MARKETS FOR EMISSIONS CREDITS SHOWING STRENGTH ON ALL FRONTS
Article from Environmental Business Journal Volume XVIII No.5/6 2005
Although the origins of emissions credit trading go back to the 1970s and the development of the Emissions Offset Policy, Bubble Policy and Emissions Banking in the United States, the concept of reducing pollution through market-based mechanisms such as credit trading owes much of its current popularity to the success of sulfur dioxide (SO2) allowance trading that began in the 1990s under EPAís Acid Rain Program. Today, thanks largely to this success, emission credits are changing hands in substantial volumes through several robust markets, both in the United States and in Europe.
The significance of the SO2 allowance program is straightforward: It demonstrated that pollution reduction goals are achievable at affordable pricesóindeed, in the Acid Rain Programís case, even at costs less than the programís designers initially anticipated. It is with these benefits in mind that emissions credit trading is now widely viewed as the central mechanism for any regulatory regime designed to reduce greenhouse gas (GHG) emissions, whether that regime be the Kyoto Protocol, a replacement treaty, or a suite of more regionally based GHG regulatory systems.
Of course, the Kyoto Protocol is in force today, and the GHG trading systems under its umbrella collectively represent ìprobably the most explosive market in terms of size and volumes,î according to Andrew Ertel, president and CEO of Evolution Markets LLC (New York, N.Y.; www.evomarkets.com), a firm that structures transactions in the environmental credit markets and provides related advisory services.
GHG credits trading under the Kyoto Protocol consists of two basic tiers of activity. First, the so-called Annex I countriesó36 industrialized nations and ìeconomies in transitionîómay trade emission allowances, or ìassigned amount unitsî (AAUs), among one another. The next tier consists of two mechanismsó Joint Implementation (JI) and the Clean Development Mechanism (CDM). Under JI, an Annex I country can earn ìemissions reduction unitsî (ERUs) by participating in the financing of projects that result in reduced net GHG emissions in another developed nation. Under CDM, non-Annex I partiesógovernments and private entitiesócan generate ìcertified emissions reductionsî (CERs) by developing projects that reduce net GHG emissions.
Within the first tier of activity, the European Union (EU) nations have already begun trading GHG emission credits under the new Emissions Trading Scheme (ETS). The EU ETS market covers anywhere from 12,000 to 15,000 facilities in the power, refining, steel, cement and other industries. The emission reduction liabilities forming the basis of the market, which deals exclusively in emissions of carbon dioxide (CO2) during the first phase through 2008, took effect on January 1, 2005, but the actual trading of emission allowances began in April 2003.
In the ETS market, ìweíve seen prices double in the last two months, and volume is also exploding,î Ertel told EBJ in mid-March. On a single day in that period, Evolution Markets facilitated a whopping 30 trades. Trading volume in general is averaging just under one million tons per day, with much more than that volume changing hands on many days. ìThe pre-market trading last year totaled about 10-million tons,î notes Ertel. ìNow weíre seeing at least 10-million tons traded per month.î
All this market activity is taking place even though upwards of 90% of the affected industrial facilities have not yet officially received their emission allocations under their respective national allocation plans. Many nations have experienced delays in issuing allowances, but most parties are expected to receive their allocations during the first half of this year, and that eventuality is providing a high level of certainty in the market, according to Ertel.
ìThe first compliance dates have come into effect, and the rules are much more clear,î he notes. As a result, certainty, along with the ratification of Kyoto, ìis helping to drive markets. Now, everybody whoís receiving allocations or expects to has a position in the marketólong, short, or flatóand management is able to manage those costs.î
EU-regulated parties can also generate CERs through CDM projects, and credits so generated can be used for ETS compliance. Activity along the CDM front is thus proceeding at a high level, according to Bruce Usher, CEO of EcoSecurities Ltd. (New York, N.Y., www.ecosecurities.com). ìThere are about 1,000 projects in the works worldwide, representing about 400-million tons of GHG emissions,î he estimates. ìPrices today are about $5 per ton, so thatís about a $2-billion market. Those credits are being bought mostly by European parties, but Japan is starting to buy, and Canada will be next, because they are also subject to the Kyoto Protocol.î
|
Success of the SO2 allowance program means that emissions credit trading is now widely viewed as the central mechanism for regulatory regimes designed to reduce greenhouse gas emissions. |
EcoSecuritiesí basic business is in the facilitation of CDM projects, with 48 currently under development. These run the gamut from the typical renewable energy project, such as small-scale hydroelectric power, to landfill-gas projects and industrial projects that involve fuel-switchingófor example, from coal to cleaner-burning fuels like biomass or natural gas. The first CDM project to be registered by the company, approved in November of last year, was a waste-to-energy at a landfill in Brazil. Other countries hosting projects include Honduras, Thailand, Malaysia, India and China.
Itís very difficult and time-consuming to register a project with the designated CDM board, Usher acknowledges. ìIt takes six months at a minimum, with lots of paper work, and you have to show that there are real emissions reductions.î The projects must then be validated by an independent auditor, such as a KPMG.
Nonetheless, ìthis is a very robust market,î Usher declares. ìItís coming from a small base, but it is now a billion-dollar market. Itís not hundreds of billions like the power market, but for an environmental market, itís pretty big.î
Next in line for trading in GHG emission credits may be the Northeast and Mid-Atlantic states. Nine of these states have formed the Regional Greenhouse Gas Initiative (www.rggi.org), under which the participants have developed an action plan that was expected to result in the issuance of a model GHG emissions cap-and-trade program for the electric power sector by this spring. Representatives of the provinces in eastern Canada are observing the process, with an eye towards eventually joining the trading partners.
NOX íNí SOX
Alongside the exploding activity in GHG emissions credit trading, the established markets for SO2 and nitrogen oxide (NOX) credits are humming along fairly smoothly. Even the Regional Clean Air Incentives Market (RECLAIM) NOX trading market in southern California has come back under a new set of rules meant to adjust for the imbalances and upheaval caused by the energy crisis of 2000.
In addition to SO2 trading under the Acid Rain program, the significant credit markets include RECLAIM, the NOX SIP Call (ìSIPî for ìState Implementation Planî) market affecting 19 eastern states, and the Houston-Galveston NOX market. The fundamental drivers for these markets are the regulations defining the credits and required emissions reductions, the vitality of the local and regional economies participating in the market, and the financial performance of specific traders, according to Josh Margolis, managing director of Cantor Fitzgerald Environmental Brokerage Services (www.emissionstrading.com).
ìLook at a map of the fastest growing counties, and lay on that a non-attainment mapóchances are, you are going to see intersections,î Margolis observes. ìThose areas will be where there are good opportunities and significant trading activity.î Margolis and his colleagues track trading markets in which there is significant activity on the buy side. Among these markets are the CO2, SO2 and NOX trading systems already mentioned as well as several others, including various state NOX and volatile organic compound (VOC) markets and the Los Angeles-area NOX, SO2, reactive organic gas (ROG), PM10 and carbon monoxide (CO) markets.
SO2 credit prices ìhave remained strong,î reports Evolution Marketsí Ertel, while NOX credit volumes have been steady and SO2 volumes have been ìchoppy.î In fact, SO2 credit prices had been trading at about $200 per unit, but the weighted average of winning bids during the spot auction in EPAís 13th annual SO2 allowance auction was $702.51 per allowance. That price bump is probably an effect of the recently issued Clean Air Interstate Rule (CAIR), which tightens the SO2 allowance market for the 28 affected states.
Peter Zaborowsky, a managing director at Evolution Markets, explains that, under CAIR, regulated entities in the 28 states ìwill have to submit two allowances for every one ton of SO2 they emit in 2010. Right now, itís a one-for-one submittal.î The ratio will go to 2.86-to-one in 2015. All sources affected by CAIRóessentially, all generators of 25 megawatts of power or moreóhave received their allowances all the way out to 2034. ìAnother interesting twist,î notes Zaborowsky, ìis that the rule allows any leftover credits for 2009 or earlier vintage to carry over into the future at full value.î
The tighter cap ìwill be tougher to comply with,î he continues. ìThe cost to scrubóto put flue gas desulfurization in placeówill get higher, because all the low-hanging fruit will be scrubbed. And as you have to suddenly start to scrub where the plants are finding it logistically difficult to scrub, the costs per ton go up. With SO2, significant additional amounts will be spent to comply, and there will be a higher cost to the credits.î
CAIR will also affect the NOX SIP Call trading program, by continuing and expanding the seasonal NOX, or ozone, program, and by establishing a new year-round program to address particulate pollution. Currently, 19 states participate in the seasonal ozone program, which extends from May through September. Under CAIR, that number expands to 25 states with the addition of Arkansas, Florida, Iowa, Louisiana, Mississippi, Missouri and Wisconsin, and the subtraction of Rhode Island. The year-round program affects all 28 CAIR states. The credits earned in the seasonal NOX program and in the annual NOX program cannot be interchanged.
Interestingly, the price of NOX credits traded among sources in these 28 states could fall as a result of the new CAIR program, according to Zaborowsky. The preferred approach to dealing with NOX is to install selective catalytic reduction (SCR) systems on baseload coal-fired facilities, ìand now you will be amortizing the capital costs of these systems over 12 months rather than over five months,î he explains. ìThat notwithstanding, there could be a short period of time when thereís a crunch of supply, and the newly regulated facilities wonít have time to comply. As more equipment comes on line, the price trends down. Right now, all sources under the SIP program that have installed SCRs have also installed bypasses on the SCRs for the off-season to reduce operating costs.î
One more important factor to note, says Zaborowsky, is that, in CAIR, EPA has directed the states to make reductions in NOX emissions, but the agency is allowing the states to go their own way. ìYou could see states bow out and say they will go the way of command-and-control,î he warns. However, ìwe feel that trading has a lot of traction; 19 states are already trading seamlessly.î
Still to come, provided it survives the court challengesóa big ìifîóis the cap-and-trade system authorized under EPAís recently issued Clean Air Mercury Rule (CAMR). ìWhile CAIR allows an open-trading approach to deal with NOX and SO2, for mercury weíve yet to see the details,î Zaborowsky remarks. ìThat will be a big one. The reason itís so important, especially for SO2, is that the mercury limits effectively become a scrubber mandate at eastern facilities. That in turn will bring SO2 credit prices down.î
REVIVED RECLAIM
Meanwhile, in southern California, the 11-year-old RECLAIM system is bouncing back after the South Coast Air Quality Management District (SCAQMD) issued rules in January tightening emissions limits and allowing the largest emitters back into the trading system. Those sources had been removed from the market in 2001 after the California energy crisis resulted in increased power production, a corresponding increase in emissions, and thus a substantial jump in RECLAIM Trading Credit (RTC) prices from the neighborhood of about $2 to more than $60 per credit.
That dramatic price increase squeezed a number of sources that had failed to adopt hedging strategies, and to stabilize prices, SCAQMD pulled the major sources from the market and required them to install NOX control technologies. To avoid a destabilizing surplus of credits going forward, these sources have been allowed back into the market on a graduated basis in terms of allowances issued, and with a schedule of ever-tightening emissions limits.
The special problems experienced with the RECLAIM system shouldnít be taken as a sign of fundamental flaws in the credits-trading concept. ìI think trading has been a success,î concludes Cantor Fitzgeraldís Margolis. ìIt has put a value on something that was not valued. It has caused people to pursue technologies and emission control strategies that they would not have otherwise pursued.
According to Margolis, the criteria for a successful emissions credit trading system are as follows: the system must at the very least match the performance of any command-and-control regulatory system, and it must be faster, better and cheaper. ìYouíve got to stick to those criteria and not over-reach. If the system is designed and implemented well, with the input of stakeholders, there will be great opportunities to use this tool. It can produce great good for the public and the environment, or it can have ill effects, so we need to have smart policy makers.î
ï ï ï
[Home] [EBJ] [Reports] [Data] [Info by Segments] [Links] [Free Sample] [About EBJ] [Contact]
------------------------------------