Tuesday, October 10, 2006

SURVEY: CLIMATE CHANGE Selling hot air

SURVEY: CLIMATE CHANGE

Selling hot air
Sep 7th 2006
From The Economist print edition

Kyoto's main achievement was to create a market in carbon. It's flawed, but better than nothing

THE huge hall at the Kölnmesse, Cologne's massive conference centre, looks like any other trade fair: rows of sellers' booths, some with buyers milling around them, some deserted. The participants' costume is a little unusual—not just the standard suits, but also chinos and T-shirts with green slogans. But what is being sold is very different: industrial gases to be captured from Chinese factories, trees to be planted in Africa, methane to be extracted from pig-effluent in Brazil. This is the carbon market, the main achievement of the Kyoto protocol.

Kyoto was a hard-fought attempt to do something immensely difficult: create a global mechanism for solving a long-term problem. Not surprisingly, its achievements have been limited. America and Australia did not ratify the treaty. Canada looks as though it may fail to comply. It signed up for a 6% reduction below 1990 levels by 2012, but the latest figures suggest that it is now running around 23% above 1990 levels. According to the new environment minister, Rona Ambrose, “it is impossible, impossible, for Canada to reach its Kyoto targets.”

Japan is supposed to be cutting its emissions to 6% below 1990 levels. It has no mandatory scheme, but many companies are participating in a voluntary one. Still, emissions are currently running at 24% above 1990 levels, so it will probably have to buy credits from other countries.

The EU has taken Kyoto most seriously. In 2005 it launched the European Emissions-Trading Scheme (ETS), which is supposed to cut emissions from the EU's five dirtiest industries. Most big European countries have additional schemes to penalise big CO2 emitters and to boost renewables, which is why wind farms are sprouting all over Europe. Some big European countries, such as Germany, France and Britain, are either near to meeting their targets or have already done so by cutting domestic emissions. Others, such as Spain and Italy, are further behind.

America was heavily involved in the design of the Kyoto protocol, and insisted that it should include the possibility of a market in emissions credits, on the ground that its trading scheme to reduce sulphur-dioxide emissions had been a big success. Europe reluctantly agreed and, once America walked away from Kyoto, turned out to be the mainstay of the carbon market that the protocol has created.

The carbon market works like any other commodity market: companies trade and the market sets prices. But it is unusual in that the commodity being bought and sold does not exist: it is the certified absence of carbon emissions. The market is big, and growing fast. In the first half of 2006, carbon to the value of €12 billion ($15 billion) was traded, five times more than in the same period in 2005.

There are two parts to the carbon market. The first, and largest in terms of cash, is the trade in allowances handed out to companies in the EU's five dirtiest industries under the ETS. Those companies have also been given emissions-reduction targets, which they can meet by cutting their own emissions, or by buying allowances from other companies, or by purchasing credits from developing countries. That is the second bit of the carbon market. The trade in allowances does not actually reduce emissions. The trade in developing-country credits does.

The Carbon Fair in Cologne, organised by the World Bank, is the annual get-together of the second bit of the market. The buyers are from the participants in Europe's ETS and Japan's voluntary-reduction scheme. The sellers are developing countries. The rich countries that ratified Kyoto are expected to produce 3.5 billion tonnes of carbon above their targets by 2012, so the prospects for sellers look good.

Some of the sellers at the Kölnmesse are more popular and better organised than others. The Chinese state planning committee stall has a glossy 200-page book crammed with projects, and a crowd of potential buyers. The man on the Senegalese stall has a photocopied piece of paper with six projects, and no customers.

The middlemen are niche investment banks, such as Climate Change Capital and Natsource, and project-management companies, such as Camco and AgCert. Camco, which floated earlier this year, works mainly in China. It identifies factories that emit lots of greenhouse gases and works out how to cut emissions; AgCert builds sealed pools to contain the pig-effluent in Brazil and Mexico, captures the methane it produces and burns it to produce electricity.

Projects have to be certified by the UN. Most involve cutting emissions not of CO2 but of more potent greenhouse gases. HFC, for example, an industrial gas, has 11,000 times the greenhouse effect of CO2. Some 58% of the credits sold between January 2005 and March 2006 were for HFC projects. Capturing it costs little—under $1 per tonne of CO2-equivalent—and selling it is lucrative. Thanks to the insatiable demand for credits, developing-country sellers have been getting up to $24 a tonne. Two Chinese deals alone, set up by the World Bank, which has put together a consortium of buyers, are worth $930m. At current prices, China is reckoned to have about $6 billion-7 billion-worth of HFCs that could be captured.

Not surprisingly, given both Chinese efficiency and the amount of dirty industry in the country, two-thirds of the deals signed between January 2005 and March 2006, by value, were with China. Keen to keep hold of the cash for its own purposes, the Chinese government has slapped a 65% tax on HFC projects and is funnelling the money into a “sustainable development” fund. “Sustainable development!” snorts a Chinese official. “It'll be spent on infrastructure.”

All right for some
Observers have three concerns about the carbon market. The first is about profits and prices. Giving the ETS allowances away (rather than auctioning them) made the scheme easy for the power-generators and other polluters to swallow. But it also, in effect, handed them wads of cash: they simply passed the extra costs on to consumers and pocketed the money. According to a report by IPA Energy Consulting, Britain's power-generation sector alone made a profit of around £800m ($1.5 billion) from the scheme in its first year.

Meanwhile, power prices went up steeply. According to a paper by Jos Sijm of the Energy Research Centre in the Netherlands, when allowances were €20 a tonne, European generators passed on between €1 and €19 per MWh to customers, depending on the structure of the market and the sources of electricity. In France, where the price is determined largely by carbon-free nuclear generation, they passed on least. In Germany, where it is largely determined by coal, they passed on most. Partly as a result, German off-peak electricity prices doubled in the two years to January 2006, to just over €40 per MWh, setting consumers squawking.

The second worry is about the purchase of credits from developing countries. Partly thanks to the Chinese government's 65% tax on emissions-reduction credits, European companies are paying many times the actual cost of reducing emissions. That price they pay is passed on to European consumers, who may eventually revolt when they realise how much money they are pouring into Chinese government coffers.

Third, the time-horizons for Kyoto (up to 2012) and, even more, for the ETS (whose first period runs only up to 2008) are too short. So whereas projects in the near term (such as capturing nasty Chinese gases) are financially worthwhile, longer-term ones that may be just as desirable (such as investing in cleaner power-generating plant) are not.

All that said, this is the first attempt to deal rationally with a hugely complex problem, so it would be odd if it did not encounter difficulties. And it has made some headway: last year it got rich-world consumers to invest $2.7 billion to cut developing-country greenhouse-gas emissions by around 374m tonnes of CO2 equivalent. That is only about half of Texas's annual emissions—but it's a start.

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