Segments of the Carbon Market
-
A Compliance-driven Market
The carbon market has so far been essentially a compliance-driven market, where buyers largely engage in carbon transactions because of carbon constraints (current or anticipated) at international, national or sub-national levels. The Kyoto Protocol is the largest potential market and EU ETS, a tributary scheme, has spawned a thriving market for allowances and for project-based ERs. The main buyers of compliance units in carbon market today are:
- European private buyers interested in EU ETS;
- Government buyers interested in Kyoto compliance;
- Japanese companies with voluntary commitments under the Keidanren Voluntary Action Plan
- A number of intermediaries, such as aggregators, trading houses, compliance funds and banks
- Asset managers (investors carbon funds, hedge funds), investing in a new commodity market
- U.S. multinationals operating in Europe or Japan or preparing for the Regional Greenhouse Gas Initiative (RGGI) in the Northeastern U.S. States, or anticipating California Assembly Bill 32 which would establish a state-wide cap on emissions;
- Powers retailers and large consumers regulated by the New South Wales (NSW) market in Australia;
- and North American companies with voluntary but legally binding compliance objectives under the Chicago Climate Exchange (CCX).
-
Voluntary Market
A voluntary carbon market, with demand not motivated by compliance requirements, has steadily gained momentum since 2005. It encompasses all the transactions of ERs by entities that voluntarily decide to limit their carbon footprint. To the extent ERs offered in this marketplace are credibly additional, the voluntary carbon market may also contribute to the global mitigation effort. The voluntary market remains small in volume and value, especially in comparison to the broad Kyoto compliance market.
Corporate Social Responsibility and green buzz are indisputably drivers of demand for offsets in this category which are often “charismatic” in dimension, i.e. they arise typically from projects demonstrating community benefits or strong sustainability components. The regulatory vacuum in some countries and the anticipation of imminent legislation on GHG emissions is central to the growth in the activity of the voluntary market in recent months. This is particularly true in the U.S. and Australia where buyers are seeking to secure pre-compliance and early action offsets and constitute thereby a significant fraction of demand. The recent growth in the voluntary market has increased the interest of several private sector financial institutions, in parallel to their activity in the compliance carbon market.
-
A Fragmented Carbon Market: Proliferation of Currencies and Poor Linking
There are several carbon markets, encompassing both allowances and project-based assets, that coexist with different degrees of interconnection, leading to a fragmented global carbon market. The emergence of multiple regimes to manage GHG emissions has so far resulted in a proliferation of carbon units or currencies with limited linking between markets. The main interconnection to date has been indirect in nature through competition on the project-based market, chiefly for CDM assets, a United Nations Framework Convention on Climate Change (UNFCCC) supervised standard considered to convey a high degree of credibility. They also are regarded by many participants as being high in transaction costs, arising out of their use of expert-vetted methodologies, third-party verification and monitoring, subject to second-guessing by the CDM Executive Board, and requiring a high degree of public disclosure and reporting.
European companies interested in EU ETS, Japanese companies with voluntary commitments under the Keidanren Voluntary Action Plan, Governments with a Kyoto commitment and more recently buyers on the voluntary market have been competing for CERs. However, a number of qualitative and quantitative restrictions apply and limit global demand for CDM. With regard to other regimes, the New Zealand ETS is the most progressive in its open market-oriented stance on linking and a number of compliance units, including allowances, from other regimes are eligible, as are JI and the CDM.
The Challenge of Linking Carbon Markets and Broadening the Scope of Carbon Finance to Achieve the Required Mitigation Effort
Carbon markets so far have mostly been operating in isolation from each other, except where there is a linking through the CDM and JI markets. Provisions for linking exist for a number of cap and trade schemes but their diversity in design creates a significant challenge. A number of issues need to be considered and agreed upon before effective linking and some of the most important are listed below:
- ambition of target and existence of cost control mechanisms (safety valve, penalty for noncompliance);
- treatment of offsets: supplementarity limit, eligible offsets standards and asset classes and treatment of domestic offsets;
- treatment of installations (grandfathering or benchmarking, sale, auction or free allocation, treatment of new entrants and existing installations);
- differential treatment of sectors, with potential leakage and competitiveness issues;
- absolute vs. intensity target;
- emergence of a financial and regulatory governance in the carbon market.
Achieving better linking across carbon markets would better connect mitigation potential across sectors and regions with sources of demand. A more efficient and inclusive global carbon market could also encourage nations to take on tougher targets while allowing for more flexibility through trading.
Science-based Mitigation Targets
In its latest assessment report, the IPCC made clear that the evidence of warming of the climate system is unequivocal and that a delay in reducing GHG emissions significantly constrains opportunities to achieve lower GHG atmospheric concentration stabilization levels while increasing the risk of severe (and possibly irreversible) impacts. A range of stabilization levels under consideration can be achieved by the deployment of a portfolio of technologies that are currently available or soon expected to be available at commercial scale. Policies that provide a real or implicit price of carbon could create incentives for producers and consumers to significantly invest in low- GHG products, technologies and processes.
Mitigation Potential
IPCC also reports that by 2030, a global mitigation potential of 13.5 GtCO2e can be tapped at a cost of below US$20 per tCO2e. Half of this potential is in developing countries, many of which are investing heavily in long-term infrastructure. At a carbon cost below US$50 per tCO2e, the mitigation potential expands to 19.5 GtCO2e – with slightly more than half of mitigation located in developing countries.
Buildings often represent the cheapest mitigation opportunities, with a significant portion of the potential coming at “negative” cost. At a cost below US$20 per tCO2e, these opportunities represent 40% of all mitigation opportunities and between 25-30% at costs below US$50 per tCO2e. Mitigation opportunities in the forestry and agriculture sectors account also for a meaningful share of abatement opportunities: 30% in developing countries, 20-25% globally. These sectors have barely been touched by the carbon market so far and it is encouraging to observe initiatives aimed at cultivating these new sources of supply, among others by developing new methodological approaches to address
technical issues and decrease transaction costs.
Source: State and Trends of the Carbon Market, , World Bank 2008 |
|
