climate change
Introduction
Impact of climate change
The world has been experiencing a significant rise in the use of fossil fuels for the production of industrial output since the late 19th century which has resulted in the production of large amounts of gasses and pollutants. However it was only until two decades ago that the world came to accept that human activities such as a result of industrial process, burning of fossil fuel, and significant reliance and use of non bio-degradable material such as plastic have made a measurable and potentially irreversible negative effect on the environment and our quality of life.
In the 21st century global warming is no longer considered a trendy catch phrase but is now considered a hot topic by governments, corporations and the public. This sudden change in attitude is primarily because of the markedly increase in the volumes of industrial activity that have created new uses and demand for hydrocarbons such as coal, natural gas, coke, petroleum and oil. Today greenhouse gasses such as methane, chlorofluorocarbons (CFCs), nitrous oxide, and tropospheric ozone (O3) released as a result of coal mining, leaking gas pipelines, and the large numbers of meat and dairy cattle we farm account for about 30% as much warming as carbon dioxide (CO2). Similarly the use of fertilizers and other chemicals used in industrial production and agriculture, release nitrous oxide which contributes 10 times more to global warming as CO2 emissions do. An increase in such greenhouse gasses has caused increase in wind intensity, decline in permafrost coverage, and increases in drought and heavy precipitation events. Moreover, mountain glaciers and snow cover has declined in both hemispheres resulting in an increase in overall sea level from 1.8 mm/year between 1961-2003 to 3.1 mm/year between 1993-2003 <add source>.
The increase in the release of greenhouse gasses in the Earth’s atmosphere have started causing an imbalance in the Earth’s natural cooling process. The radiation generated when sunlight passes through the Earth’s atmosphere is absorbed by the Earth’s surface and as the surface starts heating it releases the radiation back into the atmosphere. However, due to an abundance of greenhouse gasses in the atmosphere the radiation does not escape the atmosphere; instead it gets absorbed by the gas molecules, which in turn end up emitting heat in all directions. When this heat is emitted towards the Earth’s surface, it causes a rise in the Earth’s temperature. According to Climate Change 2007, the Fourth Assessment Report which was a research conducted by the United Nations Intergovernmental Panel on Climate Change (IPCC), 11 out of the 12 years between the period of 1995 to 2006 were ranked among the top 12 warmest years. Over the past 100 years global average temperatures have increased by 0.74 degrees Celsius and the oceans have been absorbing 80% of the heat causing ocean temperatures to have increased to depths of at least 3000 meters (9000 feet).
As such, concerned parties have started measuring the impact of global warming by following a new metric known as the Carbon Footprint. This metric is used to measure the amount of carbon generated from direct and indirect individual and corporate activities. Carbon Footprint is now considered the foremost metric in measuring the negative effects of carbon emissions, as extensive research has proved that CO2 and greenhouse gasses (GHG) are the primary contributors to global warming. As recognition of the negative impact of carbon on our lives is becoming more and more widespread, both private and public sectors are taking immediate steps to develop mandatory and voluntary systems and controls to ensure that organizations and individuals can take the necessary actions to prevent and/or cut down their impact and contribution to global warming. On the other hand, governments too have played a major role in curbing the effects of global warming by mandating regulations, legislations, and penalties.
What it means to be carbon neutral
The term carbon neutral refers to balancing one’s own carbon release to the smallest level possible. To become carbon neutral individuals and corporations must ensure that the CO2 emissions produced as result of their operations is reduced to the lowest amount possible and the leftover amount can be netted to a zero sum through Carbon Offsetting. Carbon offsetting is the measurement of CO2 emissions in quantifiable terms. For example, one tonne of CO2 is equal to one credit of carbon offset. Essentially these credits are measured in tons of CO2 and are bought and sold over the primary and secondary market. An individual or corporation can participate in carbon offsetting and attain carbon credit for such activities by fostering the development of alternative projects such as wind, solar and reforestation.
The process of becoming carbon neutral comes in three basic stages with a fourth optional stage <Source: The Carbon Handbook, EcoVentures>:
Measuring direct and indirect carbon emissions
Reducing internal emissions to the lowest possible level
Offsetting the remaining emissions through external projects which recycle or reduce emissions
Communicate carbon neutrality – this stage is optional but beneficial in displaying corporate social responsibility (CSR).
<add diagram here from Carbon Handbook)
Benefits of being carbon neutrals
Today there is immense pressure from stakeholders, government, and not for profit agencies on individuals and corporations to participate and demonstrate their impact on global warming. While some organizations are in the process of re-aligning their corporate strategies in line with carbon management strategies, other have been quick to recognize the business value of taking credible action and have used these carbon management strategies as a source of competitive advantage. For example, General Electric’s CEO Jeffrey Immelt, expects to double revenues up to $20 billion by 2010 from the company’s eco-centric project known as Ecomagination. With the success of Ecomagination, GE has shown that it is possible to be successful by earning the best possible returns for its stakeholders and at the same time solve global issues such as improving energy efficiency and reducing environmental impact. Since the launch of Ecomagination, GE has saved reduced their greenhouse gas emissions by 1.01 million metric tons and their energy use by 4.42 million MMBtus (MMBtus = one million British Thermal Units). <add source: http://ge.ecomagination.com/#/annual-report>
Like GE other organizations all over the world have become conscious of their energy consumption and are increasing developing dedicated practices to achieve carbon neutral status. Another such organization is the Carbon Disclosure Project (CDP) a not-for-profit whose mission is: “To collect and distribute high quality information that motivates investors, corporations and governments to take action to prevent dangerous climate change.” <Add source http://www.cdproject.net/about-cdp.asp>. The CDP is a neutral agency that collects analyses and reports data that provides valuable insight into the strategies deployed by some of the world’s largest companies to tackle global warming and climate change. It therefore acts as a coordinating secretariat for institutional investors (3000 of the world’s largest companies in 2008) with $57 trillion of assets under management. <add source: Reports: CDP 2008 Quick Facts - Global 500 / S&P 500 / FTSE 350>
As organizations recognize the need for carbon management initiatives, some of them are beginning to push such initiatives even down their supply chains. Hence suppliers that are already positioned on the lines of carbon management initiatives will be the ones with the competitive advantage and with the most likelihood to continue a business relationship with their carbon-cutting buyers. For example, Wal-Mart announced recently that it has made it mandatory for all its suppliers to measure and report their greenhouse gas emissions to CDP. Wal-Mart will be measuring its suppliers sustainable practices and their potential impact on the climate and energy consumption. <add source: CDP Report on Wal-Mart www.cdproject.net>
Initiatives taken by corporations as mentioned above demonstrate that there is now a fast developing trend, one that is aimed at reducing global greenhouse gas emissions. From the diagram below we have demonstrated the value that organizations can obtain from having an effective carbon management strategy <add diagram from the carbon handbook>.
As stated in the above diagram, corporations need to have an effective carbon management strategy for the following reasons:
Investor Interest
Stakeholders which comprise not only of investors but also employees, promoters, government, suppliers and society have become more and more aware of the impact that carbon emissions has on a corporation’s balance sheet. They analyze assets and liabilities with a potential of generating carbon emissions as much as they do with other items on financial statements. Therefore, if the stakeholder feels that the corporation is not strategically managing its impact on global warming and climate change, this lack of oversight will definitely have an impact on the corporation’s share price. To help stakeholders make an educated and informed decision of whether to invest in a corporation or not, several not-for-profit companies such as FTSE, a collaboration between the Financial Times and London Stock Exchange have developed index series such as FTSE4Good which is used to track the performance of corporations that have implemented globally recognized corporate responsibility standards thereby providing stakeholders the information they need to invest in those companies. <add source: http://www.ftse.com/Indices/FTSE4Good_Index_Series/index.jsp>
Public Demand:
Now that information about the negative effects of global warming and industrialization is available to us in a matter of seconds from its occurrence, our society has become aware of the impact on the planet and its people. As such we are constantly improving the means by which we live, consume food, travel, and, buy and sell products. By way of lobbying and making our voice heard, governments in several countries have implemented legislations and regulations that are aimed to minimize our carbon footprint. For example, because of public demand the Government of Delhi recently banned the use of plastic bags in all its shops and stores.
Supply Chain Management:
Several small companies feel that due to their limited scale of operations their impact on global warming is rather insignificant as compared to a large multi-national. In other words a company with low revenues and 100 employees may contribute directly and/or indirectly to global warming as much as a multi-national corporation with revenues running into millions of dollars and more than 1000 employees. For example if a small-size shoe manufacturer buys leather and chemicals such as adhesives from suppliers who have large carbon footprints; indirectly the small shoe manufacturer has also increased its own carbon footprint. Thus no matter how big or small a company you are, choosing the green supplier should be and is becoming standard practice.
Reducing Raw Material Costs:
Today corporations are allocating a significant amount of their annual budget in to research and development of innovative and low carbon emitting raw materials that are not only helping them improve efficiency but also reducing their overall costs of procuring raw materials. This in turn will reduce the corporation’s carbon emissions and improve their profit margins.
Reputation and Corporate Image:
As a result of successful carbon management strategies several governments and corporations are boasting their achievements by adding the message to their internal and external communications. By doing so these entities are in fact promoting their brand name and improving their corporate image as socially responsible thereby setting an example for other entities to follow suit. We believe this branding is expected to explode in the Gulf Countries Corporation (GCC) region as there has been a substantial increase in the number of organizations that are in the process of becoming carbon neutral.
Middle East carbon footprint
Carbon Market
Structure of carbon market
While organizations across the world recognize the need to cut down carbon emissions but no organization can in be fully carbon neutral. In other words a corporation will still generate some amount of carbon footprint even if it reduces it to a great extent. As such there are other innovative mechanisms through which can help corporations further lower their carbon emissions. One such mechanism is to buy carbon credits. Carbon credits are investments in projects that are aimed to cut down carbon emissions and are measured in tones of CO2 per year. These credits can be exchanged between corporations or bought and sold at the prevailing market price on the international markets. By trading in carbon credits corporations can cut down their GHG emission levels to acceptable levels and then neutralize their carbon footprint.
The Carbon Market is the market where trading in emissions takes place. It is an approach taken by governments and corporations to control emission levels and provide economic incentives for companies that are successful in lowering their carbon emissions. By allowing individuals and corporations the flexibility to exchange the emissions they emit, with each other thereby giving them the option to either reduce emissions internally or pay a third party to help reduce their emissions for them.
Currently there are two types of markets for carbon credits namely the Voluntary Market and the Compliance (Regulatory) Market
Voluntary Market
The voluntary markets include all carbon offset trades that do not fall under the jurisdiction of government regulation such as those imposed by the UNFCCC Clean Development Mechanism instead they are verified by third party organizations. The carbon credits sold in the voluntary markets are referred to as Verified Emission Reductions (VER). A voluntary carbon offset provider has the flexibility sell credits to the regulated and the voluntary markets. Projects initiated in this market are usually of a smaller scale; organizations that emit up to 15,000 tonnes CO2e per annum and mostly in developing countries. According to a report published by Ecosystem Marketplace and New Carbon Finance in May 2008, 65.1 million tonnes of carbon dioxide equivalents (MtCO2e) with a value of $331 million were traded on the voluntary carbon market <add source: State of the Voluntary Carbon Markets 2008). Specifics related to the amount traded on the OTC and CCX are provided under their respective headings. The voluntary carbon market can be at the broadest level divided into two main segments:
Chicago Climate Exchange (CCX):
The CCX is voluntary but a legally binding cap-and-trade system that is rules and membership based. The CCX is owned by Climate Change PLC, which also launched the European Climate Exchange (ECX). The allowances generated by the EU ETS are now primarily traded on the ECX. Members join on a voluntary basis and have to conform to the exchange’s reduction policies. The CCX converts six different GHGs into one common unit of tCO2e. The CCX’s unit of trade is the Carbon Financial Instrument (CFI) which represents 100tCO2e. CFIs can either be Allowance Based Credits that are issued by members in accordance with their emission baselines and the exchange’s reduction goals, or Offset Credits which are generated as a result of emission reduction projects that are conducted by member firms. More than 90% of the credits traded on the CCX are allowance based as offset credits can only be used to offset 4.5% of the member’s total emission. <add source: The Chicago Climate Exchange Website (CCX). Available online at http://www.chicagoclimatex.com>
In 2007, approximately a third (22.9MtCO2e) of the volume transacted in the voluntary market of 65.1 MtCO2e was exchanged on the CCX. The market share has doubled as compared to 2006 when only 10 MtCO2e were traded on the CCX. In 2007, the average credit price on the CCX was $3.15 with prices ranging from a low of $1.62 to as high as $4.20. While the market share of CCX to the total voluntary carbon market in 2007 was valued at $72.4 million it is uncertain whether this number was generated as a result of the number of carbon offset or allowance based credit transactions. This is primarily because the CCX does not segregate the numbers based on the type of transactions. Though the CCX noted a rapid annual increase since its launch in 2004, its overall market share dropped from 40% of the total voluntary carbon markets volume in 2006 to 35% in 2007 primarily due to the launch of OTC. <add source: State of the Voluntary Carbon Markets 2008)
Over the Counter (OTC):
Outside of the cap-and-trade CCX operates the OTC market which consists of all carbon offsets originating from project based transactions. as the trading in the OTC market is not done over a structured exchange and is not subject to any emissions cap it is labelled as the OTC market. Credits traded on the OTC market are often referred to as Verified Emission Reductions (VER) or carbon offsets.
Because the OTC market is not based on a cap-and-trade system which specifies how much a corporation is allowed to emit and how much it should trade, buyers in this market participate in carbon offsetting primarily for personal motives such as brand recognition, enhancing market position on a corporate level, to fulfil their CSRs, need to prepare for expected regulations, and intentions of selling the credits at a profit in the future. Sellers of carbon credits in this market are categorized into four major types <add source: State of the Voluntary Carbon Markets 2008):
Project Developers: develop GHG reduction projects and sell carbon to wholesalers, retailers, and/or the end customers.
Aggregators/Wholesalers: Trade carbon offsets in bulk and own a large portfolio or credits.
Retailers: trade smaller amounts of credits to individuals and corporations, mostly online trading and have a smaller portfolio of credits as compared to wholesalers.
Brokers: do not own credits but only facilitate the buying and selling of VERs.
It must be noted that a seller can operate as a buyer, wholesaler, retailer or even a broker and is allowed to sell in the voluntary as well as compliance markets. A seller in the business of selling carbon credits could and is allowed to have other sources of income. Additionally, transactions between the various categories of sellers can be simple transactions, i.e. direct sale between a buyer and a project developer or involve complex transactions brokered between a project developer and a wholesaler. The wholesaler in turn may sell the credits to various retailers, who then sell them to the final buyers. It has been noted that with time the supply chains in the market for carbon credits are becoming increasingly complex.
In 2006, OTC transactions amounted to 14 MtCO2e where as in 2007, out of a total of 65.1 MtCO2e transacted on the voluntary market, at least two-thirds or 42.1 MtCO2e ($258.4 million) were transacted on the international OTC market. In other words the volume of transactions on the OTC market has tripled within a year. The average price of carbon credits transacted on the OTC market was $6.10/tCO2e representing an increase of 49% from the 2006 average of $4.10. Prices on the OTC market ranged from a low of $1.80 to a high of $300/tCO2e.
<add source: State of the Voluntary Carbon Markets 2008)
To ensure that VERs traded in the voluntary markets were not traded solely for the purpose of profit making but also for environmental benefits and could be from trusted sources, the Climate Group, the International Trading Association and the World Economic Forum came together and launched the Voluntary Carbon Standards (VCS) in 2005. The first version of VCS was released on March 28, 2006 and is used as both a consultation document and a pilot standard for use in the market. After two years of revisions and several steering committees later, VCS 2007 was released
Compliance Market
The Compliance Market on the other hand is governed by the United Nations Framework Convention on Climate Change (UNFCCC) and operates under statutory requirements as mandated in the regulation. At the moment the compliance market accounts for the majority of carbon credit transactions in the global carbon credit market as it is in this market where countries as well as multi-national corporations trade CO2 emission allowances as per the cap and trade mechanism agreed to in the Kyoto Protocol.
Cap and Trade Mechanism:
The cap and trade mechanism is the primary way by which governments and companies reduce their greenhouse emissions. Besides cap and trade, governments can use taxes or offer direct subsidies to corporations that implement low carbon technologies. In the cap and trade mechanism participants set limits (caps) on the levels of emissions generated as a result of their activities and are legally bound to the agreements. These emissions are traded in a market allowing the participants to exchange the right to emit with one another (the trade). In the cap and trade mechanism, trading is performed at the prevailing market price which ensures that organizations reduce their greenhouse emissions at the lowest cost. Besides, it also allows flexibility for participating organizations to either reduce emissions by implementing low cost carbon technologies or paying someone else to reduce their emissions. By obligating all participants to limit their emissions as per their caps and only allowing them to trade with those that have not over shot their emission caps, the cap and trade mechanism provides some certainty that industrial activities will have a limited impact on the environment. The cap and trade mechanism provides three flexibility mechanisms: Emissions Trading, Joint Implementation (JI) and the Clean Development Mechanism (CDM). These flexible mechanisms are established under the Kyoto Protocol to help industrialized countries cut down the costs of greenhouse emissions:
Emission Trading
The Emissions Trading system allows developed countries to purchase carbon credits from developing countries. The Emissions Trading market resulted in the creation of the world’s largest multinational GHG emissions trading scheme known as the European Union Emissions Trading Scheme (EU ETS). Credit traded in this system are called European Union Allowances (EUA). According to the World Bank, in 2007 the EU ETS market traded approximately 2,060.8MtCO2e valued at $50,097.4 million. <add source: World Bank, State and Trends of the Carbon Market 2008, May 2008>
Joint Implementation (JI)
The JI system allows developed countries or countries in Annex 1 of the Kyoto Protocol to purchase carbon credits on project-based transactions that are aimed at reducing greenhouse gas emissions, implemented in other developed countries or countries with an economy that is in transition. Credits traded in this system are called Emission Reduction Units (ERU). According to the World Bank, in 2007 the ERU market traded approximately 41.1MtCO2e valued at $494.8 million. <add source: World Bank, State and Trends of the Carbon Market 2008, May 2008>
Clean Development Mechanism (CDM)
Is also a project based transaction system that allows developed countries to trade and acquire carbon credits from developing countries. Credits that are registered and traded in this system are called Certified Emission Reductions (CER). This mechanism provides developing countries to participate in offsetting their carbon emissions by trading with developed countries that need the credits to meet their own emissions. CERs and ERUs can also be traded on the voluntary market. According to the World Bank, in 2007 550.9MtCO2e were traded in the CER market, valued at $6,886.6 million. Some of these credits were further sold to a growing secondary market which traded 240MtCO2e of secondary CER credits valued at 8,383.6 million <add source: World Bank, State and Trends of the Carbon Market 2008, May 2008>
Other Compliance Markets:
Though the United States did not ratify the Kyoto and there is no federal requirement to regulate CO2 emissions, several states have initiated and implemented their own regulatory markets. Example of such markets include:
Oregon Standard which was the first regulation for CO2 in the United States. The Oregon Standard states that any new power plants built in the State of Oregon must reduce their CO2 emissions to a level that is 17% below that of the most efficient plant, either by emission reduction or offsets. Corporations can either propose specific emission reduction projects or pay mitigation funds to the Climate Trust, a non-profit created by the State to facilitate the implementation of such projects. <add source: The Climate Trust, “About Us,” Available Online at http://www.climatetrustorg/programs_powerplant.php>
The Regional Greenhouse Gas Initiative (RGGI) <add source: Regional Greenhouse Gas Initiative (RGGI), “Overview of RGGI CO2 Budget Training Program,” October 2007. Available at http://www.rggi.org/docs/program_summary_10_07.pdf> The RGGI was established by ten states on the East Coast with the aim to cut down their CO2 emissions using the cap and trade system. This emissions system will initially apply to power plants that use fossil fuels to generate half their electricity and have an energy producing capacity of over 25 MW. The system also has a sliding scale that limits the use of credits based on market prices. In other words, the lower the price of the credit the more restrictive is the use of the credit. For example if the price of an emission credit is under $7 then participants can cover up to 3.3% of their emissions by investing in emission reduction projects based only in the United States. However, if the price of the credit goes over $10 per tonne then the participant cant offset 10% of their emissions and is permitted to invest in emission reduction projects in the US as well as member countries of the Kyoto Protocol.
The New South Wales Greenhouse Gas Abatement Scheme: The New South Wales (NSW) Greenhouse Gas Abatement Scheme (GGAS) is an mandatory state level program implemented by the government of New South Wales in Australia. The Scheme aims to cut down and offset GHG with the production of electricity and requires annual state-wide GHG reduction targets of 7.27 tCO2e per capita. The Scheme also requires individual electricity retailers and other parties who buy and sell electricity in NSW to meet mandatory benchmarks based on their share of the electricity market in the state. <add source: NSW GGAS, “Greenhouse Gas Abatement Scheme.” Available online at http://www.greenhousegas.nsw.gov.au>
Additionally, under this scheme if an electricity retailer goes over its target then it can either pay a penalty of AU $11.50 per tCO2e or purchase New South Wales Greenhouse Abatement Certificates (NGAC) that can be used to implement emissions abatement projects only within NSW. According to the World Bank, in 2007 the NSW GGAS traded 25.41 MtCO2e with an estimated value of US$224.10 million, making it the world’s largest regulated cap and trade GHG outside of the Kyoto markets.
Pricing of Carbon Credits
Market Characteristics
Market Determinants
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