Monday, June 1, 2009

Trade but not cap? The twists of the carbon credit markets

The World Bank recently conducted a survey on the Carbon Markets, a markets based mechanism meant to reduce carbon emissions globally. The idea is to force emitters to buy carbon credits (pay a type of tax for their "sins"). The sellers would be projects that take carbon out of the system. For example in simplified terms a utility buys credits from a farmer who plants trees. The utility gets to emit CO2 and the farmer makes some bucks from selling the credits, while her trees take carbon out of the atmosphere. Then you introduce an intermediary like an exchange and speculators to create liquidity and you've got yourself a market. To make the market work one needs to force the polluters to spend money via regulation (proposed under the Kyoto protocol.) This regulation took hold in Europe, but has been operating on a voluntary basis in the US.

According to the World Bank the European carbon contract trading volumes have gone up, but the projects to take carbon out have actually dropped. They attribute the drop to the so called "additionality". The concept is that in order to be able to generate carbon credits (and sell them), a project must demonstrate that the reduction it promises will be due to the carbon credit money it gets. That is the project wasn't going to happen anyway even without the carbon money. That's often a tough thing to prove, and these proposals get stuck in the European environmental bureaucracy. The European contract has stabilized from it's 08 fall, but as a long term investment it will depend on the aggressiveness of the European carbon capping regulation and the capacity to approve more projects. With the economy in a recession there is no political will in the immediate future to do so. In the mean time European power companies are switching from coal to wood. Burning wood is viewed as "renewable" and does not require carbon credits (making it cheaper to generate power).

European carbon contract:

See this Bloomberg story on using wood as a cheaper alternative (avoiding carbon regulation).
"Power companies are burning trees because they’re renewable and can be cheaper than coal. Wood needs no permit to release carbon dioxide, a greenhouse gas blamed for global warming."
In the US, where carbon credit purchases by polluters is voluntary, the contract continues to stay depressed (a fraction of what the European contract is worth). The chart below is for the 2010 emissions contract. This implies that either the currently proposed regulation (Waxman-Markey bill) is not expected to pass in the US or that it will be extremely gradual in its implementation (with little pressure on US utilities, etc. to spend money). The Obama administration's approach is to use some of the proceeds from the initial carbon credit sales for the new US health care program. It gets messy (see Reuters story). The public views this as a tax and even the environmentalists are skeptical about a market based solution, given the issues in Europe.

The Chicago Climate Exchange 2010 contract

Here is Martin Feldstein's commentary for the Washington Post as to why the US proposal has a tough road ahead:
"The Congressional Budget Office recently estimated that the resulting increases in consumer prices needed to achieve a 15 percent CO2 reduction -- slightly less than the Waxman-Markey target -- would raise the cost of living of a typical household by $1,600 a year. Some expert studies estimate that the cost to households could be substantially higher. The future cost to the typical household would rise significantly as the government reduces the total allowable amount of CO2."

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