Natsource LLC, an emissions and renewable energy asset manager, has completed its annual analysis of greenhouse gas (GHG) market activity in 2005 and the first quarter of 2006 on behalf of the World Bank’s Carbon Finance Unit.
The analysis shows extensive growth in traded volumes for European Union Allowances (EUAs) and Certified Emission Reductions (CERs) created by Clean Development Mechanism (CDM) projects located in developing countries that have ratified the Kyoto Protocol (KP). These transactions were valued at $10.9 billion in 2005.
Natsource’s research was commissioned by the World Bank and incorporated into the World Bank Carbon Finance Business’s sixth annual “State and Trends of the Carbon Market” report scheduled to be released today at Carbon Expo in Cologne, Germany. These reports have covered GHG market activity from 1996-2006. Natsource is the only company that has provided information and analysis for all of these reports.
“The initiation of the European Union Trading System and entry into force of the Kyoto Protocol increased firms’ and governments’ demand for compliance instruments to meet greenhouse gas emission reduction requirements. The issuance of allowances by European governments and increased clarity regarding the rules governing the project-based mechanisms provide buyers with more options for meeting compliance requirements,” said Jack Cogen, President of Natsource, LLC. “This is good for the marketplace. We believe the market will continue to mature as the Kyoto deadline approaches and as European governments announce and allocate their targets for installations in Phase 2 of the EU ETS.”
Growth of Trade in European Union Allowances (EUA)
The European Union Emissions Trading Scheme (EU ETS) establishes emission reduction requirements for approximately 10,000 large industrial and electricity generating sources accounting for nearly half of Europe’s emissions of carbon dioxide (CO2). Phase 1 of the EU ETS started in January 2005 and runs through 2007. Phase 2 corresponds to the 2008-2012 first commitment period of the KP. European Union allowances are EU ETS compliance instruments which are allocated by EU governments to regulated installations. They can be purchased by entities with short positions to comply with their reduction targets.
The market for EUAs experienced explosive growth in 2005, increasing from approximately 9 million tonnes (Mt) in 2004 to over 322 Mt in 2005 — a nearly 35-fold increase. Prices also increased dramatically during 2005, moving from euro 7 ($9) to a high of approximately euro 30 ($37). This increase was driven by factors such as: rising natural gas prices which increased the need for coal-fired generation, the relative absence in the market of some sellers from Eastern Europe due to delays in bringing their emissions registries on line, delays in creating project-based supply, and other regulatory delays. In 2005, the value of EUA trades in 2005 totaled $8.2 billion. The EU market saw continued expansion in the first quarter of 2006, with approximately 203 Mt traded at a value of approximately $6.6 billion.
On April 28, 2006 the EU market experienced its largest price drop to date, with prices falling to euro 13 ($16) following reports of lower-than- expected emissions for 2005 from six EU countries. All EU ETS countries’ 2005 verified emission reports will be made public by May 15, 2006.
Growth in Trade of Project-based Emission Reductions
Traded volumes of carbon dioxide equivalent (CO2e) emission reductions created by projects grew by 240%, from 110 million tonnes (Mt) in 2004 to 374 Mt in 2005. Approximately 346 Mt (or 93%) of this volume was created from CDM projects hosted by developing countries that ratified the Kyoto Protocol. The value of trade in project-based transactions in 2005 totaled US$2.7 billion. In the first quarter of 2006, approximately 79 Mt were traded, with a value of approximately $0.9 billion (an explosive transaction increase of over 4,000% since 2001). This growth was driven by at least three factors:
– The launch of the EU Emissions Trading Scheme in January 2005 and rising prices for EUAs. CERs created by projects located in developing countries can be used to comply with EU emissions targets.
– The entry into force of the Kyoto Protocol, which establishes GHG emission reduction targets for industrialized country signatories, and the approach of the KP’s first commitment period (2008-2012).
– An increase in the clarity of the rules that govern CDM project approvals and the creation of CERs that will be usable for compliance.
Future Activity
Although prices in GHG markets will continue to fluctuate over time as in similar markets, emission reduction requirements at the national level under the KP, and at the firm level under the EU ETS, will likely continue to drive demand and activity in greenhouse gas markets. Natsource estimates that the countries that comprise the European Union, Japan and Canada will be approximately 3-4 billion tonnes short of achieving their emission reduction targets in 2008-2012, based upon business-as-usual emissions trends.
This year’s analysis identified the following key trends in the international GHG market:
– Growth in trading of project-based emission reductions continues to increase year over year. Total trade of project-based emission reductions increased from 110 Mt in 2004 to 374.3 Mt in 2005. 79 Mt were traded in the first three months of 2006. Since 2001, traded volumes have increased by a factor of 40, from approximately 9 Mt in 2001 to 374.3 Mt in 2005.
– Prices for compliant project-based reductions have increased, but vary considerably depending on type and contract terms. In 2005, the (volume-weighted) average price paid for Verified Emission Reductions (VERs – candidate CERs from CDM projects that have not been registered by the CDM Executive Board) was $4.43, up 12% from $3.95 in 2004. In Q1 2006, the average VER price was $5.65, up 14% from the 2005 average price. The average price for CERs (candidate CERs from CDM projects that have been registered) in 2005 was $7.04, up 37% from $5.15 in 2004. In Q1 2006, the average CER price jumped to $11.56, up 64% from the 2005 average price. In the secondary market, the average price for CERs in 2005 was $22.21, or nearly 300% higher than the 2004 average price of $5.82. In Q1 2006, the average price was $23.33. The average price for Emission Reduction Units (ERUs) from Joint Implementation (JI) projects in 2005 was $4.63. This represented a 22% decrease from the 2004 average price of $5.95. In Q1 2006, the average ERU price was $7.18. The ERU price lag was perhaps due to perceived risks and uncertainties relating to the JI institutional framework at the national and international level.
– HFC23 destruction projects accounted for the largest share of traded reductions. HFC23 destruction projects created CERs that accounted for 58% of project-based transaction volumes, up significantly from 36% in 2004. The next-largest categories were landfill gas projects, at 9% of traded volume, and coal mine methane, at 6% of traded volume. The combined share of hydro, wind, biomass, other renewables and energy efficiency projects declined in 2005.
– China created 66% of the project-based reductions traded. Asia created 73% of the project-based reductions that were traded during 2005 and Q1 2006. China alone created 66%, up from only 5% in 2004. India’s share decreased from 43% in 2004 to only 3% in 2005 and Q1 2006. Latin America accounted for 17% of traded volumes, down from 25% in 2004. Projects located in Brazil created 10% of traded volumes – second after China.
– European buyers are largest buyers in the market, followed by the Japanese private sector. EU buyers purchased 56% of the project-based reductions that were created in 2005 and Q1 2006, up from 41% in 2004. 77% of European purchases (or 43% of total market volume) are attributed to private sector buyers. Japan accounted for 38% of traded volumes (versus 36% in 2004), with the private sector accounting for nearly all of these transactions.
Natsource has been a major participant in the GHG market since the late 1990s. In October 2005, Natsource announced the final close of the Greenhouse Gas-Credit Aggregation Pool (GG-CAP). A total of euro 510 million (approximately US$640 million) was committed to GG-CAP by 26 participants located in Europe, Japan and Canada. This capital will be used to purchase and manage delivery of a large pool of CERs and ERUs which participants can use to comply with GHG emission targets from 2005-2012.
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