Carbon emission trading -- Creating money out of thin air

July 28, 2008

The market for carbon emissions trading doubled to $64 billion in 2007, with experts predicting it could exceed $1 trillion by 2020. Most of this is a result of the EU's Emission Trading Scheme (ETS) that caps emissions for any company doing business in the EU. A recent EU proposal to extend the ETS until 2020 has helped legitimize carbon trading markets by making them more permanent. (Source: Global Finance, What a Gas!, July 2008)

Carbon emissions trading really took off when the EU restricted, or capped, the amount of carbon dioxide that heavy industries and utilities could emit. Each company (emitter) receives its allowed amount of carbon emissions in the form of an allowance. The EU issues about two billion of these European Allowances (EUA's) each year. To comply with the EU mandate, companies may either 1) reduce their emissions and sell the surplus EUA's or 2) buy EUA's in the marketplace.

Certified Emission Reductions (CER's) credits are also traded. These were created by the Kyoto Protocol, and are credits eissued to projects in developing countries that reduce emissions. There are also greenhouse gas emission credits which can be used to fulfill meets nation-specifc caps in the USA, UK, Canada, New Zealand and Japan.

This ability to buy and sell EUA's, CER's and other units on a freely traded market has created a new form of "currency". Traders include not only the emitters themselves, but also banks, hedge funds and other investors, who provide liquidity and increase market efficiency. A unit of carbon trading equals the reduction of one metric ton of carbon dioxide orits equivalent in other greenhouse gases. (Source: Cantor CO2 web site)

What carbon emissions trading means:
The recent global credit crisis is a result of the creation of new types of derivatives, CDO's, mortgage-backed securities whose value expanded far beyond that of the hard assets that upon which they were based. The current crisis is a correction in this expansion, but creation of new forms of currency is bound to continue.

The idea that a tradeable market is now based on something that is not much more than a concept takes this to a new level.

Even if the value of a mortgage-backed security is far removed from its underlying asset, you can still trace it back to something tangible, a loan made by a bank to a person who owns a house.

The value of EUA's, CER's and the like can only be traced back to a colorless, oderless gas, and a measurement of how much of that gas could have been emitted. What is one unit of carbon really worth? Like gold, and unlike a house, it doesn't really have a useful value other than what the market says it has. Thus, in some ways, these EUA's and such are new forms of currency.

Action steps:
There is $5.6 billion invested in carbon trading funds, according to a recent study by ICF International. However, these funds are so new that they are too risky for the individual investor. Instead, ask your financial planner about tracking some of them to see which will emerge as potential additions to your diversified portfolio.

See Carbon Trading Related Articles in:

Economic Effects of Global Warming

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