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| CARBON CREDITS – A MARKET OF
THE 21st CENTURY |
| With growing concerns among nations to curb
pollution levels while maintaining the growth in their economic
activities, the emission trading (ET) industry has come to life.
And, with the increasing ratification of Kyoto Protocol (KP)
by countries and rising social accountability of polluting industries
in the developed nations, the carbon emissions trading is likely
to emerge as a multibillion-dollar market in global emissions
trading. The recent surge in carbon credits trading activities
in Europe is an indication of how the emissions trading industry
is going to pan out in the years to come.
What is a carbon credit? Simply put, one
carbon credit is equivalent to one tonne of carbon dioxide
or its equivalent greenhouse gas (GHG). Carbon credits are
“Entitlement Certificates” issued by the United
Nations Framework Convention on Climate Change (UNFCCC) to
the implementers of the approved Clean Development Mechanism
(CDM) projects. The potential buyers of carbon credits shall
be corporates in various Annexure I countries that need to
meet the compliance prevailing in their countries as per the
Kyoto Protocol or those investors who would like buy the credits
and with the expectation of selling them at a higher price
during the KP phase (2008-12). The extension of KP shall be
ratified by the current signatories of KP in their future
meetings essentially to curb GHG emissions into the environment.
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| Sources of demand & supply |
Emerging carbon credit markets offer enormous
opportunities for the upcoming manufacturing/public utility
projects to employ a range of energy saving devices or any other
mechanisms or technology to reduce GHG emissions and earn carbon
credits to be sold at a price. The carbon credits can be either
generated by project participants who acquire carbon credits
through implementation of CDM in Non Annexure I countries or
through Joint Implementation (JI) in Annexure I countries or
supplied into the market by those who got surplus allowances
with them. The buyers of carbon credits are principally from
Annexure I countries. They are:
- Especially European nations, as currently
European Union Emission Trading Scheme (EU ETS) is the most
active market;
- Other markets include Japan, Canada,
New Zealand, etc.
The major sources of supply are Non-Annexure I countries
such as India, China, and Brazil.
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| Trading In Carbon Credits |
| Emissions trading (ET) is a mechanism that
enables countries with legally binding emissions targets to
buy and sell emissions allowances among themselves. Currently,
futures contracts in carbon credits are actively traded in the
European exchanges. In fact, many companies actively participate
in the futures market to manage the price risks associated with
trading in carbon credits and other related risks such as project
risk, policy risk, etc. Keeping in view the various risks associated
with carbon credits, trading in futures contracts in carbon
allowances has now become a reality in Europe with burgeoning
volumes.
Currently, project participants, public utilities, manufacturing
entities, brokers, banks, and others actively participate
in futures trading in environment-related instruments. The
European Climate Exchange (ECX), a subsidiary of Chicago Climate
Exchange (CCX), remains the leading exchange trading in European
environmental instruments that are listed on the Intercontinental
Exchange (ICE), previously known as International Petroleum
Exchange (IPE). |
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| Price influencing factors |
| In Non-Annexure B countries (the developing
countries) across the world, CER prices are influenced by various
factors including EUA prices, crude oil prices, electricity,
coal, natural gas, the level of economic activities across Annexure
I countries, among others |
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| Some of the major price influencing
factors: |
- Supply-demand mismatch
- Policy issues
- Crude oil prices
- Coal prices
- CO2 emissions
- Weather/Fuel prices
- European Union Allowances (EUAs) prices
- Foreign exchange fluctuations
- Global economic growth
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| Risks associated with carbon credits |
| The coming into being and operation of the
EU-ETS, the ECX futures exchange platform, revealed that there
are market- and policy-related risks for CER producers, including
the supply-side risks starting from the DNA approval risk to
the CER issuance risk in a complete CDM approval cycle. Apart
from these risks there are a host of other risks from both the
supply and demand sides that the real market players confront
with.
Most CDM projects by their very nature take a long time to
generate the CERs and hence, face the aforesaid risks in large
proportion, which if not hedged would lead to reduced realization.
Under such a situation, the realization of CER generators
at times may not even cover the investment put in to generate
the CERs and thus, has the potential of even making a CDM
project unviable in the long term. Given the long gestation
period of CDM projects and the risks involved, it is rather
inevitable that they pre-sell their potential credits in the
futures market (preferably a domestic futures market, to avoid
forex risk attached to participation in a foreign exchange)
and thereby, cover their probable downside in the physical
market. |
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| Potential participants in carbon
credits trading are as below: |
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| Hedgers |
- Producers
- Intermediaries in spot markets
- Ultimate buyers
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| Investors |
- Arbitragers
- Portfolio managers
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| Diverse participants with wide participation
objectives |
- Commodity financers
- Funding agencies
- Corporates having risk exposure in energy
products
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| India as a potential supplier |
| India, being one of the leading generators
of CERs through CDM, has a large scope in emissions trading.
Analysts forecast that its trading in carbon credits would touch
US$ 100 billion by 2010.
Currently, the total registered CDM projects are more than
300, almost 1/3rd of the total CDM projects registered with
the UNFCCC. The total issued CERs with India as a host country
till now stand at 34,101,315 (around 34 million), again around
1/3rd of the total CERs issued by the UNFCCC. In value terms
(INR), it could be running into thousands of crores.
Further, there has been a surge in number of registered projects
in India. In 2007, a total of 160 new projects were registered
with the UNFCCC indicating that more than half of all registered
projects in India happened last year. It is expected that
with increasing awareness this would go further up in the
future. The number of expected annual CERs in India is hovering
around 28 million and considering that each of these CERs
is sold for around 15 euros, on an average, the expected value
is going to be around Rs 2,500 crore. |
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| Various industries that have scope
of generation of CERs: |
- Agriculture
- Energy ( renewable & non-renewable sources)
- Manufacturing
- Fugitive emissions from fuels (solid,
oil and gas)
- Metal production
- Mining and mineral production
- Chemicals
- Afforestation & reforestation
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| The role of MCX |
| Multi Commodity Exchange of India Ltd. (MCX)
entered into a strategic alliance with CCX in September 2005
to initiate carbon trading in India. The tie-up would provide
immense scope and opportunity for domestic suppliers to realize
better prices for their carbon credits. Further, the MCX-CCX
alliance would also integrate the Indian market with its global
counterparts to foster world-class best practices in the commodities
futures market as related to emission trading. With MCX keen
to play a major role on the emission front by extending its
platform to add carbon credits to its existing basket of commodities
with regard to commodities futures trading, the existing and
potential suppliers of carbon credits in India have geared up
to generate more carbon credits from their existing and ongoing
projects to be sold in the international markets. With India
supposed to be a major supplier of carbon credits, the tie-up
between the two exchanges is expected to ensure better price
discovery of carbon credits, besides covering risks associated
with buying and selling. |
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| Advantages of an MCX carbon contract |
| In India, currently only bilateral deals
and trading through intermediaries are widely prevalent leading
to sellers being denied fair prices for their carbon credits.
Advantages that the MCX platform offers are: |
- Sellers and intermediaries can hedge
against price risk;
- Advance selling could help projects generate
liquidity and thereby, reduce costs of implementation;
- There is no counterparty risk as the
Exchange guarantees the trade;
- The price discovery on the Exchange platform
ensures a fair price for both the buyer and the seller;
- Players are brought to a single platform,
thus, eliminating the laborious process of identifying either
buyers or sellers with enough credibility; and
- The MCX futures floor gives an immediate
reference price. At present, there is no transparency related
to prices in the Indian carbon credit market, which has
kept sellers at the receiving end with no bargaining power.
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