TODAY’S STUDY: CARBON MARKETS ON HOLD

Carbon 2012; A Market Waiting for Godot

Carina Heimdal, Emil Dimantchev, Hongliang Chai, Emilie Mazzacurati, Anders Nordeng, Ingvild Sørhus, Natalia Yakymenko and Elizabeth Zelljadt., 21 March 2012 (Point Carbon)

EXECUTIVE SUMMARY

This year’s survey shows that in the EU ETS, the low carbon prices lead to emission reductions in fewer of the companies covered by the scheme and that the carbon price is a less decisive factor in investment decisions than previously. This underpins the need for political action, either through a deepening of the EU wide emission reduction target or through a reduction in the amount of allowances distributed to EU ETS companies. These issues are at the centre of discussions in the European Parliament, among member states and in the European Commission. This will be the main policy issue to drive carbon prices in Europe this year.

The assessments of the EU ETS cost-effectiveness and maturity show a stabilisation – this is also likely related to the current low price levels, as well as to thefts from registries in early 2011 and to the changes to the scheme which will kick in next year, when the programme enters phase 3. Forty-seven percent of respondents think the EU ETS is the most cost-efficient way to reduce emissions, and thirty-seven percent agree with the statement that the EU ETS is a mature market.

The EU ETS continues to be seen as more cost-effective and mature than the CDM. For instance, 36 percent of respondents think the largest Kyoto flexible mechanism is the most cost-effective way to reduce emissions in developing countries. Assessments of the CDM are more positive than last year, and this is 5 percentage points up from the 2011 survey.

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As much as 28 percent agrees that the CDM market is mature – up from 19 percent last year. We think that the more positive assessments of the CDM come from more efficient project registration and issuance by the UNFCCC, greater use of standardised baselines and default values, and more frequent use of stakeholder consultations by the CDM Executive Board.

On a more negative note, the outlook for CDM investments and trading of CERs is gloomy. Much higher shares than last year plan to decrease or completely stop investing in CDM projects, trading primary and secondary CERs. These results are not surprising in a context of a bearish price outlook and poor outlook for demand for credits towards 2020. The results also show that the EU ETS restrictions on international offsets in phase 3 are starting to bit on investment plans.

In North America, of the respondents voicing an opinion, more thought that regulators will tighten the Regional Greenhouse Gas Initiative’s cap in the coming years than did not. However, even more respondents didn’t know or had no opinion on whether the cap will tighten, reflecting the state of uncertainty around the future of RGGI’s current over-allocation.

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In California, emitters prepare for the cap-and-trade scheme starting in 2013 mainly through preparations for allowance and credit purchases. A large majority of emitters in California participating in the survey have no plans to move production out of the state due to carbon costs. However, one fifth of respondents covered by the upcoming cap-and-trade scheme in the Golden State are considering to do so.

Nearly 70 percent of respondents in Australia think the national carbon scheme will go ahead as planned, while a quarter think it won’t. This may reflect concern over threats from the opposition to dismantle the scheme if they win the elections in 2013. We think that the “flexible price” period of the carbon scheme will start as planned on 1 July 2015, but there may be changes to the price floor and ceiling.

Moving to the international scene, respondents were somewhat more dissatisfied with the outcome in Durban than in Cancun. Nearly forty percent of respondents think the global policy framework after 2020 will be a pledge-and-review system. Under such an international set up, countries pledge emission reduction targets reflecting decisions at national level, and the UN Convention on Climate Change merely gathers these pledges and coordinates reporting of emissions - without a Kyoto like compliance regime. Meanwhile, thirty-four percent of respondents think there will internationally binding targets for major emitters post- 2020. Finally, 18 percent think that countries will fail to agree.

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FOREWORD As the California Air Resources Board (CARB) completes the final preparations for distribution of CO2 allowances to the State’s largest industries, including an auction of about 10% of the allowances in the first compliance period under a broad cap and trade regulation, opponents of climate action are converging on Sacramento. Some object to having to buy allowances; others want to eliminate or expand the ability to use offsets; a few even question the need for action, citing continued challenges to the science of climate change or the perceived unfairness to California residents of placing a price on carbon when other states and countries are doing nothing.

In the face of a new round of well-funded efforts to overturn the program, renewed efforts are underway to educate policymakers, businesses and consumers about what to expect and why cap and trade makes sense. This is no easy task. While most voters understand that climate change is a real threat, and many are willing to support action, few people can explain cap and trade and even fewer believe it’s the best way to reduce greenhouse gas emissions. So how do we go about building and maintaining the support necessary to carry us through the start-up of this new venture?

First and foremost, we are working on our own and with our partners in the Western Climate Initiative to make sure that when the (imaginary) bell rings for opening day there are no administrative glitches. We have carefully studied the experience of RGGI and the EU ETS, both good and bad, as well as the cautionary tale of California’ disastrous experiment with deregulating electricity markets. Every aspect of allowance creation, tracking and use has been designed to deter fraud. We are retaining an independent market monitor whose job is to be on constant lookout for any symptoms of irregularity or problems in the trading of allowances that might be symptoms of abuse or market manipulation. A blue-ribbon market oversight committee will review and advise if action needs to be taken to correct problems.

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Our goal, of course, is to launch a system that runs smoothly, that achieves the stipulated reductions in greenhouse gas emissions at a cost that is acceptable to the general public and that fits well within a set of policies designed to encourage investment in energy efficiency, renewable electricity generation, and rapid adoption of advanced technology vehicles and fuels.

Looking ahead, I see three major areas where we will need the help of creative business and financial thinkers.

1. Compliance-grade offsets. The demand for fully verified offsets developed under approved CARB protocols will grow quickly. The Board is eager to find offset types that fit our rigorous criteria. While there are no current plans to relax the geographic boundaries or numerical limits on offsets, these aspects will be under close scrutiny and may be revised if need be.

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2. Voluntary offsets. As forward-looking businesses and state and local permitting agencies with responsibility for environmental impact review and mitigation begin to incorporate assessment of GHG emissions in all kinds of plans, project developers will need to find and lock in emissions reductions. Such offsets will be required both by law and public scrutiny to demonstrate that they are real, enforceable and exceed any current or likely future regulatory requirements.

3. Investment. Making sure that the benefits of free allowances and the proceeds of auctions are used wisely is emerging as a major political issue. Without losing the benefit of a price signal to those who can choose to reduce GHG emissions cost-effectively while at the same time protecting the general public against rate shocks requires careful calibration. For the public sector, the temptation to seize any new revenue to fill general budget holes may be irresistible. Any diversion of proceeds from the cap and trade program to non-AB32 purposes risks a judicial stop to the rule. But there are ample opportunities to think creatively about using the robust new revenue stream that will start flowing when transportation fuels and natural gas come under the cap in 2015.

By then, we are hopeful that an improving economy and increased public awareness of the visible impacts of climate change will combine to give politicians in other states and regions the encouragement to move forward with their own climate plans. Following the lead of Gov. Edmund G. Brown Jr., who is constantly spreading the good news about the benefits of investing in California’s clean energy economy, there are indications that other leaders may be willing to re-engage in the climate debate. When they do, we will be ready with the case studies to show that using market instruments can play an important role in solving the global climate crisis…Mary D. Nichols…Chairman, California Air Resources Board

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INTRODUCTION

We are already well into the last year of the EU ETS’ phase 2 and of the first Kyoto commitment period as this report is published. In the EU ETS, the largest carbon market segment, we expect increased market activity this year. Compliance entities optimise their portfolio as the end of phase 2 approaches, while utilities gear up hedging activity in anticipation of the need to purchase all allowances in the market from 2013. The discussion around a possible intervention in the EU ETS through a withdrawal of allowances from the market is heating up. In North America, Quebec and California work on the launch of their markets, planned for 2013.

In this report, we present the results of our seventh annual Carbon Market Survey, which aims to gather the views of carbon market participants and observers across the globe. We have asked questions related to market participants’ behavior and expectations, tailoring questions based on each respondent’s market involvement. We cover the EU ETS, CDM, JI, New Zealand ETS, California and Quebec markets, emerging carbon markets in Asia and Australia, as well as international negotiations.

Some 3 149 respondents answered this year’s survey, roughly 600 more than last year. The survey ran from 6 to 26 February 2012, and responses were garnered through a web based tool.

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Among the respondents, around half were involved in trading of various compliance carbon allowances and credits, or owned such instruments. Looking at carbon market roles, the largest subset comprises consultants/ advisors (see Figure 1), while the second largest group was CDM project developers or investors (receiving CERs). Companies regulated by the EU ETS represented the third largest group. Twelve percent of the respondents were not directly involved in the carbon market.

Looking at geographical origin, the US is again the home of the largest share of respondents, with 14 percent of the total. The next countries are the UK (10 percent), India (6 percent), Germany (5percent), Australia (5 percent), China (4 percent), Canada (4 percent) and Norway (2 percent).

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It should be noted that this survey is conducted among individuals that are significantly more than average interested in carbon markets and policy.

Participation is voluntary, and we expect that those most interested in the topic will to a larger extent respond than others. The sampling is thus not representative of the larger population. All interpretations of the survey’s results – which are sometimes surprising – should therefore be read bearing in mind that the sample may be subject to a bias in favor of carbon. Furthermore, inference to general public opinion should be avoided…