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Your ask the expert: Carbon trading, part 2

  • Story Highlights
  • Abyd Karmali answers your questions on carbon emissions trading
  • Question: Can capitalism support the environment?
  • Question: How much do C02 emissions have to be reduced?
  • Question: Isn't trading carbon ethically wrong?
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You wanted to know more about carbon trading, and Abyd Karmali, Managing Director and Global Head of Carbon Emissions at Merrill Lynch answered you questions.

How can the man on the street invest in the carbon market?

"What's the best way to become a Carbon Emissions Trader and understand the markets?"
Haider Khan

Karmali: Regrettably there are no university courses which can teach one how to become a carbon trader Haider. We can try to break down the skills required into different areas though to demonstrate what sort of training and experience would provide a good foundation.

First, the carbon emissions market is a derivatives market (futures, options, and contracts for difference) so having a strong quantitative background is certainly helpful.

Second, like any market, supply and demand in the carbon emissions market are driven by their own set of fundamentals which include fuel markets, power markets, weather, industrial abatement, and carbon credit supply curves.

There is one over-riding difference between the carbon market and other commodities, however, and that is that the carbon emissions market is heavily policy-driven.

Government decisions about the strictness of carbon emission reduction targets and the timetables send very strong signals to market participants. So an inclination for reading the tea leaves and understanding the nuances of various policy decisions that affects the above variables is also very important!

"How much will global CO2 emissions have to be reduced (percentage reduction) in order to stop temperature increase caused by the greenhouse effect? Best estimate or range of estimates would be fine."
John Wendt

Karmali: To correct one point in your question, we actually want to preserve the greenhouse effect. It is this naturally occurring greenhouse effect that makes the earth inhabitable.

What we are seeking to limit is the adverse impacts of climate change caused by excess emissions of greenhouse gases that are enhancing the natural greenhouse effect.

What scientists tell us is that to avoid dangerous impacts of climate change (changes in temperature and precipitation, sea level rise, increasing frequency of extreme weather events etc) we need to try to stabilize concentrations of greenhouse gases in the atmosphere to around 450-500 parts per million (ppm).

In terms of reducing emissions, this means that we need to reduce emissions by around 80 percent of 1990 levels by 2050 and 25 to 40 percent of 1990 levels by 2020.

"Has it been proven scientifically, that man-made C02 emission causes global warming?"
Mikkel, Denmark

Karmali: For this question Mikkel, I refer you to the Intergovernmental Panel on Climate Change (IPCC) reports which publish the latest state of the science.

Their most recent report, the Fourth Assessment Report, was published in 2007 and provides evidence to suggest that the link between humans and climate change is becoming more compelling.

In simple statistical terms, this is expressed as more than a 90 percent probability that human activity is causing climate change. The IPCC was awarded the Nobel Peace Prize in 2007 in recognition of its important efforts.

"Do you think that capitalism can fund and support our environment where the average man on the street can get a return on their money from investing in carbon credits and what mechanisms are in place for this to be a reality?"
Peter Hatz, Hong Kong

Karmali: Absolutely Peter. Carbon markets can help investors do well by doing good.

Mainstreaming carbon considerations into investment products so that individual and institutional investors can take advantage of carbon-related investment opportunities is certainly something that Merrill Lynch and other financial institutions are trying to do and is one of the most innovative pockets of the financial markets right now.

Investment opportunities can come in many forms: baskets of equities that benefit from upside from carbon themes (e.g., renewable energy companies), bonds (which could allow carbon value to accrue and be realized over the life of the bond), and more complex structured emission products which allow sophisticated investors a higher-risk means of investing in the carbon market through equity-like structures.

Clearly, to create sound investment products around climate change, it is crucial for there to be a solid foundation of reliable data.

This is one of the reasons why Merrill Lynch is a global sponsor of the Carbon Disclosure Project (CDP), an initiative that now represents investors with some $57 trillion of assets under management, which seeks to have an annual dialogue with listed companies about their emissions and carbon risks/opportunities posed by climate policy.

The data provided through the CDP process is a rich repository of carbon emissions information that helps companies like Merrill Lynch design carbon-related investment products for individual and institutional investors.

"Carbons are generated by: Deforestation, forest fires, industries, pollution of water, and others, the main reasons which provide the increase of global warming. How can a trade of a thing (carbon), which was produced by illegal ways (the process of production against the sustainable development), be a solution for the level of environmental degradation?"
Tiago Monteiro, Brazil

Karmali: Tiago, please remember that it is not just trade but cap-and-trade. The cap is what sets the limit on emissions.

As long as a proper cap is in place that creates a value for environmental scarcity, carbon trading can be very effective in redirecting investments towards lower-carbon activities and in making human behavior more environmentally sustainable.

For example, Merrill Lynch shares the view of many environmental and conservation NGOs that the most effective way to address deforestation which is responsible for 20 percent of global greenhouse gas emissions is to create a financial incentive to keep forests standing.

We sincerely hope that such a mechanism will be included in the successor agreement to the Kyoto Protocol. This will provide competition to the underlying causes of deforestation and reward those who implement sustainable forestry management.

More generally, we have to accept that carbon dioxide is a by-product of many different human activities, most of which are legal and necessary human activities that range from the production of electricity to subsistence farming which contributes to deforestation.

There is no question that we need urgently to de-carbonize the global economy. Sir Nicholas Stern estimates that the average per capita carbon footprint will need to be reduced to 2 tonnes per person (with an expected population of 9 billion people in 2050) for us to limit the adverse impacts of climate change.

What carbon markets attempt to do is to price the environmental externality (emissions of greenhouse gases) so people making decisions have a truer picture of the full cost of their actions. The carbon market can therefore be an effective tool to reduce emissions and is already proving its merits.

For example, the first phase of the EU Emissions Trading program, which contained several design flaws that have since been rectified, has already been found to have reduced emissions by around 100 million tonnes of CO2 mostly by forcing a shift of load from coal to gas power plants and providing an incentive for inefficient coal plants to improve the thermal efficiency of their boilers.

Another success of the global carbon markets has been to provide a financial incentive that will result in around 2.5 billion tonnes of emission reductions being created in developing countries during 2008-2012.

This is a remarkable success since developing countries did not take on any reduction targets under the first commitment period of the Kyoto Protocol.

The carbon markets will certainly not be the only policy mechanism required for us to achieve the environmental objective scientists warn us we need to meet but it can certainly be an effective tool to begin to scale up the finance and investments that will put us on a safer carbon emissions trajectory.

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