Carbon 2007

Carbon 2007
A new climate for carbon trading

13 March 2007
TO THE POINT
Global carbon markets were worth €22.5 billion in 2006. The market saw transactions for 1.6 billion
tonnes of CO2e. The EU ETS accounted for 62 per cent of the volume and over 80 per cent of
the value.
EU ETS saw 1 billion tonnes of CO2 transacted, worth €18.1 bn. This was 2.5 times higher than in
2005. The OTC and exchanges dominated by 817 Mt and €14.6 billion.
Developing countries continue to deliver reductions. The CDM saw transactions for 523 Mt CO2e
in 2006, with a secondary market adding 40 Mt and a combined value of €3.9 billion.
Our reference scenario expects volumes in the carbon market to grow by 50% in 2007. We expect more
than 2.4 billion tonnes CO2e to transact over the year. Using current prices as a benchmark,
the extra volume marginally increases the total value to €23.6 billion.
65% of survey respondents say EU ETS have initiated internal abatement projects. This is a marked
change from last year’s survey, where only 15% said the introduction of carbon trading had
initiated abatement.
EU ETS is main compliance strategy for 37% of survey respondents. Internal abatement and
investment/trading of CDM/JI credits (both about 25%) are seen as the second most important
strategies. Relocation of production is only mentioned by a handful of respondents.
More confidence in CDM/JI than one year ago. The CDM/JI market is a success, at least compared
to the 2006 survey. The project market is seen as more mature (although not a mature market),
and is resulting in cost-effective emission reductions.
Close to complete pass-through of carbon into power prices. The impact of the CO2 price has been
one of almost complete pass-through in the UK and German power markets, despite a slow
response to the introduction to the scheme for continental power prices. The impact on the
Nordic power market is primarily through the interconnection with Germany.
Import of credits from CDM/JI will not be enough to meet shortfall in EU ETS. Survey respondents
expect levels of abatement in the EU ETS to higher in Phase II than in Phase I. Although the
system opens for substantial imports of credits from CDM/JI, 82% of respondents find that
this will not be enough to meet the shortfall in Europe.
Survey finds €17/t for EUA price in 2010, €23/t in 2020. Survey respondents do not expect import of
credits to be enough to avoid domestic reductions in the EU ETS. Thus, the price of carbon
should reflect fuel-switching prices rather than the price of CDM/JI credits.
71% of respondents expect a global climate agreement post-2012, with a 60% likelihood that USA and
Australia will join. Only 9% of respondents do not expect a global agreement. China (36%) is
seen as a more likely candidate than India (30%) in such an agreement.
This report was published at Point Carbon’s 4th annual conference, Carbon Market Insights 2007 in
Copenhagen 13 - 15 March 2007. For more information, see www.pointcarbon.com
All rights reserved © 2007 Point Carbon

Carbon 2007
About Point Carbon
Providing critical insights into energy and environmental markets

Point Carbon is a world-leading provider of independent news, analysis and consulting services for
European and global power, gas and carbon markets. Point Carbon’s comprehensive services provide
professionals with market-moving information through monitoring fundamental information, key
market players and business and policy developments.
Point Carbon’s in-depth knowledge of power, gas and CO2 emissions market dynamics positions us as
the number one supplier of unrivalled market intelligence of these markets. Our staff includes experts
in international and regional climate policy, mathematical and economic modelling, forecasting
methodologies, risk management and market reporting.
Point Carbon now has more that 15,000 clients, including the world’s major energy companies,
financial institutions, organisations and governments, in over 150 countries. Reports are translated
from English into Japanese, Mandarin, Portuguese, Polish, French, Spanish and Russian.
This year Point Carbon’s Carbon Market Insights (CMI07) will gather over 1,500 key players for the
carbon community’s most important annual conference. Point Carbon also runs a number of high-level
networking events, workshops and training courses.
Point Carbon has offices in Oslo (Head Office), Brussels, Kiev, London, Tokyo and Washington.
About the report:

This report was written and edited by Kjetil Røine and Henrik Hasselknippe.
For citations, please refer to: Point Carbon (2007): ”Carbon 2007 - A new climate for carbon trading”
Røine, K. and H. Hasselknippe (eds.) 62 pages.
ii All rights reserved © 2007 Point Carbon

13 March 2007
Executive Summary
This report presents an overview of the state of the carbon market in 2006, our outlook for 2007, and
expectations for the future. The study is based on the results from the largest ever survey on the carbon
market, with 2,250 respondents to our web-based questionnaire. The results are complemented by analysis
undertaken by Point Carbon.
Point Carbon finds that the international carbon market in 2006 saw a total of 1.6 billion tonnes of carbon
dioxide equivalent (CO2e), worth approximately €22.5 billion in transactions. In comparison, the market in
2005 saw an estimated 799 Mt CO2e, worth €9.4 billion.
Our forecast for 2007 suggests that volumes in the market could reach 2.4 billion tonnes CO2e, which, at
current prices in the various market segments, would be valued at €23.6 billion. This would mark a marked
increase in volume combined with marginal growth in value, based on today’s prices.
The EU Emissions Trading Scheme held the highest financial value in 2006. In total, the brokered and
exchanged market saw 817 Mt CO2 changing hands, corresponding to €14.6 billion. Brokers did 71per cent
of this volume, whereas the ECX took over 75 per cent of the volume carried on exchanges. Point Carbon
further estimates that the direct bilateral market (company-to-company, not through brokers or exchanges)
doubled in size from 100 Mt in 2005 to 200 Mt in 2006, with a value of €3.6 billion. The total volume in the
EU ETS in 2006 was just over one billion tonnes CO2, worth €18.1 billion.
We expect growth to continue in the EU ETS and forecast 1.5 billion tonnes CO2 in the OTC and exchange
segment alone in 2007, with another 200 Mt CO2 through bilateral deals. At current prices this would value
the EU ETS in 2007 at €18.5 billion. Last year showed clearly that prices could move up or down, and
liquidity could be impacted by a number of factors. Even so, the EU ETS has shown that it will remain a
multi-billion-euro market.
The Clean Development Mechanism (CDM) also grew in 2006, as well as the emergence of a secondary
market. Point Carbon finds that transactions in the primary market totalled 522 Mt CO2e in 2006, with the
secondary market adding 40 Mt. Assuming payment on delivery and a 7 per cent discount rate, together
they are valued at €3.9 billion. The other project based mechanism, Joint Implementation (JI) reached just
21 Mt, €95 million in 2006 – less than in 2005.
Our forecast for 2007 is for the primary CDM market to shrink for the first time to 456 Mt CO2e, while the
secondary market more than doubles to 96 Mt CO2e. The combined value would be €4.3 billion at prevailing
prices. The JI market is also forecast to more than double to 45 Mt CO2e, worth €277 million.
The publication of the verified emissions data for 2005 was a major blow for the EU ETS, as the market
turned out to have been long allowances in 2005, and not short as previously thought. The surplus is
probably due to a combination of two factors; i) generous allocation and ii) internal abatement and efficiency
improvements. The first is by far the most important. But have emission reductions taken place?
The results of our survey suggests that internal abatement projects are indeed taking place, with 65% of
respondents stating that the EU ETS has resulted in internal abatement in their company. This is a striking
change from last year’s survey, where 60% of respondents answered that the introduction of carbon trading
had not resulted in any internal abatement at all. Hence, if we take the survey results at face value, large
emissions reductions due to internal abatement could be expected for 2006 compared to 2005.
Trading within the EU ETS is seen as the main strategy for compliance in Europe, for 37 % of the respondents.
Internal abatement is considered the primary compliance strategy by 25 % of the respondents, with
utilisation of CDM/JI at around the same level. The CDM/JI market is a success, at least compared to the
2006 survey. The project market is seen as more mature (although not a mature market), and is resulting in
cost-effective emission reductions. In general, it seems that the respondents have more confidence in the
CDM market now than just one year ago.
iii All rights reserved © 2007 Point Carbon

Carbon 2007
What is the impact of carbon prices on the power market? We have looked at evidence of how the German,
UK and Nordic power markets have responded to date to the introduction of CO2 pricing. We find that, prior
to the start of EU ETS, the German spreads did not appear to factor in the market price for CO2 into the 2005
contract. The increase in spreads from the carbon pass-through occurred gradually, and it appeared that by the
end of 2005 the full opportunity costs of carbon were being factored into the year-ahead contract. From this,
we conclude that despite a slow start to recognising the likely impact of the EU ETS on the market, German
forward power prices now appear to be pricing carbon fully into the price of power for future delivery.
Throughout summer 2005 the carbon price was at a level sufficient to encourage gas-fired generation over coal-
fired generation in the UK. However, following the collapse in EUA prices at the beginning of May 2006, coal-
fired generation in the UK was consistently more competitive than gas throughout the summer. The exception to
this was for a limited time period at the end of September/beginning of October 2006, when commissioning of
new gas infrastructure in the UK pushed NBP gas prices down to levels where it was competitive to switch.
The Nordic market has showed a similar pattern to that seen in German prices, with the dark spread continuously
increasing in line with the CO2 price. As with Germany, the forward prices did at first not seem to be fully pricing
in 100% of the CO2 price. The year-ahead contracts in the Nordic market have followed the behaviour of the
German market, with spread levels increasing and persisting at a high level following the CO2 readjustments
of prices. This suggests that the main impact of the EU ETS on the Nordic power market has been through the
trade with Germany – which often is seen as setting the marginal value of water in this system.
As of early March 2007, the European Commission had given its ruling on 14 out of the total 27 EU Member
States’ allocation plans. The EC has requested cuts in most of the plans so far, reflecting the importance placed
on the 2005 verified emissions in their assessment. The results of our survey show clearly that there is an
expectancy of much higher levels of internal abatement in the EU ETS in Phase II, with 70% of respondents
expecting more reductions in the EU ETS in the future than what was seen in the 2005-2007 period.
The allocation plans specify levels for import of credits from CDM/JI project. The results of our survey suggest
that it is not enough to rely solely on imports, with 82% of respondents claiming that credit flows from CDM/JI
will not be enough to eliminate the need for internal abatement in the EU ETS.
Survey respondents find on average that the EUA price in 2010 will be about €17.5/t. Based on current forward
prices this is only slightly more than €1.5/t above the price for delivery in December 2010. Looking further ahead,
our survey respondents expect the EUA price to increase in the post-2012 period, with an average expectation
of €23.1/t in 2020. The long-term price is seen as a decisive factor for long-term investment decisions for 30%
of respondents, and as an influencing, but not decisive factor, for 45% of respondents.
The ongoing stalemate in the current post-2012 negotiations is as expected, with the lack of US engagement
constituting one principal reason for the impasse, along with general distrust between developing and developed
countries. Our analysis indicates a 72% likelihood that the next US President will support strong climate policy.
We are reasonably confident he or she will bring the US back to international climate negotiations. US re-
engagement will increase the likelihood of a new Protocol for the immediate period after 2012.
71% of the survey respondents expect there to be an international climate agreement post-2012, with only 9%
not expecting any agreement at all. USA and Australia are both seen as likely (60%) to join the new agreement,
and China (36%) is seen as a more likely candidate than India (30%). Emerging regional trading schemes are
expected to link to the EU ETS post-2012, where aviation and land transport are seen as the most likely sectors
to be included in Phase III.
Recent political developments and the positions of the most important US presidential candidates support our
view that a new and broader climate agreement is likely post-2012. US re-engagement and deepened Chinese
commitments will lead to comprehensive international emissions trading – involving most major countries and
emitting companies – expected to be fully operation from 2018 and beyond. Consequently, we expect that we
will see the emergence of a truly global carbon market in the years to come.
iv All rights reserved © 2007 Point Carbon

13 March 2007
Foreword
While 2005 in many ways marked the birth of the some way to go before the carbon market deals
global carbon market, 2006 represented both a rude with information release in the same way as more
awakening and a fresh start. The European carbon mature financial markets.
market came under massive criticism following the
Secondly, the results from our survey suggest
price collapse in April/May last year, when it became
that the EU ETS is starting to work as it should, by
clear that far too many allowances had been handed
initiating internal abatement and bringing companies
out by European governments. But the publication
to the market to benefit from these abatements.
of the 2005 data also provided the market and
Whereas last year only about 15% of respondents
policy-makers with something that had been lacking,
answered that the EU ETS had initiated internal
a set of reliable data to base political- and trading
abatement projects in their company, a whole 65%
decisions on. It was time to fall back, regroup and
of respondents claimed it had done so this year.
take charge!
We also find that there are many more companies
The publication of this report comes against a
now using the market actively, with about 36% of
backdrop of record high public interest in climate
respondents citing trading in the EU ETS as their
change and carbon trading. It seems that not one day
prime strategy for meeting their emission targets.
goes by without climate change being mentioned in
The claims from parts of European industry that
the media. Several things have contributed to this
carbon restrictions will lead to relocations are
new climate for climate change: The latest IPCC
not supported by our survey, as this option was
report has concluded more strongly than before that
mentioned by only a handful of respondents.
man-made climate change is real and happening
now, as well as highlighted the dangers we face if Finally, we now find it increasingly likely that we will
we don’t curb our emissions quickly. see a truly global carbon market emerging soon.
Developments in USA and Australia suggest that we
A different but complementary view was offered by
will soon see operational emission trading schemes
the Stern report, comparing the costs of action to
established in these countries. With every one of
the economic consequences of not acting on this
these systems relying on offset opportunities from
challenge. Finally, the movie “An inconvenient truth”
projects in other parts of the world, it is inevitable
has been making the rounds on cinemas across the
that we will soon see the emergence of a common
world, reaching audiences that have so far not paid
carbon prices. It will still take some years before we
much attention to climate change, and even collecting
see exactly what this market will look like, but its
an Academy award to show for its success. We’re of
contours are quickly becoming visible.
course both honoured and privileged to have Al Gore
with us for this year’s Carbon Market Insights. This report presents further information about
these findings, and a whole lot more. The analyses
The results from the analysis going into this report
presented here represent the essence of the work
bring forward three important conclusions: Firstly,
that goes on in Point Carbon every day. The rapid
the market is moving on despite there being severe
development in the carbon market has resulted in
problems with the allocation of allowances in the
our analyses covering even more of the world than
first phase of the EU’s emissions trading scheme.
it has done in the past, and we believe this report
The price collapse in the EU ETS resulted in massive
represents the most comprehensive overview of
criticisms from politicians and market participants
the carbon market to date. We hope you find this
alike, not only because of the results but also the
report both useful and interesting. We certainly had
way the results were revealed to the market.
a great time making it.
The lessons from the 2005 verification have not been
lost on (most) policy makers, and the allocations
for the next phase of the EU ETS are considerably Kristian Tangen
stricter than what has been the case so far. The Director and Senior Partner
publication of market sensitive information has also Point Carbon
taken several steps forward, although there is still

Carbon 2007
From the editors
This is the second issue of our annual report on the carbon market, providing an
overview of volumes and values, as well as our expectations for the future. More
importantly, rather than just presenting what we think the future will hold, this
report presents the answers from the largest ever survey on the carbon market.
We are indebted to each and every one of the 2,250 individuals who took the
time to participate in the survey; this report would never have been possible
without you.
We would also like to thank everyone in Point Carbon for their contribution to
this report. The analysis that you have contributed throughout the past year has
served as starting points for everything presented in this report. Special thanks
go to those who have contributed to our Carbon Market Analyst publication
series, sharing your knowledge on all things carbon, as well as the different
European power and gas markets. In particular, the continuous efforts of Point
Carbon’s EU ETS and CDM & JI teams has made it possible for us to use our
comprehensive databases for the market analyses presented in this report.
Some of our colleagues deserve special mention for their contribution to this
report: Endre Tvinnereim and Andreas Arvanitakis for their contributions to the
Outlook for 2007 and the post-2012 section. Kevin Gould and Trevor Sikorski have
both provided lots of input to the cross commodity chapter.
If you have any questions or comments to this report we would be delighted
to hear from you, see the Colophon for contact details. We hope the report
provides you with a good insight to the carbon market, and that it will further
enable your contribution towards a less carbon intensive future.
Kjetil Røine and Henrik Hasselknippe
Editors
vi All rights reserved © 2007 Point Carbon

13 March 2007
Table of contents
1 Introduction 1
2 The Kyoto market: How does it work? 3
3 Carbon market activity in 2006 6
3.1 EU ETS 8
3.2 Kyoto markets 17
3.3 Other markets 24
4. Carbon across commodities 25
5 Outlook for 2007 30
5.1 EU ETS 30
5.2 Kyoto markets 31

5.3 Other markets 35
6. First Kyoto period and beyond 36
6.1 2008 - 2012 36

6.2 Post-2012 43
vii All rights reserved © 2007 Point Carbon

13 March 2007
1. Introduction expectations for the first Kyoto period (chapter 6)

and possible outcomes for the international climate
Although there is still another 10 months to go before regime post-2012 (chapter 6).
the first Kyoto commitment period starts, the global
carbon market is alive and kicking. Advocated by This report is based on a variety of sources. First, the
unusual weather conditions worldwide, by the Stern analyses that have gone into our publication series
report published in November last year showing the Carbon Market Analyst (CMA) are to some extent
economical consequences of global warming, as reflected in this report although the level of details
well as the US slowly re-entering the global carbon is lower here. As last year, a Carbon Market Survey
arena after years in hibernation, 2006 was the year is carried out. Contrary to last year, we employed
when climate change was on the top of the political a web-based survey software this year, contributing
agenda. Putting value on greenhouse gas emissions to that a total of 2250 individuals responded to our
has now become mainstream thinking. web-survey, up from 800 responses last year.
The present report, Carbon 2007, provides a detailed

overview of the global carbon market. Chapter 2
2250 participants in our web-survey
takes a top-down approach and look at how the this year, up from 800 in 2006
Kyoto market mechanisms are intended to work. This
includes the flexible project-based mechanism under
the Kyoto protocol (Clean Development Mechanism Who responded to this year’s Carbon Market
(CDM) and Joint Implementation (JI)) as well as Survey? Figures 1.1-1.3 show the distribution of the
regional emissions trading schemes, with particular respondents to the web-survey. Less than 40% (50%
focus on the EU Emissions Trading Scheme (ETS). last year) of the respondents did not represent GHG
emitting industries, while about 25% represented
Moreover, in chapter 3 particular attention is given only small emission levels, i.e. below 0.5 Mt per
to volumes and values in the global carbon market year. 12.5% of the respondents represented major
in 2006 as well as lessons learnt from the previous emitters, with more than 10Mt per year.
year. In chapter 4 we give a short overview of the
impact carbon prices have had on European power The share of “non-emitters” is also reflected in the
markets. The remaining chapters look into the future; break-down of respondents on sectors, see Figure
presenting the market outlook for 2007 (chapter 5), 1.2. Service providers dominates the picture. and
Figure 1.1 Some big, many small

Respondents to the survey, broken down on their company’s annual emissions level. Comparison
of respondents in 2006 and 2007.
60%
50%
Share of respondents
40%
30%
20%
10%
0%
No 0 – 0.5 Mt 0.5 – 1.0 1 – 5 Mt 5 – 10 Mt > 10 Mt
emissions Mt
Source: Point Carbon 2006 2007

Carbon 2007
Figure 1.2 Still mostly outside trading sectors

Respondents to the survey, broken down on sectors. Comparison of respondents to the 2006 and 2007 surveys.
20.0%
16.0%
12.0%
8.0%
4.0%
0.0%
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Source: Point Carbon

EU
academics, governments and finance & banking one main difference. There are relatively more
have their share of the respondents. In total, 24% respondents from the U.S. this time, increasing
are covered by a CO2 regulation, while 42% of the the “Other Annex-1” category to 30 %. Still, half
respondents are involved in the EU ETS. of all the respondents come from the EU, with 32
% from Northwest Europe, 10% from Central and
The respondents are still dominated by those Eastern Europe, and 8% from Southern Europe. In
standing outside of the trading sectors. That said, addition, 6% were from European countries not in
the relative share of respondents in the trading the EU. Of the remaining respondents 20% were
sectors power & heat, industry and oil/gas/refineries from industrialised countries, whereas another 20%
have increased compared to last year. were from developing countries, i.e. non-Annex I
The geographical distribution of respondents countries.
is more or less the same as in 2006, with only
Figure 1.3 European responses

Comparison of respondents to the survey in 2006 and 2007,, broken down on geographic location. Annex 1
refers to industrialised countries as defined under UNFCCC. CEE: Central and Eastern Europe.
40%
30%
20%
10%
0%
EU: Other Non-Annex- EU: CEE EU: South Europe:
Northwest Annex-1 1 Non-EU

13 March 2007
2. The Kyoto market: How does JI projects function more or less in the same way,
rewarding emission reduction projects in developed
it work? countries, i.e. countries with a Kyoto-target,
with Emission Reduction Units (ERUs). For both
The international carbon market is a direct
mechanisms there are specific requirements that
consequence of the Kyoto protocol. While there
have to be met, e.g. it has to be proven that the
is carbon trading also in non-Kyoto countries, the
emission reductions are real.
market is to all extents and purposes based on the
mechanisms specified in the Kyoto Protocol. How is Finally, carbon allowances from regional emission
the carbon market structured? trading systems are issued either based on a certain
cap (cap-and-trade) or on proven improvements
The carbon market’s sole mission is to place a cost
done from a certain baseline (intensity-based
on carbon emissions, a value on emission reductions,
trading). The EU Emissions Trading Scheme is the
and to enable trade of the resulting allowances or
only operational regional cap-and-trade scheme for
credits. There are four main mechanisms at play:
CO2, where European Union Allowances (EUAs) are
the tradable units.
1. International Emission Trading Figure 2.1 displays the structure of the carbon
2. Clean Development Mechanism market in the 2008-2012 period. The market consists
of governments and private entities, and the rules
3. Joint implementation
governing their trading relationships
4. Regional/Domestic Emission Trading
The left side of the figure displays the governments
specified in the Kyoto Protocol’s Annex B, with
All countries with a Kyoto-target will be issued with an emissions target for the 2008-2012 period.
Assigned Amount Units (AAUs) that can be used The demand side, i.e. the governmental purchase
in international emissions trading under the Kyoto programs, will manifest itself in Western Europe,
Protocol. In order for a country to meet its target Japan, Canada, and New Zealand – that are legally
it has to deliver allowances and credits equivalent bound to control emissions. The supply side will be
to its emissions in the Kyoto period (2008-2012), concentrated in Eastern Europe.
and will have to either buy AAUs from other
countries or purchase credits from projects under
the Clean Development Mechanism (CDM) or Joint How are countries meeting the
Implementation (JI). Kyoto challenge?
The main theoretical supply of AAUs is expected to
come from Eastern Europe, and Russia and Ukraine Governments with demand for allowances in
in particular, as these countries have actual emissions the Kyoto period can also forward part of their
far below their Kyoto target (their assigned amount). compliance to the private sector through emissions
Thus, they can sell the surplus to countries that need trading schemes or other measures. In this report
the allowances for compliance. we distinguish between the (currently) largest
operational regional CO2 trading scheme, the EU
ETS, and other planned or possible trading schemes
The carbon market’s mission: To in other countries.
place a cost on carbon emissions
The CDM/JI – EU ETS linkage is responsible for
much of the recent increase in project credit
CDM and JI are often referred to as the project- supply. Primarily because the EU ETS is the largest
based flexible mechanisms under the Kyoto operational trading scheme, but also due to the
Protocol. CDM rewards emission reduction projects perceived high prices of EUAs. Conversely, growing
in developing countries with so-called Certified project credit supply is keeping the EUA price lower
Emissions Reduction (CERs), which can then be than what it would have been without such import
used by governments to meet their Kyoto target, as possibilities.
well as by the private sector for compliance under
regional emission trading schemes. Consequently, European policy and market events
will have a profound influence on the carbon market

Carbon 2007
elsewhere in the world through the CDM/JI link. one hand while lowering the purchasing power of
Outside the EU, however, CER/ERU demand is also governments on the other.
strong, notably from Japanese utilities. It is also
Even with all their procurement plans filled, the
possible that non-EU trading schemes, for instance
countries of Western Europe, Japan and Canada will
in New Zealand or Canada, will produce some
still on track to missing their Kyoto targets. However,
credit demand in the Kyoto period, although this is
the potential supply of AAUs from Eastern Europe is
currently far from certain.
sufficiently abundant to put their carbon budgets in
the black. But is the supply of AAUs really there?
Governments already buying carbon
credits
Eastern EU members probably hesi-
tant to sell large volumes of AAUs
Governments are already buying CERs and ERUs
in order to meet their Kyoto target. In fact, most
Most Eastern EU members will probably be hesitant
countries with a Kyoto target have drawn up carbon
to offer substantial volumes of AAUs. This is partly
procurement plans, with the largest programs in
because they might need the surplus allowances
Spain, Japan, the Netherlands and Italy.
in the future, but also because they are covered
However, if the costs for project investments in by the EU ETS, which may present more lucrative
CDM/JI increase, or if governments are forced emissions trading opportunities.
to purchase issued credits (trading at the highest
Russia and Ukraine, however, might decide to sell
market price), the volume of the purchases will be
parts of their government allowances when they
reduced. Strong EU ETS demand thus presents a
become eligible for emissions trading (i.e. transfer
dilemma by stimulating new CDM/JI projects on the
of AAUs) in 2008-2009, see Figure 2.2.
Figure 2.1 How it works, at least in theory

The interplay of flexible mechanisms, purchasing programmes and trading schemes. Non-market
policies and overall allocations set the frame.
Political framing decisions
Gov. AAU sales JPN/CAN/NZ
CDM/JI
Gov. Purchase EU ETS

programmes Governments Private sector Internal trading,
abatement
= Supply Forwarding
compliance
= Demand
Political framing decisions

13 March 2007
On the other hand, there is not much of a demand The common factor for all the different market
side here either, despite the substantial shortfall segments described above is their link to CDM and
amongst Kyoto countries. There are difficult issues JI. Governments and companies alike, in all regions
regarding public acceptance of trading so-called of the world, will be able to use CERs and ERUs for
“hot air”, i.e. excess permits arising from declined compliance.
production not caused by intentional efforts to curb
emissions.
Private sector AAU demand expec-
To make AAU trading more politically palatable,
therefore, Green Investment Schemes (GIS)
ted to be limited
have been devised. In a GIS, income from AAU
sales is earmarked for GHG reduction or general Thus, these project based credits will act as the
environmental purposes. There is, however, no carbon market’s interconnector, ensuring that
regulation for how such earmarking could occur, there is at least indirect price linkage between the
nor is there an obligation on either buyer or seller to systems, as the stream of credits will in theory go to
undertake such “greening”. the system with the highest price. Although there
are no directly linked trading schemes as of yet,
Green Investment Schemes (GIS) the projects in developing countries have already
are politically palatable resulted in a global carbon market, with implications
for governments and companies all over the world.
Private sector AAU demand is expected to be limited
and confined to Japan (it is not allowed in the EU
ETS). Japanese entities are reportedly pursuing GIS
in Bulgaria and Romania and are planning to enter
Russia and Ukraine later.
Figure 2.2 Potential supply more than enough

Net short and long positions for countries and regions, i.e. when all policies and procurement plans have been
accounted for. Aggregated for the 5-year Kyoto period
EU 15
Japan
Canada
Other
Ukraine
Eastern Europe
Russia
-5 -4 -3 -2 -1 0 1 2
Gt CO2e

Carbon 2007
3. Carbon market activity in 2006 began to decline.
2006 saw, as all previous years in the carbon market, The dropping value of first phase allowances (for
a substantial growth in the traded volumes and delivery in 2006 or 2007) was coupled with growing
corresponding values. Table 3.1 shows the overall volume in the second phase (delivery in the 2008-
numbers from 2006, compared to 2005 as well as our 2012 period), which held its price level relatively well.
expectations for 2007. The total transacted volume For that reason the financial value of the market did
seen in the regulated carbon markets in 2006 was not collapse with the first phase. The brokered and
exchanged market totalled €14.6 billion in 2006.
1.6 billion tonnes of CO2 equivalent (CO2e), while
the financial value came in at €22.5 billion. Assuming a similar split between first and second
phases in the bilateral segment as for the exchange
We estimate that the EU ETS saw a total volume of
and brokered segments, the financial value of bilateral
1,017 million tonnes of CO2 in 2006. This includes
trades in 2006 is put at €3.6 billion throughout the
confirmed transactions for 583 Mt conducted over-
year, bringing the total estimated financial value of
the–counter (OTC) and 234 Mt on various carbon
the European market in 2006 to €18.1 billion, over
exchanges, yielding a total of 817 Mt.
2.5 times higher than 2005.
Carbon market saw 1.6 billion Mt, Total transactions in the Kyoto markets in 2006 are
€22.5 billion in 2006 estimated to be 584 Mt CO2e, worth €4 billion.
Compared to 2005, this is an increase of 36% in
volume and nearly 100% in financial value. The JI
The remaining 200 Mt in the total volume is based
volume came in at 21 Mt, while the CDM market
on our estimate of bilateral trades. As always, this
transacted a total volume of 562 Mt including
market segment is hard to pin down. Transactions
secondary transactions.
are less frequent and larger in clip size than the
brokered or exchange-based segment, and they are Of the total financial value, the primary and secondary
also almost always confidential. CDM market saw a combined €3.9 billion in trade,
while the JI totalled just €95 million. JI volume and
The rise in volume seen in the first half of 2006 fell
value both came in under 2005 levels (28 Mt and
off during the third quarter, but rose to a new record
€96 million). This unusual development marks the
in the fourth quarter, reflecting end-of-year trading
first step backwards for carbon markets.
as well as increased volatility as the short-term price
Table 3.1: Reported volumes and value 2005, 2006, forecast 2007
Reported and estimated volumes 2005 and 2006, together with forecasted volumes for 2007, in Mt CO2e and million €. 7 %
discount rate employed for CDM and JI where price is at point of delivery. Prevailing carbon prices at time of writing for 2007
forecast.
2005 2006 2007

Final figures Final figures Forecast
[Mt] [€ million] [Mt] [€ million] [Mt] [€ million]
EU ETS total 362 7,218 1,017 18,143 1,750 18,503
- OTC + exch. 262 5,400 817 14,575 1,550 15,903
- Bilateral 100 1,818 200 3,568 200 2600
Other ETSs 7.8 52 31 300 50 500

CDM 397 1,985 523 3,349 456 3,260
CDM 2nd 4 50 40 571 96 1,061
JI 28 96 21 95 45 277
Sum 799 9,401 1,632 22,458 2,397 23,601

13 March 2007
Figure 3.1 Stairway to 07

Reported and estimated contracts 2003-2006, forecast for 2007, Mt CO2e.
2,500
2,000
1,500
Mt CO2e
1,000
500
0
2003 2004 2005 2006 2007
Source: Point Carbon CDM JI EU ETS Other
Other carbon markets (in USA and Australia) have case in our Outlook series, which dates back to
gained in size since last year, although their share of February 2002, we do not attempt to forecast carbon
the global market was reduced in 2006 compared to prices in 2007 in this report, instead using prevailing
2005. The volume in 2006 was at 31 Mt CO2e, while market value at time of writing to give an illustration
the financial value was at €300 million. of the potential financial value of the market in 2007.
With the EU ETS price down from last year, and the
wider effect that the EU prices have in the carbon
Kyoto markets saw 583 Mt, worth market, the total financial value of carbon markets
€4 billion in 2006 grows to a lesser extent from €22.5 billion to €23.6
billion.
For 2007, we expect growth in all market segments
except for primary CDM. This brings our forecast for
global volumes to 2.4 billion tonnes of CO2e, almost
50 per cent up from 2006. As has always been the
Figure 3.2: Still dominated by the EU ETS

Distribution of the different market segments for physical volumes and financial value in 2006.
Physical volume (1,632 Mt CO2e) Financial value (€22.5 billion)

Other Other
1.9 % 1.3 %
EU ETS CDM
62.4 % 17.5 %
CDM EU ETS
34.5 % 80.8 % JI
0.4 %
JI
Source: Point Carbon 1.3 %

Carbon 2007
Figure 3.3 Ups and downs in 2006

Quarterly volumes and values in the EU ETS, Mt and € million
300 5,000
-5% 4,500
250
36% -30% 4,000
-17% 3,500
200 30%
6%
3,000
Mt CO2
€ mill
150 2,500
2,000
100
1,500
1,000
50
500
0 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
3.1 EU ETS 3.1.1 Volumes and values

The EU ETS is still the dominant emissions trading Transactions in the EU ETS take place through
scheme in the world. In 2006, it reached record brokers (OTC), exchanges and bilateral trades. The
levels in transacted allowances, both in volumes and EU ETS saw transactions through brokers and on
values. It was also a dramatic year with respect to exchanges totalling 817 Mt in 2006. Of this, 583
the reliability of the scheme, as the publication of Mt (71.4 per cent) was in the OTC market, with the
verified emissions data for 2005 showed that the EU remainder in the exchange-based market.
ETS was in fact long allowances, and not short as The European Climate Exchange (ECX) still carries
previously expected. the largest volume of the exchanges, with over
three quarters of all exchange volumes (not including
exchange-for-physical, where OTC transactions are
cleared through the exchange). Powernext (13.3 per
More volume on exchanges in Q4

Figure 3.4: Change towards exchanges? 2006
The relative shares of daily volumes for the brokered and
exchanged market in the EU ETS in 2006. Pure bilateral cent), in second place, is still almost twice as large
trades not included as Nord Pool (7.4 per cent), while the only other
100%
exchange with volume to speak of is the European
Energy Exchange (EEX) (3.6 per cent).
80%
There was notable development towards relatively
more volume on exchanges in Q4, coinciding with
60%
the declining Phase I price. Much of the increase
40%
came through spot trading, possibly indicating more
industrial selling in this period, but also of course a
20% natural increase in trading activity was as the year-
end approached.
0%
Most of the trades in 2006 were for Phase I delivery,
2-Feb-06
2-Aug-06
2-Sep-06
2-Apr-06
2-Jun-06
2-Jul-06
2-Jan-06
2-Mar-06
2-Nov-06
2-Dec-06
2-May-06
2-Oct-06
although the relative share of Phase II volume

increased steadily throughout the year. In total over
Source: Point Carbon OTC Exchanges the year, Phase II accounted for 24.4 per cent (199

13 March 2007
Figure 3.5: Still dominated by ECX

Monthly volumes of EUA trades in 2006 at the different carbon exchanges, in Mt CO2.
35
ECX 75.6%
30 Powernext 13.3%
Nord Pool 7.4%
25 EEX 3.6%
EXAA 0.1%
20
Mt CO2
15
10
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: Point Carbon ECX Powernext Nord Pool EEX
Mt) of the volumes done on exchanges and through estimated the bilateral market to be somewhere
brokers. Most of this, 143 Mt came in the last half between 10 and 25 per cent of total trading activity,
of the year. while another 24 per cent estimated it to be between
25 and 50 per cent.
In addition to the trading activity on exchanges and
through brokers there is a direct bilateral market, Using the result of our survey as a starting point,
with transactions executed directly between two and taking a conservative approach, we estimate the
companies. Estimating this bilateral market is difficult direct bilateral activity to account for 20 per cent of
as such deals are rarely, if ever, reported. In the all EU ETS trading activity in 2006, or about 200 Mt
Carbon Market Survey we asked the respondents to CO2. Including this direct bilateral volume we find
give their opinion on how large this market could be. that the EU ETS traded a total of 1,017 Mt in 2006.
Of the 427 respondents that said they were in one
way or another active in the CO2 market, 26 per cent
Most Phase II volumes traded in
second half of 2006
Figure 3.6 What the market thinks
Respondents expectations of the relative size of the In financial terms, the EU ETS volumes on exchanges
bilateral market, limited to respondents that are actively and through brokers totalled €14.6 billion last year,
participating in the EU ETS market. of which €10.8 billion came through allowances for
40% delivery in Phase I. This is about three times more
than the exchanged and brokered value from the
30%
previous year (€5.4 billion), and a whopping two
hundred times more than in 2004.
Share of responses
20%
The financial value of the direct bilateral volume is
difficult to assess, as there is no way of knowing
how much of it that was in Phase I delivery and how
10% much that was in Phase II. It is plausible that there
was a larger share of Phase II volumes in direct
company-to-company deals, as companies take new
0%
0-10% 10-25% 25-50% 50-100% Do not know
positions in the coming trading phase, but in our
analysis we assume that the distribution between

Carbon 2007
the phases is the same in the direct bilateral market in the high-teens for the middle quarters of the year.
as in the brokered/exchanges market. This was put down to short-term demand by utilities
buying on the back of forward power sales. Much of
Using this split between vintages we find that the
the supply was held back by industrials that either
direct bilateral market saw values of €3.6 billion
did not have the appetite or capability to sell before
throughout the year, bringing the total estimated
they had ensured their own compliance.
financial value of the European market in 2006 to
€18.1 billion. As power companies finished hedging most of
their production for 2007, leading to a gradually
The development throughout the year shows that
decreasing demand side, and more of the surplus
volumes went down in the third quarter, both as
came to market as industrials entered the market,
a result of stabilising prices after the Phase I price
the price of an allowance began to subside. In early
crash in the second quarter, and the slow summer
November, the Dec-07 contract slipped below €10
months when trade activity is usually lower. In the
and declined from there. At the time of writing, the
last quarter of 2006 the volumes went back up,
07-contract is traded at around €1. The EU ETS phase
registering the highest quarterly level of activity
I is for all practical purposes over and done with, and
ever. This was a result of increased industrial selling
unless there are enormous surprises in connection
towards the end of the compliance year, as well
with the verification data for 2006, to be released in
as interest in Phase II taking off in response to the
April/May 2007, nothing will alter this picture.
first set of NAP announcements for the 2008-2012
period. The second-phase allowances broke free from
their correlation to first-phase allowances finally
In financial terms, the second half of the year came
in October, as the Dec-08 contract responded to
in with lower results as the Phase I price continued
credible signals from the European Commission
its steady decline in value towards rock bottom.
that it would ensure that the second phase was
short. The correlation between 07-contracts and 08-
3.1.2 What drives the EUA price? contracts over the first nine months of 2006 was
The EUA price is, as in any market, set by supply 0.88, while the last three months saw a negative
and demand. The supply is here determined by correlation at -0.74.
the allowances and carbon credits available to the
market (EUAs, CERs and ERUs). Demand is set by
the amount of emissions through the year in relation
Combined fuel and weather correla-
to the overall allocation. The demand is influenced
tion to EUA was 0.41 in 2006
by a number of factors, primarily fundamentals
What were the main drivers for the price development
like weather (as temperature determines power/
over the year? Fig 3.8 shows the development of the
heat demand and precipitation the potential for
EUA Dec-07 price throughout 2006 in relation to the
hydropower production) and fuel prices (as the
impact from fuel and weather to the overall short
relative price differential between coal and gas will
position, i.e. the impact on Point Carbon’s allowance
determine which of the fuels that will be used for
demand indicator E-t-C from relative coal/gas prices
power production). Relatively cheaper coal compared
and temperature/precipitation. The correlation (R2)
to gas will increase GHG emissions as more power
between the EUA price and the combined effect
production will be based on coal which emits more
from fuel and weather was 0.41 over the year as
GHGs per unit of output than gas. Higher CO2
a whole, while in 2005 it was 0.92. The individual
emissions will increase the carbon price.
correlations to fuel prices and weather were 0.46
The Dec-07 contract (for delivery in December 2007) (0.89 in 2005) and 0.35 (0.48 in 2005), respectively.
began the year at €22.70, and was traded by the The correlation between the Dec-07 price and
end of the year more than €16 lower at €6.55, the weather and fuel for the entire year is relatively low
year’s lowest value. Its highest value was on 19 April due to the price crash in April/May, which obviously
at €31.58, just before crashing on the haphazard was not due to dramatically changes in fuel prices
release of verified emissions data to €9.70 on 11 or weather, but rather the political publication of
May, see Figure 3.7. verified emissions data.
By the end of May the Dec-07 contract had It is evident from the graph that the market is to a
recovered, reaching €20 at one stage, and remained large extent trading on changes in the fundamentals.
10 All rights reserved © 2007 Point Carbon

13 March 2007
Figure 3.7 Daily volumes and prices

Daily prices for 07- and 08-contracts, as reported by Point Carbon together with daily volumes in
the OTC and exchanged markets.
14 32
12 28
24
Million tonnes CO2
10
20
€ / tonne
8
16
6
12
4
8
2 4
0 0
4-May-06
2-Jun-06
28-Sep-06
27-Nov-06
28-Dec-06
29-Jan-07
2-Mar-06
1-Feb-06
31-Mar-06
3-Jul-06
1-Aug-06
27-Oct-06
30-Aug-06
Source: Point Carbon's Carbon Market Trader Volume EUA 07 EUA 08
Figure 3.8 Driven by weather, fuel prices and verification

EUA 07 in 2006, left axis in €/t, compared to the changes to Point Carbon’s allowance demand indicator E-t-C from fuel
prices and weather, accumulated throughout 2006, right axis in Mt CO2.
35 50
2 2
1.1 -13.4: R = 0.57 1.1 -31.12: R = 0.41
30 40
30
25
2
1.6 -31.12: R = 0.98 20
20
Mt CO 2
€/t
10
15
0
10
-10
5 -20
0 -30
02- 02- 02- 02- 02- 02- 02- 02- 02- 02- 02- 02-
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: Point Carbon EUA 2007 Fuel + weather (accumulated)

Carbon 2007
Figure 3.9 Short-term price drivers in the EU ETS

Based on responses from our web-survey
Weather
Phase 2 EUA
prices
CDM/JI supply
Other factors
Fuel/power prices
Political decisions
0% 20% 40% 60% 80%

Share of responses
From June to December the combined correlation for It is also clear that the market is trading on different
weather and fuel to the carbon price was 0.98, with fundamentals at different times. For instance,
a fuel-correlation on 0.89, and weather-correlation during the period 1.1 – 13.4 the overall correlation
on 0.98. This is explained by the combination of was 0.57, with a fuel-EUA correlation of -0.15 and
warm and wet weather throughout the period in weather-EUA correlation of 0.87. Hence, trading was
combination with falling fuel prices, leading the done primarily on the weather during this period,
downward trend of the EUA price. while at other times it was the development in one
or other of the fuels that set the sentiment. The
Figure 3.10 Long-term price drivers in the EU ETS

Weather
Other factors
Long-term prices
Fuel/other
commodity prices
CDM/JI supply
Political factors
0% 20% 40% 60% 80%

Share of responses

13 March 2007
publication of verified emissions data in April/May the weather is not seen as a main factor for the EUA
broke all correlations between fundamentals and price. Only 4 % consider the weather to be a main
EUA price as the crash of the latter obviously did price driver, less than half of what was the case in
neither influence fuel nor weather. 2006.
The prices for second phase allowances behave much
Political factors drive prices as the first-phase price, with short-term responses
to the underlying energy complex combined with
Do these developments confirm what market policy signals on the allocation process. The EC’s
participants see as the most important factors for decisions for the second phase are expected to
carbon price development? Figures 3.9 and 3.10 be done by this spring, but the final allocation to
show the response from Carbon Market Survey installations is likely to drag on at least until autumn
2007, compared to the survey carried out in 2006. A of 2007, given government tardiness and the odd
striking difference is that while the fuel and power legal challenges to the EC’s decisions. The survey
prices were considered to be the most important shows that political decisions are currently believed
price determinant in our 2006 survey, followed by to be the most important price driver also for Phase
“political decisions”, these factors have changed II.
places in 2007.
A plausible explanation for this is the publication 4.1.3 What did the verification show us?
of the verification data in May. Looking only at the The second year of the European emissions trading
answers of those respondents directly regulated by market was noteworthy in many respects. First, and
the EU ETS, the picture looks pretty much the same, most importantly, the realisation that the market
indicating that although fundamentals like fuel prices was indeed long in 2005 and the following collapse
and weather have seen a high correlation with the of carbon prices had its effect not only on the
EUA price over major parts of the year, the price behaviour of market participants, but also influenced
crash caused by the verification has indeed been the the European Commission’s decisions for Phase II.
most decisive factor for the EUA price level.
So what did actually the verification data show
Contrary to the correlation our data shows between us? Companies in the UK, Spain, Italy, Ireland and
weather and the EUA price, the survey shows that Austria emitted more than their cap with a total
Figure 3.11 2005 verification results - country level

In MtCO2
UK
ESP
ITA
IRL
AUT
GRC
SVN
PRT
LUX
LVA
BEL
SWE
EST
HUN
SVK
NLD
LTU
DNK
FIN
CZE
FRA
DEU
POL
-40 -30 -20 -10 0 10 20 30 40

Mt CO2
Source: Point Carbon/CITL

Carbon 2007
Figure 3.12 2005 verification results - sector level

In Mt CO2
deficit of 47.4 Mt. Other countries had allocated ‘non-power & heat’ sectors. ‘Metals’ and ‘Other’
more emission rights than actually used, 112.6 Mt were the longest sectors in absolute terms (35.3 Mt
in total, providing a net long position of 65.2 Mt for and 26.3 Mt, respectively), while ‘Pulp and paper’
EU-21. Figure 3.11 shows 2005 emissions to cap (E- and ‘Others’ were the sectors being longest relative
t-C), calculated as verified emissions minus the sum to their caps (21 % and 17 %, respectively).
of allowances allocated in each EU country, except
from Poland as full installation level data are not The surplus is probably due to a combination of
available at the time of writing. two factors; i) generous allocation and ii) internal
abatement and efficiency improvements. The first is
Large countries like Germany and France were by far the most important. Evidence suggests that
considerably long, 21 Mt and 19 Mt, respectively, especially smaller industrials appear to have received
being 4.3 % and 12.7 % below their caps. UK, on generous allowances. For installations emitting less
the other hand were 27 Mt short, corresponding to than 100 kt CO2 in 2005, the average surplus is 26
emissions being 12.6 % above the cap. per cent of the cap.
But do reductions actually take place? There are
EU ETS was 97.2 Mt long in 2005 empirical evidence for some site specific reductions,
such as increased energy efficiency and own bio-fuel
Turning to the sector level (without data for Poland), based power production (e.g. in the Pulp & Paper
Figure 3.12 shows that across the EU, companies sector). Closing of production, either permanently or
in the power & heat sector emitted 36 Mt CO2 temporarily, is another reason for surplus emissions
above their allowances. The main circumstances – as was moved production. But this would only
influencing emissions in this sector were abnormal apply for a small handful of installations and not for
dry and cold conditions in Spain and Italy, above the industrial sectors in general.
normal precipitation in Scandinavia and record-high
gas and EUA prices. For the metals sector the production levels in 2005
decreased in relation to the 2004 numbers, partly
Moreover, all industry sectors had surpluses, adding due to high level of stocks in the supply chain.
up to a net aggregate long position of 102 Mt for Demand has increased again in 2006, which is

13 March 2007
Figure 3.13 Has the EU ETS initialised inernal abatement in your company?
Do not know
No
Yes
0% 10% 20% 30% 40% 50% 60% 70%

Figure 3.14 What is the primary carbon compliance strategy?

Relocation
Other
Internal abatement
Trading CDM/JI
Trading within EU
ETS
0% 10% 20% 30% 40%

Share of responses

Carbon 2007
Figure 3.15 Assessing the EU ETS

EU ETS is a mature
market
EU ETS is a success
EU ETS is the most

cost-efficient way to
reduce emissions
EU ETS facilitates
emissions reductions
EU ETS is more
mature now than one
year ago
0% 20% 40% 60% 80%

Share of responses
2006 2007
likely to bring with it higher emissions. Efficiency Turning to a broader compliance strategy for the
improvements have historically been made at a EU ETS participants, figure 3.14 illustrates what
number of installations, and there is not much survey respondents cite as their primary compliance
potential for increased efficiency. strategy. The main change from last year’s survey is
that trading within the EU ETS is seen as the main
In the other sectors there are also specific situations
alternative, with 37 % of the respondents. Internal
which have lead to emission reductions. In the
abatement is considered the primary compliance
Cement sector there is some evidence of increased
strategy by 25 % of the respondents, with utilisation
use of alternative fuels, and repairs or replacements
of CDM/JI at around the same level.
of kilns during 2005. In the Chemical sector there has
been some disruption to production (in particular in
the UK) in Q4 2005, due to high gas prices. However, Trading is the primary carbon comli-
in general the majority of the emission reductions ance strategy
that have taken place cannot be explained by major
abatement initiatives arising from the introduction of
the EU ETS. The EU ETS has been through some turbulence
during 2006. What is the standing of the EU ETS
What do the respondents to the survey think about
among the respondents to the survey compared
this? The difference from 2006 survey is striking as
to last year? Although the changes from the 2006
last year 60% of respondents answered that EU
survey is not striking, figure 3.15 indicates that
ETS had not initiated internal abatement projects in
the EU ETS is considered less of a success now
the company, while only 15 % replied that it had. In
than what was the case in our 2006 survey. Fewer
2007, the situation is the opposite, with 65% of the
respondents think that the EU ETS facilitates
respondents claiming they have initialised internal
emissions reductions and, most surprisingly, fewer
abatement projects as a result of the EU ETS and
respondents think the EU ETS is a mature market
only 15% have not. Hence, if we take the survey
compared to one year ago. This last point is, however,
results at face value, large emissions reductions due
within the range of methodological uncertainty, and
to internal abatement could be expected for 2006
should therefore be read with caution.
compared to 2005.

13 March 2007
3.2 Kyoto markets in 2006

The Kyoto markets include projects under the
Clean Development Mechanisms (CDM) and Joint Figure 3.16: Most towards the end
Implementation, as well as Green Investment Quarterly volumes of CDM and JI contracts in 2006, regis-
Schemes (GIS). The latter involves the sale of tered and estimated by Point Carbon, in Mt CO2e.
Assigned Amount Units (AAUs), the governmental
emissions trading unit under the Kyoto Protocol. 200
3.2.1 CDM in 2006 150

Transacted CDM volumes in 2006 ended at 563 Mt
Mt CO2e
CO2e in total, including primary (523 Mt CO2e) and
100
secondary transactions (40 Mt CO2e), constituting
more than 96 per cent of the total project market
(CDM & JI). In total, the financial value of the CDM 50
transactions in 2006 was €3.9 billion for CDM
transactions, including secondary transactions.
0
Q1 Q2 Q3 Q4
Of the primary transactions, 436 Mt CO2e are
CDM JI
confirmed in our transaction database, while the Source: Point Carbon
remaining 86 Mt CO2e are additional transactions
that we expect to have occurred. The additional
transactions are included because we know that
the total volume of transactions is higher than only 34 Mt CO2e in our database, and estimate that a
those confirmed, and by combining Point Carbon’s total of 40 Mt CO2e were completed in 2006, worth
transaction database and project database we get a more than €500 million.
reliable proxy for these additional transactions. Volumes in primary transactions increased in Q1 and
The secondary CER market was limited in volumes Q2 until the EU ETS price crash, then fell back in Q3,
in 2006. We have confirmed transactions totalling as both sellers and buyers took a time-out to think
things through. Volumes increased again in Q4,
Figure 3.17: Who are they and what do they want, Part I
The relative share of categories of CDM buyers (left) and project types (right) in 2006.
Fugitive
emissions
Government LULUCF
Energy 7%
8% 1%
efficiency
7% HFC-23
33%
Waste
Funds 9%
34%
Private Other/unknown
58% 10%
Renewable
N2O
energy
Source: Point Carbon 13% 21%

Carbon 2007
Figure 3.18: Made in China

The relative share of CDM country sellers (left) and buyers (right) in 2006.
Malaysia Other
Unknown/Other
Egypt 1% 12%
11%
2% Japan
USA 3% United
Brazil 4%
Kingdom
3% Spain
36%
4%
India
Luxembourg
12%
5%
China
70% Canada
13%
Source: Point Carbon Italy
24%
as confidence in a sound second phase of EU ETS, and funds selling to such companies have also
and to some extent demand from governments and had a much larger appetite for large-scale non-CO2
Japanese companies increased. projects. Moreover, European countries dominate
The UK and Italy top the list of buyer countries. amongst governmental buyers. While there are
Italy’s high position stems from ENEL’s procurement hints at more Japanese activity in the CDM market,
of CERs from HFC-23 and other projects in China, our expectation of limited Canadian and Japanese
as well as the Italian government’s activity through activity on the demand side has proven correct.
the World Bank. The chart of buyer countries reflects
that more financial institutions have become active
China by far the largest CDM selling
in the market – a large chunk of the market activity
country
out of the UK is financial, not compliance-driven. This
is obviously also the case for Luxembourg (financial With regards to project types in 2006 forward CER
players registered there) and the US (primarily due contracts, HFC-23 and adipic acid N2O projects
to the World Bank funds). Also, the Greenhouse stole the show. Most of these types of projects
Gas Credit Aggregation Pool’s (GG-CAP) HFC-23 are now under contract, and we see the contours
purchases are the sole reason why Canada figures of a more balanced picture between project types.
on the list. Interestingly, Japan has only 3 per cent The dominance of HFC-23 was far clearer in 2005.
of the buyers’ volume although their interest in the Renewables, energy efficiency, waste (including
market is reportedly still high. landfill gas capture) and fugitive emissions (including
coal mine methane) have all experienced growth in
2006, which is likely to continue.
Privates still the largest buyer of
CDM contracts China completely dominated the CDM sell side in
2006, miles ahead of India and Brazil, bringing the
bulk of the HFC-23 and adipic acid N2O volumes to
The private sector is dominant on the buy-side (58 the market. China felt confident enough in its role as
per cent), as increrasingly more companies see the a dominant supplier to introduce and maintain a price
value of project credits. In addition, new financial floor, which it raised from €7/t to €8-9/t during the
vehicles are established to cater to this market, year. With 70 per cent of the total contracted CDM
contributing to the funds segment of 34 per cent. In volume coming from China, this is a very strong
general, companies with EU ETS compliance price signal in a market that is still fairly small.

13 March 2007
More transactions are done in India now than has Furthermore, the rules for Chinese host country
been the case for a while, mainly for two reasons. approval require project participants to reveal a CER
Firstly, Indian sellers were renowned to be more price, and it is not allowed to receive consultancy
optimistic than others before the EU price crash, revenues in CERs. This has forced project developers
but the crash brought them back to the negotiating to take buy side positions in order to be able to
table. obtain CERs early and sell them for a profit later. This
will likely boost secondary CER market volumes in
Secondly, this development mirrors a more mature
the years to come. When some project developers
market; many Indian sellers had sat on the fence,
also start buying for their own books, many buyers
in the belief that selling a mature asset yields more
are likely to seek out project developers that don’t
revenue, and are now selling as their project is
buy for their own books in order to obtain unbiased
registered or has had its first issuance of credits.
advice.
Apart from the developments in China and India, the
picture is still fragmented on the sell side, which is The prospect of non-Kyoto and non-EU ETS CER
interesting in itself: many more seller countries are buyers became more real in 2006. US and Australian
now represented in the market than previously. states further developed or started implementing
trading schemes, and are reportedly planning to
open for submitting CERs for compliance. To the
Chinese price floor at €8-9/t provides
extent this influenced the current market at all,
a strong price signal this (together with the post-2012 negotiations)
strengthened the belief in a post-2012 CDM market,
The CDM market in 2006 can also be summed
and some very few forward CER trades now include
up in other ways. First, market players learned
Verified Emission Reductions (VERs) or CERs for the
the hard way that there are real risks related to
post-2012 period.
methodologies, for instance the slashing of CERs
from manure management projects and general
delays due to lack of UNFCCC staff, host country 3.2.2 JI in 2006
approval (Thailand and Brazil), project performance Point Carbon reckons that the JI project market
compared to plans (especially landfill gas) and saw 20.5 Mt CO2e transacted in 2006. Of that,
Executive Board approval (several projects rejected, 16.7 Mt CO2e represents confirmed transactions
or delayed due to reviews). registered in Point Carbon’s transaction database,
Figure3.19: Who are they and what do they want, Part II

The relative share of categories of JI buyers (left) and project types (right) in 2006.
Funds Unknown ENEF

2% Fuel
21% 15%
Waste switching
16% 2%
Fugitive
emissions
6%
Private Government
18% 61% Industrial
Renewable processes
37% 22%

Carbon 2007
Figure 3.20: From East to West

The relative share of JI country sellers (left) and buyers (right) in 2006.
Others Others
11% Bulgaria
Poland 17% 10% Austria
6% World Bank 29%
12%
Ukraine Czech
15% Republic
21% Netherlands
13%
Russia
Romania
15%
15%
Source: Point Carbon Denmark
36%
while the remaining 3.8 Mt CO2e are estimated We estimate the total financial value of JI transactions
using data from Point Carbon’s project database to be €95.2 million in 2006 money (7 per cent
and regular contact with market participants. The discount rate), almost exactly at the same level as in
quarterly average was 5.1 Mt, with a somewhat 2005. Taking only the confirmed JI transactions into
smaller volume of contracts in the second quarter account, we end up with a volume-weighted unit
and higher volumes in Q4. price of €6.5/t (€5.1/t in 2005).
Reported ERU prices in 2006 were between €4.5
and €12.5. The price did not see any abrupt changes, Average price for JI transactions in
partly because JI is still dominated by governmental 2006: €6.5/t
buyers which have limits on their budgets and are
not very flexible with the prices they offer. They Governmental buyers still dominate the JI market,
also usually negotiate the price at early stages of with 61 per cent of the purchases in 2006, although
the projects, and the resulting price at the date of there are other buyers also entering the picture. Funds
contract signature does not necessarily reflect the and private buyers both have market shares around
latest market trends. 20 per cent. The situation changed dramatically in
Table 3: CER prices throughout 2006

Price of primary transactions at start and end of 2006, the range as well as the volume weighted
unit price for the year in total, in €/tonne.
Start 2006 End 2006 Range Vol.weighted unit price

Price category 1 €4 €5 €3.5 - €7 €5.87
Price category 2 €7 €7 €3.5 - €15 €8.09
Price category 3 €14 €10 €8 - €18 €12.99
Price category 4 €18 €13 €13 - €18 €16.97

13 March 2007
2006 from 2005, when the governments covered were not contracted before January 2007 (eg. one
96 per cent of the buy-side in the JI market. 10 Mt CO2e contract), there are at least four reasons
Still, in many cases, JI appears to be more favourable why the volume of JI transactions did not increase
for governmental buyers than for private. The most in 2006, but ended approximately at the same level
active ERU buyers in 2006 were Denmark (36 per as in 2005.
cent of all JI transactions), Austria (29 per cent) and
the Netherlands (13 per cent). The most active sellers Procedural uncertainty limits JI
were the Czech Republic (21 per cent) followed by transactions
Bulgaria, Romania, Russia and Ukraine (15 per cent
each). First, there is still considerable uncertainty related to
The most significant project types among JI contracts JI projects in Russia. Russia is potentially the largest
in 2006 in terms of volume were renewables (37 seller of ERUs, but did not manage to establish its
per cent), industrial processes (22 per cent), waste JI procedures in 2006, and it took until the end of
(16 per cent) and energy efficiency (15 per cent). the year before several key ministries reached an
Renewable energy projects, although not big in size, agreement on the principles of JI guidelines.
were numerous, with several biomass, wind and Second, the regulatory infrastructure in Ukraine
hydro projects. was not resolved until the end of 2006 and, thus,
for most of the 2006 it was still uncertain, with few
Renewable JI projects biggest in projects receiving a Letter of Approval (LoA) from
2006 the Ukrainian government.
Third, the threat of EU ETS double counting rules
Conversely, there were few industrial processes has been slowing JI transactions over 2006. The
projects, represented by N2O reductions, which double counting avoidance guidelines practically
brought relatively high volume to the market. Landfill rule out all future projects in EU ETS trading sectors,
gas recovery and energy efficiency contributed leaving mainly non-CO2 gases for JI. This significantly
around 15 per cent of contracted volume each. limited the scope for JI in host countries that recently
In addition to the fact that some large deals that joined the EU. Finally, despite the increase of private
we had expected to be concluded in 2006, actually buyers, there is rather low interest from the private
Figure 3.21 Short-term price drivers for CDM and JI

Other factors
Earlier deals
CDM Methodology panel
Governmental demand
Actual project costs
EU ETS 08-12 price
Political factors
0% 10% 20% 30% 40% 50%

Share of responses

Carbon 2007
Figure 3.22 Long-term price drivers for CDM and JI

Other factors
Earlier deals
CDM Methodology panel
Governmental demand
Actual project costs
EU ETS 08-12 price
Political factors
0% 10% 20% 30% 40% 50% 60%

Share of responses
Figure 3.23 Assessing the CDM/JI market

The CDM&JI market is a

mature market
The CDM&JI market is a

success
The CDM&JI market is the

most cost-efficient way to
reduce emissions
The CDM&JI market is

more mature now than one
year ago
The CDM&JI market

facilitates emissions
reductions
0% 20% 40% 60% 80%

Share of responses

13 March 2007
sector as companies are still not familiar with JI. around €15. The volume-weighted average price for
Investors preferred CDM which has established a secondary transactions was €14.3/tonne in 2006.
track record, while JI is only preparing its routines.
What does the survey reveal of price drivers in
The Joint Implementation Supervisory Committee
the CDM/JI market? Figures 3.21 and 3.22 show
(JISC) started its work in 2006 and officially
what the respondents to our web-survey saw as
launched the JI Track 2 process on October 26
the most important price drivers in the short- and
2006. Once the JI mechanism gets up and running
long-term. The main change from last year is that
it is possible that we will see further private sector
political decisions have become far more important,
interest in credits from Eastern Europe, but this is
with more than 40 % of the responses on the short-
still uncertain.
term horizon, and above 50 % in the longer term
horizon, citing policy decisions as the key price
What drives the CDM/JI prices? driver. Interestingly, it is the political decisions in
Reported forward CER prices in 2006 have varied developed countries and on the international arena
between €3.5 and €20, and have clearly been that constitute the majority of these responses, and
influenced by the variations in the EUA-prices. not the decisions taken by the CDM methodology
Table 3 shows the ranges and variations seen in panel, which is seen as a less important price driver
Point Carbon’s CER forward price categories. compared to last year.
The price impact of the EU price crash came later
for category 1 and 2 deals than for category 3
Volume-weighted average CER price
deals. This is not too surprising as category 1 and
€8.32/t in 2006
2 deals are often more closely linked to long-term
carbon finance structures for projects that are still
in early stages of development. As CDM covers more than 90% of the entire project
market, it seems fair to assume that the respondents
Also, many of them are done by governments,
to the survey for the most part focused on this market
which are less sensitive to short term EUA price
when answering questions relevant for both CDM
developments. Volume-weighted unit price in 2006
and JI, see Figure 3.23. For instance, a larger share
was €8.32/tonne, up from €6.70/tonne in 2005.
of the respondents thinks that the CDM/JI market
Secondary CER prices have fallen relative to EUA is a success, compared to the 2006 survey. This fits
prices, as they were squeezed between primary well with the market results presented above. The
market prices of up to €10 and EUA 2008 prices of CDM market grows continuously, CERs are issued
Figure 3.24: And now for something completely different...

The relative share of other carbon markets, physical volume and financial value.
Physical volumes (30.5 Mt CO2e)

Financial value (€300 million)
UK ETS
2%
UK ETS
CCX 1%
33%
NSW GGAS CCX NSW GGAS
66% 9% 90%

Carbon 2007
on a regular basis, and the demand for these credits transferred on the registry tripled from 6 million
increases as the EU ETS phase II is approaching. In in 2005 to 20 million in 2006. Accordingly, the
general, it seems that the respondents have more estimated financial value jumped three-and-a-half
confidence in the CDM market now than just one times from A$78.2 million (€48.5 million) in 2005 to
year ago. A$268.3 million (€160 million) in 2006.
The NSW scheme administrator registered just over
3.3 Other markets 669 transactions over the course of 2006. February
Several greenhouse gas emissions trading schemes was the busiest month again last year, followed by
exist beyond the bounds of the Kyoto Protocol and December, with 84 and 70 transfers each.
its spin-off markets. The Chicago Climate Exchange The Chicago Climate Exchange in the U.S. has grown
is voluntary, although once a company has joined, tenfold in stature in a year when a firm domestic
the cap is binding. The New South Wales scheme federal carbon policy has appeared on the horizon.
in Australia imposes a mandatory cap on power Its share of the “other” market grew from 18%
suppliers, but leaves the door open to local offset of the volume in 2005 to 33% in 2006, and from
projects. 5% of the financial value in 2005 to 9% in 2006.
The UK ETS expired at the end of 2006, with The Chicago Climate Exchange (CCX) continued its
compliance due in March 2007. Official data for the growth path with 225 members at the end of 2006,
up from 129 in 2005. With new vintages traded out
to 2010, there was a ten-fold increase in volumes,
Other markets did 31 Mt, €300 mil- from 1.43 Mt CO2e transacted in 2005 to 10.2 Mt
lion in 2006 CO2e in 2006.
2006 trading year is not released until May 2007.

We have excluded the increasing voluntary sector The New South Wales dominating,
(offsets for air travel, etc.), which is building in 66% of physical volume
size and dynamism, from this report, but this will
be subject to an analysis by Point Carbon later this There was also an eerily exact doubling in the
year. average market price for the 2005 vintage, from
Last year saw an interesting development, as the US$1.78 in 2005, to US$3.56 in 2006 for the same
total volume in the category of ‘other’ emissions vintage. The result is a 13-fold increase in financial
markets grew four-fold, from 7.8 Mt CO2e in 2005 value from US$2.83 million (€2.37 million) in 2005
to 30.9 Mt CO2e in 2006. In financial terms, the to US$36.5 million (€28 million) in 2006.The UK
increase was almost six-fold, from €52 million in ETS, another voluntary scheme, was launched
2005 to almost €300 million in 2006. in 2002 and expired at the end of 2006. The final
compliance cycle will take place in March 2007.
This sharp growth trend in these markets was put However, the climate change agreements segment
down in part to the increased number of participants, of the market continues. As a result, the UK ETS
new members and vintages in the case of CCX, and now demonstrates what a pure compliance market
newly approved offset projects in the NSW scheme. looks like, without the activity of speculators. In the
In the case of the latter, the new projects brought UK scheme, it makes for a flat price curve and little
supply and therefore volatility to a hitherto stagnant change in volumes from day to day.
market, further increasing volume.
In its dying year, the UK ETS showed no growth
The New South Wales scheme in Australia, the only either in volume or value, with approximately
mandatory scheme in this segment, still dominates 500,000 tonnes CO2e transacted and a financial size
amongst the “other” trading schemes, with 66 per of GBP1,000,000 (€1.5 million).
cent of the total physical volume transferred, and 90
per cent of the financial value.
There was also an advance in the average spot
price, from A$12.80 to A$13.31 in 2005 and 2006
respectively. The volume of New South Wales
Greenhouse Gas Abatement Certificates (NGACs)

13 March 2007
4. Carbon across commodities non-CO2 emitting forms of generation (predominantly

hydro). The Nordic market is interconnected with the
The impact of carbon prices on the power prices
Continental markets (Germany) which operates as
across Europe has received a lot of attention since
swing supply in response to hydro availability.
the start of the scheme. However, there is still not
“one” European power market and the level of pass- How is the carbon price passed on to the power
through of CO2 prices into the power price will vary price? When looking at the impact of CO2 on power
across the different markets. market dynamics, it is important to realise that the
proportion of the CO2 price provided for free (through
We look at evidence of how the following power allocation) will have a role to play. However, from an
markets have responded to date to the introduction economic optimisation standpoint it is incorrect to
of CO2 pricing: assume that if the majority of the CO2 allowances
1. The European Continental market using the German are provided free to the operator, then the CO2
baseload price as the basis price for this market. The price will not subsequently influence power pricing.
market encompasses Germany, France, Austria and This is because the traded CO2 price becomes an
Switzerland which all have prices with high levels of opportunity cost for the generator that it must take
convergence. This market is characterised by having into account in deciding to generate.
considerable coal capacity (around 70% of installed
thermal capacity in Germany is coal fired) sitting How is the carbon price passed on
alongside non-CO2 emitting forms of generation such to the power price?
as nuclear, hydro and wind;
2. The UK market which is characterised by an almost The carbon price is an opportunity cost because in
even mix of coal and gas fired installed capacity, with deciding to generate, a power producer will use up
gas plant now being the marginal thermal plant in both its fuel and the EUAs required to off-set the
many periods; emissions from that generation. In a perfect power
3. The Nordic market which brings together the power markets, generators will only generate electricity
markets of Norway, Sweden, Finland and Denmark. if the revenue from selling electricity exceeds the
This market is characterised as being dominated by revenue that they could earn from selling their fuel
Figure 4.1 German year-ahead contracts 2003 - 2006
45
100% pass Upwards
50% pass through into adjustment in
40 through into forwards underlying
forwards spreads??
Dspread
DGSPREAD
35
ADGspread
30
25
no pass through into forwards
20
€/MWh
15
10
0
03
03
03
03
04
04
04
04
05
05
05
05
06
06
06
06
-5
0
0
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
1
0
/0
/0
/0
/1
/0
/0
/0
/1
/0
/0
/0
/1
/0
/0
/0
/1
01
01
01
01
01
01
01
01
01
01
01
01
01
01
01
01
-10

Carbon 2007
Figure 4.2 Switching potential in UK, 2005 - 2006
Gas fired generation cheaper than coal

COAL - GAS
(including generation carbon costs)
40
Gas-fired generation made competitive with

the CO2 price during the energy summer CO2 price not at a level to make
20
gas-fired generation competitive
against coal
0
€/MWh
-20
Coal consistently in
the money against
gas throughout
-40
-60
Coal fired generation cheaper than
gas (including generation carbon
-80
05
05
05
05
05
05
06
06
06
06
06
06
0
0
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
/2
1
1
/0
/0
/0
/0
/0
/1
/0
/0
/0
/0
/0
/1
04
04
04
04
04
04
04
04
04
04
04
04
and EUAs in the respective (spot) markets. This as this starts to impact on the level of fixed costs
will influence power prices as the electricity market that are recovered.
needs to provide a higher level of remuneration for
generators to secure the same volume of electricity. When looking at the evidence of carbon influencing
However, this does not necessarily mean that the power prices, we focus on looking at the following
spreads.
CO2 price will influence the electricity price in every
hour. 1. Spark spread – the power price less the price of gas
adjusted for the efficiency of gas-fired generation plant;
German spreads did not factor in the 2. Dark spread - the power price less the price of coal
price for carbon prior to 2005 adjusted for the efficiency of the coal-fired generation
plant;
As the off-peak power market is the most 3. Spark green spread – the spark spread less the price
competitive, we would expect that this is when the of CO2 adjusted for the carbon intensity of gas-fired
carbon price will have the biggest impact on power generation; and
prices. In periods when the power price is likely to
4. Dark green spread – the dark spread less the price
exceed short-run marginal costs (fuel and carbon),
then generators do not need any additional incentive of CO2 adjusted for the carbon intensity of coal-fired
to produce generation to meet demand and prices generation.
should remain unaffected. Reflecting the generation mix in each of these
countries, we look at dark spreads for German
In addition to being opportunity costs, some cost power and spark spreads for UK power. As the low
of the EU ETS will have been incurred for this
CO2 emitting Nord Pool system trades directly with
sector as power producers in aggregate were short
the German system, we look at dark spreads for
allowances in 2005. Generators will want to recover
Nord Pool as well.
any costs associated with allowances purchased on
the market to off-set generation. As this increasingly We focus on the CO2 impact on the forward curve
becomes the case for Phase II (less free allocation (price for future delivery) rather than the spot
and more incurred cost), we would expect that the price (for immediate delivery). Forward spreads
impact on the power price will increase to all periods reflect participants expectations of average future

13 March 2007
Figure 4.3 Spreads for the year-ahead contracts in UK
20
Spark Spread
18 Green Spark Spread
16
14
12
€/MWh
10
0
Jun 03
Dec 03
Feb 04
Jun 04
Dec 04
Feb 05
Jun 05
Dec 05
Feb 06
Jun 06
Dec 06
Aug 03
Apr 04
Aug 04
Apr 05
Aug 05
Apr 06
Aug 06
Oct 03
Oct 04
Oct 05
Oct 06
outcomes (as this influences their willingness to pay to well over 20 €/MWh do not seem fully consistent
for a hedge) and these tend to be more constant. with demand and supply side developments in this
Indeed, these are more influenced by expected market.
changes in annual demand and supply patterns and From this, we conclude that despite a slow start to
these only change gradually year to year. recognising the likely impact of the EU ETS on the
market, German forward power prices now appear
Germany to be pricing carbon fully into the price of power for
future delivery. This has had the effect of increasing
Figure 4.1 shows how the spreads attached to front
dark spreads by anywhere between 10–30 €/MWh
year contracts in Germany have traded over the last
few years. We find that, prior to the start of EU ETS, depending on the prevailing CO2 price
the German spreads did not appear to factor in the
market price for CO2 into the 2005 contract. The UK
increase in spreads from the carbon pass-through Our analysis of the carbon impact on UK power
occurred gradually, and it appeared that by the end focuses on the switching opportunities introduced
of 2005 the full opportunity costs of carbon were by carbon prices. We compare the variable costs of
being factored into the year-ahead contract. coal-fired generation against gas-fired generation in
the UK including the opportunity costs (or market
German forward power prices now price) of CO2 since 2005. If coal is more expensive
appear to fully price in carbon than gas one would expect a “switch” to cleaner gas-
fired generation (we have not considered whether
such changes are constrained by other parameters,
Coinciding with the correction in the EUA price in
but look only at the price evidence). Have carbon
April/May 2006, the underlying dark green spread
prices induced a switch towards gas in the UK?
increased despite a reduction in the dark spread.
The increase in that spread became even more Figure 4.2 shows the development of prompt power
noticeable given further reductions in the EUA price prices in the UK, highlighting the periods when the
at the end of the year. The increase in those spreads CO2 price made gas-fired generation competitive

Carbon 2007
Figure 4.4 Carbon impacts on Nordic market through Germany
45
Dark Spread
Dark Green Spread
35
Adjusted Dark Green Spread
25
€/MWh
15
5
May 03
Sep 03
May 04
May 05
Nov 03
Sep 04
Nov 04
Sep 05
May 06
Nov 05
Sep 06
Jan 03
Mar 03
Jan 04
Mar 04
Mar 06
Nov 06
Jul 03
Jul 04
Jan 05
Mar 05
Jul 05
Jan 06
Jul 06
-5
-15
to coal. A positive number means the coal is more traded with an average spark spread of around 7.5
expensive than gas whereas a negative number €/MWh, and that there was a sharp and immediate
means that gas is more expensive than coal. increase in the spark spread in 2005, to around €12/
MWh. The green spread remained at the same level
We find that throughout the energy summer in 2005
as before, suggesting an immediate and full pass-
the carbon price was at a level sufficient to encourage
through of the carbon price.
gas-fired generation over coal-fired generation.
However, following the collapse in EUA prices at the 2006 continued in the same pattern established
for 2005, with spreads rising and falling with the
Coal consistently more competitive developments in the carbon price and the green
than gas throughout summer 06 spread remaining around the 7.5 €/MWh level. The
increasing green spark spread at the end of the year
beginning of May 2006, coal-fired generation was reflects the rapidly declining carbon price, and we
consistently more competitive than gas throughout also see that softening gas prices impacted both
the summer. The exception to this was for a limited spreads.
time period at the end of September/beginning of
October 2006, when commissioning of new gas The impact of CO2 price on UK po-
infrastructure in the UK pushed NBP gas prices down wer has been 100 % pass-through
to levels where it was competitive to switch. Due to
these dynamics, coal burn in the power sector in the
UK in Q3 2006 was 25% higher than in Q3 2005. The UK market has seen only minor changes in
the last three years, with no significant retirement
Fig 4.3 shows the different spreads for the year- of plants, little new build and only very low levels
ahead contracts in the UK market. We see that the of demand growth. As such, we would expect the
contract for delivery of power in 2004 (pre-ETS)

13 March 2007
average forward spread level to have remained

largely constant throughout the years under study.
We therefore conclude that the impact of the CO2
price on the UK power has been one of 100% pass-
through.
Nordic market
As the low CO2 emitting Nord Pool system trades
directly with the German system, we look at dark
spreads for the Nordic market as well. From Figure
4.4, we see that the contract for delivery of power in
2004 (pre-EU ETS) was such the dark spread traded
between 10 and 15 €/MWh, across what was a dry
year (2003) for most of Europe.
2005 traded with a dark spread that was reasonably
constant around the 6 €/MWh level, reflecting
increasing reservoir levels throughout 2004. Given
the consistently negative dark green spreads
throughout the period, we conclude that the CO2
price had no impact on forward power prices
throughout this period.
In 2006 the Nordic market showed a similar pattern
to that seen in German prices, with the dark spread
continuously increasing in line with the CO2 price.
As with Germany, the forward prices did not seem
at any point in that year to be fully pricing in 100%
of the CO2 price with the second half of the year
having relatively constant spreads with the previous
year with a 50% pass-through level.
Main impact of the EU ETS on Nor-

dic power market through the trade
with Germany
2007 again follow closely on the behaviour of the

German market, with spread levels increasing
and persisting at a high level following the CO2
readjustments of prices.
We see that the underlying forward spreads in the
Nordic power market have followed the lead of the
German market and behaved in a similar manner –
responding slowly to the introduction of the scheme
but now passing through a reasonably high level of
the carbon price into the forward power prices. This
suggests that the main impact of the EU ETS on the
Nordic power market has been through the trade
with Germany – which often is seen as setting the
marginal value of water in this system.

Carbon 2007
5. Outlook for 2007 in the industry sectors. This was the situation seen
in Q4 2004 when e.g. the European metals sector
produced at a maximum, reportedly postponing any
5.1 EU ETS
maintenance to 2005 (although it is far from certain
To arrive at our expectations for 2007 we first need that this shift was due to carbon pricing being
to specify the assumptions behind our volume introduced…).
forecast. We expect Phase I activity to die out as the
year closes and compliance needs fade away, leaving High Q1-08 power prices in relation to Q4-07
a lot of industrials with excess allowances and no could potentially lead to hydro producers moving
buyers to pick up the length. Increased activity could production forward, given the higher value of their
be seen in the last three months of Phase I, as all water in 2008. This could in turn lead to increased
installations have to ensure end-of-year compliance. thermal production towards the end of the year,
sustaining compliance needs.
There could be surprises for the 2006 verification
that could change the overall picture. We still expect Trading activity shifts towards Phase
Phase I to be comfortably long, especially given the II
large volumes of New Entrant Reserves Member
States still claim will make their way to market.
Our second assumption on EU ETS volumes in 2007
is that most of the activity shifts to Phase II. This
Phase I still expected to be comfor- would be a direct continuation of the trend seen so
tably long far, and we expect activity to increase further once
most of the allocation plans are finalised.
There are also other developments that could counter
our expectations of Phase I dying out. If industry With time, traders will also be allowed to trade
companies choose to maximise their production further out on the curve, in particular as they need to
towards the end of the year, in order to minimise hedge strips of forward delivery of CERs. We could
the production needs at the beginning of 2008, also see more speculators entering the market,
this could lead to length being absorbed internally many of them returning after having burnt their
Figure 5.1 What will be the price of EUA phase 1 and phase 2 forward
contracts by the end of 2007?
Lower than today
At same level as
today
Higher than today
0% 20% 40% 60% 80%

Share of responses
Source: Point Carbon Phase 1 Phase 2

13 March 2007
Figure 5.2 What will be the price of EUA phase 1 forward contracts by the end of 2007?
Higher than today
At same level as
today
Lower than today
0% 20% 40% 60%

Share of responses
the total financial value to €18.5 billion, based on

fingers on Phase I. We’d also expect to see more of
current prices. This is not much of an increase from
the mid-ranking operators entering the carbon game
2006, but is due to the relatively low prices for both
early on.
phases. However, the total value is not likely to
The start of 2007 has seen daily traded volumes be much lower, as the EUA Phase II price seems
averaging at 4.8 Mt/day. A simple continuation of to have good support above €12/t. If Dec-08 prices
this would lead to over 1.1 Gt for the year as a whole. increase to €20/t, the total value for EU ETS in 2007
Actually, we expect trading activity to increase could increase to €27.6 billion.
throughout the year, as the interest in Phase II
What do the respondents to the survey think about
trading takes off. Accounting for lower activity in
the forward prices? Figure 5.1 shows that by the
the summer and daily volumes approaching 7-8 Mt/
end of 2007 phase 1 forward contracts are expected
day towards the end of the year, we estimate the
to be at today’s level, while phase 2 contracts are
total volume for 2007 to be 1,550 Mt, essentially a
expected to be higher than today. Figure 5.2 clearly
doubling from OTC and exchange volumes in 2006.
illustrates the difference between this year’s survey
Including the elusive direct-bilateral volumes at 200
and last year. In 2006, before the publication of the
Mt we forecast total trading activity in 2007 at 1,750
verified 2005 emissions, the prices were expected
Mt.
to increase one year ahead. Indeed, they did not,
which is reflected in this year’s survey.
We expect EU ETS to do 1,750 Mt,
€18.5 bn in 2007 5.2 Kyoto markets in 2007
Based on current prices (€1.00/t for Dec-07 and
5.2.1 CDM
€13.00/t for Dec-08) and that 400 Mt of the total
will come in Phase I allowances, we find that the We expect a slight decrease in primary contracted
financial value of the brokered and exchange market volumes in 2007, from 522 Mt CO2e in 2006 to
could reach €15.9 billion for the year ahead. 456 Mt CO2e. The corresponding financial value of
these transactions, using a 7 per cent discount rate,
Assuming that much of the direct-bilateral volumes
is estimated to €3.3 bn (€3.4 bn in 2006). We have
will come in Phase II allowances this would bring
employed the CER price at the time of writing, €9/

Carbon 2007
Figure 5.3 Rise and fall of CDM project types

Expected volume of CDM project types in 2007, compared to 2006, in Mt CO2e.
200
180
160
140 2006 (523 Mt CO2e)

2007 (456 Mt CO2e)
120
Mt CO2e
100
80
60
40
20
t
3
2O
te
ns
ng
g
y
en
rg
nc
-2
ri n
as
io
hi
LU
N
FC
no
e
em
ie
fla
s
W
it c
en
fic
is
LU
nk
H
sw
as
em
e
ef
/u
l
G
ab
er
el
y
e
rg
w
th
Fu
t iv
e
e
gi
En
en
Fu
R
tonne, which reflects the Chinese price floor, being year, we expect some quite large multilateral and
slightly higher than the volume-weighted average government-driven deals to be made within 2007.
price for 2006 at €8.32/tonne. These are distributed among the different project
types in our 2007 estimate.
As mentioned above, a huge chunk of the volumes
contracted in 2006 were from HFC-23 and N2O adipic We have previously highlighted the possible
acid projects. Almost all pre-2012 CERs from such inclusion of so-called new capacity HFC-23 under
projects have been bought now. Therefore, while the CDM, and potential volumes arising from such
volumes in other categories will keep on growing, projects in 2007. However, the Nairobi COP/MOP in
these low hanging fruits are now more or less taken. November 2006 delayed its decision on this matter
for another year at least, so this is not included in our
We expect N2O volumes to go significantly down, as
scenario, being another reason for the estimated
many of the available projects are much smaller than
drop in primary CDM transactions in 2007.
the ones already contracted. While the projected
HFC-23 volume is still quite high, two projects might
fall out due to lack of host country approval in China. HFC-23 and N2O projects possibly
If so, HFC-23 volumes might go down by as much as over the top
80Mt, reducing our total estimate on primary CDM
transactions in 2007 to 380 Mt CO2e, €2.7 bn. The secondary CER market has lots of similarities
with the bilateral EUA market, and the best way to
assess market volumes is to make inferences from
Kyoto markets expected to do 597 the primary market developments.
Mt, €4.6 bn in 2007
Our conservative assumption is that all secondary
We expect an increasing number of sizeable deals trades in 2007 will be based on volumes issued to
within energy efficiency, gas flaring reduction, fuel aggregators, financial funds and companies in the
switching and coal mine methane projects, see EU power sector, and that all volumes issued to such
Figure 5.3. The controversy around the so-called players in 2007 will be resold once. This is based
‘programmes of activities’ will likely be solved on the assumption that EU power companies have
relatively soon. While such projects take time to an active carbon portfolio management favouring
prepare, so that few of them will be contracted this dynamic trading, and that CER aggregators most
likely will look to hedge their positions by selling

13 March 2007
Figure 5.4: Rise and fall of JI project types

Expected volume of JI project types in 2007, compared to 2006, in Mt CO2
30.0
25.0
20.0 2007 (45.2 Mt CO2e)

2006 (20.5 Mt CO2e)
Mt CO2e
15.0
10.0
5.0
0.0
Fugitive Renewable Industrial Fuel Waste ENEF Unknown
emissions processes switching
on some of the volumes in their portfolio. Although be slightly pessimistic – after all, there are examples
many aggregators were recently publicly listed, and of secondary forward deals based on projects on
thus received a solid amount of funding, some of relatively early stages of development. As a result,
them still could face the need to sell off parts of their the volume of secondary trades in 2007 might turn
portfolio during 2007 to raise more cash. out higher than our estimate.
Our projected volume of issued CERs in 2007 On the other hand, it is rather optimistic to assume
combined with our information on the distribution that all volumes issued to aggregators, financial
of project participants yields a total projected size of funds and companies in the EU power sector will
the 2007 secondary CER market of 96 Mt. Current be sold on, although the issued volume until end
secondary CER prices are at about 85 per cent of 2006 was smaller than the confirmed secondary
the EUA 08-contract (€13/t), providing a secondary transactions that year.
CDM market worth €1.06 billion in 2007. This is
considerably up from 2006 where 40 Mt CO2e were It could be argued that the 2006 volumes were
traded worth €570 million. boosted by a number of large barter deals where
technology providers got CERs in return for
providing technology and competence to project
96 Mt, €1 bn expected from the hosts reducing HFC-23 or N2O adipic acid. It is
secondary CDM market in 2007 unlikely that such deals will be as frequent (or large)
in 2007.
Although this is our best estimate, there are
uncertainties related to this. We do not assume The CDM Executive Board now has a solid financial
any secondary trades based on volumes issued to situation, and is aggressively hiring new staff. We
governmental purchasing programmes, industry, believe the clogging of the methodology process
compliance funds or non-EU power companies. will be reduced during 2007 as a consequence of
this, which will delay fewer deals for this reason.
Nor do we assume any secondary forward deals
based on not yet issued volumes from projects On the other hand, the strengthened support
that are scheduled to have issuance within end structure also means the EB will be able to scrutinise
2007, or based on CERs from projects that are not more projects’ additionality claims, so the number
scheduled for issuance until after 2007. This might of reviews and rejections of projects is not likely
to go down, with corresponding consequences for

Carbon 2007
transactions based on these projects. It wouldn’t might establish its JI guidelines and start to approve
be surprising if 2007 brought court cases over its first JI projects this year, giving space for some
rejections and/or CER volumes shaved off for contracts. Also, positive developments in Russia
regulatory reasons. may trigger a number of conditional contracts being
signed, even before they receive LoA as the rules
5.2.2 JI become clear and the risk of non-approval reduces.
We expect the contracted JI volumes to increase Some contracts will continue to come out in Romania
in 2007, with a best estimate of 45.2 Mt CO2e, and and Bulgaria, mainly from projects developed in the
a range of 30 – 75 Mt CO2e, worth €277 million. previous years. At the same time, few new projects
This allows both for contracts that were not quite are expected in new EU Member States, since the
finalised by the end of 2006 and new JI projects that scope for JI is restricted by the EU ETS double-
started to develop after the launch of JI Track 2 that counting rules.
reach a stage where they can conclude an ERPA.
Fugitive emission reduction projects, mostly Fugitive emission reduction projects
coal mine methane and leakage reductions in to increase considerably
gas distribution networks in Ukraine and Russia,
respectively, are expected to grow considerably
from 2006. The first JI projects may start to receive final PDD
determination under the JI Track 2 procedure this
A number of PDDs for such projects are currently year, and will be able to charge higher price for
going through the determination process, suggesting their ERUs. At the same time, the number of such
that some of them may sell their ERUs in 2007. The projects will be somewhat limited as the publication
fugitive emission projects will dwarf the relative of the determination reports will be delayed in many
contribution of other technologies, which will mostly cases by the lack of approval from host and investor
remain at approximately the same level in terms of counties, unless the JISC reverses its decision.
volume.
Also, the JISC is set to face funding problems as the
Ukraine will probably speed up the project approval countries that pledged to funds its operation have
process and more LoA will be issued, which will not implemented their promises. This may constrain
open the door for more ERPAs. Meanwhile, Russia
Figure 5.5 What will be the price of an issued CER by the end of 2007, Part I
Higher than today
As today
Lower than today
0% 20% 40% 60% 80%

13 March 2007
Figure 5.6 What will be the price of an issued CER by the end of 2007, Part II
CER more expensive

than EUA
CER=EUA
CER less expensive

than EUA
0% 20% 40% 60%
JI project assessment under Track 2 and put off the

There is interest from buyer countries, notably
finalisation of PDD determinations for projects.
Japan and progress on the necessary institutional
What do the respondents to the survey think about arrangements in some potential AAU seller countries.
the CERs in the 2007? Figure 5.5 shows that the While it is possible the first pilot AAU deals occur by
respondents think that the CER prices will be higher the end of 2007, we deem it unlikely and have put
than today by the end of 2007. That said, relatively our expected volume in 2007 at zero.
fewer respondents are that optimistic about the rise
However, when GIS transactions do finally take
in the CER prices, compared to last year’s Carbon
place, the volume of AAUs in each transaction will
Market Survey.
be high, most likely within the range of 20-80 Mt
CO2e in each trade.
Other markets expected at 50 Mt,
€500 milion in 2007
5.3 Other markets in 2007
Moreover, this year’s respondents think that the In 2007, CCX is unlikely to roll out many new vintages
CERs will be less expensive than the EUAs by the further out on the forward curve, now that it has
end of 2007. Interestingly, compared to last year, it contracts up to 2010. The value of NGACs in the
seems that the respondents think the CER prices NSW scheme is likely to continue to slide with new
will be closer to the EUA price off-set projects coming online. We expect the ‘other
markets’ segment to grow in volume and value next
5.2.3 Green Investment Scheme (GIS) year, but at a slower rate, with predictions of 50 Mt
The third Kyoto mechanism, international emission CO2e in volume and €500 million in value in 2007.
trading, has not yet reached the transaction stage.
The Green Investment Scheme (GIS) is a catch-all
name for AAU sales where the revenue is invested
by the seller country in environmental projects,
either to reduce greenhouse gas emissions (‘hard’
greening) or for other activities with environmental
benefits (‘soft’ greening).

Carbon 2007
6. First Kyoto period and beyond NAPs, the EC’s Guidance Document for Phase II
included a set “NAP common format summary
Trading is already well under way in the second year tables” for Member States to submit with the NAPs,
of the EU ETS, and new projects are coming into providing key numbers and replies to standardised
the CDM and JI pipelines on a regular basis. But questions regarding e.g. new entrants- and closure
where will the carbon market go in the future? The rules. How were these efforts taken into account in
market for EUAs with 2008 delivery has not yet fully round 2 of the NAPs?
taken off, and there are very few CDM/JI projects
that extend beyond 2012. What are the challenges
and opportunities that market participants will face No need for abatement due to credit
in the years ahead? import?
This chapter will explore some of the major
developments expected to take place in the market The general answer is: to a little degree. We still
in the near-term future, and discuss whether they see a great variation in allocation methods between
will have any significant implications for current countries. The Guidance Document’s definition of
market activity. “combustion installation” has largely been followed,
resulting in a more harmonised coverage of these
6.1 2008 – 2012 installations across Member States in Phase 2
compared to Phase 1. The “NAP common format
2007 is the last year before the Kyoto period starts, summary tables” are invaluable in the evaluation of
with substantial changes for the carbon market as a the individual NAPs and in the comparison between
whole. The EU ETS will finish its first phase, often them – that is, if they have been filled out by the
referred to as a trial period. How are the preparations Member States. Far from all Member States have
going for Phase II of the EU ETS? CDM and JI submitted these tables, and none had completed all
markets are also gearing up for the Kyoto period, with the tables in their submitted NAPs (although they
governments and private companies alike expected might have done so later on).
to increase their purchasing budgets considerably
in the coming years? Will the developments in the To auction or not to auction?
CDM and JI markets in fact result in so many credits
Auctioning has been a topical issue throughout the
available that the European private sector can import
NAP-process, and is closely linked to the wider
everything it needs, not having to resort to internal
discussion about windfall profits to the power
abatement at all?
industry. The directive allows for up to 10% of the
allowances to be auctioned in Phase II of the EU ETS,
6.1.1 Preparing for EU ETS Phase II against 5 % in Phase I. While more countries are
Most EU Member States submitted their national set to auction a proportion of their allowances than
allocation plans (NAPs) for Phase II to the European in the 2005-2007 period, where only four countries
Commission last year, outlining the volume of used this opportunity, it is quite clear that the level of
allowances they intended to provide to the EU ETS auctioning will remain modest also in Phase II.
sectors in the 2008-2012 period. As in Phase I, there
In total, the volume set aside for auctioning
were considerable delays in the process at Member
represented just above 1% of the total caps
State level, but in the end the first decisions by the
suggested in the NAPs. The volumes to be auctioned
EC were seen in late November 2006. What does
remain low partly because the level is modest in
the allocation process and the EC rulings tell us
most countries, but also because few of the larger
about the outlook for the future carbon market?
countries will use auctioning. Large countries such
Still far from harmonised as Spain and Italy have refrained from auctioning,
while Poland will only auction 2.6 Mt/yr of its yearly
One of the main criticisms against the allocation allocations. In its draft NAP, France proposed to auction
process for the 2005-2007 period was the lack 10 per cent of the allowances. There was, however,
of harmonisation across EU, with very different no mention of auctioning in the NAP submitted to
approaches to the setting of targets seen in the EC. Germany is also reportedly considering
Member States. In order to obtain a greater degree introducing auctioning in Phase II, although it was
of transparency and facilitate comparison between not mentioned in the submitted NAP. In addition,

13 March 2007
and as in Phase 1, auctioning is further planned The EC also made public its methodology for NAP
or considered by a number of countries (Belgium, assessments in connection with the 29 November
Spain, France, Germany, Greece, Luxembourg, announcement. Essentially, there are two methods
Latvia, Poland, Romania, Slovakia and the United for determining a country’s allowed ETS allocations.
Kingdom) as the mechanism for distributing any First, the Commission will consider whether a
surplus allowances in the New Entrants Reserve at plan will result in over-allocation, by comparing the
the end of the second commitment period. intended allocation with the 2005 verified emissions
for the ETS sectors.
And the decision is…
As of early March 2007, the European Commission
had given its ruling on 14 out of the total 27 EU Maximum allocation = (2005 ETS emissions *
Member States’ allocation plans. The first set of Growth * Carbon intensity) + new installations
decisions came on 29 November 2006, when the
EC ruled on 10 countries; Germany, Ireland, Latvia,
Lithuania, Luxembourg, Malta, Slovakia, Sweden It is worth to note that the only number in this
and the UK. Decisions have later been passed on calculation that is taken from the submitted plan is
the Netherlands and Belgium (16 January 2007), the new installations expected to come in for Phase
Slovenia (5 February), and Spain (26 February). Table II. For all other numbers the EC is relying on official
6.1 shows the status of all Member States’ NAPs, EU documentation. While this ensures a transparent
what they asked for and what they got. and consistent method for all countries, it also to
Table6.1: The decisions...

Status for Member States’ MS suggestions, EC’s decisions and the difference between these
Country NAP EC decision Change

Mt CO2 Mt CO2 Mt CO2 %
Belgium 63.1 58.5 -4.6 -7.3
Germany 465.0 453.1 -11.9 -2.6
Greece 75.5 69.1 -6.4 -8.5
Ireland 22.6 21.2 -1.5 -6.4
Latvia 7.7 3.3 -4.4 -57.1
Lithuania 16.7 16.7 -7.9 -47.3
Luxemburg 4.0 2.7 -1.3 -32.5
Malta
No real substance in Asia-Pacific
3.0 2.1 -0.9 -29.0
climate partnership
Netherlands 90.4 85.8 -4.6 -5.1
Slovakia 41.3 30.9 -10.4 -25.2
Slovenia 8.3 8.3 0.0 0.0
Spain 152.7 152.3 -0.4 -0.3
Sweden 25.2 22.8 -2.4 -9.5
UK 246.2 246.2 0.0 0.0

Carbon 2007
some extent centralises the allocation – as there is who got everything approved. In some cases the
no need to rely on what the Member States claim. EC has also deemed transportation policies to be
To us, it is obvious that the EC has learnt from the lacking, although this has only been the case for
mistakes of Phase I, where several Member States some countries.
applied for considerably more allowances than
What does the stricter allocation mean for the supply-
needed.
But establishing the maximum allocation will not be Higher level of internal abatement
enough for some countries. Many of the EU Member expected in Phase II than in Phase I
States will have an expected Kyoto gap, i.e. their
2004 emissions (or the projected 2010 emissions)
are above their Kyoto target. For these countries the demand balance in EU ETS Phase II. The results of
EC has considered whether the sum of all measures our survey show clearly that there is an expectancy
is enough to meet the Kyoto target, i.e. whether the of much higher levels of internal abatement in the EU
sum of ETS reductions, government purchase of ETS in Phase II, with 70% of respondents expecting
credits, and domestic policies will close the Kyoto more reductions in the EU ETS in the future than
gap. The Commission has here considered whether what was seen in the 2005-2007 period. However,
policies and measures are “substantiated”, and in as many as 26% expected the levels of abatement
cases where the purchase plans or domestic policies to be about the same as in Phase I, i.e. very little.
are found to be lacking, the EC has demanded cuts With the apparently very strict rulings from the EC,
in the allocation to ETS sectors. how is this possible?
It is difficult to say exactly what the EC needs in order One answer might lie in the availability for EU ETS
to find a plan to be “substantiated”. So far the whole companies to utilise CDM/JI credits for compliance.
range of outcomes has been seen, with countries Imports of credits from projects abroad will remove
like Ireland not getting any of its government the need for internal abatement, and the European
purchase approved, to Spain and the Netherlands reductions will primarily take place in e.g. China or
Figure 6.1 Level of internal abatement?

What level of internal abatement initiatives foreseen in the EU ETS during the period 2008-12 compared
to 2005-07? Based on responses to our web-survey
Lower than in the 05-07

period
About the same as in the

05-07 period
Higher than in the 05-07

period
0% 20% 40% 60% 80%


13 March 2007
Figure 6.2 CDM/JI limits

Cuts and additions in EC’s decisions on CDM/JI limit
60
50
40
% of total allocation
30
20
10
0
Ireland Spain Sweden Germany
Source: Point Carbon NAP limit Final limit
Figure 6.3 Enough CERs?

Will the credit flows from CDM/JI projects eliminate the need for internal abatement in EU ETS phase 2?
Based on web-survey.
No
Yes
0% 20% 40% 60% 80% 100%

Carbon 2007
India. But are the import limits flexible enough to private sector completely from the international
meet the entire shortfall, and will there be enough carbon market, and has set a 10% minimum limit
credits for everyone? for imports.
Cleaning up abroad? So far, only three countries have had their CDM/JI
limits cut down, while Germany opted to increase its
The allocation criteria number 12 in Annex III of the
limit from 12 to 20 per cent once the Commission’s
Directive requires Member States to specify the
methodology was known. Figure 6.2 shows the
maximum amount of CERs and ERUs (from CDM
impact of the EC decisions.
and JI projects, respectively) that may be used for
compliance purposes in phase 2 of the EU ETS. The What is the impact of the lowered CDM/JI limits? If
limit is defined as a percentage of the total allocation the limits proposed in the NAPs had been approved,
to each installation. The percentage shall be there is no doubt that the level of import would have
consistent with the Member State’s supplementarity been enough to meet the entire shortfall in the EU
obligation under the Kyoto Protocol. The limit shall ETS, and there would not have been the need for
be specified by each Member State in the NAP. any internal abatement at all. Then again, the limits
as they are today are still fairly wide, providing a
Not surprisingly, a wide range of limits were proposed
lot of flexibility for imports. But is it enough? The
results of our survey suggest that it is not enough
EC has set a 10 % minimum limit for to rely solely on imports, with 82% of respondents
import of carbon credits claiming that credit flows from CDM/JI will not be
enough to eliminate the need for internal abatement
by Member States, from 4% in the Walloon Region
in the EU ETS.
in Belgium up to 70% in Spain (power sector) and
50% in Ireland. Only three countries set the limit One reason why the import will not be enough to
below 10%. The Czech Republic and Slovakia had cover the entire short in the EU ETS is that the limits
limits on national level in their NAPs, essentially are per installation level. Thus, for the full import
introducing a “first-come, first-served” basis for potential to be realised, each installation across
imports. All other countries set their limits on the EU ETS would have to submit imported credits
installation level. A number of countries, including for compliance. With so many diverse installations
Belgium, Finland, Portugal, Spain and the UK, set (and companies) across all sectors and countries,
different limits across the sectors. The argument for there is reason to believe that the full import will
doing so is basically that the power sector is given not be realised. But it is nevertheless obvious that
the strictest allocation and will thus have the largest the imports will eliminate some of the need for
need to import credits for compliance. internal abatement, keeping the European carbon
price lower than what it would otherwise have been.
In its decision on 29 November the EC also
introduced a methodology for limiting the import of
CDM/JI credits to the EU ETS sector. Essentially,
Figure 6.4 Finding the price of carbon
what the EC does is to specify the supplementarity
Schematic showing Point Carbon’s probabilistic approach
principle under the Kyoto Protocol, where it is stated
to determining a fair price for Phase II EUAs
that the purchase of allowances/credits from abroad
shall be supplementary to domestic reductions. The
EC defines this so that no more than “half of the
Price ceiling (fuel switching)
effort undertaken by a Member State, taking into
account government purchases, is made through
the Kyoto flexible mechanisms”.
Fair price
In effect, this means that for a country where the

government is planning to buy a lot of credits, there
will no be much import flexibility for the private
sector. And the other way around: in countries where Price floor (CERs/ERUs)
the government have no plans for CDM/JI purchases
the private sector will have the opportunity to import
0 X 100%
substantial amounts of project credits from abroad.
However, the EC finds that it cannot exclude the

13 March 2007
Then again, the carbon market was always intended fuels in the power and heat sector, which in turn
to be global, and opening up for credit imports from defines a ceiling for EUA prices.
abroad simply means that the price of carbon will
This implies that the carbon price in the 2008-2012
influence investment decisions all across the world.
period will be a function of the probability that
What does it mean for prices? domestic reductions will be needed in the EU ETS.
Point Carbon defines this probability by the following
Current estimates (and the results from our survey) simplified formula:
suggests that the NAPs and the EC’s decisions will
create a substantial initial shortfall before taking
into account supply of CERs/ERUs and allowances
Phase II price = X * Switching price + (1- X) *
from various reserves. The question is thus whether
supply of CERs/ERUs and reserves will be sufficient CER/ERU price
to cover the entire shortage?
Importantly, the carbon price in the 2008-2012 Here X denotes the probability that domestic
period should not drop towards zero - as seen in reductions will be required to cover the shortfall.
2007 - due to the opportunity to bank allowances The Switching price is the cost of switching to less
into a post-2012 period. This in effect leaves us carbon-intensive fuels in the power and heat sector
with two competing regimes for Phase II. On the (ceiling) and the CER/ERU price is the price of credits
from CDM (CER) and JI (ERU) projects (floor). See
What is a fair price for allowances in Figure 6.4 for a schematic overview.
EU ETS Phase II As we have seen above, the results of our survey
one hand, if supply of credits from CDM/JI projects suggest clearly that there will not be enough credits
is sufficient to cover the entire shortfall, the price available for the EU ETS in order to cover the shortfall.
for EUAs should approach the price of CERs/ERUs But exactly how many credits will the CDM and JI
which defines a price floor. projects generate in the 2008-2012 period?
On the other hand, if the supply from abroad is not Point Carbon’s proprietary database of CDM and JI
enough, the market will have to resort to domestic projects currently contains over 1,800 CDM projects
reductions. In this case, the EUAs should be priced at so-called Project Design Document (PDD) level
against the cost of switching to less carbon-intensive and above, and over 250 JI projects at the same
Figure 6.5 Issued CERs/ERUs by 2008 and 2012

Accumulated volume of issued CERs/ERUs to the global carbon markets in 2008 (left) and 2012 (right)
Based on responses to our web-survey
50%
40%
Share of responses
30%
20%
10%
0%
< 1Gt 1 - 2 Gt 2 - 3 Gt > 3Gt < 1Gt 1 - 2 Gt 2 - 3 Gt > 3Gt

Carbon 2007
level of maturity. Based on the information in the of carbon should perhaps reflect the fuel-switching
project documentation these projects would yield price rather than the CER/ERU price floor? As
reductions well over 2,000 Mt CO2. shown in Figure 6.6, the survey respondents find
on average that the EUA price in 2010 will be about
But not all of these projects will be realised, and
€17.5/t. Based on current forward prices this is only
many of them will not deliver as much as they plan.
slightly more than €1.5/t above the price for delivery
Furthermore, it is difficult to say anything precisely
in December 2010 (assuming cost of carry from the
about exactly how many new projects that will come
Dec-09 price). Looking further ahead, our survey
on-line in the Kyoto period. The past years have seen
respondents expect the EUA price to increase in
growing interest in the CDM and JI market, but
the post-2012 period, with an average expectation
at some point it will be more difficult to find new
of €23.1/t in 2020. Hence, as shown in Figure 6.7,
investment-worthy projects.
the cost of carbon is expected to have increasingly
Our survey is not conclusive on the level of importance in business decisions.
reductions that will be generated from CDM and JI
What will it take for the carbon market to reach an
projects, with over half of the respondents unable
to give an answer on this. What is clear, however, is Average expectation for EUAs in
that those that did give an answer expected there 2020 is €23.1/t
to be a substantial growth in volume of credits
from 2008 to 2012. While the survey respondents
average price of about €23/t in 2020? And, more
on average expected 1.2 Gt of accumulated issued
importantly, who will be subject to this price?
volume of credits by 2008 (which might seem overly
Will the carbon market continue to be primarily a
optimistic given current developments), this number
European exercise, with project investments in
had increased to 1.9 Gt by 2012 (which seems
developing countries, or will more countries join in
more reasonable). Figure 6.5 shows the growth in
on this international effort? The next section looks
expected volume of credits from 2008-2012, based
more closely at the expectations for the future
on the answers of more than 900 individuals.
carbon market, discussing what the international
But even with these volumes coming in, our survey climate regime will look like post-2012 and what the
respondents do not expect it to be enough to avoid implications might be for international business.
domestic reductions in the EU ETS. Thus, the price
Figure 6.6 EUAs in 2010 and 2020

What will be the price of EUAs in 2010 and 2020? Based on responses to our web-survey
40%
Average price:
2010: €17.4/tonne
30% 2020: €23.1/tonne
Share of responses
20%
10%
0%
<€5 €5-10 €10-15 €15-20 €20-25 €25-35 >€35

13 March 2007
Figure 6.7 Increasingly important

How important is the price of carbon for short term and long term business decisions? Based on
responses to our web-survey
Decisive factor
Influencing
calculation, but
not decisive
No importance
0% 10% 20% 30% 40% 50%

Share of responses
Source: Point Carbon Short term Long term
6.2 Post – 2012 negotiate targets for the following commitment

periods, 2013-17, 2018-22 and so on. These
6.2.1 Status of the current negotiations negotiations were initiated in Montreal in December
2005.
While investment horizons for major emitters
span several decades, the Kyoto Protocol’s first There is general support for the view that global
commitment period only covers the five years from GHG emissions need to be cut significantly to avoid
2008 to 2012. There is thus a major disjuncture irreversible and catastrophic damage. However,
between the existing global framework for GHG an impasse exists over how to implement such
emissions trading and the long-term certainty cuts and who should bear the costs. The positions
needed for investment in low-carbon capital stock. are currently deadlocked, principally due to strong
In this last chapter, we address the main questions disagreements between developed (Annex 1) and
about the future of the carbon market. What does developing (non-Annex 1) countries.
the state of current negotiations say about the
likely international climate regime after 2012? Will
the US come on board, and if so, when and with
Long time horizons needed for low-
what targets? What about China and other major
carbon investments
developing countries?
The Kyoto Protocol specifies emissions reductions First, although the US has not ratified the Kyoto
targets for the developed countries listed in the Protocol, it casts a long shadow over negotiations
Protocol’s Annex B to be met over the 2008-12 by its refusal to engage meaningfully in international
period. A future global climate regime will most or domestic GHG reduction efforts. The Bush
likely be based on the KP because of the global administration justifies its lack of action by pointing
nature of the problem, and because Kyoto’s set of to developing countries and competitiveness
legally binding targets makes it currently the most concerns. Bringing the US back to the negotiation
robust instrument for addressing climate change table would thus be a first step to achieve a powerful
globally. The KP framework is also defined for an post-2012 regime.
infinite period of time. The parties that have ratified Second, the developing countries are unwilling
the Protocol, 168 countries to date, are obliged to to act before developed countries have already

Carbon 2007
Figure 6.8: The view from the G-77 and China

Per capita emissions and population in 2000, selected countries/regions, all six Kyoto gases. Note
that total emissions are given by the area of each rectangle. Source: Climate Analysis Information Tool
Version 4.0, World Resources Institute
25
1 billion
Emissions per capita (tonnes CO2e)
20
1
a
15
x
si
n ne
us
pa An
R
Ja er
th
O
10
European Union
United States
5
China Other non-Annex 1

India
0
Relative population size
demonstrated their readiness to cut their own 6.2.2 Will the US come on board?
emissions. China and the G77 suggest that until
The US midterm elections on 7 November 2006
the emissions per capita (height of bars in Figure
produced strong gains for the Democratic Party,
6.8) are lowered, there is no need for them to lower
which won a comfortable 233-202 majority in the
theirs. The US counters that the total emissions
(the surface area in Figure 6.8) of China and India A change in the US position would
are growing to compete and ultimately overtake the
have a momentous impact
US.
Developing countries want Annex B targets to be House of Representatives and a narrow 51-49 lead
at least as strict as in 2008-12, while the Annex B in the Senate. The change of House majority is
Parties themselves are split over whether new significant because any legislation will need to pass
targets should even be agreed on before the end both houses.
of 2012. This stalemate is as expected, based on
The main potential of the 2007-2009 congressional
behaviour in previous negotiations. The Kyoto
session is in shaping domestic climate policy.
Protocol itself was hammered through on overtime,
Rather than a subdued debate on whether or not to
overruling reservations by key countries.
do anything about US GHG emissions, as has been
The current situation thus does not mean that an seen in Congress until now, we are likely to see a
extension of Kyoto will not be agreed in time for more animated debate over competing bills offering
the post-2012 period. What it does mean, however, different caps and kinds of regulations.
is that a change in the US position will have a
Such a debate will also serve to satisfy part of the
momentous impact on the negotiations. But will the
oft-quoted 1997 Byrd-Hagel resolution, by many
US change its stance?
perceived as the litmus test of US climate policy.
The less well known second half of the resolution
demands a “detailed explanation of any legislation

13 March 2007
or regulatory actions that may be required to questions need to be asked: Who are the most likely
implement” the outcome agreed to in international candidates to win the 2008 presidential election?
negotiations. The hearings, discussions and What are the climate policy positions of these
proposals promised by the incoming committee presumed candidates? To identify the top candidates
chairs, mean that the US may be moving towards and subsequently to assess the probability of each
fulfilment of this second criterion of Byrd-Hagel. of them winning, we use the online betting site
Tradesports.com.
In sum, the US elections in November 2006 increased
the probability that the US will enact significant We then analyse the stated or expected climate
domestic climate policy in the future. However, the policy positions of the three most likely presidential
main impact up to the end of 2008 will come through candidates of each of the two major parties. The
a change in the national debate and legislative candidates are scored on a 0-1 binary scale, where
preparations rather than signed legislation, as we do
not expect the current president to experience any US midterm elections hold promise
Damascus moment on climate change, and since for lively national climate debate
no climate bill would have the two-thirds majority
support in both chambers to override a presidential
veto. When a new Administration takes over in 1 indicates that we are confident that the candidate
January 2009, however, a significant part of the will bring the US back to the negotiation table and
legislative work necessary for meaningful domestic support significant domestic GHG policy, notably a
US action may well already have been done. robust US ETS; 0 if otherwise.
Climate policies of the next US President While election forecasting is always a tricky
business, Tradesports.com provides a reasonably
A new president will be elected in November 2008 transparent method, and does not directly contradict
and will take office in January 2009. To assess the the assessments of other observers. While our
likely climate policies of the next president, two
Figure 6.9: The view from the Annex I countries

Emissions from in 2004, projected emissions in 2022 and breakdown of growth 2004-2022 by country or
region. All numbers represent CO2 from energy production only.
Source: Climate Analysis Information Tool Version 4.0, World Resources Institute (EIA Reference Case

 
 














 

 


  

Carbon 2007
Table 6.1: Climate policy positions of the most likely presidential candidates
The top six individuals with the highest bets on the contract “2008 US presidential election - Winning individual” on the
Tradesports.com website on 16 January 2007. The likelihood of victory is calculated as the average between bid and offer. A
climate policy score of 1 has been given to the individuals where we are reasonably confident that they would bring the US
back to international climate negotiations and support a US ETS if elected. The individuals mentioned have been included
regardless of whether they have “officially” declared their candidacies.
Candidate Party Position Score Likeli- Score *

hood likelihood
Strong. Co-authored Climate Stewardship and
Innovation Act with Sen. Lieberman to introduce
John McCain R 1 20% 0.20
GHG cap-and-trade with an absolute cap and no
“safety valve”
Ambivalent to negative. Participated in founding
RGGI, then withdrew due to fear of regional
disparities; finally upheld CO2 caps on power
Mitt Romney R plants in Massachusetts - a tougher standard 0 9% 0.00
than RGGI. Thought to reverse his green
positions to appeal to the Republican party
nationwide.
Not well known. Did not have jurisdiction over
Rudy Giuliani R 0 11% 0.00
major climate issues as mayor of New York.
Strong. Legislative record indicates strong
Hillary Clinton D support for federal cap-and-trade. In favour of 1 23% 0.23
returning to international negotiations.
Strong. Legislative record indicates support
Barack Obama D for federal cap-and-trade. Co-sponsored 2007 1 11% 0.11
resubmission of the McCain/Lieberman bill.
Strong. Features the fight against global
John Edwards D warming prominently in his presidential 1 9% 0.09
campaign.
Others R/D Field includes Gore, Huckabee, Gingrich 0.5 19% 0.09
Likelihood of president with strong climate policy position 0.72
top six candidates cover 81% of the money bid for negotiations. This is not to say the US will return to
candidates, others might emerge. the Kyoto Protocol, only that the next administration
The climate policy scores given in Table 6.1 are by will bring the US back to international climate talks
necessity crude representations of what a candidate under a UN framework, and seek a global solution to
might do if elected. Multiplying each candidate’s the problem of global warming.
score by his or her estimated probability of winning,
and adding up the results, we get the likely level 7.2.3 Our main political scenario post-2012
of climate policy from the next US president. As Our main political scenario for the 2013-2032 period
a result, our best estimate of presidential climate contains the following characteristics:
engagement is 0.72 on a 0-1 scale – a relatively high
number. 1. A new Kyoto-like Protocol will be signed by 2010 for
the 2013-17 period.
We thus conclude that we are likely to have a
2. The US will not ratify in time for 2013, but will begin by
president from 2009 who will engage in international

13 March 2007
linking to the global trading system and become a full a gap. New sectors such as aviation and marine
member from 2018. transport are likely to be included, as emissions
3. China will join around 2018 with targets, probably along from air traffic in particular is growing very rapidly.
with a few other rapidly industrialising developing A few emerging-economy OECD members (Mexico,
countries. South Korea and Turkey) and other advanced non-
While some progress might be made before 2009, Annex 1 countries (UAE, Kuwait, Singapore) look
we do not expect international negotiations to be likely to take on emission caps in the future, given
particularly productive before a new US president their advanced stages of development and, in
takes office. Note also that the time frame is tight, several cases, high per capita emissions. Remaining
particularly for the US, which is unlikely to be able developing countries have no commitments in the
to go from a negotiation outcome to presidential 2013-17 period.
signature and Senate ratification before the end of
2012. This is in part due to the fact that US Presidents
tend to be more enthusiastic about international
Carbon market remains best option
engagement than is Congress. The respondents to
for transition to low-carbon economy
the Carbon Market Survey supports our view on this
More than 40 % of the respondents to our survey
as 71 % think there will be a global agreement for
think South-Korea will take on commitments post-
the post-2012 period, see Figure 6.10.
2012. Interestingly, close to 40 % think China also
Scenario 2013-2017 will do, see Figure 6.11. The question in the survey
did not, however, ask when these countries were
1. A new Kyoto-like Protocol will be in force for existing expected to enter.
members and a few new ones.
We do not expect the targets in the second
2. US will enact domestic climate policy in parallel with
commitment period to be much stronger than in
the global regime.
the first period, particularly due to competitiveness
3. A US ETS will link with the EU ETS and spur CER concerns given that some major polluters are still
demand. outside the system.
For the 2013-17 commitment period, whether as a
The EU ETS, as specified in the Emissions Trading
second KP period or a new Protocol, our scenario
Directive of 2003, is set to continue in five-year
postulates that the new agreement is reached in
period with no end date. The EU has sketched a
time to build on the first commitment period without
Figure 6.10 Will there be a global agreement for the post-2012 period?
Not sure
20%
No
9%
Yes
71%

Carbon 2007
Figure 6.11 Who will participate in a post-2012 scheme with commitments?

Some developing countries full members
Sectors in developing countries
South-Korea
Mexico
India
China
Ukraine
Russia
USA
New Zealand
Australia
Canada
Japan
Europe
0% 20% 40% 60% 80% 100%

pathway towards emissions reductions of 20% by take on targets in later periods.

2020, or 30% if other industrialised countries (e.g.
the US) agree to take on targets. Despite non- However, a US ETS will need a few years to be
ratification by the US of the 2013-17 Protocol, we planned, and a few more before it gets implemented.
expect considerable American domestic action To be sure, there is a sense of urgency in the US
to emerge. Domestic emissions trading is a and once things get unlocked, targets could be set
precondition both for the US to gain experience with and implemented within one presidency. However,
GHG reduction policies and for rapidly industrialising we tentatively expect a federal US ETS is passed
developing countries – notably China – to agree to in 2010 and to be implemented around 2015.
Figure 6.12 Which new sectors will be included in EU ETS after 2012?
Households
Agriculture
Aluminium
Land transport
Maritime
Aviation
0% 20% 40% 60% 80% 100%

13 March 2007
Fig 6.13 Schemes formally linked to the EU ETS?

None
Korean ETS
Australian state level ETS
New Zealand ETS
Schemes in developing countries
Australian federal ETS
US state level ETS
Japanese ETS
Canadian federal ETS
US Federal ETS
0% 10% 20% 30% 40% 50% 60%
Source: Point Carbon Post 2012 2008-12
We find it likely that a US ETS will allow the use the second Byrd-Hagel requirement that domestic
of internationally sourced offsets for compliance, policies be in place before a new Protocol is ratified.
notably Certified Emission Reductions (CERs) and With domestic cap-and-trade in place, we expect
Emission Reduction Units (ERUs), as well as Verified the US to join the international climate regime from
Emission Reductions (VERs). 2018 with a countrywide cap.
More than 80 % of the respondents to the survey The implementation of the US ETS, and pressure
found it likely or very likely that there will be an EU from the new US administration, could subsequently
ETS phase III (2013-2017) They also think that the unlock the door to targets by major developing
scheme will be expanded with new sectors, with countries, notably China. As a new joiner, the US
aviation and land transportation as the most likely will be granted fairly lenient goals compared to
ones, see Figure 6.12 other Annex 1 countries in the 2018-22 period. The
targets taken on by China are likely to differ from
As the EU ETS is the most advanced carbon trading
those existing for Annex B countries either by being
scheme in the world, other countries and regions
aspirational targets, or covering only sectors such as
will probably look to Europe when designing their
heavy industry, rather than absolute country caps.
schemes. The results from the survey clearly say
This will remove China’s CER supply in the covered
that several of these schemes are expected to be
sectors, but open for JI instead.
linked to the EU ETS, and that the majority of this
linking will happend post-2012 Despite the current stalemate seen in climate
negotiations, there are reasons to believe that
Scenario 2018-2022 there will be a global climate regime from 2013 on.
1. The US joins Protocol with targets. Recent political developments and the positions
of the most important US presidential candidates
2. US caps are initially more lenient than those taken on
support this view. US engagement and deepened
by existing Annex B countries.
Chinese commitments will lead to comprehensive
3. China joins Protocol with targets. international emissions trading – involving most
The US ETS will satisfy the UNFCCC requirement major countries and emitting companies – in the
that developed countries move first, as well as 2018-22 period and beyond.

Carbon 2007
Carbon glossary
A Someone who thinks market prices will decline.
Bull
Someone who thinks market prices will rise.
AA and AAU, see Assigned Amount and Assigned Business As Usual Scenario (BAU)
Amount Units. A business as usual scenario is a policy neutral
Additionality reference case of future emissions, i.e. projections
Under the Kyoto Protocol, certificates from JI and of future emission levels in the absence of changes
the CDM (see explanations below) will be awarded in current policies, economics and technology.
only to project-based activities where emissions
reductions are “additional to those that otherwise
would occur”. The issue has to be elaborated further C
by the Parties to the Kyoto Protocol, and on the basis
of practical experiences. Cap and Trade
Annex B Countries A Cap and Trade system is an emissions trading
Annex B countries are the 39 emissions-capped system, where total emissions are limited or
countries listed in Annex B of the Kyoto Protocol. ‘capped’. The Kyoto Protocol is a cap and trade
Annex I Countries system in the sense that emissions from Annex
Annex I countries are the 36 countries and economies B countries are capped and that excess permits
in transition listed in Annex I of the UNFCCC. Belarus might be traded. However, normally cap and trade
and Turkey are listed in Annex I but not Annex B; systems will not include mechanisms such as the
and Croatia, Liechtenstein, Monaco and Slovenia CDM, which will allow for more permits to enter the
are listed in Annex B but not Annex I. In practice, system, i.e. beyond the cap.
however, Annex I of the UNFCCC and Annex B of Carbon Dioxide Equivalent (CO2e)
the Kyoto Protocol are often used interchangeably. This is a measurement unit used to indicate the
Annex II Countries global warming potential (GWP) of greenhouse
Annex II of the UNFCCC includes all original OECD gases. Carbon dioxide is the reference gas against
member countries plus the European Union. which other greenhouse gases are measured.
Assigned Amount (AA) and Assigned Amount Units CDM, see Clean Development Mechanism.
(AAUs) CDM EB, see Clean Development Mechanism
The assigned amount is the total amount of Executive Board.
greenhouse gas that each Annex B country is CERs, see Certified Emission Reductions.
allowed to emit during the first commitment period Certification
(see explanation below) of the Kyoto Protocol. An The certification process is the phase of a CDM or
Assigned Amount Unit (AAU) is a tradable unit of 1 JI project when permits are issued on the basis of
tCO2e. calculated emissions reductions and verification,
possibly by a third party.
Certified Emission Reductions (CERs)
B CERs are permits generated through the CDM.
Clean Development Mechanism (CDM)
Backwardation The CDM is a mechanism for project-based emission
A market condition in which a futures price is lower in reduction activities in developing countries.
the distant delivery months than in the near delivery Certificates will be generated through the CDM from
months. The opposite of contango (see below). projects that lead to certifiable emissions reductions
Baseline and Baseline Scenario that would otherwise not occur.
The baseline represents forecasted emissions Clean Development Mechanism (CDM) Executive Board
under a business-as-usual (BAU) scenario, often (EB)
referred to as the ‘baseline scenario’ i.e. expected The CDM EB is accountable to the Conference of the
emissions if the emission reduction activities were Parties to the Kyoto Protocol (see below). It registers
not implemented. validated project activities as CDM projects.
BAU, see Business As Usual Scenario. Commitment Period
Bear The five-year Kyoto Protocol Commitment Period is
scheduled to run from calendar year 2008 to calendar

13 March 2007
Carbon glossary not be financed by official development aid, but that

additional funding is to be made available for such
year-end 2012.
projects.
Contango
A condition in which distant delivery prices for
futures exceed spot prices, often due to the costs of G
storing and insuring the underlying commodity. The
opposite of backwardation. Grandfathering
COP, see Conference of the Parties. Method for allocation of emissions, where permits
Conference of Parties (COP) are allocated, usually free of charge, to emitters and
The COP is the supreme body of the United firms on the basis of historical emissions.
Nations Framework Convention on Climate Change Greenhouse gases (GHGs)
(UNFCCC). The last conference (COP-11/MOP1) was Greenhouse gases (GHGs) are trace gases that
held in Montreal, Canada in November/December control energy flows in the Earth’s atmosphere by
2005. absorbing infra-red radiation. Some GHGs occur
Countries with Economies in Transition (EIT) naturally in the atmosphere, while others result from
Countries that are in the transition from a planned human activities. There are six GHGs covered under
economy to a market-based economy, i.e. the the Kyoto Protocol - carbon dioxide (CO2), methane
Central and East European countries, Russia, and (CH4), nitrous oxide (N2O), hydrofluorocarbons
the former republics of the Soviet Union. (HFCs), perfluorocarbons (PFCs) and sulphur
hexafluoride (SF6). CO2 is the most important GHG
released by human activities.
E
EIT, see Countries with Economies in Transition.
H
Emission Reduction Unit (ERU)
Permits achieved through a Joint Implementation Host Country
project. A host country is the country where a JI or CDM
Emissions to Cap (E-t-C): project is physically located.
Emissions-to-cap (E-t-C) is calculated by subtracting Hot Air
the seasonally adjusted cap from emissions (actual Excess permits that have occurred due to economic
or forecasted). This metric gives an indication collapse or declined production for reasons not
of whether the market (for a specific period) is directly related to intentional efforts to curb
producing more or less than the seasonally adjusted emissions.
cap for that same period. More specifically, if not
taking CERs into account, a positive (negative) E-C
means that the market is fundamentally short (long), J
suggesting a buy (sell) signal.
Emissions Trading JI, see Joint Implementation.
Emissions Trading allows for transfer of allowances Joint Implementation (JI)
or credits across international borders. However, Joint Implementation is a mechanism for transfer
it is a general term often used for the three Kyoto of emissions permits from one Annex B country to
mechanisms: JI, CDM and emissions trading. another. JI generates ERUs on the basis of emission
ERU, see Emission Reduction Unit. reduction projects leading to quantifiable emissions
EU ETS, European Union Emissions Trading System. reductions.
F K
Financial additionality Kyoto Protocol
CDM projects have to be financially additional, which The Kyoto Protocol originated at COP-3 to the
means that the projects that Annex I countries UNFCCC in Kyoto, Japan, December 1997. It specifies
support within the framework of the CDM should emission obligations for the Annex B countries and

Carbon 2007
Carbon glossary S
defines the three so-called Kyoto mechanisms: JI,
CDM and emissions trading. It entered into force on Supplementarity
16 February 2006 A requirement in the Kyoto Protocol stating that
emissions trading should be a supplement to
domestic action. It reflects the request of the
M European Union to limit the use of the Kyoto Protocol
flexibility mechanisms. It is still not determined how
supplementarity should be interpreted.
MAC, see Marginal Abatement Cost.
Marginal Abatement Cost (MAC)
The marginal abatement cost is the cost of reducing U
emissions with one additional unit. Aggregated
marginal costs over a number of projects or activities
define the marginal abatement cost curve. United Nations Framework Convention on Climate
Memorandum of Understanding (MoU) Change (UNFCCC)
A MoU is an agreement between two parties that The UNFCCC was established 1992 at the Rio Earth
aims to formally recognise a joint desire to ultimately Summit. It is the overall framework guiding the
conclude an agreement or to achieve goals jointly. international climate negotiations. Its main objective
It may or may not have legal backing of sanction, is “stabilisation of greenhouse gas concentrations
depending upon how it is constructed. MoUs are in the atmosphere at a level that would prevent
often used as a basis for CDM/JI projects. dangerous anthropogenic (man-made) interference
with the climate system”.
N
V
National Authorities and Designated National
Authorities Verification
The national authority is the official body representing In order for AIJ, CDM and JI projects to have a
the Government which takes part in the arrangement formalised validation of an emission reduction
of CDM/JI projects. For JI host countries, the national stream, a recognised independent third party must
authority approves the projects and issues the confirm that claimed emissions reduction activity
emission reduction units. For CDM host countries, has occurred.
the designated national authority issues a non-
objection letter necessary for the project approval.
Non-Annex I countries
Annex I is an Annex in the UNFCCC listing those
countries that are signatories to the Convention and
committed to emission reductions. The Non-Annex
I countries are developing countries, and they have
no emission reduction targets.
P
Permit
Permits are often used for denoting the tradable
units under the Kyoto Protocol, i.e. AAUs, ERU or
CERs.
Project Design Document (PDD)
Document completed by project developers in order
to register their project under the CDM.

Carbon 2007
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Carbon 2007 - A New Climate For Carbon Trading

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A new climate for carbon trading

All rights reserved © 2007 Point Carbon

About Point Carbon

Providing critical insights into energy and environmental markets

About the report:

ii All rights reserved © 2007 Point Carbon

iii All rights reserved © 2007 Point Carbon

iv All rights reserved © 2007 Point Carbon

 All rights reserved © 2007 Point Carbon

From the editors

Kjetil Røine and Henrik Hasselknippe

vi All rights reserved © 2007 Point Carbon

2 The Kyoto market: How does it work? 3

3 Carbon market activity in 2006 6

3.2 Kyoto markets 17

3.3 Other markets 24

4. Carbon across commodities 25

5 Outlook for 2007 30

5.2 Kyoto markets 31

6.1 2008 - 2012 36

vii All rights reserved © 2007 Point Carbon

1. Introduction expectations for the first Kyoto period (chapter 6)

The present report, Carbon 2007, provides a detailed

Figure 1.1 Some big, many small

Source: Point Carbon 2006 2007

 All rights reserved © 2007 Point Carbon

Figure 1.2 Still mostly outside trading sectors

Source: Point Carbon

Figure 1.3 European responses

Source: Point Carbon 2006 2007

 All rights reserved © 2007 Point Carbon

 All rights reserved © 2007 Point Carbon

Figure 2.1 How it works, at least in theory

Political framing decisions

Gov. AAU sales JPN/CAN/NZ

Gov. Purchase EU ETS

Political framing decisions

 All rights reserved © 2007 Point Carbon

Figure 2.2 Potential supply more than enough

 All rights reserved © 2007 Point Carbon

3. Carbon market activity in 2006 began to decline.

2005 2006 2007

EU ETS total 362 7,218 1,017 18,143 1,750 18,503

- OTC + exch. 262 5,400 817 14,575 1,550 15,903

- Bilateral 100 1,818 200 3,568 200 2600

Other ETSs 7.8 52 31 300 50 500

 All rights reserved © 2007 Point Carbon

Figure 3.1 Stairway to 07

Figure 3.2: Still dominated by the EU ETS

Physical volume (1,632 Mt CO2e) Financial value (€22.5 billion)

 All rights reserved © 2007 Point Carbon

Figure 3.3 Ups and downs in 2006

3.1 EU ETS 3.1.1 Volumes and values

More volume on exchanges in Q4

although the relative share of Phase II volume

 All rights reserved © 2007 Point Carbon

Figure 3.5: Still dominated by ECX

Source: Point Carbon ECX Powernext Nord Pool EEX

 All rights reserved © 2007 Point Carbon

10 All rights reserved © 2007 Point Carbon

Figure 3.7 Daily volumes and prices

Source: Point Carbon's Carbon Market Trader Volume EUA 07 EUA 08

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon

All rights reserved © 2007 Point Carbon