Carbon Credits

Carbon Credit Trading
A project report submitted in partial fulfillment of the degree of Master of Finance and control

Submitted by
Sikha Jain (09MFC033) Binita Sunadhar (09MFC013) P.G. Dept. of Commerce Utkal University, Bhubaneswar

Under the guidance of
Prof. Anil Swain P.G. Dept. of Commerce Utkal University, Bhubaneswar



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Amidst growing concern and increasing awareness on the need for pollution control, the
concept of carbon credit came into vogue as part of an international agreement, popularly known as the Kyoto Protocol. And, with the increasing ratification of Kyoto Protocol (KP) by countries and rising social accountability of polluting industries in the developed nations, the carbon emissions trading is likely to emerge as a multibillion-dollar market in global emissions trading. The recent surge in carbon credits trading activities in Europe is an indication of how the emissions trading industry is going to pan out in the years to come. It is estimated that 6070% of GHG emission is through fuel combustion in industries like cement, steel, textiles and fertilizers. Some GHG gases like hydro fluorocarbons, methane and nitrous oxide are released as by-products of certain industrial process, which adversely affect the ozone layer, leading to global warming. The Concept of Carbon credit came into existence as a result of increasing awareness on the need for pollution control. Kyoto Protocol The Kyoto Protocol is an international treaty to reduce greenhouse gas (GHG) emissions blamed for global warming. The Protocol, in force as of 16 February 2005 following its ratification in late 2004 by Russia, provides the means to monetize the environmental benefits of reducing GHGs. Kyoto Protocol is a voluntary treaty signed by 141 countries, including the European Union, Japan and Canada for reducing GHG emission by 5.2% below 1990 levels by 2012. However, the US, which accounts for one-third of the total GHG emission, is yet to sign this treaty. The preliminary phase of the Kyoto Protocol is to start in 2007 while the second phase starts from 2008. The penalty for non-compliance in the first phase is E40 per tonne of carbon dioxide (CO2) equivalent. In the second phase, the penalty will be hiked to E100 per tonne of CO2. The Protocol and new European Union emissions rules have created a market in which companies and governments that reduce GHG gas levels can sell the ensuing emissions credits . These are purchased by businesses and governments in developed countries such as the Netherlands that are close to exceeding their GHG emission quotas. Major contributors of Greenhouse Gas emissions are cement, steel, textiles, and fertilizer manufacturers. The major gases emitted by these industries are methane, nitrous oxide, hydro fluro carbons, etc. which directly deplete the ozone layer. For trading purposes, one credit is considered equivalent to one tonne of CO2 emission reduced. Such a credit can be sold in the international market at a prevailing market rate. The trading can take place in open market. However there are two exchanges for carbon credit viz Chicago Climate Exchange and the European Climate Exchange. The Kyoto Protocol provides for three mechanisms that enable developed countries with quantified emission limitation and reduction commitments to acquire greenhouse gas reduction credits. These mechanisms are Joint Implementation (JI), Clean Development Mechanism (CDM) and International Emission Trading (IET). Under JI, a developed country with relatively higher costs of domestic greenhouse reduction would set up a project in another developed country, which has a relatively low cost. Under CDM, a developed country can take

Carbon Credits up a greenhouse gas reduction project activity in a developing country where the cost of GHG reduction project activities is usually much lower. The developed country would be given credits for meeting its emission reduction targets, while the developing country would receive the capital and clean technology to implement the project. Under IET mechanism, countries can trade in the international carbon credit market. Countries with surplus credits can sell the same to countries with quantified emission limitation and reduction commitments under the Kyoto Protocol. The EBRD region former centrally planned economies of central and Eastern Europe, Russia, the Caucasus and central Asia is rich in possibilities for using the Protocol to reduce emissions and energy waste and costs. Such economies are highly energy inefficient: it takes twice as much energy to produce a unit of GDP in Hungary and Czech Republic as it does in Western Europe and 10 times as much in Russia and Ukraine. Understanding Carbon Credit Carbon credits are measured in units of certified emission reductions (CERs). Each CER is equivalent to one ton of carbon dioxide reduction. India has emerged as a world leader in reduction of greenhouse gases by adopting Clean Development Mechanisms (CDMs) in the past two years. Developed countries that have exceeded the levels can either cut down emissions, or borrow or buy carbon credits from developing countries. Trading in Carbon Credit (CC) The concept of carbon credit trading seeks to encourage countries to reduce their GHG emissions, as it rewards those countries which meet their targets and provides financial incentives to others to do so as quickly as possible. Surplus credits (collected by overshooting the emission reduction target) can be sold in the global market. One credit is equivalent to one tonne of CO2 emission reduced. CCs are available for companies engaged in developing renewable energy projects that offset the use of fossil fuels. Developed countries have to spend nearly $300-500 for every tonne reduction in CO2, against $10-$25 to be spent by developing countries. In countries like India, GHG emission is much below the target fixed by Kyoto Protocol and so, they are excluded from reduction of GHG emission. On the contrary, they are entitled to sell surplus credits to developed countries. It is here that trading takes place. Foreign companies who cannot fulfill the protocol norms can buy the surplus credit from companies in other countries through trading. Thus, the stage is set for Credit Emission Reduction (CER) trade to flourish. India is considered as the largest beneficiary, claiming about 31% of the total world carbon trade through the Clean Development Mechanism (CDM), which is expected to rake in at least $5-10bn over a period of time. To implement the Kyoto Protocol, the EU and other countries have set up Cap and Trade systems. Under these systems, companies are obliged to match their greenhouse gas emissions with equal volumes of emission allowances. The Government initially allocates a number of allowances to each company. Any company that exceeds its emissions beyond its allocated allowances will either have to either buy allowances or pay penalties. A company that emits less than expected can sell its surplus allowances to those with shortfalls. Companies or countries will buy these allowances as long as the price is lower than the cost of achieving

Carbon Credits emission reductions by themselves. Currently, project participants, public utilities, manufacturing entities, brokers, banks, and others actively participate in futures trading in environment-related instruments. Sources of demand & supply Emerging carbon credit markets offer enormous opportunities for the upcoming manufacturing/public utility projects to employ a range of energy saving devices or any other mechanisms or technology to reduce GHG emissions and earn carbon credits to be sold at a price. The carbon credits can be either generated by project participants who acquire carbon credits through implementation of CDM in Non Annexure I countries or through Joint Implementation (JI) in Annexure I countries or supplied into the market by those who got surplus allowances with them. The buyers of carbon credits are principally from Annexure I countries. They are:
y y

Especially European nations, as currently European Union Emission Trading Scheme (EU ETS) is the most active market; Other markets include Japan, Canada, New Zealand, etc. The major sources of supply are Non-Annexure I countries such as India, China, and Brazil. Price influencing factors In Non-Annexure B countries (the developing countries) across the world, CER prices are influenced by various factors including EUA prices, crude oil prices, electricity, coal, natural gas, the level of economic activities across Annexure I countries, among others Some of the major price influencing factors: 

Supply-demand mismatch Policy issues Crude oil prices Coal prices CO2 emissions Weather/Fuel prices European Union Allowances (EUAs) prices Foreign exchange fluctuations Global economic growth

Economic Parameters impacting Carbon prices


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Carbon Credits
Economic Indiacators 2008 2007 2006 2005 2004

Real GDP (% change) US Japan Euro zone China India OECD
Consumer Price inflation (% change) US Japan Euro zone China 1 0.5 1 3 2.5 1.4 3 5.9 2.7 0.3 2.2 2 3.4 0.3 2.2 1.4 2.7 2.3 2.1 3.2

1.1 -0.3 1 9 7.3 1

2 1.9 2.3 11.5 8.9 2.6

2.9 2.8 2.6 11.1 9.7 3.2

3.1 2.4 1.4 10.4 9 2.7

3.6 4 2 10.1 7.9 3.6

OECD Industrial Output (YoY % change) US Japan Euro zone China






-8.9 -20.7 -12.2 5.7

1.7 1.5 1.4 17.4

1.5 5.4 5.3 14.7

2.9 3.4 2.5 16.5

3.3 1.7 0.8 14.4

Interest rates (%) US ( Fed Funds Target) Japan (12 month T-Bills) Euro zone ( Refinance rates ) China ( Lending Rate )






0.25 0.249 2.5 5.31

4.25 0.581 4 7.47

5.25 0.618 3.5 6.12

4.25 0.066 2.25 5.58

2.25 0.003 2 5.58

India ( Repo rate )
Money Supply ( YoY % change) US Japan Euro zone China






9.6 0.7 7.5 17.82

5.6 0.7 11.6 16.72

5.4 -0.6 9.9 16.9

4.1 0.3 7.4 17.6

5.7 1 6.6 14.63

Equity Index (points) US (DOW JONES)











India (SENSEX)
OECD Indicators






OECD Total Monetary Aggr. & Comp. Broad Money Index 127.3 OECD Total Purchasing power Index Manufacturing 113.83

116.9 106.9

107.6 103.7

100 100

93.9 96.16


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Carbon Credits

OECD Total CPI OECD Groups Total Energy IPB






Source: OECD, IMF, CPM gold yearbook, World Bank How Trading Carbon Credit is Done But how is the trading done? Take an industrialized country like Germany and a developing country like Kenya as an example. Both countries have enacted law to limit the emissions that businesses can produce as per Kyoto Protocol. 1. Germany has allocated a quota of 50,000 tonnes of greenhouse gas emissions per year to factory A GmbH. But factory A GmbH is putting out 75,000 tonnes of greenhouse gas emissions per year for its operations. Factory A GmbH will either have to reduce production to meet 50,000 tonnes of greenhouse gas emissions per year limit or it has to purchase the deficit of 25,000 tonnes of greenhouse gas emissions per year from the open market. 2. In the neighboring industrial area there is factory B GmbH. Factory B GmbH has been allocated a quota of 100,000 tonnes of greenhouse gas emissions per year. Factory B GmbH has invested in new and efficient machineries and CO2 emission has dropped to 60,000 tonnes of greenhouse gas emissions per year. Factory B GmbH has a credit of 40,000 tonnes of greenhouse gas emissions per year of which they can sell 25,000 tonnes to factory A GmbH. But at what price? And what if they are not in the same area, how would they have known each other? This is why Carbon Credit Commodity exchanges Market is coming about. 3. Project C Kenya Limited is a fossil fuel power generating company in Kenya. The cost of greenhouse gas reduction is far much lower in Kenya as a developing country but the atmospheric effect is globally the same. And because every game has its tricks, Factory A GmbH may find it economical to sponsor Project C Kenya Limited recover methane from sewerage waste to feed the power station that previously would have used fossil fuel. This way, Factory A GmbH will recover 25,000 carbon deficits and even generate extra carbon credit which they can sell in the open market. Carbon Finance Carbon finance is the term used for carbon credits to help finance GHG reduction projects such as the recent biomass conversion at Bulgaria s PFS paper mill. The switch from hydrocarbon to biomass will reduce the mill s GHG emissions, generating carbon credits being purchased for the account of the Netherlands government. There are two categories of countries involved in carbon credit trading and finance: One being Developing countries which do not have to meet any targets for GHG reductions. However they may develop such projects because they can sell the ensuing credits to countries that do have Kyoto targets. In the EBRD region these include Armenia, Azerbaijan, Georgia, Kyrgyz Republic, FYR Macedonia, Moldova, Turkmenistan and Uzbekistan. These countries are covered by the Protocol s Clean Development Mechanism (CDM). The other, industrialized countries which include OECD countries (the richest nations of the world) and countries in transition from

Carbon Credits centrally planned to open market economies. The latter include 13 of the EBRD s countries of operation where the industrial base and other infrastructure are highly energy inefficient: Russia, Ukraine, Bulgaria, Czech Republic, Croatia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. They are part of the Protocol s Joint Implementation (JI) mechanism. Exchanges Trading In Carbon Credit Like the way the stock market evolved, there currently are five exchanges trading in carbon credit. These exchanges are providing spot market in carbon credit allowances as well as futures and futures' options to help discover market prices and maintain liquidity. The carbon credit exchanges are: 1. Chicago Climate Exchange 2. Nord Pool 3. European Climate Exchange
4. Power Next

5. European Energy Exchange Potential participants in carbon credits trading are as below Hedgers
y y y

Producers Intermediaries in spot markets Ultimate buyers Investors

y y

Arbitragers Portfolio managers Diverse participants with wide participation objectives

y y y

Commodity financers Funding agencies Corporate having risk exposure in energy products Various industries that have scope of generation of CERs: 

Agriculture Energy ( renewable & non-renewable sources) Manufacturing Fugitive emissions from fuels (solid, oil and gas) Metal production Mining and mineral production

Carbon Credits 
Chemicals  Afforestation & reforestation

Emergent Issues Carbon Credit: RS 15,000-Crore investments likely The unfolding opportunity of carbon credits has caught the imagination of Indian entrepreneurs. The number of Indian projects, in the fields of biomass, cogeneration, hydropower and wind power, eligible for getting carbon credits, now stands at 225 with a potential of 225 million CERs (certified emission reductions). This is just the tip of the iceberg. If there is no uncertainty as to what will happen beyond 2012, the number could easily cross the 2,000-mark. The Kyoto Protocol required the developed nations to reduce greenhouse-gas emissions at least five percent from 1990 levels during the commitment period of 2008-2012. On 93rd Indian Science Congress it was estimated that the new opportunity could trigger flow of investments to the tune of Rs.15,000 crore. Projects approved by designated CDM (Clean Development Mechanism) in the developing countries could earn carbon credits and sell them to the countries that required reducing the greenhouse gas emissions under the international agreement. It was also pointed out that India is not at all under any pressure. Going for cleaner production was good for our own interest. In that process Indian companies can benefit by selling the credits. Any projects that are set up after January 1, 2000, will be eligible for CDM recognition. The Ministry had already started a project to sensitize and encourage States to take a lead in this regard. Initially five States Andhra Pradesh, Rajasthan, Karnataka, Punjab and Maharashtra were given seed funding to set up their own CDM facilities and spread the word. Now it had been extended to 15 States. It is likely that the whole country will be covered up by the year-end. Demand for Carbon Credits will grow Because of projected shortfalls and higher relative carbon abatement costs, it is anticipated that OECD countries will fail to meet their Kyoto target by 2012. The higher relative emissions abatement costs in these countries mean that they will find it attractive to buy carbon credits generated elsewhere. Private companies in industrialized countries will increasingly be subject to Cap and Trade mechanisms, such as the EU Emission Trading Scheme which started on 1st January 2005 (although this will initially cover only 50% of emissions). The EU scheme is separate from the Kyoto Protocol but the Linking Directive of 2004 allows a European company to buy Kyoto Protocol Carbon Credits to comply with their obligations under the EU Emission Trading Scheme. Governments will also have to buy Carbon Credits because the cap and trade mechanisms will initially only apply to a fraction of each state s economy and Governments are responsible under the Kyoto Protocol for meeting their country targets. OECD Governments and European companies subject to the EU Emission Trading Scheme will therefore be the main buyers of Carbon Credits. Low-cost Carbon Credits available in the EBRD s countries of operations The reference year used by the Kyoto Protocol for targets in emission reductions is 1990. Since then, emissions have dropped sharply in countries such as Russia and Ukraine, as a result of

Carbon Credits substantial real contraction of GDP. It is expected that the 13 countries of operation with Kyoto Protocol targets will remain below their agreed maximum greenhouse emissions. These countries will therefore be likely sellers of carbon credits. High carbon and energy intensities mean high potential for low-cost emissions reductions (low relative investment cost per tonne of GHGs avoided). India as a potential supplier India, being one of the leading generators of CERs through CDM, has a large scope in emissions trading. Currently, the total registered CDM projects are more than 300, almost 1/3rd of the total CDM projects registered with the UNFCCC. The total issued CERs with India as a host country till now stand at 34,101,315 (around 34 million), again around 1/3rd of the total CERs issued by the UNFCCC. In value terms (INR), it could be running into thousands of crores. Further, there has been a surge in number of registered projects in India. In 2007, a total of 160 new projects were registered with the UNFCCC indicating that more than half of all registered projects in India happened last year. It is expected that with increasing awareness this would go further up in the future. The number of expected annual CERs in India is hovering around 28 million and considering that each of these CERs is sold for around 15 euros, on an average, the expected value is going to be around Rs 2,500 crore. Role of the EBRD The main role of the Bank in the field of carbon finance is to act as financier of emission reduction projects. However, in keeping with its principle of additionality - supporting and complementing the private sector rather than competing with it - the Bank can play a number of additional roles viz; (i) Carbon Funding: The EBRD is well positioned to purchase, for the account of third parties, carbon credits from GHG emission reduction projects. The Bank s added value in this area stems from the size and quality of emission and reduction projects. The Bank is the largest financier of private sector deals in the region, with preferred creditor status, a rigorous appraisal process, and integrity and good governance requirements. It also has lengthy experience in energy efficiency and renewable energy projects. The Bank also closely coordinates the project financing and carbon buying process. EBRD s strong relationships with host country s Government and its ability to engage in policy dialogue to remove or alleviate obstacles to carbon trading and mitigate the political risks inherent to the JI and CDM project cycles. Its experience in managing funds from its shareholders for a variety of purposes (e.g. nuclear safety) has an added advantage. Banks ability to access donor funds to help develop and implement projects makes them play a key role here. In October 2003, the EBRD established its first carbon fund, the Netherlands Emissions Reductions Co-operation Fund, with the Dutch Government. The fund buys Joint Implementation Carbon Credits from its 13 countries of operations eligible for this mechanism. Its first transaction was the PFS biomass conversion. The Multilateral Carbon Credit Fund will become operational in 2006. The fund will buy carbon credits from investments under the European Union scheme as well as the Protocol s Joint Implementation and Clean Development Mechanism. It will also aim to

Carbon Credits facilitate the direct trading of carbon credits between some of its shareholders (so-called Green Investment Schemes). (ii) Donor Funding: The Bank can help Governments and companies in its region of operations overcome obstacles in emission trading by providing technical advice funded by donor governments. For example, as part of the Bank s Early Transition Countries Initiative for its poorest countries of operation, donors have approved funding to help in development of complex CDM projects. (iii) Business Opportunities for the Private Sector: EBRD s carbon finance activities create new business opportunities for the private sector in this emerging market. The selling of carbon credits increases the feasibility of emission reduction projects, which helps to attract new private investors. By being the buyer of carbon credits in a transaction, the EBRD can provide comfort to private sector buyers that would not otherwise consider these projects. Outsourcing, to private firms who are expert in this area, the work of developing emission reduction projects covered by the Protocol. This is contemplated under the Multilateral Carbon Credit Fund. The role of MCX With MCX keen to play a major role on the emission front by extending its platform to add carbon credits to its existing basket of commodities with regard to commodities futures trading, the existing and potential suppliers of carbon credits in India have geared up to generate more carbon credits from their existing and ongoing projects to be sold in the international markets. With India supposed to be a major supplier of carbon credits, the tie-up between the two exchanges is expected to ensure better price discovery of carbon credits, besides covering risks associated with buying and selling. Advantages of an MCX carbon contract In India, currently only bilateral deals and trading through intermediaries are widely prevalent leading to sellers being denied fair prices for their carbon credits. Advantages that the MCX platform offers are: y Sellers and intermediaries can hedge against price risk; y Advance selling could help projects generate liquidity and thereby, reduce costs of implementation; y There is no counterparty risk as the Exchange guarantees the trade; y The price discovery on the Exchange platform ensures a fair price for both the buyer and the seller; y Players are brought to a single platform, thus, eliminating the laborious process of identifying either buyers or sellers with enough credibility; and y The MCX futures floor gives an immediate reference price. At present, there is no transparency related to prices in the Indian carbon credit market, which has kept sellers at the receiving end with no bargaining power. MCX strives to reduce energy usage and wastage and have adopted safe recycling mechanisms.

Carbon Credits The Exchange Square building, a new headquarter of MCX, is equipped with the best global practices for conserving energy. Glass windows that are doubled vacuumed are put in place so that they conserve energy. India s First Green Exchange: Operations of MCX are almost entirely electronic with zero carbon footprint. To further India s role in the global combat against greenhouse gas emissions, MCX in January 2008 launched carbon credit futures trade. This has enabled Indian owners of Clean Development Mechanism (CDM) projects under the Kyoto Protocol to sell the carbon credits they have earned, at the correct market prices without having to negotiate or bargain. This has done away with many of the problems Indian SMEs faced in the global carbon credits market. In recognition of the environment-friendliness of its operations and the launch of carbon credit futures, MCX has been honored with the title of India s First Green Exchange. The honor was conferred on MCX by Dr. Michael Nobel, executive chairman, Nobel Charitable Trust, on behalf of the well-known NGO, Priyadarshini Academy. Risks associated with carbon credits There are market- and policy-related risks for CER producers, including the supply-side risks starting from the DNA approval risk to the CER issuance risk in a complete CDM approval cycle. Apart from these risks there are a host of other risks from both the supply and demand sides that the real market players confront with. Most CDM projects by their very nature take a long time to generate the CERs and hence, face the aforesaid risks in large proportion, which if not hedged would lead to reduced realization. Under such a situation, the realization of CER generators at times may not even cover the investment put in to generate the CERs and thus, has the potential of even making a CDM project unviable in the long term. Given the long gestation period of CDM projects and the risks involved, it is rather inevitable that they pre-sell their potential credits in the futures market (preferably a domestic futures market, to avoid forex risk attached to participation in a foreign exchange) and thereby, cover their probable downside in the physical market. Rise of Global Carbon Commodity Global carbon markets have been growing at 100% a year, touching US$126 billion in 2008. The EU ETS (European Union Emission Trading Scheme) saw 3.09 billion EUAs (European Union Allowances) traded in 2008, exceeding the annual allocation for 2008 of 1.8 billion. Spot trading in EUAs jumped significantly to 250 million out of total 2.7 billion exchange-traded EUAs in 2008 and further increased to 850 million out of total 3.2 billion exchange-traded EUAs in the first half of 2009. The explosive growth in the EUA market and the significant increase in spot trading imply a deepening of the EUA market, and if this growth continues, the year 2009 could end up with the financial market. volume for carbon in excess of 6 billion or more than 3 times the underlying physical market. Trade in primary CERs (Certified Emission Reductions), the developing world s instrument of access to the global carbon markets, was below the 2007 level at 389 million in 2008, while that in secondary CERs (CERs traded among developed economy banks, traders, and utilities) witnessed a significant jump in volumes at 1,072 million in 2008. This is 5.3 times the underlying physical market of 275 million issued CERs up to 2008. We should see greater volumes of EUA and CER trades as the carbon commodity markets

Carbon Credits deepen and reach the level of other energy markets such as electricity and natural gas markets where the total financial market is 10 to 20 times the underlying physical market or crude oil where it is more than 30 times. The linkage between the energy and the carbon emissions markets is obvious, but it is interesting that some analysts predict that the emissions market may one day overtake the energy market (electricity and gas). Estimates of the size of the global carbon market in 2020 are in the range of US$1 trillion to US$3 trillion. Bart Chilton, US Commissioner of the Commodities Futures Trading Commission, opined that the potential size and scope of a structured carbon emissions market in the US is unequivocally vast. It is certainly possible that the emissions markets could overtake all other commodity markets," while estimating emissions futures to reach US$2 trillion in five years. Data on transactions in the UK, one of the largest electricity, gas and emissions markets in the Euro Zone, can read as a first sign of rapid growth of emissions trading with high volatility in other energy markets in the last three years. Contracts transacted by UK brokers notional value of markets in £ billion.

UK power UK gas Euro power Euro gas Coal Emissions

2005 25 54 77 7 45 1.5

2006 30 108 147 11 107 5.5

2007 30 134 193 11 46 8.8

2008 63 176 178 27 111 36

Source: Financial Services Authority (FSA) survey of the energy derivatives market The European Union has agreed to take a 30% reduction below 1990 by 2020, in the event of an international agreement on emission reductions. In its absence, it will take a 20% reduction below 1990 by 2020, which translates into a 21% reduction between 2005 and 2020 in the EU ETS sectors. This implies allocation/auction of 2 billion EUAs for 2013 decreasing to 1.7 billion EUAs for 2020 valuing the physical market at US$ 50 billion a year. The demand for CDM/JI (Clean Development Mechanism/ Joint Implementation) credits is restricted, in the event no international agreement takes place, to the allowances unused during the period 2008-2012. In the event of an international agreement on emissions, the limit on use of CDM/JI credits will automatically be increased up to half the additional reduction effort. Estimates put the total limit of CDM/JI credits during the period 2008-2020 at 1.4 billion (without international agreement) and an additional 300 million in the event of an international agreement being secured. However, the CDM scheme is expected to change significantly from the one that exists today both internally, in terms of improving the existing mechanism, and externally, in scope and coverage. There are calls for the existing (improved) CDM scheme to be applicable only to least developed countries in future and making sectoral CDM applicable for major economies. Calls for exclusion of industrial gases have also been raised. On the other hand, the developing

Carbon Credits countries have been raising the issue of financing and technology transfer, the key parameters set out in the Bali Action Plan. The US is not yet a significant player in the global carbon market. However, the recent passage of the American Clean Energy & Security Act (ACES) through the US House of Representatives is expected to change that dramatically and, at the very least, has kept the momentum to Copenhagen summit (the 15th Conference of Parties in December 2009). The ACES proposes 17% emissions reduction between 2005 and 2020 (3% below 1990 levels) and 80% by 2050. Projections by EPA show that this would require an emissions reduction (against the business as usual) of 366 mtCO2e (million tons of carbon dioxide equivalent) per annum during the period 2012-2020. The total US emissions in 2005 were at 7.2 billion. The ACES does not automatically allow all CDM/JI credits but calls on the US EPA (Environment Protection Agency) to develop its own process for approving offset projects. It provides for allowable limits of two billion tons annually from domestic and international offsets, and international allowance trading. A carbon market of US GHG emissions of this magnitude will increase the global emissions market multiple times. Huge investments in green technology in Asia and steps towards domestic emissions trading are opening up the prospect of regional carbon trading. Many Asian nations are not waiting for agreement on a broader UN climate pact and see good investment opportunities to move ahead now to boost energy security and job growth. Countries such as China, Japan, Korea and Australia were likely to press ahead with their own schemes to curb greenhouse gases, Anthony Hobley, global head of climate change at law firm Norton Rose, said at a carbon conference in Melbourne. What s happening is things are growing more organically, it s a bottom-up approach and that s how international currencies trade evolved, that s how international trade in oil evolved and I think that will happen with carbon, he said. There won t be this global unified top-down carbon market but what will happen is bottom-up development made possible by Kyoto Protocol and international agreements which unleashed design principles for monitoring and setting up markets. The Kyoto Protocol is the UN s main weapon in the fight against climate change and includes a scheme that rewards investors in clean energy projects in poorer nations. Investors earn tradeable carbon offsets in a scheme worth US $20.6 billion. But UN climate talks have got bogged down on whether to extend Kyoto into a new phase from 2013 or to craft a new treaty. The United Nations says it doesn t expect nations to agree on a new legally binding treaty during major climate talks in Cancun, Mexico, in less than two months. Agreement might come a year later during talks scheduled for end2011. It could be in the future that there will be treaties that link China s domestic market with global markets, that, if not global, may be bilateral or regional market models, Hu Tao, a member of China s Carbon Forum Advisory Board, said. Japan is already looking at bilateral offset deals to help the government meet its pledged emissions cut of 25 per cent below 1990 levels by 2020, fearing the UN talks could falter. What the regional carbon currency would be remains unclear but could be based on Kyoto offsets called certified emission reductions that are widely traded. China s next five-year plan from 2011 to 2015 is expected to include a commitment to

Carbon Credits market-based emissions trading. South Korea is finalizing plans for carbon trading, while Japan hopes to launch a scheme by 2013 or 2014 if the government s climate bill passes parliament. India aims to launch renewable energy and energy efficiency trading schemes, while an Australian government panel is weighing whether to recommend a carbon price or a limited emissions trading scheme with an initial fixed price for pollution permits. New Zealand already has the world s only national emissions trading scheme outside the European Union. These steps have been buoyed by huge domestic stimulus plans, including China s US $736 billion clean energy investment pledge to 2020, India s 20 Gw solar initiative by 2022 that is expected to draw US $70 billion in investment as well as steps by South Korea and Japan.
Buyer countries Austria Belgium Canada Czech Republic Denmark Finland France Germany Greece Hungary Iceland Ireland Italy Japan Latvia Luxembourg Netherlands New Zealand Norway Portugal Spain Sweden Switzerland United K. CDCF WBCF NEFCO IBRD CCAC Number of projects 80 24 74 3 63 34 71 202 14 92 464 24 433 1 36 5 133 220 560 1155 4 1 1 16 1479 5173


Note: In some project more than one investor country participate. Projects rejected by DOEs or EB or withdrawn are not included.


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Carbon Credits Graph-1 Primary CERs Producers (2008)

Source: State and Trends of the Carbon Market 2009 - World Bank report Graph-2 Primary CDM and JI Buyers (2008)







ITALY 9% 5% 4% 2%


Source: State and Trends of the Carbon Market 2009 - World Bank report


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Carbon Credits Energy Markets in India In India, electricity exchanges have been a recent entrant in the commodity market, with Indian Energy Exchange Ltd (IEX) and the Power Exchange India Ltd (PXIL) becoming operational last year. Recently, a third power exchange, National Power Exchange Ltd, has received approval from CERC (Central Electricity Regulatory Commission). Currently a day ahead market, there are indications that term capacity contracts and intraday contracts would be allowed to be traded on the exchange. The power exchanges deepen the existing bilateral electricity trading by embedding the transmission availability within the day-ahead contract in addition to the standard benefits of a trading platform access, risk mitigation, clearing and settlement processes. On an annualised basis, the electricity traded by the trading licensees stood at 21.9 TWh (terawatt hour or billion kWh) in 2008-09, approximately 3% of the total electricity generation in India, valued at approximately US$3 billion (given the high traded prices in the range of US$150/MWh). Around 2 TWh was traded on the power exchanges in FY09 (part year operation of both the exchanges). If one were to use the 10-20 multiple benchmark of financial markets to the underlying physical markets, this shows a huge growth potential in terms of electricity trade volumes and the share of exchange-traded electricity. There are some issues relating to the appropriate regulatory agency that has primary jurisdiction over the electricity commodity market. While these issues are being deliberated, they have not come in the way of developing the exchange traded electricity market. Multi Commodity Exchange of India Ltd (MCX) inter alia trades in natural gas, which is one of the actively traded contracts, while National Commodity & Derivatives Exchange Ltd (NCDEX) has recently introduced trading in thermal coal. Crude oil and fuel oil are traded on both MCX and NCDEX. Emissions trading (see section below) got underway at both the exchanges last year. That is, an entire suite of energy and emission products is being traded on the two exchanges and is expected to grow significantly in volumes. We anticipate that, as energy markets are further liberalised, new products in the form of spark and dark spreads with and without embedded emissions will also emerge as hedging tools. Carbon Markets in India Carbon instruments were launched in India in 2008 in anticipation of significant growth in the global carbon markets and India s position as the second-largest supplier of emission reductions. MCX initially launched futures linked to EUA and later launched CER futures contracts (expiry December 2008-2012). NCDEX launched CER futures contract with expiry December 2008. Exchange-traded carbon instruments were aimed to infuse greater liquidity and depth to a market that was being serviced by the over-the-counter (OTC) market, which largely comprised compliance buyers, international brokers, traders, banks etc. The exchangetraded market s role in price discovery and transparency was of particular relevance to Indian sellers as there was a general perception of lack of transparency in the OTC market. OTC transactions generally involve longer lead times and more complex and largely bespoke emissions reduction purchase agreements with extensive provisions to deal with credit risk issues. Exchange-traded carbon instruments were seen capable of addressing all these issues.

Carbon Credits Importantly, exchange-traded carbon instruments were intended to give the treasuries of large carbon sellers in India the ability and the flexibility to actively manage the company s carbon portfolio and price risks as commodity hedging on overseas carbon markets requires regulatory approvals not many companies are willing to pursue. As with any trading scheme, primary CER sellers were seen as an important segment of the market but the anticipation was that very significant interest from speculators, traders and arbitrageurs would provide the needed liquidity. The initial trades and growth in the volumes of exchange-traded carbon instruments on MCX and NCDEX were encouraging, and there was a lot of interest. At times, the prices of CER futures contracts on these exchanges were at a premium over those of the European Climate Exchange (ECX), the world s largest carbon exchange. However, it was generally understood that the premium was on the account of speculation over the exchange price (Euro Vs INR), which was expected to rise. However, as the global recession and economic slowdown hit Europe in the latter half of 2008, the demand for the EUAs and hence for CERs began to decrease. The price fall was further fuelled by companies in Europe selling surplus EUAs to raise much needed finances. When CER prices began to decline, Indian sellers preferred to wait and watch rather than transact at lower prices. In the absence of buyers and sellers in the Indian market, speculators and arbitrators vanished. And this resulted in the drying up of trades on the Indian exchanges. The 2008 preliminary verified emissions data released in 2009 showed that EU ETS was overall short in spite of the economic slowdown but this did not cause any significant market movements as this was generally expected. Indian commodity exchanges do not allow direct participation by foreign institutions. This may not impact price discovery for domestic commodities but CERs are different as their primary use is by Annex 1 countries. As there are no compliance buyers in India and foreign traders and institutions are not allowed to participate on NCDEX and MCX, liquidity and trading volumes are likely to continue to be low (affecting the price discovery process) until some elements of this equation are modified. Apart from market participation regulations, the development of carbon markets in India will also depend on the contours of global carbon markets post- 2012, agreed in Copenhagen summit. Significant opportunities could emerge for compliance and voluntary carbon for commodity exchanges if there is continued use of market mechanisms for reducing GHG emissions in the global context post-2012. Even as India is being heralded as the next carbon credit destination of the world, with maximum growth in this front is happening in Maharashtra, Chhattisgarh and Andhra Pradesh, Gujarat is slowly emerging as the dark horse of the country on the back of rapid industrialization through its recent oil refineries and power projects. Between the end of 2005 and December 2006, 450 clean development mechanism (CDM) projects had been submitted to the ministry of environment and forests, of which around 420 CDM projects have received government approval, which make up a total of 350 million carbon credits. Of the 420 projects, around 20 are from Gujarat. Big corporates like Reliance and Essar are already present in the state. And now, most carbon credit consultants, including a few international environment players are planning to set up shop in the country, and are eyeing the Gujarat market. Of the approved companies from Gujarat, Torrent Power has the maximum number of credits to its

Carbon Credits name with 11 million credits followed by ONGC s Hazira refinery with approximately two million credits, Indian Farmers Fertilizer Cooperative Ltd (IFFCO) with 1.5 million credits, Essar Power with 0.5 million credits, Reliance Industries approval for its base in Gujarat close to 2,40,000 credits, and Apollo Tyres with 1,00,000 credits. Others include United Phosphorus, Gadhia Solar, Tata Chemicals, Rolex Rings, Alembic and Fairdeal Suppliers. Going by the current rates, where carbon credits are measured in units of certified emission reductions (CERs) and each CER is equivalent to one tonne of carbon dioxide reduction, the value of one carbon credit could be anywhere between three Euros and six Euros, and with bank guarantee can go up to eight or nine Euros. The market is very big. It may be a clue to know that a recent analysis shows that India will stand to gain $5 billion from carbon credit in seven years. After Chicago Climate Exchange and the European Climate Exchange, MCX (Multi-Commodity Exchange of India) is likely to be the third exchange in the world with a license to trade in carbon credits. Two leading international players have already begun dialogue with the government to acquire permission to set up liaison offices in India. Eco-securities is the only international developer and trader of carbon credits to have a liaison office in India as on date. SRF Ltd and Shell Trading International have entered into a deal for sale and purchase of 500,000 CERs (Certified Emission Reductions) to be delivered on or before 2007. The move made a strong impact on the charts. In March 2006, India had 310 eco-friendly projects awaiting approval by the UN. Once cleared, these projects can fetch about Rs. 29,000 crore in the next seven years. India s carbon credit market is growing, as many players (industries) are adopting the Clean Development Mechanism (CDM). US accounts for 30 per cent of global emissions, while India makes for three per cent. Now, India can transfer part of its allowed emissions to developed countries. For this, India must first adopt CDM and accrue carbon credits. In India so far, 242 projects have been identified for generating CERs while a total of 318 projects have received clearance by the Ministry of Forestry and Environment. The Indian carbon market has the potential to supply 3050% of the projected global market of 700 million CERs by 2012. Harsh Pati Singhania, senior vice president, FICCI highlighted the fact that the Indian CDM project portfolio has grown exponentially, from 297 projects in April 2006 to 753 projects in September 2007 to 1,114 projects today, with over 536 million carbon credit potential up to 2012. It has been recommended the need of reforms in the CDM framework beyond 2012, which must address ways to support mitigation by public entities to a greater extend through the CDM route. The carbon emission of India in 1990 was lower than the world average. Since India has a lower emission compared to its developed counterparts, it does not qualify for mandatory emission targets. The meeting also underlined the fact that India has a very attractive CDM portfolio with a market share close to 12%. Indian revenues are expected to grow by $10 billion by 2012. Out of the 806 projects registered India bags nearly 35.7%. The number of expected annual Certified Emission Reductions (CERs) in India is hovering around 28 million and considering that each of these CERs is sold for around 15 euros, on an average, the expected value is going to be around Rs 2,500 crore. CDM can pave the way for around Rs 18,500 crore of investment by 2012.


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Giving an introduction to the carbon market, Sarika Rachuri of FTKMC said that EU Emission Trading Scheme EU-ETS is one of the biggest trading schemes dominating the carbon space which was launched in 2005. Elaborating on the implications of Kyoto Protocol she said that it offered cost reduction in Green House Gas (GHG) abetment and has increased the investment opportunities in green and clean technologies by incentivizing it. The other person who spoke on the occasion was Umamaheswaran of GTZ - a German company which is into bilateral development. He narrated the different stages of carbon credit generation and said that carbon credit is basically reduction in emission on GHG which is caused by a project. He said that CDM Project activity cycle included validation and registration, implementation and monitoring, verification and certification and trading & CER's delivery.

Fundamentals (Million Metric tons)

Carbon Market

Vol (MtCO2e) Val (MUS$)

Vol (MtCO2e) Val (MUS$)

Vol (MtCO2e)

Val Vol (MUS$) (MtCO2e) Val (MUS$)

Project based transactions
Primary CDM Secondary CDM Sub total (including JI & voluntary market) 389 1072 6519 26277 552 240 7433 5451 450 25 4,813 444 341 10 2,417 221









Allowances market
EU ETS New South Wales Chicago Climate Exchange Sub total (including others) Total carbon market 3093 31 69 3276 4811 91910 183 309 92859 126346 2060 25 23 2108 2984 49065 224 72 49361 63007 1101 20 10 1131 1639 24357 225 38 24620 30097 321 6 1 328 710 7908 59 3 7971 10865

Source: State and Trends of the Carbon Market 2008, 2007, 2006 by World Bank Status of CDM projects At validation Request for registration Request for review Correction requested Number 2575 57 57 66

Carbon Credits Under review Total in the process of registration Withdrawn Rejected by EB Rejected by DOEs Registered, no issuance of CERs Registered. CER issued Total registered Total number of projects (incl. rejected & withdrawn) Title AIssued CERs Total CERs Requested Source: UNFCCC
Title Annual Average CERs* Expected CERs until end of 2012**CDM

13 193 30 112 480 1174 40.41636364 1214.416364 4604.416364 Number of CERs 316,818,951 324,998,220

CDM project pipeline: > 4200 of which: N/A --- 1760 are registered 310,521,163 --- 104 are requesting registration 12,982,558

> 2,900,000,000 > 1,630,000,000 > 40,000,000

* Assumption: All activities deliver simultaneously their expected annual average emission reductions ** Assumption: No renewal of crediting periods Source: UNFCCC Carbon Trading Activity In lots MCX CER
Mar-09 Feb-09 Jan-09 Dec-08 Nov-08 Oct-08 Sep-08 Aug-08 Jul-08 Jun-08 May-08 2250 2556 1815 561 219 85 129 1139 14293 18771 -

50315 79498 44013 40079 90272 65675 61724 59537 84508 56597 23142

Open Interest
15 0 108 152 2 111 106 120 161 131 -

Open Interest
110589 114383 111772 103556 112772 104717 87541 71846 62298 48823 29672


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Apr-08 Mar-08 Feb-08 Jan-08 17656 8240 16613 5259 -

Source: Exchanges' websites
Aggregate Volume in all Contracts during the month- Cumulative open interest in all contracts at end of the month.

Carbon Prices
CER Spot prices ICE-ECX ( EUR/metric tonne)CER MCX (Rs/tonne) Open High Low Close EUA spot (EUR/metric tonne) RBI rate USDNIR

Monthly Average Monthly Average

Mar-09 695.16 Feb-09 561.63 Jan-09 770.63 Dec-08 874.17 Nov-08 928.63 Oct-08 1177.42 Sep-08 1309.23 Aug-08 1267.12 Jul-08 1437.83 Jun-08 1353.50 May-08 Apr-08 Mar-08 Feb-08 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 Jul-07 Jun-07 May-07 Apr-07 Mar-07 Feb-07 Jan-07 -

10.75 11.20 9.50 10.46 10.25 10.25 7.75 8.96 13.10 13.10 10.05 10.66 14.25 14.40 12.90 13.64 14.95 16.39 13.25 13.91 19.00 20.45 14.25 15.05 21.10 21.10 17.30 18.45 17.74 21.25 16.75 21.20 21.60 23.38 17.20 17.72 17.85 21.00 17.78 20.86 17.95 16.85 17.85 16.50 15.2 16.07 16.61 15.31 15.43 2.4

11.9 9.95 11.93 15.95 15.55 17.85 22.4 25.3 21.85 28.63 26.05 23.85 22.15 21.57 19.3 21.9 0.02 0.08 0.08 0.1 0.1 0.13 0.26 0.53 1.33 0.98 44.33

51.23 49.22 48.83 48.64 49.00 48.64 45.56 42.94 42.84 42.82 42.13 40.02 40.36 39.73 39.37 39.44 39.44 39.51 40.34 40.82 40.42 40.77 40.78 42.15 44.03 44.16

Source: Exchanges' websites, RBI

Carbon Credits Conclusion However, in spite of the global interest in India for the CERs market, there is still some way to go before it catches up with the market leaders in the field. While China leads the pack with a market share of 60 percent in the carbon credit trading, India lags behind with around 15 percent market share. Compounding to its woes is its high rejection rates from United Nations Framework Convention on Climate Change (UNFCCC) s Kyoto protocol. In spite of being preferred by most companies in the UK, Germany, Japan and Denmark, the reason India is still not counted among the top three carbon credit nations is because of its project rejection rate, which is as high as 50 percent. Just because our government approves projects does not mean that validators or the CDM executive board will do so. The projects do not get approval mostly due to the consultants hired by Indian companies who if not well versed with the Kyoto protocol will not be able to comply with the strict UNFCCC norms. However, buying credits that are intangible in nature, is no substitute to domestic action to reduce emissions. The conclusion we can draw is that there is significant trading potential for traditional energy and clean energy in the Indian commodity market. However, it will be important to sort out jurisdictional and market participation issues even as we consider market mechanisms for achieving strategic clean energy objectives in India so that the commodity markets can perform the role of risk mitigation in this important sector of the economy.



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