Carbon Trading

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Carbon Trading
Darryl Jones and Elena Derevtsova
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Carbon History

• Scientist Warning to Humanity (1992)
• Kyoto Protocol (1997)
• Carbon Market
• European Energy and Climate Exchanges
• ( ISDA ) Japan Emissions Trading Working Group
• Canadians Montreal Exchange
• Australia Sydney Futures Exchange
• (CCE) Chicago Climate Exchange

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Different Instruments for the Carbon Market

• Green Futures
• Renewable Energy Certificates
• Carbon Sequestrating
• Forest Enterprises
• Industrial Carbon Credits

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Total Worldwide Exchange Derivatives
volume by Asset Class
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Chicago Climate Exchange

• Modeled after EPA Acid Rain Program
• Government sets limits
• Sale of Carbon Rights
• Requirements
• Accurately Measure and Report

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CCX Trading System

• Trading Platform
• Clearing and Settlement Platform
• Registry
• CCX Rulebook
• the CCX Rulebooks copy is available for US 495
  (plus shipping and handling).

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(No Transcript)
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Carbon Trading Market Design
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An illustration of emission allowances and
futures trading

• At the beginning of 2003, a coal-fired power
  plant receives allowances matching its carbon
  dioxide (CO2) emissions cap, say 20,000 emission
  allowances (hypothesis 1 emission allowance
  equals 1 ton of CO2 emissions)

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First situation surplus of emission allowances ?
? ? Selling futures.

• In December, the CO2 emissions of the plant equal
  only 15,000 tons thanks to the implementation of
  new CO2 filters

• Alternative 1If the treasurer of the plant
  knows that the implementation of new CO2 filters
  will lower its C02 emissions below 20,000 and if
  he plans to sell the surplus, selling a Dec 03
  futures contract on 5,000 allowances _at_12 will
  place a floor to the December 2003 market price.
• Alternative 2The plant may keep the surplus for
  use against its target in future years or sell it
  to a trader at the market price.

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Second situation shortage of emission allowances
? ? ? Buying futures

• In December, the CO2 emissions of the plant reach
  25,000 tons, it is a shortage of 5,000 allowances.

• Alternative 1If the treasurer of the plant
  anticipates an increase in the C02 emissions,
  buying a Dec 03 futures contract on 5,000
  allowances _at_12 will cap the December 2003 price.
• Alternative 2The treasurer of the plant will
  buy 5,000 allowances at the market price to fill
  up the shortage in allowances.

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Using Derivatives Good Business Practice

• Flexible
• Cost-Effective
• Maximize Returns
• Manage Risks

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Cost and Risk

• Limited scope of activity
• Government is a primary market driver
• Small number of players the majority are novices
• Illiquid market
• Allowances transfer is time consuming
• Limited ability to enter or exit the market with
  ease
• Insufficient cooperation between government
  regulatory agencies and exchanges

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Prerequisites for an Efficient Emissions Trading
Market

• Liquidity
• Need
• Sizeable market volume and sufficiently high
  number of market players
• One-stop shopping for spot and derivatives
  contracts
• Economic efficiency/minimized infrastructure cost
• Diversity of market players
• Need
• Different market participants with different
  background and different targets (power
  generators/industries/traders/financial
  institutions)
• Cross-border activity
• Standardization
• Need
• Standardised underlings because they reduce
  market fragmentation, facilitate risk management
  and reduce transaction costs

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Prerequisites for an Efficient Emissions Trading
Market (cont)

• Risk management tools / Certainty
• Need
• Improved risk management through Derivatives
  Market.
• Sound Exchange and Clearing House
• Need
• A centralised market place through which buyers
  and sellers trade carbon emissions and futures
  with reduced credit risk exposure.
• An Exchange with a market - Neutral position and
  good reputation for fairness and transparency in
  the conduct of trading
• Trade facilitation electronic access and
  transparent model.
• Legal Framework
• Need
• Establishment of the framework and rules
  governing the market.

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Conclusion

• Alaskas potential in the carbon market
• 400 Million to 500 million at current rates.
• Professors Bruce Larson,University of British
  Columbia and Brad Gentry,Yale University
• UAA Potential
• Land grant University
• Past clear cutting practices

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Test Questions

• Carbon Trading is risk free.
• True or False
• What year is the Kyoto Protocol due?
• 2004
• 2006
• 2008
• 2010