Trading Carbon

by Oscar Reyes on .

Once carbon permits are allocated and credits are issued, how are they actually traded? And what impact does this trading have? This chapter examines the increasingly complex carbon trading infrastructure, identifying this as a key ‘governance’ challenge. By concentrating power in the hands of a small number of financial sector actors and financialised utilities, the carbon market subordinates investment decisions on clean development to strategies that remain based on fossil fuel extraction and trading.

The carbon market has both a ‘primary’ and a ‘secondary’ market. Primary refers to the first time that a permit or credit is sold. Most primary credits (pCERs), for example, are sold in advance of actually being issued. This is called ‘forward selling,’ and typically involves the project developer signing an Emissions Reduction Purchase Agreement with a company, government or development bank. The first sale of the CERs can typically involve a contract that agrees a fixed price for a specified number of credits, which are expected to be delivered by a certain date. For the seller, the advantage is that up-front capital is made available, rather than the seller having to wait until after the project is up and running to gain the carbon revenues.

This type of arrangement has increasingly become a losing proposition for buyers, however. As carbon prices have declined, buyers are finding themselves locked into purchasing offsets at a rate way above their value in the current market. In response, many buyers are now seeking to renegotiate or dump these contracts by whatever means possible. This practice has been enabled by the fact that, outside of HFC or N2O projects, most CDM projects have delivered fewer credits than initially specified, or have found that credit issuance is slower than initially expected – providing legal means for buyers to break contracts and find credits at a cheaper rate elsewhere, or renegotiate fixed-price into floating-price contracts.[1]

Where this is not possible, the buyers have resorted to other means. The World Bank reports that some large buyers also reportedly used their size and contractual position to impose ERPA renegotiations. Having hired the Designated Operational Entity (DOE) themselves, these buyers threatened to delay verification or cancel the DOE contract. Alternatively, by being the sole CDM focal point in certain projects, they renegotiated contracts based on the fact that the project’s CERs would only be transferred upon their sole request, thus leaving sellers with no choice other than to accept new contractual terms.[2]

New contracts are being negotiated with increasingly flexible terms, meanwhile. The majority of pCERs are now sold as ‘options,’ meaning that the buyer purchases the option to buy the credit at an agreed price at a later date. This transfers risk from the buyer to the seller, making it even less likely that any investor would take a chance on a CDM project if it were not merely subsidising existing activities.[3]

At the same time, there have been significant changes in who is trading carbon since the start of the scheme. The CDM market was pioneered by the World Bank and government purchasers, with few private investors taking an interest until after Russia ratified the Kyoto Protocol in 2004, which brought that agreement into force.[4] The first private sector involvement came from boutique carbon specialists, such as EcoSecurities, which had advised governments on how to set up Designated National Authorities (DNAs) in the first place. Their main interest was in developing projects, in order to then resell the resulting credits to other financial speculators and to EU-based companies.

After the primary carbon market peaked in 2007, however, many of the initial speculators were over-exposed to projects that had not delivered credits, or holdings of credits whose value had declined as the financial crisis kicked in. This led to a wave of mergers and restructuring, which included investment banks taking a greater stake. For example, EcoSecurities (the largest project developer and one of the world’s largest buyers of CERs) was taken over by JP Morgan in 2009: while the project developer OneCarbon was acquired by Orbeo, a joint venture between Société Générale and the chemical giant, Rhodia, in the same year.[5]

With these new investors came new carbon credit purchasing strategies, as Alberola and Stephan point out:

Since 2008, some investors have preferred to purchase carbon credit portfolios, containing a complete range of already purchased credits, rather than finance new CDM/JI projects, a process that can take up to three years until delivery.[6]

These portfolios are arranged in a growing number of carbon funds – private, public and a mix of the two.[7] The private sector share of the carbon market continues to grow, however, alongside a shift in investment patterns. Governments seeking offsets to meet their Kyoto targets and companies looking for compliance with the ETS have mostly contracted sufficient credits for these purposes, while the majority of trades now relate to hedging or the pursuit of speculative gain.[8] A broader range of investment strategies has developed too, with a growth in direct equity stakes taken in the companies (‘special purpose vehicles’) that are often set up as the legal entity managing projects.

CER/EUA swaps are also becoming increasingly common. Under such deals, companies agree to a future exchange of EUAs (the ETS permits) and lower-priced secondary CERs (CDM credits). The assumption such deals is that since these products are functionally the same for compliance with ETS targets, there is profit to be made from speculating on the difference between the traded prices of the two commodities.[9]

In the EU market, trading has also become more concentrated in the hands of a small number of large financial firms and energy companies, which ‘rapidly expanded their market positions and influence’ in 2011, amidst a fire-sale of carbon assets as prices collapsed.[10]

The larger energy companies have developed their own trading divisions to hedge and speculate on EUAs and CERs. This reflects the broader financialisation of the energy sector, in which the leading companies derive an increasing proportion of their profits from financial speculation on the relative price of fossil fuel commodities.[11] The introduction of carbon into this mix helps energy companies to hedge the risks these companies take when purchasing energy futures, although it does nothing to stimulate a shift towards renewables.

Such strategies are part of a broader trend towards more complex carbon market trading strategies. Whereas the theory of carbon trading presents a system of exchanges between two polluters to optimise the costs of meeting emissions reduction targets, in practice the majority of the market in operates in the following way. Speculators seek to profit from ‘arbitrage’ opportunities (analysing and betting on price differentials), as well as on the basis of statistical algorithms and models forecasting how carbon relates to the relative cost of coal and gas; oil, gas, coal, power and weather derivatives; currency trading; and meta-analyses of analysts’ own expectations.[12] Most of what is traded is permits and credits, or the option to buy these at a specified point in the future, which does not yet exist.[13]

The development of ever more complex trading and speculative strategies is the true ‘governance’ challenge posed by the carbon market, which concentrates power in the hands of a few large financial and energy corporations. It is consistent with the broader ‘giant bow-tie structure’ of interwoven financialised interests, where most capital flows through a tightly-knit core of institutions that straddle the financial sector as well as companies operating in the ‘real economy,’ such as power producers, which also make investment decisions based on complex hedging strategies and speculative gaming.[14]

The carbon market produces knowledge (and ignorance) that reinforces this financialised power structure.[15] By abstracting ‘carbon’ as a tradable commodity, it frames climate change as a problem of cost adjustments that can be managed by a market that is assumed to allocate goods efficiently, rather than as a historically embedded problem of the dominant fossil fuel-based development model. As this market has grown, it has established a whole new infrastructure and market for financial derivatives products based on validating, verifying, accounting, risk-assessment, future-modelling and commodity hedging that shifts the frame of decision-making about whether and where emissions reductions take place into the hands of analysts whose interests are profit maximisation, not environmental protection or social well-being.

[1]     Kossoy, A. and P. Guigon (2012), State and Trends of the Carbon Market 2012, World Bank, Washington DC., p.51

[2]     Ibid. p.54

[3]     Ibid. p.49

[4]     Alberola, E. and N. Stephan (2012), Carbon Funds in 2010: Investment in Kyoto Credits and Emissions Reductions, CDC Climat, Paris, p.9

[5]     Ibid. p.9

[6]     Ibid. p.9

[7]     Ibid. p.14

[8]     Alberola and Stephan, Op. Cit. p.15

[9]     Eurex (2008), Trading Strategies in CO2 Products, Eurex, Frankfurt., p.4

[10]   Kossoy and Guigon, Op. Cit., p.34

[11]   Kossoy and Guigon, Op. Cit., p.38

[12]   Kossoy and Guigon, Op. Cit. p.34; Karmali, A. (2008), ‘Will Carbon Allowance Auctions Crowd Out Free Allocations?’, International Carbon Action Partnership, 2nd Global Carbon Market Forum, Washington DC., p.4

[13]   Kossoy and Guigon, Op. Cit. p.34

[14]   Vitali, S., J.B. Glattfelder, and S. Battiston (2011), The Network of Global Corporate Control, ETH, Zurich.

[15]   Lohmann, L. (2008), ‘Carbon Trading, Climate Justice and the Production of Ignorance: Ten Examples.’ Development 51 (3): 359–365. doi:10.1057/dev.2008.27.


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