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STATE AND TRENDS OF THE EUROPEAN CARBON
MARKET APEX CONFERENCE Powernext SA Paris -
October 15 16th
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AGENDA

• State of the EU Carbon market
• Global policy framework
• Key dates in the establishment of the EU ETS
• Price dynamics
• CO2 and energy prices
• The pass trough issue
• Lessons learnt
• Outlooks for phase II
• Main changes in phase II
• Functioning of a CDM project
• CER estimated market size
• Legal technical issues on the CER underlying
• Powernext results and perspectives
• Market Model for EUAs and CERs
• Powernext Carbon EUA market
• Post 2012 issues

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• STATE OF THE EU ETS

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Global policy framework

• In order to help achieve its Kyoto targets, the
  EU a established an Emission Trading Scheme (ETS)
  for its large industrials emitters
• Participants
• All EU 27 countries
• All electricity, ferrous metals, pulp paper,
  cement and all facilities with installed capacity
  gt 20MW
• Member states develop National Allocation Plans
  (NAPs) by sector and installation
• Installations receive allocations of EUAs below
  their business as usual requirement (2094 Mt
  each year) and can either
• Reduce their emissions to equal their EUA
  allocation or
• Purchase additional EUAs in the market, or
• Purchase emissions-reductions certificates (CERs)
  to cover surplus emissions

Breakdown of CO2 emissions in the EU-15 in 2005,
and estimated of emissions covered by ETS
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Key dates in the establishment of the EU ETS
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Price dynamics

• Price on the market is mainly driven by
• Weather conditions
• Economic activity
• Energy prices
• Institutions decisions
• Price collapse in April 2006
• 1st publication of emissions data
• Surplus of allowances (4 in 2005 and 1 in 2006)
  due to
• Over allocation
• Abatements to what extent? (fuel switch/
  investments in low emitting technologies)
• No banking allowed between phase I and II

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CO2 and energy prices

• With the system of CO2 allowances, electric power
  generators must now integrate the price of the
  allowance into the management of their existing
  power generation stations.
• In the short term, their operating costs mainly
  consist of fuel prices. That is why power
  generation plants are managed on the basis of
  spreads, which constitute their operating cash
  flow.
• If a power plant burns natural gas, the spread is
  called the spark spread
• If it burns coal, the spread is called the dark
  spread.
• The higher the spread, the more profitable the
  use of the power plant.

• From now on, these spreads are to be corrected by
  the carbon value.
• Its the clean spread, which have now become
  the signals that guide the management of the
  fleet of existing power generation plants.
• All other things being equal, the higher the
  price of carbon dioxide, the more the operators
  have an incentive to switch from the power plants
  with the highest emissions to those that produce
  fewer emissions.

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The pass trough issue
Carbon contribution to electricity prices in
several EU countries (/MWh)

• Lack of competition in the electricity sector
  allows utilities to pass the CO2 price in their
  prices (between 3 and 14 /MWh)
• Impacts mostly energy intensive industries who
  saw their energy bill increase by about 15,
  paying not only for their own emissions (if
  caped) but also for utilities emissions

Source London Economics (2007)

• The Commission should answer this issue in the
  Guidelines for phase III
• Full auction for the electricity sector
  allowances ?
• Auctioning allowances to power producers may not
  alter all electricity prices effects (and might
  even increase them again)
• However, it would avoid the need for governmental
  allocation, its associated political issues and
  generate revenues for the governments

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Lessons learnt

• Timeframe is too short
• 3 and 5 years for phase I and II
• Lack of visibility for new investments
• It should be possible to bank allowances between
  2 phases
• Allocation issues
• Harmonization of allocation methodologies to
  avoid distortion amongst EU member states,
  especially for new entrants allocation and
  closure rules
• The stringent monitoring and verification
  requirements
• have proved effective and valuable
• but raise questions about whether the threshold
  of 20MW thermal is too low, increasing
  transaction costs for small environmental gain
• Information disclosure needs to be more frequent
  the market had no idea there was an over supply
  until April 2006

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• OUTLOOKS FOR PHASE II

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Main changes in phase II

• EUAs are linked to European Member States
  allocation (Assigned Amount Units)
• Stricter Commission decisions on NAPs
• 1st period total cap 2 142,5 Mt/y
• Proposed cap 2 126,14 Mt/y
• EU Decision 1 927 Mt/y ? -10 vs. proposed cap
• Possibility to auction up to 10 of the total
  allocation (vs. 5 in phase I)
• Safety valve use of Kyoto credits for compliance
  (CERs from Clean Development Mechanism ERUs
  from Joint Implementation) but limited to about
  300 Mt/y (15 of total annual allocation)
• CERs already represent a huge market

French AAUs 550 Mt/y
EUA II 132 Mt/y
Part of the AAUs are converted in EUA II
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Functioning of a CDM project

• Kyoto  flexibility mechanism  to facilitate
  the achievement of emissions reductions
• The project developer must prove the projects
  additionality

Host party (non annex 1) No emission reduction
commitment
Investor party (annex 1) With a AAU stock
AAU stock (CERs are additional)
CER
CER
Planned Emissions
Emissions
BAU scenario
Project scenario
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CER estimated market size
Breakdown of registered projects (number)
Breakdown of registered projects (volume of CER)

• There are few HFC projects (fluoride gases) but
  they generate a large amount of credits (more
  than 40) amongst registered projects. Indeed,
  HFCs global warming potential (GWP) is 12 000
  times higher than CO2.
• As of today, more than 2 000 projects are being
  validated or already registered by the CDM
  Executive Board.
• The flow of delivered credits should be about 175
  M for 2007 and 250-300 Mt over the 2nd period.
• At the end of August 2007
• 763 projects were registered ( 160 Mt/an)
• 230 projects had issued credits 70Mt
• But these data only concern the primary market, a
  pre paid market where the buyers use CER for
  their own compliance.

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Legal and technical issues on the CER underlying

• Legal issues CERs are not fully fungible

• Technical issues the project type is not
  available in the Serial Number of the CER in CDM
  registry (only project identifier number) is only
  available on UNFCCCs website (thanks to the
  project identifier number).
• Market players cant visualize the project type
  automatically such as big hydro dam
• Back offices will have to reconcile each CER
  types for every transaction (serial number versus
  project identifier UNFCCC list to find project
  type)

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• POWERNEXT RESULTS AND PERSPECTIVES

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Market Model for EUAs and CERs

• Powernext Carbon is
• EUA spot market launched in June 2005
• CER spot market (launch planned for the end of
  2007)
• Same market model for both instruments
• Trading on Global Vision from 9 to 5 pm
• Real time Payment versus Delivery

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Competitive environment

• Share between Exchanges and OTC market 60/40
• Share between Futures and. Spot Markets 80/20
• Share of Powernext 60 among European spot CO2
  Exchanges
• Record volume in February 2007 (around 6Mt on
  Powernext Carbon)

EUA Spot market
EUA Futures market
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Powernext Carbon EUA market

• Variety within the members worldwide banks,
  utilities, industrials, retailer,
• Thanks to a flexible and simple market model
  continuous implementations

74 European members
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Post 2012 issues

• Review of the EU Directive expected for December
  2007
• Directive may need adjustment for Phase III to
  address issues around
• perverse incentives (new entrants, closures)
• allow for much greater auctioning for the longer
  term, continuing free allocation will require
  greater institutional independence of allocation
  authorities. The logical solution to most
  problems with the EU ETS would be to work towards
  greater auctioning over time
• potentially address competitiveness issues
• Integration of the aviation sector from 2011
• Linkage with other cap and trade systems ?

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Contacts
www.powernext.fr 33 1 73 03 96
00 information_at_powernext.fr