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BUSINESS FOR CLIMATE PLATFORM

EMISSIONS TRADING SYSTEM

EPC ETS

Final Report: March to November 2015

Summary Report

Delivered by: In partnership with:

August/2016

mailto:[email protected]

http://www.fgv.br/ces


MASTHEAD

REALIZATION

FUNDAÇÃO GETULIO VARGAS Centre for Sustainability Studies (GVces)

GENERAL COORDINATOR

Mario Monzoni

VICE COORDINATOR Paulo Branco

EXECUTIVE COORDINATOR Guarany Ipê do Sol Osório

TECHNICAL COORDINATOR

Mariana Nicolletti

TEAM Betania Ap. Perboni Vilas Boas Guido Couto Penido Guimarães

COLLABORATORS Fernanda Rocha

Guilherme Borba Lefèvre Inaiê Takae Santos

ACKNOWLEDGEMENTS

EPC ETS 2015 Advisory Council

Alexandre Kossoy (World Bank), David Lunsford (Delta Carbon Ag), Jeff Swartz (IETA), Mario Monzoni (GVces), Nicolette Bartlett (CDP and We Mean Business), Pedro Moura Costa (BVRio), Stephan Schwartzman (Environmental Defense Fund – EDF)




Contents

INTRODUCTION 4

KEY CONCLUSIONS 5

1. ABOUT EPC ETS 2015 6

2. RESULTS AND ANALYSIS 8

3. STRATEGIES AND PERFORMANCE 11

4. CHALLENGES AND LESSONS LEARNED 14




INTRODUCTION

The main objective of the simulated Emissions Trading System of the EPC (Business for Climate

Platform) is to offer the Brazilian business sector the opportunity to experiment with a market

instrument for carbon pricing and, at the same time, enable its contribution to the debate on

this matter in Brazil and internationally.

The second operational cycle of the EPC ETS was held in 2015, with the participation of 23

companies from different sectors of the Brazilian economy who sought to balance their 2015

emissions at the lowest possible cost using bonds available on the EPC ETS (emissions

allowances and offsets). This report contains the results, analysis, challenges, and lessons

learned from the EPC ETS 2015, operational between March and November.

Emission data from the EPC ETS is real and covers Scope 1 emissions from the emissions

inventories of the participating companies, these being registered through the Brazilian GHG

Protocol program, which annually publishes the previous year’s corporate emissions

inventories every August. It is thus only now possible to attain final results and analysis of the

EPC ETS 2015.

The Rules and Parameters of the EPC ETS are annually revised and were defined in conjunction

with the companies participating in the initiative, in 2013, based on studies and debates on the

main emissions trading systems, such as the EU ETS1, California Cap and Trade2 Program,

among others. There is a rule dealing with the confidentiality of the participating companies:

their performances and strategies are disclosed only through pseudonyms.

All transactions occurred through the Instituto BVRio| Bolsa de Valores Ambientais transaction

platform and are carried out with a fictitious currency, the EPCents (Ec$), which is pegged to

the Real (Ec$1,00 = R$ 1,003).

Table 1- Key Information regarding the EPC ETS 2014 and 2015

General Information 2014 2015 Comparison 2014-2015

Number of participating companies

22 23 >5%

Global Cap 23.486.332

tCO2e 30.782.427 tCO2e >31%

Financial Volume- Secondary Market

Ec$ 25.541.400 Ec$ 49.605.017,50 >94%

1 The European Union Emissions Trading System (EU ETS) is the first and the world's largest emissions trading system, covering 2007.8 MtCO2e. Over 11,000 power plants and production facilities of pulp and paper, cement, oil and gas, among others, are covered by the EU ETS (ICAP, 2016). 2 The California Cap and Trade Program regulates 350 entities of transport, industry, and power generation, responsible for coverage of approximately 85% of the state's emissions (394.5 Mt CO2e). 3 At the beginning of the operational cycle, a financial allocation of 150% of the value of allowances needed to be acquired by the company is made, taking into account base year emissions.



https://s3.amazonaws.com/arquivos2.gvces.com.br/epc/original/epc-ets_rules-and-parameters.pdf

http://www.bvrio.org/


Maximum Allowance Price - Secondary market

Ec$ 35 Ec$ 41,50 >18%

KEY CONCLUSIONS

➢ In the 2015 cycle, the EPC ETS limited Scope 1 emissions of the group of participating

companies to 30,782,427 tCO2e (global cap), which represents a 12% reduction

(relative to levels of 2013). However, these companies reported direct emissions 9%

above the established limit (33,600,767 tCO2e). Between 2013 and 2015, the

companies reduced their direct emissions by 3%. The reduction happened, more

specifically, between 2014 and 2015, given that between 2013 and 2014 companies

increased their emissions by 1%.

➢ Notable participating sectors are services, who increased emissions by 43% between

2014 and 2015; the manufacturing industry, representing 85% of emissions covered

by the initiative, and which decreased emissions by 4%; construction, for presenting

the greatest reduction in emissions, 23%; and energy, which kept the same level of

emissions.

➢ Of the 24 participating companies4 of the EPC ETS 2015, ten (42%) were able to

balance their direct emissions, and four (16%) came close. On the other hand, ten

(42%) companies didn’t balance their emissions.

➢ Of the 10 companies that balanced their emissions, 7 obtained surplus allowances,

even taking into account the banking strategy5. Only Ágata, Tatu Bola, and IP&S

acquired a volume of bonds close to the volume of emissions, reflecting a strategy of

participation in the simulation closest to the emissions management of the

company.

➢ On average, companies had an average net cost of acquisition of bonds (financial

indicator) of Ec$ 30 per tCO2e. Among the group of companies who balanced their

emissions the lowest financial indicator was Ec$ 21.11, and the greatest was Ec$ 40.

➢ Allowances reached a trade price of Ec$ 41.50 on the secondary market, presenting

throughout the cycle an appreciation of 40%, while offset type 1 appreciated by 60%.

Offset type 2 presented a smaller appreciation of 13%, after the verification simulation

in November.

➢ Different strategies were adopted by the companies with the best performance,

among them: active participation in allowance auctions, portfolio diversification with

offsets, acquisition of bonds on the futures market, and financial speculation.

➢ In addition to a participation strategy in the EPC ETS, it is essential that the

relationship between carbon pricing and business competitiveness be made clear to

companies, given that by making carbon intensive projects and investments less

4 One company is participating with 2 players, due to the difference in its business activities. As such, indicators and analysis

account for the participation of 24 players in the EPC ETS 2015. 5 Part transfer of excess allowances (up to 5% of Scope 1 allowances of the current cycle) to the next cycle.




attractive, this economic instrument provides a reduction in risk for companies facing

possible regulation.

1. ABOUT EPC ETS 2015 23 companies of the most varied sectors of the Brazilian economy took part in the second

operational cycle, in 2015, of the EPC ETS.

Figure 1 - Participating Companies in the EPC ETS 2015

The EPC ETS 2015 was responsible for the coverage of 34,476,3186 tCO2e, which represents approximately 3% of national emissions7 of 2014, excluding emissions from land use change. Only five companies account for nearly 86% of emissions coverage of the EPC ETS 2015. The global cap was calculated at 30,782,427 tCO2e, once a 12% reduction target was applied

to Scope 1 emissions of 2013, base year of the EPC ETS. Approximately 50% of allowances that

make up the global cap were allocated for free, based on the result of the indicator for

carbonic intensity of each sector.8

In total, 8 auctions took place during the second operational cycle. In practically all auctions

demand outstripped supply9. On average, demand was 81% higher than supply. In addition,

the price of allowances progressively appreciated. The final auction registered a closing price

of Ec$ 46, compared with the opening price of the first auction, at Ec$ 22. On average, closing

prices at auctions were 17% greater than opening prices.

6 Taking into account Scope 1 of participating companies, in 2013, base year of the EPC ETS. 7According to the SEEG (Estimative System of Greenhouse Gas Emission), national emissions, in 2014, were 1,071,834,529 tCO2e,

excluding emissions from land use change. 8 The company with the best indicator receives 60% of the volume of allowances needed to balance their base year emissions, the company with the worst indicator receives 40%. For sectors where a benchmarking study wasn’t possible due to lack of data of companies of the same productive activity, the allocation is of 50%. Another portion of the allowances were sold through auctions which took place throughout the cycle. 9 The volume of allowance purchase orders was greater than the volume supplied by the Managing Committee at auction.




On the secondary market in 2015, a total of 649,000 tCO2 in allowances was traded, 1,529,423

tCO2 in type 1 offsets, and 433,689 tCO2e in type 2 offsets (Graph 1).

Graph 1- Volume of bonds (allowances and offsets) traded on the secondary market of the EPC ETS

2015

The scarcity of allowances resulted in an increase in the demand for offsets, specially for offset

type 1, which presents no performance risk. As such, offset type 1 saw an appreciation of

approximately 60% over the cycle, while allowances appreciated 40%, taking into account the

average bond price. Offset type 2 presented a greater appreciation (13%) after the simulation

verification in November, as by then the bond no longer presented a performance risk (Graph

2).

I

n

Graph 2 – Average Price (Ec$) traded on the secondary market of the EPC ETS 2015

In 2015, the futures allowance market10 was implemented in the EPC ETS, with the purpose of

offering participating companies new operational strategic possibilities. 7,136 allowance

contracts for Ec$34 were traded on this market. At the time of settlement of these contracts at

the end of the cycle, allowances were being traded on the secondary market for Ec$ 41.50.

2.0 RESULTS AND ANALYSIS

Operational Analysis

10 Futures contracts are traded on this market, which are agreements to buy and/or sell an asset at a determined future date at a

previously determined price.

0

250

500

750

March April May June July August September October November

Tho

usa

nd

s

Allowance Offset type 1 Offset type 2

15,

20,3

25,5

30,8

36,

41,3

31/3 30/4 30/5 30/6 15/7 15/8 15/9 15/10 15/11

Ec$

Allowance Offset type 1 Offset type 2




Of the 24 participating companies11 in the EPC ETS 2015, ten (42%) were able to balance their

direct emissions: Ágata, Jenipapo, Mico Leão Dourado, IP&S, Onça Pintada, HOM, FCE,

Paineira, Mailu, and Tatu Bola.

Four (16%) came close to balancing their emissions: Sapphire, Mimus Sartuninus, Ubuntu, and

Floresta, with an operational indicator of between 0.75 and 0.95. On the other hand, 10 (42%)

companies did not balance their emissions, with an operational indicator below 0.50 (Graph 3).

Graph 3- Percentages of company positioning with relation to Scope 1 emission balance of 2015, with

EPC ETS bonds.

Of the 10 companies balancing their emissions, 7 obtained excess allowances, taking

into account the banking strategy. Only Ágata, Tatu Bola, and IP&S acquired a volume of bonds

close to volume of emissions, reflecting a strategy of participation in the simulation closer to

the emissions management of the company.

Notable among the participating sectors are: services, which increased its emissions by 43%

between 2014 and 2015, with 2 of the 6 sector companies balancing their emissions; the

manufacturing sector, which represents 85% of emissions covered by the initiative, and which

decreased its emissions by 4%, with 3 of the 6 companies reaching their target of balancing

their emissions. The construction sector presented the greatest reduction in emissions, of 23%,

composed of 3 companies, 2 of which balanced their emissions. The energy sector maintained

the same level of emissions, and two of the three participating companies balanced their

emissions.

Financial Analysis

Overall, the financial indicator average,12 the average cost of bonds acquired on the market,

was of approximately Ec$ 30, disregarding 4 companies which did not operate on any market

of the EPC ETS (Tamanduá, Vitória Régia, Pink, and Pau Brasil) and, as such, possess no

financial indicators. In terms of companies which balanced their emissions, Onça Pintada and

11 One company is participating with two players, due to the difference between its business activities. As such, indicators and

analysis take into account the participation of 24 players in the EPC ETS 2015. 12

The financial indicator reflects the bond price at the moment the company operated on the market, taking into account only the

average liquid cost of bond acquisition on the EPC ETS market.

42% of companies balanced their emissions 42% of

companies did not balance their emissions

16% of companies came close to balance




FCE were the companies that acquired allowances on the market at the lowest average cost,

their respective financial indicators being Ec$ 21.11 and Ec$ 24.15.

Another indicator monitored on the EPC ETS is the cost of balance13, which represents the

monetary cost per portfolio bond, rather than considering only the average cost of bonds

acquired on the market. For portfolio bonds, allowances obtained via initial free allocation and

bonds acquired on the market are taken into account.

Among companies which balanced their emissions, in terms of cost of balance, Tatu Bola, Mico

Leão Dourado, and IP&S are noteworthy, with respective balance costs of: Ec$ 13.67, Ec$

15.47, and Ec$ 16.03 (Graph 4). During the 2015 cycle, penalties pertaining to the 2014 cycle

were applied. Thus, for penalised companies, the cost of balance also took into account the

penalty cost from the previous cycle, as well as the cost of acquiring bonds on the market.

Graph 4- Indicators: financial and cost of balance per company participating in the EPC ETS 2015.

Finally, a sectoral analysis indicates that participating companies from the pulp and paper

sector presented overall the greatest cost of balance - Ec$ 50.40. This is due to penalties

pertaining to the 2014 cycle incurred in 2015. The group with the second highest cost of

balance was the manufacturing industry, at Ec$ 25.96. Companies from the service sector also

came close to this average, with Ec$ 23.87. It is worth emphasising that companies

representing the manufacturing industry presented a 4% decrease of emissions, and the

service sector a 43% increase in emissions, in the period between 2014 and 2015.

The groups representing the energy and construction sectors are notable for their lowest

average cost of balance: Ec$ 19.73 and Ec$ 16.62 respectively. It is important to mention that

the participating companies of the energy sector practically maintained their emissions stable

between 2014 and 2015, while the construction sector reduced its emissions by 23%.

13 Is the ratio between the total net expenditure of the cycle and the volume of securities in the portfolio, both recorded at the

end of the cycle.

0,

17,5

35,

52,5

70,

HOM JAT SAP PAI IPS MIS JAC JAG UBU ONP TAA PIK

Ec$

Financial Indicator Indicator of Balance Cost




Finally, it is important to highlight that the financial indicator and the cost of balance don’t

take into account the marginal cost of abatement of companies which invested in emission

reduction. It should be emphasised that, in a real ETS, when the marginal cost of abatement is

lower than the cost of balance, the company should invest in emission reduction. As such, in

this case, the best strategy, whether to internally reduce emissions or acquire allowances,

depends on the marginal cost of emission reduction versus the price of allowances on the

markets.

3.0 STRATEGIES AND PERFORMANCES

The performance of the companies participating in the EPC ETS 2015 depends on a

combination of the operational result and the financial result, where the goal is to balance

direct emissions from the current cycle with bonds available on the EPC ETS, at the lowest

possible cost14.

Among companies that reached the best operational performance, which is to say, came close

to an exact balance, Tatu Bola presented the lowest cost of balance, Ec$ 13.67; for IP&S and

Ágata this cost was respectively of Ec$ 16.03 and Ec$ 23.16 (Graph 7). The companies in the

best position (closest to the 1 on the X-axis and lower on the Y-axis) sought to align their

participation in the EPC ETS operation with their emission management and sought to identify

the best moment for the purchase of bonds, factoring opportunity cost.

14 In addition to the operational indicator, the final analysis also takes into account the cost of balance, which encompasses the

cost of acquiring bonds on the market and the cost of penalisation from the previous cycle, and also considers the allowances

received via the initial free allocation.




Graph 6- Performance of the companies participating in the EPC ETS 2015, according to a combination of the operational indicator and the cost of balance. Acronyms and their respective pseudonyms: Ágata=AGA;

FCE=FCE; Floresta= FLO; Hiteco=HIT; HOM=HOM; IP&S=IPS; Jacarandá=JAC; Jacutinga=JAT; Jaguatirica= JAG; Jenipapo= JEN; Mailu= MAI; Mico Leão Dourado=MLD; Mimus Sartuninus = MIS; Onça Pintada=ONP; Paineira=PAI; Pau Brasil= PAB; Pau Ferro= PAF; Pink= PIK; Sapphire= SAP; Surubim= SUR; Tamanduá=TAA; Tatu Bola= TAB; Ubuntu= UBU; Vitória Régia= VIR.

The indicators of the 2015 cycle of the EPC ETS shown previously, as well as the Cartesian

performance graph (Graph 7), account for the penalties relative to the previous cycle (2014)

incurred in 2015, showing the real situation of the participating company at the end of the

2015 cycle. Thus, if the company received penalties in 2015 pertaining to the non-balance of

the previous cycle, its indicators will reflect this adversity. Furthermore, due to using more

than one indicator, the performance graph - despite indicating the best and worst

performance - doesn’t allow for a direct ranking of participants, as there isn’t a metric to

assess the relative importance of each of the two indicators analysed15.

Therefore, as a ranking exercise, purely portraying performances in the 2015 cycle - without

taking into account penalties from the previous cycle - a single performance indicator was

15

That is, the cost of balance indicator and the operational indicator.

0

10

20

30

40

50

60

70

80

0 0,5 1 1,5 2 2,5

C

ost

of

Bal

ance

PAF

AGA

SAP

TAA

JEN

VIR

PIK

MLD

SUR

MIS

ONP

UBU

TAB

HOM

FCE

JAT

IPS

JAC

HIT

JAG

FLO

MAI

PAI

PAB

Operational Indicator




elaborated. This indicator takes into account the complete performance in the 2015 cycle,

including penalties and amount of surplus allowances (beyond banking) generated in this

cycle.

The indicator is based on a comparison between the hypothetical cost16 for the

company to balance its emissions and the actual cost17, which adds the net cost in the cycle

plus penalties (financial and operational, the latter being converted to financial value).

Table 3- Performance Ranking of Companies Participating in the EPC ETS 2015.

Ranking Company Pseudonym Indicator

Ranking Company

Pseudonym Indicator

1 Tatu Bola 0,94 13 Hiteco 2,16

2 Mico Leão Dourado 0,99 14 Pau Ferro 2,34

3 IP&S 1,05 15 Pink 2,35

4 Ágata 1,11 16 Pau Brasil 2,35

5 Mailu 1,18 17 Floresta 2,38

6 Ubuntu 1,22 18 Jaguatirica 2,49

7 FCE 1,28 19 Jacutinga 2,86

8 Sapphire 1,49 20 Vitória Régia 3,48

9 Mimus Sartuninus 1,51 21 Jenipapo 3,53

10 Paineira 1,75 22 Jacarandá 4,24

11 HOM 1,80 23 Tamanduá 5,30

12 Surubim 1,90

Tatu Bola presented the best performance indicator of the 2015 cycle, with 0.94. This means

that its real cost was 6% inferior to the hypothetical cost calculated based on the average price

of allowances in the cycle.

16

Hypothetical cost is determined by the average allowance price of the cycle and the bonds needed for balance of each company at the beginning of the cycle (after initial free allocation) 17Actual cost = net cost + financial penalty + (operational penalty - banking). Considering 2015 data.




One company was left out of the ranking, Onça Pintada, as it had a significant reduction of

emissions in the cycle, so that the bonds obtained through the free allocation were more than

enough to cover its total emissions for the cycle.

The performances are reflections of the strategies adopted by the companies. The operational

and financial results of Ágata, Tatu Bola, and IP&S demonstrate that the primary strategy of

those companies was to align their participation in the EPC ETS with emission management. Of

those companies only Tatu Bola reduced its emissions. Between 2014 and 2015 the company

reduced its Scope 1 emissions by approximately 9%.

Tatu Bola, IP&S and Mico Leão Dourado actively participated in auctions, especially in the first

ones, with purchase orders for large volumes of allowances at opening18. The strategy of Ágata

is noteworthy, being the only company to operate on the futures market of the EPC ETS 2015.

Ágata acquired approximately 67% of its volume of portfolio allowances on the futures

market.

Ágata, IP&A and Mico Leão Dourado also invested in diversifying their portfolio with offsets,

once they were being traded through the cycle at a lower cost than the allowance. Compared

to the 2014 cycle, the number of companies adopting this measure was greater. Also in this

regard, FCE for example, inserted its own type 1 offsets in its portfolio, traded part of these

offsets obtaining financial gain, and used the other part to balance its emissions.

Finally, it is worth mentioning Mico Leão Dourado’s operation, which engaged in financial

speculation. At the end of the cycle, the company sold type 1 offsets for a price close to 25%

higher than what it paid for the bond. This strategy contributed to the company’s financial

performance, one of the best of the cycle.

4. CHALLENGES AND LESSONS LEARNED

Implementing and operating a simulated emissions trading system which involves companies

of different sectors and characteristics requires facing different types of challenges, from

structural to operational. These challenges are more pronounced given that the emissions

trading system is a relatively new economic instrument in the Brazilian business context, and

dependent on public policy.

On the other hand, there are innumerable gains from the lessons learned, given that an

emissions trading system requires an understanding of conceptual issues, economic variables,

and associated technical knowledge. The joint construction, through interaction with academia

and the business sector, is as important as the lessons from the strategic field.

As such, since 2013, when the EPC ETS was first designed, important lessons and challenges

were identified in relation to the structuring of an emissions trading system, especially in

Brazil. The operations of both cycles, 2014 and 2015, brought further elements, mainly

pertaining to the following challenges and lessons:

18EPC ETS auctions respect the criteria of greatest offer, and subsequently, first bidder.




Engagement and Preparation of Leadership: most business leaders still do not recognise the

importance and relationship between carbon pricing and business strategy. Thus, at the

beginning of each cycle the EPC ETS team prepare talks and engagement material with

various companies. In this sense, the main lesson pertains to linking carbon pricing with the

company’s competitiveness.

Emission and production data: the lack of records of emissions and production was one of

the main challenges in designing the EPC ETS. This data is essential for the design of an

efficient emissions trading system. Thus, the EPC ETS built an information base including

emission and production data starting from the year 2013. In this regard, work was done

with the companies to stress the importance of inventorying disaggregated and accurate

emission and production data for better emission management.

Penalties: in 2015, after a simulated application of penalties, it was found that some

companies might be left without sufficient resources (Ec$ and/or allowances) to continue

operating on the market. Thus, penalties were reviewed and made more lenient, with the

challenge of establishing penalties to effectively discourage non-compliance without

derailing economic activities.

Futures Market: In real markets, most allowances are traded in the form of futures

contracts, and as such it was considered important for the area of company sustainability

to approach this type of market. In addition, the futures market was also understood as an

opportunity to engage the financial area in the subject. In this regard, the EPC ETS team

organised meetings at the beginning of the 2016 cycle to introduce the initiative to the

financial areas of the interested companies.

Ambition and Participation: more important than specific decisions is the search for a

system with a robust result in emission reduction. The participation of companies is

essential, mainly to help with the adjustments and improvements of the system, as well as

making available the information required for assertive decision-making on behalf of the

management body of the system. The preparation of reports and debates on results are key

factors in stimulating the participation of companies in terms of enhancing practical and

theoretical knowledge, as well as enriching the process of improving rules and parameters.



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