MARKET BASED MECHANISMS TO FIGHT CLIMATE CHANGE Jean-François

MARKET BASED MECHANISMS TO FIGHT CLIMATE CHANGE Jean-François Conil-Lacoste Chief Executive Officer, Powernext SA APEX Conference October 30, 2006 Seoul 30/10/2006

CLIMATE CHANGE IMPLIES A POLITICAL ANSWER Concentration and fossil fuel CO 2 emissions have increased greatly since pre-industrial periods because of human action. To mitigate the human impact, the Governments have set up an international climate change policy. § 1979: First World Climate Conference § 1992: “Earth Summit” in Rio § 1997: Kyoto Protocol (binding agreement reached on emissions reductions for developed countries) § 2005: Kyoto Protocol is implemented, launch of the EU ETS Kyoto protocol sets up tools to reduce CO 2 emissions through market based mechanisms: § Emissions trading (allows countries with an emissions reduction target to trade with other countries) § Joint implementation (JI) and Clean Development Mechanism (CDM): a country with an emissions reduction target can get credit by funding emissions-reducing projects other countries 30/10/2006

THE EU EMISSION TRADING SCHEME : HOW DOES IT WORK? CO 2 emissions from European industries have been capped; Each industrial plants has got allowances corresponding to its cap (one allowance = one ton of CO 2); The allowances are tradable all around Europe; Every year, industrial installations have the obligation to restitute as many allowances as actual CO 2 emissions; Two market periods: 2005 -2007 and 2008 -2012; Free banking and borrowing during each period; Limited possibilities of banking and borrowing between the two periods. 30/10/2006

MORE THAN 50% OF THE ALLOWANCES TO POWER AND HEATING ACTIVITIES Total : 2. 2 billion CO 2 (50% of the EU CO 2 emissions) 11000 industrial sources Breakdown per country 30/10/2006 Breakdown per industry

THE STRUCTURE OF THE EUROPEAN CO 2 MARKET Directive 2003/87/EC established a scheme for greenhouse gas emissions allowance trading (1 rst period 2005 -2007) in Europe. 30/10/2006

A GROWING LIQUIDITY FOR THE EU ETS A very important growth of the OTC market between 2004 (10 Mt) 2005 (250 Mt) and 2006 (800 Mt). 50 to 80 counterparties negotiate regularly on the market (source : Fortis Bank) Share between Exchanges and OTC market : 60/40 Share between Futures and. Spot Markets : 90/10 Share of Powernext : 60% among European spot CO 2 Exchanges Record volume in October 2006 : around 3 Mt on Powernext Carbon 30/10/2006

WHAT WE HAVE LEARNT: 4 MAIN MARKET DRIVERS Long term Ø Level of carbon constraint Ø Economic growth Ø Energy relative prices Ø Temperature and rainfall Short term 30/10/2006

CO 2 PRICE : THE CORNERSTONE OF THE ENERGY PRICES (1/2) A strong correlation between CO 2 and power prices. With 65% of its CO 2 emissions produced by the combustion of fossil fuels, the European power generation sector is the largest emitter and is allocated about 30% of the allowances. Consequently, the power producers add to the production cost of the fuels the price of the allowance multiplied by the quantity of CO 2 emitted per MWh generated. 30/10/2006

CO 2 PRICE : THE CORNERSTONE OF THE ENERGY PRICES (2/2) Power generation plants are managed on the basis of “spreads”, which represent their operating cash flow calculated as the difference between the selling price of electricity during peak hours and the price of the fuel used, weighted by the energy output of the power plant. § If a power plant burns natural gas, the spread is called the “spark spread”, § And if it burns coal, the spread is called the “dark spread”. All other things being equal, the higher the price of carbon dioxide, the more the operators have an incentive to switch from the power plants with the highest emissions to those that produce fewer emissions. 30/10/2006

THE 2005 DIFFERENCE BETWEEN EMISSIONS & ALLOWANCES Sum of shorts 179, 4 Mt [ 9, 1% ] Sum of longs 254, 0 Mt [ 12, 9% ] Net 74, 6 Mt [ 3, 8% ] -200 -100 0 Millions tons – CO 2 EUAs 30/10/2006 100 200

SUMMARY ON EU ETS A significant technical and political achievement § The only real CO 2 market, emerging standard for carbon credits; § Easily the most important global climate policy development; § A price on 10% of global emissions. A multinational emissions trading system § 25 sovereign nations of widely differing circumstances and commitments to climate policy; § Successful allocation of common burden among EU 15 and between EU 15 and 10 accession states of Eastern Europe. Global implications § An example for others; § A “fact on the ground” in global climate negotiations; § Creating predisposition to and interest in CO 2 trading in China, India, Brazil and others. 30/10/2006

POWERNEXT: AN ENERGY EXCHANGE AS A LINK BETWEEN ENERGY PRICES Powernext is an exchange with: § stable and European shareholding with 11, 5 M€ capital § solid market models and IT systems § provides several price references and indices: short term electricity to hedge balancing needs and volume risks: Powernext Day-Ahead™ since November 2001 medium term electricity to hedge price risks: Powernext Futures™ since June 2004 CO 2 allowances to hedge greenhouse gas emissions non-compliance risks: Powernext Carbon since June 2005 in cooperation with Météo France, a full range of weather indices taking into account the economic reality of the zones considered: Powernext Weather since November 2005. 30/10/2006

POWERNEXT CARBON: THE LEADING SPOT MARKET IN EUROPE Powernext Carbon is: § An anonymous, centralized and transparent market § Secured by a real time payment versus delivery guarantee Powernext Carbon has a European and diversified membership of 60 members 30/10/2006

CONTACTS www. powernext. fr +33 1 73 03 96 00 information@powernext. fr 30/10/2006