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Environmental finance

From Wikipedia, the free encyclopedia

The field of

environmental finance

, part of both environmental economicsand the conservation movement, exploits variousfinancial instruments (most notably land trusts) to protect biodiversity.Dr. Gretchen Daily, of Stanford Universityhas written a book,

The New Economy of Nature

that addresses the issue of financingecosystem services.Dr. Jürg P. Blum, defined the term environmental finance (Dissertation: CorporateEnvironmental Responsibility and Corporate Economic Performance..... 1994 at USIU)asa fairly new field, "concerned mainly with finance and investment regarding theecological environment. The term environment, although frequently used in areas, suchas strategic management (Ansoff, 1968), has been popularized throughout literaturesynonymously with the term ecological environment."

[ edit

] Background

Burning of fossil fuels is a major source of industrialgreenhouse gas emissions, especially for power, cement, steel, textile, fertilizer and many other industries which relyon fossil fuels (coal, electricity derived from coal, natural gas and oil). The major greenhouse gases emitted by these industries are carbon dioxide, methane,nitrous oxide, hydrofluorocarbons(HFCs), etc, all of which increase the atmosphere's ability to trapinfrared energy and thus affect the climate. The concept of carbon credits came into existence as a result of increasing awareness of the need for controlling emissions. The IPCC (Intergovernmental Panel on ClimateChange) has observed

[2]

that:

Policies that provide a real or implicit price of carbon could create incentives for producers and consumers to significantly invest in low-GHG products, technologies and processes. Such policies could include economic instruments, government funding and regulation

,while noting that a tradable permit system is one of the policy instruments that has beenshown to be environmentally effective in the industrial sector, as long as there arereasonable levels of predictability over the initial allocation mechanism and long-term price.The mechanism was formalized in theKyoto Protocol, an international agreement between more than 170 countries, and the market mechanisms were agreed through thesubsequentMarrakesh Accords. The mechanism adopted was similar to the successful USAcid Rain Program to reduce some industrial pollutants.

[edit] Emission allowances

The Protocol agreed 'caps' or quotas on the maximum amount of Greenhouse gasesfor developed and developing countries, listed in its Annex I

[3]

. In turn these countries setquotas on the emissions of installations run by local business and other organizations,generically termed 'operators'. Countries manage this through their own national'registries', which are required to be validated and monitored for compliance by theUNFCCC

[4]

. Each operator has an allowance of credits, where each unit gives the owner the right to emit one metric tonne of carbon dioxide or other equivalentgreenhouse gas. Operators that have not used up their quotas can sell their unused allowances as carboncredits, while businesses that are about to exceed their quotas can buy the extraallowances as credits, privately or on the open market. As demand for energy grows over time, the total emissions must still stay within the cap, but it allows industry someflexibility and predictability in its planning to accommodate this.By permitting allowances to be bought and sold, an operator can seek out the most cost-effective way of reducing its emissions, either by investing in 'cleaner' machinery and practices or by purchasing emissions from another operator who already has excess'capacity'.Since 2005, the Kyoto mechanism has been adopted for CO

trading by all the countrieswithin the European Unionunder itsEuropean Trading Scheme (EU ETS) with the European Commissionas its validating authority

[5]

. From 2008, EU participants must link with the other developed countrieswho ratified Annex I of the protocol, and trade the six most significantanthropogenicgreenhouse gases. In theUnited States,which has not ratified Kyoto, andAustralia, whose ratification came into force in March 2008, similar schemes are being considered.

[edit] Kyoto's 'Flexible mechanisms'

A credit can be an emissions allowance which was originally allocated or auctioned bythe national administrators of a cap-and-trade program, or it can be anoffsetof emissions. Such offsetting and mitigating activities can occur in any developing countrywhich has ratified the Kyoto Protocol, and has a national agreement in place to validateits carbon projectthrough one of theUNFCCC's approved mechanisms. Once approved, these units are termedCertified Emission Reductions,or CERs. The Protocol allows these projects to be constructed and credited in advance of the Kyoto trading period.The Kyoto Protocol provides for three mechanisms that enable countries or operators indeveloped countries to acquire greenhouse gas reduction credits

[6]

•

Under Joint Implementation (JI) a developed country with relatively high costs of domestic greenhouse reduction would set up a project in another developedcountry.

•

Under theClean Development Mechanism (CDM) a developed country can 'sponsor' a greenhouse gas reduction project in a developing country where the

cost of greenhouse gas reduction project activities is usually much lower, but theatmospheric effect is globally equivalent. The developed country would be givencredits for meeting its emission reduction targets, while the developing countrywould receive the capital investment andclean technologyor beneficialchange in land use.

•

Under InternationalEmissions Trading(IET) countries can trade in theinternational carbon credit market to cover their shortfall in allowances. Countrieswith surplus credits can sell them to countries with capped emission commitmentsunder the Kyoto Protocol.Thesecarbon projects can be created by a national government or by an operator within the country. In reality, most of the transactions are not performed by nationalgovernments directly, but by operators who have been set quotas by their country.

[edit] Emission markets

For trading purposes, one allowance or CER is considered equivalent to one metrictonne of CO

emissions. These allowances can be sold privately or in the international market atthe prevailing market price. These trade and settleinternationally and hence allow allowances to be transferred between countries. Each international transfer is validated bytheUNFCCC. Each transfer of ownership within the European Union is additionallyvalidated by the European Commission.Climate exchanges have been established to provide aspot market in allowances, as well asfuturesandoptions marketto help discover a market price and maintainliquidity. Carbon prices are normally quoted inEurosper tonne of carbon dioxide or its equivalent(CO

e). Other greenhouse gasses can also be traded, but are quoted as standard multiplesof carbon dioxide with respect to their global warming potential. These features reducethe quota's financial impact on business, while ensuring that the quotas are met at anational and international level.Currently there are five exchanges trading in carbon allowances: the Chicago ClimateExchange, European Climate Exchange, Nord Pool, PowerNext and the European Energy Exchange. Recently, NordPool listed a contract to trade offsets generated by a CDMcarbon projectcalled Certified Emission Reductions (CERs). Many companies nowengage in emissions abatement, offsetting, and sequestration programs to generate creditsthat can be sold on one of the exchanges. At least two private electronic marketshave been established in 2008:CantorCO2e

[7]

andPreserval Marketplace

[8]

.Managing emissions is one of the fastest-growing segments in financial services in theCity of Londonwith a market now worth about €30 billion, but which could grow to €1trillion within a decade.

[

citation needed

]

Louis Redshaw, head of environmental markets atBarclays Capitalpredicts that "Carbon will be the world's biggest commodity market, andit could become the world's biggest market overall."

[9]

[edit] Setting a market price for carbon