Understanding Financial Instruments and Carbon Price

Presented by: Steven Messner - SAIC

Carbon Counting 2008Chicago, ILJuly 15, 2008

Energy | Environment | National Security | Health | Critical Infrastructure22

IntroductionSAIC’s Consulting Work in Climate Change Policy

• Public Sector Clients• DOE 1605(b) Program• EPA Climate Leaders• California Energy Commission• California Climate Action Registry• The Climate Registry• NASA• State of Maryland• National Intelligence Council

• Commercial Clients• Sacramento Municipal Utility District• Nebraska Public Power District• ConocoPhillips• Siemens AG• Bank of America• Chevron Texaco• Natural gas associations (INGA, AGA) • American Council for Capital Formation

Energy Modeling and Analysis

Emissions Accounting

and Forecasting

Emission Abatement Cost Curves and Plans

Energy Efficiency and Engineering

Projects

Emission Offset Procurement and Auctions

• Forecast energy and allowance prices

• Understand local market conditions

• Inventory corporate emissions

• Forecast emissions• Seek offset project

opportunities

• Seek short-term project opportunities

• Seek capital opportunities

• Integrate allowance prices into curve

• Serve both large scale buyers and sellers

• Position for multibillion dollar federal auction

Vision: Policy consulting supports efficiency and engineering projects for large commercial, industrial, and government clients

Energy | Environment | National Security | Health | Critical Infrastructure

Overview

1.Understanding price fundamentals as the key to carbon finance

2.Recent US Developments3.Key Elements of Proposed Federal Legislation4.Forecasted Impacts of Proposed Legislation on

Energy Marketsa) Analytic Approachb) Resultsc) Cost Drivers & Conclusions

5. Incorporating price into financial decisions

Energy | Environment | National Security | Health | Critical Infrastructure4

CO2 price

• Understanding CO2 price fundamentals allows use of any and all financial instrument approaches• Futures• Derivatives• Indexed approaches

• Also becoming a key factor in future investment analysis

Energy | Environment | National Security | Health | Critical Infrastructure5

Recent U.S. Federal Policy Developments

• Push for climate change legislation in Congress• 8 proposed emissions trading bills

• Lieberman-Warner bill debated on Senate floor – 1st week of June

• 2 proposals for carbon tax

• 1 bill proposes inventory of CO2 storage sites

• Creation of House Select Committee on Energy Independence and Global Warming

• Weekly hearings on climate change• House Energy and Commerce Committee and Senate Committee on

Environment and Public Works soliciting comments from public

• Private sector pushing for federal legislation to avoid patchwork of state laws

– Others, including proactive states, oppose Federal preemption

Energy | Environment | National Security | Health | Critical Infrastructure66

Proposed Federal GHG Legislation

Energy | Environment | National Security | Health | Critical Infrastructure77

Proposed Federal GHG Legislation

Energy | Environment | National Security | Health | Critical Infrastructure

Modeling Approach

SAIC uses National Energy Modeling System (NEMS)

We help clients to:

1. Understand the potential impacts of GHG legislation on their business. • SAIC runs NEMS in conjunction with commercial models to provide more specific

analysis by state or facility• SAIC alters assumptions to reflect those of the client on specific components (e.g.

offset availability, energy efficiency, natural gas supply)

2. Provide an analytical basis to enhance their discussions with Congress on pending and alternative policies in legislation

NEMS has been used by SAIC clients to analyze the McCain-Lieberman, Warner-Lieberman, and Bingaman bills.

Energy | Environment | National Security | Health | Critical Infrastructure

NEMS Overview NEMS: A Truly Integrated Energy Modeling Tool

NEMS integrates the North American energy market across industry segments as well as the economy

Energy | Environment | National Security | Health | Critical Infrastructure

Modeling Approach – Benefits of NEMS

Benefits in using NEMS for analysis of GHG legislation • NEMS was designed to address energy and emissions issues• Same analytical tool used by Congress and others in government • Provides insights into the analysis provided by EIA to Congress• Allows analysis under alternative assumptions • Narrows the debate to merits of different policy choices and

assumptions– Rather than models deployed or methodologies used

• Provides an “apples to apples” comparison of GHG initiatives• Identifies potential solution paths

Energy | Environment | National Security | Health | Critical Infrastructure

Overview of CO2 price fundamentals

No. Factor Increase Variability CO2 Price Impact

1 CO2 Emission Cap Low -

2 Fuel Prices - Gas to Coal Spread Large +

3 Offset/Banking/Borrowing Provisions Large +, -

4 Technology Upgrading Cost Large +

6 Weather - Winter Temperature Large (In Northern States) -

7 Weather - RainfallLarge (In certain hydro

power regions)-

8 Economic Growth Medium +

9 Energy Demand Growth Medium +

Energy | Environment | National Security | Health | Critical Infrastructure

Major Results of Analyses

• Results of analyses of Lieberman-Warner and other bills are driven by assumptions

• Major cost drivers • New nuclear • CO2 capture & storage• Renewables• Offsets

Energy | Environment | National Security | Health | Critical Infrastructure

SAIC-NEMS Conclusions

• Legislation would severely limit use of fossil fuels in power generation, unless:

– Carbon offsets,– Carbon allowances, and – Technologies such as CCS are employed

• Particularly sensitive to assumptions about available offsets, choice of technologies, and the use of carbon allowances

• Under the Natural Gas Council assumptions, natural gas will play a more prominent role in GHG emission reduction than projected in the EIA “Core Case” analysis.

Energy | Environment | National Security | Health | Critical Infrastructure1414

Lieberman-Warner Bill Impacts — Potential Allowance Prices

Source: National Energy Modeling System runs S2191.D031708A, S2191HC.D031708A, S219BIV.D031608A, S2191NOINT, D032508A, S2191BIVNOI.D033108A, and S1766_08.D031508A.

Energy | Environment | National Security | Health | Critical Infrastructure1515

Lieberman-Warner Bill Impacts – Changes in Electric Power Sector

Source: EPA Analysis of S. 2191 Scenario 2 (ADAGE)http://www.epa.gov/climatechange/downloads/s2191_EPA_Analysis.pdf

Energy | Environment | National Security | Health | Critical Infrastructure1616

Integrating CO2 price forecast with CO2 allowance finance

Source: EPA Analysis of S. 2191 Scenario 2 (ADAGE)http://www.epa.gov/climatechange/downloads/s2191_EPA_Analysis.pdf

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Reference Price Case Low Price Case High Price Case

Hedging Boundary

Opportunity to Sell

Opportunity to Buy

History Forecast

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History Forecast

Energy | Environment | National Security | Health | Critical Infrastructure1717

SAIC’s Comprehensive Suite of Energy Management Services

Efficient Operations

Clean Technologies

Sustainability

Climate Change

Green IT

Risk Management

Energy Procurement

Education and Training

Facility Assessments

Facility Modeling

LEED® Certification

DesignBuildsm

Performance Contracting

Systems Integration

AMI and Smart Grid

Demand Response

Project Management

Quality Assurance

Metering and Verification

Modeling and Forecasting

Energy | Environment | National Security | Health | Critical Infrastructure

Characterize Energy Price Risk

Measure Risk• VaR

– Delta (Variance Covariance)– Monte Carlo– Econometric (historical)

• Expected Shortfall• Time Evolution of Risk• For new parameter (CO2), Monte

Carlo approach often used

Characterize the statistical properties of risks, their inter-relationships and the way they impact the Investment Metrics.

InvestmentStrategy

EnergyPrices

Credit

Regulation CO2 costs

Energy | Environment | National Security | Health | Critical Infrastructure

Simulate and Stress Test

Simulate and stress-test entire distribution of inputs, correlations to yield entire distributions of potential outcomes

Distribution of

Outcomes

Distribution of

OutcomesCasesCases

Traditional

SAIC

Target Forecast: NPV

Long Term Natural Gas Average ($/MMBtu)91.6%*

Long Term Natural Gas Prices ($/MWh) 7.9%*

Jan On-Peak Demand (KW) 0.2%*

Jan Off-Peak Energy (KWh) 0.1%*

Jan On-Peak Energy (KWh) 0.1%*

100% 50% 0% 50% 100%

Measured by Contribution to Variance

* - Correlated assumption

Sensitivity Chart

Frequency Chart

$/MMBtu

.000

.007

.015

.022

.029

0

7.25

14.5

21.75

29

$4.9725 $6.7175 $8.4625 $10.2075 $11.9525

1,000 Trials 985 Displayed

Forecast: Natural Gas

Energy | Environment | National Security | Health | Critical Infrastructure

Measure and Report

Strategy• Monitor exposure of investment or

procurement metrics• Identify the breaking points

affected by assumptions• Identify market/contractual

mechanisms to protect investment metrics and assumptions

Result• Assure performance of investment

Results are executive-level summary of measurements, assumptions and distribution of outcomes.

$7.00

$8.00

$9.00

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0%-10%

OptimumHedge

Energy | Environment | National Security | Health | Critical Infrastructure

Investment at Risk (“IaR”) - IllustrativeStrategy and Protocols to Protect NPV of Approved Investment

• Evaluated NPV of 100MW generator in the Northeast and identified critical assumptions affecting the Net Present Value used to approve the investment.

• Established strategy and protocols around Natural Gas Prices and Power Prices to protect against undesirable levels of NPV. Now updated to factor CO2 pricing.

• Investor is able to analyze robustness of NPV and guarantee that it will materialize.

Distribution for TZ6NY ($/MMBtu)

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$7.60 $7.90 $8.20 $8.50 $8.80

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Negative NPV

Above $8.50 MMBtu

Best NPV below $8.00 MMBtu

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$220 $226 $233 $239 $245

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NPV Associated with Approved

Investment

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Best Case

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Gas Prices

Net Present Value

Power Prices

Energy | Environment | National Security | Health | Critical Infrastructure22

Please contact

Steven MessnerWestern Region Manager – Climate Change ServicesPh: 858-220-6079E-mail: steven.d.messner@saic.com

Learn how SAIC’s energy and climate change teams can help you.

Thank you

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