectors there are also specic situations
which have lead to emission reductions. In the
Cement sector there is some evidence o increased
use o alternative uels, and repairs or replacements
o kilns during 2005. In the Chemical sector there hasbeen some disruption to production (in particular in
the UK) in Q4 2005, due to high gas prices. However,
in general the majority o the emission reductions
that have taken place cannot be explained by major
abatement initiatives arising rom the introduction o
the EU ETS.
What do the respondents to the survey think about
this? The dierence rom 2006 survey is striking as
last year 60% o respondents answered that EU
ETS had not initiated internal abatement projects in
the company, while only 15 % replied that it had. In2007, the situation is the opposite, with 65% o the
respondents claiming they have initialised internal
abatement projects as a result o the EU ETS and
only 15% have not. Hence, i we take the survey
results at ace value, large emissions reductions due
to internal abatement could be expected or 2006compared to 2005.
Turning to a broader compliance strategy or the
EU ETS participants, gure 3.14 illustrates what
survey respondents cite as their primary compliancestrategy. The main change rom last years survey isthat trading within the EU ETS is seen as the main
alternative, with 37 % o the respondents. Internal
abatement is considered the primary compliance
strategy by 25 % o the respondents, with utilisation
o CDM/JI at around the same level.
The EU ETS has been through some turbulence
during 2006. What is the standing o the EU ETSamong the respondents to the survey compared
to last year? Although the changes rom the 2006
survey is not striking, gure 3.15 indicates that
the EU ETS is considered less o a success nowthan what was the case in our 2006 survey. Fewer
respondents think that the EU ETS acilitates
emissions reductions and, most surprisingly, ewer
respondents think the EU ETS is a mature market
compared to one year ago. This last point is, however,
within the range o methodological uncertainty, andshould thereore be read with caution.
Trading is the primary carbon comli-ance strategy
0% 20% 40% 60% 80%
EU ETS is more
mature now than one
year ago
EU ETS facilitates
emissions reductions
EU ETS is the most
cost-efficient way to
reduce emissions
EU ETS is a success
EU ETS is a mature
market
Share of responses
2006 2007Source: Point Carbon
Figure 3.15 Assessing the EU ETSBased on responses rom our web-survey
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3.2 Kyoto markets in 2006
The Kyoto markets include projects under the
Clean Development Mechanisms (CDM) and JointImplementation, as well as Green Investment
Schemes (GIS). The latter involves the sale o
Assigned Amount Units (AAUs), the governmental
emissions trading unit under the Kyoto Protocol.
3.2.1 CDM in 2006
Transacted CDM volumes in 2006 ended at 563 Mt
CO2e in total, including primary (523 Mt CO2e) and
secondary transactions (40 Mt CO2e), constitutingmore than 96 per cent o the total project market
(CDM & JI). In total, the nancial value o the CDMtransactions in 2006 was 3.9 billion or CDM
transactions, including secondary transactions.
O the primary transactions, 436 Mt CO2e are
conrmed in our transaction database, while the
remaining 86 Mt CO2e are additional transactions
that we expect to have occurred. The additionaltransactions are included because we know that
the total volume o transactions is higher than only
those conrmed, and by combining Point Carbons
transaction database and project database we get a
reliable proxy or these additional transactions.The secondary CER market was limited in volumesin 2006. We have conrmed transactions totalling
34 Mt CO2e in our database, and estimate that a
total o 40 Mt CO2e were completed in 2006, worth
more than 500 million.
Volumes in primary transactions increased in Q1 andQ2 until the EU ETS price crash, then ell back in Q3,
as both sellers and buyers took a time-out to think
things through. Volumes increased again in Q4,
0
50
100
150
200
Q1 Q2 Q3 Q4
M
tCO2e
CDM J ISource: Point Carbon
Figure 3.16: Most towards the endQuarterly volumes o CDM and JI contracts in 2006, regis-
tered and estimated by Point Carbon, in Mt CO2e.
Private
58%
Funds
34%
Government
8%
Source: Point Carbon
Figure 3.17: Who are they and what do they want, Part IThe relative share o categories o CDM buyers (let) and project types (right) in 2006.
Renewable
energy
13%
HFC-23
33%
LULUCF
1%
Fugitive
emissions
7%Energy
efficiency7%
Waste
9%
Other/unknown
10%
N2O
21%
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as condence in a sound second phase o EU ETS,
and to some extent demand rom governments and
Japanese companies increased.
The UK and Italy top the list o buyer countries.Italys high position stems rom ENELs procurement
o CERs rom HFC-23 and other projects in China,
as well as the Italian governments activity through
the World Bank. The chart o buyer countries refects
that more nancial institutions have become active
in the market a large chunk o the market activityout o the UK is nancial, not compliance-driven. This
is obviously also the case or Luxembourg (nancial
players registered there) and the US (primarily due
to the World Bank unds). Also, the Greenhouse
Gas Credit Aggregation Pools (GG-CAP) HFC-23purchases are the sole reason why Canada gures
on the list. Interestingly, Japan has only 3 per cent
o the buyers volume although their interest in themarket is reportedly still high.
The private sector is dominant on the buy-side (58
per cent), as increrasingly more companies see thevalue o project credits. In addition, new nancial
vehicles are established to cater to this market,
contributing to the unds segment o 34 per cent. In
general, companies with EU ETS compliance
and unds selling to such companies have also
had a much larger appetite or large-scale non-CO2projects. Moreover, European countries dominate
amongst governmental buyers. While there are
hints at more Japanese activity in the CDM market,our expectation o limited Canadian and Japanese
activity on the demand side has proven correct.
With regards to project types in 2006 orward CER
contracts, HFC-23 and adipic acid N2O projects
stole the show. Most o these types o projects
are now under contract, and we see the contours
o a more balanced picture between project types.The dominance o HFC-23 was ar clearer in 2005.
Renewables, energy eciency, waste (includinglandll gas capture) and ugitive emissions (including
coal mine methane) have all experienced growth in
2006, which is likely to continue.
China completely dominated the CDM sell side in2006, miles ahead o India and Brazil, bringing the
bulk o the HFC-23 and adipic acid N2O volumes to
the market. China elt condent enough in its role as
a dominant supplier to introduce and maintain a price
foor, which it raised rom 7/t to 8-9/t during the
year. With 70 per cent o the total contracted CDMvolume coming rom China, this is a very strong
price signal in a market that is still airly small.
China
70%
Malaysia
1%Egypt
2%
Other
12%
Brazil3%
India
12%
Source: Point Carbon
Figure 3.18: Made in ChinaThe relative share o CDM country sellers (let) and buyers (right) in 2006.
Italy
24%
Unknown/Other
11%
United
Kingdom36%
Spain
4%
USA
4%
Luxembourg
5%
Canada
13%
Japan
3%
Privates still the largest buyer oCDM contracts
China by ar the largest CDM sellingcountry
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13 March 2007
More transactions are done in India now than has
been the case or a while, mainly or two reasons.
Firstly, Indian sellers were renowned to be more
optimistic than others beore the EU price crash,
but the crash brought them back to the negotiatingtable.
Secondly, this development mirrors a more mature
market; many Indian sellers had sat on the ence,
in the belie that selling a mature asset yields more
revenue, and are now selling as their project is
registered or has had its rst issuance o credits.Apart rom the developments in China and India, the
picture is still ragmented on the sell side, which isinteresting in itsel: many more seller countries are
now represented in the market than previously.
The CDM market in 2006 can also be summed
up in other ways. First, market players learned
the hard way that there are real risks related tomethodologies, or instance the slashing o CERs
rom manure management projects and general
delays due to lack o UNFCCC sta, host country
approval (Thailand and Brazil), project perormancecompared to plans (especially landll gas) andExecutive Board approval (several projects rejected,
or delayed due to reviews).
Furthermore, the rules or Chinese host country
approval require project participants to reveal a CER
price, and it is not allowed to receive consultancy
revenues in CERs. This has orced project developers
to take buy side positions in order to be able toobtain CERs early and sell them or a prot later. This
will likely boost secondary CER market volumes in
the years to come. When some project developers
also start buying or their own books, many buyers
are likely to seek out project developers that dont
buy or their own books in order to obtain unbiasedadvice.
The prospect o non-Kyoto and non-EU ETS CERbuyers became more real in 2006. US and Australian
states urther developed or started implementing
trading schemes, and are reportedly planning toopen or submitting CERs or compliance. To the
extent this infuenced the current market at all,
this (together with the post-2012 negotiations)
strengthened the belie in a post-2012 CDM market,
and some very ew orward CER trades now include
Veried Emission Reductions (VERs) or CERs or thepost-2012 period.
3.2.2 JI in 2006
Point Carbon reckons that the JI project market
saw 20.5 Mt CO2e transacted in 2006. O that,
16.7 Mt CO2e represents conrmed transactions
registered in Point Carbons transaction database,
Government
61%
Funds
21%
Private
18%
Source: Point Carbon
Figure3.1: Who are they and what do they want, Part IIThe relative share o categories o JI buyers (let) and project types (right) in 2006.
Industrial
processes
22%
Renewable
37%
Unknown
2% Fuelswitching
2%Fugitive
emissions
6%
Waste
16%
ENEF
15%
Chinese price foor at 8-9/t providesa strong price signal
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Carbon 2007
while the remaining 3.8 Mt CO2e are estimated
using data rom Point Carbons project database
and regular contact with market participants. The
quarterly average was 5.1 Mt, with a somewhatsmaller volume o contracts in the second quarter
and higher volumes in Q4.
Reported ERU prices in 2006 were between 4.5
and 12.5. The price did not see any abrupt changes,
partly because JI is still dominated by governmental
buyers which have limits on their budgets and arenot very fexible with the prices they oer. They
also usually negotiate the price at early stages o
the projects, and the resulting price at the date o
contract signature does not necessarily refect the
latest market trends.
We estimate the total nancial value o JI transactions
to be 95.2 million in 2006 money (7 per cent
discount rate), almost exactly at the same level as in
2005. Taking only the conrmed JI transactions into
account, we end up with a volume-weighted unitprice o 6.5/t (5.1/t in 2005).
Governmental buyers still dominate the JI market,with 61 per cent o the purchases in 2006, although
there are other buyers also entering the picture. Funds
and private buyers both have market shares around
20 per cent. The situation changed dramatically in
CzechRepublic
21%
Romania
15%
Russia
15%
Ukraine
15%
Poland
6%
Others
11% Bulgaria
17%
Source: Point Carbon
Figure 3.20: From East to WestThe relative share o JI country sellers (let) and buyers (right) in 2006.
Table 3: CER prices throughout 2006Price o primary transactions at start and end o 2006, the range as well as the volume weighted
unit price or the year in total, in /tonne.
Start 2006 End 2006 Range Vol.weighted unit price
Price category 1 4 5 3.5 - 7 5.87
Price category 2 7 7 3.5 - 15 8.09
Price category 3 14 10 8 - 18 12.99
Price category 4 18 13 13 - 18 16.97
Austria
29%
Denmark
36%
Netherlands
13%
World Bank
12%
Others
10%
Average price or JI transactions in2006: 6.5/t
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13 March 2007
2006 rom 2005, when the governments covered
96 per cent o the buy-side in the JI market.
Still, in many cases, JI appears to be more avourable
or governmental buyers than or private. The most
active ERU buyers in 2006 were Denmark (36 percent o all JI transactions), Austria (29 per cent) and
the Netherlands (13 per cent). The most active sellers
were the Czech Republic (21 per cent) ollowed by
Bulgaria, Romania, Russia and Ukraine (15 per cent
each).
The most signicant project types among JI contracts
in 2006 in terms o volume were renewables (37
per cent), industrial processes (22 per cent), waste
(16 per cent) and energy eciency (15 per cent).
Renewable energy projects, although not big in size,
were numerous, with several biomass, wind andhydro projects.
Conversely, there were ew industrial processes
projects, represented by N2O reductions, which
brought relatively high volume to the market. Landll
gas recovery and energy eciency contributed
around 15 per cent o contracted volume each.
In addition to the act that some large deals thatwe had expected to be concluded in 2006, actually
were not contracted beore January 2007 (eg. one
10 Mt CO2e contract), there are at least our reasons
why the volume o JI transactions did not increase
in 2006, but ended approximately at the same level
as in 2005.
First, there is still considerable uncertainty related to
JI projects in Russia. Russia is potentially the largestseller o ERUs, but did not manage to establish its
JI procedures in 2006, and it took until the end othe year beore several key ministries reached an
agreement on the principles o JI guidelines.
Second, the regulatory inrastructure in Ukraine
was not resolved until the end o 2006 and, thus,or most o the 2006 it was still uncertain, with ew
projects receiving a Letter o Approval (LoA) rom
the Ukrainian government.
Third, the threat o EU ETS double counting rules
has been slowing JI transactions over 2006. Thedouble counting avoidance guidelines practically
rule out all uture projects in EU ETS trading sectors,
leaving mainly non-CO2 gases or JI. This signicantly
limited the scope or JI in host countries that recently
joined the EU. Finally, despite the increase o private
buyers, there is rather low interest rom the private
0% 10% 20% 30% 40% 50%
Political factors
EU ETS 08-12 price
Actual project costs
Governmental demand
CDM Methodology panel
Earlier deals
Other factors
Share of responses
2006 2007Source: Point Carbon
Figure 3.21 Short-term price drivers or CDM and JIBased on responses rom our web-survey
Renewable JI projects biggest in2006
Procedural uncertainty limits JItransactions
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0% 10% 20% 30% 40% 50% 60%
Political factors
EU ETS 08-12 price
Actual project costs
Governmental demand
CDM Methodology panel
Earlier deals
Other factors
Share of responses
2006 2007Source: Point Carbon
Figure 3.22 Long-term price drivers or CDM and JIBased on responses rom our web-survey
0% 20% 40% 60% 80%
The CDM&JI market
facilitates emissions
reductions
The CDM&JI market is
more mature now than one
year ago
The CDM&JI market is the
most cost-efficient way toreduce emissions
The CDM&JI market is a
success
The CDM&JI market is a
mature market
Share of responses
2006 2007Source: Point Carbon
Figure 3.23 Assessing the CDM/JI marketBased on responses rom our web-survey
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13 March 2007
Physical volumes (30.5 Mt CO2e)
NSW GGAS
66%
UK ETS2%
CCX
33%
Source: Point Carbon
Figure 3.24: And now or something completely dierent...The relative share o other carbon markets, physical volume and nancial value.
Financial value (300 million)
NSW GGAS
90%
CCX
9%
UK ETS
1%
sector as companies are still not amiliar with JI.
Investors preerred CDM which has established a
track record, while JI is only preparing its routines.
The Joint Implementation Supervisory Committee
(JISC) started its work in 2006 and ociallylaunched the JI Track 2 process on October 26
2006. Once the JI mechanism gets up and running
it is possible that we will see urther private sector
interest in credits rom Eastern Europe, but this is
still uncertain.
What drives the CDM/JI prices?
Reported orward CER prices in 2006 have variedbetween 3.5 and 20, and have clearly been
infuenced by the variations in the EUA-prices.Table 3 shows the ranges and variations seen in
Point Carbons CER orward price categories.
The price impact o the EU price crash came later
or category 1 and 2 deals than or category 3
deals. This is not too surprising as category 1 and2 deals are oten more closely linked to long-term
carbon nance structures or projects that are still
in early stages o development.
Also, many o them are done by governments,
which are less sensitive to short term EUA price
developments. Volume-weighted unit price in 2006was 8.32/tonne, up rom 6.70/tonne in 2005.
Secondary CER prices have allen relative to EUA
prices, as they were squeezed between primary
market prices o up to 10 and EUA 2008 prices o
around 15. The volume-weighted average price or
secondary transactions was 14.3/tonne in 2006.
What does the survey reveal o price drivers in
the CDM/JI market? Figures 3.21 and 3.22 show
what the respondents to our web-survey saw asthe most important price drivers in the short- and
long-term. The main change rom last year is that
political decisions have become ar more important,
with more than 40 % o the responses on the short-
term horizon, and above 50 % in the longer term
horizon, citing policy decisions as the key pricedriver. Interestingly, it is the political decisions in
developed countries and on the international arenathat constitute the majority o these responses, and
not the decisions taken by the CDM methodology
panel, which is seen as a less important price drivercompared to last year.
As CDM covers more than 90% o the entire project
market, it seems air to assume that the respondents
to the survey or the most part ocused on this market
when answering questions relevant or both CDMand JI, see Figure 3.23. For instance, a larger shareo the respondents thinks that the CDM/JI market
is a success, compared to the 2006 survey. This ts
well with the market results presented above. The
CDM market grows continuously, CERs are issued
Volume-weighted average CER price8.32/t in 2006
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Carbon 2007
on a regular basis, and the demand or these credits
increases as the EU ETS phase II is approaching. In
general, it seems that the respondents have more
condence in the CDM market now than just one
year ago.
3.3 Other markets
Several greenhouse gas emissions trading schemes
exist beyond the bounds o the Kyoto Protocol and
its spin-o markets. The Chicago Climate Exchange
is voluntary, although once a company has joined,
the cap is binding. The New South Wales scheme
in Australia imposes a mandatory cap on powersuppliers, but leaves the door open to local oset
projects.
The UK ETS expired at the end o 2006, with
compliance due in March 2007. Ocial data or the
2006 trading year is not released until May 2007.We have excluded the increasing voluntary sector
(osets or air travel, etc.), which is building in
size and dynamism, rom this report, but this willbe subject to an analysis by Point Carbon later this
year.
Last year saw an interesting development, as thetotal volume in the category o other emissions
markets grew our-old, rom 7.8 Mt CO2e in 2005
to 30.9 Mt CO2e in 2006. In nancial terms, the
increase was almost six-old, rom 52 million in
2005 to almost 300 million in 2006.
This sharp growth trend in these markets was putdown in part to the increased number o participants,
new members and vintages in the case o CCX, and
newly approved oset projects in the NSW scheme.
In the case o the latter, the new projects brought
supply and thereore volatility to a hitherto stagnant
market, urther increasing volume.
The New South Wales scheme in Australia, the only
mandatory scheme in this segment, still dominates
amongst the other trading schemes, with 66 per
cent o the total physical volume transerred, and 90
per cent o the nancial value.
There was also an advance in the average spot
price, rom A$12.80 to A$13.31 in 2005 and 2006
respectively. The volume o New South Wales
Greenhouse Gas Abatement Certicates (NGACs)
transerred on the registry tripled rom 6 million
in 2005 to 20 million in 2006. Accordingly, the
estimated nancial value jumped three-and-a-hal
times rom A$78.2 million (48.5 million) in 2005 to
A$268.3 million (160 million) in 2006.
The NSW scheme administrator registered just over
669 transactions over the course o 2006. February
was the busiest month again last year, ollowed by
December, with 84 and 70 transers each.
The Chicago Climate Exchange in the U.S. has growntenold in stature in a year when a rm domestic
ederal carbon policy has appeared on the horizon.
Its share o the other market grew rom 18%
o the volume in 2005 to 33% in 2006, and rom
5% o the nancial value in 2005 to 9% in 2006.
The Chicago Climate Exchange (CCX) continued itsgrowth path with 225 members at the end o 2006,
up rom 129 in 2005. With new vintages traded out
to 2010, there
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