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					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
                                                                                  martin.young@nomura.com
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              javier.suarez@nomura.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
                                                                                  jonathan.constable@nomura.com
prevent the market from crashing.                                                 +44 20 7102 0950
                                                                                  Christina Ward - NIplc
Three basic options to deal with carbon, two unlikely, in our view                christina.ward@nomura.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           roger.reynolds@nomura.com
                                                                                  +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




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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




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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




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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.




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STOCKS
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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


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company's earnings differ from estimates.




                                                                                                                                               14
Nomura | Carbon market                                                                                                                                            July 3, 2012


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Description: Short-term deficit could push carbon price upward, but what’s next?