So, I know I’ve left the blog sleeping over the past 3 weeks. Oops! Life was *definitely happening — one weekend I became a certified Laughter Yoga Instructor, another weekend, I was fortunate to catch up with my wife (who is still finishing school on the east coast!), and also spent a lot of time listening to Eckhart Tolle and Oprah, WOW!, and working at Habitat For Humanity. So I’m back, and wanted to share for those trying to build up their knowledge about carbon finance and carbon markets, my understanding of the main takeaways from the World Bank’s recent report, “State and Trends of the Carbon Market, 2007” (pdf).
The scope of this report focuses on the financial issues — where are the markets? how big are they? how fast are they growing? How well are they working, from a financial perspective? What should governments do to make them work better?
Unfortunately it doesn’t address: how well are carbon markets working versus other solutions (such as taxes or tariffs) for helping countries and companies become more aware of the external costs of their emissions.
Or, How practical is a global carbon market? What will it take, in terms of political effort and time, to get one working? This report is great to get an overview, especially since carbon markets have so many different acronyms involved (often for very similar things, such as carbon credits for reduced emissions), to understand the current landscape.
I got into this report after my friend Dave suggested it, and as I start to learn more about new ideas for helping businesses and societies manage true costs of doing business, enabling businesses to create more balance and harmony, while still generating revenue and progress. Anyway, more on that later.
A few terms: “allowance-based” systems = cap-and-trade systems. “Project-based” systems = generally anything sanctioned by the Kyoto Protocol, where basically wealthier countries pay poorer countries for emissions reduced by these projects. Joint Implementation and Clean Development Mechanism are 2 types of projects in this category.
Here are the basic findings:
Coverage (I’ve added in some of my back-of-the-envelope calculations, using global emissions data)
- Allowance-based coverage is small, growing fast, and focused on power generation and industry:
- Grew 2.5X in CO2e (CO2-equivalent emissions) traded from 2005-06, covering 1-2% of global emissions.
- To date, allowance-based projects cover mainly power generation and industry (eg, EU ETS covers ~40% of EU emissions). Note some legislation in the US Congress is proposing coverage of up to 80% of emissions — more on legislation in future posts.
- Key markets are EU, New South Wales, and Chicago Climate Exchange (CCX)
- Project-based plans are smaller, growing slower, and based on developing countries using coal-cleaning and renewables to sell to more expensive markets:
- Covering ~0.5-1% global CO2e and growing at 70% CAGR, 2005-06.
- Chief sellers are China (61%) and India (12%), to buyers in UK (50%) and rest of Europe (36%), with dramatic UK expansion.
- Most projects are from scrubbing coal-related emissions (reducing HFCs 34%, N2O 13%, and CMM 7% – total coal-related is ~ flat) instead of renewables (16%, growing ~33-50% 2005-06), though these are growing.
- Mostly these are compliance markets (ie, polluters are required to participate), but a few are voluntary (eg, Chicago Climate Exchange).
Impact on emissions
- For allowance-based projects, overall impact so far has been flat [insert citation of EU emissions changing by 3%] due to lack of strong market controls and transparency, price volatility, and portability of credits over time (to facilitate stable investing):
- The EU and others (New South Wales, Australia) have struggled with too many credits, lack of tight information control, and a mild “cap”, leading to emissions staying almost flat, from 2005 to 2006, and the price of a ton of CO2 emissions dropping to ~50% of its 2006 value.
- The EU has struggled with price volatility, which appears to have been driven by a) lack of a long-term investment mechanism in the market, b) speculation. [admittedly I still don’t understand all the drivers here]
- For project-based systems, prices have been lower and more stable, markets are still not transparent nor credits standardized (from registration to trading), and growth in projects are limited by registration bottlenecks:
- Prices are more stable, in part due to China’s $11 price floor. Questions for next time — are there other drivers? What rules allow a country to enforce a price floor for selling these credits?
- CDM primary and secondary markets lack clear rules, standardization across countries, and pricing clarity
- Need for integrity standards for voluntary markets
- Validation and registration is complex and time-consuming, leading to a large bottleneck at the front of the project pipeline.
- Developing countries are punished by language from Kyoto requiring emissions reductions to result in “Grid-based” power
Outlook / takeaways
- Politicians, scientists and companies must collaborate to accurately target credits and the cap
- Developing countries will benefit by having more transparency in generating credits to sell to more expensive markets
- Startup funding, capital investment incentives, and cheaper technologies will still be needed, for poorer countries to use truly renewable sources besides hydropower. And the penetration of project-based credit practices seems like too little, too slow, to have a global impact yet.
- Participation is growing fast and structures are maturing…but will it be fast enough to make a global impact?