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Trading in California’s Carbon Market: A summary of trading activity, products and drivers Prepared by: John P. Battaglia Director, Carbon Markets Prepared for: American Carbon Registry and Marten Law – California’s Cap-and-Trade: Strategies for effective market participation July 17, 2013

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Table of Contents

I. Tools for Hedging Price Risk Types: spot, forward, futures, options, etc. Prices Futures contract specification (ICE)

II. Trading Activity Auction highlights Historical pricing and volumes

III. Conclusions

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Tools for Managing Carbon Price Risk

Early Action Credits (AB32-eligible CRTs) Trades OTC bilateral (relatively inactive). Spot/forward/options contracts. CRTs that are eligible to be converted into CCOs under AB 32, i.e. US ODS

Active Participants •Commodity

Traders • Banks •Hedge Funds • Power generators • Industrials •Offset Project

Developers

California Carbon Offsets (CCOs) Primary: project-specific. Secondary: non-project specific. Dec ’13 or later

forwards, no spot yet. CCOs trade w/ 3, 8 or no invalidation risk

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

futures/options & OTC bilateral spot and forwards. Vintages: ’13, ’15, ‘16

California Compliance Instruments (CCIs) Bundled allowance and offsets product. Trades OTC bilateral under

bilateral contracts. Indexed or Fixed price

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Prices

Evolution Markets Inc. – Proprietary & Confidential

$10.50

$11.50

$14.35

Dec ’13 V13 California Carbon Allowance (CCA)

Dec ’13 CCO (3), Buyer wears three years invalidation risk

Dec ’13 Golden CCO, Seller wears invalidation risk

Note: prices are indicative based on current market conditions and are subject to change. Date: 7/16/2013

$8.50

Early Action Credit (US ODS, AG, Forestry CRTs)

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Exchange-Cleared CCA Contracts

Intercontinental Exchange (ICE) •Most liquid contracts: V13 Dec ’13, V13 Jul ’13, V16 Dec ‘15 •Settlement: physical if CITSS is operational* Seller delivers CCAs into Buyer's CITSS

Account (or FCM Holding Account) on last business day of the month •If CITSS isn’t operational at settlement, the parties financially settle against the Reserve

Price for that CY •1 contract = 1,000 CCAs •Minimum price tick: $0.01 per CCA, $10.00 per contract •Minimum margin: $2,000 per contract ($2 per ton) + variation margin posting is 100%

of market price change •Futures, spreads, calls & puts • In 2013, Average Monthly Volume for Dec ‘13 V13 CCA: 3M tons •End of June Total Open Interest in all V13 Futures and Options: 18.5M tons •Most active Option contracts (all v13, mostly Dec ’13 expiration):

• Calls: $15, $17, $17.50, $20 • Puts: $11.50, $12, $12.25, $12.50, $14

* It is conceivable, like in other emissions markets, CITSS remains intact after a legal challenge/order, i.e. stay, vacate, etc., resulting in

trading below the Price Reserve on ICE

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Auction – Highlights

• Stable carbon price($14-$15/ton for the past 5 months), levels forecasted by most analysts. Relatively liquid CCA market w/ most (78%) volume trading OTC via clearing brokers.

• Prompt vintage allowance (V13) trading over future vintage (V15, 16) due to program risk and regulated entity hedging programs. However, future vintages are trending towards higher demand/pricing.

• Relatively stable now, but volatility a real possibility the balance of ’13 lawsuits, Quebec link, weather, etc.

Auction V13 Volume V15 Volume

V16 Volume

Reserve Price

V13 Price

V15 Price

V16 Price

# of Qualified Bidders

ICE V13 Dec ‘13 CCA Auction Day Settle

Nov ‘12 23,126,110 (100% sold)

39,450,000 (14% sold)

- $10.00 $10.09 $10.00 - 73 $12.05/ton

Feb ’13 12,924,822 (100% sold)

- 9,560,000 (46% sold)

$10.71 $13.62 - $10.71 91 $13.45/ton

May ‘13 14,522,048 (100% sold)

- 9,560,000 (79% sold)

$10.71 $14.00 - $10.71 81 $14.80/ton

Aug ‘13 13,865,422 - 9,560,000 $10.71 ? - ? - -

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Open Interest (millions)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

Total V13 OI (Futures & Options)

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

550,000

600,000

650,000

700,000

750,000

$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

29

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-May

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-May

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Volume Daily Price Settlement

Benchmark California Carbon Contract: ICE CCA V13 Dec ’13

Source: Intercontinental Exchange

Nov ‘12 auction clears $10.09/ton

Feb ‘13 auction clears $13.62/ton

May ‘13 auction clears $14/ton

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Closing Comments

• All sectors are actively hedging carbon risk today but power generators/marketers and speculators are most active in secondary market trading

• Volumes and liquidity are relatively healthy; participation is growing

• Pricing is stable right now, but regulatory changes, lawsuits, etc. could mean price volatility

• Despite relative thinness, the offset market is growing each month w/ new compliance entities starting to procure

• Future vintage allowance markets (v15, v16) remain nascent. Despite clearing at the Price Reserve each auction, demand is trending higher for future vintage allowances

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Contact Information

John P. Battaglia Director, Carbon Markets 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