Carbon Credits: A new trading opportunity

Carbon dioxide, the most important greenhouse gas produced by combustion of fuels, has become a cause of global panic as its concentration in the Earth’s atmosphere has been rising alarmingly.

This devil, however, is now turning into a product that helps people, countries, consultants, traders, corporations and even farmers earn billions of rupees. This was an unimaginable trading opportunity not more than a decade ago.

Carbon credits are a part of international emission trading norms. The total annual emissions are capped and the market allocates a monetary value to any shortfall through trading. Businesses can exchange, buy or sell carbon credits in international markets at the prevailing market price.

India and China are likely to emerge as the biggest sellers and Europe is going to be the biggest buyers of carbon credits. Last year global carbon credit trading was estimated at $5 billion, with India’s contribution at around $1 billion. India is one of the countries that have ‘credits’ for emitting less carbon. India and China have surplus credit to offer to countries that have a deficit.

India has generated some 30 million carbon credits and has roughly another 140 million to push into the world market. Waste disposal units, plantation companies, chemical plants and municipal corporations can sell the carbon credits and make money. Carbon, like any other commodity, is traded on India’s Multi Commodity Exchange.

What is carbon credit?

The Kyoto Protocol has created a mechanism under which countries that have been emitting more carbon and other gases (greenhouse gases include ozone, carbon dioxide, methane, nitrous oxide and even water vapour) have voluntarily decided that they will bring down the level of carbon they are emitting to the levels of early 1990s.

A company has two ways to reduce emissions. One, it can reduce the GHG (greenhouse gases) by adopting new technology or improving upon the existing technology to attain the new norms for emission of gases. Or it can tie up with developing nations and help them set up new technology that is eco-friendly, thereby helping developing country or its companies ‘earn’ credits.

India, China and some other Asian countries have the advantage because they are developing countries. Any company, factories or farm owner in India can get linked to United Nations Framework Convention on Climate Change (UNFCCC) and know the ’standard’ level of carbon emission allowed for its outfit or activity. The extent to which the country emit less carbon (as per standard fixed by UNFCCC) it gets credited in the developing country. This is called carbon credit.

How does it work in real life?

Assume that British Petroleum is running a plant in the United Kingdom. Say, that it is emitting more gases than the accepted norms of the UNFCCC. It can tie up with its own subsidiary in, say, India or China under the Clean Development Mechanism. It can buy the ‘carbon credit’ by making Indian or Chinese plant more eco-savvy with the help of technology transfer. It can tie up with any other company like Indian Oil or anybody else, in the open market.

China and India ensures that new technologies for energy savings are adopted so that they become entitled for more carbon credits. They sell their credits to their counterparts in Europe. This is how a market for carbon credit is created.

How does MCX trade carbon credits?

Many companies did not apply to get credit even though they had new technologies. Some companies used management consultancies to make their plant greener to emit less GHG. These management consultancies then scouted for buyers to sell carbon credits. It was a bilateral deal.

However, the price to sell carbon credits was not available on a public platform. The price range people were getting used was about Euro 15 or maybe less per tonne of carbon. Today, it is much more. MCX is the futures exchange. People get price signals for the carbon for delivery in next five years. The exchange is only for Indians and Indian companies.

Every year, in the month of December, the contract expires and at that time people who have bought or sold carbon will have to give or take delivery. They can fulfill the deal prior to December too, but most people will wait until December because that is the time to meet the norms in Europe.

Say, if the Indian buyer thinks that the current price is low for him he will wait before selling his credits. The Indian government has not fixed any norms nor has it made it compulsory to reduce carbon emissions to a certain level. So, people who are coming to buy from Indians are actually financial investors. They think that if the Europeans are unable to meet their target of reducing the emission levels by 2009 or 2010 or 2012, then the demand for the carbon will increase and then they may make more money.

So investors are willing to buy now to sell later. There is a huge requirement of carbon credits in Europe before 2012. Only those Indian companies that meet the UNFCCC norms and take up new technologies will be entitled to sell carbon credits.

There are parameters set and detailed audit is done before you get the entitlement to sell the credit. In India, already 300 to 400 companies have carbon credits after meeting UNFCCC norms. Till MCX came along, these companies were not getting best-suited price. However they are now getting better prices.

Is this market also good for the small investors?

These carbon credits are with the large manufacturing companies who are adopting UNFCCC norms. Retail investors can come in the market and buy the contract if they think the market of carbon is going to firm up. Like any other asset they can buy these too. It is kept in the form of an electronic certificate.

In the short-term, large investors are likely to come and later we expect banks to get into the market too. This business is a function of money, and someone will have to hold on to these big transactions to sell at the appropriate time.

What’s the flip side of this business?

Like in the case of any other asset, its price is determined by a function of demand and supply. Now, norms are known and on that basis European companies will meet the target between December 2008 and 2012. However it cannot be predicted how much credit will be available in the market at that time. If these norms are changed, prices can go through correction. But, as of now, there is a very transparent mechanism in which the norms for the next five years have been fixed.

Other than this, it’s a question of having correct information. How much will be the demand for carbon credit some years from now? How much will the supply be? It is a safe market if you have more information on the extent of demand and supply of carbon credit market.