Introduction to Mitsui & Co. Commodity Risk Management

STRICTLY PRIVATE AND CONFIDENTIAL

Carbon Emissions Tradingfor ShippingHow does Cap and Trade work?
Lets consider two companies with identical emission totals and required cuts butwith differing costs of abatement

Limit on emissions but no trading
Obligatedcut by 10pct
Emissionscapped at
90pct of‘business
as usual’

$15/t

$50/t

ABCplcXYZ
Co. Ltd

ABC plc

XYZ Co. Ltd

Cost to abate
1tonne ofCO2$15/mt$50/mtCost to abate
10,000t$150,000$500,000

TotalcombinedcostCap and TradeObligated
cut by 10pct
Optional cutof 10pct

$15/t
$5/t
$15/t

ABCplc$17/t
ABC makes
optional
reduction
costing $15/t
because it
can sell to
XYZ for aprofit.

XYZCo. Ltd$650,000

ABC plc

XYZ Co. Ltd

Cost to abateor buy 1tonneof CO2$15/t less $2/t
of profit fromsale to XYZ$17/mtCost to abateor buy 10,000t$130,000$170,000

Total
combined
cost$300,000

Same 20,000t cut in emissions, half the cost due to Cap and Trade2

Cap and Trade – Abate or Emit?
Decisions on the volume of carbonemissions require each EU ETS
participant to have knowledge ofboth the cost to abate and market
price to buy the emissions.

As we saw in the previous example Cap and Trade uses market mechanisms toseek out the cheapest abatements across the scheme. Focus on overall emission
reduction target, not per operator.
With incentives for fuel efficiency already well entrenched, it is likely thatshipping will compete to buy allowances from the wholesale secondary market.

3What influences emission allowance prices?
1. Potential for fuel switching in European Power Production
Power price

EUAs req

EUAs req

EUAs req

EUAs req

EUAs req
EUAs req

Cost of coal

Cost of coal +EUAs > Cost ofgas + EUAs =prefer gas as fuel

Cost of gas

Cost of coal

Cost of gas

Cost of coal

Cost of gas needed to produce power

Cost of gas +EUAs > Cost ofcoal + EUAs =prefer coal asfuelCost of gas +EUAs = Cost ofcoal + EUAs =fuel switch level4

What influences emission allowance prices?
2. The broader economic picture
Positive economic news =increased demand for power,
goods = higher carbon price

Poor economic news =decreased demand forpower, goods = lower carbon
price5What influences emission allowance prices?
3. News with direct impact upon emissions
Conflict in Ukraine causes gas prices to dramatically rise. Initial assessment of impact on
EU economy is lower use of gas for power production, decreasing economic activity, hence
lower than expected emissions and therefore less demand for EUAs.

Price quickly
slumps as
market factors
in decreased
demandEUA
Dec2023
price(EUR/t)Source – MBCL internal marks

6What influences emission allowance prices?
4. Weather
A hot summer increasing power
demand for air-conditioning

A cold winter increasing demand forheating

Windy conditions allowing renewablewind energy to produce

A wet winter raising levels of water
stored for hydro power

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What influences emission allowance prices?
5. Supply of allowances
The supply of allowances is from a finite source. Additional volume brought into themarket whether from scheduled auctions or release from MSR will affect the price.
Auction volumes of EUAs.
If supply bigger than demand, price falls. When demand exceeds supply,price rises.

8What else influences emission allowance prices?
6. Policy announcements
Tighter caps, increased Linear Reduction Factor
Legal challenges, rulings
Changes in auction schedules – Eg. REPowerEU
EU emission reduction targets – Eg. ‘Fit for 55’
Annual verified emission reports
Overlapping policies – Carbon Border Adjustment Mechanism
Details of industrial emissions benchmarking
And many more, it’s not simply another commodity market

9Upside and Downside price risks remain
Downside risk

Upside risk••••••

Energy efficiency, industrial abatement
technology rolls out quickly and atcheaper prices than expected
Coal phase-out leads to significantly
lower demand/supply balance than
anticipated
Fuel switch economics see gas
replacing more coal as power fuelWeak economic growth
Ambition dialled back due to economic
circumstances•••

Political ambition to encourage private
investment in emission reductions
sees prices rise to levels to drive fuelswitch and encourage private
investment in industrial abatement.
Potential for further tightening of EU
ETSStronger economic growth
Price signal from fuel switch sees
more coal in power production

Refer to our weekly commentary for:market events explanation andtechnical analysis (support and resistance levels)

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The EU ETS Year

Monitor Emissions January -December
30 Sep31 DecRegular Auctions of EUA
Verification
processes

Surrender
allowances
equivalent
tocomplianceobligation

When does your price exposure become realised?
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EUA – a more proactive approach hedging?
Financial risks of EU ETS have become real!
After the price rises and volatility of recent years the financial exposure fromhaving a reactive approach to hedging EUAs have been realised.
Just waiting until shortly before compliance deadline to buy has been
exposed for the gamble that it was.
You can choose to hedge your exposure when it arises without paying for theallowances upfront.
Cashflow becomes an important consideration at higher prices. If you hedge
using forwards and you can still pay approaching the compliance deadline
whilst protecting your exposure to even higher prices now.
BUT you will have counterparty risk, do not underestimate it.
In EU ETS companies develop policies to manage their exposures to volatile
prices by hedging when exposure becomes realised, when they agree deals
that give rise to large requirements or by layering hedges over time eg.
minimum of 25pct by 2 years ahead, 50pct by 1 year ahead, 75pct by 6months ahead.
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Counterparty Risk
Trading losses or third party failure can and do cause financiallyweak counterparties to fail, potentially taking your assets with them!
High prices put a strain on the finances of not just compliance installations
but also companies providing hedging solutions in EU ETS. This isespecially true for small traders who only deal in emissions and do not havethe financial resources and balance sheet of a large multi-national company
with several business lines.
What is their net worth/Equity? Is the risk you are taking >10pct of theirEquity?
Do they have cash/bank accounts on balance sheet which they could use if
their circumstances change? If not, what about headroom on bank lending
facilities?
What is their current ratio? (a measure of liquidity - current assets/currentliabilities) Is it >1?
Do they have a recognised credit agency rating? Is it investment grade orbetter?
MOODY’S
STANDARD & POOR’S
LONG-TERM RATING MITSUI & CO., LTD. LONG-TERM RATING
A3A

MITSUI BUSSAN COMMODITIES LTD. (“MBC”)

13Documentation Risk
Market standard documents: ISDA, IETA, EFET
Master agreement/Emissions annex specifically deals with trading under
EU ETS

Legal certainty about the enforceability of document
Short form bespoke documentation might be easy to understand butoften will not protect you when unexpected problems occur.

Market Standard Documentation has been tested in court, therefore you
can have much greater confidence on it to protect you when things gowrong.
Why should I care?
At current higher and volatile prices you do not just have settlement risk
when buying forward. Eg. If you buy forward from Company A @ EUR
75.00 and price rises to EUR 150.00 you have a large financial exposure.
If Company A becomes bankrupt you are unhedged, you must now buy atmarket.
Does local law recognize EUAs as a financial debt/obligation?
Can you take counterparty successfully to court to regain losses?

14How to trade in the market?
Trade Spot

Trade Forward

Buy Option

Trade Indexed

Buy at Auction

Buy allowances fordelivery in next fewdays

Fix a price for allowances
to be delivered at a futuredate

Buying an option gives theright but not the obligation
to buy allowances at afuture date.
Limited flexibility in termsof expiries, strike prices.

Trade linked to average
published settlement
prices over an agreed
periodCompete to buy EUAs set
aside to be sold at auction

Low/No utilisation ofcredit lines.
When used to cover
exposure fromjourneys alreadymade eliminates
potential for adverse
price movement
before compliance.

Enable budgeting ofemissions costs in thefuture.
Allows cash to remain
available to the business
until nearer compliancedate.
Removes risk of adverse
price movement.

Removes risk of adverse
price movement whilst
retaining ability to benefit
from favourable move.
Low/No utilisation of credit
lines.

Smoothes price volatility
over agreed period.
Can be used for forward
hedging but likely limited
to December or spot
deliveries.

Transparent price

Makes it difficult tobudget emissions
costs on a forwardbasis.
Ties up cash now that
may be better put touse in the business
Requires a trading
account now which
could cost money andis unnecessary for acompliance entity inEU ETS.

You have counterparty
risk, need to choose yourtrading partner carefully.
Requires credit lines andpotentially collateralagreements.

Significant minimum size
required 50k+ per deal.
Illiquid market with few
market makers, closing
out positions if required
can be a challenge.
Upfront premium may bepayable.

Minimum volumes per day
can be a challenge.
You commit to buy a
specific volume before
you know the price.

Spot deal – same issues.
Once a day auction time
reduces flexibility in avolatile market damaging
ability to time purchases
on intra-day dips.
No guarantee that yourbid will succeed in volumeor price.

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What can Mitsui offer?
Expert in trading
Employs experts with knowledge of local market
Management active in EU ETS trading since the beginning
Direct access to experts for market analysis and prices
One of the largest liquidity providers to compliance entities in EU ETSStrong credit worth entity
Global commodity trader with very strong strong financial profile
Highly rated and creditworthy counterparty
Able to offer credit facilities for forwards not just spot

Customer approach
Value long-term client relationship over quick profit
Work firm orders to capture brief opportunities in fast moving market
Weekly market analysis and ad-hoc reports
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Contacts
Chia Ren Neo – Head of Energy+33 1 75 85 09 13

chiaren.neo@mbcl.com

Ziad Ghusayni, Head of Energy Sales, UKMEA+44 207 489 6745

ziad.ghusayni@mbcl.com

Oliver Graves, Head of Energy Sales, Europe+44 207 489 6758

oliver.graves@mbcfrance.com

Kenneth Low, Head of Asia Sales - Energy+65 6372 8039

kenneth.low@mbcl.com

Yasumasa Tsugane, Senior Marketing Manager (Mitsui & Co., Ltd.)

1st Floor, Warwick Court
5 Paternoster SquareLondon, EC4M 7DX

112 avenue Kléber
75116 Paris, France+81 3 3285 3713

12 Marina View, #12-01
Asia Square Tower 2Singapore 018961

y.tsugane@mitsui.com

200 Park Avenue
New York, NY 10166