A Global Carbon Market is Closer Than You Think

Setting up a cap-and-trade carbon market isn’t easy. Throw in a global economic crisis and continued domestic and international wrangling over policy and it becomes almost impossible. Yet in an interesting article, Timothy Gardner over at Reuters highlights one way to get around all of this:

“Rich countries may act on their own to reduce greenhouse gas emissions by developing a carbon market they hope will lure in poor nations even if U.N. climate talks get bogged down…

“The rich world, including the European Union and the United States, may form a carbon market outside or parallel to the U.N. talks. Rapidly developing countries like China may be inspired to join the market to sell emissions offsets such as clean energy projects.”

That may sound like pie-in-the-sky stuff, but the chances of linking CO2 trading between the world’s largest industrial countries are better than you might think.

That was a recurrent theme when I talked to traders, analysts, and policy-makers for a recent article on banks' activity in preparation for a U.S. federal cap-and-trade scheme. Here's how it might work. If/when a U.S. nationwide plan is finalized, market participants could buy/sell foreign credits, including European allowances, to offset domestic emissions. At first, the price disparities would allow financial arbitrage opportunities between the regions, but over time, the markets would (theoretically) iron themselves out. That would increase trading activity, improve liquidity and transparency, and -- more to the point -- provide a global response to the global challenge of climate change.

And how to get recalcitrant emerging economies on side? Well, the U.S./European market could allow credits from developing countries, such as the clunkily-worded Clean Development Mechanism (green investments in places like India and China that can be sold on to polluters), that already are permitted in many carbon schemes worldwide. That would provide an economic incentive for the world's largest emerging economies to participate -- an economic carrot, if you will, to sweeten the binding CO2 targets the Western world wants them to accept.

This all sounds technical and somewhat wishful thinking, particularly as a U.S. federal scheme has yet to be finalized. But talking to financial players already active in Europe -- and who are readying themselves for the U.S. -- linking carbon trading to European activity shouldn't be that difficult.

If they're right, then maybe the dead-end talks many expect in Copenhagen this December over a post-Kyoto agreement won't be that big of a deal. Sure, policy-makers might not agree on how to act, but market players may just push ahead without them.

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