NCRM News: Carbon Credit Trading

World Finance News, September 4th, 2010

Carbon dioxide, the most important greenhouse gas produced by combustion of fuels, has become a cause of global panic as its concentration in the Earth’s atmosphere has been rising alarmingly.  This devil, however, is now turning into a product that helps people, countries, consultants, traders, corporations and even farmers earn billions of rupees. This was an unimaginable trading opportunity not more than a decade ago.

 

What is carbon credit?

GROWING concern about the biosphere and increasing awareness of the need for pollution control have given rise to the concept of `carbon credit’. Carbon credits are a part of international emissiontrading norms. They incentivise companies or countries that emit less carbon. The total annual emissions are capped and the market allocates a monetary value to any shortfall through trading. Businesses can exchange, buy or sell carbon credits in international markets at the prevailing market price.

In Simpler words Companies that are involved in any activity which helps reduce the carbon content of air, such as industries manufacturing energy-saving devices or setting up waste-processing systems, are given `credits’. These can be used by other companies which emit carbon beyond a certain extent to avoid being penalised for the damage they cause to the atmosphere.

 

Historical Background:

Though the concept was suggested by the US in 1997, at the Kyoto Conference, it has only just started gaining momentum in India, especially in the light of large number of windmills functioning in the country. However, the UK and Denmark are far ahead in implementing the trade and are closely followed by Australia, Netherlands and New Zealand.

The `Kyoto Protocol’ was drafted in November 1997 to give a full and final shape to the scheme and to draft a policy framework based on it. The ICC (International Carbon Credit Committee) is now working on this with various governments, businesses, investors and members of the public in Australia, Japan and other countries to investigate the proposed schemes, quantify them and assess their `credibility’.

While the volume of carbon-dioxide emissions by the units can be measured fairly easily, discussions are now going on at different levels with various experts on how to determine the extent of their contribution in reducing or absorbing the carbon content in the atmosphere.

Certainly, once the Kyoto Conference proposals are finalised and given effect, strict obligations on businesses and countries for reduction of carbon dioxide emissions will be enforced and will also result in the establishment of a global carbon-trading market. Once brought into force it will undoubtedly have a direct impact on a country’s forex rates as also its wealth.

 

Who are the key players?

Last year global carbon credit trading was estimated at $5 billion, with India’s contribution at around $1 billion. India is one of the countries that have ‘credits’ for emitting less carbon. India and China have surplus credit to offer to countries that have a deficit.

India has generated some 30 million carbon credits and has roughly another 140 million to push into the world market. Waste disposal units, plantation companies, chemical plants and municipal corporations can sell the carbon credits and make money.

The Kyoto Protocol has created a mechanism under which countries that have been emitting more carbon and other gases (greenhouse gases include ozone, carbon dioxide, methane, nitrous oxide and even water vapour) have voluntarily decided that they will bring down the level of carbon they are emitting to the levels of early 1990s.

Developed countries, mostly European, had said that they will bring down the level in the period from 2008 to 2012. In 2008, these developed countries have decided on different norms to bring down the level of emission fixed for their companies and factories.

A company has two ways to reduce emissions. One, it can reduce the GHG (greenhouse gases) by adopting new technology or improving upon the existing technology to attain the new norms for emission of gases. Or it can tie up with developing nations and help them set up new technology that is eco-friendly, thereby helping developing country or its companies ‘earn’ credits.

India, China and some other Asian countries have the advantage because they are developing countries. Any company, factories or farm owner in India can get linked to United Nations Framework Convention on Climate Change and know the ‘standard’ level of carbon emission allowed for its outfit or activity. The extent to which I am emitting less carbon (as per standard fixed by UNFCCC) I get credited in a developing country. This is called carbon credit.

These credits are bought over by the companies of developed countries — mostly Europeans — because the United States has not signed the Kyoto Protocol.

 

How does it work in real life?

Assume that British Petroleum is running a plant in the United Kingdom. Say, that it is emitting more gases than the accepted norms of the UNFCCC. It can tie up with its own subsidiary in, say, India or China under the Clean Development Mechanism. It can buy the ‘carbon credit’ by making Indian or Chinese plant more eco-savvy with the help of technology transfer. It can tie up with any other company like Indian Oil, or anybody else, in the openmarket.

In December 2008, an audit will be done of their efforts to reduce gases and their actual level of emission. China and India are ensuring that new technologies for energy savings are adopted so that they become entitled for more carbon credits. They are selling their credits to their counterparts in Europe. This is how amarket for carbon credit is created.

Every year European companies are required to meet certain norms, beginning 2008. By 2012, they will achieve the required standard of carbon emission. So, in the coming five years there will be a lot of carbon credit deals.

 

What is Clean Development Mechanism?

Under the CDM you can cut the deal for carbon credit. Under the UNFCCC, charter any company from the developed world can tie up with a company in the developing country that is a signatory to the Kyoto Protocol. These companies in developing countries must adopt newer technologies, emitting lesser gases, and save energy.

Only a portion of the total earnings of carbon credits of the company can be transferred to the company of the developed countries under CDM. There is a fixed quota on buying of credit by companies in Europe.

 

How does the trade take place ?

This entire process was not understood well by many. Those who knew about the possibility of earning profits, adopted new technologies, saved credits and sold it to improve their bottomline.

Many companies did not apply to get credit even though they had new technologies. Some companies used management consultancies to make their plan greener to emit less GHG. These management consultancies then scouted for buyers to sell carbon credits. It was a bilateral deal.

However, the price to sell carbon credits at was not available on a public platform. The price range people were getting used to was about Euro 15 or maybe less per tonne of carbon. Today, one tonne of carbon credit fetches around Euro 22. It is traded on the European Climate Exchange. Therefore, you emit one tonne less and you get Euro 22. Emit less and increase/add to your profit.

The Indian government has not fixed any norms nor has it made it compulsory to reduce carbon emissions to a certain level. Therefore, if the Indian buyer thinks that the current price is low for him he will wait before selling his credits. So, people who are coming to buy from Indians are actually financialinvestors . They are thinking that if the Europeans are unable to meet their target of reducing the emission levels by 2009 or 2010 or 2012, then the demand for the carbon will increase and then they may make more money.

So investors are willing to buy now to sell later. There is a huge requirement of carbon credits in Europe before 2012. Only those Indian companies that meet the UNFCCC norms and take up new technologies will be entitled to sell carbon credits.

There are parameters set and detailed audit is done before you get the entitlement to sell the credit. In India, already 300 to 400 companies have carbon credits after meeting UNFCCC norms. Till recent years these companies were not getting best-suited price. Some were getting Euro 15 and some were getting Euro 18 through bilateral agreements. When the contract expires in December, it is expected that prices will be firm up then.

 

Is this market also good for the small investors?

These carbon credits are with the large manufacturing companies who are adopting UNFCCC norms. Retail investors can come in the market and buy the contract if they think the market of carbon is going to firm up. Like any other asset they can buy these too. It is kept in the form of an electronic certificate.

In the short-term, large investors are likely to come and later we expect banks to get into the market too. This business is a function of money, and someone will have to hold on to these big transactions to sell at the appropriate time.

 

Isn’t it bit dubious to allow polluters in Europe to buy carbon credit and get away with it?

It is incorrect to say that because under UNFCCC the polluters cannot buy 100 per cent of the carbon credits they are required to reduce. Say, out of 100 per cent they have to induce 75 per cent locally by various means in their own country. They can buy only 25 per cent of carbon credits from developing countries.

 

The flip side of the business?

Like in the case of any other asset, its price is determined by a function of demand and supply. Now, norms are known and on that basis European companies will meet the target between December 2008 and 2012. People are wondering how much credit will be available in market at that time. To what extent would norms be met by European companies.

As December gets closer, it is possible that some government might tinker with these norms a little if the targets could not be met. If these norms are changed, prices can go through a correction. But, as of now, there is a very transparent mechanism in which the norms for the next five years have been fixed.

Governments have become signatories to the Kyoto Protocol and they have set the norms to reduce the level of carbon emission. Already companies are on way to meeting their target.Other than this, it’s a question of having correct information. How much will be the demand for carbon credit some years from now? How much will the supply be? It is a safe market because it is a matter of having more information on the extent of demand and supply of carbon credit market.

 

Conclusion:

Despite all the research, carbon credit cannot be a standardised system as it is basically a policy-created commodity. But it would allow for a great deal of policy and project level experimentation over the next few years until the various systems converge on some accepted modalities.

It is expected that it will be the electricity companies, on the one (selling) side, and the cement companies, on the other (purchasing) side, to first explore the market. Some of the companies or projects that could benefit from carbon credits are: Renewable energy; biomass; hydropower; geothermal; wind and solar energy; co-generation; fuel switch; waste processing; landfill gas extraction; biogas applications; afforestation/reforestation, and so on. Carbon credit is thus expected to redefine global trade and may bring about a drastic change in the ratings of various countries in the global market in the near future.

India and China are likely to emerge as the biggest sellers and Europe is going to be the biggest buyers of carbon credits.



 

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