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Carbon emission trading is not only catching up, but also reducing after-affects of trade

The ever growing concerns among environmentalists and policy makers to curtail pollution along with keeping the economies growing, have given birth to the concept of emission trading. With the world getting more and more business-like, day by day, this carbon emission trading makes more sense than other similar measures.

Clubbed with this, increasing acceptance by countries of Kyoto Protocol and growing social responsibility, this trading scheme is most likely to take shape of a multibillion-dollar industry.

This system entails the member, company or country, to meet their carbon emission targets. The members are actually countries (as in the case of the Kyoto Protocol), or companies (as in the case of a domestic trading system). The countries or companies have to buy units (credits) in order to emit pollutants above their set targets, or even may sell units if they emit pollutants below their set targets. The Clean Development Mechanism (CDM) under the Kyoto Protocol allows industries in developing countries to create emission credits (units).

In simple words, carbon credits are nothing but an equivalent to one tonne of carbon dioxide or its equivalent Greenhouse Gas (GHG). A limit is prescribed to the amount of greenhouse gases a firm can let out in the atmosphere.

The carbon credits are “Entitlement Certificates” issued by the United Nations Framework Convention on Climate Change (UNFCCC) to the implementers of the approved CDM projects. These credits/units can be marketed at both domestic and international level. Under a typical emissions trading scheme, industries are issued an allowance for emissions up to a mandated cap. If the industry uses only a partial allowance, the rest can be sold to other industries.

The initial allocation or the capping is based on traditional provision where the capping or emitting provision is decided on basis of its trend of emissions. Moreover, the national budget for environment is left to be spent on environmental activities and further can be invested to earn credits by reducing the national pollution level. The emission trading can fructify to best results when, a safety valve is applied to it. This system has an emission cap, with tradeable permit but the maximum (or minimum) trading price is fixed. Thus, the emitters Inc. is left with choice of either trading their credits/units in the market or purchasing them from the government without charging prices beyond the permissible limits (safety valve). Consider this: According to the World Bank’s Carbon Finance Unit, 374 million metric tonnes of carbon dioxide equivalent were exchanged through projects in 2005, a 240% increase, relative to 2004. What’s more, the size of this market is estimated to be anything between $40 billion and $100 billion by 2010.

The current size of the emissions-related trading market is small globally but it is expanding by leaps and bounds. As per reports by the World Bank (May 2006), the emission trading market is worth about $30 billion for 2006, but the market size is growing exponentially.

The EU-ETS (European Union-Emission Trading Scheme) is a trading scheme using the cap and trading scheme, the UK’s Climate Change Levy is a price system using a direct carbon tax and China uses the CO2 market price for funding of its Clean Development Mechanism projects with the safety valve clause.

In order to check increasing local levels of pollutants, the EU have their greenhouse gases scheme in place, the US has established their own national market schemes to reduce Acid Rains and several other regional markets schemes to check emission of Nitrous Oxide. Nevertheless, the trading market for emissions is still ruled by the hazardous Carbon Dioxide. But then the existing emission trading market also addresses the problems and pollutions dealing (with local problems) with smog, Sulfur Dioxide and Nitrogen Oxides. The success of these localised policies shows that few customised local schemes should be in place to check the pollutants unique to a particular locality.

Even the Chinese environmentalist officials had started many such trading schemes and had seen noteworthy success and have also initiated several other emission trading test projects. Learning from their counterparts, Hong Kong Government had also started many a pilot emission trading tools which aim to reduce amount of Sulfur Dioxide and other pollutants. This will not only reduce concentration of pollution over China & Hong Kong but also over whole of Asia and the world. The future of this trading system is very promising as the whole of Asia (especially the developing countries) is largely facing global pressure to reduce such emissions.

With CDM being the part of Kyoto Protocol, the Chinese companies are making big bucks (61% market share in an emission trading) from it. They are actually selling their credits (called Certified Emission Reductions) to companies in rich economies, who whole-heartedly buy them to fulfill their stringent emission targets. Whereas, Asia as a whole dominates about 80% of the CDM market. India also captures a giant pie, grabbing not less than 12% of the market in 2006, a 3% increase from 2005 figure. It’s no doubt that emission trading has created a large pool of brokers like any other trading system. These brokers range from foreign banks to obscure middlemen.

The whole concept of carbon trading is based on global co-operation, but with developed countries (especially USA) showing reluctance, the whole essence of the scheme seems to lose relevance or go into oblivion. Studies of British industry published by Britain’s Carbon Trust undermine the idea that a carbon price of $30 a tonne would be a huge burden. However, the same Carbon Trust reveals that the ETS can bring about deeper cut-backs in its next phase, without harming competitiveness. The recent rush in carbon credits trading in the EU is an indication of future of this immature trading industry.

Emission trading is any day better than the direct carbon tax regulations. This not only reduces the chance of parallel black market (as in the case of carbon tax) but also is cheaper and politically viable.

India: the future market

India is one of the leading players in the carbon trading industry as it generates a huge amount of carbon credits through CDM. According to industry estimations, the carbon trading would touch a figure of US$ 100 billion by 2010. Presently, no less than 300 projects are registered with CDM while the total issued carbon credits with India stands at 34,101,315.

Moreover, the recent surge in project registration with CDM shows a whole new tappable market. In 2007, about 150 new projects were registered with the UNFCCC. The number of expected annual carbon credits in India is predicted to be about 28 million and with each of these carbon credits being sold at 15 euros.

As per Multi Commodity Exchange of India Ltd. (MCX), industries like agriculture, energy, manufacturing, fuels, mining & mineral, chemicals and afforestation & reforestation are the most viable industries to generate carbon credits. With MCX interested in playing a major role on the emission trading by adding carbon credits to its existing portfolio of commodities, the existing and potential market of carbon credits had increased manifold. This will also help in getting around the price hedging, advance selling and avoiding counterparty risk. MCX also will give the seller a platform for demonstrating their bargaining capabilities.

Sray Agarwal

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Source : IIPM Editorial, 2008

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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