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Thu 22 Nov 2007 12:00 AM

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Counting the carbon credits

The Kyoto protocol created a market, but are the Gulf states ready to trade pollution?

The economics of global energy supplies could be in for a radical shake-up. Reducing pollution has become big business, and pollution markets play a major role in encouraging industries to adapt to the requirements of a non-carbon intensive world future.

"Money and the environment are not enemies, in fact they work fantastically together," says Tilak Doshi, executive director of energy at the Dubai Multi Commodities Centre. "The best way to cure problems of pollution are in fact to use the market in order to create the correct incentives."


It’s a system that’s so important for the climate of this planet that where it has shortfalls we need to work on those.

Often criticised for lack of transparency and openness to corruption, the carbon trading system is relatively young. But Rod Beckstrom, a board member of the influential Environmental Defence Fund that co-drafted the Kyoto Protocol, believes it is a system the world can't afford to give up on. "I believe it's a system that has integrity," he maintains, "and it's certainly a system that's so important for the climate of this planet that where it has shortfalls, boy we need to work on those shortfalls. But we don't need to get rid of the system because we need this system." And it needs to grow: "we need this system to be much more expansive and include the US, China and the GCC."

Currently there are no limits on how much companies in the region can pollute, but despite this in some countries carbon clean-up operations are already in place. In May 2007, one of the GCC's first UN approved clean development mechanism (CDM) registered projects was established in Qatar. Developed by Qatar Petroleum, the Al Shaheen Oil Field Gas Recovery and Utilisation project is set to reduce the company's greenhouse gas emissions by over 2m tonnes of carbon dioxide a year.

In Egypt, the ancient mud-brick industry is quietly overhauling itself and switching from the use of mazot, a dirty heavy oil, to natural gas to fuel the factories. Fertiliser factories are also taking advantage of CDM compliant techniques to reduce their emissions and enable them to trade their carbon credits.

At the financial heart of one of the globe's biggest hydro-carbon producing regions, Dubai is preparing to launch its own carbon exchange platform. The Dubai Multi Commodities Centre (DMCC) is working with EcoSecurities, one of the world's largest carbon trading firms, and companies with large carbon footprints that are interested in carbon trading. These include Dubai Municipality, DEWA and several major cement companies. "Even though we might not have pollution controls here, we can participate in cleaning the environment in an economically feasible way," says Doshi, "there are no controls as in Europe. But we can cut pollution, generate carbon credits and sell those credits to countries who want to buy them."

The DMCC is positioning itself as a free to use ‘one-stop-shop' for companies to get emission reduction operations approved by the UN, a complex task. Once a critical mass of registered CDMs have been created making trading viable, an exchange platform will be set up. "It would be a DMCC-led venture and it would most likely be in our exchange in which we have majority share, the Dubai Gold and Commodities Exchange," explains Doshi. Partnering the firms it has assisted, the DMCC will benefit from revenues generated when trading commences.

The carbon trading market is both compliance driven and attracts investors who see the pollutant and its equivalents - classified under the Kyoto Protocol and all referred to in financial terms as carbon credits - as commodities to be traded in the same way as any others. The market is complex and many factors affect the price of the credits, significantly the price of other energy commodities. Robin Gregory, emissions trader at CantorCO2e, explains: "the price essentially is derived from all the other energy commodities so if someone is really looking to invest in this market they need to have an awareness of the other energy commodities. Therefore they can then take a view on where this market's going."
A London-based broker, Gregory works on the European Union Allowances desk matching buyers and sellers in the wholesale market. The EU Emissions Trading Scheme is the biggest international carbon trading market. The main market indicators are the price of oil, German power, UK gas and coal. "It's not really something that an unsophisticated investor can get into," says Gregory. "You need to be aware of what's happening in the other wholesale commodities, otherwise you're going to be speculating completely blind."

In Europe those active in the market include all the big utilities and many of the large banks and hedge funds. "There's a huge amount of speculative money that's involved in the market," says Gregory. "That's what all of the big banks are doing and all of the funds. Generally the pure investment banks don't have any need to be involved. They see a liquid market which they can trade to make money, and that's why they're in there."

This increases liquidity and deepens the market. Banks also offer compliance driven clients a route to market, facilitating the whole system. "You need those guys in there," Gregory confirms, "the more money that flows through the markets the more of a success it's going to be."

But the international landscape of the carbon credit marketplace is uneven. "It's not helpful, there's not doubt about it," says Andrei Marcu, CEO of the International Emissions Trading Association. "But there's a concerted effort to link the market." Rod Beckstrom agrees: "there is not a global homogenous carbon market. Even within Kyoto there are different kinds of carbon units that are traded. So it's a fragmented market and because it's a new market it's a little embryonic, so you're going to have some inefficiencies."

It has also experienced some unsteadiness. "There has been instability at the beginning," admits Marcu, adding, "there were very good reasons for that because there was no data and the infrastructure was not completed." He now sees a market maturity reached after rapid initial growth, driven by the requirements of Kyoto. "The market has been behaving in a much more rational way," he notes, but warns, "at some point you will reach saturation." This is illustrated by the status of the market covering trading of the first phase of Kyoto reduction requirements. "The first phase is well over-supplied and the price has crashed," Gregory explains. "Occasionally you get a compliance buyer coming in and picking up some volume; it's just turned into a compliance market for this first phase." Attention is now focused on market movement in the second phase of the Kyoto Protocol, the three years to 2012, and on the situation after the current Kyoto agreement expires in 2012.

Much now depends on what decision the US reaches regarding carbon emission caps and the international regulatory framework. "Both of these things will play a very important role," says Marcu. China's commitment is also critical, but Beijing is showing signs of interest in pollution trading and has just enacted a sulphur dioxide market. The future trajectory of the carbon credit demand supply curve is heavily influenced by regulatory regimes. But as pollution trading gains traction across the globe the bottom line is clear. The carbon content of fuel, or how much carbon dioxide is released per unit of energy, could become as important as what it costs to produce the fuel. In fact, the carbon content could have an equal, if not greater influence in what the fuel costs the consumer. Marcu is adamant on this: "carbon trading is the mirror image of hydro-carbon trading. You cannot be effective in setting a price for hydrocarbons if you don't understand the carbon market."

A US decision on its carbon emissions regulatory environment is imminent. Beckstrom believes that within three years Washington will approve a binding cap and trade solution for greenhouse gases: "I would give it at least a 90% probability." This would coincide with the provisional time frame Doshi has for setting up a carbon trading platform in Dubai. "I think three years would be a very reasonable period," he says. "At least I could say that by the end of three years, if not earlier, we certainly would be in a position to begin formulating the platform and the structure of the contract." The introduction of more stringent US emission regulations would create a very favourable environment in which to launch a Gulf exchange. "But these things can catapult and be extremely quick," adds Doshi. "It really is hard to put a time frame. The logical order is to promote investment in carbon emission reduction, and generate those credits. And with those credits begin to develop a market to trade them."

The response to the DMCC's activities has been impressive. "People want to get involved," says Doshi. His aim is clear: "our purpose is to promote a vigorous carbon credit market within the Gulf. All the incentives work together. We promote a greener, cleaner UAE, very much in the ruler's vision. And at the same time create incentives for people to benefit by."


The international responseThe international political response to climate change began with the UN Framework Convention on Climate Change (UNFCCC) adopted in 1992. The UNFCCC set out to stabilise atmospheric concentrations of greenhouse gases to mitigate the impact of human interference with the climate system. The 1997 Kyoto Protocol to the Convention was ratified by more than 170 countries. It committed many industrialising nations and transitional economies, Annex 1 countries, to legally-binding targets to reduce emissions of greenhouses gases by at least 5% by 2012. Non-Annex 1 countries are not bound by restrictions but can participate in reduction strategies.

In addition to establishing the first international target for greenhouse gas emission reduction, the Kyoto Protocol outlined a market-based solution. Under Kyoto three flexible mechanisms are available to businesses to enable them to reach greenhouse gas emission reduction targets. At an international level emission trading allows the international transfer of national allocations of emissions rights between Annex 1 countries.

The clean development mechanism (CDM) allows for the creation of certified emission reduction (CER) credits through emission reduction projects in less developed countries. Finally, through joint implementation initiatives industrialised Annex 1 countries or companies from these countries can create emission reduction credits through transnational investment between themselves. At the heart of all three trading mechanisms lies the rationale that climate change is a global problem and the location of emission reductions is irrelevant. As Rod Beckstrom tells Arabian Business, "it doesn't really matter where in the world we save a tonne of carbon from the atmosphere - there's only one atmosphere." Along with the European Union Emissions Trading Scheme (EU ETS), the UNFCCC trading mechanisms have created the largest market in the world for carbon.

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