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Carbon trades fuel City boom
London is establishing itself as the centre of a rapidly growing new market
Jonathan Leake
You can’t see it or smell it and it’s hard even to measure it, but buying and selling carbon dioxide – or the right to emit it – is making the fortunes of a new generation of City traders.

In London, the scale of trading and employment in this new commodity only recently became clear. The carbon trading teams have mostly sprung up quietly within existing banks, hedge funds and other financial institutions. The impact became clear, however, when the trade held its annual beano, Carbon Expo 2007, in May.

“Five years ago London’s carbon trading community would have fitted into a Starbucks,” said Anthony Hobley, chair of London Climate Change Services, the trade association for firms involved in carbon markets, as he surveyed the 4,000 or so bankers, lawyers, traders and others thronging the hall in Cologne. “Now carbon trading is maturing into seriously big business.”

Flogging greenhouse gases, or rather the right to emit them, seems an odd business to the uninitiated. The principle underlying it is called cap and trade. Governments first cap the overall national emissions of greenhouse gases and then grant permits to polluters, such as power companies, to emit limited amounts of them. The trick is to set these limits slightly below what the firm is emitting so that if it wants to emit more than its allocation it has to buy extra permits.

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This creates an incentive to introduce efficiency measures. If a firm subsequently emits less than its permits allow, then it can sell the spare ones. The traders are the middlemen, buying carbon credits from firms with allocations to spare and selling them to those with a deficit.

A second approach to saving the climate involves setting up projects to cut emissions in developing countries. These include schemes in China that capture emissions from landfill sites or trap the greenhouse gases emitted by air-conditioning manufacturers. Western firms can pay for the relevant technology to be installed and then claim credits for the carbon emissions their investment has prevented.

These credits can be used to “offset” the excess emissions generated in their home countries. The bonus is that it is generally much cheaper to cut emissions in developing countries than in Europe. Again, the carbon traders buy and sell the resulting credits.

The rules for selling these “emissions rights” are enshrined in the Kyoto treaty and the European emissions trading scheme (ETS), whose very complexity has benefited the City, one of the few places in the world with the infrastructure and skills for dealing in such obscure financial instruments. Hobley, who heads the carbon finance team at Norton Rose solicitors, believes London is well placed to become the centre of the global carbon trade.

“Five years ago this business hardly existed but by early 2006 there was £6 billion of capital in the carbon funds and by April 2007 it was up to £12 billion. About 75% of carbon trading goes through London. So far the Kyoto treaty and the ETS have aimed to cut global emissions by 3%. In the long term we have to cut carbon emissions by 20 times that – so this market is going to grow and grow.”

A consequence of this growth is a shortage of people with the skills and experience to run carbon investment funds or manage emissions reduction projects – and that means surging salaries. Claire Skinner, director of Ruston WHEB, a London recruitment consultancy specialising in the carbon trading and management communities, says such shortages mean recruitment packages worth more than £500,000 are becoming standard for top jobs.

“We have been in this market seven years and I have never seen it grow so fast. The demand has nearly tripled in the past 12 months. It’s being driven by money pouring in from investors who see this as a sector that can only grow as governments try to deal with climate change. There is a serious shortage of people, from fund managers to technical experts, who can deliver the carbon capture projects that will reduce emissions.”

Such competition recently saw one carbon fund manager being offered four jobs, each with a $1m remuneration package, within a week of Ruston WHEB sending out his CV.

That growth is reflected at other levels. Climate Care is a firm specialising in offering carbon offsets for the so-called “voluntary market”. This caters for people and businesses who are not covered by the ETS but still want to make their lives or businesses carbon neutral. They can do so by paying for schemes that cut carbon emissions elsewhere in the world, for example by replacing wood stoves with cleaner ones that burn kerosene in central Africa.

Climate Care’s recent recruits show the diversity of people needed. Elizabeth Harris, 28, took a degree in geography and worked as a manager with Citibank. After an MSc in environmental technology from Imperial College London, she last year joined the company, where her job is to find new carbon reduction projects. “The carbon markets are going to play a critical role in tackling climate change,” she says. “It’s an exciting time.”

Other arrivals include Robert Stevens, 35, a former Lufthansa sales manager now promoting offsets to the travel industry, and Edward Hanrahan, 35, the chief operating officer, whose background is starting online travel companies promoting cheap aviation. He recognises the irony in his move from encouraging aviation to trying to mitigate the damage it causes, but says: “While I have been involved in start-ups in the travel industry for more than 12 years, the environment has been my passion for much of that time.”

Voluntary carbon offset firms such as Climate Care are growing fast but the big money is still being channelled into private equity and hedge funds. Some experts predict that if such growth is maintained, greenhouse gas emissions may become the world’s largest commodity market. A study published in April by New Carbon Finance, which analyses the carbon markets, said: “The UK has emerged as the clear leader in carbon fund management, with 72% of private carbon funds and 50% of all carbon funds being managed out of London.”

However, Liz Bossley of the Consilience Energy Advisory Group, a consultant on the carbon business, has warned that although the City may benefit from carbon trading, the rest of Britain could lose out. This is because making British manufacturers pay to emit greenhouse gases creates an incentive for them to move to countries not covered by the Kyoto agreement or ETS. It also gives foreign firms a competitive advantage.

“The expansion of the emissions industry and the application of greenhouse gas constraints will lead to a redistribution of wealth and manufacturing jobs worldwide,” she said. “Britain is at the forefront of confronting climate change and must prepare for the adverse national consequences of success, particularly the loss of jobs in manufacturing.”

Perhaps the biggest question is whether all this frantic trading will actually achieve any genuine reductions in global carbon emissions, now standing at about 27 billion tonnes a year. Some think not.

“Carbon trading schemes allow us to sidestep the most effective response to climate change that we can take, which is to leave fossil fuels in the ground,” says Kevin Smith, a researcher with the pressure group Carbon Trade Watch. “Market-based mechanisms such as carbon trading are an elaborate form of creative accountancy. What incentive is there to start making these costly, long-term changes when you can simply purchase cheaper, short-term carbon credits?”

The Netherlands Environmental Assessment Agency (MNP) announced this week that according to preliminary estimates for 2006 China topped the list of CO2 emitting countries, surpassing the USA by an estimated 8%. To evaluate the implications of these rising emissions in China and other countries in the context of the climate policy issue, other aspects must be taken into account, such as economic development, per capita emissions, historical contribution to the current global warming and the fact that China manufactures many goods for export.

he following aspects are key for a balanced comparison between countries:

- Accounting for the size of countries: emissions per capita or per US$ of GDP
- Manufacturing of goods for export to industrialised countries
- Other country-specific circumstances.

Country size matters: emissions per capita or per US$ of GDP
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Obviously, countries with larger population and larger economies will use more energy and thus emit more CO2. Therefore it is not surprising that large countries or regions such as the USA, China, the European Union, India and Russia are in the top-5 of CO2 emitters. In country inter-comparisons and in policy discussions often emissions per capita or emissions per unit of Gross Domestic Product are used. It is also generally acknowledged that industrialised countries emit more CO2 per head than developing countries and have emitted more CO2 and other greenhouse gases in the past.
In the Summary for Policy Makers of the IPCC’s Fourth Assessment report of Working Group III released in May 2007, this is illustrated in Figures 3a and 3b (reproduced below). Average greenhouse gas emissions (total, including non-CO2 gases) for all developing countries are currently about 4.2 ton CO2-eq. per head versus 16.1 ton CO2-eq. per head for industrialised countries. Emissions expressed per unit of GDP show the opposite pattern: about 1.1 vs. 0.7 kg CO2-eq. per US$(PPP) of GDP (on a purchasing power parity basis). A comparison between China, European Union (15) and USA shows that per capita CO2 emissions are presently roughly about 5, 10 and 20 ton CO2/cap, respectively.

Manufacturing of goods for export to industrialised countries
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Another element in the comparison of emissions between countries is that in newly industrialised developing countries such as China, Malaysia, Mexico and South Korea, a large fraction of the goods produced by the manufacturing industry is subsequently exported, particularly to high-income industrialised countries: a substantial part of China's emissions growth is being driven by consumers in industrialised countries buying Chinese goods. This means that the fast increase of these countries’ emissions is partly due to their increasing share in the global production of goods for the global market. Although we have not seen recent studies that are conclusive on the fraction of national greenhouse gas emissions directly related to these exported goods it is clear that for countries like China this is not an insignificant part of their national emissions. It should be mentioned though that the accounting used for the UN Framework Convention on Climate Change (UNFCCC) does not take account of these so-called “embedded emissions” in exported goods.

Other country-specific circumstances
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Differences in other country-specific circumstances can also be relevant to emission reduction potentials, e.g. differences in climate; geographical structure; economic structure, notably of the manufacturing industry; fuel mix of thetotal primary energy supply and particularlyin the power generation sector.

Global emission reductions required and technically feasible to limit global climate change
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The Fourth IPCC Assessment report of Working Group III also indicates that in order to limit climate change to a global mean temperature increase in 2100 of a few degrees C, global greenhouse gas emissions growth needs to stop within the next 10-25 years, followed by a sharp decline. Emission scenarios show that emission reductions in industrialised countries alone are not sufficient to achieve this. However, the IPCC report also shows that in all countries a portfolio of greenhouse gas reduction options is available, e.g. energy conservation and energy efficiency improvement, the use of more renewable energy or nuclear power, recovery and abatement of methane and nitrous oxide emissions of various sources, sequestration of carbon in forests and soils and carbon capture and storage (CCS), etc. Tapping the potential in developing countries is therefore needed, although this does not prejudge who should pay for this.

More information on “common but differentiated responsibilities” in mitigating climate change
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In international discussions and negotiations on climate change mitigation the equitable sharing of efforts on emission reductions and related international cooperation between developed and developing countries are key issues. MNP has supported this process by publishing studies on different options for such equitable sharing of global emission reductions, taking into account various national circumstances, such as income levels, capacity to mitigate and contribution of emissions. At the MNP website several reports of these studies can be found.

to publications on the MNP themesite FAIR: Click here

"We acknowledge that the UN climate process is the appropriate forum for negotiating future global action on climate change. We are committed to moving forward in that forum and call on all parties to actively and constructively participate in the UN Climate Change Conference in Indonesia in December 2007 with a view to achieving a comprehensive post 2012 agreement (post-Kyoto agreement) that should include all major emitters."