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An Introduction To Carbon


“Carbon will be the world’s biggest commodity market and it could become the world’s biggest market overall” Louis Redshaw, Barclays Capital


Since the late 1970s scientists have made reference to the term global warming. Although widely discussed, researched and referenced, it truly came to prominence in 1997 with the signing of the United Nations’ Kyoto Protocol. This agreement acknowledged the overwhelming evidence that human activity, particularly the burning of fossil fuels, was having a hugely detrimental effect on mean global temperatures and a range of countermeasures had to be introduced. As a consequence of the legal commitment to reduce emissions, a new tradable commodity was born - the carbon credit.

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“Carbon prices may triple by 2013”

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Potential For Growth The potential market for carbon credits is huge. Under the Kyoto Protocol, not just companies, but governments are forced to offset their emissions. Even outside of the agreement, many companies are buying up credits to help their corporate image and to encourage their customers to go green. As announced at Budget 2011, the UK will be the first country in the world to introduce a carbon price floor. The price floor will provide certainty and support for low-carbon investment, vital if the UK is to move towards a genuinely low carbon future. It will also help ensure that the UK meets legally binding targets to reduce harmful emissions over the medium to long term. The Budget 2011 announced the introduction of a carbon price floor from 1 April 2013. The floor will start at around £16 per tonne of carbon dioxide (tCO2) and follow a linear path to target £30 per tonne in 2020. Bloomberg New Energy Finance (BNEF) released its annual forecast of where they see the global carbon market going in 2011. Based on their analysis, the market will see renewed growth with a projected total value of €107b ($136bn) - a 15% increase over 2010. Projected carbon market size 2005-2011 (EURbn) 120

15% 5%

5%

100

80% 85

89

107

Forecast AAUs

93

Others RGGI

80

pCERs

67%

60

sCERs

47

EUETs

138%

40

Forecasted growth 2011

28

20 0

12

2005

2006

2007

2008

2009

2010

2011

Source: Trading figures taken from ECX Blueprint, EEX.CCX. Nordpool, other sources include UNFCCC and our own Bloomberg New Energy Finance estimations

“The trading floor price for carbon credits will start at £16 per tonne in 2013, and hit £30 per tonne by 2020.” George Osbourne, Chancellor of the Exchequer, March 2011

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“Carbon could become one of the fastest growing markets ever�

Chris Leeds, Head of Emissions Trading, Merril Lynch

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Why Purchase? If you currently have exposure to stocks, bonds, or any other traditional assets and are currently seeking a diversification to your asset portfolio, then purchasing carbon credits as an asset may be the solution for you. “Carbon Trading” is one of the fastest growing markets and industries today. A very recent quote from the Environment Audit Committee has called for the government to introduce a minimum carbon price of €100 per ton to bolster investment into these markets. As in any other market, the price of allowances is determined by supply and demand. Individuals can purchase carbon credits to not only hold for the inherent anticipated appreciation in price, which is being fuelled by demand; but since CAP (City Asset Partnership) only procure and sell carbon credits that are Verified Carbon Standard (VCS), there is an opportunity to dispose of their holding to companies that are seeking to voluntarily offset their own carbon footprint. With the Verified Carbon Standard (VCS), there is an opportunity to look to dispose of their holding to companies that are looking to reduce their own carbon footprint in the future, so companies such as these can reduce their own carbon footprint. Please find below a list of compelling reasons why CAP thinks this is the fastest growing market to buy into:

• Lower entry point carbon credits such as Voluntary Emission Reductions (VERs), are led

by private sector investment with strong potential to outstrip the more mature compliance market of the CERs and EUAs.

• The European Union (EU), governments, and the world’s largest financial institutions all agree carbon credits are one of the solutions in the reduction of global greenhouse gas emissions (GHGs).

• The global carbon emission level will continue to get stricter, and there will be fewer easy sources of carbon credits creating demand and pushing up prices.

• Speculative opportunity to see potential considerable returns in the future. • Barclays Capital said that Carbon could be the world’s largest commodity market. • VER market increased 34% during 2010 alone. • There is the potential that VERs could outstrip the mainstream compliance market. • There is immense pressure on governments and the European Union to reduce greenhouse gases and their output of pollution.

• It is showing similarities to the early oil market. • Governments are calling for a unified price in Carbon. • The potential prospect of merging the Mandatory and Voluntary markets together to remove the disparity in price.

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Who’s Buying? COMPANIES ACTIVE IN CORPORATE SOCIAL RESPONSIBILITY (CSR). An increasing number of blue chip companies, global organisations and smaller businesses have started to make changes in the way that they operate to reduce carbon emissions. Changes such as decreasing their manufacturing output emissions, cutting down on employee flights and investing into verified carbon offsetting schemes, mean that not only are they on the road to becoming carbon neutral, but also preparing for what most feel will be the inevitable - legislation to offset the majority of carbon emissions. This change will not happen overnight. That said, with the sheer amount of businesses joining this way of thinking, the length of time that it will take to both plan and implement new projects and the compelling fact that virtually all major businesses will need to purchase credits to offset their emissions each and every year for the life of the company, the supply and demand argument remains utterly compelling.

Co-op “We will render our operations carbon neutral by 2012, with carbon offset solutions provided by a programme of international co-operative projects.”

Land Rover “Land Rover’s carbon offset programme currently has 14 emissions reduction projects in China, approximately 45% of the total portfolio by volume.” Land Rover also offsets 100% of the manufacturing assembly CO2 emissions in both UK factories, where all Land Rover products are assembled. This is all part of our carbon management plan.”

Marks & Spencer “We still have nine commitments to achieve for 2012, so our primary focus will be on our targets to reduce carbon emissions and investing in carbon reduction projects outside of our own operations. We’ll also continue the roll out of systems to improve carbon and energy efficiency in our supply chains.”

BP “While a global cap-and-trade system should be the long-term goal, we recognize that regional and national approaches are a necessary first step, with some temporary exemptions from the carbon price for domestic industrial sectors that are internationally traded.” “We support policies that we believe can address climate change while also making it possible for society to meet growing demand for secure and affordable energy.”

GlaxoSmithKline “The long-term goal included in our new environmental sustainability strategy is for our entire value chain to be carbon neutral by 2050 and the first step will be a 10% reduction in the carbon footprint by 2015.” 7


What are Carbon Credits? The opportunity to trade carbon credits was created by the United Nations’ Kyoto Protocol, a legally binding document committing countries to efforts for the reduction of greenhouse gases (GHGs). To facilitate this, the Kyoto Protocol gave GHGs a value, known as a carbon credit. One carbon credit is the equivalent of one metric tonne of CO2 in the atmosphere. If a company produces emissions in excess of its allowance, it can offset this excess by purchasing carbon credits. Conversely, companies able to emit less than their C02 allowance are able to trade this ‘surplus’ in the carbon markets. Additionally, projects (usually located in developing countries) which either remove carbon from the atmosphere or promote green technologies can become eligible to produce carbon credits. These credits can be purchased by off-setters thereby simultaneously penalising polluters and rewarding proponents of clean development.

Verified Carbon Standard (VCS)

The VCS Program provides a robust, new global standard and program for approval of credible voluntary offsets. VCS offsets must be: • Real (have happened) • Additional (beyond business-as-usual activities) • Measurable • Permanent (not temporarily displace emissions) • Independently verified and unique (not used more than once to offset emissions). VCS aims to:

• Standardize and provide transparency and credibility to the voluntary offset market.

• Enhance business, consumer and government confidence in voluntary offsets.

• Create a trusted and tradable voluntary offset credit; the Verified Carbon Unit. (VCU). This is a VER which is VCS approved.

• Stimulate additional investments in emissions reductions and low carbon solutions.

• Experiment and stimulate innovation in emission reduction technologies and offer lessons that can be built into future regulation.

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The Voluntary and Compliance Carbon Markets VERs

Verified Emission Reduction credits (VERs) are generated by projects verified by an independent third party. This means that individuals and companies can reduce their emissions in a more efficient and cost effective way. VERs are subject to achieving a high standard. Companies and individuals can voluntarily purchase these VERs in order to reduce or offset their carbon footprint. By far the most credible and widely recognised level of verification is the VCS standard. CAP sources and trades only Verified Carbon Standard (VCS) approved credits. The VER market is fast growing. In 2010, 131 million metric tones of CO2 were transacted, a 34% increase on 2009 according to Bloomberg. General market opinion is that the wider scope of the voluntary market, and growth led by the private sector, not public policy, means that it has a strong potential to outstrip the mature market size of the compliance regime. By the end of 2013, the total value transacted in the carbon markets is projected to reach US$669 billion, making it one of the biggest growth stories in investment history. (Carbon Emissions Trading Markets Worldwide, 2010).

CERs

Certified Emission Reductions (CERs) were created under the Kyoto Protocol’s Clean Development Mechanism (CDM) to allow industrialised countries to invest in emission reducing projects in developing nations. The CDM projects generate CERs, credits that can then be used to offset emissions on the EU ETS. Once a CER has been issued it carries the same compliance value as an EUA.

Bloomberg estimate demand of 460 Million tonnes of VER’s by 2015 and 1.6 Billion tonnes of VER’s by 2020.

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FAQs What are carbon credits? Carbon credits are similar to certificates that represent a reduction of greenhouse gases in the atmosphere. Projects that prevent the generation of greenhouse gases or remove greenhouse gases from the atmosphere earn these credits, which can in turn then be “sold” to other businesses and individuals to “offset” the emissions they generate. One carbon credit is the equivalent to a saving of one tonne of carbon dioxide (CO2). Where do carbon credits come from? Carbon credits fund the environmental projects designed to reduce CO2 emissions including: • The removal of carbon dioxide from the atmosphere and the storage of it in a “sink” e.g. forestry. • The reduction of carbon dioxide emissions by replacing fossil fuels with renewable energy sources e.g. wind and solar energy. • The capture of greenhouse gases and alternative use or destruction of them e.g. methane capture at landfills. • The reduction of emissions through energy efficiency, e.g. reduce the amount of fuel or electricity needed. Who buys carbon credits? There are two markets for carbon offsets. In the compliance market, companies, governments, or other entities buy carbon offsets in order to comply with regulations on the total amount of carbon dioxide they are allowed to emit. In the voluntary market, individuals, companies, or governments purchase carbon offsets to mitigate their own greenhouse gas emissions from transportation, electricity use, and other sources. Those buying voluntary credits to offset their emissions are generally buying for Public Relations/branding and Corporate Social Responsibility reasons. The next most common reason for purchases in this market is as a “pre compliance buy” (those buying in anticipation of regulation). Individuals can purchase carbon credits to hold for the inherent anticipated appreciation in price, which is being fuelled by demand. Other buyers are purchasing offsets for branding and competitive advantage reasons and taking action on greenhouse gas emissions to address the threat of climate change. Some companies or individuals can reduce their emissions a little or a lot, and for others it can be extremely difficult, impossible or not economically viable to reduce their emissions. Purchasing credits earned from a verified emission reduction project can help to offset such emissions and in turn, the revenue earned from the sale of those credits helps to fund that emission reduction project. What credits do you use? CAP use only VCS credits, which are premium credits coming only from projects which have been to the highest possible standard outside of the compliance market. The VCS quality benchmark promotes sustainable development in carbon markets and certifies real emission reductions.

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FAQs Project Verification & Registration The role of verification is to inform the buyer what they are buying and whether it is real i.e. that the credit has been earned from a genuine emission reduction project; that has been implemented and verified according to a leading international standard and most importantly that the credit resides in the registry that has been appointed by that standards authority to issue and manage the credits earned from projects in accordance with those standards. A previous conflict of interest arose from the fact that verification auditors are currently chosen and paid by a project’s developer. There is this pressure on auditors to approve projects in order to preserve their business relationships with the developers. This compromises the auditors’ independence and neutrality. To account for this all premium projects are now validated by a third party verification auditor to approve and accept the project prior to the issuance of the carbon credit. The three main registries for the voluntary markets are: • APX • Caisse des Depots, CDC Climat • Markit Can I purchase Carbon Credits with my SIPP? Yes you can purchase through your SIPP and we have a team of IFA’s who are willing to assist you with the process.

Project Types & Standards There are many different types of projects to help reduce carbon emissions including:

• Agricultural Methane Collection • Renewable Energy • Industrial Gas • Energy Efficiency • Fuel Switching • Geological Sequestion • Fugitive Emissions • Forestry and Land Use Carbon offset markets exist both under compliance schemes and as voluntary programs. Compliance markets are created and regulated by mandatory regional, national, and international carbon reduction regimes, such as the Kyoto Protocol and the European Union’s Emissions Trading Scheme. Voluntary offset markets function outside of the compliance markets and enable companies and individuals to purchase carbon offsets on a voluntary basis.

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Disclaimer Price, liquidity and risk • Any carbon credit price shown is indicative only and based on current exchange rates. The price of Carbon Credits can go down as well as up. It may be difficult to ascertain a market value for VERs as many are transacted “over the counter” and, as such, prices may vary from reseller to reseller.

Risk Warning • Currently VER’s are illiquid in comparison to the credits traded on the Compliance EUA Credit Market. There may also be a big difference between the buying and selling prices of carbon credits. Trading in carbon credits involves risk. You may get back less than your total outlay and there is a risk that you will make no recovery. However you may also Price, liquidity and risk benefit from any possible increase in the value of the carbon credits. Any growth shown or suggested is a projection only and cannot be guaranteed.

Any prices of carbon credits shown are indicative only and are based on current exchange rates. Carbon Credit CAP main activity prices can go down as delivery well asofup. It may beonly difficult to obtain for VERs as many are trans• CAP deals in the physical carbon credits and operates mainlytrue in themarket Voluntaryprocess Credit Market. acted “over carbon the counter” and as suchand values may vary from reseller to reseller. CAP source credits from recognised independently verified projects to ensure the emission reductions are effective. Currently VERs are illiquid in comparison to the compliance EUA credit market. There may be a big difference between the and selling priceany ofsale carbon credits. Trading in carbon credits involves risk. You may get Requirement of buying specific instruction before back than your outlay inYour extreme recovery. growth shown • The less credits can be heldtotal for any length and of time. credits cases are soldmake only onno your instructionAny and will never be sold or suggested is a collectively only or without yourbe specific sell order. projection andtaking cannot guaranteed. Purpose of and reliance on CAP online and printed material

• Efforts beenhandled made to ensure that data and other and information presented of in this document and other CAP Type of have credits by Mason Warburg requirement client’s instruction before any sale materials are accurate but no warranty as such can be given. Additionally, information applicable to the Carbon Credit Markets is subject to change.

Mason Warburg deals in the physical delivery of carbon credits only operating mainly in the voluntary credit • The purpose of this report is solely to providecredits introductory information and some to the specific topic. It is market. Mason Warburg use carbon from recognised andbackground independently verified projects to ensure the not intended for use directly or indirectly in market forecasting or for making decisions. emission reductions are effective. The credits can be held for any length of time. Your credits are sold only on your instruction andof will neverthe berecipient sold collectively without taking yourthis specific order. • By accepting delivery the content agrees not to or reproduce and/or distribute whole orsell in part. Liability Purpose of and Reliance on Mason Warburg Online and Printed Material

• CAP and/or its directors, agents or employees accept no responsibility or liability for any losses or damages incurred as a result of use of this report. The content of this document and other CAP material, printed and electronic, shouldefforts not be construed as CAP (the to Company) an offer to sell, an invitation to subscribe for orreport invest inare Whist have been made ensuremaking that the data andnor other information in this the Company.

accurate, no warranty as such can be given and, additionally, information applicable to the carbon credit markets is subject to change. • No representation or warranty, expressed or implied, is or will be made as to the accuracy or completeness of the information including projections or opinions containedintroductory in the text and no liability is accepted the Company The purpose of thisallreport is solely to provide information and by some background to the specific and/or its directors, agents or employees. topic. It is not intended for use directly or indirectly in market forecasting or for making decisions. Mason Warburg and/or its directors, agents employees accept no responsibility or liability for any losses or The recommendation for clients to consult third partyor advisers •damages Recipientsincurred are advised to consult their own advisers and consider themselves legal and as a result of use of this report. Theforcontent of the thisfinancial, document andother other Mason Warburg consequences of any purchase before doing so. promotional material, printed and electronic, should not be construed as Mason Warburg (the “Company”) making anstatus offer to sell, nor an invitation to subscribe for or invest in the Company. Regulatory • CAP is not regulated by Financial Service Authority and recipients arewill reminded of the as riskto factors No representation orthe warranty, expressed or implied, is or be made the accuracy or completeness of described in the content and in our Terms of business. the information including all projections or opinions contained in the text and no liability is accepted by the Company and/or its directors, agents or employees. By accepting delivery of the content the recipient agrees not to reproduce and/or distribute this whole or in part. Regulatory status and the need for clients’ consultation with third parties Recipients are advised to consult their own advisers and consider for themselves the financial, legal and other consequences of any purchase before doing so. Mason Warburg is not regulated by the Financial Service Authority and recipients are reminded of the risk factors described in the content and in our Terms of business.

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“JP Morgan isn’t alone, All the big global banks including Barclays, Citigroup, Goldman Sachs and Merrill Lynch are hurrying into Carbon Trading”


Mason Warburg 27-28 Clements Lane, London EC4N 7AE TEL: 0203 207 9035 FAX: 0203 207 9100 Email: info@masonwarburg.co.uk Website: www.masonwarburg.co.uk Registered in England and Wales No: 8009695


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