European Wholesale Carbon Market Development

European Wholesale Carbon Market Development

Introduction

Against a backdrop of challenging carbon abatement targets and reduced European carbon emission allocations, the role of traded carbon markets is growing in importance as the second leg of the EU-ETS takes effect. The marketing and product development for carbon financial instruments is growing rapidly as greater volumes are swapped on increasingly liquid platforms across Europe.

Scope

*An overview of the Kyoto Protocol, climate change regulations, emissions trading and carbon markets, with a particular emphasis on phase II EU-ETS

*Detailed analysis of Phase II caps and the bullish implications for carbon allowance demand, pricing given the aggressive limits on CDM/JI credits

*Insight Insight into why carbon abatement shortfalls will drive European wholesale market growth, offset by fuel switching, CCS and limited supply

*A range of carbon compliance scenarios based on the likely evolution of the power generation mix in key EU markets and the impact on carbon markets

Highlights

The over-allocation of EUAs and ensuing lack of price-tension seen during phase 1 of EU-ETS will not be repeated in Phase 2. The phase 2 cap - well below 2007 adjusted emissions - has set the tone for a very ambitious energy-policy package out to 2020 which points to significantly higher carbon prices and demand over 2008-20

The optimal compliance strategy for the ETS as a whole is to use the largest possible allocation of carbon credits during Phase 2, thereby minimizing the cost of compliance in Phase 2 to the EUR40/t implied by the LRMC curve while buying time to build the extra switching capacity needed to meet the cap over Phase 3

Reasons to Purchase

*Understand how carbon markets are likely to evolve as key European players leverage switching capabilities within their power generation mix

*Leverage Phase 2 of the EU-ETS to your advantage having understood how demand, supply and price conditions are likely to evolve in key EU markets

*Formulate and apply successful strategies to leverage greater demand for financial carbon instruments as liquidity and price efficiencies materialise

DATAMONITOR VIEW 1
CATALYST 1
SUMMARY 1
SOURCES 1
ANALYSIS 2
Emissions trading allows countries to meet their carbon abatement obligations under the Kyoto Protocol 2
The Kyoto Protocol binds most developed nations to a cap and trade system 2
Emissions trading is an administrative approach used to control pollution by way of economic incentives 3
The European Union Emission Trading Scheme (EU-ETS) is the leading emissions trading system 4
The 'global' carbon emission trading market is still very much Eurocentric 5
EU-ETS continued to dominate global carbon trading volumes in 2007 5
In 2007, EU- ETS sustained its lead in terms of total traded financial values 6
The EU is pivotal to establishing a truly 'global' carbon market 7
An increasing majority of European carbon is traded over-the-counter 8
No changes on the exchanges: the ECX continues to lead the standardized market for EU emissions trading 9
EUA-II prices recovered strongly mid 2006 on the expectation that Phase II compliance caps would be tightened 10
EUA-II prices recovered strongly mid 2006 on the expectation that Phase II compliance caps would be tightened 11
Carbon markets will grow in importance as emission trading is reborn under phases II and III of EU-ETS 12
ETS Phase ll will bring a dramatic shift in market fundamentals 12
Phase ll of EU-ETS looks a lot tighter than Phase 1 and has bullish implications for EUA demand and pricing 13
It is likely that ETS installations will largely favour the use of carbon credits in Phase ll and lower carbon generation in Phase lll 14
Upside risks could be introduced into current abatement targets, causing more upward pressure on demand and pricing 15
Germany, the UK, Italy, Poland and Spain will be structurally short carbon credits in 2008, based on their respective 2007 emissions 16
European countries will see a dramatic rise in the need for carbon abatement in Phase ll ETS, and to a much larger extent Phase lll 17
Carbon abatement shortfalls will drive European wholesale market growth, offset by fuel switching, CCS and limited supply 19
APPENDIX 21
Definitions 21
Ask the analyst 21
Datamonitor consulting 21
Disclaimer 21
List of Figures
Figure 1: EUA trading forms the bulk of traded volumes, followed by project-based activities and voluntary transactions 5
Figure 2: EUA trading forms the bulk of trading values, followed by project-based activities and voluntary transactions 6
Figure 3: Active trading programs exist in several pollutants worldwide, yet EU-ETS remains by far the largest carbon market, with 62% of the physical market and 70% of the financial market 7
Figure 4: Non-brokered bilateral trading is losing ground to OTC and exchange-based trading 8
Figure 5: The Anglo-Dutch ECX continues to dominate formalized EU emissions trading 9
Figure 6: Market focus is shifting from an increasingly meaningless ETS Phase I towards increasingly stringent Phase II allocations 10
Figure 7: The inclusion of 85Mt of new emissions not covered in Phase 1 means that the Phase ll cap has effectively been reduced by 13% 12
Figure 8: The transition from Phase I to Phase II allocations will see the current surplus of credits replaced with an EUA shortfall from 2008 13
Figure 9: The suggested EU emissions cap of 1,720Mt by 2020 presents a very challenging target, with severe implications for demand and pricing, given the aggressive Phase lll limits on CDM/JI credits 14
Figure 10: The five European countries with the largest carbon abatement targets also display the largest carbon allowance deficits 16
Figure 11: Of the 5 countries that will be significantly short carbon credits in 2008, only Spain will be long on average over phases 2 and 3 17
Figure 12: EU wholesale carbon market growth 19