Wizards of Money Part 21: "Playing Russian Roulette in The Carbon Markets"
TABLE OF CONTENTS
Introduction
1. Global Carbon Flows BC (Before Coal)
2. How the Carbon Accounts become Unbalanced
3. The World's First International Carbon Market
4. A Market Miracle?
5. English Ambitions
6. Tree Farms and Cow Farts "Down Under"
7. Back to the Dark Ages to See What the US is Up To
8. The Pivotal Role of Russia
9. Stuffing Your Wastes Under the Ground
10. Will the US be Left Out of Emerging Financial and Energy Markets?
Introduction
In this, the twenty first
edition of the Wizards of Money, we're going to look at the hottest market
on the globe. Well, it's actually the market designed to cool things down
a bit - the global carbon market.
While the US has developed a sudden fascination with the so-called "Dark
Ages", a time when the earth was much toastier than it is today, the rest
of the world is looking forward and has decided to do something about man-made
weather impacts.
Most developed nations have now ratified the Kyoto Protocol of the United
Nations Framework Convention on Climate Change, including all 25 member states
of the European Union, as well as Canada and Japan. By ratifying the Kyoto
Protocol on climate change, these countries have pledged to reduce their greenhouse
gas emissions by a significant amount over the next decade. This pro-Kyoto
world has given up on the main country that refused to ratify the Protocol
- the USA, who doesn't seem the least bit embarrassed by their noticeable
gaseous emissions.
Forging ahead, the Kyoto team holds out hope that Russia will join them
by year-end 2003, which would finally bring the Kyoto Protocol officially
into effect. In anticipation, this pro-Kyoto world is gearing up for compliance
and is implementing new regulations, markets and market mechanisms - indeed
a whole new way of doing business globally - that the US is now being left
out of.
This episode of the Wizards of Money will explore the developments in the
global carbon markets that have taken place mostly outside of the United States,
and get very little attention in this country. These developments include
the world's first international market in carbon-based financial instruments,
national taxes and levies on corporate energy use, and even a tax on cow
farts and burps in New Zealand!
To get to know these new markets we'll talk to the director of global operations
at CO2e.com in London, the carbon emissions trading subsidiary of Cantor-Fitzgerald,
to an energy specialist for the Climate Action Network in Brussels and to
the head of the Australian Petroleum Cooperative Research Center.
But first, we'll start with a refresher on the cycle we can't afford to
ignore anymore - the global carbon cycle.
Song: "Carbon is a Girl's Best Friend"
1.
Global Carbon Flows
BC (Before Coal)
Just like with the water
cycle that we spoke about in Wizards Part 7, in the carbon cycle, only a tiny
fraction of carbon on earth actually participates in the carbon cycle relevant
to us terrestrial creatures. And just like the water cycle, any carbon we
have in our bodies today has certainly done the rounds over thousands or
millions of years: through plants, soils, other animals, the ocean and the
atmosphere. And you can forget property rights when it comes to carbon! When
the carbon in us is ready to depart, it will just go off and be somewhere
else.
Before the industrial revolution got underway, global carbon flows ran as
follows: Carbon in the air, stored as carbon dioxide (amongst other gases),
is used by plants in photosynthesis and becomes part of the plant. Some of
these plants get eaten by animals and the carbon in them is then used in various
molecules to make body tissue and to burn up energy. Other plants, or parts
of them, like leaves, just get old and die. This decomposition releases some
carbon back to the atmosphere, as does the process of respiration by animals.
The other 99.9% of the world's carbon that didn't participate in this cycle
just stayed underground - mostly buried in the ocean, in sedimentary rock
and in fossil fuels.
Before fossil fuel use by humans entered the scene, losses of carbon from
the earth and into the air from decaying vegetation and animal respiration,
in the form of various gases such as carbon dioxide and methane, were pretty
much balanced by carbon storage or "sequestration" by plants during photosynthesis.
The carbon cycle chugged along in this balance between about 1000 AD and the
early 1800s, and so the amount of carbon in the air stayed pretty constant
over this time period since the middle ages. To give you an idea of magnitude,
this annual exchange was about 100 million gigatons of carbon (where a gigaton
is a billion tons), from the earth into the atmosphere, balanced by an equal
exchange from the atmosphere back to the earth.
Insert: Treebeard (LOTR, "The Two Towers")
2. How the Carbon Accounts become Unbalanced
But then came the industrial
revolution, powered by the burning of carbon rich fossil fuels, and accompanied
by massive clearing of forest land for agricultural and other purposes. These
two activities have extracted another 7-8 gigatons of carbon out of the earth's
sources per year, of which the oceans and the world's forests have decided
to absorb just over half of this release. So the remaining 3-4 gigatons of
carbon has nowhere to go but into the air. Over the past 200 years, the level
of carbon dioxide in the atmosphere has risen by 30%, and the amount of methane
has more than doubled.
An excess of carbon gases, like carbon dioxide and methane, are known to
trap heat in the biosphere, making things toastier for all of us. This so-called
"global warming" has many known and unknown impacts on climate.
That humans have significantly increased the amount of carbon gases in the
atmosphere, and that these gases do contribute to temperature increases is
generally not in dispute between the two main parties on either side of the
Kyoto Protocol. What is under debate is the degree to which global warming
is caused by natural versus man-made factors. The fairly recently discovered
indications that the middle ages may have been warmer than the current ages,
has the leadership in the US scrambling to promote studies to show that natural
causes are a primary contributor to climate change.
Satisfied that human activities are contributing to climate change, the
countries that have now ratified the 1997 Kyoto Protocol on global warming
are trying to do what they can to get as much as possible of this excess
carbon out of the atmosphere by implementing mechanisms designed to reduce
overall carbon emissions.
The naysayers team, reluctant to give up their high carbon diets, led by
the United States and Australia, are diverting significant resources into
figuring out how carbon wastes can be buried underground or in the sea in
a process known as artificial carbon sequestration. The US has also developed
a sudden interest in the climate endured by King Arthur and his Knights of
the Round Table - when temperatures were much warmer than they are today.
If only they can understand why the mythical Knights were so toasty, they
can cast doubt on the idea that human induced greenhouse gases are largely
responsible for climate change.
Insert: Camelot
3. The World's First International Carbon
Market
Sure,
international markets for various forms of carbon products already exist.
Why, there are markets for diamonds, graphite, wood products and, of course,
fossil fuels themselves. But now there's a new carbon market.
In this new carbon market a monetary value is assigned to a carbon gas emission
allowance. Such an allowance could only have a monetary value if there are
a finite number of such emission allowances and the total amount allowed in
the market is close to, or even below, the total amount that is currently
being emitted. For this market to exist in the first place there must be someone
or some body, most likely a government body, that sets the total number of
allowances for the market.
This is exactly what the European Union has done. It has used the "cap and
trade" approach to moving towards Kyoto targets, which for the EU, requires
greenhouse emissions to get to 92% of 1990 levels by the end of this decade.
As announced on July 23rd 2003, the European Commission has formally adopted
a market structure for a "cap and trade system" for carbon dioxide emissions
that will begin operations at the start of 2005. Under the EU emissions trading
scheme the EU member states will set limits on carbon dioxide emissions from
energy intensive companies by issuing allowances for the amount of gas each
is allowed to emit. The total number of allowances will reduce each year until
the final target is reached. This list of companies includes approximately
10,000 companies accounting for about half of the EU's cabon dioxide emissions
and encompasses the following industries: steel, power generation, oil, paper,
glass and cement.
A company that is able to lower its emissions at relatively low cost, may
sell its excess allowances and hence, the argument goes, the emissions market
will act as a catalyst towards finding lowest cost emissions reduction solutions.
Other companies that have difficulty meeting their targets inexpensively can
buy these excess credits in the market, at whatever the prevailing market
price is. In effect then, they are providing the financing to the seller of
the credits for the seller's emissions reductions efforts, since this was
cheaper than reducing emissions in their own operations. And, if companies
decide to neither meet their targets nor buy credits in the market to offset
their excess, they will have to pay large fines to the government, well in
excess of the market price of credits. Hence the incentives are there for
companies to either comply or buy credits, thus ensuring that the total amount
of emissions will remain below the target.
This method of allowing the market to cut emissions quickly where it is
cheapest and easiest to do will presumably have the least detrimental effect
on the health of the economy, an issue largely driving the US "flat-earth
believer" approach to man-made climate change.
Insert: CO2e.com Interview
4. A Market
Miracle?
It does seem like some
kind of miracle that a bunch of 25 countries as diverse as the European Union
and who were at war with each other not so long ago, could unite over a proposal
that is bound to bring some shocks to their local economies. Even the European
environmental community seems fairly pleased with the EU's approach to global
warming. But, like all such complex agreements involving so many and
varied parties and lots of different political interests, this one is not
without controversy or room for abuse.
During the discussions leading up to the 1997 Kyoto Protocol, some of the
most controversial provisions had to do with the ways in which companies and/or
countries could accumulate excess greenhouse gas credits other than by cutting
emissions below their target level. Some of these so-called "Kyoto Mechanisms"
included:
- Creating "Carbon Sinks": Such as planting new forests,
or even certain types of timber farming
- Joint Implementation Projects: Which means funding emission
reductions projects in other industrialized nations
- Clean Development Mechanisms: Which means funding "clean
energy" projects in developing nations.
Many people fear that credit accumulation or emissions offsets gained under
these methods may be the most wide open for abuse and therefore may not bring
about real change in the battle to stem the release of greenhouse gases into
the atmosphere.
The recently approved EU Emissions Trading Scheme, set to begin trading
in 2005 did not provide for these Kyoto Mechanisms.
However, a recent Directive proposes an amendment allowing two of these
mechanisms - Joint Implementation and Clean Development Mechanism Projects
in other countries - as methods to accumulate carbon emissions credits. Climate
Action Network in Brussels discusses their concerns about these mechanims:
Insert: Climate Action Network
Nevertheless, these developments in Europe have really made the EU the world
leader in trying to stem man-made contributions to climate change, and without
these efforts it is possible that the Kyoto process would have collapsed after
the US took its sabbatical to study the Knights of the Round Table.
5.
English Ambitions
Even though they will be
able to participate in the EU emissions markets, in 2002 the United Kingdom
set up the first national emissions market of its own, similar to the EU "cap
and trade" mechanism. The UK actually plans to significantly exceed, or do
better than, its Kyoto targets by the end of the decade and they have gone
further than just capping, trading and fining violators.
In 2001 the British government imposed a Climate Change Levy in the form
of a tax on business use of fossil fuel based energy sources. Relief on this
tax can be gained by meeting certain targets in the emissions trading program.
Insert: CO2e.com Director
6.
Tree Farms and Cow Farts
"Down Under"
Different countries face
very different challenges in meeting their Kyoto targets. For less populated
and more agricultural-dependent countries like Australia and New Zealand,
carbon dioxide emissions from fossil fuel use are not the main problem areas.
Though one doesn't like to talk about these things in polite company, believe
it or not, cow and sheep burps and farts are a much bigger problem! Cattle
and sheep grazing and their subsequent emissions of smelly gases as by-products
of the digestive process, contribute an abundance of the most potent of the
greenhouse gases - methane. In fact, farm animal farts and burps account for
about one half of all greenhouse gas emissions in New Zealand.
Unlike its less cooperative neighbor Australia, the country of New Zealand
has ratified the Kyoto Protocol and had to do something about these smelly
air bubbles. In a move that was far less socially acceptable than either the
pops themselves or Britain's Climate Change Levy, the New Zealand government
took the drastic step of taxing farmers for the natural bodily functions of
their farm stock - they introduced the world's first tax on farting! A farmer's
rebellion got underway immediately and it is unclear what will happen next.
Insert: Cow Farts and Burps (maybe)
Across the Tasman pond, Australia has some similar problems, but more broadly
faces the reality that greenhouse emissions have increased over the last decade
primarily due to land use changes, including deforestation and agricultural
practices. As forest land is cleared and burned to make way for agricultural
and other uses, and under certain types of agricultural practices, much carbon
that was stored in plants and soils is released back into the atmosphere.
This feature of Australia's greenhouse gas profile appeared to be partly
responsible for a flurry of activity witnessed at the Sydney Futures Exchange
in the late 1990s as Australia was about to develop the world's first derivatives
market for carbon credits. Working with the State of New South Wales Forestry
Department and also closely with the forest investment divisions of global
financial institutions such as the US-based John Hancock Insurance Company,
the stage was set for the first international market in carbon futures, backed
by the trees in new and growing forests in Australia.
These carbon-based instruments were to be based on the quite controversial
provision in the Kyoto Protocol whereby "Carbon Sinks" such as certain forests
and forest management practices, can be used to accumulate credits in carbon
emissions trading programs. However, this world-first futures market collapsed
by the year 2000, mainly due to the controversial nature and uncertainties
surrounding the definition of Kyoto Forests and Carbon Sinks. It also didn’t
help matters that Australia failed to ratify the Kyoto Protocol.
7.
Back to the Dark Ages to See What the US is Up To
In the final week of July
2003, while the EU was busy putting its final touches on the world's first
international carbon emissions market, certain high profile leaders in the
US were continuing to emphasize the importance of the climate of the middle
ages and labeling the pro-Kyoto team as "environmental extremists".
Perhaps the man most enamoured with the Dark Ages, is one Senator James
Inhofe, a Republican Senator from Oklahoma. He Chairs the Environmental and
Public Works Committee. He spoke on the Senate floor on Monday, July 28th,
2003 and here is some of what he had to say:
Inhofe on Senate floor
Later he had some extra words of wisdom about this big UN Conspiracy to
share with CSPAN.
Insert: Inhofe on C-SPAN
Senator Inhofe is primarily funded by energy companies.
In his efforts to bring ocean views to his inland voters, President Bush
ignores the absolute cuts in greenhouse gases mandated by the Kyoto Protocol
and has instead produced his own definitions of what it means to cut greenhouse
emissions.
Insert: Bush on GHG
8.
The Pivotal Role of Russia
The Kyoto Protocol will
become official international law when the emissions levels of countries that
have ratified the protocol amount to at least 55% of total emissions from
the developed world. To date the countries that have ratified Kyoto including
all members of the EU, Canada and Japan account for about 44% of these total
emissions. The US would add another 36% and Russia alone would add 17%. Hence,
while the US continues to avoid the Protocol, only Russia's ratification
can bring it into effect.
Now, Kyoto targets are based on 1990 greenhouse gas emission levels, and
this benchmark year is the year before the collapse of the Soviet Union. The
subsequent economic collapse in this region has meant that, today, Russia's
emission levels are actually about 30% lower than its Kyoto targets.
By ratifying Kyoto, the Protocol would become International Law and Russia
would then be able to start making money by trading its excess emission allowances
on the new international carbon markets. Many people view this as a sufficient
incentive for Russia to ratify the protocol. However they had been counting
on US companies to be among the buyers in the markets, to help push up the
prices of these credits. And these buyers won't be there. Furthermore, it
is possible that Russia may make its ratification of the Protocol contingent
upon entry into the World Trade Organization. So some very interesting dynamics
are playing out between the US, Russia and the EU on these critical issues
over the next few months.
9.
Stuffing Your Wastes Under the Ground
If the investigations of
the warm temperatures in the Dark Ages bear no fruit, the US has at least
a Plan B and a Plan C. As the EU was announcing its implementation of the
world's first International Carbon Markets, the Bush Administration on July
25, 2003 ("Wall Street Journal") announced a new $100 million climate change
research plan. This project will deploy satellites and other technology to
primarily study natural causes of climate change, particularly the role of
clouds.
If this fails to prove that global warming is all Mother Nature's fault,
well, there is one more thing you can do without having to cut down on fossil
fuels - and that's to bury the extra greenhouse gases. A collection of countries,
led by the US and Australia, are cooperating on finding ways to sweep our
extra greenhouse gases under the proverbial rug.
You can expect to hear a lot more about this solution to global warming
in the coming months and years.
Insert: APCRC
10.
Will the US be Left Out of Emerging Financial and Energy Markets?
As the carbon markets emerge
in other countries, you can expect to see the US-based investment banks and
brokers getting involved, despite the fact that the US is not a signatory
to the Kyoto Protocol. You can also expect some rumbles from multi-national
companies based in Europe that also do a lot of business in the US. Furthermore,
the companies that have to start complying with the European rules and who
are spending money to comply, will be able to green-wash their image with
some legitimacy. This, in conjunction with growing shareholder activism on
climate change in the US may apply significant pressure for change in this
country.
It is likely that even US based companies across the financial, energy,
and other sectors will be significantly impacted by the Kyoto Protocol, even
without ratification by the US. There may also be a concern from many companies
that they are missing out on opportunities in new markets, such as the carbon
markets and new energy markets, because the US is not a party to the agreement.
Perhaps the US may end up stuck in the Dark Ages after all, if the rest
of the world moves ahead quickly without it.
That's all for Wizards of Money Part 21. Wizards of Money has a web site
at www.wizardsofmoney.org where you can get the text and references of all
episodes.