Trading places: the global carbon market

Q. The European Union Emissions Trading Scheme (ETS) was the first international emissions trading scheme to be established following the Kyoto Protocol on Climate Change. As it enters its second phase, how is it regarded?

A. It’s the biggest market and is quite an achievement. It covers 12,000 installations – everything from the big energy companies to big dairies, to ceramic factories and textiles – in 27 countries.

There have been mistakes, though. In the first stage of being set up prices crashed to zero because too many allowances were issued for free and this wasn’t picked up until half way through the second year.

In this second phase of the scheme (ETS) there are still some problems and so the European Commission and other EU institutions are working on making it more effective in order to increase the demand for carbon credits. The higher the demand, the more you ensure there is a robust price.

In the next phase of the ETS – 2013 to 2020 – emissions reduction targets have been set much higher, capped at 21 per cent below 2005 levels. In the first phase, there was no reduction and in this one only a small reduction.

Heavy carbon emitters are under no obligation to reduce their emissions so long as they have enough carbon allowances to offset their emissions; one carbon allowance is worth one tonne of CO2, so if an installation is emitting 100 tonnes of CO2 and its got to cap it at 80 then it can buy another 20 or cut its emissions to 80.

Companies can also import allowances from outside the EU – say, from a wind farm in China – but there is a quota on importing credits into the EU and that will much reduced in the next phase.

The idea is to encourage more companies to hold onto their credits and try and sell them in the next phase when it is expected prices will be much higher – upwards of €40 (£38) a unit.

Q. What is the carbon market, how big is it in how is it expected to grow in the future?

A. The carbon market is really a combination of different market segments, the EU ETS being the largest single market. Within the EU, governments can issue in total two billion allowances a year.

In the first half of this year, the global carbon market generated €38 billion (£36 billion), almost as much as did throughout the whole of 2007.

Trades within the EU ETS alone generated €30 billion (£28 billion) over the first six months of 2008, up 161 per cent on the first half of 2007.

Several new markets and market segments have been introduced, including the Greenhouse Gas Initiative in the US, the trading scheme in Alberta, Canada, and the upcoming Australian Emissions Trading Scheme.

With the introduction of a greenhouse gas cap and trade scheme in the US, the global carbon markets could be worth almost €2 trillion (£1.9 trillion) by 2020.

Q. What effect is the global economic downturn having on the carbon markets?

A. The price of emissions respond to other things such as the price of oil, but carbon prices are dropping and one of things that people are expecting is that the economic slowdown will mean fewer emissions.

Q. The UK Government recently conducted the first carbon allowance auction of Phase Two of the EU ETS. What was the significance of the auction within the UK carbon market, the ETS and the global carbon markets?

A. The real significance of the auction this time around is it is the first big allowance auction of this phase of the EU ETS scheme and this time around Governments can auction up to 10 per cent of their allowances – it sets the theme for many more auctions to come.

What the UK Government wanted to show is that it works and that it is the best way to allocate emissions, rather than giving them away for free.

In the wider context, it is interesting because the auction came just after Barack Obama became president-elect. He has specified that under his presidency there would be a US ETS and it would use auctioning.

Meanwhile, under the regional Greenhouse Gas Initiative, where a dozen US states are applying the same rules at the same time, the decision has be made to use the auctioning method.


Q. What other methods, other than auctioning, can governments use to pass on these allowances?

A. Up to 12 per cent of allowances must be sold by governments and then the rest must be given away free. Germany, for example, this year decided to sell some allowances while it was setting up its rules for auctioning. It just placed them in market and instructed a state-owned bank to sell them anonymously.

Q. Was the UK auction the first under the EU ETS scheme and did it deliver?

A. There were four held in the first phase of the scheme – by Ireland, Lithuania, Denmark and Hungary – but they weren’t considered very important.

The UK auction seemed to work very well, with minor disruption to market; the markets went a bit quiet before hand, but it provided a strong price signal for the wider carbon allowances market.

The auction raised just under €16 (£15) a unit, less than the €23 (£22) sold per unit in the German sale. However, the German intention was to raise as much revenue as possible, while the UK was trying to demonstrate a political point – that the allowances were being sold at market price and not for free.

Q. Why did the UK not want to give them away for free?

A. The big power companies that need the allowances under the cap and trade scheme operating in Europe have been accused of making windfall profits by passing on the cost of carbon to their users, even though the allowances they use are mostly given away for free. Around 90 per cent of allowances are given away free to heavy industry.

Q. Who can trade on the carbon markets?

A. It tends to be power companies, but anyone can buy stocks in London Stock Exchange-listed companies and you can buy carbon credits themselves. 10,000 credits is the smallest standard transaction under the EU ETS scheme, which is not too different from other commodities.

You have to buy through one of the intermediaries and if they acted on your behalf you would have to prove credit worthiness.

Q. Should all carbon-emitting companies eventually be regulated by carbon emissions trading schemes or should a voluntary system lead?

A. For the time being voluntary will lead, but with increasing pressure from investors and the carbon disclosure programme, you can see that more and more companies, particularly the top 100 companies, are having to look at ways to reduce their carbon emissions through pressure from investors rather than government.

Related Content
Carbon Trading News
Emissions Trading Scheme

Related Sites:
www.pointcarbon.com