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M h 2011
C b k t tl k
March 2011
Carbon market outlook
Trevor Sikorski+44(0)20 3134 0160
trevor.sikorski@barcap.com
PLEASE SEE ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 24
EU ETS price history: phase 2
Phase 2: Coming out of rangeg g
€/t
Utilit h d i30
Utility hedging season
20
25
15
20
5
10
5Jan Apr Jul Oct
EUA 2008 EUA 2009 EUA 2010 EUA 2011
Source: ECX, Barclays Capital
March 29, 20112
Contango and backwardation
The contango in the EUA curve is large on 12-13
While the CER curve is in backwardation and contangog
€/t €/t
14 0
15.0
192021
12.0
13.0
14.0
16171819
10.0
11.0
Dec 2010 Dec 2011 Dec 2012 Mar 2013 Dec 201312131415
Dec 2010 Dec 2011 Dec 2012 Mar 2013 Dec 2013
12/ 11/ 2010 01/ 09/ 2010 31/ 12/ 2010
31/ 01/ 2011 18/ 03/ 2011
112011 2012 2013 2014
EUA fair trade (€/ t) EUA (€/ t)CER (€/ t) CER fair trade (€/ t)
Source :Barclays Capital Source :Barclays Capital
March 29, 20113
Japan and Germany and early auctions
• Japan – secondary impact on market via LNG
• Germany:• Direct impact by replacement of nuclear with coal / gas – phase 2 impact = 60 MtDirect impact by replacement of nuclear with coal / gas phase 2 impact 60 Mt• Indirect impact via impact on coal and LNG
E l ti• Early auctions:• 420 Mt in 2012 – bearish• 60 Mt reduction to 2013 + 2014 cap
• Set Aside Reserve (SAR800?)• A new uncertainty of EUAs removed from phase 3 annual cap• A new uncertainty of EUAs removed from phase 3 annual cap• Either released late in phase or cancelled• Post 2014 resolution likely
March 29, 20114
Sector emissions performance
2009 emissions were down 11.2% But power was the only short –but a big short
-20
-
-5%
0%400MtMt
-6%-7%
-80
-60
-40
%
-15%
-10%
5%
100
200
300
-140-120
-100
-30%
-25%
-20%
-200
-100
0
-5%-160Power and
heatOil and
gasMetals Cement /
lime /glass /
Pulp andpaper
-35% Power andheat
Oil andgas
Metals Cement /lime /glass /
ceramics
Pulp andpaper
Source: CITL, Barclays CapitalSource: CITL, Barclays Capital
glass /ceramicsMt %
ceramics
2008 2009
Biggest proportional reductions in metals Overall position after first 2 years of phase is long 45 Mt: A net
subsidy…
March 29, 20115
Looking forward –2011 economic activity modest improvement
GDP: 2009 - 4% y/y reduction, 2010 - 1.7% y/y growth
Sector 2009 2010y y g
2011 - 2.1% y/y growthIndustrial production
(total)
-15% 7.4%
15%
Source :Barclays Capital
Oil refining -7% -4%
Cement and lime -19% -5%5%
0%5%
10%
Source Barclays CapitalGlass -8% 10%
-20%
-15%
-10%-5%
Pulp and paper -9% 16%
St l 30% 26%
-25%
Jun
08A
ug 0
8
Oct
08
Dec
08
Feb
09Ap
r 09
Jun
09A
ug 0
9
Oct
09
Dec
09
Feb
10A
pr 1
0Ju
n 10
Aug
10O
ct 1
0D
ec 1
0Steel -30% 26%
Y/ Y change in EU indust rial production (%)
March 29, 20116
Source Eurostat, Barclays Capital
EUA fundamentals: power sector
With dispatch favouring gas-fired generationPower sector demand down in 2009 – 6% y/y
YTD 2010 – up 2.6%
TWh
340
15
Gas SRMC - coal SRMC €/ MWh
280
300
320
340
0
5
10
220
240
260
280
-15
-10
-5
200Jan M ar May Jul Sep Nov
2007 2008 2009 2010
-20Feb-10 M ay-10 Aug-10 Nov-10 Feb-11
54% v 30% 48% v 36%
Source ECX, Barclays CapitalSource :ECX Barclays CapitalSource :ECX, Barclays Capital
2007 2008 2009 2010
March 29, 20117
The EU ETS market balance
The market balance looks long But we are bullish on prices
Phase 1 2008 2009 2010 2011 2012 Phase 2
EUA Allocation (cap) 2107 2003 2045 2077 2192 2383 10,700
Emissions 2071 2119 1882 1938 2006 2300 10,260
Emissions – cap -36 116 -162 -139 -186 -83 -455
Contract (€/t CO2)
2007 A 2008 A 2009A 2010A H1 11 H2 11 2012 Phase 3 (13-20)
Source :Barclays Capital
EUA 19.6 22.6 13.4 14.5 16.5 21 28 40
CER 16.4 17.4 11.8 12.4 13 16 20 25
EUA CER 5 8 5 2 1 6 2 1 3 5 5 8 15EUA-CER spread
5.8 5.2 1.6 2.1 3.5 5 8 15
Source :Barclays Capital
March 29, 20118
The great market unknowns: Phase 3
Known UnknownCAP 20% What above?
Early volumes NER 300 +120 Mt TimingEarly volumes NER 300 +120 Mt Timing
Quality restrictions HFC 23 / N20 – 1 May 13y y
Free allocations Benchmarks Sector caps
Auctions Regulation + opt outsAuctions Regulation + opt outs
March 29, 20119
Why so bullish: post-2012 shorts
The EU ETS looks increasingly short in phase 3
With system CER limits being exhausted by 2019
Mt Mt
2400
2 500
3,000
0
800
1600
1,500
2,000
2,500
-1600
-800
0
500
1,000
-2400
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
02013 2014 2015 2016 2017 2018 2019 2020
Non-power sector Power sect orAviat ion Total cap 20%tot al cap 30%
Source :Barclays CapitalSource :Barclays Capital
Forecasting 120 Mt of abatement required after use of banked EUAs
20% gap net posit ion 30% gap net posi tiontot al cap 30%
g q
/ CER allowance
March 29, 201110
Early volumes: How tight phase 2
Mt CO2
160018002000
F tGap = 80
120014001600 Forecast average
power sector emissions
NER300 +120
Gap 80
600800
1000CER/ERU
use
0200400
EUA length
Sum pre2013
2013 2014 2015
2010 hedged 2011 hedged 2102 hedged
March 29, 201111
Quality restrictions: SupplyMillion CERs 2012 2013-20 2020 total
Supply Pipeline Risk Adj Pipeline Risk Adj Pipeline Risk Adjpp y p j p j p j
Registered projects 1,964 1,050 2,846 1,995 4,810 3,045
HFC-23 477 500 624 655 1,100 1,155
N20 247 272 381 420 627 691
LDC supply 5 1.6 11.5 3.4 16.6 5
At Validation 794 90 2,890 860 3,840 950
HFC 23HFC-23 - - - - - -
N20 6 0.6 15 8 21 8
LDC supply 8 1 44 9 51 9.5
ERU supply 250 250
TOTAL SUPPLY 2,882 1,390 5,736 2,855 8,564 4,195
Supply ex HFC/N20 post 2012 2,882 1,390 4,731 1,780 7,489 3,121
March 29, 201112
CER/ERU markets biggest question is demand
DEMAND 2012 2013–20 2020 total
EU Sovereign 200 500 700
EU ETS 800 900 1,700
Japan 210 ? ?
US - ? ?
Australia - ? ?Australia - ? ?
Others* 40 50+ 110
Total 1,250 1,450+ 2,790
March 29, 201113
Post 2012: International agreement
K P l (KP) KP2 KP
Negotiating texts
COP 15 COP 16 COP 17 COP 18
Kyoto Protocol (KP) 2 KP2 KP2
Copenhagen Cancun S. Africa ????
Oth i (LCA) LCA LCA
Single Agreement??
Other issues (LCA) LCA
Copenhagen
Accord
Some key issues being negotiated:
Aviation +
Shipping
Adaptation
financingLegal basis
+ level of targets
NAMAs(Developing country
i i i )
REDD+(Forestry emissions
d i )
CDM
JIpp gggemissions actions)reductions)
J
March 29, 201114
Post 2012: Domestic action and linking
<1.4 bn 2013-2020Bilateral Offsets
ChinaEU ETS
CAP size: 2 Gt
EUAs Japan
CAP i 1 Gt
BC, Ontario, Quebec
Cap size: 300 Nt South K
???
CAP size: 1 Gt
???Korea0.4 Gt
California
CAP size: 350 Mt
CCAs
???~200 mn/yrPremium CDM/JI
Standard CDM/JI
CCAs
No limit on useInter. Forestry
Australia
CAP size: 0.4 Gt
????
New Zealand
CAP size: 0.06 Gt
NZEUDom. Forest + offsets
Dom. Forestry
March 29, 201115
Cancun progressBuilding block Issues at stake Progress
Annex 1 targets Annex 1 targets: the targets pledged in the Copenhagen Accord (CA) from the Annex 1 countries for
emissions reductions to 2020, while likely to be the best we are going to get, are opposed by non-
Annex countries as not being in-line with the 2 degrees C target. Bridging that gap of non-Annex
expectations against Annex 1 targets remains a difficult call.
No deepening of targets so this remains an issue of difference with the developing world, particularly the Latin Americans and the
small island developing states. The KP text agreed at Cancun calls on Annex 1 parties to increase the ambition of their target
levels to be in line with that level. Remains to be seen if there is any response, but with US ambition not going anywhere
quickly, the only ray of hope may be the EU.
AAU surplus AAU surplus –dealing with the large volumes of surplus AAUs held by Russia and the Ukraine. The issue is the KP allows for full banking of AAUs, so how do you deal with the legacy over-
allocation (some 10 Gt) unless the banking rules are changes. And what can you give Russia and
the Ukraine to accept this?
Discussion of text on banking of AAUs with three options: i – leave banking rules as is: ii – allow a percentage (10%, 1%, 0.1% ) of
surplus AAUs to be banked; iii – allow KP1 AAUs to be used to make up KP2 shortfall but not tradeable and any additional
after that would be cancelled.
Sudden opposition to KP from Russia can be somewhat understood in the context of this discussion. p pp
Continuation of CDM / JI In the absence of confirmation of KP-2, there remains residual concern around the continuation of the
CDM and JI mechanisms.
No complete confirmation of this but there was text agreed to confirm that the flexible mechanisms continue to be available to parties
to meet their “quantified emission limitation and reduction objectives in accordance with relevant decisions of the CMP
(COP/MOP)”. Does put this in the context of a future agreement.
CDM reform A much anticipated area of potential progress going forward with this focused on the working of the
CDM and simplifying procedures for certain project types.
- Positive lists - Prioritise development of first-of-its-kind projects and recognizes standardized baselines for renewable projects up to 5
MW and energy efficient projects saving up to 20 GWh per year.
- Grid emissions factors – EB to develop procedures with view to decision next COP- Standardised baselines - Proposals may be submitted for standardised baselines. EB to develop standardised baselines for projects that
are applicable to LDCs, small island developing states (SIDS), and countries that have less than 10 registered projects. EB to
k d d d b l COPreport on work on standardized baselines at next COP.
- Appeals process – for special appeals against EB decisions procedures, mechanisms and institutional arrangements to be agreed at
next COP.
- Reduce waiting times for consideration of new methodologies.
- Materiality of errors in submissions – referred to SBSTA to come to a recommendation on the topic.
JI issues The main issues are that the JI is not self financing and there are issues around its continuation. Fees to be charged on track 1 projects to help with financing the JISC
LULUCF Land use, land use change and forestry (LULUCF) which is not really seen as being subject to MRV
regime which is consistent and transparent. Some big swings in LULUCF inventories have been
Tasked the working group to consider if a cap should be applied to emissions and removals from forest management and how
extraordinary occurrences should be treated.g p g g
seen and there are also issues about force majeure events such as weather driven forest fires.
y
Source: Barclays Capital
March 29, 201116
Airlines – EU ETS 2012 and onwards2012 Phase 3 (2013-2020)
Cap 97% of 2004 2006 emissions = 213 Mt 95% of 2004 2006 emissions = 208 5 MtCap 97% of 2004-2006 emissions = 213 Mt 95% of 2004-2006 emissions = 208.5 Mt
CER/ERU import limits 15% of emissions = 34 Mt (estimate) Minimum 1.5% of emissions
Credits EUAA – Aviation EUA. Can only be used by aviation sector for
compliance
As 2012
Bankability EUAA – fully bankable
CER limits – annual, not bankable
CER – subject to general scheme rules on post-2012 eligibility
As 2012
NER 3% of cap As 2012
Auctioning 15% of total cap, from 1 Jan 2013 Minimum 15% of total capg p, J p
Free allocation Benchmarked according to 2010 tonne/km flown. As 2012
Source: EC, Barclays Capital
March 29, 201117
Sector emissions performance
Forecast sector emissions + cap Cumulative Emissions - Cap
MtMt
300
500Cumulat ive E-CCumulat ive E C O (1 5% CERs)
200
250
300
300
400Cumulat ive E-C-O (1.5% CERs)Cumulat ive E-C-O (15% CERs)
50
100
150
100
200
0
50
2008 2010 2012 2014 2016 2018 2020 -100
0
2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: CITL, Barclays CapitalSource: CITL, Barclays Capital
Sector emissions (M t) Sector cap (Mt)
Growing traffic – flat cap Overall position after first 2 years of phase is long 45 Mt: A net
subsidy…
March 29, 201118
Aviation – final thoughts
Expectations on pricing:
• EUA > EUAA > CERs > CERp
Key issues
• Qualitative restrictions: Likely ban on HFC-23 / N20 from 1 May 2013
• Impact of bio-fuels on sectoral emissions: -132 Mt could be abated 2013-2020
March 29, 201119
Analyst Certifications and Important DisclosuresAnalyst Certification(s)I, Trevor Sikorski, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.
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March 29, 201120
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