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Hot Air Rises But Carbon Markets Fall

Politics / Climate Change Jan 03, 2012 - 12:12 PM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleThe potential for carbon finance to hit a final limit to its credibility, and implode in 2012 is high and rising. As we know, global warming theorists would be short of talkshow material without "tipping points" and climate forcing, drawing on everything from heavily overworked CO2 to more exciting, seemingly higher tech specialty themes like the possible role of adipic acid, freons and halocarbons, 'black carbon' and heavy metals, even cosmic ray breakdown particles in the atmosphere - - to explain why they believe global average temperatures have to rise. As we also know or are invited to believe, carbon traders huddled over their playstation consoles doing the Fibonaccis and losing other peoples' money are preventing this happening.

The menace facing the Carbon Trader species - threatened with extinction - is the likely tipping point reached through oversupply of alphabet soup "climate change paper", meaning unit prices will first crash to nothing, before the game is abandoned. The US "voluntary basis" CCX emissions market, in Chicago, closed at end 2010 with final trades valuing the right to emit 1 ton of CO2 at 5 US cents. At those prices, there is no problem feeling voluntary about Saving the Planet, we can add !

The last or only mandatory emissions trading system and its markets, in Europe, with two-only outposts in Australia and New Zealand were supplied with twice as many new carbon credits in 2011 than in 2010, damping brokers' and traders' hopes there will  a recovery from dangerously free falling unit prices, with the fall accelerating since November. The year 2012 could be the end of the line for this hot-air-powered gravy train unless credits are withdrawn.

Making the oversupply even more critical, the upstream suppliers - the European Commission, its financial institutions like the EIB (Investment Bank) and national governments of the 27 member states - have in particular generated a massive oversupply of the "higher tech", more obscure and eccentric emissions reductions credits, particularly based on the underlying security or tradable asset of "avoided CO2 emissions" and one or two fluocarbons, as well as nitrous oxide. Added to the non-CO2 permits, credits and emissions reduction engagements based on investment operations outside Europe, which can avoid CO2 emissions in Europe and destroy or substitute the high-tech gases, are now also drowning in tradable paper.

These are "offset credits" which in theory cut European emissions by raising them outside Europe. When they only concern operations in low income developing countries they are called JI-Joint Implementation Clean Development Mechanism offsets.

If the European-based emissions markets survive, total supply of offset credits in the nine years through to 2020, including those from the smaller JI CDM program, will be 4.7 billion tons. Demand over the same period, including that from the EU carbon market, is forecast by analysts as unlikely to exceed 3.2 billion tons, leaving an oversupply of at least 1.5 billion tons. Operated with the UN FCCC, Clean Development Mechanism credits were issued with gay abandon in 2011. Possibly as many as 350 million were printed, compared with 132 million in 2010, producing a totally unsurprising 62% fall in average CDM unit prices through the year, concentrated in the last quarter.

Prices falls in this previously very promising market niche, for traders and brokers and their friends in national governments and the European Commission, have cut unit prices to around $4 or 3 euro.

Through 2011, there was a similar and related surge in print runs for Certified Emissions Reduction credits, generated by projects claimed to "avoid emissions" of CO2, while other CERs, and some CDMs cover projects claimed to destroy two "high tech" industrial gases, hydrofluorocarbon-23 and nitrous oxide. This is another niche market which, due to previous high unit prices and the near total opacity, and flimsy verification procedures governing CER validation, has been engulfed by massive amounts of fraud, only slowly acknowledged by the European Commission and its international institutional partners, the UN FCCC and the World Bank Carbon Finance Corp..

Response from Brussels to threats that this niche market could collapse was to push hard on the printing press start button from late 2011, continuing into 2012, while also announcing that the European Union will stop recognizing nearly all of this category by May 2013. The pomposity of Brussels bureaucrats can be glimpsed in the wording used: The Commission said the credits offer "exorbitant rates of return", especially when the same credit is recycled several times between rogue governments and traders, and this exorbitant privilege creates "a perverse incentive for investors", which in turn will "undermine the market’s environmental integrity".

The bottom line is the CER offset market is now glutted, like CDM offsets, and this cancer is now gnawing at the CO2 market. So-called "investors" have rushed to trade credits issued to beat the coming deadline, also because they know so many more will be printed in coming months. On the ICE climate futures Europe exchange, CER unit prices fell by about 60% through 2011 from a first half average of 12.10 euro, with the largest falls in Dec 2011. Present prices hover around $5.50 (4.20 euro) after hitting a mid-December low at 3.80 euro.

The workhorse EUAs, or CO2 emissions permits issued by EU member states cover about 11 000 major CO2 emitting businesses in Europe, especially power plants and cement works, but without international extension of the European-centred trading process this market can only shrink. To a certain extent the process of killing the golden goose can be called "a victim of its own success". European emissions trading provides large incentives to any major industrial energy user to quit Europe. As they quit Europe's shores, raising unemployment, cutting government tax revenues and raising European trade deficits, their need for EUAs limiting emissions inside Europe can only decrease. Despite this perhaps being a little too complex for Brussels bureaucratsss to understand, EUA issuance has gone on rising with an inevitable result: through 2011 EUA credit prices fell by more than 50% to end the year at about 7.50 euro: long gone are the rosy days of 2009 when EUAs could fetch as much as 20 euro and Carbon Boomers pontificated that "carbon finance" could become the world's biggest single market.

Potential emergency action to stop prices falling, for EUAs, CERs and CDMs, necessarily includes a quick cut in issuance. One proposal concerning supply of CERs is to cut their emission by 13% in 2012 to about 280 million tons, according to the CDM Executive Board, which has oversight on CER issuance, and its Orbeo regulator, a Paris-based joint venture between Societe Generale SA and Rhodia SA which have the whip hand in this nearly completely opaque market.

Even if the supply of CERs and CDMs only slows down, and does not shrink, the market will have more credits than emitters need to buy in each year forward to 2020, according to market watchers such as Bloomberg's New Energy Finance. Due to this, forward price estimates for emissions paper continue being revised downward, with the dangerous "tipping point" of 4 - 5 euro becoming clearer, and nearer.

Officials from over 190 nations essentially agreed on nothing at the Durban climate talks ending December 10. European attempts to extend, and save the carbon finance game were completely thwarted, shrinking the market area for "climate finance" to Europe, Australia and New Zealand - with a rising certitude that mandatory (or even voluntary) emissions trading in the US, China and India will never happen.

This sets easily calculated market limits, and maximum possible printing limits for hot air paper.

Issuance of credits specifically linked to the reduction of industrial gases hydrofluorocarbon-23 and nitrous oxide were set to rise before the announced May 2013 EU ban. This sub-category of offset projects, called "HFC-23 and N2O", grew to as high as 63% of all new CERs issued in the 12 months to November 2011, based on UN FCCC data. The unrealistically distorted but highly "market driven" character of this sub-category is underlined by these figures - which should be compared with any set of figures coming out of the most "warmist" global warming promoter organizations, starting with the UN IPCC. Industrial gases are rarely given a higher role than a few percent in claimed global warming. The role of face value, or nominal value of the printed credits was far more important !

More critical to survival of the hot air gravy train, global turnover in carbon paper hit about $35 billion in 2009 but since that high point has continued to fall - in part due to European players being unable to stop printing more paper, then panicking when its unit price crashes. The Durban talks offered no way out for the extreme European stance - described off record by a senior Indian negotiator as "hypocritical, naive and aggressive" - making it at least possible, even probable the European-initiated carbon paper market will implode to nothing, and be abandoned, this year.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2011 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2022 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


robert miller
03 Jan 12, 18:22
Carbon trading

"Trading on Thin Air" A must watch documentary for all those interested in the trading of one of the strangest financial instruments of our time. or watch it here

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