All is not quite gloom and doom in the financial world. Carbon markets have continued to post healthy gains through the year. Third quarter updates by New Carbon Finance, a provider of carbon market analysis, stated that carbon markets had reached $87 billion — an 81 per cent growth over the first nine months of the year. Other analysts confirm growth of similar value.
Carbon markets could breach the $100 billion mark this year, from $64 billion already recorded in 2007. Yes, carbon prices have fallen since the financial meltdown and slowing of industrial demand, but still, New Carbon Finance projects that carbon markets will grow to $116 billion this year and are likely to cross the half trillion mark by 2012. The introduction of a federal carbon regulation in the US, already favoured by the new administration, could easily quadruple the market size.
Certified Emission Reductions (CER) generated from Kyoto Protocol-based projects in developing countries currently account for approximately 20 per cent of the carbon market. India has benefited from the Clean Development Mechanism (CDM). Indian projects account for a quarter of issued credits or approximately 48 million, comprised mostly of renewable energy and industrial energy efficiency.
THE CARBON MARKET IN INDIA
Market activity in India is mostly dominated by CER sales — about how much money companies have made by selling credits. Large projects early on had the involvement of foreign buyers in the project design stage, but most projects today are developed with little or no pre-project engagement with the carbon buyer or investor. There has been limited voluntary carbon market activity, mostly restricted to projects that do not qualify under CDM or projects that have taken too long to register.
There are signs of other developments taking place, albeit slowly when compared with the international marketplace. India has a very saturated support market. As many as 300 different entities support CDM activities in one form or another with little distinction in focus. Distinction between advisory services, brokers and investors are often blurred.
India’s two commodity exchanges, MCX and NCDEX, have launched products for carbon credits on their exchanges. State Bank of India has spoken of a lending product that hinges toward securitising a carbon purchase contract. Other banks are considering linking carbon to their lending activities.
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Many foreign buyers, however, have diffused enthusiasm on the Indian carbon market. Some have started looking elsewhere to purchase CERs. Indian developers have high price expectations, volumes are often too small and sellers are unwilling to sell on a forward basis.
MISSED GATEWAYS
Though banks have recently announced plans to engage in the carbon business, by and large, the vast majority remain passive and possibly unlikely to stray from their core areas to take on carbon more significantly. Despite such an aversion, what is being missed are “gateway” opportunities. Indian financial institutions own the gateways to large-scale investments. They have the capacity to reach small, mid and large-scale enterprises. They have strong networks. These gateways could become powerful mechanisms to not only create new business opportunities but also leverage carbon finance to reach customers and project developers that can achieve the largest opportunities for emission reductions.
THE MARKET, INTERNATIONALLY
London is casually referred to as the “carbon capital” of the world. Almost all the big financial houses have trading desks that buy and sell carbon assets, with varying degrees of complexity in the trades. Many have developed specialised financial products — swaps, bonds, derivatives and guarantees. Parhelion Capital, for example, offers an insurance product designed to underwrite risk of non-delivery of carbon credits from CDM/Joint Implementation (JI) projects, targeted at anyone that is in the business of buying CERs and Emissions Reduction Units (ERUs). In June 2008, the World Bank together with Daiwa Securities priced a $25 million bond linked to UN-approved carbon credits. CER-EUA swaps have become almost commonplace.
As carbon credits promises to become a long-term incentive, banks and other financial houses are enhancing their clean energy portfolios. Investment in clean energy has grown very rapidly — from $33.4 billion in 2004 to $148.8 billion in 2008. The second half of 2008 saw growth stall, falling back 20 per cent from peak quarterly volume, but overall investment levels are still substantially ahead of recent years. Many of the same banks also offer advisory services for the carbon market, in addition to the traditional professional services firms that have taken on carbon market expertise.
WASHINGTON: A NEW LIGHT?
The promise of a new administration in Washington is renewing enthusiasm for action on climate change. With a cap & trade system seeming increasingly likely, banks like Goldman Sachs are purchasing offset portfolios from project development companies, perhaps preparing to beef up capacity in advance of a cap & trade scheme in the country. Merrill Lynch and ICF International launched the “Green and Gold” climate change initiative in April this year to help identify voluntary carbon strategies for companies and offer high quality offsets while lowering their operating costs. Many of these offsets come from projects in the developing world.
SO WHAT DOES ALL THIS MEAN FOR INDIA?
It is not about whether India gets carbon limits, or about CDM projects, or the money from CER sales. It is about the potential to build an international market. Indian businesses need to recognise carbon as a solid commodity, and start thinking about how best to benefit from its overall development, and not focus solely on CER sales.
OPPORTUNITIES AMIDST REGULATORY UNCERTAINTIES
There is no global climate change agreement after 2012. Yet. The annual international meeting of governments took place in Poland this December, but an agreement is unlikely before 2009, possibly even 2010. The new President-Elect has not even taken office. The international community coming to an agreement without the States is impossible.
So, what happens then in the absence of global agreement beyond 2012? According to the October 2008 proposal for an EU Directive for the 2013-2020 period, CDM and JI credits will be accepted into the Emissions Trading Scheme (ETS) allowing companies to meet almost half of their compliance obligations. Any unutilised project credits from the current phase can be carried over to the next period.
This gives at least the broad certainty of credits being recognised post-2012, evidenced by the fact that demand for post-2012 reductions is already on the rise. Project developers in India should continue to think about incorporating the carbon incentive into decision-making, processing projects, and find ways to commercialise the reductions. Maybe sell some and hold some; some at fixed, some at variable. The variations are enormous; all that is needed is planning and creativity. This is hardly the time to reduce the enthusiasm.
Mahua Acharya is with ArcelorMittal. Bishal Thapa is with ICF International. Views are personal and do not represent those of the organisations