Yesterday I reported on the basics of carbon credit trading using the Chicago Climate Exchange (CCX) website as my source for information in an article published here.
As I began to dig deeper into the subject, I discovered that there are a number of global exchanges that handle this unique trading instrument, each with their own definitions, rules and regulations. There is, for example, the European Climate Exchange (ECX), which I have examined for this article.
The ECX website contains a page that gives a background on emissions trading. In principle, the idea behind carbon credit trading (specifically referred to as “emissions trading” on the ECX site) is the same all over the world, but there are slight differences in how the process is handled. On the ECX, for instance, the tradable instrument is called a European Union Allowance (EUA – the instrument traded on the CCX is called a Carbon Financial Instrument – CFI). Each EUA entitles the holder to emit one metric ton of CO2.
The process is regulated under the EU Emissions Trading Scheme (EU ETS), which the website declares is “the world's first multi-country emissions trading system and the largest scheme ever implemented.” From the website:
The scheme includes roughly 12,000 energy and industrial plants across EU’s 27 Member States and applies to companies of all types – not just utilities and industrials who are naturally covered by the regulation, but also many of the world’s major financial installations who play a crucial role as liquidity providers and intermediates. These include investment banks, hedge funds, trading houses and brokerages.
When it comes to meeting national (or international) emissions standards, people often wonder what the penalty is for non-compliance. Here is how it’s handled under the EU ETS, and how the EUAs fit into the picture:
The ‘cap-and-trade’ approach, being used in the EU ETS, sets an overall cap or maximum amount of emissions per compliance period. Companies are given allowances which represent their target or ‘cap’ for a compliance period. At the end of the period they must surrender sufficient allowances to reconcile against their total emissions during the period. If this is below their cap they have allowances to sell; if not, they must purchase allowances from companies which have exceeded their emissions reductions targets. Each allowance permits the holder to emit one tonne of CO2. If an operator does not hold sufficient allowances to meet its total emissions at the compliance date, a penalty of €40 for Phase I 2005-2007 (rising to €100 in the Phase II 2008-2012) per excess tonne will apply.
Now this is interesting, because with this information, we can begin to assign intrinsic value to an EUA, which, if you’ll recall, is good for one metric ton of CO2 emissions. If the penalty for going over the “cap” by one metric ton is 100 Euros, it suggests that the value of one EUA might trade at or close to (under but not over) 100 Euros. Is that what is happening on the trading floor? No.
Here is a tear-out from the chart for EUA settlements from the ECX website:
click here for full-sized chart
The website states that prices are expressed in Euros per metric ton, and so this chart shows that you can trade one metric ton of CO2 for just under 25 Euros.
Why there is such a large discrepancy in the cost of the penalty for going over the allowance by one metric ton (100 Euros) and the price of a tradable credit (25 Euros) is a mystery to me. If a company knew in advance that it would not meet its emissions target by some kind of predictable amount, and if that company was not alone, would not these competing polluters bid up the price of the credit to approximate the penalty cost? Perhaps the discrepancy is indication that more companies actually expect to come in under the emissions target, and that there is an emissions credit supply glut keeping the price low – though this is hard to believe.
If there are readers out there who can shed some light on the subject, please do so below in the comments section.
As a side note, I received a couple of comments on the first installment of the carbon trading article series, which you can view by scrolling to the bottom of the piece. SH member chapeau said, “I own 70 acres of bush and 130 acres of pasture. How can I benefit [from] carbon credit trading? What is the procedure to follow to participate.”
I thought that was a good question and I’ll write more on what I uncover on that subject soon.
Please post comments in the comment box below.