Carbon Market Futures

Report for

Manchester Enterprises Study: Secondary Market Emissions Trading

Prepared for Baron Frankal

By Wood Holmes Group Ref: 3455

November 2008

Manchester Enterprises Study: Secondary Market Emissions Trading Contents 1

Introduction and Overview

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2

Key Principles of the Carbon Market

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Considering an Uncertain Future

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Strategic Directions for GM

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Proposed Action Plan

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Final Thoughts and Next Steps

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Appendix 1 – Carbon Market Details

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Appendix 2 – PESTEL Analysis

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Introduction and Overview This report documents progress in a study of the emissions trading market undertaken

by Wood Holmes Group on behalf of Manchester Enterprises.

In 2008 the Climate Change Agenda and subsequent profile of Carbon Dioxide (CO2) emissions has fuelled the development of the Carbon Market. Divided into regulated and voluntary systems, the market currently presents a series of tradable credits, prime examples being; CERs, ERUs, EUAs, RECs, VERs, and CFIs. ‘Global carbon markets worth €40 billion in 2007, up by 80 percent from 2006. The total traded volume increased by 64 percent from 1.6 Gt (1.6 billion tonnes) in 2006 to 2.7 Gt in 2007’ (Point Carbon 2008) The UK arguably occupies a position of leadership in this developing arena of emissions trading. In policy terms the UK pioneered the operational concept in the form of the UKETS; the voluntary precursor of the current EUETS and this leadership continues with Defra’s Offset Standard and the establishment of the UKCRC trading scheme. This is reflected in business, with the UK being home to a series of industry leading players across primary, secondary segments of the voluntary and compliance markets.

However, the future of the market is subject to uncertainty internationally as competing political responses to climate change threaten crucial regulatory mechanisms and implications of the global financial crisis are yet to mature. The proposed relief for those businesses mandated by the EU ETS trading scheme1 presents a clear indication that current economic conditions challenge this developing market. Yet, despite such challenge, the fervour with which individuals on the EU council, G8, and UNFCCC pursue the climate change agenda, paired with key documents such as the Garnaut Climate Change Review2, continue to bolster political mechanisms that drive the market.

The World Bank, considering prospects for the carbon market in mid-2008, repeatedly considers high annual growth rates amidst volatility and risk influenced by a series of economic, political, and social drivers3. Looking forward at the end of 2008, a series of milestones in the political debate are on the horizon as the future of the Kyoto Protocol post-2012 is considered. A key issue for this report is to consider how such trends, and more, integrate to determine the future.

1

Mathiason. 2008. ‘EC set to grant industry relief on carbon trading’. Observer 12/10/08. http://www.guardian.co.uk/business/2008/oct/12/europe-carbon-trading 2 Garnaut. 2008. ‘Garnaut Climate Change Review: Final Report’ 3 World Bank. 2008. ‘State and Trends of the Carbon Market 2008’.

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Within this context, the opportunity for growth and leadership presented to Greater Manchester (GM), specifically its financial and professional services sector, appears to be immense. However, the market is relatively novel, complex in its composition, with growth trends uncertain, and component risks high; under such conditions, the critical targeting of specific, risk balanced, and achievable strategies for growth in GM must be developed.

In response, Wood Holmes Group have developed an approach that directly answers the inherent complexity and uncertainty to deliver reliable analysis capable of informing robust policy decisions focused on securing Manchester’s key position in the global market. The key terms of reference for the work are:

1. Foresight analysis of the qualitative/quantitative prospects for the carbon emissions trading market founded on a full-spectrum ‘PESTEL’ analysis of trends and drivers

2. Exploration of key dimensions of the future market, applying the foresight research within the Scenario Planning approach to effectively address aspects of uncertainty, risk, and probability. Specifically delivering visions of the nature/structure of the future market and its growth

3. Mapping of the decision making framework adopted by key players in the market when targeting strategic investment in specific locations; considering specific patterns of perception, attractors, and priorities

4. Development of a strategic Action Plan to drive inward investment from players in this market into Manchester over both the immediate/short-term and longer-term in conjunction with the developmental strategies supporting indigenous growth

The following sections provide a guide through key research and analysis phases, concluding with an action plan for the development and growth of GM’s specific emissions trading activity.

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Key Principles of the Carbon Market The global carbon emissions trading market presents a relatively novel and evolving system which, in 2008, is characterised by a high degree of nuance and complexity in both its structure and operation. A fuller review of the key structures and dimensions of the carbon market are outlined and discussed in Appendix 1, it is strongly advised that those with no prior understanding of the carbon market read that section.

The Carbon Market has emerged as a core principle of the climate change agenda and associated political objectives to reduce (mitigate and abate) national/global CO2 emissions. The Kyoto Protocol, which came into force in 2005, placed formal emissions reduction targets on signatory nations delivered in the form of tradable credit emission ‘allowances’. In 2007, the Bali Roadmap set out a development process for a Kyoto post-2012 successor to be ratified at Copenhagen in 2009. Key downstream impacts of Kyoto include the establishment of the EU’s Emissions Trading Scheme (EUETS) which has run since 2005 and the proposed initiation of the UK’s Carbon Reduction Commitment (UKCRC) trading scheme in 2010.

In 2008 the international emissions trading market presents a fragmented stage of development in which multiple forms of a carbon credit (Fig 1) pass, with restrictions, within and between component segments. Recent figures from leading observers such as Point Carbon place the global carbon market-worth in 2007 at €40b up 64% from 2006; proposing a growth to €63b in 20084.

Fig 1 – Carbon Credits Although traded carbon credits are almost universally presented as a CO2 tonnage (tCO2e), the following fundamental classifications must be recognised: Allowance-based Project-based Corresponding to units of carbon that Corresponding to units of carbon together form the total acceptable VS. generated by abatement projects emissions limit or ‘cap’ imposed on a developed specifically to reduce or mandated facility reverse CO2 emissions AND Compliance-grade Voluntary-grade Credits created under international and Credits created under varying national regulatory frameworks for use VS. standards outside formal regulation within mandated trading schemes applicable to CSR-type voluntary ‘offsetting’ markets

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Point Carbon – ‘Carbon 2008’ – www.pointcarbon.com

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Three dominant credit types illustrate the implications of such a classification scheme:

EU Allowance (EUA) – allowance-based compliance-grade credits issued to mandated facilities within the EU Emission Trading Scheme (EUETS).

Certified Emissions Reduction (CER) – project-based compliance-grade credits generated by the Kyoto Protocol’s Clean Development Mechanism (CDM) applicable to a number of compliance schemes including the EUETS.

Voluntary Emissions Reduction (VER) – project-based voluntary grade credits generated by a number of non-regulatory standards serving CSR markets often in an offset-retail format.

Despite the diversity in the carbon market, the significant majority of trade can be associated with two components; the EUETS and CDM markets. In 2007, the EUETS demonstrated a traded volume of 1.6Gt (62% global market) and a value of €28b (70% global market) whereas the CDM market presented traded volume of 947Mt (35% of global) and a value of €12bn (29% of global) with an increasingly prominent secondary market component.

The nature of trade includes exchange trading, OTC, and bilateral trades across primary and secondary market segments. As the market evolves in the late 2000s, the secondary market has shown significant growth with key components including EUETS exchange trading and the secondary CERs market. In this process opportunities are increasingly recognised by established players in the financial and professional services sector; an evolutionary trend recognised by Alexandre Kossoy of the World Bank5: ‘Financial institutions have entered the carbon world acquiring pioneering carbon aggregators and building a base for origination of carbon assets globally. An increasing number of carbon contracts and carbon-based derivatives are becoming available. Specialized companies and institutions have sprung up to service several aspects of the carbon value chain; some have begun to pair carbon finance with more traditional skills found in other commodity markets’ The result is a complicated value chain populated by specialist new ventures and longestablished businesses which combine to form mutually supporting business ecologies.

In the primary market activities surround the development of project-based assets (CDM, JI, etc) which implicates a series of project development consultants, financiers, engineers, etc. In addition primary market also concerns the initial sale of allowance based credits to mandated businesses either through state-run auctions or sales of surplus credits; again implicating a sophisticated service/advisory sector concerned with emissions management and credit strategies.

5

World Bank. 2008. ‘State of the Carbon Market 2008

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In the secondary market activities are concerned with the trade exchange flow of project and allowance based assets from intermediaries to the end user and other intermediaries. Currently the secondary market implicates a series of established commodities trading businesses and investment banks supported by specialised trading platforms, exchanges, and registries.

The development of a business ‘ecology’ that supports carbon markets has been demonstrated most effectively by new venture and diversification within London’s financial and professional services sector strengths6. Informed by such examples, a complex value chain of constitutive carbon credit flows, financial instrument transfers, and service sector roles can be considered to form the global carbon market.

In order to allow an overview of the component value chains and key players in the carbon market the following diagram has been developed. For further exploration of the issues considered in the section and the graphic, please refer to Appendix 1.

Finally, within this overview, it is important to consider a future that presents uncertainty and risk associated with the projection of current growth trends and the impact of policy decisions made at international and national levels. It is this latter point that arguably presents the greatest potential impact as key compliance frameworks are dependant on international and national policy, and politics, postKyoto (2012). As of 2007, many nations have plans for emissions trading schemes post 2012 (UK, EU, NZ, AU, and JPN); the question may be whether political force will persist to drive their implementation. Such uncertainty clearly has implications for a risk-balanced strategy for Mancunian business; an issue that will be considered in following sections.

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IFSL Reseacrh. 2008. ‘Carbon Markets 2008’. June 2008, www.ifsl.org.uk

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2.1

Overview of the Carbon Market Associated Groups: Governance Legal and Regulatory

Support Services Quality Control, Legal Advisory, Knowledge and Research, Capacity Building, Registries

Intermediaries Financial firms mediating compliance and voluntary trades without end-user motive:

Suppliers Market system concerned with the design, planning, and implementation of projects resulting in carbon credits: Project Consultants

Brokers

End users

Traders

Exchanges

Project Developers Technology Providers

Speculative Investors

Local/Regional Policy Bodies

Governments Large Compliance Buyers

EU ETS

Trading Platforms

Finance Providers

Mandated Installations Carbon Funds

Arbitrage

CCX

UK CRC

Voluntary buyers:

Private sector financial business providing finance products to suppliers and end users:

Credit supply derived from individual cap-and-trade surplus:

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Primary credits Secondary credits Financing and hedging products Risk mitigation products Voluntary-credit (offset) retail Financial Instruments and derivatives

Compliance buyers:

Aggregators Project Financiers

Key

Individuals

Asset Managers Voluntary Credit Retailers

Risk Mitigation

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Businesses

3

Considering an Uncertain Future Currently, the carbon market remains in an early development phase relative to international and national policy objectives with steep growth trends in primary and secondary components establishing an expectation of rapid change in the market.

Furthermore, moving forward to 2012, a number of knife edge issues or forks in the road are evident; not least the political debate surrounding the Kyoto successor post 2012. Under such circumstances, strategic planning must integrate a degree of resilience to uncertainty and risk.

Within this context, scenario planning emerges as a key tool

The inherent complexity and uncertainty of future trends limits the value and increases the risk associated with policy based on single ‘best-bet’ futures; in response the scenario planning approach is increasingly adopted by business and policymakers alike.

The future scenarios developed for this study will each integrate trends and drivers in a holistic manner to outline the range of plausible futures; drilling down on key attributes, developing an understanding of key relationships, and identifying potential tipping points. Resulting policy decisions informed by such scenarios will thus be robust in the face of uncertainty and more able to act on emergent opportunities and identify barriers to growth/investment.

The following sections map out the process of scenario-set construction and subsequent development of strategic implications:

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3.1

PESTEL analysis Following on from a PESTEL analysis7 that has been informed by literature review and consultation, an array of trends and drivers with potential implications for the structure and practice of the secondary market are apparent (please refer to Appendix 2 for full discussions):

Faced with such diversity, the process of building relevant and useful future scenarios must be guided by the end-use of the scenarios as opposed to the exploration of a diffuse and abstract ‘general’ view. In the selection of specific trends and drivers for application within the scenario planning format, an emphasis on those trends and drivers with the greatest uncertainty and the greatest potential impact presents readers with the best opportunity to strategically address the inherent risk, uncertainty, and complexity:

*

Prime Issues

* Degree of Uncertainty

*

*

*

*

*

Trends and Drivers

Extent of Potential Impact

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Political, Economic, Social, Technological, Environmental, Legal/Regulatory trends identification and analysis

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Through this process, the following trends have emerged, through literature review and consultation, with the highest impact/uncertainty regard: National and international policy Political determination has proved the strongest driver of the climate change agenda.

Globally, this has been is achieved in the main through the UNFCCC and Kyoto.

Whilst only part of the climate change agenda, one of the most significant translations of the political drivers has been the establishment of regional and national emission trading schemes that are gaining increased uptake even from non-Kyoto signatory countries such as the US. The key drivers are the political debates around the Kyoto successor, LiebermanWarner bill and the wider climate change agenda.

Global recession and financial downturn Economic trends and drivers are clearly essential considerations when analysing the carbon markets. The commodity model of the carbon markets provides the economic incentives of cap-and-trade, but wider consideration is required of the strong linkage to broader issues of energy prices and global political processes.

Currently, markets are mainly based on regulatory requirements that support supply and demand. However, the key economic driver of the carbon markets is the current global economic downturn that reduces project investment, yet also results in emission reductions as a consequence of reduced productivity.

Perceptions of climate change Perception strongly influences actions taken to mitigate the effects of climate change.

Directly, social concerns impact the voluntary market through a greater uptake of voluntary credits motivated by individual or organisational CSR. Indirectly, public perception of the importance of the issues of climate change drives political action.

The impact of climatic events, media interpretations, and political messages influence how perceptions form and are acted upon.

Advances in mitigation and adaptation technologies Technology is inherent in the carbon markets, being associated with the practicalities of trading as well as the development and trade of carbon assets.

Technologies used in carbon trading apply to all commodities, but can enable the establishment of smaller niche exchanges that emerge out of markets such as carbon related trading.

Carbon assets are driven by technological innovation. The mitigation of, or adaptation to climate change are driven by technology. Renewable energy installations result in Job no - client name - 04/11/2008 Š Wood Holmes Group Limited

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credits and innovation such as carbon capture and storage can be funded by credits when the feasibility of technology and price meet.

Climate change impacts The understanding of anthropogenic effects on climatic conditions was the key motive to act against climate change. Environmental events that may be caused by climate change directly impact the carbon markets as social awareness increases political and economic pressures. Therefore, it is evident that environmental conditions will continue to affect how the carbon markets function to help mitigate and adapt to climate change.

Harmonisation Regulation drives the compliance that constitutes the majority of the value of the carbon markets. Value is created through the scarcity of carbon credits. The assets that generate these credits are diverse in origin and result in a variety of credit types within limited or no fungibility across trading schemes. Outside the far smaller voluntary market, this lack of credit harmonisation reduces the trading of credits beyond regionalised schemes.

3.2

Scenarios Through the integration of key trends, plausible future scenarios with internal integrity are presented. Three mutually supporting scenarios for 2014 have been constructed which each illuminate distinct issues for application in strategic foresight. In this manner, the goal is not to find a single expected scenario, rather to establish a set that considers the range of diversity and complexity in a manner that is capable of conferring robustness to subsequent policy thinking. As such, scenarios must be considered as a set.

Key issues to be considered in each include:

structure of the market

nature of profit

technological basis

business models employed

skill sets employed

key players and their business relationships

nature of transactions

size of the market (global/EU)

legal conditions

size of components

The implications of three scenarios are discussed (NB – key statistics are based on Point Carbon, New Carbon Finance, and Caisse des Depots statistical releases8):

8

www.pointcarbon.com, www.newcarbonfinance.com, www.caissedesdepots.fr

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Scenario 1 – Emergence of the Single Carbon Market Following the widespread ratification of the Kyoto Protocol’s successor at the Copenhagen summit in 2009, paired with the U.S. adoption of ‘Lieberman-Warner’ type cap and trade mechanism, the political force necessary to support growth and extension of a truly global carbon market is in place by 2014.

The impetus developed at international policy level is echoed in the execution of cap and trade emissions trading schemes, broadly modelled on the EU ETS, in the U.S, EU, Australia, New Zealand, Canada, Japan, Korea, Mexico, and Turkey. Key policy instruments such as the UK Climate Change Bill and EU ‘20/20/20’ policy are pivotal factors leading up to 2010.

As a result, the $100bn mark reached by the global market at the end of 2008 extended to $650bn by 2012 in a manner expected to continue to a point of $3 trillion per year by 2020 (a trading volume of ~40Gt CO2e per annum). Despite a slowdown in early 2009, the political support of climate change agenda components such as renewable energy and energy efficiency projects confers a degree of resilience to carbon trade amidst global recession.

The U.S. emissions market accounts for 65% of the global total, with the EU controlling the second largest share. In this 2014 state, global trade is achieved through the development of the primary and secondary components evident in 2008.

In the primary market, development of emissions reduction projects implicates a host of energy and efficiency engineers, technologists, financiers, and consultancies spanning renewable energy and emissions management arenas. In addition a consultancy market servicing the emissions management (measurement, reduction, and credit management) continues to build around mandated facilities in the UKCRC and EUETS. The secondary market too demonstrates sustained growth as secondary CER (sCER) markets continue to grow, and carbon derivatives become essential tools in the linkage of different national schemes. The secondary market is populated by skills derived from established commodities trade and whilst new businesses are evident, the majority of players reside within established institutions supported by a restricted number of specialised registries and exchange/auction platforms.

Traffic in the market concerns sales of credits into the secondary market and direct to consumers, as well as the allowance scheme auctioning. In the secondary market, derivatives and securitisation develops novel carbon products with relevance to the broader financial sector. As such, OTC, bilateral, exchange, retail, and auction creditpathways are apparent.

A key component of the carbon market is the carbon fund, as an attractor of new private-sector money into the market, an investment vehicle, and as a crucial financier of credit-resulting mitigation/abatement projects across CDM and JI systems, extending Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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to voluntary/CSR relevant projects. In 2008/2009, funds such as Sindicatum Climate Change Partnership, Akeida’s Environmental Master Fund, Arcelor Mittal Carbon Fund, Nordic Carbon Fund, NEFCO Carbon Fund, Brazil Sustainability Fund, Credit Suisse CER Fund, DWS CO2 Opportunities Fund (closed $4.5m), and Green Ventures India Carbon Fund demonstrated an ability to attract new money amidst the turmoil of financial crisis.

As the compliance sector develops, harmonisation of international standards in the voluntary market was pushed through by 2010; the resultant new VER carrying a respected verification process that facilitated its restricted inclusion into specified compliance schemes as well as voluntary CSR-orientated retail sales.

Calls for global harmonisation of project-based credits across fragmented and loosely linked national schemes remain, with the international acceptance of CDM and JI credit systems being fungible on all schemes developing in 2012. In the meantime, a number of accreditation systems persist in a manner that continues to support a sophisticated measurement, verification, and accreditation industry surrounding mitigation and abatement projects.

Severe climatic conditions and diplomatic incidents around energy and resource massively raised public awareness as to the importance of mitigation measures and, increasingly the adaptive responses to climate change and energy security.

Subsequently, and with recovering economic conditions towards the end of 2010, the voluntary carbon market had a large and sustained uptake for projects investing in energy efficiency measures and renewables with CSR-orientated individuals and SMEs outside mandated schemes accounting for the majority of traffic.

Ultimately in 2014, the top-down origins of ETSs paired with the continued development of the voluntary market serves to enhance the awareness of carbon capand-trade principles and the relationship between carbon prices and resource costs.

This clear and increasing link between costs and carbon emissions drives public demand for a bottom-up approach to emissions trading in a manner that appears to support movements toward a carbon economy post-2020.

Potential Implications for the UK and GM:

Development of EUETS and UKCRC presents opportunities for a service/support sector presenting an emissions management portfolio drawing in established energy and efficiency sectors and linking with low carbon economy arenas

Initiation of the UKCRC presents a legal/regulatory system, and associated industries to roll out across English regions

Increased demand for mitigation projects drives renewable energy R&D and associated academia

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Infrastructure (energy) project development arenas will increasingly be implicated in mitigation/abatement projects within CDM, JI, and Voluntary systems across overseas forestry, renewable energy, resource efficiency, and built environment arenas.

Technological/academic expertise in the fields of measurement and verification; leadership in such areas presents a clear opportunity

The secondary financial intermediation market will swell, albeit arguably subsumed within the existing commodities trade infrastructure of financial centres supported by specialised registries, state-sponsored auctions, and exchange platforms

The voluntary, CSR-orientated market would continue to grow amongst an increasingly aware public and within businesses not mandated by the UKCRC/EUETS framework; credit-retail opportunities are apparent

The relative flexibility of voluntary credit verification (when compared to CDM/JI) presents a series of opportunities to drive low carbon economy improvements in the regions with associated carbon credit revenues. Again low-carbon technological R&D appears as a key opportunity.

The complexity of a bottom-up system will require innovative solutions to issues of allowances, monitoring and management. As with verification, it is likely that respected academic organisations that have been working in this field will provide the initial research for practical implementation, with spin-out or partnering firms then implementing systems nationally and internationally where required.

Scenario 2 – More of the Same In 2014, a highly fragmented carbon market system with restricted primary and secondary components persists.

The economic slowdown that built in 2008 slowed the political process across the EU, U.S., and Kyoto signatories such that the EU’s 20/20/20 objective and the Bali Roadmap to Copenhagen in 2009 suffered repeated setbacks. The outcome in 2009 was an agreement supporting the principle of emissions trading that suffered from delayed or absent ratification from key nations and was unable to agree tougher emission reduction targets.

In the EU, countries opposed stringent cap-and-trade schemes and compromises were set that saw a commitment to continue the EU ETS but with a stronger focus on the immediate financial concerns. Further regionalised approaches were seen globally, with introverted solutions to balance climate change mitigation and economic pressures.

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Under such conditions a globally fragmented system of numerous emissions trading schemes, each with specific credit types, predominate; led by the EUETS phase III and national schemes in the UK, Australia, and Japan. In essence, regionalised economic recoveries paired with developed vs. developing status determined patterns of ETS uptake post 2012.

In the secondary market, stability was conferred by policy stability in active cap-andtrade systems which supported sustained growth post-2008. Without the U.S. entry into the carbon market, a fragmented system of regional and national ETSs is still capable of reaching the $550bn mark by 2012, and projected to reach $2trillion per annum by 2020.

Serving harmonisation, the secondary market derivatives further presented a vital source of funding for project development in the primary market. However, the fragmented political debate continues to populate the market with a large and diverse range of credit types, rather than a unified system of measurement and accreditation.

In the primary market, the business network supporting the development and execution of CDM and JI mitigation and adaptation projects received continued public and private finance support. However, the diminished force of private finance post 2008 paired with bureaucratic barriers in the planning process restricted progress in large-scale renewable energy development. In the UK, U.S. and EU, support of new fossil-fuel power stations in response to feared threat to energy security diverted renewable energy funding streams.

The demand for technological innovation in the primary market is a key issue in the CDM project market as larger infrastructure projects are increasingly replaced by an equal frequency of smaller mitigation/abatement projects in a manner that limits CER volumes with knock-on effects for trading patterns. This process of replacement is due to the progressive completion of larger, easier to deliver, projects rather than decreases in the demand of subsequent credits.

In this environment of diminishing project types, populated by investors aiming to balance delivery risk with pre-compliance, innovation for mitigation/abatement projects is an increasingly prominent issue. As such, expertise in the cost effective design, development, and execution of novel projects presents opportunities to players in the primary market.

The public perception of climate change paired with the media response to major weather events fuelled consumer demand for CSR-orientated voluntary credits.

However, financial restraints and ‘greenwash’ critiques continued to stifle growth in voluntary market; as such a distinct demographic pattern of those who are ‘able to afford’ dominates the voluntary market.

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were becoming increasing affordable and competitive with the rising fossil fuel dependent energy prices. With the prospect of sustainable and secure energy, along with a recovering global economy in 2012, there was increased investment in renewable technologies.

Potential Implications for the UK and GM:

A risk-balanced strategy of development must acknowledge the uncertainty that faces the market. This drives attention towards the opportunities associated with players not dependent on the carbon trade alone

The economic conditions expected over the short to medium term are likely to limit the rate of growth in the carbon market with implications for growth and development across the primary and secondary markets.

As the economic climate improves there is likely to be increased harmonisation between carbon credits and a move towards standardised top-down trading systems. This will see renewed growth in the emissions trading market, building on the long-standing strength of the UK in this industry.

Lack of harmonization allows smaller scale, local and voluntary schemes based on CCX example to be trialed

For GM an opportunity to establish itself as a centre providing services related to top-down emissions trading is apparent. These include carbon footprinting and emissions management systems, carbon abatement technologies, energy efficiency services, provision of carbon credits, and finance.

Exposure and risk become key principles of the secondary market

Low-carbon, green-tech, renewable energy, and energy efficiency value chain emerge as a pivotal sector with a degree of resilience to fluctuation in carbon market sentiment following political debate

The demand that a top-down system will create for project credits is likely to result in opportunities for carbon funds investing in CDM and JI (or future equivalents)

Expertise in the design, management, and financing of innovative projects is increasingly sought as new technologies and locations are considered

The key role of political leadership supporting regional and local schemes presents a key opportunity

There will be a need to bring suitable adaptation technologies to market by effectively bridging technical, financial and business networks and services.

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Scenario 3 – Dominance of Adaptation In 2014, the global economic crisis that built over 2008, and the subsequent recession that swept Western EU nations and the U.S. took priority over other issues, including the climate change agenda. Within this context, relief of the cost burden associated with the EUETS, slow progress of the Lieberman-Warner bill, and reduced force behind the Bali Roadmap to the Kyoto successor reduced the size and value of the carbon market.

As such the ETS concept persists in national and international policy, yet presents a series of intractable debates blocking their implementation which amplified by a decreasing regard for trading as a valuable measure within the climate change agenda.

Environmentally, events between 2010-2012, made the ‘tipping point’ an apparently past occurrence; shifting attention towards adaptation rather than hopes of neutralizing the pace of climate change.

The relative collapse in demand, caused dramatic price reductions, and challenges for those relying on the revenue to execute CDM and JI projects; as a result, the market value appears set to dip below 2006 levels (~$25bn), with significant increases in the voluntary sector share.

The financial intermediation sector witnessed the most dramatic decline in traffic and value as the demand for derivatives that was supported by the high value growth of the carbon market between 2005 and 2008 had greatly diminished by 2012. The lag in the initiation of a compromised EUETS phase III presented the largest blow in this regard.

Despite such broad decline, elements of the secondary market became too big in 2008 to simply dissolve away; in this regard an element of self perpetuation is evident in the secondary market where the CCX voluntary cap and trade model persists to a degree regionally in the EU, UK, and Japan beyond 2012.

Within the political debate, IPCC updates, paired with Stern and Garnaut Reviews began to emphasise adaptation as a response to climate change in preference for perceived futility of mitigation efforts. This message was supported as, still in a period of global recession, there was a need to continue to reduce energy usage/costs, and also supply affordable, reliable and secure energy.

As such, renewable energy driven by ‘resource efficiency’ rather than ‘emissions reduction’ became a key political objective. In this manner, renewable energy and energy efficiency project developers (and associated service sector players) that formed around the primary carbon market maintain activity, albeit driven by different revenue streams. These revenue streams were skewed towards the public funding (PFI/PPP) that remained in the absence of private sources. The period 2008-2012 presented distinct challenges for key players as the private revenue from key Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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instruments such as carbon funds was replaced to a lesser degree by public budgets and smaller scale private adaptation/efficiency projects.

Furthermore, the cautious attitude of the financial credit market post-2008, stifled large scale energy projects.

Forestry emissions mitigation projects suffer harsh criticism from the mounting greenwash scrutiny of NGOs such as Carbon Trade Watch. In addition organisations such as Sandbag, continue to retire credits up to 2012, as criticism of emissions trade systems to drive investment in real climate change action builds, stifling the debate on post-2012 ETSs. Crucially, the U.S. position quickly moved towards adaptation rather than ETS-type mitigation in an effort to support its indigenous industry (manufacturing and energy) and thus dulled the momentum of Bali and the global ETS movement.

Trends increasingly translated to voluntary markets as ‘green fatigue’ resulted in a lack of resource and willingness to invest in voluntary credits. The result was a movement towards charitable donations (and affiliation) with local sustainability projects in line with the ‘adaptation agenda’.

During 2012, as economic conditions improved, more credit was available for investment in energy technologies and associated infrastructure. The parity between the objectives for adaptation to climate change and energy security (supply and price) increased and the opportunities were realised on a scale far larger than previously envisaged during Kyoto. It was this surge in investment that resulted in a reduction in the dependence on fossil fuels to an all time low and a substantial move towards sustainable energy production on a large scale.

The replacement of fossil fuel dependent infrastructure continued up to 2014, with the generation of vast new industries and global opportunities.

Potential Implications for the UK and GM:

Potential failure to develop sufficient political force in support of national and international ETSs presents severe implications for secondary market intermediaries in a manner that emphasises balanced risk portfolios in 2008.

The financial industry generally will not be significantly affected as carbon as a commodity is merely a part of a much larger portfolio with skills transferable to other commodity markets. Specific organisations specialising in carbon will be adversely effected by the decline.

Skills and capabilities developed in service of the primary and service sectors are transferable to the emerging adaptation agenda in which energy efficiency, resource management, and renewable energy are core components

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Adaptation agenda will require a variety of service and technology based businesses. Essentially the emphasis would move from an existing mitigation stance to one of adaptation, e.g. invest in technology to reduce energy usage and reduce CO2 emissions, moving to, invest in technology to ensure continuity and security of energy supply; both may see investment in on-site renewables.

The requirement for commercially viable energy technologies will provide significant opportunity for innovative SMEs and universities that can rapidly protect IP and develop their technologies in good time. Academic expertise and technological SMEs (spin out and new ventures) appear relevant in this climate.

Adaptation within regions will be an high profile issue as energy security, high energy price, and resource scarcity continue to drive a low carbon agenda outside the carbon market. In this manner, the business network supporting adaptation projects (design, advisory, and delivery) appears as a key opportunity.

Opportunities are apparent for innovating developments, financing, installing and servicing of technologies for climate change adaptation measures with relevance to the engineering, project management, and consultancy sector implicated in the primary carbon market.

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4

Strategic Directions for GM Through trends analysis and extensive research integrating literature and consultation with key players, a vision for the nature of the opportunity presented to Mancunian sectors by the carbon market has been developed.

As such the requirements of this section are to test the initial research question concerning the viability and value of developing secondary market components in GM, extending to consider where GM’s greatest opportunities lie. This process serves as an essential stage in establishing an effective action plan.

Consulted parties include representatives of; RBS, CantorCO2e, Dresdner Kleinwort, Deutsche Bank, Camco Global, and Bank of England, Merrill Lynch alongside nontrading commentators in academia and policy such as Prof. Denny Ellerman (MIT).

Alongside such expert consultees the study has benefited from the significant insight of Dr Robert Rabinowitz of the European Climate Exchange9.

Through such processes it is made clear that Greater Manchester is presented with a series of threats and opportunities when considering growth and development of its carbon market sector.

In support of robust strategic outcomes this study has combined an analysis of the external operating environment and perceptions/opinions of key players in the carbon market alongside a knowledge of GM’s internal assets/capabilities represented by key stakeholders forming the project’s steering group.

4.1

Considering secondary market intermediation The first issue to consider is which components of the carbon market present viable and valuable targets. Initially, this study centred on testing the suitability of secondary market financial intermediation as the strategic development target. To this end a series of discussions were undertaken, posing the following questions: 1. To which locational assets do specific business types desire physical proximity?

2. What do specific business types seek access to in deciding which locations to base business?

3. What intervention or incentives are relevant to specific business types when deciding where to locate?

9

www.europeanclimateexchange.com

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4. As a global centre for the global emissions trade, what structural features explain London’s current strength and depth?

Such lines of enquiry reveal a series of drivers that determine the London-centric location of key players in secondary market financial intermediation specific to the carbon market:

Cultural inertia within the London-centric financial sector

Extension of commodity trading practices

Legacy of existing financial sector geography

Presence of the ECX

Attraction of long-established financial institutions

Predominance of diversified established financial players within the carbon market

Continuation of operations within established financial players

Enduring first mover advantage associated with the UK ETS and EU ETS

Proximity to the key policy bodies regulating the market

Perception of London as only UK option for a European base

Access to opportunities arising from the progressive GL policy agenda surrounding climate change adaptation

Proximity to primary carbon market players; particularly those financing and delivering emissions reduction projects

Integration with broader green-tech, renewable energy, and energy efficiency investors/financiers

Through discussion it is possible to conclude that the current status of London as a centre for secondary financial intermediation in the carbon market can be traced to parallel activities in established commodities markets resulting in entrenched practice and limited share for novel carbon market specific business; a context that significantly impacts a Mancunian strategy. In short, the apparent reason why London occupied leadership status in this area of the carbon market is due to structural and cultural factors derived from its leadership status as a global financial centre.

Exploring opportunities for GM with this key stakeholder-base, and integrating key literature, the opinion that targeting of secondary market financial intermediation was not viable on the basis of the following necessities:

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Relocation of a large investment bank and a significant pool of associated businesses

Establishment of an exchange platform with significant trade traffic

Transference of commodity trade cultures and structures (incorporating social networks)

Establishment of a strong trader skill-base and employment market

The implication is that, if viable at all, a series of high cost, high risk, and long term strategies are required to access any share of secondary market financial intermediation. Furthermore, such actions are in danger of driving an ultimately illfated imitation strategy at the cost of strategic directions presenting potential leadership opportunities.

It is this study’s strong recommendation that the secondary carbon market is not pursued as a development target for Manchester for the following reasons:

4.2

Secondary trade is predicated on businesses surrounding a small number of long established, entrenched investment banks in London, for which the significant costs of attraction appear to outweigh the value brought to Manchester as a result

The future of the secondary market beyond 2012 is uncertain which presents a significant exposure to risk associated with any investment committed by Manchester

The current crisis of banking and financial sectors presents an environment of huge risk and uncertainty; although disruptive innovation is expected, decentralization of commodity trading is definitely not a clear result

Establishing target businesses The process of this work has established the original target of secondary market financial intermediation to be overly stringent. A number of growth and development opportunities associated with activity in the carbon market are apparent with regards to potential Mancunian strategy; targets specifically in primary market and service sector segments:

Firms spanning the primary-secondary space

Non-trading financial intermediaries

Key players in the primary market

Consultancy/advisory supporting sector

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Such business concerns mitigation/abatement project development in the primary market; its engineering, financing, and consultancy support alongside a broader energy/environment/carbon/efficiency advisory sector differentially supporting supplyside and demand-side players. These components will be explored in greater depth within the subsequent action plan.

In this manner a specific portion of the value chain is identified; a mutually supportive business ecology which offers significant opportunities for GM stakeholders to stimulate and support growth. It is proposed that such targets bypass the limitations of city trader cultures to access a series of businesses with relevance beyond the carbon market (i.e. low carbon industry, renewable energy, etc). As a result, these targets present a degree of resilience to uncertain futures where other portions of the value chain may not.

We cannot disregard the status of such growth as an attractor; as such the emphasis is placed on the development of a functional, relevant, resilient business network capable of driving subsequent inward investment and seeding new ventures. In this manner theories concerning the genesis of industry clustering and geographical economics are being answered. As a result however, the value of business growth in this area is a complex issue to determine as both high value and lower value players in the ‘knowledge industries’ are required for the development of a functional whole.

These considerations will be extended in greater depth within the subsequent action plan.

4.3

Considering the basis of a development strategy A development strategy can be considered which incorporates three mutually supportive components: 1. Support for development and diversification amongst existing Mancunian financial/professional services to which the market presents opportunity 2. Targeting and securing of inward investment into Mancunian sectors 3. Implementation of new initiatives and ventures with the potential to act as a seedbed and attractor for growth in Manchester’s sector To this end, an array of activities may be carried forward in the action plan: New Initiatives • Development of a Carbon Fund* • Network building/management • Umbrella initiatives engaging stakeholders • Development of HE education and research synergies • Start-up incubation

Support and Development • Asset mapping/recognition

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• • •

Support of diversification Development of networks and cross-linkage Business self-awareness

Strategic Inward Investment • Specific messages • Targets • Incentives • Recruitment/application of asset-base

*Considering a Carbon Fund A carbon fund is an investment vehicle that realises a return for its investors through financial value created by the carbon market. The World Bank estimates that US$9.5 billion (€7 billion) were invested in 2007 in 58 public and private funds that either purchase carbon directly or invest in projects and companies that can generate carbon assets. The total capitalization of carbon vehicles could reach US$13.8 billion (€9.4 billion) in 2008, with 67 such carbon funds and facilities.

Within this strategy it is the model of a Carbon Fund that appears to present significant opportunity for Manchester in the execution of this three pronged strategy; a rainmaker initiative with potential to serve each of the three components. Specific to GM, the carbon fund might take a traditional focus on CDM projects but may also focus on low-carbon technology or invest in UK emission reduction projects that will generate a return via the mandatory or voluntary markets. There are at least three ways in which a carbon fund might have a “Greater Manchester” flavour: 1. The fund could target investors based in the North or North-West of England, whether financial investors or entities subject to emission reduction targets under the EU ETS or Carbon Reduction Commitment 2. The fund could be based in Greater Manchester, helping to strengthen the social networks of carbon market professionals in the region 3. The fund might focus its investment on assets with a link to Greater Manchester, e.g. technology developed from regional universities, products developed in the region or assets based in the North or the North-West of England

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5

Proposed Action Plan This action plan, intended as a primer for debate and discussion amongst key GM stakeholders, can be considered in terms of four mutually supportive areas of activity each orientated towards specific market opportunities and developmental goals.

In overview the four broad areas are: 1. Development of a Carbon Fund 2. Consultancy/associated services sector growth 3. Building and supporting a business ecosystem 4. PR, awareness, and messaging For each area the what, why, and how of specific components will be considered in the following sections in order to outline the strategic role to be played by each element alongside the practicalities of their implementation.

5.1

Overview of Research Findings Through trends analysis and extensive research integrating literature and consultation with key players, a vision for the nature of the opportunity presented to Mancunian sectors by the carbon market has been developed. It is this study’s strong recommendation that financial intermediation in the secondary carbon market is not pursued as a development target for Manchester for the following reasons:

Secondary trade is predicated on businesses surrounding a small number of long established, entrenched investment banks in London, for which the significant costs of attraction appear to outweigh the value brought to Manchester as a result

The future of the secondary market beyond 2012 is uncertain which presents a significant exposure to risk associated with any investment committed by Manchester

However, a number of growth and development opportunities associated with the carbon market do remain for Manchester; specifically in primary market and service sector segments:

Firms spanning the primary-secondary space

Non-trading financial intermediaries

Key players in the primary market

Consultancy/advisory supporting sector

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In this manner it is proposed that GM can become the premier regional centre of carbon market expertise by focusing on specific opportunities within the ‘carbon market value chain’. As such, the roles implicated include; mitigation project developers, consultancies, professional services, and specialised tech-firms (concerned with measurement, verification, etc).

The following sections build on these conclusions.

5.2

Development of a Carbon Fund A carbon fund is an investment vehicle that realises a return for its investors through financial value created by the carbon market; a fund that supports emissions mitigating projects (e.g. CDM and JI) in return for saleable, primary market, carbon credits (e.g.

CERs or VERs).

A GM-based carbon fund might take a traditional focus on originating and funding CDM projects but may also focus on low-carbon and energy-efficiency technology installations to generate a balanced risk-portfolio capable of withstanding flux in the carbon market as it reaches the crucial 2012 post-Kyoto date, with returns generated within mandatory or voluntary market segments.

Pending business model development, the Mancunian nature of the fund could be achieved through one of several ways:

The fund could target investors based in the North or North-West of England, whether financial investors or entities subject to emission reduction targets under the EU ETS or Carbon Reduction Commitment

The fund could be based in Greater Manchester, helping to strengthen the social networks of carbon market professionals in the region

The fund might focus its investment on assets with a link to Greater Manchester, e.g. technology developed from regional universities, products developed in the region or assets based in the North or the North-West of England

Such considerations draw attention to the case in support for efforts towards a Mancunian carbon fund. Primarily the carbon fund represents a strong element of the primary carbon market; as discussed one that offers particular opportunity to Manchester.

The potential success of carbon funds is supported by the World Bank estimate that US$9.5 billion (€7 billion) were invested in 2007 in 58 public and private funds that either purchase carbon directly or invest in projects and companies that can generate carbon assets. The total capitalization of carbon vehicles could reach US$13.8 billion (€9.4 billion) in 2008, with 67 such carbon funds and facilities.

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Stemming from the initial commercial opportunity apparent with the carbon fund a series of potential secondary beneficial effects can be identified:

An opportunity for Mancunian stakeholders to rapidly generate a strategic presence in the primary carbon market

Potential to serve the inward-investment proposition

A focus for PR/awareness activity

An element of a functioning business eco-system concentrated on primary market and service segments of the carbon market

In terms of the practicalities for the fund a phase of business planning must be considered in light of numerous variables and options. However, the following initial requirements are clear:

Feasibility study, review of existing funds, and development of the business plan

Development of business plan

Targeting engagement and recruitment of potential investors

3-4 staff initially, including a senior carbon fund manager and senior carbon sourcing manager/carbon originator

Support services: legal, regulatory compliance, financial control and reporting

FSA regulation

Retain an investment bank to promote the fund to investors

As such, costs concern initial staffing and legal/administrative setup that could be implemented in the form of a budget released to private enterprise for competitive tender pertaining to the management of such a fund10 or through PPP/PFI model that would clearly need detailed evaluation. Analysis of current skills market, the potential need to attract quality staff, and the estimates of leading observers place initial costs in the region of £1million.

In terms of the risk associated with this outlay we must consider the potential breakdown of regulatory structures supporting the current carbon market. However, as the U.S. appears to gear-up emissions trade legislation, Kyoto signatories continue to make post-2012 plans, and the voluntary/CSR emissions trade grows, the ability of

10

E.g. the example of NStar: ‘NStar is an investment organisation funded by the RDA ONE, constituted as a company limited by guarantee. Any surpluses generated within the business may only be used either to support our core activities or to offset the public sector investment in funding our operations’

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risk-balanced fund management to withstand uncertainty appears to mitigate a degree of associated risk.

5.3

Consultancy/associated services sector growth Throughout this study the growth potential presented by the diverse set of organisations forming the support sector component of the carbon market has emerged as a prime opportunity for GM. As such, strategic support, development, and enhancement of the key consultancy/advisory sector are proposed.

In this manner particular focus falls upon consultancies with portfolios spanning emissions management, energy efficiency, and EUETS/UKCRC compliance; a business sector that forms a key (and growing) value component of the carbon market service sector. Importantly, when considering longevity and exposure to risk with regards to this market segment trends in environmental regulation, resource depletion, and energy price rise appear to present a positive future regardless of cessation to carbon market trade as we currently know it.

A series of consultancy advisory roles are implicated which are increasingly being developed by larger players into integrated turnkey/pipeline offerings:

Project consultants – design and implementation of emissions mitigation projects

Legal advisory – mediation of regulatory compliance

Knowledge and research – delivering strategic intelligence

Quality control – supporting measurement and verification

Business/management consultancy – capacity building

Environmental consultancy – strategic adaptation

Specific opportunities concern the consultancy services required by those businesses mandated in the EUETS and now the UKCRC regulatory frameworks as well as those seeking efficiency-based cost savings and CSR marketing benefits from emissions management. To this end a series of potential clients requiring specialized consultancy input are presented regionally, nationally, and internationally.

The benefits of such effort focused on the consultancy sector are both direct and indirect:

Strategic capture of a value-rich component of the high-growth carbon market in an achievable and risk-balanced manner

Enhancing complement to, and a ‘sound-fit’ with, existing GM public and private organisations (including the existing consultancy presence and HE strengths)

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Support of a knowledge-based sector key to the development of a connected, integrated business ecosystem

Practically, the objective of growth in this industry focuses attention to support of existing GM players and inward investment attraction of a diverse set of professional service sector organisations with an explicit carbon market/emissions management offering.

The cost to GM stakeholders associated with such activity is clearly highly relevant to specific growth/investment propositions; at this level of resolution consideration in terms of the requisite proportion of MIDAS resource is required.

5.4

Building and supporting a business ecosystem Throughout the research process the concept of regional trading exchanges and regional trading schemes have been tested amongst key players with very limited approval. However, the support of regional networking between players across the value chain has emerged as a universal recommendation for driving growth and investment.

Effective clustering for mutual support is a classic strength demonstrated by geographic centres of industry (Silicon Valley, Navarre, Fraunhofers, etc); such connectivity is a common issue cited by key players resolving London’s rise to dominance in the carbon market.

The implication for GM is the assembly and support of a mutually supportive, well connected public (HE, policy, etc) and private ecosystem focused on the area of the carbon market identified as most opportune for GM. To this end a number of objectives are apparent:

Recruitment of existing GM business players with current or potential activity in the carbon market to an explicit GM-carbon market networked system

Gap analysis, targeting, and attraction of complementary non-GM business players into the GM network

Development of public-private sector connectivity in the city

In this manner two key roles are clearly relevant; inward investment (MIDAS) paired with network management. In terms of targets, research has isolated the following key targets for such extended strategic inward investment and industry building efforts:

Suppliers: Those organisations associated with the origin of the carbon asset in either project or allowance form effectively constituting the core of the primary market: Mitigation project developers: • Private firms Job no - client name - 04/11/2008 Š Wood Holmes Group Limited

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Local Communities/LAs/RDAs/CRCs Specialist NGOs Mandated installations: • EUETS • UKCRC Mitigation project financiers: • IFIs • Carbon Funds • Banks Mitigation project consultants: • Development Agencies • Engineering Companies • Project Design Document (PDD) Writers • Methodology Developers • Specialist NGOs Technology providers • Renewable Energy • Energy Efficiency • Green-Tech Governing Organisations: Those legislative and regulatory bodies providing the stimulus, drive, and steer to the carbon market, together with policy bodies communicating advice to actors in the market: The UKCRC governing department (Defra/DECC team and the Environment Agency)11 Environmental NGOs UKCRC/EUETS mandated industry association offices End-Users: The compliance and voluntary buyers of the carbon asset: Compliance buyers • UKCRC • EUETS Voluntary buyers CSR-orientated business (i.e. an awareness issue) Associated services: Covered somewhat within the consultancy sector component above: a diverse array of stakeholders providing services to those active in the carbon market: Quality control Legal advisory Knowledge and research Capacity building Environmental consultancy Measurement and verification • •

11

Currently the UK CRC planning phase is being lead by the Carbon Reduction Commitment Team, Climate and Energy: Business and Public Sector Division – originally part of DEFRA but expected to be part of the new energy and climate change department – DECC. Key administration and regulation roles are tentatively assigned to the Environment Agency. Further consultation and policy statements are planned during the development of the UKCRC tethered to the UK Climate Change Bill.

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Beyond the synergy between this activity area and the ‘consultancy/associated services sector growth’ section above (strategic inward investment, etc), the requisite action must be focussed on network development/management. Relevant costs concern the appointment of a network manager paired with resource to run events, develop the forum, etc for which high level estimates begin at £100k per annum.

In this manner, the ‘benefit’ would be appraised based on network units (meetings, events, contacts, membership) on the basis that clustering and GVA are inherently linked (a proposal that would require a detailed business case to be investigated).

However, beyond such direct benefits, GVA or otherwise, the clearest benefit of an effective network would be as an attractor alongside the carbon fund for use within the inward investment proposition and associated GM-branding.

In terms of ordering such an approach, the first key step appears to be the development of an explicit carbon market network amongst existing GM players; drawing carbon market activity within their portfolio towards GM base, developing connectivity, and enhancing the messages. Inward investment and branding opportunities would thus stem from a functioning network.

Rough Overview of Network Targets with GM (NW) Presence A host of key players support a significant presence in GM and/or the wider NW, in no particular order; The Bank of New York, Royal Bank of Scotland, Barclaycard, AIG, JP Morgan, Deloitte, Accenture, Cooperative Financial Services (Banking & Insurance), MBNA (Europe), Cheshire Building Society, Halliwells, Rathbones, Royal London, Esure, Alliance and Leicester, Rothschilds, PWC, KPMG, Baker Tilly, Grant Thorntonm, Bank of America, Kleinwort Benson, Daniel Stewart & Co, Investec, Hiscox, and the State Bank of India.

Drilling down on the existing potential of Manchester to make strides within the carbon market, a series of environmental-specific businesses is apparent. Taking a regional perspective, the NW environmental and technological services sector presents at least 1500 businesses employing ~53,000 individuals with a turnover of £2.8bn.

Key strengths are clear within the Envirolink NorthWest database which lists 76 Environmental Consultancies with a GM presence including leading players such as Atkins, AMEC, Arup, Capita Symonds, Mott MacDonald, Enviros, Faber Maunsell, and Sinclair Knight Merz (Europe) amongst many more. Further scanning reveals a plethora of businesses readily applicable to the carbon market value chain and to the development of the mutually supporting business ecology discussed in earlier sections of this work.

In terms of graduate skills, expertise, and academic reputation the GM HE system presents a series of strengths; University of Manchester (UK top 5 teaching and research in relevant fields, Tyndall Centre, Manchester Technology Fund, MBS, PREST, MII), Manchester Metropolitan (Department of Environmental and Geographical Sciences, CATE Centre for Aviation Transport and the Environment), and Salford University (The Research Institute for the Built Environment, Centre for

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Environmental Systems Research (CESR), Centre for Sustainable Urban and Regional Futures (SURF)).

5.5

PR, awareness, and messaging The proposals of preceding sections present a series of assets and attractors with applicability to early action; in order to support an effective curve of growth into the long term PR messages and branding are required.

As has been proposed the key objective supported by the research phase is Greater Manchester as the premier regional centre of carbon market expertise, focusing on specific opportunities within the carbon market value chain. This objective is clearly a vital foundation of the network proposed above.

In the development of this message a number of key audiences are apparent; primarily the business community but incorporating an element of cohesion amongst existing public initiatives (Manchester Green City, Manchester is my Planet, Environmental Business Pledge, NW Climate Change Action Plan, BREW, Envirolink, and ENWORKS).

Key action clearly concerns extension of existing branding and PR in place across inward investment and business engagement processes; associated costs stemming from subsequent discussions.

5.6

Conclusion This document maps out four areas of activity. Each area can be clearly connected to the others in a manner that limits the boundary between specific activities in terms of those inputting and the nature of subsequent outputs. It is important to consider that, whilst the carbon fund strongly links and supports the other activities and is likely to add significant value, it does, to a degree, stand alone in its development and is not essential in achieving the other outcomes. However, we reassert the apparent opportunities for growth and development, including leadership status, presented by an activity such as a carbon fund as a ‘primer’ or ‘rainmaker’ initiative.

With the potential strength apparent within existing GM sectors, it is this cohesion that forms a key dimension of this approach; addressing awareness and connectivity as a priority before other interventions.

As this action plan evolves the identification of potential facilitators/project leaders amongst GM stakeholders will allow development of proposed actions in greater detail.

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6

Final Thoughts and Next Steps This focus of this study has been the development of a viable, achievable strategy serving the effective capture of market share in the emission trade arena by GM public and private stakeholders. The result is a mutually supportive four-strand action plan that implicitly recommends growth and development activity in a highly targeted portions of the carbon market; those with growth potential in the Mancunian context and representing a fundamental component of a growth market.

With strategic directions identified, a series of specific projects within each area will have to be undertaken by GM stakeholders. The action plan goes some way to identifying potential projects, but specific cost-impact analyses remain a requirement for future work; not least in the design-process of a carbon fund.

Key research questions in the design of a Carbon Fund Projected unit returns • Calculable via CDM-cost, CER-price indices • Econometric forecasts Potential public fund leverage • GM stakeholder buy-in • Policy objective returns Business model • NStar type model vs. commercial • (e.g. adopting the NStar mission) Subsequent projected buy in from private sources Specificity of fund targets • Supporting the application of Mancunian-origin technologies overseas • Sectoral specificity • Pursuit of voluntary market credits from projects within GM Relationship with the NW Climate Fund • Resolving the GM-NW relationship • Recognising the difference in the two funds Establishing the start-up mechanism Establishing the delivery of the fund • Competitive management tender • GM Stakeholder control • Legal requirements (conflict, FSA, etc) Considering investment-fund fundamentals • Relationships with investment banks • Insurance Securing Mancunian location and ‘flavour’ • Physical housing in GM • Accompanying messages/audience/investor group Defining application of potential returns • Financial return to investing parties • CSR donations • Return on public investment

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The proposed extent of projects was introduced in an early iteration of the action plan (NB illustrative only):

It is proposed that this level of planning is required to support specific cost-return analyses beyond the high level strategic indicators presented in this report; in essence projected returns require an indication of potential commitment.

Finally, to round off the discussion, a few final issues may be considered in support of future work:

The proposed action plan is predicated on the development of a mutually supportive functional unit of the broader carbon market; as such efforts to select out only those businesses proposed to be ‘high value’ is a hazardous strategy.

Emphasis must be placed on the network being the key in terms of regional economic development; cluster-type growth a potential reward.

In this vein, the EUETS and UKCRC do present a heightened demand for emissions management consultancy sector players albeit arguably consisting of relatively small scale projects and businesses. However, initiatives such as Carbon Action Yorkshire’s (CAY) response to the UKCRC and UK Climate Change Bill present opportunities to attach key inward investment messages to relatively small networking ventures.

The carbon market presents a highly specific and specialised audience; conflation of ‘carbon’ and ‘climate’ action in messages is a key issue when considering attraction.

We must consider that key players in the carbon market are not motivated solely by responsibility to climate change.

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In this vein, the proposed NW Carbon Fund presents a potentially valuable stimulus to local low-carbon economy adaptation. However, key differences between the proposed function of the Climate Fund and the potential nature of a Carbon Fund must be recognised and resolved; they cannot be assumed to serve the same purpose.

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7

Appendix 1 – Carbon Market Details The knowledge base serving discussions in the main body of this report are outlined and discussed in the following sections:

7.1

Historical Context The operational carbon market is an invention of the late-1990s and early 2000s; emerging as a concept from the international political debate concerning climate change and its effects. The following timeline of events is important to establishing the context for 2008 and beyond.

1987

1988

1992

1993 1997 2001 2002-2005 2005 2005 2005-2012 2007 2007 2007-2009 2008-2012 2012-2020 2012

The Brundtland Report – commissioned by the UN General Assembly in 1983 to address ‘the accelerating deterioration of the human environment and natural resources and the consequences of that deterioration for economic and social development’ cementing the agenda of global sustainable development Intergovernmental Panel on Climate Change (IPCC) – established by the UN’s World Metrological Organisation (WMO) and the United Nations Environmental Programme (UNEP) tasked to evaluate the risk of climate change UNFCCC – international environmental treaty produced at the United Nations Conference on Environment and Development (UNCED, aka Earth Summit) aiming to ‘achieve stabilization of greenhouse gas concentrations in the atmosphere at a low enough level to prevent dangerous anthropogenic interference with the climate system’ Los Angeles' Regional Clean Air Incentives Market (RECLAIM) – the first emissions trading program focussed on the reduction of sulphur dioxide and nitrogen oxide emissions in the U.S. Kyoto Protocol signed – an update to the UNFCCC encoding national commitments to reduce GHG emissions Danish pilot GHG trading scheme of 8 businesses European development of the EU Emissions Trading Scheme (EU ETS) – piloted in the form of the voluntary UK ETS, issued as a directive in 2003, and coming into force 2005 Kyoto Protocol comes into force Japanese Voluntary Emissions Trading Scheme (JVETS) of 34 businesses 1st engagement period of the Kyoto Protocol Signing of the non-binding Washington Declaration – an ‘in principle’ outline of the post-2012 successor to the Kyoto Protocol 33rd G8 summit states explicit objective to halve global CO2 emissions by 2050 UNFCCC movement towards the development of a binding Kyoto successor at Copenhagen in 2009 through the Bali Roadmap (2007) and Poznan (2008) Phase II of the EU ETS Tentatively discussed Phase III of the EU ETS Proposed implementation date of numerous national ETS systems

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Such a timeline reveals the 20 year (at least) political process that has lead to the 2008 context; a period during which emissions trading was established as a potential mechanism 15 years ago. In this manner the historical context not only frames the following sections, but will aid consideration of the pace and direction of political movement from 2008.

In addition, when considering the future post-2008 we cannot ignore the political complexity of the UNFCCC’s Bali Roadmap to Copenhagen 2009 process, especially during its convergence with the global financial crisis and recession.

An example of this latter element was clear in the EU council meeting of mid-October (2008) during which the financial crisis was presented as an ‘excuse to renege’ on climate change commitments during energy talks12.

7.2

Segmentation of the Carbon Market The international carbon market is, in 2008, governed by two primary systems which drive trade according to regulatory compliance or voluntary conscience in two respective market segments:

Compliance Markets Compliance markets are based on emission reduction measures encoded within international, national, and regional policy; a primary international framework being that which has developed from the Kyoto Protocol.

The Kyoto Protocol commits signatory countries to reduce collective greenhouse gas emissions by 5.2% below 1990 levels over the 2008 to 2012 period. Subscribing governments are divided into ‘developed’ Annex I nations, which each have a greenhouse gas emission reduction obligation supported by a formalised GHG inventory (UK’s obligation being -8%), and ‘developing’ non-Annex I nations who participate without emissions obligations. Within this structure compliance is achieved through emissions reduction strategies accompanied by the trade of carbon assets governed by Clean Development Mechanism (CDM) or Joint Implementation (JI) accreditation schemes.

A second tier of the compliance market communicates the Kyoto emissions obligation through to a national context, regularly passing (devolving) the task of reduction straight on to high emitting private sector industry. By far the most established and sophisticated of these schemes is the EU European Trading Scheme

12

Vidal and Jowit. 2008. ‘Fears rise that EU may drop climate pledge’. The Guadian, 10/10/2008. http://www.guardian.co.uk/environment/2008/oct/10/carbonemissions-climatechange Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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(EU ETS); currently the major Kyoto tributary scheme, largest carbon market component, and an apparent ‘best-practice model’ for future development.

The EU ETS is divided into phases for which EU Member States must develop a National Allocation Plan (NAP); a defined carbon account that fulfils the 12 criteria set out in the Emission Trading Directive and must be approved by the European Commission.

In the first phase (2005-2007), the EU ETS included around 12,000 installations across electricity generation, iron/steel, mineral processing, and paper processing industry; a set which was said to account for approximately 40% of EU CO2 emissions. However, towards the end of the phase, the generosity of caps given to industry, and subsequently the lack scarcity of allowances, sent the price tumbling from a high of around €30 per tonne CO2 to €0.10 in September 2007. As such, Phase II (2008-2012) of the scheme has been less generous and more compliant with Kyoto; as any organisation trading through the EU ETS should meet the international trading obligations under Kyoto. Phase II will end in 2012, the same time as the end of the first Kyoto commitment period and agreement must be sought on post-2012 emission targets as the EU ETS enters Phase III. There are already a number of solid suggestions from the European Commission (EC) relating to Phase III. For example, it already seems clear that the cap will be considerably tighter than in Phase II, as the overall emissions in the EU ETS in 2020 are expected to be capped at around 21 percent below the 2005 level.

Whilst the EU ETS is the largest multi-national, emissions trading scheme in the world, there are other schemes linked with or relating to Kyoto that are currently, or plan in the near future to be operating. However, significant differences in the approached being taken limits uniformity and presents obstacles to the translation between national systems in the development of a unified market; an issue that will be considered in later sections. Currently a number of schemes exist at different developmental/operational stages: Scheme

UK Carbon Reduction Commitment (UK CRC)

Overview Starting in January 2010 with a three year introductory phase, the Carbon Reduction Commitment is a mandatory emissions trading scheme being introduced by the Government to cover large business and public sector organisations whose annual half-hourly metered electricity use, and 70 kilowatt metered electricity use in Northern Ireland, is above 6,000 MWh. Designed to cover both direct energy use emissions and electricity use. CRC will also focus on emissions outside Climate Change Agreements and the EU ETS.

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From 2013 there will be a Government imposed cap on the number of allowances, and all allowances will be sold each year via an auction – a world first for this type of scheme.

(NZ ETS)

Commenced in 2008 but legislation is still to pass through parliament. The scheme initially covers forestry, expanding to full coverage of all sectors and gases by 2013.13

Norwegian Emissions Trading Scheme

Commenced in 2005 covering CO2 emissions from energy, oil, coking coal and industrial production.

Canadian Emissions Trading Scheme

Due to be introduced in 2010, covering around half of Canada’s emissions from electricity, oil, gas, iron, steel, cement, chemicals and fertiliser. All sectors would be required to reduce their emissions intensity from 2006 levels by 18% by 2010, with two per cent continuous improvement every year after that.

New Zealand Emissions Trading Scheme

US Regional Greenhouse Gas Initiative (RGGI)

Due to commence January 2009. Cooperative effort by nine Northeast and Mid-Atlantic states to constrain CO2 emissions to current levels in 2009, and then reduce 10% by 2019. Initially covers emissions from power plants.

US Western Climate Initiative

Currently under development. Arizona, California, New Mexico, Oregon and Washington, Utah, Montana and the Canadian provinces of British Columbia and Manitoba have agreed to develop an initiative to reduce aggregate emissions to 15% below 2005 levels by 2020.

The Midwestern Greenhouse Gas Accord

The Accord was agreed in November 2007 although no specific targets or design elements have been released.

Accord includes six US states and one Canadian province. Parties intend to have targets for reducing emissions from all six (Kyoto) gases in place by November 2008, and to finalise the design of the scheme within one year.

The New South Wales Greenhouse Gas

Commenced on 1 January 2003 in Australia, this is a mandatory greenhouse gas trading scheme that aims to

13

http://www.climatechange.gov.au/greenpaper/factsheets/pubs/fs11.pdf

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Abatement Scheme (GGAS)

lower greenhouse gas emissions to 7.27 tonnes of carbon dioxide per capita by the year 2007.14

Voluntary Markets Whilst much smaller than the compliance market, the voluntary market has seen continued growth over the past few years. Existing outside regulatory compulsion, the voluntary segment of the carbon market is demand driven with the purchase of ‘offsets’ growing in profile. Much of the demand comes from the developed and more environmentally aware markets in North America and Europe although the value chain implicates developing nations as the source of offsets15.

Within these markets, individuals, business and governments buy carbon credits motivated by CSR, marketing, green initiatives, and increasingly in anticipation of regulatory reforms (termed ‘precompliance’). Currently the CSR-motivated private business market accounts for the majority of voluntary trades.

Despite the isolation from legislative regulation, the voluntary market does present an array of self-regulating standards and accreditations intended to tackle issues of credibility and ‘greenwash’ that present obstacles to the growth of the market. In this manner a series of well supported, often third-sector sponsored, standard frameworks exist:

Voluntary Carbon Standard (VCS)

VER Gold Standard (VGS)

VER+

Voluntary Offset Standard (VOS)

Green-e

The Greenhouse Friendly-Standard

Plan Vivo and Climate Community and Biodiversity Alliance

Proprietary Standards for VERs (e.g. CarbonNeutral®)

A further regulatory instrument is evident in the development of voluntary credits that are sold as pre-registered CDM projects thus incorporating the same design features required by the CDM system. Crossover between compliance and voluntary segments of this nature may present early signs of a harmonisation of the market; an

14 15

http://www.greenhousegas.nsw.gov.au ENDs. 2008. ‘ENDS Guide to Carbon Offsets’. ENDS Report. http://www.endscarbonoffsets.com

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issue that will be explored in later sections.

The division between voluntary and compliance is further blurred by schemes such as the Japanese Voluntary Emissions Trading Scheme and the Chicago Climate Exchange which pioneered a system of voluntary subscription to a binding, compliance-type, emissions trading system.

7.3

Fundamentals of the Carbon Asset In the construction of the carbon market the nature of the carbon asset remains a fluid and debateable issue. However, a number of core features are evidently common.

As determined by the Intergovernmental Panel on Climate Change (IPCC)16, the carbon asset almost universally a measure of ‘tonnes CO2 equivalent (tCO2e)’; a measure of CO2 emissions combined with of five other GHGs scaled to a CO2 equivalent through application of their respective global warming potential:

Methane (CH4)

Nitrous Oxide (N2O)

Hydrofluorocarbons (HFCs)

Perflourocarbons (PFCs)

Sulphur Hexafluoride (SF6)

Subsequently, the prevailing unit measure of a carbon asset is 1 metric tonne of CO2 equivalent (tCO2e) which translates 1:1 with the unit of the majority of traded carbon assets. In this manner the standardisation of a single carbon price is arguably achievable, albeit once obstacles to the linkage of regulatory frameworks and component markets are fully addressed.

The carbon assets circulating the market exist in two fundamental forms dependant on the underlying regulatory regimes.

The ‘allowance-based’ form is based on the issue of emission allowances by regulators operating cap-and-trade regimes in which a total emissions output allowed from a selected group of emitters is fixed at a point below the projected business-asusual level on the basis of individually allocated allowance credits (i.e. the cap).

Subsequently the trade is based on the sale of excess allowance credits secured through emissions reduction strategies and the purchase of allowance credits to cover emissions over the allocated allowance.

16

http://www.icbe.com/emissions/calculate.asp

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‘Such schemes combine environmental performance (defined by the total amount of allowances issued by the regulator, setting a cap on the global level of emissions from mandated entities) and flexibility, through trading, in order for participants to meet compliance requirements at the lowest possible cost’ (World Bank 2008 pg 60) In contrast the ‘project-based’ form is based on the generation of verified emissions reducing projects; in effect the subsequent credits present units of funding for specific reduction activities.

‘Projects must reduce emissions by an amount that is ‘additional’ to business as usual. For example, if an industrial efficiency measure to reduce pollution and CO2 was required by legislation, it would be considered a business-as-usual reduction. In contrast, if the project was not legally required and relied on the income from the sale of the offset credits to be completed, it would be considered additional or going beyond business-as-usual reductions’ (ENDS 2008 pg 12) As introduced earlier, the modes by which a carbon asset is characterised, through accreditation or certification, are diverse; a situation derived from the inherent challenges facing the reliable and accurate measurement of associated CO2. Despite the variability between prominent protocols such as CDM, JI, and VERs-standards, significant features remain relatively common; the ‘VALID(T)’ system outlines key components of a credible project-based carbon asset:

7.4

Verifiable – reliable emissions baseline and reduction measurements available

Additional – emissions reduction/saving is additional to business as usual trends and reliant on the offset income to progress

Leakage Free – offset project doesn’t inadvertently increase emissions elsewhere in the ecosystem/supply chain

not-Impermanent – the carbon saving is permanent

not-Double Counted – an emission reduction is only valid if it is generated once, sold once, claimed once, and retired permanently

Time-aligned – timeline of the emissions saving and actual emission effectively matched, or at best, emission saving already in place prior to the emitting action

Key Carbon Currencies Due to the necessary politicisation of the carbon market, a fragmented construct of allowance and project based assets with variable applicability to international, national, and regional compliance or voluntary frameworks currently prevails, The result is a wealth of carbon asset types which are variably referred to as ‘units’, ‘credits’, or ‘currencies’ being presented to the market:

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Name

Assigned Amount Units

Certified Emissions Reduction

Forestry Certified Emissions Reduction

Emission Reduction Units

EU Allowances

Abbreviation

Description

AAU

Allowance-based credits governed by Article 17 of the Kyoto Protocol and traded on a compliance cap and trade basis amongst signatory nations with an emissions reduction requirement

CER

Project-based credits generated through the Kyoto Protocol’s Clean Development Mechanism (CDM).

Applicable to Kyoto-compliance and voluntary market segments.

tCER and lCER

Project-based credits based on afforestation and reforestation. Longterm CERs (lCER) and temporary CERs (tCER) are available, based on rules of expiry.

Applicable to national compliance with Kyoto emissions reduction requirements.

ERU

Project based credits generated through the Kyoto Protocol’s Joint Implementation (JI) mechanism.

Applicable to Kyoto-compliance and voluntary market segments.

EUA

Allowance-based cap and trade system governed by the Kyoto-compliant EU Emission Trading Scheme (EUETS).

Applicable to EUETS compliance.

Renewable Energy Credits REC (aka Tradable Renewable Certificates and Green Tags)

(TRC)

Voluntary Emissions Reductions

VER

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Project-based credits applied largely by non-Kyoto signatories to generate investment in renewable energy development. Applicable to specific regulatory systems such as specific US state programs (green tags) and voluntary markets.

Project-based credits produced outside any legal framework, verified by any one of a number of standards largely based

42

on the VALID(T) system. Only applicable to voluntary markets driven

by CSR and cannot serve regulatory compliance.

Exist in verified (VER), non-verified (ER), and prospective (PER) forms.

Carbon Financial Instruments

New South Wales GHG Abatement Certificates

Removal Unit

Emerging National and State-Level mechanisms

CFI

Allowance-based schemes run by the Chicago Climate Exchange (CCX) and the sister European Climate Exchange (ECX). Applicable to members of the CCX/ECX voluntary cap and trade scheme and the wider voluntary market.

NGAC

A project-allowance based hybrid scheme governed by the NSW GHG Abatement Scheme (GGAS). Applicable to Australian regulatory compliance and voluntary market segments.

RMU

Project-based credits based chiefly on reforestation projects overseen by the Kyoto Land Use, Land-Use Change and Forestry (LULUCF) framework granted to Kyoto signatory nations. Applicable to Kyoto national emissions requirements A series of national mechanisms informed by Kyoto approaches in development for the post-2012 era. A number of systems are discussed, the majority of which are based on an allowance/compliance cap and trade model:

‘_’ ETS

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New Zealand Emissions Trading Scheme

•

Norwegian Scheme

•

Japanese Voluntary Trading Scheme

Emissions

Trading

Emissions

43

•

Canadian Emissions Trading Scheme

•

US Regional Initiative

•

US Western Climate Initiative

•

US/Canadian Midwestern Greenhouse Gas Accord

•

UK Carbon Reduction Commitment

Greenhouse

Gas

The degree of coherence and integration between these schemes, including their translation to a global carbon market and associated international policy, is an issue for further discussion in subsequent sections.

Applying the key characteristics established above we can apply the following system of differentiation to reveal four asset groupings: Allowance Based

AAU EUA CFI (National Capand-trade) NGAC

Voluntary Grade CER

VER

Compliance Grade

RMU

REC ERU t/l CER

Project Based

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Under such conditions of diversity, the carbon market is constrained by the regulatory regimes which oversee the creation, scarcity, and value of the specific asset. As such the specific pattern of applicability of currency to asset is a prime determinant of the subsequent market. A vision the variable linkage and applicability of these carbon currencies within specific regulatory/voluntary structures must be developed.

An overview is presented by Point Carbon (2008 pg21) in the consideration of segmentation in end-user purchases within the carbon market:

Market Linkage The array of governance mechanisms together with associated standards and guidance present a fragmented structure for the international carbon market as a whole: ‘There are several carbon markets, encompassing both allowances and project based assets that coexist with different degrees of interconnection, leading to a fragmented global carbon market. The emergence of multiple regimes to manage GHG emissions has so far resulted in a proliferation of carbon units or currencies with limited linking between markets’ (World Bank 2008 pg 62) The relevant patterns of applicability and utility may be considered in the following table adapted from the World Bank’s ‘State and Trends of the Carbon Market 2008’ (pg 63):

Carbon Markets Compliance

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Voluntary

CCX

RGGI

NSW

Keidanren VAP

UNIT AAU

NZ ETS

EU ETS

Framework

Kyoto

Voluntary

o wa nc

7.5

45

Project

EUA NZU NGAC CFI CER t/l CER ERU RMU VER REC Applicable without restriction Applicable with restriction(s)

The nature of such crossover can be considered to largely reflect an effort by those controlling cap-and-trade schemes to allow project-based credits. Such efforts are seen as a tool serving the achievement of the environmental objectives in a cost-effective manner; offering a choice between reduction measures or carbon credit purchase to those in the schemes. In this manner, the inclusion of project credits into a cap and trade scheme effectively extends the quantity of issued allowances, largely based on investment in developing country projects.

As such, the crossover presents a focus for criticism directed towards trading as the moral and ethical principles are debated, accusations of grandfathering thrown, and parallels with Papal indulgencies cast. Perhaps in some form of response, restrictions to the substitutability of different assets are evident in some schemes; presenting upper-limits for the use of project based credits in cap and trade schemes.

When considering future trends, the balance between harmonisation and specificity of the market appears to be an issue that presents inherent flux and as such the future fungibility and supplementarity are key issues for further examination in this work.

On one hand, further diversification may be likely as new national and sub-national markets are established and their new recognised trading units are brought into existence. Such diversification may act to limit the international circulation of carbon assets as typologies restrict crossover such that units are not recognized and cannot be sold or redeemed in foreign markets.17 However, on the other, within the context of diversification, a strong trend of harmonisation is evident; both in the form of commonalities in the certification of assets and through the growth of international registries. A centralised registry of carbon credits is proposed to effectively police the tracking and ‘double-selling’ of carbon credits; in the process registries may further serve to bridge distinct trading schemes. The start of this type of registry will be seen from October 2008 when the

17

http://www.law.harvard.edu/students/orgs/elr/vol32_2/Button%20Final%20Final.pdf

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EC and the UNFCC have agreed their project based carbon credit registries can be linked together.

An issue for future consideration, the difference in the nature and restrictions of markets for allowance and project based credits is clearly significant to this study.

7.6

Transactions and Flows The context of tradable allowance and project based assets facilitates a series of transactional flows within the carbon market; demonstrating cash, equity, debt, convertible debt/warrant, or in kind payments. Efforts to characterise the market include the following overview adapted from Bayon18: Offset Project/Programme Developers

Intermediaries and Funds

Retailers

Business: Internal

Business: Embedded Product

Individuals

Applying this overview, it is possible to isolate a structure of primary and secondary markets for carbon assets that echoes established market systems with two key components:

Primary – concerning the over-the-counter flow of project and allowance based assets from the originating project developers and suppliers to end-users and intermediaries

Secondary – concerning the trade exchange flow of project and allowance based assets from intermediaries to the end user and other intermediaries

This system implicates a range of public and private players in governance, administration, and trade. Three broad transaction types are evident, most visibly associated with the EU ETS: i.

Initial Auctioning

18

Bayon. 2007. ‘Voluntary carbon markets: An international business guide to what they are and how they work’.

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7.7

ii.

OTC

iii.

Bilateral trades

iv.

Exchange trading

Market Players Capital providers – Individuals, corporations and foreign investment Advisers – Consultants, analysts and credit rating Investors – Fund managers, investment banks and project finance Lenders – Corporate banking, mortgages and commercial loans Insurers – Re-insurers, underwriters and brokers Brokers/dealers – Investment dealers, commodity traders and brokers Users of capital – Individuals, corporations and governments Regulators – Listing/disclosure, accounting standards and banking law

Five broad groups can be isolated, each concerned with specific elements of governance, supply, trade, application, and support within the market: We may consider five key groups: 1. Governing Organisations – those legislative and regulatory bodies providing the stimulus, drive, and steer to the carbon market: Governing Organisations Legislative Bodies

Regulatory Bodies

•

UNFCCC

•

UNFCCC Secretariat

•

EU Commission

•

CDM Executive Board

•

National Governments

•

JI Supervisory Committee

•

Voluntary Standard Sponsors

•

Compliance Committees

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•

Designated National Agencies

•

Non-Governmental Organisations

2. Suppliers – those organisations associated with the origin of the carbon asset in either project or allowance form: Suppliers Project Developers

Mandated Installations

Private/public stand alone developers Those businesses in allowance schemes able and aggregators such as: to sell a credit excess, for example those within: • Ecosecurities • EU ETS • MGM • CCX/ECX CFI system • Local Communities •

Specialist NGOs Project Financiers

Project Consultants

Capital and backing behind project Bodies serving developments: implementation:

project

•

IFIs

•

Development Agencies

•

Carbon Funds

•

Engineering Companies

•

Banks

•

Project Design Writers

•

Methodology Developers

•

Specialist NGOs

Technology Providers

design

Document

and

(PDD)

Local/Regional Policy Bodies

Technology firms presenting carbon Local and regional policy bodies applying reduction capability behind projects, key budget to carbon reduction programmes: industries include: • Local Authorities • Renewable Energy • Development Agencies • Energy Efficiency •

Green-Tech

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3. Intermediaries – facilitators of carbon asset trading supporting brokerage, exchange, and carbon price-development to establish the secondary market: Intermediaries Brokers •

Evolution Markets

•

TFS

•

Cantor CO2e

Traders •

Emissions Trading PLC

Exchanges •

CCX

•

ECX

•

BlueNext

Private Financial Companies Standard players in established financial markets supporting; liquidity, arbitrage, structured products for project financing, risk mitigation, capital leveraging, and financial diversification (index and bonds): •

Banks – Fortis, Credit Suisse

•

Asset Managers – RNK, Natsource

•

Insurance Agencies

Large Compliance Buyers •

Platforms

Shell

•

Asia Carbon Exchange

•

CDM Bazaar

Within this system of categorisation it is the ‘intermediaries’ group of organisations that contribute several key dimensions important to the consideration of the future within this study:

A chief driver and facilitator of the secondary market

Presenting linkage of carbon market with broader financial markets

Demonstrating application of existing commodity models to the carbon market

Facilitating the introduction of new products and instruments

Levering greater investor capital into the market

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Compliance Buyers

Voluntary Buyers

•

Kyoto Annex B Governments

•

EU ETS businesses

•

Those subscribed to national ETSs

•

Private Business (motivated by CSR or pre-compliance purchase)

•

Public Bodies

•

NGOs

•

Individuals (retail)

5. Associated Services – a diverse array of stakeholders providing services to those active in the carbon market: Associated Services Quality Control

Legal Advisory

•

DOEs

•

Baker and McKenzie

•

NGOs

•

Climate Focus

Knowledge and Research

7.8

Capacity Building

•

Carbon Finance

•

Multilateral Development Banks

•

Point Carbon

•

Development Agencies

•

New Carbon Finance

•

Policy Bodies (DNAs)

•

IDEA Carbon

•

IETA (UKETG)

•

Ecosystem Marketplace

•

NGOs

•

Reuters

•

IETA (UKETG)

•

Academic Departments

Quantification of the Carbon Market Beyond fundamental shifts in governance, rigour in the speculation over the future of the carbon market can be conferred though an understanding of the key quantified indicators currently being applied to the market.

A number of dominant sources present specific metrics for the carbon market:

Point Carbon

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Caisse des Depots

New Carbon Finance

Point Carbon – Carbon 2008 ‘Global carbon markets worth €40 billion in 2007, up by 80 percent from 2006. The total traded volume increased by 64 percent from 1.6 Gt (1.6 billion tonnes) in 2006 to 2.7 Gt in 2007.

The EU emissions trading scheme saw a traded volume in 2007 of 1.6 Gt and a value of €28 billion. This represents a volume growth of 62 percent and a value growth of 55 percent from 2006. The EU ETS now holds 62 percent of the physical global carbon market and 70 percent of the financial market.

The CDM market increased to 947 Mt and €12bn in 2007. This is an increase of 68 percent in volume terms, and a staggering 200 percent in value terms from 2006, constituting 35 percent of the physical market and 29 percent of the financial market.

The market for secondary trading of CDM credits is the fastest growing segment. From limited activity at the start of the year, over 2007 the market saw around 300 Mt of sCER trades, much of this related to EUA-sCER swaps.’

Such sources contribute to a current market status for 2007 that may be considered in the following volume and value charts: Other 2%

JI 1%

2007: Total Volume Traded

sCDM

% of 2.7 Gt

13%

Source - Point Carbon

pCDM 22%

EU ETS 62%

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JI Other

1%

0.5% sCDM

2007: Total Value Traded

14%

% of Eu40bn Source - Point Carbon

pCDM 15%

EU ETS 69.5%

Combining associated tracking systems, patterns of growth are evident; demonstrated in the following table integrating data from the World Bank’s ‘State the Carbon Market’ series: 2004 2005 2006 2007 Volume Value Volume Value Volume Value Volume Mt Mn Mt Mn Mt Mn Mt CO2e US$ CO2e US$ CO2e US$ CO2e Allowances EU ETS 8.49 ~ 321 7,908 1,104 24,436 2,061 NSW 5.02 ~ 6 59 20 225 25 CCX 2.24 ~ 1 3 10 38 23 UK ETS 0.53 ~ 0 (0.3) 1 n/a n/a n/a Sub Total 16.28 ~ 328 7,971 1,134 24,699 2,109

pCDM sCDM JI Other Voluntary) Sub Total Total

as of

Value Mn US$ 50,097 224 72 n/a 50,394

Project-Based Transactions ~ ~ 341 2,417 ~ ~ 10 221 ~ ~ 11 68

537 25 16

5,804 445 141

551 240 41

7,426 5,451 499

~ ~

~ ~

20 382

187 2,894

33 611

146 6,536

42 874

265 13,641

n/a

n/a

710

10,864 1,745

(inc

31,235 2,983

64,035

Such data is clearly invaluable to analysis of the market, albeit with some restraint. The variance in data presented from different sources is significant, in a manner that may point to differences in the definitions, boundaries, and tracking methodologies being applied to the ever developing market.

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Furthermore, as outlined above, the operation of the carbon market is in great part dependent on the scarcity and value conferred upon it by regulatory frameworks; in addition the compulsion of voluntary markets can be attributed to responsibility informed by the same policy structures. The result is a market that not only ebbs and flows in alignment with policy action and regulatory timeframes, but also appears prone to crashes associated with gulfs in public-private approaches to the market.

Under such conditions quantitative trends used to characterise the market must be approached with a degree of caution.

The impact of such ‘command economy’ features is evident in the failures of governing bodies to effectively control the supply-demand balance; a failure that is associated with historic EU ETS market and CER-price collapses.

Despite such necessary qualifications growth trends are apparent which present implications for consideration of the future: Total European Market Volume OTC and Exchanges Source - Point Carbon 250,000

Volume/kt

200,000

150,000

100,000

50,000

Ju n08

08 Ap r08

Fe b-

-0 7

-0 7 D ec -0 7

O ct

Au g

Ju n07

07 Ap r07

Fe b-

-0 6 D ec -0 6

O ct

-0 6 Au g

Ju n06

06 Ap r06

Fe b-

D ec -0 5

0

Month

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International Kyoto Credit Market Volume Source - Point Carbon 45,000 40,000

Volume/kt

35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Month

Applying such statistical measures with consideration of drivers in the political, regulatory, and economic arenas, leading bodies do venture short-term quantified forecasts for the market: In Point Carbon’s ‘Market Outlook 2008’ the pattern of strong growth is expected to persist: ‘The global carbon market will see 4.2 billion tonnes CO2e transacted during 2008, up 56% on last year. At today’s prices, the market would be worth €63 billion ($92bn)’ Adding: ‘Point Carbon expects the primary CDM market to shrink in 2008, while secondary transactions will continue to grow strongly. The forecast total volume of the CDM market in 2008 would be 1.2Bn tonnes CO2e, worth €15 billion ($22bn) at current prices’ Such a result would cast the following four year trend:

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(Point Carbon 2008 ‘Outlook for 2008’) Such efforts outline the multidimensional issues that must be incorporated into thinking regarding the future of carbon trading and the secondary market for carbon emissions; an approach that strongly aligns with the methodology adopted within this study.

Using the details identified here as a baseline understanding, subsequent sections will seek to drill down on the ‘PESTEL’ trends and drivers that impact on the future of carbon trading.

7.9

Secondary Market Emissions Trading A core element of this study is a critical appraisal of the opportunities associated with the secondary market emission trade. As such, the secondary market is explored here in depth in order to establish a baseline context for subsequent discussion. The task of establishing such a baseline is challenged by the relative novelty of the secondary market in 2008; with a significant portion of the relevant measures only reaching back to 2004/05. However, despite such challenges, an effective baseline, illuminated by key issues, can be developed.

7.9.1 Introduction

As explored above, the market potential presented by the plethora of tradable allowance/project based assets has attracted an array of established financial actors into the carbon market arena which subsequently serve increasingly essential roles.

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focussed on project-based credit trades and swaps. The World Bank identifies such entrants as key facilitators: ‘To bridge the gap between a heterogeneous primary market for projects-based ERs and a standardised allowances market, the financial sector has been instrumental in developing a secondary market for ERs, bringing to buyers standardised asset, coming with guaranteed firm volume deliveries and achieving full price discovery’ (World Bank 2008 pg 61) In reflection Point Carbon observe the entry of financial players into the market ‘in force’ during 2007 most evident with NYMEX, the world’s largest physical commodities futures and options exchange, announced that it would join the market by launching its own CO2 emission products19.

Furthermore, in the same report, Point Carbon mark strong growth of the secondary CER (sCER) market (attributed in a large part to EUA-CER swaps) in a manner that could result in trading for the total CER market could overtake the EUA traded volume in 2009 or 2010.

Such development of the market has resulted in the trade of carbon instruments to financial investors outside the compliance and voluntary end-user group, purchasing credits on the spot market for speculation purposes and future contracts via exchanges. Consistent advance in the secondary market results in value estimates of $60bn in 2007 through the participation of banks, brokers, funds, arbitrageurs, and private traders20.

The health of the secondary market is evident in the steep incline in numbers of exchanges focussed on the carbon market as an alternative to the dominant OTC practice. Currently exchanges including CCX, ECX, BlueNext, Green Exchange, MCX, and Nordpool all demonstrate movement in terms of increased traffic, product innovation, and diversification to new participants.

One result is that portions of the carbon market increasingly appear to follow a standard commodities market formation facilitated by established, non-carbon financial actors. However, the relative novelty of the carbon market paired with the diversity and flux clear in the governance and structural components outlined above, confers a high degree of uncertainty over the future nature of the market and the degree of incorporation into existing systems. This issue is most evident in the debateable nature of the carbon asset as commodity or currency which has significant implications for its subsequent trade.

19 20

Point Carbon – ‘Carbon 2008: post 2012 is now’. 11/3/08. www.pointcarbon.com

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7.9.2 Operation and Traded Volumes

The secondary market presents a diverse selection of tradable instruments which financial investors purchase on the spot market for speculation purposes, or link to derivatives; futures/forward contracts, options, and swaps. Trade within the secondary market implicates an array of banks, brokers, funds, arbitrageurs and private traders who largely follow a business and market model derived from established commodities trading practice.

As discussed, the analysis of numeric trends illuminating the secondary market are hampered by issues relating to its novelty and developmental status. In this manner it is not until 2004 that effective measures for secondary components become available.

The most prominent of these measures is the secondary CER (sCER); the trade of which found significant motive from EU ETS developments in 2004: sCER Volumes World Bank Data 6000

250

5000

Million $

4000 150 3000 100

$ 2000

Million Tonnes

200

Tonnes 50

1000

0

0 2005

2006

2007

Year

2005 2006 2007

Million Tonnes 10 25 240

Million US$ 221 445 5451

The importance of sCERs in the carbon market is demonstrated by the proportion of the total CDM project-based credit trade that is attributable to sCERs trades. pCER sCER Total CERs Tonnes Value Tonnes Value Tonnes Value Mns Mn$ Mns Mn$ Mns Mn$ 19982003 2004 97 485 97 485 2005 341 2417 10 221 351 2638 2006 537 5804 25 445 562 6249 2007 551 7426 240 5451 791 12877 Job no - client name - 04/11/2008 Š Wood Holmes Group Limited

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Such figures demonstrate the recent growth trend for sCERs to ~40% of all CER transactions in 2007, up from just ~4% in 2006. In order to develop this vision of the secondary market the growth of exchange trading can also be considered:

Exchange Trading - EU ETS 1400

1200

ECX

Nord Pool

BlueNext

EEX

Million Tonnes

1000

800

600

400

200

0 2005

2005 2006 2007

ECX 94.3 452.9 1020

2006 Year

NordPool 28 59.6 95.1

BlueNext 4.4 31.5 23.8

2007

EEX 2.8 8.8 5

Totals 129.5 552.8 1143.9

In addition, an increasing number of new financial instruments, carbon contracts, and carbon-based derivatives are becoming available; serviced by specialised firms translating their offering from existing commodities markets:

FINANCIAL INNOVATION IN THE CARBON WORLD Alexandre Kossoy, World Bank Financial institutions have entered the carbon world acquiring pioneering carbon aggregators and building a base for origination of carbon assets globally. An increasing number of carbon contracts and carbon-based derivatives are becoming available. Specialized companies and institutions have sprung up to service several aspects of the carbon value chain; some have begun to pair carbon finance with more traditional skills found in other commodity markets.

Several dedicated funds focusing on developing and participating in greenfield projects have been launched (i.e., these funds are either partially replenished with carbon revenue streams

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or account with the sale of the credits to meet investor expectations of return). Large international banks have established structured origination teams to pick up principal positions in carbon-rich projects and have set up carbon trading desks, seeking arbitrage opportunities.

Financial institutions offer products that reduce or transfer risk, for instance by offering delivery guarantees for carbon assets in the secondary market. Some financial products being rolled out include: Monetization of future carbon receivables: loans are provided by financial institutions against future carbon credit proceeds in forward purchase contracts. The purchase contracts are pledged for the loan’s repayment under a commodity-backed, corporate or project financing models. The structure allows the future carbon revenue streams to be frontloaded and used in the project’s investments monetizing. Full securitization structures have not been identified yet, as insurers/reinsurers report not been able so far to undertake the risk of many spending political and regulatory issues involved in the discussions of a new international regime; Carbon delivery guarantees: A few financial institutions, including the World Bank Group’s International Finance Corporation (IFC) have maximized the price of credits to project developers through back-to-back forward contracts. These institutions provide a credit enhancement and guarantee the delivery obligation of primary market projects to secondary market buyers, and the premium in pricing obtained by the investment grade sellers in the secondary markets is passed on to the projects net of guarantee fees. Similar structures have been provided by many financial institutions, although the arbitrage gains are usually retained by them Derivatives: These financial products were rare to find until last year due to the low liquidity and factored in a very high level of implied volatility. They have become more liquid since mid last year alongside with the increased liquidity in issued credits. Swaps between CERs and EUAs, as well as CERs and ERUs provide a hedging alternative for investors over-exposed to a specific carbon asset. Carbon spread options based on the differential price between CERs and EUAs (i.e., option’s strike price represents the difference between these two asset prices) allow investors to access to pricing upsides, as call options will pay a higher premium if the differential between the two asset prices widen. In addition, call options on future carbon credits have supported selected project finance structures, as the upfront premium can be used by project developers to face project’s investment expenses. Other derivatives based on a basket of carbon assets have been developed; Insurance/guarantees: Guarantees and insurance can protect investors from factors such as advance payments, pricing fluctuation, delivery risks, and projects/credits eligibility under the regulatory schemes. Insurers (Multilateral Investment Guarantee Agency or MIGA for example) insure against investor loss in the event that specified political events in the host country results in a breach of contract related to the investment. The long involvement of insurance providers in the market, reduced uncertainties in a long-term market and better weather-related data and on the costs of mitigation and adaptation to climate change lead us to believe that new comprehensive tools are soon to come;

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Carbon-linked bond transactions: Investment and retail banks started to issue notes with payouts based on the future prices of carbon credits (i.e., investors get higher returns on coupons with increase in carbon prices). These bonds are targeted to retail and institutional clients seeking climate friendly investments. Some vary, linking coupons to spot prices and are without delivery risk, while others are linked to delivery of carbon credits in specific projects. In addition, some institutions have targeted their bonds to large investors and use the capital raised to invest in new carbon credit-rich projects, which in turn may generate more credits; Others: These include green credit cards, carbon neutral products, the sale of German EUAs, the upcoming auctioning of the UK EUAs, and the sale of the CERs of the adaptation fund and initiatives focusing the climate change agenda (such as the Climate Investment Fund) are expected to support financial engineering structures. The core functions in carbon trading are undergoing rapid standardization and evolve fast. While the carbon exchanges facilitate price discovery in the (still not transparent) primary market and offer hedging products, the development of platforms for auctions might reduce the gap between the primary and secondary markets.

The urgency and the scale of the climate agenda posts challenges and opportunities to financial institutions. The carbon market will benefit from the development of: (i) comprehensive insurance/guarantee products underwriting political risks inherent in international negotiations and collective international action, as well as contract frustration risks at the project level, (ii) financial engineering solutions to frontload future demand to allow transition until new international regime(s) are agreed (for instance, bonds backed up by future commitments and post-2012 carbon funds, such as funds announced by the European Investment Bank and the World Bank), and, (iii) project-level mechanisms to leverage the limited impact of carbon credits in low-carbon technologies.

We may broadly characterise such developments as one of two product groups on offer from carbon market intermediaries; the offer of financing and hedging products to suppliers in the carbon market, or the offer of structured risk mitigation products to the end users. The future of the financial products emerging from the secondary market is clearly a prime issue for this study and will be considered in greater depth in subsequent stages of this report.

7.9.3 Value Chain

Investigation of a secondary market for emissions trading reveals what may be best considered as an ecosystem of interlinked intermediaries integrating organisations that straddle the primary and secondary arenas rather than a distinct component.

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A series of organisation types are engaged in emissions trading in the form of an intermediary and/or supporting services provider – demonstrating the complexity of the ‘ecosystem’ within which the secondary market resides21:

Verification

Investment

Funds

Offset Providers

Brokerage

Exchanges

Trading Scheme Design

Consultancy

Project Development

Technology

Engineering

Legal

Trading

Such a system can be populated with a number of key representative organisations whose activities relate to one or more ‘intermediary’ class (NB this classification is intended to be indicative only and cannot be taken as a complete encapsulation of a firm’s portfolio):

Traders

Registry services

Brokerage services

Legal Services

Project Developer

Financial Services

Consultancy

Accounting

ABN Amro AES AgCert Agrinergy Ashton Commodities Baker & McKenzie Barclays Capital BNP Paribas C02 Balance Camco International CantorCO2e Carbon Capital Markets Carbon Clear Carbon Resource Management CEAG Citigroup Climate Care Climate Change Capital Climate Focus Credit Suisse

21

Adapted from – Steen. 2008. ‘Carbon finance and trading – UK offering’. Nicola Steen, Senior Vice President – Transaction Specialist, CantorCO2e Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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Deutsche Bank DLA Piper Dresdner Kleinwort EcoSecurities Ltd EEA Fund Management Ltd Emissions Trading PLC Euroclear SA/NV European Climate Exchange First Climate Fortis Bank Green Gas International (UK) Limited Green Power Conferences GreenStream Network Hunton & Williams ICAP plc ICECAP Ltd ING JP Morgan KPMG LEBA Lehman Brothers Linklaters Lovells Macquarie Bank Limited Merrill Lynch Mitsubishi Corporation (UK) Plc Nabarro NATIXIS E&I New Carbon Finance Norton Rose PwC Rabobank RBS Sempra Sindicatum Carbon Capital Societe Generale Standard Bank Sustainable Forestry Management TFS Green The CarbonNeutral Company Tricorona UniCredit / HVB Van Ness Feldman, P.C. WSP Environmental (Adapted from Carbon Markets Association22 self-classification membership listings)

22

www.carbonmarketsassociation.net

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As such, refining the focus to financial services, the following activities are readily translated from an established financial services/commodity trade arena to the carbon market:

Capital providers – Individuals, corporations and foreign investment

Advisers – Consultants, analysts and credit rating

Investors – Fund managers, investment banks and project finance

Lenders – Corporate banking, mortgages and commercial loans

Insurers – Re-insurers, underwriters and brokers

Brokers/dealers – Investment dealers, commodity traders and brokers

Users of capital – Individuals, corporations and governments

Regulators – Listing/disclosure, accounting standards and banking law

As such, much concerning the technology, skills, transactions, legal support, business models, and key players of the established financial sector is directly attributable to the carbon market, which may be considered as an emergent niche area within existing operations.

7.9.4 Dominant Locations

The example of leading centres of the secondary market for emissions trading further supports the vision of trends and drivers underlying development. Currently a wealth of qualitative and quantitative evidence proposes London to dominate the carbon market. Reasons for this current status are introduced by IFSL Research23: ‘London is a leading global centre in carbon markets. The UK is a lead investor in CDM, accounting for 59% of purchases in 2007, and the carbon futures contract traded on ECX in London remains the dominant exchange contract in the EU ETS. London gained key experience from the UK’s voluntary Emissions Trading Scheme which ran from 2002 to 2006.

Carbon markets are increasingly intertwined with the emerging industry from renewable energy development: London is a key centre in the provision of finance to this market, with 69 renewable energy companies having joined the Alternative Investment Market (AIM) by the end of 2007’ (IFSL Research 2008 pg 1) In part we can attribute the evidential subsumption of the carbon market within the established commodities market can be attributed to the significant efforts made by financial services associations to consider the impact of climate change. In this manner a series of strategy documents from the early 2000s flag opportunities for established

23

IFSL Reseacrh. 2008. ‘Carbon Markets 2008’. June 2008, www.ifsl.org.uk

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financial services firms from key sources including UNEP Finance Initiative24 and GLA Economics25.

Such analysis reveals strategic drivers determining the London-centric carbon market location of players in the secondary market:

Cultural inertia within the London-centric financial sector

Legacy of existing financial sector geography

Attraction of long-established financial institutions

Predominance of diversified established financial players within the carbon market

Continuation of operations within established financial players

Enduring first mover advantage associated with the UK ETS and EU ETS

Proximity to the key policy bodies regulating the market

Perception of London as only UK option for a European base

Access to opportunities arising from the progressive GL policy agenda surrounding climate change adaptation

Proximity to primary carbon market players; particularly those financing and delivering emissions reduction projects

Integration with broader green-tech, renewable energy, and energy efficiency sectors

24

UNEP/Innovest. 2002. ‘Climate Change & The Financial Services Industry’. Prepared for the UNEP Finance Initiatives Climate Change Working Group by Innovest. With guidance from UNEP Finance Initiatives Project Coach Dr. Andrew Dlugolecki. July 2002 25 GLA Economics. 2002. ‘Financial Services and Climate Change’.

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8

Appendix 2 – PESTEL Analysis The PESTEL approach to foresight is a method that acknowledges inherent complexities associated with considering the futures of systems such as the emissions trading market through the integration of multiple dimensions into the analysis.

Specifically the dimensions to which the PESTEL acronym refers are:

Political

Economic

Environmental

Social

Legal/Regulatory

Technological

However, the adoption of such an expansive approach demands a pragmatic scoping of the issues being considered. In this manner, informed by the original project brief, the focus will centre on characterising the future of the secondary market emissions trading sector through exploration of associated consequential trends and drivers. To this end an understanding of the following core features of the secondary market is vital to this study’s core objectives:

Core features of interest regarding the secondary market emissions trading sector

Structure of the market

Technological basis

Skill sets employed

Method and location of transactions

Legal conditions

Nature of profit and business models employed

Key players and their business relationships

In the following sections the PESTEL issues will be explored.

8.1

Political The climate change agenda is motivated and has been enacted through political will; in the main through the UNFCCC and Kyoto. The political drivers for, and significant implications of emissions trading on international politics, arguably make an understanding of the political issues of paramount importance when attempting to understand how emissions trading will develop.

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The following key issues should be considered: Climate Change Agenda The climate change agenda has an inherently political nature that relates to carbon market policy26. The importance of the climate change agenda in politics continues to increase in prevalence through the commitment by nations to the Kyoto protocol in addition to increasing public concern.

However, some individual governments continue to argue their commitment to ambitious domestic policies and measures may limit competitiveness in light of the potential ‘free-riding’ by other countries27.

This concern is particularly argued in the US, who have not signed up to Kyoto, yet, through experience of SO2 and NOx trading, did significantly influence the use of trading as a method to reduce emissions, which has since been taken up for the capand-trade schemes linked to Kyoto28.

The climate change agenda is likely to continue to be controversial with significant challenges such as setting appropriate targets, approving projects and overseeing monitoring requirements – to achieve these requires better international harmonisation26.

It is important to distinguish the fact that emissions trading is just part of the climate change agenda (although a very large part) and it is one of a range of possible solutions and requires other policies and measures within an overall sustainable development agenda that addresses climate security, as well as food, water, energy and other “securities”26 National Emissions Trading Schemes (ETS) The political will in relation to the climate change agenda is driving competition at national and multi-national levels to develop and lead on the issue. For example, the EC emphasised the EU commitment of ‘transforming Europe into a highly energy efficient and low greenhouse-gas-emitting economy’29.

An essential element to the success of trading schemes is the political will to set longterm policy and visibility to give value to carbon as commodities and subsequently bolster investor confidence25.

26

Gledhill R., Grant J. and Ping Low L. PricewaterhouseCoopers (2008) Review of Carbon Markets.

Breaking the Climate Deadlock, Briefing Paper.

27 Cédric Philibert (2005) Approaches for future international co-operation. OECD environment directorate International Energy Agency.

28 Congressional Research Service (2006) Climate Change: The European Union’s Emissions Trading System (EU-ETS) 29 European Commission (2008) Proposal for a directive of the European parliament and of the council amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading system of the Community Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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The UK and the rest of the EU are far beyond the US in terms of advancement of an ETS as well as general discussions of climate change – at every level of politics, business and amongst the general public.

The US involvement, however, is essential if there are to be the levels of emissions reductions required to mitigate the effects of climate change; with calls for US involvement from long-standing and more recent signatories of the Kyoto Treaty30.

There is considerable movement in the sub-national schemes in the US such as RGGI, as well as the voluntary sector; although the latter is motivated by marketing and green initiates as oppose to compliance through a cap-and-trade scheme.

More broadly, the number of national schemes is likely to increase in the near future, as more countries look to create schemes to reduce their emissions and exceed their Kyoto allowances. This could in turn result in the linkage and harmonisation of national schemes forming a global scheme31 through a ‘bottom-up’ system of national, sub-national and regional linkage, as oppose to the ‘top-down’ approach of the current Kyoto system26.

The linkage of national ETS is already occurring to a degree, with allowance and project credits becoming increasingly fungible between schemes32 and as the value of CERs is approaching that of EUAs, thus increasing the credibility of project based allowances within national schemes.

Post-2012 Strategy Post-2012 there is likely to be significant changes in the global set-up of emissions trading. The EU ETS, as a consequence of momentum, will continue to grow regardless of policy post-2012.

However, a comprehensive post-2012 global agreement could re-open the door for domestic ETS schemes to develop in a more open fashion, making them more common26 If the US is to enter a national ETS scheme, it will only be post-2012, and is likely to be shaped mainly be US domestic policy, with little regard for international schemes.

How post-2012 trading interacts will largely be dependent on the environmental integrity, competitiveness33 and fungibility of emission units between schemes32 (regional, national, multinational, allowance or project based)

30

http://www.thewest.com.au/default.aspx?MenuId=28&ContentID=92522 McKibbin, W. (2007) An Evaluation of the Report of the Prime Minister’s Task Group on Emissions Trading, http://lowyinstitute.richmedia-server.com/ 32 Button. 2008. ‘Carbon: Commodity or Currency? The Case for an international market based on the currency model’. Harvard Environmental Law Review, Vol.32.

33 Müller, B. (2005) Climate Change post-2012: Transatlantic Consensus and Disagreements. Journal for Energy Literature,Vol.11, Issue 1 31

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It is widely accepted that post-2012 compliance needs to increase, but with reform of CDM to give clearer and less bureaucratic projects.

Post-2010, the UK will initiate its carbon reduction commitment, which has implications for those large organisations (over 6000MWh usage per year on half hourly meters) that are not currently under the EU ETS. This further demonstrates a domestic commitment to meet and/or exceed Kyoto targets34.

8.2

Economic As a financial system, the implications of economic trends on the carbon market are an essential consideration for this foresight process.

The following key issues must be considered: Global Environmental Conditions The potential impacts of the current slowdown of US and EU economies on the carbon market will be in part masked by the complexity of the knock-on relationships that communicate macro-economic trends through to specific market segments.

However, amidst such complexity, a series of important implications for the future carbon market may be resolved.

Prime amongst these is the impact of the credit crunch on the financing of large-scale CDM/JI/VER emissions reduction projects; potentially stifling supply and impacting on credit prices. However, such impacts appear limited to project credits as commentators note the resilience of credits from allowance based schemes conferred upon it by the careful control of caps by governing bodies35.

Extending the discussion surrounding the project based credit; economic slowdown appears to present different challenges for different project types as the upfront capital required for renewable energy installations versus energy efficiency measures vary.

This is evident in the apparent market concern surrounding the delivery of credits from CDM projects that are suffering delays in implementation derived from economic conditions alongside planning issues36.

However, with demand for carbon credits secured by regulatory compliance, the financing of CDM projects may be able to weather the economic conditions that currently challenge other commodities markets37. With the high degree of uncertainty surrounding the financial sector, definite conclusions concerning future trends are

34

Department of Trade and Industry (2007) Meeting the Energy Challenge. A White Paper on Energy. http://www.berr.gov.uk/files/file39387.pdf 35 Haddon. 2007. ‘Carbon trading the success story in credit crunch, say fund managers’. City Wire, 27 September 2007, www.citywire.co.uk/selector/-/news/other/content.aspx?ID=287537 36 Point Carbon. 2008. ‘Carbon Market 2008’.

37 CommoditiesOnline. 2008. ‘Will stock market meltdown hit commodities?’. January 25, 2008, www.rediff.com/money/2008/jan/25commodity.htm Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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limited. The result appears to present a variable outcome that lies between resilience and market restructuring that must be maintained within the final scenarios.

Future of Commodity Markets Increasingly cast as a commodity, the carbon asset is potentially subject to similar forces acting on the broader commodities market system of which it is the secondary market that appears to demonstrate greatest development.

Global commodities markets currently demonstrate rapid investment growth as new players are drawn by the high returns on offer when compared with equity and debt markets; as a result fundamental shifts in structure and practice may be expected: ‘New entrants are flooding into the market in large numbers, in many cases without physical exposure to the underlying commodities. They are contributing to volatility by exacerbating any movements in price, which coupled with the rise in algorithmic trading is causing risk management strategies to be re-evaluated in light of the breakdown of historical trends’ (Datamonitor 200838) The implication for this study may be a breakdown in the specificity of the carbon market and its key players in the secondary market as generalist speculators combine carbon credits within the broader churn of commodity derivatives.

Currency versus Commodity Approaches The issue of that apparent dichotomy of the carbon market between a carboncurrency, versus a carbon-commodity based system has been discussed earlier in the report. The carbon market of 2008 appears to exist in a developmental phase in which prevailing tendencies cast carbon as a commodity, despite the carbon asset in its allowance form arguably existing as a sui generis right which can be traded like a currency39: ‘The characterization of carbon is a buried issue, because convergence between Kyoto and non-Kyoto trading systems has not yet occurred. The characterization of carbon should be done in a functional fashion so as to facilitate the creation of a trading system that maximizes economic and environmental benefits of environmental markets. Because carbon units are essentially synthetic assets, the international community has the opportunity to treat them however they wish: it should consider whether measuring carbon by the ton, like corn and soybeans, instead of measuring it as a unit whose value is reflective of the performance of the government that backs it, like Euros and Dollars, will hinder the convergence of these diverse markets, rather than facilitate it. Which approach to take should be agreed as a priority before the convergence of incompatible global carbon markets’ (Button 2008)

38

Datamonitor. 2008. ‘Technology options in commodities trading (Strategic Focus)’. 24 April 2008, www.datamonitor.com/industries/research/?pid=DMTC2183 39 Button. 2008. ‘Carbon: Commodity or Currency? The Case for an international market based on the currency model’. Harvard Environmental Law Review, Vol.32.

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The evolution of this issue beyond Kyoto in 2012 is clearly a key determinant of the nature of the secondary carbon market. Currently it is clear that a commodity model prevails that appears to be derived from the legacy of players that currently form the secondary market. However, questions arise concerning the future of such a context:

Will regulation continue to support the commodity model?

Can the carbon market survive without the financial weight conferred upon it by established commodity traders?

What is the political vision for the post-2012 market?

To what degree will national ETSs converge to form a unified market?

These questions must be considered in the development of future scenarios.

Impact of Energy Prices The energy bill for individual facilities mandated for compliance in the EU ETS is clearly a factor in the decision over the balance between compliance through trade versus compliance through emissions reduction; increasing energy prices potentially forcing economic decisions in favour of the latter. As such, energy efficiency strategies, driven by energy prices rather than EU ETS compliance, present a key component in the demand-profile of allowance and project based credits40.

Conclusions Economic trends in 2008 present a host of uncertainties for the future of the market that greatly favour treatment within scenario planning rather than single forecasts.

When drawing the discussion back to the shape and practice of the secondary market a series of issues demand recognition in the subsequent scenarios. In developing the scenarios, no single issue stands out as ‘prime’; rather it is the complexity and interconnectedness of these issues demands recognition.

8.3

Social As a component force behind political agendas and a key target for the voluntary emissions trading market, social trends and attitudes to carbon trading must be considered: We may consider the following important themes: Perception of Climate Change

40

World Bank. 2008. ‘State of the Carbon Market 2008’.

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The social perception of climate change trends may be considered to contribute to the ‘public opinion’ driving CSR-motivated voluntary market, together with a more indirect input into international and national policy decisions. In this manner we may relate to public opinion regarding climate change to the shape and size of the future carbon market(s).

In 2008, the public profile of climate change may be considered to have reached a peak (at least in the EU, Kyoto signatories, and US) attributable to popular media portrayals; including those of commentators such as Al Gore41 and George Monbiot42 who each appear to take public engagement on the issue as a prime activity.

The result of such comment from the large group of commentators that surround the media-public debate appears to be the unity between public and scientific opinion regarding anthropogenic climate change trends43, albeit with some opposition44.

However, the durability of such opinion in the light of current economic conditions fronted by the ‘credit crunch’ may mean that current consensus represents a peak heralding post-2008 decline. This is most evident in the perceived drop-off in public fervour concerning climate change in the UK45.

Within such a context it is still possible to project support for measures proposed to oppose climate change, such as emissions trading, as the price of energy inefficiency seems set to figure highly in coming years46. As such we may consider public opinion as a facilitator of the carbon market, providing the link between emissions trade and reduction of climate change trends holds fast in public opinion.

Public Judgement of Trading As proposed above, a necessary perception of emissions trading as a solution to climate change may form a knife-edge across which society may form a facilitator or inhibitor of the carbon market.

Signs that the emissions trade is viewed in a positive light are evident in the growth demonstrated by the voluntary VERs offset trade headed by firms such as Climate Care and Carbon Neutral Company47. Furthermore, the strong uptake of footprinting,

41

www.climatecrisis.net www.guardian.co.uk/profile/georgemonbiot 43 BBC. 2007. ‘Man causing climate change poll’. Tuesday, 25 September 2007, http://news.bbc.co.uk/1/shared/bsp/hi/pdfs/25_09_07climatepoll.pdf 44 Begley. 2007. ‘The Truth about Denial’. NEWSWEEK, Aug 13 2007, www.newsweek.com/id/32482 45 Macalister. 2008. ‘A change in the climate: credit crunch makes the bottom line the top issue’. The Guardian, Thursday March 6 2008, www.guardian.co.uk/business/2008/mar/06/greenbusiness.creditcrunch 46 Crooks. 2008. ‘Supplier warns of higher energy prices’. FT, June 3 2008, www.ft.com/cms/s/0/61aa9576-3196-11dd-b77c-0000779fd2ac.html 47 Broekhoff. 2008. ‘The Voluntary Carbon Market’. World Resources Institute, www.vsbn.org/docs/20080306_Voluntary_Carbon_Markets_WRI.pdf 42

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evidenced by the growth of online calculators48, may be considered to support the offset as a natural conclusion to such measurement activities.

However, a significant anti-emissions trade movement is apparent with Carbon Trade Watch apparently heading a sceptical response to failings in CDM-methods and grandfathered windfalls in the EU ETS with publications such as ‘The Carbon Neutral Myth: Offset Indulgencies for your Climate Sins’49. Beyond this extreme, apparent frailties of the CDM paired with the £11Bn windfall for energy sector engaged in the EU ETS proposed by Ofgem50 appears to challenge any good favour for emissions trading held within public opinion.

A series of speculative results may be considered for the purposes of this study: i.

Public opinion supports trading and market grows across all sectors

ii. Public opinion opposes trading resulting in voluntary market fall and pressures for those operating with CERs iii. Public opinion supports highly regulated cap-and-trade only thus challenging secondary markets The actual result is unlikely to demonstrate any consensus between these three, nor is the power of public opinion likely to cast any great shadow over international private financial sector. However, implications for voluntary markets and the evolution of the political agenda remain.

Global Economic Development Amidst Western low-energy and low-emissions policy agendas, global economic development across the developing world apparently threatens to eclipse much of the emissions reduction achieved in the developed world.

Such issues are captured in the ‘Environmental Kuznets Curve51 theory that traces a pattern of rising emissions related to early economic development; the heart of which is expressed in the presentation of ‘Clean Growth’: ‘Our first goal is to find the way to achieve "clean" growth and I want to defend this idea here today. We haven't got to choose between saving the planet and growth. We need to have growth and save the planet. So we need a growth that consumes less energy and fewer raw materials. A new economy must be invented’ (Sarkozy speech to the UN Assembly 2007)

48

The Home Energy Saver Library – http://hes.lbl.gov/hes/carbon-calculators.html http://carbontradewatch.gn.apc.org 50 Webb. 2008. ‘Fuel firms set for £11bn windfall in CO2 trading’. Observer, Sunday August 10 2008, http://www.guardian.co.uk/environment/2008/aug/10/emissionstrading.utilities 51 http://en.wikipedia.org/wiki/Kuznets_curve 49

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Such sentiment is echoed in analysis of necessary changes in the ‘carbon intensity’ of economic development by leading research bodies such as Caisse Des Depots52.

In short, economic development appears tethered to fuel use and emissions; as such the demand for abatement and reduction solutions can only grow with global economic development. In such a context, the position of carbon market as one solution within a larger group seems strong across compliance, voluntary, primary, and secondary segments.

Conclusions The power of social trends and public perception to determine the characteristics of the carbon market may be limited in scope outside the CSR-orientated voluntary market. Influence over the future of the market appears to be restricted to the power of public sentiment acting on political agendas, with implications for the broad approval of the carbon market and its components.

In this manner, the position of the emissions trade as a successful solution to anthropogenic climate change in the public perception is a key determinant of a facilitating versus inhibitory public response. In 2008, this judgement may be considered to exist in a state of uncertainty.

8.4

Technological The carbon market is inherently supported by technologies associated with the development and trade of the carbon asset; as such the implication of future innovation must be considered.

To this end we may consider the following topics: Innovation in Commodity Trading As has been covered at length in preceding sections, established commodities trade practice has been translated to the emissions trade arena such that numerous parallels exist across transactions, contracts, and trading platforms. In this manner technological innovation in carbon trade can be considered, in part, the extension of commodities practices to the emissions trade.

In this manner, as has been discussed, a number of new market entrants, novel contracts, and supporting service providers have entered the carbon market space to mediate trade and form the secondary market.

52

Caisse Des Depots. 2007. ‘Growth without warming? The carbon intensity of the developed economies’. Research Report no. 10, January 2007, www.caissedesdepots.fr/IMG/pdf_CaisseDesDepotsClimateResearchReport_10_Growth_without_war ming.pdf Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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Technological innovation impacting on the secondary market is most evident in exchanges; within which the mechanism of trading is increasingly remote; ‘open outcry’ exchanges are in the decline and virtual market place supported by online networks featuring program trading and automated systems appear to be favoured by the larger players. Through such technology exchanges and markets are increasingly accessible to intermediaries and end-users alike; extending global involvement in the secondary market and arguably supporting harmonisation53.

Furthermore, competition amongst exchanges is increasingly based on technological innovation in product and service with some commentators proposing an IT based ‘arms race’: ‘As exchanges have moved away from being membership-led organisations and have entered into the for-profit world, they have found that the price of freedom is the need to make money and diversify’ (Trading Technology 200354) Considering the emissions trading context the ECX appears to command the European exchange market over other relative minority players such as Nord Pool and BlueNext based on its status in the EU ETS. In terms of future trends key issues surround the ability of specialised exchanges to compete with diversifying exchanges.

Abatement Technology and Credit Demand A strong trend in technological innovation focuses on low energy futures, energy efficiency, and resource efficiency in a manner that appears to support those mandated in compliance schemes to achieve their emissions cap through reduction strategies alone, without the need for trading. Subsequently the future of such technological trends has a strong bearing on the emissions trading market.

The implication when considering the future of carbon trading is that technological abatement advance potentially exerts force acting against growth in emissions trading.

However, a level of complexity must be considered: The ability of mandated facilities in the EU ETS scheme to emit below their cap through technological advance is a component of the explanation for the windfall profits expected from phase II of the scheme55. In fact, by the nature of compliance schemes, mandated facilities currently make an economic decision regarding the balance of technological investment and emissions trading employed in the achievement of the cap56. As such, the uptake of technology to reduce emissions can be related to the level of the emissions cap imposed upon these businesses.

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Carlsson. 2007. ‘The Future of Exchange Trading Technology’. http://fixglobal.com/back_issues/Q12/Lowres_global1.pdf 54 Trading Technology. 2003. ‘A Strategic Study of Stock Exchange Technology’.

55

Hotten. 2008. ‘EU says companies profit from carbon trading’. Telegraph, 22/01/2008, www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/01/21/cnets121.xml 56 World Bank. 2008. ‘Stare of the Carbon Market 2008’.

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In this manner, the advance of abatement technology must be considered separately from the uptake of abatement technology which presents a higher degree of uncertainty, due to the apparent fact that such innovation both determines, and yet is also determined by, the status of the carbon market.

Emissions Reduction Projects and Credit Supply The project-based credit, whether it is achieved through forestry or renewable energy, is technology based and thus subject to innovation trends. As such, the march of innovation in renewable energy and energy efficiency arenas appears to present new opportunities for the development of CERs and VERs alike. However, because a range of CDM project types contribute to the CER total, the complex relationship between project cost and the resulting CER price appears to direct the market towards specific project types.

Under such circumstances the supply of such projects and their associated credits is a key determinant of the health of the market as oversupplies threaten to crash prices and limitations in supply derived from delays in the project pipeline push prices higher57.

The implication is that market governance by the CDM EB and counterparts represents a pivotal point about which the market can flourish or decline based on the balance of supply to meet demand.

Conclusions Technological innovation appears to present a series of uncertainties for the future carbon market both in terms of evolution of market practice and the very nature/origin of the traded asset. Of these twin issues it is the nature of projects that deliver credits that appear to require development in the shape and nature of the secondary market.

8.5

Environmental The origin of the carbon market is as an emissions reduction (abatement) solution designed to oppose the march of anthropogenic climate change; as such environmental trends have implications for the nature and purpose of emissions trade.

In this manner we may consider the following key issues: Relationship between Climate Change and Credit Demand Two key dimensions of a relationship between climate change and credit demand are evident which draw direct implications of climate change for the carbon market:

57

Reuters. 2008. ‘CER supply and Kyoto's CDM project pipeline’. Mon Jun 30, 2008, http://uk.reuters.com/article/oilRpt/idUKL2615042120080630 Job no - client name - 04/11/2008 Š Wood Holmes Group Limited

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Alignment of weather patterns with emissions patterns such that extreme weather drives extreme fuel usage among those mandated by compliance schemes; threatening the facility’s achievement of its emissions cap and thus driving credit demand58

Alignment of public sentiment and voluntary market activity with extreme weather patterns59

The context of continued anthropogenic climate change trends appears to foretell futures of evolving geographic weather patterns and new extremes (precipitation, temperature, etc); as discussed in the IPCC Fourth Assessment Report (AR4)60. Under such conditions and in the knowledge of the correlation outlined above we may expect increased emissions and thus increased emissions trade as a result of climate change.

However, to complete the picture, we must consider the relationship in reverse, to ask; what is the impact of emissions trading on climate change trends? Because of the relative novelty of the market that is in part based on long-term projects, paired with difficulties in measuring and attributing emissions reduction results, the impact of the carbon market on climate change is not readily considered. However, we may consider that, if in the long term this link cannot be made, the political force supporting the market may wane. This issue lies at the centre of Sinks Watch’s61 attack on the veracity of emissions reductions and positive climate effects associated with projects delivering carbon credits.

Overall, the result appears to present environmental trends in support of a carbon market that casts itself as a solution to anthropogenic climate change. However, threats to this casting present threats to the carbon market as a whole; placing a burden on CDM, JI, VER standards systems to establish and maintain the market’s claim to emissions reduction and the resulting climate change solution.

Pressures Facing Specific Reduction Projects The base carbon asset resource for project-based credits is derived from a number of project types; for example the CDM project-type split is currently thus:

58

Point Carbon. 2008. ‘Carbon 2008’. www.pointcarbon.com World Bank.2008. ‘State of the Carbon Market: 2008’.

60 IPCC. 2007. Climate Change 2007: Synthesis Report’. Fourth Assessment Report, www.ipcc.ch/pdf/assessment-report/ar4/syr/ar4_syr_spm.pdf 61 www.sinkswatch.org 59

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CDM Project Types 2007 World Bank data CMM 5%

HFC

N2O

8%

9%

Other 1%

Waste

Fugitive

Management

3%

4% Hydro

LFG

12%

5%

Agro Forestry

Wind

1%

7% Biomass 5%

Energy Efficiency and Fuel Switching 39%

Other Renewables 1%

Such a pattern is subject to development as new technology such as carbon capture and storage are considered for inclusion within CDM schemes62. Beyond the clear technological drivers, the key issue in terms of environmental trends appears to be the limits of project types; an example might be limited fuel and material resources for renewable energy component manufacture or limited land resources for forestry. As such we must consider a churn of project types forming tradable CERs. Such considerations raise issues for the very long term; however, in the shorter term we must consider the potential for CER demand to outstrip the supply from CDM projects as environmental conditions force the development of new projects. Such a situation further appears to drive uptake of the JI and other project systems.

Conclusions The carbon market it inherently tethered to the environmental context, with market activity and the nature of the asset determined by climate change and resource depletion. The key issue for this study is whether this context is set to change within the shorter term and whether uncertainties surround such change. In response to this environmental trends driving the market appear set for the long-term; however, the nature of the carbon asset may see movement in the patterns of CDM, JI, and other project-based accreditation mechanisms.

62

OECD/IEA. 2007. ‘Carbon capture and storage in the CDM’. www.iea.org/textbase/papers/2007/CCS_in_CDM.pdf

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In addition a number of environmental trends may be considered to contribute to a mounting strain on the project-based system of trade; pushing policy and the subsequent market toward allowance based systems in preference to the failings of CDM projects.

8.6

Legal/Regulatory The role of regulation as stimulus and controller of the carbon market cannot be underestimated; as such development of the regulatory framework applied to emissions trading is a core aspect of the market’s future.

In this manner a number of trends must be considered: Development of the ETS Landscape Following the lead of the UK ETS and EU ETS, the enforced cap-and-trade scheme appears as the format of choice for national responses to emissions reduction commitments made by Kyoto signatories. As a result, a plethora of national ETS schemes are in the pipeline for the period 2008-2012 which include large emitters in US, Australia, and Canada industry63.

Such developments present a significant boost for international growth of the carbon market which would appear to support the secondary market as a necessary component. However, in the development of distinct national systems, the issue of linkage and credit applicability between the schemes in pursuit of a single, global carbon price raises issues for the scope of trade within the secondary market. Stern considers the necessary steps in ‘international collective action’ required to achieve a global market: ‘Linking and expanding regional and sectoral emissions trading schemes, including sub-national and voluntary schemes, requires greater international co-operation and the development of appropriate new institutional arrangements’ (Stern 2006 Chap 2264) Currently it may appear that the CDM/JI based CER is the glue which unifies the fragmented ETS landscape governed a by complex pattern of credit-scheme applicability. Such a fragmentary structure arguably acts as a barrier to the development of a globally unified market presenting a single carbon price and thus may limit the scope for the emissions trade to follow a global commodities trade model.

Furthermore, the cap-and-trade allowance-based system appears to dominate plans for the carbon market in a manner that may be considered to threaten those surrounding the development and trade of project credits. Although there is restricted inclusion of

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Australian Government. 2008. ‘Emissions trading in the rest of the world’. July 2008, www.climatechange.gov.au/greenpaper/factsheets/pubs/fs11.pdf 64 Stern. 2006. ‘Stern Review: the economics of climate change’. Chapter 22, www.hmtreasury.gov.uk/media/7/4/Chapter_22_Creating_a_Global_Price_for_Carbon.pdf Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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CERs across the majority of existing and developing ETSs, implications such as increased segmentation and decrease project credit volumes may be proposed.

However, fragmentation arguably serves the development of the secondary market through its capacity to harmonise credits within exchanges and the array of financial instruments. In this manner, fragmentation of the carbon credit type may be considered to support growth in the secondary market.

Prospects for the Voluntary Credit As compliance segments of the carbon market promise a future for trading beyond 2012, the future of the voluntary trade appears much more insecure due to its lack of governmental recognition, the encroachment of compliance schemes on voluntary territory, and waning CSR interest amidst economic pressures.

The UK presents a relatively sophisticated emissions trade landscape, with Kyoto, EU ETS, and UK CRC schemes alongside the Climate Change Bill’s consideration of personal carbon credits65. Through such developments the space available for voluntary trade appears to be increasingly squeezed. Importantly, within the UK Government’s recent draft code of best practice for offset providers, the VER was not acknowledged due to the variety of standards that currently exist66. As such conflict between Defra and key bodies such as the offset industry group ICROA67 and the WWF continue68.

As such the voluntary segment of the carbon market presents a degree of uncertainty, and further adds to the fragmentation and barriers to linkage expressed by the market as a whole. Because VERs standards such as the Gold Standard and VCS often more than match the rigour of CDM and JI methodologies, the future of voluntary trade appears to secure; however, without mutual linkage with compliance credits, the voluntary market seems set to remain an isolated component leaning toward OTC/retail activities rather than trade.

Competing Compliance Approaches Complexity in the market occurs as a consequence of competing compliance approaches. The allowance and project based credits have been discussed in terms of restrictions of fungibility and how this may evolve going forward. The existing strength of the emissions trading market should be carefully managed so as to not allow a flood of cheap unrestricted credits that would be detrimental to ongoing market success and project investment. One such approached, proposed by the Centre for Clean Air 65

Defra. 2008. ‘Climate Change Bill Status’. www.defra.gov.uk/environment/climatechange/uk/legislation/ Defra. 2008. ‘Draft Code of Best Practice for Carbon Offset Providers: Accreditation requirements and procedures’. February 2008, www.defra.gov.uk/environment/climatechange/uk/carbonoffset/pdf/carbon-offset-codepractice.pdf 67 International Carbon Reduction and Offset Alliance – www.icroa.org 68 Murray. 2008. ‘Is the government's offset standard up to the mark?’. 29 Jul 2008, http://www.businessgreen.com/business-green/analysis/2222779/government-offset-standard-mark 66

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Policy (CCAP), is a dual market approach that will enable newer, and potentially cheaper credits derived from reducing emissions from deforestation and degradation (REDD). In order to protect the main market, CCAP are proposing a dual system that may enable a proportion of allowances to be met from REDD credits, with the remainder from CERs, EUAs and other relevant systems. In doing so, a dual market will protect the main market from an influx of cheap credits, enable developing nations to protect forestry through the income generated, and give the nascent REDD credits times to evolve and stabilise to ultimately become more widely integrated into a main market69.

A dual market approach may be a viable option going forward as newer systems and technologies are explored that may produce large numbers of cheaper credits, but need testing before release onto the main market. The potential of instability in carbon prices can affect the projects that may require a carbon price level to be reached before it can proceed – for example, for CCS to receive private investment would require a carbon price of €30-40 to be reached. Some argue that one of the benefits of the less legally compliant, but still openly transparent voluntary market is the flexibility to experiment with different emission reduction projects.

However, the impact of a dual market system will be at the primary market stage and is unlikely to have implications for the secondary market, with the secondary market continuing to provide financial instruments that give an element of stability around the emergent and diverse carbon commodities available.

Post-2012 Approaches The Bali Roadmap70 leads Kyoto signatories toward an uncertain post-2012 future challenged for attention by competing international political agendas. However, plans for post 2012 ETS systems exist globally, such that a market surrounding allowancebased cap and trade systems appears to be assured a strong future.

By way of example the UK presents post-2012 iterations of the EU ETS and UK CRC schemes with extension of mandated industries in a manner that will increase volumes and trade of allowance based credits; the key example being current discussions surrounding the inclusion of the aviation industry into the EU ETS by 201171.

Within this context, we may propose that, despite the strong financing of CDM projects, the role of the CER within an increasingly allowance based system is uncertain; due to restrictions on CER applicability within ETSs and the force of anti-

69

Ogonowski, M., Helme, N., Movius, D. and Schmidt, J. (2007) Reducing Emissions from Deforestation and Degradation: The Dual Markets Approach. Report by the Center for Clean Air Policy, available at http://www.ccap.org/docs/resources/69/FINAL_REDD_report.pdf 70 UNFCCC Bali Report – http://unfccc.int/meetings/cop_13/items/4049.php 71 Commission proposal to include aviation in the EU Emissions Trading Scheme – http://ec.europa.eu/environment/climat/aviation_en.htm Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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CDM rhetoric. However, the use of the EU ETS as a model of best practice supports an expectation that the CER remains an important component of the carbon market.

Together with the generation and extension of ETSs globally runs the evolution of existing ETS schemes to higher levels of sophistication; one component of which is the move toward the 100% auctioning of allowance credits to mandated facilities72.

‘The CRC is a scheme which we believe is, so far, unique for this type of organisation, designed to drive emissions reductions by providing organisations with financial incentives through emissions trading and combining this with reputational incentives through publishing performance in the form of a league table. CRC will auction 100% of allowances to participants and will recycle the revenue raised from the auction back to participants on the basis of their performance.’ (Ian Pearson 200773) Such development appears to increase the demands on mandated facilities in terms of capacity to plan and trade within the market; as such we may propose development of internal trading capabilities within mandated firms as an additional component of the market.

Conclusion Compliance, rather than voluntary motives, presents the fundamental drive underlying the carbon market, with regulation contributing an essential input in the development of the necessary value and scarcity on the traded carbon asset. As such, change in regulation is a key driver of change within the market, with implications across primary and secondary segments. Judging by current trends, and concentrating on ‘high-level’ issues, extension of the carbon market in both volume and scope seems assured by the implementation of national ETSs. In addition the post 2012 landscape appears to be fragmented and differentially linked.

Within this context, key questions emerge concerning the relationships between national, regional, and local ETSs on a global platform. Such development, alongside drivers for the growth of in-house trading capabilities by mandated facilities, presents a high degree of uncertainty for the secondary market.

72

Grubb. 2006. ‘EU ETS and the Future’. Presentation to Point Carbon conference, Copenhagen, 28 Feb 06, Professor Michael Grubb, Chief Economist, the Carbon Trust, www.ieta.org/ieta/www/pages/getfile.php?docID=1528 73 Written Ministerial Statement by Ian Pearson on the Carbon Reduction Commitment (CRC) consultation publication - 26 June 2007 – www.defra.gov.uk/corporate/ministers/statements/ip070626b.htm Job no - client name - 04/11/2008 © Wood Holmes Group Limited

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