Cloudy outlook for carbon markets

Carbon market participants are downbeat on future expansion thanks to global politicians' failure to make any binding decisions in Copenhagen in December. Maybe it's time to rethink the United Nations' role in climate change management.

Not surprisingly, there's a gloomy outlook for any expansion in new carbon markets this year, thanks to policy uncertainty, according to respondents to a recent carbon market survey. However, confidence in existing market segments remains solid.

Between January 20 and February 4, Point Carbon, which is a provider of analysis and consulting services for global power, gas and carbon markets, conducted its fifth annual carbon market survey. Yesterday, the organisation released the results of the survey, which garnered 4,767 responses from 118 countries -- the highest number of respondents to date, making it arguably the most comprehensive overview of the international carbon market to date.

The ABCs of carbon trading start with the Kyoto Protocol to the United Nations Framework Convention on Climate Change, which came into force in February 2005, and defined targets for developed-country emissions during the 2008 to 2012 period. Hopes had run high that this past December global leaders would agree at a meeting in Copenhagen to continue this agreement in some shape or form. But no solution was reached.

The Kyoto Protocol also prompted the launch of the EU's Emissions Trading Scheme (ETS). The EU ETS is the world's first international greenhouse gas emissions trading scheme. It works on a cap-and-trade basis, where the total volume of permitted emissions -- the cap -- is set at the start of a trading period. EU Allowances (EUAs) are the tradable units under the EU ETS, each representing a permit to emit one metric tonne of carbon dioxide equivalent (CO2e). Up to a certain limit, companies regulated by the EU ETS are also allowed to use carbon credits from third countries -- and this is where Asia typically comes into play -- instead of EUAs.

Some 70% of respondents to the recent poll expressed dissatisfaction with the lack of a decision from the Copenhagen meeting. This dissatisfaction was evident in all countries polled, and only just a bit more than a third of respondents (37%) said they expect a deal in Cancun (where the next UN Climate Change Conference will be held at the end of this year), down from 59% who had expected Copenhagen to yield binding agreements when asked this time last year.

Hopes for a US cap-and-trade scheme by 2015 are also fading. Only 61% of the respondents now believe this will happen -- the lowest level for three years and down from 81% in last year's survey. Respondents this year anticipate a lower global carbon price of €31 ($42) in 2020 than the €35 that was predicted last year.

Interestingly, only a month ago, Point Carbon forecast that the global carbon market will be worth $170 billion in 2010, up 33% on last year -- thanks to growing volume and value from some areas, which goes to show that forecasts can vary depending upon whom you ask.

"To what extent this anticipated reduction in carbon prices may impact investment in the longer term is not yet clear, but 47% of respondents representing companies covered by the EU Emissions Trading Scheme (ETS) cited the long-term carbon price as a decisive factor for new investment," said Endre Tvinnereim, senior analyst and one of the authors of the report.

And then there's the issue of corruption, which could be seen to be worse. So perhaps these poll results aren't too bad. In the Clean Development Mechanism (CDM) and joint Implementation (JI) arena, 15% of respondents said they had witnessed fraud, embezzlement or corruption in connection with a CDM or JI project and in China the figure was 28%. JIs and CDMs are the two project-based mechanisms which feed the carbon market. JI enables industrialised countries to carry out joint implementation projects with other developed countries, while the CDM involves investment in sustainable development projects that reduce emissions in developing countries.

A glimmer of good news

However, the survey also shows that, for the first time, an outright majority of respondents (54%) say the EU ETS has caused visible emission reductions in the companies they represent. Some 43% of all respondents think the EU ETS is the most cost-effective instrument for reducing emissions in the EU, against 20% who disagree.

And against falling optimism for a US ETS by 2015, in Japan, the share of respondents expecting a Japanese ETS is up from 61% to 80%.

"The survey throws up interesting issues regarding the UN and its future role, prompted by the clear disappointment expressed in the Copenhagen outcome by respondents," said Per-Otto Wold, CEO of Point Carbon. "The increased complexity of global climate negotiations is certainly making a global climate deal more difficult, and the consensus-based decision-making process chosen under the UNFCCC is not making this easier. Consequently, after Copenhagen, we may be entering an era in which talks move to other, less inclusive arenas. One potential way forward could be a pledge-and-review system, where countries present their mitigation policies, but where no international compliance mechanism exists."

While questions about the UN's role are perhaps inevitable, there were also some clear indications by respondents that faith in the UN is still strong in areas such as deforestation. Notably, three-quarters of respondents expect a post-2012 framework for reducing deforestation and forest degradation in developing countries.

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