Transcript State and Trends of the Carbon Market 2003

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Glenn S. Hodes
UNEP Risø Center
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Why a Carbon Market?
• Regulations, present or anticipated, create
constraints on greenhouse gas (GHG) emissions of
governments, firms (e.g. Kyoto Protocol obligates
industrial Parties to reduce emissions by avg 5 %
below their 1990 emissions over 2008-12.
• Since GHGs mix in the atmosphere, it does not
matter where emissions are reduced
• Compliance with regulation can be achieved
through in-house (“make”) or flexibly through
purchase (“buy”) “GHG commodities”. The market
has responded to the entry into force of Kyoto and
the EU ETS – and is now a real compliance
market.
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Benefits of Carbon Finance
• As a new source of private investment for
development + public goods, carbon finance offers an
unique opportunity to increase private and public
investment in clean technologies in developing
countries.
• Between 10-50% of revenue for waste management +
renewable energy projects can come from CF.
• Powerful leverage effect on other FDI.
• Payment on regular schedule and in hard currency 
smoothes cash flow and can securitize critical up-front
capital for project construction (e.g. bridge loans).
• Help increase sustainability and extend the social and
community impacts/benefits of typical energy projects
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Structure of the Carbon Market
Project-Based
Transactions
JI and CDM
Allowance
Markets
EU Emission
Trading Scheme
UK ETS
Voluntary
Retail
Other
Compliance
New South Wales
Certificates
Chicago Climate
Exchange
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Annex B
Non-Annex B
The Kyoto Protocol• 3 Flexibility
• Assigns
GHG emission
targets to Annex B
countries between 2008
and 2012
Mechanisms
- Emissions
Allowance
Market
- Joint
Implementation
- Clean Development
Mechanism
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EU Emissions Trading Scheme
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• Caps over 40% of EU CO2
emissions
• 2 phases : 05-07 and 08-12
• JI and CDM authorized…
• But NOT LULUCF
(review in 2006)
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Canada
• Sectoral covenants under
negotiation
• Domestic carbon market
• Strategy calls for some use
of CDM; could be largest
bilateral buyer program
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Japan
• National Policies still in
the making
• Firms and government
active on CDM market
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USA
• Policies constraining GHG • Chicago Climate
emissions in various States
Exchange (CCX), private
(e.g., Oregon, Mass., etc.)
allowance market
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Kyoto Compliance Gap
• CERs from CDM projects are in high demand
– OECD almost 6.0 Billion tCO2 below KP target.
– Assuming 50% met from domestic measures,
projected gap of 3 Billion tons. Less than 20%
booked for delivery by 2012.
• But supply market is highly competitive
• And CDM competes with domestic/internal
measures!!
– Gains from trade fundamental to carbon market:
country mitigation cost curves matter.
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Growing Voluntary Market
• A large and growing number of companies have
engaged in programs to reduce their GHG
‘footprint’ absent regulations
– Various motivations: corporate responsibility,
public relations, strategic positioning,
competitive advantage, learning-by-doing, etc.
– These firms have large-scale emissions (2002
survey: 18 firms with more CO2 emissions than
France had voluntary targets for 2010)
• Individuals and Firms have engaged in purchases
of carbon credits to be “carbon neutral” (event,
corporation, or product)
– Example: World Cup, G8 Summit, BA travel
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2005 State and Trends of the Carbon Market Report
• Funded by World Bank CF-Assist Program.
• Based on material provided by
Evolution Markets LLC, Natsource LLC, and on
interviews with many market players. Limited public
information on transactions.
• Database of 487 project-based transactions
(signed or advanced stage of negotiation) +
aggregated data on allowance markets
Report downloadable from: www.carbonfinance.org
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600
Total Value of Contracts over 1 b$ (data
in million U.S.$, nominal)
500
Known
Estimated
400
300
200
100
0
1998
1999
2000
2001
2002
2003
2004
2005
(Jan-Apr)
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Buyers: European Governments and Firms
In percent of volume purchased From Jan.04 to Apr.05
USA
Australia
4%
3%
Canada
Japan
5%
21%
New Zealand
7%
Gov. Netherlands
16%
Other EU
32%
UK
12%
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Supply Concentrated
In percent of volume sold from January 2004 to April 2005
Rest of Latin America
22%
OECD
14%
Transition
Economies
6%
Africa
0%
Brazil
13%
India
31%
Rest of Asia
14%
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Biomass energy
Number (%) of CDM projects in each sector
Hydro
EE Industry
Wind
Agriculture
Landfill gas
Fossil fuel sw itch
Biogas
Cement
HFCs
Fugitive
Solar
Geothermal
EE Households
N2O
EE Service
Tidal
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Prices Depend on Risks
$8.00
(weighted average prices from Jan. 2004 to April 2005 in U.S.$ per metric tonne of
CO2e)
$6.00
$4.00
$2.00
$0.00
ER
VER
CER
ERU
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Key Price Determinants
• Guarantee of delivery of registered ERs
• Creditworthiness of project sponsor
• Viability of underlying project, and liabilities of
seller in case it under-performs
• ER vintage: pre- or post-2012
• Cost of validation and potential certification
• Host country support or barriers
• Additional environment and social benefits
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Allowance Markets Exploding (in million tCO e)
2
40
35
30
25
20
15
10
5
0
2002
2003
2004
2005
(Jan.-March)
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Insights on Price Differential
• Large price differential:
– EU Allowances: 7 up to 25 euros / tCO2e (spot
and forward contracts)
– Project-based: 3 to 7+ dollars / tCO2e (forward
contracts on expected CERs)
• Allowances and project-based contracts have very
different risk profiles:
– Project and country risks: high in CDM, none in
allowances
– Compliance/regulatory risks: high in CDM, none
in allowance
– Delivery risks: higher in CDM
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Intermediation - a key to success
• Identify project opportunities at lower cost
• Get equity and debt financing when the
intermediary is a financial institution
• More effectively design and/or evaluate projects
• Reduce transaction costs
– Example of Infrastructure Development Finance
Corporation (IDFC), India, one of the most successful
intermediaries agreement with over a dozen opportunities
identified/ evaluated
– Development Bank of Southern Africa
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Conclusions and Caveats
• Volumes should increase rapidly for CERs …
• Almost 600 CDM projects already registered or in
process of validation.
• Uncertainties still need to be addressed.
– How many allowances will Russia and Ukraine
bring to market?
– How much volume will CDM deliver? Issue of
projects lead-time
– Will UN and EU emission registries be fully
operational and compatible by 2008 (i.e. extent of
arbitrage)?