Climate exchange faces major challenges

24 October 2007

Worldwide market so far is a mix of mandatory and voluntary efforts

The Montreal Exchange is the subject of much discussion about a possible merger with the TSX Group.
The issue is whether the two exchanges would be better off combining their trading activities, given the global consolidation now underway in the exchange business.
But while the ME decides whether or not to go it alone, it faces a more immediate challenge: getting its climate exchange up and running.
The ME is making a substantial bet on its climate exchange platform, and is now seeking the necessary regulatory approvals.
In partnership with the Chicago Climate Exchange, the ME plans to offer electronic trading for carbon futures contracts, based on underlying credits for greenhouse gas reductions.
Participation would be voluntary, but those who join will be bound by rules. Companies that have invested to reduce their carbon footprint could then sell their credits to others.
Based on a cap-and-trade system, the idea is to give corporations a financial incentive to act.
But there are many questions hanging over the project. Much will depend on what kind of emission reduction targets, if any, are established by the federal government.
The irony here is that the Harper government is walking away from the Kyoto Accord at just the time the ME is launching its venture.
Even so, the exchange insists it’s confident that the government and emitters can agree on a standard for trading credits.
The jury is still out on how efficient the global carbon-trading market can become, says Axel Perron, an analyst at the Boston-based consulting firm Celent.
“We’re far from having a harmonized market on the types of instruments that are traded worldwide,” Perron said in an interview yesterday.
Most trading schemes are based on a system that assigns quotas to players and permits allowances and credits to be exchanged.
But the worldwide market so far is a mix of mandatory and voluntary efforts.
Regulations sometimes establish countrywide emission reduction targets and in other cases target specific industries.
“This situation creates a lot of confusion” about what kind of contracts can be traded, how to value them and who can play, he notes.
As well, there’s great uncertainty over what will come after the Kyoto Protocol, which expires in 2012.
“Many potential participants are still wondering whether to get involved in a market that could eventually change its form or even disappear,” Perron observes.
Despite all that, there’s still considerable potential in emissions trading, which so far is largely concentrated in Europe.
Trading value jumped from less than 9 billion euros in 2005 to 23 billion euros last year. By 2012, it’s expected to reach the 40-billion-euro mark.
Much of the trading is done over the counter, although the European Climate Exchange handles about 400 transactions a day.
The market, however, is concentrated among a few leading players and has a lack of both transparency and liquidity.
These factors “do not play in favour of electronic trading at this time,” the Celent study warns.
Traders are hampered by a lack of reliable information on current emission levels and quotas.
“Trading in the carbon market today is like trading in the equity market without research and company annual reports,” Perron warns.
And that makes it highly risky, particularly for speculators.
As well, the price of carbon in Canada can be affected by a host of factors. If there’s a lot of surplus quota available in Russia, that will depress the price of quota here.
The future cost of energy sources is also a wild card.
Perron says banks and financial institutions have shown some interest in carbon futures trading, “but they’re being very cautious.”
And they’ve done a poor job of explaining the potential benefits to corporate clients.
The ME’s partner, the Chicago Climate Exchange, began with a grant in 2000 from the Joyce Foundation, a philanthropic organization specializing in public policy.
Trading volume on the CCX has been soaring since its launch, but so far it represents only about two per cent of the volume traded in Europe.
One thing seems clear, Perron says: It’s too soon to tell whether the carbon-trading market can succeed.
phadekel@videotron.ca