Last updated: May 1, 2007 4:11 pm

The carbon market

Carbon credits & offsetting

Fiona Harvey, the Financial Times’ environment correspondent, found numerous problems during a six-week investigation into the ‘green gold rush’ - the rapidly-evolved industry that caters to growing concerns about climate change by attempting to reduce carbon output.

Voluntary carbon offsetting projects - in which companies or individuals pay money towards carbon reducing projects in order to ‘offset’ their own carbon emissions - have proliferated recently, as have intermediary companies who broker payments between the offsetters and the projects. But the process is far from simple, and numerous potential pitfalls are faced by companies who rush to offset their carbon emissions without carefully evaluating whether their money will actually make a difference.

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Meanwhile, carbon trading, a way of reducing carbon emissions by using a regulated 'market' in emissions credits, is also not without problems.

The EU’s carbon credits trading scheme has seen the value of its credits plummet due to an over-allocation at the outset.

More of her coverage can be found here.

Fiona Harvey and Gilles Corre answer readers’ questions about both voluntary carbon offsetting and the regulated carbon credits markets.

Gilles Corre is director of environmental markets at Evolution Markets in London, which he joined three years ago. He leads the group’s brokerage operations for the carbon credit market, which includes Verified Emissions Reductions and projects under the UN’s Clean Development Mechanism. He also manages Evolution’s trading in EU carbon allowances.

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Forests capture carbon dioxide from the atmosphere but release it again when they decay - as was recognised in the early work of the IPCC. However if the plant material is charred (by partial combustion) half the carbon is converted to a form (effectively charcoal) that seems to last almost indefinitely in soil. It appears to have a beneficial effect on the fertility of the soil, but this has yet to be demonstrated for a wide range of soils. This would open the way to ‘produced’ carbon credits - we could move progressively to a position in which carbon credits become a hard currency, not simply issued by governments but produced and sold by farmers. To cover all present fossil fuel combustion would require a huge effort, taking time to develop, but it appears feasible, and would put a relatively stable price on carbon credits. What issues do you see posed by such a scheme? David Wayne, Chester

Fiona Harvey: Farmers can already participate in the voluntary market for carbon credits under the system operated by the Chicago Climate Exchange, because they issue credits for ‘soil sequestration’ which reflects farmers undertaking changes in their agricultural practices. This results in less carbon being released into the atmosphere. Provided farmers can show that their activities reduce greenhouse gases then they can participate in the voluntary market.

Gilles Corre: Although I am not familiar with this scheme, it seems to have the same characteristics of other carbon capture and sequestration schemes, namely:
- the science is still uncertain, but the potential carbon capture is huge.
- proving the capture and the fact that it is not re-released into the atmosphere is difficult.
- the technology to make these schemes feasible will require large investment
- having a carbon price is what makes these ideas economically feasible

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What precludes a multinational corporation with a manufacturing presence in both the voluntary and regulated carbon markets to transfer credits to the market where the highest value can be realized?
Ben Hill, US

Fiona Harvey: Companies who qualify for the UN protocol generally try to get credits under the Kyoto protocol first, because they get more money for these credits. However if they do not get through the process, sometimes they sell those same credits through the unregulated voluntary market. The only thing you cannot do is sell the same credits through both markets.

Gilles Corre: Nothing, provided the credits are fully fungible in both markets. International emissions trading assumes this will happen, and thus the lowest cost of abatement worldwide will be brought to market.

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Can a retail investor purchase ETS (Emission Trading Scheme) carbon permits? If this is possible, is the price close to the market offer price?
Andrew Walter, London

Fiona Harvey: Yes, but you will have to shop around to find a broker and a good price. If you’re investing in phase 1 credits, you should know the risks about which we have written.

Gilles Corre: No. Retail investors are not able to participate directly on this market as dictated by financial regulators. Some banks have created financial lookalikes that follow the price of EUAs(European Union Allowances). There is always a small spread in the range of a few percent.

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What is the size of the voluntary offset market? Where are the consumers concentrated (i.e. UK, EU, US)? Where will the consumer demand come from in the future?
Are you observing prices for project credits deliverable post-2012? If so where do they trade?
Mark Townsend, London

Fiona Harvey: The size now is difficult to estimate but it is not more than a few hundred million dollars. But ICF International estimates that it is projected to grow very fast to $4bn by 2010. Consumers are concentrated in the UK, the US, and mainland Europe in that order. I think we will see much more demand in the future from the US.
The UN only issues credits for carbon reductions in the present, but you can get voluntary market credits from projects that deliver after 2012. Those are called Voluntary Emissions Reductions and Verified Emissions Reductions. These do not trade on trading platform, and because they are part of the voluntary market they must be sourced independently.

Gilles Corre: The voluntary market has been growing exponentially so estimating its size is difficult. Large voluntary offset buyers are more likely to be corporations offsetting their emissions on a voluntary basis rather than retail consumers offsetting their flights for example.
UK corporations have certainly taken a lead (HSBC, Eurostar, Aviva) but American companies have recently become big buyers.
The size of the market is in the double-digit millions of tons at the moment. Continued growth will come from the Western corporations. This is estimated to grow to a billion tons in the next few years.

Evolution brokered the first ever trade for post-2012 EUAs a couple months ago. The trade was between Morgan Stanley and US environmental fund RNK Capital for 50,000 thousand EUAs at a price of €20.05. At the time EUAs for 2008 vintage were trading at around €16.

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What are the 5 biggest issues in the carbon credit market today faced by the large investment banks?
Charlie Pool, London

Fiona Harvey: The first issue is how they can get into this market because it is set to be worth $50bn by 2010.
The second issue is what happens after 2012, when the current provisions of the Kyoto protocol expire. Banks will be wondering if there is still going to be a market.
A third issue is what is happening in the US, where there are moves afoot to introduce a mandatory cap-and-trade system for carbon.
Fourthly, banks are wondering what will happen in phase two of the EU trading scheme which runs from 2008 to 2012. The big question is whether the caps on emissions will be tight enough
The final issue is risk. Analysts told FT that half of all the credits expected to be issued under the UN Kyoto protocol will not be delivered.

Gilles Corre:
- This is a market created by policy, so dealing with regulatory risk is always an issue.
- Uncertainty of the size of the ”short” for EUAs created by the Commission and thus its impact on the price of EU allowances (short meaning more demand than supply)
- The amount of credits that will be created under the UN Clean Development Mechanism and how easily it will fill the demand created above
- The amount of Assigned Amount Units that will be sold by countries like Russia and Ukraine.
- Access to experienced and qualified staff

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Does any project that reduces carbon emissions qualify as a carbon off-setting project? And for how long does it need to be effective?
Andrew Hoy

Fiona Harvey: Yes, because the voluntary offsetting market is unregulated, any project that reduces carbon emissions can sell offsets to consumers and businesses.

Gilles Corre: No. Projects need to show they will reduce emissions compared to what would have happened in business as usual. Emissions also need to be verifiable and last for ideally an infinite amount of time. This is why reforestation/afforestation activities are controversial as measuring the amount of CO2 captured and for how long is very difficult and imprecise.

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The disgraced Enron corporation was a major lobbying force behind America’s advocacy during 1997 to 1998 that a carbon trading scheme should be adopted as a part of the Kyoto protocols. Did the fall of Enron in 2001, in part due to another fraudulent scheme of trading electricity in California, give rise to any re-examination in Europe about the merits and demerits of embracing carbon credit trading?
Kalani, Texas, USA

Fiona Harvey: I don’t think the fact that Enron backed carbon trading means it is a bad idea. The European scheme is potentially a very good way of reducing carbon, but it did not work well in the first phase because of over-allocation. The second phase should work properly.

Gilles Corre: Enron was a major lobbying force for all types of markets and were forerunners in the energy trading industry. The fact that they turned out to sometimes use fraud instead of playing by market rules shook all energy markets in the subsequent years. Their bankruptcy also sent shockwaves through the energy industry as many counter-parties were exposed to their credit.
Nonetheless, carbon trading has been embraced in Europe and its merits are still believed in even if frauds and other swindlers will always try and make a quick buck.

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Could you advise on an American carbon offsetting company that could represent my company in the United States? We have voluntary carbon offsets to sell that are the result of saving mature trees. Paul De Domenico, Santa Fe
Paul De Domenico, Santa Fe

Fiona Harvey: I would rather not recommend specific companies, but Clean Air Cool Planet have done a study of the offsetting market in which they rate different companies, so you could look at that. Also Tufts University have done a study.

Gilles Corre: Using a broker like Evolution will enable you to access the widest worldwide market possible and thus get the best price for your credits

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We are the developers of a wastewater treatment plant in the Emirate of Fujairah, UAE. We are thinking of capturing the methane gas produced in the wastewater treatment in order to produce power in a diesel engine; and installing PV cells on the roof of the plant to produce electricity. What is the procedure for us to apply for credits? Could you kindly suggest the UN agency or office that administers carbon credits? What price should we expect from the abatement of methane and from the production of electricity from the sun?
Achilles G. Adamantiades

Fiona Harvey: If you go the UN website http://unftcc.int you will find all the information you need there. In terms of what it will cost you, you would need to ask a specialist, but the price for credits is usually between $5 and $10.

Gilles Corre: Both projects would most likely qualify for credits under the Kyoto protocol but each would use its own methodology. You would need to apply to the UN to get your project registered. before applying for registration you would first need to write a PDD(project design document) and get it validated by an independent and UN accredited third party. The issuing agency would be the UNFCCC (unfccc.org). Both projects would generate CERs and they would have the same value. Prices at the moment range from 8 euros to 13 euros depending on the stage of the project.

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Who actually are the offsetters and how do they police the credits against the emissions?
David Jezeph, Bangkok

Fiona Harvey: Anyone can be an offsetter and the short answer is they are not policed. But some industry organisations do set voluntary standards.

Gilles Corre: Offsetters usually buy offset credits from project developers. Projects need to be validated by an independent and accredited third party. Also, any actual emissions need to be verified by another third party before emission credits are actually issued. The whole process is quite lengthy, complicated and expensive.

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How can we measure carbon emissions and carbon fixation. How do we know that a forest of birch for example fixes more carbon than a pine forest?
Jorge Canhoto Coimbra, Portugal

Fiona Harvey: There are means of measuring emissions: the EU has a set of guidelines, as does the UN. As for carbon fixation, the UN has methodologies for working this out.

Gilles Corre: Each type of emission and fixation uses a different type of calculation. For example a power plant measures its efficiency and figures out the average amount of CO2 emission per ton of fuel. Measuring the amount of fuel burned is relatively straightforward.

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