For the last decade carbon markets have played an important role in focusing attention on action to address climate change. However, they are currently in a state of transition, due to: 1/ A crisis of confidence resulting from low EUA and CER prices; 2/ The change from the Kyoto Protocol (KP) architecture to an architecture that is expected to be more decentralized; 3/ An increasing debate on how to address the risk of carbon leakage, with options such as free allocation but also as the current discussion in California on Boarder Carbon Adjustment. In discussing the impact of the change in the architecture of the global agreement1, two questions emerge: 1/ What would be the role of carbon markets in the 2015 agreement; 2/ Do carbon markets need a provision in the post 2020 agreement?

The answer to the first question is that carbon markets can only be seen as a tool for price discovery, a necessary but not sufficient tool. A good price discovery will lead to a rational asset allocation, and help direct finance flows to decarbonization efforts. There is an implicit assumption that the carbon markets that we are discussing will be used for compliance with obligations taken under the post 2020 international agreement, irrespective of their nature.

This is critical in order to minimize costs to society, allow for increased levels of ambitions, and tap private flows of private finance. Public money will continue to be available, but it is becoming clear that it will need to be used to leverage private flows of capital. The Green Climate Fund discussion, as well as the discussion in the Standing Committee on Finance in the UNFCCC process, leaves no doubt about that. A good price discovery requires well-functioning markets, which are liquid and transparent, as well as recognition of the regulatory nature of such markets, including the need to provide for market correction by the regulator. However, carbon pricing cannot be a silver bullet. It will need other policies in the toolbox to do the job, especially when it comes to a long-term price signal, which is needed for the development of new technologies and investments with a long time horizon.

The answer to the second question is more complex, and depends largely on assumptions on the nature and architecture of the post 2020 agreement and on the evolution of carbon markets. The evolution of the carbon markets could take a number of avenues which could be: 1/ A super KP track, an unlikely scenario, which would see a “international regulator decide on the obligation on each covered entity; 2/ A Cartesian UNFCCC-linked carbon markets, with a set of subnational/national/regional market approaches, linked through the backbone of an international; 3/ A globally networked carbon market created through different domestic units (similar to currencies), which would have a rating for use for global and domestic compliance. In this case there would be no effort to ‘link’ carbon markets, an effort whose complexity and fallout could be underestimated.

These scenarios will need to be coupled with the architecture of the new agreement that could also emerge along a number of avenues which would be: 1/ A regime in which any international units could be used for compliance without any global standards; 2/ A decentralised climate change regime with some minimum environmental standards provided, as guidance only; 3/ Environmental standards to be observed without approval required for the units used for compliance; 4/ Global environmental standards defined by the COP and to be observed.

The past should also provide some lessons for the future. The KP was, after all, based on some very simple provisions: 1/ Accounting for international transfers (Articles 3.10-3.12); 2/ Trading of UN distributed permits (AAUs - Article 17); 3/ Creation of UNFCCC baseline-and-credit mechanisms, CDM & JI (Articles 6 & 12). We may conclude that the 2015 agreement will need provisions that will enable carbon markets to continue and develop, but they don’t need to be elaborated in great detail in the Paris agreement.

Andrei Marcu - Head CEPS Carbon Market Forum

1. Marcu A.,“The Role of Market Mechanisms in a Post-2020 Climate Change Agreement”, CEPS Special Report, No. 87 / May 2014.

Carbon markets and the post-2020 Agreement

Trading volumes: EUA –20.1%, CER –1.1%, ERU +11.6%

Source: CDC Climat Research calculation, based on data from EEX, ICE Futures Europe, NYMEX, Nasdaq OMX, and LCH Clearnet

Income from Phase 3 auctions: 189 Me in May (+3.31%)

Price of Dec. 14 contract: EUA –2.3%

Source: CDC Climat Research, ICE Futures Europe

Key points • EU ETS reforms: on 25th June, the

EU Commission will host a panel of experts to discuss technical aspects of the proposal of the Market Stability Reserve.

• Market Stability Reserve of the EU ETS: Germany supports the Commission proposal of a market stability reserve and calls for a launch of the mechanism significantly before 2020, i.e. already in 2017.

• 2030 energy and climate package: on 26th and 27th June, the EU Council will discuss the target of CO2 emissions reduction of 40% by 2030 to take a final decision as soon as possible and later in October 2014.

Source: CDC Climat Research based on data from ICE Futures Europe, EEX

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A newsletter of CDC Climat Research

Production

According to the data released by Eurostat, the industrial output in EU27 countries decreased by 0.4% in March 2014. This decrease can be attributed to the fall in the production of energy by 0.6%, intermediate good by 0.5%, durable goods by 0.4%, capital goods by 0.2% and non-durable goods by 0.1%. Annual comparison shows an increase of 1.5% in industrial production from March 2013. Amidst fears of Eurozone deflation, in March 2014, industrial producer’s price fell by 0.2% in the euro area (EU18) and 0.3% in the EU28 and have decreased by 1.6% in both zones compared with March 2013. This has led the European Central Bank to take raft of unconventional steps to avoid deflation which includes a 0.1% cut in its main interest rate and a lowered deposit rate of minus 0.1%. Our EU ETS sector production index (including electricity) remained unchanged compared to February 2014 while the index excluding electricity dropped by 1%. Electricity generation in EU27 countries in February 2014 was 264.1 TWh. This amounts to a 10% decrease in electricity generation compared to January 2014 and a drop of 4.9% compared to February 2013.

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Electricity generation (TWh)

EU 20 (in TWh) Feb. 14 Jan.14Year-on-Year (% change)

Production 264.1 558.9 –4.0%

of which - Combustible fuels 112.4 243.3 –14.5%

- Nuclear 72.7 154.9 0.7%

- Hydro 46.8 96.0 0.7%

- Geoth./Wind/Solar/Other 32.2 64.7 33.3%

Production indices (Index base year 2010)

EU 27 Mar. 14Last month

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Indust. Prod (excl. construction) 103.9 0.1 1.8

EU ETS sectors production* (incl. electricity) 90.8 –1.4 –2.4

EU ETS sectors production* (excl. electricity) 92.1 –1.8 1.4

Electricity. gas and heating 90.1 –1.3 –4.5Cement 79.1 –5.4 1.5Metallurgy 101.7 –0.5 3.0

Oil refinery 92.3 0.0 –1.3

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Energy

In May, the average monthly price of Brent crude oil has increased by 1%, with a high volatility attributed to the political climate in Libya and Ukraine, to achieve $109.2/b. The gas prices have fallen strongly over the course of the month of May: NBP prices fell by 8.2% to €19/MWh while TTF spot prices fell by 6.4% to €19.1/MWh. However, volatility in gas prices could return if significant changes are made to Ukraine’s gas debt when EU, Russia and Ukraine meet this month. With regards to electricity, German spot prices fell by 2.2% and calendar 2015 prices saw a small decrease of 0.1%. This was because a decline in demand was offset by a decrease in nuclear and wind energy generation. The stable outlook on the spot market conditions ensured that the year ahead contracts remained stable. As a result, the German clean dark prices rose on both the spot and the futures market. UK saw a similar trend with the prices falling by 3.9% in the spot market and a slight increase on both summer and winter 2015 contracts. Finally, the theoretical carbon price that would make switching to natural gas profitable was calculated around €20/tCO2 for the spot market.

Primary energy prices and electricity prices Clean dark, clean spark spreads et prix du switch

German baseload – monthly average of Cal. 2015 clean dark and clean spark spreads

May 2014

Coal API # 2 CIF ARA (First month in USD/t) 75.6

Natural gas

NBP (spot in €/MWh) 19.0

TTF (spot in €/MWh) 19.1

Crude oil Brent (First month in USD/b) 109.2

Electricity

Germany (€/MWh)

Spot 32.9

Calendar 34.5

United Kingdom(€/MWh)

Spot 48.7

Next summer 61.2

Next winter 68.0

Clean spark (e/MWh)

Clean dark(e/MWh)

Switching Price (e/tCO2)

spot futures spot futures spot futures

Germany* –7.2 –16.4 9.2 8.8 20.9 28.9

United Kingdom* 12.9 11.1 23.7 34.6 20.0 26.9

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Coordination of CO2, EE and RES policies

On May 26th, a meeting of the informal council of the 28 EU energy ministers was convened to outline medium-term measures to improve security of energy supply in Europe, including notably diversification of supply sources and development of renewable energy. With the recent crises in Ukraine, the EU’s external energy dependence has received considerable focus and attention. Consequently, on May 21st the EU Commission presented an in-depth study on energy security. It is currently in the process of building a comprehensive plan to reduce import dependence from external sources. This plan would be submitted to the EU Council in June. On May 21st, the EU Commission has put forth a new strategy to start monitoring the amount of CO2 emitted by new trucks. Next year, it will propose a new legislation pertaining to emissions by heavy duty vehicles.

Institutional environment

On May 2nd, the EU Commission announced that the total number of international credits exchanged for allowances by EU ETS operators by 30 April 2014 amounts to 132.8 million of which 50% were Certified Emission Reductions (CERs) with the rest being Emission Reduction Units (ERUs). On May 14th, the EU Commission highlighted the growing surplus of emission allowances despite the fact that emissions declined faster than in previous years. On May 20th, the EU Commission stated that it is open to reform the EU ETS by 2021. Therefore, on 25th June, the EU Commission will host a panel of experts to discuss technical aspects of the proposal of the Market Stability Reserve. Expectations are that the EU Parliament work on this proposal will start after the EU elections. On May 20th, in a bilateral dialogue between the EU and China the two parties decided to launch a three-year co-operation agreement on carbon emission trading scheme. With European help, China will establish a national carbon trading emissions scheme.

CER and ERU supply

May 14 Last month change

Number of CDM projects 12,201 +1,068.0

of which - registered 7,516 +20.0

with - CER issued 2,587 +8.0

Cumulative volume of CER issued (Mt) 1,457 +6.0

Number of JI projects 788 0.0

of which - registered 604 0.0

Cumulative volume of ERU issued (Mt) 849.5 +0.5

via - Track 1 824.1 +0.1

via - Track 2 25.4 +0.4

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* CDC Climat Research’s model: http://www.cdcclimat.com/The-risks-of-CDM-projects -how-did-only-30-of-expected-credits-come-through,900.html?lang=fr

2030 Energy and Climate package proposal: Sectorial GHG emissions reductions compared to 2005

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Phase 3 supply balance table

2013 2014*

Auctions (MtCO2) 804 290.6*

Free allocation (MtCO2) 843 767

*till May 2014

Note: The resulting projections of the Scenario Reference show a decline in total GHG emissions of 24% in 2020, 32% in 2030 and 44% in 2050 relative to 1990. GHG40 refers to the scenario with only a 40% GHG target, GHG40/EE refers to the one with additional ambitious energy efficiency (EE) policies. Source: European Commission, Impact Assessment, A policy framework for climate and energy in the period from 2020 up to 2030, PRIMES model, 2014

Free allocation status table

EU Member State 2013 2014

France 82 81

Germany 169 163

United Kingdom 66 64

Others 526 459

TOTAL 843 767

Primary market - EUA auctions in Phase 3

Secondary market - Prices (e/t) and volumes: EUA, CER (ktCO2)

Emission-to-cap by EU ETS sector and country: difference between distributed allocations of allowances and verified emissions

Primary market - CER and ERU issued (MtCO2)

Carbon markets dashboard

May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14

ICE Futures Europe

Daily spot

Price EUA phase 3 3.51 4.25 4.22 4.41 5.22 4.91 4.53 4.79 4.98 6.51 6.11 5.22 5.1

Volume EUA phase 3 14,731 38,427 24,076 5,564 14,672 10,483 7,136 14,965 14,405 21,075 35,324 49,429 19,271

Price CER 0.39 0.44 0.53 0.62 0.65 0.56 0.42 0.36 0.39 0.36 0.19 0.17 0.12

Volume CER 0 112 0 57 170 0 47 1,204 80 375 1,028 2998 745

Dec.14

Price EUA 3.72 4.46 4.39 4.58 5.38 5.07 4.69 4.92 5.07 6.61 6.19 5.28 5.50

Volume EUA 59,334 95,104 48,690 74,289 93,620 135,862 163,545 240,590 450,338 527,394 640,679 360,681 469,397

Price CER 0.39 0.48 0.56 0.62 0.62 0.52 0.41 0.35 0.37 0.36 0.18 0.16 0.23

Volume CER 1,949 8,891 7,134 6,505 12,753 7,949 16,224 20,287 15,305 13,092 20,681 8006 15527

Dec.15

Price EUA 3.88 4.67 4.55 4.75 5.59 5.28 4.89 5.10 5.26 6.91 6.41 5.46 5.50

Volume EUA 34,689 91,861 41,204 20,176 46,207 57,629 55,672 57,784 102,312 116,329 120,993 60,524 467,135

Price CER 0.46 0.55 0.64 0.70 0.71 0.60 0.48 0.45 0.48 0.52 0.48 0.41 0.23

Volume CER 4,087 6,792 2,617 620 3,184 5,586 4,158 10,987 8,766 7,711 11,991 2012 15510

Dec.16

Price EUA 4.04 4.89 4.75 4.96 5.85 5.54 5.12 5.32 5.49 7.26 6.76 5.7 5.50

Volume EUA 18,256 27,115 11,902 7,216 26,918 21,449 16,416 17,398 36,721 62,380 101,196 45,597 466,631

Price CER 0.51 0.60 0.66 0.72 0.74 0.62 0.50 0.46 0.50 0.55 0.49 0.42 0.33

Volume CER 0 134 1,134 0 0 0 10 0 689 245 982 164 800

2008 2009 2010 2011 2012

Combustion –253.1 –113.5 –125.8 –76.9 –40.6

Oil refining –1.4 7.6 14.3 16.0 24.2

Coking plants 1.5 6.8 2.9 3.1 5.7

Metal ores 4.3 11.0 8.8 8.9 9.8

Steel production 51.6 89.3 71.4 72.8 74.0

Cement 20.9 61.4 61.0 62.8 74.1

Glass 2.5 6.1 5.5 5.4 6.4

Ceramic products 5.3 10.0 10.2 9.6 10.4

Paper 6.9 11.3 10.0 11.1 12.9

Other activities 0.2 4.3 1.3 –0.7 6.2

Total (Mt) –161.3 94.2 59.8 112.1 183.2

2008 2009 2010 2011 2012

Germany –84.0 –36.6 –54.4 –49.5 –27.8

United Kingdom –50.8 –15.0 –16.8 2.5 –2.2

Italy –8.5 24.1 8.5 5.3 12.8

Poland –3.1 10.8 5.9 4.2 16.1

Spain –9.6 13.7 29.5 18.4 17.4

France 5.5 17.5 23.4 33.9 35.8

Czech Republic 5.2 12.2 10.6 12.2 17.1

The Netherlands –6.8 2.8 0.1 8.9 10.6

Romania 7.7 24.9 27.7 23.6 26.9

Others –17.0 39.8 25.3 52.7 76.6

Total (Mt) –161.3 94.2 59.8 112.1 183.2

May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14Cumulative volume of CER issued UNEP-Risoe (Mt) 1,335 1,353 1,362 1,369 1,388 1,400 1,409 1,419 1,428 1,433 1440 1451 1457

Cumulative volume of ERU issued (Mt)

Track 1 (Mt) 714.5 757.0 757.0 785.1 801.5 802.4 803.5 803.7 803.8 809.6 816.1 824 824.1Track 2 (Mt) 23.9 24.4 24.6 24.7 25.1 26.7 25.4 25.4 25.4 25.4 25.4 25 25.4

Sources: EEX, ICE Futures Europe

Sources: UNEP-Risoe, CDC Climat Research

Sources: ICE Futures Europe

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CDC Climat Research is the research department of CDC Climat, a subsidiary of the Caisse des Dépôts dedicated to the fight against climate change. CDC Climat Research provides public research on the economics of climate change.ISSN: 1953- 0439

CDC Climat Research Publication manager: Benoît Leguet Editor in Chief: Aseem Patelaseem.patel@cdcclimat.com47, rue de la Victoire - 75009 Paris

May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14

Common Auction Platform + United Kingdom & Germany

Price (€/t) 3.40 4.23 4.16 4.40 5.19 4.83 4.51 4.62 5.00 6.45 6.35 7.35 5.03

Volume (Mt) 66.45 65.89 76.65 33.65 80.33 80.62 84.53 50.90 76.31 80.33 60.98 35.22 37.72

Auction Revenues (M€)

Germany 69.46 68.98 67.09 44.50 84.82 78.19 91.29 36.66 92.28 121.62 85.73 36.53 59.46

United Kingdom 28.69 35.06 49.65 18.30 42.33 38.40 37.87 18.27 48.43 57.88 31.69 26.48 25.35

France 13.58 18.29 20.16 8.76 24.28 21.28 19.65 13.43 22.21 31.21 24.78 13.13 11.65

Others 116.04 156.10 172.06 76.64 265.65 252.38 232.84 166.63 218.98 304.96 245.15 106.82 92.56

Total 227.66 278.43 308.96 148.20 417.08 390.25 381.64 235.00 381.89 515.66 387.35 182.96 189.02