CHAPTER 9

Key Players in the Carbon Markets

Martin Whittaker Director: Mission Point Capital1

INTRODUCTION

The growth of the global carbon market since early 2005, when trading on the European Union emissions trading scheme (EU ETS) began in earnest and the Kyoto Protocol finally entered into force, has surpassed the expectations of even the most bullish carbon pundits. Recent reports have estimated that 2005 saw 799 MtCO2e in carbon-related transactions worth approximately €9.4 billion, with the volume traded in the EU ETS alone in 2005 at 262 MtCO2, corresponding to €5.4 billion (Point Carbon 2006a).2 This phenomenon has been driven by many factors, including:

The market formation process has not been without its struggles, indeed there have been moments when the future of Kyoto’s flexible mechanisms looked to be in serious jeopardy. However, with the basic elements of the global carbon finance system now in place, the stage is set for long-term market development. More and more, organizations from the mainstream financial world are staking out their positions in the market.

This chapter will describe some of the types of organizations that have become, or are becoming, the carbon market’s key players; the nature of their involvement; some of their experiences to date; and their potential roles in the future. It is not intended to be an exhaustive list of all market participant types, and the bona fides of any companies mentioned below cannot be vouched for. Although mention is made of the activities of certain public sector and multilateral institutions, the emphasis of the chapter is on the private sector (and particularly the financial sector) and how carbon finance is being pursued as a new business opportunity. The macroeconomic implications of climate change itself, the implications of adaptation requirements, and the broader activities relating to investments in low-carbon technologies, renewable energy, and clean industrial processes are described in earlier chapters.

BASIC ELEMENTS OF THE MARKET

EU ETS Trading

As previous chapters have detailed, today’s carbon market is dominated by two very different but directly connected transactional environments; the EU ETS market, which is a cap-and-trade system confined to European industrial installations, and the Kyoto project market, in which carbon credits are generated from projects that reduce emissions below business as usual scenarios. Although other markets—notably the Japanese and Canadian domestic carbon regimes, and various U.S. state-level initiatives such as the Regional Greenhouse Gas Initiative (RGGI)—are under development and have seen some initial precompliance trading activity, the ETS–Kyoto system remains the central driving force behind today’s global carbon business and, therefore, the primary context of the discussions in this chapter.

The basic mechanics of the EU ETS have been described in previous chapters. It is estimated that around 50 companies currently trade on a regular basis, although participation has varied considerably depending on proximity to the compliance “true up” period in March and April. The most frequent traders are mainly utilities and merchant energy companies, industrial conglomerates, as well as a group of financial institutions that have established environmental market desks. Trading typically occurs via specialist brokers, clearing agents, or directly on exchanges. Information on prices and market conditions is generally supplied by the brokers (e.g., TFS, Evolution Markets, CO2e.com, Natsource) and exchanges (notably the European Climate Exchange and NORD Pool), in addition to certain specialist information providers and reporting/research organizations (e.g., Point Carbon), and the business journals Environmental Finance and Carbon Finance. Contracts tend to be based on established International Swaps and Derivatives Association (ISDA) or European Federation of Energy Traders (EFET) master trade agreements, although a customized contract has been developed by the International Emissions Trading Association (IETA). Choice of contract tends to depend on previous familiarity: for example, financial institutions tend to prefer the ISDA contract, whereas utilities lean toward the EFET contract. Minor differences still exist between these contract versions although work is under way to create a single standardized document. Legal, accounting, and tax support is provided by a growing cadre of established professional law and accounting firms.

During 2005, daily volumes for the various forward delivery contracts typically ranged between 100,000 and over 1 million tons, depending on the vintage. This number is trending upward: In early 2006, increased participation pushed trading volumes of the 2006 contract toward the 2 million mark, and during the frenzy of early June of that year, when 2005 emissions data first reached the market, beyond 10 million. Bid/ask spreads have generally narrowed since trading commenced, and liquidity has steadily climbed. Continuous spot trading began toward the end of 2005 and a derivatives market is currently forming. Two exchanges, ECX and Powernext, recently entered into an agreement to trade both the CO2 emission futures and spot contracts on a continuous basis. Some of the fundamental trends affecting prices are listed in Table 9.1.

TABLE 9.1 Fundamental Trends Affecting the Price of Carbon

Source: Point Carbon.

Bullish Signals Bearish Signals
Colder-than-expected winters; warmer-than-expected summers Warmer-than-expected winters; colder-than-expected summers
Widening spark and dark spreads (especially in German and U.K. baseload) either due to rising gas/oil prices or rising electricity demand Thinning of spark/dark spreads, or lower gas/oil prices
Tightening of EUA supply from NAPs Relaxation of emissions controls from governments
Tightening of supply of carbon credits via Linking Directive Loosening of restrictions on use of Kyoto credits for ETS compliance
Heightened political commitment to cutting GHGs after 2012 Softening of political will to extend Kyoto or relax efforts to cut GHG emissions
US support for domestic GHG emissions restrictions and cap-and-trade legislation Distancing of U.S. from Kyoto, GHG emissions controls and market-based GHG legislation

Clean Development Mechanism (CDM) and Joint Implementation (JI) Projects

As far as the Kyoto project-based markets are concerned, the key players until mid-2005 were the World Bank and certain national governments looking to procure carbon credits for market development and Annex 1 country buyers concerned about Kyoto compliance, respectively.

During 2005, however, greater confidence in the future of the market led to the formation of a number of purely private-sector carbon funds that provide buyers with the opportunities to benefit from a managed portfolio of carbon securities. Currently, over $3 billion is thought to reside in such funds, although the private nature of many of these funds makes the precise number difficult to determine. Since the EU Linking Directive made possible the use of CERs and ERUs for compliance in the ETS (to what extent still remains to be seen), demand for such credits has also taken off among large European industrial emitters regulated under the trading scheme seeking to diversify their sources of compliance instruments. Over 1,420 projects are currently being planned, valued at $2.5 billion at today’s prices. Over the last 12 months, approximately 58 million tons of CO2e have been purchased, at $4 to 8/t, or $232 million to $464 million. Point Carbon has estimated future demand for credits is currently put at 600 to 700 million tons annually, worth more than $5 billion (Point Carbon 2006b).

This step up in project activity has not surprisingly lead to a significant pick up in businesses for CDM and JI project developers, to the extent that such companies have seen their standing in the market rise dramatically. Several have become publicly listed companies. The provision of financial and technical verification and engineering services to such projects is also a rapidly growing business.

Intermediaries, Speculators, and Professional Services

Beyond the compliance trading market and so-called pure play carbon companies lies a growing body of support services, ranging from investment banking and equity research to credit ratings and insurance. In particular, the potential for carbon regulation to influence the future market valuation of publicly listed companies has required mainstream financial analysts and bond rating agencies to devote research resources to understanding the implications of carbon finance more thoroughly. The link between emissions prices and energy commodity prices has resulted in commodity trading desks setting up carbon contract trading capabilities as a natural extension of their energy and power trading operations. To the extent that carbon finance issues are also affecting power generation economics, corporate operating and finance departments are now incorporating carbon finance into strategic decision making. Many companies need advice on this from investment banks, who understand the implications of carbon finance within the corporate finance complex. Insurers are taking steps to develop credit delivery guarantees and other structured insurance products so that counterparties to a transaction can transfer the risk of nondelivery or project failure more effectively. Banks are being asked to lend against future carbon cash flows. Investors are being invited to provide equity capital based on a view of the future value of carbon-related business. Private investors in the clean energy infrastructure markets, whether they be focused on venture, equity, mezzanine, or senior debt financing, need to understand the impact of carbon finance on future cash flows, company valuations, and power project economics. A growing number of speculative investors, hedge funds, and private pools of capital are coming to market in search of new, uncorrelated returns based solely on carbon price movements.

Finally, many smaller companies with a direct financial stake in the carbon market have floated shares on the stock exchange, or raised private equity and debt capital in the financial markets. This has necessitated the formation of specialty carbon finance expertise within investment banking, brokerage, and advisory companies. The majority of these publicly listed carbon finance companies have been floated on U.K. equities markets.

KEY PRIVATE-SECTOR PLAYERS

Compliance Participants

Industrial compliance–driven market participants form the backbone of the global carbon market and remain, along with national governments, the major source of business activity. The ETS itself directly affects over 6,000 companies and organizations from major industrial sectors including cement, ceramics, iron and steel, natural gas, pulp and paper, power (which received 56 percent of EUAs issued), and refining. The positioning of these companies in the carbon market—whether they are short or long, whether they are pursuing internal abatement strategies or using the market to meet compliance targets, how they plan to trade and settle their positions during the year, and the extent to which they aim to use Kyoto project credits to satisfy compliance—exerts a major influence on prices and overall market conditions. U.K. and German energy firms have a substantial allocation of EUAs, and EUA prices are therefore highly correlated with German baseload power contracts and U.K. gas prices. The major compliance traders on the ETS during the first year of operation have been the utilities and energy companies, particularly those with established energy trading desks, who need to hedge their financial exposure to emissions compliance by trading EUAs.

Commercial Banks

With the exception of a few early pioneers, the commercial banking sector has been a relative latecomer to the carbon finance market. This can be attributed in part to the conservative nature of these institutions and the immature state and small size of the carbon business relative to other financial markets. As the market has matured, however, commercial banks, especially those with a strong European presence, have begun to involve themselves in structuring and financing emissions reduction projects.

A good example of this is provided by the Bank of Ireland, which struck an arrangement with Irish power plant Edenderry in which the bank agreed to deliver to Edenderry emission allowances equivalent to their shortfall at a price indexed to the EUA prices quoted on the ECX (Point Carbon 2005). This agreement provides much more price certainty for Edenderry, which will help them budget for emissions compliance more efficiently. Dutch bank ABN Amro has targeted the carbon market as an area of strategic interest, launching a number of sustainable private equity funds worldwide, and becoming involved in carbon trading, clearing of exchange-based carbon trades, and the financing of prepaid carbon credits by European corporate buyers (ABN Amro 2005). Belgian bank Fortis has also been an early participant in the carbon market’s formation, offering trading, counterparty services, clearing, and financing based on carbon finance. Many other European-based commercial banks—notably Rabobank, Barclays, and HSBC—are following suit, particularly in the area of corporate carbon banking and advisory services.

Carbon Funds

The emergence of specialist carbon funds has been a prominent feature of the markets over 2005 and 2006. Descendents of the World Bank Prototype Carbon Fund, these funds now constitute a major source of capital for CERs and ERUs in the global Kyoto markets. It is estimated that approximately $2 billion is committed to such funds, although the actual amount is difficult to determine. Their investors tend to be either major compliance buyers wishing to outsource or diversify their credit purchasing activities (such as is the case with Natsource’s Greenhouse Gas Credit Aggregation Pool [GG CAP] fund, or the European Carbon Fund), or speculative investors who take the view that the rising price of carbon is a source of return (see Table 9.2).

TABLE 9.2 Examples of Carbon Funds

Source: Based on estimates from Morgan Stanley, International Emissions Trading Association, and Point Carbon.

Fund Estimated Target Size (€ million)
World Bank Funds
Prototype Carbon Fund (PCF) 150
Dutch JI and CDM Funds 222
Community Development Carbon Fund 77
BioCarbon Fund 77
Multilateral Carbon Credit Fund 100
Italian Carbon Fund 77
Spanish Carbon Fund 200
Danish Carbon Fund 27
Government Funds
Austrian JI/CDM Tender Unknown
Belgium Federal JI/CDM Tender 9
Canada PERRL 12
Danish Carbon Tender Unknown
Ecosecurities Standard Bank Unknown
Finnish JI/CDM Pilot Tender 20
German KfW 80
Rabobank/Dutch Gov’t CDM Facility Unknown
Swiss Climate Cent 100
Japan Carbon Fund Unknown
Private Funds
Natsource GG CAP 500
European Carbon Fund 105
Trading Emissions 200
Japan Carbon Finance 110
ICECAP 250
Merzbach Fund Unknown
Climate Change Capital 50
Total 2,366

A summary of the carbon funds currently open to outside investors is shown below, although it should be cautioned that this is a rapidly changing area of the carbon markets, such that the number and size of these funds may have varied considerably since publication.

Speculative Investors

The emergence of any new market attracts risk capital and early speculative investors and the carbon market is no exception. A number of hedge funds and private investment funds from Europe and the United States have begun to deploy capital either in the form of equity stakes in carbon companies or as purchasers and/or traders of carbon credits. These include:

Excitement about the future carbon market has even spawned the creation of new funds. In early 2006, publicly listed hedge fund Alpha Capital and Dutch Bank ABN Amro announced the listing of a new hedge fund on the London Stock Exchange seeking to exploit opportunities in new sectors including the emissions market (Point Carbon 2006d). The fund’s general partners were reported to be hoping to raise up to £80 million (€115 million) from the issue of some two million shares.

As the market matures, and liquidity and participation expands, it is expected that there will be a considerable step up in involvement from more mainstream investors, pension funds, foundations, and other plan sponsors, as has occurred in other markets such as commodities and mortgage backed securities.

Project Developers and Aggregators, Consultants

As the Kyoto project markets have taken off, so have the fortunes of many of these primarily small companies that have painstakingly developed portfolios of emissions reducing projects over the years. These companies have typically been involved in the market for many years, some since before the emergence of the Kyoto Protocol itself. Table 9.3 summarizes the size and nature of the portfolios of leading project developers, in addition to their respective positions in the market.

TABLE 9.3 Carbon Project Developers

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Equity Research

Like the commercial banks, the mainstream equity research houses (treated together in this section) have been relative latecomers to the market. However, as capital has begun to be attracted to the market, and as companies involved in the market have sought financial advisory and capital raising assistance, many established banks have stepped up their interest and sought to capture a share of the carbon finance market.

The growing involvement of the Wall Street banks is exemplified by the recent spate of research reports focused on the carbon market:

JP Morgan’s European Corporate Research team issued “All you ever wanted to know about carbon trading: Quick answers to some key questions” on January 11, 2006 (JP Morgan 2006). In the report, JP Morgan states that it believes that CO2 will grow in importance as an issue for European corporates—in all industrial sectors, and not just the power business—and hence for equity and credit markets.

Morgan Stanley’s European Equities group issued “Equity Plays on the Emerging Carbon Market,” which examined the background to the emerging carbon market, the fundamental drivers of demand for emission allowances, and initiated coverage of several carbon industry companies, including AgCert and Climate Exchange (Morgan Stanley 2005).

Merrill Lynch’s Commodities Group arranged a “Carbon Market Outlook Conference Call,” with the Head of Commodity Research and Director of Emissions Trading, in which they discussed market fundamentals and Merrill’s view on future direction of prices (Merrill Lynch 2006). The company followed this up by issuing a trading note, in which they articulated a belief that EU emissions are still undervalued versus fundamentals.

Goldman Sachs’ Environmental Policy Framework explicitly states that the company intends to act as a market maker in emissions trading (CO2, SO2), weather derivatives, renewable energy credits, and other climate-related commodities, and look for ways to play a constructive role in promoting the development of these markets (Goldman Sachs, n.d.)

A diametrically opposed view was represented by an e-mailed communication from UBS to its clients in early 2006 which said that the price of carbon allowances could collapse by May 15, adversely affecting power prices for utilities and hence their share prices, as there was a “significant possibility” that the carbon market was not as short of carbon allowances as was first thought (Point Carbon 2006e).

Deutsche Bank’s European Utilities team issued a report in November 2005 entitled “What if? The risk of much higher carbon and power prices,” in which they discussed the potential shortfall in permits required to meet the overall ETS Phase One cap, various other influences over the long-term price of carbon, and the implications for European power generating companies.

These and other bank-based research groups now compete with one another to produce the best research on the carbon markets, and the depth and quality of investment research in the sector will likely increase as the market continues its expansion.

Carbon Brokers

A number of brokers specialize in the carbon markets, usually as part of a strategic focus on the broader emissions and environmental products market. These brokers are active in both the EU ETS and the Kyoto project markets, where transactions continue to be highly structured and the value-add of a knowledgeable broker is considerable. The key brokers currently involved in the carbon markets include Evolution Markets, CO2e.com, Prebon, Spectron, TFS, ICAP, and Natsource. The relationships between those buying and selling in the market and their broker is an important one, and is determined by a number of factors including cost, trust, knowledge of the market, and transaction structuring skill. Brokers are a critical source of market intelligence for their clients on either the buy or sell side, particularly in the CDM and JI, where transactions tend to be more highly structured, larger in size, and lengthier in the execution. As the exchanges capture more market share within the EU ETS, the Kyoto project market and the regional carbon markets will likely be the primary hunting ground for carbon brokers in the coming years.

Exchanges

The following exchanges currently trade EUA contracts on a forward or spot basis: European Climate Exchange (cleared by IPE), European Energy Exchange, Energy Exchange Austria, NORD Pool, and Powernext. The ECX has managed to capture the largest market share of exchange-based trading thus far, followed by NORD Pool, and typically sees daily trading volumes of approximately 500,000 to 1 million metric tons. On the ECX, ECX Carbon Financial Instruments futures contracts are listed by the International Petroleum Exchange (IPE) and traded on the electronic trading platform owned and operated by the IPE’s parent company—Intercontinental Exchange Inc.—known as the Interchange or ICE Platform.

The IPE has even introduced an Emissions Trading Privilege for those members who are seeking to trade only ECX CFIs. The delivery mechanism for ECX-traded contracts is represented schematically in Figure 9.1

FIGURE 9.1 IPE’s membership categories and delivery mechanism

Source: European Climate Exchange.

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Currently, 16 clearing members are currently ready to offer clearing and trading services for clients in ECX futures contracts at IPE (as per May 9, 2005).3 Exchange-based trading is expected to increase steadily in the coming years as ETS market liquidity deepens and transactions tend toward standardized, anonymous, and fully cleared deals.

Credit Rating Agencies

The potential for carbon emissions regulation to impact the long-term creditworthiness of industrial companies has required the mainstream credit rating agencies—S&P, Moody’s, Fitch—to incorporate carbon finance considerations into their research processes. This is usually most relevant within the utilities and power/energy sector analysis. In their special report on Emissions Trading, written by the Global Power/North America group, Fitch provided an overview of the various emissions trading markets under development or currently operational. Fitch’s view was that it

anticipates more stringent pollution control requirements leading to increased operating and capital costs. A well-structured emission-trading program can assist companies in managing and reducing capital expenditures for compliance with environmental regulations. (Fitch Ratings 2004)

The involvement of the two primary rating agencies, Standard and Poor’s and Moody’s, has been more observation based. Both companies have been reported as incorporating carbon finance considerations into their respective bond rating activities, and are known to be tracking the emissions trading markets, particularly in Europe.

Insurers

The involvement of the insurance and reinsurance industries in carbon finance has been driven by two primary forces: a need to understand the potential impacts of climate change trends on the property, casualty, life, and health risks underwritten by the industry, and the sense of new business opportunities arising from the growth of the carbon market. As the two largest reinsurance companies in the world, Swiss Re and Munich Re, initially adopted broader market-building roles that sought to deepen understanding of the economic impacts of climate change and explore the development of new insurance products specifically designed for carbon market trading. U.S.-based insurance giant AIG has also recently begun to follow suit with a string of initiatives announced in early 2006 (LeBlanc 2006).

With the sudden expansion of the markets, particularly the Clean Development Mechanism, demand for carbon credit delivery guarantees that transfer, the risks of nondelivery of carbon credits away from the buyer or seller has increased. Counterparties to a transaction are increasingly seeking ways to remove the risks of nondelivery, and insurance has a key role to play in this. As the need for insurance products has increased, so the role of the insurance brokers, such as Aon and Marsh, has grown.

During 2005 and 2006, interest across the carbon markets has fostered more competition among insurance companies for carbon finance business, and large players such as AIG and Zurich have announced plans to introduce their own carbon delivery guarantees and project insurance products. As both the size and scope of carbon markets grows, and the financial consequences of noncompliance or poor risk management becomes a more significant financial issue, risk management and insurance services will become more prominent. Many industrial companies affected by the ETS do not view the emissions business as core to strategy, and increasingly look to transfer risks to third parties capable of helping them meet their compliance obligations. Larger insurance carriers, with their strong credit rating, risk-taking ability, market knowledge, client/investor relationships, and global reach, have a natural role to play in the development of the market. The development of integrated risk management product offerings, that hedge total climate-related risk together (weather, emissions, and power), is a particularly attractive growth area for the larger insurance players.

KEY PLAYERS FROM THE PUBLIC SECTOR

National Governments

National governments have been long-time actors in the carbon markets as early purchasers of carbon credits and as architects of the Kyoto Protocol itself. Annex 1 governments with emissions targets under Kyoto have tended to purchase CERs and ERUs either directly, or through intermediaries. Direct purchases have typically been made through competitive tendering or direct sourcing. An example of this is provided by the Danish government, which issued a public Request for Proposals for an undisclosed volume of CERs and ERUs via a rolling tender process in early 2006. The Dutch government, among others, has also been a noted leader on a national level, issuing public competitive tenders for CERs and ERUs very early in the Kyoto process well before the Protocol had entered into force.

Indirect sourcing activities typically involve the retention of a third-party organization to administer funds on the government’s behalf. The Dutch government has also been active as an indirect purchaser, setting up a dedicated carbon credit purchasing facility within the European Bank for Reconstruction and Development, for example. This facility has been an active buyer of ERUs from central and eastern Europe JI projects. Other governments have begun to follow suit. In fall 2003, the World Bank entered into an agreement with the Ministry for the Environment and Territory of Italy to create a fund for Italian private and public sector entities to purchase carbon credits from CDM and JI projects (World Bank, n.d.). Similar facilities have also been established for the Spanish, Danish, and Dutch governments. Advising and administering funds on behalf of national governments has been and will continue to be an important role for carbon businesses as the markets expand.

National Business Associations

In addition to sourcing credits themselves, governments have also encouraged national business associations and other institutions to enter the carbon market. In early 2006, for example, the Swiss government has formed the Klimarappen or Climate Cent Foundation, which aims to purchase 10 million metric tons of greenhouse gas (GHG) emission reductions (10 Mt CO2e) by 2012 from CDM and JI projects. The Climate Cent Foundation launched activities in October 2005 as a voluntary initiative of four major Swiss business associations.4 The Foundation is a completely private-sector, compliance-driven buyer. It will invest its annual revenues of 100 million Swiss francs (around $65 million), generated by a charge levied at a rate of 1.5 Swiss cents (1.0 cents) per liter on petrol and diesel imports, in effective and credible climate protection projects in Switzerland and abroad.

Similarly, the Japan Carbon Fund, established in December 2004, represents the carbon credit purchasing vehicle of several Japanese private sector enterprises and public lending institutions, including the Tokyo Electric Power Company, Japan Bank for International Commerce and the Development Bank of Japan. In Germany, government banking group KfW has set up a carbon fund in cooperation with the Federal German Government in order to purchase emission credits from JI- and CDM-projects. Three-quarters of the companies participating in the Fund are German, the remainder comes from Austria, Luxembourg, and France. The majority is power generating companies, but chemical and cement companies also participate. The fund has a total of €80 million available for purchasing credits and signed its first deal, the purchase of CERs from an Indian HFC 23 project, in October 2005.

Multilateral Banks

The formation of the World Bank’s Prototype Carbon Fund, which gave governments and large corporations a low-risk vehicle for accessing carbon credits and which as of July 2006 had approximately $180 million under management, provided the organization with a dominant position in the Kyoto project markets through the end of 2005. The various World Bank purchasing facilities have subsequently been consolidated through the establishment of the World Bank Carbon Finance Business and the concomitant creation of other carbon funds, including the Community Development Carbon Fund, the BioCarbon Fund, and several nationally oriented carbon funds.

The World Bank’s private investment arm, the International Finance Corporation (IFC), has also been active in the carbon finance markets through its Carbon Finance Facilities. These facilities, which as of May 2006 had approximately $80 million under management, are designed to purchase CERs and ERUs on behalf of the Government of the Netherlands.

Similarly, the European Investment Bank (EIB) made early efforts to develop carbon-focused funds, in the form an agreement with the World Bank, to pursue a Pan European Carbon Fund to support climate friendly investment projects throughout Europe. The primary focus of EIB’s activities at present is the Multilateral Carbon Credit Fund (MCCF), a joint effort with EBRD that will generate carbon credits from projects in central and eastern Europe and the Commonwealth of Independent States (CIS). The MCCF will be open to public and private-sector participants, and will use external private carbon managers to handle certain operational activities. Finally, the Asian and Inter-American Development Banks have each announced plans to create special financing vehicles for CDM projects in their respective regions of operation.

INFORMATION SERVICES

The availability of timely, reliable, and accurate information on the state of the market and the existence of secure, dependable trade execution and settlement infrastructure are clearly two critical elements of any properly functioning marketplace. Traders need information to develop and execute trades, develop trade structures, negotiate transaction terms and conditions, price their bids and offers, understand their financial exposure, quantify risk factors and market volatility, and interpret fundamental market trends. The development and creation of high-quality, credible information networks has therefore been an important stage in the maturation of the market.

Such information is primarily provided by carbon exchanges and brokers. Market data, including daily bid-ask-last prices; daily settle prices; spot, forward, and options trades; and implied volatility data, are obtained in real time from brokers (Evolution Markets, TFS, Natsource, GTI) and exchanges (ECX, EEX, Powernext, NORD Pool).

The most prominent independent supplier of carbon market research and information is Point Carbon. Point Carbon publishes daily price charts and research on market fundamentals, as well as complete listings of CDM and JI projects and host countries. Other sustainability-oriented research and investment advisory companies such as Innovest and IRRC have also begun to supply specialized information on the carbon assets and liabilities of large publicly listed companies, and the Carbon Disclosure Project collects and publishes information on the carbon market strategies of some of the world’s largest industrial companies. Dow Jones Newswires, Platts, Argus, and Reuters also provide subscribers with daily market summaries that include data on prices, trading views, and news on basic market drivers.

PROFESSIONAL SERVICES

Accounting

The accounting and tax treatment of carbon credits is another important consideration for market participants. Although there has been considerable progress on the issue over the course of 2005 and 2006, this is still an area of considerable uncertainty, with many key questions yet to be resolved. In a recent report on the carbon markets, PricewaterhouseCoopers (PWC) summarizes its tax specialists’ current views on how emissions trading should be treated from a corporate income tax and value-added tax (VAT) perspective. Accounting practices in the carbon markets are typically based on an analysis of existing sources such as case law and discussions with authorities, which are ongoing.

Legal

Law firms have been involved in the development of the carbon market since the early stages of the Kyoto Protocol negotiations, the development of the flexible mechanisms, and the formation of the EU ETS. In addition to the basic legal design issues surrounding these systems, the focus of legal activity has been the establishment of title over the emissions credits themselves, the means by which title can be transferred via trading, the content and design of transaction agreements, the regulations dictating how companies can trade on the ETS, and so on. Many companies have had to develop in-house legal expertise as their trading activities have escalated, and the number of lawyers specializing in carbon trading has risen steadily since early 2005.

NEW HORIZONS FOR THE CARBON MARKET

Carbon as an Asset Class

The first phase of the transformation of the carbon markets from a negotiated policy instrument to a functioning economic marketplace appears to be complete. The requisite financial and capital market functions are at an advanced stage of development and buyers and sellers are coming forward. As the secondary market forms, liquidity deepens and fundamentals become more economically rather than politically motivated, the shift toward carbon becoming a genuine asset class will undoubtedly hasten. As this process takes place, carbon will increasingly be seen like other commodities, and will come to be traded and financed and underwritten. Underpinning this evolution, however, is the attachment of economic value to avoided greenhouse gas emissions. It is critical to remember at all times that emissions themselves are not an economic good, only the avoidance of emissions as framed by international political convention. Thus, a fundamental political and social commitment to reducing greenhouse gas emissions through the use of market-based policy instruments is the ultimate determinant of carbon value and the viability of carbon as an asset class in the future.

Mainstreaming into Project Finance

The recognition of carbon as an asset or liability, as a future source of cash flow or expenditure, or as a source of return and risk, means that the introduction of carbon finance into the mainstream of financial decision making is assured. However, whether it will become a major factor or merely a marginal one remains to be seen. The attachment of a clear and predictable price signal to avoided carbon emissions will be a critical factor. Also important will be the attitudes of carbon market authorities, who must approve their quality as compliance instruments (for example, on the additionality issues that relate to the environmental integrity of emissions reductions) in order for the market to value them. Before established providers of project equity, mezzanine and senior debt within the large, emissions-intensive industrial sectors can price future carbon credit cash flows into the financing equation, they must be confident that these cash flows will materialize and that they will have a value that can be reasonably predicted. When this happens, carbon finance will have taken a step closer to becoming more fully integrated into mainstream project finance.

CONCLUSION

The key players in the carbon markets have evolved rapidly over the past 24 months as the market has grown. Early market movers were primarily government-sponsored entities, large corporations establishing strategic positions, environmental consultants trying to grow the market, and small entrepreneurial outfits trying to gain early commercial advantage. Nowadays, the major players are major industrial GHG emitters, international financial houses, large hedge funds, clean energy technology providers, and specialized brokers, traders, and professional services providers. As the size and scope of the market continues to expand in the years to come, the need for specialized carbon finance expertise and services across the financial services industry will grow commensurately. However, unlike in the early days of the market, this expertise is more likely to be embedded within much larger mainstream financial and corporate institutions.

1. www.missionpoint.com.

2. Author’s discussions with ETS brokers.

3. ABN AMRO Cargill Merrill Lynch

ADM Investor Deutsche Bank Morgan Stanley

Bear Sterns Fimat Banque Refco

BHF Bank Fortis Clearing UBS

BNP Paribas Goldman Sachs

Calyon Financial MAN Financial

4. Swiss Business Federation, Swiss Association of Small and Medium Sized Enterprises, Swiss Road Federation, Swiss Petroleum Association.