As global carbon market stumbles, a former trader thinks locally

March 26, 2011

Vibhav Nuwal was once an enthusiastic supporter of the global carbon market. The Indian-born banker started in September 2009 to develop carbon credits, targeted at investors in Europe and Japan, for Mumbai-based private-equity fund Managing Emissions. Less than a year later, he quit his job, convinced that the United Nations’ failure to broker a global agreement to reduce greenhouse-gas emissions meant that the carbon credit market was effectively dead.

Now, Nuwal, 32, has set up a business helping companies that earn incentives from renewable-energy projects under a new Indian government program. Nuwal says that in the absence of a global consensus, investors are more likely to channel funds into incentive programs in local markets such as India, where they can make three times as much as they do selling credits under the global, U.N.-sponsored plan.

“There is a base being built for a really strong local economy around this,” says Nuwal, a former J.P. Morgan Chase investment banker. “Carbon is getting more and more difficult. A significant amount of the business that is done in the carbon space should shift.”

Nuwal’s decision is one more sign that the consensus reached 14 years ago by 193 nations and the European Union in Kyoto, Japan, may have fractured beyond repair. The plan, which introduced greenhouse-gas restrictions to support a global carbon market, is breaking down as the United States and China grapple over how, when and to what extent they can reduce pollution.

With the two biggest economies blocking progress on emissions, global temperatures last year matched the record highs of 2005 while droughts and flooding wrecked harvests from Karachi to Rio de Janeiro. Today, the price of carbon languishes at less than half the level Deutsche Bank says is needed to meet the U.N.’s aims for controlling global warming. Officials and investors say local initiatives such as Nuwal’s may offer the best chance of both slowing emissions and making money from the process.

“People are moving on to Plan B,” says John O. Niles, director of Tropical Forest Group, a nonprofit lobbying organization. “That means taking what we can get wherever we can get it.”

The latest casualties of the death of the Kyoto plan may be the companies and executives who bet their careers and their capital that credits to release carbon into the environment would become a globally traded commodity to rival the $21 trillion market in crude oil.

So far, the carbon market is a comparative blip on the landscape. Banks and brokers traded $128 billion of carbon credits last year.

‘Not enough investment’

“All the people I’ve seen who went into carbon trading have failed and moved out,” says Jason Kennedy, chief executive officer of headhunter Kennedy Associates. “There’s not enough volume, not enough pay and not enough investment.”

Even pilot programs are being killed.

IntercontinentalExchange closed its voluntary carbon-trading platform on the Chicago Climate Exchange on Jan. 31, while J.P. Morgan Chase shut down carbon credit origination at several offices and fired staff after acquiring EcoSecurities Group, the biggest offset developer. The Geneva-based International Emissions Trading Association says its membership has declined about 16 percent since the international divisions emerged at the 2009 annual climate summit held in Copenhagen.

There was little anticipation of such a failure in December 1997, when U.N. members, after 11 days of talks in Kyoto — Japan’s former imperial capital — agreed to reduce emissions in wealthy countries by 5 percent from 1990 levels. Those nations pledged to reduce emissions of the six key greenhouse gases that scientists say are largely responsible for changes in the Earth’s atmosphere: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride.

Developing countries, including China, weren’t given carbon limits and could sell credits to Western nations if they reduced their own emissions.

A market imagined

The United States, then the world’s biggest polluter, turned away from the deal. President Bill Clinton, who pushed for carbon trading to be included in the treaty, never submitted it for ratification, gauging that he couldn’t muster the 67 votes required to win approval in the Senate. Clinton’s successor, George W. Bush, supported the carbon-trading concept during the 2000 campaign but reversed his position after taking office.

Barack Obama’s election in 2008 revived hopes for a real global carbon market after he pledged to make climate change a priority for the United States. As a candidate, Obama supported cap and trade — a system in which companies can buy and sell a gradually declining number of emission permits. The plan would allow cleaner organizations to profit by selling their credits to more polluting enterprises. Yet once in office, Obama focused his legislative efforts on passing changes to the health-care system.

“After all these years, what we can say is there is a strong cultural resistance in the U.S. to a move to cap carbon,” says Emmanuel Fages, an analyst at Orbeo, a carbon-trading joint venture between French investment bank Societe Generale and chemical manufacturer Rhodia. “Whatever the excuses, whatever the context, they just don’t manage to pass any constraining carbon cap into law. They cannot.”

Trade stalled

“Ten years ago, you would have said by 2010 carbon will be a global commodity just like all the other commodities, fungible across different regimes,” says Jon Anda, vice chairman of UBS’s securities unit, who runs the firm’s environmental business. “We didn’t get any of that.”

Today, carbon trading remains a backwater of the global commodities market, and it’s not even included in the benchmark Dow Jones UBS Commodity Index. Without demand from institutional investors spurred by global limits on emissions, the price of carbon has languished compared with the fossil fuels that policymakers are aiming to marginalize.

Investors trade two families of carbon emissions: E.U. permits, which allow companies to vent gases in Europe, and U.N. credits that represent avoided emissions in developing countries. The price of U.N. carbon credits fell 6.9 percent from December 2009, at the beginning of the Copenhagen climate talks, to March 21.

That compares with a 66 percent gain in northern European steam coal over the same period and a 50 percent rise in Brent crude. E.U. carbon futures for December delivery traded at 15.77 euros in London on March 10, the day before the earthquake in Japan. That price is about where they started six years ago. It rose to 16.85 euros on March 21, after the quake and subsequent tsunami triggered a radiation leak at a nuclear plant north of Tokyo and spurred Germany to review its atomic energy program.

While carbon trading is stalled, the world remains on course for potentially catastrophic climate shifts. Even if governments manage to limit emissions in line with existing rules, average global temperatures will likely rise about 4 degrees Celsius by 2100, according to a team led by John Sterman of the Massachusetts Institute of Technology.

India’s experiment

India’s renewable-energy-trading program offers investors a way to engage with the problem while multiplying the returns they would make on carbon. Under the plan, power distributors have to source up to 14 percent of their energy from renewable sources or buy renewable energy certificates, or RECs, from wind farm and solar park operators to cover the shortfall. If they don’t, state energy regulators will buy the certificates and bill the companies.

The Indian government has imposed a minimum price of 1.5 rupees per kilowatt-hour for the RECs to guarantee a certain return for investors. That’s almost three times what developers earn from U.N. credits, Nuwal says. He expects companies to be able to register, earn and sell RECs in about five months compared with delays of as much as three years in the U.N. program.

Nuwal, with his Bangalore-based partner, Vishal Pandya, planned to set up a business to steer companies and investors through the process. His company, REConnect Energy Solutions, is helping clients produce credits for the market that began trading in March. Nuwal and his partner project that revenue at the company will rise to $3 million by 2013, up from $750,000 expected this year.

“The carbon market has metastasized into a huge range of climate finance initiatives around the world,” says Marc Stuart, co-founder of EcoSecurities, the carbon credit developer bought by J.P. Morgan Chase in 2009. “These things don’t lead to tradable securities.”

European officials are sticking to their plans for extending carbon trading. The E.U.’s Emissions Trading Scheme has operated since 2005 and covers 11,000 energy and manufacturing companies across the 27 E.U. members plus Iceland, Liechtenstein and Norway.

Airlines will be included in the program next year, and aluminum makers and petrochemical companies will be included in the third phase of the program, which is scheduled to run from 2013 to 2020. In the third phase, the E.U. will auction most permits instead of allocating them to polluters for free.

The state of the market is a far cry from the urgency of the late 1990s, when Clinton said ahead of the Kyoto summit, “The science demands that we act. We owe it to our children.”

As Nuwal builds the business he hopes will help provide a secure financial future and a more stable environment, it’s local policymakers in India, rather than U.N. diplomats, who are providing the outlet for his entrepreneurial spirit.

A version of this article appears in the May issue of Bloomberg Markets magazine.

A flat market

Change in the price of coal, crude oil and carbon futures since the beginning of the Copenhagen climate talks in December 2009:

i65%
Northern European steam coal price, per metric ton

i 42%Brent crude oil futures price,
per barrel

m5% Carbon futures price, per metric ton

SOURCES: Bloomberg, IntercontinentalExchange

NOTE: Percentages calculated from Dec. 7, 2009 to March 15, 2011.

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