Friday, November 7, 2008

Carbon Credits. Or why the rich will always get richer and the poor will get poorer

In short, Carbon Credit Mechanism is an Emission Trading Scheme to mitigate global warming. It all started with the Kyoto protocol, which limited the amount of Greenhouse Gases that the developed and developing countries (their businesses in fact) can emit. Each local business (called operator) has the right to emit a certain number of credits (one unit = one metric tonne of carbon dioxide or equivalent GHG). Their excess quota/unused credits might be sold or bought on the open market. A very attractive market I might add and with high perspective, as the emissions will continue to grow over time.
A credit can be an emissions allowance which was originally allocated or auctioned by the national administrators of a cap-and-trade program, or it can be an offset of emissions. Such offsetting and mitigating activities can occur in any developing country which has ratified the Kyoto Protocol, and has a national agreement in place to validate its carbon project through one of the UNFCCC's approved mechanisms. Once approved, these units are termed Certified Emission Reductions, or CERs
What happens on the market?
Basically, if I was a factory that emits a lot of greenhouse gas and I have exceeded my emission quota for this year, according to the Kyoto protocol, I have some alternatives:
- I can pay the carbon tax – too expensive
- I can invest in a new, lower emission machinery, but the capital cost would be very high
- Or…I can buy carbon credits from the open market from two different sellers:
1. From an organization that is investing in a lowering emission project in a developing country (the main idea: it is cheaper to invest in lowering emission in a developing country, so as long as we are still lowering emission levels, it does not matter where this takes place)
2. From a seller that has already invested in low emission machinery so that he might have surplus of allowances.
Let’s say US Steel is running a plant in Ohio. Say, that it is emitting more gases than the accepted norms of the UNFCCC. It can tie up with its own subsidiary in Kosice under the Clean Development Mechanism. It can buy the 'carbon credit' by making the Kosice plant more eco-savvy with the help of technology transfer. But it can also tie up with any other company like Indian Oil , or anybody else, in the open market. Under the CDM you can cut the deal for carbon credit. Under the UNFCCC, charter any company from the developed world can tie up with a company in the developing country that is a signatory to the Kyoto Protocol. These companies in developing countries must adopt newer technologies, emitting lesser gases, and save energy.
Interesting is that India and China are likely to emerge as the biggest sellers and Europe is going to be the biggest buyers of carbon credits.
India, China and some other countries have the advantage because they are developing countries. Any company, factories or farm owner in India can get linked to United Nations Framework Convention on Climate Change (UNFCCC) and know the 'standard' level of carbon emission allowed for its outfit or activity. The extent to which they are emitting less carbon (as per standard fixed by UNFCCC) they get credited in a developing country. This is called ‘carbon credit’. These credits are bought over by the companies of developed countries.
How and who can apply for selling carbon credits?
Only those companies that meet the UNFCCC norms and take up new technologies will be entitled to sell carbon credits. There are parameters set and detailed audit is done before you get the entitlement to sell the credit.
Ex: In India, already 300 to 400 companies have carbon credits after meeting UNFCCC norms
So far, the sellers have been large manufacturing companies who are adopting UNFCCC norms. Retail investors can come in the market and buy the contract if they think the market of carbon is going to firm up. Like any other asset they can buy these too. It is kept in the form of an electronic certificate.
Carbon Credit Market, as any other market is a supply-demand interplay. Say, if the Indian buyer thinks that the current price is low for him he will wait before selling his credits. The Indian government has not fixed any norms nor has it made it compulsory to reduce carbon emissions to a certain level. So, people who are coming to buy from Indians are actually financial investors. They are thinking that if the Europeans are unable to meet their target of reducing the emission levels by 2009 or 2010 or 2012, then the demand for the carbon will increase and then they may make more money.

My idea here, and i know for sure that at this moment, some of the developing countries have the most polluting steel plants in the world. Do you think they will buy and install new equipment to improve air quality?
Nope, they will buy cheap carbon credit from developing countries who have been struggling to buy and install new technologies for fewer emissions. Yes, of course, big powerful states might be drivers for the carbon projects in the developing countries, but that’s in my opinion a kind of laundry.

So…big steel guys in US will continue to stay big and rich. But…how much now? Because hihihi Indian and Chinese will become more and more competitive because of their new technology, automation and productivity. So, Sam….what do you say now?

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