Carbon trading finds its feet again

Channels: Carbon, Corporate, Markets, People, Policy

Companies: Evolution Markets, Redshaw Advisors, Tullet Prebon, Citigroup, ETS Markets, DNV GL, Baker & McKenzie, EEX, CTX, Karbone, Ruby Canyon Engineering, ICE Futures Europe, First Environment, Vitol, EOS Climate, Koch Supply & Trade, Climate Connect, Blue Source, ICIS, Kanaka Management Services, CTX, Tuv Nord

People: Andy Ertel, Louis Redshaw, Nitin Tanwar, Martijn Wilder, Graham Stuart, Randy Lack, Rick Saines, Izzet Bensusan, Michael Coté

The winners of 2015’s carbon-related Market Rankings say it’s been a good year for trading systems worldwide, with more regulatory certainty and overall activity than last year in many markets. Sophie Robinson-Tillett reports

The carbon markets have kept up last year’s optimism, with 2015’s Market Rankings suggesting most participants are bullish – particularly about the North American and European regimes. Ruby Canyon Engineering, Element Markets and Redshaw Advisors have all hired new staff this year, or are planning to expand in 2016 on the back of expected growth in business. Evolution Markets hopes to triple the size of its London team, although this is across its entire commodities platform, not just carbon.

Prices are on the rise across many of the major markets. The exception in 2015 has proven to be China, where the price of carbon credits on most of the seven pilot markets fell throughout the year – dramatically so in the case of Beijing, Shanghai and Guangdong. 

The drop has been blamed on the expected launch of a national market, which has created “quite some uncertainty” about the future of allowances generated under the pilot programmes, according to Nitin Tanwar, CEO of Climate Connect, which was voted joint Best Advisory/Consultancy for the Chinese carbon markets in this year’s poll.

In September, Chinese president Xi Jinping confirmed that the national system – originally slated for implementation at the end of 2016 – would launch in 2017. An outline for the scheme is expected to be published next year, which Tanwar says will help stabilise the current market.

“They are unlikely to come out with firm emissions targets in the first draft, but at least it will provide clarity on the design front,” he says, adding that there is no certainty about whether the programme will be a replica of one of the pilot schemes, or an amalgamation of different elements from each.

Baker & McKenzie continued its longstanding record in the annual Rankings, winning the title of Best Law Firm in the carbon markets of China, North America, California, the EU and in Kyoto credits, as well as bagging titles for its work in renewable energy certificates.

Martijn Wilder, head of the global environmental practice at Baker & McKenzie, says China’s pilot schemes “provide significant options” for the design of the national scheme, but adds that the development of the system – including the level of trading activity – is “uncertain”. 

Box 1: Redshaw

After the market design has been agreed, Climate Connect – whose Chinese operations are carried out in partnership with Hangzhou Chaoteng Carbon Asset Management – will create a carbon price forecasting model for China, up to 2030. Tanwar expects this to take at least six months and says it will help compliance entities under the national scheme plan for the long term.

In Europe, it’s been a landmark year for the EU Emissions Trading System (ETS), with many giving a sigh of relief as the market showed signs of finding its feet again, after years of regulatory uncertainty.

“One reason things have settled down is that people are getting much more used to backloading,” explains Louis Redshaw, whose firm Redshaw Advisors was voted Best Trading Company for spot & futures, and options in the EU ETS, as well as Best Advisory/Consultancy for the EU ETS and best secondary market trading company for Kyoto credits.

Backloading refers to the mechanism introduced last year to remove surplus allowances from the ETS. This, he says, is also the reason for the “slight uptick” in price over the course of the year. January saw allowances trading at around €7.15 ($7.86), falling to a low of €6.28 in March – which Redshaw attributes in part to Spanish utility Endesa buying 25 million project-based offset credits, converting them to EU allowances and selling them into the market. But things have steadily improved since, and credits are currently trading at around 8, having peaked at 8.71 in October.

Another big change has been the European Commission’s approval in September of the Market Stability Reserve (MSR), which is now slated for 2019 – a compromise between proposals from different interested parties, which ranged between 2017 and 2021. The MSR will remove surplus allowances from the market when supply significantly exceeds demand, and inject additional allowances into the market when supply is low.

“We’ve been through a period of several years of uncertainty about how oversupply will be dealt with – and when – and that’s now being put to rest by the MSR,” says Graham Stuart, head of Baker & McKenzie’s London environmental markets practice.

“From a legal perspective the most important outcome is that people involved in the trading system now know the rules and have clarity about long-term market stability, so they can plan accordingly.”

While decisions about the MSR have restored some much-needed certainty to the EU ETS, new speculation has arisen surrounding the next phase of the system, which will be devised next year. Phase Four, which will cover the period between 2021 and 2030, will see offsets finally excluded from the EU ETS altogether – after a gradual phase-out over recent years.

“Carbon risk will get bigger for companies – especially factories – as they will have fewer choices for how they manage it,” explains Redshaw. “Historically, they’ve had more free allocation than they’ve required, or – when they haven’t – prices have been low and there has been recourse to the use of offsets.” The combination of the increase in price, the reduction in free allocations and the removal of offsets from the eligibility criteria means this is changing, he says.

A third factor contributing to these increased risks and, according to Stuart, the biggest point of debate surrounding Phase Four, is the Commission’s assessment of which companies are entitled to free allocations of carbon permits – and how many – to protect industries exposed to ‘carbon leakage’ from costs that their competitors outside Europe do not face.

“The principle of 100% free allocation for exposed industries is being markedly eroded in Phase Four, under the current proposals,” says Stuart. “There is still a headline political message that trade-exposed sectors are substantially protected and won’t be forced to shut down or move out, but the reality is looking like it’s going to be quite different.”

In North America, things are also looking up, with the election of a more climate-focused government in Canada and President Obama continuing to push his climate change strategy in the US.

“It really feels like we’re in growth mode again around greenhouse gas credits in North America,” says Randy Lack, founder of Element Markets, which was named Best Trading Company for spot & futures and Best Advisory/Consultancy in California in this year’s awards. “We really built into a crescendo in 2008-2010, but then there was a complete slowdown and we’ve ended up with these Balkanised markets.”

A key part of Obama’s vision on climate change is the Clean Power Plan (CPP), proposed last year but currently facing a slew of legal challenges from companies and states that oppose it. If it goes ahead, it will require power plants across the country to cut their carbon emissions by 30%. One way for states to achieve this – and put an end to the “Balkanised markets” Lack describes – would be to introduce or widen trading schemes.

Andy Ertel, CEO of Evolution Markets, which once again won several awards in this year’s Rankings – including Best RGGI Broker, and Best Broker for spot & futures and options in California (as well as Best Broker, options, in the EU ETS) – believes there could be up to 20 environmental markets in the US within a few years, covering different regions and products

California and the Regional Greenhouse Gas Initiative (RGGI) have been leading the way in the US, and Lack says they are likely to be adopted by other states.

“There will be individual states which may decide not to participate in trading schemes under the CPP, but if they do they will look to the California and RGGI markets as mechanisms to meet compliance,” he says.

Rick Saines, who heads up the North America climate change and environmental markets practice at Baker & McKenzie, says that RGGI, in particular, has this year sought to position itself as a viable system for wider adoption – partly by reducing the level of allowances being offered at auction by some 45%, which pushed up the clearing price to $7.50 this month from $5.21 in December 2014.

“RGGI has been beefing up the stringency of its market so that it’s not just languishing around the reserve price every auction,” he says. “As it previously existed, RGGI wouldn’t have satisfied the [CPP] targets, because the level of over-allocation of credits meant there was no real restriction on emissions. Reducing them by nearly half positions RGGI as a more robust environmental mechanism.”

Indeed, Evolution’s Ertel says RGGI, which was launched in 2009, is “beginning to feel like a proper market now”, with volumes and prices up in 2015. “The margins are thin for the traders, but the overall trend is good,” he adds.

Izzet Bensusan, CEO of Karbone Group, which retained the title of Best Advisory/Consultancy for North America, agrees with Ertel, saying RGGI volumes are up, partly because participants are taking the market more seriously.

“More and more people are seeing that RGGI is here to stay, and so it’s better to invest when credits are less expensive than when it becomes mandatory,” he explains.

Element’s Lack says that, as more states join up to RGGI under the CPP, he expects linkage to develop between RGGI and California – which has also had a good year – and, over the long-term, the two could become a single programme.

Ertel says Evolution’s business in the Californian carbon markets in 2015 “has been a multiple of previous years”, with particularly strong growth in the offset market – although allowances continue to make up the lion’s share of the company’s work.

“Offsets are the more lucrative side of the business because they’re more sophisticated so there’s a lot more work that needs to be done on those transactions,” he explains.

Lack says the Californian market, overall, has been “relatively flat” in 2015 but, like Ertel, he’s noticed greater offset activity, which he claims is driven chiefly by an increase in participants using them for compliance – which they are entitled to do for up to 8% of their requirements.

“This is an important change this year, and has taken time to evolve, but compliance buyers are starting to understand offsets and take advantage of their lower prices,” he explains, adding that this signifies “a maturation of the market”.

The general consensus among the winners of this year’s rankings is that this is just one sign of California’s trading system settling down.

“There are relatively few major compliance entities in the state,” says Saines, referring to fuel producers, importers and big utilities. “They’ve dominated market demand. That’s beginning to change now – we’re definitely seeing more interest in the market from a wider group of participants, and that’s because it’s persisted. People feel it’s here to stay.”

That change in sentiment has fuelled another trend too, according to Lack, who says that, historically, many clients have considered the Californian compliance market on a year-by-year basis. “They are now starting to look out along the curve and plan for 2020,” he says, adding that lots of companies are beginning to price it into their business model and consider hedges.

Ertel has witnessed the same thing, and claims that 2015 has seen the market “take a really healthy step forward”, with “people beginning to look at it as traders, for the first time”.

“This year was the first year when compliance entities really started to factor the system into their hedging,” he says. “Where it really starts ramping up is over the next couple of years, when they start realising they could be really short. In 2016 we’ll see more participants and better hedging, which will create more liquidity for everyone,” he predicts.

There are still signs of the market’s infancy, though, including uncertainty brought about by longstanding legal challenges by California’s Chamber of Commerce and others against the system’s operator, the Air Resources Board (ARB), about the proceeds it receives from the auctions. These are currently being appealed but they create a degree of uncertainty for participants about the future of the market – and any revision of the system would, “have a disruptive effect for a certain period,” Saines says. 

Box 2: Redshaw Advisors

There has also been volatility in the offset market, with the ARB approving some new project categories but curbing the use of others. For example, this year has seen landfill-site verifications continue to decline, following California’s decision a few years ago not to include them under the ARB compliance rules.

To offset this, Ruby Canyon Engineering, which held on to its title of Best Verification Company in the North American markets, is moving into new sectors such as forestry. It completed one forestry project in 2014, but was approved this year as a forestry verifier by The American National Standards Institute, and completed six more projects.

Company president Michael Coté says he expects this to grow further in 2016, following ARB’s changes to California’s forestry protocol in October. “About 60 new forestry projects were listed with ARB right before the changes took place, so there could be a little bubble of forestry verifications next year; and we’re well poised for that.”

As in 2014, the Californian compliance market has driven most of Ruby Canyon’s workload this year. Coté is also excited about the incipient market in Ontario, which was announced in April and is expected to come into force in January 2017, linking with Quebec and California.

“We see really good opportunity there,” he says, adding that he is also hopeful that Canada may develop a national scheme under its recently-elected government, which plans to focus more on climate issues than its predecessor.

Baker & McKenzie’s Saines agrees that Canada is in a state of “rapid political change” when it comes to climate change.

“You’re starting to see it manifest itself in Ontario and Alberta [which announced plans this summer to double its carbon price within two years] but also at a federal level now, and I think that’s going to lead to some really interesting opportunities in Canada, whether it’s a national scheme or more provinces adopting programmes and linking with the US.

“The market will start looking at that and working out how it will impact the supply/ demand equation – not only nationally but in terms of its effects on the US offset market if Canada decides to pulloffsets from there, ” he explains. 

The Kyoto markets are stil troubled, however.

"Since Canada, Japan and Australia are not buying certified emission reductions (CERs), as of today, the  EU ETS is the only hope," says K Sudheendra, director and head of operations at EPIC Sustainability Services of Bangalore, again voted Best Verification Company for Kyoto Project Credits in this year’s poll.

However, he says there is currently  no real demand from the EU ETS, as the market continues to have an oversupply of allowances.

Having said that, he remains optimistic. He works with projects that have emission reduction purchase agreements in place, and he believes Africa and other emerging markets have the potential for many projects if CER prices rise.

Forestry is another potential growth sector. 

 "The mood is positive but cautious," he concludes. "We are hopeful that 2016 will be better than 2015." EF

For all the results from Environmental Finance's Annual Market Rankings, see Ready for take-off