Geneva, June 17, 2009

Ms. Emi Hijino

Swedish Environment Ministry
Tegelbacken 2
SE-103 33 Stockholm, Sweden

Impact of AAU surplus on the international negotiations and carbon markets

Dear Ms. Hijino,

The surplus of unused and unsold Assigned Amount Units (AAUs) built up in the first
Kyoto commitment period and the recent increase in size and frequency of un-greened
AAU trades are extremely serious issues for the global carbon market and therefore of
major concern to IETA.

Permitting the unqualified transfer of a substantial surplus of AAUs into the Post-2012
crediting period, or neglecting to consider the effects of such a transfer when
negotiating new emission caps, could seriously undermine efforts toward the
achievement of the UNFCCC’s core objective. A full or substantial transfer will distort
calculations of the true impact of post-2012 targets and destabilise the market by
undercutting savings achieved through the Clean Development mechanism (CDM) or
other mechanisms. The price of carbon would be watered down substantially, and there
would be uncertainty until it became clear whether and how those AAUs would be
utilised. Until this surplus is dealt with, there is a structural imbalance that could
seriously impact the ability of the market to function effectively, and could impact on
the environmental integrity of the future international agreement. This damage could
occur at a very sensitive time for the adoption of a market approach in the US and for
the future of the CDM.

One way of dealing with the issue, or at least signalling the seriousness with which the
European Union treats it and proposes to deal with it in the negotiations on the next
Kyoto commitment period, would be to propose an amendment changing Article 3.13 of
the Kyoto Protocol so as to limit the ability of Parties to carry forward Assigned Amount
surpluses into a subsequent period. Amendments to the Kyoto Protocol that are
proposed for agreement at the Copenhagen Conference of the Parties (COP15) need to
be submitted by 17 June. However UNFCCC document FCCC/KP/CMP/2009/2 of 11 June
2009, which is the Czech Presidency’s proposal for amendment to the Protocol, does not
cover this matter.

IETA – Making markets work for the environment

24, Rue Merle d’Aubigné 4th Floor, office n. 412 1850 M Street, NW, Suite 600 350 Sparks Street, Suite 809
Geneva, 1207, Switzerland Rond-Point Schuman 11 Washington, DC 20036 Ottawa, Ontario
Tel: +41 (22) 737 0500 Brussels, 1040, Belgium USA Canada, K1R 7S8
Tel: +32 (2) 256 7535 Tel: +1 (202) 629 5980 Tel: +1 (613) 594 3912
Reg. 0889.072.702
Fortunately it appears that another Party or Parties has made a similar proposal, since
the Chair’s text at the start of the recent Bonn negotiating sessions included, at Option
2.2, para 39 of FCCC/KP/AWG/2009/8, a proposed decision that “the carry-over of Kyoto
units to the subsequent commitment period shall be limited to […]”. No proposals for
actual amendment to Article 3.13 are included in the Chair’s text, but clearly a decision
text is regarded as equally effective. While the exact fate of the elements of the Chair’s
text following the closure of the Bonn discussions is not wholly clear to observers, it
seems reasonable to assume that this proposed decision remains on the table.
The purpose of this letter is to remind the Presidency of this last chance to propose a
formal amendment to the Kyoto Protocol provision that allows unrestricted carry-
forward, and to confirm that if this route is not taken, the opportunity presented by the
decision text will be pursued as a means of securing an effective limitation of carry-
forward.

If surplus AAU cannot be removed in the negotiation of targets, they must at least be
heavily limited, including by requirements to `green’ the proceeds of sales by
committing them to investment in emission-reducing projects whose cost will create a
fair price – so-called Green Investment Schemes (GIS).
Some further background on this issue and IETA’s approach to it may be appropriate.
Many surplus AAUs are being sold at present to Japan and other countries expected to
be short in 2012. But there are many more, especially in Russia, widely expected to be
able to carry forward between 4 and 6 bn tons. The marginal cost of putting these AAUs
on the market is zero. Demand from the whole of the EU emissions Trading scheme
from 2012 to 2020 is only about 2.2 billion tons. While the EU is one of a number of
trading schemes limiting the direct purchase of these surplus AAUs by firms, the surplus
will have an indirect but very clear effect on prices across the whole market. The Kyoto
limits were established 12 years ago, and the large differences from actual emissions
that have emerged since then must not be allowed to hang over the market for the next
10 years.

We are delighted and relieved to see that Green Investment Schemes (GIS) are finally
being put into practice, after years of debate. IETA believes that it is the responsibility of
the Buyer and Seller to call for adherence to a GIS agreement that adequately ensures
the climate additionality of investments, measurability and permanence of promised
emission reductions. At present, Parties looking to transact AAUs have mostly
developed their own unique approaches to GIS, giving rise to various “greening ratios”.
We recognize this as the initial steps of a young market, in need of guidelines and
consistency. Already, standard GIS techniques are emerging, such as the GIS Model
Agreement which was released on 16 March 2009 by the EBRD. The EBRD’s GIS Manual
and Model Agreement aims to provide certain standard provisions which could serve as
a "toolbox" to assist in contract negotiations and structuring sale and purchase
transactions of AAUs under a GIS, incorporating various options, generally acceptable to
the market. IETA applauds the EBRD’s efforts to bring consistency, reliability, and
credibility to Green Investment Schemes.

However, we are concerned that the persistent lack of transparency, which we have
witnessed with regard to some recent AAU trades, will seriously undermine these
efforts. For the sake of the credibility of the Kyoto framework and the carbon markets,
we urge Buyers and Sellers to adhere to the EBRD guidelines and ensure that AAU
trades meet the highest greening and transparency standards. We are very glad to see
some EU Member States acting in this spirit, and working together with the EBRD: we
urge a similar approach by all Member States, whether buying or selling.

Yours sincerely

Henry Derwent
President and CEO
International Emissions Trading Association