With the highly-anticipated Copenhagen conference now in the books, many are cheering steps towards drastic cuts and a coordinated response to global climate change. Some emerging markets are calling on rich countries to cut their emissions by 40% compared to 1990 levels, as well as making a personal call to President Obama to have the U.S. join the Kyoto Protocol.
All of these developments and calls for reform are sure to impact countries across the globe, but it will perhaps have the greatest impact on the carbon market in the EU, the only region with a developed carbon credit trading system. The market allows companies to buy credits in order to pay for carbon emissions that their firms produce. This money is then used to pay for more sustainable initiatives in clean power and industrial efficiency programs in order to limit greenhouse gas emissions as quickly and efficiently as possible.
Tighter Emission Controls
Despite the complexity of keeping track of carbon emissions, the carbon credit market is relatively simple. With the advent of phase II of the European carbon credit trading system, as well as calls at the Copenhagen conference for the EU to cut its emissions by more than the 20%, it is likely that much more stringent emissions standards will be imposed on Europe, which could result in fewer carbon credits and thus higher prices.
Demand is likely to remain high for sometime since the majority of Europe is still dependent on fossil fuels (although much less so than the U.S.). European countries do tend to have much more robust manufacturing bases, so it remains to be seen how much demand for carbon credits these energy intensive industries can actually cut.
Currently fines are at 100 euros per ton over the allotted amount, 150% higher than they were in 2005. Such steep fines may encourage companies to either buy the permits (which will increase the price), or develop new technologies and programs to reduce emissions. At least initially, it will likely be much cheaper to buy up credits, which could bode well for carbon credit investors.
Failure of Phase I
Phase one of the European Union Emission Trading scheme was by most accounts a failure. There were far too many permits to begin with, and at one point a company could buy permits to emit five tons of CO2 for the same price as the fine for one extra ton of emission of CO2. This caused companies to simply buy up the cheap credits instead of either paying the fines or actually improving their processes to reduce emissions. In fact, emissions actually increased in Europe between 2005 and 2007 by almost 2% showing just how ineffective the program was at curbing emissions. Due to this failure, expectations for the current trading scheme, phase II (which runs until 2012) have been tempered significantly.
However, it seems as if the system is much improved; the second version imposes a modest cap and even includes airline emissions in the totals, a component that was lacking from Phase I. It remains to be seen if the countries will stick to these levels given the economic downturn and the growing discontent in many of Europe’s major cities. If the countries do stick to the plan, it would be welcomed news for carbon investors who could potential profit from the increase in scarcity in carbon permits.
Carbon Credit ETN
The iPath Global Carbon ETN (GRN) is currently the only true way to play the carbon market. The fund tracks the Barclays Capital Global Carbon Index Total Return which consists of European Union Allowances (EUA) and Certified Emission Reductions (CER) credits, weighted at about 79% and 21%, respectively. EUAs are carbon credits that each company that emits carbon dioxide must surrender every April 30th for every ton of CO2 emitted in the previous year. CERs are investments that help to offset greenhouse gas emissions by putting money to work in green projects including technologies that turn waste to energy and renewable sources of power.
GRN fund charges an expense ratio of 0.75% and is down almost 11% year to date. But if the Europeans follow through on their pledge to drastically cut emissions it could help bring this ETN back into positive territory.
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Disclosure: No positions at time of writing.