Carbon Emissions Trading
Beginning
Louis Redshaw, a 34 year-old former electricity trader, founded carbon emissions trading. In 2004, Redshaw met with five investment bankers to discuss the possibility of trading carbon dioxide as a means to reduce harmful greenhouse gases into the air. Barclays Capital was the only bank interested in his venture. Currently, this market is worth $30 billion and is expected to grow to $1 trillion within the next ten years. Investment banks, such as Goldman Sachs and Morgan Stanley, are starting to expand their carbon business rapidly. Hedge funds and private equity funds in the Mayfair district in London, as well as emerging niche investments banks, are vibrantly pursuing the idea of carbon emissions trading very seriously.
Background on Carbon Dioxide
Carbon dioxide (CO2) emissions are the principal source of global warming. These emissions come from fossil fuels, cement manufacturing, and changes in agriculture and land usage, such as deforestation. The combustion of fossil fuels, including oil, natural gas, and coal, are used to generate 66% of electricity worldwide. In 2007, the world is producing 6% more CO2 than in 1990. Between 1990 and 2003, the United States and Japan increased their CO2 emissions by 20% and 15% respectively. The European Monetary Union (EU) increased their emissions by 3%, which failed to follow their compliance with the Kyoto commitment of an average reduction of 5.2% from 1990 levels by 2012. During this same period, China and India became major emitters by increasing their output by 73% and 88%, respectively. Even though these numbers sound high, they are still small in terms of per-capita in relation to the average usage by Americans.
In the developing world, deforestation and land use change are the key forces increasing their CO2 emissions. For example, Indonesia is the world's third largest emitter after the United States and China. From 1990 to 2005, low income countries lost 45,000 square kilometers of forest and lower middle countries devastated 38,000 square kilometers. In 2007, over 2 billion people in poor countries still use wood fuels as their primary source of energy. To reduce deforestation, a new form of energy must be developed.
Carbon Trading
What exactly is carbon trading? Under the EU scheme, the goal of trading carbon is to reduce the amount of emissions released into the atmosphere. Caps are placed on companies every year to bring about an economic incentive to make the atmosphere cleaner. These caps vary by country and are lowered every year. As the supply decreases and the demand increases, the cost of acquiring more CO2 becomes more expensive. Individual companies can use their extra carbon as they see fit. The extra carbon leftover are called carbon credits. Companies wanting to emit more than their allotted amount of carbon emissions must purchase more carbon from firms that have cut their emissions and have extra carbon credits. If a company has used their allowance and cannot meet their need from another firm, however, they must turn to the market. Industries participating in the emissions trading scheme are power generation, iron, steel, glass, and cement.
The European Union Emission Trading Scheme (or EU ETS) is the largest multi-national, greenhouse gas emissions trading scheme in the world and was created in conjunction with the Kyoto Protocol. It is currently the world's only mandatory carbon trading program.
London the world largest carbon trader
The real question is: Why is London the premier trader in carbon emissions? According to the World Bank in 2006, the city of London is recognized as the leading location for international carbon trading. Not only can London communicate with markets around the world, London handles a great deal of international projects tied to reducing emissions. Banks and brokers are becoming heavily involved due to the growth and profits carbon trading can produce. Even though carbon trading was invented in London, many of the trades to purchase carbon from London are generated from buyers not based in the United Kingdom. London trades more carbon than any other city in the world. Not only does the London financial markets trade carbon allowances, they are also investing in projects that promote the creation of additional credits. Why is carbon emissions trading needed? By reducing the amount of carbon emissions into our environment, the detrimental effects to our climate can be stopped. Carbon Emissions Trading is a viable way to reduce the amount of emissions. Under Kyoto Protocol, developed countries are obligated to reduce the amount of Greenhouse Gases (GHG) being released into the atmosphere. These GHG include carbon dioxide, methane, nitrous oxide, hydro fluorocarbons, and sulfur hexafluoride. The protocol allows the government to put caps on how much CO2 companies are allowed to emit into the air. Between 2008 and 2012, these targets must reduce their emissions by an average of 5.2 percent relative to their 1990 levels.
Currently, the United States and Australia have not joined this endeavor. United Nation-based bodies are responsible for enforcing these commitments. The protocol expects more out of developed nations due to those countries easier ability to pay the cost of cutting emissions and their higher historical contribution of higher emissions than developing countries. To allow for some flexibility in meeting their emission reduction targets, the Protocol developed three different mechanisms: Emissions Trading, Joint Implementation, and the Clean Development Mechanism. These mechanisms allow participants to earn and trade emissions credits that have been created by projects implemented either in other developed countries or within developing countries. Rich countries might be able to reach their goals by creating and funding projects, such as wind farms and solar energy generators, that will help reduce the emissions in poorer countries. These projects would generate carbon credits that can be traded in the international marketplace. China and India are the most popular locations for projects creating carbon credits. In 2006, China took 63 percent of the market share for selling credits, along with India's 12 percent of the credits. By 2012, Europe is required to cut their emissions by 8 percent. By reducing the amount of permits given out, we should see a decrease in CO2 levels being emitted. The Kyoto Protocol expires in 2012, by which time a new international agenda will need to have been ratified to replace this first important step in reducing GHS emissions.
Benefits
Emissions trading can have a positive outcome for both trading companies. If one firm can reduce their emissions enough to have credits, they are allowed to sell their credits to another firm or the market for a second source of income. However, if a firm has used all of their given credits and they need more, they are allowed to purchase either from another firm or the market. Currently, firms are buying from other firms because it is cheaper than purchasing from the market. Companies will soon have to turn to the market instead, however, due to further caps placed on emitting CO2.
Has trading CO2 been successful? The idea behind Europe's trading scheme has been hailed as a positive step in saving the atmosphere. This scheme is an effort to tackle human-induced climate change. Germany truly believes in this project and has agreed to reduce its emissions by 21 percent below that of 1990 levels between the given timeframe. To date, Germany has already reduced their emissions by 19 percent. However, issues have arisen as a result of this agreement. The European Monetary Union (EU) has handed out too many free allowances, which resulted in less than optimal results. With an over allocation fueled by volatility, larger than expected profits were realized. With the United States being one world's largest producers of GHG, the EU is still trying to convince America to join the effort. Australia fears this protocol might hurt their economies.
Carbon emissions are bound to become the world's biggest market. Currently, humans generate 38 billions tons of CO2 annually. The government regulates only a small amount of these emissions. At its current price of $3.50/ton, the potential carbon market is worth $133 billion. ($3.50 x 38billion). With the arrival of 2008 just occurring, governments will be placing another cap on the amount of credits given. As a result, we hope that there will be a decrease of carbon credits which will make the price skyrocket.
Jumping into Carbon Trading
How can individuals participate in carbon market trading? As demand for carbon credits increases, so does the amount of firms specializing in reducing emissions. This is a bull market and is great to invest in. The downside is that this type of trading is very expensive and can be cost prohibitive for most. The only unadulterated way to invest is to buy Certificates in Emission Reductions (CERs). Large capital firms, such as Climate Change Capital, are the only sources of CERs. The minimum investment is $33.3 million, which is required to break into trading CERs. For those with a smaller pocketbook, individuals can invest in a company that actually owns the carbon exchange like Climate Exchange Plc. An investment made a year ago has increased over 540 percent. Some alternatives are to invest in companies that reduce carbon emissions as part of there business, such as BP, Shell, and ConcoPhillips, or invest in dirty companies (companies that emit a great deal of CO2) that want to reduce that emissions to sell their credits as a second source of income.
Future of Carbon Trading
What happens next? The second phase of the Emissions Trading Scheme has just begun 2008-2012. Commission is expected to have a reduction of 30 percent from 1990 levels by the year 2020. With more stringent targets and a reduction in the number of credits, this market will explode. Just recently, Australia's Prime Minister accepted an invitation to look further into carbon trading, but refused to sign the Kyoto protocol, still fearing it would damage their economies. Only time will tell what will happen to this expanding market, but I suggest the United States participate in this effort to reduce their GHG emissions.
Keeping Updated in Carbon Emissions Trading
Since Carbon Emissions Trading is a relatively new concept worldwide, it is important to keep track of its progress and stay current with new developments and issues surrounding this concept. A recommended website to seek the resources needed to stay updated is Point Carbon. Point Carbon is a world-leading provider of independent news, analysis and consulting services for European and global power, gas and carbon markets.
Point Carbon's comprehensive services provide professionals with market-moving information through monitoring fundamental information, key market players and business and policy developments. Point Carbon's in-depth knowledge of power, gas and CO2 emissions market dynamics positions us as the number one supplier of unrivalled market intelligence of these markets. Their staff includes experts in international and regional climate policy, mathematical and economic modeling, forecasting methodologies, risk management and market reporting. Point Carbon now has more that 15,000 clients, including the world's major energy companies, financial institutions, organizations and governments, in over 150 countries. Reports are translated from English into Japanese, Chinese, Portuguese, Polish, French, Spanish and Russian.
Follow this link to stay updated on Carbon Emissions Trading: http://www.pointcarbon.com/About%20us/category371.html