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Larry She and Tom Heintzman of CIBC Capital Markets discuss different types of carbon markets and their prices, the influences that shape pricing, why liquidity is a challenge and how the markets are addressing price volatility.

Tom Heintzman: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape. I&#8217;m your host, Tom Heintzman. Please join me as we explore today&#8217;s most pressing issues with special guests that will give you some new perspectives and help you make sense of what really matters.
Larry She: Buyers have to go to the over-the-counter market to access the products that they need. The bilateral nature of deals means that there&#8217;s less price transparency and an already opaque market. This clearly has an effect on liquidity, but I think it&#8217;s less impactful on volatility and demand.
Tom Heintzman: Welcome to our multi-part series profiling the carbon markets. The purpose of this series is to examine some of the most significant issues facing our clients in both the voluntary and compliance markets. On today&#8217;s episode, we&#8217;ll take a deeper dive into carbon market pricing. In particular, we&#8217;ll examine the different types of carbon markets and their prices, the influences shaping pricing, why liquidity is a challenge, and how the markets are addressing price volatility. I&#8217;m very excited to welcome Larry She. He is Executive Director and Head of our Environmental Trading Desk at CIBC Global Markets. Larry brings multidisciplinary experience from across the energy value chain with over ten years of trading and environmental products. Good afternoon, Larry. Welcome and thanks for joining us on today&#8217;s episode of The Sustainability Agenda.
Larry She: Hey, Tom, thanks for having me on the podcast.
Tom Heintzman: Great. Let&#8217;s dive right in, Larry. There are many types of carbon markets, each with its own marketplace. Can you highlight for us some of the key elements of the main markets you&#8217;re following, such as size, volume, current price ranges, just to compare one market with the other?
Larry She: When talking about carbon allowance markets, our business looks to three of the mature markets, EUAs in Europe and CCAs and RGGIs domestically. Starting with EUAs. This market is the most mature. More than 10 million tonnes exchanged hands every day. In the last year, they&#8217;ve traded in a range between 70 and €100 per tonne. This market really sets the tone for global markets. Next, we have the WCI market, which includes California and Quebec. This Market an order of magnitude smaller in a couple respects. It trades a few million tons a day and prices today are around $37 a ton. Lastly, we focus on RGGI, which is smaller again by volumes and price. Daily traded volumes are often less than a million tons a day and they trade around $14 a ton.
Tom Heintzman: And Larry, just for our listeners, the EUAs are allowances under the EU Emission Trading System, otherwise known as the EU-ETS. Is that correct?
Larry She: That is correct.
Tom Heintzman: So let&#8217;s dive deeper into each of those markets. Let&#8217;s start with the EU-ETS. We&#8217;ve historically seen a fair bit of price volatility, particularly in the early days. What&#8217;s driving pricing today and why is it high relative to the American markets you were talking about, and is price volatility still a concern?
Larry She: You&#8217;re right about volatility, especially in the early days. It&#8217;s still a concern but not to the same magnitude. The regulators introduced a market stability reserve in 2015 as a tool to manage supply and demand. It&#8217;s comprised of two mechanisms one as a pressure relief on prices where additional tons are injected into the market if necessary. And two, there&#8217;s a price floor that&#8217;s designed to remove supply during times of sustained weakness. Back loading is a third mechanism, which allows regulators the ability to defer supply to later years. Together, these three program design elements reduce volatility in markets. As for what drives price today, volatility dynamics are really driven by supply side expectations in the long run and demand side in the short run. Supply side factors include legislation, program rules, and ETF stability. Demand factors include fuel switching economics between natural gas and coal for power generation. The total number of surplus allowances in circulation, and the expectations for weather.
Tom Heintzman: Larry. The EU-ETS is also extending to include emissions from maritime shipping and a new ETF for buildings, road transport and fuels. How do you see these changes affecting EU allowances and the price evolving over the next, let&#8217;s say, 5 to 10 years?
Larry She: The ETS is expanding its scope, which is a natural evolution of these programs, to include additional covered sectors as the EU-ETS Two covers fuel, combustion and buildings, road transport and small industries. I think in the longer term, prices of carbon will converge with the long term cost of a Tek removal offset when these markets become truly commoditized. A ton of CO2 will have the same price across allowances and high quality offsets, and they&#8217;ll provide certainty for companies to make capital investment decisions to shrink their physical footprints. I think that the price is going to be far lower than the current cost of a tech removal, but higher than where we are with EUAs today. So for the EUA market right now, short term supply and demand may impact the price path. But in the longer term, certainly within the 5 to 10 year horizon of your question, I think we&#8217;d go higher.
Tom Heintzman: Okay. That&#8217;s helpful. Now let&#8217;s move this side of the Atlantic. Now the two markets that you referenced earlier are the RGGI market in the east and the WCI CCA market. What influences are shaping prices in these markets, and what impact are revisions to the CCA having on pricing and why?
Larry She: Starting with CCAs, ultimately, supply and demand fundamentals drive long term market pricing. Supply side dynamics are driven by regulatory changes. We&#8217;re in the midst of a regulatory review for both CCAs and RGGIs at this very moment. Changes to allowance allocations, auction supply rules around offset usage and price containment mechanisms can all impact price. Demand side dynamics are impacted by power demand, clean technology development, new tech adoption such as electric cars and hydrogen, fuel switching economics, weather and broad macroeconomic trends. Speaking specifically about the current WCI program review, the California Air Resources Board is choosing between three scenarios a 40%, 48% and 55% reduction below 1990 emissions for the year 2030. We expect the California Air Resources Board to ultimately remove the majority of its allowances through future budgets and apply the 48% scenario as its target. Due to the progressive nature of California&#8217;s push to neutrality, it&#8217;s unlikely that the program will continue on its current 40% trajectory, especially when the EU-ETS has designated 55% as its goal. However, 55% is quite unrealistic, especially given California&#8217;s 48% goal is already subject to numerous caveats, such as aggressive growth in renewable hydrogen and 20 million tons of mechanical CO2 removal from DACs by the year 2030. From a RGGI lens, the same market forces drive its pricing with the addition of an ever present potential for new states to join. RGGI focuses only on the wholesale power sector, so represents a modest step for purple states to get involved in carbon trading programs and a relatively straightforward and simple way.
Tom Heintzman: Okay, great. And so then if you put on your future looking glasses, what do you see for pricing trends in RGGI and CCA over the next 5 to 10 years?
Larry She: With regards to price outlooks, prices have to move higher. California&#8217;s on the right trajectory, but especially with key member states such as New York talking about an economy wide cap and trade program, RGGI really risks falling into irrelevance. Low prices fail to send the price signals that are necessary to change behaviour and really functionally act more like a tax, just something that needs to be paid. In the end. I mentioned above, in my long term price predictions for EUAs, I expect prices to converge with high quality offsets. So in the 5 to 10 year horizon, I think prices move up.
Tom Heintzman: Great. Well, let&#8217;s turn now from the compliance markets to the voluntary market, otherwise known as the VCM. I believe from knowing your work that there are a few different stratifications of pricing within the voluntary carbon markets. The voluntary carbon market is typically based on OTC or bilaterally priced deals rather than exchange listed prices. So what impact does the way in which voluntary carbon markets run have on price volatility and liquidity and demand in the voluntary markets?
Larry She: VCM Future prices are based on a minimum quality to deliver concept from my lens buyers in the voluntary market are largely buying the story behind an offset and support offsets that are aligned with their values in the image that they look to portray. To get the right tons and the right story, buyers have to go to the over-the-counter market to access the products that they need. The bilateral nature of deals means that there&#8217;s less price transparency in an already opaque market. This clearly has an effect on liquidity, but I think it&#8217;s less impactful on volatility and demand. Price volatility has less to do with the fact that there are a lot of OTC trades, and more to do with the fact that these markets are heterogeneous in nature. If I look at the crude markets as a proxy, crude markets manage with a handful of global benchmarks with hundreds of basis points for geography and quality spec differences. Sour crude oil has a measured spec for sulphur. In time, carbon offset markets will mature and differences to benchmarks will also be objective. The market isn&#8217;t there yet, but I think we all hope it&#8217;ll get there. With regards to demand, there is demand, but the idea of buying offsets is a tangible demonstration to a voluntary ambition, with the risk to be criticised after the fact for greenwashing is really unappealing. It&#8217;s a fact that low quality offsets exist today. It&#8217;s a fact that the market is making great strides to rapidly improve, and that the market for quality offsets will intensify, and with it, confidence for voluntary buyers will increase.
Tom Heintzman: That&#8217;s fascinating and particularly like your analogy of offsets to oil and gas market. What is your outlook on VCM pricing over the next 5 to 10 years? Given these developments that you see forthcoming.
Larry She: Within the next 5 to 10 years, we&#8217;ll be nearing or past the 2030 interim goal. My hope and expectation is that the macro VCM market will have gravitated towards a handful of robust market rules around quality. Protocols will be more robust, MRV will be more robust, the knowledge of buyers and the public at large, whom buyers are looking to impress, will be materially higher than it is today. I think offset buyers will demand high quality and know how to recognise it. I think prices will be an order of magnitude higher than they are today for nature removals, and tech removals will be cheaper than they are today as we find ways to improve technology. More importantly, I think this nascent market will have more price stability, which is what&#8217;s most needed for long term funding to the extent that tech removals require a lot of power. I expect future penetration of renewable energy sources, coupled with improved battery technology at the wholesale level to really lower the operating costs for tech removals. You can call me an optimist, but I never bet against human ingenuity. I think this market&#8217;s going to improve and I think we&#8217;re going to get there together.
Tom Heintzman: Larry I really like that vision. Thank you so much for taking the time to join the show today, and thanks to our listeners for tuning in. If you&#8217;d like to learn more about how your business can navigate the carbon markets, join us for CIBC&#8217;s Carbon Summit on October 26th, 2023 in Toronto. The Summit will bring together experts in carbon market structure, project development, and policy. To register, please contact your CIBC Relationship Manager. Please join us next time as we tackle some of Sustainability&#8217;s biggest questions, providing you different perspectives to help you move forward. I&#8217;m your host, Tom Heintzman, and this is The Sustainability Agenda.
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Tom Heintzman

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