CORPORATE FINANCE FINANCIAL INSTITUTIONS ENERGY AND INFRASTRUCTURE TRANSPORT TECHNOLOGY

Fact, Fiction, or Fancy? An International Carbon Market

Anthony HobleyPartner, Norton Rose LLP

Global Head of Climate Change and Carbon Finance

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In its 4th Assessment Report (2007) the Inter-Governmental Panel on Climate Change (IPCC) found that•It is very likely – that is, there is a greater than 90 per cent probability – that climate change is due to the observed increase in anthropogenic greenhouse gas emissions•A reduction of at least 25–40 per cent by 2020 on 1990 levels will need to be made by developed countries to limit the global average temperature rise to below two degrees Celsius•Global greenhouse gas (GHG) emissions must peak in the next 10-15 years and must then be followed by substantial reductions to achieve this end

•Nations are deciding not on the whether they should act, but what they should do and how it best be done

Emissions reduction and mitigation frameworks have become a reality for both individuals and corporations

The Climate Change Reality

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What Will It Cost?

“In the Peak Scenario,CO2 emissions from the world’s energy infrastructure peak at 30.8 GtCO2-e in 2019. In order to achieve this target, annual investments need to rise from $55 billion today to $500 billion by 2020.”

UNEP / New Energy Finance, June 2009

“This adds up to a total of at least €65–100 billion per year on average from 2010-2020, ramping up over that time.”

Climate Works Foundation, June 2009

•UNFFCC: up to 86 per cent of the global finance needed to respond to climate change will come from private investment sources•World Bank: the private sector will have to bankroll close to 85 per cent of all clean energy and climate projects in the future

The global carbon market grew by 100 per cent between 2007-20081

It is projected to grow to a value of $550 billion by 20122

Sources: (1) World Bank, (2) New Carbon Finance

4Sources: (1) World Bank, (2) New Carbon Finance

New South Wales Greenhouse Gas

Abatement Scheme

$183 million

* Africa 2%

* Asia 88%

* Latin America

5 %

EU ETS

$93 billion

Chicago Climate Exchange

$307 million

Regional Greenhouse Gas Initiative (RGGI)

$246 million

• Current policy framework has two pillars : the Kyoto Protocol government-level compliance obligations and the EU ETS

• The global carbon market was valued at $126 billion in 2008• EU ETS accounted for $93 billion, and Kyoto mechanisms for $33 billion

* Regional share of Kyoto project-based credits suppplied

The Global Carbon Market

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CDM Project Cycle

Verification by DOE of the GHG emission reductions and

Certification by the DOE of the emission reductions achieved

CDM project identified

Validation of the project by an independent designated operational

entity (DOE)

Project Design Document (PDD) completed

Project meets CDM participation and eligibility criteria

Registration of the Project (i.e. the project is formally

accepted by the CDM Executive Board as a CDM

project)

Monitoring of the Project and provision of a monitoring report to

the DOE

Designated National Authority of the Host Country issues a letter of approval

DOE delivers Certification Report to the CDM Executive Board which constitutes a request for issuance of CERs equal to the

emission reductions achieved by the CDM project achieved.

Issuance of CERs

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Traditional CDM Project StructurePossible Issues• No (or delayed) registration• Late commissioning• Under-performance• Poor monitoring leading to

delayed issuance of CERs

PROJECTSELLER

PROJECTBUYER

ERPA

Assumptions• Seller responsible for managing successful development of Project• Buyer pays for CERs if they are delivered

... Some Risks• Licensing / Regulatory: registration, appraisal (PDD), certification, verification, monitoring, crediting• Political: host country approval, regulatory change, tax change, etc.• Financial: currency, price, etc.• Technology: performance, etc.• Cost / Delay: compliance, completion, etc.• ERPA Counterparty: credit etc.

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Bali Action Plan• “Shared vision” to be developed by all Parties on

tackling climate change going forward• Four building blocks

― Mitigation― Adaptation― Technology transfer― Financing

• Negotiations amongst developed and developing states for a new climate deal

• AWG-KP: Ad-hoc Working Group tasked with detailing the second commitment period of the Kyoto Protocol

• AWG-LCA: Ad-hoc Working Group tasked with detailing the details of the Long-Term Cooperative Action, as mandated by the Bali Action Plan

• Two-track negotiations: discrete, but intrinsically linked

TECHNOLOGY TRANSFER

FINANCING

MITIGATION

ADAPTATION

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Copenhagen AccordModerate success?• Resort to “bottom-up” approach (versus European “top-down”) championed by the US• First truly global declaration on climate change

Abysmal failure?― Only politically binding― No timeline for global legally-binding agreement― No commitments to specific aggregate mid-term targets― No agreement on tenets of Bali Action Plan via the AWG-LCA

Next steps• COP16, Mexico City, December 2010 aim for legally binding framework• Until then regional developments key

FINANCINGUSD 30bn by 2012USD 100bn by 2020

MRVDeveloping country supported NAMAs

TARGETSDue by January 31(deadline flexible)

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“Too much conversation, a little more action please ....”

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European Union – Under Pressure• World leader in carbon markets and legislative action to reform economy• Backseat in Copenhagen process• A War Lost leadership backfires at COP15 accusation: unrealistic expectations?• Scrambling to regroup post-COP15

Recent developments• Copenhagen Accord: maintains 20 per cent reduction by 2020 pledge; 30 per cent conditional• Markets already suffering: analyst expectations low, investors withdrawing

Next steps• New mechanisms plans severely compromised, but EU still

carries “demand stick”• Possibility of tariffs for imports: 9 per cent

(in line with WTO regulations, IEA)• Inter-EU Member dissent: who cuts most?• Worries in Brussels: Transatlantic carbon market

compromised – all eyes on Washington

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United States – Recent Legislative ProgressJune 26, 2009

House of Representatives passes American Clean Energy and Security Act (ACES) – the Waxman-Markey

BillSTATUS: PASSED

September 30, 2009Clean Energy Jobs and

American Power Act (CEJAPA) –the Kerry-Boxer Bill

STATUS: BEING DEBATED ON SENATE COMMITTEE LEVEL

September 22, 2009EPA issues mandatory monitoring rule

under the authority of the Clean Air Act. Entities emitting 25Mt+ CO2-e per year, required to report GHG emissions

data annually starting January 2010. First annual reports due to EPA in

2011.

IN PROGRESS: Bipartisan comprehensive energy bill,

being drafted by Senators John Kerry, (D) Joe Lieberman, (I)

and Lindsey Graham (R)

December 14, 2009EPA adopts

Endangerment and Cause and Contribute

Findings (GHGs “threaten public health”so under CAA EPA will

regulate)

September 15, 2009EPA and National

Highway Traffic and Safety Administration propose standards for light-duty vehicles (for adoption March 2010)

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United States – Piecemeal MarketsWestern Climate Initiative (WCI) Regional GHG Initiative (RGGI)

• 7 US States, 4 Canadian provinces (3 provinces, 6 Mexican states observers)

• Regional goal of 15 per cent below 2015 by 2020• To begin on January 1, 2012• Two phases: Phase I implicates emissions from

electricity, industrial combustion and processes• Phase II (2015) includes transportation fuels etc.

California Cap-and-Trade Chicago Climate Exchange (CCX)

• Established December 2005 by Governors of North-eastern and Mid-Atlantic States

• Sets a cap on fossil-fuel fired electricity generators greater than 25 MW in size

• First cap emissions at current levels in 2009, then reduce by 10 per cent by 2018

• Auctions quarterly, use of offsets from other sectors

• AB32: product of the Californian Global Warming Solutions Act of 2006

• STATUS: California Air Resources Board will issue regulations by January 1, 2011.

• Effective 2012• Subject to a consultative process• International offsets eligible (CERs, REDD?)• Emissions reductions 27.3Mt by 2020

• Launched in 2003, now more than 450 members• Voluntary listing, mandatory reporting of emissions• World’s first and US’s only cap-and-trade system

for all 6 GHGs• Members make voluntary, legally-binding

commitment to reduce emissions by 6 per cent from 2000 levels by 2010

• Cumulative cuts of more than 400Mt achieved

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United States – Prospects• Obama’s State of the Union address January, 2010:

― Called for comprehensive energy and climate bill to “make― clean energy the profitable kind of energy in America”― No reference to ETS, but not excluded: hybrid approach?

• Legislative priorities 2010: ― Economy – jobs, jobs, jobs― Healthcare― Financial sector reform

• Senator Scott Brown’s (MA) victory (January 19, 2009) = no more Democrat Senate majority• If no legislation Q1/Q2 unlikely until 2011 mid-term elections November 2010• Hurdles: Congressional partisanship, economic concerns, busy legislative agenda, timing:

legislative structure: post-Senate new Bill in joint sitting, then President signs into law• Copenhagen Accord: 17 per cent by 2020; difficult , not impossible without cap-and-trade• Cap-and-trade not good for jobs creation message – good for cutting compliance costs

More likely: Energy and jobs Bill, renewable energy target, GHG regulation inthe short-term, instead of cap-and-trade: business has not been vocal

Nuclear, off-shore drilling: hooks for Republicans?

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China – Ahead of the Game• Copenhagen Accord: reduce "carbon intensity" by 40-45 per cent on 2005 levels by 2020• WRI: “comparable to US targets” but will do no more – worries about economic growth. • Will measure only energy consumption and industrial activity emissions• Will likely significantly exceed targets = bargaining chip in future negotiations

Prospects for a carbon market?• Have relied more on administrative measures vs markets – bottom-up approach• But government encouraging domestic carbon market creates incentives for emissions reductions• Plans to include pilot emissions trading system in Five Year Plan 2010-15• Already operating, largely in VERs and with small volumes: Beijing Climate Exchange, Shanghai

Climate Exchange, Tianjin Climate Exchange

Next steps• Will bank on technology transfer • Already majority market share of renewable energy generation parts• Government committed to capitalizing on global shift in priorities• Also – energy security big issue. China needs to cut own

dependence on fossil fuels.

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Japan – Temperature Rising• Copenhagen Accord: 25 per cent from 1990 levels by 2020 conditional upon global agreement• New climate bill due March 2010: likely to include cap-and-trade, some form of tax, no start dates• Renewable energy target: 10 per cent of primary energy by 2020 (currently 1.3 per cent)

Obstacles?• Already energy efficient: what percentage to come from domestic action?• Strong opposition from business and industry: compliance costs likely to be very high

Purchased To Purchase

Prospects for carbon market• Voluntary ETS since October 2008: created demand for CERs and AAUs by business• April 2010: mandatory ETS for businesses in Tokyo to begin• March 2010 bill to include mandatory national ETS

$2.15bn on carbon credits by end of 2012

25 million CERs+

71.6 million AAUs

Energy efficiency decrease of 1.6 per cent by 2013 + target

through of carbon credits

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Australia – Leading from Behind• Rudd Government severely burned by Senate failure and Copenhagen outcome• Worst-case scenario: no measures – double dissolution unlikely considering election timeline• Opposition leader Tony Abbott – climate sceptic, appealing to Conservative minority• Carbon Pollution Reduction Scheme (CPRS) due for Senate reintroduction February 2, 2010

― Need 7 non-Party votes to pass – last attempt failed by 5 votes― 2 Coalition Senators crossed the floor in last vote (have stated that reserve right to repeat)― 5 Greens Senators – all opposed (looking for no less than 25 per cent reduction)

Recent developments• Copenhagen Accord: Australia first to associate. 5 per cent on 2005 level “unconditional offer”;

15 and 25 per cent reduction trajectories dependent on global agreement• Government ex-climate change advisor Ross Garnaut calls for tax of AUD20 as interim measure• Coalition looks to soil carbon and no-cost alternatives to reaching 5 per cent target• Australia may be short on Kyoto compliance (new LULUCF data released) compliance will

come from public chequebook without CPRS• Federal election end of 2010: legislation late 2010 / early 2011?• Mandatory Renewable Energy Target (MRET) 20 per cent by 2020 – scheme under review

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Canada – The Rogue Nation• By 2007, 34 per cent above Kyoto target – Government: compliance = economic ruin• Criticized by developing countries, now calls for Commonwealth suspension• Copenhagen Accord: 17 per cent on 2005 levels or 3 per cent on 1990 levels by 2020• What Canada wants: no limits on mining tar sands in Alberta for oil• Conservative Government at 30 per cent approval in polls

Recent developments• December 30, 2009: PM Harper announces “period of prorogation”

– 36 bills failing to receive Royal Assent prior to recess, cease to exist; all legislative committee activity stops

• PM likely to appoint handful of Conservative nominees to Senate (Liberals lose control of upper house)

• March 3, 2010: PM to deliver new Throne Speech to launch 40th Parliament; federal budget released, new committees formed, bills reinstated or reintroduced

Next steps• Focus on provinces, members of WCI: Ontario, Quebec, Manitoba and British Columbia• Continuing dialogue with the US: we move when (and if) you move

Tar sands: significantly more carbon intensive than regular extraction

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South Africa – BASIC Concerns• Acute shortage of electricity generation capacity and supply: threatens economic progress• Continues energy rationing amongst industrial users (implemented after blackouts in 2008)• Copenhagen Accord: 34 per cent below projected BAU by 2020 (conditional on international deal

and financial support) after meeting with other BASIC leaders in Delhi• Renewable energy target: 4 per cent of all energy by 2013

Existing policies and measures• 2009: instituted Africa’s first wind feed-in tariff of ZAR1.25

($0.16) per kilowatt hour – more than EU member states• Currently: less than 10 megawatts (MW) of operational wind capacity• Early 2008: Eskom solar water heating rebate program• Mid-2007: Eskom Energy Efficient Motors Programme promotes

replacing old, inefficient motors by subsidizing purchase cost

Next steps• Development of NAMA• Continuation of project finance via CDM (E+/E- issues)

Natural resources and mining: Africa’s biggest export industry

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Russia – Hot Air and Indifference• Historically poor engagement with international

climate change process / discussions • No significant domestic policy to speak of • Some measures involving fines for high-polluting

vehicles – status undetermined• Less JI projects than Eastern bloc neighbours • Resource companies nationalised • No energy security issue energy dependence

of others critical for international status• No sale of AAUs 1997-2009• Sberbank authorized to sell 300 million AAUs• EC concerned about market flooding, but no

significant buyers for the amount (Canada?)• Substantial project finance and REDD potential, but no government moves to develop• Copenhagen Accord: December 2009 increase reduction pledge from 10-15 per cent to 25 per

cent on 1990 levels but still significant surplus, not yet affiliated with Accord• AAU banking issue to remain contentious in any post-2012 policy framework• Engagement unlikely

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South Korea – On the Move• Copenhagen Accord: 30 per cent reduction on BAU by 2020 (4 per cent on 2005 levels)• December 31, 2009: Low Carbon Green Growth Act passes Korean National Assembly • January 13, 2010: President signs LCGGA into law• Effective from April 13, 2010, will provide comprehensive legal ground to all subsequent

regulations, policies and measures to “transform South Korea into low-carbon society”• Enforcement ordinances, regulations to be created by government ministries in next few months

Singapore – Ambition Decreases• Post-Copenhagen: emissions cut by 7-11 per cent on BAU levels by 2020 (pre-COP, 16 per cent)• Ambitions of being Asian carbon trading hub

New Zealand – A Soft Start• Conditional targets 10 to 20 per cent on 1990 levels• Emissions trading scheme enacted late 2009• July 1, 2010 – January 1, 2013 transition period. Emitters pay fixed price of NZ$25 ($18.25) per

tCO2-e (1 unit for every 2 emissions units). Assistance phased out 1.3 per cent / year from 2013. • NZUs not for export, but forestry NZUs can be converted to AAUs and sold abroad

Others

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A Truly Global Market?

CDM Hosting Countries /

SectoralMechanism

Potential future linking opportunity

Linking via Kyoto project mechanisms

CDM Host Countries /

Sectoral Mechanisms

CDM Host Countries

CDM Host Countries /

Sectoral Mechanisms

EU ETSUS Federal Scheme

CPRS & NZ ETS

Regional Schemes

Potential total size of the global carbon market by 2020 is estimated at €2,000 billion

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Where do the Opportunities Lie?

• Clear long term signals for long term investments – confidence in policy makers• Certainty of change – e.g. to carbon constrained economy• Nuances and differences in implementation which create arbitrages• Broad spectrum of asset classes• New products required e.g.

― Financial products to manage risks

― Activities in renewable energy― Activities in nuclear ― Avoided deforestation

Opportunities or Risks?

McKinsey Low-Cost Abatement Curve

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• Two steps backwards, one step forward for global action: high-level engagement positive, UN process in question, speed of action may not meet scientific imperative

• Currently, “policies and measures” – not markets – politically palatable• Short-term outlook very bearish: EU is ahead of the game, global market some years away• Activities in renewable energy / nuclear / avoided deforestation more likely

Harbinger of success: How will Copenhagen affect the development of regional markets and schemes?

• Developments occur very quickly e.g. House of Representatives in US• Tariff threats may provide impetus• Cost-efficiency of market mechanisms will come to the fore – industry must advocate

Global action is inevitableHow coordinated the action will be remains in question

SHORT-TERMDiscrete regional schemes, first number of

years linked only by offset mechanisms

MEDIUM-TERMLinking of regional schemes,

pairing

LONG-TERMGlobal carbon market / economies

of scale

Gazing Into the Crystal Ball ...

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Global Practice: Deal Map

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Presentation

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