The Ups and Downs of a Global Carbon Market

A single global price for carbon emissions is not likely for another 10 to 15 years because governments are dragging their heels on legislation and there are still many hurdles to jump. The European Union's executive Commission hopes to have a global carbon market in which emissions trading schemes are linked by 2020. It wants to see national schemes in all OECD countries by 2013 and for those to be linked by 2015. 

However, the recent meltdown of the carbon market in Europe has  highlighted the inherent instability in the system and also hampered green investment, because as long as the price of carbon remains low, industry will remain shortsighted, and not invest the necessary resources over the medium to long -term.  

Meanwhile the U.S. cap-and-trade bill is being negotiated with carbon permit auctions by the government expected to start from 2013.  In his latest budget proposals, U.S. President Barack Obama expects to generate some $646 billion in revenues from these auctions between 2013 and 2020.  Obama's plans have so far had no major impact on carbon trading in Europe, but in the long term it is highly probable these two markets will join up creating a vast pool of liquidity.   

Price expectations under a U.S. scheme are fundamentally different to what you expect for the EU. European prices will likely be higher, so if the schemes were linked by 2015, that would mean a one-way flow of (carbon permits) from the U.S. to Europe. 

Some believe this will create the largest derivatives market in the word, as it is projected that the market could read $1 trillion in trades annually by 2020, according to New Carbon Finance, a London research firm.  Proper regulation of a U.S. carbon market is particularly important given what’s happened in financial markets over the last year. 

Wall Street banks, hedge funds and institutional investors are under a rain of public indignation and regulatory scrutiny for their role in the current financial crisis. Many legislators are concerned that creating a carbon market may simply give the same players a new opportunity for manipulation and hazardous trading.

At the same time, those institutional investors argue their activities help to provide liquidity to the market - enough trading activity that helps both to define a price and give buyers and sellers of emission allowances multiple participants with whom to trade.

Just as sketchy home mortgages set the stage for the subprime mess in U.S. banking markets, sketchy environmental initiatives threaten to create a “subprime carbon” mess, environmental group Friends of the Earth warned last Thursday.  A cap-and-trade plan would create a huge new market in emissions permits at a time when Wall Street and Washington have their hands full figuring out how to police existing markets. One key element in all the climate proposals floated so far is the use of “offsets,” or the ability to purchase emissions reductions made somewhere else, which Friends of the Earth call in a new report, “Subprime Carbon”.

Strict fool-proof regulation will be essential to ensure derivatives do not ruin the carbon market as they have others. 

Best Foot Forward

The battle rages on as the recession takes its bite, causing environmental projects to suffer, while others seek to change the footing of the world economy, away from its high consumption of fossil fuels to a low carbon basis:

• The massive injection of cash worldwide by governments to resolve the financial crisis is being compared to the 'New Deal', Franklin D Roosevelt's program in the 1930's to lift the US out of Depression.  In total the economic stimulus packages amount to more than $2,800bn.  Nick Robins, co-author of Sustainable Investing: The Art of Long Term Performance, and head of HSCB's Climate Change Centre for Excellence, says the world stands to devote $430bn for the 'Green New Deal', or about 15% of the $2,800bn stimulus to green measures. China is devoting about a third, US 10-12% and the UK only 7%, and Japan only 2.6%.   

• Ceres scored a huge victory yesterday, as after two years of intense advocacy, they have willed insurance regulators to approve a mandatory groundbreaking requirement ordering insurance companies to disclose to regulators and investors the financial risks they face from climate change, as well as actions the companies are taking to respond to those risks.It is the world’s first mandatory climate risk disclosure requirement — and it covers the largest global industry. Worldwide, insurers manage $16 trillion in assets...MORE

• European Union leaders meet tomorrow for their annual spring council meeting, and senior climate change official, Yvo de Boer has said he fears that the EU is backsliding on it promises an rewriting an agreement made in 2007 in Bali.  Poor countries will not commit to a new treaty at the UN meeting in Copenhagen this December, unless they have assurances from the developed countries that the necessary financing mechanisms will be detailed in the treaty to help fund the cuts in greenhouse gas emissions

• New Energy Finance, said investment in clean energy last year reached $155bn, about 4.4 per cent high than in 2007.  However, in the first half of last there was strong growth, but the second half this dropped off significantly, with asset finance for clean energy down 25 per cent on its peak level.  NEF forecast that this year will be flat, with about $150bn investment in the sector.

UK Working Towards Global Low Carbon Economy

The global low-carbon and environmental sector was worth £3 trillion ($4.1 trillion) last year, according to research commissioned by the UK government.  The UK government also believes the value of the global low carbon energy sector alone could be as high as $3 trillion a year by 2050, employing more than 25 million people.

Currently, the UK is the sixth-largest economy for low-carbon and environmental goods and services (LCEGS), such as renewable energy, nuclear power and recycling, analysts Innovas found, in market research carried out for the country’s Department for Business, Enterprise and Regulatory Reform.

The sector’s turnover was £107 billion in the UK in 2007/8, midway between the size of the country’s healthcare and construction sectors, and was responsible for 880,000 jobs. Innovas predicts it will grow by another £45 billion in the next decade. The total UK economy was worth £1,600 billion in 2007/8.

The report breaks down the LCEGS sector into three parts: traditional environmental services, such as recycling, and water and waste management; renewables, such as wind, hydropower and biomass; and ‘emerging low carbon’, including nuclear power, carbon finance and building technologies.

Worldwide, Innovas found that low-carbon businesses account for nearly half of the market value of the LCEGS sector, or £1,449 billion. Renewable energy accounts for another 31%, or £940 billion, with traditional environmental activities making up the final 21%, or £657 billion.

The transition to a low carbon world will transform our whole economy. Lord Stern’s landmark Review in 2006 set out the economic case for action on climate change and for investment in a low carbon economy. Recognising that economic necessity, the UK has through the Climate Change Act become the first country in the world to adopt a legally binding target to reduce carbon emissions – by at least 26% by 2020 and by 80% by 2050.

Speaking at the launch of the governments proposed Low-Carbon Business Strategy, UK Business Secretary Peter Mandelson said: “Low carbon is not a sector of our economy, it is, or will be, our whole economy, and a global market.”

The Future of Capitalism?

U.N. Secretary General Ban Ki-moon will meet with U.S. President Barack Obama Tomorrow. President Barack Obama's determination to reverse Bush administration policy on combating climate change will hopefully help produce a global agreement this year in Copenhagen. 

The U.S. didn’t ratify the only international climate change treaty, the Kyoto Protocol, whose provisions expire in 2012. The UN is seeking to broker a new accord in December in Copenhagen that draws all nations into the effort.  Eyes from every nation will be watching to see the U.S. stance on this topic and whether Obama will accept the invitation from Bank Ki-moon to attend a proposed mini-summit at the UN this spring.

Now that the green stimulus's have been rolled out, a closer look reveals that the packages of tax cuts, credits and extra spending that have been trumpeted for their environmental credentials by the governments proposing them, show that green spending account for only a small part of the bigger initiatives.

Much of the spending will go to projects that will, in fact, increase emissions, such as new roads or fossil fuel power stations, while too little money will be devoted to low-carbon projects to make a real difference, experts believe.

Lord Nicholas Stern, the former World Bank chief economist who wrote the landmark study that found the cost of tackling climate change would be far less than the costs of unchecked global warming, has led calls for green measures to be at the heart of global stimulus measures.  

He said: “It is vital that these investments do not lock us for many more decades into an unsustainable high-carbon economy. Investing in low-carbon technologies would improve the world’s economic prospects for the long term, he said. “If we are going to make this expansion, let’s look at what is going to be the growth story of the future. Low-carbon growth is going to be the only growth story of the future.”

Lord Stern calculates that governments need to spend $400bn on green measures to achieve the emissions cuts required and to help the global economy recover.  Only if spending was concentrated on low-carbon technologies would the world escape the prospect of raising emissions for years to come, and “thus having to spend much more in the future to bring them back down to safe levels”, Lord Stern said.  

What is clear is that market capitalism has arrived at a critical juncture. Even beyond the bailouts and volatility, the challenges of the climate crisis, water scarcity, income disparity, extreme poverty and disease must command our urgent attention.  Economic theory derived from the industrial revolution that does not factor in externalities and the true cost of natural resources must be changed.  Sustainable development will be the primary driver of economic and industrial change over the next 25 years.  

As Al Gore has put it, "the market is long on short and short on long. Short-termism results in poor investment and asset allocation decisions, with disastrous effects on our economy."

Today in the FT, Martin Wolf began a series on the Future of Capitalism with an article titled 'Seeds of its Own Destruction'.   He concludes that the era of financial liberalization is over, yet unlike the 1930's no credible alternative to the market economy exists and the habits of international co-operation are deep.  "I've a feeling we're not in Kansas any more," said Dorothy after a tornado dropped her, her house and dog in the land of Oz.  The world of the past three decades has gone.  Where we end up, after this financial tornado, is for us to seek to determine.

Pavan Sukhdev, a senior banker from Deutsche Bank who has worked on green ideas with the UN, said: “Investments will soon be pouring back into the global economy. The question is whether they go into the old, extractive, short-term economy of yesterday or a new green economy.”

We need sustainable capitalism, and all nations must work together to ensure green shoots of recovery.

 

Which Country has the Greenest Bailout?

After all my discussion regarding greening the stimulus packages it is comforting to see that countries have responded, but many are still lacking behind and the percentage allocation to green stimulus could still be significantly larger. Here is a excellent interactive graphic by the FT analyzing the green portion of economic stimulus's in various countries along with a breakdown of the sector allocations.  

Dawn of a New Era for Institutional Investors

The World faces it last chance to prevent fatal warming as 190 countries will meet in Copenhagen in December to try to agree to a global framework to replace the Kyoto Protocol on fighting global warming, which expires in 2012.  "It is now 12 years since Kyoto was created. This makes Copenhagen the world's last chance to stop climate change before it passes the point of no return," European Union Environment Commissioner Stavros Dimas told a climate conference in Budapest on Friday. 

Meanwhile, college endowments are rethinking the aggressive strategies they adopted after chasing the impressive performance of the Yale endowment which has had a 17.8 percent average annual return over the last decade. Endowments have suffered, and for the year ending September 30, endowments and foundations were down on average 13.2 per cent compared with average public and corporate pensions, which were down 14.8 per cent and 15.5 per cent respectively, says Northern Trust.  Considerable losses have most likely ensued since then, and this has caused endowments and pensions to rethink the structure of their asset allocation.  Endowments in the US are often the first to incorporate new strategies and asset classes in their portfolios.  Speaking at a recent conference in New York, Donald Lindsey, CIO of George Washington University says, "Rather than think about asset allocation, think about a macro view of the world.  What are the major forces that are going to have a significant impact and really change the world in the next 10 years?  Are there investable themes that can be capitalized on?"  Core to an endowments investment policy is stewardship, the necessity to maintain purchasing power of invested principal for future generations, while meeting the liabilities of current generations.  

Institutional investors behaviour must change in the months and years to come to better match the fact that their long-term horizons for liabilities and investments and diversified portfolios give them a direct and genuine fiduciary interest in the long term economic health and well-being of the world.  Now is the opportune time for institutional investors to capitalize on the sustainable themes that will be crucial to ensure long-term economic growth.  Institutional investors, including pension funds, should accept some degree of responsibility for the investment practices which have cause the global economic crisis, the UN Principles for Responsible Investment (UNPRI) Initiative has said. The body, which has over 500 members, said institutional investors should admit they made ‘mistakes’ in the run up to the crisis – but should work together in order to improve risk management and responsible investment practices in the future.  California Public Employees' Retirement System (CalPERS) chief executive and UNPRI board member Anne Stausboll said: “CalPERS believes integrating responsible investing with our asset management is part of our fiduciary responsibility. 

I urge all institutional investors to become signatories of the UN PRI and to attend the following event put on by the CFA Society of the UK Energy and Sustainable Investing Group who I have been working in collaboration with:  

The New Era in Pension Fund Investing 

Experiences from CalPERS

Date: Tuesday 24 March 2009 Venue: FTSE, Canary Wharf, London Russell Read - Founder, C Change Investments

Russell Read, founder of C Change Investments and former CIO of CalPERS will give you invaluable investment lessons based on his experiences as chief investment officer at Calpers, the largest public pension fund in the US and a recognised global leader in the investment industry.

Russell’s lecture will cover the following key issues:

• New tools/approaches needed for asset allocation and risk management— influence of private markets
• Growth versus value inflection point — re-emergence of energy and materials
• New centrality of emerging market investments
• Divergence of public pension funds from private pensions, insurance companies, & foundations/endowments
• Value-added, principled ESG investing

Sign up to attend.