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As you sowed carbon... - Views on News from Equitymaster
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  • May 9, 2007

    As you sowed carbon...

    One has to live with one's mistakes, but all the living beings on planet Earth have to now live with the consequences of the greed with which the so-called developed economies used up resources in their march towards economic one-up-man-ship. The Kyoto Protocol ensures that it is pay back time for the more conscientious among the world's citizens. It is a voluntary treaty signed by 141 countries, including the European Union, Japan and Canada for reducing Green House Gas (GHG) emissions by 5.2% below 1990 levels by 2012. The ongoing preliminary phase of the Kyoto Protocol that started in 2005 will end in 2007 while the second phase spans the next five years up to 2012.

    Companies in signatory countries have annual limits that they have to adhere to in the form of allowances to emit a certain amount of carbon. If they are well within their limits, their excess allowance can be sold to companies that have overshot theirs. Thus the market for carbon credits came into being. However, different compliance methods followed by various countries have ended up in an alphabet soup of terms for the new instruments as well as the new trading platforms.

    Quantifying pollution

    It's estimated that 60-70% of emission is through fuel combustion in industries such as cement, steel, textiles and fertilizers. Some gases like hydrofluorocarbons (HFCs) methane and nitrous oxide are released as by-products of industrial processes that affect the ozone layer. However the Protocol has initially planned to target just carbon dioxide (CO2) levels.

    One credit or Credit Emission Reduction (CER) is equivalent to one tonne of CO2 emission reduced. The amount of emissions from a co-generation power plant when compared with a similar sized, zero emission wind power plant, gives the extent of pollution. The cost of reducing one tonne of CO2 in the developed countries is about US$ 300-US$ 500, as against US$ 10 to US$ 25 in developing countries. It is this arbitrage opportunity that China, and now India and Brazil have been targeting. The GHG emission levels in these countries are below the target fixed by Kyoto Protocol. As such they are excluded from reduction requirements, and their companies can make extra money by selling the credits they earn to companies from the developed economies.

    Pricing determined by market forces

    Currently issued CERs from India have traded at US$ 16. The volatility in CER pricing can be seen from the highs US$ 35.4 in early 2006, to an average of US$ 10.5 for the last three quarters of 2006.

    European countries decided to cap the number of credits a company could buy, thus limiting demand, and also forcing them to limit emissions. Companies in a bid to keep within their allowance would reduce electricity consumption by switching off all lights at the end of the day. Weather patterns affected prices too. As a majority of entities requiring credits are in Europe, followed by Japan and Canada, if the winter is milder, their requirement of electricity to heat up homes is reduced, thus emission allowances are adhered to, and the demand for CERs reduced. At the beginning of 2005, the European winter was very mild and it rained instead of snow. There was a lot of water in reservoirs, which helped to generate hydroelectric power, which has low carbon emission, declining CER prices later in 2006.

    The price of a CER also depends upon the originating country's credibility. For eg., a CER from a project in Afghanistan would be at a relative discount to that from an Indian project.

    Carbon Market at a Glance, Volumes and Values
    2005 Jan-Sep 2006
    Volume Value Volume Value
    (MtCO2) (US$m) (MtCO2) (US$m)
    Allowances-based transactions        
    EU Emissions Trading Scheme – EU ETS 324 8,205 764 18,840
    New South Wales GHG Abatement Scheme - NSW 6 59 16 184
    Chicago Climate Exchange - CCX 2 3 8 27
    UK Emissions Trading Scheme – UK ETS 0 1 2 9
    Sub total 332 8,268 788 19,051
    Project-based transactions      
    Clean Development Mechanism – CDM 359 2,651 214 2,260
    Joint Implementation - JI 21 101 12 94
    Other compliance 5 37 8 60
    Sub total 384 2,789 234 2,415
    TOTAL 717 11,057 1,022 21,466
    Source: The World Bank

    Get paid for being 'good'

    India is considered to be the largest beneficiary, claiming about 31% of the total world carbon trade through the Clean Development Mechanism (CDM – wherein a developed country company funds a 'clean' project in India and gets credits from it later). According to a World Bank study, the total market size for carbon trading worldwide presently is about US$25 bn. India, in the initial years, is expected to garner a 10% share of the global market. By March 2007, India's Union Government had approved 550 projects complying with the Kyoto Protocol to earn carbon credits and has also completed the required formality of registering them with the United Nations Framework Convention on Climate Change (UNFCC). Another 330 projects are at the design document stage and await government's approval.

    The initial 227 Indian projects approved and registered are expected to yield approximately 250 m certified CER units, which even at the lowest price of US$ 5 per CER, could translate into potential revenues of US$ 1.3 bn. To give an example, JSW plans to use waste gases emitted by the company's Karnataka steel plant (7,500 tonnes per day) for generating power for captive consumption. The project thus contemplates reduction of emission from both the steel and power plants. The company estimates that over a period of 10 years, the plant can potentially reduce carbon emissions to the tune of 7.7 m CERs.

    So far India has barely contributed 30 m CERs of the 2 bn credits traded globally. In a classic Indian response, they hoarded their supply in response to falling global prices! However, as the annual penalty for non-compliance steps up from Euro 40 (roughly equal to US$ 54) per tonne of carbon dioxide (CO2) equivalent in the first phase to Euro 100 (US$ 136) per tonne of CO2 in the second phase beginning 2008, the market for carbon credits is expected to stabilise. After the Chicago Climate Exchange and the European Climate Exchange, Multi-Commodity Exchange of India (MCX) is likely to be the third exchange in the world with a license to trade in carbon credits

    Indian companies on the carbon–band wagon
    Company Registered CDM projects
    ACC Blended cement
    Birla Corp Blended cement
    Jaya Shree textiles Energy efficiency
    JCT Small scale biomass
    JK cement Waste heat recovery-based power project
    JSW Steel Waste heat recovery-based power project
    Kesoram Industries Steam system upgradation
    Nahar Spinning Rice husk-based cogeneration
    Rana Sugars Bagasse-based cogeneration
    RIL Energy efficiency
    Shree Cement Optimal utilization of clinker
    Tata Steel Waste heat recovery-based power project
    TNPL Methane extraction, fuel conservation
    Ultra Tech Cement Production of Pozzolana cement
    United Phosphorus Natural gas as fuel
    USWL Cogeneration
    Source: media reports

    Added bonus

    But, mind you, the essential voluntarism of joining this 'clean' brigade has seen USA, the biggest polluter (accounting for 25% -30% of global emissions), shying away from signing on the dotted line. Bankrolled as its government is by the fossil fuel industry, the largest contributor to the creation of an Earth-wide green house, the cause of US not willing to clean up its act is easy to see.

    If the US joins, demand for CERs will shoot through the roof, especially with the stricter norms of the second phase of the Protocol. And for once, developing countries will be able to 'make hay while the sun shines'!!



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