The Hindu Business Line : Carbon credit: Future is in commodity exchanges

Desert region of Barmer facing flashfloods and districts of Orissa getting historically high temperatures in recent times are attributed by experts to be clear signs of global warming, leading to major disruptions in micro-climates in various geographical regions across the country.

With global warming on the rise, such natural catastrophes are increasingly threatening human habitat, bringing misery to the people and economic losses in developed and developing countries.

These catastrophes would vary from hurricanes to heat waves, varying in impact and one knows that at best only a technological advancement can partially offset the current rate of emission of greenhouse gases (GHGs) and thereby prevent/avoid such disasters and the associated economic or eco-system losses.

The ratification of Kyoto Protocol by most countries, except for the US and Australia, came as a blessing for many developing nations in not only providing an incentive for using environmentally-sound technologies but also helping such technologies to thrive despite the high cost of their implementation with the purchase of carbon credits by "Annexure I" nations to meet their target cap.

The three mechanisms of Kyoto Protocol — Joint Implementation (JI), Clean Development Mechanism (CDM) and Emission Trading — not only promote the development and adoption of clean emission technologies, but also penalise the major polluters whose emissions exceed the cap.

Though the Kyoto Protocol is not going to solve the problem of global warming, it will certainly be a solution to the extent that it would bring both the developed and developing countries onto a single platform. Though the analysts view the Protocol sceptically, none denies that it offers the best possible way forward.

However, Indian industries, which looked at CDM implementation in their process looking at the prices of European Union Allowances (EUAs), have failed to realise fair prices in most cases due to the currently thriving OTC (over-the-counter) markets that have fleeced most sellers by buying at prices much lower than that provided by buyers.

Thriving OTC Market

The major risk in the carbon credit market is of the price, as evident in the way the EUAs in the European Union Emission Trading System (EU-ETS) crashed to a low of 7 euros in the second quarter of the year though it recovered slightly to trade at 16-18 euros now. But the dropping EUA prices certainly had a negative impact on CER (carbon emission receipts) prices thus affecting CDM operators from across the world.

In Non-Annexure B (developing) countries, CER prices are influenced by various factors including EUA prices, margins charged by the OTC intermediaries that facilitate the trade, and the prices of crude oil and natural gas. Though the recent crash in the EUA markets had only a marginal impact on the CERs, intermediaries working closely with CDM projects took this to their advantage and brought down the prices of CERs in India. This has particularly been made possible by the temporal and geographical lags between the buyers (Non-Annexure B countries) and sellers (Annexure I nations ).

OTC market

This has led to the mushrooming of the OTC market. For most part, dealers purchase CERs under their own account and sell them to customers with a a mark-up over the wholesale prices.

Though the stage and type of the project will have an impact on the CER price, in most cases these `consultants' exploit both the parties by buying CERs at a low price, some times just 5-6 euros and selling them at 13-16 euros, pocketing a tidy margin. This justifies neither the price risks they face in resale nor the economic value of services rendered.

Effective control of GHGs is possible only if the emission trading mechanism is vibrant enough to provide incentives to environmentally clean technology and processes. The vibrancy of the market is a function of the efficiency of prices for the CERs received by the CDM projects. The efficiency of the prices arrived at the market for the sellers, is a function of market transparency and the level of policy interventions.

Commodity exchanges appear as of now the best avenues to bring transparency in the market. For instance, the establishment of the European Climate Exchange (ECX), a subsidiary of the Chicago Climate Exchange (CCX), is emerging as the right platform for buyers and sellers. The increasing turnover on the ECX and the reducing importance of the OTC markets in the EU is a testimony to the ability of the futures markets to arrive at efficient prices.

Leader for CERs

India's huge potential for generation and sale of CERs needs to be harnessed by the participants especially to tap the huge opportunity in EU-ETS. Hence, in order to bring vibrancy to the emission market in the country, there is a need for a transparent platform that will help buyers and sellers get a fair deal and reduce the margins of the intermediaries to reflect the economic value-addition. With technology at India's side, it is time the country leveraged it for a susutained growth of the carbon credit market.

The national level online commodity exchanges, which have done much for most primary commodities, offer the best platform for this market.

One of the best examples is the wheat price discovered on the MCX platform that has made the MSP (minimum support price) and the procurement operations for wheat all but redundant. Keeping this in mind, the MCX, with its alliance with ECX to launch its mini-version of Carbon Financial Instruments, seems to offer the right platform for efficient price discovery for the CERs.

The MCX-CCX tie-up is expected to ensure better price discovery of carbon credits besides helping the participants cover the risks associated with selling and buying of carbon credits. Further, the exchange, with its various ways of educating the eco-system participants, would enhance the benefits accruing to them in its endeavour to make India a major global commodity-trading hub. Hence, it is time policy-makers allowed futures trading in carbon credits not only to save the proverbial "golden egg laying goose" from the OTC market players but also to help clean up the environment.

(The author is an Economist with Multi Commodity Exchange of India Ltd. The views are personal.)

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