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Short-term deficit could push carbon price upward, but what’s next?
Carbon market EUROPEAN UTILITIES EQUITY RESEARCH July 3, 2012 Carbon auction delay - positive ST, cautious LT Sector view Bearish Short-term deficit could push Remains carbon price upward, but what’s next? EC could delay 400m to 1.2bn of carbon auction in Phase 3 Research analysts Reuters reported on 14th June that the European Commission’s draft proposals to stimulate the carbon market could involve delaying the sale of European Utilities 400m, 900m or 1.2bn permits during 2013-15 and then releasing them Vu Nguyen - NIplc over 2016-18. The EC declined to comment, citing market sensitivity. Vu.Nguyen@nomura.com +44 20 7102 4776 But market fundamentals do not change without a structural solution Martin Young - NIplc firstname.lastname@example.org The 1.2bn figure clearly cheered up a carbon market, which has been +44 20 7102 1536 desperate for some good news, and carbon prices edged up over EUR8/t. Javier Suarez However, we are of the view that simply delaying the auction of some email@example.com permits in Phase 3 does not change the long-term fundamentals of the EU +39 02 7646 4698 ETS. This appears to be more of a way to kick the can down the road and Jonathan Constable, CFA - NIplc firstname.lastname@example.org prevent the market from crashing. +44 20 7102 0950 Christina Ward - NIplc Three basic options to deal with carbon, two unlikely, in our view email@example.com Out of the EU’s three basic options for dealing with the EU ETS – a +44 20 7102 1556 temporary delay, a permanent set-aside or doing nothing – we think the last two are unlikely. Intervention in the European carbon market has Industry specialist become more a question of when and how, not if, but it is hard to imagine Roger Reynolds - NIplc a permanent set-aside being implemented in the next 12-18 months due to firstname.lastname@example.org +44 20 7102 2389 the lack of political support from carbon-intensive countries, especially the Eastern Europeans and those countries that are struggling with recession. ST impact of the delay: from minimal to significant… We estimate that ~1.8bn of surplus will be coming into Phase 3, and hence a mere 400m delay over three years will be unlikely to move the carbon market materially, if at all. Meanwhile, an action towards the upper range, e.g., 900m or 1.2bn, will likely create a temporary scarcity in the system, thereby boosting the carbon prices. Regarding a 1.2bn delay, we think the EUA price could be pushed upwards to EUR9-11/t by end-2013. …and LT impact: a backwardation CO2 market from 2016 Holding back then releasing permits will create a bizarre situation whereby the market will be in deficit during 2013-15 but then jump back to surplus afterwards, we believe. This means the CO2 price could be in backwardation during 2016-18, before rising progressively to EUR30/t in 2023 – our estimate of the theoretical switching price when the CO2 market is in balance. Positive for clean and fixed-cost generators, but there’s a long way to go We estimate that a EUR1/t increment in the CO2 price would result in EUR0.7/MWh and EUR0.9/MWh uplift in the CWE and Nordic power prices, respectively. At EUR8/t carbon, a carbon upward move of EUR1-3/t would only shift our current estimates of the 2013 CWE (EUR50/MWh) and See Appendix A-1 for analyst Nordic (EUR38/MWh) prices up by 1-4% and 2-7%, respectively. This certification, important would not radically alter the picture, and in the absence of official details, disclosures and the status of we have made no adjustments to our forecasts, valuations or ratings. non-US analysts. Nomura | Carbon market July 3, 2012 Potential impacts of back-loading the carbon auctioning profile Reuters reported on June 14th that the European Commission could stimulate the European carbon prices by delaying the sale of 400m, 900m or 1.2bn permits in the first 3 years of Phase 3 (2013 – 2015) and then releasing them over the following 3 years, 2016-18 . In this note, we seek to assess the potential impact on the European carbon market if this proposal is approved. EC could delay 400m to 1.2bn of carbon auction in Phase 3 Reuters, citing an anonymous source from the European Union (EU), reported on The EU could delay sales of 14th June that European Commission’s (EC) draft proposals to stimulate the carbon 400m-1.2bn carbon permits in market could involve delaying the sale of 400m, 900m or 1.2bn permits in the first 3 Phase 3. years of Phase 3 (2013 – 2015) and then releasing them over the following 3 years, 2016-18. The EC, however, declined to comment due to market sensitivity. Reuters also quoted one source saying that the proposals being discussed in the Commission also outlined ideas for some structural changes of the EU ETS, such as tightening the cap 1 and raising target to cut carbon emissions by 30% by 2020 . However, we note that both measures have been consistently pushed back by politicians. Over the past few months, communications from policy makers have given the market much hope that the EU will step in to prop up carbon prices. The EU Climate Commissioner, th Connie Hedegaard, said on April 19 that the EC will bring forward the first annual report on the EU ETS; she then signalled on May 15th that there could be some reduction in permits being auctioned in Phase 3: “…there is still a growing buffer of unused allowances. This is why the Commission, as announced last month, is now reviewing the time profile of phase 3 auctions with a view to reducing the number of allowances for auction in the early years of 2 phase 3''. She subsequently confirmed with the EU Parliament that the change in auctioning 3 profile does not eliminate the possibility of a set-aside. The 1.2bn figure clearly cheered up a carbon market, which has been desperate for some good news, and carbon prices edged up over EUR8/t. However, it is important to note that an auction delay and a set-aside are two separate things. In terms of legislation, a delay in carbon sales only requires an amendment in the auctioning profile, which is relatively simple to get approved via the comitology procedure. Meanwhile, for a set-aside proposal to become law, it would require a qualified majority voting result (i.e., more than a 70%) in favour from European Council’s 27 member states. However, market fundamentals We believe that simply holding back some carbon auction in Phase 3 does not change do not change without a the balance of the EU ETS, and a mere 400m delay over three years will be unlikely to structural solution. move the carbon price materially, if at all. However, taking out 1.2bn will create scarcity in the system in the short term, especially for the power sector which accounts for ~50% of the total annual allowances and will not receive free permits in Phase 3, thereby boosting carbon price. That said, note that even a 1.2bn delay cannot fully eliminate the surplus coming onto Phase 3, which we believe to be close to 1.8bn permits (including usage of CER/ERU).This appears to be more of a way to kick the can down the road and prevent the market from crashing. By now, carbon prices have given back most of their gains in early 2012. Having reached ~EUR10/t in March, prices crashed to EUR6/t in April due to the bearish EU ETS emission data (2% lower vs. prior year) and the lack of developments on the set-aside proposal. Since then, carbon prices have traded mostly in line with other energy-related th commodities e.g., coal until the news on 14 June. 1 Point Carbon/Reuters – EU Commission debates size of carbon auction delay (14th June 2012) 2 http://ec.europa.eu/commission_2010-2014/hedegaard/headlines/news/2012-05-15_01_en.htm 3 Point Carbon/Reuters – Delaying EUA sales could provide quick fix: Hedegaard (26 April 2012) 2 Nomura | Carbon market July 3, 2012 Fig. 1: EUA spot (EUR/t) vs. API2 coal spot ($/t) YTD Fig. 2: Cumulative CO2 balance without intervention 2008 – 115 10 2024E (million carbon permits) 2,200 110 9 14/6/12 2,000 105 8 1,800 100 1,600 7 95 1,400 6 1,200 90 5 1,000 85 800 4 80 600 3 75 400 70 2 200 0 65 1 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 ‐200 60 0 ‐400 Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 ‐600 API2 spot ($/t) LHS EUA spot (EUR/t) RHS Cumulative surplus/(shortfall) Annual surplus/(shortfall) Source: Reuters, Nomura research Source: EC, Nomura research Auction delay or set-aside – a question of lawmaking It is hard to describe the current state of the European carbon market as anything other than a mess. Being an unusual commodity market with supply fixed for nearly 10 years in advance while demand fluctuates with the economy, the added complexity of all sorts of political interventions in this market gives little visibility as to what lies ahead. Also, despite being the largest and most liquid carbon market worldwide (transaction volume 4 worth $148bn in 2011 ), the EU ETS has been in existence for less than a decade, which means the past cannot really serve as a useful guide to the future. Hence, we are of the view that the EU ETS should not be left to function on its own as a “free” The EU ETS cannot be left to market, simply because it was not designed as such: the basic economic dynamic between function on its own as a “free supply and demand was not in place from the very start. The growth of renewable energy market” over the past few years, which was helped by generous government subsidies, and the unfavourable developments of the European economy have exposed many shortcomings of the carbon scheme. The game has changed, and we believe European policy makers may decide to intervene now precisely because they have realised the EU ETS was not designed to cope with such a situation. Therefore, we believe investors in the utility sector should not view carbon as a normal commodity such as oil or coal, but rather should also factor in the political landscape affecting carbon in their analysis. We believe that an intervention into the European carbon market has become more a An intervention into the question of when and how, not if. Over the long term, we believe that a complete European carbon market is overhaul of the system, possibly in conjunction with European energy policy at a country more a question of when, not if level, is necessary if the EU still hopes for carbon to be a pillar of the bloc’s future energy roadmap (which until now they have so indicated). In the short term, it is much simpler to modify the carbon auction profile than to implement a permanent set-aside, although doing so is by no mean easy. Such modification would have to go through the so-called comitology procedure: the EC submits the draft proposal to the Climate Change Committee – a committee of representatives from every EU country – which votes based on the EU’s qualified majority voting rule (see a simplified flow chart in Figure 3). A qualified majority vote will be reached if the following 2 conditions are met: • If a majority of Member States approve (in some cases a two-thirds majority); • A minimum of 255 votes is cast in favour of the proposal, out of a total of 345 votes There are two critical regulatory aspects of the comitology process that could facilitate a quick fix for the carbon market. First, although the Climate Change Committee will vote on the EC’s proposal, the EC can choose between implementing and reviewing the proposal in absence of a qualified majority voting against it. This implies the delay 4 State and trends of the carbon market, May 2012 – Carbon Finance at the World bank 3 Nomura | Carbon market July 3, 2012 can still go ahead without a majority vote in favour from the committee. Second, the Council of the EU (27 Member States) cannot appeal until the very last stage (i.e., “right of scrutiny” in the chart), and even if the Council opposes to the proposal, the EC does not have to abandon it. Fig. 3: Comitology procedure (simplified) EC submits the draf t proposal to the Climate Change Committee, made up of representatives f rom every EU country The Climate Change Committee vote on the EC’s proposals NO YES Qualified majority vote Qualif ied majority vote in f avour against the proposal OR absence of qualif ied majority vote against The proposal is rejected EC implements the EC reviews the proposal proposal YES The European Parliament (EP) and the Council execute the "right of scrutiny" NO YES The new regulations exceed the The new regulations do not exceed the powers conf erred by the relevant powers conf erred by the relevant legal legal basis to the Commission basis to the Commission EC reviews the draft measure in The proposal becomes law question and will explain to the European Parliament and the Council what it intends to do. Source: EC, Nomura research Most important, we believe that the big four: Germany, France, Italy and the UK will The big four, Germany, France, support the auction delay. The UK, with a carbon floor way above the current European Italy and the UK, will likely prices, has unsurprisingly spoken in favour of tightening the EU ETS to prop up prices. support a higher carbon price Similarly, Italian environment minister, Corrado Clini, said at the Clean Energy Ministerial th conference in London on April 27 that he “personally agrees” with a set-aside to ensure a convergence between the EUA price and the future Italian carbon tax. 5 France has not given their official views on the matter, but higher emission costs in Europe will make its industries more competitive, since the country generates 90% of power from clean sources. Meanwhile, the nuclear exit in Germany implies a major reorientation to renewables over the coming decade, which could be facilitated by higher carbon prices. Given that these four countries already account for 116 votes (see Figure 3 below), it is quite likely that if the EC proposes to back-load the auction profile to boost carbon price, the act will be approved and implemented. If we are right on this, then we could see an intervention by end-2012, since the process typically takes five to six months. 5 Platts - Italy supports cuts in emission allowances (27 April 2012) 4 Nomura | Carbon market July 3, 2012 Fig. 4: Distribution of votes for each Member State Germany, France, Italy, United Kingdom 29 Spain, Poland 27 Romania 14 Netherlands 13 Belgium, Czech Republic, Greece, Hungary, Portugal 12 Austria, Bulgaria, Sweden 10 Denmark, Ireland, Lithuania, Slovakia, Finland 7 Cyprus, Estonia, Latvia, Luxembourg, Slovenia 4 Malta 3 TOTAL 345 Source: Council of the European Union On the other hand, the legislation roadmap for a permanent carbon set-aside is much longer and more complex, as it requires amendments to a European directive. The procedure, known as an ordinary legislative procedure (formerly Co-decision procedure), is laid out in the Treaty of the Functioning of the European Union (TFEU): It is a long and complex process Fig. 5: Ordinary legislative (Co-decision) procedure (simplified) before a set-aside can be adopted. EC initiates the draf t amendments to the ETS and submits to both the European Parliament (EP) and Council of the European Union (the Council) First reading by EP - EP suggests Council approves all EP's amendments to EC proposal amendments. The act is ADOPTED Y E S If EP has approved EC's proposal First reading by the Council. Council adopts position without amendments, Council can ADOPT act NO Second reading by EP EP suggests amendments to Council's f irst reading NO EP rejects Council position at f irst Second reading by Council reading. Act is NOT ADOPTED NO YES Council does not approve amendements. The proposal is brought Council approves EP's to a Conciliation Committee, made up amendements via qualif ied majoriity of an equal number of representatives voting. of the Council and EP Act is ADOPTED NO YES The Conciliation Committee does not When the Conciliation Committee has agree on the joint text. The act is reached an agreement, the text will be NOT ADOPTED sent back to the Parliament and the Council f or a third reading NO YES The EP and the Council agree on the EP and Council do not agree on the joint text. The act is ADOPTED joint text. The act is NOT ADOPTED YES The new law will undergo a three- month scrutiny period where the Council and EP can still reject it Source: EC, Nomura research 5 Nomura | Carbon market July 3, 2012 Unlike the comitology procedure, the involvement of the Council in the early stages of the Co-decision process makes it particularly difficult for a permanent set-aside to pass, since it requires a qualified majority voting result in favour from the Council. In Figure 6 we list all major countries that we think may vote against the set-aside. The rationale behind this categorisation is based on our view that there are two basic reasons why a country may not favour higher carbon prices: • Its energy mix is very carbon-intensive (coal >1/3) – as in the case of most Eastern European countries, and • It is in a severe economic crisis and a higher energy price could be detrimental to the economy – as in the case of Spain, Portugal, Greece and Ireland. A counter-argument to this is higher carbon prices will raise government revenue via the auctioning process, hence support a cash-starved country to fund its recovery. In fact, an EC working paper released earlier this year estimates that a set-aside large enough for the EU to reach 30% emission reduction by 2020 would increase auction revenues by all Member States to around EUR28.5bn per annum 6. However, even if this estimate is anything to come by, we still doubt that it can really help an economy. First, the majority of the auction volume allocated to each country in Phase 3 is based on its verified emissions during 2005-07, so such low emitters like Portugal or Ireland will not have much allowance to start with (less than 2% of total for each). Second, the EU ETS law requires that 50% of that revenue must be used for reducing GHG, developing renewables, energy efficiency etc, leaving a relatively small balance to go into the economy. Based on the reasoning above, we roughly estimate the total votes against a set-aside at We think it is unlikely that a 129, leaving 226 votes in favour, just short of the 255 votes required. Although this permanent set-aside will be seems a very close result, it does not take into account (1) the incredibly complex inter- implemented, at least in the relationship among European countries. It is hard to imagine the EU willing to adopt a short term. new law that could make almost a third of EU governments unhappy, especially when the discussions of a more unionised Europe have become highly topical in light of the economic crisis; and (2) the timing required for the whole process to be completed, which could take up to three to five years. Fig. 6: Countries that might vote against the set-aside Coal % of Gas % of generation generation Vote Spain 9% 28% 27 Poland 89% 3% 27 Romania 40% 12% 14 Czech Republic 57% 5% 12 Greece 52% 20% 12 Portugal 13% 20% 12 Ireland 16% 64% 7 Bulgaria 50% 5% 10 Slovenia 33% 3% 4 Estonia 93% 0% 4 TOTAL 129 Source: Nomura research Another very interesting result from Figure 6 is that Spain, with 27 votes, could almost singlehandedly change the whole outcome. It’s true that the general attitude of Spain has been supportive to the Kyoto Protocol, and since the Spanish government does not own any integrated utility, it could follow policies that could damage the profitability of these companies. However, we would argue that the Spanish government will be more concerned about protecting the competitiveness of its local industries in the next few years and this would call for lower energy prices. Therefore, we maintain the view that a permanent set-aside is unlikely in the short term. 6 EC Staff working paper – SWD (2012) 5 final 6 Nomura | Carbon market July 3, 2012 Potential impacts of a carbon auction delay In terms of pricing, we think that the 1.2bn permits delay could push carbon price to the range of EUR9-11/t in the next 12 months, but admittedly it is notoriously difficult to provide a very meaningful forecast of carbon prices without concrete details from policy makers, and we believe it is better to be roughly right than precisely wrong. We have run some scenarios of supply withdrawal to assess the potential impacts on the supply- demand balance. Figure 7 to 9 below outline our projected carbon balance in the cases that 400, 900m and 1.2bn permits are delayed. We have assumed that the permit delays will be spread equally over 2013-2015 and then released in the same manner over 2016- 2018. Figure 10 shows our forecast for EUA prices in each situation. As illustrated, holding back then releasing permits could create a bizarre situation European carbon prices could wherein the market will be in deficit during 2013-16, but then jump back to surplus in the be in backwardation. following three years. This means the market would likely be in backwardation during 2016-2018, before rising progressively to EUR30/t in 2023 – our estimate of the theoretical switching price when the CO2 market is in balance. Fig. 7: Cumulative CO2 balance with 1.2bn permits delayed Fig. 8: Cumulative CO2 balance with 900m permits delayed 2013-15, released 2016-18 (million carbon permits, 2008-22) 2013-15, released 2016-18 (million carbon permits, 2008-22) 2,000 2,000 1,800 1,800 1,600 1,600 1,400 1,400 1,200 1,200 1,000 1,000 800 800 600 600 400 400 200 200 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 ‐200 ‐200 ‐400 ‐400 ‐600 ‐600 Cumulative surplus/(shortfall) Annual surplus/(shortfall) Cumulative surplus/(shortfall) Annual surplus/(shortfall) Source: EC, Nomura estimates Source: EC, Nomura estimates Fig. 9: Cumulative CO2 balance with 400m permits delayed Fig. 10: EUA price forecast with intervention (million carbon 2013-15, released 2016-18 (million carbon permits, 2008-22) permits, 2012-23) 2,000 1,800 30 1,600 25 1,400 1,200 20 1,000 800 15 600 400 10 200 0 5 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 ‐200 ‐400 0 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E ‐600 Cumulative surplus/(shortfall) Annual surplus/(shortfall) 400m 900m 1.2bn No intervention Source: EC, Nomura estimates Source: EC, Nomura estimates In Figures 11 to 14, we have project the annual and cumulative carbon balances in the case that the delayed carbon permits become a permanent set-aside, assuming permits are taken out in the same manner as a delay. Absent a dramatic recovery of the European economy, we think the system could still be in surplus for a large part of Phase 3 even if 1.2bn permits are taken out of the market. This is due to a combination of the large surplus existing in the system and lower emissions resulting from renewables penetrations and sluggish industrial activities. 7 Nomura | Carbon market July 3, 2012 Fig. 11: Cumulative CO2 balance with 1.2bn permits set- Fig. 12: Cumulative CO2 balance with 900m permits set- aside permanently (million carbon permits, 2008-22) aside permanently (million carbon permits, 2008-22) 2,000 2,000 1,800 1,800 1,600 1,600 1,400 1,400 1,200 1,200 1,000 1,000 800 600 800 400 600 200 400 0 200 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 ‐200 0 ‐400 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 ‐200 ‐600 ‐400 ‐800 ‐600 ‐1,000 ‐1,200 ‐800 ‐1,400 ‐1,000 ‐1,600 ‐1,200 Cumulative surplus/(shortfall) Annual surplus/(shortfall) Cumulative surplus/(shortfall) Annual surplus/(shortfall) Source: EC, Nomura estimates Source: EC, Nomura estimates Fig. 13: Cumulative CO2 balance with 400m permit set-aside Fig. 14: EUA price forecast with permanent set-aside (million permanently (million carbon permit, 2008-22) carbon permit, 2013-23) 2,000 1,800 30.0 1,600 1,400 25.0 1,200 1,000 20.0 800 600 15.0 400 200 10.0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 ‐200 5.0 ‐400 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E ‐600 Cumulative surplus/(shortfall) Annual surplus/(shortfall) 0 - 1.2bn 400m 900m Source: EC, Nomura estimates Source: Reuters, Nomura estimates Implications for European utility stocks We estimate that a EUR1/t increment in the CO2 price would result in EUR0.7/MWh and Positive for clean and fixed-cost EUR0.9/MWh uplift in the CWE and Nordic power prices, respectively. At EUR8/t carbon, generators, but it’s a very long a carbon upward move of EUR1-3/t would only shift our current estimates of the 2013 way until it becomes material. CWE (EUR50/MWh) and Nordic (EUR38/MWh) prices up by 1-4% and 2-7%, respectively. Such increases would neither radically alter the picture nor have a meaningful impact on our estimates and view. Nevertheless, we are cautious that a more aggressive price response in the CO2 market would be beneficial to the carbon-light fixed-cost generators. Fig. 15: EUA 1-yr fwd (EUR/t) vs. Nordic base 1-yr fwd Fig. 16: EUA 1-yr fwd (EUR/t) vs. German base 1-yr fwd (EUR/MWh) 2008-now (EUR/MWh) 2008-now 75 30 95 30 70 90 85 65 25 80 25 60 75 55 70 65 50 20 20 60 45 55 40 50 15 15 35 45 40 30 35 25 10 10 30 20 25 20 15 5 15 5 10 10 5 5 0 0 0 0 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Npool 1yr fwd (EUR/MWh) LHS Carbon 1yr fwd (EUR/t) RHS German 1yr fwd (EUR/MWh) LHS Carbon 1yr fwd (EUR/t) RHS Source: Reuters, Nomura research Source: Reuters, Nomura research 8 Nomura | Carbon market July 3, 2012 We estimate that each incremental EUR1/MWh achieved price would add EUR50m to Fortum (Reduce) EBIT, EUR35m for CEZ (Reduce) and EUR18m (Reduce) for Verbund. These translate to EUR40m, EU28m and EUR14m of post-tax earnings, respectively, i.e., 2-3% potential upside to our current estimates of FY13 net profits for these companies. However, in the absence of official details of a set-aside or an auction delay, we have made no adjustments to our forecasts, valuation or ratings. Fig. 17: EUR 1-4/MWh added to power price forecast for Fig. 18: Impact of higher carbon price on profit each EUR1/t on 2013 CO2 price 58.0 EDF GDF Suez E.ON RWE CEZ Fortum Verbund 56.0 54.0 Source: Nomura estimates 52.0 50.0 48.0 46.0 2013 2014 2015 2016 2017 2018 2019 Model output EUR 1/t increase in 2012 CO2 EUR 2/t increase in 2012 CO2 EUR 3/t increase in 2012 CO2 Source: Nomura estimates 9 Nomura | Carbon market July 3, 2012 Appendix A-1 Analyst Certification I, Vu Nguyen, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. Issuer Specific Regulatory Disclosures The term "Nomura Group Company" used herein refers to Nomura Holdings, Inc. or any affiliate or subsidiary of Nomura Holdings, Inc. Nomura Group Companies involved in the production of Research are detailed in the disclaimer below. Issuer name Ticker Price Price date Stock rating Sector rating Disclosures CEZ AS CEZ CP CZK 696.90 29-Jun-2012 Reduce Bearish FUM1V Fortum FH EUR 14.97 29-Jun-2012 Reduce Bearish Verbund VER AV EUR 18.07 29-Jun-2012 Reduce Bearish A4,A5,A6 A4 A Nomura Group Company had an investment banking services client relationship with the issuer during the past 12 months. A5 A Nomura Group Company has received compensation for investment banking services from the issuer in the past 12 months. A6 A Nomura Group Company expects to receive or intends to seek compensation for investment banking services from the issuer in the next three months. Previous Rating Issuer name Previous Rating Date of change CEZ AS Not Rated 29-Nov-2011 Fortum Neutral 11-May-2009 Verbund Neutral 28-Oct-2009 CEZ AS (CEZ CP) CZK 696.90 (29-Jun-2012) Reduce (Sector rating: Bearish) Rating and target price chart (three year history) Date Rating Target price Closing price 19-Jun-12 735.00 740.40 29-Feb-12 830.00 807.00 29-Nov-11 REDUCE 707.00 29-Nov-11 900.00 707.00 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology We use a sum-of-the-parts approach to value CEZ, with 50% of our EV being accounted for by its generation activities which we value over their remaining lifetime using a WACC of 8.5%. Regulated activities are valued via a 10 Nomura | Carbon market July 3, 2012 DCF on the assumption that the business is maintained into perpetuity and using a WACC of 7.5%. Deducting net debt, pension provisions and minority interests, we arrive at a value of CZK 737/share. We set CZK 735 as our target price. Risks that may impede the achievement of the target price Risks include, but are not limited to, fluctuations in electricity, coal and carbon prices as well as changes in the regulatory/political environment and nuclear availability. Fortum (FUM1V FH) EUR 14.97 (29-Jun-2012) Reduce (Sector rating: Bearish) Rating and target price chart (three year history) Date Rating Target price Closing price 19-Jun-12 15.00 14.75 08-Feb-12 18.70 18.34 20-Dec-11 19.00 16.14 18-Aug-11 20.00 16.73 20-Jul-11 22.00 19.00 08-Feb-11 23.00 21.98 03-Sep-10 20.00 18.41 03-Mar-10 19.50 19.05 18-Dec-09 18.00 17.89 03-Sep-09 17.30 17.22 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology Our price target is EUR 15.0. Our approach to valuing Fortum is to use a sum-of-the-parts approach, which captures the drivers of each component of Fortum's business mix. The valuation of Nordic generation is based on DCF with a 7.8% discount rate and zero terminal growth rate, with debt held at associates deducted. In the absence of a published RAB, the Nordic regulated business valuation is based on a benchmarking analysis to similar assets across Europe. TGC-10 is valued using a WACC of 14%. Other assets and businesses are valued using ratios, DCFs, book and market values. The benchmark index for this stock is Dow Jones STOXX® 600 Utilities. Risks that may impede the achievement of the target price Fortum is exposed to a number of risks both in the Nordic region and abroad. In the Nordic area, the key risks include generation prices and regulation. Outside the Nordic region, among other things, Fortum is exposed to political risk, namely in Poland and Russia. Verbund (VER AV) EUR 18.07 (29-Jun-2012) Reduce (Sector rating: Bearish) Rating and target price chart (three year history) Date Rating Target price Closing price 19-Jun-12 17.50 19.145 14-Mar-12 22.70 21.965 20-Dec-11 21.60 19.41 17-Nov-11 25.00 20.605 18-Apr-11 27.50 29.785 30-Apr-10 25.50 28.10 18-Dec-09 28.00 28.90 28-Oct-09 REDUCE 30.62 28-Oct-09 33.00 30.62 03-Sep-09 39.00 35.09 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology We value Verbund using a sum-of-the-parts approach. Our target price is EUR 17.5. For generation we perform DCFs by type through to 2045 using a WACC of 7.7%. Renewables is valued using a WACC of 8.7% & networks 11 Nomura | Carbon market July 3, 2012 business using a WACC of 6.2%. For international investments we use a combination of invested capital and book value to value Verbund’s interests. We deduct net debt, minorities and pension/severance provisions from our valuation to arrive at an estimated equity value. The stock rating on Verbund is relative to the DJ Euro Stoxx Utilities index. Risks that may impede the achievement of the target price With a largely fixed-cost generation fleet, European power prices are the major determinant of Verbund's valuation. Therefore key risks include not only power prices but also movements in the underlying commodities coal, carbon and gas. As the generation mix is skewed into hydro, rainfall is also a risk. Lastly, the regulatory environment on the Austrian networks will also be a driver of value. 12 Nomura | Carbon market July 3, 2012 Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on www.nomuranow.com/research, Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. 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Distribution of ratings (Global) The distribution of all ratings published by Nomura Global Equity Research is as follows: 46% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 40% of companies with this rating are investment banking clients of the Nomura Group*. 43% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 45% of companies with this rating are investment banking clients of the Nomura Group*. 11% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 21% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 March 2012. *The Nomura Group as defined in the Disclaimer section at the end of this report. Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to target price defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including, but not limited to, when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States/Europe: please see valuation methodologies for explanations of relevant benchmarks for stocks, which can be accessed at: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. 13 Nomura | Carbon market July 3, 2012 Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. 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