The New Carbon Cycle

Consulting Firm Offers Predictions of Carbon Market through 2012

Celent a French consulting firm has developed a model to predict carbon credit markets in the coming years as the first phase of the Kyoto Protocol comes to an end in 2012. As what will follow is still uncertain, perhaps predictions of the market thereafter is uncertain--will the United States be a player in the international carbon market and drive up demand?  Will credits from Russia swamp the market and drive down prices?  What will happen in China:  will China agree to caps or slower growth of their carbon emissions or will they no longer be able to sell carbon credits for small reductions when the overall growth of their national emissions continues to rise?

Predicting the market based on current European and Japanese demand for credits is probably a safer, and perhaps only reasonable approach that one can venture at this point. 

The extension of EU ETS to the airline industries and the likelihood of seeing the involvement of states and regions (such as California) that are not already active clearly play in favour of strong growth in this market.

“The carbon emission market is based on ‘negative assets’ created by regulators. Therefore it is highly dependent on the regulatory framework and its evolution. But, despite lack of harmonization and regulatory uncertainty, the carbon emission trading market has promising potential,” says Axel Pierron, analyst at Celent and author of the report.

The carbon emission market offers a wide spectrum of instruments, and the pricing is closely related to a country’s economic situation, the price of energy commodities, and the weather. Therefore, despite regulatory uncertainty, carbon emission instruments should be included in the investment strategy of any traders targeting these markets.

Liquidity is a significant issue for these carbon markets. 

“While many firms impacted by the cost of carbon emission are not yet active, it is also very surprising to see that retail banks do not offer carbon emission offsetting capabilities. With all the publicity around global warming and the increased concern about the future of our planet, retail customers are an amazingly untapped market. Expanding the scope of participants in this market will be crucial to increasing its liquidity,” Axel Pierron adds.

This lack of liquidity is a plague to the carbon emission exchanges; the carbon market is still mainly an OTC market. The fact that many exchanges provide reporting capacity to market participants that conduct OTC transactions inflates the transaction volume of carbon emission exchanges. In reality, 72% of the trades in the carbon market are conducted OTC, with a significant share of bilateral trading. Axel Pierron observes: “We certainly believe that the carbon emission market is benefiting from the emergence of exchanges such as the ECX. The question is more about the economic viability of these exchanges. We have not seen any brokers jumping into the market and developing their own platforms. We estimate that the current uncertainty over the existence of the market generates too much economic uncertainty.“

Four carbon emission exchanges (the ECX, the CCX, NordPool, and Powernext) currently exist.  If Canada and the United States join in and take an active role in the post-Kyoto treaty, then other exchanges may open in the United States and Canada.  If these exchanges are able to address the liquidity issues, then the market for these credits may increase dramatically.

Another issue that must be addressed for those looking to succeed as investors, sellers, and brokers of these credits is over allocation.  The initial European Union Emissions Trading Scheme over allocated allowances for carbon emissions, and drove the value of credits near zero.  The EU is attempting to battle over allocation, but some believe the Regional Greenhouse Gas Initiative in the northeastern states in the US are already heading to over allocation.  Like any market, without limited supply the price does not increase.  To address climate change, the "cap" side of "cap and trade" must be less than the current emissions of the regulated industry and decline over time.  Otherwise, both the market for credits and the goal of the system to reduce pollution may fail.

NYSE Euronext and Caisse des Dépôts Announce Plans to Form Carbon Credit Exchange

NYSE Euronext and Caisse des Dépôts announced that they intend to open an organized international market for trading carbon (greenhouse gas) allowances and credits. They plan to provide a full range of exchange-based services to the carbon emissions market at the global level. The new facility set to open in 2008 will be owned by NYSE Euronext as majority owner, with Caisse des Dépôts, a French bank, as the main additional shareholder.

The new exchange will offer an organized continuous market to facilitate spot transactions in CO2 allowances and credits, with services ranging from trading to settlement. They also plan to develop derivative products to enhance market liquidity and depth.

The initiative will be backed by NYSE Euronext's international network and its knowledge in managing securities markets and by the expertise of Caisse des Dépôts in carbon finance, particularly in emissions trading technology and settlement activities.

Mitsubishi to Purchase Carbon Credits from NOX Reductions from Explosive and Fertilizer Plant

Mitsubishi Corporation has agreed to purchase 822,000 tons of carbon emissions credits annually through March 2013 from a plant owned by Enaex SA in Chile.   The project was approved by the Executive Board under the Clean Development Mechanism provision of the Kyoto Protocol.  The carbon credits arise from reductions in nitrogen oxide (a greenhouse gas) emissions from a  plant that produces explosives and synthetic fertilizers.

Al Gore and the UN Intergovernmental Panel on Climate Change Win Nobel Prize

Former Vice President Al Gore and the United Nations Intergovernmental Panel on Climate Change won the 2007 Nobel Peace Prize for their efforts to build and spread knowledge about man-made climate change, and to lay the foundations for programs to reduce greenhouse gas emissions.  See Wall Street Journal article.

The Interstate Natural Gas Association of America Position on Greenhouse Gas Emission Regulation

The Interstate Natural Gas Association of America (INGAA) is a non-profit trade association representing virtually all interstate natural gas transmission pipeline companies operating in the United States and interprovincial pipelines operating in Canada. INGAA’s U.S. members operate over 200,000 miles of pipeline and related facilities that account for over 90 percent of all natural gas transported and sold in interstate commerce.  The INGAA has issued its view on the US adopting climate change legislation and caps on greenhouse gas emissions.  Although this position is several months old, I thought it would be of interest to consider their position.

Highlights of INGAA’s response to the House Energy and Commerce Committee’s questions follow

INGAA supports an economy-wide program that recognizes and accommodates the unique features of different sectors in the U.S. energy economy (i.e. differences in fuels and their end-use applications). An appropriate policy approach may involve different thresholds, regulatory mechanisms and possibly schedules for each sector based on its unique attributes.

• Given the global nature of the climate issue, and interstate commerce considerations, INGAA – which represents companies with linear, interstate pipeline assets – strongly prefers a consistent national greenhouse gas (GHG) reduction program over competing, potentially conflicting and inefficient state and regional initiatives currently taking form.
• INGAA urges lawmakers to design a program that will slow, stop, and then reduce GHG emissions gradually.  This would allow time for the economy to develop and deploy efficient, cost-effective climate change mitigation technologies and replace capital intensive energy infrastructure and equipment in an orderly manner.
• CO2 from fossil fuel combustion accounts for approximately 81 percent of total U.S. GHG emissions.  INGAA advocates, as a starting point, the regulation of CO2 from fossil fuels at the point of combustion.  The reduction of emissions from other greenhouse gases should be managed through an offset program.  Other sectors and gases could be brought into the program as it matures.
• The need for a safety valve will be determined by the key program design features, most notably timing, targets, banking and borrowing of allowances and the availability of low-cost offsets.
• Congress should determine the need and basis for allowance allocation in a cap and trade program.  INGAA supports 100 percent free allocation to sectors that are subject to comprehensive economic regulation.  Still, if such regulated sectors must pay for allowances, they also must have a guaranteed ability to pass through costs to the end user (consumer).
• Offsets are an important tool to encourage emission reductions not otherwise covered under a conventional cap and trade system.  Such reductions would provide immediate, low-cost options that would help control program compliance costs.  There should be no limit to the amount of offsets one can generate so long as they are real, quantified, verified, surplus, and have clear ownership.
• Early reduction credits should be available to industries, like the natural gas pipeline industry, that have already made significant GHG reductions.
• The U.S. can promote international participation in GHG reductions by taking a leadership role in the development of an efficient, achievable and cost-effective GHG reduction program.  U.S. innovation and the development of advanced technologies will not only contribute to global emissions reduction but will also help to create business opportunities for U.S. firms.
• A cap-and-trade program alone will not lead to new technology development.  Funds raised through a regulatory GHG program should support R&D for a variety of new and advanced technologies to provide low carbon energy services, increase efficiency of end-use consumption and sequester CO2.  Such a program should not pick winners based on current expectations but should fund the development of all feasible approaches to low carbon infrastructure, including: natural gas supply and production technologies, efficient natural gas-fired electric generation, mechanical drive and gas compression technologies, and efficient end-use gas technologies.

Based on this position statement and many others from industrial groups, most potentially regulated industries appear to favor carbon trading or the ability to offset emissions using greenhouse gas emission reductions accomplished other facilities.   It is thus not surprising that almost all bills filed in Congress and the programs developed at the state level have largely included a cap-and-trade system.

One of the key issues in this system, as identified by the INGAA, is the allocation scheme.  The INGAA favors a free allocation of the credits to regulated industries.  Unfortunately, some of the states in the northeast that are part of the Regional Greenhouse Gas Initiative are planning a 100 percent auction.  This may create a significant initial burden on the regulated industry, and detract from the carbon market.  Companies that have already paid for their allocations, may be less likely to invest in emission reductions to sell credits or offsets that would be created if they fall below their allocation of emission rights.

These and other issues will be hashed out in Congress, assuming legislation is ultimately adopted.  Care should be taken in working out the regulatory and economic impact of the various aspects of a cap and trade program.

China's Official Position on Climate Change and the Kyoto Protocol

As many of us wonder what will happen in the international negotiations to establish a post-Kyoto Protocol agreement, China looms as a central part of the negotiations as China edges out the United States as the leading greenhouse gas emitter.  To understand China's current position, I went to the source:  China's National Climate Change Programme.  This document has some interesting insights into the positions of the Chinese government.  Here are some of the more salient points.

On the Kyoto Protocol

Climate change, the impacts of which have been felt all over the world, was mainly caused by the massive emissions of CO2 and other greenhouse gases originated from developed countries since industrial revolution. Broad international cooperation is necessary to address climate change. In order to effectively address climate change and implement this national programme, China is ready to strengthen international cooperation with all countries. Meanwhile, China would like to appeal to the developed countries to sincerely fulfill their commitments under the Convention to provide financial assistance and transfer technology to developing countries so as to enhance their capacity to address climate change.

On Mitigation of Greenhouse Gas Emissions

Mitigating greenhouse gas emissions is one of the important components in addressing climate change. According to the principle of “common but differentiated responsibilities” of the UNFCCC, the Parties included in Annex I to the Convention should take the lead in reducing greenhouse gas emissions. For developing countries with less historical emission and current low per capita emission, their priority is to achieve sustainable development. As a developing country, China will stick to its sustainable development strategy and take such measures as energy efficiency improvement, energy conservation, development of renewable energy, ecological preservation and construction, as well as large-scale tree planting and afforestation, to control its greenhouse gas emissions and make further contribution to the protection of global climate system.

On Technology Cooperation and Transfer

technology cooperation and transfer should be strengthened to share the benefit of technological development worldwide. Measures in this regard should include the following: establishing an effective technology cooperation mechanism to promote R&D, deployment and transfer of technology of addressing climate change; eliminating obstacles to technology cooperation and transfer in terms of policy, institution, procedures, financial resources and protection of intellectual property rights; initiating incentive measures for technology cooperation and transfer to ensure its occurrence in reality; establishing a special fund for international technology cooperation so that environment-and-climate-friendly technologies are accessible and affordable to developing countries.

Technology will play the central role in addressing climate change. International

Technology need for mitigation of climate change. China is at the stage of large-scale infrastructure construction, and is in urgent need of technology for reducing greenhouse gas emissions. China’s technology need for mitigation of climate change mainly covers advanced energy production and utilization technology, environmental protection and resource comprehensive utilization technology, high-efficiency transportation technology, new material technology, new-style building material technology, etc. Among these needs, the high-efficiency, low-pollution coal-burning power generation technology, large hydropower generation unit technology, new generation nuclear technology, renewable energy technology, building energy conservation technology, clean fuel vehicle technology, hybrid vehicle technology, urban rail-based traffic technology, fuel cell and hydrogen technology, oxygen-rich coal-spray blast furnace & long-life span technology, comprehensive technology for transformation and expansion of medium and small nitrogenous production facilities, new paving material technology, and new-type wall-body material technology are the priorities. Introduction and diffusion of these technologies in China will make significant difference to the country’s efforts to control greenhouse gas emissions.

Thus far, China has not been willing to agree to limits on its greenhouse gas emissions.  Whether international pressure will be sufficient to convince China to agree to caps and then reductions will in part depend on the willingness of the United States to agree to such limits.