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Managing Natural Resources through Innovative Market Solutions: The Case of the Chicago Climate Exchange Dr. Richard L. Sandor Chairman and CEO Chicago Climate Exchange Chicago Climate Exchange® www.chicagoclimateexchange.com "Chance favors the prepared mind.” - Louis Pasteur Chicago Climate Exchange® www.chicagoclimateexchange.com Members of Chicago Climate Exchange Aerospace Rolls Royce Automotive Ford Motor Co. Chemicals Dow Corning DuPont Diversified Manufacturing Bayer Corporation Interface, Inc. Electronics Motorola, Inc Energy Services Sieben Energy Associates Electric Power Generation American Electric Power Manitoba Hydro TECO Energy Green Mountain Power Environmental Services Waste Management Food Processing Premium Standard Farms Legal Services Foley & Lardner Forest Products International Paper MeadWestvaco Corp. Stora Enso NA Temple-Inland, Inc. Chicago Climate Exchange® www.chicagoclimateexchange.com ® Information Technology IBM Open Finance LLC The Inter contienental Exchange Liquidity Providers AGS Specialists Michael R. Anderson Breakwater trading LLC Raymond S. Cahnman Amerex Energy Ltd. Calyon Financial Inc. Eagle Market Makers, Inc First New York Securities Goldenberg, Hehmeyer. ICAP Energy LLC Christopher J. Johnson Kingstree Trading Kottke Associates LLC Marquette Partners LP Douglas M. Monieson Natsource LLC Members of Chicago Climate Exchange Liquidity Providers (cont’d.) Non-Governmental Organization World Resources Institute American Coal Ash Association American Council on Renewable Energy Houston Advanced Research Center Refco LLC Serrino Trading Co. C. Richard Stark, Jr Jeffrey B. Stern Lee B. Stern Tradelink LLC Tradition Financial Pharmaceuticals Transmarket Group Baxter Healthcare FCT Europe The League Corporation Private University Tufts University Municipalities City of Chicago Public University University of Oklahoma Offset Aggregator University of Iowa Iowa Farm Bureau Offset Provider Klabin S.A. Resources Technology Corporation Restoration Soil & Semiconductors STMicroelectronics Steel Roanoke Electric Steel Chicago Climate Exchange® www.chicagoclimateexchange.com ® Technology Ecoenergetics srl Millennium Cell Transportation Amtrak Engineering Vanasse Hangen Brustlin, Inc Financial Services Access Industries, Inc. Consulting Domani LLC Global Change Associates Natural Capitalism, Inc Rocky Mountain Institute Members of Chicago Climate Exchange Professional Associations The Professional Risk Manager’s International Association Religious Organizations Jesuit Community of Santa Clara University Retiring/Offsets Carbonfund.org ® SRI Fund PAX World Technology BenVen LLC Ecoenergetics Srl Millennium Cell Polar Technologies CCX total emission baseline of ~250 million metric tons CO2 would make CCX one of the largest “countries” in EU CO2 Market Chicago Climate Exchange® www.chicagoclimateexchange.com Chicago Climate Exchange ® (CCX ®) Chicago Climate Exchange® (CCX® ) is a voluntary, legally binding pilot greenhouse gas reduction & trading program for emission sources and offset projects in North America and offset projects in Brazil CCX® is the world's first multi-national and multi-sector market for reducing and trading greenhouse gas emissions An unprecedented demonstration that a cross-section of North American private and public entities can design and implement a voluntary, legally binding market-based GHG emissions reduction program Chicago Climate Exchange® www.chicagoclimateexchange.com Goals of CCX® • Proof of concept: establish the viability of a multi-sector GHG emissions cap-and-trade program, supplemented by offsets, to reduce GHG emissions cost-effectively • Price discovery and dissemination of market information • Standardization of the commodity and building of market infrastructure and institutions— e.g. registry, clearing, settlement • Facilitation of trading with low transactions costs • Harmonization and integration with other trading regimes Chicago Climate Exchange® www.chicagoclimateexchange.com Seven Stages of Market Evolution 1. Structural change - demand for capital 2. Uniform commodity/security standards 3. Legal instrument providing evidence of ownership 4. Informal spot and forward markets 5. Emergence of exchanges 6. Organized futures and options markets • Homogeneity • Price Variability • Competitive Determination of Prices • Viable Cash Markets • Patterns of Forward Contracting • Contract Design • Legal and tax 7. Proliferation of OTC markets, deconstruction Chicago Climate Exchange® www.chicagoclimateexchange.com Examples of the Seven-Stage Market Evolution Process Historical: • Dutch East India Company (1605) • Wheat (1848) Contemporary: • Collateralized mortgage obligations (1970) • U.S. Sulfur dioxide emissions allowances (1990) Chicago Climate Exchange® www.chicagoclimateexchange.com Evolution of Markets - CO2: A Comparable Story Structural Change Population growth, increased fossil fuel use Uniform Commodity Property Rights, Regulation and Evidences of Ownership Informal Markets CO2e CTOs in Costa Rica Private sector activity (i.e. ZAPCO-OPG) CCX mutual agreement OTC - $50-$100 million, not uniform Exchanges, Futures and Options Chicago Climate Exchange® www.chicagoclimateexchange.com CCX and NASD (2003) CCX® Key Features • Voluntary cap and allowances for emitters • Project-based offsets: farm and forest sinks, methane destruction and eligible offset projects in the U.S. and Brazil • Include all GHGs, use IPCC global warming potentials • Registry, Electronic Trading Platform, Financial Clearinghouse • NASD market oversight • Self-regulatory organization overseen by Committees of Members, directors and staff Chicago Climate Exchange® www.chicagoclimateexchange.com Standardized Reduction Timetable 2003: Reduce emissions to 1% below 1998-2001 levels 2004-2006: target falls additional 1% per year (from 1998-2001) ® CCX Emission Reduction Schedule 100% 99% 98% 97% 96% 95% 94% 93% 92% 98-01 2003 2004 Chicago Climate Exchange® www.chicagoclimateexchange.com 2005 2006 The Role of NASD • As the official CCX Provider of Regulatory Services, NASD: • Conducts third-party verification of Members’ Emission Baselines and Annual Emission Reports • Oversees Offset Project verification • Provides market oversight •NASD’s role ensures the integrity of the commodity traded on CCX and of the emission reduction targets of CCX Members. •Development of the GHG emissions verification function is critical to the credibility and success of the global carbon market. Chicago Climate Exchange® www.chicagoclimateexchange.com CCX® External Advisory Board Honorary Chairman The Honorable Richard M. Daley, Mayor, City of Chicago Ernst Brugger, President, Brugger, Hanser & Partner Elizabeth Dowdeswell, former Executive Director, UN Environment Program Jeffrey Garten, Dean, Yale School of Management Lucien Bronicki, Chairman, ORMAT International Donald Jacobs, Dean Emeritus, Kellogg Graduate School of Management, Northwestern Joseph Kennedy II, Chairman, Citizens Energy Group; former U.S. Representative (MA) Israel Klabin, President, Brazilian Foundation for Sustainable Development Bill Kurtis, Journalist and television producer Thomas Lovejoy, President, Heinz Center; former Chief Biodiversity Advisor, the World Bank David Moran, President, Dow Jones Indexes R.K. Pachauri, Chairman, Intergovernmental Panel on Climate Change Michael Polsky, President and CEO of Invenergy Donna Redel, former Executive Director, World Economic Forum Sir Brian Williamson, former Chairman, London International Financial Futures Exchange Robert Wilmouth, President and CEO, National Futures Association Klaus Woltron, Austrian entrepreneur and Vice President of the Vienna Club Michael Zammit Cutajar, former Executive Secretary, UNFCCC Chicago Climate Exchange® www.chicagoclimateexchange.com CCX® Public Directors Maurice Strong (Vice-Chairman) Chairman, Earth Council and former Undersecretary-General of the UN Les Rosenthal (Vice-Chairman) Principal, Rosenthal Collins and former Chairman, Chicago Board of Trade Warren Batts Professor, University of Chicago Graduate School of Business, former CEO of Tupperware Governor James R. Thompson Chairman, Winston & Strawn, former four-term Governor of Illinois Chicago Climate Exchange® www.chicagoclimateexchange.com CCX® Trading Highlights to Date • Total trades: ~700 • Average daily trading volume: 7,264 metric tons carbon dioxide.* • Total allowances transferred: 2.6 million metric tons carbon dioxide. Select Cumulative Market Summary CCX Carbon Financial Instruments Vintage High Low Last Traded Volume + Auction Volume 2003 $2.00 $0.73 $1.36 309,200 + 100,000 2004 $2.03 $0.77 $1.34 694,100 + 0 2005 $2.06 $0.71 $1.20 861,800 + 25,000 2006 $2.04 $0.80 $1.27 640,400 + 0 Price: per metric ton of CO2 Volume: metric tons CO2 * based on 345 trading days, from Dec. 12 – April 21, 2005 Chicago Climate Exchange® www.chicagoclimateexchange.com Initial Results from CCX® Year One • Member’s Baselines and 2003 Emissions Audited • Program-wide emission reductions achieved • Complete operation implemented: rulebook, trading, clearing, registry, market oversight, governance • Trading active: • >600 trades (2.3 million tons) • Prices range from under $1/ton to over $2/ton • Members gaining broad practical experience, better understanding energy usage, positioning for policy Chicago Climate Exchange® www.chicagoclimateexchange.com Recent Developments European Climate Exchange (ECX) ECX products will trade on the London-based International Petroleum Exchange, and will provide a central, cleared exchange platform for trading of carbon dioxide emission allowances issued by EU member states under the EU Emissions Trading Scheme. Chicago Climate Futures Exchange (CCFE) CCFE is a CFTC-regulated futures markets, and is currently trading two variations on a Sulfur Financial Instrument (SFI) contract. CCFE will serve as the futures exchange for pollution and environmental commodities. Other Markets • Water - Quality and Quantity • Non-GHG Pollutants Chicago Climate Exchange® www.chicagoclimateexchange.com Why Join Chicago Climate Exchange ® CCX® provides you with the opportunity to Engage with all relevant stakeholders, Disclose publicly your commitment to climate change and Act by making a specific reduction commitment and thereby Participate in seeking a constructive public policy solution to a global problem Become a leader in addressing climate change and reducing GHG emissions Implications of leadership: • Create shareholder value • Limit threats to shareholder liability • Demonstrate corporate and environmental transparency • Obtain first-mover advantage in emissions trading Chicago Climate Exchange® www.chicagoclimateexchange.com Importance of Climate Change to the Public and Corporate Sustainability Climate change is an issue that we have to deal with in the future Climate change risk creates new business opportunities and challenges resulting in significant and uneven financial impacts on industries and regions: physical risk policy risk competitive risk legal risk reputation risk Bottom line is that how a corporation manages its carbon exposure can create or destroy its shareholder value. Once markets open, then financial tools can be used to minimize compliance risk. Source: CERE Chicago Climate Exchange® www.chicagoclimateexchange.com Water Markets Issues: Quantity and Quality Fragmented, non-transparent Need for price discovery, transparency Emergence of Exchanges Western U.S. – quantity NutrientNet – quality Chicago Climate Exchange® www.chicagoclimateexchange.com Fisheries Markets Overharvesting around the globe has led to decimated and unstable commercial fishery populations, glutted fish markets and bankrupt fishermen. Fragmented command & control policies have created perverse and destructive incentives in many instances. Well-designed systems that distribute scarcity using Total Allowable Catch (TAC) caps divided into Individual Transfer Quotas (ITQs) or Individual Fishing Quotas (IFQs) have proven sustainable for fisheries and profitable for individual fishermen. New Zealand has used a cap-and-trade system since 1986 Alaska’s North Pacific Fishery Management Council has been in operation since 1995 Chicago Climate Exchange® www.chicagoclimateexchange.com Innovative Market based solutions may hold the Key Well-designed systems that distribute scarcity using Total Allowable Catch (TAC) caps divided into Individual Transfer Quotas (ITQs) or Individual Fishing Quotas (IFQs) have proven sustainable for fisheries and profitable for individual fishermen. New Zealand has used a cap-and-trade system since 1986. Alaska’s North Pacific Fishery Management Council has been in operation since 1995. Chicago Climate Exchange® www.chicagoclimateexchange.com Chicago Climate Exchange http://www.chicagoclimateexchange.com Chicago Climate Futures Exchange http://www.theccfe.com European Climate Exchange http://www.europeanclimateexchange.com Chicago Climate Exchange® www.chicagoclimateexchange.com