Carbon Trading Market Creating Opportunities
June 22, 2009
Continued growth in the global carbon trading market and the anticipated adoption of a U.S. climate control bill is creating plenty of new opportunities for investment banks, nascent exchanges, technology vendors and asset servicing agents in the trading and post-trade arenas.
The carbon emissions market, which grew 75 percent to reach $116 billion in 2008 from the prior year, could expand to $2 trillion by 2020 should more markets adopt a version of Europe's "cap and trade" model for reducing greenhouse gas emissions, according to research firm Celent.
Based on the 1997 Kyoto Protocol, an international treaty, the European Emissions Trading Scheme allows for members of the European Union to create tradable European Emissions Allowances (EUAs) and Certified Emission Reduction Credits (CERs)--otherwise known as offsets. Other countries such as Australia, New Zealand, Canada and Japan are also pursuing their own versions of carbon cap and trade models as is the United States.
"The potential for carbon trading is great, as is the opportunity cost of ignoring the market," said Stephen Bruel, research director for TowerGroup. Even more lucrative than trading will be advisory services to help energy firms comply with divergent regulations to reduce carbon emissions, he believes. Harmonization between regulatory regimes to create a unified global market, while ideal, is a long way off.
"It is costly for global firms to comply with the patchwork emission schemes and investment banks can help carbon emitter clients navigate this minefield with offset strategies," said Bruel, citing BNP Paribas, Goldman Sachs and Credit Suisse as examples of firms with specialized carbon risk desks. Hedge funds, he predicted, will also want to capitalize on the arbitrage opportunities between regulatory regimes and will use algorithms to take advantage of the correlations between the price of coal or weather patterns and the price of carbon.
Although much of the trading activity and innovation in the carbon emissions market remains in Europe, where the European Climate Exchange and Bluenext are the largest exchanges, the potential passage of U.S. legislation later this year or in 2010 could easily make the U.S. the largest regulated carbon market.
Under the proposed American Clean Energy and Security Act, the ceiling on greenhouse gas emissions would be divided into billions of permits, each conferring the right to emit one metric ton of carbon dioxide. Fewer permits would be issued to utilities, manufacturers and refiners each year until emissions are 83 percent by 2050 over 2005 levels.
It is unclear what effect the legislation, if passed, would have on several voluntary regional and state projects which have already cropped up, creating emission offset contracts traded over-the-counter, largely through interdealer brokers and web-based mechanisms.
"Trading volumes will continue to expand in the over-the-counter market but U.S. legislation will likely favor exchange-traded contracts and several more exchanges could emerge," said Jubin Pejman, vice president in the Americas for Trayport, an electronic trading software firm purchased by interdealer broker GFI last year. Exchange-traded contracts are typically standardized and cleared through a centralized facility, which reduces counterparty risk--a key mantra of the new Obama administration for the over-the-counter market.
Three fledgling U.S. emissions exchanges--the Chicago Climate Exchange, its sister company Chicago Climate Futures Exchange and rival Green Exchange, stand to benefit the most from any federal mandate. The CCX, launched in 2003 as a voluntary market with binding targets, offers participants a way to buy and sell "carbon financial instruments" (CFIs) that represent a certain level of emissions reductions; the CCX overtook the over-the-counter market for the first time last year.
