It sometimes seems that plans for emissions trading are piling up even faster than the greenhouse gases they are designed to curB.In late July the first emission exchange in Australia and Canada opened, in anticipation of mandatory carbon-trading schemes in both countries. America already has a healthy voluntary carbon market, and will soon add an obligatory one for utilities in certain states. But the evidence from the most advanced such 'cap-and-trade' programme, the European Union's Emissions Trading Scheme (ETS), suggests that companies are struggling to make the most of carbon markets.
In theory, cap-and-trade schemes allow firms to reduce their emissions at the lowest possible cost. Governments put a limit on the amount firms can pollute, and issue an equivalent number of allowances. Those companies that find they do not have enough must either cut emissions or buy spare allowances from others. But for the system to work efficiently, firms must take advantage of all opportunities to reduce the costs of participation.
Not all of them do, however. Last year, after the price of European allowances plunged, New Carbon Finance, a research firm, and Cantor CO2e, a brokerage, surveyed 452 participants in the ETS. The price had fallen because it had become obvious that governments had issued too many allowances and the market would soon be floodeD.Yet 31% of respondents with allowances to spare said they would not sell them until the end of 2006, just in case a last minute surge in their emissions left them short. Another 16% said they would wait until the end of this year, when the first phase of the ETS winds up. This caution has cost them dearly. The price of permits, which was roughly 15 ($19) at the time, is now less than 0.15 ( $0.21).
The root of the problem, says Guy Turner of New Carbon Finance, is that many companies view the ETS as a regulatory burden, rather than a chance to make money. They tend to put environmental experts, rather than financial whizzes, in charge of their participation in the schemE.The former, in turn, tend to concentrate on making sure that their firm has enough allowances, rather than on maximising their valuE.They are seldom used to trading, and are sometimes uncomfortable with the idea of 'profiteering' from a system designed to cut pollution. Moreover, they have little incentive to stick their necks out by proposing elaborate transactions in the carbon markets, since they are unlikely to be rewarded if they succeed, but risk dismissal if something goes wrong. Governments do not help matters by handing out allowances to polluters for free, giving them little incentive to capitalise on what are actually valuable assets.
James Emanuel of Cantor CO2e points to several signs that firms are not exploiting carbontrading opportunities to the full. One example is the difference in price between European allowances and Certified Emission Reductions (CERs), which are carbon credits derived from emissions cuts in poor countries. Under the ETS, CERs are interchangeable with European allowances, within certain limits. Yet they are much cheaper. Firms holding European allowances could sell them now, buy CERs instead, and pocket the differencE.The persistent difference in price suggests that few are doing so.
By the same token, on the futures market, there is hardly any difference between the price of European allowances to be delivered in 2008 and those to be delivered in 2009. Since firms receive their allowances from governments more than a year before they actually need them for compliance purposes, they could sell them and sign a futures contract agreeing to buy the permits they need a year later, at only marginally higher cost. This is tantamount to taking out a loan at an enticingly low interest ratE.
What is ETS? In what way does it help to reduce carbon emissions?