Press Room
Ian Johnson: Beware of the coming Carbon Bubble
By Tom Holland
Carbon markets are growing fast and look set to balloon in Asia over the coming decade, with Hong Kong a favoured trading location. But although market forces may just help to save the planet, their success in combating climate change is far from assured. The challenge for governments and businesses alike will be to avoid devising an overly restrictive regulatory regime, while eschewing the sort of light touch supervision that fuelled the sub-prime mortgage bubble and led to the credit crisis.
Get the balance right, however, and the potential could be enormous. In a workshop held yesterday by think-tank Civic Exchange a packed house at the Hong Kong stock exchange heard former World Bank environmental policy chief Ian Johnson predict that the global carbon market could be worth Euro500 billion, or more than HK$6 trillion, by the year 2020.
A lot of that business will come to Asia. Mr Johnson explained there is an emerging consensus that the world needs to reduce its greenhouse gas emissions to around 50 per cent of 1990 levels by the middle of this century if the concentration of carbon dioxide in the atmosphere is to be stabilised at acceptable levels. That will be expensive, costing around 1 per cent of global gross domestic product, so around 80 per cent of the reductions will need to made by rich countries. Or rather, the reductions will be paid for by developed countries. Because the cost of cutting of carbon emissions can vary from as much as Euro150 per tonne in the rich world to as little as Euro10 for a new project in a developing country, it makes sense for developed country companies to invest in emission reductions in Asia rather than at home.
This is already happening. Under the European Union's existing regime, up to 15 per cent of mandatory emissions' reductions can be sourced from projects outside the EU via the Clean Development Mechanism outlined in the Kyoto treaty. A climate bill which goes before the United States Senate next month contains a similar provision. Projects are vetted by the United Nations and the carbon credits packaged as tradable Certified Emission Reductions or CERs. Around 1,000 projects have been registered so far, a third in China, with several thousand more in the pipeline.
But there are big problems with the current mechanism. Getting projects registered and approved is a long and expensive process. Investors complain of regulatory bottlenecks and sky-high legal fees that squeeze out all but the largest projects. Even then, observers estimate that as many as 20 per cent of projects may fail to result in any genuine emission reductions.
Clearly a better supervisory framework is needed. Yet more onerous regulation would risk stifling the nascent market in its crib. Costs would soar, while approvals would grind to a halt, defeated by a vast and monolithic carbon bureaucracy.
For the CER market to produce meaningful emission reductions, it must be allowed to achieve economies of scale. Investors and dealers would like to streamline the approval process, perhaps by employing private sector carbon rating agencies to assess projects. Meanwhile financial engineers want to be allowed to pool reductions from different, smaller projects and package them as CERS, in much the same way banks pool mortgages and package them as asset backed securities.
The Hong Kong stock exchange wants to offer CER futures and options as a hedging tool, while banks and brokers would like to insure against projects falling short of planned emission reductions by selling carbon default swaps. If this all seems familiar, it is because it sounds just like the language of the sub prime mortgage and structured credit markets, which got the world's financial system into such a mess last year. It is hard to shake off the impression that financiers stung by the collapse of credit markets are simply leaping on the emissions bandwagon just as they jumped into credit derivatives following the dotcom bust. If so, there is a real danger of a carbon bubble and bust a few years down the road, which would be just as bad for our environment as over-regulation of a promising new market.