A carbon market, to encourage the energy transition?

The carbon market… What is it?

Roughly speaking, it is a market similar to the equity market where we find buyers, sellers and brokers, but instead of trading shares, we negotiate rights or credits for CO2 emissions. Companies are first subject to emission quotas that they must reach, and then during each year, a CO2 emission quota is allocated to each facility (1 quota = 1 ton of CO2). In the European Union, if a company emits more carbon than the imposed limit by the European Union Emissions Trading Scheme (EU ETS), the company must buy a “right to pollute” from a company that consumed less than its quota.

Effectively, companies that fail to ensure their quotas must purchase “rights” to emit more CO2. On the other hand, a company that has managed to emit lower quotas than what was imposed, will obtain credits of which can be sold on the market, all through different types of contracts. The aim of this system is to reward the “good performers” who invest in clean technologies by allowing them to earn money by selling their credits and penalizing those who exceed their quotas by forcing them to buy “rights” to pollute more.

There are two types of carbon markets: A “regulated” and a “voluntary” carbon market. The regulated carbon market concerns the countries that are part of the Kyoto Protocol. It is binding, and concerns the five sectors considered as the most polluting sectors: electricity production, steel, paper, refining, and glass. On the other hand, the voluntary market is open to everyone: anyone can offer CO2 credits, but for this to work you need at least a label.

In the regulated market by the Kyoto Protocol, there are different types of mechanisms for green project financing. For example, the “joint implementation mechanism” gives companies the opportunity to invest in “clean projects” outside of their national territory and subsequently generates greenhouse gas emission credits that can be used by these investors. There is also the “clean development mechanism”, which allows developed countries to achieve their greenhouse gas emission reduction targets by investing in projects that reduce these emissions in developing countries. In return, they obtain emission credits that can be used for their own greenhouse gas reduction targets.

Several types of gas are involved in this market:

Carbon dioxide (CO2), Methane (CH4), Nitrous oxide (N2O), Sulfur hexafluoride (SF6), Hydrofluorocarbons (HFC), Perfluorocarbons (PFC) or per fluorinated hydrocarbons.

Some key data…

The carbon market is also a public policy tool to reduce greenhouse gas emissions (mainly CO2) in the atmosphere, of which are responsible for global warming. As a result, companies are driven to invest in green and less polluting technologies, whether in the energy, transportation, housing or agriculture sectors.

Nowadays, 60% of global GDP is covered by a carbon price, and to reach it, 46 countries and 26 provinces/cities have introduced carbon pricing, whether through tax or emissions trading schemes.

Nonetheless, this level still seems too low to support the transition to a low-carbon economy in both public and private sectors, according to the I4CE, Institute for Climate Economics:

Indeed, more and more countries have introduced taxes or markets since the Paris Agreement to give CO2 a price, each country has its own carbon price and the differences vary by less than 1 Euro, as in Poland and Ukraine, up to 139 € in Sweden. There is no common global carbon price and prices vary considerably from one country to another!

As a result, it is difficult to assess the economic consequences of climate change. However, US researchers have calculated the effects on the world economy if we line up on a trajectory of 1.5 ° C by the end of the century. The result is a gain estimated at $ 20 trillion.

We can also note that 75% of emissions are covered by prices not exceeding $10 per tonne of CO2. The objective of limiting the global temperature to 2 ° C by the end of the century as set by the Paris Agreement cannot be achieved given these large price differences. According to economists and presidents of the High Level Commission on Carbon Prices, Stern and Stiglitz, prices should vary between $ 40 and $ 80 per tonne by 2020, then between $ 50 and $ 100 by 2050 to achieve this goal.

Carbon revenues are an increasingly important source of financing for the environment and the economy” stated by the I4CE.

Indeed, this carbon pricing generates 32 billion dollars of revenues in 2017, against 22 billion dollars in 2016. These revenues are used for the general public budget, for projects dedicated to low carbon transition, to finance tax exemptions and a small part is transferred to companies and households.

China creates the world’s largest carbon market

Heavyweights like China and Canada; respectively because of coal-fired power plants and tar sands industry, are among the largest emitter of greenhouse gases. Thus, between 2016 and 2018, the percentage of global emissions covered by carbon pricing has almost doubled from 13% to 25%, mainly through the entry into force of the Chinese trading system in 2017. For the coming years, more than 25 pricing instruments are announced.

As of 19th December 2017, China has created the largest carbon market in the world, and largely surpasses the European emissions trading market. The more companies pay to pollute, the more motivated they will be to invest in the clean energy sector, where China is already a world leader in term of investment. Surprising, no?

With the launch of this carbon market, China not only sees a market opportunity, but also intends to be at the forefront of the global warming fight, just when the United States decided not to more honor their commitments. At the Paris agreement, China promised to reduce its carbon emissions by 60% to 65% per unit of GDP by 2030, compared to 2005 levels.

When it comes to reducing carbon emissions, it’s not just about what governments can do, but about what the population itself can do. The United Nations reported that the entire process of producing, harvesting, transporting, and packing food waste generates more than 3 billion tons of CO2. If this food waste quantity was a country, it would be the third largest greenhouse gases emitter behind the United States and China.

Other regions are pulling out of the system, and see it as a disadvantage: Ontario

Ontario, however, sees things differently. Ontario’s new Prime Minister Doug Ford since the 29th June 2018, rather conservative, is fulfilling his election promise to take the province out of the common carbon market with Quebec and California.

Why?

According to him:

Cap and trade systems for greenhouse gas emissions are nothing more than tax levies that do not represent any gain for the environment and deprive taxpayers of their money – they primarily serve to fund large government programs.

The Earth biodiversity will undergo important changes if humans do not react in time!

International trades are primarily derived from fauna and flora, and global warming will impact them seriously.

This would result the extinction of several hundred thousand plant species. CO2 causes an increase in the growth rate of plants, but the increase in temperature will have repercussions on their lives. Global warming will also increase the severity of disease in the ocean and cause a deterioration on the marine ecosystem health (fish, algae, corals, etc.), and the entire food chain will be impacted.

Reducing these inequities and inefficiencies would save a lot of money. Does the human race realize that if plants disappear because of the increase of CO2 present in the atmosphere and the decrease of the oxygen, many forests would disappear, there would be less food for human consumption and many species would become extinct? Life in general would suffer unthinkable consequences. As a result, the Earth’s biodiversity will undergo significant changes if humans do not react in time.

Nowadays, there is a lack of projects that allows or targets waste transformation into energy, and that in some countries landfills are burned, partly responsible for greenhouse gas emissions instead of being used for example in transportation or local energy.

Therefore, the carbon market seems to be a good tool to encourage a real energy transition and to unite all countries efforts.

For that to occur, all countries would need to abide by these rules through energy production, agricultural transformation and waste management. Countries would need to take advantage of these financial resources to be able to invest differently and durably!

The Earth biodiversity will undergo significant changes if humans do not react in time.”

Sources:

http://edgar.jrc.ec.europa.eu/overview.php?v=CO2andGHG1970-2016&sort=des8

https://www.contrepoints.org/2018/06/22/318712-lenergie-par-le-marche-plutot-que-par-letat

https://www.novethic.fr/actualite/environnement/climat/isr-rse/le-bon-prix-pour-le-carbone-50-a-100-la-tonne-en-2030-144475.html

https://www.ecologique-solidaire.gouv.fr/marches-du-carbone

 

Ilias KACHMAR

Ilias KACHMAR

Ilias KACHMAR is a Business Engineer. After being under-graduated in electronics and computing sciences from the University of Bordeaux, he obtained a Master degree in Strategy & Business Development from KEDGE Business School and integrated the Specialized Master in Commodities Trading & Asset Management at the Paris ESLSCA Business School. He began his career as Business Developer for the semiconductor giant STMicroelectronics in Paris, and would like to pursue his career in the world of energy trading.


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