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Market for Emissions Picks Up Steam As Kyoto Protocol Takes Hold

Posted on: Wednesday, 6 July 2005, 12:00 CDT

For a market that is less than a year old and still feeling its way, European trading in carbon dioxide emissions has grown in liquidity and complexity well beyond the expectations of most of those involved.

Back in February, the Kyoto Protocol on climate change came into force and most industrialized countries with the United States conspicuous by its absence set binding targets to reduce carbon dioxide emissions. The methods agreed upon were project-based schemes and carbon trading. While the United States pioneered emissions trading under the administration of former President George Bush, Europe has become the leading innovator with the only officially sanctioned emissions trading system in place. Still, global growth prospects seem rosy, with the United States and Asian countries likely to get involved, and the first stirrings of trading in United Nations pollution certificates.

"We hadn't expected such a fast take up," said Albert de Haan, the commercial director of the European Climate Exchange in Amsterdam, one of the exchanges on which the allocation of emissions are traded. "We have grown very rapidly and it has been a big, positive surprise for us." EU emissions trading started in January to help members meet commitments to the Kyoto Protocol. National allocation plans for the amount of carbon dioxide the gas most blamed for global warming that energy-intensive installations may emit are sent by member states for approval by Brussels. Governments then break down the accepted plans among companies, which buy or sell allowances to regulate the release of polluting gases. Penalties are imposed on each metric ton of carbon dioxide emitted above the allowance. Each excess polluter also has to surrender allowances in the second year to make up for overshooting in the first year.

The first phase of the plan runs from 2005 to 2008 and covers between 12,000 and 16,0000 factories and plants, responsible for 40 percent of emissions in the European Union, according to the consultancy CO2e.com. It covers power generation, oil refining, glass, ceramics, steel, paper and packaging, some chemical plants and lime and cement.

A second phase will run from 2008 to 2012. The European Commission is planning to retain the same industrial sectors for this stage and allocation plans are expected to be in place by mid- 2006. The third phase, after 2012, is where significant change is expected to start showing, experts say, adding that Brussels is considering including shipping, road and air transport under the plan, as well as sulfur dioxide and nitrogen oxide emissions.

"This is really a try-out and a learning stage," de Haan, of the European Climate Exchange, said "so we can be ready for stage two when the real trading will start."

De Haan said governments in Europe and beyond had swung firmly behind the idea of emissions trading as the most efficient means of providing incentives to cut pollution. "The system is here to stay, no matter which sectors are added," he said. "If you emit less you will have lower energy costs and a profit on sale of the allowance."

As well as the Amsterdam market, emissions trading in spot or futures contracts in Europe is available through Powernext in France, Nord Pool in Oslo, Nord Pool, the European Energy Exchange in Leipzig, and markets in Austria and Spain. There are three different versions of emissions contracts in common use, opening traders and hedge funds to arbitrage possibilities. Trades are also carried out away from the exchanges using brokers. Norway and Switzerland appear set to join the EU system, while Canada, California, South Korea and South Africa have also expressed interest in linking to the program.

"We've had a healthy start to the market," said Alte Christiansen, an Oslo-based director of Point Carbon, a provider of analysis, forecasting and indexes for the emerging carbon emission markets. "It's too early to say this is a big success, but volumes are up, prices are up and the market is responding to a combination of policy and fundamentals."

The price of a one-ton carbon dioxide emission allowance started around 8, or about $9, in January and has since surged to near 30, bringing a healthy profit for early buyers. The standard trading contract on the European exchange is for 1,000 tons, and trades are typically done in lots of 10,000 to 25,000 tons. An important reason for the price rise was a decision by the European Commission to reject attempts by some EU member states, including Italy, Poland and the Czech Republic, to run over their allocations. Britain has challenged its allocation in court, but for now London is following the commission's plan. The commission's stand calmed market concerns that it would be pushed aside by national governments. Weather has also helped to drive up prices and trading volume. A cold spell in January and February, and dry conditions in Spain, helped to push up prices for oil, gas, and hydroelectricity. That made energy production from those sources more costly, prompting a switch to coal which pollutes more and forces the power generators to buy more carbon permits. Market participants see this as a test of the system's environmental credentials. While the carbon credits accommodate more pollution in the short term, their rising price should gradually eliminate the cost advantage of coal, prompting a switch back to cleaner fuels.

The Amsterdam-based European Climate Exchange, the effective leader in European markets, is a wholly-owned subsidiary of the Chicago Climate Exchange, which in turn is owned by Climate Exchange, an Isle of Man-based company that is listed on the Alternative Investment Market in London.

Its futures contracts have traded on London's International Petroleum Exchange since April, reaching a cumulative volume of more than 10 million tons of carbon allowances, de Haan said. In trading this week, volume broke above one million tons a day for the first time on Monday, as the price surged 10 percent to an intraday record of 29.35 per ton.

More than 80 companies now trade ECX futures products, either directly or through clearing member brokers. The futures contract has a 1-year maturity, for settlement in December.

In June, the Amsterdam exchange announced a deal to jointly trade carbon dioxide emissions futures and spot contracts with Powernext of France. Traders will have access to both exchanges' contracts through a single screen. The two markets said the deal would create Europe's biggest market in CO2 emissions.

Retail investors can also now buy a CO2 participation certificate that tracks the market value of EU CO2 emission allowances, with a new securitized product from Dresdner Kleinwort Wasserstein.

In the United States, which did not sign the Kyoto Protocol, the market is far less developed than in Europe. But trading is still likely to develop regardless of the attitude of the U.S. government as Europe moves ahead and as cities, states and companies exert pressure for market liquidity.

"In the absence of political leadership, companies such as GE and Cinergy are fine-tuning their strategies and investments to improve their competitive positioning on the climate change issue," said Fred Wellington, a senior analyst at the Washington-based World Resources Institute, an environmental research and policy organization. "Yet without certainty on U.S. climate policy, investors are having a difficult time clearly differentiating which companies will be best positioned in the future." Since 2003, the Chicago exchange has traded 37,900 tons, with approximately 80 percent of that volume traded in 2004 and 2005.

The price per ton of a carbon emission is around $1.75, and has barely risen this year.

The system, in place since 2003, works by members establishing an agreed emissions reduction target, which is currently 1 percent a year until 2006. Participants that can exceed their targets can sell credits. Multinational companies including American Electric Power, DuPont, Motorola and Ford Motor are members of the Chicago exchange.

Elsewhere, Singapore plans to open Asia's first carbon credit exchange by the end of this year. The Asia Carbon Exchange will be set up by a company, Asia Carbon International, with government backing, and aims to trade up to eight million tons of credits a year from 2009.

Trading is also slowly picking up in emissions reduction certificates allowances for emissions related to projects in developing countries issued by the United Nations under its Kyoto Clean Development Mechanism.

Source: International Herald Tribune

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