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CFI

Carbon (CFI)

CARBON CREDITS – A MARKET OF THE 21st CENTURY

With growing concerns amongnations to curb pollution levels while maintaining the growth in their economicactivities, the emission trading (ET) industry has come to life. And, with the increasingratification of Kyoto Protocol (KP) by countries and rising socialaccountability of polluting industries in the developed nations, the carbonemissions trading is likely to emerge as a multibillion-dollar market in globalemissions trading. The recent surge in carbon credits trading activities inEurope is an indication of how the emissions trading industry is going to panout in the years to come.

What is a carbon credit? Simplyput, one carbon credit is equivalent to one tonne of carbon dioxide or itsequivalent greenhouse gas (GHG). Carbon credits are “Entitlement Certificates”issued by the United Nations Framework Convention on Climate Change (UNFCCC) tothe implementers of the approved Clean Development Mechanism (CDM) projects.The potential buyers of carbon credits shall be corporates in various AnnexureI countries that need to meet the compliance prevailing in their countries asper the Kyoto Protocol or those investors who would like buy the credits andwith the expectation of selling them at a higher price during the KP phase(2008-12). The extension of KP shall be ratified by the current signatories ofKP in their future meetings essentially to curb GHG emissions into theenvironment.

Sources of demand & supply

Emerging carbon credit marketsoffer enormous opportunities for the upcoming manufacturing/public utilityprojects to employ a range of energy saving devices or any other mechanisms ortechnology to reduce GHG emissions and earn carbon credits to be sold at aprice. The carbon credits can be either generated by project participants whoacquire carbon credits through implementation of CDM in Non Annexure Icountries or through Joint Implementation (JI) in Annexure I countries orsupplied into the market by those who got surplus allowances with them. Thebuyers of carbon credits are principally from Annexure I countries. They are:

Especially European nations, ascurrently European Union Emission Trading Scheme (EU ETS) is the most activemarket;

Other markets include Japan,Canada, New Zealand, etc.

The major sources of supply areNon-Annexure I countries such as India, China, and Brazil.

Trading In Carbon Credits

Emissions trading (ET) is amechanism that enables countries with legally binding emissions targets to buyand sell emissions allowances among themselves. Currently, futures contracts incarbon credits are actively traded in the European exchanges. In fact, manycompanies actively participate in the futures market to manage the price risksassociated with trading in carbon credits and other related risks such asproject risk, policy risk, etc. Keeping in view the various risks associatedwith carbon credits, trading in futures contracts in carbon allowances has nowbecome a reality in Europe with burgeoning volumes.

Currently, project participants,public utilities, manufacturing entities, brokers, banks, and others activelyparticipate in futures trading in environment-related instruments.

Price influencing factors

In Non-Annexure B countries (thedeveloping countries) across the world, CER prices are influenced by variousfactors including EUA prices, crude oil prices, electricity, coal, natural gas,the level of economic activities across Annexure I countries, among others

Some of the major price influencing factors:

Supply-demand mismatch

Policy issues

Crude oil prices

Coal prices

CO2 emissions

Weather/Fuel prices

European Union Allowances (EUAs)prices

Foreign exchange fluctuations

Global economic growth

Risks associated with carbon credits

There are market- andpolicy-related risks for CER producers, including the supply-side risksstarting from the DNA approval risk to the CER issuance risk in a complete CDMapproval cycle. Apart from these risks there are a host of other risks fromboth the supply and demand sides that the real market players confront with.

Most CDM projects by their verynature take a long time to generate the CERs and hence, face the aforesaidrisks in large proportion, which if not hedged would lead to reducedrealization. Under such a situation, the realization of CER generators at timesmay not even cover the investment put in to generate the CERs and thus, has thepotential of even making a CDM project unviable in the long term. Given thelong gestation period of CDM projects and the risks involved, it is ratherinevitable that they pre-sell their potential credits in the futures market(preferably a domestic futures market, to avoid forex risk attached toparticipation in a foreign exchange) and thereby, cover their probable downsidein the physical market.

Potential participants in carboncredits trading are as below

Hedgers

Producers

Intermediaries in spot markets

Ultimate buyers

Investors

Arbitragers

Portfolio managers

Diverse participants with wideparticipation objectives

Commodity financers

Funding agencies

Corporates having risk exposurein energy products

India as a potential supplier

India, being one of the leadinggenerators of CERs through CDM, has a large scope in emissions trading.Analysts forecast that its trading in carbon credits would touch US$ 100billion by 2010. Currently, the total registered CDM projects are more than300, almost 1/3rd of the total CDM projects registered with the UNFCCC. Thetotal issued CERs with India as a host country till now stand at 34,101,315(around 34 million), again around 1/3rd of the total CERs issued by the UNFCCC.In value terms (INR), it could be running into thousands of crores.

Further, there has been a surgein number of registered projects in India. In 2007, a total of 160 new projectswere registered with the UNFCCC indicating that more than half of allregistered projects in India happened last year. It is expected that withincreasing awareness this would go further up in the future. The number ofexpected annual CERs in India is hovering around 28 million and consideringthat each of these CERs is sold for around 15 euros, on an average, theexpected value is going to be around Rs 2,500 crore.

Various industries that have scope of generation of CERs:

Agriculture

Energy ( renewable & non-renewablesources)

Manufacturing

Fugitive emissions from fuels(solid, oil and gas)

Metal production

Mining and mineral production

Chemicals

Afforestation & reforestation

The role of MCX

With MCX keen to play a majorrole on the emission front by extending its platform to add carbon credits toits existing basket of commodities with regard to commodities futures trading,the existing and potential suppliers of carbon credits in India have geared upto generate more carbon credits from their existing and ongoing projects to besold in the international markets. With India supposed to be a major supplierof carbon credits, the tie-up between the two exchanges is expected to ensurebetter price discovery of carbon credits, besides covering risks associatedwith buying and selling.

Advantages of an MCX carbon contract

In India, currently onlybilateral deals and trading through intermediaries are widely prevalent leadingto sellers being denied fair prices for their carbon credits. Advantages thatthe MCX platform offers are:

Sellers and intermediaries canhedge against price risk;

Advance selling could helpprojects generate liquidity and thereby, reduce costs of implementation;

There is no counterparty risk asthe Exchange guarantees the trade;

The price discovery on theExchange platform ensures a fair price for both the buyer and the seller;

Players are brought to a singleplatform, thus, eliminating the laborious process of identifying either buyersor sellers with enough credibility; and

The MCX futures floor gives animmediate reference price. At present, there is no transparency related toprices in the Indian carbon credit market, which has kept sellers at thereceiving end with no bargaining power.

Source :- www.mcxindia.com

Web Resources On

www.unfccc.int

www.cdmindia.nic.in

www.cdmcapacity.org

www.cseindia.org

www.cdmbazaar.net

www.envfor.nic.in/cc/cdm

www.nordpool.com

www.eex.com

www.ieta.org

www.pointcarbon.com

www.Carbonfund.org

 

 

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