Washington DC, June 2011state and trends of the₂₀₁₁Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure Authorizedstate and trends of the₂₀₁₁Environment DepartmentThis report was prepared by a World Bank team comprising ofNicholas Linacre, Alexandre Kossoy and Philippe Ambrosi,with important contributions from Manelle At Sahlia, Veronique Bishop,Benot Bosquet, Christophe de Gouvello, Taisei Matsuki and Monali Ranade.2 | State and Trends of the Carbon Market 2010New Approach for the 2011 ReportWith the goal of providing a comprehensive discus-sion of the issues that most affected the carbon mar-ket in 2010, the authors of last year’s report have re-structured State and Trends of the Carbon Market for 2011. The report still provides an overview of the size and reach of the carbon markets, as well as the evolu-tion of the Kyoto flexibility mechanisms, and offers potential supply/demand scenarios for coming years. However, it no longer includes a detailed breakdown of carbon transactions, as in previous years. Instead, the report provides a more in-depth analytical dis-cussion of the regulation and policy issues that will guide future carbon market development.The findings and opinions expressed in this report are the sole responsibility of the authors and should not be cited without permission. They do not necessarily reflect the views of the World Bank Group, its cutive Directors, the countries they represent or of any of the participants in the carbon funds or facilities man-aged by the World Bank. The World Bank does not guarantee the accuracy of the data included in this work. This report is not intended to the basis of an investment decision. The bound-aries, colors, denominations, and other ination shown in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries.Section 1 photo credit Jan Golinski / UNFCCCSection 2 photo credit Veer IncorporatedSection 3 photo credit Veer IncorporatedSection 4 photo credit Dreamstime LLCSection 2 photo credit Veer IncorporatedDesign Studio GrafikPrinting Westland PrintersState and Trends of the Carbon Market 2010 |3AcknowledgementsThe report benefitted greatly from colleagues in the carbon market who provided their written contribu-tions and perspectives Olga Christyakova, Martin Lawless, and Damien Meadows.We wish to extend our gratitude to those who offered their cooperation and insights during the elaboration of this report Edwin Aalders, Schwan Badirou Gafari, Ellysar Baroudy, Jean-Jacques Barberis, Franois Beaurain, Luca Bertali, Agns Biscaglia, Martina Bosi, Ana Bucher, Marcos Castro, Lance Coogan, Isabelle Curien, Keith Davis, Karen Degouve de Nuncques, Eduardo Dopazo, Jason Dunn, Saša Eichberger, Emmanuel Fages, Laura Fidao, Greger Flodin, James Foster, Javier Freire Coloma, Martin French, Pranab Ghosh, Matthew Gray, Pierre Guigon, Isabel Hagbrink, Katherine Hamilton, Henrik Hasselknippe, Carina Heimdal, Andrew Howard, Robert M. Hunt, Daigo Koga, Werner Kornexl, Ganna Korniyenko, Benot Leguet, Gautier Le Maux, Mark Lewis, Zijun Li, Peter Lloyd, Thomas Marcello, Allison McManus, Rachel Mountain, Akiko Nishimae, John O’Brien, Klaus Oppermann, Molly Peters-Stanley, Vicky Pollard, Leila Pourarkin, Neeraj Prasad, Brice J. M. Quesnel, David Rapin, Heike Reichelt, Renaud Scardina, Kai-Uwe Barani Schmidt, Guido Schmidt-Traub, Chandra Shekhar Sinha, Trevor Sikorski, Milo Sjardin, Yvon Slingenberg, Sara Stahl, Andy Stone, Aurelien Tignol, Sarah Underwood, Laurent Valiergue, John Virgoe, Alessandro Vitelli, George Waldburg, Xueman Wang, Vikram Widge, Yevgen Yesyrkenov, Peter Zapfel, Ivan Zelenko, Elizabeth Zelljadt. We would also like to thank all of those who took time to respond to the market survey. Without your responses the report would be less than it is. Finally, we want to thank the many market participants strug-gling to make a difference on a critical global issue.The State and Trends of the Carbon Market 2011 re-ceived financial support from the CF-Assist Program, managed by the World Bank Institute WBI.4 | State and Trends of the Carbon Market 2010List of Abbreviations and AcronymsAAU Assigned Amount UnitAAUPA AAU Purchase AgreementAB 32 Global Warming Solutions Act of 2006 Assembly Bill 32ACR American Carbon RegistryADB Asian Development BankAfDB African Development BankAMF Autorit des Marchs FinanciersAWG-KP Ad Hoc Working Group on Further Commitments for Annex I Parties under the Kyoto ProtocolAWG-LCA Ad Hoc Working Group on Long-term Collaborative ActionCAPEX Capital ExpendituresCARB California Air Resources Board CAR Climate Action ReserveCCP central counterpartiesCCS Carbon Capture and StorageCCX Chicago Climate ExchangeCDM Clean Development MechanismCER Certified Emission ReductionCFL Compact Fluorescent LampCFTC Commodities Future Trading CommissionCH4MethaneCMM Coal Mine MethaneCMP Conference of the Parties serving as the Meeting of the Parties to the Kyoto ProtocolCPF Carbon Partnership FacilityCO2Carbon Dioxide CO2e Carbon Dioxide EquivalentCOP Conference of the PartiesCPA CDM Programme ActivityCPRS Carbon Pollution Reduction SchemeCP-1 First Commitment Period under the Kyoto ProtocolCRE Commission de rgulation de l’nergie CRT Climate Reserve TonneDNA Designated National AuthorityDOE Designated Operational EntityEB cutive Board of the CDMEBRD European Bank for Reconstruction and DevelopmentEC European CommissionECX European Climate ExchangeEE Energy EfficiencyEIT Economy in TransitionEITE Emission-intensive, Trade-exposed ER Emission Reduction ERPA Emission Reduction Purchase AgreementERU Emission Reduction UnitESC Energy Savings CertificateESS Energy Savings SchemeETS Emissions Trading Scheme EU European UnionEUA European Union AllowanceEU ETS European Union Emissions Trading SchemeEURIBOR Euro Interbank Offered RateFSB Financial Stability BoardGDP Gross Domestic ProductGGAS New South Wales Greenhouse Gas Reduction SchemeGHG Greenhouse GasGIS Green Investment SchemeHFC HydrochlorofluorocarbonIFC International Finance CorporationIEA International Energy AgencyIFI International Financial InstitutionIFRS International Financial Reporting StandardIMF International Monetary FundIRR Internal Rate of ReturnJ-VETS Japan-Voluntary Emissions Trading SchemeJI Joint ImplementationJISC Joint Implementation Supervisory CommitteeKM Kyoto MechanismLBFR Law on Banking and Financial RegulationLDC Least Developed CountryLEDS Low Emission Development StrategieslCER Long-term Certified Emission ReductionLFG Landfill GasLoA Letter of ApprovalLRET Large-scale Renewable Energy TargetLULUCF Land Use, Land Use Change and ForestryMAD Market Abuse DirectiveMCCF Multilateral Carbon Credit FundMDB Multilateral Development BankMiFiD Markets in Financial Instruments DirectiveMOP Meeting of the Parties MRET Mandatory Renewable Energy TargetMRV Measurement, Reporting and VerificationNAMA Nationally Appropriate Mitigation ActionNCCP National Climate Change PolicyNDRC National Development and Re Commission N2O Nitrous OxideNAP National Allocation PlanNPV Net Present ValueNZ ETS New Zealand Emissions Trading SchemeNZU New Zealand UnitOECD Organization for Economic Co-operation and DevelopmentOTC Over-the-CounterpCER Primary Certified Emission ReductionPDD Project Design DocumentPFC PerfluorocarbonPIN Project Idea NotePMR Partnership for Market ReadinessPoA CDM Programme of ActivitiesState and Trends of the Carbon Market 2010 |5POI Proof of IdentityPP Project ParticipantR the continuation of the Kyoto mechanisms, including important improvements and res to the Clean Development Mechanism CDM; the inclusion of reduced deforestation through REDD and REDD plus REDD; and the al recogni-tion of developing countries’ pledges of Nationally Appropriate Mitigation Actions, which are aimed at achieving a deviation in their GHG emissions com-pared to business-as-usual trends by 2020. The best case analysis from the 2010 United Nations Environment Programme UNEP Emissions Gap Report estimates that developed and devel-oping country pledges are 60 percent of what is needed by 2020 to place the world onto a trajec-tory that will keep global temperature rises to less than 2˚C in comparison to preindustrial levels.10The International Energy Agency IEA 2010 also estimates that the 2˚C goal will only be achievable with a dramatic scaling-up effort,11particularly from major emitters.This section focuses on key elements of the Cancun Agreements and current market sentiment. “Developed and developing country pledges are 60 percent of what is needed by 2020 to place the world onto a trajectory that will keep global temperature rises to less than 2˚C”8. http//unfccc.int/files/meetings/cop_16/application/pdf/cop16_kp.pdf Access date 28 Feb 2011.9. The United Nations Climate Change Conference took place in Cancun, Mexico, from 29 November to 10 December 2010. It encom-passed the sixteenth Conference of the Parties COP and the sixth Conference of the Parties serving as the Meeting of the Parties to the Kyoto Protocol CMP.10. UNEP 2010. Emissions Gap Report. “Are the Copenhagen Accord Pledges Sufficient to Limit Global Warming to 2˚C or 1.5˚C A Preliminary Assessment.” http//www.unep.org/publications/ebooks/emissionsgapreport/ Access date 9 March 2011.11. IEA 2010. World Energy Outlook. http//www.worldenergyoutlook.org/ Access date 29 March 2011.14 |State and Trends of the Carbon Market 20101.1 IMPROVEMENTS TO THE CLEAN DEVELOPMENT MECHANISM AND CONTINUING SUPPORT FOR MARKET MECHANISMSThe major area of improvement and re of the CDM is arguably the introduction of standardized baselines and monitoring ologies. These deci-sions are aimed at maintaining environmental integ-rity, but reducing transaction costs, enhancing trans-parency and predictability, and facilitating access to underrepresented project types and regions.12Such decisions that seek to improve the access of under-represented regions in the CDM are particu-larly important in the face of the EU’s decision to restrict CERs from CDM projects registered after December 31, 2012 to those generated by projects located in least developed countries LDCs. A sig-nificant change is needed in order to be able to scale up the virtual absence of LDC projects from the CDM pipeline for further details see Section 4.1.Emissions trading and the project-based mechanisms under the Kyoto Protocol will continue to be avail-able to Annex I Parties as means to meet their quan-tified emission limitation and reduction objectives,13but the future of the Kyoto Protocol itself remains unresolved. Additionally the Cancun Conference under the Ad Hoc Working Group on Long-term Cooperative Action under the Convention AWG-LCA negotiation track agreed to consider the estab-lishment of one or more market-based mechanisms to enhance the cost-effectiveness of mitigation ac-tions by Parties.14These changes are not yet providing the regulatory predictability the market is seeking. Clarity is still urgently needed on the post-2012 international cli-mate change regime and on countries’ plans to use market-based mechanisms to meet domestic GHG objectives. As highlighted in Box 1, the European Union is seeking to provide such clarity.“Emissions trading and the project-based mechanisms under the Kyoto Protocol will continue to be available to Annex I Parties as means to meet their quantified emission limitation and reduction objectives, but the future of the Kyoto Protocol itself remains unresolved.”12. COP 16. Decision -/CMP.6. “ Further guidance relating to the clean development mechanism.” http//unfccc.int/files/meetings/cop_16/conference_documents/application/pdf/20101204_cop16_cmp_guidance_cdm.pdf Access date 4 Feb 2011.13. Outcome of the work of the Ad Hoc Working Group on Further Commitments for Annex I Parties under the Kyoto Protocol at its fifteenth session http//unfccc.int/files/meetings/cop_16/application/pdf/cop16_kp.pdf Access date 28 Feb 2011.14. http//unfccc.int/resource/docs/2010/cop16/eng/07a01.pdfpage2 Access date 29 April 2011.State and Trends of the Carbon Market 2010 |15BOX 1. The European Union’s Approach to International CreditsThe strategic importance of a broad and deep international carbon marketThe EU is by far the biggest buyer of emission re-duction credits15from third countries, providing for continued financial flows and technology transfer to developing countries, also after 2012 even in the ab-sence of the certainty that should come from a new international agreement to effectively tackle climate change. If designed properly and underpinned by ro-bust targets, the international carbon market can play a major role in global abatement efforts, and create increasing financial flows to support mitigation activi-ties in developing countries. Design limitations of the CDMTo make this happen, we need to improve our existing tools and create new, advanced and scaled-up mar-ket mechanisms. Despite its successes, as a project-based systemand one that in practice covers so far a limited number of project typesthe CDM is simply not designed to drive the structural transation of industry in developing countries that the transition to a low-carbon economy requires. By definition, offset mechanisms such as the CDM cannot reduce global emissions in net termsyet this is what is needed if we are to keep global warming below 2C.Need for a move to sectoral crediting mechanismsThat is why the EU and other Parties are advocat-ing the creation of new and more ambitious sec-toral mechanisms that make it possible to tap into far greater emissions-saving potentials and provide more revenue for financing reductions in developing countries. Because only actions that go beyond a previously defined threshold or target are credited, this would ensure net benefits to the atmosphere. Sectoral mechanisms and the CDM could co-exist but the CDM should increasingly focus on less developed countries, where it should continue to target low cost options for saving emissions. For the major emerging economies in the developing world, the CDM should gradually be replaced by new sectoral mechanisms. Provisions in the climate and energy packageSeveral provisions of the EU’s domestic climate leg-islation provide the tools to incentivise a move away from the CDM and towards sectoral mechanisms. The EU ETS and Effort Sharing Decision foresee that after 2012, even without an international agreement, these instruments can provide a market for CERs from new projects in Least Developed Countries. In addition, CERs from existing projects in other coun-tries can continue to be used. The EU’s standards on HFC-23 and adipic N2O credits, which have been discussed extensively and will apply from 2013, cre-ate more space for other CDM credits and can pro-mote a shift to credits from bil