california cap trade webinar 12 1 11

California’s cap-and-trade program:

What it means for the future of carbon markets

Michael Ball

Carrie Sisto

1December 2011

London, Houston, Washington, New York, Portland, Calgary, Santiago, Singapore, Beijing,

Tokyo, Sydney, Dubai, Moscow, Astana, Kiev, Hamburg and Johannesburg

Agenda

• AB 32

• The current landscape

• Compliance obligations

• Auctions and cost controls

• Offsets

• Linkage

• Potential changes and hurdles

AB 32

• Passed in 2006

• Cut emissions to 1990 levels by 2020

• The California Air Resources Board must set rules to

“achieve the maximum technologically feasible and cost-

effective greenhouse gas emission reductions”

• The board has authority to use market-based

mechanisms

Scoping plan

• Adopted in 2009, re-adopted in October 2011

• 2020 cap set at 427mn metric tonnes CO2 equivalent

(CO2e)

– 2020 allowance budget is 334mn mt CO2e in 2020

Mechanisms to achieve the 2020 cap

15.0

23.4

39.8

12.0

8.9

18.0

0 10 20 30 40 50

LCFS

RPS

Transportation

Energy efficiency

Other

Cap-and-trade

mn mt

California’s 2010 emissions by sector

Electric generators34.6%

Petroleum refineries

30.5%

Oil, gas production 11.3%

Cogeneration facilities

8.5%

General stationary combustion

7.1%

Cement plants5.1%

Hydrogen plants2.6% Other Industrials

0.3%

Covered CO2e emissions in California, 2010

Note: Does not include electricity imports or

emissions from the use of transportation fuels

Source: California Air Resources

Board

Cap-and-trade timeline

• Changes to adopted rules H1 2012

– Allocation methods

– Use of auction revenue

– Offset protocols

• Practice auctions H1 2012

– Auction, allowance account manager(s) still not selected

• First auctions August, November 2012

• Compliance obligation begins 2013

Emissions cap and allowance set-asides

Allowance

budget

Electric utility

share

Number of

offsets that can

be used

Containment

reserve

Advance

auction

Voluntary

renewables

2013 162.80 95.84 13.02 1.63 0.81

2014 159.70 94.09 12.78 1.60 0.80

2015 394.50 92.23 31.56 15.78 39.45 0.99

2016 382.40 90.37 30.59 15.30 38.24 0.96

2017 370.40 93.11 29.63 14.82 37.04 0.93

2018 358.30 92.23 28.66 25.08 35.83 0.90

2019 346.30 91.35 27.70 24.24 34.63 0.87

2020 334.20 90.37 26.74 23.39 33.42 0.84

Electric Utilities

• Point of regulation: electricity deliverers

• Allowances

– ~90pc of allowances allocated for free, based on historical

emissions

• 2013s allocated July 15 2012

• 2014-2020 allocated on November 1 of each calendar year

– IOUs must sell allowances at state-run auctions

• Spending rules being developed by CPUC

• Imports are included

– Specific plant or default emissions rate

Top-emitting electric utilities

Note: Based on default emissions rate of 0.428mt/MWh

Does not net out renewable energy imports or simultaneous exports

(mt CO2e) Direct IndirectPercent of free

allowances

Southern California Edison 2,354,482 11,427,585 34

Los Angeles Department of Water

& Power2,892,879 7,535,938 14

Sacramento Municipal Utility

District1,825,623 1,285,965 3

Pacific Gas & Electric 1,547,356 2,329,149 26

San Diego Gas & Electric 1,261,052 449,695 7

PacifiCorp 700,506 0.75

Source: California Air Resources Board

Top-emitting merchant generators/power

marketers

Note: Based on default emissions rate of 0.428mt/MWh

Does not net out renewable energy imports or simultaneous exports

(mt CO2e) Direct Indirect

Calpine 8,260,924 953,818

Iberdrola Renewables 2,597,946

Sempra Generation 2,163,495

La Paloma Generating Company, LLC 2,041,841

Dynegy 1,537,206

Elk Hills Power, LLC 1,396,453

Inland Empire Energy Center, LLC 1,312,153

High Desert Power Project, LLC 1,287,518

Sunrise Power Company 1,230,666

AES 1,205,478

WAPA - Sierra Nevada Region 1,180,922

Morgan Stanley Capital Group Inc. 1,117,907

Source: California Air Resources Board

Industrial sources

• Point of regulation: industrial facilities

• Allowances

– ~90pc allocated for free, based on energy efficiency benchmarks

– Updated annually to reflect emissions intensity

• Transition Risk

– Assistance offered to industries to help preserve

competitiveness

• Leakage Risk

– Adjustments to prevent companies from leaving the state

Assistance factors based on leakage risk

Leakage risk IndustryIndustry assistance factor

2012-2014 2015-2017 2018-2020

High Oil and gas extraction 100% 100% 100%

Inorganic chemical manufacturing 100% 100% 100%

Paper and paperboard manufacturing 100% 100% 100%

Glass manufacturing 100% 100% 100%

Cement manufacturing 100% 100% 100%

Lime manufacturing 100% 100% 100%

Iron and steel mill 100% 100% 100%

Medium Petroleum product manufacturing 100% 75% 50%

Food manufacturing 100% 75% 50%

Pesticide, agricultural chemical 100% 75% 50%

Breweries 100% 75% 50%

Sawmills 100% 75% 50%

Metal processing 100% 75% 50%

Gypsum product manufacturing 100% 75% 50%

Apparel manufacturing 100% 75% 50%

Polystyrene manufacturing 100% 75% 50%

Low Pharmaceutical, medicine manufacturing 100% 50% 30%

Aircraft manufacturing 100% 50% 30%

Transportation Sector

• Refineries covered in 2013

• Fuel suppliers/importers in 2015

• Refinery allowance allocations

– 90pc allocated for free

– Favors most efficient facilities

– First compliance period – two-pronged benchmark approach

• Only accounts for energy efficiency

– 2nd and 3rd compliance period – CO2 weighted approach

• Accounts for greenhouse gas efficiency

• Leakage and transition risk

Upstream emissions

Fuel producers’ 2010 upstream emissions in metric tonnes

Chevron 4,916,911

Aera Energy 3,275,302

Berry Petroleum Company 1,084,006

Plains 926,644

Oxy 831,817

Vintage Production 477,626

ExxonMobil 390,462

Seneca Resources 210,258

Macpherson Oil 206,199

BreitBurn Energy 44,584

TRC 37,925

Signal Hill 31,376

Intergy 30,330

Linn Operating 30,165

Sector total: 12.5mn mt

Source: California Air Resources Board

Chevron 23.7%

Conoco Phillips 17.5%

Shell 13.3%

BP13.2%

Valero 11.2%

Tesoro10.8%

ExxonMobil 8.7%

Alon 0.9%

Kern Oil 0.4%

Other refiners0.4%

Downstream emissions

Refiners downstream emissions, 2010

Total: 33.6mn mt CO2e Source: California Air Resources

Board

Early trade

• California Carbon Allowance Forward Trade Agreement

– Trended <$15/mt in early trade

• California Carbon Allowance ICE contracts

– Forwards launched 29 August

– Options contracts launched 19 September

• Natural players still largely absent

California Carbon Allowance pricing

15

17

19

21

23

25

27-Aug 18-Sep 10-Oct 1-Nov 23-Nov

$/m

t

Dec-12 Dec-13

Auctions

• 2012 – August 15 and November 14

• 2013 and beyond:

– February 12, May 12, August 12, November 12

• Purchase limits

– Applies to auctions in 2012-2014

• 15pc of allowances offered

• Investor-owned utilities exempt

– Advance auction allowances: 25pc

– Non-compliance entities: 4pc

Cost controls

Cost-containment measures

($/mt) Floor Ceiling Tier 1 Ceiling Tier 2 Ceiling Tier 3

2013 10.00 40.00 45.00 50.00

2014 10.76 43.04 48.42 53.80

2015 11.58 46.31 52.10 57.89

2016 12.46 49.83 56.06 62.29

2017 13.40 53.62 60.32 67.02

2018 14.42 57.69 64.90 72.12

2019 15.52 62.08 69.84 77.60

2020 16.70 66.80 75.14 83.49

Assuming Consumer Price Index for Urban Consumers is 2.6pc/yr (1990-2010 average).

Source: California Air Resources Board

Compliance

• Annual requirement

– 30pc of each years’ verified emissions

– Due on November 1 of following year

• Triennial true-up

– Balance of three-year compliance period emissions

• Excess emissions

– 4:1 penalty

– Due 5 days after next auction

– 3/4 of penalty allowances put in auction reserve

Offsets

• Four compliance protocols

– Ozone depleting substance destruction

– Livestock methane capture

– Forestry

– Urban forestry

• Early action credits

Splintered market

• ODS considered less risky

• Forestry sees offsets shaved off for buffer pool

• Livestock methane smaller projects

Offset price trends

2

4

6

8

10

12

Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11

$/m

t

California-compliant Non-California compliant

Offset supply v. demand

• Total allowed offsets in 2013-2014 is 25.8mn

– Climate Action Reserve projects it will issue 28.5mn by 2014

• Additional protocols under consideration

– Rice cultivation

– Pneumatic valve replacement

– Fertilizer management

• Risk of invalidation and buyer liability

• Buying direct from project developer

– Better positioned to re-verify

– Better positioned to convert to early action credits

Linkage

• Western Climate Initiative

– British Columbia, California, Manitoba, Ontario and Quebec

• Regulatory alignment

– Equal recognition of compliance products?

– Unified offset protocols/requirements

• Tracking system

• Regional auctions

California predominance

California59%

Ontario23%

Quebec10%

British Columbia8%

Other41%

WCI total emissions, 2008

Source: ARB, Environment

Canada

Potential paths for change

CARB/CPUC

Legislation Court Challenges

www.argusmedia.com

Michael Ball

michael.ball@argusmedia.com

Carrie Sisto

carrie.sisto@argusmedia.com

202.775.0240

London, Houston, Washington, New York, Portland, Calgary, Santiago, Singapore, Beijing,

Tokyo, Sydney, Dubai, Moscow, Astana, Kiev, Hamburg and Johannesburg