TOPIC: CARBON CREDIT AND ITS FINANCIAL IMPLICATIONS AUTHOR 1:D.CHIBHI AUTHOR 2:C.

BHAVADHARANI DEPARTMENT OF MANAGEMENT STUDIES, ANNA UNIVERSITY, TIRUCHIRAPALLI.

WHAT IS CARBON CREDIT?

A permit that allows the holder to emit one ton of carbon dioxide or other green house gases. These credits are awarded to countries or groups that have reduced their green house gases below their emission quota. Carbon credits can be traded in the international market at their current market price with respect to need and surplus. ONE TON OF CO2 = ONE CARBON CREDIT

NEED FOR CARBON CREDIT

Over millions of years, our planet has managed to regulate concentrations of greenhouse gases through sources emitters and sinks reservoirs. Carbon in the form of CO2 and methane is emitted by volcanoes, by rotting vegetation, by burning of fossil fuels and other organic matter. But CO2 is absorbed, by trees, forests or by some natural phenomenon like photosynthesis and also oceans to some extent. In modern times the burning of fossil fuels like coal, oil and natural gas in which carbon has been stored for millions of years combined with accelerated land clearance has led to exceptional levels of greenhouse gas emissions. Vegetation, largely forest, is already absorbing about one-third of human-induced emissions, planting more forests could increase absorption. Carbon sinks cant keep up, and concentrations of greenhouse gases in the atmosphere have risen dramatically leading to an enhanced greenhouse effect which will result in very rapid warming of the worlds climate. If the Earth heats to the unsafe level it is expected to then our national security is at stake. It is now accepted worldwide that the globe is warming to such an extent that the livelihoods of large swathes of the worlds population are under serious threat. The results are likely to include intensified droughts and floods, changed weather patterns, agricultural breakdown, ecosystem disruption, rising sea levels, epidemics, and social breakdowns that ultimately threaten the lives or livelihoods of hundreds of millions of people. As global economies grow, use more natural resources, and emit more Carbon Dioxide (CO2), more solutions will be needed to reduce global warming. People have become increasingly concerned about the possible effects of global warming. Global warming is a serious threat to humanity as a whole. Since CO2 is the main contributor to the effects of Global Warming the Greenhouse Gases are known collectively as CO2 emissions. At some point the build-up of carbon dioxide and other greenhouse gases in the atmosphere will change the climate disastrously. The financial markets provide one unique way of limiting CO2 emissions through the creation of a carbon credit market. The concept is that this would give companies, countries, and individuals a financial incentive to produce less CO2. Its goal is to stop the increase of carbon dioxide emissions. It encourages compliance and financial managers to pursue cost effective emission reduction strategies and

provide incentives to emitters to develop the means by which emissions can inexpensively be reduced.

HOW CARBON CREDIT EMERGED? KYOTO PROTOCOL

The Kyoto Protocol is an international agreement linked to the United Nations Framework Convention on Climate Change. The major feature of the Kyoto Protocol is that it sets binding targets for 37 industrialized countries and the European community for reducing greenhouse gas (GHG) emissions .These amount to an average of five per cent against 1990 levels over the five-year period 2008-2012. The major distinction between the Protocol and the Convention is that while the Convention encouraged industrialized countries to stabilize GHG emissions, the Protocol commits them to do so. Recognizing that developed countries are principally responsible for the current high levels of GHG emissions in the atmosphere as a result of more than 150 years of industrial activity, the Protocol places a heavier burden on developed nations under the principle of common but differentiated responsibilities. The Kyoto Protocol was adopted in Kyoto, Japan, on 11 December 1997 and entered into force on 16 February 2005. The detailed rules for the implementation of the Protocol were adopted at COP 7 in Marrakesh in 2001, and are called the Marrakesh Accords.

MECHANISM OF CARBON CREDIT EMISSIONS TRADING

Parties with commitments under the Kyoto Protocol (Annex B Parties) have accepted targets for limiting or reducing emissions. These targets are expressed as levels of allowed emissions, or assigned amounts, over the 2008-2012 commitment period. The allowed emissions are divided into assigned amount units (AAUs). Emissions trading, as set out in Article 17 of the Kyoto Protocol, allows countries that have emission units to spare - emissions permitted them but not "used" - to sell this excess capacity to countries that are over their targets. Thus, a new commodity was created in the form of emission reductions or removals. Since carbon dioxide is the principal greenhouse gas, people speak simply of trading in carbon. Carbon is now tracked and traded like any other commodity. This is known as the "carbon market."

CLEAN DEVELOPMENT MECHANISM

The Clean Development Mechanism (CDM), defined in Article 12 of the Protocol, allows a country with an emission-reduction or emission-limitation commitment under the Kyoto Protocol (Annex B Party) to implement an emission-reduction project in developing countries. Such projects can earn saleable certified emission reduction (CER) credits, each equivalent to one tonne of CO2, which can be counted towards meeting Kyoto targets. The mechanism is seen by many as a trailblazer. It is the first global, environmental investment and credit scheme of its kind, providing a standardized emission offset instrument, CERs. A CDM project activity might involve, for example, a rural electrification project using solar panels or the installation of more energy-efficient boilers. The mechanism stimulates sustainable development and emission reductions, while giving industrialized countries some flexibility in how they meet their emission reduction or limitation targets.

JOINT IMPLEMENTATION
The mechanism known as joint implementation, defined in Article 6 of the Kyoto Protocol, allows a country with an emission reduction or limitation commitment under the Kyoto Protocol (Annex B Party) to earn emission reduction units (ERUs) from an emission-reduction or emission removal project in another Annex B Party, each equivalent to one tonne of CO2, which can be counted towards meeting its Kyoto target. Joint implementation offers Parties a flexible and cost-efficient means of fulfilling a part of their Kyoto commitments, while the host Party benefits from foreign investment and technology transfer.

HOW CARBON CREDIT BECOME A TRADING INSTRUMENT

With growing concerns among nations to curb pollution levels while maintaining the growth in their economic activities, the emission trading (ET) industry has come to life. And, with the increasing ratification of Kyoto Protocol (KP) by countries and rising social accountability of polluting industries in the developed nations, the carbon emissions trading is likely to emerge as a multibillion-dollar market in global emissions trading. The recent surge in carbon credits trading activities in Europe is an indication of how the emissions trading industry is going to pan out in

the years to come.

HOW CARBON CREDIT IS TRADED IN INTERNATIONAL MARKET?

Emissions trading (ET) is a mechanism that enables countries with legally binding emissions targets to buy and sell emissions allowances among themselves. Currently, futures contracts in carbon credits are actively traded in the European exchanges. In fact, many companies actively participate in the futures market to manage the price risks associated with trading in carbon credits and other related risks such as project risk, policy risk, etc. Keeping in view the various risks associated with carbon credits, trading in futures contracts in carbon allowances has now become a reality in Europe with burgeoning volumes. Currently, project participants, public utilities, manufacturing entities, brokers, banks, and others actively participate in futures trading in environment-related instruments.

THE ROLE OF MCX

With MCX keen to play a major role on the emission front by extending its platform to add carbon credits to its existing basket of commodities with regard to commodities futures trading, the existing and potential suppliers of carbon credits in India have geared up to generate more carbon credits from their existing and ongoing projects to be sold in the international markets. With India supposed to be a major supplier of carbon credits, the tie-up between the two exchanges is expected to ensure better price discovery of carbon credits, besides covering risks associated with buying and selling.

ADVANTAGES OF AN MCX CREDIT CONTRACT

In India, currently only bilateral deals and trading through intermediaries are widely prevalent leading to sellers being denied fair prices for their carbon credits. Advantages that the MCX platform offers are: Sellers and intermediaries can hedge against price risk; Advance selling could help projects generate liquidity and thereby, reduce costs of implementation; There is no counterparty risk as the Exchange guarantees the trade; The price discovery on the Exchange platform ensures a fair price for

both the buyer and the seller; Players are brought to a single platform, thus, eliminating the laborious process of identifying either buyers or sellers with enough credibility; and The MCX futures floor gives an immediate reference price. At present, there is no transparency related to prices in the Indian carbon credit market, which has kept sellers at the receiving end with no bargaining power.

FACTORS INFLUENCING THE PRIZE OF CARBON CREDITS

Supply-demand mismatch , Policy issues , Crude oil prices , Coal prices, CO2 emissions ,Weather/Fuel prices ,European Union Allowances (EUAs) prices ,Foreign exchange fluctuations ,Global economic growth .

RISK ASSOCIATED WITH CARBON CREDITS TRADING

There are market- and policy-related risks for CER producers, including the supply-side risks starting from the DNA approval risk to the CER issuance risk in a complete CDM approval cycle. Apart from these risks there are a host of other risks from both the supply and demand sides that the real market players confront with. Most CDM projects by their very nature take a long time to generate the CERs and hence, face the aforesaid risks in large proportion, which if not hedged would lead to reduced realization. Under such a situation, the realization of CER generators at times may not even cover the investment put in to generate the CERs and thus, has the potential of even making a CDM project unviable in the long term. Given the long gestation period of CDM projects and the risks involved, it is rather inevitable that they pre-sell their potential credits in the futures market (preferably a domestic futures market, to avoid forex risk attached to participation in a foreign exchange) and thereby, cover their probable downside in the physical market.

POTENTIAL TRADING

PARTICIPANTS

OF

CARBON

CREDITS

Hedgers

Producers Intermediaries in spot markets Ultimate buyers

Investors

Arbitragers Portfolio managers

Diverse participants with wide participation objectives

Commodity financers Funding agencies Corporate having risk exposure in energy products

INDIA AS A POTENTIAL SUPPLIER

India, being one of the leading generators of CERs through CDM, has a large scope in emissions trading. Analysts forecast that its trading in carbon credits would touch US$ 100 billion by 2010. Currently, the total registered CDM projects are more than 300, almost 1/3rd of the total CDM projects registered with the UNFCCC. The total issued CERs with India as a host country till now stand at 34,101,315 (around 34 million), again around 1/3rd of the total CERs issued by the UNFCCC. In value terms (INR), it could be running into thousands of crores. Further, there has been a surge in number of registered projects in India. In 2007, a total of 160 new projects were registered with the UNFCCC indicating that more than half of all registered projects in India happened last year. It is expected that with increasing awareness this would go further up in the future. The number of expected annual CERs in India is hovering around 28 million and considering that each of these CERs is sold for around

15 Euros, on an average, the expected value is going to be around Rs 2,500 crore.

VARIOS INDUSTRIES THAT HAVE SCOPE OF GENERATION OF CERs

Agriculture Energy ( renewable & non-renewable sources) Manufacturing Fugitive emissions from fuels (solid, oil and gas) Metal production Mining and mineral production Chemicals A forestation & reforestation

CONCLUSION
Emission of GHS is major threat to environment all over the world. Due to industrialization and modernization the emission of carbon and other GHS has become un avoidable, but this problem has to be countered at right time or else there will be a great disaster to living beings, carbon trading is one of the good solutions for that by which the emission of carbon and other GHS can be controlled and a monetary benefits can also be created to the nations who contribute more in saving the environment.