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www.kestrelmanagement.com Carbon Trading: Opportunities and Cautions Philip Trowbridge Kestrel Management Services Email: [email protected] Direct Phone: (512) 795-9119 Management Systems • Risk and Liability Management • Process Improvements ©Copyright 2007 Kestrel Management Services, LLC Presentation Overview • Emissions trading overview • Purpose • Explanation • History • Policy & regulatory development • Kyoto • EU • US & regional • Climate change program considerations • Exchange vs brokerage ©Copyright 2008 Kestrel Management Services, LLC Emissions Trading Overview ©Copyright 2008 Kestrel Management Services, LLC Climate Change Importance • McKinsey surveyed nearly 2200 Executives • 60% - climate change important to strategy Source: McKinsey Global Survey December 2007 ©Copyright 2008 Kestrel Management Services, LLC Climate Change Importance • McKinsey surveyed nearly 2200 Executives • 61% - climate change impact profits positively Source: McKinsey Global Survey December 2007 ©Copyright 2008 Kestrel Management Services, LLC Climate Change Importance • McKinsey surveyed nearly 2200 Executives • 61% - regulation likely Source: McKinsey Global Survey December 2007 ©Copyright 2008 Kestrel Management Services, LLC Climate Change Importance • McKinsey surveyed nearly 2200 Executives • 47% - carbon tax likely Source: McKinsey Global Survey December 2007 ©Copyright 2008 Kestrel Management Services, LLC Climate Change Importance • McKinsey surveyed nearly 2200 Executives • 49% - cap & trade likely Source: McKinsey Global Survey December 2007 ©Copyright 2008 Kestrel Management Services, LLC Climate Change Importance • McKinsey surveyed nearly 2200 Executives However, only 30% of companies incorporate climate change into their corporate strategy Source: McKinsey Global Survey December 2007 ©Copyright 2008 Kestrel Management Services, LLC Emissions Trading • Goal: Reduce emissions • Often referred to as “Cap & Trade” ©Copyright 2008 Kestrel Management Services, LLC Emissions Trading • Market forces reward reductions ©Copyright 2008 Kestrel Management Services, LLC Emissions Trading • Alternative to: • Voluntary measures ©Copyright 2008 Kestrel Management Services, LLC Emissions Trading • Command and control ©Copyright 2008 Kestrel Management Services, LLC Emissions Trading • CO2 tax ©Copyright 2008 Kestrel Management Services, LLC What is a Cap & Trade System? • Cap – emissions limit • Limit at or below current emissions ©Copyright 2008 Kestrel Management Services, LLC What is a Cap & Trade System? • Government either gives away or auctions emission allowances ©Copyright 2008 Kestrel Management Services, LLC What is a Cap & Trade System? • Permits issued within limits ©Copyright 2008 Kestrel Management Services, LLC What is a Cap & Trade System? • Reduction goals included in regulatory limit ©Copyright 2008 Kestrel Management Services, LLC What is a Cap & Trade System? • Purchased offsets are retired ©Copyright 2008 Kestrel Management Services, LLC What is a Cap & Trade System? • Trading occurs between companies/continents • Market forces drive price ©Copyright 2008 Kestrel Management Services, LLC How Cap & Trade Works Image Credit: Union of Concerned Scientist ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Established in U.S. through 1990 Clean Air Act Amendments ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Established in U.S. through 1990 Clean Air Act Amendments • SO2 & NOx trading ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Allowances are “free” ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Lessons learned ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Flexibility provided by ‘banking credits’ ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Allowances allocated at no cost ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Monitoring & enforcement ©Copyright 2008 Kestrel Management Services, LLC Cap & Trade History • Limited regulatory involvement ©Copyright 2008 Kestrel Management Services, LLC Policy & Regulatory Developments ©Copyright 2008 Kestrel Management Services, LLC Kyoto Protocol Kyoto Protocol (1997) • Established mechanisms for trading CER’s between countries/continents ©Copyright 2008 Kestrel Management Services, LLC Kyoto Protocol • Emissions trading ©Copyright 2008 Kestrel Management Services, LLC Kyoto Protocol • Clean Development Mechanisms (CDMs) ©Copyright 2008 Kestrel Management Services, LLC Kyoto Protocol • Joint Implementation ©Copyright 2008 Kestrel Management Services, LLC Kyoto Protocol • CDM’s • 15 sectoral scopes ©Copyright 2008 Kestrel Management Services, LLC Kyoto Protocol • Project verifier approved per scope ©Copyright 2008 Kestrel Management Services, LLC EU Emissions Trading Scheme • Largest emission trading system in world • Covers 10,000 installations EU Emissions Trading Scheme • Largest emission trading system in world • Covers 10,000 installations • Includes variety of heavy industry EU Emissions Trading Scheme • Other industries to be added EU Emissions Trading Scheme • Covered only CO2 initially EU Emissions Trading Scheme • Allowances (EUA’s) are “free” EU Emissions Trading Scheme • First phase (2005-2007) plagued with over allocation EU Emissions Trading Scheme • Second phase (2008-2012) to limit allowances U.S. Policy Overview • Seven Cap & Trade proposals introduced in U.S. Congress in 2007 ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview • Most recent – Lieberman/Warner bill made it out of committee – Died June ‘08 ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview • Expect some harmonization with EU Emission Trading Scheme (ETS) ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview • States actions include voluntary reporting of CO2 emissions and emission reduction targets ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview • Regional initiatives formed for registry and cap and trade systems (WCI, RGGI) ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview – continued • Carbon trading program considerations • Economy-wide program – regulated “upstream” ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview – continued • Multiple GHG’s – beyond CO2 ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview – continued • Auctioned allowances ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview – continued • Mechanism to limit price risk ©Copyright 2008 Kestrel Management Services, LLC U.S. Policy Overview – continued • International trading ©Copyright 2008 Kestrel Management Services, LLC Western Climate Initiative • Formed: February 2007 • Partners: NM, AZ, CA, OR, WA, MT, UT, BC, MAN ©Copyright 2008 Kestrel Management Services, LLC Western Climate Initiative • Goal: 15% reduction by 2020 (2005 baseline) ©Copyright 2008 Kestrel Management Services, LLC Western Climate Initiative • All Partners members of The Climate Registry ©Copyright 2008 Kestrel Management Services, LLC Western Climate Initiative • Expect Cap & Trade proposal August 2008 ©Copyright 2008 Kestrel Management Services, LLC Western Climate Initiative • Point of Regulation – tbd • Allocation of allowances • Reporting ©Copyright 2008 Kestrel Management Services, LLC Regional Greenhouse Gas Initiative • Formed: August 2003 • Partners: CT, DE, ME, NY, VT, MD, ©Copyright 2008 Kestrel Management Services, LLC Regional Greenhouse Gas Initiative • Reduction Goal: Developed by each state ©Copyright 2008 Kestrel Management Services, LLC Regional Greenhouse Gas Initiative • Action Plan • Launch Cap & Trade system by 2009 • Cap set relative to 2000; 10% cap reduction by 2019 ©Copyright 2008 Kestrel Management Services, LLC Regional Greenhouse Gas Initiative • Allowances auctioned ©Copyright 2008 Kestrel Management Services, LLC Corporate Climate Change Program Considerations ©Copyright 2008 Kestrel Management Services, LLC Corporate Strategic Response Considerations • Strategic timing – understand why taking action now is the right time (leader, close follower, laggard) ©Copyright 2008 Kestrel Management Services, LLC Corporate Strategic Response Considerations • Establish appropriate levels of commitment and priority at all levels (BOD, CEO, & others) ©Copyright 2008 Kestrel Management Services, LLC Corporate Strategic Response Considerations • Participate/Influence policy development ©Copyright 2008 Kestrel Management Services, LLC Corporate Strategic Response Considerations • Shift thinking from business risk to business opportunity ©Copyright 2008 Kestrel Management Services, LLC Corporate Strategic Response Considerations • Overcome short-term solution tendency ©Copyright 2008 Kestrel Management Services, LLC Corporate Strategic Response Considerations • Systematic approach to program development – including direct and indirect source emissions ©Copyright 2008 Kestrel Management Services, LLC Benefits of Participating in Carbon Trading Today • Development & maturity of GHG accounting practices ©Copyright 2008 Kestrel Management Services, LLC Benefits of Participating in Carbon Trading Today • Demonstrates commitment to climate change strategy ©Copyright 2008 Kestrel Management Services, LLC Benefits of Participating in Carbon Trading Today • Potential leadership recognition ©Copyright 2008 Kestrel Management Services, LLC Benefits of Participating in Carbon Trading Today • Gain knowledge of carbon trading platform/practice ©Copyright 2008 Kestrel Management Services, LLC Benefits of Participating in Carbon Trading Today • Experience to help drive policy development ©Copyright 2008 Kestrel Management Services, LLC Benefits of Participating in Carbon Trading Today • U.S. has experience with SO2 trading ©Copyright 2008 Kestrel Management Services, LLC Carbon Trading Cautions • C&T is a redistributive system – net reductions? ©Copyright 2008 Kestrel Management Services, LLC Carbon Trading Cautions • Voluntary market limits participation ©Copyright 2008 Kestrel Management Services, LLC Carbon Trading Cautions • Additionality principle ©Copyright 2008 Kestrel Management Services, LLC Carbon Trading Cautions • Carbon restrictions impact economic growth ©Copyright 2008 Kestrel Management Services, LLC Carbon Trading Cautions • Due diligence ©Copyright 2008 Kestrel Management Services, LLC Carbon Trading Cautions • Point of regulation ©Copyright 2008 Kestrel Management Services, LLC Exchange vs Brokerage ©Copyright 2008 Kestrel Management Services, LLC Chicago Climate Exchange (CCX) • • • • Launched 2003 (+300 members) Voluntary, legally binding Trades six GHG’s (CO2, N2O, HFCs, PFCs, CH4, SF6 ) Carbon Financial Instruments (CFI’s) issued annually (CFI’s = 100 metric tons priced/ton) • Offset project verification • Initial and annual third party verification • Reports reviewed by CCX and FINRA • Reduction targets - 3% existing members; 6% new members ©Copyright 2008 Kestrel Management Services, LLC Chicago Climate Exchange (CCX) Source: www.chicagoclimatex.com 06/10/08 ©Copyright 2008 Kestrel Management Services, LLC Cantor CO2e • Provide professional brokerage services to the energy and environmental commodity markets in U.S. & EU • Headquarters: London & San Francisco • Began emissions trading in 1992 • Trade CO2, NOx, SOx, VOC’s, REC’s, • Carbon related services include: • Support for “carbon neutral” – corporate and consumer • Market carbon offsets ©Copyright 2008 Kestrel Management Services, LLC Trading: Exchange Member or Broker? • Annual membership fee $5K to $35K • Transaction fee $5 per trade • Audits reviewed by NASD to ensure conformance ©Copyright 2008 Kestrel Management Services, LLC Trading: Exchange Member or Broker? • • • • No membership fee No Master Agreement Brokerage fee 3% to 5% No reduction target requirement • Rigorous due diligence process ©Copyright 2008 Kestrel Management Services, LLC Conclusion • U.S. has a history of cap & trade • Carbon trading will likely be part of climate change regulation solution • Preparation depends on part you want to play • Market participation may help better prepare you for future • Economics may help resolve whether to use brokerage or exchange ©Copyright 2008 Kestrel Management Services, LLC Thanks! ©Copyright 2008 Kestrel Management Services, LLC