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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