©2008 chicago climate exchange, inc. michael j. walsh, ph.d. executive vice president, research...

©2008 CHICAGO CLIMATE EXCHANGE, INC.

Michael J. Walsh, Ph.D.Executive Vice President, ResearchChicago Climate Exchange®, Inc.

Reproduction or quotation is expressly forbidden without consent of the author.

Implementation of Market-based Solutions to Climate Change


“Business Increases pressure on G8 to set up global emissions trading system”

“Steve Lennon, chair of the environment and energy commission of the International Chamber of Commerce, which represents hundreds of

thousands of companies in 130 countries, said:

“We see a global system of emissions trading as inevitable”

Financial Times, June 10, 2005, page 1


Global Status of Legislated Carbon Market Activity

European UnionAustralia Canada

21%

US RussiaUkraine Japan

36%

Rest of World43%

Green = live market or final planning stages

Yellow = signs of progress

Red = market activity limited to CDM

percentage share of global emissions


The Growing CCX Global Platform

Chicago Climate Exchange (CCX) Launched 2003 with 14 members, now 400+ members (US, CA, MX, BR, NZ, AU, CH)

European Climate Exchange (ECX)FSA-regulated futures market for European CO2 AllowancesLaunched April, 2005 – accounts for 80-90% of total exchange traded volume in the EU ETS

Chicago Climate Futures Exchange (CCFE)CFTC-regulated futures exchange for U.S. SO2 and NOx allowancesLaunched in December 2004, world’s first environmental derivatives exchange

Montreal Climate Exchange (MCeX)Joint venture with the Montreal BourseHosts Canadian GHG trading, other environmental markets: launched May 30, 2008

New York Climate Exchange™ and Northeast Climate Exchange™ Developing instruments for northeast Regional Greenhouse Gas Initiative (RGGI)

India Climate Exchange(In development)


• Arthur Pigou (early 1900s): • environmental damages due to wrong prices• tax harmful actions, subsidize positive ones

• Ronald Coase (1960s)• ill-defined property rights preclude fair settlements• ownership, low transaction costs => negotiate, settle

• Joseph Schumpeter (early 1900s): • inventive process: invention, innovation, replication

Climate Policy, Economic Thought


• Flexibility: lower cost to cut emissions compared to inflexible mandates

• Wise use of scarce resources: static efficiency• more environmental protection per dollar spent

• Lower cost makes larger cuts politically acceptable

• Works with/harnesses business capabilities: another asset and materials flow to be managed

• Price signal guides resources, indicates real cost

• Profits stimulate innovation: dynamic efficiency

Emissions Trading: Rationale


Example: Economic Benefits of Emissions Trading - Total Cost to Society to Cut Emissions 2 Tons is Lowered Through Trading

$0

$100

$200

$300

$400

Plant A Plant B NoTrading

Trading

cost per ton of

reductions$100 per ton

$225 per ton

Each plant cuts 1 ton,

total cost = $325

Plant A cuts 2 tons (sells one ton of credit to Plant B),

Plant B “hires” A (by purchasing one ton),

total cost= 2 x $100 = $200$225(Plant B)

$100(Plant A)

$100

industry pollution control

cost structure

$100

Same overall emission cuts realized (2 tons),

cost to society is reduced through trading


• Multiple emission sources cause common problem (mixing)

• Able to define and monitor reduction objective

• Differences in mitigation costs across sources allow cost savings through trading:• those facing low cost to cut emissions make extra cuts and sell allowances to those facing high cost

• Enforce rules while maintaining other protections (e.g. local air rules)

• Functional legal/business environment:• effective governance, enforceability• rules stability and confidence therein• reliability of contracts and commerce

Emissions Trading: Needed Conditions


Emissions Trading: Basics

Example: Baseline, Target and Actual Emission Levels

0

20

40

60

80

100

120

Baseline Seller Buyer

Em

issi

on

Le

ve

ls

Emission target: 95 tons (5% cut)

100 ton baseline

85 tons

105 tons

10 ton surplus

10 ton shortage


• Set targets: overall and source-specific limits• based on environmental goals, affordability

• Assign tradable allowances to sources (=target)

• Define eligible offset projects, issue credits

• Monitor and report emissions, track transfers• emissions database• allowance registry

• Periodic “true-up”: retire allowances in amount equal to emissions• annual true-up for “accumulative” pollutants (e.g. SO2, CO2) • seasonal true-up for time-sensitive pollutants (e.g. ozone/NOx)

Emissions Trading: Implementation


U.S. Electric Power Sector SO2 Emissions

0

5,000

10,000

15,000

20,000

1980 1985 1990 1995 2000 2005 2010 2015 2020

Thou

sand

Ton

s

Projected Emissions w/ CAIR* Existing Title IV Cap*

CAIR Caps*

Source: USEPA


Impact of trading on SO2 pollution

Based on EPA’s latest air quality trends data the national composite average of SO2 annual mean ambient

concentrations decreased 48 percent between 1990 and 2005.

Annual Mean Ambient SO2 Concentration1989-1991 2004-2006

12


Pre-1992 Forecasts of SO2 Allowance Prices vs. Actual Allowance Prices

$0

$500

$1,000

$1,500

$2,000

$2,500

1 11

Pri

ce p

er t

on

"Phase 1 Middle" prices, Source: Hahn and May, The Electricity Journal, March 1994

$981 United Mine Workers$785 Ohio Coal Office

$688 Electric Power Research Institute$446 Sierra Club $392 American Electric Power

$309 Resource Data Intl.

$275 - average auction price, 1993-2008

$1500 EPA Emergency Supply

$2000 Fine Level


Schoolchildren buy and retire SO2 allowances: low transaction costs allow efficient

outcomes

Chicago Board of Trade, March 1994 (Photo Source: Mainichi Evening Eye)


• Multiple environmental and economic successes

• U.S. SO2 market: • 100% compliance• emissions fell ahead of schedule• active trade, low cost to consumer

• Other successes: gasoline lead; L.A.; U.S. NOX

• International carbon markets:• CCX, EU ETS markets now live• Australia, NZ, Canada, Japan markets planned• U.S. market proposed in numerous legislative drafts

Emissions Trading In Practice


• Atmospheric concentrations of carbon dioxide and other greenhouse gases are up – no dispute

•Atmospheric concentrations of carbon dioxide an other greenhouse gases are up – no dispute

• Risk: global temperature rise, more extreme heat waves, drought and precipitation events: stress on water, energy, infrastructure

• Risk: Sea-level rise: thermal expansion, land-ice melt • coastal damage• inundation

• Risk: Spread of temperate disease, pests• human health• agricultural, forestry

• Risk: bad policy could yield less environmental progress for any given investment in resources: how to optimize return on investment?

Global Climate Risks


• Lower carbon fuel: natural gas, CO2 neutral fuel (biomass)

• More efficient fuel use: MPG, lighting, insulation

• Methane capture/combustion

• Abatement devices, alternative chemicals

• Carbon sequestration:• reforestation, carbon accumulation, preservation• agricultural soils• geologic

How to Reduce Greenhouse Gases


Getting Started With A Pilot Market: A Concept Becomes Reality, Yet Still No Implementation by Western Hemisphere Governments


What is Chicago Climate Exchange?

Chicago Climate Exchange (CCX®) is the

world’s first and North America’s only voluntary,

legally binding greenhouse gas reduction, audit,

registration and trading program for emission

sources and offset projects in North America,

Brazil and globally.


CCX Market Architecture (2003-2010)

Phase I: Members made legally binding commitments to reduce or trade 1% per year from 2003-2006, for a total of 4% below baseline.Phase II: Members make a legally binding commitment to reduce to 6% below baseline by 2010.Baseline = Avg. emissions from 1998-2001, emissions in 2000 (Phase II)

CCX is synergistic with and complementary to all emerging policy, precludes none – whetherstate, regional, national, voluntary or mandatory.


GHG Reduction Targets: CCX, Proposed Legislation

70

80

90

100

110

120

130

2000 2005 2010 2015 2020 2025 2030

Year

Em

issi

on

targ

ets

rela

tive

to y

ear

2000

leve

ls

trend

CCX "B"([email protected]%/y)

proposedLieberman-Warner

proposedFeinstein-Carper

proposedCalifornia

proposedBingaman- Specter

Federal/Cal Proposals “catch-up” to CCX path around 2020-2030

CCX ongoing and extended paths

Trend = +1%/yr


CCX Membership(Over 400 - All Sectors)

*Application in process

Electric Power AGL Hydro PartnershipAllegheny Energy Inc.Alliant EnergyAmerican Electric PowerAmerican Municipal Power-OhioAssociated Electric Cooperative Avista CorporationCentral Vermont Public ServiceDTE Energy IncDuquesne Light CompanyGreen Mountain PowerHoosier Energy Rural ElectricManitoba HydroNRG Power Marketing Inc.Puget Sound Energy, Inc.Reliant Energy Services Inc.TECO Energy, Inc.

ElectronicsMotorola, Inc.Sony Electronics Inc.Square D/Schneider Electric

Aerospace & EquipmentRolls-RoyceUnited Technologies

Agricultural ProductsAgrium U.S. Inc.Cargill, IncorporatedMonsanto Company

AutomotiveFord Motor Company

Beverage ManufacturingNew Belgium Brewing

ChemicalsDow CorningDuPontRhodia Energy Brasil Ltda

Coal MiningJim Walter Resources, Inc.PinnOak Resources LLC

Commercial InteriorsKnoll, Inc.Steelcase Inc.

Counties & StatesKing County, WashingtonMiami-Dade County, FloridaSacramento County, CaliforniaState of IllinoisState of New Mexico

Diversified ManufacturingEastman Kodak Company

Environmental ServicesAtlantic County UtilitiesLancaster County Solid WMAVeolia Environmental Services Wasatch Integrated WMAWaste Management, Inc.

©2008 CHICAGO CLIMATE EXCHANGE, INC. *Application in process

RetailSafeway, Inc.

TechnologyFreescale SemiconductorIBMIntel CorporationSTMicroelectronics

TransportationAmtrakSan Joaquin Regional Rail

UniversityUC San DiegoHadlow CollegeMichigan State UniversityUniversity of IdahoUniversity of IowaUniversity of MinnesotaUniversity of OklahomaTufts University

ManufacturingBayer CorporationInterface, Inc.Ozinga Bros., Inc. Smurfit-Stone

MunicipalitiesCity of AspenCity of BerkeleyCity of BoulderCity of ChicagoCity of FargoCity of OaklandCity of Melbourne, AustraliaCity of Portland

PetrochemicalsPetroflex Industria e Comercio

PharmaceuticalsBaxter International, Inc.RecreationAspen Skiing Company

Ethanol ProductionCorn Plus LLP

Financial InstitutionsBank of America

Food ProcessingMeister Cheese Co. LLCPremium Standard FarmsSmithfield Foods, Inc.

Forest Products Abitibi-Consolidated Aracruz Celulose S.A.Cenibra Nipo Brasiliera S.A.International PaperKlabin S.A.Masisa S.A.MeadWestvaco Corp.Neenah Paper IncorporatedStora Enso North AmericaSuzano Papel E Celulose SATembec Industries Inc.Temple-Inland Inc

CCX Membership(Over 400 - All Sectors)


540

339

237

232

206

174

171

151

130

94 86

71 60 56 45 37 33 31 30 29 22 22 19 11 9 4 3

170

496

0

100

200

300

400

500

600

CC

X

Ger

man

y

Can

ada

Pola

nd Ital

y

Uni

ted

Kin

gdom

Aus

tral

ia

Spai

n

Fran

ce

US

NE

Stat

es (R

GG

I)

Cal

iforn

ia

Cze

ch R

epub

lic

The

Net

herl

ands

Gre

ece

Belg

ium

New

Sou

th W

ales

Finl

and

Port

ugal

Aus

tria

Den

mar

k

Slov

akia

Hun

gary

Swed

en

Irel

and

Esto

nia

Lith

uani

a

Slov

enia

Latv

ia

Luxe

mbo

rg

Hun

dred

Mill

ion

Met

ric to

ns C

O2

Live Market

Market in development

Under discussion

Size of Live, Emerging, Possible GHG Markets

CCX includes more industrial emissions under its legally binding cap than any country in the world

2012 Start2003 Start

2009 Start

Included emissions


CCX Associate Members (“Carbon neutral”-selection)

Architecture/PlanningMithun, Inc.

Brokerage ServicesAmerex Energy

ConsultingDomani, LLC

Global Change AssociatesNatural Capitalism, Inc.

RenewSource Development, L.P.

Rocky Mountain Institute

Diplomatic SectorEmbassy of Denmark, Washington DC

Documentary ProductionCloverland, Inc.

Energy and Management ServicesOrion Energy Systems LtdSieben Energy Associates

Thermal Energy International

EngineeringRumsey Engineers, Inc.

Vanasse Hangen Brustlin, Inc.

Financial ServicesAccess Industries, Inc. MB Investments, LLC

Financing AgenciesOhio Air Quality Development Authority

Green Power MarketersGreen Mountain Energy Company

Information TechnologyOpen Finance LLC

Intercontinental Exchange

Legal ServicesFoley & Lardner, LLP

Sullivan & Cromwell, LLP

Non-Governmental OrganizationsAmerican Coal Ash Association

American Council on Renewable EnergyDelta Institute

Houston Advanced Research CenterMidwest Energy Efficiency Alliance

Private CollegesPresidio School of Management

Risk ManagementThe Professional Risk

Managers’International Association

Religious OrganizationsJesuit Community of Santa Clara

University

Renewable EnergyAirtricityIntergy

Reknewco, Ltd.

Retiring/OffsetsCarbonfund.orgTerrapass, Inc.

Social InvestmentKLD Research & Analytics

Pax World

TechnologyMillennium Cell

Polar Refrigerant Technology

Trade AssociationsConfederation of British Industry


CCX Participant Members (selection)

Offset AggregatorsC-Green Aggregator, LLC

Delta InstituteEnvironmental Carbon Credit Pool,

LLCEnvironmental Credit Corp.

First Capital Risk Management, LLCIowa Farm Bureau

National Carbon Offset CoalitionNorth Dakota’s Farmers Union

Offset ProvidersBeijing Shenwu Thermal Energy Trading

Hubei Sanhuan Gallo Cattle

Granger HoldingsIntrepid Technologies, Inc.

Lugar Stock FarmPrecious Woods Holdings

Sexton EnergySustainable Forestry Management, Ltd.

AGS Specialists, LLCAmerex Energy

Breakwater Trading, LLCCalyon Financial, Inc.

Cargill Power Markets, LLCEagle Market Makers, LLC

Evolution Markets, LLCEXO InvestmentsFCT Europe, Ltd.

First New York Securities, LLC.

Friedberg Mercantile Group, Ltd.

Liquidity Providers

Galtere International Master Fund, LP

GFI Securities, LLCGoldenberg, Hehmeyer & Co.

Grand Slam Trading, Inc.Grey K Environmental Fund, LP

Haley Capital ManagementICAP Energy, LLC

Kottke Associates, LLCThe League Corp.

Marquette Partners, LPNatsource, LLC

Peregrine Financial GroupRand Financial Services, Inc.

Serrino Trading Co.Shatkin Arbor, Inc.S.R. Energy, LLC

SwissRe Financial Products Corp.

TEP Trading 2 Ltd.TradeLink, LLC

Tradition Financial Services, Ltd.

TransMarket Group, LLC


Practical and strategic drivers:

• Competitive advantages through leadership:

reduce greenhouse gas emissions in a rules-based, independently audited market system

obtain practical expertise through “hands-on” participation

build institutions: first-mover; global linkages

get ahead of disparate regulations, prepare for policy

reduce long-term mitigation costs

improve focus on energy efficiency, identify free savings

build carbon price into minds of operators and planners

trading profits, possible early action crediting

positioning in face of major growth in social investing

meet fiduciary commitments to shareholders and other stakeholders

Benefits of CCX


Rationale For Business Leadership to Build the Carbon Market

“It's because by participating in the Chicago Climate Exchange, whichreally governs IBM's own business operations and our company's owncarbon footprint, we are better able to understand the entire arena of

creating an inventory of carbon emissions, accounting for them in an auditready manner, presenting them to an exchange so they can be verified

and considered to be tradable and how one does and doesn't makemoney on an exchange”

Wayne BaltaIBM

VP, Corporate Environmental AffairsSeptember 26, 2007


Web-accessible

secure Electronic Trading Platform

CCX® Comprehensive Market Structure

Member’s Electronic Market Registry Comprehensive Rules System •Emitters: Standard baseline, multi-year allowance stream equal to reduction targets

• Offset Providers (project credits)

• Liquidity Providers• Associate Members


188,422,450

22,903,0008,400,000

219,725,450

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

Internal On-siteEmission

Reductions atMember Facilities

Project-basedOffsets

ForestManagement

Total

met

ric

tons

CO

2

86%

10% 4%

Emission Reductions and Project-based Offsets in CCXYears 2003 through 2006* (metric tons CO2)

*As of 5-20-08. A portion of new member emission reductions are currently undergoing verification.


CCX Monthly Price & Volume

Price (US$/metric ton CO2)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

10,000,000

Dec

-03

Mar

-04

Jun-

04

Sep

-04

Dec

-04

Mar

-05

Jun-

05

Sep

-05

Dec

-05

Mar

-06

Jun-

06

Sep

-06

Dec

-06

Mar

-07

Jun-

07

Sep

-07

Dec

-07

Mar

-08

Date

Vo

lum

e (

MT

)

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

$5.50

$6.00

$6.50

$7.00

$7.50

$8.00

Pri

ce


0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

2005 2006 2007 2008

Chicago Climate Exchange Average Daily Volume (metric tons CO2)

Value of Annual Allocation approx: $3.8

billion

2008 vintage spot price:

CCX CFI: $7.40

Value of daily turnover: approx: $2.4 million (annualized = $600

million/yr)


Target Actions with Major Mitigation Potential

− Non-CO2 gasses: low-cost, multi-benefit

− Agriculture: soils hold 183 years of global CO2 emissions

− Forestation: forests hold 75 years of global CO2 emissions

− Advance broader societal goals: sustainable agriculture and forestry, energy efficiency, renewables

− Advance all mitigation options identified by IPCC, others

SES Field Inspector conducting

soil sampling in no-till corn

Defining CCX Offsets: Principles


Verified Offset projects sequester or eliminate GHGs, earn Carbon Financial Instruments marketable to CCX members

Pre-defined offset projects:− Landfill, agricultural coalmine methane destruction − Carbon sequestration: reforestation, agricultural soils: standardization− Renewable energy, fuel switching, energy efficiency, ODS destruction− Independent verification by authorized entities: SGS, DNV− Others in development, as per member requests

Minnesota dairy farmer receives first check from sales of

methane-destruction CCX Offsets

CCX Emission Offsets Program


CCX Offset Projects--Standardized Verification by World-Leading Entities

Agricultural Methane Capture and CombustionAgri-Waste Technology, Inc.SES Inc.TUV SUD Industrie Service GmbH

ForestryBVQiForecon Inc.SGS TUV SUD Industrie Service GmbH Winrock International

Agricultural Soil Carbon SequestrationAgri-Waste Technology, IncAssociation of Illinois Soil and Water Conservation DistrictsNorth Dakota Association of Soil Conservation DistrictsSES Inc.Agriculture Financial Services CorporationSaskatchewan Crop Insurance Corporation

Energy EfficiencyEconergy Corporation InternationalFranklin Energy ServicesICF Consulting Canada Inc.TUV SUD Industrie Service Gmbh

Landfill MethaneARM Group Inc.Det Norske Veritas (DNV)Econergy Corporation InternationalFirst Environment Inc.Richardson Smith Gardner and Associates, IncKleinfelderTUV SUD Industrie Service GmbH

SGS is a world leading inspection, verification, testing and certification company, and is recognized as a global benchmark for quality and integrity. With more than 48'000 employees, SGS operates a network of over 1’000 offices and laboratories around the world.

DNV is a leading independent greenhouse gas verifier operating globally. Their GHG experts are used by international organizations, governments, and industry, delivering independent, third party services for climate change activities.

35


CCX Membership Accomplishments

• Four compliance cycles successfully executed: major emissions cuts achieved

• Four years of continuous transparent public carbon prices

• Hundreds of Meetings of CCX Governance Committees: rules address nearly all now-viable GHG mitigation options identified by IPCC

• Over 11,000 trades executed, cleared and delivered

• Major knowledge gain by diverse members, as well as verifiers, traders, etc.

• Full integration of multiple offset types, with scale

• All mitigation activities covered under CCX rules are contained in draft U.S. cap-and-trade legislative proposals


U.S. House of Representatives Purchases Emission Offsets Through CCX as Part of “Greening the Capitol” Initiative

Auction results Announced November 1, 2007

U.S. House acquired balanced portfolio of 30,000 metric tons CO2 of verified U.S. domestic offset projects involving: agricultural methane, coalmine methane, landfill

methane, agricultural soils, reforestation, renewable fuels*

CCX Chairman & CEO, Dr. Richard L. Sandor; U.S. Representative Rahm Emanuel;U.S. House of Representatives CAO Dan Beard; U.S. Representative Dan Lipinski;

U.S. Representative Mark Kirk * auction was oversubscribed with a weighted average clearing price of $2.97 per ton


Key Issues to Watch in U.S. Legislation

• Included sectors, targets, gasses, timetables (start date, true-up periods)

• Availability and cost of domestic and international offsets

• Safety valves? (price, quantity, policy?)

• Openness to domestic and international project-based offsets

• Parallel technology and policy development efforts (e.g. CAFE standards)

• International market and policy linkages

• Initial Allocation of tradable permits

• grandfathering

• auctions

• benchmarking

• accommodation of growth/new entrants?


Main Features of Leading GHG Limitation Proposals in U.S. Senate

Legislative

Proposal

2020

emission

Targets

2030

emission

Targets

Coverage/style Early

Actions

Credited?

Other

Lieberman/ Warner

(with: Coleman R-MN, Harkin D-IA, Dole R-NC, Cardin D-MD, Collins R-ME, Klobuchar

D-MN. (S. 2191)

Equal to 1990 level

22% below

1990 level

Most of the economy covered;

downstream for

large coal burners,

upstream for

liquid fuels + natural gas

Yes,

documented emission cuts

plus early “projects”

Large/growing auctions - proceeds

for efficiency, technology etc.

allows borrowing

from future (with interest); market

overseen by “Carbon Market Efficiency

Board”

Bingaman/ Specter

(with:Akaka, D-HI, Harkin, D-IA, Casey,

D-PA, Murkowski, R-AK, Stevens,

R-AK

(S. 1766)

Equal to 2006 level

(~5% above

2000 levels)

1990 level Most of the economy covered;

downstream for

large coal burners,

upstream for

liquid fuels + natural gas

Yes – documented

emission cuts

Auctions smaller than L-W, but grow

Price cap starts

at

$12/ton, rises {5%/yr + inflation

rate}


Bi-Partisan Views on CCX

“The Chicago Climate Exchange is providing an innovative means of involving American businesses and citizens in the effort to protect the environment…I listed my farm in Indiana on the Chicago Climate Exchange to set an example for farmers and foresters in my state and throughout America…For example, the exchange mechanism could be utilized by turning unused farmland into tree farms that sequester carbon while providing farmers with extra money… In short, American farmers could become the vanguard in using market forces to the benefit of both the environment and the pocketbook…” Senator Richard Lugar (R-IN), Chairman of Senate Foreign Relations Committee

“To deal directly with climate change, something we failed to do in the last energy bill, we should use a market-based strategy that gradually reduces harmful emissions in the most economical way…..Right here in Chicago, the Chicago Climate Exchange is already running a legally binding greenhouse gas trading system” Senator Barack Obama (D-IL), April 3, 2006

“The CCX is leading the way toward a future in which reducing greenhouse gases could bring not only environmental rewards, but financial ones too.” Al Gore, from An Inconvenient Truth, 2006 (book version).

“What would be wrong, at least on a theoretical basis, with taking what you have come up with by way of requirements for your (CCX) members and essentially mandating that everybody in the country comply with those?” Senator Jeff Bingaman (D-NM), Chairman Senate Energy & Natural Resources Committee, April 4, 2006

©2008 chicago climate exchange, inc. michael j. walsh, ph.d. executive vice president, research...

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