The recent floods and forest fires are a result of global warming forcing climates to change. Yet people continue to emit polluting gases. Carbon trading may be one solution to the problem. This article looks at the complexity of carbon trading.
ON 11 January 2011, the European Commission (EC) suspended trading in carbon credits after hackers allegedly compromised the accounts of Czech traders and siphoned off around US$38 million. This followed another attack in July 2010 when anti-carbon trading activists shut down the Web site of the European Climate Exchange (ECX), by replacing the home page with a spoof lampooning the industry. According to their spokesperson, the attack was an attempt to try to raise awareness about “carbon trading as a dangerous false solution to the climate crisis.”
In Singapore there are online sites dedicated to personal carbon footprint, as well as theoretically, two carbon credit trading exchanges (ACX and Singapore Mercantile Exchange), and yet on the countless occasions I’ve brought the subject up during conversations, I was greeted mainly with either glazed looks or uncertain nodding. Even with a postgraduate science degree, it took me a while to figure it all out, and see where this trend was going. So what makes this specific trading platform so susceptible to raised passions, and financial fraud, and yet appear to be under the average person’s radar? What is carbon credits trading and does it have any relevance to the average business in Asia?
To begin, carbon is an essential element that living things on the planet breathe out as carbon dioxide. The gas is also emitted by companies burning fossil fuels (coal, natural gas, petroleum) into the atmosphere. These companies usually are from industries such as cement, fertilisers, steel, and chemicals. They also emit other gases such as methane, nitrous oxide, and refrigerants that together with carbon dioxide are termed greenhouse gases which speed climate change and global warming much faster than any natural process.
Despite initial scepticism, partly fueled by energy companies funding anti-global warming lobbyists, it is commonly agreed that this is a problem for future generations. Now, not only is there a proliferation of online campaigns encouraging us to be mindful of daily actions that increase carbon emissions, suddenly everyone is talking about low carbon footprints, sustainability of existing resources, and getting “dirty” industries to clean up their act.
While this sounds great, it is an uphill task to get entire industries to change their processes, or eliminate some production. It can’t happen overnight. Global commerce would be affected and many goods that are considered essential could not be manufactured. You could argue that the world would be better off consuming less, but the interests of industries are intertwined with governments and multinational corporations with powerful lobbyists. This makes it very complicated, particularly when jobs are affected.
Kyoto Protocol The Kyoto Protocol in 1997 first addressed the fight against global warming and the reduction of greenhouse gases. Up to 2010, 192 countries had signed the Protocol (not the United States) aimed at reducing greenhouse gases. Most European countries, Australia, and New Zealand, have specific obligations to reduce emissions. This, however excludes fast growing economies like China, South Africa, India, and Brazil, nor any Association of Southeast Asian Nations members, including Singapore. Those who have obligations are called Annex I countries.
The poor response from governments points to political agendas to alleviate poverty and increase living standards. Reducing greenhouse gases inevitably increases the cost of doing business, which will impact on the flow of global business. Still China faced with the growing pollution, is expected to become a leader in green technologies over the next 10 years.
Asean countries contributed approximately 3.8 per cent of global carbon dioxide emissions. This figure is expected to rise due to emerging economies like Vietnam.
Trading through Flexibility Mechanisms
So where does the money to make the Earth a greener place come in? Within the Protocol there is provision for “flexibility mechanisms” that encourage emissions trading through international financial exchanges (IET), as well as the much criticised Clean Development Mechanisms (CDM) and Joint Initiatives (JI), aimed at reducing emissions. These are typically large scale projects focusing on destroying hydrofluorocarbons (HFC) found in refrigerant gas.
Other examples include the Delhi Metro, registered by the United Nations as a claimer of carbon credits (Times of India, 5 Jan 2008). In Singapore, the National Environmental Agency has made provisions for a S$100,000 grant for approved CDM projects, and the tax incentives accommodate carbon trading. The take-up rate so far has not been high.
The World Bank estimated that the carbon market, where carbon dioxide can be traded as a form of spot and futures market, jumped from just under US$11 billion in 2005 to almost US$65 billion in 2007, based on a four-fold increase in carbon dioxide production over the same period, and is predicted to grow to over one trillion Euros by 2020. (Source: speech by Chan Lai Fung, Permanent Secretary Finance-Performance, Ministry of Finance, 2010). Until very recently, it was seen as a credible and profitable alternative to traditional financial trading platforms. In 2010, there were 30 emission trading companies in Singapore, including Tricrona and Gazprom (natural gas).
How Carbon Credits Work There are two terms to describe carbon credits: A) carbon credits used in international trading, and B) carbon offsets in voluntary schemes.
Carbon credits are defined as “a certificate showing that a government or company has paid to have a certain amount of carbon dioxide removed from the environment”. It is usually traded as one certificate giving the right to emit one tonne of carbon dioxide equivalent.
Capped greenhouse gas emissions are then allocated to regulated trading markets, allowing market forces to drive industrial and commercial processes towards delivering lower carbon dioxide emissions. Each project generates credits, which can then be used to finance carbon reduction schemes between trading partners.
Carbon offsets have two markets—compliance and voluntary. Compliant companies, governments, or other entities buy carbon offsets to comply with caps on the total carbon dioxide they are allowed to emit. In 2006, US$5.5 billion of carbon offsets equivalent to a reduction of 1.6 billion tonnes of carbon dioxide were purchased in the compliance market (World Bank, 2007).
In the voluntary market, anyone can purchase carbon offsets to lower their own greenhouse gas emissions from transportation, electricity use, and other sources. For example, some local Web sites are certified as green by a carbon neutral Web hosting company. Or an individual might purchase carbon offsets to compensate for the greenhouse gas emissions caused by personal air travel. Qantas offers each customer this option every time they purchase an airline ticket. In the past I have declined the option, thinking that it was another way for the airline to make more money from me, and not a genuine attempt by them to reduce their carbon dioxide emissions.
In 2008, about US$705 million of carbon offsets were purchased in the voluntary market, representing 123.4 million metric tonnes of carbon dioxide reductions, (Ecosystem Marketplace, New Energy Finance State of the Voluntary Carbon Markets, 2009). Offsets are commonly used to support projects that reduce the emission of greenhouse gases in the short- or long-term, for example, renewable energy such as wind farms. Others include energy efficiency projects, the destruction of HFCs, or agricultural by-products, destruction of landfill methane, and forestry projects (UNEP, 2009). Methane is considered to be 23 times more potent than carbon dioxide as a global warming mechanism, so projects to destroy or convert methane are considered to be particularly invaluable.
There is an attempt to price carbon like any other trade or commodity. The current pricing schemes are bought and sold mainly through six climate exchanges, where spot, futures, and options markets are available. The exchanges are the Chicago Climate Exchange, European Climate Exchange, NASDAQ OMX Commodities Europe, PowerNext, Commodity Exchange Bratislava, and the European Energy Exchange.
A few years ago, some financial analysts predicted that carbon could become the world’s largest commodity market and the biggest overall market. In 2007, City of London finance houses were transacting the equivalent of 30 billion Euros, rising globally in 2009 to approximately 110 billion Euros.
Let’s see how this would make sense to a company that is involved in the production of carbon dioxide, and therefore liable to purchase carbon credits. This is not a real example.
A factory in Germany emits annually 50,000 tonnes of carbon dioxide. As its government is a signatory country, the law states that no business can produce more than 30,000 tonnes. So the factory either reduces its emissions to 30,000 tonnes or has to purchase carbon credits to offset the excess. A cost-benefit analysis indicates that it is more economical to buy carbon credits on the open market rather than invest in new machinery that year. So it is basically paying to delay introducing more efficient systems. You could also argue this is a form of taxation based on the polluter pays principle.
But a similar factory in a non-signatory country has no obligation to either delay the purchase of new machinery or buy carbon credits.
The Kyoto Protocol has made it a reality for a company to purchase lower emission equipment and offer carbon credits to other companies that require them. In theory, anyone could set up a fund of carbon positive initiatives (helping reduce carbon dioxide emissions) and offer them through the exchanges to companies who require the carbon credits.
The 2008 economic crisis has forced many governments to prioritise their economic concerns to other areas. The outlook for some exchanges turned bleaker after the 2009 United Nations Climate Change Conference in Copenhagen showed that governments would not provide a new direction or stimulus to the market. Since then, the Australia Climate Exchange has closed down, and the Chicago Climate Exchange was reported to have laid off half its staff. Over the past two years, the pace of expansion in this specific market has slowed down, though the overall size of the carbon trading market is still growing.
Other players are coming in with different business models, and it is anticipated that this particular market will either adapt and grow, or evolve into something else. Ultimately, carbon dioxide emissions remain one of the most serious long term issues for the people on this planet. It is probably too late to halt some of the effects that our future generations will experience, including changing weather patterns, rising oceans, coral bleaching, and damaged crops.
Still, carbon trading seems most likely to survive the current “blip” and probably see more convergence between the established players. The building of eco centres, such as Abu Dhabi’s carbon neutral Masdar City, point to many investors still banking on this to be of long term potential for very big returns.
In Singapore, both the Asian Carbon Exchange (ACX) and the Singapore Mercantile Exchange have yet to produce any significant carbon trades. In August 2010, ACX traded only 250,000 carbon credits with a market value of 2.1 million Euros. The Mercantile Exchange is still evaluating the situation. For carbon trading to make any significant impact, Singapore must decide whether it should be a signatory and obliged therefore to work with agreed binding emissions reductions, or remain a non-signatory country albeit aggressively encouraging carbon reduction projects. Either way, the direction has to be set by the government and will determine its role in helping to make the world a cleaner place for future generations.