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CA-QC Linked Carbon Market: Overview of instruments, trading and strategies for

compliance

Prepared by:

John Battaglia

Director, Carbon Americas Group

Prepared for:

International Emission Trading Association – Business Cap and

Trade Dialogue

Toronto – July 2015

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Business Overview

• NFA-registered Introducing Broker (IB) providing

professional voice brokerage for wholesale

energy and environmental markets

• Founded in 2000 by current management team

• Leader in the global energy and environmental

commodities sector

• Privately held

• ~80 employees in New York, San Francisco,

Houston, London, and Singapore

• Award-winning, client-focused services

• Trade execution for energy and environmental

commodity markets

• Structured environmental products

• GHG compliance strategy services

• Environmental asset origination, including

carbon, emission credits, renewable energy &

fuels

• Advisory on renewable power purchase

agreements

• Market analytics and data

• Largest dedicated environment and energy

markets brokerage

• Advised market design of carbon programs in

EU, California, and Northeast US

• Facilitated first trades in EU-ETS, California,

RGGI, and RECs in NEPOOL, Texas, & PJM

• Evolution principals launched weather

derivatives market

• Forefront of US coal and nuclear fuels markets

• Fortune Global 500 Firms

• Banks

• Hedge Funds

• Utilities & Power Generators

• Industrials

• Project Developers

• Private Investors

Company Overview Market Pioneer

Extensive Counterparty Network

Services

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Clean Power • Global renewable power markets; US renewable energy

certificates (RECs)

• Green power purchase agreement structuring and negotiation

• Green energy policy analysis

Environmental Attributes • Global/regional carbon allowance and offset markets

• Fuel-derived markets, i.e. Low Carbon Fuel Standard (LCFS) and RINs

• US Federal and State emissions markets

Clean Fuels • Global biomass and biofuel markets

• Nuclear fuel supply, risk management and hedging

• Physical natural gas

Power/Natural Gas • Integrated brokerage service for US power markets (PJM,

MidCon, NEPOOL, Texas) and US natural gas markets

Energy Derivatives • Global energy swaps and options coverage, including crude,

natural gas, coal, and power

Our Markets

ENVIRONMENT

ENERGY

FINANCE

EMISSIONS CARBON RENEWABLE ENERGY

WEATHER ENERGY EFFICIENCY WATER

COAL POWER NATURAL GAS BIOMASS

NUCLEAR FUELS BIOFUELS OIL

STRUCTURED TRANSACTIONS CARBON FINANCE

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Traded Carbon Products

California* Carbon Offsets (CCOs) Primary: project-specific, i.e. ODS CCO(3). Secondary: non-project specific. Dec ’15 or

forward, spot/issued. CCOs trade with or without invalidation risk

California Carbon Allowances (CCAs) Primary: auctions/direct allocations. Secondary: exchange-cleared (ICE)

futures/options & OTC* bilateral spot and forwards. Vintages: ’13-’18

Carbon Compliance Instruments (CCIs) Bundled allowance and offsets product. Trades OTC via bilateral contracts. Indexed or

Fixed pricing

Quebec Compliance Instruments Quebec Carbon Allowances (QCAs) or offsets. Primary: auctions/direct allocations.

Secondary: QCAs via ICE CCA* & OTC bilateral spot and forwards. Vintages ‘13-’18

• Over-the-Counter (OTC)

• QCAs are deliverable under the ICE futures contract

• Quebec offset opportunities are limited, currently

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Price Spreads

$10.35

$11.65

$12.65

July ’15 V15

Carbon

Allowance

Spot CCO (3)

Spot “Golden”

CCO

Note: prices are USD and indicative based on current market conditions.

Date: 7/2/2015

$9.95 Spot CCO(8)

Evolution Markets Inc. – Proprietary & Confidential

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Auction – Highlights

Auction Current Vintage Volume

Future Vintage Volume

Reserve Price (USD)

Current Vintage Price

Current Vintage Ratio Qualified Bidders :Supply

Future Vintage Price

CA Nov 2012 23,126,110 (100% sold) 39,450,000 (14% sold) $10.00 $10.09 1.06* $10.00

CA Feb 2013 12,924,822 (100% sold) 9,560,000 (46% sold) $10.71 $13.62 2.47 $10.71

CA May 2013 14,522,048 (100% sold) 9,560,000 (79% sold) $10.71 $14.00 1.78 $10.71

CA Aug 2013 14,522,048 (100% sold) 9,560,000 (100% sold) $10.71 $12.22 1.62 $11.10

CA Nov 2013 16,614,526 (100% sold) 9,560,000 (100% sold) $10.71 $11.48 1.82 $11.10

QC Dec 2013 2,971,676 (34% sold) 6,319,000 (27% sold) $10.75 CAD $10.75 CAD 0.34 $10.75 CAD

CA Feb 2014 19,538,695 (100% sold) 9,260,000 (100% sold) $11.34 $11.48 1.27 $11.38

QC Mar 2014 1,049,111 (99% sold) 1,527,000 (84% sold) $11.39 CAD $11.39 CAD 0.98 $11.39 CAD

CA May 2014 16,947,080 (100% sold) 9,260,000 (44% sold) $11.34 $11.50 1.46 $11.34

QC May 2014 1,049,111 (100% sold) 1,527,000 (85% sold) $11.39 CAD $11.39 CAD 1.02 $11.39 CAD

CA Aug 2014 22,473,043 (100% sold) 9,260,000 (70% sold) $11.34 $11.50 1.14 $11.34

QC Aug 2014 1,049,111 (66% sold) 1,527,000 (95% sold) $11.39 CAD $11.39 CAD 0.66 $11.39 CAD

JOINT Nov 2014 23,070,987 (100%) 10,787,000 (100%) $11.34 USD $11.39 CAD

$12.10 USD 1.73 $11.86 USD

JOINT Feb 2015 73,610,528 (100%) 10,431,500 (100%) $12.10 USD $15.01 CAD

$12.21 USD 1.14 $12.10 USD

JOINT May 2015 76,931,627 (100%) 10,431,500 (94%) $12.10 USD $12.08 CAD

$12.29 USD 1.16 $12.10 USD

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-

250,000

500,000

750,000

1,000,000

1,250,000

1,500,000

1,750,000

2,000,000

$10.00

$11.00

$12.00

$13.00

$14.00

$15.00

$16.00

$17.00

$18.00

$19.00

$20.00

$21.00

$22.00

1/3

/20

12

2/2

1/2

01

2

4/1

1/2

01

2

5/3

0/2

01

2

7/1

8/2

01

2

9/5

/20

12

10

/24

/20

12

12

/12

/20

12

1/3

1/2

01

3

3/2

1/2

01

3

5/9

/20

13

6/2

8/2

01

3

8/1

9/2

01

3

10

/8/2

01

3

11

/26

/20

13

1/2

4/2

01

4

3/1

4/2

01

4

5/5

/20

14

6/2

3/2

01

4

8/1

2/2

01

4

9/3

0/2

01

4

11

/18

/20

14

1/8

/20

15

2/2

6/2

01

5

4/1

7/2

01

5

6/5

/20

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Volume Daily Price Settlement

ICE V13-15 CCA, Dec Delivery

Source: Intercontinental Exchange

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CCA vs. CCO Settles

Source: Evolution Markets, Inc.

CCA

Golden

CCO

CCO(3)

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Brokered Trades

Assistance: Broker assisted trades enable participants to gain access and insight into the markets,

including ideas for effective price risk management, structured finance trades and other strategies for

minimizing compliance costs

Full Product Coverage: ICE-cleared allowance futures, options, spreads, and bilateral offset and

allowance products for California, Quebec, RGGI and other emerging carbon programs such as Ontario’s

Price Transparency: increased exposure to market pricing and transaction opportunities. Brokers

communicate with market participants and therefore provide price discovery and liquidity in the market

Competitive Trade Execution: When trading on ICE parties increase their exposure vs. trading direct

with 1-2 enable parties OTC which limits price discovery.

Anonymity: Brokers are used to handle larger “block trades.” For example, 25 contracts (25,000 MT) is

typically traded electronically on the ICE. A party may enter the market and want to purchase 1,000

contracts (1 million MT). Putting a bid 1,000 contracts on the benchmark Dec ‘15 V15 CCA contract in a

thin market will discourage sellers to sell competitively. The buyer can use an OTC voice broker to find a

seller that is willing to sell their size at a competitive price. The trade is put together OTC by the broker

and then given up to the parties’ banks for clearing.

Neutral: Introductory Brokers (IBs) are market neutral. We do not take principal positions in the market

and therefore, do not trade a book which could impact the price we’re providing to the market.

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Contact Information

John P. Battaglia, ERP

Director – Carbon Markets, North America Evolution Markets Inc.

3 Embarcadero Center, Suite 1630

San Francisco, CA 94111

tel. +1.415.963.9137

mob. +1.917.287.9688

email jbattaglia@evomarkets.com

website www.evomarkets.com

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Market Leadership

Since Evolution Markets was founded, we have received more than 140 awards for

excellence in brokerage. Below is a sample of our most recent awards from 2014/2015.

For a full list, please visit www.evomarkets.com

Annual Customer Survey

Best Broker, Spot & Futures – EU Emissions Trading Scheme

Best Broker, Options – EU Emissions Trading Scheme

Best Broker, Secondary Market Kyoto Project Credits

Best Broker, Spot & Futures – North American Markets

(California)

Best Broker, Options – North American Markets (California)

Best Broker, North American Markets (RGGI)

Best Broker, Renewable Energy Certificates, North America

Best Broker, U.S. Coal

2014

House of the Year: U.S. Coal (2010)

Specialist Broker of the Year (2008)

House of the Year: European Emissions (2007)

House of the Year: Weather / Emissions (2004)

2014 Annual Commodity Rankings

Annual Awards

*

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Carbon Price Drivers: Fundamental

NOTE: ARB released ‘13 emission data from capped sectors. Trends show declining

emissions largely due to the recession, but there are other reasons. ‘13 covered

emissions in CA amounted to 145M tons. The ‘13 cap was 163 million – market is

oversupplied compliance instruments, before accounting for 8% offsets

Macro-economic

• Electrical load and industrial growth in CA the state’s recovery is picking up

Power

• Annual hydro power variability – California has declared a drought emergency which

means low hydro power/high fossil generation, yielding higher emissions/CCA demand

• Record renewable energy generation in ’13; escalating RPS (33% by 2020)

Transportation

• Added to cap in 2015 -- GHG policies such as clean car standards and LCFS have

resulted in lower gasoline demand and emissions per unit of gas product

• Fuels are 100% short; comprise approx. 160 million tons, or 40%, of emissions cap

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Carbon Price Drivers: Fundamental

Offset Supply

• Current offset utilization rate is below 8% allowable limit

• 5 project types approved by ARB to date (MMC,ODS, Livestock, Urban Forestry,

Forestry)

• Currently approx. 18 million tons available vs. approx. demand from CA-QC for First

Compliance Period (2013-2014) of 27.52 million tons.

Linkage with other Programs

• QC-CA linked January 1, 2014 making compliance instruments between the program

fungible

• QC has a more stringent reduction targets than CA and less abatement opportunity

• Section 111(d) of The Clean Air Act: EPA proposal may lead to additional U.S. States

joining CA & Quebec, RGGI

• Ontario joining – what does it mean for the QC-CA supply-demand balance?!!!

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Carbon Price Drivers: Technical & Legal

Hedging Behavior

• Generators buy carbon when selling wholesale power; mismatched timing of supply

and demand, some argue, could lead to short term price spikes albeit they would be

limited given the oversupply

• Utility procurement restrictions adversely impacting liquidity

• Fuels have a large short to cover; we’re starting to see fuel hedging in the V16 Dec ‘15

ICE CCA contract

Structural/Regulatory

• Price floor + 5% escalator and CPI provide price support

• Holding limits adversely impacting liquidity

• High level of free allocations, flexibility to comply, i.e. use ‘V14 against ‘13 emission

obligation

• Resource shuffling “safe-harbor provisions”; 18 month non-enforcement period

Legal

• All environmental markets are ripe for legal challenge

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Financing Trade

Cost of Carry • Buy carbon, i.e. auction or secondary market, roll forward at low rates

– entities carrying allowances (selling the spread) have low financing costs, i.e. banks

– trades are executed via exchange (spreads) or can be OTC bilateral between counterparties

• Recent trades:

TRADE DATE PRODUCT Vintage TERM PRICE VOLUME # MO SPREAD $/MONTH $/YEAR ANNUALIZED

6/18/2015 CCA Futures 15 Jun-15 -12.56 200 2 0.06 0.03 0.36 2.89%

6/18/2015 CCA Futures 15 Aug-15 12.62 200 2

6/16/2015 CCA Futures 15 Jun-15 -12.56 1000 7 0.19 0.027 0.32 2.59%

6/16/2015 CCA Futures 15 Jan-16 12.75 1000 7

6/15/2015 CCA Futures 15 Jun-15 -12.55 150 6 0.15 0.025 0.3 2.40%

6/15/2015 CCA Futures 15 Dec-15 12.7 150 6

6/10/2015 CCA Futures 18 Jun-15 -12.34 800 6 0.13 0.022 0.26 2.11%

6/10/2015 CCA Futures 18 Dec-15 12.47 800 6

6/10/2015 CCA Futures 18 Jun-15 -12.34 100 6 0.13 0.022 0.26 2.11%

6/10/2015 CCA Futures 18 Dec-15 12.47 100 6

6/10/2015 CCA Futures 17 Jun-15 -12.5 100 6 0.13 0.022 0.26 2.09%

6/10/2015 CCA Futures 17 Dec-15 12.63 100 6