The emerging carbon marketan introduction

Presentation to the PCF/WBI TrainingIntegrating Carbon Finance in Bank’s Work

November 19, 2001

Franck Lecocq – DECRG / PCFplus Research

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Early carbon market1996-2001

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Greenhouse gases emission reductions an unusual commodity

• Different “qualities” of ERs depending on the credibility of the baseline scenario

• Players are interested in different “brands” depending on their objectives

Emission Reductions=

Hypothetical baseline emissions - Effective emissions

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$0t/Co2

$1t/Co2

$2t/Co2

$3t/Co2

$4t/Co2

$5t/Co2

$6t/Co2

$7t/Co2

$8t/Co2

$9t/Co2

$0/tC

$5/tC

$10/tC

$15/tC

$20/tC

$25/tC

Optionss

Non verified ERs

Third-Party Verified

CDM

Government approved permits

Carbon prices in past transactions

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Sellers

• Key motivations:

– Gain additional revenue

– Strategic positioning to take advantage of future demand for ERs (e.g. Costa-Rica)

• However, at prices much below $3/tCO2e, carbon finance has too small an impact on projects’ IRRs (except maybe for some forestry activities).

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Motivations of buyers• Regulations in place• Expect regulations on GHG

emissions in the future– Hedge against future costs– Influence future regulation– Learning– Strategic positioning

• “Green” factor– Hedge against risk of appearing bad– Differentiating products

Governments

Firms(large utilities,

energy cies, etc.)

Individuals

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Quantities in past transactions

• Partial information available.• Within OECD and EITs: 40-60 MtCO2e have been

transacted.• In developing countries: Less activity but

growing. Mostly government funded, but private activity growing.

• General trend towards sophistication: buyers clubs (PCF), traders, financial derivatives (options), integrated marketplaces, etc.

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How may the market look like in coming years?

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Emerging market drivers

1. Regulations constraining GHG emissions are being developed:

– National policies (e.g. UK, The Netherlands)– Subnational regulations (e.g. some US States)– Regional initiatives (EU-wide trading)

2. Firms are increasingly taking action, in particular voluntary emission commitments

3. Parallel markets are emerging: e.g. carbon neutral certification.

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Current or projected national policies Trading? Start-up Project-based mechanism?

EU Yes 2005 At least from 2008UK Yes . 2001 YesFrance Yes 2003? YesNorway Yes 2005 or earlier YesGermany No LaterDenmark Yes 2001 YesSweden Yes 2005 or later YesNetherlands Ongoing work YesFinland Ongoing work YesIreland Ongoing work Ongoing workAustralia Yes US dependent YesUSA Yes ? YesCanada Yes US dependent Japan Ongoing work YesNew Zealand Yes Not decided YesRussia No Yes

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The Netherlands

• Government funded Emission Reduction Unit Procurement Tender (ERU-PT) and Certified Emission Reduction Units Procurement Tender (CERUPT)

• Buy ERs in Eastern Europe (JI) and non-Annex B countries (CDM) respectively

• 2000 tender (completed): $19 M

• Average price for first tender: $7/tCO2e

• Second Tender ERUPT, First Tender CERUPT opened.

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United Kingdom

• Climate Change Levy (April 2001)– Tax on energy use– Rebates in exchange for voluntary commitments– Benefits recycled in other corporate tax rebates

• Emission Trading (end of 2001)– On a voluntary basis for a limited range of

companies– Projects outside UK are considered for 2002.

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Regional regulations US/Canada

• Oregon: CO2 emissions standard for new energy utilities. Price cap: $0.57/tCo2. Utilities can offset emissions using project based mechanisms.

• Washington: New plants must demonstrate the use of best available techniques for CO2 emissions control.

• Massachusetts: CO2 emissions cap for energy utilities effective in 2005. Utilities can offset excess emissions using project-based mechanisms.

• New-England + Eastern Canadian Provinces: -20% in 2020 compared to 1990.

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Voluntary corporate commitments

• Rapid survey indicates 52 major companies representing 1 billion tCO2e emissions in 1999 have pledged to reduce GHG emissions by 2010.

• Resulting demand depends on the baseline. If we set baseline at 1999 emissions, we obtain a total demand of 500 MtCO2e over the next decade.

• At least eight have said they would use project based mechanisms.

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Alcoa -- 25% below 1990 in 2010BP Amoco 79.8 Cumulative 2%/year below 1990 Chubu EPCo. 51.3 0.410 kgCo2/kWh in 2005Dupont 44.4 65% below 1990 in 2010Kaidanren 478.6 level of 1990 in 2010Kodak -- 20% below 1990 in 2004Fortum 9 0.5 MtCo2e below baseline in 2010 IBM 4.1 Cumulative 4%/year below 1998 until 2004Intel 3.3 10% below 1995 in 2010 (PFCs) Johns.&Johns.1.5 7% below 1990 in 2010Motorola -- 50% below 1995 in 2010 (PFCs)Ontario PG 26 6% below 1990 in 2010 PEMEX 177 -1% per year until 2010 Shell 99 103 MtCo2e in 2002 Statoil 8.3 1.5 MtCo2e below baseline in 2010 Suncor 5 -1.5%/year until 2002 (-1%/year for 2003-2008) Transalta 38.5 -----

1999 Emissions Commitment Internal Trading

CDM/JI

Voluntary corporate commitments

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

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Chicago Climate Exchange

• 42 entities (mostly firms + Chicago and Mexico city) will agree on emission targets by the end of 2001 and start trading in 2002.

• Objectives: -2% below 1998 level in 2002, additional -1% period year between 2003 and 2005.

• Allows for offsets through project-based mechanisms.

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Emerging carbon fundsPrototype Carbon Fund +…

• About 5 private sector funds to capture JI/CDM Carbon credits in all investments.

• Handful of private equity funds also seeking carbon credit investors to raise IRR in deals.

• Major forestry funds thinking about C credits.

• New energy private equity and mutual funds might seek C credit deals if demand rises.

• Social funds use C as screening indicator.

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Market for “carbon neutral” products and services

• Increasingly, individuals and private or public organizations are looking for credible ways to offset the emissions their activities cause.

• Some firms provide this service – Future Forests, 550ppm or Klima – and buy ERs.

• Typically market for third-party verified ERs (but not necessarily Kyoto compatible)

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Conclusion• The carbon market already exists, and is growing

rapidly.

• With success in Bonn/Marrakesh, market for Kyoto compatible ERs (CDM, JI) and Emission Quotas (Trading) now likely to grow.

• However, demand for non-Kyoto ERs likely to remain strong because of US-based demand, climate neutral business activity and “green” motivation.

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For more information

State and Trends of the Carbon Market – NatsourceSummary available at www.prototypecarbonfund.org (PCFplus Research section). Full report available to Bank Staff on demand to PCF.

Carbon Market Intelligence Report – EcoSecuritiesTwo reports available at www.prototypecarbonfund.org (PCFplus Research section). Third report expected Febr. 2002.

National Strategic StudiesExplore ER supply opportunities for some of the Bank’s client countries. Available at http://www-esd.worldbank.org/cc/.

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Annex: some insights on future prices and quantities

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Demand and supply with Kyoto

Total Annex Bdemand for ERs Mitigation within Annex B

(domestic or via trading or JI)

Hot Air financial flow to Russia and EE

CDM Market

Domestic Carbon Sinks

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Hot Air

800

900

1000

1100

1200

1300

1400

1500

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

An

nu

al G

HG

em

iss

ion

s (

MtC

e)

Emission target

hot air

>

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Volumes in Kyoto w/o the US

Gross annual demand for ERs 1400 – 2400 MtCO2ebetween 2008 and 2012

- Credits for hot air 950 – 2150

- Credits for Annex B Sinks 330 ( 200)

= Net demand 0 – 1800 MtCO2e

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Carbon Market Impact

• Hot-air and new Annex I sinks allowances depress CDM/JI market

– W/o US, up to 100% of OECD needs may be met by hot air + sinks.

• Both CDM/JI “project-based” and “hot –air” (emissions trading) markets will be “policy-driven”

– Hot air may be cheap but politically unpalatable

– CDM/JI project-based more expensive and difficult but high quality and politically acceptable

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Prices in Post CoP6 World

• With full competition, our market analysis suggests:

– CDM trades from near zero up to $8/tCO2e

– Range of $1.50-4/tCO2e more likely in our view– PCF currently pays $3-4/tCO2e

• Non-KP Market drivers are significant: OECD domestic regimes and Corporate Voluntary market