4 December 2003 —    (Washington, DC)  Natsource LLC announces the completion of its third annual analysis of the global greenhouse gas (GHG) market. The analysis shows that trading activity more than doubled over the past year.  The analysis was commissioned by the World Bank’s Carbon Finance Unit.  Based on the contributions by Natsource and two other firms, the World Bank developed a publicly available report entitled, “The State and Trends of the Carbon Market 2003,” which chronicles global GHG trading activity.  The report was released today at the ninth Conference of the Parties (COP-9) to the United Nations Framework Convention on Climate Change in Milan, Italy.

The World Bank has commissioned Natsource to analyze trading activity over three periods of time. The first analysis assessed market activity from 1996-2001. A second analysis covered the year 2002. This year’s market analysis, which covers 2003, shows significant growth in traded volumes.  Traded volumes in metric tons of carbon dioxide equivalent (CO2e) increased from 13 million tons in 2001, to approximately 29 million tons in 2002, and to approximately 71 million tons during 2003.  Expectations of future GHG emissions limitations, combined with greater clarity regarding the rules for creating compliance eligible emission reductions, have driven this growth. Natsource is the only firm that has participated in all three of these market reviews.

“As our analysis for the World Bank confirmed, trading activity in the GHG market increased considerably in 2003,” said Jack Cogen, President of Natsource LLC.  “We believe that increased trading will benefit the environment and provide incentives to achieve low cost emission reductions. Increased trading activity will likely continue in the years that follow.  As a result, our business lines that provide strategic advisory, brokerage and asset management services expect steady growth in 2004,” said Cogen.       

In addition to showing steady growth in traded volumes, this year’s report also identified a number of other key trends in the emerging international GHG market.  These trends are described below. 

• Approximately 90% of total traded volume involved emission reductions that may ultimately become usable for compliance. These are reductions that may be recognized by governments as eligible for compliance with legally binding emission reduction requirements.  This is a shift from prior years in which a significant percentage of traded volume involved reductions that were not likely to become usable for compliance with emission reduction obligations.
• Projects in the power sector created approximately 50% of the reductions that were traded.  Emission reductions created by renewable resources represented approximately 37% of traded volumes. 
• Prices of pre-compliance project-based emissions reductions have increased to between $4.00/ton to over $6.00/ton. Higher prices were paid when the seller accepted greater liability for failing to deliver upon contractual obligations.  
• Approximately 80% of GHG emission reductions were created in Latin America, Asia and Europe. 
• Governments and multilateral agencies were the most prominent buyers, accounting for approximately 55% of purchased tons.  In the past, private sector entities had been the most active buyers. 

These and other trends are discussed more thoroughly in the brief analysis that follows this release.

Natsource LLC is a provider of strategic advisory, brokerage, and asset and portfolio management services for energy related products in emissions permit, power, natural gas, coal, and weather hedging markets.  A pioneer in energy and environmental brokerage, Natsource assists leading private firms and governments around the world in strategic management of energy and environmental risk.  Natsource is headquartered in New York and has a global reach, with offices in many of the world’s major financial centers.

2003 Greenhouse Gas Market Analysis

This analysis elaborates on the information provided in the press release announcing the results of the World Bank’s 2003 Greenhouse Gas (GHG) market analysis.  Natsource was a major contributor to this work.  This analysis describes the following: (1) rationale for emissions trading; (2) structure of the global greenhouse gas (GHG) market; (3) types of GHG commodities; (4) key GHG trends as identified in PCF's 2003 market analysis; and (5) future outlook. 

1. Rationale for GHG Trading
Emissions trading is an environmental policy instrument that can reduce the costs of achieving environmental objectives.  Emissions markets, such as those for sulfur dioxide (SO2) and nitrogen oxides (NOx) allowances in the US, have achieved compliance with emissions limitations at significantly lower costs than under traditional “command-and-control” regulations.   The Kyoto Protocol (KP), a treaty that would impose legally binding limitations on developed countries' GHG emissions, contains several emissions trading provisions that are designed to minimize the costs of achieving the treaty's emission reduction requirements. 

As early as 1996, in anticipation of an international agreement that would impose emissions limitations and the development of a system of international trade in GHGs, some entities had already begun to engage in voluntary trades.  These early trades were driven by a variety of objectives. These included, but were not limited to: (1) buyers' interest in demonstrating the viability of emissions trading; (2) achieving voluntary emission reduction commitments; (3) learning-by doing; (4) informing the public policy debate; and (5) demonstrating leadership.  Sellers shared many of the same objectives and also stood to gain from an additional source of revenue generated by emissions mitigation projects.  More recently, governments in some jurisdictions have begun to require GHG emission reductions (ERs) and have allowed regulated firms to utilize emissions trading for compliance.

2.  Structure of the Global GHG Market
The global GHG market is not a single homogeneous entity. At the current time, it is comprised of several distinct sub-markets.  The market for pre-compliance project-based ERs is by far the largest sub-market as measured by transacted volumes.  The market for UK allowances, which exists under the UK Emission Trading Scheme, has accounted for the largest number of transactions of any sub-market to date, though the total volumes traded are small relative to the ER market. 

Other smaller sub-markets include those for the following GHG commodities:
(1) European Union Allowances in anticipation of the EU Emissions Allowance Trading Scheme, which is scheduled to begin operation in 2005; (2) Oregon project-based offsets, which are purchased by developers of new fossil fueled power plants that are required to offset a portion of a new unit’s emissions; (3) Assigned Amount Units (AAUs), in anticipation of the Kyoto Protocol's entry into force; (4) Chicago Climate Change (CCX) allowances, under a voluntary program involving mostly North American companies; and (5) Danish allowances under the now expired 1999 CO2 Quota Act.

3. Types of Traded GHG Commodities
Three types of GHG commodities are traded in the GHG sub-markets described above.  These include the following.

• Compliance Tools. Compliance tools, which are issued by a regulatory authority and can be used by entities to comply with binding GHG emission reduction requirements;
• Emission Reductions. ERs, which were the first GHG commodity to be traded.  ERs that conform to evolving rules for generation of "compliance tools" may, in the future, be usable for compliance against binding emission limitations.  Within this category, Verified Emission Reductions (VERs) are ERs that have been verified by an independent third party (i.e., not the buyer or seller);
• Financial Derivatives. Financial derivatives, which are contracts involving rights and responsibilities between two parties regarding the terms of potential future trades of GHG compliance tools or ERs.    

4. Key Market Trends
Key trends in the GHG market are described below and illustrated with figures. 

Traded Volumes Are Increasing. The analysis shows that traded volumes have significantly increased, more than doubling in each of the past two years. Figure 1 below illustrates that traded volumes increased from approximately 29 million tons in 2002 to over 70 million tons in 2003. 

Buyers are Purchasing Higher Quality Reductions. In anticipation of binding emission reduction requirements, buyers are purchasing a greater volume of potential compliance tools. Figure 2 below illustrates that approximately 90% of the purchased reductions in 2003 can be considered pre-compliance instruments. The purchase of such reductions at current prices serves as a hedge against potential higher prices for compliance instruments in the future, which may result from greater demand.  In the past, most trades involved reductions that did not conform to emerging rules for the creation of compliance tools, as they were undertaken to achieve a variety of non-compliance related objectives.

A Large Percentage of Traded Reductions are Created by Projects in the Power Sector. Figure 3 below illustrates that emissions reductions created by projects in the power sector accounted for approximately 50% of traded volumes.  Among traded reductions, approximately 37% were created by renewable resources such as hydro, biomass and wind. 

Price and Quality of Emission Reductions Are Correlated.  Figure 4 below illustrates that prices for compliance instruments are higher than those for reductions that are not likely to be usable for compliance. Prices are higher for compliance instruments in which the seller accepts a greater level of liability for failing to deliver upon their contractual commitments. 

Approximately 80% of the Volume of Traded Reductions Has Been Created in Three Regions of the World.  Figure 5 below illustrates that over 60% of the reductions traded are from Latin America and Asia. 

Governments and Multilateral Agencies Were the Most Prominent Buyers.  Figure 6 below shows such entities accounting for approximately 55% of purchased tons. The analysis also illustrates that buyers in Japan increased their activity over the past year while Canadian firms reduced their activity during the same time period. 

5. Outlook
In the near term, trading volumes and market activity are likely to grow in anticipation of binding GHG emission reduction requirements and as clarity continues to increase regarding the rules that will govern the creation of project-based compliance tools.  Russia's decision regarding its ratification of the KP will determine whether the Protocol enters into force and the pace of market development.  The experience gained with emissions trading since the mid 1990’s and the promise that it holds for achieving environmental and economic objectives suggests it will be a key component of the international community's response to the threat of global climate change.