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Global Carbon Market: Profits as Prolific as Pollution?

Although emissions trading began in the United States, which is the world's largest emitter of greenhouse gases, the United Kingdom and European Union are miles ahead in the development of a market for CO2 emissions credits. Now that Democrats control both houses of Congress, change could be afoot, but no one expects it to be quick or easy.

Carbon control proposals are proliferating in the House and Senate, noted Stanford Group Co. researchers Christine Tezak and K. Whitney Stanco. However, "we don't think any of this is going anywhere fast anytime soon -- meaning this Congress," they wrote in a Thursday research note.

"In this week before the State of the Union address, we're not surprised (or impressed) by the activity we see on global warming legislation," they said. "Introduced bills are not enacted bills. Ego is huge; a presidential race looms, and everyone is looking for headlines."

The analysts aren't the first to express cynicism for the political process, and they're not alone in their skepticism on the near-term future of carbon emissions legislation. Mark Proegler, director of BP's emissions markets group, said legislation creating a cap-and-trade mechanism for carbon emissions is unlikely in the remaining two years of the Bush White House.

Even some environmentally oriented nongovernmental organizations (NGO) are saying they don't want a carbon bill to make it to the president's desk, for fear a watered-down mechanism is what would be adopted, said Proegler. On the other hand, he said, that begs the question of whether those opposed to capping carbon emissions would try to push something through under the current administration, which might be friendlier to polluters than the next one.

"There has been quite an impact from the elections," Proegler said, noting that legislation introduced specifies market-based solutions as opposed to a carbon tax. "There is growing interest at the federal level. There's a lot of buzz flying around that there will be something about climate change in the State of the Union address next week."

Proegler spoke Thursday in Houston at the one-day conference Emerging Opportunities in Global Carbon Emissions Trading: Creating Value, Managing Risk. The event was sponsored by the Greater Houston Partnership and UK Trade & Investment. Attendees heard from Proegler and others about how carbon markets have developed in Europe and what could be in store for the United States and the rest of the world.

In March 2002 the United Kingdom launched the world's first economy-wide greenhouse gas emissions trading scheme (ETS), which ran until December 2006. The idea was to give British participants experience prior to the introduction of an ETS for the European Union (EU) in January 2005. For its part, the UK plans to cut CO2 emissions by 60% by 2050, mainly on the back of emissions trading. Legislation is being considered to make this a statutory target. The EU ETS is the largest multi-country, multi-sector greenhouse gas emissions trading scheme in the world.

According to UK Trade & Investment, carbon emissions as a financial commodity represent an international market worth more than $30 billion. And the United Nations Environment Programme's Finance Initiative estimates the global market for greenhouse gas emissions credits could reach $2 trillion by 2012.

Meanwhile, China is building a new coal-fired power station every week, creating 60 GW of new coal-fired capacity every year. "Every two years they build the whole power generation portfolio of Germany," said Leonard Birnbaum, director, McKinsey & Co. "This is going to be the market that you're going to sell [credits] to."

The EU Commission recently began approving national allocation plans (NAPs) for Phase II of the ETS and the first Kyoto Protocol commitment period (2008-2012). The plans are intended to help EU members achieve the EU Kyoto goal of reducing greenhouse gases by 8.5% below 1990 levels by 2012. Ten NAPs have been received by the EU Commission, but only the UK's has been considered sufficient.

European progress may be plodding, but Proegler is hopeful the concept of emissions trading will expand globally. "We're a global emitter, and we want a global solution," he said. "We want the opportunity to take action where it makes the most sense."

At the same conference, Toby Campbell-Colquhoun, a trader in the environmental products division of Shell Trading in London, provided an update on European progress. The market is seeing exchange-traded volumes of 3-4 million allowances per day and about as many again traded on a bilateral basis. He said that 3-4 million allowances is the typical allocation for a medium-size power plant.

Transaction costs are low and depth and liquidity have come to the EU carbon emissions market as there is "a significant number of liquidity providers," Campbell-Colquhoun said. Some of these represent pure speculative capital from a number of hedge funds, "which has been a very interesting development." The market also offers spot allowances, forwards, index tracking, and after some time standardized contracts have been developed. The forward curve is robust enough to trade out two to three years fairly comfortably, he said, but "that's something we could do better at. We do need certainty beyond 2012...There's no post-2012 certainty at the moment."

But there's even less certainty in the United States, of course.

"There isn't a government on the planet that is smart enough or powerful enough to solve the climate problem by dictate...You wouldn't want a government powerful enough to make those decisions for you," said James Cameron, vice chairman of investment banking group Climate Change Capital. "Once you grasp the scale of the problem and you know you crave a solution quickly, it becomes easy to kind of want an autocratic intervention...You go very quickly into 'I know what's best for you and I can tell you what to do...'"

Cameron said he envisions a U.S. carbon market developing largely on the back of the Internet and the communications capabilities it provides and entrepreneurial initiatives it inspires. Carbon pricing and the management of carbon will become integral to the economy, taking up residency at the independent central and reserve banks, in other words, in the hands of the same folks managing interest rates. Ultimately, Cameron said, the carbon market needs to be so robust that at any time the basic carbon price is readily quotable as well as the price for ancillary carbon products. There should be no shortage of capital and such a market would be stable enough to allow for long-term business decisions on the back of the carbon price.

"Finish the completion of those systems and we end up with a robust, thriving and ultimately necessary system for aligning and protecting the interests of the environment and economic growth."

The political will for such a market is growing in the United States and abroad, said Birnbaum. "Emissions trading is important from a business perspective even if you don't care about the long-term... Even if you're cynical it's important, and if you believe [in global warming], it's even more important."

Birnbaum said the Kyoto Protocol is driving interest in carbon markets because it's helping to set a price signal. "It doesn't really matter whether you're in or out of Kyoto from a business perspective; to me, it's money to be made or lost."

U.S. multinationals are participating in greenhouse gas emissions trading for their international operations and some domestic companies are trading in the voluntary market as well on the Chicago Climate Exchange (CCX), the world's first and North America's only voluntary, legally binding greenhouse gas reduction and trading system.

Other than CCX, development of carbon markets in the United States has been piecemeal on a regional basis. California's Global Warming Solutions Act of 2006 requires a 25% reduction in the states' greenhouse gas emissions by 2020 and is the first legislation aimed at global warming in the United States. In the Northeast, the Regional Greenhouse Gas Initiative (RGGI) is a cap and trade program for CO2 emissions from power plants in seven states in the Northeast and Mid-Atlantic regions. Hawaii, Washington and North Carolina are looking at vehicle emissions, and 31 states have active programs in carbon emissions registry, which is a prerequisite to any cap and trade mechanism, said Proegler.

While efforts on the U.S. east and west coasts might be admirable a national approach would be better. "Then you're operating on the same playing field," Proegler said. A national policy also prevents businesses from migrating to states where it's less costly to pollute.

"State initiatives should be assessed as precedents to a federal system and whether they create any roadblocks," warned Ian Carter, North American policy coordinator for the International Emissions Trading Association. He pointed out that RGGI only regulates emissions of power plants, where costs of emissions abatement are thought to be considerably greater than elsewhere in the carbon-emitting universe, and expressed concern about the use of carbon offsets as a market safety valve.

Carter also said it's not a wise idea to auction emissions credits as this could drive up their price and "might be inimical to the proper functioning of the market" as it would remove incentives for overcompliance, which is really what drives down emissions. Mason Henderson, manager, Cantor Fitzgerald Brokerage, agreed and warned of creating a market for carbon credits among speculators, at least initially.

Ultimately, the carbon emissions market speakers described is global, simple, transparent, linked to carbon offsets and with strict reporting, monitoring and verification requirements.

"We're just at the beginning of this giant carbon market, in my view," said Proegler.

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