European Wholesale Carbon Market Development

SUMMARY

Abstract

Overview

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 2 of EU-ETS
• Detailed analysis of Phase 2 of ETS and the bullish implications for EUA demand and pricing against a backdrop of considerable upside risk
• Insight as to why demand for carbon credits will differ greatly across Europe, underpinned by generation mix and fuel switching capabilities analysis
• 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

Report 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 €40/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

TABLE OF CONTENTS

Table of Contents

• DATAMONITOR VIEW
  • CATALYST
  • SUMMARY
  • SOURCES
• ANALYSIS
  • Emissions trading allows countries to meet their carbon abatement obligations under the Kyoto Protocol
    • The Kyoto Protocol binds most developed nations to a capand trade system
    • Emissions trading is an administrative approach used to control pollution by way of economic incentives
    • The European Union Emission Trading Scheme (EU-ETS) is the leading emissions trading system
  • The 'global' carbon emission trading market is still very much Eurocentric
    • EU-ETS continued to dominate global carbon trading volumes in 2007
    • In 2007, EU- ETS sustained its lead in terms of total traded financial values
    • The EU is pivotal to establishing a truly 'global' carbon market
    • An increasing majority of European carbon is traded over-the-counter
    • No changes on the exchanges: the ECX continues to lead the standardized market for EU emissions trading
    • EUA-II prices recovered strongly mid 2006 on the expectation that Phase II compliance caps would be tightened
    • EUA-II prices recovered strongly mid 2006 on the expectation that Phase II compliance caps would be tightened
  • Carbon markets will grow in importance as emission trading is reborn under phases II and III of EU-ETS
    • ETS Phase ll will bring a dramatic shift in market fundamentals
    • Phase ll of EU-ETS looks a lot tighter than Phase 1 and has bullish implications for EUA demand and pricing
    • It is likely that ETS installations will largely favour the use of carbon credits in Phase ll and lower carbon generation in Phase lll
    • Upside risks could be introduced into current abatement targets, causing more upward pressure on demand and pricing
    • Germany, the UK, Italy, Poland and Spain will be structurally short carbon credits in 2008, based on their respective 2007 emissions
    • 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
    • Carbon abatement shortfalls will drive European wholesale market growth, offset by fuel switching, CCS and limited supply
• APPENDIX
  • Definitions
  • Ask the analyst
  • Datamonitor consulting
  • Disclaimer
• List of Figures
  • Figure 1: EUA trading forms the bulk of traded volumes,followed by project-based activities and voluntary transactions
  • Figure 2: EUA trading forms the bulk of trading values,followed by project-based activities and voluntary transactions
  • 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
  • Figure 4: Non-brokered bilateral trading is losing ground to OTC and exchange-based trading
  • Figure 5: The Anglo-Dutch ECX continues to dominate formalized EU emissions trading
  • Figure 6: Market focus is shifting from an increasingly meaningless ETS Phase I towards increasingly stringent Phase II allocations
  • 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%
  • Figure 8: The transition from Phase I to Phase II allocations will see the current surplus of credits replaced with an EU A shortfall from 2008
  • 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
  • Figure 10: The five European countries with the largest carbon abatement targets also display the largest carbon allowance deficits
  • Figure 11: Of the 5 countries that will be significantly short carbon credits in 2008, only Spain will be long on average overphases 2 and 3
  • Figure 12: EU wholesale carbon market growth