Photographer: Luke Sharrett/Bloomberg

Carbon Markets Are Making a Slow, But Steady, Comeback

Updated on
  • The prophets of carbon markets think their day has come. Again
  • OECD head chides politicians for being ``a little trivial''

Two decades ago, Richard Sandor had a grand plan to reduce the pollution that causes global warming -- and maybe get rich in the process.

Richard Sandor

Photographer: Jerome Favre/Bloomberg

The rich part worked. For the rest, reality intervened.

Today, Sandor’s vision of thriving global carbon markets -- capitalist arenas that would turn the right to pollute into a commodity like gold or oil and, over time, reduce emissions -- has fallen well short of the mark. In its first attempts, prices collapsed, trading waned and early enthusiasts withdrew. The invisible hand of the market has yet to establish a firm grip.

But with 195 countries now wrestling in Paris over how to reduce harmful greenhouse gases, the father of carbon markets, as Sandor is often dubbed, and his fellow travelers remain unbowed. They maintain their market-based solution, despite its stumbles, still offers the best way forward.

“I do think it’s an inexorable trend,” said Sandor, who has some experience in the matter. The 74-year-old is a serial inventor of trading mechanisms and widely credited with creating interest-rate futures and helping propel the Chicago Board of Trade from grain and pork bellies to sophisticated financial derivatives. In 2003, he formed the world’s first carbon exchange, which he sold seven years later for $600 million.

Carbon Markets

A second generation of carbon markets has begun blooming from Brussels to Beijing to Boston.

South Korea arrived in Paris 11 months into a national carbon market. China, the world’s biggest greenhouse polluter, has been running pilot projects and plans to initiate a nationwide emissions-trading system as soon as 2017. While the U.S. Congress still shows no sign of embracing a national market, a regional exchange covering nine northeastern states is up and running and California, Quebec and Ontario are also joining together. Manitoba is also planning to link.

“There’s really a momentum there,” Quebec Environment Minister David Heurtel said. “I think the important thing from our perspective, and I know some other governments feel the same, we’re definitely moving towards convergence but we may not be there just yet.”

In all, 21 regional and national governments have created markets, the World Bank said in a September report, with another 17 examining them. Advocates expect this patchwork of exchanges will joint forces over time. Xie Zhenhua, China’s special representative on climate change, said his country’s market may in the future link up with other cap-and-trade programs.

“I think not only between China and Europe and China and Korea; we can establish a much bigger market in Asia or even in the whole world,” he said. “This way we would speak the same language. We would join our efforts to tackle climate change.”

Map of climate pledges known as Intended Nationally Determined Contributions

Source: International Emissions Trading Association

The concept of carbon trading is simple enough: Governments set a cap on emissions and then auction off or give away permission to pollute within the cap. These permits can be sold by more efficient to less efficient producers. The cost to the laggards creates an incentive to cut emissions through innovation, with pressure building as governments periodically lower the caps. The result: overall emissions fall.

If this all sounds familiar, that’s because it is. The U.S. lobbied hard for carbon markets in the last big international climate agreement, the 1997 Kyoto Protocol. Detractors resisted a system that established ‘rights’ to pollute, almost derailing the talks.

With its failure to ratify Kyoto or pass President Barack Obama’s 2009 cap-and-trade bill, the U.S. never got into the game. In Europe, the first carbon market got off the ground in 2005 and then quickly crashed under the weight of the financial crisis and the issuing of too many permits by politicians seeking to appease carbon-intensive industries. From a high of 31 euros ($33.59) in 2006, the price of a permit for the emission of a metric ton of carbon fell to a low of 2.46 euros in 2013.

The negative trend line can be seen even in Sandor’s 2010 sale of his Climate Exchange Plc. While he pocketed a princely sum, two years earlier the company had been worth three times more.

‘Beautiful’ Market

Last year, carbon trading totaled just $34 billion worldwide, little more than a rounding error compared to oil, and just $10 billion more than moved through European exchanges a decade ago. The promised synthesis of capitalism and altruism that would mint a new cohort of wealthy yet planet-friendly traders -- what a banker once described as a “beautiful” market -- has yet to materialize.

Detractors, including some environmental groups and developing countries, have never overcome their suspicions that carbon trading is just another capitalist contrivance designed more to produce profits than save the planet. They tend to prefer straight-up carbon taxes. Proponents of cap-and-trade argue market mechanism allow reduction of emissions in the cheapest way, guarantee a cap on emissions and reward the best performers.

“I still need to see a credible alternative that has performed better in delivering the environmental output,” said Daniele Agostini, head of low-carbon policies, carbon regulation at Enel SpA, Italy’s biggest utility.

The guy who heads the think tank for the world’s big economies came out strongly for taxes over trading systems last week. As the Paris conference opened, OECD Secretary-General Angel Gurria argued that Europe has failed in four attempts to get an emissions trading system to take flight. He’s also not sold on China’s pilot projects. Carbon taxes, employed in about the same number of jurisdictions as trading, have proven the better performer, Gurria said.

Carbon Taxes

“Politically, people don’t like to talk about taxes,” the one-time Mexican finance minister acknowledged. “It sounds a little bit trivial as a reason because effectively if it works better -- and we know that it works better; we know that it bites -- perhaps it should be the choice.”

The club of carbon market pioneers say decision-makers should not allow impatience for results to obscure the ultimate benefits. Markets, they say, promote innovation and place a hard ceiling on emissions. “Carbon markets are going to be a necessity and not a luxury,” said Andrei Marcu, a former lobbyist for emissions-trading firms now with the Center for European Policy Studies in Brussels.

For his part, the ever-bullish Sandor is “stunned” the EU market has been tagged a failure. Emissions are down and having a carbon price has achieved its objective of changing behavior, he said. To the extent exchanges haven’t lived up to expectations, their backers pin the blame on governments for lacking the political courage to tighten the caps.

Sandor draws on economic history in arguing the system just needs time to get fully established, as with earlier innovations ranging from power steering to personal computers to his own interest-rate futures. “My experience is it takes ten to 20 years for any market to mature,” he said. “It’s going to come.”

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