Carbon Credits
IntroductionWhat are GHGs? What is Carbon Trading? Why are GHGs traded? What are UNFCCC and Kyoto Protocol? What is CDM? What is CER? What are Emission Allowances?
GHGs regulated by KP
Carbon dioxide Equivalents (CO2e) Global Warming Potential (GWP) What is one unit of GWP?
Participants
Annex I Parties: OECD countries+ EIT countries, including the Russian Federation, the Baltic states and several Central and Eastern European States. Annex II Parties: OECD members of Annex I excluding the EIT parties.
required to provide financial resources to enable developing countries to undertake emission reduction activities and to help them adapt to adverse effects of climate change
Non Annex I: Developing countries India and China is a part of non-Annex I.
They are usually the net sellers of emission offsets.
International Carbon Map
Highlights: USA: Biggest Emitter Australia changed position The EU and Japan ratified it: Biggest Buyers
Kyoto Mechanism
The Clean Development Mechanism (CDM)
Earn and Trade Covers developing countries CERs
The Joint Implementation (JI)
Earn and Trade Covers developed countries ERUs
International Emissions Trading
Cap and Trade Only for developed countries AAUs
Types of Transactions
Allowance Based
AAUs, EUAs prevalent under a cap and trade system
Project Based
Projects are funded, conceptualized by companies in developed countries and implemented in developing countries or financially more viable countries Is covered by CDM and JI.
Trading in Theory
Tradable products under UNFCCC
Comparison between EUA, ERU and CER
Allowances v/s Credits
Contd
Only 10% of excess emissions can be covered under EU ETS
Fungibility
The Process (Allowances)
Cap and Trade
Cap = Limit on emissions Trade = trade for deficit/surplus and ensure you are under Cap Trading Options:
Buy from fellow compliance participants having surplus Buy from offset projects (ie CDM)
Penalty
In EU fine of Euro 100 per tonne of CO2e that is above the cap In addition to this the exceeded emissions need to be covered up in the subsequent year.
The Process (Credits)
Earn and trade
Earn = Reduce carbon emissions through more efficient projects and get it certified by UNFCCC Trade = Sell these certified reductions with buyers in need.
Principle of Additionality
Around the World
Who is Selling?
Sub Saharan AfrBy Volume (ktCO2e 2012)
Source: Point Carbon
Expected annual CERs from registered Projects (By Country)
Source: www.unfccc.int
No. of Projects (By country)
Inferences
India has 32.42% of total projects but generates 14.37% of total CERs Korea which is No. 4 in terms of total CERs generated, lies at No.7 in terms of total number of registered projects. Chinese projects are the most efficient. 198 projects generate 107,128,288 CERs.
Top Buyers
RWE, ENEL and EDF Trading are compliance buyers
Rest of the buyers are Carbon Credits intermediaries/ aggregators
Composition of Buyers (By Country)
Source: State of the Carbon Market
Macroeconomic Price Determinants
Upward Price Pressures
Japanese buying from 07 to 08 EU demand Australian demand post ratification
Downward Price Pressures
Canadian govt. rejection Increased registration of CER projects Major non CO2 mega projects (e.g $1 bn Chinese HFC projects) Corporations with excess allocations not trading yet
Price Signals
Demand Side Signals
Gas Coal Price Spread Oil Prices (Weak correlation) Weather Conditions Regulatory Conditions (case of EU) Economic Growth Rate
Supply Side Signals
CER Supply
Long Term Indicators
Potential supply of surplus AAUs from EIT countries
AAU prices in turn affects CER prices
EU allocation issues will be the biggest driver (Compliance levels from 10% to 5%)
EUA already a benchmark for domestic prices
Contd
Prices influenced by COP
Provides positive or negative signals through their decision
Development of internal ETS akin to EU ETS Prices of CERs at different stages of the project life cycle.
Indian Markets
Introduced on the two leading commodity exchanges MCX NCDEX MCX CFI Futures Contract was introduced in the Indian markets on Jan 21, 2008 The NCDEX CER Futures Contract (CERNCDEX) in carbon credits was introduced on Apr 10, 2008.
Contract Specifications
1 MCX EUA Futures Contract = 200 tonnes of CO2e = 200 EUAs Underlying asset: EUAs
1 NCDEX contract = 500 tonnes of CO2e = 500 CERs Underlying asset: CERs
Prices and Volume (Before Apr 2008)
Prices and Volumes (NCDEX Contract)
Prices and Volumes (after Apr 2008)
Notes
Only Dec contract has been considered because:
Only Dec contracts have significant liquidity.
Both on the Indian as well as international markets
CERs traded only on the NCDEX.
No contract for EUA
Conclusions
MCX drives volumes upto 76000 tonnes of CO2e or 76000 EUAs NCDEX although a late starter managed to drive up the same volume in just 2 days. After the launch of the NCDEX contract, MCX managed to trade just 5600 tonnes of carbon offsets from 10th April to 5th May. During the same period NCDEX oversaw trading of 2,370,200 tonnes of carbon credits
Contd
Low volumes implies low volatility. Unable to fulfill aim Difference due to different underlying assets
EUA cannot be used, produced or held by Indians Basis Risk, Hedging and Arbitrage opportunities
Risks
Over-allocation of Allowances
Excess allowances meant target easily achieved Volatility lead to speculation and profit trading
Regulatory impediments and hurdles Lack of liquidity Post 2012 uncertainty
