Carbon Trading – Synergy Between Environmental & Economic Goals

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Many companies have taken lead in corporate governance, social and environmental responsibility. Self-motivation of these companies is highly commendable. But the proportion of such companies is still very less. I always wonder as to how an organisation can be motivated to invest in society and the environment. How can an organization convince its stakeholders about its investments if they do not make any economic sense?

After the corporate greed and fall of organizations such as Enron, World Com, Tyco and others, companies have realized the importance of corporate governance for long term survival. The importance of ethical behaviour has been realized by companies due to its benefits such as respect in society and increase in brand recognition, which translates to increased sales in the long run. We have many examples of products being recalled from the market by companies for even minor defects. These actions have improved the perceived value of the brand in long standing. But still larger issues like society and environment still fail to get an organization’s attention as there is no visible effect of these issues on its bottom line or survival. In this regard, I consider carbon trading a path breaking measure which gives incentives to organizations to contribute towards environmental protection. Recently, there has been much activity in ‘Carbon Trading’ with increase in trading volumes, opening up of new exchanges and the advent of new tradable, fungible instruments. In India, many Indian villages and Indian corporate companies have jumped on the bandwagon and are selling carbon credits.

What is ‘Carbon Trading’? For readers who are new to this term, the word ‘carbon’ in carbon trading symbolizes carbon dioxide, the most widely produced greenhouse gas. The emissions of other greenhouse gases can be recorded and counted in terms of carbon dioxide equivalents. The genesis of the carbon credits can be traced back to the Kyoto Protocol of 1997, by which all countries were required to reduce their greenhouse gas emissions by 5% (from 1990 levels) by the end of 2012, or pay a price to those that do. Nations that have contributed most towards global warming have tended to benefit directly from greater business profits and higher standards of living. On the other hand, the negative effects of global warming are felt all over the world. The idea of the protocol was to make developed countries pay for emissions and monetarily reward those countries which followed good environmental behavior. Developing countries start with clean technologies and are rewarded by those which continue with the polluting ones. This is popularly known as the ‘Cap and Trade’ approach.

The rules and mechanisms of the working of ‘Cap and Trade’ approach were not worked out until the Marrakesh Accords in 2001. Three flexible mechanisms were established to allow polluting entities (covering sectors like power generation, steel, glass, cement, ceramics and paper) to acquire rights to pollute beyond their assigned limits/caps. These mechanisms are Clean Development Mechanism (CDM), Joint Implementation (JI) and Emissions trading. CDM and JI are environmental projects which reduce greenhouse gas emissions and hence generate carbon credits. These carbon credits then can be bought by an entity whose pollution goes beyond the emissions cap. The polluting entities are given specific Pollution Allowances (i.e. rights to pollute, like the EUA – European Union Allowances). These Allowances can be traded under Emissions Trading.

Any polluting entity exceeding the cap can take one of three steps.

» The first option is payment of a tax at the end of the compliance period, which is generally very high.

» The second option is to buy Pollution Allowances (like EUA) from an entity under Emissions Trading, which has polluted less than its quota.

» And the third option to buy carbon credits from CDM or JI projects. Carbon credits generated by CDM/JI and Pollution Allowances constitute the carbon market of today.

The major buyers of carbon credits have been Europe and Japan. The Pollution Allowance based markets are the European Union Emissions Trading Scheme (EU ETS), New South Wales Greenhouse Gas Abatement Scheme, Chicago Climate Exchange (CCX) and United Kingdom Emission Trading Scheme (UK ETS). In 2006-07, the carbon market has grown by leaps and bounds. Out of these, the EU ETS is the largest carbon market by far and fully compliant with the Kyoto Protocol. According to the World Bank, the carbon market grew to 30 billion dollars in 2006. The market for carbon credits, including CDM and JI, in 2006 was worth 146.2 million dollars, three times that of 2005. The transactions during the first three months of 2007 crossed the total transactions of 2006. This clearly indicates that carbon trading is here to stay. But like any other innovative approaches it had its starting problems. The European Union has been too far generous in its allocation of allowances. As a result there was great volatility in prices at EU ETS. Also, the allowances from Phase I (Jan 05 to Dec 07) were not allowed to carry forward to Phase II (Jan 08 to Dec 10). These led to a market slump. Taking Phase I as a learning experience, the caps in Phase 2 of EU ETS are going to be tightened. Marketing continuity and banking of carbon credits will also be brought in.

Even though Carbon Trading is a step in the right direction, it cannot be considered the ultimate panacea to environmental problems. The enormity of climate change will require a profound transformation in the way industries function for bringing about a cleaner environment. These include making public and private investments in research and development of cleaner technologies and diffusion, economical and fiscal policy changes to promote environment protection and the removal of distorting subsidies for high carbon fuels and technologies. In essence, devising a workable popular market mechanism does not absolve the policy makers from their responsibility to the environment and society.

Carbon trading has influenced me in two major ways. Firstly, it symbolizes a remarkable, path breaking and innovative market-based approach to counter global warming, a radical departure from traditional means like direct tax and regulation. It is a classic example of human ingenuity. Based on the 2005 emissions data, CO2 emissions reduced by 50 – 200 Metric tones in 2005. In 2006 alone, 493 Metric tones of CO2 emission were prevented or destroyed by the way of environmental projects under CDM/JI. With further refinement in policies, carbon trading is likely to become more potent in future. Such out of the box, paradigm changing solutions inspire me to break away from traditional methods and look for new innovative approaches to problems. Secondly, I am excited by the promise that Carbon Trading holds for developing countries.

India, being a developing country, is a signatory of the Kyoto Protocol as a Non Annex I country. Only Annex I countries are required to limit and reduce emissions. It implies that there is no cap for India yet, and India can host environmental projects and sell carbon credits to Annex I countries for their compliance. GFL & SRF are two Indian companies which have sold carbon credits worth 87 million dollars and 37 million dollars respectively in 2006. This sale has contributed to their profits handsomely and all they did was to install an incinerator to destroy the pollutant HFC23 (their industry waste). Carbon trading makes an otherwise average business opportunity, significantly more lucrative. Many environmental projects considered not worth taking up by traditional business thought, are now being pursued, thanks to carbon trading. India also receives funding for such projects. The World Bank has recently earmarked 10 million dollars for the India Infrastructure Development Finance Company to fund ‘clean’ projects, which gives an extra stimulus towards the development of environmental projects, which otherwise would not have been taken up in normal course. With India developing at the rate of 8% annually, this is the right time for infusion of clean technologies because a developed India in the future will be based on clean technologies, unlike countries today which are stuck with polluting technologies.

The best part is the role of rural India in the emerging Carbon Trading market. The first time was in 2004, when a village in India name ‘Powerguda’ sold carbon credits worth 645 dollars to the World Bank. These carbon credits came from CO2 saved by Bio Diesel (pioneered in India) which was extracted from 4500 Pongamia trees. Bio diesel does not pollute the air at all as compared to petrol. Since then many villages have started following this trend. In India 75% of the population lives in villages and it is indeed very heartening to note that carbon credit trading has opened the door for the development of Indian villages.

Carbon trading is here to stay and promises a clean and healthy environment for our progeny and posterity. The example of the synergy created between environmental goals and economic goals by carbon trading is worth emulating in other areas like social welfare, organization culture etc. The only requirement is to devise a breakthrough mechanism to integrate seemingly opposite goals.

Ashutosh Agrawal