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Energy Risk Management Energy Risk Management Series Series ERM 01 ERM 01
What is Carbon ?
It is not a good
What is Carbon ?
It is not a Service
What is Carbon
Is it an “off balance sheet entry ?”
What is Carbon
Straight into the income statement. From Where?
Carbon: from where?
Carbon comes from the Chimney
Carbon: from where?
It is the proverbial hot air from our stacks, or the emissions
What is Carbon
Carbon permits are a subsidy to the energy industry
Carbon: why ?
As per Kyoto pact there are half a dozen GHG emissions that need to be tackled and mitigated. They are Carbon C02, Methane CH4, Nitrous Oxides N20 and CFC HCFC, namely Fluorocarbons etc.
Carbon: why ?
Carbon is chief cause of Global warming as per studies done by IPCC at UNFCCC
37 Industrial nations who produce 80% of the Global emissions have agreed in Kyto in 1997 to lower GHG emissions by minimum 5 % before 2012. US has not ratified the pact.
Implemented largely in the European Union, the emission control under the EU Emission Trading Scheme has been based on the theory that emissions can be capped if Carbon is traded like a marketable commodity.
The EU ETS
The EU ETS 1 was developed to usher in a cap and trade market in 2005, for Carbon trading.
The EU ETS permits
Under the EU ETS1 each member state of the EU could on basis of existing industry capacity issue carbon permits licensing energy producers to emit Co2.
Those who did not use their full quota of permits could sell them, while those who needed more would have to buy the permits either from EU ETS auctions or off the market.
EU ETS energy subsidy is to all
The EU ETS has no
benchmarking procedure, which means that free carbon permits, were issued to all units and were not related to an industry’s emission efficiency.
General Energy Subsidy
The CDM under the Kyoto pact also does not make it mandatory to invest the proceeds of carbon sales into renewable energy, so it is not a specific subsidy against capital expenditure for any environmental gains, but a general subsidy.
Carbon as a energy subsidy
Proceeds from its Carbon sales can be at best entered in the books as ‘income from other sources.’ like any other subsidy.
Treating Carbon as a subsidy
Wait a minute……. Carbon a subsidy? Then why is it not under the WTO.
Carbon subsidy under WTO
As a general subsidy, Carbon sales proceeds become a protectionist tarrif for Europe’s emitters.
Carbon subsidy tariffs
Why has Europe’s largest steel plants, profiting billions from carbon credits not been slapped with Carbon equalizing duties or antidumping tariffs. Why? ….only time will tell !!!
Risk Managing Carbon
Risk Managing Carbon is not easy
For it is both a grant as well as a cost
For most of the time it is a free issue and a subsidy. But at some of the times it could be a cost.
Free and auctioned permits
93 % of Carbon permits in UK in 2008 have been free issues. Only 7% (4 million) Carbon permits were auctioned at GBP 54 million.
The 4 million permits issued under EU ETS2 had a cost price, and need a different treatment in accounting.
Carbon pricing in 2008
Let us say that 1 million Carbon units were bought under auction by a European steel maker under EU ETS 2 and this Carbon permit was accounted as a fuel surcharge for the year ended 2008 worth at its cost price which was GBP13.6 million
Carbon pricing in 1st Quarter 2009
If the Carbon allowances were sold in the summer of 2009, by the steel major, they would have fetched 28 million Pounds, generating an additional nonoperating profit of GBP 14.4 million
Carbon pricing in 3rd Quarter 2009
If the Carbon allowances were sold in the autumn of 2009, by the steel major, they would have fetched 8 million Pounds, generating a net loss of GBP5.6 million
Due to its nature of price volatility, free carbon permits must be entered in the income statement only after realization. Under the EU ETS 1 scheme millions of legitimate Carbon allowances were not realized, for there no buyers in the market
Like in EU ETS 2 Carbon prices in EU ETS 1 had crashed below par within 6 months of its issue and volumes were manipulated by EU to keep it above the floor prices. Hence free issue carbon may be entered in the books only after sales are realized.
Carbon market is volatile
So Risk Managing Carbon is a duel hazard
The free Carbon permits are neither good, nor services and can be only treated as a general subsidy or other income. The auctioned permits too are subject to price volatility and is often below the issue price at the auctions.
Carbon through auctions
Carbon purchased through auctions must be carefully evaluated. Purchase only if it cannot be deferred. Value at cost in the Books of account as a fuel surcharge. Integrating it as a part of fuel cost and spreading it over time is a fail safe technique, to account for Carbon. Since the allowances of 1 million carbon bought would be normally for use over a period of 6 months or a year 1 year, it is wiser to allocate the carbon cost over the entire fuel cost during that extended period of operation.
Buy carbon off markets
From the trends available for EU ETS 1 and EU ETS 2 it is highly unlikely that Carbon prices will rise, especially now, due to the arrival of carbon offsets in the market The Risk manager would advise staying away from the auctions, and purchase off markets only, against plant demand, at this stage.
The EU ETS has been amended twice but still only 45% the total C02 emissions are measurable today under the Kyoto pact and a only 3 % mitigated in the UK, the best operating EU model.
Effectiveness of EU ETS
How mitigation was done
Emission reduction was done at the plant level by additional oil and gas support to conventional coal fired units, which is the easiest way to reduce coal consumption and consequently carbon emissions
Mitigation leads to price hikes
This resulted in speculative positions in oil by the commodity traders, resulting in futures of Brent Oil spurting and creating a global price spiral.
Pollution permits burn European consumers
Did EU ETS "Cap and Trade" Cause Energy Prices to Skyrocket?
Effect of Cap and Trade on Oil Price rise (ORB) since
Difficulty in cap and trade enforcement
High increase in frauds including VAT frauds since enforcement of cap and trade in Europe Europol says 90% Cap and Trade transactions are fraudulent in some EU states, as VAT fraud crosses Euro 5 Bn.
Asia refuses to bite
Biggest blow to Cap and Trade ETS was received at Copenhagen meet when Asia and the developing world refused to accede to Europe’s mitigation methods. The US quickly broke ranks to join the BASIC nations to frame a new deal, that put Carbon trading in the backseat and EU negotiators on the back foot.
Bill in US to kill Cap & Trade
US Senator Graham (R-S.C.), backed Senators Kerry (DMass) and Liebermann(IConn) who are proposing a new bill to do away with CAP and Trade in its present form, shortly.
So Risk managing Carbon has only one option. To include it as a income only after realization. Any other treatment including the effort of securitization will be prone to hazard, as less than 20 % of the Global economy has accepted it.
Carbon is high Risk
As we have seen carbon is either a subsidy or a cost and not a commodity. It is a fact that though it was traded in the commodity markets as a good, it could never establish a benchmark price because it had no intrinsic value. It was a non-commodity in a commodity market, hence susceptible to high risk volatility.
Europe can’t sustain the carbon burden alone
It is highly unlikely that Europe will be able to convince other nations to follow the Cap & Trade Carbon economy. In all probability, they may abandon it in favor of a Carbon Tax before the end of this year, bringing an abrupt end to the $100 billion carbon trade industry.
Exit Carbon strategy
Industries who have free carbon permits should not add it to their stocks or income statement unless proceeds have been realized. Those who have bought permits through auctions may spread it over their annual fuel bills.
Big Banks exposure to carbon allowances is risk prone
Banks which are active in Carbon trade, would possible be tested for exposure : Barclays Capital Deutsche Bank J P Morgan Morgan Stanley Orbeo BNP Paribus
Ecology to Economics
Our goal is to help promote clean, safe and better practices in economy and ecology worldwide. Balanced, efficient and a little more sustainable. Amazon Kindle Blog : Ecothrust http://bit.ly/7XwAG or http://bit.ly/ecothrust RSS feed for Technorati http://technorati.com/people/Ecothrust/index.xml
Thanks to our Creative Director Katerina Voutsara for Art & Video presentation. For any questions on the presentation please send your queries to the Author Sandip Sen at email@example.com
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