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Trading Carbon : December - January 2011
25 NORTH AMERICA With no shortage of controvers y, California passed final r ules for its carbon market in October, a cr ucial step in the US's most important climate change policy. The state believes the greenhouse gas (GHG) market, which starts in 2013, will let it address global warming in a low-cost way and become the centre of alternative energy industries, such as solar. However, some businesses fear higher energy prices. Much is riding on the effort, since it could influence policy in the US and around the globe. "When the nation addresses the growing danger of climate change, as I believe it must and will, California's climate plan will serve as the model for a national programme," said Mary Nichols, California Air Resources Board (ARB) chairman, following the approval. The most populous US state is moving ahead with the plan after Congress rejected a similar idea for the country, partly on concerns of the effect on businesses. The ARB voted eight--zero to adopt the market regulations, which officials said are critical to the state's goal of c utting carbon emissions to 1990 levels by 2020 -- about a 22 percent reduction from forecasted business-as- usual output. Power companies and factories will be able to trade a gradually decreasing number of permits to emit carbon dioxide (CO2) and other GHGs under the cap-and-trade plan, which counts on market forces to lead companies to find the cheapest way to c ut emissions. About 350 firms representing 600 California factories and oil refineries must begin complying with the programme in 2013. By 2015, when transportation fuels are brought under the cap, the s ystem will cover 85 percent of the California economy, which is the eighth largest in the world. Markets have already emerged for California carbon allowances (CCAs) and offsets expected to count for compliance in the system. In November, CCAs for delivery in 2013 averaged about $18 per allowance. With EU carbon prices crashing -- about ¤10 ($13.5) a tonne of CO2, as Trading Carbon went to press -- California is c urrently home to the highest priced carbon in the world. But since compliance with the programme was delayed by one year, trading of forward contracts has been thin. Currently, between 100,000 and 200,000 CCAs are traded and then cleared on the IntercontinentalExchange (ICE) per week. The Green Exchange has also launched CCA futures and options contracts. One broker said that he continues to see more companies covered by the state's future carbon market preparing to meet their obligations. "They're starting to devote resources toward it, but it takes time," the broker said. "For a new company dealing with cap-and-trade, they have to bring in their finance, legal and risk teams. They have to coordinate six different groups at the company," he said. He added that the most efficient manufacturers in the state are poised to be long carbon at the start of the programme, while inefficient oil refineries will either have to reduce CO2 output quickly or dive into the allowance market early. Brokers and traders said that barring some major Dec 2011/Jan 2012 obstacle to the programme, transaction volumes will continue to rise going forward. Trevor Sikorski, head of environmental market research at Barclays Capital, predicts that CCAs will trade at around $14/t of CO2 during the market's first compliance period, rising to $26 in 2015--2017 and $68 in 2018--2020. Sikorski called the current price "somewhat inflated" over the value he expects to see in 2012, because there are c urrently more buyers than sellers in the market. "The history of emissions markets is one of relatively high prices at the start of a new trading period before sufficient supply-side activity helps moderate those prices," he said. The market will also drive demand for carbon offset credits. Companies covered by the state's scheme will be able to use carbon credits from emission reduction projects, instead of CCAs, to cover up to 8 percent of their emissions. With CCA prices already fetching 30 percent more than prices for EU allowances, it could trigger a gold r ush for cheap offset projects to meet the demand for about 221 million offsets over the next eight years. So far, eligible credits can come from four project types endorsed by regulators -- those that c ut emissions of ozone depleting substances, methane from agric ulture and two others that store carbon in trees. The number of approved projects is set to expand, as is the total number of projects. "Yes, we do expect a significant bump in offset projects with many of the nearly 500 projects already in our system now getting the green light to go ahead to verification and lots of new projects coming in," said Gary Gero, president of the Climate Action Reserve, which approves project types on behalf of the states. Enthusiasm for the offset market is being tempered, however, by a controversial r ule surrounding the revocability of offsets. California will hold the buyer of an offset liable for replacing it if it is invalidated, a position market sources have warned will greatly damage offset liquidity. Brokers, traders and lawyers have complained that the liability provision will scare buyers away from the offset market, sending them into the more expensive allowances market and raising the overall cost of the programme. California officials have said the companies that are pushing for the elimination of the buyer liability provision are entities that are not actually part of the regulation, but market makers. "They're people who make their money on market liquidity. And their main concern is that by having the buyer liability provision in place, it may slow down or reduce market liquidity, and they make that money on trades," said James Goldstene, an exec utive officer at ARB. California did make some changes to the r ules governing offset invalidation as concessions to those upset by the regulation, but have made it clear they will not go any further on the issue. Nearly 500 projects are already in our system getting the green light to go ahead to verification Gary Gero, Climate Action Reserve