11/27/2014

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Carbon(CER)

CARBONCREDITSAMARKETOFTHE21stCENTURY
With growing concerns among nations to curb pollution levels while maintaining the
growth in their economic activities, the emission trading (ET) industry has come to life.
And, with the increasing ratification of Kyoto Protocol (KP) by countries and rising social
accountability of polluting industries in the developed nations, the carbon emissions
tradingislikelytoemergeasamultibilliondollarmarketinglobalemissionstrading.The
recent surge in carbon credits trading activities in Europe is an indication of how the
emissionstradingindustryisgoingtopanoutintheyearstocome.

What is a carbon credit? Simply put, one carbon credit is equivalent to one tonne of
carbon dioxide or its equivalent greenhouse gas (GHG). Carbon credits are Entitlement
Certificates issued by the United Nations Framework Convention on Climate Change
(UNFCCC) to the implementers of the approved Clean Development Mechanism (CDM)
projects.ThepotentialbuyersofcarboncreditsshallbecorporatesinvariousAnnexureI
countries that need to meet the compliance prevailing in their countries as per the Kyoto
Protocol or those investors who would like buy the credits and with the expectation of
selling them at a higher price during the KP phase (200812). The extension of KP shall
be ratified by the current signatories of KP in their future meetings essentially to curb
GHGemissionsintotheenvironment.

Sourcesofdemand&supply
Emerging carbon credit markets offer enormous opportunities for the upcoming
manufacturing/public utility projects to employ a range of energy saving devices or any
other mechanisms or technology to reduce GHG emissions and earn carbon credits to be
sold at a price. The carbon credits can be either generated by project participants who
acquire carbon credits through implementation of CDM in Non Annexure I countries or
through Joint Implementation (JI) in Annexure I countries or supplied into the market by
thosewhogotsurplusallowanceswiththem.Thebuyersofcarboncreditsareprincipally
fromAnnexureIcountries.Theyare:
Especially European nations, as currently European Union Emission Trading Scheme
(EUETS)isthemostactivemarket
OthermarketsincludeJapan,Canada,NewZealand,etc.
The major sources of supply are NonAnnexure I countries such as India, China, and
Brazil.

TradingInCarbonCredits
Emissions trading (ET) is a mechanism that enables countries with legally binding
emissions targets to buy and sell emissions allowances among themselves. Currently,
futurescontractsincarboncreditsareactivelytradedintheEuropeanexchanges.Infact,
many companies actively participate in the futures market to manage the price risks
associated with trading in carbon credits and other related risks such as project risk,
policy risk, etc. Keeping in view the various risks associated with carbon credits, trading
in futures contracts in carbon allowances has now become a reality in Europe with
burgeoningvolumes.
Currently, project participants, public utilities, manufacturing entities, brokers, banks,
andothersactivelyparticipateinfuturestradinginenvironmentrelatedinstruments.

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Priceinfluencingfactors
InNonAnnexureBcountries(thedevelopingcountries)acrosstheworld,CERpricesare
influenced by various factors including EUA prices, crude oil prices, electricity, coal,
naturalgas,thelevelofeconomicactivitiesacrossAnnexureIcountries,amongothers

Someofthemajorpriceinfluencingfactors:
Supplydemandmismatch
Policyissues
Crudeoilprices
Coalprices
CO2emissions
Weather/Fuelprices
EuropeanUnionAllowances(EUAs)prices
Foreignexchangefluctuations
Globaleconomicgrowth

Risksassociatedwithcarboncredits
There are market and policyrelated risks for CER producers, including the supplyside
risks starting from the DNA approval risk to the CER issuance risk in a complete CDM
approvalcycle.Apartfromtheserisksthereareahostofotherrisksfromboththesupply
anddemandsidesthattherealmarketplayersconfrontwith.
MostCDMprojectsbytheirverynaturetakealongtimetogeneratetheCERsandhence,
face the aforesaid risks in large proportion, which if not hedged would lead to reduced
realization.Undersuchasituation,therealizationofCERgeneratorsattimesmaynoteven
cover the investment put in to generate the CERs and thus, has the potential of even
making a CDM project unviable in the long term. Given the long gestation period of CDM
projects and the risks involved, it is rather inevitable that they presell their potential
credits in the futures market (preferably a domestic futures market, to avoid forex risk
attached to participation in a foreign exchange) and thereby, cover their probable
downsideinthephysicalmarket.

Potentialparticipantsincarboncreditstradingareasbelow
Hedgers
Producers
Intermediariesinspotmarkets
Ultimatebuyers
Investors
Arbitragers
Portfoliomanagers
Diverseparticipantswithwideparticipationobjectives
Commodityfinancers
Fundingagencies
Corporateshavingriskexposureinenergyproducts

Indiaasapotentialsupplier
India, being one of the leading generators of CERs through CDM, has a large scope in
emissions trading. Analysts forecast that its trading in carbon credits would touch US$
100 billion by 2010. Currently, the total registered CDM projects are more than 300,
almost1/3rdofthetotalCDMprojectsregisteredwiththeUNFCCC.ThetotalissuedCERs
with India as a host country till now stand at 34,101,315 (around 34 million), again
around 1/3rd of the total CERs issued by the UNFCCC. In value terms (INR), it could be
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runningintothousandsofcrores.
Further,therehasbeenasurgeinnumberofregisteredprojectsinIndia.In2007,atotal
of160newprojectswereregisteredwiththeUNFCCCindicatingthatmorethanhalfofall
registered projects in India happened last year. It is expected that with increasing
awarenessthiswouldgofurtherupinthefuture.ThenumberofexpectedannualCERsin
India is hovering around 28 million and considering that each of these CERs is sold for
around15euros,onanaverage,theexpectedvalueisgoingtobearoundRs2,500crore.

VariousindustriesthathavescopeofgenerationofCERs:
Agriculture
Energy(renewable&nonrenewablesources)
Manufacturing
Fugitiveemissionsfromfuels(solid,oilandgas)
Metalproduction
Miningandmineralproduction
Chemicals
Afforestation&reforestation

TheroleofMCX
WithMCXkeentoplayamajorroleontheemissionfrontbyextendingitsplatformtoadd
carbon credits to its existing basket of commodities with regard to commodities futures
trading, the existing and potential suppliers of carbon credits in India have geared up to
generate more carbon credits from their existing and ongoing projects to be sold in the
international markets. With India supposed to be a major supplier of carbon credits, the
tieup between the two exchanges is expected to ensure better price discovery of carbon
credits,besidescoveringrisksassociatedwithbuyingandselling.

AdvantagesofanMCXcarboncontract
In India, currently only bilateral deals and trading through intermediaries are widely
prevalent leading to sellers being denied fair prices for their carbon credits. Advantages
thattheMCXplatformoffersare:
Sellersandintermediariescanhedgeagainstpricerisk
Advance selling could help projects generate liquidity and thereby, reduce costs of
implementation
ThereisnocounterpartyriskastheExchangeguaranteesthetrade
The price discovery on the Exchange platform ensures a fair price for both the buyer
andtheseller
Players are brought to a single platform, thus, eliminating the laborious process of
identifyingeitherbuyersorsellerswithenoughcredibilityand
The MCX futures floor gives an immediate reference price. At present, there is no
transparency related to prices in the Indian carbon credit market, which has kept
sellersatthereceivingendwithnobargainingpower.

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