Carbon futures

10 July 2008

The primary and presidential election process in the United States may be long and arduous but one thing is for sure: the next American president will be in favour of emissions trading, writes Stephen Gardner. All the potential next incumbents supported Lieberman-Warner, otherwise known as America's Climate Security Act. This draft bill was blocked in the Senate in June, but is likely to be back in one form or another. Lieberman-Warner would have capped US greenhouse gas emissions at around 30 percent of their current level by 2050. An emissions trading scheme will be at the centre of the reduction effort. Republican presidential candidate John McCain has been the strongest endorser of Lieberman-Warner. In October 2007, he said he was “bittely disappointed” by US inaction on climate change so far. “The Europeans implemented a cap and trade system; they stumbled and had their problems but it is still the right thing to do,” he said. Peter Liese, a German centre-right member of the European Parliament, says a US scheme, which could be up and running by 2012-13, is crucial both for the establishment of cap and trade worldwide, and for a global agreement on greenhouse gas reduction targets after 2012 when the Kyoto Protocol expires. The US coming on board will be “a very important signal for all other countries; nobody will have an excuse any more,” says Liese, who is in charge of steering through the parliament European Union legislation on including aviation in emissions trading. A rolling bandwagon In fact, a cap and trade programme is becoming a must-have for every industrialised country. New Zealand is launching a scheme; Japan has been persuaded of cap and trade's virtues; Swiss and Norwegian programmes are underway. In Australia, prime minister Kevin Rudd immediately ratified the Kyoto Protocol on taking office in December 2007 and has a plan to start an emissions trading system (ETS) in 2010. Rudd has called climate change “the great moral and economic challenge of our age.” Cap and trade is gaining ground not only because it is seen as the least painful and most politically acceptable way of reducing greenhouse gas output, but because it has been successful – at least in terms of creating value. The World Bank's latest State and trends of the carbon market report, published May 7, shows that the global carbon market more than doubled in value in 2007 compared to 2006. Trading in carbon credits added up to a “whopping” US$ 64 billion, according to the report. The world's largest cap and trade scheme, the EU ETS, accounted for US$ 50 billion. Andrew Humphrey, an emissions trading analyst at Morgan Stanley, says the success of the model in creating a viable commodity market means it is supported by the financial sector. “A lot of big banks invest in the sector either by employing people on trading desks or by taking stakes in specialist companies,” he says. “Most of the [banks'] investments are long term and strategic.” Sara Stahl of the European Climate Exchange, the main EU ETS trading platform, says the market is ready for more. “The market would love it if it grows in scope and regional coverage,” she says. A post-Kyoto emissions cutting agreement with a global cap and trade mechanism at its core is “the only thing the market is waiting for.” Pressure for emissions trading So with momentum building up, what might a future worldwide cap and trade system look like? Clues were given at the European Parliament in late March when Rajendra Pachauri, head of the United Nations Intergovernmental Panel on Climate Change, said negotiations to find a successor to the Kyoto Protocol could result in either a global carbon pricing scheme, or a framework agreement that leaves countries free to decide the details of their own carbon pricing systems. The world's policymakers hope to finalise a deal in Copenhagen, Denmark, at the end of 2009. This “may leave details to be worked out,” Pachauri said, but there should be “a definite agreement on placing a price on carbon,” with “coordinated action” to ensure the scope for disputes between countries is reduced. Conceivably, some countries may choose to levy carbon taxes. But the momentum is behind cap and trade, with the likely emergence of a series of linkable schemes across developed countries. Avril Doyle, an MEP from Ireland's Fine Gael party who is overseeing the European Parliament's response to European Commission proposals to revise the EU ETS, said at a parliamentary session May 7 that different countries' legislation “must dock together. The principles [of different schemes] must support one another.” The result may resemble a beefed-up EU ETS. An overall carbon cap will be fixed, but individual countries will be left to decide how to share out the allowances they are given. National registries, which record allocations made to scheme participants such as industrial plants or power stations, will connect to a central registry, as presently happens in the EU with the Community Transaction Log. The carbon price will be determined by demand for allowances, which will in turn be determined by the cap. This must be sufficiently tight. A carbon price that is too low will not incentivise companies to make the emissions-cutting investments the world needs. Setting up a global system may therefore not be unnecessarily complex. Carbon markets are commodity exchanges, with the commodity in question being permits to emit one ton of carbon dioxide or carbon dioxide equivalent. A pilot infrastructure is in place, with functioning carbon exchanges in Europe and the US (in the US case, the voluntary Chicago Climate Exchange). Certainly, there have been teething problems. The EU has seen late establishment of national registries and delays in finalising allocations of allowances to individual market participants. But overall a nascent system is functioning. Crucially, a way of bringing the developing world into global cap and trade already exists. This is the UN Clean Development Mechanism (CDM), which allows emerging countries to earn tradeable Certified Emissions Reductions (CERs) from carbon-cutting projects funded by the industrialised world. Projects deal with issues such as energy efficiency, building renewable energy capacity, and reforestation and avoided deforestation. There are currently more than 1000 projects in 49 countries, says David Abbass of the CDM. The infrastructure for trading in CERs includes a registry and an International Transaction Log (ITL), which brokers are starting to connect to. Plans are also afoot to link the ITL with the EU ETS, though this has been delayed. Countries buy CERs to offset their Kyoto obligations. Private companies also purchase the permits. EasyJet and SAS Airlines, which then sell the CERs onto customers who wish to make their travel carbon neutral, are two examples, says Abbass. According to a Morgan Stanley report on the emerging cap and trade market published in December 2007, developing countries are gaining crucial emissions trading experience because of the CDM. Russia and China are two major emerging economies “developing the infrastructure for emissions trading through participation,” the report said. Some way to go But although an infrastructure is emerging, there is some way to go before a “real, proper market” is in place, says Morgan Stanley's Andrew Humphrey, one of the December 2007 report's authors. This is even the case for the EU ETS, the world's largest cap and trade scheme. As the Morgan Stanley analysis notes, “most of the current trade in emissions is based on short-term compliance requirements rather than the recognition of a long-term shift to a carbon-constrained environment.” The market “needs real demand,” says Humphrey. A tight emissions cap will force market participants to make strategic decisions: whether to invest in carbon-cutting technology, or to take positions on the market to offset the pollution they pump out. When this happens, money will start to flow and a real, liquid market will emerge. Global agreement at Copenhagen on tough greenhouse gas reduction targets will be the key. Agreement will also be needed on standards, in particular to regulate emission reduction credits. In addition to Kyoto mechanisms such as the CDM, a voluntary offset market has emerged in the last few years. But this is “not yet a robust mechanism for actually creating emissions cuts,” says Tejas Ewing, author of the Guide to Carbon Offsets 2008. Instead offsets are a “mish-mash of systems and standards,” says Ewing. The credits traded on the world's largest offsets market, the Chicago Climate Exchange (CCX), lack transparency and have high risks associated with their measurability and verification, he says. CCX credits are generated by a variety of projects including methane trapping, restoration of carbon-rich soils, and renewable energy. For the credits “to get to the level where they would be acceptable for a global programme would take at least five years,” Ewing says. Evolution not revolution Emergence of a global cap and trade system will thus be an evolutionary process rather than a big bang. But regulators are convinced by the arguments in favour of carbon trading, while companies on the whole prefer it to direct pollution taxes or other more heavy-handed ways of forcing emissions down. The Association of European Airlines, for example, supports including aviation in the EU ETS, though it calls for a rather generous cap of 110 percent of baseline emissions. Furthermore, for those at the heart of the debate, the prospects of gaining worldwide agreement at Copenhagen are improving, with barriers gradually being cleared out of the way. German MEP Peter Liese says the main obstacle has been US opposition but “the major problem will no longer exist when a new president is in power.” Sara Stahl of the European Climate Exchange says although it is too early to say if it will be possible to have a “truly global carbon price,” politicians will increasingly come under pressure to deliver emission reductions because of worsening climate change. It is, she says, “hard for western governments to argue against that.” A version of this article originally appeared in Ethical Corporation.

 

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