Come December, every bureaucrat of consequence from pretty much every country will converge on Copenhagen, Denmark, to thrash out a new climate change agreement. These discussions have important consequences on carbon markets and how countries trade and sell their emissions.
Ram Babu, managing director, Asia, CantorCO2e
At the heart of carbon markets is the Kyoto Protocol, an international agreement that aims to limit emissions of greenhouse gas, or GHGs (mainly carbon dioxide emitted during electric power generation, and methane, produced when bio-matter degrades in conditions with insufficient oxygen), to prevent global warming and climate change. This requires developed nations to bring down their emissions by around 5% from their 1990 levels and report the same to the United Nations (UN), during 2008-12. The nations—and these are largely developed European countries—that have committed to reduce GHG emissions till 2012 have expressed their intent to continue the same beyond 2012 also, but how and in what manner will be discussed at the December global meet in Copenhagen.
Developed countries that have committed to reduce emissions of GHGs can achieve reductions in their own countries, or invest in projects in developing countries that can ensure such emission reductions. They are allowed to procure these emission reductions from developing countries to meet their targets under a mechanism called the Clean Development Mechanism, or CDM.
There is a wide disparity in the costs of reducing emissions across nations and sectors. It is this price difference that needs to be harnessed through carbon market mechanisms to achieve targeted emission reductions at the lowest possible costs. While it could cost only $1 (around Rs50) to reduce 1 tonne of carbon dioxide in Indonesia or Mexico or India, it would cost at least $50 in Japan or the UK.
The Kyoto Protocol has been in effect since 2006 and the European Union (EU) has taken significant initiatives to meet Kyoto commitments that have, subsequently, catalyzed trade in emission reductions under a scheme called the EU Emission Trading Scheme, or EU-ETS. This scheme allocates EU emission allowances (EUA) to local companies based on their history and technology.
At the end of each year during 2008-12, all companies covered under the EU-ETS have to submit audited emission inventories of their facilities and offset them with their EUAs or Certified Emission Reductions, or CERs, which are generated from CDM projects undertaken in developing countries.
If the annual emissions exceed the allotted EUAs, then they have to buy EUAs from companies that have excess credits, or pay a penalty of €100 (around Rs6,500) per tonne of emission reduction. This mechanism, and its operation since 2005, has created a liquid market for carbon credits (EUAs, CERs, etc.) and the associated infrastructure of exchanges, broking houses, traders, investors and project developers.
Though a lot is talked and written about this innovative and “highly romantic” market, it is actually quite inefficient and highly volatile. The demand and supply (both in the short and the long run) are quite uncertain.
Moreover, the demand and supply is fundamentally politically determined and regulatory bottlenecks may potentially destroy both. Worse, the supply and its marginal costs are also not known.
The first few years of the market surprised everybody, by bringing to the table very low-cost emission reductions from incineration of HFC 23 (hydrofluorocarbons) gases—a greenhouse gas several times more threatening than carbon dioxide—in the refrigerant industry.
The experiences of the last five years have brought out many hidden, unanticipated opportunities of emission reductions, raising the hope that developed countries can take deeper and wider commitments and, more importantly, do so at reasonable costs.
Apart from being supported by better research and information, this rapidly evolving market needs improved coordination from politicians and from different organizational processes that certify commodity and compliance requirements.
And there’s an unexpected recession to deal with. Point Carbon, a leading analyst organization, says, “The economic downturn is hitting carbon project investments and credit purchases. Falling emissions in the EU-ETS produce more companies with surplus, fewer with deficits—price expectations are down for 2010, but remain strong for 2020.” Similarly, Deutsche Bank’s market update of January this year revises its earlier estimates of credit prices from €30 to less than €10 for this year.
Ram Babu is managing director, Asia, CantorCO2e, an advisory firm for environment and energy services. Respond to this column at firstname.lastname@example.org